AGENCY 5

DETERMINING AGENCY 5

Creditor Liability for Acts of Debtor 5

PRINCIPAL LIABILITY TO 3RD PARTY IN CONTRACT 6

Actual Authority 6

Apparent Authority 7

Express Apparent Authority 7

Implied Apparent Authority 7

Inherent Agency Power (catch all) 8

Ratification 9

Estoppel 10

AGENT’S LIABILITY TO 3RD PARTIES IN CONTRACT 10

LIABILITY OF PRINCIPAL TO 3RD PARTIES IN TORT 11

Actual Agency 11

Servant vs. Independent Contractor 11

Service station cases 12

Franchises 13

Apparent Agency 14

FIDUCIARY OBLIGATIONS OF AGENTS 15

Use Principal’s assert during agency relationship 15

Stealing Principal’s business 16

After termination of Agency 16

PARTNERSHIP 18

DETERMINING THE EXISTENCE OF A PARTNERSHIP 18

Formation 19

Partners vs. Lenders 20

Partnership by Estoppel 20

FIDUCIARY OBLIGATIONS OF PARTNERS 21

Taking an Opportunity 21

Grabbing and Leaving 23

Expulsion 24

PARTNERSHIP PROPERTY 25

Sales of property/ Transfers of rights 26

RIGHTS OF PARTNERS IN MANAGEMENT 26

Voting 27

PARTNERSHIP DISSOLUTION 29

1

Judicial Dissolution 29

Consequences of Dissolution 31

Wrongful Dissolution Continuation Option 32

Sharing losses 33

Buyout Agreements 34

LIMITED PARTNERSHIPS 35

LIMITED LIABILITY PARTNERSHIP 36

CORPORATIONS 37

KEY FEATURES OF CORPORATIONS 38

THE INCORPORATION PROCESS 39

LIABILITY 40

PIERCING THE CORPORATE VEIL (PCV) 41

Alter-Ego Liability 41

Enterprise Liability 43

CHALLENGING BUSINESS ACTS 44

Ultra Vires Acts 44

Business judgment rule 45

Waste of Corporate Assets 47

Derivative Actions 47

Procedural Requirements 48

Policy Rationale 48

Demand requirement 49

Special Litigation Committees 51

FIDUCIARY OBLIGATIONS OF DIRECTORS, MANAGERS, & OFFICERS 53

Duty of Care 53

Interaction of Duty of Care and Business Judgment Rule 55

Duty of Loyalty 56

Corporate Opportunity Doctrine 57

Obligation of Good Faith 58

Executive compensation 58

Director oversight 58

FIDUCIARY OBLIGATIONS OF DOMINANT SHAREHOLDERS 59

DEFENSE OF RATIFICATION 60

Board Ratification 60

Shareholder Ratification 61

INDEMNIFICATION, INSURANCE, ADVANCING FUNDS 63

2

Rules for Indemnification (DE) 63

These rules can be altered by the corporation 64

Advancement of funds 65

Rules for Insurance 65

CONTROL IN LARGE CORPORATIONS 65

PROXY FIGHTS 65

Proxy Voting 66

Private Right of Action if false or misleading 67

Control contests 69

Reimbursement of Expenses 70

SHAREHOLDER PROPOSALS 71

Proxy access proposals 72

Grounds for exclusion – 14a-8 73

Failure to meet procedural requirements(s) 73

Failure to satisfy substantive requirement(s) a/k/a Question 9 73

Board refuses to act 75

Bylaw Amendments 75

SHAREHOLDER INSPECTION RIGHTS 76

Inspection of Book and Records per DGCL § 220 76

What is a Proper Purpose? 77

SHAREHOLDER VOTING 78

Stock can only have voting rights 78

Delaware Default Rules for Voting 79

Possible Modifications 80

CONTROL IN CLOSELY HELD CORPORATIONS 81

SHAREHOLDER AGREEMENTS 82

FIDUCIARY OBLIGATIONS OF SHAREHOLDERS 84

Remedy for breach 88

MASS.: NO RIGHT TO CONTINUED EMPLOYMENT UNLESS REASONABLY EXPECT CONTINUED EMPLOYMENT 88

Involuntary Dissolution / Forced Buy-outs 89

RESTRICTIONS ON TRANSFERRING CONTROLLING BLOC 92

Duties of Shareholders Selling Control Bloc 92

Exceptions That Require Sharing the Premium 93

Right of First Refusal and Take Along Provisions 93

LIMITED LIABILITY COMPANIES 95

FORMATION 95

3

PIERCING THE LLC VEIL 97

FIDUCIARY DUTIES IN LLCS 98

CORPORATE OPPORTUNITIES 98

DISASSOCIATION & DISSOLUTION 99

DISSOCIATION WITHOUT DISSOLUTION 99

DISSOLUTION 99

CONSEQUENCES OF DISSOLUTION 100

CORPORATE DEBT 101

DEBTOR’S SALE OF SUBSTANTIALLY ALL ASSETS 102

INCUR ADDITIONAL DEBT 103

DETAILED INDEX 105

4

AGENCYDetermining Agency

Agency is contractual: can be explicit or implicit No need for compensation or formal agreement

Legal Definition (Rst § 1)

Agency is a fiduciary relationship that results from the manifestation of consent by the Principal to Agent that Agent shall act on Principals’ behalf and subject to Principals’ control

And, Agent’s consent to so act, either by words OR implied by conduct

Judged from objective reasonable person standard

Not what the parties actually thought, but what reasonable person would think given facts Parties characterization is not always followed

Policy rationale

Law and economics: Owner of car is arguably the person best able to insure against these kinds of losses, because “principal” owner may be the cheapest cost avoider.

Gorton v. Doty - Teacher volunteered car to the coach to take the students to the football game. The

teacher and the coach were sued because on the way to the game there was an auto accident. Was the coach an agent of the teacher?o On her behalf because she wanted kids to go to game and could have driven.o Subject to her control because she said only coach could driveo Agent’s (coach) consent implied from fact he drove

- Prima Facie Assumption w/car lender driver cases: There is a prima facie presumption that driver is agent of the owner.o Note: Court says that the agent/principal relationship does not necessarily have to

involve some matter of business, but only that where one undertakes to transact some business or manage some affair for another by authority and on account of the latter, the relationship of principal and agent arises. P. 2. Also not crucial that there be a contract, the agent promise to act in a certain way, or that compensation is involved.

o Policy rationale problem: Underlying the decision is that she did in fact have insurance.

o The best advice may be to make sure that she has insurance, because it is very hard to rebut the presumption

Perhaps the courts use agency law to create incentives for car owners to insure against these kinds of accidents because she is owner of car and she can insure for instances when she and other people drive the car.

Internalize the costs of doing business

Creditor Liability for Acts of Debtor

Become liable if exercise de facto control over debtor

Creditor becomes a principal at that point at which it assumes de facto control over the conduct of the debtor, regardless of the formal terms of the contract. Rst § 14O

Gay Jenson Farms Co v. Cargill Inc. (1981) p.7

5

- Farmers sold grain to Warren (Grain Elevator) who sold almost all of its grain to Cargill (Grain Dealer). P’s want to collect from Grain Dealer? o Borrowing relationship:

Grain dealer keeps loaning funds to Grain elevator. Dealer has the right of first refusal on the grain Significant veto control over decisions and operations of business (debt, stock,

div)o Defense: They are merely in a buyer/supplier or creditor/borrower relationship

- Apply the definition (Rest. § 1)o A manifestation of consent by Cargill that Warren act on Grain Dealer’s behalf by

procuring the grain for Grain Dealer as part of its ordinary operationso Subject to Grain Dealer’s control by interfering in Warren’s operationso And Agent consents to so act, is implicit with agent’s actions

- Court says nine factors shows controlo Grain Dealer’s constant recommendations to Grain Elevator via telephoneo Right of first refusal on grain

90% of grain supplied to them. Doesn’t always create agency (lack of independence)

o Couldn’t do significant financial outlays: (mort. Dividends, purchase stock). o Right of entry onto Warren’s premise to carry on periodic checks and audits. o Correspondence and criticism about salaries and financeso Cargill’s determination that Warren needed strong paternal guidance o Drafts written under Grain Dealer’s name (suggests less independence)o Financing of all of Warren’s purchases of grain and operating expenseso Cargill’s power to discontinue financing of Warren’s operations

Principal Liability to 3rd Party in Contract

Authority is the starting point for analysis

Restatement 144: a Principal “is subject to liability upon contracts made by an agent acting within his authority …”

Actual Authority: express or implied Apparent Authority: express or implied Inherent Authority/Power: “catch all” category Rest. § 161 and 195 / Watteau Estoppel: Rst § 8 “changed position” / Hoddeson Ratification: Rst § 82 / Botticello

Actual Authority

Express or implied to agent because incidental/reasonably necessary Rst § 7: Agent’s power to affect Principals’ legal relations by acts in accord with Principal’s

consent to Agent Requires a “manifestation of consent” from the principal to the agent to do an act

- Express or Implied Consent (Restatement § 26)- Objective Reasonable Person Standard (Restatement § 33:)

Express Actual Authority

P expressly manifests consent to A by spoken or written words (Restatement § 7)

6

Implied Actual Authority

It’s based on the agent’s understanding of his authority. Must be determined whether agen Implied by context (e.g., custom, prior practice, course of dealing) “Incidental” or “usually accompany it” “reasonably necessary” ((Restatement § 35) Mill Street Church v. Hogan

- Did Bill (the agent) have the authority to hire his brother Sam? Yes, had done so before and church allowed & necessary to complete job.

- Don’t need but would also be apparent authority and ratification (church paid wages)

Apparent Authority

Manifested explicitly or implied to third party because of position Rst § 8: Agent’s power to affect P’s legal relations by acts in accord with Principal’s

manifestations to Third Party

Requirements

Requires a Manifestation by Principal or an authorized agent to Third party, reasonably interpreted by Third Party- Objective Reasonable Person Standard. Rst § 27

Policy rationale

Put burden on the principal instead of third parties Cheapest cost Avoider?

- Cheaper and more effect for the P to inform the world that A has no authority than to require each T who deals with A individually to inquire?

Control your employees rationale? Possible incentive to adopt effective internal controls and clear hierarchy of authority? (e.g., Lind)

Express Apparent Authority

Principal/Authorized Agent expressly tells 3rd Party that the Agent has authority. Special case: Principal is aware that there is a manifestation from someone claiming to be an

agent to the 3rd party- If the P is aware of it, and keeps silent then P has made the manifestation to third party.

P can’t become liable solely b/c someone says they are his agent (need his manifestation).

Implied Apparent Authority

Implied to TP from position of Agent, reasonably, (e.g., manager) that agent has authority.- Note: There must be some holding out

Three-Seventy Leasing v. Ampex Corp (1976)- 370 wanted to lease computers from Ampex. 370 told Ampex that they wanted to deal

exclusively with Kays. Kays presented a sales agreement that 370 signed, but blank spot for Ampex’s signature. Ampex sent around internal memo confirming sale and Kays sent 370 a letter confirming delivery dates.

- Did Kays have apparent authority? Yeso Kays was salesman and its customary for them to be able to enter into sales Kso Company knew 370 wanted to deal with Kayso Ampex didn’t notify that Kays had limited authority and Kays didn’t tell 370

- Original K wasn’t really a K because not signed by Ampex (just an offer to sell)

7

o But, court finds that letter confirming delivery was a promise to ship

Inherent Agency Power (catch all)

Don’t go here first because merely an equitable principal- Catch all category that captures cases that doesn’t fall into the other categories, but just

seems fair to hold P liable. Very fuzzy standard, courts reluctant to apply it.

Distinction from Apparent authority

Does not have a reasonableness requirement , but courts may bring it in by implying such a requirement. In some jurisdictions they merged this into the apparent authority doctrine.

Because Principal is undisclosed, there can be no implied apparent authority (because its not traceable back to the principal’s manifestations).- When the Principal is disclosed, apparent authority by position should generally yield the

same outcome as inherent agency power.

Restatement treatment

Rst § 8A: “Power of an agent [not based on] authority, apparent authority or estoppel, but [only on] the agency relation and exists for protection of persons harmed by or dealing with . . . agent.

Third party has not received any manifestation from the Principal, - Third party might not even know the principal exists.

E.g. Acts of Manager appearing to be Owner

Rst § 195: Undisclosed Principal is bound (even if she instructed A not to act so) if:- Transaction is USUAL in such business;- And, on the PRINCIPAL’S ACCOUNT

Rationale

Fairness : Necessary, otherwise P’s would hide behind agents and setup sham transactions Cheapest cost avoider , It’s cheaper for Principal to monitor his employees than to require

every third party that comes into contract to inquire/determine with the Agent is there a principal.

Power v. Authority

Power: ability of Agent to change Principal’s legal situation by doing or not doing a given act. (Rest § 6). - A may bind P even when A lacks any form of authority

Watteau v. Fenwick (1892)

Humble sold the Victoria Hotel to defendants, a firm of brewers, but remained as manager. The beer license was taken out in Humble’s name and his name was on the door. Humble had no authority to buy any supplies except bottled ales and waters. However, Humble bought (but did not pay for) cigars from plaintiff

Actual Authority?- He was expressly told he did not have actual authority He could not have reasonably

believed he had such authority so no implied actual authority. Actual Apparent Authority?

8

- No, the Principal never communicated to the Third Party, that he was an agent for principal.

Implied Apparent Authority?- No, because there was no holding out by the Principal that the Agent exists. Plaintiff

didn’t even know that the principals existed. Inherent Power

- “[T]he principal is liable for all the acts which are within the authority usually confided to an agent of that character,” despite limitations on that authority (p.27)

- It does sound like apparent authority, in that he was hired as a manager so third parties would look at him as having authority to do this type of activity. But, the TP didn’t know that the principal existed.

Ratification

Ratification: Affirmance by person of prior Act purportedly made on his behalf but without authority thereby giving the Act effect as if originally authorized by him.

Affirmation: My agent didn’t have right but now that she did….I’m happy and agree to be bound

Rules

May be express or implied from circumstances Original act must have purportedly been made on P’s behalf

- So, merely accepting benefits if not on P’s behalf is insufficient - Botticello And, P must know or have reason to know all material facts of the specific transaction Receipt of benefits is not alone sufficient unless other elements already present Until ratification occurs, unilateral right so TP can avoid the K but P cannot

Botticello v. Stefanovicz (1979)

H/W owned farm as TIC. H entered into K to lease with option to buy. ∆’s refused to honor option K. Argue wasn’t binding because W wasn’t in the K and didn’t ratify it.

Held: She wasn’t bound.- Marriage alone isn’t enough- She knew tenant paid rent & improved the property but H had authority to lease his

undivided half and that’s consistent. She received benefit, but before that can be a ratification, the other requisites must be

present.- Here, H didn’t purport to enter the K on her behalf so the proceeds alone don’t make her

a party.

Problems

Problem 1: W is a writer, H enters into K for her next book to publisher. Publisher sends check to W who spends it.- Publisher wins. She accepted benefits and appears to have been a party to the K.

Problem 2: Same, but she argues she thought was royalty from previous book.- Depends, she has to know, or should have known, material facts…so if she’s persuasive.

Problem 4: P is investor who opened account at brokerage and told him to invest only in bonds. He bought high-risk stock, she realized after next monthly statement but decided to wait and see. The stock went down dramatically. She closed account and demanded he pay the losses.

9

- Did she ratify it? Yes, she knew and decided to accept the benefits (by prolonging). She got all of the details in her statement.

Problem 5: P owns a mansion. A enters sales K for mansion with T without authorization. Mansion burns down. Then P ratifies. T says too late.- Not effective…won’t be effective where will harm the rights of the third party.- Its unilateral…if T changed his mind before burned down, he can avoid but P is bound.

Estoppel

Equitable doctrine to protect third parties

Rules

Rst 8B: A person who is not otherwise liable . . . is nevertheless subject to liability to persons who have changed their positions because of their belief that the transaction was entered into by or for him, if:- He intentionally or carelessly caused such belief- Or, Knowing of such belief and that others might change their positions because of it, he

did not take reasonable steps to notify them of the facts.

Hoddeson v. Koos Bros (1957)

She goes into the store and finds furniture she likes and she goes to someone she thinks is the manager and he says give me the money and we’ll ship it to you. Later, they claim it was an imposter in the store and they have no record.

Not apparent authority because he’s not held out by store that he was an employee- Could make argument that it was implied apparent authority if they saw him and did

nothing. Court remands for her to prove estoppel grounds

- She changed position- Acts or omissions of principal leading to her belief

o Did they take steps to make sure customer was protected from imposters?- That her reliance was reasonable

Agent’s liability to 3rd Parties in Contract

Partially disclosed: Rst § 4(2): Know A is or may be acting for P but don’t know P’s identity- If partially disclosed, Agent is party to K himself

Disclosed Principal

Generally no liability for agent (A merely a representative of P)- Unless clear intent all parties be bound- Or, Agent made K but without authority

Rationale: The third parties are aware they are not contracting directly with the agent so principal liability makes senses.

Partially disclosed (know P exists but no who) or undisclosed principal

Agent treated as though a party to the contract - To avoid, Agent must disclose acting as Agent and identity of P.

10

Rationale: Partially disclosed principals: W/o knowing the identity of principal 3rd party is relying on the trustworthy of the agent. And in the case of undisclosed they have no idea.

BUT Default Rules can be circumvented by agreements.

Liability of Principal to 3rd Parties in Tort

General rule

Principal liable for servant’s torts w/scope employment Vicarious Liability Centerpiece

- Principal is liable for the servant’s torts provided they’re in the “scope of employment” Rest s 219(1) with some additional exceptions 219(2)

Analysis

Tort by alleged agent Is there an agency relationship?

- Servant or contractor? For servants, liable within scope of employment or has authority from master

- General nature, time/authorized, etc.- Bushey v. U.S.

o Drunken sailor opens valves on dry dock scuttling ship. Contract had required dry dock to let sailors go to ship.

o Purpose: Opening valves wasn’t intended to benefit employer (US)o But, it was a foreseeable risk so they hold employer liable

For contractor, only if:- Retain control over aspect of work in which tort occurs- Principal engages an incompetent contractor (cheapest cost avoider)- Activity contracted for is a “nuisance per se”

o “Inherently dangerous activity” that creates a peculiar risk of harm to others unless special precautions taken

o Distinguish ultra hazardous where strictly liable

Actual Agency

Generally, principal not liable for torts committed by independent contractors Key is, do they control the means (time/place) or just the results? Courts split on whether must control the instrumentality (Vandemark)

Servant vs. Independent Contractor

Look to:- Who controls day-to-day operations- Who bears financial risk or exercises financial control

Factors

Pivotal Issue is the Degree of Control of P over A’s work P and A are in different occupations? Type of occupation normally done by specialist without supervision

- More likely to be indep contractor. E.g. plumbers Degree of skill required?

11

- When skill is required, more likely to be indep contractor Length of employment

- Shorter period tends to be indep contractor, shorter more discrete.- Longer duration looks more like employment relation

P is a business entity of which A’s work is a regular part of business - Tends to show employee-employer relationship

Parties’ intent - Not dispositive by itself.

Is pay by time or by job?- Paid by job is discrete task, by time looks more like employer, employee relationship

Service station cases

Weird hybrid cases because of structure of industry- They do business under oil company name, sell oil company’s products, and oil company

want to ensure quality/customer service.

Policy

Fairness : They should be made whole. Efficiency : Because gas company are in control, they are the cheapest cost avoider: By

imposing liability, we force them to internalize the social costs of doing business. - But, some of these were most easily avoided by local owners

Appearance of responsibility

Humble Oil & Refining Co v. Martin

Held: Owner was just like a commission employee. Humble had all of the control- Humble had lots of risk in bad times and unlimited upside in good

o Humble bore risk of non-sale of products because it retained titleo Humble paid large portion of operating costso Rents were adjusted based upon sales so in bad times, could have negative rents

- Strict financial control by Humble- Little or no business discretion by station owner- Unilateral right to terminate lease at will- Humble controlled hours of operation- Required owner to do basically anything Humble wanted

Hoover v. Sun Oil Co

Held: Not an agent For agent relationship

- Sun owned station, equipment, most tools, and all advertising displays- Lease could be terminated by either party with 30 days notice- Wore Sunoco uniforms, Sunoco placed over owner’s name- Attended training at Sunoco- Weekly inspections

Against or neutral- Owner could sell competitor’s products- Rental partially determined by sales but with min/max rate- Under no obligation to follow advice from regional rep

12

- Owner assumed all risk of profit/loss- Owner determined own hours

Franchises

Defined (R. Rosenberg)

“A system for the selective distribution of goods and/or services under a brand name through outlets owned by independent businessmen, called ‘franchisees’”

Franchisee gets the profit and bears risk of loss, pays fee to franchiser The contract regulates franchisee’s activities.

- Franchisee fee is often based on local revenues- Extensive contract (regulatory rules) that govern with rules: question is if this creates so

much control that they’re liable for the torts of the franchisee

Compare FTC Definition

A commercial relationship with the following three elements:- The franchise distributes goods . . . or services identified by the franchiser’s trademark or

other commercial symbol.- The franchiser exerts or has authority to exert significant control over franchisee’s

method of operation- To operate, franchisee is required to make a payment to franchiser.

Advantages of Franchisee Agreements

Franchisee- Ready made things: training, advice how to run business, - Advertising- Relative autonomy over day to day operation of business

Franchisor- Bare less financial risk as they would if operated within the firm (need less capital)- Greater diversification if they can operate across markets.

Customers- Standardization: can rely on constant quality of service and product

Risk- Liable if exert too much control

Murphy v. Holiday Inn

Plaintiff is staying at a hotel that is a “Holiday Inn”, although Betsy-Len Corporation may have a sign saying they are just a franchisee. Hotel guest slips and falls injuring herself.

The factors outlined look like standard franchise relationship: these are to maintain consistency in quality and maintain goodwill- But do NOT give control over day to day operations: daily maintenance of premise,

current business expenditures, fix customer rates, or demand a share of the profits, hire employees, etc.

- Disclaimer clause: ”Licensee in the use of the name . . shall identify Licensee as being the owner and operator … and the parties hereto are completely separate entities”(although we know this not dispositive)

Outcome: Not sufficient control to create master servant relationship: “System” not adequate. Why not bring it under apparent agency instead of master servant?

13

- Some court may say there is sufficient factual basis to have apparent agency

Vandemark v. McDonald’s

Employee of McDonald’s franchise was injured when the restaurant was robbed. The employee sued McDonalds, claiming the franchisee was an agent of the franchisor.

Court makes a narrow construction and looks at the particular area of where the harm was done, and did McDonald’s have a say in that particular area of business. - Since McDonald’s exercised no control over security of operations, not liable even

though had control over other elements. This is the more modern approach, look to the specific instrumentality causing the harm.

Apparent Agency

ONLY APPLIES IN TORT

Even if not actual agent, or franchisor doesn’t maintain sufficient control, can still be liable under apparent agency theory.

A non-master principal can be liable as a master if she created reasonable appearance of being master:- We cannot assume that customer will understand that Franchisor is not the Master.

Elements

An apparent agency exists if:- Representation of principal

o By action or inaction: Usually present because using franchisor’s trademarks, etc.o TP must reasonably believe that the franchisee is the franchisor’s agent or dealing

with franchisoro Proper notice can defeat this element if prominent enough

- Reasonable reliance on representation by TPo Critical: This is where most of the action iso Proper notice of independent ownership can defeat this element

- A change of position or damage to TP

Restatement

Rst § 267: “One who represents that another is his servant or other agent and thereby causes a third person justifiably to rely upon the care or skill of such apparent agent is subject to liability to the third person for harm caused by the lack of care or skill of the one appearing to be a servant or other agent as if he were such.”

Miller v. McDonald’s

Person bites on thing in food and sues McDonald’s. Actual Agency relationship:

- There is no finding of an ACTUAL agency relationship, but the court says there could be and then moves on to discuss whether or not apparent agency exists.

- Control test: π would try to show McDonald’s had control over hours, method of food preparation, wages, moderating employee’s behavior

Apparent Agency:- As far as a layperson is concerned you think you’re dealing with McDonald’s, although

corporate headquarters doesn’t have sufficient control over that store.- Analyzed under elements:

14

o 1. Purported Principal held out the other party as its agent Signs and symbols of ownership: McDonald signs, uniforms and NOTHING

prominently to the contrary saying McDonald was not the owner. Problem with sign indicating independent: if too prominent customers may be less

inclined to go thereo 2. 3rd party Justifiably relied on such holding out

McDonald’s was trying to argue that she needed to prove that she new specifically McDonald owned restaurant, and not in general that McDonald name brought her there.

o 3. Harm is obvious

Fiduciary Obligations of Agents

Duty of Care

Rst § 379: Duty to use standard care, std skill in the occupation and locale, and any special skill you possess.

Reasonable care standard (like in torts)

Duty of Loyalty

Rst § 387: Duty to act solely for benefit of principal in ALL transactions connected with the agency

Agent is entitled to reasonable compensation but no other profits unless Principal knowingly consents

Use Principal’s assert during agency relationship

Test: Sole cause vs. opportunity

Were the P’s assets the sole cause of the profit vs. “merely gives an opportunity of” profit PG 82.- If Sole Cause : Disgorgement of Profit- If merely opportunity : No disgorgement of Profit

Under Reading can Krier keep profits from his property casebook?- Michigan is by no means sole cause of his creation: use of Michigan’s resources do not

predominate. Could argue he is just using the time and not acting in competition with Michigan.

- Policy: We don’t want so restrictive with the rules so that they will not develop their own human capital

Disgorgement of profits.

Must disgorge profits if use P’s assets to obtain benefit Rst § 404: “An agent who, in violation of duty to his principal, uses for his own purposes or

those of third person assets of the P’s business is subject to liability to the P for the value of the use. - “If the use predominates in producing a profit he is subject to liability, at the principal’s

election, for such profit”

Exception: Using time only and not in competition with principal

No disgorgement if use time only and not acting in competition

15

Rst § 404: “he is not, however, liable for profits made by him merely by the use of time which he has contracted to devote to the P unless he violates his duty not to act adversely or in competition to P.””- E.g. Trading securities at work during business hours of work

Reading v. Regem p.80

Evil doers used Military person to help smugglers get stuff through Cairo, because of his uniform and position could avoid inspection and then received money.- It was the position that gave him the ability to engage in that activity.- Whatever value (profit) he derived goes to the Principal.

What if someone had never been in the army and bought the uniform?- No, because there was never an agency relationship. Maybe criminal but no breach of

fiduciary duty. Gulf war hero? Earns Medal of Honor and becomes public hero. One night goes to popular

restaurant in his uniform and reporters came and took his photo and the manger have him $1,000 in cash when leaving. He then went several more times…getting $10,000 in cash total?- No, because not getting money from the uniform (per se) but because of actions during

war.

Stealing Principal’s business

Rash v. JVIC

Rash hired to start and manage division of industrial maintenance business. Rash started his own scaffolding business but didn’t tell JVIC. He then awarded contacts to his own business. Eventually, JVIC started its own scaffolding business.

Held, breach of his fiduciary duties Relevant rules:

- Duty to account for profits arising out of employment- Duty not to act adversely to or compete with P, without P’s consent in matters relating to

subject matter of the agency- Duty to disclose material info related to the P’s business; duty to disclose any potential

conflicts of interesto This is a general duty to disclose what the principal should rightly know about things

affecting his interests. Problem: If JVIC had never formed scaffolding business, would the result change?

- No, he’d still be acting adversely because he was still awarding to himself.

After termination of Agency

Competition

Rst § 396(a): Unless otherwise agreed, after the termination of the agency, the agent may compete with the principal

Use of confidential information

Rst § 396(b): has a duty t not to use or to disclose, in competition with the principal or to his injury: trade secrets, written lists of names, or other similar confidential matters given to him only for the principal's use or acquired by the agent in violation of duty.

16

- He may use general information concerning the method of business of the principal and the names of the customers retained in his memory, if not acquired in violation of his duty as agent;

Accounting for profits if misuse confidential information

Rst § 396(c): has a duty to account for the profits, whether or not in competition with the principal

Cleaning Service: Town & Country v. Newberry

Some employees left and took the cleaning list when they left. Successfully solicited former customers.

Problem here isn’t the cleaning method, it’s the list of customers which took a long time to accumulate. These weren’t people that could be looked up in the phonebook. They contacted hundreds of housewives to find ones that wanted cleaners.

So if they made $50,000 in profits for taking the customer lists: must give back profits, but only to extent that the new customers are from old customer list.

Ok if the names and numbers in memory and not actual lists- BUT if deliberatively tried to remember it, not okay.

Problem: Hairdresser leaves salon

Hairdresser leavers Salon. Can she take the customer lists gather carefully by salon owner? - She can casually mention she’s leaving, and they can say let me know where we’re going

and want to come with you. And that’s okay. Implicit Wages

- Professor thinks that you can actually reduce the profits you give back by the implicit wages you would pay yourself but didn’t.

Remedies under fiduciary breach vs. contract claim

No need prove actual damages in a fiduciary suit:- Contract claim:

o Remedy: Must prove ACTUAL damageso No moral condemnation

- Breach of fiduciary duty:o Remedy: Disgorgement (immediately gets back without proving loss of profits, less

evidentiary burdeno More, moral condemnation

17

PartnershipStatutory body of law

o UPA (Uniform Partnership Act) (1914) {most states}o RUPA (1997) {California}

UPA: Most rules are default rules that can be contracted around.

o Default rules: share profits equally and management equallyo BUT Power to bind partnership in contract cannot be waived.o All partners are deemed agents of other partners.

This leads to fiduciary responsibilities.

What is a Partnership?

DEFINED “A partnership is an association of two or more persons to carry on as co-owners a business for profit.” UPA § 6(1) (PG32 Supplement)

General vs Limited

In general partnerships, all partners equal In limited, have 1 or more limited partners

- General partners = manage and have unlimited liability- Limited partner = No liability for partnership debts beyond investment in partnership

o Cannot partake in management…have to be passive. In LLP, all partners have limited liability

Partner’s Liability (UPA § 15)

Joint liability for contract obligations of the partnership Joint and several liability for all other obligations of the partnership (e.g., tort)

- Particularly true for torts, (we’re assuming general partnership, not limited)- Liability NOT limited to capital investment in firm, can go after personal assets

Determining the existence of a partnership

Rules for determining existence of a partnership (UPA § 7)

(1) Persons who are not partners as to each other are not partners as to third persons, except as provided in § 16.

(2) Joint tenancy or part ownership does not of itself establish a partnership. (3) Sharing of gross returns does not of itself establish a partnership. (4) Receipt by a person of a share of the profits of a business is prima facie evidence that he

is a partner in the business, but NO such INFERENCE shall be drawn if (see below)

Summary of Factors Relevant to Partnership Existence

(Taken from UPA § 7): Right to share profits, but not if:- A debt- Wages to employee or rent to landlord- Annuity to a widow or rep of deceased partner- Interest on loan- Consideration for the sale of good-will/property of a business

Obligation to share loss

18

Joint ownership and control Joint liability for partnership debts Conduct toward third parties Right to capital contribution upon dissolution

Formation

No formalities necessary to form a partnership

But, must comply with requirements of K law…so oral agreements acceptable unless statute of frauds applies.

The parties must agree to be partners

Look at parties’ intent (p. 93) UPA § 6(1): There must be an association of two or more parties to act as co-owners of a

business See also UPA s. 18(g)

A written agreement is evidential but not conclusive

UPA doesn’t address; developed via case law Facts showing intent may overcome the written contract (p. 94)

Fenwick v. Unemployment Comp. Comm’n p.91

Salon (Fenwick owner) enters agreement with receptionist where she gets % of profits instead of wage. Call themselves partners in agreement. He does not want her to be an employee, because he wouldn’t get the unemployment tax exemption.

Issue: Is she an Employee vs. partner?- All indications appear on a daily basis this is an employee- Sharing profits alone, w/o sharing liabilities/mgmt right = not enough.

Suggests not partners- Liability : Only Fenwick liable per their agreement- Management Rights : All control and management w/ Fenwick. - Initial Investment : She made NO investments into partnership.

o Could argue, that she invested her human capital. It is possible for one person to put in capital and the other person to put in labor. So this alone is not dispositive

- Control Total lack of joint control over business’s day to day affairs (even though both could terminate only Fenwick managed)

- Third Parties: Didn’t hold themselves out as partners. Strongest argument for partnership’s existence?

o They are sharing profits (receipt of shared profits is evidence of partners as a business, fact she gets 20% and he gets 80% of profits).

o But this looks more like a wage under UPA § 7(4)(B) Q3: How could you as a lawyer draft an agreement that appears to give control but leaves

Fenwick in control and is consistent with UPA § 18(e)?- He could agree he is the “managing” partner. Look at law firms. - Perhaps agree he had 80% of the vote and she has 20%, so practically he calls all shots.

Q4: How can Fenwick’s lawyer make sure he gets his property back after dissolution, assuming pship to beg. w.?

19

- 18(a): each partner will get their contributions back but agreement can also explicitly provide for this.

- He could also simply RENT his property to the partnership, so always the owner.

Partners vs. Lenders

Degree of Profit sharing/veto right okay if interest on loan & no day-to-day control

Martin v. Peyton p. 96

Investment partnership in financial trouble. It needs an infusion of cash. Three parties give it marketable securities it could use as collateral for bankrupt. - But in exchange these parties got veto over some of the speculative investments and

dividends of securities and had some investment rights, and inspection rights. o They have NO DAY TO DAY decision power, and NO RIGHT TO BIND them in

contract. - They have an option to buy 50% equity stake in the firm if they desire to do so,

o BUT not uncommon for creditors to have this option to take an equity stake in the firm, as incentive for them to issue a loan in bad states.

Is Peyton (Freeman and Perkins) a lender(s) or partner(s)? See UPA § 15 Lenders - If creditors, they get paid first. If partners, other creditors go first. If partners, also

jointly and severally liable for torts/breaches and jointly for all other debts. Why do these not make them de-facto partners?

- Profit share – Entitled to receive 40% of profits up to $500,000 and floor of $100,000o UPA 7(4)(d) Let’s you rebut the presumption if it is interest on a loan even if it is

profit sharing. This is merely repayment on the loan of 40% of profits so a degree of profit sharing is okay.

- They can force members of the firm to resigno Okay, b/c Court saw it just as another protective mechanism for worried creditors

- Veto right – why not?o Directly related to what the firm got in trouble in the first place was speculative

investments on foreign securities. Contrast with Cargo, when Cargo oversaw Warren was seen to be the principal in an agency

relationship. - Professor: DAY to DAY control of the business is lacking, but rather their veto rights

here were limited to speculative investments and dividendso Otherwise daily running of business left to partners. o No pervasive control.

Partnership by Estoppel

Rules

UPA § 16(1):- Representation to third party;- Consent by alleged partner;- Reliance by third party; and- Third party extends credit to the partnership on the faith of the representation

20

Hypo

What if H told Bank’s CEO that P was a partner, and based on P’s reputation, Bank lent money? - We would have to know if P consented to the representation.

Young v. Jones p.101

Plaintiffs put money in bank that loaned to another bank based on financial statement prepared by Price Waterhouse-Bahamas. They attempt to sue Price Waterhouse-US alleging they are partners.- Brochures just said Price Waterhouse and said offices around the world.

If partners, the US partnership would be J&S liable for Bahamas screw up. Court says not partners

- No showing that they relied on the brochure- No evidence they lent money based upon representation- Further, no act or statement of US partner indicating partnership with Bahamas

partnership.

Fiduciary Obligations of Partners

Default rule

UPA § 21: Every partner must account to partnership for any benefit, and hold as trustee any profits derived by him without consent from any transaction connected with partnership or use by him of partnership property

RUPA § 404- Duty of Loyalty

o Must account to partnership, including the appropriation of a partnership opportunity- Duty of Care

o Limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law

- (e): Doesn’t violate duty simply because partner’s conduct furthers his own interest

Limitations on modifying

Cannot restrict rights of third parties, e.g., can’t limit their obligations to third parties Cannot eliminate the duty of loyalty/care by contract RUPA § 103(b)

- (3) Duty of Loyaltyo Cannot eliminate Duty of Loyalty but ay identify specific activities that don’t counto All, or number specified, of partners may authorize or ratify otherwise violation after

full disclosure- (4) Duty of Care

o Cannot unreasonably reduce the Duty of Care

Relevance of Partner Status

All have fiduciary obligations its just a matter of degree Managing fiduciaries generally held to stricter standards because have more information

- Control creates opportunity for abuse- In the modern understanding, Meinhard may have been considered a limited partner

21

Taking an Opportunity

Rule

Opportunities are partnership property and cannot be taken without first disclosing to the partnership and giving them an equal opportunity to compete. UPA § 21; RUPA § 404(b)(1)

Meinhard v. Salmon p. 105

Salmon formed a partnership with Meinhard to manage the Hotel Bristol. As 20 yr. lease on building was expiring, Salmon negotiated to take the reversion (new lease) and develop a new building. Meinhard sues. - Parties had agreed Salmon managing partner and Meinhard who contribute capital.

Salmon get 60% of profits for 5 years, other partner get 40% and after that split evenly. - Gary was trying to lease the land, and not necessarily Salmon or Meinhard, so he

approached Salmon and they came to the agreement. o Meinhard was not given an opportunity to engage in the new lease.

Is this a violation of fiduciary obligation for partners?- Held: breach of “duty of the finest loyalty” to “coadventurer”- Sole Cause vs. Opportunity:

o Could try to argue this was “merely an opportunity” and not the “sole cause” o BUT from the facts, they would not have come into contact if it were not for him

managing the partnership. - Duty to Disclose

o He needed to at least inform the other of the opportunity. o Cardozo suggests must have to do more, but not realistic: “the thought of self was to

be renounced”…e.g. he should have invited Meinhard to join in Under RUPA § 404(e): Not a violation merely because done for partner’s benefit. (This gets

rid of Cardozo’s argument that must give up all sense of self.) But same result because:- Under (b)(1), opportunity belonged to partnership- Under (b)(2), acting adversely to partnership- Under (b)(3), competing with the partnership

What if Salmon had seen Gerry’s ad in the newspaper instead? Any obligation to notify Meinhard?- Connection with the partnership here is much more remote

o Mitigates argument violated the fiduciary obligation.- Agreement: Would be relevant if there was something in the agreement for this situation. - Equal Opportunity: Now could also say both parties had “equal” opportunity to learn of

this opportunity.

Sandvick v. LaCrosse

4 guys bought oil lease to sell. Lease paid for from business “JV” account and held in partnership’s name. Later, two bought top lease that came into effect when old lease expired. Other 2 sued on basis of violation of fiduciary obligations.

CoA concludes this is a Joint Venture (similar to partnership but more limited in scope and duration)- Meinhard could be seen as a Joint Venture under modern understanding

Conflict because once renewed, the two that will keep owning have a conflict with current partners that want to sell the lease before it expires. (They are acting adversely to others.)

22

Hypos

Mark and Norma are lawyers and they practiced as partners for a few years. One day someone comes and asks Mark to represent a wrongful death case, particularly because he heard how good Mark was. Can Mark take the client for himself and break the partnership?

Client came based on reputation, but knowing it came to the partnership law office. - Bare facts: Violate the fiduciary duty if he took the opportunity as his own.

o He must tell her of the opportunity. I expect this amount of money, and I’m planning on leaving and taking this client with me.

o Then she’d turn to the partnership agreement: they would try to split the value of that representation. Disclosure would force the parties to negotiate over the client

o If Mark had decided before she came in Look to see what the agreement is, if it could be dissolved by any partner at will

of any partner at any time or if it was for a fixed number of years. o If you decide to take an opportunity there is a common law duty to disclose.

Trading on the information for own benefit considered property of the firm, and once they’ve traded on the information they have duty to disclose

Suppose Peter approaches him in the sports club but knows he’s a partner with Norma- Norma: she’d argue that still came because of the partnership- She has equal right because it came to the partnership.

Suppose Peter approaches him in the sports club knowing he is a lawyer but does NOT know he is a partner.- Tough. If done strict like Meinhard would have a duty to disclose- BUT arguably could take it and setup on his own, because it didn’t approach him at the

firm or knowing he was a partner. In Real Life Look at the pship’s agreement

- Planning structure the partnership agreement to anticipate such issues- Compensation Eat what you killed (if tend to be more productive) as opposed to lock-step- Removal Requirement

Grabbing and Leaving

Rules for Analysis

Partner’s duty of loyalty (UPA § 21, Meinhard, Singer)- Duty of Loyalty (basically duty to faithfully serve principal) (Rst § 387)

o Duty to act solely for benefit of principal in ALL transactions connected with the agency

Agency rules RE using customer lists- Agent’s duty not to use lists of customers and other confidential info in competition with

former principal Rest 2d Age. § 396(b), Town and Countryo § 396(b): Agent is entitled to use general information and any names of customers

retained in his memory (from efficiency point of view not good idea not to let them take their skills with them, and not fair; so there are limitations on what they can do after relationship terminates.)

- Agent’s liability to principal for personal use of principal’s assets for profit if such use is predominant cause of such profits (Rest Ag. § 404)o But no duty not to compete after termination of agency relationship (Rest Ag. §

396(a)) Permissible v. Impermissible Conduct

23

- Clearly okay: Locate office space, negotiate merger with another firm, contact clients before leaving firm (after announcing departure), keep plans to leave confidential (Meinhard), negotiate with fellow partners, remind clients of right to have counsel of own choice, take desk files (personal notes/created yourself reviewing legal doctrines)

- Grey Areao Contact clients before announcing departureo Negotiate with associates

- Red Area NOo Take client files: client files = Partnership propertyo Deny plans when asked directly

UPA § 20: Duty to render true and full information of all things affecting partnership.

o Not inform clients of right to have counsel of own choice (i.e., stay with the firm).

Meehan v. Shaughnessy p.117

Partners leave law firm and take some associates and clients. - People : Invited 3rd partner to join and 3 associates secretly - Clients : Put together lists of clients they’d want to take.

o Created the list before they actually gave notice of leaving. o Prepared letter, gave notice leaving to partners, then sent the letters out considerably

before identifying who they were planning on taking. Agreement explicitly contemplated removal of clients : Departing partners could take pending

cases that came to the firm through their personal effort or connection, if paid a fair charge.- 3 months notice requirement but law firm waived it.

Court finds breached fiduciary duties to the partnership by- Unfairly acquiring consent from clients (no choice presented to clients)

o Wrong: Instead of saying we’re leaving and we’d like you to go with us. o Okay: Explicitly let them know have choice to stay with the firm.

- Maintaining secrecy about which clients they were taking / trying to takeo Violated UPA § 20 (Duty to render information)o Did not inform their old partners who they were contacting for a long timeo Denied they were leaving when asked

- Did not give their partners a meaningful opportunity to compete because of their failure to disclose

But, it was ok for them to get an architect, sign a lease, etc. Nor did talking about handling cases unfairly breach their duties because no evidence they

did so.

Expulsion

Expelling a partner is not itself a violation of the other partner’s fiduciary duties Freedom of Contract is respected: guillotine clause fine if in agreement

Lawlis v. Kightlinger & Gray p.125

Lawlis was a partner in law firm and became an alcoholic. Mgmt committee created treatment plan that said no second chance but they gave him one anyhow. Then he proposed his units of participation be increased and they expelled him by a 7-1 vote. Lawliss sued, claiming expulsion was unlawful.

24

Breach of partnership agreement (Breach of Contract) - When they told him they were going to hold a vote to expel him they took his files, this

was defacto expulsiono Held: Not expulsion because they still paid him

Breach of fiduciary duty – opportunism- Executive committee had the right to expel them within the terms of contract (guillotine

clause)- Because that was their agreement in K, court not holding them to the highest possible

fiduciary dutieso Good faith does not trump the terms of agreement.

W/o provision in K, what would he need to show for Breach of Fiduciary Duty?- Not acting in good faith

o E.g. His productivity was greater than what was being paid for Takeaway: Freedom to K extends to limiting fiduciary duties

- If silent default UPA/RUPA rules apply.- Strict fiduciary duties can be waive-able

Partnership Property

UPA § 25: A partner is co-owner with partners of partnership property- Such that, every partner has right to possess for partnership purposes but no right to

possess for any other reason without others’ consent- Right in property not assignable unless all partners assign their rights- Cannot be attached by creditors unless a claim on the partnership

o But, court can charge the partner’s interest and appoint a receiver to receive profits § 28

- Does not pass to heirs, etc.

What is partnership property?

CL & RUPA § 203: Property acquired by partnership is partnership property and not property of partners individually

§ 204: Partnership property if:- Acquired in name of partnership- One or more partners and indicates in instrument acting in capacity as partner and

partnership name appears in transfer document- Presumed if purchased with partnership assets, regardless of name or capacity- (d) Otherwise, presumed separate property even if used for partnership purposes

o If not acquired in name of partner with indication acting in capacity as partner

Partnership capital

Can contribute capital, special experience, etc. Capital account keeps a running total of equity ownership

- Allocation of profits increases capital account (as does capital contributions)- Allocation of losses decreases capital account (as do draws, distributions)

Indemnification for personal payments

UPA § 18(b): Partnership must indemnify every partner for any payments/personal liabilities reasonably incurred by him in ordinary course of business or for preservation of business or property

25

Legal claims are partnership property

Legal claims are property so if you sell interest, you also sell known/unknown legal claims- Unless fraudulent concealed by other partners

Putnam v. Shoaf p. 132- Π Sold 50% ownership interest to partners who assumed all liabilities. Later, discover

bookkeeper embezzled over the years. Π wanted to recover her 50% of judgment against bookkeeper.

- Held: Not entitled because the partnership owned the inchoate claim (a “chose in action” ) and Mrs. Putnam gave up her interest in the partnership.

- Principal : Partnership property (including legal claims) belongs to partnership, not the individual partnerso She’s no longer a partner so no claim to partnership property.o Exception : If fraud and the other partners knew and tricked her different outcome

Sales of property/ Transfers of rights

UPA § 24: Partner has rights to (1) specific partnership property, (2) his interest in the partnership, and (3) his right to participate in management

Sales of interest/property require consent of all partners

Cannot sell membership without consent UPA § 18(g) Cannot sell part of partnership assets because only the partnership can sell. UPA § 25

Removal of property contributed to partnership

Hypothetical: Partner wants to remove some of the equipment he contributed to the Salon partnership. Can he?- Doesn’t matter that he contributed them, once contributed them he needs to seek the

others consent, or he can dissolve partnership in which case the rules for dissolving partnership kick in

Assigning rights

Can assign rights to profits but not to specific property or management (unless consent by all others) UPA § 27- Can sell cashflow but if sold management rights the buyer would defacto be a partner

Assigning interest in partnership does not result in dissolution. RUPA § 503(a)(2)- But note: Under RUPA § 601(4), partners can expel member who transfers substantially

all of their interest

Rights of Partners in Management

Rights

Right to full information about partnership affairs UPA §§19, 20; RUPA §403 Right to be involved in management. UPA §18(e); RUPA §401(f) Right to bind partnership to 3rd parties. UPA §18(b); RUPA §401(c) Right to veto certain decisions. UPA §§ 9(3)

- Assign property in trust for creditors- Dispose of good-will- Any other act that would make it impossible to carry on partnership - Confess a judgment

26

- Submit a claim or liability to arbitration or reference- Make any other person a partner (consent of all req’d). UPA § 18(g); RUPA § 401(i)- Any act in contravention of any agreement between the partners. UPA § 18(h)

Partner’s authority to bind partnership

Act within usual way of business binds partnership (unless no auth & TP aware)- UPA § 9(1): Every partner is an agent of the partnership and the act of every partner

apparently carrying on in the usual way of business binds the partnership, unlesso Lacks the authorityo And, 3rd party is aware

Otherwise, need authorization from other partners to bind Nabisco v. Stroud

- Two partners run grocery store. One partner tells Nabisco will no longer be liable for more bread. Other partner buys more, then partnership dissolves.

- Here, both partners had authority to order. The only way to remove his authority is if they unanimously agreed. They didn’t, so he could order more bread and bind the partnership. o One partner cannot unilaterally remove power from another partner.

- If he had ordered shoes instead of bread, partnership not bound because not the usual way of business.o § 9(2): Act not apparently for carrying on business of the partnership in the usual way

does not bind the partnership unless authorized by other partners. (Unless Walmart that sells both groceries and shoes…)

- To effectuate, would have to dissolve partnership and notify suppliers to escape liability.- Problem here is, they are stuck in a deadlock. Always avoid even numbers! Or provide

for a tiebreaker.

Voting

Majority vs Unanimous

In ordinary course of business = Majorityo § 18(h): “Any difference arising as to ordinary matters connect with the partnership

business may be decided by a majority of the partners.” Contradicting partnership agreement = Unanimous (unless agreement says otherwise, Sidley)

o E.g. Admitting a partner, or partners voting to increase their drawo § 18(h): “No act in contravention of any agreement between the partners may be done

rightfully without the consent of all partners”

Allocation of votes

By default voting done by partners not by capital accounting. § 18(h)- But note: partnership agreement could say go by capital contributions

Deadlock situations

Need a majority to change ordinary course of business, so if Status Quo remains in effect if deadlock situation.- Note: Always design structure so this doesn’t happen!

Summers v. Dooley p.142

27

- Summers and Dooley had equal stakes in trash collection partnership. Summers decided that they needed a third man, but Dooley disagreed. Summers hired a third man anyways, paid him himself and then tried to make the partnership reimburse him for it.

- Court says hiring someone else is NOT for benefit of the partnership. The default position was that they did NOT hire anyone else.

- Default Rule: 18(h) “Any differences arising as to ordinary matters connect with the partnership may be decided by a majority of the partners; but no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners. “o This requires a majority vote, and Summers doesn’t control a majority (UPA § 18(h))o It is manifestly unjust to permit recovery of an expense which was incurred

individually and not for the benefit of the partnership”- Who sought to change the “status quo”

o In previous case, status quo was transacting with Nabisco: in order to flip from norm of buying to not buying he had to get a majority vote.

o In this case the status quo was that if they would hire help they would pay out of their own pockets, and now trying to make partnership pay. Without agreement of majority (in this case both) they can’t change ordinary

business- What if hired help was not paid at all and seeking claim against partnership?

o Then from perspective of employee he could make the case for apparent authority. Problem ABC are partners in a grocery store. Charles has hired son. Can A and B fire son?

- If firing Don is an ordinary business decision that partners usually make collectively then A and B can out vote C and fire o Question is, is this part of the ordinary business? Then majority of partner vote.o But of course if the partnership agreement said that only C can hire help then this

would control

Partnership Agreements can significantly deviate from default

Partnership agreement can specify different rules for voting (even getting rid of unanimity requirement)

Sidley & Austin v. Day p.144- After the merger of Sidley with Libman firm, Mr. Day was forced to share his

chairmanship of the DC office with a Liebman partner, so he quit. During merger, they had promised no partner would be worse off.

- Freedom of K. o The partnership agreement said all the decisions would be made by the executive

committee, so he can’t say later that excluding him is fiduciary breech because he accepted those terms.

o Exceptions: amending partnership agreement, merger, etc., however is his vote was not pivotal.

o If there was not the fact that a majority vote was all that was needed he may have had a better argument (by default all partners would be needed to vote for it.) Even if they had disclosed it, it vote would not make a different.

- Derogating from Default by Contracto Sidley illustrates the extent to which courts allow partnership agreements to derogate

from statute:

28

Use of executive committee to make most firm policy decisions Unequal voting and management rights Use of majority approval for matters requiring unanimity per statute (e.g., merger,

admission of new partners, amendment of the partnership agreement.)- Why give executive committee such power:

o When a firm grows very large, decision making becomes more complex, and you can have collective actions problems, and deadlocks so by delegating it to a smaller subset of partners you can mitigate the problems.

o These partners may have expertise that junior partners wouldn’t have. o They tend to be the people that make important clients happy.

Partnership Dissolution

Timeline

Dissolution The Winding up Period Final Termination- Dissolution is the “change in the [legal] relation of the partners caused by any partner

ceasing to be associated in the carrying on” of the firm’s business. UPA § 29o Dissolution is not the same as going out of business

- “Winding up”: The process of shutting down post-dissolution (see, e.g., UPA §§ 30, 27).

When can a partner dissolve the partnership?

Every partner has the power, but not necessarily the legal right to dissolve the partnership. Rightful causes of dissolution. UPA § 31

- By termination of a definite term or particular undertaking specified in K- By the express will of any partner when no definite term or particular undertaking- Express will of all partners when term (before or after expiration)- Expuls ion of any partner in accordance with agreement- Any event makes unlawful to continue business or partnership- Death of any partner- Bankruptcy of partner- Court Decree (Judicial dissolution)

Judicial Dissolution

May seek this if it gets not very nice and want judicial help dividing assets. Or, not clear at will partnership and don’t want to risk being held in breach

Grounds for judicial dissolution

UPA § 32 : On application by or for partner, court shall decree dissolution where a partner is:- Declared a lunatic- Becomes in any other way incapable of performing- Guilty of conduct tending to prejudice carrying on of business- Willful or continual breach of partnership agreement

o Or, otherwise conducts self in matters relating to partnership that not reasonably practicable to carry on the business with him E.g. deadlock. Owen

- Can only be carried on at a losso Unless “bad” partner’s fault and bad partner is seeking dissolution. Collins

- Other circumstances render dissolution equitable

29

Benefit of judicial dissolution

Court has wide discretion to create an equitable conclusion - E.g. going beyond the K in the interest of fairness Owen

Prevents being accused of wrongfully terminating partnership , Even if appears to be “at will” not always clear not implied term

What is the legal effect of the order for dissolution? What is the likely practical effect?- Legal Effect:

o Break off the assets and sell them piecemealo But before the court does that the parties could come together and bargain.

- Practical Effect: Buy each other out: Either partner could buy the other partner out. o It is kind of a deal-making measure.

Owen v. Cohen p.150

At Will Partnership is profitable but not getting along. One partner wants to have gambling and the other doesn’t. One partner doesn’t want to do the non-managerial work either. Deadlock on many important issues. Owen made a loan of $6,900 to the firm, which they had agreed would be paid out of profits. Owen seeks judicial dissolution. - D: “that it is not reasonably practicable to carry on the business in partnership with him”- F: “Other circumstances render a dissolution equitable.”

Court has wide discretion to create an equitable conclusion: - Since the one partner was the source of the hostility he should not be entitled to the

benefit of the original agreement and goes beyond contract in the interest of fairness: awarding him back the loan, even though it said that it would only be paid out of profits.

Why does Owen sue for dissolution rather than simply declare dissolution?- B/c relations are so bad; it may be very difficult to get money back.- He might have been accused of wrongfully dissolving the partnership

o If he wrongfully dissolved, the other guy could keep carrying on the business

Collins v. Lewis p.153

50-50 partnership in cafeteria business. Collins is contributing money and Lewis is the manager/businessman. Definite 30 year term. Startup costs greater than expected.

Collins seeks judicial dissolution because dissolving would clearly violate the agreement and he would be subject to negative consequences. § 38(2)

Collins is trying to say the firm is unprofitable and the firm disagrees with that. - Court refuses dissolution because it’d be profitable if he’d only give it more money.

o Basically saying he is the cause of the unprofitability of the firm. Costs can be underestimated and he assumed that liability without limitations.

o Lewis’s responsibility is to pay the agreed $30K a year, and he did so when you factor in that he paid expenses that Collins wrongfully refused to pay.

Page v. Page p.158

Brothers partner in linen supply company. Both partners put in money to start. In past businesses, they had repaid these loans with profits. Business was unprofitable but becoming profitable. One brother alleges other wants dissolution in bad faith so he can take over the business.

Lower court says for a term because to be paid out of profits and when such an agreement is made, the partnership is for a term reasonably required to repay the loan.

30

- However, CoA reverses and finds At Will because you have to show explicitly intended this…not just hoped that loan would be paid back out of profits.

- Therefore, brother has power to dissolve but if found to have breached his fiduciary duties and appropriate the new partnership, the dissolution would be wrongful.

In Lawlis, the court said it was good faith so long as they paid the excluded partner what he was owed. Is this consistent?- There court seemed to say he was paid FMV. If he hadn’t, court would have likely found

a good faith violation. If brother wanted to take over and run with new partner, what should he do?

- The facts don’t support judicial dissolution.- They can’t agree on the value, so get an appraisal and try to bargain with brother.

What if he wants to liquidate and pickup the best clients?- He can dissolve because at will partnership. - But client list belongs to partnership…he can’t just take…it’d be analogous to trade

secrets under agency principals.o He’d have to get his brother’s consent and negotiate payment to him.

Consequences of Dissolution

Actions after dissolution

After dissolution, the partnership must be wound up , absent agreement among the partners to carry on the business

Assuming that the business will not be continued, the winding up process generally contemplates that the firm’s assets will be distributed to the partners.- Authority of partners to act on behalf of partnership terminated except in connection with

winding up of partnership business. UPA § 33; RUPA § 804 Can continue by the acquisition of assets/business by some partners and continuation Can continue per explicit provision in partnership agreement that the firm continues w/o

existing partner. - Technically a new partnership- Old creditors automatically become creditors of new partnership- Departing partner:

o Entitled to accountingo Interest from date of dissolution in event of unreasonable failure to payo Remains liable on all firm obligation unless released by creditors. UPA § 36

- New partners liable on old debt, but limited to partnership property…not personally liable beyond that.

Can continue following wrongful dissolution by non-breaching partners

Rules for distribution

UPA § 40: When settling between partners, assets distributed (in order) to:- Creditors other than partners- Partners other than capital and profit (e.g. loans)- Partner capital- Profits

Choice between continuing business vs. liquidating is crucial

Asymmetric information problem

31

- Partners have more information about the value of the partnership than a third party purchaser.

- Lemon car problem: buyers discount across the board.- Firm sold piece meal is likely to be discounted.

Firm may be worth more as a going concern rather than be broken up. Intangible characteristics: Goodwill that customers have toward it, partner’s expertise, etc.

Acquisition of assets/business by some partners is fine

It’s fine after court orders dissolution for remaining partners to buyout other partner at a bid. Prentiss v. Sheffel p.163

- Business can continue with a subset of partners. 3 member partnership and a shopping center. 3 partners, Sheffel and Iger own 85% of the firm and another party isn’t doing well. Firm making losses and each required to contribute their part of their losses, and the other partner didn’t pay.

- Trial court finds: partnership was dissolved b/c they “froze other partner out (b/c he is no longer participating in the decision-making of the firm. It doesn’t have a moralistic or wrong tone.) Court orders dissolution.

- There is an auction and the two partners that want to carry on bid and win. Court says this is fine.o Structurally other partner wasn’t precluded from participating. He benefited from the

fact they made the bid because otherwise the sale price would have been lower.

Wrongful Dissolution Continuation Option

Early dissolution of a term partnership is a “wrongful” dissolution

Subjects the wrongful dissolver to damages for breach of the partnership agreement UPA § 38(2)(a)(II)

Prevents her from participating in the winding up process. UPA § 37

Remaining partners have absolute right to continue the business

UPA § 38(2)(b): Partners not wrongfully causing dissolution have right to carry on partnership for remainder of original term even if no agreement covering- May continue to use partnership property for this purpose

Wrongfully dissolving partner’s entitlement if continued

UPA § 38: If the business is continued, the wrongfully dissolving partner is entitled to:- The fair value of his or her share in the partnership, minus any damages caused by his or

her breach of the agreement and minus her share of the business’ goodwill; in cash or secured by a bondo Goodwill: Extent to which company is worth more than its net assets

- Wrongful partner released from any outstanding liabilities Compare RUPA §701

- Wrongfully dissolving partner entitled to her share of assets’ value (the greater of liquidation value or going concern value) minus damages

- Does NOT exclude goodwill from calculation of such partner’s interest

Pav Saver v. Vassco Corp p.164

P-ship for permanent term to manufacture paving machines using PSC’s patents and Vasso’s financing. P-ship agreement has liquidated damages clause should the p-ship terminate and

32

provides that the P-ship’s license to use PSC’s trademarks and patents would go away upon expiration. PSC wrongfully dissolves. Vasso wants to continue as permitted by UPA § 38(2)(b)

Liquidated Damages Clause - Liquidated damages = 4 times gross royalties received by PSC in 1973, payable in 10

equal annual installmentso PV = $384,000 according to trial courto Business valuation = $300,000 and PSC’s interest = $165,000 (excludes goodwill b/c

wrongfully dissolved partnership) Clause 3: IP to be returned to PAV-SAVER when the p-ship ends

- But court finds that Vasso couldn’t carry on without the IP and the statute provides that right, so the provision requiring the return of their IP is ineffective and Vasoo can keep manufacturing with the trademark/patent.

- Further, no value assigned for IP because that is goodwill and the wrongful party doesn’t get value for this. o Note: IP no longer considered goodwill. Accounting rules require reporting them

individually on the balance sheet.o Also under RUPA § 701, the wrongful partner does get goodwill so would have been

credited for value of patents. Dissent: The UPA provides that parties can depart by agreement, and here the IP return

requirement is their agreement that neither party could continue the p-ship if it was wrongfully dissolved.

Default rules vs Contract (which prevails)- Regarding trademarks and patents

o Court says, it’s nearly impossible to continue the business without the trademarks, so the court found to give them the right to continue the partnership, they had to ignore the contracts.

o In order to continue with the business the contract should be ignored - Regarding liquidated damages

o Contract prevails on the liquidated damages, follow what was followed for in the contracts.

Sharing losses

Default rule = losses follow allocation of profits

UPA § 18(a). But, can be modified by agreement § 40(d): "partners shall contribute . . .the amount necessary to satisfy the liabilities"

Exception (UPA only): Service partnerships

In service partnerships (where agreement says one partner contributes only labor), the laboring partner does not share in losses by default.- Explicitly rejected in RUPA § 401 (comment)

Kovacik v. Reed (p. 179)

Capital contribution: Kovacik $10,000; Reed $0, labor. Profits: equally divided; no salaries. 10 months later--Kovacik dissolves on grounds partnership is losing money. They were silent on matter of how to share losses and took no salary.- Loss = $8,680 Remaining assets = $1,320

33

Court creates exception to default rule (share losses) because Reed only contributed services to the partnership.- Kovacik Rule: When one party contributes only labor no sharing of net losses by

defaulto Rejected in RUPA § 401

- “Where one party contributes money and the other contributes services, in the event of a loss each would lose his own capital—the one his money and the other his labor….in such a situation the parties have, by their agreement to share equally in profits, agreed that the value of their contributions—the money on one hand and the labor on the other—were likewise equal; it would follow that upon the loss . . . of both money and labor, the parties have shared equally in the losses” (p. 180)

What concerns might the capital-only partner have about the Kovacik rule?- The service only partner would have NO downside on losses: so service only partner

would perhaps want to take on WAY more risk.o Money partner is not running the business, the service partner is.o Service Partner: Incentive to take on substantial excessively risky ventures, or

perhaps not work hard enough to save business if runs into trouble.- If they know this going into venture: try to contractually impose greater risk sharing of

losses, and appropriate incentives for collective profit maximization for entire firm.

Buyout Agreements

Malpractice not to recommend

Lawyer who fails to recommend a buyout agreement for clients forming a partnership (or LLC or close corporation) is committing malpractice- Liquidity is a special problem in small businesses (because not traded publically)

Key negotiating points

Trigger Events- Death, disability, retirement, breach of partnership agreement, etc.

Obligation versus option to buy- Liquidity important

o Who has obligation to buy departing partners: the firm? need outside investors? Price

- Agreement- Appraisal (Market Value, but they’ll disagree about it, so how it’s done important)- Book value (what’s recorded in firm’s books)- Formula (e.g., 3 times average earnings over last 3 years)

Method of payment- Cash, installments, (time value of money) interest

Protection against debts of partnership Procedure for offering either to buy or sell

- First mover sets price to buy or sell, first mover forces others to set price

Parties can contract buyout formula that is more/less than FMV

Business can be worth more than book value due to goodwill, etc.

34

G&S Investments v. Belman (p. 183)

Real estate partnership (Century Park) to run apartment complex. Buyout clause said it would be trigged with death of a partner. Nordale died and G&S decided to apply the buyout clause instead of seeking judicial dissolution per § 38(2)(b)

This is a limited partnership, but the general partnership statute applies because Nordale was a general partner.- The Uniform Limited Partnership Act (ULPA) did not speak to the specific issue

presented. UPA § 6 provides that it governs limited partnerships as well Buyout formula in contract: Buyout price = Nordale’s capital account plus average of prior 3

years earnings Nordale’s estate challenge the buyout clause: “capital account” is ambiguous

- Market vs. book value of capital account? Market Value > Book Valueo Book value: Historic Costo Mkt value: Fluctuates.

- Court: Capital Account refers to how treated in the partnership books, which under GAAP is cost basiso Absent fraud or duress, courts will enforce Buyout clauses even if for more/less than

FMV of business at time of death.

Limited PartnershipsGeneral partnership liability

J&S for torts, breach of fiduciary duties. UPA § 15 Jointly for all other debts/obligations of partnership Corporate Liability Compared MBCA § 6.22(b): “… a shareholder of a corporation is not

personally liable for the acts or debts of the corp except … become personally liable by reason of his owns acts or conduct.

Formation

A partnership formed by two or more persons and having one or more general partners and one or more limited partners

Requires filing documents required by statute, usually with the secretary of state.

Structure

Both persons and other business entities can serve as partners. General Partner: runs the business, manages day to day affairs

- But note that general partner can be a corporation, e.g., private equity fundo Shareholders behind that corporation are protected as in Pav-Saver.

Limited Partner: passive investor; may not partake in management

Liability in Limited Partnerships

General Partner = Full personal Liability Limited Partner = No liability, unless take on the kind of control a general partner has.

If exercise too much control, limited partner will be treated like general partner

Holzman rule: “A limited partner shall not become liable as a general partner UNLESS in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business ” p197.

RULPA does it differently and extends liability only to extent TP reasonably believed GP:

35

- RULPA § 303(a): Only limited partners who participate in control can be held liable AND

- They can be held liable only to those who reasonable believe that they are general partners

RULPA § 303(b) Examples of conduct not deemed to constitute participation in control (safe harbors):- Just consulting and giving general advice

Holzman v. De Escamilla p.179

Farming business. 2 limited partners were supposed to be just investors and Escamilla was supposed to be the general partner. 2 LP’s had a lot of say as far as what crops were planted and could veto the general partner. (In order to spend money had to get 2 of the 3 partners to sign off on it.)

Consequence: They became liable for partnership debts as if they were general partners- Agency : Cargill & Warren: Creditor assumed liability as principal b/c creditor assumed

too much control and therefore became principal under agency law. - Partnership : Can be liable as partner if takes too much control.

o With control comes potential liability Would two LP’s be liable to the creditor under RULPA in previous case?

- Question: Did the creditors believe / have reason to believe they were general as opposed to limited partners.o Third party creditor seeing them write out checks might give you reason to believe

general partners. Writing checks could be consistent with passive investor

o Limited partners replacing others. In actual case probably not enough to show o Could argue that the creditors only hear “consultation and advice” but if they had

heard them calling the shots.- What if general partner had said, “Those guys are limited partners, but they think they

can give me orders and I don’t have a choice to do what they say.”o Then creditors have NO reasonable basis to believe they are general partners. o BUT perhaps go by control anyways, and ignore statute.

Limited Liability Partnership

True general partnership . . . but with limited liability

RULPA § 306(c): “An obligation of a partnership . . . is solely an obligation of the partnership .. … A partner is not personally liable … solely by reason of being … a partner.”

State variations: Contract vs Tort

Many states restrict the liability limitation to tort actions. Contract Liability remains unlimited.

Rules are state based, we’ve just been looking at general expressions of default rules: must look at rules in your particular state

Formation

Formed by filing a “statement of qualification” with secretary of state

36

- Convert a general partnership to LLP by filing- Conversion does NOT cause a dissolution; See RUPA § 201(b)

37

CorporationsThe Universe of Corporations

Public (publically held)- Characterized by a public secondary market where shares are listed for traded e.g., NYSE

Close (closely held)- Characterized by absence of a secondary market for its stock

o May not be able to sell your shares without others consent- Often relatively small # of shareholders who actively participate in management- May display many partnerships’ characteristics

Limited Liability Partnership (LLP)- General Partnership with limited liability; filing required

Limited Liability Company (LLC)- Hybrid; flexible (but less so in some states); can be taxed a partnership (check the box)

Limited Partnership- Limited liability for LPs if they do not participate in control; taxed as partnership; can use

corporation as general partner so no individual is personally liable. S Corporation

- A corporation that elects to be taxed similarly to partnership (single tax, pass-through of losses); limits on number and types of shareholders and capital structure.

Partnership / Corp comparison chart

Partnership CorporationFormation Informal; UPA Formalities required; Articles of

incorp; By-laws; Board of Directors; officers; minutes; elections; filings.

Limited Liability No, but can bargain for it; use LLP; buy insurance

Yes, but creditors may seek guarantees

Free Transferability No, but can agree to allow; continuity agreement

Yes, but can restrict if appropriate; need agreement

Continuity At will—unless agree on continuity;Need an agreement

Indefinite, but can limit; need exit agreement

Centralized-Management

No. Each partner an agent; but can use executive committee and limit authority by agreement and notice.

Yes, but may want to modify to prevent freeze-out.

Cost Zero, but should hire lawyer Need lawyer; filing fees, etc.Default Rules Extensive More extensiveClient Perception Hard to understand; need to use

entity concepts; low prestigeEasier to understand, but misleading; high prestige

Flexibility Great Not quite so great and awkward in some instances

Tax Single; losses can be used by partners

Double on distributed earnings; losses only useable by corporation.

38

Key Features of Corporations

Legal personality

The corporation is an entity with separate legal existence from its owners- Possesses (some) constitutional rights (e.g., corporation can’t be forbidden from doing

business in a state, has some free speech rights)- Separate taxpayer

Limited Liability

See e.g. MBCA § 6.22(b)- A shareholder of a corporation is not personally liable for the acts or debts of the

corporation except that he may become personally liable by reason of his own acts or conduct.” E.g. Piercing the Corp Veil (PCV)

Separation of Ownership and control

Exception : sometimes very large shareholders may exert significant influence DGCL (Delaware Corporate law) § 141(a) (Default Rule)

- “The business and affairs . . . shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter, or in its [cert of incorp]”

Shareholders do elect the directors on an annual basis Rule of thumb

- Boards ACT- Shareholders REACT (at most)

Shareholders entitled to vote on: (default rules, could put something else in the charter)- Election of directors DGCL § 211- Any amendments to the articles of incorporation (i.e. corporate charter found document)

and, generally speaking by-laws (DGCL § 242, 109)- Fundamental transactions (e.g., mergers DGCL § 251) or selling major assets, or

acquisitions.o Done to prevent abuse by self-dealing.o Corporate officers might do “empire building” that doesn’t make sense for owners.

- Odds and ends, such as approval of independent auditors in states adopting Model Business Corporation Act (MBCA)

Liquidity

Mainly applies to public corps Secondary trading markets (primary market is the IPO that happens once)

- E.g. NYSE and NASDAQ

Flexible capital structure

The permanent and long term contingent financial claims on the corporations assets and future earnings issued pursuant to formal contractual instruments call securities

Many ways to package such claims e.g., stocks and bonds or bank loans.

Contingent Financial Claims: Debt v. Equity

Bonds and other debts securities typically consist of two distinct rights

39

- 1. Entitled to receive a stream of payments in the form of interest over a period of years- 2. At the end of the bond’s prescribed term (i.e., at maturity) entitled to the return of the

principal- Creditors: NOT owners

o They go before the stockholders in collecting but lack control rights Equity securities (i.e., stock or shares)

- Represents “the units into which the proprietary interests in the corporation are divided”- Residual claimants : equal right to participate in distribution of the firm’s earnings.

o In the event of liquidation, to share equally in the firm’s assets remaining after all prior claims have been satisfied

- A limited right to participate in the corporate decision-making by electing directors and voting on major corporate decisions.

Shareholders have two rights

Cash flow right (right to receive dividends, if not paying now get when it liquidates) Control right (right to vote) Can have these split: could own 30% of the equity but 80% of the vote

The Incorporation Process

Paul v. Virginia US 1869 : A state may not exclude a foreign (another state; alien is another country) corporation engaged in interstate commerce.

Delaware’s Preeminence

No Minimum capital requirements- Vs. in Sudan need 500,000 to start one.

Need only one incorporator (a corporation may be the incorporator) Favorable franchise tax in comparison to other states Favorable tax rules for companies doing business outside of Delaware

- No corporation income tax- No sales tax, personal property tax, or intangible property tax on corporations- No taxation upon shares of stock held by non-residents- No inheritance tax upon non-resident holders

Corporation can keep all of its books and records outside of Delaware and can have a principal place of business/address outside of Delaware

Highly competent judiciary in company law and extensive case law.

The Incorporation Process

In practice, most lawyers use an incorporation service to handle paperwork- Service will also act as necessary registered agent

1. Draft Articles of Incorporation- Mandatory terms: DGCL § 102(a)

o E.g., naming the corporation, address of registered office, nature of business (i.e. any lawful act or activity so as not to pigeon hole you and have to amend the articles), number of authorized shares, preferences and rights for different classes of shares

o If imposing liability on shareholders or limiting director liability, need to be in articles.

- Optional terms DGCL § 102(b)

40

o E.g., Delaware corporate code: default is majority voting, but they can mandate supermajority for certain issues if they want.

o Limitations on duration of corporate existence 2. Incorporator files Articles with Secretary of State 3. Upon receipt of Articles and fees, you’re incorporated pursuant to DGCL § 106

Post-Incorporation Activities

Hold organizational meeting (DGCL § 108)- If necessary name directors (hold office until first annual meeting of shareholders)- Adopt Bylaws (DGCL 107, 109); corporate governance document- Appoint officers

Issue stock (DGCL § 151) Some contracts formed pre-incorporation (see, e.g., Southern-Gulf Co No 9 Inc. v. Camcraft,

Inc.)

LiabilityPromoters and the Corporate Entity

Π corporation not formed when K entered into, but corporation still held to K. Southern Gulf Marine Co. p.202 (Pre-incorporation contract) (Rod: didn’t read this)

- Plaintiff Corporation had not been formed before contracts were entered into with it. Defendant tried to get out of the contract with the corporate plaintiff. Defendant’s true motive was that assets had appreciated.

- Both Defendant and Plaintiff’s will be held to the contract- What if corporation was never formed?

o They could still sue the promoter of the corporation under the understanding that he’d bring his best efforts to bring the corporation into existence.

- If Representing Ship Builder what terms to take into consideration corporation had not been formedo Explicit insurance that promoter would actually complete corporation and absent that,

that he’d be individually liable.

Limited Liability of owners (except for PCV)

DGCL § 102(b)(6): The stockholders of a corporation shall not be personally liable for the payment of the corporation’s debts except that they may be liable for reason of their own conduct or acts- 1. Shall not be personally liable for losses greater than the amount invested in the firm- 2. The corporation’s debts are a corollary of the corporation’s status as a separate legal

person- 3. Except that they may be liable for reason of their own conduct or acts

o Encompasses “piercing the corporate veil” PCVo Data shows courts more likely to pierce the corporate veil in contract, but it is quite

rare to do so.

Limited Liability Praises and Problems

Praises

41

- Leads to more capitalization, people willing to invest.- No need for shareholders to monitor the firm, etc.

Problems- Externalities

o Might allow entrepreneurs to avoid some of the social cost of their activities b/c they won’t ultimately be held liable

Piercing the Corporate Veil (PCV)

Alter-Ego Liability

Recovery is against the shareholder of the corporation Look at control at time the K/act was done. In re Silicon

Sea-Land test (individual as shareholder)

Unity of ownership and interest so that separate personalities of the corporation and shareholder no longer exist. Sea-Land- Failure to maintain records or observe corporate formalities - Commingling personal and corporate assets- Undercapitalization - One corporation treating assets of another as its own

Not to do so would promote fraud or injustice - Generally not looked to in tort cases

Subsidiaries (only when corporate shareholder)

Note: Just because parent liable for subsidiary as alter ego, does not mean that every other subsidiary liable for actions of subsidiary. Sheffield- There is no respondeat superior between subsidiaries.

When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder, the corporate form may be disregarded in the interest of justice”- Consistent with Sea-Land except no requirement of fraud in Delaware (maybe

subsumed into “interests of fairness”).o Particularly in tort caseso But, 2nd prong may be required in other jurisdictions

- For parent to be liable for subsidiary, totality of circumstances must show substantial domination. o Common officers/directorso Consolidated financial statements/tax returnso Parent finances subsidiaryo Parent incorporated subsidiaryo Parent pays salarieso Only business comes from Parento Parent uses subsidiary’s property as its owno Daily operations not kept separate

Parent corporation vs. Individual distinction

If it is an individual shareholder: require Sea-Land: unjust, unfair etc. But for corporations, court drops the 2nd prong because it is a parent corporation owning a

subsidiary of any percentage

42

- In Delaware, you may need 2 nd prong in other jurisdictions. Justification: In case of individual you are going after their individual assets whereas owners

of the parent corporation are shielded.

Justification: Tort vs. Contract distinction

Is there a sound reason to treat them differently when deciding whether to PCV? Contract Creditor: Easier to negotiate things up front, check firm’s creditworthiness. Tort Interaction: You can’t foresee it so don’t require showing of fraud/injustice.

Note: Can insulate from PCV by having Limited P’ship with Corp General partner

Limited Partnership Mr. X and Y are Limited Partners. Corporation is General partner.- Mr. X and Mr. Y are directors and controlling shareholders and make all the decisions

(day to day control) for the corporate general partner.- They run the day-to-day affairs, but if they have respected ALL corporate formalities

(holding minutes, no mingling funds, etc.) then the court will respect the distinction and will not be held liable.

Frigidaire Sales Corporation vs. Union Properties Inc. p.211: “When the shareholders of a corporation, who are also the corporation’s officers and directors, conscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or manifest injustice is perpetrated upon third persons who deal with the corporation, the corporation’s separate entity should be respected.”

If X and Y were not limited partners, just officers and directors, Alter ego theory could try to hold them liable.- Control and Unity of interest with corporate general partner

If just limited partners: can be held liable because they controlled day to day affairs of the partnership. (Standard control issue)

Sea-Land Services Inc. v. Pepper Source p.194

Contract claim. P is arguing all the corporations are alter-egos of D and one another. P won summary judgment in lower court and D appealing here.

Why reversal of summary judgment of SL? - Plaintiff’s argument is if the veil was not pierced P couldn’t collect on judgment.- Court: If that were sufficient, then the test would collapse, because in any case it is unfair

if P doesn’t win.- There must be: unjust enrichment on the part of the D if the P were not compensated. So

an allegation that the D deliberatively used corporate structure to escape its creditors.o Level of fraud burden of proof is lower: but need some element of fraud’t intent.

Why is the failure to comply with corporate formalities relevant?- With contract creditors they can inquire about a firm’s credit worthiness, much easier for

3rd party to investigate their credit worthiness with the books and records.o Indicates a potential disregard for creditors’ interests: If you play fast and loose with

formalities, maybe we expect that you played fast and loose with your bills tooo We want to encourage a world where creditors can investigate buyer’s

creditworthiness 1st prong met

43

- He didn’t even have a personal bank account, always used corporate.- Did not hold meetings.- He doesn’t even remember corporations creating bylaws.- Ran all corporations out of single office using same phone line, expense accounts etc.

2nd prong met on remand- Able to show that D was engaged in tax fraud, using personal funds for benefit, and

promised shipping bill would be paid while at the same time stripping corporations of assets.

In re Silicon Gel Breast Implants Products Liability Litigation p. 204

Parent Bristol wholly owns its subsidiary MEC, a corporation. Breast implant lawsuit wants to go after the parent. Piercing the corporate veil, arguing the controlling shareholder should be held liable for injuries caused by wholly owned subsidiary.

***See test above Corporate Formalities (goes to the first prong)

- Negotiated the purchase of two corporations in Medical Engineering’s name- Bristol-Myers made the major (and even some of the minor) financial decisions regarding

Medical Engineering- Bristol-Myers set employment policies and wage scales for Medical Engineering

Advice- Hold meetings, make sure majority of the board of directors are different, allow

subsidiary to determine its own wage rates, and major financial decisions, etc. - BUT delicate balance Parent as the sole owner has an interest that it is run well, but if

it exerts too much control could be held liable. Timing:

- Look at control at the time the harm was done Any indicia of fraud?

- No fraud here, no dividedness de-capitalizing- Insured them for 2 billion.- Generally tried to maintain its financial health- But, Bristol Myers stripped MEC of its assets

Why does the court reject summary judgment for Defendant BM?- In Delaware at least, not necessary to show fraud if the subsidiary is alter ego.

o First prong is enough in a parent subsidiary situationo And they may be nicer in torts as opposed to contracts. May mater

- Even if fraud was required, they vouched for products with their name in brochure but didn’t permit subsidiary to retain sufficient assets to pay for injuries (triable issue)

Enterprise Liability

Seeking to hold all the corporations liable for the acts of the other , under the theory that they’re all alter egos of the other, so they do not separately exist.

Agency is the basis of Enterprise Liability, not fraud.

Evidence needed

Such a unity of interest between the two (or more) entities that their separate existence has de facto ceased- Funds mingled across corporations- Decisions were made jointly,

44

- Failed to follow corporate formalities: didn’t maintain separate minutes Treating the two entities as separate would sanction fraud or promote injustice

- Without this, courts won’t look beyond the formalities of corporate structure…

Walkovszky v. Carlton p.207

Taxicab driver injures person. 10 separate corporations each owning 2 cabs controlled mainly (more than a majority stake owned) by one shareholder (controlling shareholder). Each cab only had the minimum required amount of insurance of $10,000 per cab (20,000 per corporation, and the medallions are judgment proof.)

Complaint: having the cabs organized across 10 corporations constitutes a fraud, because of structure.- Therefore he should be able to sue all corporations (enterprise liability) and to the

shareholder (to pierce the corporate veil) and hold owner personally liable.- Needed to: make particularized statements that the D’s and business were actually doing

business in their individual capacities, shuttling their personal funds in and out of the corporation

Enterprise Liability Theory: - Allows claimant to proceed against assets of other corporations that are involved in

the business “operated … as a single entity, unit and enterprise … and all are named as defendants”

- Plaintiff’s argument: Multiple corporate structure was a fraud on the public Court’s response: o Agency is the basis for enterprise liability not fraud

- Enterprise liability is horizontal while PCV is vertical!

Challenging Business Acts

Ultra Vires Acts

Purposes of Corporations

A business is organized and carried on primarily for the profit of stockholders. Specific corporate purpose defined in Articles, but they are all written broadly now

- MBCA §3.01: “any lawful business unless a more limited purpose is set forth in the articles of incorporation”

Definition

Acts beyond the power of the corporation to perform - E.g. Illegal acts, acts lacking a business purpose

Consequences

Possible Consequences DGCL § 124- Action by attorney general to dissolve corporation- Action by or on behalf of corporation against the shareholders who ordered the action- Action by a shareholder to enjoin the action

Charitable Donations

Ok if reasonable amount in relation to company value, not pet charities, some benefit to corp.- If charity is recognized, generally have not held it to be Ultra Vires - Not recognized charities, greater taste of problems or issues of self dealing

45

A.P. Smith Mfg. Co v. Barlow PG 282- Decided via board resolution to give $1,500 to Princeton University. Some of the

shareholders challenged the gift (as ultra vires) and AP Smith sued for declaratory judgment. A law was enacted after corporation was formed in New Jersey explicitly permitting such giving.

- Charitable Giving history: Early common law, corporations could just seek profitso Today: Pretty much every states’ corporate law permits corporate giving.

- Limitations on holding: Charitable Donation must be a “reasonable amount” in relation to value of company (e.g., not $18 million if FMV $20 million)o Corporations prohibited giving to more than 10% of a corporation’s stock per NJ

statuteo Contributions could not be given to pet charities: charities related to officers.o Must be able to argue there is some benefit to the corporation, however remote

- Disclosing to the board and getting its approval should sanitize the gift

But, businesses aren’t run to serve as charities themselves

Dodge v. Ford Motor Co. p.270- Ford was hugely successful and paid regular dividends of 60% of the 2M investment.

Awash in Cash. Henry ford dominated; owned 58% of the stock. Ford eliminated the special dividend and announced expansion plans. The Dodge brothers (10% owners) sue.

- Court: Ford must issue the special dividendo Business judgment rule: Courts will generally give great deference but courts will

intervene if it shows an abuse of discretion as would constitute a fraud or breach of good faith (or illegality or self dealing).

o But here, Ford stupidly testified he had a non-business purpose for keeping the money: he thought the company was making too many profits He wanted to lower profit by employing more people and lowering prices.

But it is not within the power of the board to conduct the business’s affairs primarily to benefit others

This testimony is what drove the entire outcome of this case!- But, Ford Motor Company can continue the expansion.

This is a decision for the board and the complaint alleges no fraud, etc.

Business judgment rule

Rebuttable presumption acting in interest of corporation

Absent a showing that a business decision was fraud, a breach of good faith, illegal, or self-dealing as would constitute an abuse of discretion the court will not substitute its judgment.- Good faith: Business person of ordinary sound judgment would see rational basis for the

decisions: “Irrationality is the outer limit” — Essentially a gross negligence standard- Once you approach decisions that no businessperson of sound judgment would make,

then pushing against the outer limit of business judgment rule. Rebuttable presumption that judgment of directors was formed in good faith and was

designed to promote the best interests of the corporation they serve.- Once overcome BJR, then you have to prove your case (fraud, etc)

Rationality is the outer limit

Decision won’t be upheld if cannot be attributed to any rational business purpose.

46

- E.g. irrational disposal of assets = corporate waste.

Shlensky v. Wrigley p.275

Cubs consistently lost money. Shareholders sue directors (which include Wrigley as a 80% controlling shareholder and president/officer) for violation of a fiduciary Duty of Care.- He claimed he thought baseball was a daytime sport, and concerned about the

surrounding neighborhood. Plaintiff is alleging these are nonprofit motives. Court says this could be construed as a reasonable business decision.

- BJR: In the absence of a showing of fraud, illegality or self-dealing by the directors, their business decision is final and not subject to review by the courts.o Once the court decides the BJR rule applies, it abstains and doesn’t delve further.

- Rebuttable presumption that judgment of directors was formed in good faith and was designed to promote the best interests of the corporation they serve.o If π rebuts, still has to show prima facie case. E.g. negligence.

“Wall Street Rule” Notion if you’re not happy with the way the corporation is being run, you may want to exit

What strategy would you adopt toward crazy shareholder/officer as a hostile witness?- Try to get him to state explicitly it is more of a personal decision rather than a business or

profit decision

Chart showing BJR application and fiduciary duties

- Note: There can be parallel claims in one suit

Two ways of thinking about the business judgment Rule

Abstention Doctrine- Court will not review director’s decision, just their process- Preconditions: No Fraud (duty of loyalty) No Illegality; No Self Dealing (duty of

loyalty); Decisions not egregious As a standard of Liability

- No Liability for negligence

47

- Instead liability based on: Fraud, Illegal conduct, Self-dealing, Egregious conduct, Gross Negligence?

- Business Judgment rule—Post-Van Gorkomo A standard of liability Directors may be held liable for gross negligence in failing to

make an informed decision (but since then pulled back)o A rule of abstention : Courts will not review substance of directors’ decision

(substance), only the decision making process. Was decision informed? (Not was it badly informed)

Waste of Corporate Assets

Very hard to prove

Standard

Waste (fraud) if “an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.

Irrationality is the outer limit

Occurs in rare case where directors irrationally squander or give away assets. In re Walt Disney

Thus, irrationality serves as the outer limit of the BJR test. Brehm v. Eisner p.391

If required to pay under K, look at whether K obligation itself constituted waste

“The payment of a contractually obligated amount cannot constitute waste unless the contractual obligation is itself wasteful.” In re Walt Disney p.390.

E.g. In re Walt Disney, employment K required payment of severance. So look at whether wasteful ex ante (there whether incentivized him to leave early)

Cannot be ratified

Even if ratified by a majority of disinterested shareholders or directors, π can still prove gift or waste to void transaction.

Derivative Actions

Direct v. Derivative Suits

Direct = Brought by the shareholder in his own name.- Cause of action belong to the shareholder in his individual capacity- Arises from an injury directly to the shareholder

o E.g., breach of a contractual duty owed the shareholder (dissolution of voting rights). Eisenberg v. Flying Tiger

- Recovery goes to the shareholder Derivative = Brought by a shareholder on corporation’s behalf.

- Cause of action belongs to the corporation as an entity, not the shareholdero Arises out of an injury done to the corporation as an entityo Shareholder’s injury is derivative of the injury to the corporation

- Recovery goes to corporation, then shareholder recovers indirectlyo Exception : In a closely held corporation court may distribute it directly as ordering it

back to evildoers not a good idea. We got a good example of when this would be fucking weird. Find it

- Suit in equity

48

o Suits alleging harm to the corporation must technically be filed by the corporation, because the shareholders at law do not have standing

o This is why this is a suit in equity to tell corporation to sue the third party, so technically the corporation is a defendant.

Delaware approach to determining direct vs. derivative

- Two prongso Who suffered harm?o Who would receive recovery?

ExamplesDirect Derivative

Loss of voting rights Failure to pay dividend

guaranteed by charter

Embezzlement by employee Failure to get sh’dr vote for sale

of substantially all assets Excessive salaries Insider trading Failure to pay dividend Duty of Care / Good Faith

Should recovery go to individual or corporation?

ALI Principals: individual recovery should be ordered when it is “equitable in the circumstances and adequate provision has been made for the creditors of the corporation.”- For example, the plaintiff shareholders owned approximately 63% of the corporation’s

stock. Having determined defendant’s potential liability to be just under $2,126,280.91, the trial court awarded the plaintiffs 63% thereof—$1,339,769.62—plus interest and costs (pro rata distribution)

Close corporation exception followed in many jurisdictions Other cases in which courts have allowed individual recovery in a derivative suit:

- Corporation in liquidation- Former shareholders who discovered concealed wrongdoing after the fact

Procedural Requirements

Contemporaneous ownership of the shares (see, e.g., Fed. R. Civ. P. 23.1)- Must have been owner since cause of action arose and continuously through trial and

appeal (if any) Verification of complaint (see, e.g., Fed. R. Civ. P. 23.1)

- Plaintiff reads the allegations and attests that she, in good faith, believes they are true Security for expenses

- Plaintiff with small ownership stake may have to pay defendants’ costs if she loses or abandons the suit; secured with a bond (Cohen)

Demand requirement- “The stockholder’s right to bring the action does not ripen…until he has made a demand

on the corporation which has been met with a refusal by the corporation to assert its causes of action….”

Policy Rationale

49

Structural issues

If all board of directors involved in the wrong doing, they’re not going to sue themselves. Derivative suits allow shareholders to hold directors accountable

- Supreme court called it a remedy born of stockholder helplessness (Cohen)

Potential abuses — Strike suits

Small shareholder may sue to recover from corporation for the “nuisance value” of the suit. - Small shareholder has less at stake, so their likelihood of getting a settlement that is

greater than the value of investment is high; large shareholder bears more cost of suit- Nuisance suits brought for settlement value.

o Corporation settles just to get rid of them.

Checking abuses — Security statutes

Some states reduce incentive for strike suits by requiring π owning less than a % or $ value to post bond for ∆ corporations legal fees.

Demand requirement

Role of the Demand Requirement

A way to separate cases where the board should be allowed to control suit from those in which shareholders should be allowed to do so.

As a result, people prefer direct over derivative claims

Competing Policy Concerns

Derivative suits a mechanism of managerial accountability, but potential for bias b/c cannot expect directors to sue themselves.

But, cause of action belongs to corporation, like all assets, litigation should be under control of Board of directors- And shareholder interests may diverge (e.g., strike suits) so BoD should have some say in

the process.

Advantages

May actually forestall litigation b/c work out issues before go to court May filter out frivolous Results

- Demand acceptedo Corp would control suit

- Demand refusedo If good process, then decision protected by BJR.o But may have been wrongfully refused Grimes

Demand wrongfully refused if: Can allege facts with particularity creating reasonable doubt to rebut BJ presumptiono Reason to doubt board independence or due care.

Note: Difficult situation because haven’t had discovery yet.- Demand excused as futile

o Allege with particularity that majority of board engaged in self-interested transaction,

50

Universal Demand Requirement

Some States always require a demand before shareholders to file derivative suit

Delaware’s Demand Requirement

Basic idea is that the P must approach the board and demand that it sue the wrongdoers.- If demand is required, failure to make demand results in dismissal (and maybe prejudice).

Excusal of Demand Requirement (file suit directly without approaching board) - When it would be futile: e.g., the board is self-dealing and would not sue itself.

o P must allege particularized facts creating a reasonable doubt that the board is capable of making a good faith decision on suit.

o 1. Majority of board has material financial or familial interest;o 2. Majority of the board lacks independence (domination and control by wrongdoers)

Not enough that majority of the board are named as defendants if simply conclusory

o 3. Or, transaction not product of valid exercise of the BJ This is very hard to overcome, probably want to prove 1 or 2 so can bypass the

BJR standard- Discovery not permitted, must use the “tools at hand”

o § 220 : access to records and books to company with corporate purpose. o Public information

- If demand is excused , what is the consequence?o The stockholder will under most circumstances will control the litigation, but the

board could reassert its control by forming a special litigation committee But then fail to have the favorable BJR standard

What happens if make demand but the board refuses to institute the action?- The BJR applies to the board’s decision to dismiss and π is likely to lose, - Have to argue that the demand was wrongfully refused.

Legal Effect of making Demand

Once you’ve made a demand on one claim, you’ve conceded the board is independent as to all other claims.

Danger: If they make demand, then the decision to dismiss the lawsuit is a matter of business judgment rule and then they’ll lose because business judgment presumption is nearly impossible to overcome…especially since P is not entitled to discovery in the pre-suit.

Cohen v. Beneficial Industrial Loan p.214

Diversity proceeding in federal district court in New Jersey. Corporation incorporated in Delaware. New Jersey has a security for expenses statute but neither Delaware code nor FRCP 23.1 requires security for expenses.- NJ provides that a shareholder who brings a derivative suit and who owns less than 5% of

the stock or stock worth $50,000 is liable for the corporation’s reasonable expenses if suit fails

- Corporation can ask court to require such a plaintiff to post a bond to secure such expenses before suit goes forward

Under Erie Railroad v. Tomkins, Federal law governs procedural issues and State law governs substantive issues.- NJ security for expenses statute is substantive because it creates a new liability

Plaintiff alleged breaches of fiduciary duty: theft, waste, and mismanagement

51

- Delaware Corporate law applied to decide whether defendants breached dutyo Law of state of incorporation applies to substantive corporate law issues

- But NJ law applies as to the security statute.

Grimes v. Donald p.223

Shareholder brought suit, alleging a breach of fiduciary duty by the board because they abdicated its authority, failed to exercise due care, and committed waste. Board entered employment agreement that said CEO would be constructively terminated if the board or a substantial shareholder unreasonably interfered in his good-faith judgment.- Π demanded board abrogate the agreements but they refused.

While the other claims are derivative, the abdication claim is direct as he was only seeking a declaration that the agreements were invalid.

Abdication claim: severe financial penalties for interfering with CEO will inhibit and deter the board from exercising its duties.- Held, not sufficiently plead because the agreement didn’t formally preclude the board

from interfering.o Business judgments are not abdication simply because the limit the board’s freedom

in future actions. Derivate claims

- Must make formal demand on board or allege with particularity why justified for not making demand. Grounds:o Reasonable doubt that the board is capable of making independent decisions to assert

the claim. Majority of the board has a material financial or familial interest. Majority incapable of acting independently for some other reason such as

domination or control. Underlying transaction is not the product of a valid exercise of business.

o Shareholder can only use the “tools at hand” to discover the information to plead these. Such as inspection rights

- If demand is made and rejected, the board gets BJR protection unless the shareholder can allege facts with particularity creating a reasonable doubt the board is entitled to the protection.o Reason to doubt the board acted independently or with due care in responding to the

demand.- Here, he made a demand that was refused and then later argued demand was excused.

o Held, once you make demand, you can no longer argue demand is excused. He only alleged couldn’t have investigated because they refused the demand…

which is insufficient to overcome the BJR.

Special Litigation Committees

Timeline

Shareholder sues w/o demand b/c futile. Board then constructs a special committee to handle litigation that is independent and has no conflict of interest.

52

Policy

Board Account Remedy, “born of stockholder helplessness, was long the chief regulator of corporate management and has afforded no small incentive to avoid at least grosser forms of betrayal” Cohen.

Board Authority “[T]he derivative action impinges on the managerial freedom of directors.” Grimes

Balancing Act: Dismiss strike suits; preserve board authority Vs. Preserve derivative suit’s effectiveness as intra corporate means of policing board of directors

Needed: a filter to weed out cases in which the board is disabled by conflicts of interest from acting an independent decision in good faith. SLC plays the role of a filter.

Court may evaluate SLC’s independence and procedures

Auberbach v. Bennett- Independent investigation revealed some employees had paid bribes and some individual

directors have been personally involved. Board delegated authority to investigate and determine response to 3-member committee composed of members that weren’t on the board at the time (disinterested).o Determined not in best interest of corporation to pursue claims and told GC not to

take over derivative actions.- Court holds that BJR applies because nothing suggests the SLC members were not

disinterested. Nothing prevents the court from determining the SLC’s independenceo Just because they serve on board with ∆ directors does not destroy their

independence.o Business judgments because SLC chose procedures to investigate and then made

substantive judgment based upon the results.- The court may, however, look into the adequacy and appropriateness of the committee’s

investigative procedures. Courts have lots of experience with this.o But they may not use this as a pretext to trespass on business judgment.o If proof offered investigation was half-hearted and really a sham, would not be

protected by BJR because would raise questions of good faith or conceivably fraud.

Standard for reviewing SLC recommendations

Two step inquiry per Zapata Step 1: SLC committee must prove it is independent and in good faith

- Note: Burden has shifted to SLCo Inquiry into independence

Independence inquiry of directors: “[W]hether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind.” Oracle

But, the relationship must be of a bias-producing nature. Mere personal friendship or outside business relationships, alone, are insufficient to create reasonable doubt. Beam p.262

o Inquire into good faith (basis supporting committee’s recommendations; procedural due care) How deliberated, bring outside experts, costs to company, cost of litigation,

distraction.

53

Step 2: (optional) court may apply its own business judgment as to whether the case is to be dismissed and review the substance of decision.

o Even if board followed the correct procedure, may evaluate them. o Intended to thwart instances where meet step 1 but result does not satisfy spirit.o Requires balance of many factors: public relations, commercial impact, employee

relations, distraction bring to directors subject to lawsuit, ethical considerations, effect on company’s bottom line, effect on company, effect on share price; Also law and public policy: sense that certain types of claims should be litigated

because the law is not clear in this area so they want it: role of this case as creating a precedent

o Function of this? Allow meritorious suits to proceed and account for structural bias.

Zapata Corp v. Maldonado PG 261

Derivative lawsuit over excessive compensation. P did not make demand and demand was excused as futile. Appears there is reasonable doubt about board’s indep, so must find: - 1. Is it okay for the board to create special litigation committee

o Yes under 141(c) Board is authorized to delegate authority to subcommittee of board.o They put people on committee who were not members when questioned

compensation was paid.- 2. SLC recommends that the suit should not go forward.

o Consider effect on company reputation; effect on efficiency effect on main job, costs of litigation vs. benefits of litigation.

Power of SLC to dismiss a suit already begun- Under a normal situation, board’s decision would be subject to BJR.- But here, under a different intermediate standard because demand was excused.

Fiduciary Obligations of Directors, Managers, & Officers

De Facto Officer

Can be considered an officer even if for some legal reason lack actual legal title to that office if: In re Walt Disney p.381- Actually assume possession of office- Under the claim and color of an election or appointment- And, is actually discharging the duties of that office

Duty of Care

Key is, did you follow the correct process?- Basically, a do not be negligent rule.

Very rare to impose liability on directors!

Director’s duties

MBCA § 8.30(a): Each member of the board of directors when discharging duties of a director, shall act: - (1) in good faith, and - (2) in a manner the director reasonably believes to be in the best interests of the

corporation” (b): Board members “shall discharge their duties with the care that a person in a like position

would reasonably believe appropriate under similar circumstances.”

54

Essentially all about the process

If the proper process hasn’t been followed, then the duty of good faith has been breached.

Board can appoint committee to provide process

DGCL permits BoD to appoint committees and to delegate to them a broad range of responsibilities.- So long as the committee has made itself aware of the material terms.

Uninformed Decision

Board has duty to inform itself of “all material information reasonably available to them”- Failure to do so amounts to gross negligence.

The Board’s failure to inform itself is not fixed by shareholder approval, as their vote is also uninformed due to the Board’s failure.

Note: under new DGCL § 144(e): Board can rely on officers or experts oral opinions so long as they exercised care in hiring them.

Smith v. Van Gorkom p.314- Leasing company (mainly railroad cars) generated lots of tax credits and had lots of cash,

natural target for a LBO. Trans Union chairman Van Gorkmom decides to sell company through an LBO, and negotiates with financier (which benefits him personally b/c shares were under-valued and he wanted to retire soon). He pretty much suggests the price to acquirer w/o any support for value, other than he thought it would be feasible for a LBO at this price. Transunion becomes a wholly owned subsidiary of Pritzker and gets $55/share.

- In DE, both BoD and shareholders (both acquirer and target) must vote to approve.o Trans Union Board approved but they looked at no real evidence

Only Chairman’s 20 min. oral presentation. Amendments executed and delivered without Board’s having read them.

o Shareholders voted 70% in favor 7% opposed- Duty of care analysis: Plaintiff must prove that BoD failed to inform itself of “all

material information reasonably available to them”o Yes they violated their duty because the board was making an uninformed decision

and the BJR rule doesn’t protect that.o The board knew Pritzker was willing to pay a $17 premium over the prevailing

market price and that’s an indication the market price is inaccurate.o “A publically traded stock price is solely a measure of the value of a minority

position and, thus, market price represents only the value of a single share. He may be willing to pay more because of what the control it represents means.

o While directors have right to rely upon reports from officers, reliance here was unreasonable because only uninformed oral statements. Under new DGCL § 141(e), can rely on just opinions if take care when hiring

officer.- For mergers: Duty “to act in an informed and deliberate manner in determining whether

to approve an agreement of merger before submitting the proposal to the stockholders”o Irrelevant Shareholders approved it as they had insufficient information. o “A director may not abdicate that duty by leaving to the shareholders alone the

decision to approve or disapprove the agreement.”- “Market Test” Defense: 90 day test period would put company up for auction

o Failed, as defense b/c not adequate market test.

55

Could not solicit bids nor provide proprietary information to bidders Pritzker’s lockup option may have been a deal killer.

If informed decision and followed process BJR Protection

Brehm v. Eisner: Claim for Waste (Executive Compensation) Followed process (relied on expert) Board Gets Off- When P alleges waste and due care violations in connection with executive compensation

court will not review substantive merits only process due care. DGCL § 141(e) – “A member of the board of directors . . . shall, in performance of such

member’s duties, be fully protected in relying in good faith upon”- The records of the corp,” and - “Info, opinions, reports, or statements presented to the corp by any of the corp’s officers

or employees, or by any other person as to matters the members reasonably believes are w/in such other person’s professional or expert competence and who has been selected w/reasonable care”

Kamin v. American Express p.310- Derivative lawsuit. Suit brought by the shareholders against board who allegedly decided

to distribute stock to shareholders directly (in-kind) thereby failing to take advantage of tax loss.o They argued they’d have to report a loss in earnings and would cause stock price to

fall. - Conflict of Interest: Plaintiff argued they made decision based on their self interest b/c

some had incentive stock options, but a majority of the board didn’t so not a problem.- Process looks okay, duty of care is about process and not judgment, they met and

discussed it. o They met at π request and specifically considered π’s objection. They may have made

a bad choice but it was their choice. So long as the process is ok, the court won’t review.

Failure to act or make a decision = no BJR

Duty to be informed and act so lose BJR protection- Francis v. United Jersey Ban k: Widow was an inactive director and allowed officers

(sons) to mismanage companyo Rare case: She had never even attended meetings or reviewed statements.

Duty to be informed & act: Obligation of basic knowledge and supervision. - Stay abreast of financial affairs (even if don’t audit books) - Do not rely on subordinates when know that they are misbehaving

Π then still has to prove violated duty of care, which caused damages- Duty of care: must prove negligence and her behavior was the proximate cause of the

loss. o Ordinary businessperson would not have behaved that way…. completely in-attentive

to business. - Because presumption doesn’t apply so it collapses into a negligence case.

Illegal decision or action = no BJR

Explicit decision to break law not protected by BJR - Trucking company and board of directors deciding to violate weight limit if fine is only

$200 and chance of getting caught is 20%.

56

Causation needed: If there was no net loss b/c of decision then shareholders can’t recover.

Interaction of Duty of Care and Business Judgment Rule

BJR is essentially a standard of review

In a duty of care case: the allegation is the directors of officers have violated the duty of care to the corporation.- Very rare to impose liability on Directors.

Business judgment rule is basically the standard of review, in reviewing their decision.- If they’ve deliberated (somewhat) and gone through the process, then in most cases you’ll

never prevail on the claim. Business judgment rule insulates directors from negligence liability – liability only for fraud,

self dealing, illegality, intentional misconduct and possibly gross negligence as in Van Gorkom, but exceedingly rare.- Van Gorkom sent shockwaves so many states passed statutes insulating directors from

personal liabilities for violations of DoC (but not DoL!)o Excludes officers

Duty of Loyalty

DoL arises when director’s interest on both side of the transactions

Duty of loyalty comes up when a director or officer or controlling shareholder or a business in which she has an interest is on other side of transaction with the corporation.- Late 19 century : such contract voidable by any shareholder regardless of fairness or

ratification ex post- 20 th century courts increasingly okay, especially when ratified by board/shareholders.

Example: Direct vs Indirect

Example- Direct Director’s other company makes handmade puppets and sells handmade

puppets to company.o Issue: Is she charging a price higher than she would in an arms length transaction

- Indirect Disney director is an officer of Comcast.o There is a contract between Comcast and Disney and she has fiduciary obligations to

both.

Once conflict shown, director’s burden to prove good faith and inherent fairness

Strict scrutiny by court Structural bias thesis: Sometimes, like Bayer, court treats all Directors as conflicted because

they work very closely and so the conflicted director may exert undue influence (all insiders and he dominates the board)

Possible defenses

Board Approval - Material facts disclosed or known- Board authorizes in good faith- By affirmative vote of majority of disinterested directors

Approval of Majority of Shareholders- They approve it

57

- And, conflict disclosed

Bayer v. Beran p.336

Director’s wife is awarded a radio singer contract. Concern is she’s getting a K that she otherwise wouldn’t, corp. not getting best deal, she’s getting paid too much.- Duty of Care: BJR protects Advertising on radio decision itself. Not corp. waste bc

salary not absurdly high.- Duty of Loyalty issue: Conflict of Interest, therefore NO BJR protection for decision

to hire his wife. Directors win, transaction was “inherently fair” & benefited corp.

- Her services really worth value and they got what they paid for Okay no formal board action, small decision, they were a working directorate and all knew

what was going on, not a huge decision like a merger.

Corporate Opportunity Doctrine

A subset of the general Duty of Loyalty: Fiduciaries (officers, directors, controlling shareholders) may not take CO for themselves

When a CO exists

Broz v. PriCellar : A Corporate opportunity exists where:- 1. The corporation is financially able to take the opportunity

o If the other party is “unwilling” to work with company no matter what not “able” - 2. The opportunity is in the corporation’s line of business

o LOB if “fundamental knowledge, practical experience, and ability to pursue”- 3. The corporation has an interest (contractual right) or expectancy in the opportunity

o Expectation also not met if corp actually not interested- And, 4. Embracing the opportunity would create a conflict of interest between director’s’

self interest and the corporation.- 5. Relevant in which capacity the opportunity came?

o Relevant but not dispositive: if came under capacity w/corporation higher burden of proof for D.

Do you need to satisfy all above elements?- Some courts suggest need to satisfy all elements while others say they must be balanced- For test, don’t need all of the elements

Board or Shareholder approval not required but creates “safe harbor”

Under DE law, formally presenting the opportunity to the board is NOT required to prove you didn’t wrongful taking of a corporate opportunity, but creates a “safe harbor” that shields the transaction from ex post judicial review

Corporation cannot have CO if illegal for them to perform act

If spinning had been illegal in Ebay as it is now, no interest or expectancy in illegal action so firm would not prevail under this claim.

Even if not a CO, Agency law may require profit disgorgement

Rest Agency § 388: “[A]gent who makes profit in connection . . . under a duty to give such profit to the principal.”

Directors/officers are agents of the corporation.

58

So, in transactions on behalf/associated with/connected with principal any profits should be disgorged BACK to the corporation.

Ebay Shareholders Litigation PG 389

Basically IPO bank offered some of the IPO shares to the officers/directors and then after 1 week they often flip them. This is corporate opportunity case: could argue corporation should have gotten opportunity to make these investments.

Corporation is financially able to take the opportunity Opportunity is in the corporation’s line of business

- Considerable amount actually was invested into marketable securities. o If had been much smaller part of overall business then perhaps not problem.

No contract interest, but expectation b/c investing was significant part of their return Embracing the opportunity created a conflict of interest: Created an incentive to stay with

Goldman Sachs because of the “kickbacks” not because best bank in town Also consider capacity (i.e., how opportunity came.) Strengthens corporate opportunity

taking because came in the corporate capacity

Obligation of Good Faith

Implicit in both duty of care and duty of loyalty.

Not a separate cause of action

Stone v. Ritter - Makes clear that Duty of Good Faith is really a subsidiary element of DoL

o Lack of good faith means directors not acting in best interest of corp IVO DoL

Includes actual intent & conscious disregard for duties

Encompasses both actual intent to do harm (subjective) and a conscious disregard for one’s duties. In re Walt Disney.- Does not apply to gross negligence without malevolent intent.

Duty to be Informed & Act

Obligation of basic knowledge and supervision. Stay abreast of financial affairs (even if don’t audit books)

Do not rely on subordinates when know that they are misbehaving Object to misconduct and, if necessary, resign. In some cases duty may be greater: bring in counsel; report to authorities Note: BJR doesn’t apply for failure to act unless business decision not to act

Executive compensation

Will not evaluate reasonableness of advisor fees

Too many variables and courts are not rate regulators. Jones v. Harris Associates p.392

59

In re Walt Disney Co. Derivative Litigation p.376

Disney hired O to be new President. Contract for 5 years provided for severance if fired without cause. They fired him and he collected $130M.

Held, decision of compensation committee entitled to BJR because exercised DoC and not in bad faith.- Bad faith includes

o Subjective bad faith (actual intent to do harm).o And, intentional dereliction of duty (conscious disregard for one’s responsibilities)o But, gross negligence is not “bad faith”

Director oversight

Standard

Directors failed utterly to implement any reporting or information system or controls Or, having implemented such a system, consciouslt failed to monitor or oversee its

operations thus disabling themselves from being informed of risks or problems requiring their attention.

But, must show that directors knew they were not discharging their fiduciary obligations.- Otherwise not conscious disregard sufficient to rise to the level of bad faith.

In re Caremark

Directors not liable for losses due to ignorance or criminal conduct if:- Attempt in good faith to assure a corporate information and reporting system that is

adequate- Which the board concludes is adequate

“[O]nly a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability.”

Elements of Law Compliance Program

Would include: Policy manual, training of employees, compliance audits, sanctions for violation, provisions for self-reporting of violations to regulators, appropriate disciplinary measures.

If board adopted minimal compliance program, ok?- Yes, BJR would apply because decision was made.

o So long as acted in good faith and followed rational processo May decide not to have, they’re expensive.

Fiduciary Obligations of Dominant Shareholders

Controlling shareholders owe other shareholders fiduciary duties

Shareholders acting as shareholders owe one another no fiduciary duties- Directors : hired to look after shareholders.- Shareholders : just buy to make profits

But, controlling shareholders owe fiduciary duties to the minority- They have a degree of control that others don’t have, which means they can actually

control the board, so some of board’s fiduciary duties fall on controlling shareholder.

60

- Shareholder may have incentive to oppress minority shareholders, so deal with that with fiduciary obligations.

Controlling shareholder can own <50%

Can own 100%, Can also own less, such as 50.01%, Or minority control of subsidiary

If parent is self-dealing, defendant has burden to show intrinsic fairness

Self-dealing in this context “parent receives something form the subsidiary to the exclusion of and detriment to the minority stockholders of the subsidiary”

Other conflict of interest between parent and subsidiary/minority shareholders Sinclair Oil v. Levien p.357

- Derivative action in which minority shareholder of subsidiary bringing action on behalf of organization. Everyone on board of directors of Sinven have been nominated by parent who owns 97%

- Contest Sinven’s large dividendso Court determined no self dealing because minority shareholders received their

proportionate share, advantage fell equally on all shareholders.o P could argue improper motives amounting to corporate waste, but waste is a very

hard thing to prevail, it would have to be extremely disproportionate.- Prevented from expanding (parent expanded in other companies but denied opportunity

to them: usurped corporate opportunity)o Opportunity to expand came to Parent company separately.

- Violated: Breach of contract between parent and subsidiary that injured subsidiary, and subsidiary didn’t enforceo Intrinsic Fairness rule applies because self-dealing

BOP on D to show transaction was intrinsically fair to Subsidiary. o Parent receiving something to exclusion of minority so apply inherent fairness test.

D Fail to prove fairness so P prevails.

Defense of Ratification

Ratification of conflicted interest transactions

A conflicted interest transaction may be ratified by votes of directors or shareholders, after full disclosure of all material facts related to the transaction and the conflict of interest.

Effect of ratification

Burden of proofThat raises the question as to the effect of ratification. - In general, ratification—by the board or by shareholders—shifts the burden of proof to

the plaintiff. So, for DoL cases, this would shift the burden from the Board back to π.

Standard of review.- States’ statutes and court decisions are all over the board- And, it also depends upon whether the interested transaction has been ratified by the

board or by the shareholders.

Delaware’s approach

§ 144(a): - “No contract or transaction between a corporation and 1 or more of its directors or

officers ... shall be void or voidable solely for this reason, or solely because the director

61

or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because any such director’s or officer’s votes are counted for such purpose, if:–o (a)(1) approved by a majority of the disinterested directors oro (a)(2) approved by a majority of the shareholders…

Note: Courts read disinterested requirement into this route- But, § 144(a) does not preclude judicial review as there may be other reasons for voiding

(e.g., waste or gift)

Board Ratification

Board ratification shifts the BoP to π

Applicable standard of review

Depending on the jurisdiction, the standard of review is either:- Fairness

o Even though the disinterested directors have ratified the transaction, some courts still apply an “entire fairness” review. Plaintiff must prove that the transaction is unfair to the corporation

- Or, Business Judgment Review In others, board ratification transforms the conflict of interest transaction into an

ordinary board decision and the applicable standard of review is the business judgment rule.

Ratification “cleanses” the initial conflict Will be very difficult to prevail unless can show “gift or waste”

o Waste is much harder to prove than unfairness.

Quorum rules

(Default rule) DGCL 141(b): “A majority of the total number of directors shall constitute a quorum.”

§ 144(b):“Common or interested directors may be counted in determining the presence of a quorum”- Majority of those present suffices them to authorize a transaction

§ 144(a)(1): “the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum”

Shareholder Ratification

Not corporate opportunity claims

Corporate Opportunity rules evolved separately so just follow the Broz test.

Duty of Care claims

Informed vote of majority extinguishes DoC claims against Board. Van Gorkom Probably still a “gift or waste” standard of review.

DoL with interested director = π BJR

Fully informed vote shifts burden of proof to plaintiff to prove waste Standard of review = BJR. E.g., to show waste.

62

DoL with controlling shareholders = π fairness

Fully informed vote shifts burden of proof to plaintiff to show unfairness Standard of Review = Fairness. Wheelabrator

- Worry that minority shareholders may approve a transaction favored by the majority shareholder merely out of fear of retaliation (e.g. a freeze-out)

Essentially the same standard as if this was a conflicted transaction without approval, bur burden shifts to π to prove unfair (versus parent proving fair).

If all material facts are not disclosed or no majority = ∆ fairness

∆’s burden to show fairness of transaction § 144(a)(3) would be relevant when:

- Transaction approved without requisite majority of disinterested directors or shareholderso Procedural defect

- Defective disclosure Statute requires disclosure of “all material facts” (Benihana) When can transaction still be upheld: e.g., procedural defects and failure to disclose

information?- It holds that if the transaction is “fair” then it still may be upheld b/c fair to corporation- D. bears the burden of proof, no burden shifting to P.

Fliegler v. Lawrence p.367

President of corp acquired related properties and gave company option to purchase. Board exercised option and shareholders ratified.- If majority of shareholders approve, shifts burden to π to show that terms amount to gift

or waste.- Does the mere fact the board approved purchase mean BJR?

o No, fact the board approved doesn’t change it because conflict of interest. § 144 can’t fix it because we don’t have disinterested directors

- Does shareholder ratification satisfy § 144?o Since the directors, who are interested, control the majority shareholders = no shifting

to BJR.o Court reads disinterested requirement into statute.

- Therefore have to apply the “intrinsic fairness test”o They were able to prove transaction was fair to corporation.

In re Wheelabrator p.370

Action from WTI shareholders brining a derivative suit. There is a merger between Waste Inc. and WTI. There were shared directors between the two companies. Non-waste directors unanimously approved the deal separately. At time of decision Waste owned 22% of WTI. WTI went through all necessary steps. Acquired company’s shareholder’s approval without counting interested shareholders

Effect of Approval by Shareholders per 144(a)(2)- Duty of care claims

o BJR kicks in by fully informed vote by shareholders (Van Gorkom)o Now π would have to show WASTE, not just unfairness.

- Duty of Loyalty claims against interested directorso Fully informed vote shifts burden of proof to P to show waste: BJR

- Duty of loyalty claims against controlling shareholder

63

o There is still a fairness standard, but burden shifts to the P.

Hypoos

- Contract with third Party maybe connected with board of director so potential conflict of interest. Closely held corp with 3 directors. Flintstone gets a contract to act in movie.

- Board approves contract with third party, contracted with Oliver stone by vote 2-1. o If you view the two contracts as separate

BJR seems to apply. Mouse looses unless can show wasteo If you view the contracts as inter-related

Could argue not BJR: saying only 1 to 1 bc Flintstone’s contract is inseparable/inter-related from stone’s so there is a duty of loyalty/conflict of interest and so he’s interested

- Contract involving director, so conflict of interesto BJR does not apply. We now have contract between corporation and one of directors

§ 144(a) requires majority of disinterested, but here its 1 to 1 Flintstone: bears burden of proof that the contract is fair to the corporation.

- Corporate Purpose Challengedo Flintstone objects to wacky left wing views. Remaining two don’t care

This is not question about conflict of interest, but corporate purpose. As long as proper corporate purpose (not sacrificing profits to make money) then

2-1 is sufficient (remember the Ford case). No violation of fiduciary duty by having controversial thing in film.

- Mouse was absent on vote of Flintstone contract, and approved by vote 2-0. Two objections o Invalid for lack of a quorum?

Quorum because majority of total number of directors (we count interested)o Has the K been authorized?

Majority of those present suffices them to authorize a transaction But, not immune from duty of loyalty, challenge just because it is authorized. o Don’t have a majority vote under § 144, b/c majority of disinterested directors

would be 2 of 2 and only have 1 of them voting in favor. o Therefore, no board ratification, so Fairness standard with burden of proof lying

on D Flintstone.

Indemnification, Insurance, Advancing Funds

At CL, directors not entitled to indemnification

At common law, corporate employees were entitled to indemnification for expenses incurred on the job, including certain legal liabilities, but directors were not.

Rules for Indemnification (DE)

Opt (Direct): May indemnify D/O for expenses, judgments, fines in civil/criminal if good faith

145(a) authorizes the corporation to indemnify the director or officer (& ee’s) for expenses plus “judgments fines, and amounts paid in settlement of both civil and criminal proceedings- Covers BOTH officers and directors.- Covers both expenses (e.g., attorney fees) and damages (e.g., P’s award)

64

Opt (Derivative): May indemnify D/O for expenses (incl atty fees) if good faith or with court order if found liable

145(b) authorizes indemnification of officers, directors (and employees) for expenses, including attorney’s fees

If the director or officer was held liable to corporation indemnification of expenses requires court approval (court of chancery). - Only expenses are covered, not judgments, fines or settlements. - No recovery for damages

Good faith = manner reasonably believed in, or not opposed to, best interests of company

So not if embezzlement, etc.

Req’d (both): Must indemnify D/O if successful on the merits or otherwise

Required: Under 145(c), the corporation MUST indemnify a director or officer who “has been successful on the merits or otherwise” in a direct or derivative suit

Note: Court will not ask why successful. Just not personally paying any monetary damages for a claim will be considered a success, even if company settles and that’s why he didn’t pay.

If unsuccessful, indemnification optional unless prohibited by statute

For unsuccessful directors and officers, indemnification is permissive, so long as it is not precluded by statute.

Waltuch v. Conticommodity Services

Corporation required to indemnify officers, directors and other employees for expenses they necessarily incurred in an action for which they are parties (with an exception for any matters they were judged to be negligent or liable for misconduct).

Two sets of litigation: - 1. Private litigation for fraud (Firm settled for $35M. He spent $1.2M defending private

litigation and was eventually dismissed after the company settled.o With respect to private litigation, the court says he must be indemnified

145(c) requires firms to indemnify officers who are successfulo D counters that he escaped paying only because it paid the claimants $35M

Court will not ask why D was successfulo He did not pay any monetary damages out of pocket so we will consider it success.

145(c) is a bright line rule: we do not look at how are why It only requires they escape liability, not that they were morally exonerated

- 2. Enforcement action by government. (He paid a fine of $100k and agreed to 6th month ban on trading.) He spent $1M defending the government litigation.o He admitted guilt/paid fine so 145(c) doesn’t apply.o Court agrees that indemnification per Article 9 for the government litigation is

inconsistent with the scope of the corporations power to indemnify as delineated in § 145(a)

o Their agreement covers this, but 145(f) doesn’t allow them to enter agreements requiring indemnification where not permitted under (a) or (b). He had acted in bad faith.

If the board reimbursed Waltuch for all his expenses (both for the private litigation and for the government enforcement action) could shareholders recover in derivative action?

65

- Yes, the court ruled corporation lacked the power to reimburse him with respect to enforcement action.o This action would be ultra vires? (illegal) so no BJR protection and derivative action

would be successful.

These rules can be altered by the corporation

May bind themselves by written agreement to pay expenses beyond requirement

145(f) authorizes corporation to enter into written indemnification agreements with officers and directors that go beyond the statute Lets firms bind themselves to pay certain expenses.

But, cannot make agreement violating express prohibition (e.g. good faith)

LIMITATION: Cannot make an agreement that violates something prohibited above explicitly, e.g., waiving the “good faith requirement”,

E.g. would permit indemnification agreements that mandate firms advance expenses, even though under 145(e) only makes its option.

Corporation may limit Director’s personal liability for breaches of fiduciary duties

§ 102(b)(7) provides that a certificate of incorp may (but need not) contain:- A provision eliminating or limiting he personal liability of a director to the corporation or

its stockholders for monetary damages for breach of fiduciary duty as directoro ONLY applies to directors. Officers are denied exculpation here.

Restricted to monetary liability still can get injunctions against them. This is affirmative defense for directors

o Applies to the Duty of Care Exceptions provided that such provision shall NOT eliminate or limit the liability of a

director:- (i) For any breach of the director's duty of loyalty to the corporation or its stockholders;- (ii) for acts or omissions not in good faith or involve intentional misconduct or a

knowing violation of law; (iii) under §174 of this title [relating to liability for unlawful dividends]; or

- (iv) for any transaction from which the director derived an improper personal benefito Self dealing director would not be protected, or director engaged in insider trading

would not be protected

Advancement of funds

May advance funds if D/O agrees to pay back if later found not entitled to indemnification

145(e) the corporation may advance expenses to the office or director provided the director later undertakes to repay any such amount if it turns out he is not entitled to indemnification.

Rules for Insurance

May purchase insurance without good faith requirement even if can’t indemnify

145(g) allows for insurance without good faith requirement imposed by 145(a), (b) and (f), e.g., because conduct was done in bad faith. - 145(g) lets them purchase insurance for directors and officers even if not permitted to

indemnify them. Argument: for letting them do it: prevents them from being judgment proof.

66

- Almost all corporations provide for such insurance but have exclusions for fraudulent conduct, which often pushes them to settling b/c they want to be covered.

Control in Large Corporations

Proxy Fights

Shareholder’s Role in Governance

Do not manage the corporation Mainly elect directors who mange the company

- Shareholders do have the advantage of not having conflict of interest be a real issue. Shareholder’s are generally less informed decision makers than are directors.

- But perhaps have fewer conflicts of interest than incumbent managements who may be motivated by self-entrenchment.

Proxy Process

Mechanism that governs communication with shareholders that are related to the shareholder voting process: main goal is investors are informed and the process is not plagued by misleading information (lies, falsehoods, or omissions) so there is meaning to shareholder franchise.

Shareholder Voting: Annual Meeting

Required to meet at least once per year under most states’ statutes. e.g., DGCL § 211(b) Failure to call meeting may give right to sue e.g. DGCL § 211(c) Main task is to vote for directors (although on rare occasions) may vote on other matters

- All the board may be replaced at the same time or it may be a staggered board Notice and quorum requirements must be met.

- Firm must notify shareholders of time, place and subject matter of meeting.- Important: decide whether to attend, whether to delegate vote, would want to get

informed on issue. - Quorum: Minimum number of shares that need to be present in person or proxy to hold

vote on particular matter.o Delaware : Default is that a majority is a quorum. However, it cannot be altered < 1/3

Special Meeting- Not regular, but called by BoD for special issues under DGCL § 211(b)

o Mergers, charters, amendments, sale of major assets, dissolutiono Notice and quorum requirements must still be met.

Votes Per Share- Default is one share, one vote,

o But different classes of shares can have unequal voting rights.

Consequences of Dispersed Ownership

Few individual shareholders have sufficient incentives to attend meetings in person Yet most states have quorum requirements Proxies are the “solution” so that quorum requirement can be met.

- Shareholder with interest can solicit proxies and collect enough to affect in another way.

67

Proxy Voting

Shareholder appoints a proxy to vote his/her shares at the meeting- A form of agency: shareholder is principal and proxy is agent.- Proxy card: either tell them how to vote or give them discretion to vote as they want.

Street name- Most stocks are held in “street name” in the brokers’ name. So the broker sends the

material to the beneficial owner. Securities Exchanged Act of 1934

- Federal securities legislationo There is federal jurisdiction over the matter, because of this act

- But still governed under state corporate laws.

All proxies RE registered securities must comply with Commission rules

Securities Exchange Act § 14- It shall be unlawful for any person, by use of the mails or by any means or

instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit … any proxy … in respect of any security … registered

2 important goals- 1. Make sure shareholders make an informed vote.- 2. Make managers accountable to shareholders (which is related to first, because if

shareholders are not informed cannot hold management accountable.

Must provide written proxy statement before soliciting proxy

Rule 14a-3- Anyone who “solicits” a proxy must provide shareholders a written proxy statement

before soliciting the proxy and - Proxy statement must provide information on

o Subject matter of the meetingo Shareholder’s voting rightso The person(s) soliciting the proxies.

E.g., Warren buffet seeking it - In the cases of proxy fights for control, incumbents must also provide:

o Background information about the nomineeso Information on the board structure and its operation.o Information about directorial conflicts of interesto Information of management compensationo Information on annual report, projections

- This puts pressure on corporations so just knowing they have to include this information may give them an incentive to make sure their procedures are sound.

Rule 14a-6: All this must also be filed with the SEC

Proxy materials may not be false or misleading about material facts

Rule 14-a-9- Prohibits proxy materials which are false or misleading with respect to material facts

o By omission or commission

68

- Exampleso Claims of future market value, like stock price doubling in a year without support.o Blanket statements without backing them up.

Private Right of Action if false or misleading

Private Right of Action in both direct/derivative lawsuits

J.I. Case Co. v. Borak - Court reads private right into § 27

o Grants jurisdiction to District Courts over all suits brought to enforce any liability or duty created under the Act.

- Injury usually flows to shareholder through damage done to corporation, so not permitting private action would be to deny all private relief.o And the Commission is busy and needs the help of shareholders acting as private AGs

But shareholder are rationally apathetic.

Elements of Action

Violation of Rule 14a-9- Material misstatement or omission of material fact

o “Material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”

o Must have significantly altered the “total mix” of information available.- Causation: Misstatement of material fact “causes” the harm

o 1. If omitted fact was material, no need to show that omission was essential to completing transaction

o 2. But, must show that proxy solicitation was an essential link in completing the transaction So if didn’t need the vote to go through, no action.

Mills v. Electric Auto-lite - An allegedly false and misleading proxy was distributed to shareholders of a target for a

merger at a special meeting at which proposed merger was voted on.o It not disclose that the majority of the board of the target was dominated by the

acquirer, and it was a close vote. - Elements of Action: Materiality*

o TEST: Would a reasonable shareholder consider the information important in deciding how to vote: statement or omission must have “a significant propensity to affect the voting process.”

o Modern definition “material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” (Texas Gulf Sulfur and TSC Industries): Probability/Magnitude test

- Elements of Action: Causation* How Proveno 2 Elements

1. If omitted fact was material, no need to show that omission was essential to completing transaction

2. But, must show that proxy solicitation was an essential link in completing the transaction

Footnote 7: i.e., if it didn’t need the vote of the minority shareholders in order to go through then okay.

69

o These are the elements for private litigation: SEC could still inflict harm. Seinfeld v. Bartz p.543

- Derivative action saying company should have included Black-Scholes valuation of stock options in proxy approving an increase in options for Outside Directors.o Would have been easy for them to do because they used this same formula to report

the value on their financials statements.- “Substantial” likelihood a reasonable shareholder would consider this important in

deciding how to vote?o Other courts had held this valuation of grants was not material as a matter of law.o Wouldn’t the investor want to know if it was a reasonable value?

But, at the time the law didn’t require the company to expense these options at the time they were granted.

Now, they must expense when granted. Probably changes outcome here. They distinguished from a case because tax

regulations required the options be valued at the time of the grant. Prof: I’d want to know! Why does it matter if the law requires them to calculate.

- Held: Nothing required the company to calculate the value of the options at the time of the grant.

Remedies

Prospective (if hasn’t gone through yet)- Injunction (corrective disclosure)

Retrospective- Damages

o Must be a monetary injury; plaintiff must prove Rescission (undo transaction)

- Most courts say no if the deal is long since done. Reimbursement of expenses

- If the P’s win, their costs of bringing the suit are reimbursed. Attorney’s fees

- Default American rule is no reimbursement- But, exception when confers “substantial benefit” on corporation.

o All the shareholders benefited at π’s expense.o So, corporation must reimburse successful plaintiff.

Control contests

Additional requirements for proxy statements

See above under 14a-3.

Timeline

Annual report sent - Only incumbents in control need to do this

Proxy statement and card sent - Check how want to cast vote: both sides will do this

Free writing w/o statement - Free written communication, can’t do before previous step.

Vote

70

- Everything else must occur so sufficient time for them to process information before vote

Corporation must provide shareholder list or mail insurgent’s proxy materials

Rule 14a-7. Insurgents have to pay the expense of mailing. Note: They’d rather have the list so they can contact the major shareholders and not pay to

contact everyone.

Proxy Contests Relatively Rare

Costly: Asymmetry - Insurgents only reimbursed if they win.- Most benefit goes to other shareholders (Free-Riders)- Tender offers allows insurgent to capture full benefit of increase corporate value.

o Buying control is more expensive in absolute dollar terms, but then to extent you benefit the firm you capture full benefits b/c majority or total owners of firm.

Shareholder apathy- 100 votes out of 30 million.- Opportunity cost of being informed, why bother- Wall Street Rule

o If really dissatisfied, why not just sell rather than try to influence management. Proxy fights fell into disfavor when tender offers became more popular.

- Proxy fights have come back recently as a way of undoing management defenses for takeovers from tender offers.

- There are also state law rules that protect current management: which says they can take into consideration other interests than just shareholders when deciding how to respond: it can consider effect on employees

- Quite often to see tender offer and a proxy contest: Oracle did an offer for peoplesoft initially failed. So they did a proxy contest to elect their people to board of directors. They then ended up agreeing to work something out.

Reimbursement of Expenses

Dispute must concern policy and not personal control/personality

Must be an effort to inform shareholder (strategic vision) - Not just spending this money for a contest of personality as opposed to policy underlying

the business.

Amount must be reasonable

Firm may reimburse only reasonable/not excessive and proper/legal expenses.- Disclosure statements to shareholders- Telephone solicitations- In person visits to major shareholders

o Winging and dining said shareholderso Private jet to bring to HQo Lavish expenses are really only justifiable for persuading major shareholders.

But great deference as to what is reasonable. Rosenfeld

Firm may reimburse incumbents (current mgmt), win or lose

Incumbents can have corporation pay or reimburse expenses without shareholder approval

71

Presumably protected by BJR, assuming a bona fide policy dispute. - Plaintiffs would have the burden to show wasteful, but waste is much harder to prove

than mere unfairness. Levin v. MGM

- Mgmt can use corporate funds to pay for expenses it incurs in conducting their proxy solicitation.

- Policy: Why allow management to solicit proxies?o Corporate stability is an important value, because could be very harmful to

shareholders to continuously change. o Having current management pay personally out of pocket to defend themselves is

insane, because someone sitting on the board of directors may have little or less incentive to be on board.

Firm may reimburse insurgents only if they win

Shareholders must ratify the payment after full disclosure. Policy: Insurgents may only be compensated if they win. Is asymmetry justified?

- Dampens their incentive to seek out firms. But will only do so if they think they can win.- Weed out frivolous insurgents.- However, could argue fact they are being contested might suggest doing a bad job, but by

providing disincentive you weed out both frivolous and some non-frivolous cases

Challenges due to Conflict of Interest

Can challenge expenses if there is an apparent conflict of interest.- E.g. hire PR firm partly owned by Director’s brother.

Duty of loyalty claim: Burden shifts to the incumbent management - They don’t have to show just that the process is fair (i.e, arms length), but entire fairness:

e.g., reasonable rate. - Under DE § 144, transaction would be acceptable if approved by majority of disinterested

directors or shareholders in either case after full disclose of material facts/conflicts of interest.

What if merely owned by a friend?- Friendship is generally NOT sufficient to do a duty of loyalty review requiring entire

fairness.

Rosenfeld v. Fairchild Engine & Airplane Corp.

Reimbursement is the issue here. The losing incumbents were paid 106k +26k, and the insurgents (win) $127k.

Judgment for new management, insurgents can get reimbursed. Management may use corporate funds to pay for expense they incur in conducting their

proxy solicitation provided- The amounts are reasonable- The contest involved policy questions rather than personal control- Can reimburse successful insurgents under the same conditions.

o NOTE: management must believe in good faith that policy is in the best interest of the firm and the firm’s shareholders

- Lingering issue: is it that easy to separate policy from personal dispute?o Dissent makes a convincing case that the distinction is unreal because

72

You can frame an argument that the underlying motive is concern about protecting your position.

Great Deference for reasonableness (cite to for this proposition)- Majority was unwilling to carve out an exception for “having too much fun” while

informing shareholders

Shareholder Proposals

Qualifying shareholders may submit proposals for shareholder vote

Rule 14a-8: Allows qualifying shareholders to put a proposal to a shareholder voteo See below for definition of qualifying

- At the company’s expense- Company must include proposal in its proxy materials for upcoming annual or special

shareholder meeting. Why prefer/oppose a proposal as compared to a proxy fight?

- Expenseo Shareholder proposals are cheaper, because happens at the company’s expense.o Proxy fights are very expensive.

- Board of Directorso Proposal, with you don’t get any people on the board of directors: it is much more

indirect: company need not actually implement your proposal. o If your underlying motive is control: Management often tries to exclude shareholder

proposals Not often successful

- Lose getting it in the proxy materials more than they win. - However, there could be some abuses of it which are wasteful: proposals that are

submitted by “radical” fringe groups: no evidence they actually improve company’s stock price.

Why Proposals Good- Gives shareholder voice- Gives shareholders motivation to make good suggestions; by lowering the free rider

problem of making suggestions: More Democratic.

Two Common Types of Shareholder Proposals

Corporate Governance- Eligibility criteria for directors (i.e. age)- Require directors hold a specified minimum number of corporate shares- Split CEO and chairman of board- Executive compensation- Shareholder committee to advise directors

Social/Political Issues- Human rights- Environment- South Africa- Animal rights- Anti-discrimination- Anti-Affirmative Action

73

Note Rule itself deliberately written in question answer format to make it easier to read.

Responses to Proposals

Attempt to exclude on procedural or substantive grounds- Must have specific reason to exclude that is valid under Rule 14a-8.

Include with opposing statement- “We recommend you don’t vote for”

Negotiate with proponent- Wide range of possible compromises

Adopt proposal as submitted

Process for excluding a proposal

Mgmt files a notice of intent to exclude with SEC- Accompanied by opinion of council if relying on legal issues- Under 14a-8, must give notice to shareholder is something that can be remedied.

SEC Response Shareholders can ask for another review or seek injunctive relief

Proxy access proposals

Eligibility for 2011 version

Same as below (1% or $2,000 and held >1 year)

Shareholders may now submit and vote on “proxy access proposals”

In the 2011 revision to 14a-8(i)(8). Can put in proposals to give shareholders the right to include director nominees in company

proxy materials.- Cheaper than soliciting proxies at your own expense.

Grounds for exclusion – 14a-8

Failure to meet procedural requirements(s)

(b) Ownership threshold (1% or $2,000 of company’s voting shares for at least one year and through the voting date).

(d) Less than 500 words: (c) 1 proposal per shareholder per meeting: (h) Must attend shareholder meeting (or have representative at meeting). (e) Deadline: Rule 14a-8(e)

Failure to satisfy substantive requirement(s) a/k/a Question 9

Burden of Proof on company

Company seeking exclusion bears burden of proof Rule 14a-8(g)

Provision 1: subject would be improper under state law

Delaware § 141(a) says all corporate powers will be exercised under the authority of the board of directors- So can’t be a binding order. Lovenheim- But if it is drafted as suggestion then often okay.

74

Provision 2: Violation of law

Provision 3: Violation of Proxy rules

Any of the rules, including 14a-9 (false or misleading)

Provision 4: Personal grievance or special interest

Personally benefiting you and not shareholders at large E.g. proposal by union to offer employees a more generous pension.

Provision 5: Relevance (not significantly related to company).

First prong: If issue is NOT 5% of earnings, assets or sales AND Second prong: If issue is NOT “otherwise significantly related to the company’s business”

- Interpreted to mean ethically/socially significant and relates to the business. - If social/ethical issues implicated & show society thinks important (e.g., b/c on news

channels): then only need to be related to company’s business o E.g., humane treatment of animals of company’s food supplier. Lovenheimo But, not if you submit proposal on rainforest preservation for a company performing

arts

Provision 6: Beyond Power to Effect/Control/Implement Proposal

E.g., suggesting company lobby for national health care reform may be futile.

Provision 7: Management functions (ordinary [mundane] business)

E.g. proposal directing Microsoft to evaluate a particular litigation strategy. Not bright line rules, so bring in as much evidence as can to make it look like it falls within

the exception. Exception:

- Significant strategic decision- Will significantly affect the manner in which a company does business- Involves an issue of social significance “evidenced” by “widespread public debate”

Provision 8: Concerns a Director election

If it seeks to include a specific individual, not just a proposal to allow shareholders in general to nominate Directors.- Also if would disqualify nominee, question nominee’s qualifications, etc.- Or would otherwise effect upcoming election.

Provision 9: Conflicts with company’s proposal

Giving explicit preference to company’s view (e.g., management may put its own environment proposals to exclude shareholders)

Co. could probably prempt by making its own proposals that conflicted with the shareholder’s.- Must abide by the required procedures.- But, bad PR for most proposals so don’t do.

Lovenheim v. Iroquis Brands PG 559

Shareholder proposed they form a committee to investigate the methods used by the firm’s suppliers in producing stuffed ducks and to report results to shareholders. - Does not actually say they have to exclude it so doesn’t violate Provision 1

75

o An attempt to shed light on the issue, but does not require the company to take a particular course of action.

Rule 14a-8(i)(5) analysis- First prong: Not 5% of earnings, assets or sales- Second prong: If issue is NOT “otherwise significantly related to the company’s

business” o Lesser std if social/ethical issues implicated o FN 3: Significant in ethical or social sense: e.g., human treatment of animals.

Must demonstrate both you and society think this is important issue. Prove with historical stuff, news coverage, legislative debate, support of non-

profits, NGOs, etc.- Must be related to the business though

o If you submit proposal on rainforest preservation to a company performing arts it would not adequately be related.

CA v. AFSCME

Proposal requiring board to reimburse successful insurgents of reasonable expenses.- Allowed board to determine reasonable.

Held, improperly impinges the board’s discretion whether to reimburse or not.- Simply requiring expenditure of funds doesn’t remove process component.

o E.g. requiring the board to rotate cities for shareholder meetings- But, can’t require the board to potentially violate their duties.

Hypos

Proposal recommending firm to ban sexual orientation discrimination- Ordinary Business Grounds because relates to personnel policy.- Just recommendation : so not improper under state law- (Economically not relevant AND not implicating important social or ethical issues:

however from the animal cruelty case you could assume this is a lower standard)- Merely a personal grievance and not related to shareholders at large- SEC: Did not allow the company to exclude the proposal (did not issue a no action letter)

Anti-affirmative action proposal submitted by white supremacist group- Ordinary Business Grounds- Personal Grievance- SEC: AT&T had to include the proposal, but wrote a statement deploring the proposal.

To prepare report on company’s in Burma: particularly to ensure not benefiting from human rights violations (.01% of sales)- Economic threshold and not significantly related socially and adequate nexus

o Includable Having Microsoft include particular strategies in their anti-trust litigation

- Object: on ordinary and business grounds (no ethical/social exception here.) - No action letter

Requiring company to report sales in developing country- Object on ordinary business grounds- Had to include it.

Problem 1, p.555: Auto Co. that specialized in small economy cars began producing sports car. Expected not to make a profit but thought it would improve their image.

76

- Proposal 1: Company shall not make car.o Excludable, making it obligatory IVO (7). o Also improper under (1) because improper under state law.

- Proposal 2: Shareholders recommend not make the car.o Probably permissible.

Gets around (1) because not binding. Not a management function under (7) because significant strategic decision.

o But, Co. could still not implement and get BJR protection so long as make some kind of consideration and then decide not to.

- Proposal 3: Amend by-laws to prohibit production of sport cars.o Didn’t get to in class, check slides.

Board refuses to act

Board decision not to act is protected by BJR

Even if resolution passes board can still not act and is protected by the BJR. Shareholder could try to submit a duty of care claim but absence fraud, self interest, or

illegality protected by rule.

Bylaw Amendments

Under state law, shareholders can amend the bylaws. Includable under AFSCME v. AIG, Inc. (2d Cir. 2006)

- Company may exclude a shareholder proposal for a bylaw amendment concerning a specific seat that allows shareholders to place their nominees on the corporate ballot.o They want included alongside incumbent board’s nominees in the company’s proxy

materials.- Exclusion for proposal that “relates to an election.”

o They don’t want a specific person put on the ballot, they want the procedure changed.- Court says conflicting SEC interpretations and they go with earlier one: exclusion only

applies to proposals RE a specific seat.- The rule was subsequently modified to over-rule this outcome.

o But then it was amended again so now the outcome would be the same as here.- Pros/Cons of excluding:

o When employee union, proposals may be beneficial to employees but not to shareholders.

o Might fight shareholder apathy

Shareholder Inspection Rights

Note: this is one of the “tools at hand” mentioned in demand cases to obtain sufficient information.

In proxy fight, rules don’t require disclosure of shareholder list

Rule 14a-7: Requires a corporation to mail the insurgent’s material at insurgent’s expense or simply give them the shareholder list and allow them to send out the materials. - Corporations prefer not to give up their shareholder list. - Does not require them to provide the shareholder list or other corporate records.

77

Insurgents often find this unsatisfactory so look to state law for requirements

Competing Policy Concerns

Interest in holding the board accountable via proxy system (b/c agency problems/may shirk obligations).

But junk mail and competitor access to proprietary corporate info (solely to gain advantage) cautions against releasing lists.

General requirements

Own shares for at least 6 months or own > 5% of company- Keep you from buying litigation, but note that DE doesn’t have this requirement.

Have a proper purpose

Inspection of Book and Records per DGCL § 220

Any shareholder has the right to inspect and copy for a proper purpose

Right: Any stockholder shall have right to inspect and make copies of stock register, list of stockholders, and its other books and records. DGCL § 220(b)

Shareholder must make a written demand setting forth a proper purpose. DGCL 220(b) Corporation must respond within 5 business days, and if they don’t they may apply to the

Court of Chancery (which has exclusive jurisdiction) very broad discretion DGCL 220(b)

Burden of Proof

DGCL § 220(c): If shareholder only seeks access to the shareholder list, BOP on corporation to show improper reason

o Arguably, the shareholder list is less invasive so require corporation to meet burden If shareholder seeks access to other corporate records, BOP on shareholder to prove proper

purpose.

Directors may always inspect if reasonably related to position

If directors did not have such access, it could be impossible to exercise their duty of care. DGCL § 220(d)

What is a Proper Purpose?

Must be “reasonably related to such person’s interest as a stockholder”

DGCL § 220(b) Proper

- Gather information to help prove mismanagement or help you value your shares.- Seeking explanation for decline in profits.- Communicating to engage in proxy contest to oust others. Crane Co.

Improper (ulterior or vindictive motives)- Proprietary info for competitors

o But, mere fact that requestor is a competitor isn’t enough.- Get prospects for personal business- Institute strike suit- Pursue political/personal agenda

78

Communication with other shareholders RE wellbeing or value of corporation is appropriate

Crane v. Anaconda p.557- Crane wanted to buy shares of Anaconda. Crane requested a list of the shareholders but A

only wanted to contact the large shareholders to save money.- Anaconda argued seeking control was not a proper purpose for demanding the list.- Held, the matter was proper as it was one of general interest to A’s shareholders by virtue

of their common interest in the corporation as shareholders.o Whenever a corporation faces a situation having potential substantial effect on its

wellbeing or value, the shareholders are necessarily affected and the business of the corporation is involved.

Primary purpose must relate to the value of your investment

State Ex Rel. Pillsbury v. Honeywell p.560- P bought Honeywell stock because he was upset that they were making fragmentation

bombs. Π requested access to Honeywell’s shareholder list and corporate records relating to production of the bombs. He admitted didn’t care about the effect of the value of this on the stocko Applying Delaware because Delaware corporation

- How could he have prevailed? o Framed his argument: these fragmentation bombs are harming our reputation, which

will ultimately hurt our bottom line. - Shareholder proposal assuming 14a-8 okay (procedural req. ownership amount, holding

period) o Company’s natural inclination would be to exclude it because not relevant but he

could argue that this is exception for social significance. - The primary motivation must have to relate to the value of your investment.

o If sole purpose is maintaining proceedings of this kind, the person is not truly interested.

Doesn’t matter if you have a secondary purpose, so long as primary is proper

Doesn’t matter if have a secondary purpose so long as the primary purpose is okay. - Once you successfully frame it is about your investment doesn’t matter you have

secondary purposes.

Sadler v. NCR Corp PG 578

AT&T doing tender offer and proxy contest and wants to take over the board. NY shareholder access statute applies here. AT&T had no right under NY or Maryland law to shareholder list because didn’t own 5% of the shares and didn’t own it for 6 months. So they work with Sadler (shareholder) who did meet this requirement. They call AT&T an agent for Sadler. - AT&T wants the CEDE list (doesn’t give the names of shareholder but only the

intermediaries) and the NOBO list (gives the specific names of the underlying investors who have not objected). o NOBO list is what is crucial here.

Corporation is trying to argue that the statute gives access to the CEDE list but not the NOBO list (because NOBO list takes significantly more time to prepare.)

Holding- Corporation must provide both lists to AT&T

79

- NCR must prepare NOBO list even if not pre-existingo Delaware law to the contrary: Delaware only requires preparation of CEDE list.

- Rationaleo Liberal interpretation of statute “to facilitate shareholder communication.”

Now changed by legislation, they only have to provide the NOBO list if it is already maintained. - It is of course possible they may have it for their own purposes. - Makes NY more like Delaware courts: Delaware courts do not require the company to

produce the NOBO list.

Shareholder Voting

Common Stock as a Bundle of Rights

Economic rights (i.e., cash flow rights)- Receive dividends (distribution of profits) when and as declared by the board of directors

o BJR standard of review for dividend decisions- Residual claim on assets in liquidation

o Many other creditors paid first, then preferred shares, then common stock. Voting rights (i.e., control rights): Elect directors and approve some extraordinary matters

Rationale for Shareholder Voting Rights

Link ownership and control- Put your money at risk, you should have some say in how the company is run. - Residual control right accompanies residual cash flow right

Prevent managerial overreaching Managerial authority v. accountability

Stock can only have voting rights

The economic/control rights of shares can be unbundled.

- Have to have one of three or its not a share though. Stroh v. Blackhawk Holding

- Class B shares have both economic rights and control rights. But, Class B shares have voting rights but no economic rights. For management, the per share cost of a vote was cheaper. Managers paid 50 cents per vote. (and 500,000 votes at $1,250) Shareholders paid $4/vote.

- Risk: management may be unaccountable to shareholders; agency costs. o May be more motivated to make a big gamble because less at stake.

- Why didn’t they just sell nonvoting shares to the public? o IL constitution at the time it was unconstitutional to sell shares without a voting right,

so couldn’t simply sell nonvoting shares.- Validity of Class B shares: P’s argues stock interest necessarily includes both economic

and voting interesto Court disagrees, Class B shares are valid. Stock, need not have all three rights, it can

be unbundled.o Illinois statutory definition of “share”: “units into which a shareholders’ rights to

participate in control [voting] of the corporation in its surplus or earnings [cash flow], or in the distribution of its assets, are divided [cash flow].

80

Policy analysis

Against allowing- Voting shareholders might take advantage of non-voting shareholders

o Power without accountability (classic agency problem)o Possibly perverse incentives for voting shares

- Inverse relation between value of voting and non-voting shares. Positive reasons for promoters wanting to maintain control

- Startup company: founders need to raise additional capital but reluctant to give up control b/c they believe they have the best vision for company.

Why might shareholders wish to deviate from perfect alignment of cash flow (economic and control voting rights?- Attract top employees. - Lender, we’ll lend to you, but perhaps bank will also want at least temporary voting

control.

Delaware Default Rules for Voting

Voting Thresholds

DGCL § 216(1): quorum = majority of shares entitled to vote (default, but no less than 1/3) (2): matters other than election of directors majority of quorum present (default) (3): election of directors – plurality (default)

Default rule regarding per share voting right

DGCL § 212(a): One share, one vote- Can be modified. DGCL § 151(a).- Delaware is liberal, no votes are possible, but some states more restrictive view.

P&W v. Baker - 1 vote for each share of 50 or less. 1 vote for every 20 shares after 50. & Limit of 25%

voting shares for any stockholder: Plaintiff had 28% of the shares but only 3% of the vote. P tried to say this is against Delaware law, but court upheld this.

- What legitimate purpose? Structure generally ensure promoters maintain control over corporation.o Lack accountability, but may accept anyway if expected return is high enough.

Possible Modifications

Classes of stock can have different voting/cash flow rights

DGCL § 151(a): Classes of stock with differential voting rights and/or cash flow rights is permissible. (but must be noted in the articles)- Stroh v. Blackhawk

o Stock need not have the rights, e.g., can be voting only. SEE NEXT PAGE

Plurality voting

Default rule for BoD elections in the majority of states. Whoever receives the most votes wins…don’t need a majority.

- So, theoretically a director could be elected with one vote in an uncontested election. Example

- 20 shareholders each with one vote, 5 board seats, and 6 nominees.

81

o Each shareholder gets to vote for 5 directors (so each candidate has up to 20 votes for/withheld).

o Top 5 directors by # of for votes are elected.

Majority voting

Each candidate must receive a majority of votes or they aren’t elected.- 81% of S&P 500 companies now use majority voting.- So if three candidates had 8 yes/12 no, etc…only the other 3 would get elected because

the other 3 don’t get a majority. Failed elections

- In practice, many companies have provisions that require the failed director to tender their resignation but give the board large discretion to not accept it.o Result is that most companies have failed elections but those directors remain seated.

Theory: If move to majority, may result in failed elections but will increase director accountability.

Cumulative voting

DGCL § 214: Cumulative voting In straight voting, a shareholder with a majority of shares will control all elections. Straight Voting

- E.g., straight voting 6 director slots: Shareholder A: 60 shares. Shareholder B 40 shares.

- Straight Voting: Shareholder A chooses all 6 seats (60 votes per candidate) Cumulative voting: each shareholder can cast total votes in any manner.

- Total votes per shareholder = number of votes per director times number of directors.o Shareholder A 60 x 6 = 360o Shareholder B 40 x 6 = 240

- Number of shares required to elect one directoro Approximately = Number of Voting Shares / Number of directors +1o 100 shares / (6 slots + 1) = 14.28o At least 15 votes per director should get a person on the board.

Shareholder A has 40 shares / 15 shares/position = 2 directors of 6. - Thwart this formula by

o Increasing the total number of voting shares (of majority shareholder)o Elect fewer directors voted on per period (staggered board elect 2 every year) (play

with denominator)

Staggered vs. annual board elections

Under annual, all directors elected each year.- 81% of S&P 500 now use.

Under staggered, portions are elected each year.- Results in the incumbent board being more entrenched. If you want to replace the board

by proxy, have to do it for 3 years.

Control in Closely Held CorporationsSalient Features

Only a few shareholders (often founders and family members)

82

Shareholders are usually also directors, officers, or employees- Degree of familiarity and awareness not present in public corporations- Passive investing is rare.

Awkward fit, b/c default rules designed for public corporation (kind of rules would have negotiated by default)- Closed corporation shareholders are likely to want to modify the default rules.

No secondary market (public trading) for the shares - i.e., “Wall Street” rule inapplicable.- Raises peculiar liquidity issues- No “exit” implies minority investors need more “voice”

Common Contracting Issues in Close Corporations- How decisions will be made- Personnel, Hiring and Firing: Who will be directors/officers and their tasks- Salaries and dividends- Bringing in new shareholders

Remedy : is specific performance appropriate in context of closely held corporations- Many courts award specific performance. - Damages perhaps preferable.

Requirements to be a Closely Held Corporation

DGCL § 342 allows election of close corporation status, if:- Articles provide that company is a close corporation- No more than 30 shareholders- The corporation did not issue stock in a “public offering”- Stock is subject to one/more transfer restrictions specified in § 202

o Mandatory redemption / Forced transfero Corporation or SH approval of the transfero Restriction on transfer to certain persons (unless manifestly unreasonable)o “Any other lawful restriction on transfer or registration…”o Etc.

Shareholder Agreements

Mechanisms for adjusting the authority structure

Shareholder agreements restricting directors’ discretion, e.g., McQuade, Clark Shareholder Voting agreement:

- Vote pooling (where shareholders will agree to vote together), e.g. Ringling, - Voting Trusts (title of shares transfer to trust and trustee votes shares according to

provisions of the trust agreement) Different classes of shares

Shareholders may agree to elect directors, but cannot remove BoD’s discretion RE officers, salaries, or policies

McQuade v. Stoneham - McQuade Treas. & Dir (70 shares); McGraw VP & Dir (70 shares); Stoneham Pres & Dir

(1306 shares). They make an agreement to use their best efforts to elect themselves as directors. And as directors, they agreed to appoint themselves as officers at specified salary. Stoneham and McQuade then have a falling out.

83

o Minority shareholders are not part of this agreement .o Court granted monetary damage but didn’t award specific performance.

- Doctrinal basis: Inappropriate to give shareholders right to fundamentally interfere with the directors. o “A contract is illegal and void so far as it precludes the BoD . . . from changing

officers, salaries, or policies, or retaining individuals in office.”- So the court voids the restriction on the board’s discretion.

o Problem is that they agree not to fire McQuade for any reason. Removes all discretion. Pooling their votes and agreeing who will elect as directors is not the

problem. They cannot agree as shareholders what officers they will elect.

- How could they have assured him of his position as an officer? o Through an employment contract (could put in provision only for cause, and require

unanimous consent of all directors, large “penalty” clause.) - Dissent: This is an artificial distinction. They are shareholders and can remove directors

not electing officers they like.

Exception: Unless all shareholders are party to the agreement

But still look for fraud/injury to public. Clark v. Dodge p.588

- Two drug companies with two shareholders. Clark 25% knows formula; Dodge owns 75%. Main agreement is keeping Clark as an officer in exchange for him revealing formula to Dodge’s son. o Dodge promises that he votes his shares in such a way as Clark as a director and as

director vote to keep Clark as general manager (subject to Clark being faithful, efficient and competent) and agree Clark gets at least 25% of profits.

- Clark got ousted from general manager, b/c of personality conflicto Court upholds agreement.

- Agreement similar to McQuade.o But court upholds the agreement because no minority shareholders or creditors

here to worry about (they had all agreed). Court worries about protecting minority shareholders in closely held corporations

because they can’t just sell their shares due to no market.- Court grants specific performance and orders him to be reinstated.

Under modern approach, also more latitude if reasonable, no objecting minority interest and no public injury

Galler v. Galler p.595- Ban (& Emma) own 47%; Isadore (& Rose) own 47%; Employee Rosenberg owns 6%.

Two 47% shareholders make agreement that benefits surviving widows if one of the brothers die. Isadore and family refuse to perform agreement when wife tries to collect the death benefits. Minority shareholder Rosenberg did NOT object to agreement.o Agreement Valid even despite lack of unanimous shareholder consent

- Adopts modern approach: Protect freedom of contract where no one appears to be hurt and no policy rationale against it.o 1. Corporation is closely-held (look at substance of corporation)

84

o 2. Minority shareholder did not object (under McQuade if agreement does not include all the shareholders cannot bind the board in that matter but, no problem if no object)

o 3. Terms are reasonable- If Minority shareholder Rosenberg had objected about any of the agreement’s terms?

o No because the agreement probably would have appeared to be reasonable.

Penalty for violating pooling agreements = contract damages (and maybe vote invalidation)

Ringling Brothers (Del. 1947) p.576- Agreement between 2 of 3 stockholders that they’d agree on directors and vote as a bloc,

if they couldn’t agree they’d arbitrate and the arbitrator’s decision would be binding. They can’t agree and one of the shareholders refuses to vote as the arbitrator directs.o Stated purpose was to aid them “acting jointly.”

- The agreement didn’t empower the arbitrator to actually vote the shares.o No express delegation and it was not a necessary or usual incident to that function.o Agreement did not make the arbitrator a trustee of an express trust.

- Nor did it empower one party to vote the other’s shares.o No express provision and the language used suggests action by each.o This would be a more effective way of enforcing the arbitrator’s decision, but no

grounds for the court to read it in.- Pooling votes like this is not illegal.

o There was a statute imposing restrictions on voting trusts, but the court held this statute didn’t address mere agreements to vote. Voting trusts and pooling agreements are very different things.

o “A group of shareholders may, without impropriety, vote their respective shares so as to obtain advantages of concerted action.”

o Reasonable provisions for cases of failure to agree are also unobjectionable. Here, agreement doesn’t allow them to take any unlawful advantage of the outside

shareholder.- So, the votes here were in breach of contract. And DE law allows the court to reject votes

from registered shareholders that are in violation of the rights of another person.o That’s the proper remedy, not voting her shares or declaring the election invalid.

Agreement may be enforced by allowing others to buy violator’s shares

Ramos v. Estrada - Voting agreement between two groups of people that formed corporation together to get a

tv broadcast license. This is not a closely held corporation but it resembles one.o Agreement provided that is any shareholder voted against the group, it was deemed

consent to sell to the remaining shareholders at a predetermined (fair) price.- Court holds this agreement was not a proxy (subject to different rules).

o They weren’t giving someone else the authority to vote their shares, they were agreeing how they’d vote them.

- A statute recognizes the right of shareholders in closely held corporations to pool their votes by written agreement. o Even though the corporation is not legally a closely held corp (no declaration), the

court says the agreement is valid and binding. The comment to the statute said it wasn’t intended to affect other valid

agreements, like the one at issue here.- Nor is the buy-out clause a problem.

85

o The statute gives the court equitable power to enforce shareholder voting agreements.o There was no fraud in procuring the party’s agreement.o And, this isn’t a forfeiture of their shares, they voluntarily chose to breach and they

get full compensation for their shares.

Fiduciary Obligations of Shareholders

Introduction

At early common law, shareholders had no fiduciary obligations to firm or fellow shareholders.- Some erosion vis a vis controlling shareholder of public corporations (e.g., Sinclair Oil v.

Levien)- More erosion in close corporation

Mass. Golden Rule: Shareholders in CLC owe each other duty of “strict good faith”

- “Utmost good faith and loyalty” = may not act out of avarice, expediency, or self-interest in derogation of their duty of loyalty to the other stockholders in the corporation.

Donahue v. Rodd Electrotype analogized close corporations to partnerships- Very protective of minority shareholders in close corporations- Applied partnership like fiduciary duties to shareholders of close corporations

o Explicitly invoked Cardozo’s decision in Meiinhard v. Salmon. (“duty of finest loyalty”)

o Tampering off: Initially appear to be fully force with partnership standards but they lesson so fiduciary obligation ends up between partnership and public corp, but closer to partnership.

But, balance legitimate business purpose with practicality of less harmful alternative

A balancing test between fiduciary duty of majority and right to selfish ownership- 1. If challenged majority must have some legitimate business purpose (burden on them

D)- 2. Burden then shifts to minority P to show less harmful alternative

o Court must then balance the legitimate business person against practicability of proposed alterative.

- Rationale: majority invested more in corporation, so should have more control, but not come unduly at the expense of the minority: minority investor new full well of control structure (assumption of risk)

Wilkes v. Springside Nursing Home - 4 equal shareholders. All officers and directors of corporation. There is a disagreement

relating to the sale of a corporation asset to one of the shareholders, which makes him mad so then takes it out on Wilkes out by (1) stripping him of his employment and director position, and (2) refusing to buy his shares at fair price.

- Wilkes gave notice of intent to sell shares: He was stripped of his salary and offices; Other shareholders continued to draw salaries. Connor made lowball offer for Wilkes’ shares. o Problem is that he loses his investment entirely, because it is paying it out only in

terms of salary, and third person reluctant to buy in, in this situation.

86

So from this, the court infers an employment right.- Legal Claim:

o Breach of fiduciary duty by being improperly “frozen out” Directors breached their duty or as controlling shareholders breach fiduciary duty.

o Ways to be frozen out: Donahue way: bought back only majority shareholders at given price, not

minority. Denial of employment (when employment is essential way to realize return) Frozen out by voice, but still receive dividends

- Stockholders in close corporations must discharge their management and stockholder responsibilities in conformity with strict good faith standard. o Therefore, must ask whether the controlling group can demonstrate a legitimate

business purpose for their action. Legitimate Business Purpose: Court have argued P services are no longer

necessary, but P could argue he has other skills Or that P was violating duty of care/loyalty or behaving in a negligent manner.

o If a legitimate business purpose is advanced, burden shifts to minority stockholder to show that the same legitimate objective could have been achieved though alternative course less harmful to the minority’s interest.

o Court must then balance the legitimate business purpose against practicability of proposed alternative.

- What remedy does the court grant to Wilkes against other shareholders?o Not granted reinstatement, but awarded damages against others in their personal

capacityo In general sense the excess value is outside of the corporation so needs to recover

unjust enrichment Could Wilkes have brought another claim against them as directors?

- A derivative claim on behalf of the corporation: The corporation is harmed by paying the others excess salary. Controlling shareholders were all directors

Paid excessive salaries to themselves as officers in violation of DoL to corporation and shareholders

o What standard would apply to the claim Conflict of interest: So, no BJR Entire Fairness standard would apply: D directors must prove that the salaries

they paid themselves were entirely fair to the corporation. o Remedy: repay excessive salaries to corporation. But sometimes courts just send the

correct amount directly to minority investor: - Why reluctant to bring derivative claim?

o Concern is forced to pay excessive salaries to corporation.o They may decide then to keep money in the firm and decline to pay a dividend, and

then we would get to the question of by refusing to declare dividend if freezing minority out.

o JWC: potential tax ramifications Result under partnership law?

- Cannot “fire” Wilkes as a partner o Partners are entitled to participate in the business

87

- What remedy would Wilkes have in that situation?o Wilkes could have threatened to dissolve the partnership, thereby forcing the others to

buy him out This seems to have been what he wanted

Problems- Suppose board had declared $1,000 dividend for all except for shareholder

o Shareholders are entitled to pro rata payment of dividends. To extent that the salaries exceeded a fair payment for services, they were (non

pro rata) dividends.o Claim would be duty of loyalty so no BJR presumption: have to prove decision was

entirely fair. If salaries exceeded fair payment for services, would implicitly contain a

dividend.- Suppose there was evidence that board found another person to do the grounds at a lower

salary, and then fired him?o They would be able to show a legitimate business purpose, he may have been able to

argue there was an alternative: giving him a lower salary. Ordinary BJR and Wilkes would lose (legitimate corporate objective is lower

wage bill)o Problem arises if other officers receive above market salaries: i.e., included an

implicit dividendo Have parties implicitly contracted out of the BJR b/c agreed to keep each other on

directors/officers?- How would you advise parties to avoid this litigation

o Shareholder agreement to maintain each other in office. Enforceable? Probably under McQuade (contracts where the shareholders bind the director’s

hands regarding which officers they appoint and run the company would be null and void, but under Galler if there are no minority shareholders not privy to agreement then enforceable per Galler.)

o Explicit employment agreement with Wilkes proving for terminationo Buyout agreement under which the parties are requires to buyout a disgruntled

investor on fair terms.

Mass.: A minority shareholder has fiduciary duty to majority if has a veto power

Smith v. Atlantic Properties Inc. p.623 (Veto Power Case)- 4, 25% partners. Articles say 80% must vote in favor, which means anyone has veto

partner. (Original intent was the initial owner didn’t want to be ganged up on, but downside is creates potential for deadlock.) They got a lot of accumulated earnings (accumulated earnings tax), so much if they didn’t pay them out or re-invest them they’d be assessed a penalty. o Mr. Wolfson was in highest tax bracket ranging 70-90% for income (and dividends).

Maximum capital gains tax rate 25%, so it did not make sense to him to have them pay dividends.

o Others refused to do renovations, because they wanted dividends. - A minority shareholder, at least where he has a veto power over corporate action, has

fiduciary duties to the majority (which flips the normal rule that majority have fiduciary obligation to majority)

88

o Wolfson use of his veto power was inconsistent with that duty because it subjected the corporation to an unnecessary assessment of penalty taxes; dividend declaration is ordered

- Why is the problem Wolfson’s Fault?o Could argue the others voted for dividends because they were in the lower tax

bracket. o You could argue that each shareholder rationally voted their self interest, and that

caused the corporation liable for this accumulated earnings tax.: if all equally liable because indep. voted in self interest then keep the liability at the corporate level: court’s view is more he acted out of spite.

In Delaware, no special fiduciary duties for close corporations

Controlling shareholders only subject to Sinclair std RE conflict of interest- Nixon v. Blackwell

o Delaware rejects special close corporation fiduciary duties Emphasizes freedom of contract, “definitive provisions of self-ordering” Controlling shareholders subject to Sinclair Oil fiduciary standard that we see in

the public corporation contract. o “Minority stockholder may bargain for protection before parting with consideration.

It would be inappropriate judicial legislation for courts to fashion a judicially created rule for minority investors who could have bargained ex ante or favorable provisions in charter by laws or shareholders’ agreements.”

Applicable Sinclair Oil fiduciary std- Intrinsic fairness and BoP on ∆ only if D is self dealing (i.e, on both sides of the

transaction) or other conflict of interest o BoP on D to show transaction was intrinsically fair to P.

- Otherwise Business Judgment Rule (std of review)o BoP on π to rebut presumption of business judgment (prove fraud, waste,

irrationality) How would Wilkes be decided under Delaware law?

- Issue was whether entitled to continue in his position because a minority shareholder.- Delaware would say you should have bargained for that explicitly

o But Mass. (following “golden rule”) was willing to infer right and reasonable expectation of continued employment.

- Freedom of K o Critique

There is a problem of ex-post opportunism on part of majority. Also a problem with unsophisticated investors not realizing what entering into.

o Pro From an economic point of view: you paid the price for discount (meaning you

paid less because you knew you’d have less control) Critique: but could counter hard to value shares in advance, and maybe you

miscalculated the discount. Some investors prefer more flexibility (corporation) others want more fiduciary

standard (opt for partnership) Court’s should respect the party’s intent by leaving private investors free to go as they

wish and not intermix.

89

Some profitable investments / opportunities will never be made if one cannot make such bargains limiting the minority’s rights.

Remedy for breach

Proper remedy for freeze-out: restoration to position would be without wrongdoing

So, if reasonably expected employment, may order reinstatement, back pay, or both.- If expected to participate in favorable result of operations (profit), entitled to participate

to the extent those results have been wrongly appropriated by the majority. Brodie v. Jordan (Mass. 2006) p.619

- Widow of deceased founding shareholder and former president frozen out by other two shareholders. They paid no dividends but paid themselves salaries. They refused to vote for her nomination to the board. Trial court ordered a forced buy-out of her shares.

- They didn’t dispute they froze her out. They disputed the remedy.o A freeze out is a violation of the duty of utmost good faith and loyalty.

She should be allowed to participate. Giving her access to financial records. Maybe paying her a small dividend. Reasonable effort on others to justify their salaries.

o But, the court held that a forced buy-out was not the appropriate remedy in this case.- The proper remedy for a freeze-out is to restore the party to where they’d be without the

wrongdoing.- But here, there was no buy-out agreement between the parties. The judges order created

an artificial market for shares that, as a close corporation, have little or no market value.- Remand to consider monetary relief (where injury can be quantifies) and injunctive relief

requiring they allow her to participate in the company.o Arguably, they’d be putting her into a tough position (animosity) and dividends

would be more appropriate.

Mass.: No right to continued employment unless reasonably expect continued employment

Ingle v. Glamore Motor Sales - 4 Shareholders. Explicit buyout agreement gave dominant shareholder option to buy

shares of any other shareholders whose employment ceased for any reason. Ingle, person being bought out, is not unhappy about the price of his shares. o Argument: as shareholder he wants to have fiduciary protection against being fired.

- Court: Concludes as shareholder (who was previously just an employee) no legal right to employment security.

- Dissent: argued once he became minority shareholder he could no longer be fired at will and he should have some fiduciary protection for continued employment. o Distinction by majority: Ingles is an employment case primarily; Wilkes is primarily

closed corporation. Is it possible to reconcile the result in Ingle with result in Wilkes?

- The parties in Ingle had a shareholder agreement while the parties in Wilkes did not: explicitly acknowledged could be terminated.

- In Wilkes all the shareholders started together as shareholders which created basis of their relationships, whereas in this case Glamore was original owner who brought in a person who started as employee and only later brought in as shareholder.

90

Involuntary Dissolution / Forced Buy-outs

4 Grounds for ordering buyout at fair value

1. Buyout agreement between parties 2. Forced buyout in lieu of judicial (involuntary) dissolution

- Oppression, fraud, illegality, waste, deadlock- Because liquidation is extreme remedy, courts have recognized alternatives such as

ordering the purchase of the minority shareholders stock at a fair price. 3. Statutory Appraisal

- Fundamental corporate change (merger/consolidation/sale of almost all assets) and shareholder dissented

4. Remedy for breach of fiduciary duty to her (only if other shareholders were offered a buyout not offered to the shareholder suing)- Equal Treatment Rule: Treat equally with the other shareholders- Remedy is limited to what the other’s received that she didn’t.

Involuntary judicial dissolution if fraud, oppression, illegality (towards the minority), deadlock, or waste

Deadlock among directors to extent firm unable to function & shareholders unable to resolve it. MBCA § 14.30(e)(i)- Unable to elect board for two consecutive years. MBCA § 14.30(e)(iii)

Oppression is defined differently in different jurisdictions

Meiselman Approach to oppression: Conduct that defeats the minority’s “reasonable expectations”

Did they invest with reasonable expectation of employment or participation in management and were they defeated by majority shareholder’s conduct- Must be something more than mere disappointment- The very reasons for participating in the business have been defeated

Reasonable Expectations?- 1. Were reasonable under the circumstances- 2. Known or should have been known to the majority- 3. Central to the petitioners decision to join the venture- 4. Limited it to expectations embodied in understandings express or implied among

participants.

Examples of oppression

Directors paying themselves salaries and fees, but not providing any return to her. Not telling her about shareholder meetings until too late. Nor providing pro rata dividends among shareholders. Freeze-out and low ball offer for shares. Alaska Plastic v. Coppock p.640

91

- 3 Investors. One transferred 1/6 interest to ex-wife. 3 Original owners paid themselves directors’ fees and some personal expenses (and actually overpaying previous husband), but paid no dividends. She’s not realizing any return on her investment. o Professional valued company at $23,000-40,000. They offered her $20k, she refused. o Lower Court required AP to buy her shares at their “fair value” and both sides

appealed. Remanded, for more facts determination. - Besides oppression, what other claims could she have brought?

o Derivative suit (Duty of Care/ Duty of Loyalty) Court disallows it because argues no evidence corporation was harmed: size of pie

was the same, just made her slice too small. Argue: paying themselves excessive salaries

o Individual action against the corporation for her share of the “constructive dividends” (0 vs. 1/6) But this would just be a one shot fix, and not get at the fundamental problem of

being generally shut out form operation of business. Constructive, meaning in terms of inflated salary.

- Individual Action against the other shareholders for her share of the “constructive dividends” to extent of their excess payments.o Because her ex-husband got 1/3 instead of 1/6 and she got zero.

Reluctance to dissolve, so generally just order buyout at fair value

Because buyout can destroy synergies Although if dissolution is ordered, they will probably just bargain and agree on “fair value”

to avoid going through court channel or be sold at FMV.

Disillusionment statutes may provide for buyout if oppression (frustrate expectations)

Pedro v. Pedro (Minn. 1992) p.657- Family Business: Alfred, Carl, Eugene. 1/3 each. Each an employee for all adult life.

Equal vote in management. Had a stock retirement agreement (device to buy-out exiting investor at 75% of book value of the firm).o Appears that Carl and Eugene were stealing money from the firm b/c cash is missing

from firm. When Alfred demands an investigation, they fire him so he gets no salary, and they pay no dividends. Denial of employment when reasonable expectation of lifetime employment w/o

cause Concern about his ability to realize investment return.

- Court finds that shareholders have duty to each other to deal “openly, honestly, and fairly with other shareholders.”o Pretty broad expansion of duties!

- Statute grants court broad authority to fashion equitable relief in closely held corporations.

If oppression, increase damages to FMV despite buy-out agreement

Damages for breach of fiduciary duty to act openly honestly and fairly are FMV minus amount due under SRA (plus SRA amount already getting).- So full book value and not the discounted SRA amount.

Damages for breach of implied contract of “lifetime employment”

92

- Closed corporation there may be reasonable expectation of lifetime employment for stockholder, but relates to shareholder’s intent.

- Unlike Ingles, this buyout K does not appear to contemplate being terminated. Just death or their voluntary sale. o Note: Right not originating from this status as a shareholder, inferring his expectation

from their course of dealing. They had all founded, other family members worked there entire life, they seemed

to plan that the brothers would work until they died/retired there.- Damages for breach of implied contract of lifetime employment wages until 72- Should the court have found such a contract?

o In corporate law if you want a contractual right, you negotiate it. It wasn’t reasonable for him to expect lifetime employment.

Maybe provide damages and lost wages if see owner/employee as separate interests

Court says this isn’t a double recovery because two separate interests: owner and employee.- Again broad equitable power of court due to statute.

o Without this broad grant, the court may not have granted to “double” recovery like they did in Wilkes.

- Could argue they thought they were K’ing out of the statute with the SRA.o But, the SRA doesn’t address oppression so they’d still have recourse there.

Does the court interpret the SRA or impose mandatory terms?- It appears to be imposing the mandatory terms of the statute. It’s awarding FMV even

though they K’d for less than that.- It appears from this that the court considers the statute to be more than simply a default

provision. After this case, the statute is amended to make clear that the court should consider the

expectations of all the shareholders. Not just the π.- And, they added language that written agreements should be presumed to reflect the

parties’ reasonable expectations.o Their expectation appears to be that they’d be entitled to 75% of book value, not

FMV.- The courts themselves have also become less permissive in granting relief when a

minority shareholder was terminated.o Probably wouldn't change the conclusion about lifetime employment given their

course of conduct.o So his recovery would be lost wages and the amount provided by the SRA.

But, should still have buy/sell agreement because only covers oppression

Still useful if want to exit and haven’t been oppressed. There the statute doesn’t help you.- Want a legally enforceable mechanism to exist.- But, stating you want to negotiate a buy sell up front may raise some suspicion.

Not oppressed unless completely shut out—no dividends (disagree with strategy not enough)

Stuparich v. Harbor Furniture Mfg., Inc. p.663

93

- Family business. Malcolm has 52% of voting stock. Candi and Ann each own 19% of the voting stock. All of them also own 1/3 of the non-voting shares.

- Court refuses to grant a dissolution.o Relevant provision: was that it would be “reasonably necessary to protect their rights

and interests.” The court applies the BJR and finds that it is not sufficient they are not getting

along with their brother about business strategy. Their only interest as a minority shareholder is the right to receive dividends.

They will never be able to win against the larger voting bloc.o Not a per se right to get a dividend, but once its declared all shareholders must get

a pro rata share.o There was no evidence of abuse and they received dividends (even without a salary).

They have no complaint about not taking a salary. They hadn’t been frozen out like in Alaska Plastics, so no need to dissolve here to

protect them.- Could Malcolm reduce dividends to modernize the furniture business (they were upset

because losing money) and buy them out?o If self-dealing (somehow it disproportionately helped his family who was employed

there), he would have to demonstrate entirely fair to corporation.o But if done so genuinely to improve, then protected by BJR.

Restrictions on Transferring Controlling Bloc

Duties of Shareholders Selling Control Bloc

Market rule: No obligation to share control premium with other shareholders

Zetlin v. Hanson Holdings, Inc. Hanson Holdings and Sylvestri family own 44.4% of the shares of company. Controlling bloc sells share at more than market price. P argues should share in the premium. - Under US law controlling shareholders have no fiduciary duty to share in this premium.

o Rejects the “equal opportunity rule”- “Absent looting of corporate assets, conversion of a corporate opportunity, fraud or other

acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium price”

Why would the purchaser pay this premium?

Entrepreneur: Shares worth more in hands of new controlling owners because incumbent is doing a bad job of managing the new business or because new owners have better mgt skills, resources, etc.- Ideally entrepreneur would want to buy all the shares (to capture all of the added value

Looter: New owner pays a premium because he believes that the control shares carry special benefits in the form of generous excessive salaries perquisites, self-dealing. (e.g., controlling shareholder on board appoint themselves as officers and set their own salaries and generally speaking courts reluctant to intervene b/c BJR unless absurd.)- Looter, would only want to buy sufficient shares to exercise effective control over the

firm.

Equal Opportunity Rule (not the rule)

Must share premium with minority shareholders.

94

- Would transform sales of control blocks to a tender offer for all the shares and would discourage looters.

Would create greater expense, making it harder for potential buyer to do it. Critique: More direct way to deal with self-dealing by shareholders.

- But it will preclude a lot of beneficial take over by company

Exceptions That Require Sharing the Premium

Duty not to sell to known looter (act in bad faith)

Duty not to engage in naked sale of corporate office w/o selling underlying shares

Essesx Universal : naked sale of corporate office (selling control of the board when not selling effective control of shares) is impermissible.- e.g., one of the elements of the K is the board resigns is impermissible.- While he was selling them a majority share, their board was classified so it would have

taken several years for the purchaser to actually obtain control of the board.- Exception if buyer purchases enough shares to gain control of the board.- Concurrence (Friendly): Directors are fiduciaries of all shareholders so you need 51% for

the election to be a mere formality. Litigation over what fraction is sufficient to gain effective control (28.3% appears that it

might be enough in public corporation).

Duty not to usurp a corporate opportunity or asset

Permlan v. Feldman . Feldman is shareholder director and CEO. He sells his stake in steel company to Wilport for a premium ($20 when trading at $10 to $12). Wilport wants access to steel at standard market price w/o implicit premium, so took control.- P alleges Feldman sold a corporate asset, the ability to get an implicit premium, not just

control.- Court concludes violated duty as director, officer, and shareholder.

o Probably strongest argument is violated duty as director: if as director you are agreeing to sell corporate asset, that’s not in the best interest of corporation.

- Does not overturn the market rule. Unique profit-making opportunity here because of government price controls.o Value of that profit could be capitalized and divided between the purchaser and seller

of the control block.o He wasn’t merely selling his controlling stake, it was also a valuable corporate asset.

- Dissent: Argues as controlling shareholder did not violate fiduciary obligation b/c under market rule can sell shares for premium, but P may argue that as director violated fiduciary obligations. Professor agrees.

- Remedy: Compensate corporation for lost value: shareholders are entitled to recover their proportionate share of the premium: didn’t want it going back to the corporation b/c back to the “bad doers”

Right of First Refusal and Take Along Provisions

Right of First Refusal

Majority must first offer stock to person at the same rate they are asking from anyone else. But, a merger is not a sale that would trigger most provisions because company extinguishes

and so can’t be stuck with majority.

95

Also, doesn’t cover sale of corporate assets such as stock in other companies. Frandsen

Take me Along provisions

If sell, the majority must purchase the person’s stock at the same price they paid.

Rationale

Don’t want to be left behind with a stranger majority that may be oppressive, etc.

Frandsen v. Jensen-Sundquist Agency p.669

Holding company owned stock in bank and wanted to sell out. First they proposed the deal as a merger whereby Jensen would extinguish. Then they simply sold the stock they owned (corporate asset) and liquidated.- Shareholder agreement

o Right of first refusal: Majority would offer stock to Frandsen first if they decided to sell.

o Take me along: If Frandsen declined to buy, they had to buy his shares for the same price at which they sold their shares.

Frandsen tried to exercise his right of refusal so Jensen sold its shares in the bank and then liquidated.

Held: There was no offer to sell stock so Frandsen’s right of refusal wasn’t implicated. - This wasn’t a sale of stock, it was a merger at which Jensen would extinguish and have

no more stock.o These agreements protected him from being stuck with a stranger majority that may

be oppressive and that’s not implicated here.o Note: Very formalistic interpretation to reach a result that matched the expectations

the agreement addressed. Nor is the word “sell” sufficiently ambiguous to include the sale of all or some of the

company’s assets.- Not the same thing as selling a majority bloc and it doesn’t have the same stranger risks.- And right of first refusal agreement are to be interpreted narrowly.

96

Limited Liability CompaniesSalient features

Unincorporated business entity Tax advantages of partnerships, i.e., not double taxation and loss “pass through” Limited liability of corporation. ULLCA § 303

Financial Interests

Profit and Loss Sharing = distributions Absent contrary agreement, most statutes allocate profits and losses on the basis of the value

of member contributions- Compare with partnership law’s equal division.- ULLCA § 405(a) uses partnership like equal shares rule for distributions (analogous to

dividends)

Withdrawal

Member may withdraw and demand payment of their interest upon giving the notice specified in the statute of the LLC’s operating agreement.

Member may assign an interest in cash flow rights to third party, but can only get other control rights if can become a member.

FormationFile articles of organization in the designated State office

ULLCA § 202(a) Required and optional contents set forth in ULLCA § 203 Filing fees and Franchise tax

Other Formation Tasks

Choose and register name: LLC statutes generally require the name of the LLC to include the words limited liability company, the abbreviation LLC or similar phrases. ULLCA § 105- Water, Waste & Land v. Lanham : once registered, sufficient to state Name, LLC to put

party on constructive notice that it is a LLC.o If agent contracting on behalf of LLC you should disclose you are an agent to avoid

liability under agency law. o Common law rule of agency: liable

Designate office and agent for service of process Draft operating agreement

- Basic contract governing the affairs of LLC and stating the various rights and duties of the members.

Conversion

§ 902 discusses conversion of partnerships to LLC’s- But note that the partners would remain liable for pre-existing debts

There is no provision for corporations to convert. However, a LLC can merge with an LLC.

97

Funding and Management

Members contribute financial capital but may also contribute other forms, e.g., property, services other obligations ULLCA § 401- Analogous to shareholders- In exchange for contribution, members get management and financial rights in the LLC

Absent contrary agreement, each member has equal rights in the management, ULLCA § 404(a)(1)- Most matters decided by majority vote. ULLCA § 404(a)(2)- Significant matters (e.g., merger, new member, dissolution, etc.) require unanimous

consent. ULLCA § 404(c) Manager –managed LLC option, ULLCA § 404(b)

- Management may be structured as a “board of directors,” a CEO or both.- Must be specified in the articles or organization- The default is member-managed.

Limited Liability

No member or manager of a LLC is obligated personally for any debt, obligation, or liability of the LLC solely by reason of being a member or acting as a manager of the limited liability company ULLCA § 303 PG80- Veil piercing is still possible, which we’ll discuss later.

Operating Agreement

Can alter most of the default rules but can’t unreasonably reduce duty of care/loyalty- Courts are highly deferential to private contracts

Elf Atochen NA Inc. v. Jaffari - Two corporations that come together and decided want to be an LLC as a joint venture.

One party brings knowledge to table of making solvent-based stuff. Other party brings capital. Delaware gives people ability to sue under their corporate law but the operating agreement mandated arbitration and forum. Π alleged breach of fiduciary duty and brought suit in Delaware court.

- Arbitration and forum selection clause enforceableo Court says: LLC law is designed, like the Limited Partnership law, to give parties

considerable freedom of contract.o The LLC itself is bound by the operating agreement even though it didn’t sign.

- Compare to Arbitration Clause with a Corporationo Probably upheld if in corporate bylaws under modern approach

- Enforceable Hypo: “each member relieved of liability for acts against other members or the LLC, irrespective of any allegations of willfulness, intention, or gross negligence”o Not enforceable, against public policyo § 103(b) places limitations on freedom of K: members cannot eliminate duty of

loyalty entirely (but could say certain conduct does not violate this duty). No unreasonably reduce the duty of care.

Make sure not to structure so deadlocks happen as courts won’t add terms on its own- Fisk Ventures LLC v. Segal

o Three classes of shares, both class A and B got to put people on board. They deadlocked when couldn’t raise money.

98

o Court granted judicial dissolution because deadlocked so not reasonably practicable to carry on and agreement didn’t provide way around. So there was basically no business to operate.

o Segal counterclaimed alleging breach of K but court found they hadn’t agreed to the Class B people waiving their put options.

Piercing the LLC Veil LLC liable for member’s or manger’s actionable conduct

A limited liability company is liable for loss or injury caused to a person, or for a penalty incurred, as a result of a wrongful act or omission or other actionable conduct, of a member or manager acting in the ordinary course of business of the company or with authority of the company.

But, members/managers not liable for LLCs liability solely because members/manager

ULLCA § 303 Liability of Members and Managers- . . . A member or manager is not personally liable for a debt, obligation, or liability of the

company solely by reason of being or acting as a member or manager. Of course they can contract around this, and opt out of limited liability.

Under ULLCA, failure to follow formalities is not grounds for imposing personal liability

ULLCA § 303 Liability of Members and managers- (b) The failure of a limited liability company to observe the usual company formalities or

requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or manager for liabilities of the company. If a company does not observe usual company formalities not a ground for

imposingly personal liability- Different than corporation: Where failure to follow the corporate formalities was at

least the first prong for piercing the corporate veil piercing for corporations. Remember Walkovsky hit by taxi cab. Seeon Cap Corp was thinly capitalized. Effect of limited liability is to shield claims. Issue in that case, was whether

corporation was mere alter ego. Doctrine messy not clear cut. Under capitalization not sufficient by itself, co-mingling, not following proper formalities. Also separate prong in Sea Long, failure to post corporate veil would impose fraud and injustice.

Absent a statutory mandate, courts will still probably apply PCV in appropriate cases

It did so Kaycee Land & Livestock v. Flahive - Available corporate law doctrines as readymade body of law are attractive to courts.- We can discern no reason, in either law or policy, to treat LLCs differently than we treat

corporations.- But piercing not contemplated by LLC statue while it is in corporate statue.

If Judge ask: law and economics does it induce efficient behavior / legislative history. - They are distinct, what is efficient in LLC may not be efficient.

Should LLCs be treated like corporations for veil piercing?

Theoretically: contract-arian model views rules that govern business entities as off rack default rules, and some cannot be contacted out of.

99

Important value of keeping these distinct is parties can choose which one they want: many vs. few owners actively involved in business.

Courts may allow people to maximize their welfare by keeping stuff separate. Proper role of courts: should courts do this, or should it be left to legislature.

Why would you want to be a corporation given benefits of LLC’s tax basis?

Decision making much harder to coordinate

Fundamental Differences between corporations and LLC’s that are relevant to veil piercing?

Degrees of informality and separation. Perhaps in LLC context degree of informality should not be enough to pierce corporate veil.

Fiduciary Duties in LLCsManagers (manager-managed) and Members (member-managed) have duties of care/loyalty

Managers of a manger-managed LLC have duties of care and loyalty.

But, members in manager-managed have no duties to the LLC or other members

In contrast, members of a manager-managed LLC usually have no duties to the LLC or its members by reason of being members.

Duty of Loyalty

§409: Duty to account and hold in trust any benefit derived in conduct/winding up Refrain from dealing with the company during conduct/windup on behalf of party with

adverse interest. Refrain from competing with the company in the conduct of the company’s business before

dissolution of the company.

Duty of Care

Limited to refraining engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.

Corporate Opportunities

Like Corps, breach to take opportunity from LLC

ULLCA § 409 –like Corp. Opp, acct profit/property/no compete but can opt out in op agreement unlike corporations

But, unlike Corps, can limit duty in Operating Agreement and permit members to compete

Can also do in Partnership agreements, just not Corporations McConnnel v. Hunt Sports Enterprises

- Seeking a hockey franchise. One party was acting unilaterally ultimately rejects the offer. McConnel then says fine, I want to venture off on my own take the lease and build the franchise. That is what they did. McConnel wants a declarative judgment that, that is fine.

- Taking an LLC Opportunity?o In absence of Operating agreement, McConnel has taken a company LLC

opportunity. - Any member has a duty to account to company any property/profit/no compete with

company per ULLCA § 409(b)(1), (3)

100

o Completely analogous to corporate opportunity doctrine.- Effect of operating agreement

o Did McConnel breach his fiduciary duty in the CHL by competing with it for the arena and franchise? No, because their operating agreement explicitly allowed them to compete

with the corporation including any business that might compete the company. See ULLCA § 103(b)(2): Operating agreement may not eliminate the duty of

loyalty, but may identify specific types of categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable…”

o Corporate Context Different: They cannot opt out of corporate opportunity doctrine

Limitations on Duty just cannot be manifestly unreasonable

§ 103(b)(2): Cannot eliminate DoL but can identify specific types of conduct that don’t comply and specify required number to authorize or ratify otherwise violating conduct.

Disassociation & Dissolution Unlike partnership, dissociation does not lead to dissolution by default

Disassociation = withdrawal or expulsion

Dissolution = winding up of LLC

Dissociation without Dissolution

Withdraw/expulsion of mbr does not lead to dissolution like in partnerships

Withdrawal or expulsion of a member. ULLCA § 601- This does not lead to dissolution of the LLC by default, as it would with a partnership.

UPA.

Disassociated member’s interest must be bought by LLC

Dissociated member’s interest must be purchased by the LLC ULLCA § 603- Judicial appraisal proceeding available ULLCA § 702

Members rights to participate in the business terminates (ULLCA § 603(b)(1) Management right extinguishes except to extent participating in winding up

Dissolution

Events of Dissolution

ULLCA § 801. By operation of law: Upon the happening of

- Any event specified in the LC operating agreement.- Vote of members (as specified in operating agreement)- It becomes unlawful for all or substantially all of the business to carry on.

Upon court order: - Economic purpose frustrated (e.g., deadlock, one goes to court and seeks judicial

dissolution). - Misconduct by members- Not otherwise practicable to carry on in conformity with Operating Agreement- Etc.

101

New Horizon v. Baack

Kickapoo, LLC went out of business leaving 1,000 owed to New Horizons. (Account was in the name of the LLC). Haack made representations that she was a partners and that she would make payments on bill. LLC was then dissolved but formal procedures were not followed. Some assets were distributed to Haack, may have been used to pay off other creditors.

New Horizon sued Haack on an alter ego theory (she and the business entity are not distinct entities, and that it should be treated as general partnership rather than an LLC, and personally liable for its liabilities)- Trial court entered judgment against Haack (1,009) but erroneously relied on fact they

filed taxes as partnership. Why is Haack liable?

- She did not follow the proper procedures for dissolution.o She didn’t properly notify the outstanding creditors. o If she had notified properly, she’d only have been liable for her 50% share.

Statutory basis § 183.0907 If the dissolved limited liability company’s assets have been distributed in

liquidation, a member of the LLC to the extent of the member’s proportionate share of the claim or to the extent of the assets of the LLC distributed to the member in liquidation, whichever is less, but a member’s total liability for all claims under this Section may not exceed the total value of the assets distributed to the member in liquidation.

o Technically fully following the statute she would only be liable for half if her brother was a 50-50 member, only get half, but perhaps he was no longer a member. For dissolution, creditors get first rights. She didn’t show what happened to the

assets, that she didn’t receive $1,000 or more from the firm.

Consequences of Dissolution

Business must be wound up if dissolved per 802(a)

Business must be wound up, Any member who did not wrongfully dissolve may participate in winding up.

May be continued, with unanimous consent if per 802(b)

Requires unanimous consent (including partner wanting dissolution) of all members, except wrongfully disassociating partners.

102

Corporate DebtClasses of Securities

Equity (residual control rights) Common Stock / Preferred Stock Debt (fixed contractual claim w/o control right)

- Bonds: secured long-term- Debentures: unsecured long-term- Notes: short term (secured or unsecured) Commercial paper / Secured or unsecured

Bonds

Typically issued in 1,000 denominations Coupon rate expressed as some percentage of the face value of the bond

- A 1,000 bond with a 7% coupon rate pays $80 per year in interest. Duration

- Bond instrument will prescribe a time when interest and principal must be paid.- Bond may be callable at option of issuer before the due date of principal amount.- Zero-coupon bond : Issuer simply agrees to make one payment in the future; No periodic

interesto E.g., 10 year bond sold for $386 today, pays $1,000 at maturity assuming implicit

10% rate. Valuation

- What is the relationship between the bond’s current price and the market interest rate?o Inverse relationship: if market rates have risen, since the bond was issued, its

current price will fall. o Intuition: get a fixed coupon rate: if paying 8% annually, but market rate goes up to

10%, bond worth less. So they are only willing to purchase it from you if they discount the price. (Comparable risk/duration)

Risks- Issuer’s two promises: 1. Interest to be paid periodically 2. Principal to be repaid in future

on maturity- Interest rate fluctuations: macroeconomics factors beyond debtor’s control- Prepayment risk- Default: factors within debtor’s control

o Change in nature of business – risk of return are proportional.o Change in risk without corresponding return is problematic.

Bond Indenture

A contract in which corporation agrees NOT to engage in specified conduct that would increase bondholder’s risk

Key players:- Issuer- Lead underwriter- Indenture trustee (representative of bondholders who is to enforce their terms, and

supposed to mitigate the collective action problem with dispersed bondholders.) Bond Indenture: Key Provisions

- Statement of events of default

103

o If a default occurs bondholders are entitled to accelerate the maturity of the bonds: they become immediately due and payable.

- Redemption provisions:o Call provisions (if they can retire the bond before maturity date)

- Restrictive covenants:o Limit the firm’s ability to pay dividendso Limit uses of proceedso Specify financial ratios E.g., current assets to current liabilities

- Negative pledge covenants PG 884o Restrict the firm’s ability to issue debt senior to the bond in questiono Restrict the firm’s ability to incur new debto Rationale: pretend issue new debt above yours in priority

Debtor’s Sale of Substantially All AssetsBoilerplate: Right of immediate redemption if liquidate company

Sharon Steel v. Chase Manhattan Bank - UV Industries has 5 series of unsecured notes/debentures. The company has 3 major

concerns: 1. Federal Pacific, 2. Oil & Gas, and 3 Mueller. Divesture starts in late 1978 pursuant to plan of liquidation (must be completed in 12 months for tax reasons). Sold Federal for 345 million. Sold other +100 million. Sold Mueller to Third Party, and wanted Third Party to assume the debt. Trustees were not happy.

- Lenders are unhappy because?o They want Sharon to pay off the face value of the bonds now because the FMV is less

than that.- Indenture Provision

o Successor obligor clause in covenant on consolidations In the case of merger or sale of all or substantially all the corporations assets, the

surviving corporation assumes issuer’s debt Sharon: argued that it was the surviving corporation; clause applies and it assumes

the debt.o Trustee Chase Bank: clause does not apply and Sharon must immediately redeem

debt, because the third party only has 51% of the book value of the assets. - Sharon’s position: it bought all the assets of UV and therefore is entitled to assume

liabilities- Debt holders: that all assets include those at the start of UV’s plan of liquidation

o Court’s concern about asset substitution.o Court is concerned that the debtor gradually substitute assets to shareholders and

transfer it to new debtor with substantially different risk profile. - Trustee’s objection

o Debtor’s assets and management have changed. If they had a security interest in specific assets or had some contract clause

requiring continuity assets they might be entitled to relief. But they didn’t because they held long term unsecured debt.

- Holdingo “boilerplate successor obligation clause do not permit assignment of the public debt

to another party in the course of a liquidation unless “all or substantially all” of the

104

assets of the company at the time of the plan of liquidation is determined upon are transferred to a single purchaser” So P holders win; indentures are due and payable.

o Rationale: Keep Company risk profile constant and protect debt holders.o JUDGE

Judge goes beyond assets at the third stage and looks at the beginning when liquidation planned.

Stretches interpretation beyond plain text to provide protection.

But if acquired all assets that existed when liquidation planned, then right to assume debt

Hypothetical

Successor obligor clause if sold substantially all then they’d assume the debt. Actual Case- In the case, they sold off two lines first, and then sold the last, and question was acquiring

corporation entitled to assume debt or trigger immediate redemption: if you look at the corporation at the time of transaction that would seem to constitute sale of substantially all assets, however court held relevant time frame was how company looked at initial time of liquidation.

Suppose UV had decided to switch from being a manufacturing company to a financial services company. UV sells of its existing assets gradually, but along the way it acquires new assets, such as a bank and an insurance company. Along the way it also acquires new management. Would this trigger the clause?- No; there is never a disposition of substantially all assets.- Yet, there is no continuity of assets or management in that cause—which is precisely

what the trustees claim the holders are entitled to. Simultaneous sale of all the assets and purchase of all the other?

- Sold substantially all assets, so would seem to let purchaser obtain the debt. - Doesn’t give good guidance because court went beyond plain language.

Suppose UV had merged with Sharon, would that have triggered the redemption?- No Sharon would clearly have been allowed to assume the debt.

Incur Additional DebtNo implied covenant not to take on extra debt unless K’d for

Metropolitan Life Insurance Company v. RJR Banisco Inc. - KKR private equity firm engages in a leveraged buyout of the company financed by both

cash, buying out existing shareholders, and issuing new debt as part of consideration for new debt. New debt is on equal terms with the old debt. Metlife, owner of old debt is upset.

- Two relevant provisionso Negative pledge clause (did not prohibit issuance of new debt or subordination of

new debt. No senior debt; no security interest in assets Allowed unsecured debt Did not mandate a debt to equity ratio Did not mandate subordination of new debt.

o Successor obligor provision in M&A clause Allows mergers conditioned on successor firm assuming debt obligations.

105

- What happened in transaction was equity cushion was diminished which increased probability of default.

- P Sue: Contractual claim, there is no fiduciary obligation for debt holders: breach of implied covenant of good faith and fair dealing

- Issue #1 Interpreting Boilerplateo P argued Executives implied debt would remain safe implicitly promising they would

not lower their credit rating. But can’t consider the executives’ speeches on importance of protecting RJR’s

crediting rating because of parol evidenc rule.- Issue #2 Implied covenant of good faith?

o Designed to fulfill mutual intent of parties. Determined from the express terms of the contract

o Breached? No Implied only to protect the “fruits” of the contract

Limited to protection of interest and principal Derives content from express terms of contract Ne new terms of contract can be impliedo Policy reasons

If we don’t know what the court would imply it will stabilize the market. Moreover, initial 11% probably reflected the risk that such a thing could occur.

Effect of New Issue on Bond Value

Assume Acme has assets 1 billion -- liabilities 30 year bond with face amount of 100 million bearing interest at rate of 11%. Balance Sheet: Assets 1 Billion; Liabilities 100M; Shareholder Equity 900 Million.

New debt issues: 1.7 Billion Assets = 100 M liabilities, 700 M new liabilities, Shareholder’s Equity 900Milliion.

Buyback shares: Old Assets 1 billion = Liabilities 100 M + Liabilities New 700 + Shareholder Equity 200M

Basically equity cushion So new issues have to be at higher rate. Why did MetLife hold on to the RJR bonds and invest in US treasury obligations?

- Because added return justified the risk How could company signal that is has lower probably of risk?

- Issue more restrictive covenants, and pay lower rate on debt What about a provision that we will not take any action that will “materially” reduce

probability of paying interest and principal when it is due?- Too vague, too broad.

What effect on bond prices if RJR Nabisco prospers?- Increase value- Investors in high yield bonds expect to profit (in part) from increase in the value of the

bonds if their judgment about the future success of the issuer is sound and the risk of default declines.

- Thus, protection against redemption (“call” protection) is important; without such protection debt investors will lose the benefit of declining default risk.

106

Detailed Index

AGENCY 5

DETERMINING AGENCY 5

Legal Definition (Rst § 1) 5Judged from objective reasonable person standard 5Policy rationale 5

Creditor Liability for Acts of Debtor 5

Become liable if exercise de facto control over debtor 5

PRINCIPAL LIABILITY TO 3RD PARTY IN CONTRACT 6

Authority is the starting point for analysis 6

Actual Authority 6

Express Actual Authority 6Implied Actual Authority 7

Apparent Authority 7

Requirements 7Policy rationale 7

Express Apparent Authority 7

Implied Apparent Authority 7

Inherent Agency Power (catch all) 8

Distinction from Apparent authority 8Restatement treatment 8E.g. Acts of Manager appearing to be Owner 8Rationale 8Power v. Authority 8Watteau v. Fenwick (1892) 8

Ratification 9

Rules 9Botticello v. Stefanovicz (1979) 9Problems 9

Estoppel 10

Rules 10Hoddeson v. Koos Bros (1957) 10

AGENT’S LIABILITY TO 3RD PARTIES IN CONTRACT 10

Disclosed Principal 10Partially disclosed (know P exists but no who) or undisclosed principal 10BUT Default Rules can be circumvented by agreements. 11

LIABILITY OF PRINCIPAL TO 3RD PARTIES IN TORT 11

General rule 11Analysis 11

Actual Agency 11

Servant vs. Independent Contractor 11Factors 11

107

Service station cases 12Policy 12Humble Oil & Refining Co v. Martin 12Hoover v. Sun Oil Co 12

Franchises 13Defined (R. Rosenberg) 13Compare FTC Definition 13Advantages of Franchisee Agreements 13Murphy v. Holiday Inn 13Vandemark v. McDonald’s 14

Apparent Agency 14

ONLY APPLIES IN TORT 14Elements 14Restatement 14Miller v. McDonald’s 14

FIDUCIARY OBLIGATIONS OF AGENTS 15

Duty of Care 15Duty of Loyalty 15

Use Principal’s assert during agency relationship 15

Test: Sole cause vs. opportunity 15Disgorgement of profits. 15Exception: Using time only and not in competition with principal 15Reading v. Regem p.80 16

Stealing Principal’s business 16

Rash v. JVIC 16

After termination of Agency 16

Competition 16Use of confidential information 16Accounting for profits if misuse confidential information 17Cleaning Service: Town & Country v. Newberry 17Problem: Hairdresser leaves salon 17Remedies under fiduciary breach vs. contract claim 17

PARTNERSHIP 18

Statutory body of law 18What is a Partnership? 18General vs Limited 18Partner’s Liability (UPA § 15) 18

DETERMINING THE EXISTENCE OF A PARTNERSHIP 18

Rules for determining existence of a partnership (UPA § 7) 18Summary of Factors Relevant to Partnership Existence 18

Formation 19

No formalities necessary to form a partnership 19The parties must agree to be partners 19A written agreement is evidential but not conclusive 19Fenwick v. Unemployment Comp. Comm’n p.91 19

Partners vs. Lenders 20Degree of Profit sharing/veto right okay if interest on loan & no day-to-day control 20Martin v. Peyton p. 96 20

108

Partnership by Estoppel 20

Rules 20Hypo 20Young v. Jones p.101 21

FIDUCIARY OBLIGATIONS OF PARTNERS 21

Default rule 21Limitations on modifying 21Relevance of Partner Status 21

Taking an Opportunity 21

Rule 21Meinhard v. Salmon p. 105 22Sandvick v. LaCrosse 22Hypos 22

Grabbing and Leaving 23

Rules for Analysis 23Meehan v. Shaughnessy p.117 24

Expulsion 24

Lawlis v. Kightlinger & Gray p.125 24

PARTNERSHIP PROPERTY 25

What is partnership property? 25Partnership capital 25Indemnification for personal payments 25Legal claims are partnership property 25

Sales of property/ Transfers of rights 26

Sales of interest/property require consent of all partners 26Removal of property contributed to partnership 26Assigning rights 26

RIGHTS OF PARTNERS IN MANAGEMENT 26

Rights 26Partner’s authority to bind partnership 26

Voting 27

Majority vs Unanimous 27Allocation of votes 27Deadlock situations 27Partnership Agreements can significantly deviate from default 28

PARTNERSHIP DISSOLUTION 29

Timeline 29When can a partner dissolve the partnership? 29

Judicial Dissolution 29

Grounds for judicial dissolution 29Benefit of judicial dissolution 29Owen v. Cohen p.150 30Collins v. Lewis p.153 30Page v. Page p.158 30

109

Consequences of Dissolution 31

Actions after dissolution 31Rules for distribution 31Choice between continuing business vs. liquidating is crucial 31Acquisition of assets/business by some partners is fine 31

Wrongful Dissolution Continuation Option 32Early dissolution of a term partnership is a “wrongful” dissolution 32Remaining partners have absolute right to continue the business 32Wrongfully dissolving partner’s entitlement if continued 32Pav Saver v. Vassco Corp p.164 32

Sharing losses 33Default rule = losses follow allocation of profits 33Exception (UPA only): Service partnerships 33Kovacik v. Reed (p. 179) 33

Buyout Agreements 34

Malpractice not to recommend 34Key negotiating points 34Parties can contract buyout formula that is more/less than FMV 34G&S Investments v. Belman (p. 183) 34

LIMITED PARTNERSHIPS 35

General partnership liability 35Formation 35Structure 35Liability in Limited Partnerships 35If exercise too much control, limited partner will be treated like general partner 35Holzman v. De Escamilla p.179 35

LIMITED LIABILITY PARTNERSHIP 36

True general partnership . . . but with limited liability 36State variations: Contract vs Tort 36Formation 36

CORPORATIONS 37

The Universe of Corporations 37Partnership / Corp comparison chart 37

KEY FEATURES OF CORPORATIONS 38

Legal personality 38Limited Liability 38Separation of Ownership and control 38Liquidity 38Flexible capital structure 38Contingent Financial Claims: Debt v. Equity 38Shareholders have two rights 39

THE INCORPORATION PROCESS 39

Delaware’s Preeminence 39The Incorporation Process 39Post-Incorporation Activities 40

LIABILITY 40

Promoters and the Corporate Entity 40Limited Liability of owners (except for PCV) 40

110

Limited Liability Praises and Problems 40

PIERCING THE CORPORATE VEIL (PCV) 41

Alter-Ego Liability 41

Sea-Land test (individual as shareholder) 41Subsidiaries (only when corporate shareholder) 41Parent corporation vs. Individual distinction 41Justification: Tort vs. Contract distinction 42Note: Can insulate from PCV by having Limited P’ship with Corp General partner 42Sea-Land Services Inc. v. Pepper Source p.194 42In re Silicon Gel Breast Implants Products Liability Litigation p. 204 43

Enterprise Liability 43

Evidence needed 43Walkovszky v. Carlton p.207 44

CHALLENGING BUSINESS ACTS 44

Ultra Vires Acts 44

Purposes of Corporations 44Definition 44Consequences 44Charitable Donations 44But, businesses aren’t run to serve as charities themselves 45

Business judgment rule 45

Rebuttable presumption acting in interest of corporation 45Rationality is the outer limit 45Shlensky v. Wrigley p.275 46Chart showing BJR application and fiduciary duties 46Two ways of thinking about the business judgment Rule 46

Waste of Corporate Assets 47Standard 47Irrationality is the outer limit 47If required to pay under K, look at whether K obligation itself constituted waste 47Cannot be ratified 47

Derivative Actions 47

Direct v. Derivative Suits 47Delaware approach to determining direct vs. derivative 48Should recovery go to individual or corporation? 48

Procedural Requirements 48

Policy Rationale 48Structural issues 48Potential abuses — Strike suits 49Checking abuses — Security statutes 49

Demand requirement 49Role of the Demand Requirement 49Competing Policy Concerns 49Advantages 49Universal Demand Requirement 49Delaware’s Demand Requirement 49Legal Effect of making Demand 50Cohen v. Beneficial Industrial Loan p.214 50Grimes v. Donald p.223 50

111

Special Litigation Committees 51Timeline 51Policy 51Court may evaluate SLC’s independence and procedures 52Standard for reviewing SLC recommendations 52Zapata Corp v. Maldonado PG 261 52

FIDUCIARY OBLIGATIONS OF DIRECTORS, MANAGERS, & OFFICERS 53

De Facto Officer 53

Duty of Care 53

Director’s duties 53Essentially all about the process 53Board can appoint committee to provide process 53Uninformed Decision 53If informed decision and followed process BJR Protection 54Failure to act or make a decision = no BJR 55Illegal decision or action = no BJR 55

Interaction of Duty of Care and Business Judgment Rule 55BJR is essentially a standard of review 55

Duty of Loyalty 56

DoL arises when director’s interest on both side of the transactions 56Example: Direct vs Indirect 56Once conflict shown, director’s burden to prove good faith and inherent fairness 56Possible defenses 56Bayer v. Beran p.336 56

Corporate Opportunity Doctrine 57When a CO exists 57Board or Shareholder approval not required but creates “safe harbor” 57Corporation cannot have CO if illegal for them to perform act 57Even if not a CO, Agency law may require profit disgorgement 57Ebay Shareholders Litigation PG 389 57

Obligation of Good Faith 58

Not a separate cause of action 58Includes actual intent & conscious disregard for duties 58Duty to be Informed & Act 58

Executive compensation 58Will not evaluate reasonableness of advisor fees 58In re Walt Disney Co. Derivative Litigation p.376 58

Director oversight 58Standard 58In re Caremark 59Elements of Law Compliance Program 59

FIDUCIARY OBLIGATIONS OF DOMINANT SHAREHOLDERS 59

Controlling shareholders owe other shareholders fiduciary duties 59Controlling shareholder can own <50% 59If parent is self-dealing, defendant has burden to show intrinsic fairness 59

DEFENSE OF RATIFICATION 60

Ratification of conflicted interest transactions 60Effect of ratification 60Delaware’s approach 60

112

Board Ratification 60

Board ratification shifts the BoP to π 60Applicable standard of review 60Quorum rules 61

Shareholder Ratification 61

Not corporate opportunity claims 61Duty of Care claims 61DoL with interested director = π BJR 61DoL with controlling shareholders = π fairness 61If all material facts are not disclosed or no majority = ∆ fairness 61Fliegler v. Lawrence p.367 62In re Wheelabrator p.370 62Hypoos 62

INDEMNIFICATION, INSURANCE, ADVANCING FUNDS 63

At CL, directors not entitled to indemnification 63

Rules for Indemnification (DE) 63

Opt (Direct): May indemnify D/O for expenses, judgments, fines in civil/criminal if good faith 63Opt (Derivative): May indemnify D/O for expenses (incl atty fees) if good faith or with court order if found liable 63Good faith = manner reasonably believed in, or not opposed to, best interests of company 63Req’d (both): Must indemnify D/O if successful on the merits or otherwise 63If unsuccessful, indemnification optional unless prohibited by statute 64Waltuch v. Conticommodity Services 64

These rules can be altered by the corporation 64May bind themselves by written agreement to pay expenses beyond requirement 64But, cannot make agreement violating express prohibition (e.g. good faith) 64Corporation may limit Director’s personal liability for breaches of fiduciary duties 64

Advancement of funds 65

May advance funds if D/O agrees to pay back if later found not entitled to indemnification 65

Rules for Insurance 65

May purchase insurance without good faith requirement even if can’t indemnify 65

CONTROL IN LARGE CORPORATIONS 65

PROXY FIGHTS 65

Shareholder’s Role in Governance 65Proxy Process 65Shareholder Voting: Annual Meeting 66Consequences of Dispersed Ownership 66

Proxy Voting 66

All proxies RE registered securities must comply with Commission rules 66Must provide written proxy statement before soliciting proxy 67Proxy materials may not be false or misleading about material facts 67

Private Right of Action if false or misleading 67Private Right of Action in both direct/derivative lawsuits 67Elements of Action 67Remedies 68

Control contests 69Additional requirements for proxy statements 69Timeline 69Corporation must provide shareholder list or mail insurgent’s proxy materials 69

113

Proxy Contests Relatively Rare 69

Reimbursement of Expenses 70

Dispute must concern policy and not personal control/personality 70Amount must be reasonable 70Firm may reimburse incumbents (current mgmt), win or lose 70Firm may reimburse insurgents only if they win 70Challenges due to Conflict of Interest 70Rosenfeld v. Fairchild Engine & Airplane Corp. 71

SHAREHOLDER PROPOSALS 71

Qualifying shareholders may submit proposals for shareholder vote 71Two Common Types of Shareholder Proposals 72Responses to Proposals 72Process for excluding a proposal 72

Proxy access proposals 72Eligibility for 2011 version 72Shareholders may now submit and vote on “proxy access proposals” 72

Grounds for exclusion – 14a-8 73

Failure to meet procedural requirements(s) 73

Failure to satisfy substantive requirement(s) a/k/a Question 9 73Burden of Proof on company 73Provision 1: subject would be improper under state law 73Provision 2: Violation of law 73Provision 3: Violation of Proxy rules 73Provision 4: Personal grievance or special interest 73Provision 5: Relevance (not significantly related to company). 73Provision 6: Beyond Power to Effect/Control/Implement Proposal 73Provision 7: Management functions (ordinary [mundane] business) 73Provision 8: Concerns a Director election 74Provision 9: Conflicts with company’s proposal 74Lovenheim v. Iroquis Brands PG 559 74CA v. AFSCME 74Hypos 74

Board refuses to act 75Board decision not to act is protected by BJR 75

Bylaw Amendments 75

SHAREHOLDER INSPECTION RIGHTS 76

In proxy fight, rules don’t require disclosure of shareholder list 76Insurgents often find this unsatisfactory so look to state law for requirements 76Competing Policy Concerns 76General requirements 76

Inspection of Book and Records per DGCL § 220 76

Any shareholder has the right to inspect and copy for a proper purpose 76Burden of Proof 76Directors may always inspect if reasonably related to position 77

What is a Proper Purpose? 77

Must be “reasonably related to such person’s interest as a stockholder” 77Communication with other shareholders RE wellbeing or value of corporation is appropriate 77Primary purpose must relate to the value of your investment 77Doesn’t matter if you have a secondary purpose, so long as primary is proper 78

114

Sadler v. NCR Corp PG 578 78

SHAREHOLDER VOTING 78

Common Stock as a Bundle of Rights 78Rationale for Shareholder Voting Rights 78

Stock can only have voting rights 78

The economic/control rights of shares can be unbundled. 78Policy analysis 79

Delaware Default Rules for Voting 79

Voting Thresholds 79Default rule regarding per share voting right 79

Possible Modifications 80Classes of stock can have different voting/cash flow rights 80Plurality voting 80Majority voting 80Cumulative voting 80Staggered vs. annual board elections 81

CONTROL IN CLOSELY HELD CORPORATIONS 81

Salient Features 81Requirements to be a Closely Held Corporation 81

SHAREHOLDER AGREEMENTS 82

Mechanisms for adjusting the authority structure 82Shareholders may agree to elect directors, but cannot remove BoD’s discretion RE officers, salaries, or policies 82Exception: Unless all shareholders are party to the agreement 82Under modern approach, also more latitude if reasonable, no objecting minority interest and no public injury 83Penalty for violating pooling agreements = contract damages (and maybe vote invalidation) 83Agreement may be enforced by allowing others to buy violator’s shares 83

FIDUCIARY OBLIGATIONS OF SHAREHOLDERS 84

Introduction 84Mass. Golden Rule: Shareholders in CLC owe each other duty of “strict good faith” 84But, balance legitimate business purpose with practicality of less harmful alternative 84Mass.: A minority shareholder has fiduciary duty to majority if has a veto power 86In Delaware, no special fiduciary duties for close corporations 87

Remedy for breach 88

Proper remedy for freeze-out: restoration to position would be without wrongdoing 88

MASS.: NO RIGHT TO CONTINUED EMPLOYMENT UNLESS REASONABLY EXPECT CONTINUED EMPLOYMENT 88

Involuntary Dissolution / Forced Buy-outs 894 Grounds for ordering buyout at fair value 89Involuntary judicial dissolution if fraud, oppression, illegality (towards the minority), deadlock, or waste 89Meiselman Approach to oppression: Conduct that defeats the minority’s “reasonable expectations” 89Examples of oppression 89Reluctance to dissolve, so generally just order buyout at fair value 90Disillusionment statutes may provide for buyout if oppression (frustrate expectations) 90If oppression, increase damages to FMV despite buy-out agreement 90Maybe provide damages and lost wages if see owner/employee as separate interests 91But, should still have buy/sell agreement because only covers oppression 91Not oppressed unless completely shut out—no dividends (disagree with strategy not enough) 91

RESTRICTIONS ON TRANSFERRING CONTROLLING BLOC 92

115

Duties of Shareholders Selling Control Bloc 92

Market rule: No obligation to share control premium with other shareholders 92Why would the purchaser pay this premium? 92Equal Opportunity Rule (not the rule) 92

Exceptions That Require Sharing the Premium 93Duty not to sell to known looter (act in bad faith) 93Duty not to engage in naked sale of corporate office w/o selling underlying shares 93Duty not to usurp a corporate opportunity or asset 93

Right of First Refusal and Take Along Provisions 93

Right of First Refusal 93Take me Along provisions 93Rationale 93Frandsen v. Jensen-Sundquist Agency p.669 94

LIMITED LIABILITY COMPANIES 95

Salient features 95Financial Interests 95Withdrawal 95

FORMATION 95

File articles of organization in the designated State office 95Other Formation Tasks 95Conversion 95Funding and Management 96Limited Liability 96Operating Agreement 96

PIERCING THE LLC VEIL 97

LLC liable for member’s or manger’s actionable conduct 97But, members/managers not liable for LLCs liability solely because members/manager 97Under ULLCA, failure to follow formalities is not grounds for imposing personal liability 97Absent a statutory mandate, courts will still probably apply PCV in appropriate cases 97Should LLCs be treated like corporations for veil piercing? 97Why would you want to be a corporation given benefits of LLC’s tax basis? 98Fundamental Differences between corporations and LLC’s that are relevant to veil piercing? 98

FIDUCIARY DUTIES IN LLCS 98

Managers (manager-managed) and Members (member-managed) have duties of care/loyalty 98But, members in manager-managed have no duties to the LLC or other members 98Duty of Loyalty 98Duty of Care 98

CORPORATE OPPORTUNITIES 98

Like Corps, breach to take opportunity from LLC 98But, unlike Corps, can limit duty in Operating Agreement and permit members to compete 98Limitations on Duty just cannot be manifestly unreasonable 99

DISASSOCIATION & DISSOLUTION 99

Disassociation = withdrawal or expulsion 99Dissolution = winding up of LLC 99

DISSOCIATION WITHOUT DISSOLUTION 99

Withdraw/expulsion of mbr does not lead to dissolution like in partnerships 99Disassociated member’s interest must be bought by LLC 99

116

DISSOLUTION 99

Events of Dissolution 99New Horizon v. Baack 100

CONSEQUENCES OF DISSOLUTION 100

Business must be wound up if dissolved per 802(a) 100May be continued, with unanimous consent if per 802(b) 100

CORPORATE DEBT 101

Classes of Securities 101Bonds 101Bond Indenture 101

DEBTOR’S SALE OF SUBSTANTIALLY ALL ASSETS 102

Boilerplate: Right of immediate redemption if liquidate company 102But if acquired all assets that existed when liquidation planned, then right to assume debt 103Hypothetical 103

INCUR ADDITIONAL DEBT 103

No implied covenant not to take on extra debt unless K’d for 103Effect of New Issue on Bond Value 104

DETAILED INDEX 105

117