I.

AGENCY
A. Master/servant agency relationship: Principal is responsible for acts of the agent.
1. Legal Standard (Restatement §1): Agency is a relationship that results from:
1. The manifestation of consent by P to A that A shall act
a. On P’s behalf, and
b. Subject to P’s control; and
c. A’s consent to so act
2. Distinguish agent from gratuitous bailee (borrow car for own use).
B. **Agency implication**: A way to hold someone else responsible for someone's actions.
C. Principal-Agent relationship creates mutual duties:
1. A must put P's interests ahead of her own; P must honor all obligations that arise b/t A and 3rd parties in
contract or tort.
2. A is bound by duty of loyalty to P (can't compete directly w/ P; misappropriate P's profits, property, or business
opps.; can't breach P's confidences).
E. Coase, Nature of the Firm
1. Firm = ongoing relationship (command entity) – Transaction costs push you into a long-term
relationship in the form of a firm (rather than just allowing market to make production decisions).
2. Difference b/t firm and market is control. Comes down to best way to foster a productive relationship.
F. PRINCIPAL'S LIABILITY IN CONTRACT:
1. Restatement §144: A principal "is subject to liability upon contracts made by an agent acting w/in his
authority if made in proper form and w/ the understanding that the principal is a party."
1. Cargill: Debtor/creditor relationship was turned into control (agency) relationship.
2. 4 TYPES OF AUTHORITY:
1. Actual Express Authority (AEA)
2. Actual Implied Authority (AIA)
3. Apparent Authority (AA)
4. Inherent Authority (IA)
3. Principal is always responsible regardless of what type of authority there is.
4. ACTUAL AUTHORITY: Requires a "manifestation of consent" from P to A.
1. ACTUAL EXPRESS AUTHORITY (AEA): P tells A to do x. A does x. P is liable for consequences (to
T) of x.
a. T can enforce the contract against P, not just A, regardless of whether T knows A is acting for
P.
2. ACTUAL IMPLIED AUTHORITY (AIA): P actually intended A to possess authority and includes such
powers as are practically necessary to carry out her duties. KEY: signal P to A.
a. AIA: P tells A to do x, but in order to carry out x, A takes other (not explicitly stated) actions
(y) in order to do x. P is bound to T for y. Rationale? Checking back...
5. APPARENT AUTHORITY (AA): Not actual authority. Not intended by the principal to delegate to the agent.
The authority the agent is held out by the principal as possessing. Seems like the agent has this type of
authority. Matter of appearances on which 3rd parties come to rely. KEY: signal received by T.
1. Rationale: Gives P incentive to take care - will carefully avoid having 3rd parties misled.
a. Wrinkle: P may signal T through A. If P authorizes A to make such statements, then P will
be liable to T under AA for statements made by A. Lind and Ampex...
2. Absent knowledge on the part of 3rd parties to the contrary, an agent has AA to do those things which
are usual and proper to the conduct of the business he is employed to conduct (Ampex).
3. AA can exist even where no agency relationship b/t P and person who appears to be A.
4. Mill St. Church v. Hogan: Both AIA and AA were present here - Bill has implied authority to hire Sam
b/c of past church actions, and Sam relied on Bill's representation.
5. Lind v. Schenley: Kaufman had AA b/c someone else in company told Lind to look to Kaufman for
compensation. Lind relied upon idea that Kaufman had authority to set his salary.
6. Ampex: Kays accepts K for Ampex - does he have the authority to do so?
a. Ampex has a rule for all employees that only some of them can sign (K managers). No actual
authority b/c Ampex has a rule Kays is aware of...principal did not intend to be bound in this
case.
b. Court accepts AA - Past dealings led Joyce to believe Ampex meant to be bound.
c. Company failed to protect itself by K. Seems in the ordinary course of business that salesmen
should be able to bind their principals.
6. INHERENT AUTHORITY (IA): P is responsible for some acts of A which, while unauthorized, are close to that
which A is authorized to do.
 1. Inherent authority is UNINTENDED.
2. Restaters' catch-all category.
2. Principle of IA comes from idea that the agent possesses a special power to affect the legal rights of
the principal purely by virtue of the existence of an agency relationship.
3. Watteau v. Fenwick - Undisclosed Principal/IA case
a. IA b/c no basis for any other kind of authority (no actual; no AA b/c principal wasn’t known and
3rd party couldn’t rely).
b. To establish IA: Inference on the basis of the ordinary course of business. Might normally
expect barkeepers to stock the pub with these items.
c. Restatement §161: "A general agent for a disclosed or partially disclosed principal subjects
his principal to liability for acts done on his account which usually accompany or are incidental
to transactions which the agent is authorized to conduct if, although they are forbidden by the
principal, the other party reasonably believes that the agent is authorized to do them
and has no notice that he is not so authorized."
d. Here, secret limiting instructions on the ordinary course of business.
e. Policy - Commentary to Restatement §161: Efficient business transactions. "...3rd persons
should not be required to scrutinize the mandates of permanent or semi-permanent agents
who do no more than is usually done by agents in similar positions."
G. RATIFICATION
1. "The affirmance by a person of a prior act which did not bind him but which was done or professedly done on
his account." (Restatement (2d) §82).
2. After A acts w/o authority of any kind, P can still be bound if she ratifies the K.
3. “Requires 'acceptance of the results of the act with an intent to ratify, and with full knowledge of all the material
circumstances.'" Botticello, CB p. 38.
1. The affirmation can be express or implied.
2. BUT P must know or have reason to know all material facts.
H. ESTOPPEL
1. No authority, but if principal does something wrong, estopped (prevented) from denying the person acted for
them. (Hoddeson: Furniture store shouldn't have allowed conman access to their floor).
2. Elements:
1. Acts or omissions by the principal, either intentional or negligent, which create an appearance
of authority in the purported agent.
2. 3rd party reasonably and in GF acts in reliance on such appearance of authority.
3. 3rd party changed her position and in GF acts in reliance upon the appearance of authority.
I. PARTIALLY DISCLOSED PRINCIPAL
1. A is NOT liable to T if P is fully disclosed (identified to T), BUT A may be liable on the K if P is only partially
disclosed (i.e., not identified, see Rstmt 2d §4). Atlantic Salmon.
1. Under some circumstances, A may be made liable to P - e.g. violation of limiting instructions, breach of
duty, etc. See, e.g. Rstmt 2d §§ 160, 383, 399, 400.
2. If A wants to avoid liability, he must reveal not only (1) that he is acting on behalf of P but also (2) the
identity of P. T has no obligation to ask.
J. LIABILITY OF PRINCIPAL TO 3RD PARTIES IN TORT
1. VICARIOUS LIABILITY: "A master is subject to liability for torts of his servants committed while acting w/in the
scope of their employment." - Rstmt. §219(1).
2. 2 questions should start your analysis of tort liability in agency context:
1. Is there an AGENCY RELATIONSHIP between P and A?
2. Is A P's SERVANT or INDEPENDENT CONTRACTOR?
3. Doctrinal Distinction - *MASTER-SERVANT VS. INDEPENDENT CONTRACTOR RELATIONSHIP*
1. Master is liable for torts of its servants.
2. Servant (or "Employee")?
a. S has agreed (1) to work on behalf of M and (2) subject to M's physical control (control over
process as well as result).
b. Humble Oil: Control over day-to-day operational activities; ct. finds M-S relationship.
3. Independent Contractor?
a. Not subject to physical control - i.e. P controls what, not how.
b. Hoover & Holiday Inns: No control over day-to-day operations; no M/S relationship.
4. Test - control of day-to-day operations. Is this sufficient?
a. Hard to find control - proxy? (e.g., risk-bearing (Cargill)).
 b. Policy: Makes sense to have legal liability turn on question of control. Trying to find the least
cost avoider, which is the person in control.
4. Franchise Relationships - Miller v. McDonald's Corp.
1. Is McDonald's liable? Need master-servant relationship - control. 2 prongs:
a. Traditional means of finding control: Control over day-to-day operations.
b. Reliance argument: Customer relied on the relationship (one where there is complete control
by principal); had no reason to believe this McD's wasn't controlled by corp.
2. Default rule: You have to provide notice to plaintiff; there was no notice to P.
3. McDonald's should make clear in franchise agreement leaving all control to franchisee.
5. Negligent Act - Bushey v. US
2. Court rejects motive test (purpose of employment relationship test). Foreseeability embraced (scope of
relationship test) - foreseeable that crew members get drunk on shore leave
3. Court says if he burned down the bar (even though foreseeable) wouldn't be Navy's problem. But, tort
happened on the dock. There is a relationship aspect.
4. Test is rooted in foreseeability but no bright lines - Foreseeability + some type of relationship.
6. Intentional Torts: To make P liable for A’s actions, plaintiff must show "employee's assault was in response to
conduct which was presently interfering with employee's ability to perform his duties successfully." (Manning v.
Grimsley)
1. For intentional torts, relationship must be closer b/t acts and incitement - rooted in employer/ employee
relationship.
7. Conoco: Court focuses on disclaimer - language doesn't establish that Conoco has control over day-to-day
operations and can't find M/S relationship (a statutory offense treated like intentional tort here).
1. Courts often disregard the legal form of the relationship and instead place liability where the
principal behaves like an owner.
a. Are they a residual risk bearer or more like a licensor of IP?
2. Scope of Employment Argument – 5 Factors:
a. Time, place, and purpose of the act.
b. Similarity to acts S is authorized to perform.
c. Whether act is commonly performed by S’s.
d. Extent of departure from normal methods.
e. Whether M could reasonably expect act would be performed.
8. Independent Contractors: Liability for IC's act generally stops at IC UNLESS...
1. P retains control (i.e., really a disguised M/S relationship).
2. P engages an incompetent IC.
3. The activity is hazardous, "nuisance per se." (Majestic v. Toti)
K. FIDUCIARY DUTY IN AGENCY
1. "Secret profits rule" (Regem p. 81): "If a servant takes advantage of his service and violates his duty of
honesty and good faith to make a profit for himself...he is accountable for it to his master."
1. Court held no fiduciary relationship, not acting in course of employment but get the money b/c servant
of the Crown.
2. Pp. 82-83: Hypos - *Differentiate mere relationship from personal aspect* (ex/ Gen. writes book - army
doesn't get profits b/c he did something extra to entitle himself to money).
3. How does the secret profits rule allocate a burden?
1. Allocates the burden to employee to tell the employer: More than just a duty of disclosure; gives the
employer a veto over actions taken by the employee.
2. Why give the employer the veto?
a. Control position
b. Cost of completeness
2. Fiduciary rules are default rules that can be changed/bargained over in an employment K.
4. Breach of FD
1. General Automotive v. Singer: "Under his FD to Automotive Singer he was bound to the exercise of
the utmost GF and loyalty so that he did not act adversely to the interests of Automotive by serving or
acquiring any private interest of his own."
2. Duty to "exercise GF by disclosing to Automotive all the facts regarding this matter."
a. Same as Regem: Disclosure (very similar to no secret profits).
b. Ct gives GA a ROFR - makes Singer turn down all outside offers (prob. bad rule).
5. Town & Country - "Grabbing & Leaving"
1. Problem: Client list was developed in a very specific way.
 2. If you can't ever leave w/ clients, burdens employer/employee relationship - limits incentive of
employee to invest in relationship. But if no protection of client list, the employer has no incentive to
invest in list.
3. Ct. says they violated/stole a trade secret - IP theory to the case. Decides case based on FD.
4. R2d 396: When these duties end.
6. Review - AGENT'S FIDUCIARY DUTIES:
1. Care (R2d 379)
2. Loyalty
3. Kickbacks (profits arising from M-S relationship given back to P - R2d 388)
4. Secret profits
a. From transactions w/ principal (R2d 389)
b. Use of position (Reading)
5. Usurping business opportunities from principal (Singer)
6. "Grabbing and Leaving" (Town & Country)

II. PARTNERSHIP
A. UPA § 6(1): **A partnership is an association of 2 or more persons to carry on as co-owners of a business for
profit.**
B. Requires an AGREEMENT.
1. "Partnership results from contract, express or implied." (Martin v. Peyton).
2. No written agreement necessary to form a partnership
1. UPA § 6(1) association of 2+ implies agreement.
3. Share of profits is prima facie evidence of a partnership.
C. Fenwick: No partnership - Fenwick had control and management, no sharing in losses, etc.
1. Co-Ownership - Look for: Residual risk-bearing and control.
D. Partners vs. Lenders - be careful of distinction b/t partners and debtor/creditor (a loan given w/o control,
sharing of profits, etc.)
1. UPA § 15: Partners are personally liable for the obligations of the partnership (J&S for torts, breaches of
FD; jointly for K’s). Partnership = Full personal liability for debts of the partnership.
2. UPA § 40: Loans by partners to the partnership are subordinated to the loans of creditors other than partners.
3. Martin v. Peyton: P wants to find partnership to make PPF jointly liable. Ct. concludes no partnership:
1. These are normal precautions a lender would take.
2. PPF has no legal right to control Hall - no M/S relationship.
a. Compare to Cargill - creditors had control (agency relationship), so liable.
E. PARTNERSHIP BY ESTOPPEL: Representation/holding out by the alleged partnership to the 3rd part on which
the 3rd party relied.
1. Young v. Jones: No partnership in fact and no partnership by estoppel. No evidence that Ps relied on any act
or statement by any PW-US partner which indicated existence of a partnership w/ the Bahamian partnership.
2. How would you avoid partnership by estoppel? Disclaimer.
F. FIDUCIARY OBLIGATIONS OF PARTNERS
1. "Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of finest
loyalty....Not honesty alone, but the punctilio of an honor the most sensitive..." (Meinhard v. Salmon)
1. Is disclosure enough? Does Salmon have to disclose AND share all profit opportunities?
2. Not clear what the parties would have agreed to; also not clear if disclosure is all that is required, or if
FD requires disclosure PLUS sharing.
3. Does RUPA 404(b)(1) solve the problem? § 404: General Standards of Partner's Conduct:
a. The only FD’s as partner owes to the partnership and the other partners are the duty of loyalty
and the duty of care set forth in subsections (a) and (b).
2. Contract terms can alter the terms of fiduciary duty.
1. Fiduciary duties are limited (Bane: Rights were contractual so no breach of FD).
3. Grabbing and Leaving
1. Meehan v. Shaughnessy: Ds breached FD by unfairly acquiring from clients and referring attys.'
consent to withdraw cases to new firm.
a. A partner has a duty to render on demand true and full info of all things affecting the
partnership to any partner (Ds failed to tell firm on demand; prepared to remove clients
during period of secrecy; used position of trust and confidence to disadvantage of original
partnership).
 b. Don’t read case to say you can never take clients away from your former law firm.
i. Fiduciaries may plan to compete w/ the entity to which they owe allegiance, provided
they don’t otherwise act in violation of their FDs.
i. Problem can be solved by contract.
G. EXPULSION - How to get rid of your partners.
1. Lawlis v. Kightlinger & Gray: Lawlis agreed to the expulsion clause, so the firm can fire him.
1. There is a limit of ability to alter FD contractually - Ct. reads expulsion clause w/ background of good
faith, but good faith is somewhat narrow. Main point of case: Limits of what you can and cannot
alter by contract.
H. PARTNERSHIP PROPERTY
1. Property rights:
1. Rights in specific partnership property;
2. Interest in the partnership and;
3. Right to participate in management.
2. No personal interest in any specific property or asset of the partnership, so conveyance of partnership
property held in the name of the partnership is made in the name of the partnership and not as a conveyance of
the individual interests of the partners.
3. § 203 RUPA (1996). Partnership is separate from the partners.
I. PARTNERSHIP CAPITAL
1. Partner owns initial capital contribution.
1. This goes into a Capital Account:
a. Running balance reflecting each partner's ownership equity. See UPA (1997) § 401(a).
b. Allocation of profits increases capital account.
c. Allocation of losses decreases capital account.
d. Taking a "draw" (distribution) decreases capital account.
2. Default Rule on profits: Profits are divided equally (pro rata) among partners.
1. Doesn't change even if one partner contributes more of the initial capital.
2. Can only be changed by contract.
3. Default Rule on losses: Losses follow profits. Can be changed by K. Also, if partners alter the profit rule,
the loss rule will automatically change as well.
4. Partner cannot transfer her interests in the partnership unless all the remaining partners agree or partnership
agreement permits it.
J. RIGHTS OF PARTNERS IN MANAGEMENT
1. 3 Default Rules (can be altered in partnership agreements):
1. UPA (1914) § 9(1): "Every partner is an agent of the partnership for the purpose of its business, and
the act of every partner...binds the partnership, unless the partner so acting has in fact no authority
to act for the partnership in the particular matter, and the person with whom he is dealing has
knowledge of the fact that he has no such authority."
a. Nabisco: Act of 1 partner binds partnership.
b. Exception - no actual authority and the 3rd party knows
2. UPA § 18(e): "All partners have equal rights in the management and conduct of the...business."
3. UPA § 18(h): "Any difference arising as to ordinary matters connected w/ the partnership business
may be decided by a majority of the partners; but no act in contravention of any agreement b/t the
partners may be done rightfully w/o the consent of all the partners."
a. In 2 person partnership, 1 person is not a majority. Summers: No reimbursement for P b/c
majority (both partners) didn't agree to hire 3rd man.
2. Nabisco and Summers...
1. Cases hinged on what is an ordinary matter of the business.
2. Who is suing whom? In 1st case, injured party is Nabisco (3rd party).
a. UPA § 9: You can bind the partnership to 3rd parties for usual business of the firm.
b. In 2nd case, partners are suing each other. It's what is chargeable to the partnership by the
partners.
3. UPA 18b: Partnership must indemnify every partner for purchases, etc. made in ordinary and proper
conduct of the business.
4. Ct. places burden on the party that wants something out of the ordinary; changing custom.
3. A joint venture b/t 2 corps. is a form of partnership (co-adventurers in a business for profit).
4. Partners are free to make any agreement that suits them (Day v. Sidley & Austin: P bound himself to K;
breach of FD claim fails. No court has recognized a FD to disclose this type of info (changes in internal
structure of the firm). No financial gain for Ds and remaining partners didn't acquire any more power as a result
of alleged withholding of info).
K. DURATION & DISSOLUTION
1. AT WILL VS. TERM PARTNERSHIP
1. At will = right to dissolve (UPA § 31 (1)(d)). Can be dissolved at any time.
a. Default rule: Partnerships are terminable at will.
2. Term = no right (but still power) to dissolve. But can't use power wrongfully (UPA § 31(2)).
2. "There always exists the power, as opposed to the right, of dissolution." (Collins v.Lewis).
1. Dissolution by act of one or more partners (e.g. UPA (1914) § 31).
2. Dissolution by operation of law (e.g. UPA (1914) § 31(4)).
3. Dissolution by court order (e.g. UPA (1914) § 32 (1)(a)).
3. Wrongful Dissolution
1. Can occur when a partner tries to dissolve term partnership w/o the right.
2. Owen v. Cohen: Ct. implies term on basis of the loan. Important b/c implication of a term into a
partnership makes the difference in having someone held liable for wrongful dissolution. But ct. orders
dissolution, saving Owen consequences of wrongful dissolution in spite of implying term.
4. Dissolution - Legal consequences: Remain partners but the business is put into dissolution.
1. Not the same as going out of business.
2. Simply the "change in relationship of the partners caused by any partner ceasing to be
associated in the carrying on" of the firm's business. UPA (1914) § 29.
3. Not termination. Partnership continues until "winding up" - i.e. the process of shutting down post-
dissolution.
4. After discharging partnership obligations, profits and losses are divided among the partners.
5. See also UPA §§ 31-32 (triggers of dissolution), 33-37 (effects of dissolution on partnership rights).
5. Winding up at Dissolution
1. In some circumstances (i.e. where dissolution is caused by the death of a partner), the winding up will
be accomplished by the partners who are still available to do so.
2. If this is not feasible, or if there is disagreement, a court may order a "sale."
a. Court has discretion as to the appointment of a receiver and as to how the sale is to be
accomplished (e.g. auction, use of a broker, or some other method).
b. Bid rights at winding up: The partners may bid for the assets of the partnership, including its
goodwill (i.e. piecemeal or as a going concern).
6. Judicial dissolution - available if:
1. (1) No reasonable expectation of profit, and
2. (2) The other partner's fault. (Collins v. Lewis - Ct. doesn't order dissolution b/c his fault - responsible
for ongoing capital contributions to partnership).
3. How else can you get out of partnership?
a. Sell interests to someone else. Problem: still have to fund the other guy's money.
c. Foreclose on the loan (wouldn't work in Collins b/c partnership agreement said had to keep on
funding it).
7. Partners may agree to continue in a business until a certain sum of money is earned or one or more partners
recoup their investments, or until certain debts or paid, or until certain property can be disposed of on favorable
terms. This can even be implied, but there must be evidence of the implied term. (Page v. Page - ct. doesn't
imply term on basis of hopes of profit).
1. Courts will only imply a term when a specific undertaking with a finite amount of time.
2. Distinguish Page from Meinhard v. Salmon. Here the partnership is at will. In Salmon, renewal of lease
occurred during partnership. Here, an opportunity might happen but hasn’t happened yet. Both
brothers are aware of it. But in Salmon, other party didn’t know (disclosure issue). Salmon was about
giving partner opportunity to compete.
L. THE CONSEQUENCES OF DISSOLUTION
1. Prentiss v. Sheffel: Partnership-at-will existed which was dissolved by a freeze-out or exclusion of D from the
management and affairs of the partnership.
1. UPA 18(e): Absent an agreement in the contrary, all partnerships share equally in management. Ct.
instead looks at difference in voting powers - only had 15% so low ability to influence management.
2. Pav-Saver Corporation v. Vasso
1. Dale, idea guy, decides to dissolve partnership.
2. Holding: Wrongful dissolution b/c it's in contravention of the partnership agreement (which has a
permanent term). Rights in wrongful dissolution are liquidated damages and rights to continue the
business contained in the UPA (UPA 38(2) (a) & (b)).
3. Did the partners want it to be permanent? Probably not. But it’s how P and court read agreement.
M. THE SHARING OF LOSSES
1. Default rule: Losses follow profits.
 2. Kovacik v. Reed: Ct. tries to fashion new default rule: If one party contributes only services (and other party
contributes only capital), neither party is liable to the other for contribution for any loss sustained.
3. UPA rejects the Kovacik Rule. See UPA 401(b)(1996) commentary. Might seem unfair, but partners should
foresee the application of the default rule may bring about unusual results and take advantage of their power to
vary by agreement the allocation of capital losses.
N. BASIC RULE ABOUT PARTNERSHIPS
1. Implication of being in a partnership: Full personal liability for the acts of your partners and for the
obligation of the partnership.
2. If people have a lot of foresight, can organize a limited partnership and file correct papers in Sec. of State's
office and achieve limited liability for the limited partners in the partnership. Limited partners in LP is supposed
to be a passive activity. Sort of investment partners - just put in capital while GP takes control of management.
3. How can you achieve limited liability for everyone? Make a corp. act as the GP. Then general partnership has
full limited liability for all SHs.

III. THE NATURE OF THE CORPORATION

A. 2 broad categories of corporations:
1. Public (publicly held)
1. Regulated by Sox.
2. Public secondary market in which shares of the company are listed for trade (NYSE/NASDAQ).
2. Close (closely held)
1. Not regulated by Sox.
2. Absence of secondary market for its stock.
3. Often a relatively small number of SHs actively participating in firm management.
4. Many characteristics of partnerships.
B. Basic Attributes
1. Legal personality
1. The corporation is an entity with separate legal existence from its owners.
a. Legal fiction
b. Possesses (some) constitutional rights
c. Separate taxpayer
2. Corps. can sue and be sued (impt. for making Ks).
2. LIMITED LIABILITY
1. See, e.g. MBCA 6.22(b): "Unless otherwise provided in the articles of incorporation, a SH of a corp. is
not personally liable for the acts or debts of the corp. except that he may become personally liable
by reason of his own acts or conducts.
2. **Corps. don't have limited liability. The investors/SHs do.**
3. SEPARATION OF OWNERSHIP AND CONTROL
1. DGCL 141(a): "All corporate powers shall be exercised by or under the authority of, and the business
and affairs of the corp. managed under the direction of its board of directors...."
a. Ownership: SHs.
b. Control: Board of directors.
c. Boards ACT; SHs REACT
2. SHs entitled to vote on:
a. Election of directors (MCBA 8.03-.04)
b. Any amendments to the articles of incorporation and, generally speaking, bylaws (MCBA
10.03, 10.20)
c. Fundamental transactions (e.g., mergers; MCBA 11.04)
d. Odds and ends, such as approval of independent auditors.
3. Separation solves coordination problem where different agendas, interests, etc. Creates problem of
agency costs - arise where divergence of interests b/t owner & agent.
4. Problems from agency costs: Stealing; Slacking; Managers might make decisions investors wouldn’t
have made or wouldn’t want. Idea that managers are unaccountable to SHs.
5. Easterbrook & Fischell's suggestion: Corp. is a contract b/t SHs and managers which make terms
amenable to what SHs would have wanted when they bought in.
a. SHs choose to invest - when coming in, management had to promise to act for them, and do
things that they would want. B/c investors have choices, managers have to do things to
appeal to investors. So at the time of founding of a corp., it is consensual. Underwriter makes
corp. create corporate governance firms favorable to SHs.
6. Corporation law not full of a lot of mandatory terms. Rather, it's enabling (and should be).
a. Not all contracts are bargained for, but all are priced.
 b. Govt. less likely to "get it right" than Darwinian selection in competitive markets.
c. Even if every investor not necessarily reading corporate governance terms to understand the
bargain he is getting, idea that Easterbrook Fischell expound is that there are institutions out
there buying and selling firms on these bases and these people are more likely to get it right
than anyone else.
d. Implication: We can lay off of mandatory corporate law and have largely enabling law b/c the
bargain b/t managers and SHs is priced in competitive capital markets.
7. Exceptions - Under what conditions would mandatory rules be appropriate?
a. Easterbrook/Fischell's theory only works in competitive capital market (publicly-traded).
b. Late-comer terms: Terms that come after contract entered into.
i. SHs have to vote on these terms. Amendments to articles of incorporation. Reflect
the fact that they bought into contract that is being changed and they should have
some approval.
c. If, for some reason, market cannot price its governance terms.
i. E.g. close corps. w/ no market.
d. Information asymmetries
i. Fraud, etc.
8. Principal contract is that b/t managers and SHs. But corp. has many other constituencies. Imagine
corp. as a nexus of contracts (managers, SHs, employees, misc. constituencies, communities,
creditors, all have K w/ board of directors).
4. Liquidity
1. SHs are free to transfer their shares w/o 1st obtaining approval of other participants.
2. Corp. shares highly liquid b/c w/ limited liability, it doesn't matter who other investors are. SHs hardly
ever liable for acts of corp.
a. Partnerships are less liquid b/c of general partnership rule of personal liability.
2. Secondary trading markets, e.g., NYSE and NASDAQ.
5. Flexible capital structure
1. Capital structure: The permanent and long-term contingent claims on the corp.'s assets and future
earnings issued pursuant to securities.
a. Many ways to package such claims; e.g., stocks and bonds.
2. Debt & equity securities.
3. Capital structure terminology:
a. Authorized shares: The articles must specify the number of shares the corp. is authorized to
issue. Corp. may not issue more shares than it is authorized to issue.
b. Outstanding shares: The number of shares the corp. has sold and not repurchased.
i. Only outstanding shares vote.
c. Authorized but unissued shares that are authorized by the charter but which have not been
sold by the firm.
d. Treasury shares: Once issued and outstanding, but have been repurchased by corp.
6. E&E p. 19: Depositors and other contract providers of capital to the corp. have rights fixed by their K (to be paid
interest, make withdrawals, receive account info). Their contractual rights come before the SHs' financial rights
to dividends and payments on liquidation. SH rights are residual. To protect their position, SHs receive voting
rights, litigation rights to enforce management accountability, and liquidity rights to sell their shares.
C. The Incorporation Process
1. In practice, you'll use a service to do the paperwork.
1. Draft Articles of Incorporation (Charter) and
2. File w/ secretary of state of incorporation (and pay fee)...
3. Once filed, company is authorized to act as a corporation.
2. But, where to incorporate.
1. A state may not exclude a foreign corp. (from another state) engaged in interstate commerce.
2. Corporations incorporate in DE - Why?
a. Race to the bottom; to create most invidious, lax standards of corporate accountability. DE
law is largely enabling (managers largely unaccountable) in DE. Managers pick the state to
incorporate in where it's easiest for them to rip off their SHs.
b. Another view: Race to the top. DE wins b/c most SH-beneficial state. B/c when SHs choose to
invest will only choose those that offer best corp. governance terms.
D. Liability for Pre-Incorporation Activity of Promoters
1. "Promoter": person who identifies a business opportunity and puts together a deal, forming a corp. as the
vehicle for investment by other people.
2. Promoter really acts as an agency for a principal, the corp.
1. Under general principles of agency, the promoter (as A) owes a FD to the new corp. (as P). So, if A
does not disclose her financial interest, then A must give the profit to P.
 3. Once the articles are filed, does the corp. become a party to the K? Yes, but not automatically. The corp. must
"adopt" the K (a form of ratification).
4. If the articles are not filed, is the promoter liable on the K? Yes. MCBA 2.04/Atlantic Salmon.
5. If the articles are not filed or are defectively filed, can the defectively formed entity (or individuals) enforce the
K? Yes - Southern-Gulf.
E. PIERCING THE CORPORATE VEIL
1. Veil of limited liability: Shields owners from liability any greater than their investment in the corp.
2. Piercing the Corp. Veil: A court disregards the rule of limited liability and pierces the corp. veil to hold SHs,
directors, and officers personally liable for corporate obligations.
1. Seeks to protect outsiders who deal w/ the corp., particularly involuntary creditors.
3. ONLY in closely-held corps., never in a publicly traded corp.
4. 2 prong analysis to piercing the corporate veil:
1. SEPARATENESS
a. Separate existence/"Alter ego"/personal control...
b. Relevant factors:
i. Commingling of funds
1. Funds have to be treated separately in corp.
ii. Disregard for corporate formalities:
1. Failure to hold SH meetings, board meetings, keep minutes, separate books,
issue stock, etc.
2. BADNESS
a. Fraud or injustice
b. Relevant factors:
i. Undercapitalization
5. Walkovszky v. Carlton: Ct. doesn't pierce veil - seems like undercapitalization but ok - bought the state
minimum of insurance. Not unjust or fraudulent enough to fall under badness - need more.
6. Enterprise liability: Veil stays in place - treats the enterprise as one thing and enables P to go after all assets
of enterprise. Leaves SHs/owners w/ LL but puts subsidiaries under enterprise together.
1. Common theme: The business is really run as one thing. All the same employees, same record-
keeping, etc.
7. Reverse-piercing: Can reverse pierce to get assets of corp. for personal suit or to pierce the veil of another
corp. that the SH owns (Sea-Land - alleged the corps. alter egos of e/o and hide behind the veils of alleged
separate corp. existence to defraud P and other creditors. Ct. doesn't find sufficient fraud/injustice to pierce).
8. Tort vs. Contract Piercing (Silicon Implants)
1. Torts: Care about making the injured party whole and internalization of risks.
a. Less about formalities than K.
b. Undercapitalization? Yes.
c. Only have to find lack of separateness.
2. Contracts: In a K case, you can always ask for a guarantee of liability from the owner. This is why
LLCs aren't as good for individual business owners. We shouldn't allow piercing all the time in a K
case b/c you can get compensated for it ex post w/ a higher rate of return and ex ante w/ a guarantee
of liability.
a. Formalities protect duty of due diligence. Care about fraud in K cases. Representation to you
that things would be one way, which later turns out to be a misrepresentation which you relied
on. Care less about undercapitalization that in torts cases.
b. Need more than separateness - need fraud/injustice.
9. Costs/Benefits of Limited Liability
1. Costs:
a. Increases possibility of externalities, which may lead to moral hazard.
2. Benefits:
a. Enables separation of ownership and control.
b. Permits diversification.
c. Promotes liquidity.
d. Eliminates costs of monitoring other SHs.
F. The Role and Purposes of Corporations
1. If you have control of a corp., you are free to donate corporate funds. Limitations of charity rule:
1. A.P. Smith Mfg.: Statutory cap (more than 1%).
2. Can't give away to a pet charity (ex. Brother chair of an organization that you donate to).
3. Corporate benefit - there must be a benefit to the corp. (can't be more for personal gain).
a. Benefit to corp. can go from concrete to abstract – cts. generous in finding benefit.
 b. Need benefit b/c background principle of SH profit. This is a limitation on ability of board of
directors to give money.
2. 2 main characteristics of corps.: (1) Directors have high discretionary authority, and (2) corps. are
created for SH profit, and director discretion must be directed at SH welfare.
3. Corporate purpose: SH WEALTH MAXIMIZATION
1. Dodge v. Ford - Dodge sues claiming not running company for maximum SH wealth. An economic
justification for what Ford did, but lose b/c of his testimony.
4. Board of directors: AGENTS of SHs
5. Jensen & Meckling: Theory of the Firm
1. Agency costs: Sum of:
a. Monitoring Expenditures
b. Bonding Expenditures
c. Residual loss: Loss represented by divergence b/t agent's and principal's interests.
2. J and M say things you can do to mitigate these losses.
6. BJR : Courts won't get involved in deciding the rights and wrongs of business decisions.
1. SHs have no recourse against directors making business decisions. What can they do?
2. Allege directors not making business decisions (Wrigley: P framed Wrigley's decision about lights
as ideological interest, not a business one - said board not making decisions to maximize profits. D
wins b/c legitimate interest to be concerned w/ neighborhood).
G. LLC: Limited Liability Company
1. A cross b/t partnership and corporation.
1. Tax advantages of partnerships (pass through taxation).
2. Limited liability of corporations.
3. None of the restrictions (e.g. number and type of SHs) applicable to S corporations.
a. Can't go public as an S corp. or an LLC. But less restrictions.
2. Formation
1. File Articles of Organization in designated State office. ULLCA 202(a)
2. Required and optional contents set forth in ULLCA 203.
3. Filing fees and $800 minimum franchise tax.
3. Common denominator w/ all limited liability entities: FILING MATTERS.
1. Become a partnership by acting like partners. Become a corp., LLC, etc. by filing papers.
2. Only the articles of organization have to be filed (not operating agreement).
3. Filing puts everyone on notice that they are dealing w/ a company w/ limited liability. So, if they
want recourse have to contract for a personal guarantee to make the owners liable.
4. Other formation tasks:
1. Choose and register name.
2. Designate office and agent for service of process.
3. Draft operating agreement: basic contract governing the affairs of an LLC.
5. Filing not enough - other side must be on NOTICE (saying LLC).
1. Water, Waste & Land: Basic agency principal - Correctly filed, but Clark never told Westec working as
a member of the LLC (failed to disclose the principal (LLC)).
a. An agent is liable on a K entered on behalf of principal if the principal is NOT FULLY
DISCLOSED. (Atlantic Salmon).
b. LLC members normally not liable on correctly made K's, but here undisclosed principle so
liable.
2. Certain kinds of businesses where the members can't be shielded - law, accounting, medicine.
6. Members' Interests
1. Financial Rights...
a. Profit and Loss Sharing.
i. Absent contrary agreement, profits and losses allocated according to members'
contributions.
1. Different from partnership default rule (where P & L's are equal).
b. Withdrawal:
i. Member may withdraw and demand payment of his/her interest upon giving the
notice specified in the statute or the LLC operating agreement.
1. In partnership, withdrawal = dissolution.
c. Interests assignable (unless otherwise provided in LLC agreement).
i. More liberal than partnership rules.
2. Management Rights...
 a. Absent contrary agreement, each member has equal rights in the management of the LLC,
ULLCA 404(a)(1).
i. Most matters decided by majority vote. ULLCA 404(a)(2).
ii. Significant matters require unanimous consent, see ULLCA 404(c). E.g., merger,
admission of new member, dissolution, etc.
b. Manager-managed LLC option available, UCCLA 404(b).
i. Can be structured as a "board of directors," a CEO, or both.
ii. Must be specified in articles of organization
7. Operating agreement - mandatory rules are those that have a 3rd party effect. If not, can be contracted
around. (Elf Atochem: jurisdiction doesn't affect 3rd parties so can be contracted around).
8. FIDUCIARY DUTIES OF LLC'S
1. Manager-managed LLC's (become an LLC and appoint special managers)
a. The managers of a manager-managed LLC have a duty of care and loyalty.
b. Usually, members of a manager-managed LLC have no duties to the LLC or its non-manager
members by reason of being membered.
c. Structured like a corp. Manager-members are like the board of directors, who owe a FD to the
other (non-manager) members (SHs), who don't really have FD's to e/o.
2. Member-managed LLC's
a. All members of a member-managed LLC have a duty of care and loyalty.
b. Manager-membered LLC's appoint special managers. In member-managed LLC's, like a
partnership - all have FD to each other.
3. Derivative Actions
a. Members may bring an action of behalf of the LLC to recover a judgment in its favor if the
members w/ authority to bring the action refuse to do so.
2. Does Meinhard v. Salmon rule apply to LLC's? YES
1. (But in McConnell v. Hunt parties contracted away the default rule, allowing members to compete.
SECRECY point. Court must have construed it to say disclosure was met. Narrow reading of Meinhard
which requires disclosure, and not just disclosure + sharing forever).
2. Contract alters the FD, but doesn't erase FD.
10. Exception to Limited Liability - PIERCING the LLC Veil
1. To what extent should the corporate law rules apply to LLC's?
a. Sometimes statute answers (or court).
b. ULLCA doesn't follow basic piercing rule. 303(b): failure of an LLC to observe the usual
company formalities is not ground for imposing personal liability
c. Reasons it shouldn't be allowed? #1 justification for LL of a corp. is sep. of ownership and
control; liquidity; enabling diversification. Doesn't apply to LLC's - smaller and don't have
same coordination problems requiring separation of ownership and control.
11. Dissolution
1. New Horizons v. Haack: Kickapoo goes out of business; New Horizons becomes creditor.
a. Trial court allows for piercing of Kickapoo through alter ego theory. Mrs. Haack treating LLC
as her own; treating proceeds as her own, as personal income. Problem w/ theory: This is
what it means to be an LLC. To get flow-through taxation and get taxed as an individual on
proceeds of business. Poor reasoning.
b. Appellate court says improper dissolution procedures - Improper winding up. Creditors
need to be paid a certain way, and if formalities of dissolution are not respected, creditors may
not be able to get paid as they should.
H. DERIVATIVE SHARHOLDER ACTIONS
1. SH's derivative suit: Brought on behalf of the corp. on grounds that the corp. is being cheated by corrupt
actions from w/in. Proceeds go to corp., not SHs.
1. Ex.: Excessive exec. compensation (corp. waste) and other breaches of FD.
2. Contrast w/ Representative (direct) class action: Injury to SH individually; not the corp.
1. Ex.: Voting rights
3. Bond requirement (Eisenberg).
4. Demand Requirement: SHs must make demand and ask that Board pursue the suit. Asking them b/c it’s
essentially the corp.'s claim.
1. If board says no, you can bring a suit for wrongful refusal.
2. When will demand be excused?
a. Majority of board has material financial or familial interest;
b. Majority of board is incapable of acting independently for some other reason such as
domination or control;
 c. Underlying transaction is not the product of a valid exercise of business judgment (i.e. BJR
would not apply).
3. All P has are "tools at hand" - Ability of SHs to inspect the books and records to see the minutes from
board meetings. But board minutes are usually drafted by lawyers who know to avoid placing these
kinds of things in the minutes. Other "tools": Filings w/ SEC; News media.
4. Best way is try to bring a direct suit - doesn’t require demand.
5. If demand is required, you have to make it and you're stuck if board says no.
6. Wrongful refusal distinguished from excusal
a. SH, by making demand, does not waive his right to claim that demand has been wrongfully
refused, BUT waives his right to argue that demand is excused.
7. Purposes of Demand Requirement
a. Relieve courts from deciding matters of internal corp. governance by allowing corp. boards to
correct problems before resorting to litigation.
b. Provide corp. boards w/ reasonable protection from harassment by litigation on matters clearly
w/o discretion of directors.
c. Discourage strike suits for SH gain rather than benefit of corp.
d. (Doesn’t work well - courts sift through these cases primarily through BJR rather than demand
requirement).
5. Marx v. Akers - Case on Futility
1. P's claims: (1) Excessive Executive Compensation and (2) Excessive Director Compensation
2. NY ct. rejects DE and Universal Demand Rules (require demand every time - ct. wouldn't look at futility
arguments but only wrongful refusal arguments). In the end - same analysis: Is board of directors
acting in SHs' best interest? By deciding not to bring suit, is it protected by BJR or motivated by
something else?
3. Akers court "elaborates" Barr...
a. Worried about precedent allowing Barr standard to never require futility argument.
i. Self-interest in the transaction or loss of independence b/c a director w/ no direct
interest is controlled by a self-interested director.
ii. Directors "fail to inform themselves to a degree reasonably necessary about the
transaction."
iii. Challenged transaction so egregious on its face that it couldn’t have been the product
of sound business judgment.
b. Court getting involved in making BJR analyses at this point in the litigation. Substantive stuff
for demand excusal, futility, etc. comes from BJR.
4. Some of the board received excessive compensation and the rest did nothing about it. Court's
analysis: Futility not established.
6. Derivative suit both responds to and creates incentive problems.
1. We have to solve collective action problem on the part of the SHs to encourage suit. Liability threat
forces board of directors to correct actions and engage their FD. Thus, the class action - meant to
solve that incentive problem for the SHs.
2. But, creates another incentive problem - possibility of too much litigation. We worry about too much
litigation in derivative suit b/c in derivative suits in particular, frivolous claims are brought.
7. Incentive problems:
1. Directors and officers: The ones getting sued - potentially liable; on the hook for losses.
a. Idea of holding them liable for bad decisions w/o giving them the upside of good decisions
(e.g., equity) seems wrong.
c. So what incentive do they have in becoming a board member? Want a promise of D&O
insurance and corp. indemnification.
2. Incentives in derivative litigation (at the beginning of suit): Everyone wants suit to go away except
lawyers (money).
3. If Ps succeed in getting past procedural obstacles (past motion to dismiss), interests diverge.
a. Directors and officers want the suit to go away - settle the suit as quickly as possible b/c they
don't fund the settlement.
b. Same with Corp.
c. D&O insurance: Might be doing costs/benefits analysis. Might have a slightly different interest
than D’s and O’s b/c funding costs of settlement. 1 bad effect of settlement = more litigation.
Care about systematic increase in litigation across market.
d. Lawyers: settle b/c they want money.
i. In SH derive suits, representing a large class of people and don't care about them
individually. Agency costs problem b/t lawyer and client in derivative suit.
 ii. Risk: A lot of settlements for not much recovery to Ps but for reimbursement of costs
to Ps' attys.
4. Romano: The SH Suit: Litigation w/o Foundation?
c. In deriv. suits, SH Ps rarely recover money, but Ps' attys. recover almost all the time.
d. Incentives strongly in favor of (low-cost) settlement. Liability insurers would rather fight but will
fund settlement if it is cheap - they do this by getting low enough settlement to give no money
to SH Ps but to pay lawyers.
e. What do SH Ps get? If not $, get non-monetary things (promises) to change policies, to rectify
a wrong.
f. DE has to approve settlement. Why do they allow this?
i. Corps. ultimately bear costs. D’s and O’s don't like it either. Not good for SHs b/c
monetary settlements only occur in minority of cases. Who is it good for?
ii. DE law: race to bottom/race to top? Only people who benefit are lawyers.
8. Role of Special Committees
1. Auerbach (NY): 2 tiers of review:
a. SLC Processes (independence, structure of committee).
b. Merits of SH claim
c. BUT NY only reaches level 2 if the SLC fails level 1
i. NY more deferential to management.
2. Zapata (DE): 2 tiers of review:
a. SLC process AND
b. Court undertakes independent inquiry into the merits of the SH claim (applying its own BJ).
Also apply public policy consideration - look at what’s good for society.
c. DE does both.
3. DE seems more anti-management compared to NY rule - better for SHs and lawyers (extra level of
review, more arguments, docs, etc).
a. Why does DE have more restrictive rule? Court suggests, since board appoints other directors
and committee members, that other feelings might influence decision - making of SLC -
"independence"?
4. Oracle - DE case
a. SLC concludes Oracle shouldn't pursue Ps' claims. Ties among SLC come out.
b. Judge talks about these ties not as financial, but as social ties.
i. Anytime there is structural bias like this, could apply to any level of procedural history
in derivative suit.
ii. It seems like this explanation - structural bias - proves too much. Could prob. be
raised in a large number of corp. law cases. You can almost always connect 2 board
members in U.S. w/ e/o in a couple steps.
5. Martha Stewart case: Issue comes up at demand refusal/futility point in the case. Structural bias
alleged in both cases. DE ct. says doesn't have to overrule Oracle b/c cases are distinct.
a. DE ct. said friendship is not enough w/o more to rebut presumption of independence.
b. Back to old test from before Oracle - Question is whether the personal connection calls
independence into reasonable doubt:
i. Financial ties.
ii. Familial affinity.
iii. Or a particularly close or intimate personal or business affinity.
c. This doesn't overrule Oracle b/c factual distinction. However, fairly clear indication that
structural bias hypothesis is NOT going to be adopted w/ lasting effect in DE.

IV. THE DUTIES OF OFFICERS, DIRECTORS, AND OTHER INSIDERS

A. The Obligations of Control: DUTY OF CARE
1. BJR protects board from negligence if normal business decision.
1. BUSINESS JUDGMENT RULE: Can make dumb decisions and not be held liable under DOC.
2. Idea that SHs more efficient bearers of internal risks - encourages investment (but not all risks -
embezzlement, etc.).
2. BJR doesn’t apply to acts made in bad faith and self-dealing.
2. Smith v. Van Gorkom: The 1 case in which a public company board of directors is found liable for the
breach of DOC notwithstanding the BJR.
1. Standard of BJR: Gross negligence.
a. Court tries to find things to prove that the board did things that were bad, but seems hard to
find gross negligence.
 b. Court holds directors breached their FD (duty of care) to their SHs.
c. Huge mistake by DE Supreme Ct. – Corporate Law v. Corporate Governance
d. Van Gorkom allowed for judicial expansion.
e. W/in a year, legislature passes DGLC 102(b)(7), which moves the frontier back. Gives a
maximum scope of board authority and very little judicial accountability.
3. DGLC §102(b)(7): Allows any corp. to include in its certificate of incorporation a provision eliminating or
limiting the personal liability of a director to the corp. or its SHs for monetary damages for breach of FD as a
director.
1. Doesn't eliminate or limit the liability of a director for (1) breach of director's duty of loyalty, (2) acts or
omissions in bad faith, intentional misconduct, or knowing violation of the law, or (3) transaction from
which director derived improper personal benefit (e.g. insider trading), etc.
2. This leaves out negligence/DOC. If D shows provision in charter reflecting 102(b)(7), suit immediately
dismissed and courts are never involved in 2nd guessing decisions of the board in DOC rubric.
4. BJR protects business decisions. To make a business decision, must be fully informed.
1. Francis v. United Jersey Bank: Breached DOC by failing to remain fully informed (read financial
statements). This is gross negligence. 1 oddity of case: Creditors are suing to enforce the duty of
care/FD. FDs are owed to SHs, not creditors - prob. b/c diff. type of business.
5. Why would SHs agree to BJR ex ante? Who is the BJR good for? Does it benefit SHs?
1. Risk aversion.
a. We want businesses to make risky decisions - Can argue that w/o BJR corps. would be too
risk averse and afraid to make risky decisions.
b. But why do directors get to benefit from gross negligence when rocket scientists and
neurosurgeons don't? Possible that the stakes are different; diff. beneficiaries.
2. In a way, the BJR protects SHs from each other (and keeps down litigation costs).
3. Limitations of BJR?
a. BJR does not protect: Fraud, Illegal Conduct, or Self-Dealing.
b. Loose constraint of SH wealth maximization. Ford v. Dodge. Courts wont make directors
stretch on the purpose test, but has to be in the background.
7. Caremark: Failure to actively monitor company claim - DOC case.
1. Court draws a distinction b/t Directorial Decisions (normal BJR) and Unconsidered Inaction (failure
to monitor - directors failed to do anything to make sure violations of law didn't occur).
a. How much monitoring is required?
i. Level of detail of monitoring is a "question of business judgment."
ii. Seems like there wont be many suits for failure to monitor b/c extent of monitoring
should be protected by BJR.
ii. "But duty to attempt in good faith to assure that a corporate info and reporting
system, which the board concludes is adequate, exists."
2. What would Ps have to show to establish a violation under Caremark?
a. Directors knew or
b. Should have known about violations, and
c. Made no good faith effort to prevent/remedy, and
d. Such failure proximately caused the loss.
B. DUTY OF LOYALTY - Directors and Managers
1. Fiduciary must exercise his authority over the corp. processes or property in a GF attempt to advance the
corp’s interests and not simply to advance his own or other interests. Applies to directors, officers, and
controlling SHs.
1. Directors have a duty to the corp. & its SHs.
3. Categories of DOL issues:
1. Self-Dealing - direct conflicts of interest;
2. Compensation;
3. Transactions related to power over corp. property – inside info. and corp. opportunity;
4. Mixed motivation conflict – not direct, but director has some interest – e.g. M&A deals and takeover
defenses.
4. Standard of review: Most rigorous scrutiny (Bayer v. Beran).
1. Where a conflict is found standard shifts from highly deferential standard of BJR to Entire Fairness -
transaction has to be entirely fair to SHs.
a. Ask: Does the resulting transaction approximate an arms-length deal?
b. If P establishes conflict, burden shifts back to board to prove "fairness" of transaction.
5. Lewis v. S.L. & E.: Conflict b/t brothers - SHs of 2 companies (claim undercharging on lease). Board couldn't
show transaction was fair; lose.
 6. RATIFICATION - DGCL §144: Interested Director
1. If there is a conflict, board has 3 choices for approval:
a. (1) Disclose the conflict to the board. If disinterested board approves it, it's fine.
b. (2) Disclose conflict to [disinterested] SHs, and SHs can then approve the transaction.
i. In both i and ii, burden never shifts to board to prove the transaction was fair.
ii. SHs can still void transaction by showing it was unfair. Hard burden to meet.
c. (3) Transaction is not automatically void, but burden shifts to board to show it was fair.
d. If you get approval under a1 or a2, the SHs can only attack transaction by showing
unfairness, like BJR. If no approval under 1 or 2, only ok if majority board can show it was fair.
Interested majority does not work under either one.
7. CORPORATE OPPORTUNITIES
1. Four factors (Broz):
a. Is the corp. financially able to take the opportunity?
b. Is the opportunity in the corp.'s line of business?
c. Does the corp. have an interest or expectancy in the opportunity?
d. Does an officer or director create a conflict of interest by taking the opportunity?
2. Broz: CIS isn't financially able to take opp. so no violation of DOL.
a. Court rejects influence of PriCellular used by lower ct. Acquisition hasn't yet closed,
contingent, early stage in the transaction, would open up too much litigation.
3. eBay : SH claims a corporate opportunity problem: directors took spun shares of IPO's for
themselves that should have been going to eBay.
a. In eBay's line of business: Directors invested a lot of money in the company.
b. Interest/expectancy: Shares hard to come by and only came to CEO b/c he was CEO.
c. Conflict of interest: Easier to show. Pick Goldman and keep getting free money.
d. What opens all spinning cases to corporate opportunities doctrine? Line of business prong.
Many corps. invest in securities to expand their capital accounts. If this is considered in the
line of business, this is considerable possible expansion of doctrine.
e. Problem w/ spinning: A genuine DOL problem. Fits in corp. opportunity doctrine b/c
corp. opportunity a subspecies of DOL.
8. DOMINANT SHAREHOLDERS
1. Controlling SHs have FD duties similar to those of director b/c have sufficient voting shares to
determine the outcome of a SH vote.
2. SELF-DEALING: receiving something from the subsidiary to the exclusion of and detrimental to
its minority SHs - (Sinclair: Ps win on self-dealing in breach of K claim).
a. Normally DOL and other FDs don’t apply among SHs except when a controlling SH.
3. FAILURE TO DISCLOSE - Zahn v. Transamerica Corp.: Majority SHs knew something the outsiders
didn’t know and failed to inform them. Argument that the A SHs would have converted their shares if
they had known. Breach of FD was failure to disclose.
9. Presumption is that directors have fulfilled DOC and DOL.
C. Disney cases: Good faith - suggests there is a separate liability prong on the basis of good faith.
1. Brehm v. Eisner (2000)
1. 3 DOC claims:
a. Process DOC violation (DOC is mostly process) when board entered into agreement;
i. Say board of directors is uninformed. Ct. relies on 141(e) so claim goes away.
b. Substantive DOC violation when board entered into the employment agreement;
i. No such thing as "substantive due care." CB 352. Under DOC, BJR applies, so we
never look at the substance of the BJ as long as no gross negligence. Contrast w/
DOL, in which if you find a conflict, analyze substance of BJ to see if fair.
c. (Process) DOC violation in agreeing to no-fault termination.
i. Agreeing to no-fault termination was rational, a business decision.
ii. Why didn’t the board fire him for cause? High costs/standard to meet.
2. 2003 Chancery Ct. opinion: Good faith basis of decision b/c no doctrinal basis for argument about DOC or
DOL. No DOL conflict, and no DOC b/c Disney has 102(b)(7). Complaint survives on basis of bad faith.
2. Bottom of p. 4, chancellor attempts to define bad faith: consciously and intentionally disregarded their
responsibilities...knowing or deliberate indifference...knew...simply did not care. Sounds like
indifference.
3. Good Faith Thaumatrope: Alternation b/t issues of care (process) & issues of loyalty (conflict).
4. Shifting the Authority/Accountability Balance...a middle space b/t care and loyalty for good faith?
3. 2005 Chancery Court opinion
 1. Differentiates b/t corporate governance ideals and legal standards. Court steps back.
2. What does GF mean in 2005? Directors act in bad faith act "for some purpose other than a genuine
attempt to advance corporate welfare." (*170).
a. Ex.: act for self-interest and disadvantage SHs to advantage themselves financially, but also:
greed; hatred; lust; envy; revenge; shame.
3. Ds win b/c ct. no longer believes that the board was motivated by desire to please Eisner.
4. 2006 Del. Sup. Ct.
1. "Grossly negligent conduct, without more, does not and cannot constitute a breach of GF." (6)
a. So DOC remains in place.
2. **p. 8: "the universe of fiduciary misconduct is not limited to either disloyalty in the classic sense or
gross negligence...To protect the interests of the corp. and its SHs, fiduciary conduct of this kind,
which doesn't involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross
negligence...a vehicle is needed to address such violations and that vehicle is the duty of good faith..."
a. Seems like the sup. ct. is refining loyalty.
b. Disloyalty might be more than just strict conflict of interest/familial conflict...may cover broad
group of situations where you act not in furthering interests of corp. (like Oracle).
3. 2006 opinion: in certain circumstances, we should define the duty of loyalty more broadly.
5. What explains the disruption that occurred in 02 and 03 in the context of the Disney litigation and in Oracle?
View that judiciary tries to maximize its authority. 2 threats to authority of DE judiciary:
1. Corporate Migration:
a. The "race" debate - horizontal competition.
b. If DE doesn’t do the right thing, corps. can always leave DE. Bad for everyone in DE,
especially legislatures, b/c if have to tax humans rather than corps., won't vote for you. This is
why 102b7 trumps Van Gorkom - thought it might lead to corps. leaving state.
2. Federal Preemption (vertical competition, where federal judiciary gets involved in changing the law
(Sox) - also DE legislature (102b7)).
3. In b/t the 2 threats lies the space of judicial authority.
6. Structure of DE law as a story of expansion and contraction...
1. High scandal = heightened risk of federal intervention --> judicial empowerment (boards more
accountable to courts)
2. Lesser scandal and lesser risk of federal intervention = pressure from corps. to reduce judicial activism
and return DE model to board authority.
2. What does good faith mean? Seems like DE Sup. Ct. wants to understand it as a way of understanding
loyalty as a broader way to define it than traditionally defined, but NOT a separate cause of action.
D. DISCLOSURE AND FAIRNESS
1. SECURITIES REGULATION
1. Securities Act of 1933 (aka "Securities Act" or "33 Act")
a. Regulates issuance of new securities (offering and sale of new securities).
2. Securities Exchange Act of 1934 (aka "Exchange Act" or "34 Act")
a. Regulates secondary market activity (b/t diff. buyers of a corp.'s securities).
b. Created the SEC.
3. The SEC
a. Independent agency.
b. Enforces the securities laws.
b. Promulgates rules and regulations to implement those laws more effectively.
4. Purposes of the Securities Laws
a. Provide for full DISCLOSURE
i. **1 word to define securities regulation = DISCLOSURE**
b. Prevention of fraud
5. Duty to disclose? Wanted something to protect SHs from being taken advantage of by corp.
6. A market wide incentive to disclose both good and bad news.
7. Federal regime of securities regulation - think of as mandatory disclosure.
8. Fraud already illegal so there were remedies before Acts formed.
2. 2 Approaches to Disclosure
1. Securities Act
a. Transactional
i. Registration statement filed w/ SEC.
ii. Prospectus distributed to investors.
b. Required in connection w/ any public sale of securities (unless an exemption applies).
2. Exchange Act
 a. Periodic (annual, quarterly, and episodic).
b. Only required of registered companies.
3. Exchange Act §10 (b): Statute is not self-executing - the statute doesn't make the rule. The outlawing is to be
done by the commission - that's why we have Rule 10b-5.
4. Rule 10b-5: Employment of Manipulative and Deceptive Practices:
1. It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of
interstate commerce, or of the mails or of any facility of any national securities exchange,
a. (a) To employ any device, scheme, or artifice to defraud,
b. (b) To make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances under
which they were made, not misleading, or
c. (c) To engage in any act, practice, or course of business which operates or would operate as
a fraud or deceit upon any person, in connection with the purchase or sale of any security.
2. **Most important statute - leads to many class actions.
3. 10b-5 not principally about insider trading. Most important 10b-5 litigation is usually about
misstatements, and price reaction follows.
4. Protects purchasers and sellers, publicly traded and closely held securities.
5. **No 10b-5 cause of action for omission unless there has been a prior misstatement that you have a
duty to correct.
1. If you say anything, it should be accurate.
2. Generally, no duty to disclose merger talks.
6. Standing: To bring a 10b-5 claim you must be purchaser or seller of securities. This includes options
(Deutschman v. Beneficial), but not people who would have bought or sold securities.
1. Put option: Right to sell.
2. Call option: Right to buy.
a. Options can be used to leverage your risk. All you will lose is price of option.
7. Traditional 10b-5 analysis:
1. (1) SCIENTER: Intent to deceive, manipulate, or defraud.
2. (2) PROXIMATE CAUSE: Misstatement caused the harm. Causation is about price.
3. (3) MATERIALITY: Reasonable person standard - viewed to significantly alter the total mix of info
made available. Probability/magnitude (p. 454-55).
4. (4) RELIANCE: Purchasers/sellers rely on the statement in entering into the transaction.
8. "FRAUD ON THE MARKET" theory (Basic v. Levinson - denied merger talks - violation of 10b-5):
1. Securities markets take info in, and as a result of the info, alter the expectations or value of the
securities on the market.
2. (Rebuttable) Presumption that investors relied on the "integrity" of market price - so investor
need not have seen misrepresentation.
3. Requires:
a. Material public misrepresentation.
b. Efficient market.
4. Once you have fraud-on-market theory, 4 requirements collapse into 2: P usually must prove a false
story, decline in price. Prove sold on the basis of the price to presume reliance.
5. How does info get into price?
a. Professionals adjust their reservation values to new info and won't buy or sell except at prices
reflecting the new info.
a. The market impounds info - usually does well, even w/ irrationality, except w/ liquidity
constraints (shares must be actively traded).
7. A rebuttable presumption of reliance - shifts the burden of arguing about reliance onto the Ds
instead of the Ps.
8. How can D rebut fraud on the market presumption?
a. Pros not deceived.
b. Truth entered market despite misstatements.
c. Specific Ps would have sold anyway.
9. Public vs. Private info - For fraud on the market theory, Only PUBLIC info affects price of
securities (West v. Prudential - no violation b/c info (lie) was private and Ps didn't hear/come to rely
on info and didn’t change price).
a. Fraud-on-the-market theory: if there is a misrepresentation/lie, it's in the market price.
b. Easterbrook: Private info can sometimes affect price (depending on (1) identity of trader and
(2) very large volume trade causing market maker to think there's info behind the trade). But
for other kinds of investments, don't need a large volume trade to impact upon the price.
 Commodities are based on demand curves which slope downward. Securities supply depends
on info about risk and return blend of that security. Securities have flat demand curves - only
sell at a given point. At a dollar more, no demand; dollar less, infinite demand.
2. Must show info caused price to change.
2. ** In securities law, no BJR. Factfinder will make factual findings about what was actually going on.
3. Internal Affairs Doctrine: Corp. law is determined by the state of incorporation, not the fed. govt. Ct. won't
federalize corp. law absent clear Congressional intent.
1. Santa Fe Industries, Inc. v. Green: Ps claim 10b5 violation - freeze-out of minority SHs at an
inadequate price w/ a fraudulent appraisal. Ps say the deceptive device is the transaction itself.
a. Ct. finds no 10b-5 violation. Transaction is legal under DE law - Ct. is worried about
preempting state corp. law.
2. Creeping Federalization:
a. Proscribed transactions
i. States previously chose not to proscribe these transactions. Federal govt.
rewrote state law.
ii. Ex: Sox - clearly preempts state law - Congress can change corp. law.
b. Board procedures
i. Has made NY a lesser financial center than London and Hong Kong.
c. Board structure
E. INSIDE INFORMATION
1. Martha Stewart Case: ImClone insider found out drug wouldn’t get FDA approval. Sold and tipped.
Broker called his best clients, including Stewart, who sold.
2. Pre-10b5: Common Law of Insider Trading - 3 Rules:
1. "No duty rule." Liability only for actual fraud (misrepresentation or fraudulent concealment).
2. "Duty to disclose" rule: Got info as insiders, duty to disclose to SHs before trading w/ them.
3. "Special circumstances" rule. Generally no duty to disclose, unless special circumstances,
especially 1) concealment of identity by the D and 2) failure to disclose significant facts having a
dramatic impact on the stock price.
4. Goodwin v. Agassiz: SH sold shares to director of corp. through Boston Stock exchange - D
knew geologist may have found copper - P claimed D committed fraud b/c knew something P didn't.
No insider trading b/c anonymous trade and no contact b/t buyer and seller (but status as
directors/SHs would prob. bear on ruling today). Would be insider trading under 10b-5.
5. SEC v. Texas Gulf Sulfur Co.: Same case, but after 10b-5 - mineral rights but don't want to
tell public. Insiders buy more shares b/c know will be valuable when info goes public.
a. Lie in press release - simple 10b-5 argument - misrepresentations are most important
aspect of 10b-5. 4 elements fulfilled (reliance - just show these shares are traded on liquid
exchanges, in which prices come from public info, which they are).
3. INSIDER TRADING
1. "...anyone...trading for his own account in the securities of a corporation."
2. "...access, directly or indirectly, to info intended to be available only for a corporate
purpose..."
a. Covers anyone, not just an insider, in possession of material inside info — info that
would "have a substantial effect on the market price of the security if disclosed."
3. "...take advantage of such info knowing it is unavailable to those w/ whom he is
dealing, i.e., the investing public..."
4. If a would-be trader has material inside info, then he must either (1) DISCLOSE it to the
investing public, or (2) ABSTAIN from trading in or recommending the securities...while such
inside info remains undisclosed.
a. How to determine if info is material? Material when they trade on it. Problem:
materiality is a component of what it means to engage in insider trading - a circular argument.
b. Texas Gulf: Ct. says they traded outside the line of their ordinary trading. Trading
would only not be material if trading was in line w/ usual trading - a situation where D might be
able to rebut materiality.
5. Safe to trade having disclosed only after effective dissemination to trading public - out where
traders can act on it.
6. Question Remains: What IS material inside info?
4. Chiarella: Duty to abstain or disclose arises from the relationship of trust (fiduciary
relationship) b/t a corp.'s SHs and its employees (insiders) - duty not from trading but from fiduciary
relationship.
1. Chiarella (financial printer) not an employee of the corp. whose shares had been traded (the
target company), so he had no duty.
 5. Dirks v. SEC: A TIPPEE assumes a FD to the SHs of a corp. not to trade on material nonpublic info
only when (1) the insider has breached his FD to the SHs by disclosing the info to the tippee and (2) the
tippee knows or should know that there has been a breach.
1. Under Chiarella rule about how material inside info is transmitted, Dirks wouldn't get in trouble
b/c he's an insider of another company. SEC wants to get Dirks anyway under a broad rule - material
inside info stays w/ the info.
2. How to determine whether there has been a breach of the insider's FD?
a. Depends on the purpose of the disclosure.
b. Test is whether the insider personally will benefit, directly or indirectly, from his
disclosure.
c. Absent some personal gain, there has been no breach of duty to SHs.
2. Ct. says tipper didn’t breach FD. Purpose was to get the fraud out; no financial personal gain.
If there is no breach by Seacrest, there cannot be a breach by Dirks.
3. Lawyers/accountants? See FN14: Relationship constructed b/t firm and outside
lawyer/consultant when info transmitted legitimately. Outsiders might become fiduciaries of SHs
through their engagement by the corp. So now have a duty to keep that inside info quiet.
6. U.S. v. O'Hagan - Misappropriation theory: A person commits fraud in connection w/ a securities
transaction, and thereby violates 10b and 10b-5, when he misappropriates confidential info for securities
trading purposes in breach of a duty owed to the source of the info.
1. Here, O'Hagan has FD to D&W (his law firm - source of info).
2. A fiduciary who discloses his trading intentions or receives permission to trade from the info
source would escape 10b-5 liability, since arguably no breach of abstain or disclose duty.
2. Why regulate insider trading?
1. Argument: Best thing for securities markets is to immediately reflect info, and best way to get
this is to give people who have this info incentive to use it - no liability from insider trading so the info
would get disseminated more quickly.
2. We require info asymmetry and don't regulate it. But seems like people would feel they were
at a disadvantage by trading w/ insiders.
F. Rule 16(b): Profits from purchase and sale of (equity) security w/in 6 months
1. A rule about what beneficial owners (10% owners) and insiders (directors/officers) can do w/ their
holdings w/in a 6-month period.
2. Take a 6-month period and match sales and purchases. Doesn't matter which came first or if they are
related or not. If there is gain on those transactions w/in 6 months there is strict liability under 16(b) for
gain realized on those transactions.
3. For beneficial owners, must be a beneficial owner at the time of the purchase AND the time of the sale
(must be a BO immediately prior to sale – purchase making someone a BO doesn’t count, but sale making
someone no longer a BO does).
4. For insiders, just have to be an insider at either the time of purchase OR the time of the sale. Only
have to be an insider once.
5. Sometimes described as an insider trading rule b/c it applies to insiders and beneficial owners. But this
rule wouldn't have prevented in the insider trading in Dirks, Chiarella, or O'Hagan, and many ways to get
around 16b. So what is this rule designed to do?
1. Prevent manipulation: Make insiders and BO's disgorge their profits from manipulation, not
necessarily insider trading.
2. Large owners or insiders can sometimes move the market/manipulate the price of stock.
Trading on the basis of knowledge insiders might possess, which could cause price to go up or down.
6. 16b doesn't apply to private companies (companies registered under 1934 Act).
7. Reliance v. Emerson: Sell enough stock to only own 9.96%. Then sell the rest b/c no longer a BO.
1. Captured by rule 16b for 1st transaction. But 2nd sale of 9.96% not captured by rule b/c by
that time, under 10% and no longer beneficial owners. Ct. doesn't care that doing it to evade rule.
G. Shareholder litigation
1. State law derivative suits.
1. Manager breach of duty in taking from the corp. – many procedural obstacles.
2. State law direct suits.
1. Manager breach of duty in taking from the SH individually, especially in acquisitions.
3. Securities law suits.
1. Framed around misrepresentations or inadequacies in corporate disclosure.
2. Basic concern is that company managers misused their positions to the disadvantage of their
SHs.
2. Benefit of filing a securities suit: No procedural obstacles of derivative suits.
 3. Protecting directors:
1. Substantive legal standards (e.g., the BJR).
2. Exculpation (e.g. DGCL 102(b)7 - immediate dismissals for P claims alleging breach of
DOC).
3. Indemnification: Promise by corp. to pay back any losses of its directors or officers as a
result of liabilities incurred in their official capacity - applies in all claims (derivative, direct, securities
suits), but usually a result of SH litigation (see, e.g., DGCL 145).
4. Insurance
H. INDEMNIFICATION
1. When can the corp. not legally indemnify? (DGCL 145)
1. 145(a): Corp. shall have the power (not mandatory) to indemnify any person in any suit or
proceeding (other than derivative suits)...by reason of the fact that the person is or was a director,
officer, employee, or agent...against expenses (including attys' fees), judgments, fines, and
amounts paid in settlement...if the person acted in good faith and in a manner the person
reasonably believed to be in or not opposed to the best interests of the corp....
2. 145(b): Corp. shall have the power to indemnify a person made a party to any threatened,
pending or completed action or suit by or in the right of the corp...against expenses....
3. Difference b/t a and b: Both include legal expenses, but A also includes judgments, fines, and
amounts paid in settlements.
4. You cannot be indemnified for settlement or judgment in derivative suits. Meant to
prevent weird circular wealth transfer. But you can get reimbursed for derivative suit expenses.
5. 145(c): Corp. must indemnify directors/officers if "successful on the merits or otherwise in
defense."
a. Don't "go behind the result" (Waltuch). “Success” does not mean moral
exoneration. Merely escape from an adverse judgment or other detriment – results-oriented.
b. If D is sued and the suit settles and D doesn't have to pay, that's success (so Waltuch
reimbursed for fees in defending himself (even though didn't act in good faith?)).
6. 145(f): "The indemnification...granted pursuant to the other subsections of this section shall
not be deemed exclusive of any other rights to which those seeking indemnification...may be
entitled...."
a. 145 (f) Allows for indemnification for purposes broader than those stated in the
statute, but must not conflict with §145 and its good faith requirements (Waltuch). There
are also public policy limits on §145(f).
2. Citadel v. Roven
1. Indemnification agreement b/t company and Roven says the company must indemnify him
(broader than 145(a)) - 145 is enabling). Exception in agreement: 16(b) payments, b/c they go back
into the corp. Another part of agreement: Right to advancement of expenses in any action.
2. Roven claims has right to get paid for expenses in defending 16(b) action. Company says no
right to pay b/c don't have to pay for 16(b) indemnification, so shouldn't have to advance the expenses.
Court says the 2 clauses are diff. and company has to advance expenses. When indemnification issue
comes up later can argue it. Drafted poorly – make 2 provisions relating to the same thing parallel.
I. INSURANCE
1. D&O insurance shifts the payor from company, w/ indemnification rights, to a 3rd-party insurance
company paying the director and officer for essentially the same things.
2. Can't get indemnification for settlement of derivative suits, but can get insurance. 145(g): You can
buy insurance for things even if you can't get indemnified for it.
3. 3 different "insuring agreements"? 3 separate parts of the same insurance agreement.
1. A: Insurer pays manager when corp. cannot legally indemnify.
a. Provides for the settlement of derivative suits.
b. Corp. can't legally indemnify when it’s insolvent, so insurance would take place.
2. B: Insurer reimburses corp. for indemnifying managers.
3. C: Insurer pays losses for which the corp. itself is directly liable (under securities
claims).
4. Why buy it?
1. A: Only part that goes to directors and officers. Managers insist on coverage. Avoids risk
aversion.
2. B&C: Both go to the company. Pay premium and protects corp. up to certain limit. Avoids
sudden losses to company's balance sheet. Claims are usually settled well w/n insurance policy limits,
so a good deal for companies.
 a. Can premiums control moral hazard? Premiums always cost more than the loss it
avoids. Suggests corp. insurance coverage is inefficient - SHs might prefer corps. to bear the
loss.
b. Agency costs? Insurance enables directors/officers not to miss earnings
expectations. So insurance is good for insiders of the corp. but not necessarily for corp. itself.
5. D&O premiums...
1. How should they work? What should they tell us?
a. Might tell us how well company is doing - quality of corporate governance and
likelihood of suit. 3rd party insurance company determines premium. If they see high risk, jack
up premium. Perhaps disclosure for this should be required b/c tells us something about the
corp.
6. D&O insurance is another means to insulate directors and officers from personal liability. Directors and
officers almost never pay own money in these lawsuits or settlements (exceptions are Van Gorkom and
Worldcom).

V. PROBLEMS OF CONTROL
A. VOTING CONTROL - SH Meetings and Election of Board of Directors
1. DGCL 211(b): Annual SH meeting for election of directors - required.
1. Very few SHs attend, but SHs have to elect the board of directors. So election occurs through proxy.
2. DGCL 211(d): Special meetings may be called by board of directors.
3. Proxy Voting
1. SH appoints a proxy (aka proxy agent) to vote his/her shares at the meeting.
2. Appointment effected by means of a proxy card.
3. Most important part of proxy voting: Proxy Contests - 1 set of directors running against another set of
directors - incumbents vs. insurgents.
4. Proxy contests are expensive - have to send out proxy card and proxy statement - statement is filed w/
SEC and must be sent to every SH.
B. PROXY CONTESTS
1. Reimbursement of expenses: RULES (Levin and Rosenfeld):
1. The corp. may not reimburse either party unless the dispute concerns questions of policy.
a. Personal matter can almost always be twisted into a policy matter (just like SH maximization
norm is weak constraint on directors otherwise protected by BJR).
2. The corp. may reimburse only reasonable and proper expenses.
3. The corp. may reimburse incumbents whether they win or lose.
4. The firm will reimburse insurgents only if they win, and only if SHs ratify the payment.
5. BJR seems to be animating principle in deciding whether they can be reimbursed. Presumption that
directors acting in best interests of SHs - supported here unless there is fraud, self-interest.
b. SH approval b/c obvious self-interest.
2. Proxy contests often about control. 2 ways to take over a company:
1. Buy entire company's shares - gives you right to appoint the directors yourself.
2. Win the votes.
a. Cheaper to win a proxy contest than buy a company, but rewards aren't the same. Rewards
only equal to existing ownership stake and if you win the votes you won't get all of the
improvement - if you buy the shares get 100% of the marginal improvement.
3. SEC Proxy Rules
1. Proxies regulated by SEC b/c proxy documents are disclosures to SHs.
2. Securities Exchange Act §14(a) - gives SEC broad discretion to draft laws and makes proxy
voting a federal matter as much as SEC wants it to be.
a. 14a-3: Incumbent directors must provide annual report before soliciting proxies for annual
meeting.
b. 14a-7: In a proxy contest, incumbent management must either mail the insurgent's proxy
materials for it or provide insurgents w/ the SH list.
c. Anyone who "solicits" a proxy must provide a written proxy statement BEFORE soliciting the
proxy.
i. Solicitation is broad.
ii. Bottom line - if you are soliciting proxies there must be a proxy statement and must
be provided to SEC - will be basis for fraud allegations.
d. Proxy fraud: Solicitation that is false or misleading w/ respect to any material fact, or that
omits a material fact necessary to make statements in the solicitation not false or misleading
(14a-9).
C. SHAREHOLDER PROPOSALS
1. Common SH Proposals - relate to how the corp. could be governed better:
1. To remove of poison pills;
2. To require annual election of all directors;
3. To require that directors hold a specified minimum amount of corp. shares;
4. To prevent the same person from being both CEO and chair of the board;
2. SH proposals not always about corporate governance. Sometimes about gaining publicity on an issue.
3. Requirements for SHs to get proposals into company's proxy materials? (1) 500 word limit (can't use internet),
(2) SHs have to have $2K or 1% for one year, (3) send someone to the meeting.
4. Bases on which companies can keep SH proposals out - 14a-8
1. Not "a proper subject for action" by SHs - basically forcing board to do something. Get around
limitation by framing it as a request/proposal/suggestion. Then the board can use BJ to say yes or no -
like normal corp. structure where boards make decisions based on BJ.
2. Illegal.
3. Violates proxy rules.
4. Personal grievance or benefit.
5. Relevance
a. Proposal must relate to operations which account for more than 5% of company's total assets;
and for less than 5% of its net earnings, must be otherwise significantly related.
b. Lovenheim v. Iroquois: Goose proposal. Fight on basis of relevance exception. Ct. says
"otherwise significantly related" can be matters of moral or economic significance. Wins.
6. Matter beyond power of firm to effectuate.
7. Relates to firm's "ordinary business operations" - SHs can’t have a say in that.
8. Submitted in the past w/o winning much support.
5. Dole: Proposal that Dole study the impact of national health care reform proposals (to gain publicity).
1. Dole tried to exclude it on relevance test on grounds that it:
a. Involved matters w/ only an insignificant financial relation to the company (14a-8i5).
i. Court says health care imposes large financial burden on company, so good enough.
Applied 5% test correctly?
b. Involved matters beyond Dole's power to effectuate (14a-8i6).
i. Only asks company to study effect, not to change national policy.
c. Involved ordinary business matters (14a-8i7).
i. Court says health care a matter of great social concern so goes beyond company's
own health care issues. Court allows proposal.
6. Austin v. ConEd : Proposal: Non-binding resolution (non-binding is just a suggestion so ok). Company argues
personal grievance/not ordinary business matter. Court says it's an employment compensation dispute, which
is an ordinary business matter.
D. SHAREHOLDER INSPECTION RIGHTS
1. DGCL 220(b): Any SH...shall...have the right to inspect and to make copies and extract from (1) the
corp.'s stock ledger, a list of its SH, and its other books and records...
1. Plus a limited right w/r/t subsidiary records.
2. DGCL 220(b):
1. SH must make a written demand setting forth a "proper purpose."
2. A "proper purpose" is one "reasonably related to such person's interest as a SH."
a. Crane: Tender offer (potential change of ownership) is related to business of company.
b. Pillsbury v. Honeywell: Wanting to change corp.'s policy as to dropping bombs over Vietnam
during war is a personal/ideological reason - not a basis for discovery of books and records (if
interested in economic well-being of company, maybe).
3. DGCL 220(c):
1. If SH only seeks access to SH list, burden is on corp. to show SH doing so for improper reason.
2. If SH seeks access to other corp. records, burden on SH to prove requisite proper purpose.
4. Purposes:
1. Proper:
a. Investigate alleged corp. mismanagement (“tools at hand”).
b. Collecting info relevant to valuing shares.
c. Communicating w/ fellow SHs in connection w/ a planned proxy contest.
2. Improper:
a. Attempting to discover proprietary business info for the benefit of a competitor.
b. Secure prospects for personal business.
c. Institute strike suits.
 5. Sadler v. NCR: Ct. decides to use NY law b/c "access to SH lists is a recognized exception to the internal
affairs doctrine." Under DE law don't have to produce NOBO list, but under NY law they do.
E. CONTROL IN CLOSELY-HELD CORPS.
1. Courts generally deferential to SHs in voting for directors, but reluctant to allow SHs to agree about who they
will appoint as officers.
1. Reflects BJR - Board appoints officers. Board supposed to represent SHs' interests. SHs' interests
supposed to represent all people. SHs have less of an ability to constrain appointment of officers.
2. Vote pooling agreements are valid (Ringling Brothers Circus).
3. Directors acting as SHs: "Directors may not by agreements entered into as SHs abrogate their independent
judgment..." (McQuade v. Stoneham) Directors were acting as SHs AND as directors, and directors owe FDs
to all SHs (while SHs only owe duties to e/o). As a SH, you can make an agreement in your own self-interest
but you can't restrict your decisions as a director b/c owe a FD to everybody.
4. Clark v. Dodge: Ct. doesn't accept McQuade argument b/c directors and SHs have same interests. 2 SHs;
agreement is b/t the 2 of them. No 3rd party to protect - no public policy preventing them from agreeing this
way. Also, Dodge is complying w/ his FDs in connection w/ the K and just has to show unfaithful, etc.
5. These cases all involve a small amount of people in a relatively small corp. Question is: How, as owners, do we
see a return on our investment? Either get a regular salary or a dividend.
6. How could McQuade and Clark have gotten what they wanted (cash flow and job) w/o risking these lawsuits
over contractual invalidity?
1. Separate voting agreement (as SHs), which maybe all it can do is get you a board seat.
2. Employment K (b/t individual and the corp.), to get you all that other stuff.
3. See pp. 615-16.
4. See also Galler v. Galler, p. 618, (agreements among SHs to appoint specific directors is enforceable
if signed by all SHs).
5. In closely-held corps., these types of agreements are necessary b/c rarely are people willing to invest
money in small businesses w/o any contractual right to a return. Don't want to leave all the control up
to someone else - want a way of protecting your right to a return on investment.
7. Closely held corps. with no agreement about allocating rights:
1. In general, in a closely held or publicly held corp., you have no right as an investor to a job or a
dividend. So why invest unless you get a special type of agreement like in the last few cases?
8. Where no agreement in closely held corp., a case rests on FD grounds. "SHs in the close corp. owe one
another substantially the same FD in the operation of the enterprise that partners owe to one another."
(Wilkes - 3 guys can't freeze out 4th and offer to buy him back at too low of price).
1. May not act out of avarice, expediency or self-interest in derogation of their DOL to other SHs and to
the corp.
2. This clashes w/ conception of what SHs are in business for - have right of selfish ownership.
9. Wilkes 2-Part Test - When SHs act to a disadvantage to the other SHs in a close corp.:
1. (1) Control group (majority SHs) must show legitimate business purpose for the action.
a. Special rule for closely-held corps. where the acts of a majority group disadvantage minority
group. Majority group has burden of justifying their actions - complete opposite of BJR.
2. (2) Disadvantaged minority may rebut by showing there is an alternative course of action less
harmful to the minority.
3. Test doesn't mean someone is always entitled to a job. Read it narrowly - all it means is you cannot be
unfair. Almost turns it into a for-cause job instead of at-will. But that isn't the default employment rule -
changes the relationship as a result of it being a close corp.
4. To avoid litigation, draft employment agreement for at-will termination (w/ buyout provision).
3. What is a close corp.?
1. Small number of SHs;
2. No ready market for the corporate stock; and
3. Substantial majority SH participation in the management, direction and operations of the corp.
4. Hard to get money out of a closely-held corp. b/c no secondary trading market paying out dividends.
4. Ingle v. Glamore : Unlike Wilkes, a SH agreement - at-will employee w/ buyback right. Right to buyout was in
agreement so can't sue over unfair buyout price.
1. Read Wilkes narrowly. He was suing to get money out of corp., while Ingle suing to keep himself in the
corp. Impt. distinction.
2. Wilkes doesn't change basic employment principle - it is still at-will. Ingle entered into an employment
relationship w/ expectation that it's at-will, so can be fired at any time. In a closely-held corp., you can't
abuse the majority SH position.
5. Position of a minority SH in a close corp.:
 2. No right to demand dividends; No right to a job.
3. The controlling SHs can work for the corp. and pay themselves generous (but not excessive) salaries.
a. If the controlling SHs do work for the corp. and treat themselves generously, value of minority
shares will likely be worth less than they would be if the corp. were sold as a going concern
and they received their pro rata share of the proceeds.
b. Moreover, they will have difficulty selling their shares at any price - they are locked in.
6. Sugarman v. Sugarman - Minority SHs sue. Claims:
1. Excessive compensation (deriv).
2. Freeze out (direct claim). Based on 3 wrongs by Leonard:
a. Paid himself a big salary.
i. Wrong? High standard to show and ct. looking at it like should be deriv. claim.
b. Didn't pay out dividends or salaries to minority SHs.
i. Don't necessarily have rights to a job or a dividend (Ingle). Itself not a problem.
c. Offered to buy out the minority at a low price.
i. No requirement to even buy out the minority.
3. Looking at each one individually, doesn't look like anything wrong. Ct. puts the 3 of them together and
gets evidence of a plan or device (Freeze out).
4. After this case, what does a freeze out mean? Looking for some sort of plan where they are cutting off
cash flow interest with some sort of intent (lack of good faith) to act unfairly towards minority.
7. Smith: 1 of 4 investors causes firm to incur AET (tax). 80% requirement gave control to each of 4 SHs
(requires unanimous vote and gives each veto right). Ct. holds breach of FD under Wilkes (applies not just to
minority SHs but to anyone who controls firm).
1. Look at them as directors - did anyone breach their DOC? Maybe - Wolfson could have avoided tax
assessment by paying dividends. But the other 3 did too then. If all 3 breached a FD, seems wrong for
court to only hold 1 liable.
8. Review of all 4 cases - What did the Ds do wrong?
1. Wilkes: Cut off Wilkes' salary and offered him a low price for his shares.
2. Ingle: Nothing. The allegation was that Glamore improperly bought out Ingle and the dissent agreed,
but the majority did not.
3. Sugarman: Sugarman paid himself too high a salary, didn't pay dividends, and offered the Ps a low
price for their shares.
4. Smith: Blocked the payment of dividends and failed to produce a sound plan for the investment of
retained earnings.
5. Look for unfairness. Close corp. freeze-out rule has something to do w/ unfairness. Default rule: Don't
have a right to a job or dividend as a SH in a corp. But if these 4 cases are a way to try to tweak or find
a gray area in the rule, should we change the default rule?
9. What planning techniques might have avoided litigation?
1. Wilkes: A buy-sell agreement, employment Ks, or a SH agreement.
2. Ingle: Spell out the understanding more clearly.
3. Sugarman: Buy-sell agreement.
4. Smith: Wolfson created a deadlock. How to solve a deadlock problem? Arbitration in case of impasse,
dissolution in case of impasse, or a buy-sell agreement.
5. These only apply in context of close corp. b/c of absence of secondary market for shares - no other
way for minority SHs to get the value out of their shares.
F. TRANSFER OF CONTROL
1. Frandsen v. Jensen-Sundquist: Jensens entered into a SH agreement w/ SHs they sold to.
1. 2 provisions:
a. ROFR: Prevents minority SHs from being bought out at an inadequate price.
b. Bring-Alone Rights: If majority sells their shares, they have to buy out the minority shares.
Prevents minority from becoming part of another unknown majority.
2. Rule of case : In a transfer of control of a company, the ROFRs to buy shares at the offer price are to
be interpreted narrowly. There was never an offer w/in the scope of the SH agreement; P’s ROFR was
never triggered. Acquiring bank never interested in becoming a majority SH, just wanted to acquire the
bank. A sale of stock was never contemplated.
2. Zetlin v. Hanson Holdings, Inc.
1. 44.4% owner Sylvestri. Company is diffusely held, so a large ownership stake can essentially count as
a controlling stake b/c the others aren't voting their shares. Sylvestri sells shares at control premium.
 2. Court: "absent looting of corp. assets, conversion of a corp. opportunity, fraud, or other acts of bad
faith, a controlling SH is free to sell, and a purchaser is free to buy, that controlling interest at a
premium price."
3. Perlman v. Feldmann: Breach of FD b/c majority takes something from rest of SHs (basic DOL).
1. Feldmanns buy majority SHs shares at a high premium.
2. Court says breach of FD - abuse to SHs. Feldmanns got paid for change from ethical market price to
black market price and then sold shares for black market price. Decision could have been made by
corp. but if it changed the way its resource decisions were made it would have changed value of entire
company - here only changes value of Feldmann's stake.
4. Basic Rules re: Transfers of Control:
1. Controlling SHs generally do not have to share control premia w/ minority SHs..
2. But if circumstances suggest an ABUSE of the minority in the transaction, then courts may
step in and order that the control premium be shared.
a. Abuse is not well defined.
b. Clear examples: a non-pro rata wealth transfer of something in which the minority
normally would get to share (Perlman), a sale to a looter, the sale of an office.
5. You CANNOT sell your corporate office (Essex v. Yates: K caused majority of current board to resign and
replaced w/ Essex nominees).

VI. TAKEOVERS
A. Pattern: Overture by outside player and response by board.
B. Cheff v. Mathes
1. Threat of liquidation or substantial alteration of business practices by Maremont.
1. Why liquidate? Here, good option for takeover b/c assets for themselves might be worth more than
they are now w/ current business strategies (board of directors).
2. Board starts doing a buyback of shares on the market - guarantees the management favorable vote for those
shares. Also pays Greenmail - targeted share buyback - buy Maremont's shares at a premium.
1. Harms company (SHs);
a. Makes takeover offer go away, so company strategy is never changed.
b. Depletes corp. treasury of money SHs would normally have access to.
3. Can the company do this? Yes. Standard:
1. BJR? Not quite - a little stricter (but not as strict as conflict of interest).
2. In takeover context, a change of where the burden is allocated. Normally, BJR Ps have burden (and
BJR presumes directors acted in good faith). Instead, the board of directors must show:
a. Reasonable grounds to believe a threat to corporate policy and effectiveness existed.
3. Standard for showing it: Good faith and reasonable investigation.
4. Good faith what? Business purpose, not entrenchment (keeping themselves in office).
a. Established as long as entrenchment is not "sole or primary motive."
1. Not hard burden to meet - just state another motive. Not far from BJR after all.
C. Unocal
1. Tender offer: Offer to buy SHs' shares (enough to give acquirer at least 51%). Bypasses the board and
appeals directly to SHs. Powerful tool for an acquirer.
2. Pickins tries to take over Unocal w/ a two-tier "front loaded" cash tender. Already owns 13%, so front end offer
to buy 37% at $54; back end, takeout merger for junk bonds "worth" $54.
3. Unocal's response: Exclusionary self-tender for 49% of its stock at $72, w/ "Mesa Purchase Condition" - Unocal
tender offer only kicks in after 49% of its SHs tendered into $54 Mesa offer - never happens.
1. Remove Mesa Purchase Condition, and this leaves the exclusionary offer - only SHs other than Mesa
can tender into the Unocal offer.
4. Unocal board rationales
1. Substantive Coercion: The consideration is "grossly inadequate." (?? More than market price).
2. Structural Coercion: Back end junk bond consideration would coerce SHs into tendering in front end.
(Really? $54=$54, plus credible commitment of SEC filings).
2. Not obvious, but if you do the math you get a structurally coercive tender offer.
5. Can Unocal engage in an exclusionary self tender offer to defend itself from Mesa's structurally coercive 2-tier
tender offer? Yes, but a different standard.
6. The Unocal Standard - Applies ONLY to a board’s unilateral defensive conduct in response to a perceived
threat of director self-interest in context of takeover defense. 2-part test:
1. Reasonable perception of threat of harm to SHs;
 a. Board has the burden - must show reasonable grounds for believing a danger to corp. policy
and effectiveness existed b/c of another person's stock ownership.
1. Examples: inadequacy of price offered; nature and timing of offer; questions of
illegality; impact on other "constituencies" w/in the organization; risk of
nonconsummation; quality of the securities being offered in the exchange.
1. But, weird, b/c board of directors owes duty to shareholders.
2. How can the board meet the burden of showing reasonable threat? "By showing good
faith and reasonable investigation..."
1. "Such proof is materially enhanced by the approval of a board comprised of
a majority of outside independent directors who have acted in accordance w/
the foregoing standards."
2. But good faith and reasonable investigation were the "tests" in Kors, Cheff,
and Johnson, so just show a purpose other than entrenchment and show
you had some meetings??
3. Later cases under Unocal never overturn defenses on threat grounds. Only
(rarely) proportionality grounds.
2. Element of balance/proportionality: Reasonableness in relation to threat posed.
7. Ct. is giving us an element of heightened scrutiny (after Unocal, the space of judicial authority is broadened in
context of takeover actions).
8. But every question in Unocal is answered in favor of the board's directors.
9. Unocal rarely results in overturning defensive devices. Outside of a Revlon context, Unocal doesn't grant a lot
of restraint on boards of directors.
1. Preemptive, prophylactic tactics also considered defensive conduct subject to Unocal standard, like
staggered boards and poison pills.
2. Unocal does not apply to a board’s rejection of a merger offer.
D. Policy question: To what extent should board be able to defend themselves from takeovers?
1. Defensive Thesis: Supports judicial deference to board's defensive tactics (see Unocal, FN 11 @ 776).
Argument that defending themselves is better for the long-term.
2. Passivity Thesis: Easterbrook/Fischell: Boards should do nothing b/c when they do something, they thwart the
disciplinary effect of the market.
3. Auctioneer Thesis: Bebchuk: Defensive devices might be ok, but only insofar as they raise the price of the
takeover. Tries to keep disciplinary effect going but allow board to act defensively to raise prices.
1. Debate: Assuming SHs are diversified, is it necessarily good on the whole to bid up the price (premium
paid to target SH just comes from acquiring SH)?
E. Defensive Devices
1. Unocal rule: Exclusionary self-tenders are ok. SEC overturns that narrow rule w/ 14d-10.
2. Rule 14d-10: The "All Holders Rule - Exclusionary self-tenders are no longer ok:
1. (a) No bidder shall make a tender offer unless:
a. The tender offer is open to all security holders of the class of securities subject to the tender
offer (meaning, no exclusion);
b. The consideration paid to any SH pursuant to tender offer is highest consideration paid to any
other SH during such tender offer (knocks out 2-tier device).
3. Other defensive devices
1. Crown Jewel Lock-Ups (Revlon): Promise to sell vital assets of company (crown jewel) to a single
bidder, regardless of price.
2. White Knights: Rather than selling to hostile bidder, write binding merger agreement to sell company
to someone you like. Can preserve structure of company or allow you to keep job.
3. Pac Man: Borrow a lot of money and buy the bidder.
4. Golden Parachutes: Gives top level managers a huge severance package. Idea - raises price of
takeover; but double effect – diff. from other devices b/c makes acquisition attractive to incumbent
managers.
5. Poison Pills: Most impt. takeover defense. Type of security issued by board to all of its current SHs.
Security contains rights:
a. To buy 1/100th of new class of preferred share (designed to mimic economically 1 share of
common, but purchase price set very high, so no one will ever exercise the right).
b. A right to buy common shares at steep discount, if triggering event occurs.
1. Triggering event:
1. Market purchase/"creeping acquisition."
2. Squeeze-out mergers - the Flip Over.
 2. Bidder of company is excluded from purchase right, so effect is dilution of value of
acquirer's stake. As result of dilution, no acquirer ever buys up the stake.
c. So effective that no modern poison pill has ever been triggered. Perfect defense against
tender offers acquisitions.
d. Poison pills are issued as a warrant/new class of securities. Board of directors has this
exclusive power, not SHs. So board can do this w/o SH approval - this is critically impt.
1. Boards can create a poison pill overnight.
1. Poison pills accepted by DE under Unocal standard.
1. Conclusion - every company essentially has a poison pill.
h. Board can also cancel unilaterally the poison pill and allow the acquisition to occur (board can
create w/o SH approval b/c they are securities and boards have power to issue securities). So
poison pill essentially creates a board veto power. Tender offer avoids board and appeals
straight to SHs, but w/ poison pill can't appeal directly to SHs – must get approval from board.
i. How to work around poison pill? Launch proxy fight contingent upon new board redeeming
poison pill, so if it succeeds, replace board and new directors will redeem poison pill. To get
around this?
6. Staggered Boards: Board is staggered into 3 classes. Each has 3 year term - effect is that can't get
control of one board in one election - have to wait 2 meeting cycles/years. Bidder won't promise to hold
bid open for 2 years - too much risk. So combo of poison pill and staggered boards = complete
takeover defense.
a. Staggered boards have to be adopted by board in charter amendment and approved by SHs,
but poison pill available to every corp.
b. Raise entrenchment concerns.
F. Revlon
1. Perelman approaches Bergerac about acquiring Revlon for $45/share. Bergerac turns it down b/c too low.
2. Revlon adopts poison pill - "Note Purchase Rights Plan" to buy time.
1. Every offer on corp. will be conditional on that poison pill.
2. Pantry Pride makes a hostile offer, conditioned upon redemption of NPRP.
3. Revlon buyback - Management brings in Forstmann Little (White Knight), who will buy the company for
management and allow company to run it.
4. PP comes back and says it will beat any Forstmann offer.
5. Revlon agrees to deal w/ Forstmann, supposedly on grounds that financing more secure. Agree to:
1. Cancellation fee;
2. No-Shop; and
3. A "crown jewel" lock up.
6. SHs sue - Breach of FD - DOL owed to all SHs (all these takeover cases are about DOL).
1. If sold to PP, SHs would get more money. Board instead chooses FL b/c better for their note-holders
(a diff. constituency in the corp.).
a. Note holders are fixed claimants w/ guarantees, and SHs are residual claimants, which is why
FDs come in to fill the gap.
7. "The directors' role changed from defenders of the corp...to auctioneers charged w/ getting the best
price for the SHs at a sale of the company."
8. Revlon duties are different. Unocal - can act for other constituencies. SH wealth maximization usually a weak
constraint. Here, directors' discretion changes and are held to a higher standard where have to get best price
for SHs. Does this happen every time there is an offer for sale of company?
9. "Revlon duties": When a buyout becomes inevitable (when the board authorizes management to look for a
buyer) the duty to the board changes from preservation of company as corp. entity to maximization of
company's value at sale for SHs’ benefit. When a company is going to get sold, board no longer has discretion
to pay attention to anything other than SH wealth maximization.
1. This is impt. b/c everything we have learned so much has SHWM as a weak background norm.
2. When are Revlon duties triggered?
G. Paramount v. Time
1. T-W merger: Time creates Merger Sub; Warner merges w/ Merger Sub to become subsidiary of Time.
2. DGCL 251(c): SHs of merging companies get to vote on merger. Under DE law, in triangular merger, SHs that
get to vote are essentially just the target SHs b/c they merge. Target company itself rarely merges - instead
creates subsidiary that merges w/ acquiring company. Only Warner SHs can vote under DE law.
3. But as a result of NYSE rule, Time SHs get to vote too (b/c issuing Time shares as consideration).
4. Before this, Paramount comes along, offering cash at huge premium on Time's shares to purchase Time, but
Time board rejects offer.
5. Risk for Time if accept Paramount offer: a no-vote. B/c of NYSE rule, Time board has to send proxy card to all
Time SHs. SHs likely to vote no on T-W transaction b/c would make much more on Paramount transaction.
 6. So Time restructures the transaction. Instead, a cash tender offer for Warner shares. Time SHs cut out of the
loop b/c Time is not voting (don't get 251(c) right to vote) and b/c cash, no NYSE rule. Prevents Time SHs from
having opportunity to refuse the transaction.
7. Paramount continues to raise price, and Time board keeps saying no - wants to preserve Time culture.
8. Paramount - 2 claims:
1. The Unocal claim:
a. Paramount's offer was an all shares cash tender offer - i.e. not 2-tiered or otherwise
structurally coercive - so not a legally cognizable threat; and
b. Even if there was a cognizable threat, the restructured deal was not a proportional response
(it took away all SHs' rights).
c. Ct's response - Low price alone is a threat regardless of whether it’s coercive (broad view).
Board can save the SHs from themselves. 1st prong of Unocal means very little. 2nd prong -
Ct. says Time just continuing w/ their plans. Poor reasoning - have restructured transaction.
d. Unocal analysis not a problem - board allowed to do what it was doing before (sounds like
BJR).
2. The Revlon analysis:
b. If Revlon view prevails, Time SHs win, not Time board. Revlon = more ct. stringency.
c. Chancery Ct. says Revlon is not triggered. Question is whether change of control is
contemplated - must look at specific circumstances surrounding transaction.
1. Ct. says either a cash deal or a stock for stock deal where a controlled person exists
after the transaction is a change of control. But ct. says this doesn’t occur here, b/c
both Time and Warner diffusely held.
d. Supreme Ct.: Revlon duties come into play only when:
1. Cash transaction where there is a breakup.
2. Decision to deviate from long-term strategy and seeking alternative transaction
involving breakup.
e. T-W fits neither category. Ct. says the T-W merger is ok b/c Revlon duties don't apply b/c no
change of control found in this way.
H. Revlon duties: Loosely, strict SWM, but how the board complies is up to the board
1. What triggers Revlon? A Change of Control: (1) A cash or bust up deal; (2) A deal that causes a diffusely
held company to come under the control of an individual or group (QVC).
I. Paramount v. QVC
2. Paramount (Davis); Viacom (Redstone); QVC (Diller).
3. Deal b/t Paramount and Viacom. But QVC comes along and tries to buy company.
4. Question in this and all cases: Does the target in the merger have to deal with the other suitor (prospective
acquirer), or can they go ahead w/ pre-existing plans?
1. Does the transaction involve a change of control or not?
a. If Revlon applies, there must be a process that shows SHWM has been observed.
b. We are under Revlon. Tweak of definition of change of control. B/c they are selling to a corp.
w/ a controlling SH, the sale results in a change as if a single person is buying.
c. TW: Time SHs go from being Time SHs to TW SHs. There, not considered a change of
control. Were still voting SHs.
d. Here, Paramount SHs go from being Paramount SHs to Viacom/Paramount SHs. But it
matters b/c new company would be controlled by Redstone.
1. Following the transaction, there would be a Controlling SH w/ voting power to elect
directors, cause break-up of the corp., merge it w/ another company, cash-out the
public SHs, amend COI, sell all or substantially all of the corp. assets, etc.
2. Proposed sale of control would provide new controlling SH w/ power to alter
Paramount's vision of long-term strategic alliance w/ Viacom.
3. Once control has shifted, current Paramount SHs will have no leverage in the future
to demand another control premium, b/c have no control rights.
b. Change of Control in QVC: When a majority of a corp.'s voting shares are acquired by a
single person or entity, or by a cohesive group acting together, there is a significant diminution
in the voting power of those who thereby become minority SHs.
5. Who has control in a diffusely held corp.? The Board. The board has the authority to use anti-takeover devices
w/o SH approval. Board has a veto over that transaction, so control is vested in management.
1. Minority SHs - control is really limited to voting board of directors.
2. So why not look at change of control w/ respect to management?
J. A note on appraisal rights...
 1.Remember: A 51% SH can force the 49% minority to accept a merger (b/c her 51% stake will carry the day in
approving it). Includes the right to choose the consideration.
2. Does that mean they can pay a penny? No. The minority SHs may have appraisal rights. DGCL 262.
3. Appraisal
1. Gives SHs who dissent from the merger the right to have the fair value of their shares
determined and paid to them in cash.
2. Availability of Appraisal: DE Law
a. DGCL 262(b)(1): Appraisal rights shall not be available for targets whose stock is listed on an
exchange or where the target has more than 2,000 record SHs.
1. But 262(b)(2) then gives those target SHs back appraisal rights if the consideration
paid in the merger is anything other than stock (i.e. cash).
b. Available in sale of all or substantially all of Target's assets? No.
3. Exercising Appraisal Rights
a. DGCL 262(a) requires that dissenting SHs:
1. Hold onto their shares continuously through the effective date of the merger;
2. Perfect their appraisal rights per 262(d) by sending written notice to the corp., prior to
the SH vote, that she intends to exercise her appraisal rights (inot sufficient to merely
vote against the merger at the meeting);
3. Neither vote in favor of nor consent in writing to the merger.
VII. CORPORATE DEBT
A. Classes of Securities
1. Equity: Common stock and Preferred stock (common stock w/ more fixed rights).
2. Debt
1. Bonds: Secured long-term
a. Bond Indenture: A contract in which corp. agrees not to engage in specific conduct that
would increase the bondholder's risk.
b. Key players:
1. Issuer
2. Lead underwriter
3. Indenture trustee
c. Bond Indenture: Key Provisions
1. Statement of events of default.
1. If a default occurs, the bondholders are entitled to accelerate the maturity of
the bonds: they become immediately due and payable.
2. Duration:
1. Call provisions.
3. Control/Protection - Restrictive Covenants...
1. No change in nature of business or board w/o consent - an extreme
provision.
a. Rare in bond indentures! Less rare in bank loan agreements.
2. Limit dividends.
3. Specify financial ratios (e.g., current assets to current liabilities).
2. Debentures: Unsecured long-term
3. Notes: Short term
B. Sharon Steel v. Chase Manhattan Bank
1. UV Industries issued a series of 5 notes and debentures under similar indentures.
2. UV had 3 lines of business, incl. Mueller Brass.
3. Plan of liquidation. Fight b/t prospective buyer of Mueller Brass and Chase (debt indenture trustee) about
whether debt of indentures have to be paid off or whether they can be redeemed at face value.
1. Sharon Steel wants to assume the debt of the debentures - b/c market value was less than face value
b/c issued at a time when interest rates were lower. Price of a bond/debenture falls when the price of
an interest rate rises.
2. Interests:
1. Of Trustee: Wants bonds to be paid off at full face amount - b/c that gets the most for the
bond/debenture holders.
a. Trustee is fiduciary to bondholders.
2. Of Sharon: Assume debt.
2. Of UV board (not in case): Looking out for interests of UV SH's. Conflict b/t UV debt-holders and
equity-holders. Board should want Sharon to assume debt b/c more money for SHs.
3. What was the (legal) issue?
1. The interpretation of the successor obligor clause in the covenant on consolidations.
 a. Provided that in the case of a merger or sale of all or substantially all of the assets of a corp.,
the surviving corp. assumes the issuer's debt.
b. In the case of a liquidation of the issuer, on the other hand, the debt must be paid off at the
face amount (plus call premium).
2. Sharon argues clause 1 applies to Sharon's benefit, which provides for assumption of debt. Trustee
argues not substantially all the assets sold b/c essentially only 1/3 of assets were sold.
4. Interpretation of "boilerplate" provisions of indenture are matter of law for judge, not fact-finding for jury.
5. What principles does Judge Winter announce for interpreting boilerplate?
1. "Consistency and uniformity"...
2. Explicitly rejects the "literalist approach" – instead chooses interpretation of the purpose of
successor obligor clauses – to protect lenders.
a. Idea behind clause is to keep track of what the assets are.
3. "We hold, therefore, that boilerplate successor obligor clauses do not permit assignment of the public
debt to another party in the course of a liquidation unless 'all or substantially all' of the assets of
the company at the time the plan of liquidation is determined upon are transferred to a single
purchaser."
C. Layers of financing...all has to do w/ liquidation and who gets paid 1st - the "liquidity waterfall."
1. Senior secured debt
2. Subordinated secured debt
3. Subordinated unsecured debt
4. Equity
D. Met Life
1. Equity cushion: A relationship b/t debt and equity.
1. The remaining residual, taking into account fixed claims.
2. A proxy for risk.
a. LESS EQUITY CUSHION = GREATER DEFAULT RISK.
b. Means less likely for those at bottom to get money b/c those at top can call a default.
3. Shrinking equity cushion...
a. Reductions in the value of the business (reducing value of the residual).
b. Increasing the amount of debt (increasing fixed claims).
2. RJR Pre-LBO Debt
1. Indenture included 2 relevant provisions:
a. Negative pledge clause:
1. No senior debt; no security interests in assets.
2. Allowed unsecured debt; did not mandate a debt-to-equity ratio; did not mandate
subordination.
b. Successor obligor provision in M&A clause.
1. Allows mergers conditioned on successor firm assuming debt obligations.
2. Neither are triggered, but argue it's implied.
3. Implying good faith into the bargain...
1. Content and effect of implied covenant of good faith? Court willing to accept this.
2. Only duty of good faith is to fulfill the express terms of the contract that you agreed to - narrow
meaning of good faith here.
a. This implied covenant of good faith is NOT a FD.
b. Corps. do NOT have FDs to their bondholders - their only duties are contractual.
3. No new terms of contract to be implied.
4. Ct. won't imply covenant (would prevent incurrence of new debt to facilitate the LBO).
a. They could have contracted for this term.
4. How do covenants find their way into indentures?
1. Bond issuances are repeat transactions.
2. Underwriters have incentives to demand indenture terms that produce saleable bonds.
3. Pricing mechanisms and diversification.