acing business organizations (book outline)

69
AGENCY EXAM APPROACH —Questions to ask: 1.) Is there a Principal-Agent relationship/and what type? 2.) If so, does the issue involve a TORT or CONTRACT? Agency : An agency is a fiduciary relationship that arises when one person (a principal) manifests assent to another person (an agent) that the agent shall act on the principal’s behalf and subject to the principals control. o There are three parts : 1.) Manifestation of consent by the principal that the agent act on the principal’s behalf; AND 2.) subject to the principal’s CONTROL; AND 3.) the agent manifests CONSENT Three players in agency Questions: 1.) The Principal 2.) The Agent 3.) The Third Party

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Outline based on book Acing Business Organization/Association.

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Page 1: Acing Business Organizations (Book Outline)

AGENCY

EXAM APPROACH—Questions to ask:

1.) Is there a Principal-Agent relationship/and what type?

2.) If so, does the issue involve a TORT or CONTRACT?

Agency:

An agency is a fiduciary relationship that arises when one person (a

principal) manifests assent to another person (an agent) that the

agent shall act on the principal’s behalf and subject to the principals

control.

o There are three parts :

1.) Manifestation of consent by the principal that

the agent act on the principal’s behalf; AND

2.) subject to the principal’s CONTROL; AND

3.) the agent manifests CONSENT

Three players in agency Questions:

1.) The Principal

2.) The Agent

3.) The Third Party

Page 2: Acing Business Organizations (Book Outline)

Agency Problems Involving Contract: When facing a fact pattern where

a contract is involved the question is whether the principal is not whether the

principal is liable, but whether the principal is bound by the agent’s actions.

General rule: An agent has the ability to bind a principal to an

agreement, provided that the agent has some form of authority.

Types of Authority : 1.) actual authority, 2.) apparent authority,

3.) ratification, and 4.) agency by estoppel.

o 1.) Actual Authority (Express and Implied):

Actual authority exists when P communicates to A about

the activities in which the agent may engage and the

obligations the agent may undertake. This

communication may be spoken Or written (express

actual authority). It may be through silence or implied

by the job (implied actual authority).

Actual Express Authority —

Involves examining the principal’s explicit

instructions.

Actual Implied Authority —

Involves examining P’s explicit instructions and

asking what else might be reasonably included in

those instructions (i.e. implied) to accomplish the

job.

Page 3: Acing Business Organizations (Book Outline)

Implied authority includes actions that are

necessary to accomplish the principal’s original

instructions to the agent; it also includes those

actions that the agent reasonably believes the

principal wishes him to do, based on the agent’s

reasonable understanding of the authority

granted by the principal.

o 2.) Apparent Authority

Apparent authority is created when a person (principal

or apparent principal) does or says something or

creates a reasonable impression/manifestation that

another person (the apparent agent) has the authority

to act on behalf of that apparent principal.

It is about what a third party reasonably believes the

principal has authorized the agent to do.

o 3.) Ratification—“Authority given after the fact”:

Ratification is the authority granted after the contract

has been made. It involves situations in which an agent

enters into an agreement on behalf of the principal

without any authority (actual or apparent).

P’s affirmation may be express or implied (i.e. implied

by accepting the benefits of the transaction).

Once agreement or transaction has been ratified the law

treats it as if it were originally done by the agent with

actual authority. Thus, binding both parties to the

agreement (i.e. principal and third-party).

Page 4: Acing Business Organizations (Book Outline)

To be VALID, P must know or have reason to know, at

the time of the alleged ratification, the material facts

relating to the transaction.

P MAY NOT PARTIALLY RATIFY a transaction. P must

ratify the whole transaction. Its all or nothing.

Limitations on Ratification:

If a third party manifests an intention to withdraw

from the transaction, prior to ratification, the

principal may not ratify the agreement.

Ratification will be denied when necessary to

protect the rights of innocent third parties.

Ex. Annie (agent) enters into an agreement

with Ted (third-party) to sell Pat’s (Principal)

house on day one. On day two, P’s house

burns down. P cannot ratify on day three

and say “Ok, I accept the agreement.” (P.

22)

Ratification might also be denied if the passage of

time affects the rights and liability of a third

party.

o Questions to ask to determine whether there is a valid

ratification:

A.) Did P through word or deed manifest his

assent to affirm the agreement?

B.) Will the law give effect to that assent?

o 4.) Agency by Estoppel: (P.23)

Page 5: Acing Business Organizations (Book Outline)

Estoppel is not really a form of authority. Estoppel is an

equitable doctrine which prevents the principal from

denying that an agency relationship exists.

Estoppel generally arises in agency situations in which

the principal has done something improper.

As used in agency, estoppel involves:

1.) Acts or omissions (generally wrongful) by the

principal, either intentional or negligent, which

creates an appearance of authority in the

purported agent.

2.) The third party reasonably, and in good faith,

acts in reliance on the appearance of authority.

3.) The third party changes her position in reliance

upon that appearance of authority.

Difference between between ESTOPPEL and

APPARENT Authority:

1.) Estoppel requires that the third party

alter his or her position in reliance on the

purported authority.

There is no such requirement for apparent

authority.

2.) Apparent authority requires a

manifestation by the principal (directly or

indirectly) to the principal.

Page 6: Acing Business Organizations (Book Outline)

No such manifestation is required for

estoppel, merely some culpable act or

omission by the principal.

Estoppel might arise when the principal

takes some improper action. Yet, the

improper action is not sufficient to amount

to a manifestation to the third party.

o Inherent Agency power:

This is a term used by the restatement of Agency to

indicate the power of an agent which is derived not 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 or other

agent. (Statute bk, 2)

Agent’s Liability for Contracts

Liability of--Undisclosed Principal: (P.22/29)

o Definition--A principal is undisclosed when the principal

authorizes an agent to act on the principal’s behalf with

respect to third parties, but the principal is undisclosed and

the third party is unaware that the principal exists.

Agent acts with authority:

If the agent acts with the principal’s actual,

express or implied, authority, then the principal

is bound.

There can be no apparent authority with an

undisclosed principal, because an undisclosed

principal by definition cannot have made a

manifestation to the third party.

Page 7: Acing Business Organizations (Book Outline)

These situations are covered under the concept of

liability of an undisclosed principal (was formerly

known as “inherent agency”).

Under this concept the law will sometimes

hold an undisclosed principal liable for

certain unauthorized transactions of his

agent when a third party has made a

detrimental change in position, if the

principal had notice of the agent’s conduct

and that it might induce third parties to

change their positions, and the principal did

not take reasonable steps to notify the third

parties of the facts. (Third Restatement

Agency § 2.06)—P.23

Liability of Partially Principal for Contract :

o A partially disclosed principal exists when an agent tells a

third party that the agent is acting on behalf of a principal,

but the identity of the principal is not disclosed. (P.30)

Liability of Agent for Contract:

o General Rule-- An agent is not liable as a party to the

contracts that the agent enters into on behalf of a disclosed

principal.

o There are two situations when an agent will be treated

as a party to a contract:

1.) Agent is acting on behalf of an undisclosed

principal; OR

Page 8: Acing Business Organizations (Book Outline)

2.) Agent is action on behalf of a partially disclosed

principal (i.e. unidentified principal).

o In both instances, the agent is bound by the agreement

at the election of the third party. The third party may

choose to sue the authorized agent OR principal.

UNLESS the parties specifically agree that the agent

will not be bound OR the original agreement provides

that, upon identification of the principal, the agent will

no longer be bound.

o However, in most situations in which the agent would

be found liable under an agreement the agent would

have a claim for indemnification provided that the agent

acted with P’s authority and did not cause the breach of the

agreement. (P.30)

EXAM APPROACH (Questions to Ask): (P. 28-29)

1.) Did Principal give Actual Authority to the Agent (*either express

or implied)?

2.) Did the principal make some manifestation to the third party

creating Apparent Authority?

3.) Was the Principal undisclosed, creating liability of an undisclosed

principal (formerly Inherent Agency Power (IAP))?

4.) Did the Principal ratify the contract?

5.) Is Estoppel an issue?

o Did P do something wrong or fail to do something, that

created an impression with the third party?

Page 9: Acing Business Organizations (Book Outline)

o Did the third party rely and alter his or her position to his or

her detriment?

Agency Problems Involving Torts:

1.) First determine whether an employee/employer

relationship existed.

o Asses whether the principal had the right to exert control

over the manner and the means by which the agent

performed his duty.

It is not just the actual exercise of control that is critical.

It is also the right to exercise control that is evaluated.

Factors involved in assessing P’s right to exert control

over A:

1.) Extent of control that the agent and principal

have agreed the principal may exercise over the

details of the work.

2.) Whether A is engaged in a distinct occupation

or business

3.) Whether type of work done by agent is

customarily done under P’s direction or without

P’s supervision.

4.) The skill required in A’s occupation

5.) Who supplies the tools or instrumentalities

required for work and place to perform work?

6.) Length of time A is engaged by P

7.) Whether A is paid by the job or by time worked

8.) Whether P and A believe they are creating an

employment relationship; AND

9.) Whether the principal is or is not in business.

Page 10: Acing Business Organizations (Book Outline)

Employee vs. Independent Contractor :

Under the doctrine of Respondeat Superior, P is

responsible for the torts committed by its

employee within the course and scope of

employee’s employment. Generally, P is not

responsible for the torts of their independent

contractors.

Non-Employee Agents and independent

contractors: It is possible to have an agency

relationship in which the agent is not an employee.

The Third Restatement refers to some individuals

as non-employee agents. Other sources still use

the term independent contractors

Rule:

When a fact pattern involves an

independent contractor OR a non-employee

agent, if the tort occurs over an area which

the principal exercises some control, the

principal might still be liable. (SEE Fiona

example on p. 15)

EXCEPTIONS to independent contractor rule:

There are certain situations in which a principal is

still liable for the torts of an agent who Is not an

employee and over whom the principal exercises

no control. Those situations are:

1.) Inherently dangerous activities—any

activity likely to cause harm or damage

unless some precautions are taken.

Page 11: Acing Business Organizations (Book Outline)

2.) Non-delegable duties—a duty that a

person may not avoid by the mere

delegation of the task to another person.

The hiring of the agent to perform the task

will not discharge or transfer the principal’s

responsibility or liability.

3.)Negligent hiring—this is not about

vicarious liability. Rather, it is direct

negligence. Liability is based on the

principal’s negligence in hiring the

independent contractor, not on attributing

responsibility for the tortuous act to an

independent contractor or to an innocent

principal.

2.) Was Agent/employee acting within Scope of

employment?:

o Intentional Torts:

Principals/employers are not liable for the intentional

torts of their agents/employees.

Exception:

However, when the employer’s job is such

that some part of the intentional tort might

be characterized as being done with the

intent of serving the employer P will be

liable.

o Ex. Club bouncer who ejects patron

from the club.

o Frolic & Detour:

1.) Frolic—when an agent leaves employment to do

something for personal reasons.

Page 12: Acing Business Organizations (Book Outline)

2.) Detour—If an employee is still engaged in

employment but strays only slightly from the direct

assignment, that is known as a mere “detour.”

Ex. An agent who is driving to the bank to deposit

money for the store which employs him and takes

a longer route so he can drive by the new

sculpture in the park is on a detour.

If he gets in an accident while driving by

the sculpture, the employer will still be

liable.

3.) Apparent Agency: (P.16-19)

o Apparent agency arises in situations in which the person

committing the tort is not an employee , or perhaps not even

the agent, of the principal.

Under the traditional agency analysis, P would not be

liable for the alleged agent’s tort. However, if there are

circumstances which led the injured third-party to

reasonably believe that an employment or agency

relationship existed between the P and alleged A and

those circumstances existed because of some action or

inaction on the part of P, then P might still be liable

under the theory of apparent agency.

Many courts (but not all) require proof that if the

alleged agent was under the control of P, then P

would or could have exercised control to avoid the

tort which took place.

REMEMBER:

o The Agent is always liable for his own negligence.

Page 13: Acing Business Organizations (Book Outline)

o Also, the principal always responsible for his or her own

negligence (in such an situation the doctrine of respondeat

superior does not ably).

EXAM APPROACH—TORT (Questions to ask):

1.) Is there an Employee—Employer relationship?

2.) If the agent is an employee, did the tort occur within the scope

of the employment or was it clearly outside the scope (frolic or

detour)?

3.) Even if there is NO Employee/Employer relationship—is there

sufficient control to create a “non-employee agent,” and if so, did

the tort occur within the scope of that control?

4.) Even if there is no control exercised over agent, does the event

fall into an exception such as an: i.) inherently dangerous activity,

ii.) a non-delegable duty, OR iii.) negligent hiring?

5.) If there is no liability for the Principal under a control analysis, is

there a claim for Apparent Agency because the third party

reasonably relied on the appearance of the agency and was harmed

as a result of the reliance?

Rights and Responsibilities: (P.32-33)

Agent—The agent has certain duties and obligations to P. The

agent’s knowledge is imputed to P.

o 1.) Duty of care, competence, and diligence

o 2.) Duty of loyalty

o 3.) Duty not to acquire material benefits arising out of the

agency

Page 14: Acing Business Organizations (Book Outline)

o 4.) Duty not to act as (or on behalf of) an adverse party

o 5.) Duty not to Compete

o 6.) Duty not to use the principal’s property

o 7.) Duty not to use confidential information

o 8.) Duty of good conduct

o 9.) Duty to provide information

NOTE :

o While some of these duties may be waived by the principal,

such a waiver requires that the principal ne fully informed and

that the agent still act in good faith and still deal fairly with

the principal. (P.33)

Principal—The principal has certain duties and obligations to the

agent. (P.34)

o 1.) Duty to indemnify

o 2.) Duty of good faith and fair dealing

Page 15: Acing Business Organizations (Book Outline)

Partnership

Background:

Partnerships are generally governed by state law. Most states have

adopted some version of the Uniform Partnership Act (1997) (RUPA

—which stands for the “revised Uniform Partnership Act”). The

codified versions of RUPA are known as the default rules, because

the apply if the partnership is not governed by an agreement or if

the partnership agreement does not cover a particular area.

Although most provisions of RUPA can be modified by an agreement

there are some that cannot.(See P. 41)

NOTE —No formal partnership agreement is needed, but it is

recommended.

Types of Partnership

1.) General Partnership (Outline based on general partnerships)

2.) Limited Liability Partnerships

3.) Limited Liability Companies

Partnership

A partnership is :

o 1.) An association of two or more persons

o 2.) To carry on as co-owners of a business

o 3.) For profit.

Attributes Associated with a Partnership:

Page 16: Acing Business Organizations (Book Outline)

1.) Each partner is jointly and severally liable for the debts of the

partnership

2.) Each partner has the ability to participate in the control and

management of the partnership.

o Under the Uniform Partnership Act (1997) (RUPA)—Each

partner is entitled to at least one vote regardless of how much

capital he or she contributed.

3.) In a partnership profits are shared equally. So, when a

partnership is dissolved, the money is divided up among the

partners.

4.) TAX—Partnerships are not taxed on their income.

5.) Partners owe each others owe each other the highest level of

fiduciary duty.

Partnership by Estoppel

There are instances, even if someone is not a partner in a

partnership, where he or she might still be responsible for the debts

of the partnership.

o Ex.

In a partnership by estoppel, if A, B, and C are partners,

and X Is not a partner, X still can be held liable as a

partner IF X allows the partners to act in a way that

third parties reasonably believe X to be a partner. (P.41)

Page 17: Acing Business Organizations (Book Outline)

To be liable under this theory, X must make some

manifestation which creates an impression,

allowing others outside the partnership to

reasonably believe that X is a partner; AND the

third party claiming partnership by estoppel must

rely on that impression to his or her detriment.

(P.42)

Partnership by Estoppel requires: (P.42)

o 1.) Actual reliance—

o 2.) Reliance must be reasonable—

o 3.) Some manifestation (by the alleged partner)—

Difference between Partnership by Estoppel and Apparent

Authority:

o

Fiduciary Obligations of Partners –(“The punctilio of an honor most

sensitive”):

1.) Partnership Duty of Loyalty:

2.)

o

Page 18: Acing Business Organizations (Book Outline)

CORPORATIONS

CORPORATIONS

Background:

Corporations are a method of doing business. It enables promoters to do

business through them. The corporation is the one doing the business. The

law treats corporations as legal persons as opposed to natural persons.

There are articles of corporation filed with the secretary of state (the

date they are filed that is the corps birth date)

By-Laws: There are set of rules for running the corp.

When the corporation wants to conduct business, natural persons

that are in charge of its affairs natural persons have to conduct

meetings.

A record of those meetings are called MINUTES.

The agreements (resolutions) made in the meetings are called RESOLUTION.

A Corp. can own shares in another corp.

Shareholders—are the owners of the corporation. They provide the capital

to the corp. and receive corps. Residual net profits (after creditors are paid).

The shares are evidenced by stock certificates. You keep a certified copy in

the corporate notebook and the original in a safety deposit box.

Shareholders are required to meet once a year. In that meeting one of their

primary functions is to elect a board of directors and consent to any changes

to any organizational fundamental issues (i.e. changes in articles of

incorporation)

Page 19: Acing Business Organizations (Book Outline)

Board of directors (highest level of fiduciary duty to the corp.)—is a high

position of power in corp. They have the exclusive power to manage the

corporations business. They determine if and when dividends are paid.

They are not required to contribute any money to corp. or share in losses.

They are the guardians of the corporation.

They do not get to share in the profits of the crop. as a member of the board

of directors. However, they can be compensated or not as part of the board

of directors.

Note: A shareholder could also be on the board of directors.

Board of directors elect the officers of the corporation. The officers work day

to day in the corporation. Its their job. They are responsible for carrying in

day to day business (9 to 5 job)

Example:

President, VP, secretary, CEO, CFO,

They are fiduciaries of the corporation

Dejure corportaion—A straightforward corp. formed by filing articles of

incorp. With secretary of state.

Corp. by Estoppel

Third party seeking to avoid a contract.

Elements:

1.) The court treats a firm that is not incorporated as if it were

2.) if a third person regarded them as such

3.) and third person would gain a windfall if they court now failed to

recognize the firm as a corp.

Benefits:

Allows individuals to take risks shielding them from personal liability (or

limited liability). This is the hallmark of doing business as a corporation.

Allows individuals to take risks in commerce. Allows more people to take

risks and develop business.

Page 20: Acing Business Organizations (Book Outline)

Defacto Corp

Elements:

1.) Promoters tried to incorporate in good faith

2.) had legal right to do so

3.) AND acted as a corporation.

Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc.

Corporation by Estoppel

Facts:

Plaintiff, Southern-Gulf Marine Co. No. 9, Inc., contracted with Defendant,

Camcraft, Inc., to buy a supply vessel from Defendant. Defendant refused to

comply with the agreement, arguing that the contract was invalid because

Plaintiff was not incorporated in Texas as the initial agreement stated.

Enterprise Liability

involves a bunch of different corporation. The plaintiff wants to include all of

the assets of each of the separate corporation that are operating in a single

enterprise. The plaintiff wants to pool the assets of the corporation in order

to pay for damages suffered.

Walkovszky v. Carlton

Piercing the Corporate Veil

Page 21: Acing Business Organizations (Book Outline)

Sea-Land Services, Inc. v. Pepper Source

Piercing the Corporate Veil:

General Rule :

o Generally, the owners of a corporation, as well as the

directors and officers can not be held personally liable for the

obligations of the corporation.

Exception :

o However, in some circumstances, even though a corporation

has been validly formed, the courts will hold the shareholders,

officers, or directors personally liable for the corporations

obligations to avoid fraud or in justice.

Van Dorn test—2 PRONG TEST (for Piercing the Corporate

vail) (P. 213-14)

o A corporate entity will be disregarded and the veil of the

limited liability pierced when two requirements are met:

PRONG (1.) there must be such unity of interest and

ownership that the separate personalities of the

corporation and the individual [or other corporation] no

longer exist;

Four Factors —to determine whether a

corporation is controlled by another to justify

disregarding their separate identities:

i. the failure to maintain adequate corporate

records or to comply with corporate

formalities;

Page 22: Acing Business Organizations (Book Outline)

ii. The comingling of funds or assets;

Iii. Undercapitalization; AND

Iv. One corporation treating the assets of

another corporation as its own.

PRONG (2.) circumstances must be such that

adherence to the fiction of separate corporate existence

would sanction a fraud or promote injustice.

Board of Directors (Control):

The Board of Directors are in charge of managing the corporation.

The Board of Directors hold office until the next annual meeting

unless the Articles of Incorporation states otherwise.

They can delegate duties relating to management to Officers who

are employees of the corporation.

The Board of Directors is vicariously liable for the actions of the

officers.

The Board of Directors selects the employee/officers and

determines how much salary they will make.

If a shareholder is not an employee, then the shareholder will only

receive money through dividends.

The Board of Directors determines how much, if any dividends will

be paid.

There decisions are limited by fiduciary duties, but they their

decisions are also protected by the business judgment rule.

Shareholder Control-- Voting Rights: (Acing 141-143)

Page 23: Acing Business Organizations (Book Outline)

Shareholders control the corporation indirectly to some extent by

their voting rights.

The right to vote is held by the shareholder of record on the stock

transfer book as of the day the book is closed on record day. (Flem.

10)

o Shareholders have the right to vote:

1.) for the election and removal of directors (with or

without cause at anytime)

2.)to adopt, amend or appeal laws

3.) shareholders must approve “fundamental corporate

changes.” (Flem. 10/Barbri 20)

Shareholders may vote in their own self-interest whereas directors

are bound by their fiduciary duties and must act based upon their

good faith determination of what is best for the corporation and all

the shareholders.

Voting Trusts

o A device whereby two or more shareholders place their shares

in trust. The trust has a trustee who is responsible for voting

the shares.

o The trust is typically governed by a trust agreement, which

determines how long the trust will last and how many shares

will be voted.

Typically voting trust are limited to 10 years in most

states.

o Benefits:

Page 24: Acing Business Organizations (Book Outline)

There is little question about enforcement , since

trustee holds and votes the shares.

They avoid problems of deadlocks among shareholders.

o Disadvantages:

Shareholders might be uncomfortable with turning over

possession of their shares to a trustee and the loss of

control that accompanies relinquishing possession.

Vote Pooling Agreement

o An agreement between or among, two or more shareholders

which states that the parties’ shares will be voted in a certain

way, based upon some criteria.

Vote pooling agreements are very flexible. They

can be used in a variety of situations, for example:

It may cover all shareholder votes or only certain

votes such as the election of directors;

It may be for an unlimited period of time or a

defined period;

It may cover a portion of a shareholder’s shares or

all of their shares (e.g. John will vote 60% of his

shares pursuant to a Vote pooling Agreement with

Sally, but he may vote the other 40% as he

chooses); and

It may delegate control to an individual who has a

relatively small ownership percentage.

Page 25: Acing Business Organizations (Book Outline)

There is no requirement that the person

who controls the shares under a Vote

Pooling Agreement and that person’s

relative percentage of ownership in the

corporation correlate.

Shareholder Agreements

o Shareholder Agreements deal with a wide variety of matters.

(See Acing 143)

Limitation on Shareholder Voting Agreements :

o General Rule

Shareholders may agree on how they will act as

shareholders (i.e. they may agree that they will elect

each other onto the board of Directors),

But they MAY NOT :

agree on how the directors they elect will

act (because directors have fiduciary

duties); OR

agree that once they are on the Board of

Directors they will elect each other as

officers. (Acing 145)

o Exceptions :

Shareholders can agree on how they will vote as

directors IF:

1.) the agreement is signed by ALL the

shareholders (shareholder unanimity exception)

Page 26: Acing Business Organizations (Book Outline)

OR

2.) In some states, even if the all the share-

holders are not parties to the agreement, the

agreement is still enforceable provided that:

a.) the shares of the corporation are

closely held;

b.) the minority shareholders (i.e. they

were not a party to the agreement) do not

object (or cannot object); AND

c.) the agreement is reasonable.

Proxies: (Acing Biz Org--P.126--138)

A shareholder may vote his shares either in person OR by proxy

executed in writing by the shareholder OR his attorney in fact.

o A proxy is valid for only 11 months UNLESS it provides

otherwise. (Barbri, 22)

Proxies are subject to federal control under the Securities Exchange

Act of 1934. (Barbri, 22)

A. Proxy

Often a shareholder is not able to attend a meeting but would still

like to vote on a matter. In these instances, the shareholder may

give a proxy to someone else to vote that shareholder’s shares.

o A proxy is a written (or electronic) document which is given to

someone else, allowing them to vote on a person’s behalf.

(Acing, 126)

Page 27: Acing Business Organizations (Book Outline)

It is a power of attorney given by the shareholder to

someone else to exercise the voting rights attached to

his shares. (Flem. 11)

o Proxies may give the holder discretion or no discretion in that

they may provide specific instructions on how the shares are

to be voted, or they may leave the discretion of how to vote

to the proxy holder.

Importance of Proxies :

o Proxies are often important because in order to have a

meeting of the shareholders of the corporation a quorum is

required.

A quorum is a minimum number of people, voters, or

votes (in this case shareholders), who must be present

at a meeting in order to make the meeting valid.

Without the use of proxies a corp’s shareholders would

be unable to vote because the quorum requirements

would not be met.

[quorum requirements are usually established by

statute, but may be modified subject to statutory

limitations).]

A typical quorum requirement for shareholder vote

would be 50% of votes, plus one. Because shareholders

vote based upon percentages, it is the number of shares

that is relevant and not the number of shareholders.

Ex.

If a corporation has $5,000 shares issued

and an outstanding, 2,502 shares would be

required to be represented at a meeting in

order to have a quorum.

Revocability of Proxy : (Barbri, 23)

Page 28: Acing Business Organizations (Book Outline)

o An appointment of a proxy generally is REVOCABLE by a

shareholder and may be revoked in a number of ways.

Ex.

In writing

By the shareholder showing up to vote himself,

OR

By later appointment of another proxy.

o A proxy will be IRREVOCABLE only if:

the appointment form CONSPICIOUSLY states that it is

irrevocable; AND

the appointment is coupled with an interest

Ex.

A pledgee;

A person who purchased OR agreed to

purchase the shares;

A creditor of the corporation who extended

credit to the corp. under terms requiring

appointment;

An employee of the corp. whose

employment contract requires the

appointment; OR

A party to a voting agreement.

o The proxy may be “irrevocable” for as long as the interest

lasts. (Acing 144)

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o Death or Incapacity of Shareholder—appointing a proxy

does not affect the right of the corporation to accept the

authority of the proxy holder

UNLESS :

the corporate officer authorized to tabulate votes

receives written notice of the death or incapacity

prior to the time proxy holder exercises her

authority under the appointment. (Barbri, 23)

B. Proxy Holder

The person who is give the authority is called the proxy holder and

he becomes the shareholder’s agent to vote the shares in question.

(Flem. 11)

C. Solicitation of Proxies

Several rules in Regulation 14A, adopted under the SEC Act of 1934

govern the entire proxy process, regulating the manner and means

by which proxies may be obtained or solicited.

Prior to the time that any person makes a “solicitation,” the

person being solicited must 1st receive or/ have received a “Proxy

statement.” (SEC Rule 14a-3).

o Solicitation includes : (Acing 127)

Any request for a proxy

Any request to execute OR not to execute, OR to revoke

a proxy; and

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Furnishing of a form or proxy or other communication,

reasonably calculated to result in the procurement,

withholding, or revocation of a proxy (See. Long Island

Lighting Co. v. Barbash)

Solicitation does not include : (Acing 128)

Public statements or speeches or advertisements

stating how a shareholder intends to vote AND the

reasoning behind the vote;

Solicitations by someone (other than an affiliate of

the corporation OR a party in interest) who does

not intend to act on another’s behalf;

Any solicitation made to 10 or fewer persons,

provided it is not made by the corporation; AND

Advice to any person with whom the person

furnishing the advice has a business relationship.

D. Proxy Fights

A proxy fight—is a battle to obtain control of a corporation through

a vote of the shareholders.

o Insurgent group—the group who wants to gain control and

oust existing management.

They attempt to gain control by soliciting proxies from a

large enough number of shareholders to elect its own

representatives to the Board of Directors.

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Access to shareholders--Rule 14a-7 (SEC Act 1934)

provides that when an insurgent group wants to contact

shareholders and provide materials related to the

contested vote, EITHER:

1.) management may mail the insurgent group’s

material to the shareholders directly and charge

the group for cost;

OR

2.) management can give the insurgent group a

copy of the shareholder list and let the insurgent

group distribute its own materials (this option is

generally disfavored by management. (Acing 129)

o Incumbent group—the existing management

E. Reimbursement for Costs Associated with Obtaining Proxies:

Once the proxy battle is over and one side has won and the other

has lost, the parties often turns to the issue of reimbursement.

Incumbent directors/management can use corporate funds

to defend corporate policy (i.e. by waging proxy campaigns)

as long the expenses are not excessive or illegal AND the

shareholders are fully informed.

o The rules of reimbursement are the following:

1.) The corporation MAY NOT reimburse either

party, UNLESS the dispute involves a question of

corporate policy.

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The dispute cannot be personal—i.e. an

argument that one group is better than the other.

NOTE—because of this rule most proxy

battles are presented as matters involving

“policy disputes.”

2.) The corporation may ONLY reimburse

reasonable and proper expenses.

3.) The corporation may reimburse the

incumbents whether; AND

4.) The corporation may reimburse insurgents

only if they win AND the corporation’s

shareholders ratify the reimbursement, after full

disclosure.

Shareholder Proposals—(Shareholders’ rights to include their proposals in

Proxy statements)—(SEC Rule 14a-8):

Issue—The biggest question that arises in this area is

o What needs to be satisfied in order for a shareholder proposal

to “qualify” to be included in the proxy statement? (Acing

130)

The proposals must relate to certain areas over which the

shareholders have control.

o In order to satisfy the requirement that a proposal be within

an area which is a proper subject for action by the

shareholders, most proposals are worded as

recommendations, rather than mandates and are nonbinding

in nature.

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Shareholder proposals have both procedural and substantive

requirements they must meet.

o Procedural requirements (to be eligible to submit a

proposal):

A shareholder must hold $2,000 in market value of the

company’s stock, and have held it continuously, for the

12 months preceding the proposal;

A shareholder may not submit more than one proposal

for each shareholder’s meeting;

A proposal may not exceed 500 words

Most proposals must be submitted to the company at

least 120 days before the company’s proxy statement is

released; AND

Either the shareholder or shareholder’s “qualified

representative” must attend the meeting at which the

proposal is to be considered.

o Substantive Requirements (if these requirements are

not met the proposal will be EXCLUDED):

The topic must be the proper subject for actions by

shareholders under state law;

The proposal may not cause the company to violate any

law;

The proposal may not address personal grievance or

special interest which is not applicable to other

shareholders;

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If the proposal relates to the company’s operations,

those operations must involve at least 5% of the

company’s assets, net earnings or gross sales OR the

operations must otherwise be significantly related to the

company’s business;

Proxy can not violate proxy rules by including material

misleading statements;

The proposal may not be beyond the company’s power

to implement;

The proposal may not address management functions

such as the company’s ordinary business operations;

The proposal may not relate to specific amounts of cash

or stock dividends; and

The proposal may not directly conflict with one of the

company’s own proposals, being submitted at the same

meeting.

In addition, the proposal can be excluded by company if

it was previously submitted within the last 5yrs and did

not receive the require percentage of votes. (Acing,

132)

Shareholder Inspection Rights

Right to shareholder lists :

o Shareholders have an unqualified right to obtain a list of other

shareholders and their addresses.

Right to inspection of corporate records :

Page 35: Acing Business Organizations (Book Outline)

o Shareholders have a right to inspect corporate books and

records IF Shareholder has a proper (or legitimate)

business purpose.

Ex—Proper purpose:

Shareholder wants to solicit support (consistent

with proxy rules) for a shareholder proposal.

Effort to gain control of corporation an effort to

gain a shareholder list for someone else trying to

gain control of the corporation

Effort to investigate alleged corporate

mismanagement or malfeasance

Effort to gather information to asses the value of

one’s shares; and

An effort to communicate with other shareholders

in connection with a proxy fight or a shareholder

proposal. (Acing P.133-1334)

Improper purpose:

Finding potential customers for a personal

business venture;

Persuading the corporation to adopt one’s social

or political concerns, (irrespective of any

economic benefit to the shareholders of the

corporation)—See State Ex Rel. Pillsbury v.

Honeywell, inc.

To institute a suit without substantive basis

Page 36: Acing Business Organizations (Book Outline)

Seeking proprietary information (i.e. trade secrets

or other intellectual property); and

Seeking information to aid a competitor of the

corporation.

Closely Held Corporation & Public Company

Public company

o In a public company the stock is often owned by thousands

of shareholders, most of whom do not know each other.

o The stock of the corporation (or at least one class of

stock) has been registered with the SEC and may be

bought or sold on one of the public exchanges (i.e. the

New York Stock Exchange or NASDQ).

o Battles for control—In public companies battles for control can

take the form of proxy fights or tender offers.

Closely held Corporation

o A closely held corporation’s stock is typically held by a

relative few number of shareholders.

o Its shares are not publically traded and sales of stock

take place in private transactions, typically requiring an

exemption from the registration requirements of the 1933

Act.

Page 37: Acing Business Organizations (Book Outline)

o Closely held corporations are often also called “private

companies and often have shareholders who also serve

on the Board of Directors and hold positions as officers

as well.

o Battles for control—the struggle for control often focuses on a

shareholder’s ability to control votes, often through

agreements or structure of the business.

FREEZE-OUTS: (Acing 110/148-155)—

Ask Prof about the Delaware (Majority rule) and Massachusettes rule

(Minority rule)

A freeze out involves a situation in which a minority shareholder is

blocked from holding a paid position with the corporation (i.e.

position as an officer or employee), by the majority.

o It is not just the actions or circumstances that are relevant in

evaluating a “freeze out,” but also the intent behind the

actions and the circumstances.

o Freeze outs are not always actionable—A shareholder who

owns a minority position in a corporation must know that

being frozen out is a possibility--based on the mathematical

realities of the situations.

o Ex. Of an unlawful freeze out:

Dominant shareholder pays herself a salary well in

excess of a reasonable salary leaving no funds to

distribute to the minority shareholders.

Dominant shareholder (Acing 110-115,120)

Page 38: Acing Business Organizations (Book Outline)

o Generally, shareholders do not owe each other fiduciary

duties to other shareholders.

o However, because a dominant shareholder has more influence

over the corporation and over the Board of Directors, there

are certain instances when dominant shareholders are bound

by certain fiduciary duties. In these instances only certain

“duty of loyalty” transactions are implicated.

In the instance of a dominant shareholder the board is

not allowed to “cleanse” the transaction and ratification

by disinterested shareholders just shifts the burden of

proof to PL. (Acing 111).

o Determining whether a shareholder is dominant?

Question to ask—whether the holdings of a particular

shareholder is enough to exert control, over the

corporation.

Ex. If one shareholder has 25% of corp. stock and

all other shareholders each hold 1% (or less), then

the shareholder with 25% might very well be

dominant. (Acing 112)

NOTE—A group of shareholders acting together , might

also be considered to be a dominant shareholder.

o “Freeze-Outs”--Partnership Like Analysis (Wilkes case)

—(Acing 152)

Shareholders in closely held corporations owe each

other a duty of good faith.

In a freeze out, the majority, or controlling group must

have a “legitimate business purpose” for its action, and,

Page 39: Acing Business Organizations (Book Outline)

even if there is a legitimate business purpose, the

minority shareholder will still have the opportunity to

show that the “same legitimate objective could have

been achieved through an alternative course of action

less harmful to the minority interest.

RULE 10b-5

Who can use it?

o Rule 10b-5 can be used by the SEC and by private individuals

in pursuing fraud claims.

Purpose of the Rule:

o It creates liability for anyone who makes misleading

representations or omission that is connected to the purchase

and sale of a security.

o Rule 10b-5 is also used to restrict insider trading. In fact the

rule’s greatest impact is to prohibit instances of trading

securities on the basis of inside information.

o The rule is not about correcting every wrong, it is about full

disclosure. Once full and fair disclosure is made, the fairness

of the transaction is not an issue under federal law.

Rule statement :

o Under rule 10b-5, it is 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 in connection with the purchase

of any security to:

1.) employ any device , scheme, or artifice to

defraud;

Page 40: Acing Business Organizations (Book Outline)

2.) Make any untrue statement of a material fact

or 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; OR

3.) Engage in any cat, practice, or course of business

that operates or would operate as a fraud or

deceit upon any person,

o in connection with the purchase of any security. A

violation of the rule can result in a private suit for damages,

an SEC suit for injunctive relief , or criminal prosecution.

If Plaintiff is a Private Person : To recover damages under rule

10b-5 a private plaintive must show: (Barbri 60-62)

o 1.) Fraudulent conduct:

PL must show DF engaged in some fraudulent conduct

by either:

making a material misstatement OR

making a material omission

o 2.)Materiality:

A statement will be considered material if there is a

substantial likelihood that a reasonable investor would

consider it important in making her investment decision.

No bright line test exists, but a plaintiff need not

prove that the information us statistically

significant or valid.

Page 41: Acing Business Organizations (Book Outline)

o 3.) Scienter:

The conduct complained of must have been undertaken

with an intent to deceive, manipulate, or defraud.

The Supreme Court has held that statements

made knowingly suffice, but negligence alone

does not suffice. However, some courts have held

that “deliberate recklessness” does suffice.

o 4.) in connection with Plaintiff’s Purchase or Sale of a

Security:

The fraudulent conduct must be in connection with the

purchase or sale of a security by the plaintiff.

The term “in connection” is interpreted broadly.

The term INCLUDES transactions such as

exchanges of stock assets, mergers,

contracts to sell, etc.

It EXCLUDES potential purchasers who did

not buy (because of the fraud) and people

who already own shares and refrain from

selling (because of the fraud).

Rule 10b-5 applies to ANY security, in both a

public corporation and closely held corporation.

(Acing 175)

The focus is on a sale or purchase by the plaintiff.

The defendant need not have purchased or sold

any securities.

Page 42: Acing Business Organizations (Book Outline)

E.g. A nontrading DF, such as a company

that intentionally publishes a misleading

press release, can be held liable to a person

who purchased or sold securities on the

market on the basis of the press release.

NOTE—Distinction between private PL and

Gov.:

A private plaintiff can not bring an action

based on DF’s status as an “aider and

abettor” of other defendants’ fraud.

However, the government may base an

action on aiding and abetting.

o 5.) Interstate commerce:

The fraudulent conduct must involve some means of

interstate commerce.

E.g. Use of a telephone OR mail will suffice.

o 6.) Reliance:

If a plaintiff brings a private action, there must be a

showing that he or she actually AND justifiably relied on

the defendant’s misrepresentation.

OMMISSIONS : In the case of an omission reliance is

presumed.

There are some cases in which a company or an

officer of the company has a duty to speak but do

not, in such cases, the company’s failure to speak

is considered an omission.

Rationale:

Page 43: Acing Business Organizations (Book Outline)

o Given the duty to disclose, a person is

entitled to rely that appropriate

disclosures will be made. In effect,

they can rely that on silence as a

statement that there are no material

information that the company is

required to disclose , which has not

been disclosed. (Acing 180)

FRAUD ON THE MAKET THEORY : Under the fraud

on the market theory, in a misrepresentation

action on securities sold in a well defined market

(e.g. the national stock exchange), reliance on

any public misrepresentations may be presumed.

(Barbri, 62)

This theory is generally applied in instances

involving a misrepresentation (usually

involving a large group of people), which

involve an affirmative statement (NOT an

omission), in which plaintiff cannot show

that they each relied on the statement.

(Acing 180)

o The fraud on the market theory was

developed as a way to show how a

large group of people could have

relied on a misstatement.

The fraud on the market theory creates a

rebuttable presumption that, even if the plaintiff

did not hear the misstatement, there was still

reliance. (Acing 180)

Page 44: Acing Business Organizations (Book Outline)

The theory creates a presumption that the

investor relied on the integrity of the market

price and so the investor does not even

need to have seen or heard the

misrepresentation to satisfy the reliance

element.

If DF wanted to avoid liability, DF would need to

rebut the theory by showing that the

misrepresentation: 1.) did NOT affect the market

price; 2.) DF issued corrective statements which

were also priced into the market; 3.) PLs would

have bought OR sold anyway, even with full

disclosure; OR 4.) DF did not rely on the integrity

of the market.

Fraud on the ONLY works when there is an

efficient market, It does NOT apply in private

transactions.

o 7.) Causation:

The plaintiff has to show that statement caused the

loss.

It is not enough to show that the

misrepresentation caused the transaction.

The plaintiff needs to show that the

misrepresentation caused the lass itself.

(Acing 181)

o 8.) Damages:

Plaintiff must be able to show injury/damages.

Damages in a 10b-5 may take the form of:

Page 45: Acing Business Organizations (Book Outline)

Actual damages:

o Difference between the price actually

paid/or received AND the price that

should have been paid without the

10b-5 violation.

consequential damages

Punitive damages (in extreme cases)

Note —Private plaintiffs have to prove two additional

elements (Reliance & damages)—ASK PROF!!!

INSIDER TRADING--Rule 10(b)(5)-1

o Insider trading involves a very specific trade under 10b-5 in

which someone “deceives” by omission. The “omission” is

that the person is in possession of information, which if

known, would impact the price of the security. The securities

laws try to prevent theses situations by restricting the ability

of someone in possession of such information to use it to

profit from trading.

o A person violates rule 10b-5 if by trading, he or she breaches

a duty of trust and confidence owed to: 1.) the issuer; 2.)

shareholders of the issuer; 3.) or in the case of

misappropriators. (Barbri 62)

o There is NO requirement of reliance or causation, ONLY

scienter and materiality. (Acing 192).

o Insider trading falls into two categories Traditional insider

Trading and Misappropriation. (Acing 192).

o RULE STATEMENT :

Page 46: Acing Business Organizations (Book Outline)

Under 10(b)(5)-1, an individual is prohibited from

trading securities on the basis of inside

information. A person violates this section if by

trading, he or she breaches a duty of trust and

confidence owed to: (1) the issuer; (2) the

shareholders of the issuer; (3.) or in the case of

misappropriation.

Two different types of people can be liable for

insider trading—the insiders who have access to

the inside information and the people who give

and receive tips based on the inside information

(tippers and tippees).

Tippers:

Tippers are individuals who give tips of inside

information to someone else who trades on the

basis of such information.

Tippees:

A tippee is the individual that receives the inside

information from the tipper.

o Insiders :

An insider is anyone who by virtue of his /her position

with the company owe a duty of trust and confidence to

their corporation and breaches the duty by trading on

inside information for their personal benefit. (Barbri

62/Acing 191)

Ex. of Insiders : directors, officers, controlling

shareholders, and employees of the issuer, etc.

Ex. Constructive insider : (also owe duty of trust and

confidence):

Page 47: Acing Business Organizations (Book Outline)

A securities issuer’s CPA, attorneys, accountant,

underwriter, consultant bankers performing

services for the issuer, etc.

Tipper-Tippee Liability (Traditional Analysis—Prior to

O’Hagan case)

o IMPORTANT --The above analysis involves a typical;

situation in which an insider actually trades on that

information. However, individuals might also share inside

information with others.

o The insider trading rules limit the dissemination of material,

non-public information (“tipping”) by someone in possession

of information (“the tipper”) and prohibit the use of that

information by the recipient (“the tippee”). Also, tipper/tippee

liability must also be based upon breach of duty AND, with

regard to the tippee, knowledge of that breach of duty.

An insider is only liable for tipping if he or she violated a

fiduciary duty by providing the tip.

In this analysis, the law is only interested in the duty of

loyalty.

o Tipper Liability :

A tipper is laible if he or she:

1.) Discloses material, non-public

information to others (i.e. did he or she tip any

one?); AND

Page 48: Acing Business Organizations (Book Outline)

2.) that disclosure is made in breach of a

fiduciary duty of loyalty (OR in the case of a

tippee turned tipper with the knowledge that the

information was obtained as a result of breach of

a fiduciary duty of loyalty); AND

The existence of a breach is measured by

whether the tipper personally benefitted,

directly or indirectly, from the disclosure.

o A personal benefit is broadly defined.

It can include any consideration,

such as a monetary benefit, a

tip in exchange for a tip, an

enhanced reputation, or even a

gift.

o A personal benefit is not the desire to

do public good.

3.) Someone trades on that information.

o A tipper is liable if anyone along the

chain of information dissemination

trades on the information, not just the

tipper’s direct tippee.

NOTE ---The tipper is not liable f no “personal

benefit” is received OR if no one trades on the

information.

o Tippee’s Liability :

Page 49: Acing Business Organizations (Book Outline)

A tippee’s liability is based completely on the tipper’s

liability. If there is no breach of duty by the tipper, there

can be no liability. If the tipper has no liability, then the

tippee can not have liability.

The tippee can “inherit the tipper’s fiduciary

duty to the shareholders of the corporation not to

trade on material non-public, information ONLY

when:

1.) tippee receives material, non-public

information which was disclosed in

breach of a fiduciary duty by an insider

for the insiders personal benefit at the

company who’s stock is being/or will be

traded, AND

2.) the tippee knows OR should know,

that the tip was a breach of the

tipper’s duty;

o Ex. If insider provides a tip in

exchange for money , the tippee only

needs to know that the insider tipped

for money, not that tipping for money

constitutes a breach of fiduciary duty.

3.) the tippee trades on that

information;

OR

Provides the information to others (i.e.

tips and becomes a tipper), receives a

personal benefit for the tip and

someone trades on that information.

Page 50: Acing Business Organizations (Book Outline)

o NOTE—A person can be liable both as a tipper and a

tippee:

Any tippeee who knowingly receives material,

non-public information, arising out of an insider’s

breach of duty, can also be liable as a tipper if

that individual passes that information along to

others in exchange for a personal benefit.

o If by overhearing the inside information, the person realizes

(or should realize) that he or she is overhearing a breach of

duty, then they may not trade on the information.

o A tipper may protect its tippees from liability by not telling the

tippee the source of the information.

If the tippee does not know the source of the

information, the tippee can not know or have reason to

know of the breach.

Also, if the tippee truly did not know the source of the

information, the information might not be material.

MISAPPROPRIATION (Post—United States v. O’Hagan)

o Background:

Prior to the O’Hagan case, in order to find liability, one

needed to show that the defendant breached a duty (or

in the case tippee liability, that the information arose

out of a breach of duty) to the company in whose stock

the defendant had traded.

Page 51: Acing Business Organizations (Book Outline)

o The misappropriation theory broadens liability to

extend to those who breach a duty to the source of the

information.

Instead of asking about a breach of fiduciary duty to the

company, the misappropriation theory asks about

fiduciary duties to the source of the information and

about whether DF breached (or knew about breach of) a

duty arising out of the relationship of trust and

confidence to the source of the information.

o COMPLETE –RULE :

A person commits fraud in a securities

transaction when he or she “misappropriates”

material, non-public information in breach of a

duty (typically a duty of trust and confidence )

owed to the source of the information, AND does

not disclose his intentions to trade on that

information.

NOTE—

The breach of duty is NOT just a fiduciary

duty owed to the company whose stock is

being traded; rather a breach of duty owed

to the source of the information.

In traditional insider trading, if there is no

breach of duty by the insider, there can be

no violation by the tippee, but under

misappropriation a breach of duty can arise

at any point in the chain of information

dissemination. (Acing 202)

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o In evaluating whether there might be

misappropriation liability, one needs

to ask if anyone along the chain of

information dissemination breached a

fiduciary duty or a duty arising out of

a relationship of trust and confidence.

(Acing 190)

Since Rule 10b-5 requires some fraud or

deception under the misappropriation

theory the fraud or deception occurs when

the misappropriation deceives the source of

the information by letting the source believe

the information will be treated as

confidential.

As in the traditional insider trading, tippees

who do not trade, do not become liable,

UNLESS they become a “tipper” and acquire

tipper liability. (Acing 204)

o Short Exam Rule statement (for Misappropriation) :

Under 10(b)(5)—2, a person can be prosecuted by

the government for trading on market

information in breach of a duty of trust and

confidence owed to the source of the information.

Under a misappropriation theory, the duty need

not be to the shareholder.

o List of Circumstances under Rule 10(b)-5 under which

people will be deemed to owe a duty of trust and

confidence in a misappropriation case: (Non-exhaustive)

1.) when a person agrees to maintain information in

confidence

Page 53: Acing Business Organizations (Book Outline)

2.) the parties have a history of sharing confidences

3.) When the person receives the information from a

spouse, child, parent or sibling (unless person can prove

they had no reason to know the information was

confidential). (Acing 201)

RULE 14e—3 and Insider Trading Relating to Tender offers :

(Acing 205-207)

SECTION 16(b)—SHORT SWING PROFITS (This is a rigid rule-

it either applies or does not)

o The purpose of section 16(b) is to prevent unfair use of inside

information and internal manipulation of price. This is

accomplished by imposing strict liability for covered

transactions whether or not there is any material fact that

should or could have been disclosed –NO PROOF OF USE OF

INSIDE INFORMATION IS REQUIRED. (Barbri, 64)

o This rule DOES NOT APPLY to closely held corporations.

o This rule APPLIES TO publicly held corporations whose

shares are traded on a national exchange OR that have at

least 500 shareholders in any outstanding class and more

than $10 million in assets.

o RULE :

Page 54: Acing Business Organizations (Book Outline)

Section 16(b) of the Securities Exchange Act of

1934 provides that any profit realized by a

director, officer, or shareholder owning more

than 10% of the outstanding shares of the

corporation from any purchase and sale, or sale

and purchase, of any equity security of the

corporation within a period of less than six

months must be returned to the corporation.

(Barbri, 64)

o Elements :

1.) Purchase and Sale or Sale and purchase within

six months;

2.) Equity Security;

An equity security, is a security other than a pure

debt instrument, including options, warrants,

preferred stock, common stock, etc.

3.) Officer, Director, or More than Ten Percent

Shareholder;

Deputization of Director:

A person may deputize another person to

act as his representative on the board. In

these cases, securities transactions of the

principal will come within section 16(b).

4.) Profits realized

Includes not only traditional profits, but also

losses avoided.

Page 55: Acing Business Organizations (Book Outline)

SARBANES-OXLEY ACT of 2002 (“SOA”) —ASK PROF HOW

MUCH WE NEED TO KNOW!!

o The Act was an effort to increase disclosure by, and oversight

of, publicly traded companies in the wake of the Enron

scandal.

o Some of the requirements of the Act are:

1.) A publicly traded company’s president or CEO as

well as its Chief Financial Officer (aka Treasurer) must

sign its financial statements, verifying these officers

have each reviewed the statements, the statements are

accurate, and that the signatory takes responsibility for

what is in the statements.

2.) Public companies may not make personal loans to

their officers or directors and must adopt a “code of

ethics” for their respective CEOs and various financial

officers.

3.) SOA requires that attorneys who represent publicly

held companies report evidence of material violation of

the securities laws OR breach of fiduciary duty OR

similar violation by the company or any agent thereof…

to the company chief legal officer or CEO.

If proper action is not taken in response to such a

report, the attorney is then required to refer the

matter to a higher authority within the company.

For more information see--Acing 186/Barbri 66

MERGERS & ACQUISITIONS

Page 56: Acing Business Organizations (Book Outline)

o Merger:

A merger occurs when two companies come together to

form one company.

If one of the two original companies survives then the

process is called merger.

The term is used to describe any combination of firms.

o Consolidation:

If the combination results in a new company, then the

process is called a consolidation.

o There are three basic ways companies may combine:

1.) Statutory merger:

A statutory merger involves a combination in

accordance with applicable state law.

In traditional mergers the two companies

negotiate the percentage ownership that each

respective company’s shareholders will have in

the new firm.

In a merger/consolidation the consideration

passes to the Target shareholders.

Transaction must be approved by the

shareholders of both companies

Shareholders who do not approve the

transaction are typically entitled to

appraisal rights, UNLESS both companies

are publically traded.

2.) Sale of Assets:

Occurs when one company purchases the assets

of another.

Page 57: Acing Business Organizations (Book Outline)

In a sale of assets the Acquirer corporation gives

the Target corporation either stock or cash (or

some combination of cash and stock) in exchange

for the Target corporation’s assets.

Following the sale the Target corporation

usually has few or no assets, other than the

consideration paid to the Acquirer.

In a sale of assets, the Target must usually make

its creditors aware of the sale so that creditors

may make a claim against the consideration being

paid for the Target’s assets.

Once the Target’s creditors have been paid and

the Target has received the balance of the

consideration paid by the Acquirer, the Target

may then, issue a liquidating dividend to its

shareholders.

If the target has a substantial number of assets,

the sale of assets can be a more complicated

process than a statutory merger because, among

other requirements, a sale of assets will require

the transfer of ownership of each of the specific

asset of the Target corp.

In a sale of assets the shareholders of the Target

corp. are entitled to vote on a sale of all or

substantially all of the assets.

In Delaware the shareholders of the Acquirer corp.

are not entitled to vote, but some other states do

allow shareholders in the Acquirer corp. to vote on

transactions involving the sale of assets.

Page 58: Acing Business Organizations (Book Outline)

In Delaware , dissenting shareholders in the Target

corp. are NOT entitled to appraisal rights, BUT

some states so allow the Target company

shareholders in a sale of asset transaction

appraisal rights.

Dissenting shareholders in the Acquirer corp. are

NOT entitled to appraisal rights.

The acquiring corporation will obtain the Target

corp’s assets, BUT NOT its liabilities (Acing 223-

24)

3.) Sale of Stock:

A stock sale involves the purchase of the stock of

one company by another.

Since the Target company provides stock

instead of assets, the Target corporation

winds up as a subsidiary of the Acquirer

corp. As a result, there are two surviving

corporations instead of one.

Since the Target corporation survives, its liabilities

also survive.

o NOTE —Technically the first process is a merger or a

consolidation and a sale of stock or assets is an acquisition.

o In most basic of mergers one company is identified as the

“acquirer” while the other is identified as the “Target.”

De Facto Merger Doctrine :

Page 59: Acing Business Organizations (Book Outline)

o The Defacto Merger Doctrine is applied when a company

manipulates the form of a transaction to avoid a result which

would have applied had the transaction been accomplished in

a more traditional manner. (Acing 227)

Rationale : When a shareholder is faced with a

transaction that so fundamentally changes the

corporate character of a corporation and the interest of

the plaintiff as a shareholder therein, to refuse him the

rights and remedies of a dissenting shareholder would

in reality force him to give up his stock in one

corporation and against his will accept shares in

another. (Farris v. Glen Allen Corp.—this case is in

the new casebook)

o Under the de facto merger doctrine, if the transaction has the

substantive effect of a merger, then the shareholders of the

companies involved in the transaction are entitled to the

same statutory protections they would have received had

there been a merger. (Acing 227)

o Delaware and a majority of jurisdictions do not recognize the

de facto merger doctrine,

because the courts have reasoned that states have

different processes to achieve the same results and, as

long as the process is legal, courts should not recast the

transactions which would only increase uncertainty and

litigation (See Hariton v. Arco Electronics). (Acing

227)

FREEZE OUT MERGERS :

Page 60: Acing Business Organizations (Book Outline)

o Freeze out mergers (aka “cash out mergers”) are a process by

which, in some states, a majority shareholder may force the

minority shareholders to sell their stock in a merger with (or

acquisition by) an entity owned by the majority

shareholder(s), enabling the majority shareholder(s) to

acquire 100% control of the company.

o These transactions involve a conflict of interest.

The standards for reviewing transactions involving a

controlling shareholder and a conflict of interest and a

merger is “entire fairness.” (Acing 228)—Cross check

with class notes!!!

The entire fairness standard requires that the

transaction be accomplished by both 1) a fair

process (i.e. fair dealing) and 2.) fair price.--THIS

IS DIFFERENT FROM WHAT IS IN YOUR

NOTES!!! (See Week 12)

As long as the majority shareholder

effectuates the freeze out merger at a fair

price and by a fair process, then the merger

may proceed.

o Different states have different requirements for cash

out mergers:

California & Delaware—Short Form Merger

(“Freeze out”/”cash out”):

California will only allow a majority shareholder to

“cash out” the minority in a “short form merger”

in which the majority own at least 90% of the

corporation and the transaction must be approved

by the California Commissioner of Corporations.

(Acing 229)

Page 61: Acing Business Organizations (Book Outline)

Statutory Short Form Mergers:

Short form mergers are often used following

tender offers to eliminate any remaining minority

shareholders. (Acing 229)

HOSTILE ACQUISITIONS:

Unlike “Freeze Out Mergers” (and statutory short form mergers)

were both firms’ Board of Directors must agree in order for the

transaction to proceed, there are situations in which one firm or

individual wants to acquire another, and the Board of Directors of

the Target firm does not want to be acquired or does not want to be

acquired by that particular person or firm. (Acing 230)

o The process of excluding the Board from an effort to

acquire control of a company is generally referred to

as “hostile.”

o There are three main approaches that might be used to

circumvent the Target’s Board of Directors: (Acing 230)

Tender offers—are a public offer, usually made to all

the shareholders of the Target corporation wherein the

Offeror offers to buy all of the Target’s shares at a

specific price. (Acing 230)

NOTE:

Any person who commences a tender offer

in an effort to acquire more than 5% of a

company must comply with the extensive

rules and regulations arising under sections

14(d) and 14(e) of the 1934 Act. --(Acing

231)

Page 62: Acing Business Organizations (Book Outline)

Direct Share Purchases—involve direct purchases of

stock by the potential acquirer in the public market or

privately negotiated transactions with limited number of

shareholders.

Proxy Contest—is a battle for control of the Target’s

Board of Directors through the shareholder voting

process.

TAKEOVERS : (Acing 230-31)

o Hostile Takeovers—

A hostile takeover involves an effort to acquire sufficient

shares to control the board of Directors, and then

replacing the board of Directors with the Acquirer’s own

slate of directors.

This process is often followed by some form of

statutory merger of the acquired Target entity

into an entity controlled by the Acquirer and may

or may not involve cashing out the remaining

shareholders.

Defense Tactics : (Acing 232)

o Below are some of the tactics companies use to resist hostile

takeovers:

1.) Greenmail:

Greenmail involves a payment made to a

potential acquirer to incentivize them to leave the

company alone.

It usually occurs when…..

2.) White knight:

Page 63: Acing Business Organizations (Book Outline)

3.) Poison pill:

4.) Share Repurchases:

5.) Staggered Board:

6.) Shark repellent:

7.) Golden Parachutes:

8.) Pac-man Defense:

Fiduciary Duties in Takeover Defenses : (Acing 234)

o

DISSOLUTION & LIQUIDATION