BUSINESS ASSOCIATIONS OUTLINE

I. AGENCY
A. Who is an agent?
1. 3 forms:
a. Principal and agent
b. Master and servant
c. Employer/proprietor and independent contractor (IC)
2. Agency is a relationship which results from:
a. (1) a manifestation of consent by one person (the principal) that another
person (the agent) act (a) on the principal’s behalf and (b) subject to the
principal’s control and
b. (2) the agent’s consent to so act (agent must have P’s consent to so act)
c. Test is control
d. Burden of proof is on the person who wishes to establish agency
3. Agency does not require the involvement of business, necessitate a K or promise
between P and A, or require that either receive compensation.
4. Gay Jenson Farms: Agency may result event though it is not termed as such and
even though the parties did not intend for it to result.
5. Agency can be shown by circumstantial evidence evidencing a course of
dealing between the 2 parties, although the P must have consented to the agency.
6. Control can evidence a P/A relationship and control of a debtor’s business can
lead to a creditor becoming liable as principal for acts of the debtor.
7. Analysis of Agency problem:
a. Is the problem between the A and P
b. Does it involve a 3rd party trying to hold P liable to an agreement based on
A’s conduct or an express agreement?
c. Does it involve a 3rd party trying to hold a P liable for the agent’s torts?
B. Liability of Principal in 3rd Party Ks TYPES OF AUTHORITY
1. actual authority
a. DEF: authority that P expressly or implicitly gives A
2. implied authority
a. DEF: actual authority that P actually intended A to possess and includes such
powers as are practically necessary to carry out the duties actually delegated
(Mill Street Church of Christ)
b. E.g. if P tells A to paint the house, he has the implied authority to buy paint
c. Key: relationship between P and A regardless of 3rd party
d. Implied authority determined by:
i. A’s understanding of his authority (does A reasonably believe b/c of past
or present conduct by P that P wishes him to act in a certain way or have
certain authority)
ii. Nature of the job or task
iii. Existence of prior similar practices- specific conduct by P in the past
permitting the agent to exercise similar powers is crucial (Mill Street
Church of Christ)
iv. Key: relationship between P and A regardless of 3rd party
3. apparent authority
a. DEF: arises when P acts in such a manner as to convey the impression to a 3rd
party that A has certain powers which he may or may not actually possess
(Lind v. Schenley)
i. E.g. A wears a shirt with P’s logo on it and sell’s P’s product to 3rd party
b. Exists only to the extent that it is reasonable for the 3rd party dealing with A
to believe that A is authorized. The 3rd party must also believe the agent to be
authorized (objective and subjective)
c. A has the apparent authority to do those things that are usual and proper to
the conduct of the business in which he is employed to conduct
d. Requires manifestations by P to the 3rd party of A’s authority
i. E.g. P says I’ll send my agent, Bob and Bob comes
e. Key: this is the type of relationship that exists between A and 3rd party. (not A
and P)
4. inherent authority
a. undisclosed principal
b. where P’s have enabled their agent to hold himself out as the proprietor of
the business, they are undisclosed P’s; so to charge an undisclosed P with the
acts of A, the plaintiff need only show that the goods supplied were in the
reasonable scope of the agent’s authority (Watteau v. Fenwick)
c. P’s are responsible for some of A’s acts which, while unauthorized, are
nonetheless quite close to (or incident to) that which they are authorized to do
d. Arises in cases where there is not sufficient manifestations by P to 3rd parties
to satisfy the requirements of apparent authority (but inherent agency is a
subset of apparent agency though not vice versa)
e. The customary extent of an authority can comprise a K (Kidd)
f. Key: relationship between A and 3rd party. Courts like to help out the
innocent 3rd party. exists when there is not enough (manifestation by P) to get
apparent authority.
g. Key
i. An undisclosed P is liable for the acts of an A done on his account, if
usual and necessary in such transactions, although forbidden by P
ii. An undisclosed P who entrusts an A with the management of his business
is subject to liability to 3rd parties with whom the A enters into
transactions usual in such business and on P’s account, although contrary
to the directions of P (that P gave A)
h. Indicates the power of an agent that is not derived from authority, apparent
authority or estoppel, but solely from the agency relation and exists for the
protection of persons harmed by or dealing with a servant of other A
i. Occurs when:
i. (1) A does something similar to what he is authorized to do, but in
violation of orders
ii. (2) where A acts purely for his own purposes in entering into a transaction
which would be authorized if he were actuated by a proper motive or
iii. (3) where A is authorized to dispose of goods and departs from the
authorized method of disposal
C. Ratification
1. agency requires
a. (1) manifestation by P that A will act for him
b. (2) acceptance by A of undertaking
c. (3) understanding between parties that P will be in control of undertaking
2. marital status or joint ownership of property does not prove agency
3. DEF: ratification is affirmation by a person of prior act which did not bind him
but which was done on his account
4. it requires acceptance of the results of the act with an intent to ratify and full
knowledge of the material circumstances
5. ratification can only be done where the original transaction was done on account
of P
6. transactions can be ratified in a variety of ways
a. (1) express affirmation by P
b. (2) implied acceptance of the benefits of the transaction at a time when it is
possible to decline acceptance of such benefits
c. (3) implied affirmation through silence or
d. (4) implied affirmation through bringing a lawsuit to enforce the K
D. Estoppel
1. elements:
a. (1) the P creates, through intentional or negligent words, acts, or omissions,
an appearance of authority in the purported A
b. (2) the third party reasonably and in good faith acts in reliance on such
appearance of authority; and
c. (3) the 3rd party changes his position in reliance upon the appearance of
authority
2. agency by estoppel involves the P’s failure to take reasonable care of a 3rd party
(Hoddleson)
E. Agent’s liability on the K
1. if the other party to a transaction has notice that the A is or may be acting for P
but has no notice of P’s identity, the P for whom the A is acting is a partially
disclosed P.
2. a person purporting to make a K w/ another for a partially disclosed P is a party
to the K
3. to avoid personal liability, A must disclose that he is acting in a representative
capacity and the identity of P (Curran)
F. Principal’s Liability to 3rd parties in tort
1. employer (master) is liable for the torts of its employees (servants)
2. employment relationship exists where employee has agreed (a) to work on behalf
of the employer and (b) to be subject to the employer’s control or the right to
control “physical conduct” of the employee (manner in which the job is
performed)
3. employees must be distinguished from independent contractors
G. independent Contractors v. Servants
 1. IC’s are either agent-types (who have agreed to act on behalf of P, but not
subject to P’s control) or non-agent types (who act completely independently and
enter into arm’s-length transactions with others)
2. master/servant relationship evidenced by:
a. control by master of servant, e.g. setting hours of operation, holding title to
goods sold, paying for operating costs (Humble Oil, Sun Oil)
b. also look to compensation schemes (risk and return), rent, reports to
supervisors, training, supervision
H. Defining master/servant relationships
1. the key to defining master/servant relationships is control, particularly in relation
to the methods or details of doing the work
2. master need not control work of servant, just have the right to do so
3. control is evidenced by: e.g., power to control daily maintenance of the premises,
business expenditures, set customer rates, demand a share of the profits, hire or
fire employees, determine employee wages or working conditions, set standards
for employee skills or productivity, supervise employee work routines, or
discipline employees for nonfeasance or misfeasance (Holiday Inns, Inc.)
I. Tort liability and apparent agency
1. franchisors become liable for franchisee’s negligent acts in agency relationships
where franchisor has the right to control the method by which franchisee
performs its obligations under the franchise agreement (Miller)
2. franchisors that demand franchisees to be uniform in appearance and operation
may be holding out franchisees as apparent agents (Miller)
J. Scope of employment
1. the employer should beheld liable for risks which arise out of and in the course
of his employment or labor (Bushey)
2. Liability of servants:
a. (1) if some harm is foreseeable, P is liable, regardless of the fact that that
particular type of harm may not have been foreseeable;
b. (2) conduct by servant which does not create risks different from those
attendant on the activities of the community in general (i.e. personal life
problems) will NOT give rise to liability.
c. (3) the conduct must relate to the employment
K. Liability for torts of independent contractors
1. GR: (IC rule) P not responsible for torts of IC’s
2. Exceptions to IC rule:
a. (1) if P controls or has the right to control the physical performance of the
task, the employee is a servant and not an IC and P can be held liable;
b. (2) P can be held liable if it employed an incompetent IC
c. (3) the principal can be held liable where the performance involves an
inherently dangerous activity (inherently dangerous= creation of a condition
involving a peculiar risk of harm to others (-this part not so sure its
right/check updated slides-unless special precautions are taken if the
contractor is negligent in failing to take those precautions.))
L. Fiduciary obligation of agents
 1. all A’s owe their P’s a duty of loyalty: the agent may not pursue his own
interests or the interests of a 3rd party ahead of the interests of the P
2. the duty of loyalty forbids the agent from receiving any other compensation in
connection with the agency relationship unless P knowingly and voluntarily
agrees to the contrary
3. compensation in breach of this duty is known as a secret profit
4. remedies available to agent for secret profits:
a. damages
b. action for secret profits
c. rescission/transaction voidable
M.Secret profits
1. Secret profits can arise from:
a. A receiving a payment from a 3rd party in connection with some transaction
between the P and the 3rd party (e.g. kickbacks, bribes, tips)
b. A secretly transacting with P, unbeknownst to P
c. A using the agency relationship for personal gain (Reading)
2. an A who, in violation of his duty to his P, uses for his own purposes or those of
a 3rd party, assets of the P’s business is subject to liability to the P for the value
of any resulting profit
N. Fiduciary duties
1. Duties include
a. Exercising “good faith” by disclosing all facts regarding matters involving
the agency relationship which the agent comes to know (Singer)
b. Protecting trade secrets (i.e. customer lists) and refraining from enticing
customers away from P (Town & Country)
II. PARTNERSHIP
A. Partnership v. corporation
1.
Partnership Corporation
-limited duration -unlimited duration
-unlimited liability -limited liability
-non-transferable interest -transferable shares
-informal formation req’ts -formal formation req’ts
-decentralized management -centralized management
-no tax on partnership, only on partner’s -double tax: once on corporation’s
income;
Individual earnings second on shareholder income when
distributed as dividend

B. Defining Partnership
1. in determining whether a relationship, look to:
a. the intention of the parties
b. right to share in profits
c. sharing of losses
d. ownership and control of partnership property
e. community of power in administration
f. conduct of parties towards 3rd persons
g. rights on dissolution (Fenwick)
 2. if these factors are not present, likely the relationship is master/servant
C. Uniform Partnership Act (1914) (UPA)
1. adopted in every state except LA
2. revised in 1990’s, RUPA, but RUPA not enacted in all states, so UPA still
governs
3. UPA defines partnership as “an association of 2 or more persons to carry on as
co-owners a business for profit) (§6(1))
4. evidence of shared profits if prima facie evidence of partnership, but NOT if
payment is received as payment for debt, wages, loan interest, or for sale of
good-will (§7(4))
5. * no formal requirements when starting a partnership- it is a default form of
business.
D. The Importance of profit-sharing to defining partnerships
1. although the UPA notes that profit sharing is prima facie evidence of
partnership, the court in Southex says that the presumption can be overcome
from lack of proof of control over the business or lack of loss-sharing
2. failure to file partnership tax returns and lack of risk-sharing will also go against
a finding of partnership (Southex)
E. Partnership by Estoppel
1. a person who represents himself, or permits another to represent him, to anyone
as a partner in an existing partnership or with other 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 (SC Code
Ann. 33-41-380(1); UPA §16(1))
2. thus, partners by estoppel entails liability for all parties to the partnership
(Young)
3. requires reliance on the partnership relationship in the decision to give credit
4. also need reliance on act or statement with other partner (df) to establish
partnership by estoppel
F. Fiduciary Obligations of Partners
1. UPA § 21(1): every partner must account to the partnership for any benefit, and
hold as trustee for it any profits derived by him without the consent of the other
partners from any transaction connected with the formation, conduct, or
liquidation of the partnership or from any use by him of its property
2. fiduciary obligation includes “duty of the finest loyalty”, disclosure of
opportunities, renouncement of thought of self (Meinhard)
G. Duties upon Leaving a Partnership
1. once a partner has left a partnership, no fiduciary duties are owed to him (Bane)
2. BUT partners may owe fiduciary duties to a partnership once they leave,
particularly if they plan to compete against the partnership
3. thus, cannot lie about leaving partnership, or solicit clients w/o providing notice
to the partnership and presenting clients the choice they have between staying or
leaving the partnership (Meehan)
H. Expelling a Partner
 1. partners can be expelled from a partnership in accordance with the powers
conferred by way of the partnership agreement so long as it is done in good faith
(UPA § 31(1)(d); Lawlis)
I. Partnership Property
1. Property rights of a partner include:
a. Rights in specific partnership property
b. Interest in the partnership and
c. Right to participate in management (UPA para. 24)
2. however, a partner’s specific interest in the assets is only an undivided interest as
co-tenant in all the partnership property; the partnership owns the asset
3. a conveyance of partnership property held in the name of the partnership is made
in the name of the partnership, not as a conveyance if individual interests of the
partners (Putnam)
4. a partner’s interest in the partnership is the share of profits, surplus, and personal
property (UPA para. 26)
J. Rights of Partners in Management
1. every partner is an agent of the partnership and the act of every partner for
carrying on business in the usual way of the partnership binds the partnership
(UPA§9(1))
2. Absent an agreement to the contrary, partnership decisions are governed by a
majority vote of the partners (UPA§ 18(h), Stroud)
K. Rights under Partnership
1. partnership is an entity distinct from its partners (RUPA section 201)
2. partnership may sue and be sued in the name of the partnership (RUPA section
307)
3. a partnership shall indemnify a partner for liabilities incurred by the partner in
the ordinary course of business (RUPA section 401(c))
4. ordinary course of business can include personal purposes (Moren)
L. Partnership Dissolution
1. 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 (UPA§ 29)
2. termination of the partnership does not occur on dissolution, only after winding
up of affairs is completed (UPA§ 31)
3. causes of dissolution
a. termination of the specific undertaking in the agreement
b. express will of any partner
c. express will of all the partners
d. expulsion of any partner
e. events which make it unlawful for the business to be carried out
f. death, bankruptcy, decree of court
M.Dissolution by Decree of Court
1. dissolution decreed if:
a. partner declared a lunatic
b. partner becomes incapable of performing
 c. partner guilty of conduct as tends to affect prejudicially the carrying on of the
business
d. willful or persistent breach of partnership agreement
e. losses
f. other circumstances that make dissolution equitable
2. compare with RUPA section 801(5) (p.155 in text)
N. Rights of Partners to Partnership Property Upon Dissolution
1. UPA § 38
a. (1) Dissolution not by way of contravention of partnership agreement gets
partnership property applied to discharge its liabilities and surplus applied to
pay in cash the net amount owing to partners
b. (2) dissolution in contravention of partnership:
i. (a) each partner who did not cause dissolution gets
ii. (I) all the rights as in (1) and damages for breach of agreement
iii. (b) they can also continue with the business in the same name with other
partners if they desire and can get the partnership property if they pay for
the interest of their former partner
2. UPA § (2)(c): the partner who caused the wrongful dissolution gets:
a. The rights under (1) if the other partner does not continue with the business
b. If the business is continued, gets paid for his partnership interest less
damages and his interest does not include the value of goodwill of the
business
O. Disassociation under RUPA
1. a partner is disassociated from a partnership upon the occurrence of any of the
following events:
a. Partner’s express will to withdraw as a partner
b. An event agreed to in the partnership agreement as causing the partner’s
disassociation
c. The partner’s expulsion pursuant to the partnership agreement or by the
unanimous vote of the other partners in certain conditions
d. Partner’s wrongful conduct or
e. Bankruptcy, death, etc…
2. the disassociation of a partner does not necessarily cause a dissolution and
winding up of business of the partnership
3. section 801identifies the situations in which the dissociation of a partner causes a
winding up of the business. Section 701 provides that in all other situations there
is a buyout of the partner’s interest in the partnership, rather than a windup of the
partnership business. In those other situations, the partnership entity continues,
unaffected by the partner’s dissociation.
P. Terms of a partnership
1. UPA (1914) § 31(1)(a): Term partnership defined: a term p’ship is one in
which the p’ship agreement specifies a definite term or a particular undertaking
(the end of which signals the end of the p’ship)
2. Implied term: to find an implied term, the court must find that the parties
entered into a particular undertaking.
 a. The requisite particular undertaking then must be capable of accomplishment
at some specific time (its end can be determined), even if the exact time may
be unknown and/or even unascertainable at the time the p’ship agreement is
made.
Q. Dissolution not by contravention of partnership agreement
1. Causes of Dissolution (UPA § 31):
a. Termination of the specific undertaking in the p’ship agreement
b. Express will of any partner
c. Express will of all the partners
d. Expulsion of any partner
e. Events which make it unlawful for the business to be carried out
f. Death; bankruptcy
2. Dissolution by court if: (UPA § 32)
a. Partner declared a lunatic
b. Partner becomes incapable of performing
c. Partner guilty of conduct as tends to affect prejudicially the carrying on of the
business
d. Willful or persistent breach of p’ship agreement
e. Losses
f. Other circumstances that make dissolution equitable
3. UPA § 38: what partners get upon dissolution:
a. (1) dissolution not by way of contravention of p’ship agreement, partners gets
p’ship property applied to discharge its liabilities and surplus applied to pay
in cash the net amount owed to partners (basically when a p’ship is dissolved
w/o contravention, the p’ship’s debts are paid then the rest is split according
to the percentage each partner is due)
b. (2) dissolution in contravention of partnership
i. (a) each partner who did NOT cause dissolution gets all the rights as in
(1) above AND damages for the breach of the p’ship agreement
ii. (b) they (partners who did not cause dissolution) can also continue with
the business in the same name with the other partners if they desire and
can get the partnership property if they pay for the interest of their former
partner
c. (2)(c): the partner who caused the wrongful dissolution gets:
i. (I) the rights under (1) if the other partner does NOT continue the business
(wrongful dissolver can continue the business as long as the other partners
decide not to)
ii. (II) of the business is continued (by the other partners), wrongful dissolver
gets paid for his partnership interest less damages and his interest does not
include goodwill of the business
R. Partnership Review
1. duration of p’ship: a p’ship may be for a term or at will. The default rule is at
will. A term may be implied.
2. partners are entitled to share in control
3. freeze out: when a majority deprives a partner of participation in control, it
violates the p’ship agreement
 4. upon dissolution, the p’ship does not cease. Rather, it continues for the purpose
of winding up
5. in some circumstances, the winding up will be accomplished by the partners who
are still available to do so. Otherwise, a court may order a sale.
6. after dissolution, partners may bid for the assets of the p’ship, including its
goodwill. Partners may bid to buy its assets piecemeal or as a going concern (one
big whole)
7. partners owe each other a fiduciary obligation, so they cannot dissolve in bad
faith
8. when a partner dissolves and bids for the assets of the p’ship, he or she must pay
a fair price.
S. Buyout Agreements
1. essential in both the p’ship and corporate context
2. in the corporate context, two types:
a. agreements that restrict the right of a shareholder to sell stock to whomever
they please AND
b. agreements giving a shareholder the right to force the other shareholders or
the corporation itself to buy back the stock
3. right to veto or right of first refusal on transfer of stock
4. right to force company or other shareholders to buy back stock

III. CORPORATIONS
A. What is a Promoter?
1. 3 aspects
a. A person who identifies a business opportunity and puts together a deal
b. Forming a corporation
c. As the vehicle for investment by others
2. promoters owe fiduciary duties to the corporations they create
B. Third Party Sales
1. Third party sales: If A sells land to a 3rd party, A can keep any profit
2. Principal/Agent Sales: under general principles of agency law, an agent may
not profit from a transaction with a principal unless the agent discloses that profit
to the principal. This is true both when the principal is an individual and when it
is a corporation. If the agent does not disclose his or her financial interest, then
the agent must give that profit to the principal (aka it is a secret profit)
3. Promoter Sales: when a promoter forms a new corp. under general principles of
agency, the promoter (as agent) owes a fiduciary duty to the new corporation (as
principal)
C. Pre-Incorporation contracts
1. when a promoter contracts with a 3rd party on behalf of a not yet formed corp,
who is liable on the K?
2. corp. can unilaterally adopt the K and agree to be liable even acquire rights
under the K as a 3rd party beneficiary
3. an agent for a not-yet-formed corp. is liable on the K
4. the agent is liable on the K if the corp. is never formed
 5. Investors in the unincorporated firm, if sharing profits, are partners. Under p’ship
law, they would be liable for any Ks entered into by their firm and their firm (if a
party to a K) could enforce any K’s made on its behalf.
a. See SC BCA s. 33-2-104: all persons purporting to act as or on behalf of a
corp., where there has been no incorporation are jointly and severally liable
for all liabilities created while so acting, but any person so acting while
believing in good faith that the articles have been filed shall not have any
liability
D. Piercing the corporate veil (PCV)
1. Unless otherwise provided in the articles of incorporation, a shareholder (SH) of
a corp. is NOT personally liable for the acts or debts of the corp. except that he
may become personally liable by reason of his own acts or conduct (MBCA §
6.22(b))
2. Courts will disregard the corp. form, or PCV, whenever necessary to prevent
fraud or to achieve equity
3. Whenever anyone uses control of the corp. to further his own rather than the
corp.’s business, he will be liable for the corp.’s acts on the principle of
respondeat superior.
4. otherwise, a corp. is a separate legal identity from its SHs (Walkovsky)
5. the classic fact pattern is a situation in which liability has been incurred in the
name of a corp. that has become insolvent
6. to PCV a court MUST find:
a. such unity of interest and ownership that the separate personalities of the
corp. and individual no longer exist AND
b. Circumstances where failing to PCV would either sanction fraud or promote
injustice (Sea Land Services)
7. for unity of interest, look to the following factors:
a. lack of corporate formalities (failure to maintain accurate corporate records)
( e.g. not holding SH and director’s meetings; not issuing stock; not keeping
corporate minutes, etc.)
b. commingling of funds and assets
c. undercapitalization (not having enough $ to pay debts/liabilities)(also
insolvency)
d. the use by one corp. of the assets of another
e. holding out by one that it is liable for the debts of the other
f. use of same offices and employees
g. use of one as a shell for the affairs of others
E. Imposing Liability on a Corporation
1. Alter Ego
a. Holding the equitable owner of a corp. liable for actions of the corp.
b. Alter ego liability requires corp. to be influenced and governed by other
person
c. Requires proof of fraud/injustice
d. Removes vertical barriers
* often arises in parent/subsidiary situations*
2. Enterprise liability
 a. Removes horizontal barriers
b. Requires proof of fraud/injustice
• Individual or corp. owns controlling interests in a number of corps. that are
engaged in related activities. These are sister corps. multiple corps. are used
to artificially divide what is essentially one business enterprise into segments
in order to unreasonably limit liability or to mislead creditors or customers.
• Taxi case in nutshell page 91 also has factors to consider when imposing
liability based on enterprise theory.
3. agency
a. No proof of fraud/injustice required
F. PCV v. Direct Liability (like a 4th way to impose liability on corp.)
1. injustice under PCV: insufficient assets, adding credibility to sub’s products
(Bristol Myers- breast implants)
2. Direct liability: one who undertakes to render services to another which he
should recognize as necessary for the protection of a 3rd person is subject to
liability if he increases the risk of harm, performs a duty to owed to the 3rd
person; or harm is suffered through reliance by a third person on undertaking.
(Basically: if A contracts to do something for B and B as a result harms C, A is
liable to C)
G. Avoiding PCV
1. Avoid unity of interest by respecting the separate existence of the corp.
2. respect corp. formalities
3. keep corp. funds and transactions separate from individual funds/transactions
and do not shift money in and out of corp. accounts
4. if formalities have been observed, so there can be no piercing, SHs or directors
liability is limited to the amount paid out, not for the full amount of the debt, as
in piercing
5. if the separate existence of the corp. has not been respected, problems:
a. in most cases need second element to be proved: fraud of injustice
b. but often need more to prove injustice than simply dissatisfied creditor, but
law not clear on exactly what needed
c. not necessary for the plaintiff to show awareness of the defendant’s disregard
of the entity
6. Fraud is an independent basis for liability, but requires proof of reliance. In some
piercing cases, fraud seems to be regarded as relevant without proof of reliance
H. Limited P’ships/SHs/Officers Liability
1. in general, partners are personally liable for the debts of the p’ship, but limited
partners are not
2. In general, SHs are not liable for the debts of a corp
3. in general, officers are not liable for the debts they cause a corp. to incur
I. SC Business Corporations Act
1. SECTION 33-2-101: Incorporators
a. Any person may act as the incorporator of a corp. by delivering articles of
incorporation to the Sec. of State for filing
2. SECTION 33-2-102: Articles of incorporation
a. (a) the articles of incorp. must set forth:
 i. (1) a corporate name for the corporation that satisfies the requirements of
section 33-4-101;
ii. (2) the number of shares the corp. is authorized to issue, itemized by
classes;
iii. (3) the street address of the corp.’s initial registered office and the name of
its initial registered agent at that office;
iv. (4) the name and address of each incorporator;
v. (5) the signature of each incorporator; and
vi. (6) a certificate, signed by an attorney licensed to practice in this state
(SC), that all of the requirements of this section have been complied with
3. Powers of a Corporation
a. § 3.02 General Powers/ SC Bus. Corp Act. §33-3-102
i. Unless its articles of incorp. Provide otherwise, every corp. has the power
to do all things necessary or convenient to carry out its business and
affairs, including w/o limitation power:
ii. To sue and be sued, complain and defend its corp. name
iii. To make and amend bylaws
iv. To acquire, own, hold, and otherwise deal with, real or personal property
v. To make donations for the public welfare of for charitable, scientific, or
educational purposes;
vi. To make payments or donations or to do any other act, not inconsistent
with law, that furthers the business and affairs of the corp.
4. Purpose and Ultra Vires (nutshell page 64)
a. RMBCA §3.04/ SC Bus. Corp. Act. §33-3-104:
b. (a) except as provided in subsection (b), the validity of corporate action
cannot be challenged on the ground that the corp. lacks or lacked power to act
( the corp. engages in acts beyond the purpose for which the corp was
organized)
c. (b) a corp’s power to act may be challenged: (i.e. they can’t just be sued for it
by anyone)
i. (1) in a proceeding by a SH against the corp. to enjoin the act;
ii. (2) in a proceeding by the corp., directly, derivatively, or through a
receiver, trustee, or other legal representative, against an incumbent or
former director, officer, employee, or agent of the corp.; OR
iii. (3) on a proceeding by the attorney general
J. Business Judgment Rule
1. BJR: in the absence of a showing of fraud, illegality, or self- dealing (i.e. a
conflict of interest) by the directors, their decision is final and not subject to
review by the courts.
2. Policy rationale:
a. Courts are not business experts
b. Protection of courts’ non-SH constituents
c. Preserves centralization of decision making
K. Derivative Suits
1. a derivative suit is a suit in equity against a corp. to compel it to sue a 3rd party
 2. Distinction between direct and derivative claims: a suit is direct if it alleges a
direct loss to the SH; it is derivative if it alleges a loss to SH that derives from a
loss to the corp.
3. FRCP: rule 23.1: derivative action By SHs
a. In a derivative action brought by one or more SHs or members to enforce a
right of a corp. or of an unincorporated association, the corp. or assoc. having
failed to enforce a right which it may properly assert, the complaint shall be
verified and shall allege:
b. (1) that the plaintiff was a SH or member at the time of the transaction and
that (2) the action is not a collusive one to confer jurisdiction on a court of
the US which it would not otherwise have.
c. The complaint shall also allege with particularity the efforts, if any, made by
the plaintiff to obtain the action the plaintiff desires from the directors or
comparable authority and, if necessary, from the SHs or members and the
reasons for the plaintiff’s failure
d. The derivative action may not be maintained if it appears that the plaintiff
does not fairly and accurately represent the interests of the shareholders or
members similarly situated
e. The action shall not be dismissed or compromised w/o the approval of the
court, and notice of the proposed dismissal or compromise shall be given to
SHs or members in such manner as the court directs.
4. Derivative v. Direct
a. Derivative: complaint is injury to corp. (i.e. actions of management on behalf
of corp. challenged)
b. Representative class action: injury is one to plaintiff as SH and to him
individually and not to corp. (i.e. actions of management in interfering with
P’s rights as a SH challenged)
c. Test to determine derivative or direct:
i. (1) who suffered the harm, corp. or SHs individually? And
ii. (2) who receives benefit of recovery/remedy, corp. or SHs individually?
(Tooley)
d. But usual tests for a direct action are premised on (1) injury to SH that is not
derivative of prior injury to the corp. entity or (2) a breach of a contractual
duty owed SH independent of any right of the corp
e. Strike suit: when person with a small stake in the value of the business and
brings a derivative suit in order to be bought off/out.
L. Demand on Directors
1. Plaintiffs in derivative suits are required to approach the board and demand that
it sue the alleged wrongdoers
2. If demand is required, the failure to make the demand is a procedural barrier and
the suit will be dismissed
3. The demand requirement raises 2 questions (1) when is demand excused? And
(2) what happens if demand is excused but the board does not want the suit?
4. Grimes v. Donald
a. Direct v. Derivative: Was Grimes’s complaint derivative of direct?
 i. Held: abdication claim is direct, and the compensation related claims
derivative
ii. Look to injury falling on SH for direct action and also to remedy being
sought. If monetary recovery to the corp., derivative, if not, direct.
b. Holding on direct claim:
i. If a K would effectively preclude the board from exercising its managerial
and supervisory duties, the K would amount to a de facto abdication of the
board’s fiduciary obligations
ii. Here, the K amounted to a valid delegation: A board decision to incur the
risk of such a financial penalty in order to attract a senior manager was
entitled to BJR protection
c. Holding on Demand Futility: is the board disabled by conflicted interests
from exercising independent business judgment?
i. The 3 Usual bases for excusing demand as futile are identified as:
ii. (1) a majority of the board has a material interest in the challenged
transaction
iii. (2) a majority of the board is dominated or controlled by the alleged
wrongdoer; OR
iv. (3) the challenged transaction was not the product of a valid BJ
5. Notes on Demand on Directors
a. Purpose of demand: to allow the corp. to take over the cause of action or to
resist it, according to the judgment of directors
b. Where directors cannot be expected to make a fair decision, demand would
be futile and is excused
c. Generally, where demand is made, the plaintiff is deemed to have conceded
that it was required, which, in turn, makes the decision of the board turn on
whether to dismiss as a matter of BJ
d. Demand will almost always be required unless:
i. A majority of the board is so directly self-interested in the challenged
transaction that there is a serious doubt that the BJR would protect the
transaction OR
ii. If the plaintiff can allege with particularity that the challenged transaction
was not the product of a valid exercise of BJ
e. Where demand is excused, the corp. may still move to dismiss the suit as not
in the best interests of the corp.
6. Universal Demand
a. RMBCA §7.42 requires a written demand upon the board in all cases, and,
further, precludes a SH from bringing suit for 90 days after the demand is
made
b. Demand then reviewed by the board or independent committee
c. If either the board of committee concludes in good faith that derivative
proceeding is not in the best interests of the corp., the court dismisses the
complaint
d. Alternatively, the court may appoint independent panels to determine
whether the suit should go forward. If dismissal is recommended, the court
 dismisses unless the plaintiff can prove the independent panel failed to act in
good faith or failed to conduct a reasonable inquiry.
7. Marx v. Akers
a. Purposes of demand requirement:
i. (1) to relieve courts from deciding matters of internal corporate
governance by allowing directors to correct abuses,
ii. (2) provide corporate boards with reasonable protection from harassment
by litigations, and
iii. (3) discourage strike suits for SH personal gain
b. 3 bases for excusing demand under NY law:
i. (1) majority of the board of directors interested in the challenged
transaction
ii. (2) BoD did not fully inform themselves about the challenged transaction
to the extend reasonably appropriate under the circumstances, OR
iii. (3) the challenged transaction was so egregarious on its face that it could
not have been the product of sound BJ of the directors (Barr v. Welcome)
c. Note: bare allegation that the compensation of directors is excessive is not
enough, particularity in the allegations is required
M.Special Committees
1. Role of Special Committees
a. Courts are ill equipped to evaluate BJs
b. BUT, BJR does not foreclose inquiry by courts into the disinterested
independence of special committee (Auerbach)
c. Balance: adequacy and appropriateness of SC’s investigative procedures and
methodologies is reviewable, but not their conclusions.
d. Committees Under Corporate Law
i. DGCL § 141 (c): the BoD may designate 1 or more committees, each
committee to consist of 1 or more of the directors of the corp. Any such
committee shall have and may exercise all the powers and authority of the
BoD in the management of the business and affairs of the corp.
ii. SC Bus. Corp. Act § 33-8-250 (a): Unless the articles of incorporation or
bylaws provide otherwise, a BoD may create one of more committees and
appoint members of the BoD to serve on them. Each committee must have
2 or more members who serve at the pleasure of the BoD.
2. Zapata Test for Court Review of Special Committee
a. Court inquires into independence and good faith of committee and the bases
supporting its conclusions, if satisfied, move to step 2
b. Court undertakes an independent inquiry into whether the suit should be
dismissed
c. If court’s independent BJ is satisfied, motion to dismiss suit is granted
N. Independence of a Director
1. Turns on whether director is, for any substantial reason, incapable of making a
decision with only the best interests of the corp. in mind
2. independence of directors determines derivative suits, standard of review for
related party transactions, takeover defenses, and is a precondition for
application of the BJR
 3. NYSE Independent Director Requirements
a. No director qualifies as “independent” unless the BoD affirmatively
determines that the director has no material relationship with the listed
company
b. BUT: a director is not independent if:
c. (1) within the last 3 years, the director has been an employee, an immediate
family member, or an executive officer of the listed company
d. (2) the director has received, during any 12-month period within the last 3
years, more than $100,000 in direct compensation from the listed company,
other than director and committee fees
e. (3) the director or any immediate family member is a current partner of a firm
that is the company’s internal or external auditor
f. (4) the director is a current employee or has an immediate family member
who is an employee
g. (5)the director has an immediate family member who is a current employee
of such a firm (auditing firm)
O. Caremark Violations
1. the BoD’s indifference to the alleged wrong acts was so extreme as to constitute
subjective bad faith
2. i.e. Beam v. Martha Stewart Living Omnimedia: In Beam, court rejects
Caremark allegations noting: Regardless of Stewart’s importance to MSO, she is
not the corp. And it is unreasonable to impose a duty on the BoD to monitor
Stewart’s personal affairs b/c such a requirement is neither legitimate nor
feasible.
IV. MORE CORPORATIONS
A. BJR
1. BJR: in the absence of a showing of fraud, illegality, or self- dealing (i.e. a
conflict of interest) by the directors, their decision is final and not subject to
review by the courts.
2. Policy rationale:
a. Courts are not business experts
b. Protection of courts’ non-SH constituents
c. Preserves centralization of decision making
3. Ties between BJR, Duty of Loyalty, Duty of Care
a. BJR grants to directors a broad immunity for any mistakes, but not if any
fraud, illegality, conflict of interest, or negligence
b. Conflict of interest relates to Duty of loyalty (DOL), negligence relates to
duty of care (DOC)
c. So, if directors have avoided conflicts of interest (DOL), and if they have
gathered information and thought about the problem they face (DOC), then
the courts will not second guess them (BJR)
4. Kamin v. Amex
a. Courts will not interfere with the acts of directors or the discretion of BoD
unless:
i. The powers have been illegally or unconscientiously executed;
ii. The acts were fraudulent and destructive of the rights of the SHs; or
 iii. The directors have acted or are about to act in bad faith and for a dishonest
purpose
b. Note: more than imprudence/mistaken judgment needed; need neglect of
duties
c. Bottom line: no court interference unless fraud, oppression, arbitrary action,
breach of trust
5. Van Gorkom
a. BJR does not protect and uninformed decision
b. Burden of proof is on the party attacking the board’s decision (to prove that it
is not protected by BJR)
c. Whether a BJ is an informed one turns on whether the directors have
informed themselves prior to making a business decision of all material
information reasonably available to them
d. Direct, not derivative in this case
e. Spare cash options:
i. Use of cash to acquire other businesses
ii. Payment of dividend
iii. Repurchase of stock
f. 4th spare cash option: sell the corporation
i. Normal sale or LBO (leveraged buyout) or MBO (managed buyout)
ii. LBO: purchase of a company financed by a small amount of equity and a
large amount of debt (can borrow money from banks using the collateral
of target’s assets). Also sales of target’s assets can be used to payoff loan.
Loan may appear on target’s balance sheet.
B. Director Liability
1. Reliance on expert’s report can protect a director from liability (Brehm); see
also DGCL §141(e):
a. A member of the BoD, or a member of any committee designated by the
BoD, shall, in the performance of such member’s duties, be fully protected in
relying in good faith upon the records of the corp., information presented to
the corp. by any of the corp.’s officers or employees, or by any other person
as to matters the member reasonably believes are within such other person’s
professional or expert competence and who has been selected with reasonable
care by or on behalf of the corp.
2. In re Walt Disney Litigation
a. BJR protects director decisions even when the “information and decision-
making process” by which that decision was made “was not so tidy” as would
have been the case had the directors “followed a ‘best practices’ scenario”
and falls “short of what best practices would have counseled.”
b. Possible bases for finding that directors acted in bad faith:
i. (a) conduct motivated by subjective bad faith (i.e., an actual intent to do
harm);
ii. (b) gross negligence; and
iii. (c) “intentional dereliction of a duty, a conscious disregard for one’s
responsibilities”
 c. The compensation committee had the power to approve Ovitz’s pay package,
w/o referring the matter to the full board, and exercised due care in doing so.
The full board was entitled to rely on Eisner and the compensation
committee.
d. The SH’s argument that Ovitz’s compensation package was inherently
wasteful was not accepted. The deal had a rational business purpose- i.e., to
induce Ovitz to leave his highly lucrative position at another company, and
no evidence that the deal “irrationally incentivized Ovitz to get himself
fired.”
3. Francis v. United Jersey Bank
a. Directors should acquire a rudimentary understanding of business and
exercise ordinary prudent care; a failure to do so may violate a director’s
DOC
b. Directors can rely on subordinates, but not if they have notice that
subordinates are acting inappropriately.
4. Caremark Principles
a. Director liability arises in two contexts:
i. Liability may follow from a board decision that results in a loss b/c that
decision was ill advised or negligent, but not if it was wrong
ii. Liability to the corp. for a loss may be said to arise from an unconsidered
failure of the board to act in circumstances in which due attention would
have prevented the loss
b. Note: director’s obligation includes a duty to attempt in good faith to assure
that an adequate corporate information and reporting system exists; failure to
do so may render a director liable.
c. ***if there was a rational basis for their decision and there was no fraud.
Illegality, or COI, even with the benefit of hindsight, the decision turns
out to be wrong, there will be no violation of DOC***
5. Violation of DOC by failing to monitor:
a. To show that directors breached their DOC by failing to adequately control
the employees, plaintiffs would have to show either:
i. (1) that the directors knew or
ii. (2) should have known that violations of law were occurring and, in wither
event,
iii. (3) that the directors took no steps in a good faith effort to prevent or
remedy that situation, and
iv. (4) that such failure proximately resulted in the losses complained of
(Caremark p. 371 of text)
C. Duty of Loyalty and Sarbanes-Oxley Act
1. Section 402 of SOA bars publicly held corps. Registered with the SEC from
directly or indirectly lending or arranging for the extension of credit to their own
officers or directors
2. § 402 may also interfere with such other transactions as the advancement of
expenses pursuant to a state indemnification statute or the cashless exercise of
stock options
 3. § 406 requires a corp. to adopt a code of ethics applicable to CEO, CFO,
controller, and chief accountant. Failure to do so requires an explanation.
4. the ethics code must provide for “the ethical handling of actual or apparent
conflicts of interest between personal and professional relationships”
D. Duty of Loyalty (DOL)
1. Personal transactions of lawyers with their corps. Tend to produce a conflict
between self-interest and fiduciary obligation; evidence of improvidence,
oppression, unfairness, or undue advantage will void the transaction (Bayer)
2. violation of DOL occurs when officers or directors are greedy and put their
own financial interests ahead of the interests of the corporation or its SHs
3. Courts look to fairness of the transaction to the corporation
4. Due to the conflict of interest, the BJR does not apply; so directors bear burden
of proof of fairness of transaction
5. *** BJR is not an issue in DOL cases***
E. Director’s Conflicts of interest
1. (a) absent a COI, the plaintiff has the burden of proof, and will no doubt lose b/c
of the BJR
2. (b) given and ungratified COI, the defendant directors have the burden of
proving that the challenged transaction was fair and reasonable
3. (c) given a transaction with a COI but with ratification (by disinterested SHs or
directors), the plaintiff again has the burden of proof and must overcome the BJR
4. Often looks like:
a. Interested director transactions
i. Occurs when, in effect, the officer or director is on both sides of a
transaction
b. Usurping corporate opportunities
F. Corporate Opportunity
1. A corporate fiduciary agrees to place the interests of the corp. before his own in
appropriate circumstances
2. Usurping a corporate opportunity violates the basic rule that directors and
officers cannot utilize their positions within the corp. to whom they owe
fiduciary duties to profit personally at the expense of the corp.
3. if there is presented to a corp. officer or director a business opportunity
which the corporation:
a. is financially able to undertake
b. is, from its nature, in the line of the corp’s business and is of practical
advantage to it,
c. is one in which the corp. has an interest or a reasonable expectancy, and
d. by embracing the opportunity, the self-interest of the officer or director
will be brought into conflict with that of the corporation, the law will not
permit him to seize that opportunity.
4. Corporate opportunity test as interpreted by Beam
a. In looking to whether the corp. is financially able to exploit the opportunity,
here look to whether MSO had enough authorized but unissued stock to
satisfy the investor
 b. An opportunity is within the corp’s line of business if it is “an activity as to
which the corp has fundamental knowledge, practical experience, and ability
to pursue.” A company’s line of business is one that is intended to be
profitable.
c. An interest or expectancy in the transaction requires “some tie between that
property and the nature of the corp. business.”
d. COI: “Delaware courts have recognized a policy that allows officers and
directors of corps. to buy and sell shares of that corp. at will so long as they
act in good faith.”
G. Intrinsic Fairness
1. When the situation involves a parent and a subsidiary, with the parent controlling
the transaction and fixing the terms, the test of intrinsic fairness, with its
resulting shifting of the burden of proof, is applied
2. A parent owes a fiduciary duty to its subsidiary when there are parent-subsidiary
dealings. But only where this fiduciary duty is accompanied by self-dealing will
the intrinsic fairness test be applied
3. Self-dealing occurs when the parent, by virtue of its domination of the
subsidiary, causes the subsidiary to act in such a way that the parent receives
something from the subsidiary to the exclusion of, and detriment to, the minority
SHs of the subsidiary
H. Fiduciary Duties of SHs
1. SHs and directors normally do not bear the same fiduciary duties
2. courts may impose the BoD’s fiduciary duties directly in the controlling of
majority SHs
3. Where a controlling SH uses a direct SH vote to authorize certain corporate
actions in a manner the court considers unfair, a court may hold that the SH
violated fiduciary duties to the other SHs
4. in general:
a. transactions (with a potential for self-dealing) between a controlling SH and
the corp. are subject to an intrinsic fairness test; and
b. majority SH has the right to control; but when it does so, it occupies a
fiduciary relation toward the corp. itself or its officers and directors
I. Ratification
1. 8 Del.C. § 144
a. No K or transaction between a corp. and its directors of officers, shall be void
or voidable solely for this reason, or solely because the officer or director is
present at or participates in the meeting of the board or committee which
authorizes the K or transaction, or solely because his or their votes are
counted for such purpose if:
i. (1) the material facts as to his relationship or interest and as to the K or
transaction are disclosed to the board and the board authorizes the K or
transaction by the affirmative votes of a majority of the disinterested
directors; OR
ii. (2) the material facts are disclosed to the SHs entitled to vote thereon, and
the K or transaction is specifically approved in good faith by vote of the
SHs; or
 iii. (3) the K or transaction is fair as to the corp. as of the time it is authorized,
approved, or ratified, by the BoD, a committee, or the SHs.
2. Wheelabrator
a. (a) if a challenged transaction involves a deal between the corp. and one of
the directors, then the effect of the disinterested SH ratification is to shift the
burden of proof to the plaintiff to show waste (overcome BJR)
b. (b) if a challenged transaction involves a deal between the corp. and a
controlling SH, then the effect of the disinterested SH ratification is to shift
the burden of proof to the plaintiff to show that the transaction fails the test of
entire fairness.
3. effects of disinterested ratification
a. Violation of DOC consisting of failure of the board to reach an informed
business judgment (as in van Gorkom): Plaintiff can succeed only by proving
waste or gift.
b. Lack of Board authority: Claim extinguished
c. Lack of adequate investigation and consideration by the board: (again as in
Van Gorkom) Claim extinguished.
d. Interested director: burden shifts to plaintiff. Standard is BJR (plaintiff must
prove waste or gift or gross negligence) (Wheelabrator)
e. Controlling SH: burden shifts to plaintiff. Standard is entire fairness.

V. SECURITIES
A. Regulation of Primary market
1. Securities Act 1933: requires companies issuing stock to disclose info about their
business and capital structure
2. Securities Act 1934 & Blue Sky Laws: the 1934 Act collects a variety of
different disclosure and regulatory provisions; i.e., short-swing trades (§16(b))
and fraud (Rule 10b-5) banned
a. Also requires large publicly traded companies to disclose info regularly
through forms 10-K (annual) and 10-Q (quarterly), and regulates tender
offers and proxy fights.
b. Blue-Sky laws: state statutes which purport to regulate the quality of the
securities issued. Of the regulatory commission deems a security too risky,
the issuer may not be able to sell it in this state at all.
B. Sarbanes-Oxley Act
1. requires audit committee
2. the committee must be comprised solely of independent directors
3. at least one member of the committee must qualify as a “financial expert”
4. the audit committee must establish a system for employees to anonymously
whistle blow
5. SEC is now empowered to remove officers and directors from their positions, or
bar them from serving at other public corporations on grounds of “unfitness”
6. indirectly regulates executive compensation
7. prohibits a corp. from directly or indirectly making or even arranging for loans to
its directors and executive officers
 8. prohibits executives from trading during blackout periods in which the
employees participating in stock-based pension plans are forbidden from trading
9. requires “therapeutic disclosure”
C. Definition of Security
1. An investment contract is “a contract, transaction, or scheme whereby a person
invests his money in a common enterprise and is led to expect profits from the
efforts of the promoter or a third party.”
2. What matters more than the form of an investment scheme is the “economic
reality” that it represents.
3. Query: whether the investor, due to investment agreement itself or the factual
circumstances that surround it, is left unable to exercise meaningful control over
the investment (Robinson)
D. Registration Process
1. The Securities Act prohibits the sale of securities unless the company issuing
them has “registered” them with the SEC
2. the Securities Act includes 2 types of exemptions to registration requirement:
a. some securities exempted entirely
b. some transactions exempted
3. Exempt securities need never be registered, either when initially sold by the
issuer or in any subsequent transaction
4. exempt transactions are one-time exemptions
E. Private Placements: Registration Exemption
1. limited partnership interest is a security (Doran)
2. 4 characteristics define a private placement
a. Number of offerees and their relationship to each other
b. Number of units offered
c. The size of the offering
d. The manner of the offering
3. even if the 4 factors are met, issuer needs to demonstrate that accurate info was
provided to offerees to secure the exemption
F. Misrepresentations in Security Sales
1. securities act §11: fraud committed in connection with the sale of securities
through the use of a registration statement
2. Under §11, the following parties are liable if the registration statement is
materially misleading:
a. Those who sign the registration statement (this includes the issuer)
b. Directors
c. Experts
d. underwriters
3. the issuer is liable b/c it must sign the registration statement; it has no defenses.
The other parties have the so-called due-diligence defenses of §11(b).
4. Under §(a)(4) experts not liable for misstatements in non-expertised part
5. Under §(b)(3)(A), with respect to non-expertised portions, the non-experts must
show that, after reasonable investigation, they had reasonable grounds to believe,
and did believe, that the statements were true (failure to make a reasonable
 investigation or look at it at all will result in liability b/c there was no due-
diligence)
6. Under §(b)(3)(B), with respect to expert portions, we use the same test to experts
on the expertise portion
7. Under §(b)(3)(C) with respect to expertised portions, the non-experts must show
that they had no reason to believe, and did not believe, that the statements were
misleading.
VI. RULE 10b-5
A. It shall be unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce, or the mails or of any facility of any
national securities exchange: prohibits
1. (a) to employ any device, scheme, or artifice to defraud
2. (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 light of the
circumstances under which they were made, not misleading, (any omission or
misstatement of material fact) OR
3. (c) To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person, in connection with the purchase or
sale of any security (Any act or practice that would operate as fraud or
deceit)
B. Proving a Violation of 10b-5
1. traditionally, a plaintiff suing under rule 10b-5 needed to show 4 things: scienter,
proximate cause, materiality, reliance
a. SCIENTER: Plaintiff must show that the defendant acted with an intent to
deceive, manipulate, or defraud; recklessness
b. CAUSATION: Plaintiff must show that the misstatement caused the damage
c. MATERIALITY: Plaintiff must show that a reasonable investor would likely
consider the misstatement important
d. RELIANCE: If affirmative misrepresentation, proof of reliance on the
misrepresentation IS required; If failure to disclose, absent proof by the
defendant to the contrary, presumption of reliance
C. Options
1. Under these Ks a seller agrees to sell or a purchaser agrees to buy a security at a
fixed price on or before a fixed date in the future
2. Allows for hedging against future movements in market price of securities
3. the option K gives its owner the right to buy (call) or sell (put) a fixed number of
shares of a specified underlying stock at a given price (the striking price) on or
before the expiration date of the K
4. for this option, a premium is paid, and the K is worth more or less than the
premium depending on the direction of the market price of the underlying stock
relative to the striking price
D. Evolution of Common Law Insider Trading
1. Majority or no-duty rule: liability was based solely on actual fraud, such as
misrep or fraudulent concealment of a material fact
 2. Directors who obtained inside info by virtue of their position held the info in
trust for the SHs, so directors had duty to disclose all material info to SHs before
trading with them
3. Special facts or special circumstances rule: although directors generally owe no
duty to disclose material facts when trading with SHs, such a duty can arise in
special circumstances
E. Texas Gulf Sulphur
1. Insiders who traded prior to the public dissemination of the info violated 10b-5
2. basic disclose-or-abstain rule: if a company decides not to disclose, insiders
must not buy stock
3. Disclosure of inside info required before insiders can trade
4. reasonable investor standard for materiality: info is material if a reasonable
investor would consider it important, that is if the info might affect the value of
the stock
5. the fact that insiders trade in a piece of info itself demonstrates materiality
6. insiders must wait to trade until the info has been effectively disseminated:
media of the widest circulation
F. Inside Information
1. Duty to abstain from trading on inside information arises from the relationship
between a corp’s SHs and its employees
2. if no relationship of trust between trader and the SHs of the corps whose shares
he traded, no duty to “disclose or abstain” (Chiarella)
3. not all breaches of fiduciary duty in connection with securities transactions come
under the ambit of 10b-5; manipulation or deception also needed (Santa Fe
Industries)
G. Dirks (tipping)
1. whether a tippee violates rule 10b-5 will depend on whether the tippee violated a
fiduciary duty to the firm’s SHs in giving the tip, and whether the tippee knew or
should have known of that breach
2. in this context, a fiduciary duty breach occurs only where a tipper earns a
personal benefit from the tip
3. lawyers and accountants constitute temporary insiders for the purposes of tipping
liability
4. Personal benefit test: must show
a. That the tipper breached a fiduciary duty and
b. That the tipper tipped for the purpose of obtaining some sort of personal gain
i. Ways it is often earned: selling the information; giving it to enhance one’s
reputation or standing or with the expectation of receiving some reciprocal
benefit; and giving the info to a person that the tipper has a personal
relationship with.
H. Rule 14e-3 and misappropriation
1. Rule 14e-3: prohibits trading while in possession of material, non-public info
relating to a tender offer
2. Misappropriation theory: a person commits fraud in connection with a securities
transaction when he misappropriates confidential info for securities trading
purposes, in breach of a duty owed to the source of the info.
 I. Insider trading recap
1. Generally, trading on inside info violates 10b-5 as duty to abstain from trading
on inside info arises from the relationship of trust between trader and SHs of
corp.
2. if no relationship of trust between trader and SH, no duty to disclose or abstain
(Chiarella)
3. BUT, SEC rule 14e-3 prohibits trading while in possession of inside info relating
to a tender offer
4. Tipping Liability: if a tipper violates a fiduciary duty by earning a personal
benefit from giving a tip to a tippee and the tippee knew of that breach, violation
of 10b-5 (Dirks)
5. A fiduciary’s undisclosed use of info belonging to his principal, w/o disclosure
of such use to principal, for personal gain constitutes misappropriation and
violates 10b-5
VII. PROXY
A. Allows a SH (as principal) to appoint someone else (as agent) to vote on his or her
behalf at the SHs meeting
B. Expenses for acquiring proxies if reasonable are able to be charged to the firm
(Levin)
C. Reimbursement rules for proxy fights
1. the corp. may not reimburse either party unless the dispute concerns questions of
corporate policy
2. the firm may reimburse only reasonable and proper expenses
3. the firm may reimburse incumbents whether they win or lose
4. the firm may reimburse insurgents only if they win, and only if SHs ratify the
payment
D. Regulatory schemes for proxies
1. section 14(a) of the 1934 securities act prohibits people from soliciting proxies in
violation of SEC rules
2. rules 14a-3, 14a-4, 14a-5 and 14a-11 require people who solicit proxies to
furnish each SH with a “proxy statement” in which they disclose info that may
be relevant to the decision the SH must make
3. when an insurgent group wants to contest management and solicit proxies, rule
14a-7 gives management a choice: it can either mail the material to the SHs
directly and charge the group for the cost, or provide it with a SH list and let it
distribute its own material
E. Defects in proxy statements (NS 154)
1. where the misstatement or omission in a proxy statement has been shown to be
“material,” the defect was of such a character that it might have been considered
important by a reasonable SH who was in the process of deciding how to vote
2. as a result, if the defect has a significant propensity to affect the voting process
b/c the defect is material and the proxy solicitation was essential, plaintiff has
satisfied the requirement of proof of causation
F. SH proposals (NS 153)
1. types:
a. to remove poison pills
 b. to require annual election of directors
c. to require that directors hold a specified minimum amount of corporate shares
d. to prevent the same person from being both CEO and chairman of the board
e. to require that a majority of the board and of all key committees be
independent directors
f. to link director pay to corporate performance
g. to require that the compensation committee be composed entirely of
independent directors, with its own compensation consultant; and
h. to create a committee of SHs to advise the directors
2. Excluding SH proposals
a. Rule 14a-8(i)(5) provides that if a SH proposal relates to operations which
account for less than 5 percent of the firm’s assets, earnings, or sales, and is
not otherwise significantly related to the firm’s business, the proposal may be
omitted from the proxy statement
b. However, “ otherwise significantly related” is not limited to economic
significance; matters of ethical and social significance can be included
(Lovenheim)
3. Valid reasons for excluding SH proposals under rule 14a-8
a. The proposal does not concern a proper subject for action by SHs ((i)(1))
(e.g. ordinary business operations)
b. The proposal is illegal ((i)(2))
c. The proposal violates proxy rules ((i)(3))
d. The proposal concerns a personal grievance or benefit ((i)(4))
e. The proposal concerns a matter beyond the power of the firm to effectuate
((i)(6))
f. The proposal relates to a company’s ordinary business operations ((i)(7))
g. The proposal has been submitted in the past and has not obtained much
support ((i)(12))
G. SH inspection rights
1. a SH desiring to discuss relevant aspects of a tender offer should be granted
access to the SH list unless it is sought for a purpose inimical to the corp. or its
SHs (Crane)
2. SHs must have a “proper purpose” for inspecting corp. records/requesting SH
lists; a proper purpose contemplates concern with investment return (Pillsbury)
3. Using a SH list to facilitate SH communication strengthens a request for a SH
list even where the SH is acting as an agent (Sadler)
VIII. SH VOTING CONTROL
A. A proprietary right is not just a right to profits or distributions; a right to participate
in control is also a proprietary right (Stroh)
B. Control of a corp. can be allocated based on:
1. 2 classes of shares
2. common stock
3. class specific board members
4. voting trust (NS 129)
a. SH transfers legal title to his shares to voting trustee(s) which gives the
trustee(s) the right to vote for those shares exclusively for a defined period
 5. vote pooling arrangements (NS 127)
a. vote pooling arrangements are valid (Ringling)
b. vote pooling arrangements are valid both for close corps. and among any
number of SHs of other corps. (Estrada)
c. Ks among SHs to vote their shares in the manner proscribed in the K
6. irrevocable proxies
C. Judging director action for violations of DOL:
1. Blasius standard:
a. First, the plaintiff must establish that the board acted for the primary purpose
of thwarting the exercise of a SH vote
b. Second, the board has the burden to demonstrate a compelling justification
for its actions
2. If plaintiff is unable to satisfy the initial primary purpose prong, BJR applies
D. SHs themselves may not, by agreement among themselves, control the directors in
the exercise of the judgment vested in them by virtue of their office to elect officers
and fix salaries (McQuade)
E. The McQuade rule is designed to protect minority SHs who were not party to the
agreement, so where the corp. has no minority SHs, the McQuade rule is
unnecessary (Clark)
F. SH agreements requiring the appointment of particular individuals as officers or
employees of the corp. are enforceable, at least for closely help corps., as long as
they are signed by all SHs or the minority SHs do not complain, no apparent injury
to the public/creditor is present, and the terms of the agreement are reasonable
(Galler)
G. McQuade: 3 men, as SHs could agree to elect each other as directors, but they
could not agree in advance what they would do as directors. (nutshell 117-118)
H. McQuade: a SH agreement prohibiting the board from changing officers, salaries,
or policies or retaining individuals in office is illegal and void absent express
contractual consent