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Agency Law
Core of All Business Entity Law
People Act on Behalf of the
Business to Bind the Business inRelationships with Third Parties
Course Starts with Simple AgencyRelationships
Separate Contract and Tort Cases
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Creation of an AgencyRelationship
Consensual (Contract)
Oral or Written (manifestation of consent ofone and consent by the other)
Express or Implied Ex Ante (Before the Act) or Ex Post
(Ratification; After the Act; relates back)
By Matter of Law (Equity)
Apparent Authority (Constructive)
Authority by Estoppel (Cannot Deny)
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Termination: General Rules
Default Terms: Terminable At Will of Either Party
Otherwise End of Reasonable Term or When SpecificAct Performed (or on Violation of Duty)
If Parties Stipulate a Set Term (by Time or byTask)
Either can Breach (Principal Revokes; Agent Renounces)
Remedy Limited to Damages (No specific enforcementby injunction) Policy??
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Agents Liability on Contract
General Rule: Agent not liable oncontract executed on behalf ofprincipal
Exceptions: Partially Disclosed (UnlessOtherwise Agreed) or UndisclosedPrincipal.
Atlantic Salmon v Curran: Agentliable when no disclosure of specificidentity of principal.
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Agents Fiduciary Duties
Supplement Express or Implied Contractual Terms of theAgency. Default Terms or Gap Fillers Rest. (2nd) 376.Agent is a Fiduciary. Rest. (2nd) 13.
Duty of Care. Rest. (2nd) 379 Standard (reasonable) Care and Skill for Task and Profession
Obey Directions; Act only as Authorized
Duty of Loyalty. Rest. (2nd) 387 No Conflicts of Interest. Rest. (2nd) 388-395
Account for Profits
Duty of Candor. Rest. (2nd) 381 Duty to Give Information, Keep and Render Accounts. Rest.
381-382
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Effect of Termination on Agents Duties
Duties of Confidentiality & Loyalty SurvivesTermination. Rest. 396. [written lists/memorydistinction]
Town& County House & Home v Newbery: Ex-employees solicitation of employers customers,
obtained at considerable cost, was a breach of a duty ofloyalty.
[Note Appellate Courts conspiracy theory; en massedeparture]
Partnership Cases: Meehan v Shaughnessy(nextChapter)
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Plaintiffs Problem: Lack of AgentsExpress Authority to Contract.
Principal Bound Anyway.. General Direction Only: Specific Power
Implied in Fact (Hogan). Actual Authority.
Explicit Reservation of Authority Disregarded(Cannot use Implied Authority): Apparent orInherent Authority Explicit Reservation of Authority Disregarded;
Undisclosed Principal: Inherent Authority(Watteau)
Contract Formalities Fail (Authorized AgentDoes Not Sign; Cannot use Actual Authority):Apparent Authority of Employee (Ampex)
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Vicarious Liability (RespondeatSuperior)
Principal Liable for Acts of Employees(Servants)Within the Scope of Employment[Letthe master answer] Even If Principal Does Not
Specifically Order, Direct or Intend Employees Tortious Act
Nor Breach a Personal Duty to the Victim
Limits Distinguish Non-agents/Agents Rest. 1
Distinguish Agent Independent Contractors/ServantsEmployees [Control or Right to Control] Rest. 2, 220
Distinguish Inside/Outside Scope of Employment[Kind,Time, Space, Motive] Rest. 219, 228-32
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PartnershipNot Created by the State (Privately
Created)
Distinguish Sole Proprietorship (one
owner) from Partnership &JointVenture (multiple owners)
Created by State Certificate
Limited Partnership/Limited LiabilityCompany/Corporations
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Joint Ownership: DefaultRules
All Owners (Partners)
Are Liable as Principals RUPA 305 & 6
Are Jointly and Severally Liable for Debts of
the Business
Are General Agents of Partnership(Meinhardcase) RUPA 301
Share Equally in Control RUPA401 (f) &(j)
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Partnership Formation Actual (Real; By Consent): RUPA 201
Affirmative: co-owners of a business for a profit
Negative: Not a tenancy in common,employer/employee relationship (soleproprietorship), lender/debtor relationship
Factors: sharing of profits (notgross returns)[Proxy for control??]
By Law (Implied in Law; Equity: Partnership by
Estoppel (Holding Out) RUPA 308
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Partnership Governance
Default Rule: UPA 401(j). Majority ofpartners have the power to make allbusiness decisions within the ordinarycourse of partnership business.
Minority, dissenting partner cannot opt out,even by informing third party of her dissent
Third party cannot rely on authority ofminority, dissenting partner to bind partnership
[problem: apparent authority]
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Partnership Property
Default Rules: Partnership Holds Property as an Entity Separate from
Partners. RUPA 203
Partners Property Rights. RUPA 501: (1) right to use specific partnership property (RUPA
401(g), tenancy in partnership ?),
(2) owns a partnership interest (RUPA 502, personalproperty)
(3) right to participate in management
Case: Putnam v Shoaf. Legal Claim for
embezzled funds. Did exiting partner have aninterest in the claim?? Held: No. Partner can onlyconvey interest; legal claim a partnership asset.
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Partnership Dissociation,Dissolution, and Liquidation
RUPA Terms: Dissociation/Dissolution/WindingUp/Liquidation
Default Rule for At Will Partnership RUPA801(1): Any partner can walk and force
liquidation absent other circumstances(partnership agreement/ bad behavior). Duty of Confidentiality; Duty to Account Survive
Default Rules a Problem for Modern Business (too easyto leave (no capital lock up). Remaining equity owners
must reconstitute business.
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Distribution Problems: DefaultRules (UPA)
Marshall Cash. Pay Cash in Order, UPA40(b) to
(1) Creditors
(2) Partners on Loans
(3) Partners for Capital Contributions
Partners Equally for Split of Profits
What if there is a deficiency in 1,2, or 3?UPA 18(a) & 40(d) Each Partner Pays(Suffers Losses) in Same Proportion asSplit of Profits (Default: Equal Payments).
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Dissociation Wrongful?
Dissociation Wrongful? Not Wrongful: At Will Partnership RUPA 601(1)(no term or
task); Death (7); Bankruptcy (6): Court Order (5) Wrongful:
Breach of Partnership Agreement (even if partnership at will) or Short of Agreed Term or Task
Effect of Wrongful/Not Wrongful Distinction: Can Remaining Partners Continue Partnership?? Or Must
Partnership Dissolve?? RUPA 801. At Will Partnership. Dissociation=Liquidation
Unless wrongful or plus: expulsion on proper grounds by unanimousvote or, on more general grounds, by court order; bankruptcy ofpartner; death or incapacity of individual partner
Special Rules for Term or Task partnership Does Dissociating Partner Pay Damages
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Partners Fiduciary Duties
RUPA 404 only but see RUPA 403 on old Duty of Candor
(Information)
Duty of Care: BJR (gross negligence)
Duty of Loyalty: account; conflict of interest; compete
Adds Duty of Good Faith and Fair Dealing
But RUPA 103. Agreement may not Unreasonably restrict 403(b)(information)
Eliminate Duty of Loyalty except for 1) categories of acts ifnot manifestly unreasonable or 2) cleansing vote
Unreasonably reduce Duty of Care
Eliminate DGFFD but may prescribestandards if notmanifestly unreasonable
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Expulsion of a Partner
RUPA Rules: Partners Want to Expel a Partner,Continue Business No Express Term In Partnership Agreement
By Decree of Court RUPA 601 (5)
Very Limited Circumstances: Unanimous Vote RUPA 601(4) Under Procedure Specified in Agreement. RUPA 601(3).
Note change from UPA 31(6)[bona fide], 38(1), &41(6). But DGFFD in RUPA 103(5) & 404(d).
Case: Lawlis v Kightlinger & Gray. Bona Fide in
UPA?Held: No cause guillotine procedure isbona fide if no wrongful withholding of moneyor property legally due the expelled partner atthe time he is expelled
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Partnership Tort Liability
General Rule: Partnership Liable forPartners wrongful act in ordinarycourse of business or with
authority of co-partners RUPA 305. Indemnification against partner
causing injury? Moren v Jax. DefaultRule. No. Distinguish Agency Law(indemnification against agentcausing injury is default rule).
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Limited Partnerships
New Act: ULPA (RULPA) overlays UPA.UPA applies unless a ULPA provisionchanges the rule.
Holzman v De Excamilla: Limited Partnerscan be recast as general partners if theytake part in the control of the businessof the firm. Note Change from ULPA toRULPA.
Modern Uses: Private Equity Funds(Hedge Funds; Venture Capital Funds)
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What Entity to Use? Small Businesses (Number of Investors is Under 35):
Presumption in favor of an LLC (with a Written OperatingAgreement). If business grows, convert to a C Corporation.Rebutted
by industry specific common practice (VCs as LPs)
if Net Profits are Zero (use a C Corporation)
If heavy retained earnings
Medium to Large Businesses (Likely to be Publicly Held): CCorporation.
Factors, in order: Tax (Double Tax); Attraction to Investors(Limited Liability, et al.); Operating Structure (MandatoryRules do not get in the way; Default Rules require the
least amount of tinkering in written agreement)
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The Double Tax
Firm earns $1.00, tax 35%, keeps$.65
Note: effective rate is around 18%
Firm distributes cash to investors,tax 15%, investors receive $.55.
Note: The Bush tax cut lowered the
tax from 39% (investors receive $.40)
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The Corporate Form Legal Person (Entity) with Indefinite
Life
Limited Liability of Investors
Free Transferability of Ownership(equity, stock or shares) Interests
Centralized, Specialized Management Oversight Board Elected by Equity
Investors
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Creation of a Corporation
Incorporator files an Articles of Incorporation(RMBCA; Ohio) or a Certificate of Incorporation(Del)
Secretary of State Records the Filing; Effective on
Filing Date (unless explicitly delayed) New Corp. Holds an Organizational Meeting to
Adopt Bylaws (Regulations in Ohio) thatEmpower Agents
Analogy: Certificate and By-Laws (const.documents) board resolutions (leg.) exec.decisions (Pres., agency orders)
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Corporate Charter(Articles/Certificate)
Mandatory Provisions Name; registered agent; purpose; authorized
amount of common (voting) stock; Del & Ohio,par value
Discretionary (Customized Optional)Provisions Complex capital structure: Preferred Stock;
Two-Tier Voting Stock Complex Governance Provisions: Board Terms
of up to 3 years, Staggered; Class Voting;Bylaw Amendments by Board or Lower Majority
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Promoter, Pre-IncorporationContracts
Promoter Signs Agreement with Third Party Before CorporationExists (Pre-Incorporation Contracts). Effect? Agency Law Controls: Rest.Ag. 320 & 326
Promoter Liable? No: contract; unilateral offer to corporation Yes: Contract with promoter
For good faith efforts to get corporate adoption Until corporation affirms (promoter then released) Survives corporate affirmation (promoter bound; secondary liability)
But Novation: New contract with corporation replaces old deal(promoter usually released)
Can Unincorporated (Defectively Incorporated) Firm Sue onContract?
Yes: De Facto Corporation (Close Enough) Yes: Corporation by Estoppel ( Third Party Thought It Was Corp)
Southern-Gulf Marine v Camcraft
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Terms for Shares Types: Preferred/Common; Classes;
Convertible
Authorized/Issued/Outstanding.Treasury shares
Primary/Secondary Market Sales
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Shareholder PersonalExposure
Equitable Subordination: Ifshareholder is an 1) officer and 2)a creditor of firm and misbehaves,
debts subordinated to those of allother creditors
Disregard the Registered LegalEntity (becomes a General
Partnership or Sole Proprietorship)
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Disregard the Entity
Shareholder (s) 1) dominates firmand 2) acts unjustly towardscreditors Evidence of domination is commingling of corporate and
personal funds, lack of observance of necessary entityformalities (board and shareholder meetings)(Note Ohio,lack of meetings not a factor)
Courts vary on what is unfairness or unjustness
Also Known as Piercing theCorporate Veil (or Piercing for short)
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Parent / Sub
Is shareholder control or dominationenough for disregard of entity? No, US v. Bestfoods (EPA)
Distinguish from Disregard of EntityOther Theories of Shareholder Liability Direct Liability: Direct intervention or
participation (In re Silicone, second theory)
Indirect Liability: Corp is agent ofshareholder (respondeat superior)
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Shareholder Lawsuits Distinguish: Derivative Actions/Direct Actions
(Class Actions) To Whom is Duty Owed? Cohen &Eisenberg & Grimes cases Classic Breach of Fiduciary Duty by Board,
Derivative. Cohen facts (personal enrichment). Direct:
Classic: Violation of Federal Securities Laws. State Law Voting Rights Violation. Eisenberg
facts. Problem for Plaintiffs, no cash.
Effect Procedural Hurdles, FRCP Rule 23 or Rule 23.1 Who Collects Damages?
ea arty n nterest:
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ea arty n nterest:Standing in Derivative
Actions Fed. R. Civ. P. 23.1 (Ohio Same): Plaintiff Must Have Been a Shareholder
at Time of Wrong
Plaintiff Must be Shareholder ForDuration of Action
Plaintiff Must Fairly and Adequately
Represent the Other Shareholders
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The Demand Requirement
Shareholders Must Make a Demand on the Boardto Sue (Majority of Board Disinterested) Boards Choices: It Agrees to Sue, Refuses to Sue, or
Defers to Shareholder Suit. If Refuses: Shareholder Suit Dismissed; Sue Board,
Wrongful Refusal? Grimes: BJR unless conflict or lack ofdue care
Demand on Board Excused
Board Creates a Special Litigation Subcommittee (SLC):SLC Defers or Files a Motion to Dismiss
On Motion to Dismiss, Court Review on NY or Del test(BJR/compelling interest)
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Demand Excused: Special LitigationCommittees
Form a Standing Subcommittee of DisinterestedDirectors, Delegates Absolute Discretion
Subcommittee Hires a Top Law Firm, Not onRetainer, to Investigate the Allegations
Subcommittee Determines Suit is Not in Best Interests of Corporation Argue
Legal Merits and Economic Value (Damage toReputation)
Files a Motion to Dismiss
Court Review: Independence of SLC
Merits of Decision?? Distinguish Del. (de novo) N.Y. (nooversight), & N.C. (normal BJR, presumption).
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Primary Dutyof Board of Directors(and Appointed Officers) ??
To Whom??? Firm Collectively, Firm Health. NotIndividual Shareholders or IndividualConstituencies.
How is Firm Health Measured Legally(to
evaluate performance of fiduciary agents)?? Shareholder Value (Maximize Residual Profits)
Long Term/ Short Term
Stock Market Price Inaccuracies
Total Firm Capital Value: Shareholders Returns Plus Bondholder Returns
Total Firm Value: Return to Investors Plus Income Value to Workers
Total Social Value of Firm??? Firm is better off in the long run ifsociety healthy
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When Can a Board Favor Non-Shareholder Constituencies??
Fact Patterns: Gifts to Charities,AP Smith
Distributions of Extra Cash: Higher Wages Or Dividends,Dodge v Ford
Community (Culture, Tradition) Over Profits, Shlensky vWrigley
Possible Answers: Never: Tie All Decisions to Shareholder Welfare or Do
Not Do It [Milton Freidman: Corporations Social Duty isto Generate Profits for Shareholders.]
Yes But Only If Amount is Small and Promotes The Good(Ethical): ALI
Yes, Full Board Discretion to Act in SociallyResponsible Manner: Ohio 1701.59(E).
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Fiduciary Duties of Members
Member-Managed : Owed Each Other(Partners)
Manager-Managed: Only Managers owefiduciary duties (Corporate Boards)
Ohio except to the extentthe operating
agreement provides otherwise (.29(A)) Compare (B) to (C) & (D). Duty; Action for
Equitable (Injunctive Relief; Action forDamages (But compare to corp 1701.51)
Corp. Style Provisions: Reliance on Reports(.30); Conflicts (.31); Indemnification (.32)
P Li i D i i
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Power to Limit Duties inOAs?
What Can the Members Waive??All Duty of Care Claims Other Than Willful Acts
Types of Duty of Loyalty Claims
Duty not to competeCourt Refusals to Respect WaiversBasic Contract Theory:
Strict Construction of Language
Mistake; Fraud; Contract of Adhesion etcNon-waivable Fiduciary Rights?
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LLC Formalities
Many LLCs Operate without AnyFormalities
File One Page Article of Association
Oral Implied Agreements; Custom & Course ofPractice Evidence.
Usually Member Managed But Can Be ManagerManaged (mutual unwritten understanding that onlyBeth runs the business)
Effect on Integrity of the Entity?
Court Interprets Any Implied Agreement andOtherwise Applies Default Rules
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Summary of Ohio ch. 1705
Corp. Code Model (Derivative Actions; Mergers;Dissolutions)
No Constructive Notice on Filing No Freedom of Contract Language Default Rules:
Profits Divided By Capital Contributions No Automatic Capital Calls (Feature of Limited Liability) New Members On Unanimous Vote Lock In: Members May Not Withdraw But Can Assign
Membership Interest (Assignee Becomes Member Only onUnanimous Vote of Remaining Members); Ceases to Be aMember on Death or Insolvency
Member Authority Depends on Member-Managed/Manager-Managed Distinction
Duties of Managers: Corp. Model.
f
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Common Duty of Care FactPatterns
Takeovers Board Sold for Too Little or the Board Refused a Good
Offer (Van Gorkom, Millan and Cede cases)
Shareholder Dividend Cases
Board Should (Not) Have Paid a Dividend (AmericanExpress case)
Duty to Monitor Cases Inattention (Francis andAllis-Chalmers cases)
Lack of Legal Compliance Programs (Caremarkcase,pp. 396,398)
Illegal Act Cases (AT&Tcase, not in book)
D t f C B h
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Duty of Care: Brehm case,n.66
Directors Decisions Respected (Presumption)Unless
Directors are Interested
Lack Independence Relative to the Decision
Do Not Act in Good Faith
Act Without a Rational (distinguish reasonable)Business Purpose
Use Grossly Negligent Process (includes failureto consider all material facts reasonablyavailable)
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The Business Judgment Rule
What is it? Basic Standard with Thresholds??(If good faith, Gross Negligence) AffirmativeDefense?? (Good Faith as a Defense toNegligence)
What are the Thresholds (or Elements of theDefense)??
Financially Disinterested (no conflicts of interest)
Reasonably Informed
Acting in Good Faith (in the firms interests)
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Liability Waivers: Delaware
Waiver Does Not Apply to Injunctions (Only To Claims for Damages)
to Allegations of Bad Faith or Personal
Benefit Does Apply to Damage Claims
Against Disinterested Directors Unless the Entire Fairness Test Applies
(Controlling Shareholder Transactions)Emerald Partners case.
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Ohio Liability Waiver is the Default Rule
Tighter than Delawares: Clear and Convincing Standard of Proof
Best Interests of Corporation includes otherConstituencies
No Improper Personal Benefit Exclusion
No Unocal Rule
Loser than Delaware
s Culpability includes or Reckless Disregard forBest Interests of Corporation
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Duty of Loyalty Distinguish From Duty of Care
Allegations of Sloth, Inattention or Stupidity
Disloyalty, Betrayal, Personal Benefit at FirmExpense, Selfishness
Care: plaintiffs lose; Loyalty: plaintiffs win Alternate Terms for Breach of a Duty of Loyalty
Bad Faith; Self-Interested,Self-Dealing,Conflicted,Interested, or Related-PartyTransactions; Conflicts of Interest
D t f L lt /C fli t f
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Duty of Loyalty/Conflict ofInterest Classic Cases
Director/Officer (or Controlling Shareholder, CS) on OneFirm Inks (or Causes) a Deal With a Second Firm that
Is Owned by the Director/Officer (or CS)(orFamily)(Corp. Codes) Bayer v Beran (wife of
Pres.); BOT v Benihanna (board memberbought convertible perferred stock)
Has Independently Paid (a Bribe??) theDirector/Officer (or CS)(Agency Law)
If so, Standard of Review: Entire Fairness, Burden of
Proof on the Conflicted Board. Lewis; Bayer(carefulscrutiny). Met burden in Bayerand BOT.
S f H b St t St t t
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Safe Harbor State Statutes:Introduction
DGCL 144; RMBCA 8.60 63;Ohio GCL 1701.60
Transaction Not Voidable if
Details Fully Disclosed and
Ratified by
Disinterested Directors or
Disinterested Shareholders
Fair
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144 Issues Are Ratification and Fairness Alternative Tests??
Majority: no (is or conjunctive or disjunctive?)
If no, does ratification affect fairnesstest? Split: No v Yes, use weaker test.
If yes, does ratification end inquiry? No,BJR on ratification decision by Board, butShareholders?? BJR
Is Full Disclosure Required by the Fairness Test
(as well as the Ratification Test)?? Fair Procedureand Fair Price?? Majority: Yes (Hayes Oyster,Wash.)
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Shareholder Ratification Stronger than Board Ratification ??
Shareholder Ratification of Director/Officer RelatedParty Transactions. BJR but Court usually defers.
But if waste, unanimity required Lewis v Vogelstein.
But Transaction between corporation and acontrolling shareholder, still entire fairness test,with burden shifted. In re WheelabratorTechnologies (Del.)
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The Duty to Monitor Distinguish a Breach by Commission from One by Omission.
Dumb decision/Inattention Distinguish Excusable Ignorance from Breach
Director must: understand business; keep informed ofoperations; be familiar with financial status; inquire onred flags
One Standard? Or Standards that Depend on DirectorsSophistication? Statutory Defense: Reasonable Reliance on Experts
Caselaw Old Rule: Graham: The red flag rule: Grounds for
Suspicion? If so Board must check it out. If not, no liability Caremark: Requirement of Audit or Compliance Monitoring
Systems No system is lack of good faith Stone v Ritter: breach of duty of loyalty because it is reckless
Fits more easily under breach of a duty of care (no conflicts) but nomatter as reckless conduct it is outside the BJR and 102(b)(7)under either theory.
Duty to Put in Place Monitoring
http://images.google.com/imgres?imgurl=http://www.bugwood.org/imgs/71_red_flag.jpg_s.jpg&imgrefurl=http://www.bugwood.org/pfire/redflag.html&h=225&w=150&sz=7&tbnid=2DMoY-_GdtwJ:&tbnh=102&tbnw=68&start=2&prev=/images?q=Red+Flag&hl=en&lr=&ie=UTF-8&sa=G -
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Duty to Put in Place MonitoringSystems
CaremarkDuty Adopted by Stone vRittercourt
SOXDuties
302 Executive Certifications: internalcontrols for financial data
404 Annual Report: Management
Assessment of Internal Controls Audited
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Corporate Opportunity:
Issues What Are They? Brozcase Distinguish Related Party Transactions In re E-Bay: Bribes Not COs
Standard: Interest or Expectancy Test (ALI) (Stronger:Line of Business Test: Guth case)
Can Firm/Officer Stipulate Expectations Ex Ante??
When Can Officers/Directors/ControllingShareholders Take COs Personally?? Disinterested Board Approves in Good Faith No Approval but firm financially unable??
Old: No Irving Trustcase New: Heavy Burden of Justification
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Compensation Problems
Is There Excessive Pay for Corporate Executives?Pro/Con. Law:
State Law: Disney Case; Ohio .60. Federal Law:
Tax: Limit Cost Deductions to $1M Cash. ExemptPerformance Pay Bonuses. Fed. Sec. Law:
Rule 16 b-3 (Vote on Stock Bonuses) Dodd-Frank: Advisory Vote (Say-on-Pay) every 3 yrs.
New Rule 14a-21. SOX (2002): Claw Back Rule TARP (2009): Pay Czar for Bailout Fund Recipients
Exchange Rules: NYSE Compensation Committee
Internal Firm Limits: Say on Pay By-Laws.
Sources of Corporate
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Sources of CorporateCapital
Borrow Money (Cash for promises to repay principle plus interest) Bonds, Debentures, Notes Lines of credit, Commercial paper
Sell Stock (Cash for a % of the equity) Preferred Common
Retain Earnings Hybrids
Convertible Bonds (option to exchange bond for stock) Convertible Preferred Stock (option to exchange preferred for
common) Options in Stock (Warrants) Redeemable Bonds/Stock (option to repurchase)
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Debt Covenants
Self-Help: Collateral Financial and Operational Commitments
Limits on dividends Limits on new senior debt Veto on Major Business Decisions
Repayment Terms Periodic Payments
Guarantees (Secondary Liability) Default Conditions
Broad definition Acceleration of repayment obligation
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Stock
Type Preferred (Participating / Nonparticipating)
Common (Voting / Nonvoting) Redeemable?
Dilution Control (effect on existing shareholders) Pre-emptive rights
Rules that prohibit watered stock; stock issued for lessthat fair market value (See also bonus stock ordiscount stock)
Private / Public Private: Private Offerings; i.e., Venture Capital
Public: Public Offerings
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Definition of a Security
Statutory Definition 33 Act 2(1); 34 Act 3(10). Ohio 1707.01 (title interests!!!)
Specific Instruments: Stock, Notes, Bonds
Catch-Alls: evidence of indebtedness,
investment contracts, and any instrumentcommonly known as a security .
Surprises: worm farming; condos; strips of orangegrove; oil drilling rights; pyramids sales schemes.
Scams.
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The Howey Four Part Test
Test: Investment of value In a Common Enterprise With an Expectation of Profits Solely (Now Largely) from the Efforts of Others
Application: LLC Memberships?? Robinson v Glynn(4th Cir.) Member-Managed: Presumption, Not aSecurity. Manager-Managed: Presumption,Security (Overcome on Facts) [Note problem ofcausal language shares & securities in
Operating Agreement.]
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Public Offering: 33 Act Registration
First Time? IPO (Initial Public Offering)
SH FirmUnder-writer
Public
(Dealer)
$$ $$
SharesShares
$$
Shares (Secondary Offering)
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Underwriters
Type of Offering: Firm Commitment, Normal (Dealer; Spread)
Best Efforts, Shaky (Broker; Commission)
Negotiate Offering Price(Firm/Underwriter)
Due Diligence (Gatekeeper Role)
Do Not Like Piggyback Sales
Use Contractual Lock-ups: Stop InsiderSales for 90 days after IPO
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Public Offering Process
Decision to Go Public Pre-Filing Period (no offers, no sales)
Negotiate with Underwriter; Prepare Filings
File Registration Statement with SEC Waiting Period (limited offers, no sales)
Road Shows
SEC: Effective Distribution Period (offers, sales with delivery of
prospectus)
Liability of Participants (Offering Firm
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Liability of Participants (Offering Firm,Underwriter, and Individuals)
Defective Public Offering (12, 33 Act)
No registration, not exempt (InvalidPrivate Placement)
Defective Offering Process Fraud (Material Misrepresentations or
Omissions)
Sections 11, 12 & 17 of 33 Act Rule 10b-5 (10(b) of the 34 Act)
Section 12(a)(2) Misstatements
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Section 12(a)(2) MisstatementsC/L 10(b) 11 12(a)
(1)
12(a)(2)
Materiality
State ofMind
Reliance
Causation
Damages
yes
yes
scienter
yes
yes
unlimited
yes
yes
scienter
transactioncausationlosscausation
unlimited
yes
yes
strictliability
tracingrequirement(losscausation)
offeringprice
no
no
strictliability
no
no
rescission
yes
yes
(negligence)
no
(losscausation)
rescission
Misstat.orOmission
Section 11 Liability
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Non
-
Exper
ts
yDue Diligence Defense
Expertised
reasonableinvestigation
reasonable and actualbelief in statements
11(b)(3)(B)
Non-Expertised
Exp
er
ts
no investigation
no reason to believeuntrue
11(b)(3)(C)
not applicable
11(a)(4)
reasonableinvestigation
reasonable andactual belief instatements
11(b)(3)(A)
Duty of the Company to Inform the
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Duty of the Company to Inform theMarket: Mandatory Disclosure Rules
State Law (All Companies Incorporated in State) None Unless Shareholder Vote Needed (In Notice,
Malone) Duty to inform shareholders at annual meeting? See
Ohio .38 State Blue Sky Law (Exempted Primary Offerings;
Intrastate Exemption)
Federal Law (Publicly-Traded, WhereverIncorporated) Mandatory Disclosure Rules Periodic Filings (10-K, 10-Q) Episodic Filings (Events: 8-K; Form S-1; 14d-1)
Voluntary Disclosures (CEO Statements): Duty toBe Accurate
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Rule 10b-5 Face-to-Face Fraud in Securities Transactions
(brother buys sibling's stock in a familycorporation)
Fraud in the Primary Trading Market: Firm/Shareholder Transactions (Primary Market Sales
(Placements or Distributions); Security Repurchases(Negotiated; Self-Tender Offers)
Fraud in the Secondary Trading Markets
Market Manipulation (i.e., Go short, start bad rumors,close position; Go long, falsely tout, close position)
Insider Trading/Misappropriation
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Elements of Rule 10b-5 Action
False or Misleading Statement or Omission When is Failure to Disclose Actionable? Must Be Under a
Duty to Speak Basic
SEC Filings, Mandatory Duty to Disclose Voluntary Statements, Duty to be Accurate Insider Trading, Duty to Disclose or Abstain from Trading
Materiality: Basic (probability x magnitude test) Scienter: Ernst & Ernst Standing: Blue Chip Stamps (Purchasers or Sellers of a
Security) Reliance/Causation: Basic (presumption of reliance on
the integrity of the market price in a liquid market) Injury/Damage: Ligget & Myers (disgorgement as well as
damages)
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Omission Cases: When is
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Omission Cases: When isThere a Duty to Disclose?
The Problem: Defining Actionable Omissions Common Law Fraud: Very rare; Is Insider Trading Such a
case?? (GR, no, unless special facts)
Possible Theories of Rule 10b-5:
Possession of Material, Nonpublic Information by Insiders:Duty to Disclose (or Abstain) Texas Gulf Sulphur(NowRejected)
Duty to Speak Required. Triggered by: Required SEC (Public) Reports
Voluntary Statements to Public
Trading in Shares by Fiduciaries Violating a Duty (to firm)Chiarella or (to another firm misappropriation) OHagan
Insider Trading: Potential
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Insider Trading: PotentialDefendants
Defendants: Insiders: Senior Executives, Directors,
Controlling Shareholders
Quasi-Insiders (Temporary Insiders):Professionals (underwriters (investmentbankers), accountants, lawyers, consultants)who get information with an obligation ofconfidentiality
Tippees of Insiders or Quasi-Insiders (or otherTippees)
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SEC Safe Harbor: Rule 10b5-1 Plans
Not Trading On the Basis of InsideInfo if
Insider Has Adopted a Written Plan
Before Becoming Aware of Info Specifies Mechanics for PeriodicTransactions
No Subsequent Influence Good Faith and not Scheme to Evade
Sh S i fi S
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Short Swing Profits Statute
34 Act 16(b): Congresss Definition ofInsider Trading. A Very Early Strict LiabilityProvision (Neutral of Intent)
Elements: Officers, Directors, & 10% Shareholders: Who
Must File Public Reports of All Trades (2 days) inFirm Shares [Form 4] 16(a)
Profits on Any Two Trades in Any Six Month
Period (Match Buys/Sells (Long) or Sells/Buys(Shorts))
Shareholder May Sue (Statutory DerivativeAction), Firm Gets Profits
Exception for Employee Benefit
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Exception for Employee BenefitPlans: Rule 16b-3
Tax Qualified Plans
Others:
If Ratified by
Non-Executive Directors and
Majority of Voting Shareholders and
Recipients Hold Shares Six Months
Indemnification and Insurance:
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Indemnification and Insurance:Terms
Indemnification: Firm PaysJudgments and Damages LeviedAgainst Members of the Board
D&O Insurance: Firm Pays Premiumsto Insurance Company; InsuranceCompany Pays Judgments and
Damages Levied Against Members ofthe Board
I d ifi ti
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Indemnification Mandatory Versus Optional (Discretionary)
Statutory: Mandatory: Successful Defense, DGCL 145(c) Waltuch v
Conticommodity Services:Technical Victories Count
Optional (Ex post): Amounts Paid: DGCL 145(a)&(b)
Advances: DGCL 145(e) (unsecured promise to repay) CitadelHolding Corp v Roven: reasonableness requirement
Contractual (Optional ex ante; Optional ex postbecomes Owed): Ex Ante Agreement that Firm WillIndemnify to the Full Extent Allowed Ex Post, DGCL145(f). But Some Requirements Remain -- Waltuch vConticommodity Services: Good Faith Finding forIndemnification; Citadel Holding: Reasonableness for
Advances.
E P t I d ifi ti
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Ex Post Indemnification
Ex Post: DGCL 145(a)&(b) Must Have Acted in Good Faith
Distinguish Direct/Derivative (a) v (b) (a): Limits on criminal actions
(b): Limits on Judgments (judicial out for expenses ona judgment); settlement amounts (and expenses onsettled cases) included [huge incentive to settle]
Procedure: Decision by Independent Directors (Majority or
Subcommittee),
Independent Legal Counsel, or
Shareholders
Ohi 1701 13(E)
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Ohio: 1701.13(E)
Direct/Derivative Distinction Modeled on Del. 145 Adds Court of Common Pleas to Procedure
Adds Court review to Decision by Board or IndependentCounsel
Advance for Expenses Mandatory (opt out) onpromise to repay unless court finds, under C & Cstandard, that director had deliberate intent toinjury corporation or acted with reckless disregardfor interests of corporation
B i f Sh h ld V i P
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Basics of a Shareholder Voting Proxy
Record owner (writer) grants proxy to proxy holder to voteshares at a physical meeting
Proxy is an Agency (creature of state law) Ohio .48; Del. 212(b) Proxy Holder (Agent) Proxy Grantor (Principal)
Not a written or absentee ballot Distinguish written consent procedure (MBCA 7.04)
Terms Revocable at will unless
coupled with an interest (e.g., sale of stock after record date butbefore meeting)
Supplemented by federal law if a publicly traded company
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Federal Proxy Rules What is a Proxy?
Grant of Agency
Distinguish a Written Ballot: Written Consent Procedure.
Why Are They Needed? Low Attendance at Shareholder Meetings.
What Law Controls?
State Law: Enables the Use of a Proxy. (Ohio Oddities)
Federal Law: Regulates the Proxy for Publicly-Traded FirmsOnly
34 Act 14(a)-(c)
SEC, Regulation 14A: Contains Rules 14a-1 to 14a-15 &
Schedule 14A.
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How Is a Ballot Slate
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o s a a o S a eSelected??
Board or Nominating Sub-Committee Selects Managements Slate Special Rules for Companies Listed on Stock Exchanges:
Nominating Sub-Committee Required and Must Consist ofIndependent directors. NYSE Listing Req. (Majority on theNASDAQ)
Role of CEO? GR: One Candidate Per Seat. All Seats In Play
Exceptions:
Cumulative Voting. (Ohio Default Rule .55)
Staggered Board
GR: Opponents Do Not Have Access to the Managements Proxy. But New 14a-11: 3% if held for 3 years; 25% of seats or min. one seat. (Currently
stayed by litigation in DC Cir.)
S t V ti Odditi
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Seat Voting Oddities
Choice is Yes or Abstain on Each Seat as Long as There is aQuorum Quorum: Usually 50%, can reduce to 25% in articles; Ohio .51, 1 will
do Hypos (Assume 50,000 shareholders):
1 Yes; 49,999 abstain. Director Elected 1 Yes; No-one else shows up at meeting. Elected in Ohio. Other
states fails for lack of quorum. Assume Quorum of 25%: 6,251 yes; 6,249 no. Director Elected
with 12.5% favorable. Effect of Majority Vote Bylaws
Power of ISS in Publicly-Traded Company Elections:Institutional Shareholder Service
Proxy Contest for Publicly-
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y yTraded Firm
Fed General Rule: Insurgents (to DefeatManagement Slate) Must Create Their Own Proxy Statement and Card with an
alternative slate of candidates File Materials with the SEC and
Pay to Have the Firm Mail the Material to allShareholders (or, if the Firm Elects, Mail the MaterialThemselves)
Who pays costs?? Of Incumbents: Firm pays all expenses (Levin v Metro-
Goldwyn-Mayer), no shareholder ratification necessary
Of Insurgents: Firm pays only on victory (Rosenfeld vFairchild Engine & Airplane) if ratified by shareholdervote and if on policy dispute.
Options for Thrifty
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Options for ThriftyChallengers
Ask Shareholders to Vote Abstain on theManagements Proxy The Disney Election of 2004: Eisner, the CEO, running for the
board had a 45% abstention vote. Stripped of Chairman title.He resigned in 2006.
SEC Rule 14a-11 (stayed). Major Shareholders (3%) can nominate
candidates for the Firms Proxy; 25% seats (min. of one seat). Enact Firm Specific Bylaw Changes:
Historical Note: Shareholder Resolutions on Management Proxy (Rule 14a-8(i)(8)) that AmendBylaws, Creates Procedure to Allow Shareholders to Nominate Candidates for Board. AFSCME vAIG (2nd Cir) case. Rule Change by SEC (currently stayed) Agrees.
Convince Board to Adopt Majority Vote Bylaws: Director Must Get Majority Affirmative Vote ofThose Voting to Be Seated. If lose
Hold-Over Directors or
Bylaw Stipulates: Must Submit Resignation; Other Board Members Can Chose to Accept or Reject It. Ifresignation accepted, seat vacant; board can fill it by appointment.
Rule 14a-8: Shareholder
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Proposals The Town Meeting Rule: Qualifying
Shareholders May Include SomeKinds of Proposals for a Shareholder
Vote in the Companys ProxySolicitation Material
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Types of Proposals 13 Types of Proposals are NotProper. Most
Important: Personal Grievance or Personal Interest Ordinary Business Operations (Dole proposal, study on
health care; Con Ed proposal on retirement age)
Election for a Board Seat (e.g.,AIG case) Materiality (Relevance): less than 5% of Total assets or net earning and gross sales Exception for otherwise significantly related to business
(Iroquois Brands proposal on pate)
Resubmission in five years: Less than 3% vote once;
Less than 6% twice.
Shareholder Power??
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Shareholder Power??
Are Rule 14a-8 Resolutions Binding on the Board? No!!: Corp. Codes State that Board Has Power to
Manage. Resolution must be proper subject for actionby shareholders. Rule 14a-8 (i)(1)
Possible Exception: Shareholder Power to Amend Bylaws
Solution: Make Resolutions Precatory : Recommend orRequest the Board Act
Board May or May Not Comply.
Boards Often Fail to Comply.
If they do not? Option is to vote them out.
Special Case: Bylaw
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p yAmendments
Common Practice: Shareholders Amend and Boards AmendBylaws, Unless Charter Reserves Power to Shareholders.MBCA 10.20 (Opt-Out). But Del. 109(a) & Ohio .11 (Regulations): Board Power to Amend
Must Be in Charter (Opt-In). Good Practice is to Include the Power inOhio.
Can Shareholders Therefore Amend Bylaws with a Rule 14a-
8 Resolution, Making It Binding? In Delaware issue is scope of shareholder power. Shareholders do not
have power to manage; directors do. Shareholders can change votingor decision procedures however. See CA v AFSCME (Del. 2008). Seealso Del. 112,113, & 216 (Access to Firm Proxy; Proxy ExpenseReimbursement; Majority Vote). Answer: Depends on the ByLaw.
Note Special Limits on Shareholder Votes to Eliminate a Staggered
Board in Ohio. .11(A)(2) (Double Majority Vote Requirement thatinclude a Maj. Of Disinterested).
Shareholder Inspection
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pRights
New York Statute (1315): Crane Co. v Anaconda Co.. Improper Purpose Test
Applied in Takeover exchange offer. Inspectioncompelled.
Sadler v NCR Corp. (NY Law Applies to Maryland Corp.)Tender Offer/Proxy Contest. Bidder can Demand a Cedeand NOBO list. But N.Y. Leg. Changed Law.
Delaware Statute (220): Honeywell. Shareholder Wants to Convince Company Not
to Make Bombs. Inspection denied. More carefulargument by shareholder needed and available.
Gillette (Del.Ch. 1988). Does Not Require a NOBO list.
Total Effect
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Total Effect
Management Controls Proxy Materials
Controls Nominations to Board
Plurality Rule for Elections
Controls Ballot Issue Initiation Brokers Vote for Managers If Clients Default
Institutional Investors Usually Go with Managers[Except Public and Union Pension Funds;
Universities??]
Variations on Straight
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gVoting
Vote Count: Straight v Cumulative
Class Voting (By Seat)
Dual Class Common Shares (Divided by Voting
Power) Shareholder Meeting Mechanics
Proxy (meeting) v Written Consents (nomeeting)
Record Dates; Notice Rules; Open CommentRules; Adjournments
Terms
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Terms
Distinguish Close Corporations (or Ohio: Corporation Formed with a
Close Corporation Agreement) General Corporations, Privately-Held & Controlled
Shareholders in Small Firms Want to Limit General Powers.Options
Register Register a Close Corporation: The Default Rules Include Shareholder
Restrictions on General Powers. Other Options: Use an LLC [open tocontract] orLLP, or LP (LLLP or GP as Corp.) [default rules different].
Voting Trusts (Must Also Register; Limited Time)
Unregistered (Private) Shareholder (Vote Pooling) Agreements: Shareholders Can Contract to
Affect Voting and Alienation Powers
Employment Contracts
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Shareholder Agreements v
Trusts
Shareholders Contract Among Themselves to Vote as a Unit Based on Majority View (Block Voting) Buy/Sell Agreements (Redemption Rights) Restraints on Sale (Right of First Refusal in Firm; Other
Shareholders) Elect Stipulated Officers and Payment of Stipulated Salary and
Dividends (only if all shareholders sign) See Ohio 1701.591(Close Corporation Agreement).
Compare with a Voting Trust Agreement Shareholders Transfer Legal Ownership to Trust But Retain
Beneficial Ownership Trustee Controls Shares for Benefit of Contributing Investors Public Suspicion (Use by Turn of the Century Monopolists):
Statutes Require Disclosure to Public; Limits on Terms
Ohio
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Ohio
Default: Cumulative voting ( .55) But: Notice 48 hours before meeting!!
Amendment of Articles ( .69 & .71) toEliminate Cumulative Voting. Shareholder vote
required Private Company: Veto by Shares Sufficient to Elect One
Director (Depends on size of board)
Public Company: 2/3 (or less, to an absolute majority, ifin the articles)
No dissenters rights on vote
Compare Ohio Close Corporation
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Agreement
Review Ohio .591 Unanimity Requirement
Filed with state (Open to Public Inspection)
Del. Not more than 30 shareholders
Can Restrict Discretion of Board or Even
Eliminate Board (Shareholder Managed) Court Can Appoint Provisional Director
Buy/Sell Agreement
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Buy/Sell Agreement
Who Holds the Option? Pro-Investor: Option to Sell (Put) Interest to Firm (Usually with
Heavy Conditions)
Pro-Firm: Option to Buy (Call) Interest from Investor onConditions (Common/Best Practice)
Death, Bankruptcy, Withdrawal (Attempted Transfer) or Expulsion
Exercise Price? Book Value Penalty.
Liquidation Value (Asset Sale; Neutral of Good Will)
Fair Vale or Going Concern Value Without Retiring Investor(Sale of Business; Includes Good Will)
Determination? Appraiser; If Disputed: Arbitration.
Buy Sell Agreements: Issues
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Buy-Sell Agreements: Issues
Type Put: Right of shareholder to sell (crosspurchaseor redemption agreement)
Call: Right of firm (other shareholders)to buy (one-wayand wait and seeagreements) Duff & Phelps
Trigger (Contingent on)
Purchase Price (Disputes?) Source of Funds
Courts: Fiduciary Duty in Close
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Corporations
Problem: Minority Shareholders Are MoreVulnerable in Closely Held Corporations Thanin Publicly Held Corporations Freeze-In: Take Minority Investors Money and Return Cash
Only to Majority Shareholders
Pay No Dividends Salary Only to Insiders: Family on Payroll (Exclude or Fire
Minority Investor)
Repurchase only Family Stock
Sweetheart Deals with Family (Suppliers/Customers)
Freeze-Out: There is no Market in Stock, Make an Offer at aDistress Price, No Notice of Good News. Often follows a Period
of Freeze-In Practices
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Judicial Protections Compare Massachusetts Practice with
Delaware Practice
Mass: Fashion Minority ShareholderProtections Based on an Equal Treatment
Rule. High Water Mark: Donahue v RoddElectrotype (Mass. 75). Modified in Wilkesv Springside, one year later.
Del: Minority Shareholder Gets What it
Bargained For on Purchase: Nixon vBlackwell (Del. 93)
Fundamental Changes
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Fundamental Changes
Amend the Charter (Certificate ofIncorporation)
Dissolve the Corporation
Acquisitions Merger the Corporation With Another
Survives/Does not Survive
Sell Substantially All the Assets
New: Domestication andConversion
Definition
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Definition
Change (or Potential Change) in the Charter Direct: Amendment Procedure
Ancillary: Merger Statute
Require Shareholder Ratification (Review)
State Law on Voting: Notice; Record Date
Federal Law on Proxy Solicitation
If Publicly Traded: Proxy Statement; Proxy Card
Direct Amendments to the
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Charter
Examples: Trivial: Name, Registered Agent Significant: Stock Designations; Stock Authorization;
Staggered Board; Right to Amend By-Laws; Right to UseConsent Solicitation Procedure; Liability Waiver; EliminateCumulative Voting
Procedure: Ohio 1701.69 to 74 (.71 on Amendments byShareholders) 2/3rds default (opt in: absolute maj.) Note Class Voting Eliminate Staggered Bd.: Two maj. (open maj. plus maj. of
disinterested shareholders) Eliminate Cumulative Voting: Supermaj. Limited Dissenters Appraisal Rights Under .74 (excludes
cumulative voting amendments)
Dissolution
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Dissolution
Procedure Ohio 1701.86 to 91 Voluntary: Shareholder Ratification Procedure, 2/3rds (opt in, less than
maj.vote) Judicial: Grounds , .91, oppression missing in Ohio
Problem: Effect on Unpaid Creditors .87 & Known: Notice, Right to Sue Remains
For Two Years: Directors personally liable to firm for distributions to
shareholders without payment ofknown obligations (.95(A)(1)(b)) andshareholders are liable to firm for restitution of illegal distributions (.95(D)) Creditors Can Chase Distributions In Hands of Shareholders.95(G)
UnKnown: Notice by Publication, Claim Existing?? Follow distributed assets into hands of shareholders (all shareholders are
necessary parties).
Safe Harbor in .89: Judicial winding up.
Judicial Dissolution
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Judicial Dissolution
Private Suits to Dissolve Company. Use by MinorityShareholders to Stop Abuse. Freeze-In; Freeze-Out
Grounds? Ohio .91 Narrow. Term Expired; Insolvent; Objects Failed
Abandoned or Impracticable [No Close Corp. Prov.] Maj. Shareholder (opt in, less) : Beneficial to Shareholders
Maj. Board : Deadlocked Directors or Shareholders
Compare with Alaska: When acts of those in control are illegal, oppressive, or
fraudulent Coppuck(also N.Y. Va etc)
North Carolina and California: reasonably necessary for theprotection of complaining shareholder Meiselman (N.C.) and
Stuparich (Cal.) Close Corp. Statute Cal 1800 (35 or less)