BUSINESS ASSOCIATIONS OUTLINE- Chodhury Frances Stern

8/7/2019 BUSINESS ASSOCIATIONS OUTLINE- Chodhury Frances Stern

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BUSINESS ASSOCIATIONS OUTLINE

I. AGENCY

A. Who is an agent?

1. 3 forms:

a. Principal and agentb. Master and servantc. Employer/proprietor and independent contractor (IC)

2. Agency is a relationship which results from:

a. (1) a manifestation of consent by one person (the principal) that anotherperson (the agent) act (a) on the principals behalfand (b) subject to theprincipals control and

b. (2) the agents consent to so act (agent must have Ps consent to so act)c. Test is controld. Burden of proof is on the person who wishes to establish agency

3. Agency does not require the involvement of business, necessitate a K or promise

between P and A, or require that either receive compensation.4. Gay Jenson Farms: Agency may result event though it is not termed as such andeven though the parties did not intend for it to result.

5. Agency can be shown by circumstantial evidence evidencing a course ofdealing between the 2 parties, although the P must have consented to the agency.

6. Control can evidence a P/A relationship and control of a debtors business canlead to a creditor becoming liable as principal for acts of the debtor.

7. Analysis of Agency problem:a. Is the problem between the A and Pb. Does it involve a 3rd party trying to hold P liable to an agreement based on

As conduct or an express agreement?

c. Does it involve a 3

rd

party trying to hold a P liable for the agents torts?B. Liability of Principal in 3rd Party Ks TYPES OF AUTHORITY1. actual authority

a. DEF: authority that P expressly or implicitly gives A2. implied authority

a. DEF: actual authority that P actually intended A to possess and includes suchpowers as are practically necessary to carry out the duties actually delegated(Mill Street Church of Christ)

b. E.g. if P tells A to paint the house, he has the implied authority to buy paintc. Key: relationship between P and A regardless of 3rd partyd. Implied authority determined by:

i. As understanding of his authority (does A reasonably believe b/c of pastor present conduct by P that P wishes him to act in a certain way or havecertain authority)

ii. Nature of the job or taskiii.Existence of prior similar practices- specific conduct by P in the past

permitting the agent to exercise similar powers is crucial (Mill StreetChurch of Christ)

iv. Key: relationship between P and A regardless of 3rd party


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3. apparent authority

a. DEF: arises when P acts in such a manner as to convey the impression to a 3rd

party that A has certain powers which he may or may not actually possess(Lind v. Schenley)i. E.g. A wears a shirt with Ps logo on it and sells Ps product to 3rd party

b. Exists only to the extent that it is reasonable for the 3rd

party dealing with Ato believe that A is authorized. The 3rd party must also believe the agent to beauthorized (objective and subjective)

c. A has the apparent authority to do those things that are usual and proper tothe conduct of the business in which he is employed to conduct

d. Requires manifestations by P to the 3rd party of As authorityi. E.g. P says Ill send my agent, Bob and Bob comes

e. Key: this is the type of relationship that exists between A and 3rd party. (not Aand P)

4. inherent authority

a. undisclosed principal

b. where Ps have enabled their agent to hold himself out as the proprietor ofthe business, they are undisclosed Ps; so to charge an undisclosed P with theacts of A, the plaintiff need only show that the goods supplied were in thereasonable scope of the agents authority (Watteau v. Fenwick)

c. Ps are responsible for some of As acts which, while unauthorized, arenonetheless quite close to (or incident to) that which they are authorized to do

d. Arises in cases where there is not sufficient manifestations by P to 3rd partiesto satisfy the requirements of apparent authority (but inherent agency is asubset of apparent agency though not vice versa)

e. The customary extent of an authority can comprise a K (Kidd)f. Key: relationship between A and 3rd party. Courts like to help out the

innocent 3rd party. exists when there is not enough (manifestation by P) to getapparent authority.

g. Key

i. An undisclosed P is liable for the acts of an A done on his account, ifusual and necessary in such transactions, although forbidden by P

ii. An undisclosed P who entrusts an A with the management of his businessis subject to liability to 3rd parties with whom the A enters intotransactions usual in such business and on Ps account, although contraryto the directions of P (that P gave A)

h. Indicates the power of an agent that is not derived from authority, apparentauthority or estoppel, but solely from the agency relation and exists for theprotection of persons harmed by or dealing with a servant of other A

i. Occurs when:i. (1) A does something similar to what he is authorized to do, but in

violation of ordersii. (2) where A acts purely for his own purposes in entering into a transaction

which would be authorized if he were actuated by a proper motive oriii. (3) where A is authorized to dispose of goods and departs from the

authorized method of disposal


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C. Ratification

1. agency requiresa. (1) manifestation by P that A will act for himb. (2) acceptance by A of undertakingc. (3) understanding between parties that P will be in control of undertaking

2. marital status or joint ownership of property does not prove agency3. DEF: ratification is affirmation by a person of prior act which did not bind himbut which was done on his account

4. it requires acceptance of the results of the act with an intent to ratify and fullknowledge of the material circumstances

5. ratification can only be done where the original transaction was done on accountof P

6. transactions can be ratified in a variety of waysa. (1) express affirmation by Pb. (2) implied acceptance of the benefits of the transaction at a time when it is

possible to decline acceptance of such benefits

c. (3) implied affirmation through silence ord. (4) implied affirmation through bringing a lawsuit to enforce the KD. Estoppel

1. elements:a. (1) the P creates, through intentional or negligent words, acts, or omissions,

an appearance of authority in the purported Ab. (2) the third party reasonably and in good faith acts in reliance on such

appearance of authority; andc. (3) the 3rd party changes his position in reliance upon the appearance of

authority2. agency by estoppel involves the Ps failure to take reasonable care of a 3rd party

(Hoddleson)E. Agents liability on the K

1. if the other party to a transaction has notice that the A is or may be acting for Pbut has no notice of Ps identity, the P for whom the A is acting is a partiallydisclosed P.

2. a person purporting to make a K w/ another for a partially disclosed P is a partyto the K

3. to avoid personal liability, A must disclose that he is acting in a representativecapacity and the identity of P (Curran)

F. Principals Liability to 3rd parties in tort1. employer (master) is liable for the torts of its employees (servants)2. employment relationship exists where employee has agreed (a) to work on behalf

of the employer and (b) to be subject to the employers control or the right tocontrol physical conduct of the employee (manner in which the job isperformed)

3. employees must be distinguished from independent contractorsG. independent Contractors v. Servants


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1. ICs are either agent-types (who have agreed to act on behalf of P, but notsubject to Ps control) or non-agent types (who act completely independently andenter into arms-length transactions with others)

2. master/servant relationship evidenced by:a. control by master of servant, e.g. setting hours of operation, holding title to

goods sold, paying for operating costs (Humble Oil, Sun Oil)b. also look to compensation schemes (risk and return), rent, reports tosupervisors, training, supervision

H. Defining master/servant relationships

1. the key to defining master/servant relationships is control, particularly in relationto the methods or details of doing the work

2. master need not control work of servant, just have the right to do so3. control is evidenced by: e.g., power to control daily maintenance of the premises,

business expenditures, set customer rates, demand a share of the profits, hire orfire employees, determine employee wages or working conditions, set standardsfor employee skills or productivity, supervise employee work routines, or

discipline employees for nonfeasance or misfeasance (Holiday Inns, Inc.)I. Tort liability and apparent agency1. franchisors become liable for franchisees negligent acts in agency relationships

where franchisor has the right to control the method by which franchiseeperforms its obligations under the franchise agreement (Miller)

2. franchisors that demand franchisees to be uniform in appearance and operationmay be holding out franchisees as apparent agents (Miller)

J. Scope of employment

1. the employer should beheld liable for risks which arise out of and in the courseof his employment or labor (Bushey)

2. Liability of servants:

a. (1) if some harm is foreseeable, P is liable, regardless of the fact that thatparticular type of harm may not have been foreseeable;

b. (2) conduct by servant which does not create risks different from thoseattendant on the activities of the community in general (i.e. personal lifeproblems) will NOT give rise to liability.

c. (3) the conduct must relate to the employmentK. Liability for torts of independent contractors

1. GR: (IC rule) P not responsible for torts of ICs2. Exceptions to IC rule:

a. (1) if P controls or has the right to control the physical performance of thetask, the employee is a servant and not an IC and P can be held liable;

b. (2) P can be held liable if it employed an incompetent ICc. (3) the principal can be held liable where the performance involves an

inherently dangerous activity (inherently dangerous= creation of a conditioninvolving a peculiar risk of harm to others (-this part not so sure itsright/check updated slides-unless special precautions are taken if thecontractor is negligent in failing to take those precautions.))

L. Fiduciary obligation of agents


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1. all As owe their Ps a duty of loyalty: the agent may not pursue his owninterests or the interests of a 3rd party ahead of the interests of the P

2. the duty of loyalty forbids the agent from receiving any other compensation inconnection with the agency relationship unless P knowingly and voluntarilyagrees to the contrary

3. compensation in breach of this duty is known as a secret profit4. remedies available to agent for secret profits:a. damagesb. action for secret profitsc. rescission/transaction voidable

M.Secret profits

1. Secret profits can arise from:a. A receiving a payment from a 3rd party in connection with some transaction

between the P and the 3rd party (e.g. kickbacks, bribes, tips)b. A secretly transacting with P, unbeknownst to Pc. A using the agency relationship for personal gain (Reading)

2. an A who, in violation of his duty to his P, uses for his own purposes or those ofa 3rd party, assets of the Ps business is subject to liability to the P for the valueof any resulting profit

N. Fiduciary duties

1. Duties includea. Exercising good faith by disclosing all facts regarding matters involving

the agency relationship which the agent comes to know (Singer)b. Protecting trade secrets (i.e. customer lists) and refraining from enticing

customers away from P (Town & Country)II. PARTNERSHIP

A. Partnership v. corporation

1.

B. Defining Partnership

1. in determining whether a relationship, look to:a. the intention of the partiesb. right to share in profitsc. sharing of lossesd. ownership and control of partnership propertye. community of power in administrationf. conduct of parties towards 3rd personsg. rights on dissolution (Fenwick)

Partnership Corporation-limited duration -unlimited duration-unlimited liability -limited liability-non-transferable interest -transferable shares-informal formation reqts -formal formation reqts-decentralized management -centralized management-no tax on partnership, only on partners -double tax: once on corporationsincome;Individual earnings second on shareholder income when

distributed as dividend


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2. if these factors are not present, likely the relationship is master/servantC. Uniform Partnership Act (1914) (UPA)

1. adopted in every state except LA2. revised in 1990s, RUPA, but RUPA not enacted in all states, so UPA still

governs

3. UPA defines partnership as an association of 2 or more persons to carry on asco-owners a business for profit) (6(1))4. evidence of shared profits if prima facie evidence of partnership, but NOT if

payment is received as payment for debt, wages, loan interest, or for sale ofgood-will (7(4))

5. * no formal requirements when starting a partnership- it is a default form ofbusiness.

D. The Importance of profit-sharing to defining partnerships

1. although the UPA notes that profit sharing is prima facie evidence ofpartnership, the court in Southex says that the presumption can be overcomefrom lack of proof of control over the business or lack of loss-sharing

2. failure to file partnership tax returns and lack of risk-sharing will also go againsta finding of partnership (Southex)E. Partnership by Estoppel

1. a person who represents himself, or permits another to represent him, to anyoneas a partner in an existing partnership or with other not actual partners, is liableto any such person to whom such a representation is made who has, on the faithof the representation, given credit to the actual or apparent partnership (SC CodeAnn. 33-41-380(1); UPA 16(1))

2. thus, partners by estoppel entails liability for all parties to the partnership(Young)

3. requires reliance on the partnership relationship in the decision to give credit4. also need reliance on act or statement with other partner (df) to establish

partnership by estoppelF. Fiduciary Obligations of Partners

1. UPA 21(1): every partner must account to the partnership for any benefit, andhold as trustee for it any profits derived by him without the consent of the otherpartners from any transaction connected with the formation, conduct, orliquidation of the partnership or from any use by him of its property

2. fiduciary obligation includes duty of the finest loyalty, disclosure ofopportunities, renouncement of thought of self (Meinhard)

G. Duties upon Leaving a Partnership

1. once a partner has left a partnership, no fiduciary duties are owed to him (Bane)2. BUT partners may owe fiduciary duties to a partnership once they leave,

particularly if they plan to compete against the partnership3. thus, cannot lie about leaving partnership, or solicit clients w/o providing notice

to the partnership and presenting clients the choice they have between staying orleaving the partnership (Meehan)

H. Expelling a Partner


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1. partners can be expelled from a partnership in accordance with the powersconferred by way of the partnership agreement so long as it is done in good faith(UPA 31(1)(d); Lawlis)

I. Partnership Property

1. Property rights of a partner include:

a. Rights in specific partnership propertyb. Interest in the partnership andc. Right to participate in management (UPA para. 24)

2. however, a partners specific interest in the assets is only an undivided interest asco-tenant in all the partnership property; the partnership owns the asset

3. a conveyance of partnership property held in the name of the partnership is madein the name of the partnership, not as a conveyance if individual interests of thepartners (Putnam)

4. a partners interest in the partnership is the share of profits, surplus, and personalproperty (UPA para. 26)

J. Rights of Partners in Management

1. every partner is an agent of the partnership and the act of every partner forcarrying on business in the usual way of the partnership binds the partnership(UPA9(1))

2. Absent an agreement to the contrary, partnership decisions are governed by amajority vote of the partners (UPA 18(h), Stroud)

K. Rights under Partnership

1. partnership is an entity distinct from its partners (RUPA section 201)2. partnership may sue and be sued in the name of the partnership (RUPA section

307)3. a partnership shall indemnify a partner for liabilities incurred by the partner in

the ordinary course of business (RUPA section 401(c))4. ordinary course of business can include personal purposes (Moren)

L. Partnership Dissolution

1. the dissolution of a partnership is the change in the relation of the partnerscaused by any partner ceasing to be associated in the carrying on asdistinguished from the winding up of the business (UPA 29)

2. termination of the partnership does not occur on dissolution, only after windingup of affairs is completed (UPA 31)

3. causes of dissolutiona. termination of the specific undertaking in the agreementb. express will of any partnerc. express will of all the partnersd. expulsion of any partnere. events which make it unlawful for the business to be carried outf. death, bankruptcy, decree of court

M.Dissolution by Decree of Court

1. dissolution decreed if:a. partner declared a lunaticb. partner becomes incapable of performing


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c. partner guilty of conduct as tends to affect prejudicially the carrying on of thebusiness

d. willful or persistent breach of partnership agreemente. lossesf. other circumstances that make dissolution equitable

2. compare with RUPA section 801(5) (p.155 in text)N. Rights of Partners to Partnership Property Upon Dissolution1. UPA 38

a. (1) Dissolution not by way of contravention of partnership agreement getspartnership property applied to discharge its liabilities and surplus applied topay in cash the net amount owing to partners

b. (2) dissolution in contravention of partnership:i. (a) each partner who did not cause dissolution getsii. (I) all the rights as in (1) and damages for breach of agreementiii. (b) they can also continue with the business in the same name with other

partners if they desire and can get the partnership property if they pay for

the interest of their former partner2. UPA (2)(c): the partner who caused the wrongful dissolution gets:a. The rights under (1) if the other partner does not continue with the businessb. If the business is continued, gets paid for his partnership interest less

damages and his interest does not include the value of goodwill of thebusiness

O. Disassociation under RUPA

1. a partner is disassociated from a partnership upon the occurrence of any of thefollowing events:a. Partners express will to withdraw as a partnerb. An event agreed to in the partnership agreement as causing the partners

disassociationc. The partners expulsion pursuant to the partnership agreement or by the

unanimous vote of the other partners in certain conditionsd. Partners wrongful conduct ore. Bankruptcy, death, etc

2. the disassociation of a partner does not necessarily cause a dissolution andwinding up of business of the partnership

3. section 801identifies the situations in which the dissociation of a partner causes awinding up of the business. Section 701 provides that in all other situations thereis a buyout of the partners interest in the partnership, rather than a windup of thepartnership business. In those other situations, the partnership entity continues,unaffected by the partners dissociation.

P. Terms of a partnership

1. UPA (1914) 31(1)(a): Term partnership defined: a term pship is one inwhich the pship agreement specifies a definite term or a particular undertaking(the end of which signals the end of the pship)

2. Implied term: to find an implied term, the court must find that the partiesentered into a particular undertaking.


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a. The requisite particular undertaking then must be capable of accomplishmentat some specific time (its end can be determined), even if the exact time maybe unknown and/or even unascertainable at the time the pship agreement ismade.

Q. Dissolution not by contravention of partnership agreement

1. Causes of Dissolution (UPA 31):a. Termination of the specific undertaking in the pship agreementb. Express will of any partnerc. Express will of all the partnersd. Expulsion of any partnere. Events which make it unlawful for the business to be carried outf. Death; bankruptcy

2. Dissolution by court if: (UPA 32)a. Partner declared a lunaticb. Partner becomes incapable of performingc. Partner guilty of conduct as tends to affect prejudicially the carrying on of the

businessd. Willful or persistent breach of pship agreemente. Lossesf. Other circumstances that make dissolution equitable

3. UPA 38: what partners get upon dissolution:a. (1) dissolution not by way of contravention of pship agreement, partners gets

pship property applied to discharge its liabilities and surplus applied to payin cash the net amount owed to partners (basically when a pship is dissolvedw/o contravention, the pships debts are paid then the rest is split accordingto the percentage each partner is due)

b. (2) dissolution in contravention of partnershipi. (a) each partner who did NOT cause dissolution gets all the rights as in

(1) above AND damages for the breach of the pship agreementii. (b) they (partners who did not cause dissolution) can also continue with

the business in the same name with the other partners if they desire andcan get the partnership property if they pay for the interest of their formerpartner

c. (2)(c): the partner who caused the wrongful dissolution gets:

i. (I) the rights under (1) if the other partner does NOT continue the business(wrongful dissolver can continue the business as long as the other partnersdecide not to)

ii. (II) of the business is continued (by the other partners), wrongful dissolvergets paid for his partnership interest less damages and his interest does notinclude goodwill of the business

R. Partnership Review

1. duration of pship: a pship may be for a term orat will. The default rule is atwill. A term may be implied.

2. partners are entitled to share in control3. freeze out: when a majority deprives a partner of participation in control, it

violates the pship agreement


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4. upon dissolution, the pship does not cease. Rather, it continues for the purposeof winding up

5. in some circumstances, the winding up will be accomplished by the partners whoare still available to do so. Otherwise, a court may order a sale.

6. after dissolution, partners may bid for the assets of the pship, including its

goodwill. Partners may bid to buy its assets piecemeal or as a going concern (onebig whole)7. partners owe each other a fiduciary obligation, so they cannot dissolve in bad

faith8. when a partner dissolves and bids for the assets of the pship, he or she must pay

a fair price.S. Buyout Agreements

1. essential in both the pship and corporate context2. in the corporate context, two types:

a. agreements that restrict the right of a shareholder to sell stock to whomeverthey please AND

b. agreements giving a shareholder the right to force the other shareholders orthe corporation itself to buy back the stock3. right to veto or right of first refusal on transfer of stock4. right to force company or other shareholders to buy back stock

III. CORPORATIONS

A. What is a Promoter?

1. 3 aspectsa. A person who identifies a business opportunity and puts together a dealb. Forming a corporationc. As the vehicle for investment by others

2. promoters owe fiduciary duties to the corporations they createB. Third Party Sales

1. Third party sales: If A sells land to a 3rd party, A can keep any profit2. Principal/Agent Sales: under general principles of agency law, an agent may

not profit from a transaction with a principal unless the agent discloses that profitto the principal. This is true both when the principal is an individual and when itis a corporation. If the agent does not disclose his or her financial interest, thenthe agent must give that profit to the principal (aka it is a secret profit)

3. Promoter Sales: when a promoter forms a new corp. under general principles ofagency, the promoter (as agent) owes a fiduciary duty to the new corporation (asprincipal)

C. Pre-Incorporation contracts

1. when a promoter contracts with a 3rd party on behalf of a not yet formed corp,who is liable on the K?

2. corp. can unilaterally adopt the K and agree to be liable even acquire rightsunder the K as a 3rd party beneficiary

3. an agent for a not-yet-formed corp. is liable on the K4. the agent is liable on the K if the corp. is never formed


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5. Investors in the unincorporated firm, if sharing profits, are partners. Under pshiplaw, they would be liable for any Ks entered into by their firm and their firm (if aparty to a K) could enforce any Ks made on its behalf.a. See SC BCA s. 33-2-104: all persons purporting to act as or on behalf of a

corp., where there has been no incorporation are jointly and severally liable

for all liabilities created while so acting, but any person so acting whilebelieving in good faith that the articles have been filed shall not have anyliability

D. Piercing the corporate veil (PCV)

1. Unless otherwise provided in the articles of incorporation, a shareholder (SH) ofa corp. is NOT personally liable for the acts or debts of the corp. except that hemay become personally liable by reason of his own acts or conduct (MBCA 6.22(b))

2. Courts will disregard the corp. form, or PCV, whenever necessary to preventfraud or to achieve equity

3. Whenever anyone uses control of the corp. to further his own rather than the

corp.s business, he will be liable for the corp.s acts on the principle ofrespondeat superior.4. otherwise, a corp. is a separate legal identity from its SHs (Walkovsky)5. the classic fact pattern is a situation in which liability has been incurred in the

name of a corp. that has become insolvent6. to PCV a court MUST find:

a. such unity of interest and ownership that the separate personalities of thecorp. and individual no longer exist AND

b. Circumstances where failing to PCV would either sanction fraud or promoteinjustice (Sea Land Services)

7. forunity of interest, look to the following factors:a. lack ofcorporate formalities (failure to maintain accurate corporate records)

( e.g. not holding SH and directors meetings; not issuing stock; not keepingcorporate minutes, etc.)

b. commingling of funds and assetsc. undercapitalization (not having enough $ to pay debts/liabilities)(also

insolvency)d. the use by one corp. of the assets of anothere. holding out by one that it is liable for the debts of the otherf. use ofsame offices and employeesg. use of one as a shell for the affairs of others

E. Imposing Liability on a Corporation

1. Alter Ego

a. Holding the equitable owner of a corp. liable for actions of the corp.b. Alter ego liability requires corp. to be influenced and governed by other

personc. Requires proof of fraud/injusticed. Removes vertical barriers* often arises in parent/subsidiary situations*

2. Enterprise liability


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a. Removes horizontal barriersb. Requires proof of fraud/injustice

Individual or corp. owns controlling interests in a number of corps. that areengaged in related activities. These are sister corps. multiple corps. are usedto artificially divide what is essentially one business enterprise into segments

in order to unreasonably limit liability or to mislead creditors or customers. Taxi case in nutshell page 91 also has factors to consider when imposing

liability based on enterprise theory.3. agency

a. No proof of fraud/injustice requiredF. PCV v. Direct Liability (like a 4th way to impose liability on corp.)

1. injustice under PCV: insufficient assets, adding credibility to subs products(Bristol Myers- breast implants)

2. Direct liability: one who undertakes to render services to another which heshould recognize as necessary for the protection of a 3rd person is subject toliability if he increases the risk of harm, performs a duty to owed to the 3rd

person; or harm is suffered through reliance by a third person on undertaking.(Basically: if A contracts to do something for B and B as a result harms C, A isliable to C)

G. Avoiding PCV

1. Avoid unity of interest by respecting the separate existence of the corp.2. respect corp. formalities3. keep corp. funds and transactions separate from individual funds/transactions

and do not shift money in and out of corp. accounts4. if formalities have been observed, so there can be no piercing, SHs or directors

liability is limited to the amount paid out, not for the full amount of the debt, asin piercing

5. if the separate existence of the corp. has not been respected, problems:a. in most cases need second element to be proved: fraud of injusticeb. but often need more to prove injustice than simply dissatisfied creditor, but

law not clear on exactly what neededc. not necessary for the plaintiff to show awareness of the defendants disregard

of the entity6. Fraud is an independent basis for liability, but requires proof of reliance. In some

piercing cases, fraud seems to be regarded as relevant without proof of relianceH. Limited Pships/SHs/Officers Liability

1. in general, partners are personally liable for the debts of the pship, but limitedpartners are not

2. In general, SHs are not liable for the debts of a corp3. in general, officers are not liable for the debts they cause a corp. to incurI. SC Business Corporations Act

1. SECTION 33-2-101: Incorporatorsa. Any person may act as the incorporator of a corp. by delivering articles of

incorporation to the Sec. of State for filing2. SECTION 33-2-102: Articles of incorporation

a. (a) the articles of incorp. must set forth:


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i. (1) a corporate name for the corporation that satisfies the requirements ofsection 33-4-101;

ii. (2) the number of shares the corp. is authorized to issue, itemized byclasses;

iii. (3) the street address of the corp.s initial registered office and the name of

its initial registered agent at that office;iv. (4) the name and address of each incorporator;v. (5) the signature of each incorporator; andvi. (6) a certificate, signed by an attorney licensed to practice in this state

(SC), that all of the requirements of this section have been complied with3. Powers of a Corporation

a. 3.02 General Powers/ SC Bus. Corp Act. 33-3-102i. Unless its articles of incorp. Provide otherwise, every corp. has the power

to do all things necessary or convenient to carry out its business andaffairs, including w/o limitation power:

ii. To sue and be sued, complain and defend its corp. name

iii.To make and amend bylawsiv. To acquire, own, hold, and otherwise deal with, real or personal propertyv. To make donations for the public welfare of for charitable, scientific, or

educational purposes;vi. To make payments or donations or to do any other act, not inconsistent

with law, that furthers the business and affairs of the corp.4. Purpose and Ultra Vires (nutshell page 64)

a. RMBCA 3.04/ SC Bus. Corp. Act. 33-3-104:b. (a) except as provided in subsection (b), the validity of corporate action

cannot be challenged on the ground that the corp. lacks or lacked power to act( the corp. engages in acts beyond the purpose for which the corp wasorganized)

c. (b) a corps power to act may be challenged: (i.e. they cant just be sued for itby anyone)i. (1) in a proceeding by a SH against the corp. to enjoin the act;ii. (2) in a proceeding by the corp., directly, derivatively, or through a

receiver, trustee, or other legal representative, against an incumbent orformer director, officer, employee, or agent of the corp.; OR

iii. (3) on a proceeding by the attorney generalJ. Business Judgment Rule

1. BJR: in the absence of a showing of fraud, illegality, or self- dealing (i.e. aconflict of interest) by the directors, their decision is final and not subject to

review by the courts.

2. Policy rationale:a. Courts are not business expertsb. Protection of courts non-SH constituentsc. Preserves centralization of decision making

K. Derivative Suits

1. a derivative suit is a suit in equity against a corp. to compel it to sue a 3rd party


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2. Distinction between direct and derivative claims: a suit is direct if it alleges adirect loss to the SH; it is derivative if it alleges a loss to SH that derives from aloss to the corp.

3. FRCP: rule 23.1: derivative action By SHsa. In a derivative action brought by one or more SHs or members to enforce a

right of a corp. or of an unincorporated association, the corp. or assoc. havingfailed to enforce a right which it may properly assert, the complaint shall beverified and shall allege:

b. (1) that the plaintiff was a SH or member at the time of the transaction andthat (2) the action is not a collusive one to confer jurisdiction on a court ofthe US which it would not otherwise have.

c. The complaint shall also allege with particularity the efforts, if any, made bythe plaintiff to obtain the action the plaintiff desires from the directors orcomparable authority and, if necessary, from the SHs or members and thereasons for the plaintiffs failure

d. The derivative action may not be maintained if it appears that the plaintiff

does not fairly and accurately represent the interests of the shareholders ormembers similarly situatede. The action shall not be dismissed or compromised w/o the approval of the

court, and notice of the proposed dismissal or compromise shall be given toSHs or members in such manner as the court directs.

4. Derivative v. Direct

a. Derivative: complaint is injury to corp. (i.e. actions of management on behalfof corp. challenged)

b. Representative class action: injury is one to plaintiff as SH and to himindividually and not to corp. (i.e. actions of management in interfering withPs rights as a SH challenged)

c. Test to determine derivative or direct:

i. (1) who suffered the harm, corp. or SHs individually? Andii. (2) who receives benefit of recovery/remedy, corp. or SHs individually?

(Tooley)d. But usual tests for a direct action are premised on (1) injury to SH that is not

derivative of prior injury to the corp. entity or (2) a breach of a contractualduty owed SH independent of any right of the corp

e. Strike suit: when person with a small stake in the value of the business andbrings a derivative suit in order to be bought off/out.

L. Demand on Directors

1. Plaintiffs in derivative suits are required to approach the board and demand thatit sue the alleged wrongdoers

2. If demand is required, the failure to make the demand is a procedural barrier andthe suit will be dismissed

3. The demand requirement raises 2 questions (1) when is demand excused? And(2) what happens if demand is excused but the board does not want the suit?

4. Grimes v. Donald

a. Direct v. Derivative: Was Grimess complaint derivative of direct?


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i. Held: abdication claim is direct, and the compensation related claimsderivative

ii. Look to injury falling on SH for direct action and also to remedy beingsought. If monetary recovery to the corp., derivative, if not, direct.

b. Holding on direct claim:

i. If a K would effectively preclude the board from exercising its managerialand supervisory duties, the K would amount to a de facto abdication of theboards fiduciary obligations

ii. Here, the K amounted to a valid delegation: A board decision to incur therisk of such a financial penalty in order to attract a senior manager wasentitled to BJR protection

c. Holding on Demand Futility: is the board disabled by conflicted interestsfrom exercising independent business judgment?i. The 3 Usual bases for excusing demand as futile are identified as:

ii. (1) a majority of the board has a material interest in the challengedtransaction

iii.(2) a majority of the board is dominated orcontrolled by the allegedwrongdoer; ORiv. (3) the challenged transaction was not the product of a valid BJ

5. Notes on Demand on Directors

a. Purpose of demand: to allow the corp. to take over the cause of action or toresist it, according to the judgment of directors

b. Where directors cannot be expected to make a fair decision, demand wouldbe futile and is excused

c. Generally, where demand is made, the plaintiff is deemed to have concededthat it was required, which, in turn, makes the decision of the board turn onwhether to dismiss as a matter of BJ

d. Demand will almost always be required unless:

i. A majority of the board is so directly self-interested in the challengedtransaction that there is a serious doubt that the BJR would protect thetransaction OR

ii. If the plaintiff can allege with particularity that the challenged transactionwas not the product of a valid exercise of BJ

e. Where demand is excused, the corp. may still move to dismiss the suit as notin the best interests of the corp.

6. Universal Demand

a. RMBCA 7.42 requires a written demand upon the board in all cases, and,further, precludes a SH from bringing suit for 90 days after the demand ismade

b. Demand then reviewed by the board or independent committeec. If either the board of committee concludes in good faith that derivative

proceeding is not in the best interests of the corp., the court dismisses thecomplaint

d. Alternatively, the court may appoint independent panels to determinewhether the suit should go forward. If dismissal is recommended, the court


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dismisses unless the plaintiff can prove the independent panel failed to act ingood faith or failed to conduct a reasonable inquiry.

7. Marx v. Akersa. Purposes of demand requirement:

i. (1) to relieve courts from deciding matters of internal corporate

governance by allowing directors to correct abuses,ii. (2) provide corporate boards with reasonable protection from harassmentby litigations, and

iii. (3) discourage strike suits for SH personal gainb. 3 bases for excusing demand underNY law:

i. (1) majority of the board of directors interested in the challengedtransaction

ii. (2) BoD did not fully inform themselves about the challenged transactionto the extend reasonably appropriate under the circumstances, OR

iii. (3) the challenged transaction was so egregarious on its face that it couldnot have been the product of sound BJ of the directors (Barr v. Welcome)

c. Note: bare allegation that the compensation of directors is excessive is notenough, particularity in the allegations is requiredM.Special Committees

1. Role of Special Committees

a. Courts are ill equipped to evaluate BJsb. BUT, BJR does not foreclose inquiry by courts into the disinterested

independence of special committee (Auerbach)c. Balance: adequacy and appropriateness of SCs investigative procedures and

methodologies is reviewable, but not their conclusions.d. Committees Under Corporate Law

i. DGCL 141 (c): the BoD may designate 1 or more committees, eachcommittee to consist of 1 or more of the directors of the corp. Any suchcommittee shall have and may exercise all the powers and authority of theBoD in the management of the business and affairs of the corp.

ii. SC Bus. Corp. Act 33-8-250 (a): Unless the articles of incorporation orbylaws provide otherwise, a BoD may create one of more committees andappoint members of the BoD to serve on them. Each committee must have2 or more members who serve at the pleasure of the BoD.

2. Zapata Test for Court Review of Special Committee

a. Court inquires into independence and good faith of committee and the basessupporting its conclusions, if satisfied, move to step 2

b. Court undertakes an independent inquiry into whether the suit should bedismissed

c. If courts independent BJ is satisfied, motion to dismiss suit is grantedN. Independence of a Director

1. Turns on whether director is, for any substantial reason, incapable of making adecision with only the best interests of the corp. in mind

2. independence of directors determines derivative suits, standard of review forrelated party transactions, takeover defenses, and is a precondition forapplication of the BJR


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3. NYSE Independent Director Requirements

a. No director qualifies as independent unless the BoD affirmativelydetermines that the director has no material relationship with the listedcompany

b. BUT: a director is not independent if:

c. (1) within the last 3 years, the director has been an employee, an immediatefamily member, or an executive officer of the listed companyd. (2) the director has received, during any 12-month period within the last 3

years, more than $100,000 in direct compensation from the listed company,other than director and committee fees

e. (3) the director or any immediate family member is a current partner of a firmthat is the companys internal or external auditor

f. (4) the director is a current employee or has an immediate family memberwho is an employee

g. (5)the director has an immediate family member who is a current employeeof such a firm (auditing firm)

O. Caremark Violations1. the BoDs indifference to the alleged wrong acts was so extreme as to constitutesubjective bad faith

2. i.e. Beam v. Martha Stewart Living Omnimedia: In Beam, court rejectsCaremark allegations noting: Regardless of Stewarts importance to MSO, she isnot the corp. And it is unreasonable to impose a duty on the BoD to monitorStewarts personal affairs b/c such a requirement is neither legitimate norfeasible.

IV. MORE CORPORATIONS

A. BJR

1. BJR: in the absence of a showing of fraud, illegality, or self- dealing (i.e. a

conflict of interest) by the directors, their decision is final and not subject to

review by the courts.

2. Policy rationale:a. Courts are not business expertsb. Protection of courts non-SH constituentsc. Preserves centralization of decision making

3. Ties between BJR, Duty of Loyalty, Duty of Carea. BJR grants to directors a broad immunity for any mistakes, but not if any

fraud, illegality, conflict of interest, or negligenceb. Conflict of interest relates to Duty of loyalty (DOL), negligence relates to

duty of care (DOC)c. So, if directors have avoided conflicts of interest (DOL), and if they have

gathered information and thought about the problem they face (DOC), thenthe courts will not second guess them (BJR)

4. Kamin v. Amexa. Courts will not interfere with the acts of directors or the discretion of BoD

unless:i. The powers have been illegally or unconscientiously executed;ii. The acts were fraudulent and destructive of the rights of the SHs; or


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iii.The directors have acted or are about to act in bad faith and for a dishonestpurpose

b. Note: more than imprudence/mistaken judgment needed; need neglect ofduties

c. Bottom line: no court interference unless fraud, oppression, arbitrary action,

breach of trust5. Van Gorkoma. BJR does not protect and uninformed decisionb. Burden of proof is on the party attacking the boards decision (to prove that it

is not protected by BJR)c. Whether a BJ is an informed one turns on whether the directors have

informed themselves prior to making a business decision of all materialinformation reasonably available to them

d. Direct, not derivative in this casee. Spare cash options:

i. Use of cash to acquire other businesses

ii. Payment of dividendiii.Repurchase of stockf. 4th spare cash option: sell the corporation

i. Normal sale or LBO (leveraged buyout) or MBO (managed buyout)ii. LBO: purchase of a company financed by a small amount of equity and a

large amount of debt (can borrow money from banks using the collateralof targets assets). Also sales of targets assets can be used to payoff loan.Loan may appear on targets balance sheet.

B. Director Liability

1. Reliance on experts report can protect a director from liability (Brehm); seealso DGCL 141(e):a. A member of the BoD, or a member of any committee designated by the

BoD, shall, in the performance of such members duties, be fully protected inrelying in good faith upon the records of the corp., information presented tothe corp. by any of the corp.s officers or employees, or by any other personas to matters the member reasonably believes are within such other personsprofessional or expert competence and who has been selected with reasonablecare by or on behalf of the corp.

2. In re Walt Disney Litigationa. BJR protects director decisions even when the information and decision-

making process by which that decision was made was not so tidy as wouldhave been the case had the directors followed a best practices scenarioand falls short of what best practices would have counseled.

b. Possible bases for finding that directors acted in bad faith:i. (a) conduct motivated by subjective bad faith (i.e., an actual intent to do

harm);ii. (b) gross negligence; andiii. (c) intentional dereliction of a duty, a conscious disregard for ones

responsibilities


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c. The compensation committee had the power to approve Ovitzs pay package,w/o referring the matter to the full board, and exercised due care in doing so.The full board was entitled to rely on Eisner and the compensationcommittee.

d. The SHs argument that Ovitzs compensation package was inherently

wasteful was not accepted. The deal had a rational business purpose- i.e., toinduce Ovitz to leave his highly lucrative position at another company, andno evidence that the deal irrationally incentivized Ovitz to get himselffired.

3. Francis v. United Jersey Banka. Directors should acquire a rudimentary understanding of business and

exercise ordinary prudent care; a failure to do so may violate a directorsDOC

b. Directors can rely on subordinates, but not if they have notice thatsubordinates are acting inappropriately.

4. Caremark Principles

a. Director liability arises in two contexts:i. Liability may follow from a board decision that results in a loss b/c thatdecision was ill advised or negligent, but not if it was wrong

ii. Liability to the corp. for a loss may be said to arise from an unconsideredfailure of the board to act in circumstances in which due attention wouldhave prevented the loss

b. Note: directors obligation includes a duty to attempt in good faith to assurethat an adequate corporate information and reporting system exists; failure todo so may render a director liable.

c. ***if there was a rational basis for their decision and there was no fraud.Illegality, or COI, even with the benefit of hindsight, the decision turns

out to be wrong, there will be no violation of DOC***

5. Violation of DOC by failing to monitor:

a. To show that directors breached their DOC by failing to adequately controlthe employees, plaintiffs would have to show either:i. (1) that the directors knew orii. (2) should have known that violations of law were occurring and, in wither

event,iii. (3) that the directors took no steps in a good faith effort to prevent or

remedy that situation, andiv. (4) that such failure proximately resulted in the losses complained of

(Caremark p. 371 of text)C. Duty of Loyalty and Sarbanes-Oxley Act

1. Section 402 of SOA bars publicly held corps. Registered with the SEC fromdirectly or indirectly lending or arranging for the extension of credit to their ownofficers or directors

2. 402 may also interfere with such other transactions as the advancement ofexpenses pursuant to a state indemnification statute or the cashless exercise ofstock options


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3. 406 requires a corp. to adopt a code of ethics applicable to CEO, CFO,controller, and chief accountant. Failure to do so requires an explanation.

4. the ethics code must provide for the ethical handling of actual or apparentconflicts of interest between personal and professional relationships

D. Duty of Loyalty (DOL)

1. Personal transactions of lawyers with their corps. Tend to produce a conflictbetween self-interest and fiduciary obligation; evidence of improvidence,oppression, unfairness, or undue advantage will void the transaction (Bayer)

2. violation of DOL occurs when officers or directors are greedy and put theirown financial interests ahead of the interests of the corporation or its SHs

3. Courts look to fairness of the transaction to the corporation4. Due to the conflict of interest, the BJR does not apply; so directors bear burden

of proof of fairness of transaction5. *** BJR is not an issue in DOL cases***

E. Directors Conflicts of interest

1. (a) absent a COI, the plaintiff has the burden of proof, and will no doubt lose b/c

of the BJR2. (b) given and ungratified COI, the defendant directors have the burden ofproving that the challenged transaction was fair and reasonable

3. (c) given a transaction with a COI but with ratification (by disinterested SHs ordirectors), the plaintiff again has the burden of proof and must overcome the BJR

4. Often looks like:a. Interested director transactions

i. Occurs when, in effect, the officer or director is on both sides of atransaction

b. Usurping corporate opportunitiesF. Corporate Opportunity

1. A corporate fiduciary agrees to place the interests of the corp. before his own inappropriate circumstances

2. Usurping a corporate opportunity violates the basic rule that directors andofficers cannot utilize their positions within the corp. to whom they owefiduciary duties to profit personally at the expense of the corp.

3. if there is presented to a corp. officer or director a business opportunity

which the corporation:

a. is financially able to undertake

b. is, from its nature, in the line of the corps business and is of practical

advantage to it,

c. is one in which the corp. has an interest or a reasonable expectancy, and

d. by embracing the opportunity, the self-interest of the officer or director

will be brought into conflict with that of the corporation, the law will not

permit him to seize that opportunity.

4. Corporate opportunity test as interpreted by Beam

a. In looking to whether the corp. is financiallyable to exploit the opportunity,here look to whether MSO had enough authorized but unissued stock tosatisfy the investor


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b. An opportunity is within the corps line of business if it is an activity as towhich the corp has fundamental knowledge, practical experience, and abilityto pursue. A companys line of business is one that is intended to beprofitable.

c. An interest or expectancy in the transaction requires some tie between that

property and the nature of the corp. business.d. COI: Delaware courts have recognized a policy that allows officers anddirectors of corps. to buy and sell shares of that corp. at will so long as theyact in good faith.

G. Intrinsic Fairness

1. When the situation involves a parent and a subsidiary, with the parent controllingthe transaction and fixing the terms, the test of intrinsic fairness, with itsresulting shifting of the burden of proof, is applied

2. A parent owes a fiduciary duty to its subsidiary when there are parent-subsidiarydealings. But only where this fiduciary duty is accompanied by self-dealing willthe intrinsic fairness test be applied

3. Self-dealing occurs when the parent, by virtue of its domination of thesubsidiary, causes the subsidiary to act in such a way that the parent receivessomething from the subsidiary to the exclusion of, and detriment to, the minoritySHs of the subsidiary

H. Fiduciary Duties of SHs

1. SHs and directors normally do not bear the same fiduciary duties2. courts may impose the BoDs fiduciary duties directly in the controlling of

majority SHs3. Where a controlling SH uses a direct SH vote to authorize certain corporate

actions in a manner the court considers unfair, a court may hold that the SHviolated fiduciary duties to the other SHs

4. in general:a. transactions (with a potential for self-dealing) between a controlling SH and

the corp. are subject to an intrinsic fairness test; andb. majority SH has the right to control; but when it does so, it occupies a

fiduciary relation toward the corp. itself or its officers and directorsI. Ratification

1. 8 Del.C. 144a. No K or transaction between a corp. and its directors of officers, shall be void

or voidable solely for this reason, or solely because the officer or director ispresent at or participates in the meeting of the board or committee whichauthorizes the K or transaction, or solely because his or their votes arecounted for such purpose if:i. (1) the material facts as to his relationship or interest and as to the K or

transaction are disclosed to the board and the board authorizes the K ortransaction by the affirmative votes of a majority of the disinteresteddirectors; OR

ii. (2) the material facts are disclosed to the SHs entitled to vote thereon, andthe K or transaction is specifically approved in good faith by vote of theSHs; or


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iii. (3) the K or transaction is fair as to the corp. as of the time it is authorized,approved, or ratified, by the BoD, a committee, or the SHs.

2. Wheelabratora. (a) if a challenged transaction involves a deal between the corp. and one of

the directors, then the effect of the disinterested SH ratification is to shift the

burden of proof to the plaintiff to show waste (overcome BJR)b. (b) if a challenged transaction involves a deal between the corp. and acontrolling SH, then the effect of the disinterested SH ratification is to shiftthe burden of proof to the plaintiff to show that the transaction fails the test ofentire fairness.

3. effects of disinterested ratificationa. Violation of DOC consisting of failure of the board to reach an informed

business judgment (as in van Gorkom): Plaintiff can succeed only by provingwaste or gift.

b. Lack of Board authority: Claim extinguishedc. Lack of adequate investigation and consideration by the board: (again as in

Van Gorkom) Claim extinguished.d. Interested director: burden shifts to plaintiff. Standard is BJR (plaintiff mustprove waste or gift or gross negligence) (Wheelabrator)

e. Controlling SH: burden shifts to plaintiff. Standard is entire fairness.

V. SECURITIES

A. Regulation of Primary market

1. Securities Act 1933: requires companies issuing stock to disclose info about theirbusiness and capital structure

2. Securities Act 1934 & Blue Sky Laws: the 1934 Act collects a variety ofdifferent disclosure and regulatory provisions; i.e., short-swing trades (16(b))and fraud (Rule 10b-5) banneda. Also requires large publicly traded companies to disclose info regularly

through forms 10-K (annual) and 10-Q (quarterly), and regulates tenderoffers and proxy fights.

b. Blue-Sky laws: state statutes which purport to regulate the quality of thesecurities issued. Of the regulatory commission deems a security too risky,the issuer may not be able to sell it in this state at all.

B. Sarbanes-Oxley Act

1. requires audit committee2. the committee must be comprised solely of independent directors3. at least one member of the committee must qualify as a financial expert4. the audit committee must establish a system for employees to anonymously

whistle blow5. SEC is now empowered to remove officers and directors from their positions, or

bar them from serving at other public corporations on grounds of unfitness6. indirectly regulates executive compensation7. prohibits a corp. from directly or indirectly making or even arranging for loans to

its directors and executive officers


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8. prohibits executives from trading during blackout periods in which theemployees participating in stock-based pension plans are forbidden from trading

9. requires therapeutic disclosureC. Definition of Security

1. An investment contract is a contract, transaction, or scheme whereby a person

invests his money in a common enterprise and is led to expect profits from theefforts of the promoter or a third party.2. What matters more than the form of an investment scheme is the economic

reality that it represents.3. Query: whether the investor, due to investment agreement itself or the factual

circumstances that surround it, is left unable to exercise meaningful control overthe investment (Robinson)

D. Registration Process

1. The Securities Act prohibits the sale of securities unless the company issuingthem has registered them with the SEC

2. the Securities Act includes 2 types ofexemptions to registration requirement:

a. some securities exempted entirelyb. some transactions exempted3. Exempt securities need never be registered, either when initially sold by the

issuer or in any subsequent transaction4. exempt transactions are one-time exemptions

E. Private Placements: Registration Exemption

1. limited partnership interest is a security (Doran)2. 4 characteristics define a private placement

a. Number of offerees and their relationship to each otherb. Number of units offeredc. The size of the offeringd. The manner of the offering

3. even if the 4 factors are met, issuer needs to demonstrate that accurate info wasprovided to offerees to secure the exemption

F. Misrepresentations in Security Sales

1. securities act 11: fraud committed in connection with the sale of securitiesthrough the use of a registration statement

2. Under 11, the following parties are liable if the registration statement ismaterially misleading:a. Those who sign the registration statement (this includes the issuer)b. Directorsc. Expertsd. underwriters

3. the issuer is liable b/c it must sign the registration statement; it has no defenses.The other parties have the so-called due-diligence defenses of 11(b).

4. Under (a)(4) experts not liable for misstatements in non-expertised part5. Under (b)(3)(A), with respect to non-expertised portions, the non-experts must

show that, after reasonable investigation, they had reasonable grounds to believe,and did believe, that the statements were true (failure to make a reasonable


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investigation or look at it at all will result in liability b/c there was no due-diligence)

6. Under (b)(3)(B), with respect to expert portions, we use the same test to expertson the expertise portion

7. Under (b)(3)(C) with respect to expertised portions, the non-experts must show

that they had no reason to believe, and did not believe, that the statements weremisleading.VI. RULE 10b-5

A. It shall be unlawful for any person, directly or indirectly, by the use of any meansor instrumentality of interstate commerce, or the mails or of any facility of anynational securities exchange: prohibits1. (a) to employ any device, scheme, or artifice to defraud2. (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 light of thecircumstances under which they were made, not misleading, (any omission ormisstatement of material fact) OR

3. (c) To engage in any act, practice, or course of business which operates or wouldoperate as a fraud or deceit upon any person, in connection with the purchase orsale of any security (Any act or practice that would operate as fraud ordeceit)

B. Proving a Violation of 10b-5

1. traditionally, a plaintiff suing under rule 10b-5 needed to show 4 things: scienter,proximate cause, materiality, reliancea. SCIENTER: Plaintiff must show that the defendant acted with an intent to

deceive, manipulate, or defraud; recklessnessb. CAUSATION: Plaintiff must show that the misstatement causedthe damagec. MATERIALITY: Plaintiff must show that a reasonable investor would likely

consider the misstatement importantd. RELIANCE: Ifaffirmative misrepresentation, proof of reliance on the

misrepresentation IS required; Iffailure to disclose, absent proof by thedefendant to the contrary, presumption of reliance

C. Options

1. Under these Ks a seller agrees to sell or a purchaser agrees to buy a security at afixed price on or before a fixed date in the future

2. Allows for hedging against future movements in market price of securities3. the option K gives its owner the right to buy (call) or sell (put) a fixed number of

shares of a specified underlying stock at a given price (the striking price) on orbefore the expiration date of the K

4. for this option, a premium is paid, and the K is worth more or less than thepremium depending on the direction of the market price of the underlying stockrelative to the striking price

D. Evolution of Common Law Insider Trading

1. Majority or no-duty rule: liability was based solely on actual fraud, such asmisrep or fraudulent concealment of a material fact


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2. Directors who obtained inside info by virtue of their position held the info intrust for the SHs, so directors had duty to disclose all material info to SHs beforetrading with them

3. Special facts or special circumstances rule: although directors generally owe noduty to disclose material facts when trading with SHs, such a duty can arise in

special circumstancesE. Texas Gulf Sulphur1. Insiders who traded prior to the public dissemination of the info violated 10b-52. basic disclose-or-abstain rule: if a company decides not to disclose, insiders

must not buy stock3. Disclosure of inside info required before insiders can trade4. reasonable investor standard for materiality: info is material if a reasonable

investor would consider it important, that is if the info mightaffect the value ofthe stock

5. the fact that insiders trade in a piece of info itself demonstrates materiality6. insiders must wait to trade until the info has been effectively disseminated:

media of the widest circulationF. Inside Information1. Duty to abstain from trading on inside information arises from the relationship

between a corps SHs and its employees2. if no relationship of trust between trader and the SHs of the corps whose shares

he traded, no duty to disclose or abstain (Chiarella)3. not all breaches of fiduciary duty in connection with securities transactions come

under the ambit of 10b-5; manipulation or deception also needed (Santa FeIndustries)

G. Dirks (tipping)1. whether a tippee violates rule 10b-5 will depend on whether the tippee violated a

fiduciary duty to the firms SHs in giving the tip, and whether the tippee knew orshould have known of that breach

2. in this context, a fiduciary duty breach occurs only where a tipper earns apersonal benefit from the tip

3. lawyers and accountants constitute temporary insiders for the purposes of tippingliability

4. Personal benefit test: must showa. That the tipper breached a fiduciary duty andb. That the tipper tipped for the purpose of obtaining some sort of personal gain

i. Ways it is often earned: selling the information; giving it to enhance onesreputation or standing or with the expectation of receiving some reciprocalbenefit; and giving the info to a person that the tipper has a personalrelationship with.

H. Rule 14e-3 and misappropriation

1. Rule 14e-3: prohibits trading while in possession of material, non-public inforelating to a tender offer

2. Misappropriation theory: a person commits fraud in connection with a securitiestransaction when he misappropriates confidential info for securities tradingpurposes, in breach of a duty owed to the source of the info.


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I. Insider trading recap

1. Generally, trading on inside info violates 10b-5 as duty to abstain from tradingon inside info arises from the relationship of trust between trader and SHs ofcorp.

2. if no relationship of trust between trader and SH, no duty to disclose or abstain

(Chiarella)3. BUT, SEC rule 14e-3 prohibits trading while in possession of inside info relatingto a tender offer

4. Tipping Liability: if a tipper violates a fiduciary duty by earning a personalbenefit from giving a tip to a tippee and the tippee knew of that breach, violationof 10b-5 (Dirks)

5. A fiduciarys undisclosed use of info belonging to his principal, w/o disclosureof such use to principal, for personal gain constitutes misappropriation andviolates 10b-5

VII. PROXY

A. Allows a SH (as principal) to appoint someone else (as agent) to vote on his or her

behalf at the SHs meetingB. Expenses for acquiring proxies if reasonable are able to be charged to the firm(Levin)

C. Reimbursement rules for proxy fights

1. the corp. may not reimburse either party unless the dispute concerns questions ofcorporate policy

2. the firm may reimburse only reasonable and proper expenses3. the firm may reimburse incumbents whether they win or lose4. the firm may reimburse insurgents only if they win, and only if SHs ratify the

paymentD. Regulatory schemes for proxies

1. section 14(a) of the 1934 securities act prohibits people from soliciting proxies inviolation of SEC rules

2. rules 14a-3, 14a-4, 14a-5 and 14a-11 require people who solicit proxies tofurnish each SH with a proxy statement in which they disclose info that maybe relevant to the decision the SH must make

3. when an insurgent group wants to contest management and solicit proxies, rule14a-7 gives management a choice: it can either mail the material to the SHsdirectly and charge the group for the cost, or provide it with a SH list and let itdistribute its own material

E. Defects in proxy statements (NS 154)1. where the misstatement or omission in a proxy statement has been shown to be

material, the defect was of such a character that it might have been consideredimportant by a reasonable SH who was in the process of deciding how to vote

2. as a result, if the defect has a significant propensity to affect the voting processb/c the defect is material and the proxy solicitation was essential, plaintiff hassatisfied the requirement of proof of causation

F. SH proposals (NS 153)1. types:

a. to remove poison pills


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b. to require annual election of directorsc. to require that directors hold a specified minimum amount of corporate sharesd. to prevent the same person from being both CEO and chairman of the boarde. to require that a majority of the board and of all key committees be

independent directors

f. to link director pay to corporate performanceg. to require that the compensation committee be composed entirely ofindependent directors, with its own compensation consultant; and

h. to create a committee of SHs to advise the directors2. Excluding SH proposals

a. Rule 14a-8(i)(5) provides that if a SH proposal relates to operations whichaccount for less than 5 percent of the firms assets, earnings, or sales, and isnot otherwise significantly related to the firms business, the proposal may beomitted from the proxy statement

b. However, otherwise significantly related is not limited to economicsignificance; matters of ethical and social significance can be included

(Lovenheim)3. Valid reasons for excluding SH proposals under rule 14a-8a. The proposal does not concern a proper subject for action by SHs ((i)(1))

(e.g. ordinary business operations)b. The proposal is illegal ((i)(2))c. The proposal violates proxy rules ((i)(3))d. The proposal concerns a personal grievance or benefit ((i)(4))e. The proposal concerns a matter beyond the power of the firm to effectuate

((i)(6))f. The proposal relates to a companys ordinary business operations ((i)(7))g. The proposal has been submitted in the past and has not obtained much

support ((i)(12))G. SH inspection rights

1. a SH desiring to discuss relevant aspects of a tender offer should be grantedaccess to the SH list unless it is sought for a purpose inimical to the corp. or itsSHs (Crane)

2. SHs must have a proper purpose for inspecting corp. records/requesting SHlists; a proper purpose contemplates concern with investment return (Pillsbury)

3. Using a SH list to facilitate SH communication strengthens a request for a SHlist even where the SH is acting as an agent (Sadler)

VIII. SH VOTING CONTROL

A. A proprietary right is not just a right to profits or distributions; a right to participatein control is also a proprietary right (Stroh)

B. Control of a corp. can be allocated based on:1. 2 classes of shares2. common stock3. class specific board members4. voting trust (NS 129)

a. SH transfers legal title to his shares to voting trustee(s) which gives thetrustee(s) the right to vote for those shares exclusively for a defined period


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5. vote pooling arrangements (NS 127)a. vote pooling arrangements are valid (Ringling)b. vote pooling arrangements are valid both for close corps. and among any

number of SHs of other corps. (Estrada)c. Ks among SHs to vote their shares in the manner proscribed in the K

6. irrevocable proxiesC. Judging director action for violations of DOL:1. Blasius standard:

a. First, the plaintiff must establish that the board acted for the primary purposeof thwarting the exercise of a SH vote

b. Second, the board has the burden to demonstrate a compelling justificationfor its actions

2. If plaintiff is unable to satisfy the initial primary purpose prong, BJR appliesD. SHs themselves may not, by agreement among themselves, control the directors in

the exercise of the judgment vested in them by virtue of their office to elect officersand fix salaries (McQuade)

E. The McQuade rule is designed to protect minority SHs who were not party to theagreement, so where the corp. has no minority SHs, the McQuade rule isunnecessary (Clark)

F. SH agreements requiring the appointment of particular individuals as officers oremployees of the corp. are enforceable, at least for closely help corps., as long asthey are signed by all SHs or the minority SHs do not complain, no apparent injuryto the public/creditor is present, and the terms of the agreement are reasonable(Galler)

G. McQuade: 3 men, as SHs could agree to elect each other as directors, but theycould not agree in advance what they would do as directors. (nutshell 117-118)

H. McQuade: a SH agreement prohibiting the board from changing officers, salaries,or policies or retaining individuals in office is illegal and void absent expresscontractual consent

BUSINESS ASSOCIATIONS OUTLINE- Chodhury Frances Stern

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