You are on page 1of 84

Business Organizations

OUTLINE
I. Agency
A. Who is an Agent?
- an agent is:
o one who acts for another by authority from him,
o one who undertakes to transat business or manage some affair for another by
authority and on account of the latter
Three Required Elements of an Agency Relationship:
- !" a manifestation by the #rini#a$ that the agent wi$$ at for him%
o consent by a #erson &the #rini#a$' that the other &the agent' sha$$ act on her/his
behalf
o If they consent to eah other, then ageny resu$ts and they are now bound in a
re$ationshi# that the $aw reognizes &it now has $ega$ im#$iations'
- (" ae#tane by the agent of the undertaking% and
- )" an understanding between the #arties that the principal will be in control of the
undertaking
NOTE: The re$ationshi# of #rini#a$ and agent does not need to involve some matter of business
Legal Implications:
- In order to reate an ageny, there must be an agreement, but not neessari$y a contract
between the #arties
o there doesn*t ha+e to be a ontrat between #rini#a$ and agent
o the agent doesn*t ha+e to #romise to at as suh
o neither one has to reei+e om#ensation
- ,geny is its own kind of $ega$ re$ationshi# that has its own im#$iations
o Legal implication: the #rini#a$ is res#onsib$e for what the agent does
Responsibility for Acts of Agents
- -rini#a$s are res#onsib$e for the ats of their agents
- If one is an agent, then his ations are attributab$e to the #rini#a$
o orton v! "oty# where teaher $oaned her ar to footba$$ oah and #$ayer was
in.ured" The /ourt found that the oah was ating as the teaher*s agent when he
dro+e her ar" 0he ou$d ha+e dri+en the #$ayers herse$f, but instead she hose for
the oah to dri+e her ar, with the ondition #reedent that only he drives the
car. The ourt thinks it*s an im#ortant fat that she s#eifia$$y said that on$y he
was su##osed to dri+e the ar, nobody e$sethat is e+idene that the oah was
ating sub$ect to her control. The ourt fee$s that sine the oah was the atua$
dri+er and was under her control, he onsented to the agreement"
RS 161%eneral agent# an agent authorized to ondut a series of transations in+o$+ing a
continuity of service
!
&urden of 'roof
- - has the burden to #ro+e ageny by a fair preponderance of the evidence
- ,geny is a 1uestion of fact
- NOTE: ageny is traditiona$$y #art of state $aw
Three 'rincipal (orms of Agency
- !" the re$ation of principal and agent
- (" the re$ation of master and servant% and
- )" the re$ation of employer/proprietor and independent contractor
TEST FOR AGENC:
- 2as a #arty agreed to at on beha$f of a seond #arty, sub.et to the seond #arty*s
ontro$3
o If 4E0, an ageny re$ationshi# is reated
Reality of the )ircumstances
- an agreement may resu$t in the reation of an ageny re$ationshi# even if the parties did
not call it an agency and did not intend the legal consequences of the relation to follow
- ourt $ooks to the fats and the reality of the actual situation to deide whether there was
an ageny re$ationshi# or a business re$ationshi#
o intent of the #arties does not matter5on$y their actions toward each other!
- The e6istene of the ageny may be #ro+ed by circumstantial evidence which shows a
course of dealing between the two parties
o when an ageny re$ationshi# is to be #ro+en by irumstantia$ e+idene, the
#rini#a$ ha+e consented to the agency
o one annot be the agent of another e*cept by consent of the principal
- an ageny re$ationshi# resu$ts when ob$ective riteria are met, regard$ess of the #arties
sub$ective #ersona$ be$iefs
- when #eo#$e beha+e towards eah other as #rini#a$ and agent, the $aw wi$$ ho$d them to
this
- , reditor who assumes control of his debtor+s business may beome $iab$e as a #rini#a$
for the ats of the debtor in onnetion with the business"
o ay ,enson (arms )o! v! )argill- Inc!# where farmers wou$d gi+e 7arren grain,
and they wou$d gi+e it to /argi$$" 8armers &-*s' $aim that 7arren bought grain as
an agent for /argi$$, so when 7arren fai$s to #ay the farmers for their grain,
/argi$$ shou$d #ay their debt" 7arren doesn*t ha+e any money so /argi$$ makes
an agreement to he$# them out5/argi$$ wou$d $oan money to 7arren, and then
when 7arren made money, the money wou$d be de#osited with /argi$$" 7arren
had to get /argi$$*s #ermission before doing many things &se$$9#urhase stoks,
making re#airs worth o+er :;<<<, or beome $iab$e on debts'" /argi$$ o+ersaw a$$
of 7arren*s ations and made reommendations that ertain ations shou$d be
made" ,s 7arren*s finania$ situation got worse, /argi$$ began ontating 7arren
e+eryday regarding their finanes" The /ourt finds that there is an ageny
re$ationshi#, and that /argi$$*s ations were enough to onsent to the ageny
re$ationshi#" By its ontro$ and inf$uene o+er 7arren, )argill became a
principal with liability for the transactions entered into by its agent .arren!
(
/argi$$ and 7arren did not e6#$iit$y onsent to an ageny re$ationshi#, but
/argi$$ &reditor' had suffiient ontro$ o+er 7arren &debtor', so they had an
ageny re$ationshi#, where reditor is $iab$e for the ations of the debtor"
The ourt says =we dea$ here with a business enter#rise marked$y different
from an ordinary bank finaning, sine /argi$$ was an active participant in
7arren*s o#erations rather than sim#$y a finanier" /argi$$*s ourse of
dea$ing with 7arren was a #aterna$isti re$ationshi#, where /argi$$ made
the key eonomi deisions and ke#t 7arren in e6istene">
- NOTE: a seurity ho$der who mere$y e6erises a +eto #ower o+er the business ats of his
debtor is not a #rini#a$, but if he takes o+er the management of the business and direts
whih ontrats may or may not be made, he has beome the #rini#a$ and is liable for
the agent+s actions
'ublic 'olicy
- in our soiety, when someone is e6erising ontro$ o+er someone and doing something
for that #ersons* benefit, it seems fair that they be res#onsib$e for that outome
o we want fairness and .ustie
- It is unfair if one #arty e6erises ontro$ o+er another, but takes no res#onsibi$ity for the
other #arty*s ations
o E6" /argi$$ $aimed that whi$e they had ontro$ o+er 7arren, they were not
res#onsib$e for what ha##ened to them ?this is a rei#e for a sma$$ #ie@
- The #rini#a$ is not aountab$e for every at that the agent does, on$y those that the
agent has authority to do
o E6" of the teaher and the oah5e+en if the oah was her agent when dri+ing
her ar, if he goes out and buys #ro#erty, she is not $iab$e for #ayment of the $and,
b9 she on$y onsented to the use of the ar"
-ie ,na$ogy:
- Two Aiews:
o 4ou an be onerned with di+ision of the #ie5who gets what in the #ie5
fairness/ OB
o 4ou an be onerned with the growth of the #ie5efficiency
- 7e shou$d be $ess onerned about the distribution of the #ie and more onerned about
the size of the #ie
- 4ou ou$d say you are more onerned with a fair distribution of the #ie than with your
own s$ie of the #ie
!. "ia#i$ity o% &'inci(a$ to Thi') &a'ties in Cont'act
1. A*tho'ity
Actual authority
- ,uthority that the #rini#a$, e6#ress$y or im#$iit$y, ga+e the agent
Implied authority
- Under the =atua$ authority> ategory
)
o The atua$ authority gi+en to the agent by the #rini#a$ a$so in$udes #owers that
are practically necessary to arry out the duties atua$$y de$egated"
- FOC+S: upon the agent+s understanding of his authority!
- the agent must reasonably believe- beause of #resent or #ast ondut of the #rini#a$,
that the #rini#a$ wishes him to at in a ertain way or to ha+e ertain authority
o 0#eifi ondut by the #rini#a$ in the #ast #ermitting the agent to e6erise
simi$ar #owers is ruia$
o ,gent an use irumstantia$ e+idene
the ats and ondut of the #arties suh as the ontinuous ourse of
ondut of the #arties o+ering a number of suessi+e transations
- the agent has the authority to do anything that a reasonable person wou$d think are
neessary to aom#$ish the task that he was gi+en actual authority to do
o 0ill 1treet )hurch of )hrist v! 2ogan- where hurh hired Bi$$ to #aint and he
then hired his brother, 0am" 0am be$ie+es that Bi$$ had the authority to hire him%
0am was e+en #aid for the ha$f hour of his work" 0am argues that Bi$$ was the
/hurh*s agent when he hired him" The /hurh says they ga+e ne+er ga+e Bi$$
the authority to hire 0am5on$y ga+e him authority to #aint the /hurh" The
/ourt found that 0am was an em#$oyee b9 Bi$$ 2ogan had the im#$ied authority
to hire 0am as his he$#er b9 he needed he$# #aining &he had the actual authority
to #aint'" In the #ast, the /hurh had gi+en Bi$$ authority to hire others as need"
The hurh is being he$d $iab$e for something they did not gi+e the agent
something to do, in fat it is something they rea$$y didn*t want him to do5they
wanted another guy to do it"
&urden of 'roof: the #erson a$$eging has to #ro+e that he is the agent and has the authority to at
as an agent
,. A((a'ent A*tho'ity
Two Cain /$assifiations of ,uthority:
- !" actual authority- authority that the #rini#a$ e6#ress$y or im#$iit$y ga+e the agent
o implied authority is a sub-grou# of actual authority
atua$ authority gi+en im#$iit$y by a #rini#a$ to his agent
- (" apparent authority# when a #rini#a$ ats in suh a manner as to convey the impression
to a third #arty that an agent has ertain #owers whih he may or may not atua$$y
#ossess
Apparent Authority
- the authority that the agent appears to #ossess
o It is a matter of a##earanes on whih third #arties ome to re$y
- FOC+S: on the perspective of a reasonable third party
- If #rini#a$ ho$ds out agent as ha+ing authority to bind #rini#a$ then agent wi$$ ha+e that
authority:
o e+en if #rini#a$ ne+er ga+e the agent authority% ,ND
o e+en if #rini#a$ to$d agent that he does NOT ha+e the authority"
E
- Lind v! 1chenley Industries- Inc!- where - is suing for om#ensation that is due to him out
of a ontrat" A- to$d - he was going to be mo+ed u# and to$d - to re#ort to Faufman
and he wou$d te$$ him about his new duties and om#ensation" - was #romoted and
Faufman to$d him that he wou$d get !G ommission on the sa$es of the men under him"
The /ourt found that Faufman did ha+e the authority to offer - the !G ommission b9
there is e+idene of ageny" ,$though Faufman was ne+er to$d that he had the
#ermission to make u# Lind*s sa$ary, and was atua$$y to$d that he did NOT ha+e the
authority, the 3' held out 4aufman to - as ha+ing the authority to te$$ Lind his sa$ary5
therefore there was a##arent authority" The ourt finds that that the om#any an be he$d
aountab$e for Faufman*s #romises on the #rini#a$ of =a##arent authority>% as far as
Lind was onerned, Faufman was the s#okesman for the om#any"
NOTE: inherent agency and apparent agency are both theories under whih the #rini#a$ may be
he$d $iab$e for the ats of an agent where there is no actual authority
-. Inhe'ent Agency &o.e'
- If an agent does something ontrary to the #rini#a$*s instrutions, the #rini#a$ is sti$$
$iab$e if he has he$d the agent out as having the authority to ma5e his decisions
- 7hen an agent is #$aed in #osition that genera$$y omes with ertain #owers to bind
#rini#a$s, then the #rini#a$ wi$$ be $iab$e
- RS 1/0- an undisclosed principal is $iab$e for ats of an agent done on his aount, if
usua$ or neessary in suh transations, a$though forbidden by the #rini#a$
- RS 1/1- ,n undisclosed principal who entrusts an agent with the management of his
business is $iab$e to third #ersons with whom the agent enters into transations usua$ in
suh business and on the #rini#a$*s aount, a$though ontrary to the diretion of the
#rini#a$
o .atteau v! (enwic5# 2umb$e used to own the bar and then so$d it to D &a firm of
brewers'! D makes 2umb$e the manager and 2umb$e*s name is sti$$ on the front
of the bar! 2umb$e on$y had the authority to buy a$es and minera$ water5D*s
were su##osed to do the rest! 2umb$e ends u# buying igars and Bo+ri$ from
+endors" They ask 2umb$e to #ay &whose name is on the door'! 2umb$e te$$s
them that he has no money, so - sues 8enwik for the money sine he is the rea$
owner" 2ere, the #rini#a$ is not ho$ding out his redit and the business is arried
on in the agent*s name and the goods are su##$ied on his redit, agency in fact
must be shown to make the #rini#a$ $iab$e! The rea$ owner of the bar argues that
he is not $iab$e on these ontrats b9 2umb$e did not ha+e the authority to buy the
goods, and no reasonab$e #erson wou$d think that he had the authority" The /ourt
says it is we$$ known in soiety that genera$ managers of bars ha+e the authority
to bind their #rini#a$s to the sa$es of igars and Bo+ri$"
- One it is estab$ished that 8enwik is the #rini#a$, then the regu$ar ru$es a##$y:
o The #rini#a$ is $iab$e for a$$ of the ats of the agent whih are within the
authority usua$$y onfided to an agent of that harater, notwithstanding
$imitations &as between the #rini#a$ and the agent' #ut u#on that authority
- In agency in fact, the #rini#a$ wi$$ on$y be $iab$e if the at done by the agent is within the
so#e of his ageny5not where there has been an e6ess of authority
;
TEST FOR "IA!"IT OF T2E &RINCI&A":
- Was the agent #eing he$) o*t as ha3ing the a*tho'ity to act %o' his ('inci(a$?
'ublic 'olicy
- The 8enwiks of the wor$d do not want to bother with these things
o they don*t want to ha+e to answer to e+ery +endor that wa$ks through the door, so
they hire someone e$se to do it
- if we donHt ha+e the one#t of inherent agency, it wi$$ be hard to get the igars into the
bars b9 +endors wi$$ ne+er be$ie+e or trust #eo#$e $ike 2umb$e5they wonHt trust that he
has authority and then wi$$ re1uire +endors to do $ots of researh on who they are se$$ing
to et"
o this is not effiient &$ess #ie'
- Inherent agency is $ooked down u#on in or#orate $aw and ourts try to find apparent
agency- so need not rest on inherent ageny"
Summary of Agency
Three .ays to 1how Liability of a 'rincipal to Third 'arties for the Acts of Agent:
- !" e*press or real authority, whih has been definite$y granted%
- (" implied authority- that is, to do a$$ that is #ro#er, ustomari$y inidenta$ and reasonab$y
a##ro#riate to the e6erise of the authority granted% and
- )" apparent authority- suh as where the #rini#a$ by words, ondut or other indiate
manifestations has =he$d out> the #erson to be his agent
,geny- a human re$ationshi# founded in $aw that arises in the way that #eo#$e treat eah other
- regard$ess of the sub.eti+e intent of the #arties
- the #rini#a$ wi$$ be hargeab$e9$iab$e for the ations of the agent
o but on$y those ations that the agent has authority from the #rini#a$ to do
Theories of Agency:
- actual
o e*press# #rini#a$ and agent agree on what authority the agent has
o implied# an used #ast ations to im#$y the ageny re$ationshi#5this fouses on
the #ers#eti+e of the reasonable agent
- apparent# does not $ook at the #ers#eti+e of the reasonab$e agent, but to the #ers#eti+e
of the reasonable third party
o an em#$oyee-agent has apparent authority to make an agreement binding on his
em#$oyer-#rini#a$, if, but on$y if, the em#$oyer-#rini#a$ through offiers or
other agents authorized to do so has held out that the employee#agent has such
authority
o e+en if authority was ne+er gi+en, or e+en if the agent was s#eifia$$y to$d that he
did not ha+e that authority
o most firms want there to be this ageny, so that $ients be$ie+e what the agent
says, then the #resident an easi$y de$egate authority- he doesn*t ha+e to be
a+ai$ab$e for e+ery $itt$e 1uestion, his agents an take that res#onsibi$ity
I
- inherent
o , general agent- for a dis$osed or #artia$$y dis$osed principal, sub.ets his
#rini#a$ to $iabi$ity for ats done on his aount, which usually accompany or are
incidental to transactions, whih the agent is authorized to ondut if, a$though
they are forbidden by the #rini#a$, the other party reasonably believes that the
agent is authori6ed to do them and has no notice that he is not so authori6ed!
o -rini#a$ an be $iab$e for ondut whih he did not desire or diret, to #ersons
who may or may not ha+e known of his e6istene or who did not re$y u#on
anything whih the #rini#a$ said or did
-rini#a$ is $iab$e e+en when an agent has ated im#ro#er$y in entering
into ontrats or making on+eyanes
o where a genera$ agent does something similar to what he is authori6ed to do- but
in +io$ation of orders
The #rini#a$ wi$$ beome $iab$e as a #arty to the transation, e+en though
he is undis$osed
o FOC+S: this is a$so onerned with the #ers#eti+e of the third party
o re1uires that the #rini#a$ has #$aed the agent in a situation with a ustomary
authority that wou$d bind the #rini#a$
- ratification
- estoppel
0. Rati%ication
Elements of Ratification:
- !" ae#tane of the resu$ts of the at
- (" with an intent to ratify% ,ND
- )" with fu$$ know$edge of a$$ the materia$ irumstanes">
RS 4,- =Batifiation is =the affirmane by a #erson of a #rior at whih did not bind him, but
whih was done or #rofessed$y done on his aount>
- the #rini#a$ an say that, a$though his agent did not ha+e the right to enter into the
ontrat, he is ha##y the agent did, and the #rini#a$ wi$$ affirm the transaction and agree
to be bound by the contract
- Batifiation ha##ens when somebody affirms a dea$ that was done on their beha$f, but the
dea$ was not binding at the beginning5one ratifiation ours, he9she is then bound to
the terms of the agreement
o &otticello v! 1tefanovic6- where Cary and 7a$ter &D*s' owned a farm and -
beame interested in the $and" They negotiate, D*s refuse the first offer and then
the buyers ome bak and say :J;,<<<, 7a$ter says 4es, Cary says, =I wou$dn*t
se$$ it for $ess than that"> 7a$ter and - sign the agreement" ,t the time, - did not
know that 7a$ter was a tenant in ommon with Cary% - thought he owned the
who$e $and" 7a$ter ne+er to$d - that he was ating as his wife*s agent" - starts
$i+ing on the $and and makes im#ro+ements to it and then wants to e6erise his
o#tion and #urhase the $and" D won*t $et - e6erise his o#tion to #urhase"
7a$ter says that - made an agreement with him, not with Cary, so she is not
ob$igated to the terms of the agreement" - argues that 7a$ter is Cary*s agent"
K
7a$ter had not been signing douments for her in the #ast5she had signed
anything in+o$+ed with the #ro#erty" - $aims that Cary ratified the ontrat*s
terms by her subse1uent ondut &reei+ing9ae#ting #ayments, et"' The ourt
disagrees" 0ine 7a$ter ne+er #ur#orted to be ating on his wife*s beha$f, as is
essentia$ to the effeti+e subse1uent ratifiation, Cary is not bound by the terms
of the agreement" 7a$ter is $iab$e for his share of the ontrat, but Cary is not"
- NOTE: &efore the receipt of benefits may constitute ratification- the other requisites for
ratification must first be present
o One annot #ur#osefu$$y en.oy the benefits of the $and without ratifying the dea$
There must be an intent to ratify
E6" =I hereby ratify this dea$>
- NOTE: Carita$ status does not in and of itse$f #ro+e the agency relationship LNor does
owning land together make one the agent for the other
1. Esto((e$
- 7hen a #rini#a$ ho$ds someone out to be his agent, there is a ontrat with the #rini#a$
by estoppel, regard$ess of how muh the agent e6eeds his authority, but when there has
been no ho$ding out by the #rini#a$, proof must be given of agency to ma5e the principal
liable
o The a##earane of authority must be shown to ha+e been reated by the
manifestations of the alleged principal, and not a$one and so$e$y by #roof of those
of the su##osed agent
- The #rini#a$ wi$$ be estopped from denying the ageny re$ation if the third #arty had
a$tered her irumstane in reasonab$e re$iane
- If a #rini#a$ fai$s to take reasonab$e #reautions to kee# =wou$d be agents> out of his
#$ae of business, where a reasonab$e #erson wou$d take im#ostor as agent, the #rini#a$
will be estopped from denying the agency relationship if the )rd #arty a$tered
irumstane in reasonable reliance on the supposed relationship
o 2oddeson v! 4oos &ros# - goes to D*s furniture store and is a##roahed by a sa$es
#erson, who shows her the furniture, and then starts writing the a$u$ations on a
#ad of #a#er" 0he gi+es him the money in ash, but does not get a reei#t" 7hen
the furniture doesn*t arri+e, she a$$s the store and they ha+e no reord of the
transation" It turns out the sa$esman was an im#oster. - says the store shou$d be
$iab$e as the #rini#a$, but none of the ty#es of ageny seem to fit" The - is
a$$eging #ri+ity of ontrat with the D through the relationship of agency between
the " and the salesman. The duty of the owner of the stores in$udes the e6erise
of reasonab$e are and +igi$ane to #rotet the ustomer from $oss oasioned by
the dee#tions of an a##arent sa$esman. D fai$ed to take reasonab$e #reautions to
take wou$d be im#osters out of their store. /ustomers shou$d not ha+e to in1uire
into the $egitimay of a$$ sa$es#ersons before making her #urhases"
'artially "isclosed 'rincipal
- when the other #arty to the transation has notie that the agent is or may be acting for a
principal for whom the agent is ating
- un$ess otherwise agreed, an agent who makes a ontrat with another for a partially
disclosed principal is a #arty to the ontrat
J
- Duty of ,gent
o it is the duty of the agent, if he wants to a+oid #ersona$ $iabi$ity on a ontrat
entered into by him on beha$f of his #rini#a$ to:
!" dis$ose not on$y that he is ating in a re#resentati+e a#aity% ,ND
(" the identity of his principal!
- 0ust be actual 5nowledge# It is not enough that the other #arty has the means of
asertaining the name of the #rini#a$
TEST FOR &ARTIA"" 5ISC"OSE5 &RINCI&A"S:
- 5i) the agent ('o3i)e the thi') (a'ty .ith actual knowledge that:
o 1. the agent .as .o'6ing %o' a ('inci(a$7 AN5
o ,. the i)entity o% that ('inci(a$?
- I% ES8 then agent is not $ia#$e %o' the cont'act
C. "ia#i$ity o% &'inci(a$ to Thi') &a'ties in To't
'rincipal#Agent relationship: &subategories of this re$ationshi#'
- master#servant5master is e6erising ontro$ o+er the dai$y ati+ities of the ser+ant
o $iab$e for both ontrats and torts
o ser+ant agrees to work for the master and sub.et to the master*s ontro$
o master has agreed that ser+ant wi$$ work on his beha$f when ontrating with third
#arties
- principal%non#servant agent
o agent is agreeing to work on beha$f of the #rini#a$ and the #rini#a$ agrees to
ha+e the agent work on his beha$f, but the #rini#a$ does not agree to the way that
the agent goes about it
o this on$y a##$ies in ontrat ases, not in tort
o -rini#a$ is not e6erising ontro$ o+er how the agent aom#$ishes the task of the
ageny
o -rini#a$ is $iab$e for ontrats that the agent enters into, but not the Torts &T'
the #rini#a$ is not in a #osition to #re+ent any torts, therefore he is not
$iab$e for the torts ommitted by the agent
o independent contractor5this is not a #rini#a$9agent re$ationshi#5it is a non-
agent
Not an agent at a$$% this is an arms-$ength transation
- NOTE: non-ser+ant theory M inde#endent ontrator theory
o ?.ust two different terms for it@
7on#Agency
- ontratua$ re$ationshi#s b9t business #eo#$e
- one #arty agrees to #ro+ide some kinds of good and ser+ies to another #arty
- the ontrating #arty is not authorized to enter into any ontrats with )
rd
#arty5no
authority to re#resent the #arty with whom they are ontrating in any a#aity
- the term independent contractor is used in both ageny and non-ageny re$ationshi#s
N
1. Se'3ant 3s. In)e(en)ent Cont'acto'
- dotrine of respondeat superior# a master &em#$oyer' is $iab$e for the torts of its ser+ants
&em#$oyees'
- a master-ser+ant re$ationshi# e6ists where the ser+ant has agreed:
o &a' to work on beha$f of the master % and
o &b' to be sub.et to the master*s ontro$ or right to ontro$ the =#hysia$ ondut>
of the ser+ant &that is the manner in whih the .ob is #erformed, as o##osed to the
resu$t a$one'
- Inde#endent ontrators an be both agents and non-agents
o Agent#type I)# one who has agreed to at on beha$f of another, the #rini#a$, but
not sub.et to the #rini#a$*s ontro$ o+er how the resu$t is aom#$ished
&#rini#a$ does not ontro$ the =#hysia$ ondut> of the task'
o 7on#agent I)# one who o#erates inde#endent$y and sim#$y enters into arm*s
$ength transations with others
E*! if a ar#enter is su##osed to bui$d a garage for a homeowner, and
doesn*t take any instrutions from him, but is .ust su##osed to get the .ob
done, then he is an independent contractor &not ating as an agent'
0aster 1ervant
- 2umble 8il 9 Refining )o! v! 0artin# where 2umb$e owns the gas station that 0hneider
runs! , ar was being ser+ied and ro$$s down a hi$$, in.uring the -" 2umb$e &owner'
says this is an arms-$ength transation, and he shou$d not be $iab$e for 0hneider*s
ations" 2umb$e says he is not $iab$e b9 0hneider was an inde#endent ontrator" The
/ourt found D is $iab$e for -*s in.uries" The ourt $ooks at the re$ationshi# and finds that
the ontrat s#eifia$$y states they do not ha+e a master9ser+ant re$ationshi# &no one
onsidered 2umb$e as the em#$oyer or master, 0hneider was onsidered the boss'" But
the /ourt says it does not matter that the ontrat said this, b9 there was other e+idene
#resent indiating the master9ser+ant re$ationshi#" The /ourt notes that 0hneider is
re1uired to make re#orts to 2umb$e onsistent$y, 2umb$e ontro$s the hours of the gas
station, and gi+es 0hneider instrutions" 2umb$e maintained strit finania$ ontro$ and
su#er+ision o+er his ations and the agreement re1uired 0hneider to do anything
2umb$e might te$$ him to do" The /ourt says 0hneider is a ser+ant, as a matter of $aw"
- 2oover v! 1un 8il )ompany- There was a fire at the ser+ie station o#erated by Barone,
The oi$ om#any &0un' says Barone was an I/, and therefore 0un is not $iab$e for his
neg$igene" -*s say Barone was 0un*s agent" 0un owned a$most a$$ the e1ui#ment at the
station, and ontro$$ed how Barone so$d and managed the e1ui#ment" Barone*s
em#$oyees wore 0un uniforms and there was a huge sign at the station that said 0un
#roduts were so$d there" 2e went to a ourse on how to #ro#er$y run a 0un ser+ie
station" 0un re#s wou$d a$so make week$y +isits, but &arone was only given suggestions
and was under no obligation to follow the advice" The /ourt says this is different than
2umb$e b9 Barone does not make week$y re#orts, as in 2umb$e% Barone assumes a$$ risk
of #rofit or $oss in his business o#eration% he determines his own hours of o#eration% he
was not gi+en instrutions, as in 2umb$e, and the re$ationshi# seems more $ike an
inde#endent ontrator" The ourt finds that Barone is an I/" The agreement seems to
!<
on$y estab$ish a LL9T re$ationshi# and an I/" 0un had no ontro$ o+er the detai$s of
Barone*s day-to-day o#eration, so 0un is not $iab$e for the neg$igent ats of Barone"
TEST FOR IN5E&EN5ENT CONTRACTOR:
- 2as the 9:aste'; co:(any 'etaine) the 'ight to cont'o$ the )etai$s o% the )ay8to8)ay
o(e'ation o% the 9se'3ant; sto'e?
o cont'o$ o' in%$*ence o3e' 9'es*$ts; a$one is ins*%%icient
)ontract 'rovisions
- Actual Agency is a )onsensual Relationship:
o -rini#a$ must onsent to the idea that the agent shall act on his behalf and
sub$ect to his control
o ,gent must onsent to do so
- 7hen a re$ationshi# onsidered as a who$e, estab$ishes an ageny re$ationshi#, the #arties
annot effeti+e$y dis$aim it by forma$ =onsent>
o The re$ationshi# of the #arties does not de#end on what the #arties a$$ it, but
rather in $aw what it atua$$y is
- It doesn*t matter whether there is a disclaimer clause in the contract- whether there is an
ageny re$ationshi# de#ends on the ations of the #arties
- In determining whether a ontrat estab$ishes an ageny re$ationshi#, the critical test is
the nature and e*tent of the control agreed upon
(ranchises
- B0 O (!N&!'5=a master is sub.et to $iabi$ity for the torts of his ser+ants ommitted
whi$e ating in the so#e of their em#$oyment>
o a #rini#a$ is not $iab$e for the torts of his non#servant agents &inde#endent
ontrators'
o control is an essentia$ e$ement of the definition of an ageny re$ationshi#, whether
one is dea$ing with a servant or I)
- 8ranhise:
o 7here indi+idua$ out$ets, owned by indi+idua$ businessmen, distribute goods and
ser+ies under a brand name
o The franhisee en.oys the right to #rofit and runs the risk of $oss
o The franhisor ontro$s the distribution of his goods and9or ser+ies through a
ontrat whih regu$ates the ati+ities of the franhisee, in order to ahie+e
standardization
- Being in a franhise agreement, doesn*t e6$ude the ontrating #arties from an ageny
re$ationshi#
- If a franhise ontrat so =regu$ates the ati+ities of the franhisee> as to +est the
franhisor with ontro$ within the definition of ageny, the ageny re$ationshi# arises
e+en though the #arties e6#ress$y deny it"
o 0urphy v! 2oliday Inn L where - sued 2o$iday Inn, saying that they owned and
o#erated the mote$ where - was in.ured" D says its on$y re$ationshi# with the
mote$ is an agreement to a$$ow them to use the name =2o$iday Inn"> The ourt
found that D did not own the #remises and there was no #rini#a$9agent or
!!
master9ser+ant re$ationshi#" This was a franhise agreement" The /ourt
reognizes that both D and the mote$ agreed to ertain re1uirements in the
agreement, but those re1uirements ga+e D no =ontro$ or right to ontro$ the
methods or detai$s of doing the work"> The regu$atory #ro+isions didn*t gi+e D
ontro$ o+er the day#to#day operation of the mote$ &e6" D was gi+en no #ower to
ontro$ the dai$y maintenane of the #remises5on$y the sty$e of the bui$dings and
the arhiteture, no #ower to hire and fire em#$oyees'" ,$$ suh #owers and other
management ontro$s were retained by the mote$52o$iday Inn is not $iab$e"
,. "ia#i$ity %o' To'ts o% In)e(en)ent Cont'acto's
- where a #erson engages a ontrator, who onduts an independent business by means of
his own em#$oyees to do work, not in itse$f a nuisane, he is not liable for the negligent
acts of the contractor in the #erformane of the ontrat
o
E6e#tions:
7here the $andowner retains ontro$ of the manner and means of the doing
of the work whih is the sub.et of the ontrat
7here he engages an inom#etent ontrator
If a #rini#a$ hires incompetent non#servant agents- then dotrine
is ignored and the #rini#a$ is $iab$e for torts
7here the ati+ity ontrated for onstitutes a nuisane #er se
Inherently "angerous .or5
- RS 016- $andowner is $iab$e if he engages an I/ to do work whih he shou$d reognize
as neessari$y re1uiring the reation of a ondition in+o$+ing a peculiar ris5 of harm to
others unless special precautions are ta5en- if the ontrator is neg$igent in fai$ing to take
those #reautions
o
This is onsidered work that is =inherent$y dangerous,> not =u$trahazardous>
Liability is absolute where the wor5 is :ultraha6ardous;
o
If it is an inherent$y dangerous ation, then the /ourts wi$$ ignore dotrine and
om#any wi$$ be $iab$e for torts
- The ontratee shou$d be res#onsib$e for any $oss arising out of the tortuous ondut of a
finania$$y irres#onsib$e ontrator
o
0a$estic Realty Associates- Inc v! Toti )ontracting )o!- The /ity was bui$ding a
#arking struture, so they had to demo$ish many bui$dings on the surrounding
streets5it hired D to do the work" D was demo$ishing strutures &owned by the
/ity' and damaged -*s bui$ding" D used a $arge meta$ ba$$ and e+ery time the ba$$
wou$d hit, debris and dirt wou$d f$y and -*s bui$ding wou$d rok" The /ity is
$iab$e for the ats of D, its I/" N4 has a $aw that demo$ishing a bui$ding in a busy
setion of the ity is inherent$y dangerous to surrounding bui$dings"
E*ceptions to the )ontractor/Independent )ontractor Relationships
- if you hire somebody to knok down some bui$dings for you, we wou$d a$$ this a sing$e
inde#endent ontrator re$ationshi# b9 there is no ageny
- but, if you hire someone neg$igent$y &hire an inom#etent' and they end u# hurting third
#arties, then you wi$$ be he$d $iab$e
- if you hire them to do an inherent$y dangerous ati+ity, then you wi$$ be he$d $iab$e
!(
'ublic 'olicy
- 7hy does the ourt fous on ontro$ in trying to determine whether or not the #rini#a$
shou$d be $iab$e3
o
7e want to #$ae res#onsibi$ity on the #arty that is in the #osition to #re+ent the
harm from taking #$ae in the first #$ae
o
e6" now #robab$y due to respondeat superior gas station attendants are not
a$$owed to smoke anymore - b9 gas station owners wi$$ be $iab$e

-. Sco(e o% E:($oy:ent
Two 3iews of 0aster 1ervant: <ON T2E E=A> !RING +& !OT2?
- )ommon Law
o 0otive test# under the ommon $aw, the way we deide whether a tort is within
the so#e of the ageny is whether the tort was moti+ated by a #ur#ose to ser+e
the master" If it was, then we wi$$ onsider the master $iab$e for the ations of the
ser+ant
This $aw has been rea$$y hard to im#$ement &rea$$y nebu$ous'
&ushey overturned the common law
This .o*$) #e the %ai'ness a(('oach:o'e conce'ne) .ith the
)ist'i#*tion o% the (ie
- 0odern Law
o (orseeable# The em#$oyer shou$d be he$d $iab$e for e6#eted risks, whih arise
out of and in the ourse of his em#$oyment of $abor
/ourt re$ies on dee#$y rooted human sentiment that one shou$d not esa#e
$iabi$ity for torts that you ommit if it was forseeable by your employer
o Ira 1! &ushey 9 1ons- Inc! v! <nited 1tates# where seaman ame bak drunk and
o#ens u# the sea +a$+es on the dok and the shi# begins to sink in the ana$" The
shi# started sinking and #arts of the dok sank too! ,s it was sinking, it did
damage to the dok5this is a tort" The sai$or aused the tort by oming bak
drunk! The go+" agrees that 0eaman Lane is their agent, but says they ha+e on$y
asked him to be a seaman, whih doesn*t in+o$+e getting drunk in Brook$yn and
wreking someone*s dok! The go+" says that ondut of a ser+ant is within the
so#e of em#$oyment if, the ondut was atuated at $east in #art, by a #ur#ose to
ser+e the master" The ourt says it wou$d be going too far to find that =#ur#ose>
in this ase5no one ou$d ha+e thought that turning the whee$s on the +a$+es was
to ser+e his em#$oyer! The /ourt says it is too s#eu$ati+e to say that im#osing
$iabi$ity on the go+" wi$$ $ead to more intensi+e sreening of em#$oyees" Instead,
they use a forseeabi$ity test" 2ere, it was forseeab$e that rew members rossing
the dok might do damage, neg$igent$y or e+en intentiona$$y" The seaman*s
ondut is not so =unforeseeab$e> as to make it unfair to harge the go+" with
res#onsibi$ity" , seaman getting drunk is NOT UN8OB0EE,BLE! The risk that
seamen going and oming from the shi# might ause damage to the dok is
enough to make it fair that the enter#rise bear the $oss
- PP7e want the #ie to be bigger, by gi+ing the go+ernment an inenti+e <EFFICIENC?
!)
'ublic 'olicy
- Caybe making the go+" $iab$e wi$$ gi+e them inenti+e to better sreen sai$ors before
hiring them and we wont* ha+e these shi#s rashing into the dok"
o 7e shou$d not e6#and =+iarious $iabi$ity>
- Qudge 8riend$y says: It is not at a$$ $ear that making the go+" $iab$e is the best way to
grow the #ie
o The best way is to make the dok manager $iab$e to gi+e him an inenti+e to #ut
$oks on the +a$+es5it wi$$ ost more to sreen e+ery sai$or, then it wi$$ to #ut
$oks on the +a$+es
o They are more onerned with the broad soia$ im#$iations
- 8riend$y had shown that the tria$ ourt*s +iew of what wou$d be more effiient is
om#$ete$y =f$i##ab$e>5an swith it either way
- It is no more #reise a dotrine than the ommon $aw dotrine
0. Stat*to'y C$ai:s
- in order to im#ose $iabi$ity on a D for the discriminatory actions of an employee, the -
must demonstrate that there is an ageny re$ationshi# b9t the D and the third #arty
- eneral agency# a master is sub.et to $iabi$ity for the torts of his ser+ants whih ating
in the so#e of their em#$oyment
- Arguello v! )onoco- Inc!# b$aks and 2is#anis said they were disriminated against at the
/onoo gas station" 0ome of the gas stations are franhised &/onoo-branded' and some
are owned by /onoo"
o ,s for the branded stores, the ourt dismisses the ause of ation against /onoo
itse$f" The /onoo-branded stores are inde#endent$y owned, and ha+e an
agreement where they are a$$owed to market and se$$ /onoo brand gaso$ine and
su##$ies in their store" To establish an agency relationship b/t )onoco- Inc! and
the branded stores- the 's must show that )onoco- Inc! has given consent for the
branded stores to act on its behalf and that the branded stores are sub$ect to the
control of )onoco- Inc! The agreement states that they are om#$ete$y se#arate
entities and that the /onoo-branded stores are not em#$oyees of /onoo5
therefore there is no agency relationship b9t /onoo and the branded stores"
o /onoo-owned 0tores: The 1uestion beomes whether /onoo is res#onsib$e for
the ations of its attendant" It does not matter what the stores think about their
re$ationshi#s with the om#any% it matters how they at in rea$ity" In regards to
raia$ e#ithets being s#oken o+er the miro#hone and IDs refused, /onoo said
disriminating against ustomers was not #art of the ageny re$ationshi#, so they
shou$d not be he$d $iab$e" The /ourt a##$ied the fators to determine when an at
is within the scope of employment" The attendant*s ations ourred whi$e on duty
inside the store" The use of raia$ s$urs ourred 0mith was om#$eting -*s
#urhase of her items" 0he was authorized to use the interom and make #urhase
transations" 0he was authorized to interat with ustomers whi$e making these
transations, so she did not de#art from norma$ methods of onduting business"
The /ourt re+ersed the summary .udgment, and $eft it for the $ower ourt to
deide whether she was in the so#e of her em#$oyment
(actors used to "etermine .hether Action was .ithin 1cope of Employment:
!E
- !" The time, #$ae and #ur#ose of the at
- (" Its simi$arity to ats whih the ser+ant is authorized to #erform
- )" 7hether the at is ommon$y #erformed by ser+ants
- E" The e6tent of de#arture from norma$ methods
- ;" whether the master wou$d reasonab$y e6#et suh at wou$d be #erformed
'ublic 'olicy
- The best way to ensure that you an deter this beha+ior is by making /onoo $iab$e, b9
they are in the best #osition to #rotet against these harms &by a sreening #roess, et"'
o This wou$d be #retty e6#ensi+e for /onoo to sreen dee#$y into the #syho$ogy
of its em#$oyees, it might be better to #ut the res#onsibi$ity on the ustomer to
figure out whih stores are raist and whih aren*t
- 2ow do we +a$ue those e$ements for the #ur#ose of doing a +a$ue ana$ysis3
- 4ou an*t figure this out without ta$king about the #ie &how we want the #ie to taste35
how do we want human affairs to be in ,meria3 7e want them to taste $ike .ustie and
e1uity'
5. Fi)*cia'y O#$igation o% Agents
- ,geny re1uires a fiduiary duty of good faith and $oya$ty &an agent has a fiduiary duty
toward his or her #rini#a$'
o This is defau$t ru$e5meaning it a##$ies in the absene of agreement
- ,n agent has a duty to at so$e$y for the master, and any #rofit earned whi$e +io$ating this
duty be$ongs to the master
- it doesn*t matter that a #rini#a$ is a or#oration rather than an indi+idua$
o eneral Automotive 0anufacturing )o! v! 1inger# - agreed to #ay D a sa$ary and
D agreed not to engage in any other business whi$e working there and not to share
any om#any information he $earned whi$e working there" D started working
against the om#any by bringing in $ients, but kee#ing the #rofits for himse$f"
2e brought in a $ot of business b9 of his re#utation and the om#any ou$dn*t do
a$$ of it so he did it himse$f" - sues for breah of fiduiary duty" - says this was
inonsistent with D*s ob$igations as a faithfu$ agent or em#$oyee" 2e onduted
ati+ities under their name and without te$$ing them about it" ,s an agent to
Renera$ ,utomoti+e, 0inger owed them a duty of =utmost good faith and $oya$ty>
&fiduiary duty'" D was $iab$e for the amount of #rofits that he took from them
Review of Agency:
- 7hen wi$$ the #rini#$e be $iab$e for the torts of the agent3
o in the Caster9ser+ant re$ationshi#
o It is not .ust any kind of tort, there must be some kind of one#tua$ framework
o P.ustie friend$y set the boundaries at what wou$d be most efficient%forseeabi$ity
- Liabi$ity of the agent:
o The agent is a$ways $iab$e for his own ations in tort, in addition to the where the
principal is liable
o 7hen is the agent $iab$e for the ontrats3 Is he bound by the ontrats he enters
into on beha$f of the #rini#$e3
!;
the agent is $iab$e on the ontrat when the principle is not disclosed or is
on$y partially disclosed &where third #arty knows that the agent is working
on beha$f of somebody, but the agent does not know who that #erson is'
II. &a'tne'shi(s
- a form of business enter#rise organized by two or more #eo#$e for a #rofit
- a onsensua$ arrangement, usua$$y entered into mutua$$y with onsent
o un$ike a or#oration, this an ome into e6istene without fi$ing forma$ #a#erwork
- an arrangement where indi+idua$s agree to share in #rofits in $osses5the $aw wi$$
onsider this a #artnershi#
- where these e$ements are e+ident, a #artnershi# wi$$ be found to e6ist, but even where
they are not evident- the law may find that they are still partners, a$so e+en if #eo#$e say
that they are in a #artnershi#, absent these e$ements, the $aw may find that they are not
atua$$y #artners
- a$$ #artners are agents of #artners, and are $iab$e for eah others torts
o a$$ #artners are $iab$e #ersona$$y for a$$ of the debts and $iabi$ities of #artners &no
matter whih one aused them'
o eah #artner is $iab$e for a$$ the debts of the #artnershi#
o In #artnershi# arrangements, you are res#onsib$e for a$$ of the $osses of your
#artner5you don*t want your #artner srewing u# &ma$#ratie, et"'
4ou ha+e to make sure that your #artner is not going srew you o+er
- a #artnershi# is not ta6ed as an entity as or#orations are, but money earned by the
#artnershi# is ta6ed indi+idua$$y as inome ta6 by both of the #arties
- one of the most im#ortant #arts is that it gi+es rise to a fiduiary duty
- NOTE: the $aw of partnership is a branh of the law of agency
o -artners are onsidered agents of the #artnershi# with #ower to inur ob$igations
on beha$f of the #artnershi#5a$$ #artners are $iab$e, as #rini#a$s, for #artnershi#
ob$igations
o ,ny #artner an inur debts for whih the other #artners wi$$ be $iab$e
A. What is a &a'tne'shi(? Who A'e the &a'tne's?
1. &a'tne's Co:(a'e) .ith E:($oyees
- E$ements Be1uired 8or -artnershi#s:
o !" intent of the #arties
o (" the right to share in #rofit
o )" ob$igation to share in $osses
o E" the ownershi# and ontro$ of the #artnershi# #ro#erty and business
o ;" ommunity of #ower in administration, and the reser+ation in the agreement of
the e6$usi+e ontro$ of the management of the business
o I" $anguage in the agreement
o K" ondut of the #arties toward third #ersons
fi$ing #artnershi# inome ta6, ho$ding yourse$f out as #artners to third
#arties, et"
o J" the rights of the #arties on disso$ution
!I
- It doesn*t matter what the #arties intend to $abe$ the #erson5the intent is based on the
ty#e of re$ationshi# they intended to enter into with eah other
- -rofit-sharing a$one does not a$one reate a #artnershi#, des#ite the #arty*s intentions
o (enwic5 v! <nemployment )ompensation )ommission- em#$oyee &/hesire'
wanted a raise from 8enwik, her em#$oyer" 2e did not ha+e the money for the
raise, so she said $et*s get into a #artnershi# where she got #art of the #rofit" They
made an agreement with ertain #ro+isions: the terms ga+e 8enwik ontro$ and
management of the business% said that on$y 8enwik was $iab$e for the debts of the
#artnershi#% and he reei+es J<G of the #rofits at the end of the year" They went
to ourt to determine if a #artnershi# e6isted" The ourt said she was not a
#artner, she is an em#$oyee based on all of the circumstances! 2ere the
agreement is e+ident, but the intent was to gi+e the em#$oyee an inrease in
inome if the store*s inome a$$owed for that% she did ha+e the right to share in
#rofits, but she did not share in $osses"
- NOTE: one of the key e$ements of a #artnershi# is =om#$ete ontro$ and management>
of the business
o The /ourt $ooks to the totality of the circumstances to see who maintains day#to#
day control of the business
,. &a'tne's Co:(a'e) .ith "en)e's
- 0tate $aw norma$$y #resumes that #artners share e1ua$$y or at $east #ro#ortionate$y in
#artnershi# $osses
- the $abe$s the #arties assign to their intended $ega$ re$ationshi#, whi$e #robati+e of
#artnershi# formation, are not neessari$y dis#ositi+e as a matter of $aw, #artiu$ar$y in
the #resene of ounter+ai$ing e+idene
o E+idene of #rofit-sharing does not neessari$y reate a #artnershi# formation
Qust b9 they were sharing #rofits it is not enough to o+erome the other
e+idene of no #artnershi#
- E+en if the agreement uses the term =#artner,> this a$one is not enough to find a
#artnershi#
o 1outhe* E*hibitions v! Rhode Island &uilders# where BIB, had an agreement with
0EC &whih was a1uired by 0outhe6'" 0outhe6 and BIB, thought they were
#artners" In the agreements, they a$$ed themse$+es #artners" They shared ontro$
o+er the se$etion of $oation, timing of the shows, et" BIB, didn*t $ike
0outhe6*s #erformane, so they entered into a ontrat with another #roduer"
0outhe6 sued saying there was a #artnershi# by esto##e$ &due to BIB,*s si$ene'"
The /ourt says there was no #artnershi#" The ourt $ooks beyond the sharing of
#rofits, et" and said that 0outhe6 a$one bears the $oss of #rofits" If they don*t
share a $oss of #rofits, they are not a #artnershi#" The ourt a$so sees that the
agreement is on$y a$$ed =,greement,> not =-artnershi# ,greement"> There is not
muh indiation of the intent to form a #artnershi#" There is a $ak of mutua$
ontro$ o+er business o#erations, fai$ure to fi$e #artnershi# ta6 returns, fai$ure to
set u# $oss-sharing" ,$so, 0outhe6 ne+er onduted business in the a$$eged
=#artner*s> name5it onduted business under its own name"
- NOTE: =#artnershi#s an be reated absent any written forma$ities whatsoe+er, its
e6istene norma$$y must be assessed under a =tota$ity-of-the-irumstanes> test
!K
-. &a'tne'shi( #y Esto((e$
- eneral Rule: #artners are .oint$y and se+era$$y $iab$e for e+erything hargeab$e to the
#artnershi#
- #ersons who are not #artners as to eah other are not #artners to third #ersons
- e+en if two #eo#$e do not intend to be #artners, they an be found to ha+e reated a
#artnershi# =by esto##e$> if they re#resent to the outside wor$d that they are in a
#artnershi#
o they wi$$ be $iab$e to any #erson to whom suh a re#resentation is made who has,
on the faith of the re#resentation, gi+en redit to the atua$ or a##arent #artnershi#
- If a third #arty has reasonab$y re$ied on the #artnershi#, based on the re#resentation of
one #artner, then the #arties are partners by estoppel
o =oung v! ,ones- -7/ Bahamas sent out a $etter regarding the finania$ statement
of a bank, so in re$iane on this statement, -*s de#osited money into the bank and
it disa##eared" Turns out the finania$ statement was fa$sified" The $etter was on
-7/ $etterhead and was signed by =-rie 7aterhouse"> - says it was forseeab$e
that others wou$d re$y on it" The stam# of a##ro+a$ by -7/, a re#utab$e
om#any, made -s in+est to their detriment" - $aims that -7-,meria and -7-
Bahamas are a #artnershi#, or at $east #artners by esto##e$" - an*t sue the bank,
so they sue -7/ ,meria" - argues that -7/ offies a$$ o+er the wor$d stand in
bak of this firm by their marketing and their $etterhead" If they are #artners by
esto##e$, then -7-,meria an be $iab$e for the neg$igent ats of its #artner5
-7-Bahamas" -*s $aim that -7 makes no distintion in its ad+ertising between
itse$f and entities situated in foreign .6 &foreign -7*s use same name and
trademark'" E+en -7*s brohure makes them sound $ike one and the same" But,
-*s do not ontend that the brohure was seen or re$ied on by them in making the
deision to in+est" There is nothing that shows that the '+s relied on any act or
statement by any '.#<1 partner which indicated the e*istence of a partnership
with the &ahamian partnership! No e+idene that -7-U0 had anything to do
with the $etter sent to -*s! The /ourt ho$ds that there is no #artnershi#"
!. Fi)*cia'y O#$igations o% &a'tne'shi(s
1. Int'o)*ction
- .oint ad+enturers, $ike o#artners, owe to one another, whi$e the enter#rise ontinues, the
duty of the finest $oya$ty
- =, trustee is he$d to something striter than the mora$s of the market#$ae">5/ardozo
o 2onesty a$one is not enough
- Eah #artner in a #artnershi# owes the other #artners a fiduiary duty to at in the best
interests of the #artnershi# o+er the indi+idua$ in matters onerning the #artnershi#
o 0einhard v! 1almon- 0a$mon $eased the 2ote$ Bristo$ for a (< year term" 0a$mon
&$essee' hanged the hote$ into sho#s and offies" 2e didn*t ha+e the money, so he
#artnered with Ceinhard &-', who funds the remode$ing" This was a .oint +enture
and they agreed to s#$it the money to onstrut it, then s#$it the #rofits and s#$it
$osses e1ua$$y" 0a$mon had the so$e #ower to manage" They both had fiduiary
duties, but 0a$mon had the hea+ier one b9 he had to manage" 0a$mon was then
!J
a##roahed by the owner of the $and to engage in a $onger term #ro.et" 2e enters
into the new dea$, and doesn*t te$$ Ceinhard anything about it" The /ourt says:
=0a$mon e6$uded his oad+enturer from any hane to om#ete, from any hane
to en.oy the o##ortunity for benefit that had ome to him a$one by the +irtue of his
ageny"> Ceinhard assumed from D*s si$ene that D wou$d ha+e wanted to
e6tend the $ease, as it was ending" 0a$mon wasn*t ating in bad faith, he was not
trying to defraud" The /ourt found that he breahed his fiduiary duties to -"
o Dissent: Qustie ,ndrews
They were #artners and that re$ationshi# re1uires trust and onfidene to a
high degree. 7here #arties engage in a .oint enter#rise eah owes to the
other the duty of the utmost good faith in a$$ that re$ates to their ommon
+enture. They are in a fiduiary re$ationshi#" But the +enture had a
$imited time and ob.eti+e. Ceinhard had an interest, but this interest
terminated when the .oint ad+enture terminated. 0a$mon fu$fi$$ed his
duties to Ceinhard when the $ease was o+er. Their ad+enture together
ended on a s#eifi date
'ublic 'olicy
- Do we onstrue the fiduiary duty narrow$y $ike Qudge ,ndrews wou$d ha+e us do3
o ,ndrews agreed there was a fiduiary duty, but said that it ended when the $ease
ended
- Do we onstrue it broad$y $ike /ardozo3
o If we are going to onstrue these fiduiary ob$igations as broad$y as /ardozo
wants, we may deter the 0a$mon*s of the wor$d from entering into these ontrats
- 7hy do we ha+e this ru$e of fiduiary ob$igation35they didn*t s#eify how muh of
themse$+es they eah owed the other one
o It omes from the $aw5the bakground $aw that go+erns situations where the
#arties don*t s#eify what they owe to eah other
o 8iduiary ob$igation is effiient and makes more #ie for us a$$
o Ceinhard is an in+estor5he $ikes to #$ay go$f and s$ee# $ate, if they didn*t ha+e
this agreement he wou$d ha+e to get u# ear$y and go to work, instead the $aw is
monitoring 0a$mon so he doesn*t ha+e to
o 7e want 0a$mon*s mind to be foused on the business of the #artnershi#
Types of 'artnership Law
- default rules
o P defau$t $aws are going to be $aws that most #eo#$e wou$d want
o two +iews on defau$t ru$es:
!" 0a$oritarian
the defau$t $aws e6ist so that the 0a$mons of the wor$d don*t ha+e
to sit around $isting the things that they wou$d want to be ru$es in
their agreements
(" 'enalty
O##osite of ma.oritarian
!N
This +iew says that we shou$d make the defau$t ru$es rea$$y bad so
that #eo#$e wi$$ sit down and $ist what they want out of the
agreement
- )ommon law
- 1tatutory law
o U"-"," &!N!E'
Uniform -artnershi# ,t &most states ha+e this $aw'
o B"U"-"," &!NNK'5Be+ised Uniform -artnershi# ,t
This is .ust an im#ro+ement on U-, based on hanging business #raties
and the diffiu$ties found in a##$ying it
o /a$ifornia
0imi$ar to BU-,, but has some of its own idiosynrasies
BU-, is re$ati+e$y new, so some states are sti$$ on the U-, trak and
others ha+e mo+ed on to BU-,
- Agreement
o ,$$ of the abo+e $aws an be modified by agreement of the parties
0@0Gene'a$ Stan)a')s o% a &a'tne'As Con)*ct &#" !!;'
- 8iduiary duties owed by a #artner to a #artnershi# are the duty of loyalty and the duty of
care
- 0hou$d not ha+e any interests ad+erse to the #artnershi#
- Befrain from om#eting with the #artnershi#
- Befrain from engaging in gross$y neg$igent or rek$ess ondut, intentiona$ misondut,
or a knowing +io$ation of the $aw
- a #artner*s duty of $oya$ty is $imited to the #artnershi#
- a #artner doesn*t +io$ate this setion so$e$y beause his ations further his own interests
"uties .hen Leaving a 'artnership
- #artners owe eah other a duty of utmost good faith and $oya$ty
- ,s a fiduiary, a #artner must onsider his9her #artners* we$fare and refrain from ating
for #ure$y #ri+ate gain
- , #artner has a duty to render on demand true and fu$$ information of a$$ things affeting
the #artnershi# to any #artner
o 0eehan v! 1haughnessy# where two the -*s deided to $ea+e their $aw firm and sue
for money the firm owes them" Then the o$d firm sues them for breah of their
fiduiary duties and the #artnershi# agreement by taking ases and $ients with
them and on+ining $ients to go to the new firm" In Qu$y, -*s deide they are
going to $ea+e the firm and start a new one in Deember" In Qu$y, they rent offie
s#ae and hire an arhitet" In Ot" !NJE, they meet with a big $ient a$$ed
U0,U, who agrees to go to the new firm" They #re#are a new $etter on -arker
/ou$ter*s stationary to send to $ients te$$ing them what is going on and asking
them to ome to the new firm" Bumors start to iru$ate, and the #artners ask
them three times if they are $ea+ing, and they deny it e+ery time" 8ina$$y, on
Deember )<, they admit it and send out the $etter" The o$d firm estab$ishes a
se#aration ommittee and asks the $awyers whih ases they are taking with them
and the #artners do not te$$ them" Ceehan and Boy$e take with them !E( ases
(<
out of );<" -arker /ou$ter says that Ceehan and Boy$e +io$ated their fiduiary
ob$igations when #arting" The /ourt said they did +io$ate their fiduiary duties:
they hand$ed ases for themse$+es instead of the #artnershi#% they om#eted with
the #artnershi#% and they sto$e $ients" The $awyers who $eft shou$d ha+e
onsidered their #artners* at the o$d firm and thought about their we$fare instead
of .ust their own" The /ourt doesn*t think that they breahed the fiduiary duty
by om#eting with the firm &by setting u# a new firm', on$y by taking the $ients"
They gained an unfair ad+antage o+er their o$d firm in breah of their fiduiary
duty" 7hen asked by their #artners, they shou$d ha+e admitted they were $ea+ing"
The firm asked them three times if they were $ea+ing and they $ied"
C. &a'tne'shi( &'o(e'ty
Rights of a 'artnership &under Uniform -artnershi# ,t'
- !" rights in s#eifi #artnershi# #ro#erty
o This is the #artnershi# tenany #ossessory right of e1ua$ use or #ossession by
#artners for #artnershi# #ur#oses
o This right doesn*t e6ist without the #artnershi#
- (" interests in the #artnershi#% and
o This is the #artners interest in the #artnershi# whih is defined as =his share of the
#rofits and sur#$us and the same is #ersona$ #ro#erty>
o NOTE: the partnership owns the #ro#erty or the asset5a o-#artner owns no
#ersona$ s#eifi interest in any s#eifi #ro#erty or asset of the #artnershi#
0imi$ar to the right of a o-tenant &the #artner is a o-tenant in a$$
#artnershi# #ro#erty'
- )" right to #artii#ate in mgmt
eneral Rule# a on+eyane of #artnershi# #ro#erty he$d in the name of a #artnershi# is made in
the name of the #artnershi# and not as a on+eyane of the indi+idua$ interests of the #artners
- , #artner doesn*t own any #art of the #artnershi#, so one he9she transfers his interest to
another, he9she has no interest in anything that ha##ens $ater
o 'utnam v! 1hoaf- where - transfers her interest to another and then wants to retain
#art of the $awsuit sett$ement b9 the thing they were suing o+er ourred whi$e
she was there" The ourt said sine she fu$$y intended to on+ey her interest, she
had no right to the #roeeds from the $awsuit"
5. &a'tne'shi( 5isso$*tion
Ending of a 'artnership
- dissolution- an e+ent that triggers a series of e+ents that on$ude the #artnershi#
o e6" death of a #artner
o e6" bankru#ty
o e6" e6#iration of a stated term within the agreement
o e6" withdrawa$ of a #artner from the #artnershi#
o 4ou a$ways ha+e the #ower to breah a ontrat &and one you do, you are not
bound by any of the ontrat terms'
(!
But there is a differene b9t the power to dissolve it and the right to
dissolve it
o There is .udiia$ disso$ution of a #artnershi#
- wind up
o it an take months or e+en years for a #artnershi# to om#$ete its windu#
o ontributions are #aid out &initia$ #ayments that eah #artner #ut in are #aid bak
to them'
o #rofits are di+ided u# aording to eah #artner*s share in the #artnershi#
o it is during the =wind u#> #eriod where #artners are most $ike$y to breah their
duties to the other #artners
- termination
o this refers to a om#$eted =wind u#>
NOTE: these an +ary by state, so you need to $ook at the s#eifis of eah state*s $aws
eneral Rule# a partner can move to dissolve a partnership if another partner+s conduct
undermines or breaches the partnership agreement
- , #artner may mo+e for a disso$ution of the #artnershi# if another #artner*s ondut:
o negati+e$y affets the business% or
o re#eated$y breahes the #artnershi# agreement
- /ourt wi$$ NOT disso$+e the #artnershi# for:
o minor differenes or grie+ane whih in+o$+e no #ermanent mishief
- They wi$$ issue one where:
o There are 1uarre$s and disagreements of suh a nature and to suh e6tent that a$$
onfidene and oo#eration b9t the #arties has been destroyed% or
o where one of the #arties by his beha+ior materia$$y hinders a #ro#er ondut of
the #artnershi# business>
e6" 8wen v! )ohen# o#erated a bow$ing a$$ey together, but they disagreed
on e+erything about running the business" One of the guys breahed the
#artnershi# agreement by not doing his share of the work and taking more
money from the business than his agreed amount" 2e made it so bad that
it was =not reasonab$y #ratiab$e to arry on the #artnershi# business
with him"> Based on these ations, the ourt found he had disso$+ed the
#artnershi#"
,0,6 o% the Ci3i$ Co)e <+.&.A. -,?
- A court will issue a dissolution if:
o , #artner beomes in any other way ina#ab$e of #erforming his #art of the
#artnershi# ontrat
o , #artner has been gui$ty of suh ondut as tends to affet #re.udiia$$y the
arrying on of the business
o , #artner wi$$fu$$y or #ersistent$y ommits a breah of the #artnershi# agreement,
or otherwise onduts himse$f in matters re$ating to the #artnershi# business that it
is not reasonab$y #ratiab$e to arry on the business in #artnershi# with him
"issolution by the 'artner at (ault for the 'roblems
((
- a #artner does not ha+e a right to disso$+e the #artnershi# when his own ondut is the
on$y ondut that is ad+erse$y affeting the business
- if the #arty trying to disso$+e the #artnershi# is the on$y #arty who is not abiding by the
#artnershi# agreement, he annot disso$+e it
o e6" )ollins v! Lewis# - and D had a afeteria business, where Lewis was
res#onsib$e for the finanes and /o$$ins was res#onsib$e for the management" The
mgmt #artner did his .ob, but the other one didn*t and his ondut materia$$y
dereased the earning of the business" The bad #artner sued, trying to disso$+e the
#artnershi#, but the ourt said no, sine he was the ause of the #rob$ems"
"issolution .hen Time is 7ot 1pecified
- un$ess s#eified, a #artnershi# may be disso$+ed at will by any partner, #ro+ided the
#artnershi# is e6erising good faith
o a #artner may not disso$+e a #artnershi# to gain the benefits of the business for
himse$f, un$ess he fu$$y om#ensates his o-#artner for his share of the
#ros#eti+e business o##ortunity
o if it is #ro+ed that the #artner wanting to disso$+e the #artnershi# was ating in
bad faith and violating his fiduciary duty by attem#ting to take the new #rofits for
himse$f, without ade1uate$y om#ensating his #artner, the disso$ution is wrongfu$
and the #artner wou$d be liable for violation of the implied agreement not to
e6$ude his #artner wrongfu$$y from the #artnershi# business o##ortunity"
E6" 'age v! 'age- where it was a$$eged that the brother was trying to
disso$+e the #artnershi# when the business started making a $ot of money,
so that he ou$d hog a$$ of the #rofits and not gi+e them to his #artner"
- if there is no definite term s#eified, the #artnershi# an be disso$+ed a the e6#ress wi$$ of
any #artner
o e6" 'age v! 'age# two brothers o#erate a $inen su##$y business and right when the
business gets #rofitab$e, one brother wants to end the #artnershi#" They had ne+er
had an understanding as to the term of the #artnershi# &and there was no im#$ied
agreement'"
- Implied agreements
o -artners an impliedly agree to end the #artnershi# as soon as $oans are #aid, or
unti$ a ertain amount of money is earned, et", but there must be e+idene of this
agreement
- NOTE: a #artner*s duty to act in good faith o+errides their freedom to disso$+e the
#artnershi#
The )onsequence of "issolution
- ,fter a #arty has terminated the #artnershi# wrongfu$$y, he is entit$ed to the +a$ue of his
interest in the #artnershi#, minus any damages caused to the partnership by the
dissolution, but good wi$$ shou$d not be in$uded when a$u$ating it"
- , #arty who aused the disso$ution of the #artnershi# is not entit$ed to o$$et for the
+a$ue of good wi$$ at the time of disso$ution
o e*! 'ac 1aver v! 3asso- where -a had the #atents and trademarks for the design
and marketing of the mahines and Aasso #ut in the finanes" The /ourt found
that -a terminated the #artnershi# wrongfu$$y, so Aasso was a$$owed to ontinue
()
to run the #artnershi# according to the terms of the agreement &and to do this, use
of the #atents and trademarks was neessary'"
The 1haring of Losses
- in the absene of any agreement to the ontrary, #artners #artii#ate e1ua$$y in the #rofits
and $osses of the business, regard$ess of any ine1ua$ity in the amounts eah ontributed to
the a#ita$ em#$oyed in the +enture, with the losses being shared by them in the same
proportions as they share profits
o This is different when eah ontribute one #art &money and work'5in that ase,
neither is $iab$e to the other for ontribution for any $oss sustained
- when one #artner ontributes the money and one ontributes a#ita$ and other $abor, the
#artner ontributing the money annot ho$d the other #artner res#onsib$e for money $ost,
.ust as the #artner res#onsib$e for ser+ies, annot ho$d the other #artner res#onsib$e for
any $osses he suffered
o e6" 4ovaci5 v! Reed# they were sharing #rofits e1ua$$y, but hadn*t said anything
about the $osses, so the /ourt he$d that they were eah $iab$e for their own $osses"
Therefore, the #artner with the money was not entit$ed reimbursement from the
other #artner5this way they eah ontribute to the $osses
- the $osses are shared by the #artners as they agree, or if there is no agreement, it wi$$ be
#ro#ortionate to their #rofits #erentage
&uyout Agreements
- buyout/sellout agreement# an agreement that a$$ows a #artner to end his9her re$ationshi#
with the other #artners and reei+e a ash #ayment, or series of #ayments, or some assets
of the firm, in return for his9her interest in the firm
o agreement usua$$y in$udes:
what e+ents trigger the buyout
ob$igation to buy +" o#tion to buy
#rie
method of #ayment
#roedure for offering to buy or se$$
- unti$ a ourt has dereed a disso$ution, it has not taken #$ae and the #artners an sti$$ take
ad+antage of any buyout #ro+isions under the agreement &e+en if they ha+e #etitioned the
ourt for disso$ution'
o e6" 91 Investments v! &elman- where they had fi$ed for a disso$ution and a
buyout of the bad #artner*s shares, but it ne+er was offiia$, therefore they ou$d
sti$$ use the buyout #ro+isions"
- U#on death, retirement, insanity or resignation of one of the general partners, the
surviving or remaining general partners may ontinue the #artnershi# business
o If they deide to do so, the remaining #artners must #urhases the interest of the
retiring or resigning genera$ #artner
- &uyout amount M amount of the resigning9retiring #artner*s capital account &a$u$ated
on a ost basis' S the a+erage of the #rior three years* #rofits and gains atua$$y #aid to
the genera$ #artner &or as agreed u#on the genera$ #artners'
o ,s $ong as this sum does not e6eed the a$u$ated sum in do$$ars
(E
Law 'artnership "issolutions
- in $aw #ratie #artnershi#s, in the absene of a ontrary agreement, the U-, re1uires
that any fees #aid to the #artners for ases in #rogress during the disso$ution shou$d be
a$$oated to the former #artners aording to their rights to fees during the #artnershi#s
- a disso$+ed #artnershi# ontinues unti$ the winding u# of unfinished #artnershi# business
- Two (iduciary "uties:
o !" eah former #artner has a duty to wind u# and om#$ete their unfinished
business of the disso$+ed #artnershi#
E6" a #artner an*t refuse to work on the ase and then get the benefits of
the other #artner*s hard work
o (" no former #artner may take any ation with res#et to unfinished business
whih $eads to #ure$y #ersona$ gain
- The former #artners wi$$ be entit$ed to reimbursement for reasonab$e o+erhead e6#enses
&e6$uding #artner*s sa$aries' attributab$e to the #rodution of #ostdisso$ution #artnershi#
inome
Removing )ases
- -artners in $aw firms annot #artii#ate in an agreement that restrits the right of a $awyer
to #ratie $aw after the termination of a re$ationshi# reated by the agreement
o The strong #ub$i interest in a$$owing $ients to retain ounse$ of their hoie
outweighs any #rofessiona$ benefits deri+ed from a restriti+e o+enant
o E6" 0eehan v! 1haughnessy- where the $awyers $eft the firm and took the $ients"
The /ourt said the firm was not a$$owed to restrit a de#arting #artner*s right to
remo+e any $ients who free$y hoose to retain him or her as their $ega$ ounse$"
- ,ny ase an be remo+ed, regard$ess of whether the ase ame to the firm through the
#ersona$ efforts of the de#arting #artner
"ividing the (irm+s Assets
- )apital account# the #artner*s initia$ in+estment of ash or #ro#erty, inreased by any
$ater suh ontributions, inreased by #rofits o+er the years, dereased by $osses and
dereased by amounts withdrawn"
- The statute a$$ows #artners to design their own methods of di+iding assets and, #ro+ided
the disso$ution is not #remature, e6#ress$y states that the #artners* methods ontro$s
- , #artner must aount for any #rofits whih f$ow from a breah of fiduiary duty
o E6" 0eehan v! 1haughnessy- where the $awyers breahed their fiduiary duty to
the $aw firm" If ertain $ients $eft the firm beause of this breah, then the former
#artners must aount to the #artnershi# any #rofits they reei+e on these ases"
The #artners at the origina$ firm are entit$ed to their #ortion of the fair harge on
eah of the unfair$y remo+ed ases and to the amount of #rofit they wou$d ha+e
en.oyed that the former #artners hand$ed the ase at the o$d firm"
E. "i:ite) &a'tne'shi(s
1tatutory (ramewor5
- statutory $aws5you must say =we are forming a $imited #artnershi#>
o they are reated by fi$ing a forma$ doument with a state offiia$
(;
o there must be a written agreement among the #artners
- Not disso$+ed by the withdrawa$ or death of a $imited #artner
Liability
- two kinds of #artners:
o !" genera$ #artners- eah $iab$e for all the debts of the #artnershi#
o (" $imited #artner- not $iab$e for the debts of the #artnershi# beyond the amount
that they ha+e ontributed to the #artnershi#
- Limited #artners do not #artii#ate in the management of the partnership
- a limited partner wi$$ be he$d $iab$e as a general partner if the $imited #artner ats to take
#art in the ontro$ of the business
- e+en if you aren*t $isted as a genera$ #artner, your ations an make you $iab$e as a
genera$ #artner
o If you do not want to be he$d $iab$e as a $imited #artner, you must not control the
partnership or any of its day to day activities5if you do, you wi$$ be he$d $iab$e
o E6" 2ol6man v! "eEscamilla# where the $imited #artners took #art in the ontro$
of the business, so they beame $iab$e as genera$ #artners to the reditors of the
#artnershi#" They a$$ disussed whih ro#s to #$ant and a$$ agreed before it was
done% they a$so ame to the farm to hek on it twie a week and signed the
business heks" The genera$ #artner had no #ower to withdraw money without
the signature of one of the $imited #artner"
- , $imited #artner sha$$ not beome $iab$e as a genera$ #artner, un$ess in addition to the
e6erise of his rights and #owers as a $imited #artner, he takes #art in ontro$ of the
business"
o This must be more than mere$y ad+ising the genera$ #artner on the business of the
$imited #artnershi#
- R+&A -@-BaC hanges this ru$e and says you an ha+e a $imited #artnershi#, and you are
not neessari$y $iab$e .ust by taking a #art in ontro$$ing the day to day ati+ities of the
#artnershi#s5you will only be liable if you hold yourself out to third parties as being a
limited partners
o 4ou wi$$ be $iab$e if a third #arty reasonab$y be$ie+es, based on the $imited
#artner*s ondut, that the $imited #artner is a genera$ #artner
III. Co'(o'ations
A. In Gene'a$
- two biggest ad+antages:
o !" limited liability- shareho$ders are on$y $iab$e for the amounts they #ut into the
or#oration, so if the or#" runs u# $arge debts, they are not res#onsib$e
o (" free transferability- ownershi# interests in the or#" are free$y transferab$e b9
they are re#resented by shares, whih an be bought and so$d easi$y"
- they ha+e forma$ douments
o arti$es of inor#orations, by$aws and other agreements
- or#orations are #roduts of state $aws, and must abide by state $aws
- the amount of your stake in the om#any deides how muh say you ha+e in the business
(I
o distinguish :partnership;# a fundamenta$ #resum#tion in #artnershi#s is that eah
#artner has an e1ua$ say in running the business
o where as a #artner an e6it a #artnershi# at any time by disso$+ing the #artnershi#,
an owner in a or#oration annot terminate his9her share at any time, un$ess
someone e$se is there to buy out his9her share
- entra$ized mgmt
o shareho$ders =own the or#oration> e$et the board of diretors
o board of diretors =manage> and a##oint offiers
o offiers ha+e the =day-to-day> ontro$
General Set Up
- shareho$ders:
o they ha+e the #ower to e$et diretors by +oting for them one a year at the annua$
meeting
o shareho$der*s do not ha+e the #ower to ondut business on beha$f of the
or#oration or to bind the or#oration by their ations
o shareho$ders annot gi+e orders5they annot order the board to take s#eifi
ation
but they an use shareholder resolutions to influence the &oard by
reommending ertain ations
o they an +ote to remo+e diretors
most states a$$ow the remo+a$ of diretors with or without cause
o they an a##ro+e or disa##ro+e ma.or ations ontem#$ated by the board that
wou$d $ead to fundamenta$ hanges
mergers
sa$es of a$$ or substantia$$y a$$ assets of the or#oration*s assets
amendments to arti$es of inor#oration
statutory share e6hanges &where a$$ shareho$ders are re1uired to e6hange
their shares for those in another or#oration'
disso$ution of the or#oration
o they annot remo+e an officer
- diretors
o ty#ia$$y they are u# for ree$etion e+ery year at the annua$ meeting
o their main funtion is to set the #o$iies of the or#oration
o authorize the making of im#ortant ontrats
o they de$are di+idends
o most diretors are now om#$ete outsiders &meaning they ha+e no ties with the
om#any5they are not offiers, em#$oyees, $awyers or aountants for the or#"'
o they an appoint and remove the offiers &with or without ause'
o they annot remo+e a fe$$ow diretor e+en for ause, un$ess the by$aws say they
an
- offiers
o they are a##ointed diret$y by the Board of diretors
o they ser+e at the wi$$ of the Board of diretors
(K
o arry out =day to day ati+ities>
o the o%%ice's a'e agents o% the co'(o'ation
to bind the or#oration, the offier must ha+e the authority &atua$, im#$ied
or a##arent' or the or#oration may be $iab$e by ratification
e6" inherent agency# there is ommon know$edge that the /EO an sign
non#e*traordinary ontrats on beha$f of the or#oration &e6" for su##$ies'
!. The Co'(o'ate Entity an) "i:ite) "ia#i$ity
- or#orations eah ha+e an independent legal identity
- shareho$ders are not indi+idua$$y $iab$e for ations and deaths of the other shareho$ders
- the #ur#ose of a or#oration is to a$$ow its #ro#rietors to esa#e #ersona$ $iabi$ity
o but there are sti$$ $imits
'ublic 'olicy: Reasons for Limited Liability
- without LL, in+estors wou$d ha+e to $imit their in+estments to one or two that they ou$d
wath +ery arefu$$y
- it enourages di+ersifiation in +arious kinds of enter#rises
o if you ha+e un$imited $iabi$ity, then you wou$d ha+e to s#end many resoures
monitoring the ations of eah of your enter#rises to make sure you aren*t
finania$$y res#onsib$e for anything
- so-a$$ed =unso#histiated> ontrating #arties may not know that they are dea$ing with
or#orations or may not know the onse1uenes of dea$ing with or#orations
- $imited $iabi$ity a$$ows om#anies to e*ternali6e costs
- NOTE: Limited liability is very strong%and piercing the corporate veil is very difficult
1. &ie'cing the Co'(o'ate Dei$
- the /ourt wi$$ #iere the or#orate +ei$ whene+er neessary =to #re+ent fraud or to
ahie+e e1uity>
- The ourt is more wi$$ing to #iere the +ei$ in tort ases
o b9 in ontrat ases, the - entered into re$ations with the or#oration +o$untari$y
- an indi+idua$ an be he$d $iab$e for the ations of a or#oration through the dotrine
respondeat superior if it an be shown that the indi+idua$ used his ontro$ of the
or#oration for his #ersona$ gain &to further his own, rather than the or#oration*s
business'
o .al5ovs65y v! )arlton# - was run o+er by D*s ab om#any, but instead of suing
the atua$ dri+er, he sued one of the stokho$ders of the or#oration indi+idua$$y
&#iered the or#orate +ei$'" The /ourt he$d that if the stokho$der is arrying on
business in his individual capacity, then he is $iab$e for the ations of his agent &he
is the #rini#a$, the ta6iab is his agent'" 2ere, there was not enough e+idene
that the D was dong things to ser+e his own #ersona$ interest, so he is not $iab$e
indi+idua$$y" The /ourt found that a$$owing - to do this wou$d defeat the who$e
#ur#ose of $imited $iabi$ity" The /ourt a$so said that if the insurane o+erage on
abs, as re1uired by statute, is too $ow, then it is an issue for the $egis$ators, not
the ourts" It was the $egis$ature*s .ob to raise the minimum insurane o+erage"
3an "orn Test
(J
/or#orate Aei$ wi$$ be -iered if - #ro+es:
- !" there is a unity of interest b9t the indi+idua$ and the or#oration &the se#arate
#ersona$ities of the or#oration and the indi+idua$ no $onger e6ist'% ,ND
- (" to a$$ow the $imited $iabi$ity wou$d #romote an in$ustice or sanction a fraud
o Either one &in.ustie or fraud' wi$$ suffie to satisfy this e$ement
(our (actors used in "etermining the :<nity of Interest;
- !" fai$ure to maintain ade1uate or#orate reords or to om#$y with or#orate forma$ities
o 8ai$ure to maintain the reords, or#orate forma$ities &board of diretor*s
meetings, are the fi$es in good sha#e'5adherene to forma$ity
o E6" 0hares are ne+er forma$$y issued
o 0hareho$ders and diretors meetings are not he$d
- (" the omming$ing of funds or assets
o 1ea#land 1ervices v! 'epper 1ource- where - de$i+ers #e##er to -e##er 0oure,
but is not #aid for the de$i+ery" - tried to sue the or#oration but the or#oration
had disso$+ed, so they wanted to sue the owner &Carhese'" - $aimed that C
reated and mani#u$ated these or#orations for his own #ersona$ use" C was
borrowing substantia$ sums of money from the or#orate aounts and not #aying
any interest" C used the bank aounts to #ay his own #ersona$ e6#enses
&a$imony, hi$d su##ort, eduations for his hi$dren, maintenane for his own ars'
and does not e+en own his own bank aounts" Based on this, - has definite$y
met the first e$ement of the Aan 2orn test" The /ourt says #roteting Carhese
wou$d santion a fraud or #romote in.ustie" They re$ied on the fat that he had
engaged in ta6 e+asion by treating his #ersona$ e6#enses as dedutib$e or#orate
e6#enses and used or#orate funds for his own benefit"
- )" undera#ita$ization
o 7here firm doesn*t start out with enough money to o+er $awsuits
- E" one or#oration treating the assets of another or#oration as its own
In$ustice%the 1econd 'rong
- CU0T 02O7: some wrong beyond a reditor*s inabi$ity to o$$et wou$d resu$t
- E*amples of In$ustice:
o The ommon sense ru$es of ad+erse #ossession wou$d be undermined
o 8ormer #artners wou$d be #ermitted to skirt the $ega$ ru$es onerning monetary
ob$igations
o , #arty wou$d be un.ust$y enrihed
o ,n intentiona$ sheme to #ut assets in $iabi$ity-free or#orations whi$e hea#ing
assets u#on an asset-free or#oration wou$d be suessfu$
,. &a'ent Co'(o'ations an) S*#si)ia'ies
- /or#orations hoose the #arent9subsidiary mode$ b9 the parent $ike any other
shareho$der, is not $iab$e for the debts of the subsidiary- so the #arent an undertake an
ati+ity without #utting its own assets at risk, beyond those it deides to ommit to the
subsidiary
(N
- But $ike an indi+idua$ shareho$der, if a or#orate shareho$der is not arefu$, the reditors
of the subsidiary may be ab$e to #iere the or#orate +ei$ of the subsidiary and get to the
#arent or#oration
- The #arent a$so must be arefu$ not to beome diret$y $iab$e by +irtue of its #artii#ation
in the ati+ities of the subsidiary"
- #arent or#orations are not a$ways $iab$e for the ations of their subsidiaries
'arent )orporations Are 7ot Liable If:
- !" #ro#er or#orate forma$ities are obser+ed%
- (" the #ub$i is not onfused about whether it is dea$ing with the #arent or the subsidiary
- )" the subsidiary is o#erated in a fair manner with some ho#e of making a #rofit% ,ND
- E" there is no other manifest unfairness
&urden in Tort Actions
- the burden of #roof is $ower in tort ases
o - did not hoose to enter into re$ations with the D or#oration
- - needs to show that the subsidiary or#oration is an instrument of the &#arent
or#oration' stokho$der, but there is no burden to prove fraud
o 7hen determining whether a subsidiary is onsidered an =instrument of the #arent
or#oration,> a totality of the circumstances test is used to see if there is
=substantia$ domination>
(actors <sed in Totality of the )ircumstances Test:
- The #arent and subsidiary ha+e ommon diretors and offiers
- /ommon business de#ts"
- 8i$e onso$idated finania$ statements and ta6 returns
- -arent finanes the subsidiary
- 0ubsidiary o#erates with gross$y inade1uate a#ita$
- -arent #ays the sa$aries and other e6#enses of the subsidiary
- 0ubsidiary reei+es no business e6e#t that gi+en to it by the #arent
- -arent uses the subsidiary*s #ro#erty as its own
- Dai$y o#erations of the two or#orations are not ke#t se#arate
- 0ubsidiary does not obser+e the basi or#orate forma$ities, suh as kee#ing se#arate
books and reords and ho$ding shareho$der and board meetings
E*ample of 7ot 8bserving )orporate (ormalities
- e6" 1ilicone el &reast Implants case- where D owned a$$ the shares of stok in another
or#oration &CE/', who #rodued breast im#$ants, and they were defeti+e" CE/
doesn*t ha+e a $ot of money b9 D &Bristo$' has been taking a$$ of its money" D a$so had a
$ot of ontro$ o+er CE/, so the first #art of the Aan Dorn test has been satisfied" D*s A-
is on the Board of CE/" CE/ had to get Bristo$*s a##ro+a$ before hiring any e6euti+es
or negotiating sa$aries" It was +ery signifiant that Bristo$*s name was on a$$ of the breast
im#$ant #akages, and used in a$$ #romotiona$ ommuniations with dotors b9 this
showed that it was +ouhing for the redibi$ity of the #rodue" It turns out that the
diretors were on$y diretors on #a#er% in fat, some of them didn*t e+en know that they
)<
were diretors" There were no minutes of any meetings" The $awyers shou$d ha+e to$d
them to kee# a tighter shi#" They shou$d not esa#e $iabi$ity"
-. "i:ite) &a'tne'shi(s .E Co'(o'ation as So$e Gene'a$ &a'tne'
- , $imited #artnershi# with a or#oration as the so$e genera$ #artner beame the new
+ariation on the basi $imited #artnershi#
o 7ith this new form, no indi+idua$ was $iab$e for the debts of the #artnershi#
- Limited #artners do not inur genera$ $iabi$ity for the $imited #artnershi#*s ob$igations
sim#$y b9 they are offiers, diretors, or shareho$ders of the or#orate genera$ #artner
- in $imited #artnershi#s, only the general partners are liable for the losses- and the $imited
#artners are not
- a limited partner wi$$ be he$d $iab$e if, for #ersona$ gain, he takes ontro$ of the business
over and above his normal rights as a limited partner
o e*! (rigidaire v! <nion 'roperties- where - entered into an agreement with a
$imited #artnershi#, knowing that Cannon and Ba6ter were $imited #artners, but
a$so shareho$ders in the genera$ #artner or#oration" - knew that the D was the
on$y #arty with genera$ $iabi$ity" The main or#oration $aims it has no money b9
C and B are draining it" C and B were the $imited #artners &they are the so$e
owners of the or#oration'" They ne+er he$d themse$+es out as genera$ #artners,
and ne+er $ed - to be$ie+e that they were ating in any a#aity other than in their
or#orate a#aities" They on$y ontro$$ed the $imited #artnershi# in their
a#aities as agents for their #rini#a$, the or#orate genera$ #artner" It was a
se#arate or#orate entity that entered into the ontrat with - and ontro$$ed the
$imited #artnershi#" The /ourt found that they annot be he$d $iab$e as
indi+idua$s" If - was unomfortab$e with a or#oration being the #artner, he
shou$d ha+e asked for additiona$ assuranes" -s shou$d be aware of the #arties
with whom they ontrat"
- 7hen shareho$ders of a or#oration, who are a$so the or#oration*s offiers and diretors,
onsientious$y 5eep the affairs of the corporation separate from their personal affairs-
and no fraud or in$ustice is done u#on third #ersons who dea$ with the or#orations, the
or#oration*s se#arate entity shou$d be res#eted
C. Sha'eho$)e' 5e'i3ati3e Actions
- 1hareholder derivative suit# where shareho$der sues the or#oration nomina$$y, but rea$$y
the managers of the corporation- to reo+er some o##ortunity that be$ongs to the
or#oration
- This is a way to enfore the fiduiary duties of the diretors
'ublic 'olicy:
- 0hareho$ders turn o+er the managing of the firm to agents, diretors and em#$oyees
o o##ortunity e6ists for directors to e6#$oit the firm that they are harged with
running for their own #ersona$ gain
- Diretors did not ha+e a $ot of aountabi$ity, so they ou$d easi$y profit personally at the
e*pense of the corporation
- Unti$ reent$y, stokho$ders had no standing to bring i+i$ ation at $aw against faith$ess
diretors and managers
)!
- now shareho$ders an =ste# in the shoes of the or#oration> and seek a right to the
restitution that they ou$dn*t get on their own
- But, the f$i# side, is what if the diretor is innoent and these fri+o$ous suits kee# oming
in, then he wi$$ be s#ending a$$ of his time in ourt and no one is going to be running the
or#oration, $ike he was hired to do
o If we are going to a$$ow minority shareho$ders to sue for these transations, this
wou$d be 1uite an interferene with managing the main om#any
These suits an be a great distration, so we gi+e them the o##ortunity to
dismiss these suits, by re1uiring a seurity regarding attorney*s fees
1ecurity Requirement
- ,s a resu$t of these suits, a who$e industry has de+e$o#ed of $awyers and $aw firms who
dea$ with these suits
- sometimes states re1uire that - #ro+ide a seurity for the D*s $itigation osts that the -
wi$$ ha+e to #ay the osts of $itigation if it turns out that these suits are without merit
o theses $aws on seurity +ary de#ending on the fats
Laws of "erivative 1uits
- #rodut of state $aw
- a shareho$der*s deri+ati+e suit wi$$ fo$$ow state substanti+e $aw &non-#roedura$' $aws
regarding the deri+ati+e suits when #ossib$e
- state $aws wi$$ not be u#he$d if they are #roedura$ and #reem#t &onf$it' with federa$
$aws
o e6" )ohen v! &eneficial- where the ourt u#he$d a state $aw that said -*s in a
deri+ati+e suit &who own $ess than ;G of the tota$ shares, or $ess than :;<,<<< of
the or#oration' must #ay the $ega$ fees for the Ds if they $ose" The /ourt said it
did not onf$it with federa$ $aws and was onstitutiona$"
- 0tates are within their rights to deide to determine how they want to reso$+e om#eting
interests and -s annot get around this sim#$y by remo+ing the ase to federa$ ourt
"efining "erivative 1uits
- 0uing for =in.ury to the or#oration> M derivative suit
- 0uing for =in.ury to the - as a stokho$der and to him indi+idua$$y> M individual suit
o suit may take the form of a re#resentati+e $ass ation
- when the in$ury suffered was personal- rather than an in.ury of the or#oration, the suit
wi$$ not be onsidered derivative for the #ur#ose of re1uiring a #osting of seurity for
o##osing $ega$ e6#enses
o e*! Eisenberg 3! (lying Tiger# where - said the or#oration*s reorganization
affeted his +oting rights as a minority shareho$der, and denied him of any
inf$uene o+er the affairs of the new om#any" - argued that the suit was #ersona$
&he was not suing under the or#oration*s name' so he didn*t fa$$ under the N4
$aw whih wou$d make him $iab$e for D*s $ega$ e6#enses if - $ost the suit" The
/ourt found that it was not a deri+ati+e ation, so - did not ha+e to #ost the
money ahead of time"
TESTS FOR W2ET2ER T2E S+IT IS 5ERIDATIDE
)(
- :1pecial In$ury; Test &N4 $aw'
o a s#eia$ in.ury is one that is separate and distinct from that suffered by other
shareholders- or a wrong in+o$+ing a ontratua$ right of a shareho$der, suh as
the right to +ote, or to assert ma.ority ontro$, whih e6ists inde#endent$y of any
right of the or#oration
- Two 'rong Test: &DE $aw'
o !" 7ho suffered the a$$eged harm, the or#oration or the suing stokho$ders
indi+idua$$y3
o (" 7ho wou$d reei+e the benefit of any reo+ery or other remedy5the
or#orations or the stokho$ders, indi+idua$$y3
'ublic 'olicy on 1ettlements and Attorney+s (ees
- if a derivative action is settled before $udgment, the corporation an #ay the $ega$ fees of
the - and of the Ds
o the managers started to #ay off &sett$e' the suits, and they were ab$e to do so out of
the or#oration*s treasury
- If a .udgment for money damages is im#osed on the Ds, e6e#t to the e6tent that they are
o+ered by insurane, they will be required to pay those damages and may be re1uired to
bear the ost of their defense as we$$
o if they are sued in ourt and $ose, they ha+e to #ay out of their own #okets
- The or#oration an #ay the D*s e6#enses on$y if the /ourt determines that =des#ite the
ad.udiation of $iabi$ity but in +iew of a$$ the irumstanes of the ase, the D is fair$y
entit$ed to indemnity>
- the rea$ #arty in interest in a derivative suit is the attorney b9 the or#orate managers wi$$
be re$ie+ed of $iabi$ity, if the or#oration #ays big attorney*s fees to get the - to sett$e
o ,ttorneys wi$$ often ae#t the money for the sett$ement either to a+oid $itigation
or b9 they are being #aid so we$$
- The /ourt has to a##ro+e the sett$ement, but most busy .udges wi$$ not ha$$enge one
- NOTE: 0ometimes the /ourt wi$$ #ay the - indi+idua$$y, b9 if it a$$ows the or#oration
to reo+er the money, it wou$d be returning the funds to the ontro$ of the wrongdoer
5. Sha'eho$)e'sF 5i'ecto's an) O%%ice's
- The #ur#ose of a business or#oration is to make #rofits for its stokho$ders
o Diretors are hired for this #ur#ose
o Diretors shou$d use their disretion in hoosing how to attain this end
o They do not ha+e disretion o+er:
the atua$ goa$ itse$f
the redution of #rofits, OB
the nondistribution of #rofits among shareho$ders in order to de+ote them
to other #ur#oses
eneral Rule
- A #*siness co'(o'ation is o'ganiGe) ('i:a'i$y %o' the stoc6ho$)e'sHHH
o diretors owe a fiduiary ob$igation to the shareho$ders
this $ooks a $itt$e different than the traditiona$ #rini#$e agent re$ationshi#
- shareho$ders ha+e an interest in the residua$ #rofits of the firm
))
o these #rofits are #aid to them in di+idends
- NOTE: shareho$ders are the #rini#a$, and the diretors are working for them as agents
Two different 5inds of directors
- outside
o ommittees and offiers inform them about what is going on with the om#any
o they set broad #o$iy
- inside
o these diretors ha+e some re$ationshi# to the or#oration &em#$oyees, offiers,
$awyers, et"'
- NOTE: it is better to ha+e outside diretors sitting on the board b9 they wi$$ ha+e a more
ob.eti+e +iew#oint
NOTE:
- reditors ha+e no ontratua$ re$ationshi#s with the or#oration
- ustomers are re$ati+e$y #ower$ess in om#arison to the other #arts of the or#oration
E. The Ro$e an) &*'(oses o% a Co'(o'ation
- or#orate gift-gi+ing is an ae#tab$e method of inreasing goodwi$$, but the gift shou$d
be $ess than !G of a#ita$ and sur#$us and direted to an institution owning no more than
!<G of om#any stok
- on$y diretors of the or#oration ha+e the #ower to de$are a di+idend of the earnings of
the or#oration and to determine its amount
- /ourts wi$$ not interfere in the mgmt of the diretors un$ess it a##ears that:
o they are guilty of fraud or misappropriation of the or#orate funds
o refuse to declare a dividend
when the or#oration has a sur#$us of net #rofits whih it an, without
detriment to its business di+ide among its shareho$ders% OB
when a refusa$ to de$are a di+idend wou$d onstitute a breach of that
good faith whih they are bound to e6erise toward the stokho$ders
&usiness ,udgment Rule
- ourts wi$$ show great deferene to the business to when make deisions on issues that
#ertain to the running of their business
- The /ourt wi$$ not in1uire into the moti+es of the board members, as $ong as their ats are
within their $awfu$ #owers
- the #ur#ose of a or#oration is to make a #rofit for its shareho$ders, but a ourt wi$$ not
interfere with deisions that ome under the business $udgment of directors
o e6" "odge v! (ord 0otor )ompany# where shareho$ders brought suit against the
diretors to #ay a higher di+idend and hange D*s 1uestionab$e business #raties"
D started $owering the osts of ars whih was $owering #rofits" 2e a$so sto##ed
#aying out s#eia$ di+idends" D*s defense was that a$though this deision $owered
#rofits, he wanted to s#read the industria$ ways to as many #eo#$e as #ossib$e"
The /ourt he$d that the -*s are entit$ed to a more substantia$ di+idend, but it wi$$
not interfere with D*s business .udgments on the #rie set for the ars" The /ourt
)E
wi$$ not deide whether 8ord &D' is better off with $ower #ried ars b9 those
deisions are o+ered under the &usiness ,udgment Rule!
- , /ourt wi$$ not interfere with an honest business .udgment &issues of #o$iy and
business mgmt' absent a showing of fraud- illegality or conflict of interest
o E*! 1hlens5y v! .rigley# D owns a baseba$$ team, but the minority shareho$ders
don*t $ike how 7rig$ey is running the firm" 2e didn*t insta$$ $ights $ike a$$ other
ma.or $eague #arks ha+e" D thinks that baseba$$ shou$d on$y be #$ayed during the
daytime b9 he is onerned about the neighborhood" The /ourt wi$$ not o+erturn
D*s deision not to insta$$ $ights, b9 he has #resented some good reasons for not
ha+ing them" The ourt says it wi$$ not get in+o$+ed in how to run the firm5
getting in+o$+ed in the om#any*s deisions is beyond its ro$e" The /ourt doesn*t
are whether the deision is right or wrong5if it was a business .udgment, then
they wi$$ defer to the or#oration"
- NOTE: If a shareho$der is unha##y with the way the board is running the business, why
doesn*t he .ust get out, and go in+est in some other business3 7hy is he bothering the
diretors with his om#$aints if he has the o##ortunity to e6it3
o The e6it is a $imited strategy for the shareho$ders
o The shares shou$d be worth more than they are, so he an*t e6it without taking a
$oss without taking a $oss that he shou$dn*t ha+e to take
'ublic 'olicy on "erivative 1uits v! )lass Actions
- there isn*t muh inenti+e for any shareho$der to bring a $aim against the diretor
- now #eo#$e wi$$ on$y bring suit if they ha+e an im#ortant $aim
- 'roblem5there is a war b9t shareho$ders and diretors and we are des#erate to find a
mehanism to end this war
o The diretors ha+e an unfair ad+antage in this war b9 they are trained and
e6#eriened and they ha+e their hands on the $e+er5they ha+e the key to the safe
- The one solution is derivative suits- but this is not very effective
o the ageny &monitoring' #rob$em is not so$+ed% it*s an ineffeti+e mehanism
- Lawyers:
o the rea$ #arty in interest is the $awyer b9 doesn*t ha+e to share his #iee with
anyone, whi$e any resu$t from the $awsuit is s#read out among a$$ shareho$ders5
the $awyer has the rea$ inenti+e
o now there are too many $awyers and too many $aw firms bringing suit
ID. The 5*ties o% O%%ice'sF 5i'ecto's an) Othe' Insi)e's
'ublic 'olicy: .ar &/t "irectors and 1hareholders
- batt$e on the one hand to ho$d diretors aountab$e to shareho$ders
o to make sure they are #utting the om#any*s best interest in front of their own best
interests
- one wea#on that shareho$ders might ha+e is the shareholders derivative suit
- but diretors ounter with the business $udgment rule
- shareholders derivative suits beome 1uite weak om#ared to the business $udgment rule
- before you bring a deri+ati+e $awsuit, you ha+e to raise your om#$aint with the board of
diretors first
);
o under the statute, you ha+e to make that demand first before you bring suit
o if the diretor disagrees with the shareho$der, he an go on with the suit
- NOTE: the hurd$es are 1uite substantia$ that kee# the deri+ati+e $awsuit from being
e6amined on the merits
A. The O#$igation o% Cont'o$: 5*ty o% Ca'e
&usiness ,udgment Rule:
- DE $aw5the business and affairs of a DE or#oration are managed by or under its board
of diretors
- a ourt wi$$ not interfere with the deisions of a om#any*s diretors un$ess there is
e+idene of fraud or dishonest practice
o mere errors in .udgment are not suffiient as grounds for e1uity interferene
- more than imprudence or mista5en $udgment must be shown for the ourt to interfere
o 4amin v! American E*press# where D deided to use e6tra money to #ay out
di+idends instead of #aying off a#ita$ gains, whih wou$d ha+e sa+ed the
om#any :J mi$$ion" - said this was neg$igent deision-making" The ourt he$d
that this deision may ha+e been unwise, but it is not for the ourt to deide" The
directors get to decide how dividends are declared!
'ublic 'olicy:
- the business $udgment rule rea$$y sares of shareho$ders b9 it ho$ds them to a muh
higher standard5now they ha+e to show that the om#any had a duty of are and
breahed it
- hindsight bias# when we know that an outome has ha##ened, we are muh more $ike$y
to o+erestimate their #reditabi$ity &simi$ar to =hindsight is (<9(<>'
o in or#orate $aw, when the diretor makes a bad deision and the dea$ goes bad,
.udges and .uries are muh more $ike$y to say: it was so ob+ious that it was going
to go wrong, and award damages
"uty to 0a5e Informed "ecisions
- =#resum#tion that in making a business deision, the diretors of a or#oration acted on
an informed basis- in good faith and in the honest belief that the ation taken was in the
best interests of the om#any =
o The #arty $aiming that a board deision is uninformed, must rebut the
#resum#tion that its business .udgment was an informed one
- Informed decision: It a$$ de#ends on whether the diretors ha+e informed themse$+es
=#rior to making a business deision, of a$$ materia$ reasonab$y a+ai$ab$e to them>
o The ru$e does not #rotet diretors who ha+e made an unintelligent or unadvised
$udgment
- 1TA7"AR": gross neg$igene5standard for determining whether the business .udgment
reahed by the Board was an informed one
1mith v! 3an or5om%LA7"0AR4 )A1E
- the deision made by the Board must be researched and informed
- Diretors are fu$$y #roteted if they re$ied in good faith on re#orts made by offiers
)I
o But these ha+e to be substantia$ and re$e+ant to the issues before the board
o The diretor annot .ust b$ind$y re$y on the re#orts5they must e6erise good faith
- During a #ro#osed merger, a diretor has a duty, a$ong with his fe$$ow diretors to at in
an informed and de$iberate manner in determining whether to a##ro+e an agreement of
merger before submitting the #ro#osa$ to the stokho$ders"
o 1mith v! 3an or5om# where Aan Rorkom #resented his suggestion to the Board
but did not te$$ him his methods of arri+ing at this deision" The ourt he$d that
the &oard had a duty to make an informed deision on im#ortant deisions, suh
as whether or not to do a merger" 2ere the ourt found it was an uninformed
deision b9 the diretors didn*t e+en know the +a$ue of the om#any, and
a##ro+ed the sa$e with two hours of onsideration with no notie of a risis or an
emergeny" In addition, no one knew what the meeting was going to be about and
those who did had .ust found out" The Board re$ied so$e$y on Aan Rorkom*s ora$
#resentation, no notes or written summaries were #ro+ided" ,s suh, the Board
breahed their fiduiary duty to the shareho$ders by fai$ing to inform themse$+es
of a$$ information reasonab$y a+ai$ab$e to them and re$e+ant to their deision to
reommend the merger and fai$ing to dis$ose a$$ materia$ information suh as a
reasonab$e stokho$der wou$d onsider im#ortant in deiding whether or not to
a##ro+e the offer"
- now a Board of diretors annot make a deision $ike this without many, many ourt
douments to insu$ate them from the threat of $iabi$ity
- this case says there is still the business $udgment rule but you don+t get it with out
earning it%going through lots of legal protections
o Aan Rorkom and the diretors were not entit$ed to the business .udgment ru$e
o b9 the BQ ru$e assumes that they were ating in good faith
- any =business .udgment> the Board makes must be informed and in good faith
o the ourt #ro+ides no #rotetion for diretors that make an uninformed .udgment
that is not made in good faith
Insurance Against Liability for "irectors
- -art of the sett$ement from Aan Rorkom ame from the insurane o+ering the diretors
- ,fter this +erdit, many or#orations ado#ted #ro+isions $imiting the $iabi$ity of its
diretors
- De$aware or#orate $aw #ermits firms to insure diretors against $iabi$ity for neg$igene
5E Co'(o'ate "a. 1@,B#CBIC
- a$$ows any or#oration to in$ude in its ertifiate of inor#oration:
o =a #ro+ision eliminating or limiting the personal liability of a diretor to the
or#oration or its stokho$ders for monetary damages for breah of fiduiary duty
as a diretor, #ro+ided that suh #ro+ision sha$$ not e$iminate or $imit the $iabi$ity
of a diretor:
!" for any breach of the director+s duty of loyalty to the or#oration or its
stokho$ders%
(" for acts or omissions not in good faith or whih in+o$+e intentional
misconduct or a 5nowing violation of law/
)" under O!KE of this tit$e &re$ating to #ayment of di+idends'
)K
E" for any transation form whih the diretor deri+ed an im#ro#er
#ersona$ benefit
'ublic 'olicy on Insurance
- Diretors are $iab$e for breah of fiduiary duty
o now DE res#onds to the ho$ding in 3an or5om by saying that diretors an o#t
out of this ru$e by ha+ing insurane against $iabi$ity
- Reasons against insurance:
o 7hy wou$d firms deide not to take ad+antage of this o##ortunity and say, we
wi$$ go with the default rule3
b9 it ou$d deter investors5why wou$d you want to in+est in a firm that
has wai+ed $iabi$ity35you wou$dn*t
shareho$ders wou$d be wa$king into a om#any that they know they ha+e
no $ega$ #rotetion against
o moral ha6ards problem- if diretors know they are insured, they wi$$ be are$ess
- Reasons for insurance:
o you wou$d want to insure the om#any so that the firm is #roteted b9 they ou$d
ha+e to #ay a $ot of money
o you aren*t going to get the big #eo#$e to be diretors un$ess they are insured
against $iabi$ity
5e$a.a'e Co'(o'ate "a.:
- , or#oration an inor#orate in any state it wants
o 2a$f of a$$ or#orations traded on the N4 stok e6hange are DE or#orations
- internal affairs doctrine# the interna$ affairs of the or#oration are go+erned by the state
they are inor#orated in, not the states in whih it does business
Two competing views of why "elaware has the most corporations:
- >! race to the bottom
o Diretors are #owerfu$, shareho$ders are weak
o Diretors are smart and an take ad+antage of shareho$ders &one way they do this
is by hoosing $aw that is benefiia$ to them, hoosing $aw that a$$ows them to o#t
out of neg$igene suits, et"'
Diretors an deide where to inor#orate5the states get some ad+antage
from ha+ing or#orations inor#orate in their state &there is a fee, et"'5so
there is a om#etition among states to get or#orations to inor#orate
there, and the way the states on+ine these or#orations is by making $aw
that fa+ors diretors
o 0o there is a rae to the bottom to get the worst or#orate $aw #ossib$e
worst for the en+ironment, shareho$ders, and onsumers
but the best for the #eo#$e in harge: the diretors
De$aware suks and has nothing going on, so they ha+e the worst $aws, but
the $aws attrats diretors
- ?! race to the top
)J
o This +iew says shareholders have the money and get to choose where they invest-
they are on$y going to in+est in a firm that has $aws benefiia$ to them
o They are going to in+est in om#anies with $aws that give them greater protection
o It says De$aware is the best and has #rodued the best $aws
the DE $aw $imiting neg$igene for diretors, attrats the best diretors that
wi$$ do the best for the om#any, so shareho$ders want to in+est in these
firms
- ,nother +iew is that no one an understand why e+eryone inor#orates there, but
e+eryone e$se is doing it, and it is .ust the thing to do
!. 5*ty o% "oya$ty
1. 5i'ecto's an) >anage's
- a diretor has a fiduciary duty to support the interests of the corporation o+er his own
onf$iting interests
- genera$$y when a##$ying the BQ ru$e, ourts don*t $ook at substane, but if there is an
a$$eged onf$it of interest, then they wi$$
Enhanced &usiness ,udgment Rule
- when there are om#eting interest, the BQ ru$e wi$$ sti$$ a##$y, but the /ourt wi$$ use
heightened srutiny
o &ayer v! &eran# where the diretors deide to ad+ertise o+er the radio and one of
the diretor*s wi+es wou$d star in the ad &-*s $aim it was to benefit her areer'"
The ad ost a $ot more than their ad+ertising budget a$$ows" The /ourt found this
does not breah the duty of $oya$ty" The ourt found that the ad was to inrease
their #rofits &not to benefit his wife' and had been researhed and arefu$$y
onsidered &they used are and due di$igene in this deision'"
o NOTE: the ad+ertising of a om#any wou$d ne+er be e6amined under the
business .udgment ru$e, e6e#t for the fat that the diretor*s wife was the star
- ,ny transations by diretors to in+o$+ing the or#orations that may #rodue a onf$it
between se$f-interest and fiduiary ob$igation, are e6amined with heightened srutiny
o Transation wi$$ be +oided if:
there is any e+idene of im#ro+idene or o##ression% OB
any indiation of unfairness or undue ad+antage
&usiness $udgment rule:
- matters $eft to the disretion of the Board of Diretors:
o Tuestions of #o$iy of management
o e6#edieny of ontrats or ation
o ade1uay of onsideration
o $awfu$ a##ro#riation of or#orate funds to ad+ane or#orate interests
- these are $eft solely to their honest and unselfish decision
- they wi$$ on$y be 1uestioned if the resu$ts show that what the Board did was unwise or
ine*pedient
)N
- The business .udgment ru$e yie$ds to the $aw of undi+ided $oya$ty5the $aw is designed
=to a+oid the #ossibi$ity of fraud and a+oid the tem#tation of se$f-interest>
&urden in :)onflict of Interest; )ases
- the BQ Bu$e #$aes a hea+y burden on shareho$ders
- the BQ ru$e #resu##oses that there is no onf$it of interest, so the burden shifts when the
diretors ha+e a onf$iting interest &other than as diretors of the or#oration'
- &urden on director:
o the burden is on the diretor to #ro+e:
!" the good faith of the transation% ,ND
(" to show its inherent fairness form the +iew#oint of the or#oration and
those interested in it
- Diretor must #ro+e that his ations were fair and reasonable to the corporation
o Lewis v! 1LE# where the om#any wasn*t harging his brother*s om#any enough
rent, so the non-fami$y member shareho$ders sued" The ourt found that the rent
#rie was not fair and reasonable for the time #eriod"
,. Co'(o'ate O((o't*nities
.ar &etween Accountability and Authority of "irectors:
- we are e6#$oring this -entium between authority and aountabi$ity for the diretors
o we want them to at on beha$f of the shareho$ders, but we need to gi+e them the
authority to do so
o for the most #art, diretors are gi+en substantia$ authority to run the om#any
o they must treat the or#oration as a reasonab$e #erson wou$d treat his9her own
#ro#erty
- 7hen a diretor makes a deision where he has an interest, the $oya$ty 1uestion is
im#$iated, then the ana$ysis is 1uite different
- 7here loyalty is involved, we wi$$ do a searhing in1uiry and we wi$$ $ook at the
substane
'ublic policy:
- eneral Rule:
o a or#orate fiduiary agrees to #$ae the interests of the or#oration before his9her
own in a##ro#riate irumstane
- the diretor has #ut himse$f in a situation where he has a duty to #ut the interests of his
shareho$ders abo+e his own interests
- burden: now the diretor must affirmati+e$y ome forward and demonstrate the fairness
of the transation
- 7e want diretors to dea$ with their firms sometimes
o ,s in &ro6- the thought is that this wou$d deter diretors from sitting on boards b9
they wou$d be de$ining too many o##ortunities in their own #ersona$ $i+es
"octrine of )orporate 8pportunities @&ro6 testA
- an offier9diretor annot seize a business o##ortunity for himse$f if:
o !" the or#oration an financially underta5e it
E<
o (" it is in the line of the corporation+s business and wou$d be ad+antageous to it
o )" is one in whih the or#oration has an interest or reasonable e*pectancy in the
o##ortunity
- If theses e$ements are #resent, the diretor must turn the offer o+er to his firm
- NOTE: it is not neessary that the diretor9offier #resent this o##ortunity to the board
before taking it for himse$f
- this on$y omes into #$ay where the self#interest of the officer/director wou$d onf$it
with his fiduciary duty to the corporation
o &ro6 v! )ellular Information 1ystems# where D was a diretor of -*s om#any,
/I0 &whih was being a1uired by another om#any', but so$e shareho$der of a
seond om#any, B8B/" /I0 made an agreement to #urhase the $iense, to
#ro+ide e$$ #hone ser+ie in a ertain area, but said that anyone who outbid them
ou$d ha+e it" B8B/ outbid them and - sued, saying D &owner of B8B/' had a
fiduiary ob$igation to -*s om#any as one of the diretors" The ourt he$d that D
had no ob$igation to the om#any that bought /I0" ,$so, at the time /I0 was not
finania$$y ab$e to buy the $iense and they were mo+ing out of the e$$ #hone
business% therefore /I0 had no interest or e6#etany in the o##ortunity"
- ,##$ying the &ro6 test
o In Re Ebay# where - says D took ad+antage of a or#orate o##ortunity by buying
the shares, that were offered to him by Ro$dman 0ahs, at the e6#ensi+e #rie and
then rese$$ing them for a #rofit" The /ourt finds that Ebay was finania$$y ab$e to
buy the shares% that they were in the business of buying and se$$ing seurities% that
in+esting was integra$ to Ebay*s ash management strategies and a signifiant #art
of its business" It is $ear that Ro$dman 0ahs was a $arge in+estment bank who
wanted to se$et insider diretors and offiers to reward them for #ast in+estments
and indue them to diret future business toward them" The diretors and offiers
violated their fiduciary duty by taking the o##ortunity for themse$+es and
e6#$oiting it for their own benefit"
Tender offer
- an offer to buy shares of stok from shareho$ders, who are in+ited to tender their shares to
the offeror for #urhase at a s#eified #rie within some s#eified #eriod of time
- Often the om#$etion of a transation is made ontingent on the offeror reei+ing some
s#eified number of shares, suffiient, for e6am#$e, to gi+e it ontro$ of the target
or#oration
-. 5o:inant Sha'eho$)e's
- where a shareho$der own a ontro$$ing ma.ority in the om#any, he has a fiduciary duty
to the minority shareholders
- 7hen the situation in+o$+es a #arent and a subsidiary, a standard of intrinsic fairness wi$$
be a##$ied, and the #arent or#oration*s ma.ority ownershi# ontro$s the transation and
fi6es the terms
o this means the burden shifts to the #arent om#any to #ro+e, sub.et to arefu$
.udiia$ srutiny, that its transations with the subsidiary were ob.eti+e$y fair
- The #arent or#oration has a fiduiary duty, but there must a$so be se$f-dea$ing in+o$+ed
to in+oke the intrinsic fairness standard
E!
o 1elf dealing# the situation where a #arent is on both sides of a transation with its
subsidiary, and by +irtue of its domination of the subsidiary, auses the subsidiary
to at in suh a way that the #arent reei+es something from the subsidiary to the
e6$usion of, and detriment to, the minority stokho$ders of the subsidiary
- if the #arent or#" does something that benefits them but not at the e6#ense of the
minority shareho$der, then the ourt wi$$ use the business $udgment rule
- ma.ority shareho$ders are he$d to a different standard than offiers or diretors
o 1inclair 8il )orp 3! Levien# where the #arent or#oration aused the subsidiary to
#ay out suh high di+idends that the subsidiary didn*t ha+e any inome" The
/ourt he$d the 0in$air &#arent' owed 0in+en &subsidiary' a fiduiary duty beause
they nominate a$$ of 0in+en*s diretors, but that they wou$d a##$y the norma$ BQ
Bu$e b9 there was no self#dealing involved &whih wou$d in+oke the intrinsic
fairness standardA" 0in$air reei+ed nothing from 0in+en that e6$uded or was
detrimenta$ to 0in+en*s minority stokho$ders, so there was no se$f-dea$ing" ,s
$ong as there was no fraud or gross overreaching, 0in$air*s deisions in the
di+idends must be u#he$d" In terms of the ontrat b9t 0in$air and 0in+en, sine
0in$air reei+ed the benefits of the ontrat, but didn*t ho$d u# their end of it,
0in$air breahed the ontrat" This breah was to the detriment of 0in+en, so that
#art was se$f-dea$ing" They fai$ed to meet the intrinsic fairness standard!
- Un$ike a diretor, a shareho$der &ma.ority or minority' is entit$ed to +ote in a manner that
is most benefiia$ to his9her interests
- The ma.ority shareho$ders ha+e a fiduiary re$ation toward the minority
- Big differene b9t when a stokho$der is voting strictly as a stoc5holder and when voting
as a director
o when +oting as a stokho$der, he may ha+e the $ega$ right to +ote with a +iew of
his own benefits and to re#resent himse$f on$y
o but when he +otes as a diretor he re#resents a$$ the stokho$ders in the a#aity
of a trustee for them and annot use his offie as a diretor for his #ersona$ benefit
at the e6#ense of the stokho$ders
Bahn v! Transamerica# where Transameria was the ma.ority shareho$der
of a tobao om#any and after rea$izing that the #rie of tobao had
inreased deided to redeem its shares" The /ourt he$d that the
Transameria shareho$ders owed the other shareho$ders the money b9 the
ma.ority shareho$ders had hidden their true moti+es"
Rati%ication o% an Inte'este) T'ansaction
- shareholder ratification of a transation b9t the or#oration and an interested #arty wi$$
not be legitimate if the ma$ority of the shareholders are interested parties
- 7here shareho$ders ratify, or a##ro+e of, an interested transation, that $ears the
transation
- genera$$y, shareho$der ratifiation of an =interested transation> shifts the burden of #roof
to an ob.eting shareho$der to demonstrate that the terms are so unequal that they amount
to a gift or waste of corporate assets
o (liegler v! Lawrence# where the board deided to #urhase shares of another
om#any and - sues" D says the dea$ was =ratified> by the shareho$ders" The
E(
/ourt he$d that it was a good dea$ and the D*s #ro+ed the intrinsi fairness of the
transation"
5E 1008 Inte'este) T'ansactions
- &a' No ontrat or transation b9t a or#oration and ! or more of its diretors or offiers,
or b9t a or#" and any other or#", #artnershi#, assoiation, or other organization in whih
! or more of its diretors or offiers, are diretors or offiers, or ha+e a finania$ interest,
shall be void or voidable solely for this reason, or solely because the director or officer is
present at or participates in the meeting of the board or ommittee whih authorizes the
ontrat or transation, or so$e$y beause his or their +otes are ounted for suh #ur#ose,
if :
o !" the materia$ fats as to his re$ationshi# or interest and as to the ontrat or
transation are disclosed or are 5nown to the board of directors or the ommittee,
and the board or ommittee in good faith authorizes the ontrat or transation by
the affirmati+e +otes of a ma.ority of the disinterested diretors, e+en though the
disinterested diretors be $ess than a 1uorum% OB
o (" the materia$ fats as his re$ationshi# or interest and as to the ontrat or
transation are disclosed or are 5nown to the shareholders entitled to vote
thereon- and the ontrat or transation is s#eifia$$y a##ro+ed in good faith by
+otes of the shareho$ders% OB
o )" the contract or transaction is fair as to the corporation as of the time it is
authorized, a##ro+ed or ratified, by the board of diretors, a ommittee, or the
shareho$ders"
D. "i:ite) "ia#i$ity Co:(anies
- /ombines or#oration and genera$ #artnershi#:
o #ro+ides #artii#ants with the $imited $iabi$ity &the $iabi$ity shie$d' that the
or#oration #ro+ides, but more f$e6ibi$ity in management and ontro$
Limited $iabi$ity #rotetion of a or#oration, together with a sing$e-tier ta6
treatment of a #artnershi#, a$ong with onsiderab$e f$e6ibi$ity in mgmt and
finaning
No member an be $iab$e for anything other than the amount of his
in+estment in the LL/, regard$ess of how in+o$+ed that member is in the
dai$y o#erations of the business
- Canagement:
o the LL/ an be managed by either:
a$$ its members &as in a #artnershi#'% OB
by managers, who may or may not be members &as in a or#oration'
The in+estors are a$$ed =managers>
- Ta6es:
o the LL/ has better ta6 treatment than the or#oration
o the IB0 treats LL/*s as #artnershi#s for ta6 #ur#oses, instead of $ike a or#oration
a or#oration #ays ta6es on its #rofits as earned and the shareho$ders &the
e1uity in+estors' #ay a seond ta6 when those #rofits are distributed to
them
E)
o in+estors in an LL/ are ta6ed, $ike #artners, on$y one on its #rofits, as those
#rofits are earned
0o the inome mere$y goes to the #artners, and it is not ta6ed as an entity
o LL/s a$so a$$ow greater freedom than a or#oration in a$$oating #rofit and $oss
for ta6 #ur#oses
, or#oration*s $osses an be arried forward to offset any future #rofits,
but annot be used by its shareho$ders
The in+estors in an LL/ an take aount, on their individual ta6 returns,
of any $osses of the LL/ as those $osses are inurred
- Disso$ution #ara$$e$s that of #artnershi#s
- LL/ members do owe to eah other fiduiary ob$igations of $oya$ty, as in the or#orate
onte6t
- &enefit of a )orporation )ompared with LL):
o It is muh easier to a$ienate your interests in a or#oration, than it is to se$$ them
in an LL/
"I1TI7<I12: Limited Liability 'artnership @LL'A
- Limited $iabi$ity for:
o -artnershi# debts arising from neg$igene and simi$ar misondut &other than
misondut for whih the #artner is diret$y res#onsib$e'
No #artner wi$$ be $iab$e for the #artnershi#*s ob$igation, .ust by +irtue of
being a #artner
o PNot for ontratua$ ob$igations
But some #ro+ide $imited $iabi$ity for both ontrat and tort $iabi$ities
- 0onitoring function of partnerships: They $ook out for eah other*s #artners* $ients
whih benefits the $ega$ #rofession
o One thing $ients want is #reditabi$ity
o 7ith LL/, you aren*t sure how things are going to #$ay out in atua$ fats
- NOTE: LL-s ha+e to use the initia$s, LL-, in their names
o This is so the #ub$i wi$$ know that indi+idua$ #artners won*t be $iab$e
- Now that LL- is im#$iated, they don*t ha+e to worry too muh about other #artners b9
you aren*t $iab$e for them
o It used to be that the size of $aw firms had to be sma$$er b9 you were $iab$e for
eah and e+ery member*s ations
- -artners in LL-s an #artii#ate in the management of the firm without ha+ing to worry
about beoming $iab$e as a genera$ #artner
<!ACJ TO "CC?
A. Fo':ation
- LL) statute: by fi$ing =arti$es of organization> you are gi+ing notie to any #arty that the
om#any is an LL/
o This does not apply to agency
o This statute does not re$ie+e the agent of an LL/ of the duty to disclose its
principal+s identity to a+oid #ersona$ $iabi$ity
EE
o LL/s ha+e to use the initia$s, LL/, in their names
- One the third #arty is on notie that you are an LL/, then they ha+e to abide by a$$ the
e$ements of an LL/
Agency
- #rini#a$ not fu$$y dis$osed M agent is #ersona$$y $iab$e on a ontrat
o ,n agent who negotiates a ontrat with a third #arty an be sued for any breah
of the ontrat unless the agent discloses both the fact that he or she is acting on
behalf of a principal and the identity of the principal
- If both the e*istence and identity of the agent+s principal are fully disclosed to the other
#arty, the agent does not beome a #arty to any ontrat whih he negotiates
- 'artial disclosed principal doctrine:
o where the #rini#a$ is partially disclosed &where his e6istene is known but his
identity is not', it is usua$$y inferred that the agent is the party to the contract
Agency in LL)s
- 7hen a third #arty sues a manager or member of an LL/ under an ageny theory, the
#rini#$es of ageny $aw a##$y
- state statutes #ro+iding notice to third parties when an LL/ has been inor#orated do not
e6tend to ageny $aw, where the agent does not disclose the principal
o .ater- .aste and Land- Inc! @dba .estecA v! Lanham# where one #arty didn*t
know that the other #arty &/$ark' was ating for an LL/, e6e#t for a sma$$
indiation on his business ard" Ty#ia$$y, aording to the LL/ ,t, the fi$ing of
the arti$es of organization ser+es as constructive notice of a om#any*s status as
an LL/" 2owe+er, the /ourt he$d that the statutory notie #ro+ision a##$ies on$y
where a third #arty seeks to im#ose $iabi$ity on an LL/*s members or managers
simply due to their status as members or managers of the LL)%not as agents!
The /ourt found that /$ark ne+er dis$osed that he was re#resenting an LL/, so -
did not know that /$ark was ating as an agent for the LL/" - did not know that
=-II> on the business ard stood for -referred Inome In+estors, an LL/" If the
om#any had to$d - that they were ating on beha$f of =-II, LL/,> then it wou$d
be irre$e+ant that they did not s#eifia$$y say it was an LL/ b9 aording to the
statute when an LL/ fi$es for arti$es of organization that is suffiient to gi+e
onstruti+e notie of the om#any*s $imited $iabi$ity form"
!. &ie'cing the 9""C; Dei$
- there is no $aw or #o$iy that says to treat LL/s different from or#orations when
#iering the +ei$
o This wi$$ be a$$owed for maintenane and forma$ity and some kinds of in.ustie
- #iering the or#orate +ei$ was reated to make sure that .ustie was ser+ed when a
om#any had no assets
o 4aycee Land and Livestoc5 v! (lahive# D*s om#any srewed o+er -, but has no
assets so - wants to =#iere the LL/ +ei$> and go after D #ersona$$y" The ourt
says there is no reason to treat LL/s different than or#orations" ,s suh, if the
members and offiers of an LL/ fai$ to treat it as a se#arate entity as
E;
ontem#$ated by statute, they shou$d not be immune from individual liability for
the LL/*s ats that ause damage to third #arties"
C. 5isso$*tion
- members of an LL/ an be he$d #ersona$$y $iab$e for the debts of their LL/ if they fai$ to
#ro#er$y disso$+e the LL/ under the re$e+ant statutes
- a disso$+ed LL/ may =dis#ose of known $aims against it> by fi$ing arti$es of
disso$ution, and then #ro+iding written notie to its known reditors ontaining
information regarding the fi$ing of $aims"
o 7ew 2ori6aons 1upply )ooperative v! 2aac5# where D and her brother ran a
om#any and D ke#t #romising to #ay -, but ne+er did" Later she said that the
om#any was an LL/, so she was not $iab$e" D did not #resent any arti$es of
organization or o#erating agreement" D said she was not #ersona$$y $iab$e b9 the
aounts were in the business name" D did not fi$e arti$es of disso$ution or notify
reditors of the termination of the om#any" The /ourt found that she was
#ersona$$y $iab$e on the debts b9 the om#any ated $ike a #artnershi# and #aid
ta6es $ike a #artnershi#" Therefore the $iabi$ity was gi+en to the remaining #artner
&D' sine her brother was gone" D fai$ed to take ste#s to shie$d herse$f from
$iabi$ity for the om#any*s debts after its disso$ution and distribution of assets
DI. Sec*'ities
&ac5ground on (ederal Laws
- tension between aountabi$ity and authority
o diretors must be o#erating on beha$f of shareho$ders, whi$e at the same time
being ab$e to e6erise their authority to run the om#any
o there are a $ot of reasons why diretors might be winning this war
we ha+e ta$ked about the rae to the bottom
- we begin with a broad strutura$ #rob$em
o $ots of o##ortunities for diretors thri+e at the e6#ense of shareho$ders
o there are some ases that suggest that diretors are taking ad+antage of this
struture to e6#$oit shareho$ders
- but, there are other institutions engaged in this war, in$uding the 8edera$ 0eurities
Board
- so far, we ha+e been ta$king about state $aw, but after the Rreat De#ression, awareness
rose that or#orate $aw was not res#onsi+e to the #ower of or#orations
- the 8edera$ 0eurities Law was in res#onse to the stok market rash in the !N(<s, but
a$so as an inter+ention &getting the federa$ go+" in+o$+ed'
o The federa$ go+" is not going to get in+o$+ed in the substanti+e as#et5they don*t
are about the struture of the om#any
Legis$ators are no better at making substanti+e business deisions than our
.udges
o But they wi$$ get in+o$+ed in the idea of =fu$$ dis$osure>
o /onsumers shou$d ha+e a$$ the information they need to make an informed
deision of whether or not to in+est in a om#any
EI
'ublic 'olicy
- 8edera$ $aws are not su##osed to regu$ate substane, .ust #roedure
- ,re federa$ seurities $aws beoming more substanti+e in nature, as o##osed to fousing
on dis$osure3
- If you are re1uiring firms to dis$ose in a #artiu$ar form, then you are $imiting the
substanti+e $eeway that they ha+e
o This $imits their substane deisions
- -roess and substane b$eed into eah other
A. 5isc$os*'e an) Fai'ness
- trading or#orate seurities, suh as stoks and bonds, takes #$ae on two basi ty#es of
markets:
o !" the primary mar5et
where the issuer of the seurities &the om#any reating the seurities'
se$$s them to in+estors
e6" an initia$ #ub$i offering by a or#oration takes #$ae here
o (" the secondary mar5et
7here in+estors trade seurities among themse$+es without any signifiant
#artii#ation by the origina$ issuer
E6" the N4 0tok E6hange5+ery organized and regu$ated
I:(o'tant "egis$ation
- 1ecurities Act
o /onerned with the #rimary market
o Two main goa$s:
!" mandating dis$osure of materia$ information to in+estors% and
(" #re+ention of fraud
o It mandates dis$osures by issuers in onnetion with #rimary market transations
- 1ecurities E*change Act
o /onerned with seondary market transations
o Begu$ates:
insider trading and other forms of seurities fraud
short-swing #rofits by or#orate insiders
regu$ation of shareho$der +oting +ia #ro6y so$iitations
regu$ation of tender offers
o requires periodic disclosures by publicly held corporations
o reated the 0E/ &0eurities and E6hange /ommission' as the #rimary federa$
ageny harged with administering the +arious seurities $aws
1. 5e%inition o% a Sec*'ity
- it is im#ortant to know whether or not the #artiu$ar ty#e of instrument or in+estment wi$$
be deemed a seurity
o if it is a seurity then you wou$d need to go through the registration #roess
- -*s ha+e a muh easier time when they bring suit under the seurities $aws then they
wou$d if they had to bring suit under state ommon $aw fraud ru$es
EK
o The e$ements of federa$ seurities fraud are $ess demanding and easier to #ro+e
- Definition of a 0eurity in O (&!' of the 0eurities ,t:
o !" a $ist of rather specific instruments- in$uding =stok, notes, bonds, treasury
stoks, seurity future, debenture>
o (" a $ist of general- catch#all phrases- suh as =e+idene of indebtedness,>
=in+estment ontrats> and =any instrument ommon$y known as a Useurity*>
Investment contracts# a ontrat where you in+est money in somebody,
e6#eting #rofits to ome through the ser+ies of others5you are not
going to be in+o$+ed in the atua$ business
one +u$nerabi$ity is that shareho$ders9in+estors are not in+o$+ed in
the business that their money is in+o$+ed in
- it is the =eonomi rea$ity> of a #artiu$ar instrument, rather than the $abe$ attahed to it,
that determines whether it fa$$s within the reah of the seurities $aws
o .ust beause an agreement $abe$s the instrument a seurity, that is not enough to
show that it fa$$s under the federa$ seurities $aws
)laims <nder Rule >Cb#D
- - must #ro+e fraud in onnetion with the #urhase of seurities
- Investment contract# a ontrat, transation, or sheme whereby a #erson in+ests his
money in a ommon enter#rise and is $ed to e6#et #rofits so$e$y from the efforts of a
#romoter or third #arty
o E*! Robinson v! lynn# where - in+ested in D &a e$$ #hone om#any' and beame
the om#any*s treasurer" - a$so made deisions on whih managers to a##oint" -
$aims it was an in+estment ontrat" The /ourt says that whi$e - did in+est his
money in a ommon enter#rise with an e6#etation of #rofits, he did not e6#et to
earn #rofits so$e$y from the efforts of others" - was not a #assi+e in+estor hea+i$y
de#endant on the efforts of others, name$y D" 2e had the #ower to a##oint board
members, sat on the board himse$f, and was the treasurer" 2e had #ower and
res#onsibi$ity" - was a sa++y and e6#eriened businessman who was not $eft
#ower$ess o+er his in+estment" The /ourt he$d that the =eonomi rea$ity> here
was that - was not a #assi+e in+estor re$ying on the efforts of others, but a
know$edgeab$e e6euti+e actively protecting his interest and position in the
company!
- )haracteristics of a 1toc5
o !" the right to reei+e di+idends ontingent u#on an a##ortionment of #rofits
o (" free negotiabi$ity
o )" the abi$ity of the interest to be #$edged or hy#otheated
o E" The onferring of +oting rights in #ro#ortion to the number of shares owned
o ;" the a#aity to a##reiate in +a$ue
'ublic 'olicy
- If we are rea$$y so onerned about dis$osure, why don*t the re1uirements of dis$osure
math u#3
o E+en most $awyers wou$d not understand these dis$osures
- /or#orations say if onsumers rea$$y wanted these dis$osures, they wou$d #ro+ide it
EJ
o 0ine it is not being #ro+ided, the om#anies say this means that in+estors don*t
want it
o ,re seurities $aws making om#anies9in+estors #ay for something that they don*t
need3
- /onsumers are atua$$y +u$nerab$e &for strutura$ and $ega$ reasons'
- 7hether or not you think seurities $aws are a good idea &neessary', goes to your +iew
of whether or not in+estors are +u$nerab$e &both strutura$$y within the $aw, and as regu$ar
#eo#$e'
,. The Regist'ation &'ocess
1ecurities Act:
- #rohibits the sa$e of seurities un$ess the om#any issuing the seurities has =registered>
them with the 0E/
- Three &asic Rules of 1ection D:
o !" a seurity may not be offered for sa$e through the mai$s or by use of other
means of interstate ommere un$ess a registration statement has been fi$ed with
the 0E/%
o (" seurities may not be so$d unti$ the registration statement has beome effective
o )" the #ros#etus &a dis$osure doument' must be de$i+ered to the #urhaser
before a sa$e
- 1ection E: The #ro+isions of O; do not apply to:
o !" transations by any #erson other than an issuer- underwriter- or dealer
o (" transations by an issuer not involving any public offering
Registration
- to register a seurity, the issuer must gi+e the /ommission e6tensi+e information about its
finanes and business
- issuer# the om#any issuing the seurities
- a $arge om#any about to se$$ its stok to the #ub$i for the first time wi$$ need to fi$e a
registration statement that an easi$y e6eed a hundred #ages
o this wi$$ in+o$+e its genera$ ounse$ and outside aountants
- when the 0E/ re+iews a registration statement, it does not ask whether the seurity
wou$d be a good in+estment
o instead, it asks whether the registration statement contains the disclosures
re1uired by the statute and the 0E/ ru$es thereunder and whether that information
a##ears to be aurate
- the ore of the registration statement is the =#ros#etus>5the dis$osure doument that
issuers are re1uired to gi+e #ros#eti+e buyers under the 0eurities ,t
o unti$ the 0E/ has a##ro+ed the dis$osures made in the #ros#etus, om#anies
annot se$$ the new seurities
- #rie of the seurity is another re1uirement in the registration statement
o most issuers don*t know the #rie +ery far in ad+ane, so issuers wait to se$$ their
stoks unti$ the 0E/ finds the registration satisfatory
EN
o then they #rie the seurity, amend the registration statement to inor#orate that
#rie and ask the 0E/ to make the amendment ati+e immediate$y
EKe:(tions %'o: Regist'ation ReL*i'e:ent:
- E6em#tions:
o It e6em#ts some seurities entire$y
E6em#t seurities never need to be registered
o It e6em#ts some transactions in seurities that wou$d not otherwise be e6em#t
E6em#t transactions are a one time e6em#tion
- E6am#$es of E6em#tions:
o =#ri+ate #$aements> under O E&(' &"oranA
o =transations by any #erson other than an issuer, underwriter or dea$er>
<nderwriter# someone who buys the seurity with the intention of
rese$$ing it
- , #ri+ate offering is e6em#ted from the registration re1uirement, under OE&(' of the
0eurities ,t of !N))
o /ondition of =-ri+ate -$aement> Offerings:
eah offeree has been gi+en information about the issuer &that a
registration statement wou$d ha+e dis$osed'% OB
eah offeree had effeti+e aess to suh information
if this is re$ied on, the #ri+i$eged status of the offeree &his
re$ationshi# with the issuer' must be #ro+ed
- "oran v! 'etroleum 0anagement )orporation# - in+ested in an oi$ om#any and then
right after that, the om#any*s #rofits started going down so he wanted to get out" - sued
under the 0eurities ,t" D said e+en though the transation was a seurity, it was a
#ri+ate offering whih is e6em#t from the ,t" No registration statement had been fi$ed
with any federa$ or state regu$atory body in onnetion with the D*s offering of seurities"
The transation was an =in+estment ontrat> ty#e of seurity" The /ourt didn*t find
enough #roof that - had aess to the information, regard$ess of how e6#eriened he was
in the oi$ fie$d"
- (actors the )ourt (ound Important:
o O; says that if there is no registration statement, it is un$awfu$ for a om#any to
se$$ the seurity in interstate ommere &or use interstate ommuniation or
trans#ortation to se$$ it'
No registration statement had been fi$ed with any federa$ or state
regu$atory body in onnetion with the D*s offering of seurities"
the D so$d or offered to se$$ these seurities, and that the D used interstate
trans#ortation or ommuniation in onnetion with the sa$e or offer of
sa$e
this mo+es the burden to the - to show a #rima faie ase for a
+io$ation of federa$ seurities $aws
o whether - had aess to the kind of information that wou$d be in$uded in a
seurities dis$osure, as re1uired by the 80/
;<
a$$ offerees, whate+er their e6#ertise, had a+ai$ab$e the information a
registration statement wou$d ha+e afforded a #ros#eti+e in+estor in a
#ub$i offering
there must be suffiient basis of aurate information u#on whih the
so#histiated in+estor may e6erise his ski$$s
The /ourt says - was so#histiated and had aess to the information, but
the rest of the offerees did not
o NOTE: so#histiation is not a substitute for aess to the information the
registration wou$d dis$ose
&urden of 'roof
- - has the burden of #ro+ing that it*s a security
- One the - has made out a prima facie case, the D has the o##ortunity to make an
affirmative defense, suh as =the transation is e6em#t>
- Then D has the burden to #ro+e that the seurity was e6em#t from the federa$ $aws
o "oran # - #ro+es it*s a seurity" D raises affirmati+e defense5it was e6em#t b9 it
is not a =#ub$i offering"> D then has the burden of #ro+ing it was =#ri+ate">
(our (actors to "ecide .hether an 8ffering Fualifies for an E*emption:
- !" number of offerees and their re$ationshi# to eah other and the issuer
o -ersona$ ontat with the issuer and offerees &no #ub$i ad+ertising or
intermediaries, suh as in+estment bankers or seurities e6hanges', then it is
more $ike$y to be a =#ri+ate> transation
o The number of offerees shows the know$edge of eah #erson in+o$+ed
The more offerees- the more $ike$y the transation is #ub$i
o NOTE: it is the number of offerees- not the number of purchasers that is re$e+ant
o Be$ationshi# b9t the offeree and the issuer
0hows how muh info was a+ai$ab$e
=a+ai$abi$ity of info>- means either dis$osure of, or effeti+e aess to, the
re$e+ant information
- (" number of units offered
o The sma$$er the number of offering, the more $ike$y it is e6em#t
- )" the size of the offering% ,ND
- E" the manner of the offering
"eciding .hether a Transactions is E*empt
- /ourt wi$$ $ook to the statutory #ur#ose:
o e6em#t transations are those where there is no #ratia$ need to a##$y the ,t
o deiding to a##$y OE&(' shou$d turn on whether the #artiu$ar $ass of #ersons
affeted need the protection of the Act
,n offering to those who an fend for themse$+es is a transation =not
in+o$+ing any #ub$i offering>
o The #ur#ose of the ,t was =to #rotet in+estors by #romoting fu$$ dis$osure of
information thought neessary to informed in+estment deisions>
- The e6em#tion 1uestion turns on the know$edge of the offerees
;!
NOTE: the 0eurities ,t fouses on facts:
- fats dis$osed by issuer%
- fats known to offeree% OB
- aess to fats
Regulation " E*emptions:
- if an issuer raises $ess than :! mi$$ion through the seurities, it genera$$y may se$$ them to
an un$imited number of buyers w9o registering the seurities
- if it raises $ess than :; mi$$ion, it an se$$ the seurities to u# to ); buyers
o if it raises more than :; mi$$ion, it an se$$ to no more than ); buyers, and eah
buyer must #ass +arious tests of finania$ so#histiation
- NOTE: in a$$ of these ases, the issuer:
o annot wide$y ad+ertise the seurity% ,ND
o must fi$e with the 0E/ a notie of the sa$e short$y after it issues the seurities
- NOTE: the $imits on the number of buyers, does not a##$y to =aredited in+estors>
&banks, brokers and other finania$ institutions and wea$thy buyers'
- Begu$ation D only e*empts the first sale5if the buyers re-se$$ it they ha+e to find another
e*emption or it must be registered
o E6" if the buyer is not =an issuer, underwriter, or dea$er,> he or she wi$$ be ab$e to
re$y on OE&!' for the e6em#tion
o <nderwriter# someone who buys the seurity with the intention of rese$$ing it
- Issuers an #rotet the e6em#tion by using =reasonab$e are> to make sure the buyers are
#$anning to ho$d the stok themse$+es
o This re1uires that issuers:
!" e6erise =reasonab$e in1uiry into the buyer*s #$ans,
(" dis$ose to the buyers that the stok is unregistered and sub.et to
+arious resa$e restritions% ,ND
)" #rint those restritions diret$y on the stok
- Rule >EE# sub.et to +arious 1ua$ifiations, the ru$e a$$ows buyers to rese$$ stok they
a1uire in a Begu$ation D offering, if they first ho$d it for one year and then rese$$ it in
$imited +o$umes
1ecurities Act G>>
- this is the main ause of ation direted at fraud ommitted in onnetion with the sa$e of
seurities through the use of a registration statement
- this an*t be used with an e6em#t offering b9 the misre#resentation or omission must be
in the registration statement
- 1trict liability to the firm itself for misstatements
- NOTE: -eo#$e an be $iab$e whether or not they signed the registration statement
&urden of 'roof in G>> )auses of Action
- - does not ha+e to #ro+e re$iane or ausation in his9her #rima faie ase &they are not
e$ements'
- " has the burden of proving that its misconduct did not cause '+s damages
;(
Section 11BaC
- if any part of the registration statement ontained an untrue statement of material fact or
omitted a material fact required to be stated therein, or necessary to ma5e the statements
therein not misleading, any #erson a1uiring suh seurity &un$ess he knew of the untruth
or omission at the time he a1uired the seurity', may sue:
o !" e+eryone who signed the registration statement, whih by statute must at $east
in$ude the issuer, its #rini#a$ e6euti+e offiers, and a ma.ority of its board of
diretors
o (" e+ery diretor of the issuer at the time the registration statement beame
effeti+e, in$uding diretors who did not sign the registration statement
It does not matter whether they read it or e+en understood it
o )" e+ery #erson named in the registration statement as someone about to beome a
diretor
o E" e+ery =e6#ert> names as ha+ing #re#ared or ertified any #art of the statement,
or as ha+ing #re#ared any re#ort or +a$uation used in onnetion with the
statement% ,ND
,ountants, engineer, a##raiser
o ;" e+ery underwriter in+o$+ed in the distribution
- NOTE: the $ong $ist of D*s in seurities ations
o no privity requirement- so there an be a $ong $ist of Ds
- one - makes out his #rima faie ase, the issuer is strictly liable
o the issuer an be he$d $iab$e e+en if the misre#resentation or omission was an
unintentiona$ mistake
Section 11 B#C B(. 0-IC:
- as for D*s other than the issuer, the degree of fau$t re1uired is essentia$$y a neg$igene
standard
- D has the burden to #ro+e that he was not neg$igent in #re#aring the registration
statement:
o Cust show after a reasonab$e in+estigation, he had reasonab$e grounds to be$ie+e
and did be$ie+e, at the time of the registration statement beame effeti+e, that the
statements therein were true and that there was no omission to state a materia$ fat
that was re1uired to be stated therein or neessary to make the statements not
mis$eading
o ,fter reasonab$e in+estigation, he must a$so be$ie+e &or had reasonab$e ground to
be$ie+e' that the statements were true and there was no omission to state a
materia$ fat
Section 11BcC8 reasonable investigation
- The standard of reasonab$eness shou$d be that re1uired of =a #rudent man in the
management of his own #ro#erty>
The :"ue "iligence; "efense
- usua$$y due diligence is the on$y +iab$e defense to a O!! $aim
o Due di$igene is usua$$y the $awyer*s .ob, but if he fai$s, any D*s who de$egated
that res#onsibi$ity to the ounse$ wi$$ $ose that defense
;)
- D*s an esa#e $iabi$ity, ifthey did the fo$$owing:
o 2e had, after reasonab$e in+estigation, reasonab$e grounds to be$ie+e, and did
be$ie+e, that the registration statements were true or that there were no omissions
This is a #retty e6#ansi+e defense
- NOTE: The om#any itse$f does not ha+e this defense, they are strit$y $iab$e
'ublic 'olicy &ehind G>>
- this is not a+ai$ab$e under state $aw
- in ommon $aw fraud, you are $iab$e for misstatements, but not omissions, so this is a big
dea$ on beha$f of onsumers
- there is a wide range of #otentia$ D*s
o you an sue $ots of #eo#$e5anybody to signed the statement, anyone who was a
diretors e+en if they didn*t sign the registration statement, any underwriter,
Sec*'ities Act 1,
1,BaCB1C
- im#oses strict liability on sellers of securities for offers or sa$es made in violation of GD
o e6" where the se$$er im#ro#er$y fai$s to register the seurities
o e6" where a se$$er registers, but fai$s to de$i+er the dis$osures
- main remedy M rescission- the buyer an reo+er the onsideration #aid, #$us interest,
minus inome reei+ed on the seurity
o if the buyer is no $onger the owner of the seurities, he9she an reo+er damages
om#arab$e to those whih wou$d be #ro+ided by resission
1,BaCB,C
- im#oses i+i$ $iabi$ity on any #erson who:
o offers or se$$s a seurity in interstate commerce-
o makes a materia$ misrepresentation or omission in onnetion with the offer or
sa$e, ,ND
o cannot prove he did not know of the misre#resentation or omission and ou$d not
ha+e known e+en with the e6erise of reasonab$e are
&As &'i:a Facie Case %o' Dio$ations o% Sec*'ities Act 1,:
- !" the sa$e of a seurity
- (" through instruments of interstate ommere or the mai$s
- )" by means of a #ros#etus or ora$ ommuniation
- E" ontaining an untrue statement
- ;" by a D who offered or so$d the seurity% ,ND
- I" whih D knew or shou$d ha+e known of the untrue statement
o if - #$eads D*s know$edge, the burden of proving no 5nowledge shifts to the D
- NOTE: - does not ha+e to #ro+e re$iane
- NOTE: $iabi$ity under O!(&a'&(' on$y arises with res#et to materia$ misre#resentations
or omissions made in written douments or ora$ ommuniations used in onnetion with
#ub$i offerings"
o Liabi$ity under this setion does not arise in secondary mar5et transactions or
private placements
;E
"ebentures @a form of securityA
- /om#anies an se$$ debentures to the #ub$i, whih are basia$$y IOU*s
- These shareho$ders then ha+e e1uity interest in the firm5they get what is $eft after a$$ the
#redators got their share
o They stand at the bak of the $ine
- If it is $ooking $ike the om#any is going to be +ery #rofitab$e, then #eo#$e don*t mind
standing at the bak of the $ine and waiting for the #rofits to ome to them
- But if the om#any goes be$$y-u#, the debentures get #aid before the shareho$ders get
anything
- ,t the aution of the ho$der of the debenture, they an turn it in for stok
0isrepresentations and 8missions
- the misstatement or omission must be materia$ enough to ause the in+estor to re$y on the
registration statement, when they otherwise wou$d not ha+e
- material# those matters that an average prudent investor should reasonably be informed
of before #urhasing the seurity registered
o matters that an in+estor wou$d want to know before he an make an inte$$igent,
informed deision whether or not to buy the seurity
o fats that ha+e an im#ortant bearing u#on the nature or ondition of the issuing
or#oration or its business
- Escott v! &ar)hris )onstruction )orp!# -s are ho$ders of the debentures and they sue
when the om#any goes bankru#t, saying that the registration statement ontained
materia$ fa$se statements and mis$eading omissions" There are many disre#anies b9t the
#rie in the #ros#etus &the dis$osure statement' and the atua$ figures" The ourt finds
materia$ity in many figures re$ating to the state of affairs when - #urhased the
debentures &in$uding: the o+erstatement of sa$es and gross #rofit for the first 1uarter, the
understatement of $iabi$ities, the o+erstatement of orders on hand and the fai$ure to
dis$ose the true fats with res#et to offier*s $oans, ustomer*s de$in1uenies and the
#otentia$ o#eration of se+era$ bow$ing a$$eys'" The /ourt found that some errors were
materia$ and some were so sma$$ that an in+estor wou$d not ha+e been deterred" The
/ourt says the om#any must $ook at the registration statement with whih a #erson of
reasonab$e #rudene wou$d, using due diligence!
TEST FOR >ATERIA"IT:
I% an a3e'age ('*)ent in3esto' ha) 6no.n the 'ea$ in%o':ation .o*$) it ha3e )ete''e) hi:
%'o: (*'chasing the )e#ent*'es?
Integ'ate) 5isc$os*'e an) EKchange Act 5isc$os*'es
8ld 1ystem:
- 0eurities ,t:
o Be1uires dis$osures with res#et to #artiu$ar transations, suh as new issues of
stoks or bonds to the #ub$i
- E6hange ,t:
o Im#oses a system of periodic disclosures on ertain om#anies
o Cost im#ortant$y, the ob$igation to fi$e annua$ and 1uarter$y re#orts
;;
Integrated "isclosure 1ystem:
- ,n issuer #$anning a registered offering first $ooks to the +arious registration statement
forms to determine whih form it is e$igib$e to use
- Cust fi$e re#orts re1uired under E6hange ,t
- ,$$ #ub$i$y traded om#anies, as we$$ as some $arge $ose or#orations, are re1uired to
fi$e E6hange ,t re#orts
- /o+ered or#orations must register with the 0E/ by fi$ing an initia$ 8orm !<
o This form on$y needs to be fi$ed one5the first time the issuer registers that $ass
of seurities under the ,t
o Then e+ery year, the or#oration must annua$$y fi$e a 8orm !<-F, ontaining
audited finania$ statements and management*s re#ort of the #re+ious year*s
ati+ities and usua$$y a$so inor#orates the annua$ re#ort sent to shareho$der*s
- NOTE: there is a differene b9t registering a class of securities under the E6hange ,t
and registering an offering of securities under the 0eurities ,t
o , om#any that has registered a class of securities under the E6hange ,t wi$$
sti$$ ha+e to register a #artiu$ar offering of securities of that $ass under the
0eurities ,t
o the E6hange ,t registers om#anies% the 0eurities ,t registers offerings
C. R*$e 1@!81
- ourts sometimes find a #ri+ate right of ation e+en if not s#eified in the statute
- the most im#ortant in seurities $aw, is the private right of action under E6hange ,t O
!<&b' and Bu$e !<b-;
- O!<&b' &#" EEN'
o Cakes it un$awfu$ for any #erson, diret$y or indiret$y, by the use of any means
or instrumenta$ity of interstate ommere or of the mai$s, to use or employ- in
connection with any registered or unregistered security- any manipulative or
deceptive device in ontra+ention of suh ru$es and regu$ations that the 0E/
thinks are neessary to #rotet in+estors
o This applies to any securities, in$uding seurities of $ose$y-he$d or#orations
that are genera$$y not sub.et to the E6hange ,t, and to transations in
go+ernment seurities
R*$e 1@#81
- Un$awfu$ for any #erson, by the use of any means or instrumenta$ity of interstate
ommere or of the mai$s:
o &a' To em#$oy any de+ie, sheme, or artifie to defraud%
o &b' to make any untrue statement of a material fact or to omit to state a material
fact neessary in order to make the statements made, in the $ight of the
irumstanes under whih they were made, not mis$eading% OB
o &' to engage in any at, #ratie, or ourse of business whih o#erates or wou$d
o#erate as a fraud or deeit u#on any #erson,
- In onnetion with the #urhase or sa$e of any seurity"
NOTE: reliance is an e$ement of a !<B-; ause of ation
;I
- re$iane #ro+ides the re1uisite causal connection between a D*s misre#resentation and a
-*s in.ury
1. >ate'ia$ity o% >is$ea)ing State:ents
- mis$eading statements during merger disussions wi$$ be materia$ under Bu$e !<B-; if the
misstatements would have changed the view of the total information by a reasonable
investor
- NOTE: si$ene, absent a duty to dis$ose, is not mis$eading under Bu$e !<b-;
- <11) definition of materiality- an omitted fat is materia$ if there is a substantia$
$ike$ihood that a reasonab$e shareho$der wou$d onsider it im#ortant in deiding how to
+ote
o =there must be a substantia$ $ike$ihood that the dis$osures of the omitted fat
wou$d ha+e been +iewed by the reasonab$e in+estor as ha+ing significantly
altered the =tota$ mi6> of information made a+ai$ab$e>
o It a$$ de#ends on the signifiane the reasonab$e in+estor wou$d #$ae on the
withhe$d or misre#resented information
0ergers
- 7hen the e+ent is s#eu$ati+e in nature, $ike a merger, it is hard to deide whether the
reasonab$e in+estor wou$d ha+e onsidered the omitted information signifiant at the
time"
o Test for 0#eu$ati+e E+ents:
&alance the indicated probability that the event will occur and the
anticipated magnitude of the event given the totality of the company
activity
- 7hether merger disussions are materia$ in a ertain ase, de#ends on the fats of the
indi+idua$ ase
o &asic Inc! v! Levinson# where - so$d their shares after the om#any had #ub$i$y
denied a merger &whih made the market +a$ue go down' and then the merger
ourred" 7hi$e D denied the merger, they were in the midd$e of ta$ks and
meetings about the merger" The ourt found that a merger has a high magnitude
on in+estor deisions" Using the abo+e test, a merger is the most im#ortant e+ent
that an our in a sma$$ or#oration*s $ife, so information can become material at
an earlier stage than other events!
,. &*#$ic Accessi#i$ity o% In%o':ation
- ,ording to standard finane #rini#$es, the #rie of a gi+en stok wi$$ hange whene+er
in+estors &the $arge in+estors who ontro$ enough funds to affet #ries' a1uire new
information about the stok
o The $arge in+estors ha+e aess to the +ery best seurities ana$ysts
- a fraudu$ent statement needs to be made publicly accessible in order for - to $aim that
the statement aused a $oss on the in+estment
o .est v! 'rudential 1ecurities- D*s em#$oyee to$d a$$ of his $ients that the
om#any was going to be a1uired for a $ot of money" This was a $ie b9 there
was no a1uisition #ending" -*s sue b9 they re$ied on the integrity of the stok
#rie, whih was fa$se$y inf$ated due to this untrue statement" The /ourt
;K
&Easterbrook' says that they don*t ha+e a ause of ation b9 using the =fraud on
the market theory,> the em#$oyee didn*t re$ease info to the #ub$i, and his $ients
knew they were ating on non-#ub$i information" It wou$d not ha+e the same
effet on the market b9 #rofessiona$ in+estors and money managers wou$d not
know about these statements" The causation element is missing &this info didn*t
ause any hange in the market #ries'"
Burden of -roof:
- - has to demonstrate that he re$ied on the misstatement
o One we ha+e a material statement, the burden shifts, b9 we wi$$ #resume that
the - re$ied on that misstatement
- then D has to affirmatively rebut this reliance by showing that the #artiu$ar se$$er wasn*t
re$ying on the market at a$$
o if D an demonstrate the - so$d off his stok for some other reason than the fa$$ing
stok #ries, then he is off the hook
:(raud on the 0ar5et; Theory
- The mar5et price of shares &traded on we$$-de+e$o#ed markets' reflects all publicly
available information- and hene- any material misrepresentation
o It may be #resumed that indi+idua$s re$y on the integrity of the market #rie
- B9 most #ub$i$y a+ai$ab$e information is ref$eted in market #rie, an in+estor*s re$iane
on any #ub$i materia$ misre#resentation, therefore, may be #resumed for #ur#oses of a
ru$e !<b-; ation
- most onsumers are not $ooking at the dis$osure statement5they are re$ying on the
integrity of the stoc5 prices
o in the market setting, the market transmits information to the in+estor in the
#roessed form of a mar5et price- so the market is #erforming a substantia$ #art of
the +a$uation #roess &whih is usua$$y #erformed by an in+estor in a fae-to-fae
transation'
o the market is ating as the unpaid agent of the investor- informing him that gi+en
a$$ the information a+ai$ab$e to it, the +a$ue of the stok is worth the market #rie
- Qustie 7hite*s Dissent &in &asicA:
o Isn*t it true that you buy a stok beause you think the market #rie is wrong5b9
you think that the stok is more +a$uab$e than the stok market says it &and you
se$$ the stok b9 you think it is going to go down5that the market is wrong'
'ublic 'olicy on "isclosures
- 7e saw that shareho$ders don*t read the dis$osure statements5shareho$ders aren*t
#aying attention to what diretors say and e+ery mo+e the diretors make
o onsumers9in+estors are re$ying on the market
o 7e know that shareho$ders don*t $isten to the diretors and aren*t $istening to the
statements, so it is hard so show that they re$ied on these statements
- 7hen diretors fa$se$y deny that there is going to be a merger, the market takes that
information and the stoc5 price decreases, making the stoc5 less valuable than it rea$$y is
o /onsumers are re$ying on the price- not the statement
- E+en the sma$$ #ossibi$ity of this big e+ent might be re$e+ant to some shareho$ders
;J
- )ons of (ederal Laws:
o the seurity fraud $aws are unneessary b9 if in+estors wanted the dis$osures,
then the diretors wou$d #ro+ide it
in+estors in+est in firms anyway without researhing the dis$osures
- 'ros of (ederal laws:
o the fed go+" res#onds by saying that this may be true in regards to so#histiated
in+estors, but not to uninformed and amateur in+estors
o sophisticated shareholders rea$$y do read the registration statement and take it
into onsideration
Rule >C@bA#D "oes 7ot E*tend to &reach of (iduciary "uty
- Bu$e !<&b'-; wi$$ a##$y only if there is ondut in+o$+ing =mani#u$ation or dee#tion>
o Cani#u$ation refers to #raties that are intended to mis$ead in+estors by
artifiia$$y affeting market ati+ity
- The seurities $aws were not meant to federa$ize state $aw
o they were meant to enfore dis$osure &absent a $ear ongressiona$ intent, the
/ourt is re$utant to regu$ate areas that are ty#ia$$y under state $aw'
- 1anta (e Industries- Inc! v! reen# where a short form merger took #$ae" In DE
or#orate $aw O(;), when a #arent om#any owns o+er N<G of the subsidiary om#any,
they ha+e to inform the !<G of minority shareho$ders if they are buying them out" They
don+t have to as5 the minority shareholders or get their approval- they .ust te$$ him" ,$$
the ma.ority has to do is #ay the minority shareho$ders a fair #rie" 2ere -s think that
they are getting srewed b9 they shou$d ha+e gotten more for eah share" Instead of
#ursuing their a##raisa$ rights in state ourt, they say that this #$an atua$$y onstitutes
fraud and that the on$y #ur#ose of the merger is to rob them of their rights &to stee$ from
them what is rightfu$$y theirs'" The minority shareho$ders are saying that the om#any
+io$ated its fiduiary duty to them" The U00/ said they ou$d not ha+e a federa$ ause of
ation, but they sti$$ had their state $aims"
DII. Insi)e' T'a)ing
- a buyer of stok on the market does not owe a fiduciary duty to a se$$er to dis$ose the
information that the buyer may know, e+en if the buyer is in a #osition that #ro+ides
insider information
- federa$ seurities $aws were #assed in an effort to #rotet shareho$ders from diretors*
o##ortunities to e6#$oit them
o to #rotet shareho$ders in their +u$nerabi$ities
Stoc6 O(tions
- they are a ty#e of seurities, so they are o+ered by seurities $aw
- they are sim#$y a ontrat
Two Types of 8ptions:
- /a$$ O#tion:
o Ri+es you the o#tion to buy a stok at a certain price at a certain time
o This is a ontrat that says you ha+e the right to buy a ertain stok, how muh
the stok wi$$ be and when you an buy it
;N
o E+en if the stok #rie has gone u# by that time, you sti$$ get the #rie that the
ontrat says, so you ou$d end u# making money
o If the stok #rie has gone down, then you sim#$y ri# u# your o#tion, b9 it
wou$dn*t make sense for you to buy it at more money if you ou$d get it on the
o#en market for $ess
o you #ay :! for the o#tion
o E6" I #ay :! for the right to buy ,/CE from you at :(< on or before ,#ri$ !
st
If on ,#ri$ !
st
, ,me is se$$ing at :)<, you E6erise your O#tion
If on ,#ri$ !
st
, ,me is se$$ing at :!;, you DON*T E6erise your O#tion
o Hyou buy the call option if you thin5 the stoc5 is going to go up
- -ut O#tion:
o I #ay :! for the right to se$$ you ,/CE at :(< on or before ,#ri$ !
st
o If on ,#ri$ !
st
, ,me is se$$ing at :!;, you E6erise your O#tion
- 0hort 0a$e
o Borrow ,/CE today &:(<', return it to you on ,#ri$ !
st
o 0e$$ ,/CE today, ho#e and #ray that it fa$$s by ,#ri$ !
st

0aterial Information
- insiders annot at on materia$ information &information that a reasonab$e man wou$d
deem im#ortant to the +a$ue of the stok' unti$ the information is reasonably- publicly
disseminated
o 1ecurities and E*change )ommission v! Te*as ulf 1ulphur- where the D*s had
tested the soi$ and found it was rih in minera$s so they bought a $ot of the shares,
but to$d the #ub$i that the resu$ts of the tests were unertain" D*s tried to $aim
that this was not materia$ information, but the /ourt disagreed" The resu$ts of the
tests wou$d ha+e been im#ortant to a reasonab$e in+estor and might ha+e affeted
the #rie of the stok" ,nother sign of its materia$ity was how those who knew
the info ated on it5e+en those who had ne+er #urhased stok started buying it
when they found out the info" They withhe$d this im#ortant information from the
#ub$i and #urhased the shares when on$y they knew the information" D*s
shou$dn*t ha+e ated on the information unti$ the #ub$i had a hane to at on it"
TEST %o' >ATERIA"IT:
Wo*$) a 'easona#$e (e'son thin6 that the in%o':ation .o*$) #e 'e$e3ant to the ('ice o% the
stoc6?
TEST %o' INSI5ER TRA5ING:
5oes the t'a)e' ha3e an a)3antage o3e' those .itho*t the in%o':ation?
'ublic 'olicy &ehind Rule >C@bA#D
- /ongressiona$ intent:
o #re+ent ine1uitab$e and unfair #raties% and
o insure fairness in seurities transations genera$$y, whether onduted fae-to-
fae, o+er the ounter, or on e6hanges
- e6#etation of the seurities market#$ae:
I<
o a$$ in+estors trading on im#ersona$ e6hanges ha+e equal access to materia$ info
o ,$$ of the in+esting #ub$i shou$d be sub.et to identia$ market risks
- Anyone trading in the securities of a corporation who has :access- directly or indirectly-
to information intended to be available only for a corporate purpose and not for the
personal benefit of anyone; may not ta5e :advantage of such information 5nowing it is
unavailable to those with whom he is dealing; @i!e! the investing publicA
- Insiders, as directors or management officers are, of ourse, by this Bu$e, #re$uded from
so unfair$y dea$ing, but the Bu$e is a$so a##$iab$e to someone #roessing the info, who
might not be termed an =insider>
- ,nyone in #ossession of materia$ inside information must either:
o !" dis$ose it to the in+esting #ub$i% OB
o (" if he is disab$ed from dis$osing it in order to #rotet a or#orate onfidene, or
he hooses not to do so, CU0T abstain:
&a' from trading it% ,ND9OB
&b' reommending the seurities onerned
Inside Information
- an insider is not, of ourse, a$ways fore$osed from in+esting in his own om#any mere$y
beause he may be more fami$iar with om#any o#erations than are outside in+estors
- an insider*s duty to dis$ose information or his duty to abstain from dea$ing in his
om#any*s seurities arise on$y in =those situations whih are essentia$$y e6traordinary in
nature and whih are reasonably certain to have a substantial effect on the mar5et price
of the seurity if the e6traordinary situation is dis$osed>
- an insider is not ob$igated to onfer u#on outside in+estors the benefit of his su#erior
finania$ or other e6#ert ana$ysis by dis$osing his educated guesses or predictions
- any materia$ fat must be dis$osed to the in+esting #ub$i #rior to the ommenement of
insider trading in the or#oration*s seurities
- material facts:
o information dis$osing the earnings and distributions of a om#any
o those fats whih affet the #robab$e future of the om#any
o those fats that might affet the desire of in+estors to buy, se$$, or ho$d the
om#any*s seurities
A. Theo'ies o% Insi)e' T'a)ing
C$assica$ theo'y
- , or#orate insider in #ossession of material nonpublic information must abstain from
trading in the shares of that or#oration OB dis$ose a$$ materia$ insider information
known to him
o This fouses on the duty to shareholders with whom the insider transacts
- This duty arises out of the re$ationshi# of trust and confidence b9t a or#oration*s
shareho$ders and its em#$oyees &those insiders who ha+e the information based on their
#osition with that om#any'
o <!1! v! )hiarella# D worked for a #rinting om#any that was seret$y being
a1uired by another om#any" D found out and bought shares of the a1uiring
I!
om#any" The ourt found he was not in +io$ation of insider trading $aws b9 he
was not an :insider; of the corporation whose shares he had traded!
b9 he did not owe a fiduiary ob$igation to the firm, he did not breah his
duty &he had no re$ationshi# with the or#oration'
- Now, we are saying that an insider must dis$ose or abstain, but this duty to dis$ose
resides in the fiduiary re$ationshi# b/t the insider and the shareholders of that firm
- "uty of loyalty5the insider an*t take ad+antage of any asset of the firm for his9her own
benefit5he has to turn it o+er to the firm*s owner &his #rini#a$'
o This is something +a$uab$e to the #rini#a$
- In order to formu$ate this dotrine, it is di##ing into state $aw, by resting the duty to
dis$ose in the fiduiary re$ationshi# &whih is an as#et of state $aw'
>isa(('o('iation Theo'y
- , #erson commits fraud in onnetion with a seurities transation, and thereby violates
G>C@bA and Rule >Cb#D when he misa##ro#riates onfidentia$ information for seurities
trading #ur#oses, in breah of a duty owed to the soure of the information
- an outsider who misappropriates confidential information for his own #ersona$ benefit
+io$ates O!<&b' beause there is dee#tion in connection with the purchase or sale of a
security &it defrauds the #erson of the e6$usi+e use of that information'
o this theory fouses on the duty owed not to a trading party- but to the source of
the information
- <!1! v! 8+2agan- D works for a $aw firm, who is re#resenting Rrand Cet, and omes into
materia$ non#ub$i information about -i$$sbury &it is going to beome more +a$uab$e
when Rrand Cet a1uires them' so he buys stok in -i$$sbury" The /ourt found that he
was deeitfu$ b9 he didn*t te$$ the firm or the $ients that he was using non-#ub$i
information" 2e didn*t ha+e to deei+e the seller to +io$ate the $aw" 2e does not owe a
fiduiary ob$igation to the firm that he*s trading in &-i$$sbury' b9 he is not an =insider>5
he ou$dn*t be #roseuted under the classical theory" 2owe+er, D was dee#ti+e b9 he
#retended to be $oya$ to Rrand Cet &his #rini#a$', whi$e seret$y on+erting the
#rini#a$*s information for #ersona$ gain and did not te$$ Rrand Cet what he did"
o 2e owes a fiduiary ob$igation to his firm and their $ient, Rrand Cet
o If he had traded in Rrand Cet, it wou$d be a seurity +io$ation
o The duty runs to the source of the information5his #rini#a$
o 7e know that ty#ia$$y an agent is not #ermitted to take ad+antage of any
o##ortunity that omes to her #rini#a$ &she must gi+e them to the #rini#a$'
o 2e has misa##ro#riated the inside information
- The ne*us to the deception is disclosure &D did not dis$ose'
o If O*2agan had to$d Rrand Cet that he intended to misa##ro#riate the
information and trade on it in -i$$sbury, then he wou$dn*t be +io$ating federa$ $aw
&this wou$d ne+er ha##en in rea$ $ife'
2e wou$d sti$$ be $iab$e in state $aw for +io$ating fiduiary duty
9Ti((ee; Theo'y
- 1E): when someone omes into #ossession of or#orate information, that they know is
onfidentia$ and know ame from a or#orate insider, they must either #ub$i$y dis$ose
that information or refrain from trading
I(
- a non-fiduiary in #ossession of materia$ non#ub$i info neessari$y inherits the duty
from the :tipper;
- "ir5s v! 1E)# a former offier of a or#oration &0erist' ga+e D &a broker' inside
information &materia$ non#ub$i information from =insiders> of a or#oration' about a
ertain om#any and its fraudu$ent #raties" D started to in+estigate the om#any &by
ta$king to its em#$oyees5the =ti##ers>' and when he rea$ized that the info was true, he
to$d his in+estors that it was fa$$ing a#art and to se$$ their shares to a+oid $osses" The
in+estors then re$ied on the info in trading shares of that or#oration" The 0E/ brings
suit against Dirks himse$f- saying that Dirks was in #ossession of materia$ non#ub$i
information and that he traded on that" The 0E/ argues that Dirks inherited this =duty>
from 0erist &if 0erist had traded on that info, he wou$d ha+e been in +io$ation under the
/$assia$ Theory b9 he was an offier'" The /ourt disagrees5Dirks had no fiduiary
ob$igation to the or#oration or its shareho$ders" 2e did nothing to diret$y9indiret$y
make the shareho$ders of E8 to #$ae their trust in him
o No e6#etation that they wou$d kee# their information in onfidene
o The ti##er*s reei+ed no monetary or #ersona$ benefit from re+ea$ing E8*s serets
o In the absence of a breach of duty to the shareholders by the insiders- there was
no derivative breach by "ir5s
- 7here a fiduiary has +io$ated his fiduiary ob$igation and benefited personally from that
violation in onnetion with the ti##ing of an outsider, then the outsider wi$$ be he$d to
the dis$osure or abstain standard &$ike if 0erist got something out of =ti##ing> Dirks,
then Dirks wou$d be he$d $iab$e'
o 0erist wasn*t attem#ting to benefit at a$$, in fat if anything, he was trying to
ser+e the shareho$ders by making notie of the ma$feasane
Tippee Responsibility
- Two e$ements of !<b&;' +io$ations:
o !" the e6istene of a re$ationshi# affording aess to inside information intended
to be a+ai$ab$e on$y for a or#orate #ur#ose%
o (" the unfairness of a$$owing a or#orate insider to take ad+antage of that
information by trading without dis$osure
- There is no genera$ duty to dis$ose before trading on materia$ non#ub$i information
o =a duty to dis$ose under O!<&b' does not arise from the mere possession of
nonpublic mar5et information>5it on$y arises from a fiduiary duty
o Not a$$ breahes of fiduiary duty5on$y where there is =mani#u$ation or
dee#tion>
- ,n insider wi$$ be $iab$e on$y under Bu$e !<b-; for inside trading on$y where he fai$s to
dis$ose materia$ non#ub$i information before trading on it and then makes =seret
#rofits>
- , ti##ee &$ike Dirks' assumes a fiduiary duty to the shareho$ders of a or#oration not to
trade on materia$ non#ub$i information only when the insider has breached his fiduciary
duty to the shareholders by disclosing the information to the tippee and the ti##ee =knows
or shou$d know> that there has been a breah
- MM.hat the ti((ee 6no.s a#o*t the ti((e'As :oti3ations is 3e'y 'e$e3ant
TEST %o' Ti((ees:
I)
- 1. 5i) the insi)e'As Bthe ti((e'AsC ti( constit*te a #'each o% the insi)e'As %i)*cia'y
)*ty?
o 5e(en)s $a'ge$y on the (*'(ose o% the )isc$os*'e Bso:eti:es insi)e's
:ista6en$y thin6 that the in%o has #een )isc$ose) a$'ea)yC
- ,. Wi$$ the insi)e' Bthe ti((e'C (e'sona$$y #ene%itF )i'ect$y o' in)i'ect$yF %'o: this
)isc$os*'e?
o A#sent so:e (e'sona$ gainF the'e has #een no #'each o% )*ty to stoc6ho$)e's
o A#sent a #'each #y the insi)e'F the'e is no )e'i3ati3e #'each
- I% ESF the tippee has a %i)*cia'y )*ty.
'ublic 'olicy:
- The /ourt notes that the ro$e of firms that ana$yze or#orations &$ike Dirks* firm' is a +ery
im#ortant one and often that information annot be made a+ai$ab$e to the #ub$i
Sho't8S.ing &'o%its:
G>I of the >JKE 1ecurities E*change Act
- #rohibits diretors, offiers, !<G #erent shareho$ders from buying and se$$ing shares
within a si* month period5if they do buy or se$$ then any #rofits made &or any $osses
a+oided' on the transation are reo+erab$e by the or#oration
o 0o if you buy stok in Qanuary, you must wait unti$ Qune to se$$ it
- This is a =#ro#hy$ati> ru$e5it #rohibits a $ot of trades that aren*t rea$$y insider trading
o 0o far, we ha+e on$y been ta$king about .udge-made $aw &TR0, /hiare$$a,
O*2agen, Dirks'
- 0ine /ongress did in$ude this in O!I, it seems that they did know about insider-trading
and wanted to do something to fi6 it
- /ongress #assed this b9 if insiders are trading with that fre1uent$y, then they are
#robab$y doing it based on some inside information &something the #ub$i doesn*t know'
o But it doesn*t make a $ot of sense, b9 you ou$d be trading within those I months
based on information that is #ub$i and e+erybody knows
- If you are a >CL shareholder, you are o+ered by O!I&b', but what if on Qanuary !
st
, you
are a !(G shareho$der, but then on 8ebruary !
st
you are on$y a N month shareho$der &The
/ourt an reo+er the )G that you earned', you an se$$ the rest of the NG after that and
the /ourt annot reo+er it
TEST FOR A 1@N S2ARE2O"5ER
- We'e yo* a 1@N sha'eho$)e' 9at the ti:e o% the (*'chase;?
- I% ESF then yo* a'e co3e'e) *n)e' the stat*te
o 4ou are on$y o+ered by O!I&b' if you are already a !<G shareho$der and then
you buy more5not if you .ust start at <G and then buy !<G
DIII. &'o#$e:s o% Cont'o$
A. &'oKy Fights
Introduction
IE
- Diretors ontro$ the or#oration, but shareho$ders deide ertain big deisions
- /or#orations ho$d annual meetings of shareholders for e$etion of diretors and for
+oting on a$$ other matters
- There are a$so s#eia$ meetings for s#eifi issues
o e6" getting shareho$ders a##ro+a$9disa##ro+a$ of a merger
o e6" whether to amend the arti$es of inor#oration
o e6" deiding to $i1uidate the firm
o e6" to se$$ a$$ or substantia$$y a$$ of the assets
- Diretors nominate themse$+es and ask the shareho$ders to +ote for them at these
meetings
o 0hareho$ders ha+e to be gi+en notie of the +ote
o Fuorum# Core than ;<G of the shares must be #resent
either in #erson or in =#ro6y>
- +ery few shareho$ders of #ub$i or#orations atua$$y attend these meetings
o Instead they turn their +otes o+er to a #ro6y that +otes for them
o They don*t +ote b9 they fee$ that it doesn*t matter5one +ote won*t effet the
e$etion, they ha+e too muh e$se going on, they don*t ha+e enough stake in the
outome
- 8ew shareho$ders own enough shares to make a differene at the meetings
o Their stake is genera$$y too sma$$ to affet the outome at the meetings
o But, in sma$$er firms, shareho$ders may atua$$y attend the meetings and he$#
deide the firm*s business strategy &b9 they ha+e enough shares to affet the
outome of the +ote'
- The outome of the +otes usua$$y de#end on whih grou# has o$$eted the most
=#ro6ies> &#ro6y +oting is a+ai$ab$e for sma$$ om#anies5it*s .ust $ess ommon'
o pro*y- shareho$ders may a##oint an agent to attend the meeting and +ote on their
beha$f &so the shareho$der doesn*t ha+e to be there'
pro*y# The doument that shareho$ders use to a##oint the #ro6y
o The shareho$der with the most #ro6ies wins the +ote
o Renera$$y the inumbent mgmt wi$$ ask for the =#ro6y> &the doument' diret$y
from the shareho$der, so the manager an +ote on the shareho$der*s beha$f
'ro*y (ights
- these our when an insurgent grou# tries to oust inumbent managers by so$iiting #ro6y
ards and e$eting its own re#s to the board
- this is basia$$y a fight for ontro$
- they a$so use #ro6ies to fight a defensi+e measures that the mgmt might ho#e to
im#$ement
- #ro6y fights are sub.et both to the 0eurities E6hange ,t of !N)E and state or#orate
statutes
St'ategic +se o% &'oKies
- The deision to ontinue with the #resent mgmt rests entire$y with the stokho$ders5a
/ourt may not o+erride or ditate on a matter of this nature to stokho$ders
I;
o Levin v! 00- Inc!# where I shareho$ders of CRC fi$ed suit against CRC" -
&Le+in' has been a shareho$der of CRC sine !NI; and wants to o+erthrow
inumbents" This is a onf$it for or#orate ontro$ b9t the =O*Brien> grou#
&inumbent' and the =Le+in grou#> &insurgent'" They eah want to nominate a
s$ate of diretors at the stokho$ders annua$ meeting" Le+in is om#$aining that
O*Brien is using or#orate funds to hire s#eia$ $awyers and #ub$i re$ations firms
to win the +ote, #utting the insurgents at a disad+antage" It is an im#ro#er use of
or#orate funds" -*s say D*s shou$d ha+e been #aying for these things
indi+idua$$y, not with the om#any*s money" The /ourt says O*Brien is a$$owed
to use or#orate firms as $ong as they were reasonable! The /ourt notes there are
many differenes b9t the two grou#s, but this is better so$+ed by the stokho$ders"
The amount #aid to so$iit #ro6ies is not e*cessive, and the method used is not
illegal or unfair" This is more of a business .udgment ru$e b9 they don*t want to
get in+o$+ed, absent any e+idene that they are doing this for #ersona$ gain. &The
ourt doesn*t atua$$y use the term, =BQ Bu$e>'"
- -ro6y fights aren*t the best way to do this
- They shou$d .ust go out on the o#en market and buy u# CRC, gain a ontro$$ing interest
and take ontro$ of the firm
- /ourts wi$$ gi+e 1uite a bit of $atitude to diretors who use these #ro6y fights
- NOTE: #ro6y fights are an e$ement of state $aw
!. Sha'eho$)e' &'o(osa$s
10BaC o% Sec*'ities EKchange Act o% 1/-0
- If any seurity ho$der of an issuer notifies the issuer of a #ro#osa$ for an u#oming
meeting the issuer should allow it to go in the program and the seurity ho$der an
#resent a statement of not more than ;<< words in su##ort of the #ro#osa$
o the issuer must in$ude the shareho$der*s #ro#osa$s in the #ro6y materia$s that
they send out
o #ro+ides the o##ortunity for shareho$der*s to +oie to their soia$ onerns
E*ceptions to Rule >Ea#M
- the #ro#osa$ an be omitted if it re$ates to o#erations whih aount for less than DL of
its total assets at the end of the fisa$ year or is not significantly related to the issuer+s
business
- now ethia$ and soia$ onerns are #art of that ru$e
o Lovenheim v! Iroquois &rands- Ltd!# where - $earned that the om#any was
in+o$+ed in the manufature of #ate" - wants the om#any to in$ude information,
onerning a #ro#osed reso$ution he intends to offer at the u#oming shareho$der
meeting, in the #ro6y materia$s sent to a$$ shareho$ders in #re#aration for the
meeting" 2e wants the om#any to know about the awfu$ #roedures they use to
get #ate from geese" 2is #ro#osa$ wou$d form a ommittee to in+estigate whether
this form of feeding auses undue distress, #ain or suffering to the anima$s
in+o$+ed and if it does, he wants to disontinue unti$ a more humane method is
found" The om#any re$ies on the e6e#tion to O!E, saying that #ate is $ess than
<";G of its assets" - says the e6e#tion doesn*t a##$y b9 the geese and #ate issue
II
is ethia$$y and soia$$y signifiant" The /ourt ho$ds that -*s #ro#osa$ has ethia$
and soia$ signifiane, so it sends the ase bak to the tria$ ourt"
- ordinary business o#erations
o 7here #ro#osa$s involve business matters that are mundane in nature and do not
involve any substantial policy or other considerations they an be omitted
o 7= )ity Employees+ Retirement 1ystem v! "ole (ood )ompany- Inc!- where -
&N4' wanted to #ut in information on hea$th insurane in the #ro6y materia$s"
Do$e says it doesn*t ha+e to in$ude it b9 it onerns em#$oyee benefits, whih
are an =ordinary business o#eration> and therefore, it fa$$s under the e6e#tions"
The /ourt says e+en if the #ro#osa$ does in+o$+e the way dai$y business matters
are onduted, the statement may not be e6$uded if it involves a significant
strategic decision as to those daily business matters &e6" one that wi$$
signifiant$y affet the manner in whih the om#any does business'" N4/EB0
has #ro+ed that the #ro#osa$ does not re$ate to =ordinary business o#eration">
Do$e has not shown any e+idene that they ha+e a hea$th insurane #$an, or any
e+idene of the amount of money it s#ends on hea$th are, et"
- direted at #o$itia$ #roess
- #ersona$ interest of #ro#oser
NOTE: The /or#oration has the burden of #ro+ing that the #ro#osa$ fa$$s in the e6e#tion if they
want to e6$ude it from the #ro6y materia$s
'ublic 'olicy
- now we ha+e !E&a' that says we ha+e to in$ude it if it is signifiant$y re$ated to ethia$
and soia$ onerns
- 2istory of the 0hareho$der -ro#osa$ Bu$e:
o in !NKI, the /ommission stated that it did not be$ie+e that sub#aragra#h &i'&;'
shou$d be hinged so$e$y on the eonomi re$ati+ity of a #ro#osa$
o the /ommissioner has re1uired the #ro#osa$ to be in$uded in many situations
where the re$ated business om#rised $ess than !G of the om#any*s re+enues,
#rofits or assets where the #ro#osa$ has raised policy questions im#ortant enough
to be onsidered =signifiant$y re$ated> to the issuer*s business
Pnot .ust eonomis5it in$udes #o$iy 1uestionsV
o It is $ear from the history of the ru$e, that =the meaning of Usignifiant$y re$ated*
is not $imited to eonomi signifiane
1hareholder+s 'roposal 'rocess:
- 0E/ referees the shareho$der #ro#osa$ #roess
- If a or#oration*s mgmt be$ie+es the #ro#osa$ shou$d be e6$uded from the #ro6y
statement, it fi$es a notie with the 0E/ that the firm intends to e6$ude the #ro#osa$
- If the 0E/ staff agrees, it wi$$ issue a =no-ation> $etter, meaning the staff wi$$ not
reommend that the /ommission bring an enforement #roeeding against the issuer if
the #ro#osa$ is e6$uded
- If the 0E/ disagrees &thinks it shou$d be in$uded in', the staff wi$$ notify the issuer that
the 0E/ may bring an enforement ation if they e6$ude the #ro#osa$
IK
C. Sha'eho$)e'As Ins(ection Rights
10BaC8
- re1uires diretors to turn o+er shareho$der*s $ists to the #ro#oser to a$$ow him to send
materia$s about the #ro#osa$ out to the other shareho$der*s
- if they don*t want to gi+e u# the shareho$der*s $ist, then they wi$$ offer to send the
materia$s out for the #ro#oser &and the #ro#oser wi$$ foot the bi$$'
- &in rea$ e$etions, andidates don*t usua$$y send am#aign materia$s out to e+eryone, they
on$y send it to the most inf$uentia$ +oters, but here this isn*t the way'
o They way or#orations do it, is $ess effiient
1hareholder+s List
- if you don*t $ike the way a firm, that you own shares of, is being managed, you annot
re1uire them to in$ude your own s$ate of diretors in the so$iitation materia$s, so you
wi$$ need to do your own #ro6y so$iitation
- usua$$y you #ay them to mai$ out your so$iitation materia$s
- you won*t send it to a$$ shareho$ders5instead you wi$$ identify the ho$ders of the $arge
b$oks of stok and s#end most of your efforts trying to on+ine them to su##ort you
- the om#any won*t want you to ha+e the shareho$der*s $ist, but it is +ery +a$uab$e to you
- federal pro*y rules do not require the corporation to give it to you- but that does not
impair any rights you have under state law
Inspection Rights
- one of the most im#ortant rights shareho$ders ha+e is the right to ins#et the om#any*s
books and their shareho$der $ists
- inspection rights are a species of state law
- a 1ua$ified shareho$der is a$$owed, when in good faith, to ins#et a or#oration*s stok
register in order to notify shareho$ders of e6hange and so$iitation offers for stok
- , shareho$der desiring to disuss re$e+ant as#ets of a tender offer shou$d be granted
aess to the shareho$der*s $ist, un$ess it is sought for a #ur#ose ontrary to the
or#oration or its stokho$ders"
o )rane )o! v! Anaconda )o!# // basia$$y did a hosti$e takeo+er to ,naonda" //
asked ,naonda for its shareho$ders $ist, $aiming that ,naonda had to gi+e a$$
shareho$ders information on this" // owned no ,naonda stok, so their re1uest
was denied" // went out on the o#en market and a1uired !!G so that they
wou$d ha+e more rights to the om#any" ,naonda sti$$ refused to gi+e them the
$ist, but offered to mai$ the information to the stokho$der*s at //*s e6#ense" //
wanted to show the shareho$ders that the takeo+er was rea$$y in their best interest
&e+en though the shareho$ders had +oted against the takeo+er'" ,ording to N4
$aw, the shareho$der must #ro+ide the om#any with an affida+it #ro+ing that his
interest is re$ated to the business of this firm and not some other firm" // wanted
their ins#etion rights to further the tender offer &whih re$ated to the business of
,naonda b9 it*s about inreasing the #rofits of shareho$ders'" ,naonda fai$ed
in its burden of proving improper purpose!
'ublic 'olicy:
IJ
- The #ending tender of a $arge amount of the om#any*s stok may affet both the future
diretion of the or#oration and the ontinued +ita$ity of the shareho$der*s in+estment
- Ins#etion of the $ist shou$d be a$$owed, so that shareho$ders an inde#endent$y e+a$uate
the situation
- whene+er anything ha##ens to the om#any, the shareho$ders are affeted
- whene+er the or#oration faes a situation ha+ing potential substantial effect on its
wellbeing or value- the shareho$ders are neessari$y affeted and the business of the
or#oration is in+o$+ed &0etion !)!; of the Business /or#orations Law'
N !*siness "a. 1-11:
- !" Ins#etion may not be re1uested for any other #ur#ose than the business of the
or#oration% ,ND
- (" the shareho$der re1uesting the information may not ha+e #artii#ated in the sa$e of any
stokho$der $ist within the $ast fi+e years
5E "a.
- DE $aw re1uires a =#ro#er #ur#ose> to +iew the shareho$der $ist
- Beause the #ower to ins#et is the #ower to destroy, it is im#ortant that on$y those with a
bona fide interest in the or#oration en.oy that #ower"
o 1tate E*! Rel! 'illsbury v! 2oneywell- Inc!- where - was o##osed to the Aietnam
7ar, so he bought !<< shares of stok in 2oneywe$$, a om#any that was making
bombs, with the so$e intention being to ha+e a say in its affairs" - asked
2oneywe$$ to #rodue the shareho$der $edger, om#any refused" - wanted to
ommuniate with other shareho$ders to hange 2oneywe$$*s #o$iy" They argued
o+er whether DE $aw or CI $aw a##$ies5the tria$ ourt used DE $aw whih
re1uires that #etitioner ha+e a =#ro#er #ur#ose> germane to his interest as a
shareho$der" It must be a proper purpose reasonably related to such person+s
interest as a stoc5holder! -*s onern had nothing to do with the om#any*s
#rofits" The /ourt said - had no interest in 2oneywe$$5he on$y #urhased stok
to fore 2oneywe$$ to sto# #roduing bombs" But for o##osition to 2oneywe$$*s
#o$iy, - wou$d not ha+e bought stok, wou$d not are about 2oneywe$$*s #rofits,
and wou$d not be trying to ommuniate with the shareho$ders"
10 o% the EKchange Act
- it a##ears to gi+e +oie to the shareho$ders about how firm shou$d be run
- it a##ears to #ro+ide a +enue about ethia$ +iews, mora$ +iews
- but when we $ook at the $imitations that are #$aed on ins#etion rights under state $aw, it
seems that they don*t rea$$y get these rights
- you an*t ha+e your ake and eat it too
Illusion of 1hareholder "emocracy
- it is not the ase that the mirage has no effet, that the onse1uene of the i$$usion of
shareho$der demoray is that there is no shareho$der demoray
o the mirage itse$f a$$ows $egis$atures and #o$iymakers to be$ie+e that there is no
#rob$em b9 if they wanted something different they wou$d do something about it
- this is what shareho$der*s want, otherwise they wou$d hange it
IN
- there is no reason for the $egis$ature to ste# in and say you need to sto# #roduing
wea#ons, or need to #rotet anima$ rights b/c shareholders could do it themselves and
they are not doing this
- the i$$usion of shareho$der demoray gi+es o+erage to this #rob$em
5. Cont'o$ in C$ose$y 2e$) Co'(o'ations
- non-#ub$i or#orations, owned by a sma$$ number of shareho$ders
o stok is on$y rare$y dea$t
o size is not determinati+e
- absene of a readi$y a+ai$ab$e seondary market, through whih shareho$ders an e6erise
e6it if they are dissatisfied with the diretors or the go+erning board
o $ak of any resa$e market
o sometimes these firms ha+e $imitations on the a$ienabi$ity of the stok
o many #eo#$e who own a stake in a $ose$y he$d firm get it from their em#$oyment
5they get their foot in the door by being em#$oyed there
o they don*t get di+idends, so they are #aid a sa$ary
- shareho$ders ha+e more ontro$ o+er the firm
o shareho$ders abi$ity to inf$uene the running of the firm is $imited
o shareho$ders in $ose$y-he$d or#orations are entit$ed to a $ot of $eeway
o the shareho$ders ha+e more e6#eriene in the firm, so they might take more
interest in it
o they ha+e the o##ortunity to be informed and the inenti+e to be informed
o there may be a greater non-#euniary interest
b9 shareho$ders ha+e a great stake in the or#oration, they want a greater
stake in ontro$ of the or#oration
o they ha+e the aess to the firm5they show u# at the firm, they know what*s
going on
they ha+e know$edge and the desire to be$ong at the firm
- or#orate $aw is not designed to facilitate shareholder control, it is designed to facilitate
directorial control
o the diretors wi$$ be benefiting from the #o$iies they are im#$ementing
- .6 +aries wide$y and terminations are often made on the fats of s#eifi ases
- NOTE: if a fami$y is the ma.ority shareho$ders, then they wou$d ontro$ the who$e thing,
but if one dissents and .oins with the minority, then they ha+e $ost ontro$
Limitations on "ecisions by 1hareholders
- 0tokho$ders may not, by agreement among themse$+es, ontro$ the diretors in the
e6erise of the .udgment to e$et offiers and fi6 sa$aries
o Diretors moti+es may not be 1uestioned, so $ong as their ats are $ega$
o The bad faith or the im#ro#er moti+es of the #arties does not hange the ru$e
o Diretors may not by agreements entered into as stokho$ders abrogate their
inde#endent .udgment
- Renera$$y shareho$ders annot form an agreement to ontro$ the deisions traditiona$$y
vested in the $udgment of the directors of a om#any
K<
o 0cFuade v! 1toneham# three #arties made an agreement for ontro$ of the NE/
&baseba$$ $ub' saying that they wou$d a$$ use their best efforts to make sure that
the three of them wou$d remain as diretors and they wou$d kee# +oting for eah
other" 7hen it ame time for the e$etion for treasurer, 0toneham and CRraw
abstained from +oting and another offier was e$eted to re#$ae -" - says D*s did
not kee# their #romise to he$# kee# him as treasurer" D*s say that any ontrat
whih om#e$s a diretor to +ote to kee# a #erson as an offier is i$$ega$"
0hareho$ders are not su##osed to be ating as diretors &in e$eting offiers'5
they do not ha+e a fiduiary duty" One you are a diretor, you ha+e to onsider
the interests of the firm, you ha+e that fiduiary duty" 7hen they made the
agreement, they were #utting their own interests abo+e those of the firm"
0toneham and CRraw duty was to the or#oration and its stokho$ders and they
had to use their own .udgment" The /ourt says the agreement is in+a$id"
o CTuade Bu$e:
0hareho$der agreements are #erfet$y ae#tab$e with regard to the
e$etion of offiers
0hareho$ders an se$$ their shares if they want to
0hareho$ders an om#ete with firms
0hareho$ders an +ote for whihe+er #erson they think wi$$ a$$ow them to
benefit the most
o PPIt is im# to note that the main issue in this ase is the minority interest &in
)lar5, seen be$ow, there is no minority5that*s why it is different'
Hshareholders are allowed to be selfish%directors are not
- a ontrat is illegal and void so far as it #re$udes the board of diretors, at the risk of
inurring $ega$ $iabi$ity, from hanging offiers, sa$aries, or #o$iies or retaining
indi+idua$s in offie, e*cept by consent of the contracting parties
o the who$e ontrat is +oid &you an*t s#$it the baby'
- where the directors are the sole shareholders- there seems to be no ob.etion to enforing
an agreement among them to +ote for ertain #eo#$e as offiers
o )lar5 v! "odge# where they were the on$y two shareho$ders and they made an
agreement that said they wou$d e$et eah other as diretors and $ater as offiers
of the firm" The /ourt found that the ontrat was +a$id"
o there was no in+asion of the #owers of the diretorate under that agreement
o there was no damage suffered by or threatened to anybody
o Pthis it different than 0cFuade b9 /$ark and Dodge were the on$y two in+o$+ed
there are no minority shareho$ders, so they ou$d $ook out for their own
interests and it won*t hurt anyone
Therefore the #ur#ose of the CTuade ru$e wou$d not a##$y
)<RRE7T R<LE 8( LA.:
- if the firm is $ose$y he$d, there is no om#$aining minority and the terms are reasonab$e,
then the ourts wi$$ u#ho$d the shareho$der agreement
o aller v! aller- where two brothers owned a drug om#any, and they made an
agreement saying what wou$d ha##en u#on the death of either brother" -art of the
agreement was that one of the bros wi+es wou$d be insta$$ed as a diretor of the
K!
firm% therefore they are taking this deision away from the firm" The /ourt
u#ho$ds the shareho$der agreement and states that Ra$$er $ooks a $ot more $ike
)lar5 v! "odge
- the Ra$$er ru$e is the urrent ru$e, but now there are $ose$y he$d or#oration statutes
- N4 sti$$ goes by 0cFuade
Ne. o'6 O 5e$a.a'e "a. Bno )i%%e'enceC
- they both #ermit shareho$ders in $ose$y-he$d or#orations to add a #ro+ision in the
arti$es of inor#oration that a$$ows them to e$et diretors and officers
G>E>@aA of the "elaware )orporate )ode
- 4ou are #ermitted to say that someone other than the board of diretors is managing the
om#any, but this must be in the ertifiate of inor#oration
o &this is the defau$t ru$e, but you an hange this in your agreement'
o If there is a minority shareho$der, then things hange
GI?C of 7= )orporate law on p! I>E
- &a' ,n agreement between two or more shareho$ders, if in writing and signed by the
#arties thereto, may #ro+ide that in e6erising any +oting rights, the shares he$d by them
sha$$ be +oted as therein #ro+ided, or as they may agree, or as determined in aordane
with a #roedure agreed u#on by them
- &b' , #ro+ision in the ertifiate of inor#oration otherwise #rohibited by $aw beause it
im#ro#er$y restrits the board in its mgmt of the business of the or#oration, or
im#ro#er$y transfers to one or more shareho$ders or to one or more #ersons or
or#orations to be se$eted by him or them, a$$ or any #art of suh mgmt otherwise within
the authority of the board under this ha#ter, sha$$ ne+erthe$ess be +a$id:
o &!' if a$$ the inor#orators or ho$ders of reord of a$$ outstanding shares, whether
or not ha+ing +oting #ower, ha+e authorized suh #ro+ision in the ertifiate of
inor#oration or an amendment thereof,
o &(' if, subse1uent to the ado#tion of suh #ro+ision, shares are transferred or
issued on$y to #ersons who had know$edge or notie thereof or onsented in
writing to suh #ro+ision"
'ublic 'olicy
- Cinority shareho$ders in a $ose$y-he$d or#oration are often at a disad+antage so they
wi$$ make agreements to make sure he kee#s his em#$oyment with the om#any and is
a$$owed to #artii#ate in im#ortant business deisions
- /ontrats annot #$ae $imits on the power of the directors to manage the business of the
or#oration
- ma$ority stoc5holders annot om#e$ the diretors to at a ertain way, but at the
e6#iration of the term of offie of the diretors, the stokho$ders ha+e the #ower to
re#$ae them with others whose ations oinide with the .udgment or desires of the
ho$ders of a ma.ority of the stok"
- the hoie of diretors $ies with the ma.ority stokho$ders and thus gi+es stokho$ders a
+ery effeti+e ontro$ of the ation by the board of diretors"
o It is an i$$usion
K(
- Is the minority shareho$der is entit$ed to #rotetion3
- the DE ourt says:
o basi di$emma of minority shareho$ders in reei+ing fair +a$ue for their stok as to
whih there is no market and no market +a$uation"
o , stokho$der in a $ose$y he$d or#oration an make a business .udgment
whether to buy into suh a minority #osition, and if so on what terms"
o he ou$d bargain for definiti+e #ro+isions of se$f-ordering #ermitted to a DE
or#oration through the ertifiate of inor#oration or by-$aws under state $aw" In
addition, a stokho$der intending to buy into a minority #osition in a DE
or#oration may enter into definiti+e stokho$der agreements to #ro+ide for
e$aborate earnings, buy-out #ro+isions, +oting trusts or other +oting agreements"
- The ourt is saying that if a minority shareho$der wanted #rotetion from the brother*s
ontrat, he shou$d ha+e bargained for, by $ooking at the by$aws of the firm, sine he did
not do that, we don*t fee$ bad for him
1hareholder Agreements:
- a$so a$$ed =#oo$ing> agreements
- they are designed to ahie+e simi$ar ob.eti+es to those in 0cFuade v! 1toneham and
)lar5 v! "odge
- shareho$ders agreements that ommit them to e$eting themse$+es, or their
re#resentati+es, as diretors, are genera$$y onsidered unob.etionab$e, and are now +a$id
in many .6
- as $ong they don*t interfere with the ob$igations of the diretors to e6erise their sound
.udgment in managing the affairs of the or#oration
- agreements that re1uire the a##ointment of ertain indi+idua$s as offiers or em#$oyees of
the or#oration do de#ri+e the diretors of one of their most im#ortant funtions
o but now, these agreements are enforeab$e as $ong as they are signed by all
shareholders
3oting Trust:
- s#eifia$$y authorized by the or#oration $aws of most states
o based on state $aw
- shareho$ders who want to at in onert turn their shares o+er to a trustee
- the trustee then +otes a$$ the shares, in aordane with instrutions in the doument
estab$ishing the trust
- +oting trusts are often used when a fami$y or grou# wants to maintain ontro$ of a
or#oration by a fami$y or grou#, when there is a fear that some members of the fami$y or
grou# might form a oa$ition with minority shareho$ders to shift ontro$
- these genera$$y must be made #ub$i
1pecial 1tatutory 'rovisions for )losely 2eld )orporations
- these #ro+isions +ary from state to state
- they a$$ow ertain or#orations to hoose to ha+e =$ose or#oration status>
o this is om#$ete$y +o$untary
- this means that they wi$$ be managed by shareho$ders, not a board of diretors
- one ad+antage is the need for any or#orate forma$ities
K)
E. A#*se o% Cont'o$
- 0tokho$ders in the $ose or#oration owe one another the same fiduiary duty in the
o#eration of the enter#rise that #artners owe to one another
o This is a duty of =utmost good faith and $oya$ty>
o This omes before their mgmt and stokho$der res#onsibi$ities
- shareho$ders in a $ose$y he$d or#oration owe eah other a duty of ating in good faith
- they breah this duty by terminating another shareho$der*s sa$aried #osition, when the
shareho$der was om#etent in that #osition, in an attem#t to gain $e+erage against that
shareho$der
o .il5es v! 1pringside 7ursing 2ome# where - and D went in on a nursing home
together and they were a$$ going to ser+e as diretors5there was no forma$
shareho$der agreement" They were a$$ going to own a #iee and work for the
or#oration" It beomes #retty #rofitab$e, and then the board of diretors &D' gets
together and fire - &they gang u# on him'" Instead of using the BQ ru$e, the ourt
does a =$oya$ty ana$ysis,> using the most searching scrutiny" The /ourt he$d that
D +io$ated its duty of $oya$ty to - and D*s ha+e not met their burden of showing
the =$egitimate business #ur#ose">
TEST:
5i) the :g:t )ecision that se3e'e$y %'*st'ate) a :ino'ity sha'eho$)e' ha3e a legitimate
business purpose?
&urden of 'roof
- 7hen a minority shareho$der om#$ains about being frozen out of a $ose$y he$d firm by
his fe$$ow shareho$ders:
o !" the ma.ority must ome forward and demonstrate a :legit business purpose;
for their ations &in freezing him out'
E6" he was antagonizing the residents of the nursing home or he wasn*t
showing u# to work
They don*t ha+e to demonstrate om#$ete fairness &as in the $oya$ty ru$e'
o (" Then the minority must show a =$ess harmfu$ a$ternati+e> to #ursue that $egit
business #ur#ose without harming the minority shareho$der
Employment in the (irm
- absent an em#$oyment ontrat, an em#$oyee is an =at-wi$$> em#$oyee when his
shareho$der agreement #ro+ides a buybak #ro+ision of his shares if they are terminated
for any reason
- a minority shareho$der in a $ose or#oration, by that status a$one, who ontratua$$y
agrees to the re#urhase of his shares u#on termination of his em#$oyment for any reason,
a1uires no right from the or#oration or ma.ority shareho$ders against at-wi$$ disharge"
o Ingle v! lamore 0otor 1ales- Inc!# - was hired as a sa$es manager" 2e was $ater
ab$e to buy shares" 2is em#$oyment agreement had a buy-bak #ro+ision that said
the om#any ou$d buy bak his shares if he was terminated for any reason" 2e
was an at#will employee before he was a shareholder! The /ourt he$d that D
didn*t ha+e a duty to kee# - em#$oyed, .ust beause - was a minority shareho$der"
KE
,n em#$oyee is an at-wi$$ em#$oyee if there is no em#$oyment agreement that
gi+es duration to the em#$oyment
- NOTE: a or#oration owes a duty to a minority shareho$der as a shareholder, but there is
no duty owed to him as an employee
F. T'ans%e' o% Cont'o$
- Usua$$y shareho$ders wi$$ ome u# a $imit on the transferabi$ity of shares:
o (irst option# the right to buy them at a #re-estab$ished #rie
o Right of first refusal# the right to buy them by mathing what the outside #erson is
wi$$ing to #ay
Bights of first refusa$ are to be inter#reted narrow$y
- , agreement that gi+es the shareho$der the right of first refusa$ does not on+ey the right
to ontro$ the sa$e of assets or the $i1uidation of the om#any
- NOTE: a sa$e of the ma.ority b$ok*s shares is not the same thing as a sa$e of either a$$ or
some of the ho$ding om#any*s assets
o (randsen v ,ensen#1undquist Agency- Inc!- where - &a minority shareho$der' had
the right of first refusa$ if the om#any so$d out to a third #arty" The om#any
was going to se$$ its shares to another om#any, but - wou$dn*t sign the wai+er,
and said he wanted to buy out the shares" -resident of the om#any didn*t want to
se$$ to 8 b9 he was afraid that - wou$d fire him and he wou$d $ose his .ob if -
owned the ma.ority" - sued for breah of shareho$der agreement" The /ourt says
that the agreement on$y gi+es the right of first refusa$ if the shares were offered
for sa$e" They aren*t offered for sa$e if D is on$y se$$ing some of its assets to
beome an in+estment om#any instead of a bank ho$ding o" The right of first
refusal was only triggered by an offer% here, 8irst 7isonsin didn*t want to
beome a ma.ority shareho$der5they .ust wanted the bank" The origina$
transation was a merger, so there was no :offer; to buy the shares" In this ase,
the shareho$ders wou$d ha+e reei+ed ash5their shares wou$d ha+e disa##eared
but not by sa$e, for in a merger- the shares of the acquired firm are not bought-
they are e*tinguished5there wou$d ha+e been no D om#any after the merger and
no shareho$ders in D" , merger is different than a sa$e of shares"
'remium 'rice
- 7hen someone buys so muh stok that they now ha+e a #remium interest, they ha+e to
#ay a #remium #rie, so that they don*t take ad+antage of the minority shareho$ders"
o the #remium is #aid for ontro$ b9 the buyer wants to mi$k or $oot the om#any
- The #remium is the added amount an in+estor is wi$$ing to #ay for the #ri+i$ege of
diret$y inf$uening the or#oration*s affairs
- ,bsent bad faith &i"e" $ooting the or#orate assets, on+ersation of a or#orate
o##ortunity, fraud or other ats of bad faith', a ontro$$ing shareho$der is free to se$$, and
a #urhaser is free to buy, the ontro$$ing interest at #remium #rie
o a #arty an #urhase a ontro$$ing share of a or#oration at a #remium #rie
without e6tending a tender offer to a$$ shareho$ders"
- 0hareho$ders are entit$ed to se$$ their shares at a #remium and they don*t ha+e to share it
with minority shareho$ders
K;
o Betlin v! 2anson 2oldings- Inc8 where - owned (G, and D*s owned EE"EG and
then so$d it to another #arty for muh more than the market #rie, who gained a
=ontro$$ing interest>" - $aims that a$$ of the shareho$ders were entit$ed to the
#roeeds from the third #arty" The /ourt found that D owned something that -
didn*t: control" D an se$$ that if he wants to" The new om#any bought the
shares for e6tra money beause they want ontro$.
1elling )ontrol of 0anagement
- an agreement to se$$ ontro$ of the management, a$ong with the sa$e of a substantia$
#erentage of shares is not against #ub$i #o$iy
- it is fine for someone to ome in a =buy> ontro$ of management> &#aying for some
diretors to resign'
o Esse* <niversal )orporation v =ates- - makes a dea$ with D to buy shares of the
om#any for more than they are worth, and one the dea$ is onsummated, he wi$$
get a$$ of the diretors to hand in their resignations" One at a time, one 4ates
diretor wi$$ resign and one Esse6 diretor wi$$ be hired" 7hen the dea$ is about
to go down, Esse6 is #re#ared to tender a ashier*s hek, then D hanges his
mind and says the ontrat is i$$ega$ and +io$ates #ub$i #o$iy" The ourt u#ho$ds
the agreement" - wou$d ha+e re#$aed the diretors e+entua$$y, and this was .ust
s#eeding u# the #roess"
I=. >e'ge'sF AcL*isitions an) Ta6eo3e's
0echanisms of aining )ontrol
- one way is by owning a $itt$e bit of stok and then trying to get e$eted to the board of
diretors
o but the #ro6y fight is an un$ike$y way
- practical mergers
o another way is to go on the market and start buying out stok unti$ you reei+e a
ontro$$ing interest
o when the market starts seeing you buying a$$ this stok, they wi$$ see that you
know something that they don*t5so it might raise the stok +a$ue
- statutory merger
o where you merge your firm with a =target> firm &the firm you are trying to gain
ontro$ o+er' in a way that wi$$ $ea+e you in a dominant #osition
o ertain states ha+e different ru$es on mergers
A. >e'ge's an) AcL*isitions
0ergers in eneral
- the shareho$ders in the om#any being =a1uired> end u# with stok in the acquiring
or#oration, so they ha+e a ontinued stake in the new$y-ombined enter#rise
- the a1uiring om#any then owns both om#anies
- distinguish: in a sa$e-ty#e dea$5the shareho$ders of the =a1uired om#any> end u# with
on$y ash and no stake in the new enter#rise
KI
1tatutory 0erger
- one way to aom#$ish a ombination of two om#anies
- the #roedure are set forth in state $aws
- the terms of the merger are s#e$$ed out in a doument a$$ed a merger agreement
o drafted by the #arties
o $ays out the treatment of the shareho$ders of eah or#oration
o how many shares go to the shareho$ders of eah of the two or#orations
- shareho$ders and diretors are re1uired to a##ro+e the merger by +oting
o appraisal rights# shareho$ders who +oted against the merger, wou$d be #aid by the
a1uiring om#any in ash, the fair +a$ue of their shares
'ractical 0ergers &other forms of mergers that do not use the statutory #roedure'
- buying shares from shareholders
o buying enough of another om#any*s shares to gain ontro$ of that om#any
sine this wou$d be b9t the buying om#any and the shareho$ders of the
se$$ing om#any, no +otes of shareho$ders or diretors wou$d be neessary
nor, wou$d there be any a##raisa$ rights
one the buying om#any gained suffiient ontro$, it ou$d use a s#eia$
#roedure, a$$ed a =short-form merger>
- assets acquisition
o buy a$$ the assets of the om#any you want to a1uire in e6hange for shares of
your own om#any &or for ash'
then you are dea$ing with the atua$ om#any instead of its shareho$ders
Phere, the a1uiring om#any does not take on $iabi$ities of the a1uired
or#oration, as it wou$d under a statutory merger
o 0tate $aws +ary on whether this ty#e of a1uisition re1uires a shareho$der +ote and
whether they get a##raisa$ rights
Assets Acquisitions
- a reorganization by a or#oration to a1uire the assets of another organization o#erates as
a de facto merger if the onse1uenes are the same &nature of the or#oration is
signifiant$y hanged and the shareho$der*s interest is signifiant$y a$tered'
o (arris v! len Alden )orporation# - was a shareho$der in D*s om#any &R,'"
R, so$d a$$ of its assets to List, instead of atua$$y merging the om#anies &=asset
a1uisition>' so - sued for his appraisal rights! One of the om#anies was a -,
om#any and one was a DE om#any5both states ha+e different $aws for
mergers" In -,, shareho$ders need to a##ro+e the merger and if they don*t, they
get a##raisa$ rights" The /ourt found that the =assets a1uisition> had the same
effet as a de facto merger, so - shou$d get the same rights" The /ourt said it
doesn*t matter what you a$$ it, if it has the same resu$t as the merger, then the
shareho$ders ha+e the same rights
- E+en if you try to get around the merger statute, the /ourt wi$$ im#ose the same rights on
the shareho$der
o ,sset sa$es statutes and merger statutes are inde#endent of eah other, and a
or#oration must om#$y with one or the other
KK
o 2ariton v! Arco Electronics# where they didn*t want to go the statutory route, so
they deided to find a $oo#ho$e and .ust se$$ a$$ of their assets &so it wasn*t
tehnia$$y a statutory merger'" If they were to #ursue a statutory merger, they
wou$d be re1uired to do ertain things, suh as gi+ing the dissenting shareho$ders
a +oie, get the a##ro+a$ of the shareho$ders, et" The former shareho$ders of
,ro wi$$ now be shareho$ders of Lora$" The shareho$ders said that this is .ust
$ike a statutory merger so they shou$d be gi+en their dissenters rights" The de
facto merger doctrine states that if you ome u# with the same onse1uenes then
they wi$$ #ro+ide the same rights
'ublic 'olicy &ehind the 0ar5et for )ontrol
- Now, most states ha+e gi+en u# on the statutory merger and the de fator merger
mehanism
- modern view- we want to $ibera$ize the market b9 it benefits shareho$ders and gets new
b$ood into the board
- Is it a rae to the to#3
o 2as DE found the best or#orate $aws for the best interest of shareho$ders3
- Or a rae to the bottom3
o 2as DE ome u# with the worst $aws for the shareho$ders, but the best $aws for
the diretors3
o /om#etition among states to find the best $aws for diretors
- 0hou$d the market for ontro$ be enouraged or disouraged3
- 4ou ha+e to $ook at the reasons
o Do they want it to e6#$oit the firm3
Then you wou$d want to inrease the ontro$
o OB, Do they want it to grow the firm3
Then you wou$d want to re$a6 the ontro$
- Traditiona$$y or#orate $aw has been onerned about the market for ontro$
!. F'eeGe8O*t >e'ge's
- 7here the ontro$$ing shareho$ders take e6$usi+e ownershi# of the or#oration by
finding a $ega$ way to e$iminate the outsides as shareho$ders
- you usua$$y ha+e a big shareho$der that owns ton of stok and then you ha+e the minority
shareho$ders that are oming a$ong for the ride
o often the best thing to do is to .ust get rid of them
o you think that you are making a $ot of money and e+ery do$$ar that you are
making you ha+e to share with these minority shareho$ders who aren*t doing
anything
o if you get rid of them, then you wou$d get to kee# a$$ of the money that you make
)ash out mergers
- These are #erfet$y $ega$
o The ru$e is that the ma.ority who has #re#ared the merger dea$ has an affirmati+e
ob$igation of good faith and fair dea$ing and the ob$igation to #ay the minority
shareho$ders a good #rie
KJ
- a ma.ority shareho$ders owes a fiduiary duty to minority shareho$ders to #ro+ide a$$
re$e+ant information that wou$d #ertain to a #ro#osed =ash-out merger> &they ha+e the
same fiduiary duty that they ha+e for =inside information>'
o .einberger v! <8'# where a 0igna$ owns ;!G of UO-, so they deide they
shou$d buy out a$$ of it and own !<<G of UO-5=ash out merger> ours, so the
minority shareho$ders are out of the dea$, with ash in their #okets" - is $aiming
that the minority shareho$ders did not know about the #rie and that the om#any
did not at in good faith" The om#any has a duty of fair dea$ing and good #rie,
and shou$d ha+e dis$osed a$$ information re$e+ant to the transation" The /ourt
he$d that the shareho$der +ote was not an informed +ote, and therefore, the
ma.ority shareho$ders breahed their duty to the minority shareho$ders" The
merger was not an informed one b9 the om#any ga+e the im#ression that they
had onduted arefu$ researh, but it was done 1uik$y and without are" They
were a$so denied information as to what wou$d ha+e been a fair #rie"
&urden of 'roof:
- !" - attaking the merger, must demonstrate some basis for in+oking the fairness
ob$igation
- (" the ma.ority shareho$der must show by a preponderance of the evidence that the
transation is fair
- NOTE: when a or#orate ation has been a##ro+ed by an informed +ote of a ma.ority of
the minority shareho$ders, the burden entirely shifts to the ' to show that the transation
was unfair to the minority
o But the burden remains on those re$ying on the +ote to show that they om#$ete$y
dis$osed a$$ materia$ fats re$e+ant to the transation
C. Ta6eo3e's
1. Ten)e' O%%e's
- 7hen the a1uiring om#any offers to buy eah #ub$i ho$der*s stok diret$y
o This an be arried out o+er the ob.etion of the =target> om#any*s Board of
Diretors and managers
o It is u# to eah indi+idua$ shareho$der to deide to se$$ their shares
- This ours when someone is not ab$e to negotiate a merger, but sti$$ wants ontro$
o usua$$y, they wi$$ ondition it on getting at $east ;!G of the shares, so they ha+e a
ma.ority
- #o$iy behind the two-tiered tender
o if you ha+e the :E; bakend dea$, you might think that its unfair, and you might
think that you wou$d win in ourt, but this wou$d take so muh time and so muh
money &for attorneys, et' that you might .ust want to ut your $osses and in+est
e$sewhere
o a :E; ash out for ontro$ in this firm might sur+i+e a ha$$enge
Tender 8ffers
- tender offer is another way to aom#$ish ontro$
KN
0traight &One-Tiered' Tender
- if Unoa$ stok is se$$ing for :;<9share on the o#en market
- you want ontro$ of Unoa$, but you ant negotiate with the diretors b9 they don*t are
about you and don*t want you in their om#any
- so you say to the stokho$ders, =your stok is se$$ing at :;<, I wi$$ gi+e :I< for the first
;!G of shares that wa$k in the door>
o as a minority stokho$der, notie that if someone is wi$$ing to #ay :I<, then they
must know something &that it is more +a$uab$e then that'
- you won*t gi+e it to any #erentage under ;!G b9 he wants ontro$
- PPa straight tender offers threatens stagnation
E6am#$e of 0traight Tender:
- :;< market +a$ue, :I< tender for ;!G
- the market #rie is ;< and you are offered I<
- if you think that the stok is rea$$y worth more than I<, then you are om#e$$ed to se$$ b9
you don*t want to be $eft on the bak end with stok that se$$s for :E;
- those who think this is the best offer they an get wi$$ tender
- those who thinks another raider wi$$ raise the stakes more, wi$$ refuse
Two Tiered 8ront-End Loaded
- This is a oeri+e mehanism
- 4ou are sti$$ taking your hanes that a ourt wi$$ say the bak-end is a fair #rie
- This is thought to be strutura$$y oeri+e
- If you don*t tender, you are going to be stuk in the bak end with the $ower #rie
- The 1uestion is: Do you want to em#ower boards to ome u# with defensi+e mehanisms
to a+oid this3
- Pthe two-tiered front end $oaded mehanism threatens a stam#ede
- Pmost shareho$ders wi$$ tender b9 of the fear of being $eft on the bakend
E6am#$e of Two-tiered 8ront End Loaded
- :;< market #rie, he offers :I; Tender for ;!G of the shares &the front end'
- Then he wi$$ #ay :;; ash #er share for the rest of the ENG &bak-end ashout'
- Now, you ha+e to deide whether you go through with it, or wait for another raider to
ome in with a better offer &whi$e risking being stuk on the bak end'
- E+en if you think it is worth :K;9share, you sti$$ tender b9 you don*t want to be stuk in
the bak end with :;;9share
,. 5e3e$o(:ent
- diretors ha+e a duty to #rotet the or#oration from in.ury by third #arties and other
shareho$ders, whih grants diretors the #ower to e6$ude some shareho$ders from a stok
re#urhase
- business $udgment rule# the ourt wi$$ not substitute their +iews for those of the board if
the board*s deision =an be attributed to any rationa$ business #ur#ose>
o #resum#tion that in making a business deision, the diretors of a or#oration
ated on an informed basis, in good faith and in the honest be$ief that the ation
taken was in the best interest of the om#any
J<
- when a board of diretors uses or#orate funds to remo+e a threat to or#orate #o$iy
when a threat to ontro$ is in+o$+ed, diretors must show that they had reasonable
grounds for believing that a danger to corporate policy and effectiveness e*isted because
of another person+s stoc5 ownership
o this burden an be satisfied by showing good faith and reasonable investigation
o this hoie must be moti+ated by a good faith onern for the we$fare of the
or#oration and its stokho$ders, whih in a$$ irumstanes, must be free of any
fraud or other misondut
o ne6t, the /ourt has to ba$ane5the ation taken must be reasonab$e in re$ation to
the threat #osed
- <nocal v! 0esa 'etroleum# Cesa, who a$ready owned !)G of Unoa$, ga+e a two-tiered
=front $oaded> ash tender offer for )KG of shares at :;E9share" Unoa$ Board meets in
res#onse to this and satisfies its Aan Rorkum duties5they $isten to $ong #resentations,
et" They ome to the on$usion that the dea$ is bad" The diretors who ha+e a fiduiary
ob$igation to the shareho$ders fee$ that they ha+e a duty to #rotet the shareho$ders from
this oeri+e tender offer" They bring the $awyers and deide to de#$oy a se$f-tender,
saying they wi$$ gi+e them :K(9share, but they wi$$ on$y go through with it if Cesa is
e6$uded from the tender offer" To do this se$f-tender, Unoa$ wou$d ha+e to go into
substantia$ debt" The effet of this tender offer is that the shareho$ders are not worried
about getting stuk on the bak end beause e+en if they stuk on the bak end, they
wou$d sti$$ be getting :K(" Unoa$ tries to $aim &, rule by saying they used the business
.udgment to ome u# with this idea" The ourt says: in this irumstane there is a
s#eia$ danger that the board is moti+ated by an effort not to $ook out for the best interests
of shareho$ders, but rather to make sure that they are not going to get ousted"
Enhanced business $udgment rule
- under some irumstanes the /ourt wi$$ re1uire that the diretor omes u# with #roof
that their res#onse was reasonab$e in $ight of the threat
- <nocal is ab$e to meet that standard
o They show that they $ong meetings to disuss this" The /ourt found that the Board
had both the #ower and the duty to o##ose a bid they #erei+ed to be harmfu$ to
the or#orate enter#rise"
o Unoa$ ated reasonab$y in re$ation to the threat #osed and the board e6erised
#ro#er business .udgment"
SEC Reaction to Unocal and oison ills
- after Unoa$, the 0E/ reated ru$es against discriminatory self#tenders- #rohibiting issuer
tender offers other than those made to a$$ shareho$ders
- the 0E/ does not #rohibit poison pills- whih ha+e the same effet
o offiia$ name: =0hareho$der Bights -$an>
- warrant# a right that grants the ho$der the o#tion to #urhase new shares of stok of the
issuing or#oration
o they gi+e the ho$der the right to buy issuer ommon stok at a disount form the
#re+ai$ing market #rie
'oison 'ill
J!
- this is a defense mehanism to a+oid hosti$e takeo+ers
- a om#any offers its own shareho$ders a note in e6hange for eah of their shares
- this #uts the or#oration in so muh debt that no one wou$d want to takeo+er the
or#oration
- basia$$y, you are threatening suiide of the om#any
- the #i$$ is ty#ia$$y adopted by the board of directors without any shareho$der ation
- the #i$$*s f$i#-in e$ement is triggered, ty#ia$$y, by the atua$ a1uisition of some s#eified
#erentage of the issuer*s ommon stok
- the #i$$ auses the +a$ue of the stok to derease
- when a takeo+er is ine+itab$e, the diretor*s duty is to get the best #rie for the
shareho$ders
- NOTE: one the diretor*s know that the or#oration is going to be taken o+er, the duty
to the shareholders outweigh the duty to the corporation
- no defensi+e measure an be sustained when it re#resents a breah of the diretors*
fiduiary duties
- fa+oritism for a white knight to the tota$ e6$usion of a hosti$e bidder may be .ustifiab$e
when the $atter*s offer ad+erse$y affets shareho$der interests, but when bidders make
re$ati+e$y simi$ar offers, or disso$ution of the om#any beomes ine+itab$e, the diretors
annot fu$fi$$ their enhaned <nocal duties by #$aying fa+orites with the ontending
fations
o Revlon v! 0acAndrews 9 (orbes 2oldings# where -- offered to do a friend$y
merger but Be+$on thought --*s offer was inade1uate, so Be+$on reated a #oison
#i$$" The Be+$on board says if anyone omes to own a (<G stake in Be+$on, then
the #i$$ omes into effet" If they swa$$ow the #i$$, then Be+$on wou$d be sadd$ed
with enormous debt &they wou$d owe :I< for e+ery share' and with this debt, they
wou$d no $onger be attrati+e! The who$e #oint of the #oison #i$$ is that the #i$$
wi$$ ne+er be swa$$owed% the #ur#ose is to make the firm $ess attrati+e" -- says
they wi$$ sti$$ #ay" 8orstman agrees to tender a$$ shares at their fu$$ +a$ue" In
e6hange the board agrees that they wi$$ not negotiate with any other #arty and
that he wi$$ be #aid a ane$$ation fee if anyone e$se buys the firm" The /ourt said
it beame $ear when Be+$on started searhing for a knight when they were going
to se$$ off" The firm starts $ooking for a knight in 8orstman"
-- an make a $ot more than :E;9share if he an get in and se$$ off its #arts
-- doesn*t want to get in there and grow the firm, he wants to bust it u#
- Notes on Be+$on:
o ,s -er$men kee#s inreasing his offer and the board starts rea$izing that it wou$d
be $ooking unreasonab$e not to go through with it
o ,s -ere$man starts u##ing his bid, the Be+$on Board rea$izes that it is $ike$y to
$ose the Unoa$ ha$$enge, so they start $ooking for another bidder
o 0o now they know the firm is going to be busted u#5there is no future of Be+$on
as far as shareho$ders are onerned5so they start ho$ding an aution
o The on$y duty $eft for the board of diretors is to ma6imize #rie
o There is nothing to disuss5the firm is going to be so$d, not its .ust about how to
ma6imize #rie for the shareho$ders
o "octrinal point- the ourt says the Be+$on board was wrong to #ro+ide 8orstman
with the :(; ane$$ation fee
J(
The ourt says this dea$ +io$ated the fiduiary duty to shareho$ders
o 7hen they rea$ized the om#any was going to be so$d, they now beome
autioneer
- Effet of the -oison -i$$
o If -er$man a1uires a ontro$$ing interest in Be+$on, then the #i$$ wi$$ kik in and
anyone who owns shares an turn in their shares for a :I; note
o The #i$$ threatens to rebuff the takeo+er o#tion
'aramount v! Time
- This was a statutory merger" There was no sing$e dominant shareho$der in either
om#any5they are owned in the market &both Time and 7arner are wide$y he$d' are
both run by their boards of diretors" Time*s u$ture in the media wor$d is the big dea$, so
it is im#ortant that Time*s mgmt team runs the firm" -aramount omes in and $aunhes a
tender offer at :!K;9share for a$$ shares" In $ight of the hosti$e tender offer from
-aramount, the Time board abandons its merger #$an, and says they are going to do a
takeo+er of 7arner &they were going to make the minority shareho$ders beome
shareho$ders in the new om#any through a merger'" It is no $onger a statutory merger5
it is now a hosti$e takeo+er" If this was a on+entiona$ statutory merger, then the
shareho$ders wou$d ha+e to +ote to a##ro+e it" 0hareho$ders sue to en.oin this tender
offer" It*s not BQ ru$e beause this tender offer was onsummated in res#onse to the
threatened takeo+er, so the ourt wi$$ a##$y the enhanced &, rule!
Enhanced &, Rule:
- The ourt does a reasonab$e in+estigation and finds that Time isn*t being so$d, but it
merging with 7arner and wi$$ ontinue to be a $i+e entity
o There is no aution, this is not $ike Be+$on
- Unoa$ ,na$ysis: &disussed on #" J<!'
o !" 2as there been reasonable investigation to determine that there is a threat3
o (" ,re they o#erating with good faith3
o )" Is the response reasonably related to the threat3
They are offering :K< abo+e market
- The reason it was a$$owed in Unoa$ was b9 it was strutura$$y oeri+e
2ere it was not strutura$$y oeri+e
- They were entit$ed to #rotet their shareho$ders from being onfused
o They shou$d ha+e not $ed them to think that :(<< in their #okets now was better
than being a #art of the Time 7arner /or#oration
o This was robbing them of the greater +a$ue of being #art of this or#oration
'ublic 'olicy
- The 'aramount ru$ing re#resents a ma.or ste# in the authority diretion in the war b9t
accountability and authority
- , ma.or rebuff to Easterbrook and the #assi+ity thesis
'assivity thesis#
- says the #ro#er res#onse for a om#any in a hosti$e takeo+er is #assi+ity5to do nothing
- DE has not ado#ted the #assi+ity thesis, it had endea+ored to reah some midd$e ground
J)
- In short, it is nie to ha+e an o#tion in the Be+$on ontrats, and as a resu$t of the o#tion
the shareho$ders might get :;K or more, but the on$y reasons the o#tion was ab$e to
ha##en here is b9 -- origina$$y ame to the tab$e and offered :E;
- 7hy shou$d the --*s of the wor$d go out there and $ook for firms who might be
under#erforming3Lthey are on$y going to attrat the 8orstman*s of the wor$d to the tab$e3
- ,$$owing firms to engage in the #oison #i$$ might be good now, but it wi$$ end u# saring
the 8orstman*s of the wor$d away%It wi$$ hi$$ the market for ontro$
- Carket for /ontro$:
o Does it #ro+ide an o## for outsiders to ome into a firm and e6#$oit o##ortunity3
o Does the +ery know$edge that there is market for ontro$ a+ai$ab$e make diretors
beome more arefu$ not to e6#$oit shareho$ders
JE

You might also like