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Corporations Outline #1

Business Organizations



I. Agency


A. Who is an Agent?

  • an agent is:
    • one who acts for another by authority from him,
    • one who undertakes to transact business or manage some affair for another by authority and on account of the latter


Three Required Elements of an Agency Relationship:

  • 1. a manifestation by the principal that the agent will act for him;
    • consent by a person (the principal) that the other (the agent) shall act on her/his behalf
    • If they consent to each other, then agency results and they are now bound in a relationship that the law recognizes (it now has legal implications)
  • 2. acceptance by the agent of the undertaking; and
  • 3. an understanding between the parties that the principal will be in control of the undertaking


Legal Implications:

  • In order to create an agency, there must be an agreement, but not necessarily a contract between the parties
    • there doesn’t have to be a contract between principal and agent
    • the agent doesn’t have to promise to act as such
    • neither one has to receive compensation
  • Agency is its own kind of legal relationship that has its own implications
    • Legal implication: the principal is responsible for what the agent does


Responsibility for Acts of Agents

    • Gorton v. Doty- The court thinks it’s an important fact that she specifically said that only he was supposed to drive the car, nobody elsethat is evidence that the coach was acting subject to her controlThe court feels that since the coach was the actual driver and was under her control, he consented to the agreement. 


RS §161—General agent- an agent authorized to conduct a series of transactions involving a continuity of service

Burden of Proof

  • P has the burden to prove agency by a fair preponderance of the evidence
  • Agency is a question of fact
  • NOTE: agency is traditionally part of state law




  • Has a party agreed to act on behalf of a second party, subject to the second party’s control?
    • If YES, an agency relationship is created


Reality of the Circumstances

  • an agreement may result in the creation of an agency relationship even if the parties did not call it an agency and did not intend the legal consequences of the relation to follow
  • court looks to the facts and the reality of the actual situation to decide whether there was an agency relationship or a business relationship
    • intent of the parties does not matter—only their actions toward each other.
  • The existence of the agency may be proved by circumstantial evidence which shows a course of dealing between the two parties
    • when an agency relationship is to be proven by circumstantial evidence, the principal have consented to the agency
    • one cannot be the agent of another except by consent of the principal
  • an agency relationship results when objective criteria are met, regardless of the parties subjective personal beliefs
  • when people behave towards each other as principal and agent, the law will hold them to this
  • A creditor who assumes control of his debtor’s business may become liable as a principal for the acts of the debtor in connection with the business.
  • NOTE: a security holder who merely exercises a veto power over the business acts of his debtor is not a principal, but if he takes over the management of the business and directs which contracts may or may not be made, he has become the principal and is liable for the agent’s actions


Public Policy

  • in our society, when someone is exercising control over someone and doing something for that persons’ benefit, it seems fair that they be responsible for that outcome
    • we want fairness and justice
  • It is unfair if one party exercises control over another, but takes no responsibility for the other party’s actions
    • Ex. Cargill claimed that while they had control over Warren, they were not responsible for what happened to them [this is a recipe for a small pie]
  • The principal is not accountable for every act that the agent does, only those that the agent has authority to do
    • Ex. of the teacher and the coach—even if the coach was her agent when driving her car, if he goes out and buys property, she is not liable for payment of the land, b/c she only consented to the use of the car.


Pie Analogy:

  • Two Views:
    • You can be concerned with division of the pie—who gets what in the pie—fairness; OR
    • You can be concerned with the growth of the pie—efficiency
  • We should be less concerned about the distribution of the pie and more concerned about the size of the pie
  • You could say you are more concerned with a fair distribution of the pie than with your own slice of the pie


B. Liability of Principal to Third Parties in Contract


1. Authority


Actual authority

  • Authority that the principal, expressly or implicitly, gave the agent


Implied authority

  • Under the “actual authority” category
    • The actual authority given to the agent by the principal also includes powers that are practically necessary to carry out the duties actually delegated.
  • FOCUS: upon the agent’s understanding of his authority.
  • the agent must reasonably believe, because of present or past conduct of the principal, that the principal wishes him to act in a certain way or to have certain authority
    • Specific conduct by the principal in the past permitting the agent to exercise similar powers is crucial
    • Agent can use circumstantial evidence
      • the acts and conduct of the parties such as the continuous course of conduct of the parties covering a number of successive transactions
  • the agent has the authority to do anything that a reasonable person would think are necessary to accomplish the task that he was given actual authority to do


Burden of Proof: the person alleging has to prove that he is the agent and has the authority to act as an agent


2. Apparent Authority


Two Main Classifications of Authority:

  • 1. actual authority– authority that the principal expressly or implicitly gave the agent
    • implied authority is a sub-group of actual authority
      • actual authority given implicitly by a principal to his agent
  • 2. apparent authority- when a principal acts in such a manner as to convey the impression to a third party that an agent has certain powers which he may or may not actually possess


Apparent Authority

  • the authority that the agent appears to possess
    • It is a matter of appearances on which third parties come to rely
  • FOCUS: on the perspective of a reasonable third party
  • If principal holds out agent as having authority to bind principal then agent will have that authority:
    • even if principal never gave the agent authority; AND
    • even if principal told agent that he does NOT have the authority.


NOTE: inherent agency and apparent agency are both theories under which the principal may be held liable for the acts of an agent where there is no actual authority


3. Inherent Agency Power

  • If an agent does something contrary to the principal’s instructions, the principal is still liable if he has held the agent out as having the authority to make his decisions
  • When an agent is placed in position that generally comes with certain powers to bind principals, then the principal will be liable
  • RS §194– an undisclosed principal is liable for acts of an agent done on his account, if usual or necessary in such transactions, although forbidden by the principal
  • RS §195– An undisclosed principal who entrusts an agent with the management of his business is liable to third persons with whom the agent enters into transactions usual in such business and on the principal’s account, although contrary to the direction of the principal
  • The principal is liable for all of the acts of the agent which are within the authority usually confided to an agent of that character, notwithstanding limitations (as between the principal and the agent) put upon that authority
  • In agency in fact, the principal will only be liable if the act done by the agent is within the scope of his agency—not where there has been an excess of authority




  • Was the agent being held out as having the authority to act for his principal?


Public Policy

  • The Fenwicks of the world do not want to bother with these things
    • they don’t want to have to answer to every vendor that walks through the door, so they hire someone else to do it
  • if we don’t have the concept of inherent agency, it will be hard to get the cigars into the bars b/c vendors will never believe or trust people like Humble—they won’t trust that he has authority and then will require vendors to do lots of research on who they are selling to etc.
    • this is not efficient (less pie)
  • Inherent agency is looked down upon in corporate law and courts try to find apparent agency, so need not rest on inherent agency.


Summary of Agency


Three Ways to Show Liability of a Principal to Third Parties for the Acts of Agent:

  • 1. express or real authority, which has been definitely granted;
  • 2. implied authority, that is, to do all that is proper, customarily incidental and reasonably appropriate to the exercise of the authority granted; and
  • 3. apparent authority, such as where the principal by words, conduct or other indicate manifestations has “held out” the person to be his agent


Agency- a human relationship founded in law that arises in the way that people treat each other

  • regardless of the subjective intent of the parties
  • the principal will be chargeable/liable for the actions of the agent
    • but only those actions that the agent has authority from the principal to do


Theories of Agency:

  • actual
    • express- principal and agent agree on what authority the agent has
    • implied- can used past actions to imply the agency relationship—this focuses on the perspective of the reasonable agent
  • apparent- does not look at the perspective of the reasonable agent, but to the perspective of the reasonable third party
    • an employee-agent has apparent authority to make an agreement binding on his employer-principal, if, but only if, the employer-principal through officers or other agents authorized to do so has held out that the employee-agent has such authority
    • even if authority was never given, or even if the agent was specifically told that he did not have that authority
    • most firms want there to be this agency, so that clients believe what the agent says, then the president can easily delegate authority- he doesn’t have to be available for every little question, his agents can take that responsibility
  • inherent
    • 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.
    • Principal can be liable for conduct which he did not desire or direct, to persons who may or may not have known of his existence or who did not rely upon anything which the principal said or did
      • Prinicpal is liable even when an agent has acted improperly in entering into contracts or making conveyances
    • where a general agent does something similar to what he is authorized to do, but in violation of orders
      • The principal will become liable as a party to the transaction, even though he is undisclosed
    • FOCUS: this is also concerned with the perspective of the third party
    • requires that the principal has placed the agent in a situation with a customary authority that would bind the principal
  • ratification
  • estoppel


4. Ratification


Elements of Ratification:

  • 1. acceptance of the results of the act
  • 2. with an intent to ratify; AND
  • 3. with full knowledge of all the material circumstances.”


RS §82– “Ratification is “the affirmance by a person of a prior act which did not bind him, but which was done or professedly done on his account”

  • the principal can say that, although his agent did not have the right to enter into the contract, he is happy the agent did, and the principal will affirm the transaction and agree to be bound by the contract
  • Ratification happens when somebody affirms a deal that was done on their behalf, but the deal was not binding at the beginning—once ratification occurs, he/she is then bound to the terms of the agreement
  • NOTE: Before the receipt of benefits may constitute ratification, the other requisites for ratification must first be present
    • One cannot purposefully enjoy the benefits of the land without ratifying the deal
      • There must be an intent to ratify
        • Ex. “I hereby ratify this deal”
  • NOTE: Marital status does not in and of itself prove the agency relationship –Nor does owning land together make one the agent for the other


5. Estoppel

  • When a principal holds someone out to be his agent, there is a contract with the principal by estoppel, regardless of how much the agent exceeds his authority, but when there has been no holding out by the principal, proof must be given of agency to make the principal liable
    • The appearance of authority must be shown to have been created by the manifestations of the alleged principal, and not alone and solely by proof of those of the supposed agent
  • The principal will be estopped from denying the agency relation if the third party had altered her circumstance in reasonable reliance
  • If a principal fails to take reasonable precautions to keep “would be agents” out of his place of business, where a reasonable person would take impostor as agent, the principal will be estopped from denying the agency relationship if the 3rd party altered circumstance in reasonable reliance on the supposed relationship
    • The duty of the owner of the stores includes the exercise of reasonable care and vigilance to protect the customer from loss occasioned by the deceptions of an apparent salesman. Customers should not have to inquire into the legitimacy of all salespersons before making her purchases.


Partially Disclosed Principal

  • when the other party to the transaction has notice that the agent is or may be acting for a principal for whom the agent is acting
  • unless otherwise agreed, an agent who makes a contract with another for a partially disclosed principal is a party to the contract
  • Duty of Agent
    • it is the duty of the agent, if he wants to avoid personal liability on a contract entered into by him on behalf of his principal to:
      • 1. disclose not only that he is acting in a representative capacity; AND
      • 2. the identity of his principal.
  • Must be actual knowledge- It is not enough that the other party has the means of ascertaining the name of the principal



  • Did the agent provide the third party with actual knowledge that:
    • 1. the agent was working for a principal; AND
    • 2. the identity of that principal?
  • If YES- then agent is not liable for the contract



C. Liability of Principal to Third Parties in Tort


Principal-Agent relationship: (subcategories of this relationship)

  • master-servant—master is exercising control over the daily activities of the servant
    • liable for both contracts and torts
    • servant agrees to work for the master and subject to the master’s control
    • master has agreed that servant will work on his behalf when contracting with third parties
  • principal—non-servant agent
    • agent is agreeing to work on behalf of the principal and the principal agrees to have the agent work on his behalf, but the principal does not agree to the way that the agent goes about it
    • this only applies in contract cases, not in tort
    • Principal is not exercising control over how the agent accomplishes the task of the agency
    • Principal is liable for contracts that the agent enters into, but not the Torts (T)
      • the principal is not in a position to prevent any torts, therefore he is not liable for the torts committed by the agent
    • independent contractor—this is not a principal/agent relationship—it is a non-agent
      • Not an agent at all; this is an arms-length transaction
  • NOTE: non-servant theory  = independent contractor theory
    • [just two different terms for it]



  • contractual relationships b/t business people
  • one party agrees to provide some kinds of good and services to another party
  • the contracting party is not authorized to enter into any contracts with 3rd party—no authority to represent the party with whom they are contracting in any capacity
  • the term independent contractor is used in both agency and non-agency relationships


1. Servant vs. Independent Contractor

  • doctrine of respondeat superior- a master (employer) is liable for the torts of its servants (employees)
  • a master-servant relationship exists where the servant has agreed:
    • (a) to work on behalf of the master ; and
    • (b) to be subject to the master’s control or right to control the “physical conduct” of the servant (that is the manner in which the job is performed, as opposed to the result alone)
  • Independent contractors can be both agents and non-agents
    • Agent-type IC- one who has agreed  to act on behalf of another, the principal, but not subject to the principal’s control over how the result is accomplished (principal does not control the “physical conduct” of the task)
    • Non-agent IC- one who operates independently and simply enters into arm’s length transactions with others
      • Ex. if a carpenter is supposed to build a garage for a homeowner, and doesn’t take any instructions from him, but is just supposed to get the job done, then he is an independent contractor (not acting as an agent)


Master Servant

  • Humble Oil & Refining Co. v. Martin- Schneider is required to make reports to Humble consistently, Humble controls the hours of the gas station, and gives Schneider instructions.  Humble maintained strict financial control and supervision over his actions and the agreement required Schneider to do anything Humble might tell him to do.  The Court says Schneider is a servant, as a matter of law.
  • Hoover v. Sun Oil Company– Sun owned almost all the equipment at the station, and controlled how Barone sold and managed the equipment.  Barone’s employees wore Sun uniforms and there was a huge sign at the station that said Sun products were sold there.  He went to a course on how to properly run a Sun service station.  Sun reps would also make weekly visits, but Barone was only given suggestions and was under no obligation to follow the advice.  The Court says this is different than Humble b/c Barone does not make weekly reports, as in Humble; Barone assumes all risk of profit or loss in his business operation; he determines his own hours of operation; he was not given instructions, as in Humble, and the relationship seems more like an independent contractor.  The court finds that Barone is an IC.



  • Has the “master” company retained the right to control the details of the day-to-day operation of the “servant” store?
    • control or influence over “results” alone is insufficient


Contract Provisions 

  • Actual Agency is a Consensual Relationship:
    • Principal must consent to the idea that the agent shall act on his behalf and subject to his control
    • Agent must consent to do so
  • When a relationship considered as a whole, establishes an agency relationship, the parties cannot effectively disclaim it by formal “consent”
    • The relationship of the parties does not depend on what the parties call it, but rather in law what it actually is
  • It doesn’t matter whether there is a disclaimer clause in the contract, whether there is an agency relationship depends on the actions of the parties
  • In determining whether a contract establishes an agency relationship, the critical test is the nature and extent of the control agreed upon




  • RS § 219(1)—“a master is subject to liability for the torts of his servants committed while acting in the scope of their employment”
    • a principal is not liable for the torts of his non-servant agents (independent contractors)
    • control is an essential element of the definition of an agency relationship, whether one is dealing with a servant or IC
  • Franchise:
    • Where individual outlets, owned by individual businessmen, distribute goods and services under a brand name
    • The franchisee enjoys the right to profit and runs the risk of loss
    • The franchisor controls the distribution of his goods and/or services through a contract which regulates the activities of the franchisee, in order to achieve standardization
  • Being in a franchise agreement, doesn’t exclude the contracting parties from an agency relationship
  • If a franchise contract so “regulates the activities of the franchisee” as to vest the franchisor with control within the definition of agency, the agency relationship arises even though the parties expressly deny it.
    • Murphy v. Holiday Inn D and the motel agreed to certain requirements in the agreement, but those requirements gave D no “control or right to control the methods or details of doing the work.”  The regulatory provisions didn’t give D control over the day-to-day operation of the motel (ex. D was given no power to control the daily maintenance of the premises—only the style of the buildings and the architecture, no power to hire and fire employees).  All such powers and other management controls were retained by the motel—Holiday Inn is not liable.


2. Liability for Torts of Independent Contractors

  • where a person engages a contractor, who conducts an independent business by means of his own employees to do work, not in itself a nuisance, he is not liable for the negligent acts of the contractor in the performance of the contract
    • Exceptions:
      • Where the landowner retains control of the manner and means of the doing of the work which is the subject of the contract
      • Where he engages an incompetent contractor
        • If a principal hires incompetent non-servant agents, then doctrine is ignored and the principal is liable for torts
      • Where the activity contracted for constitutes a nuisance per se


Inherently Dangerous Work

  • RS §416– landowner is liable if he engages an IC to do work which he should recognize as necessarily requiring the creation of a condition involving a peculiar risk of harm to others unless special precautions are taken, if the contractor is negligent in failing to take those precautions
    • This is considered work that is “inherently dangerous,” not “ultrahazardous”
      • Liability is absolute where the work is “ultrahazardous”
    • If it is an inherently dangerous action, then the Courts will ignore doctrine and company will be liable for torts
  • The contractee should be responsible for any loss arising out of the tortuous conduct of a financially irresponsible contractor

Exceptions to the Contractor/Independent Contractor Relationships

  • if you hire somebody to knock down some buildings for you, we would call this a single independent contractor relationship b/c there is no agency
  • but, if you hire someone negligently (hire an incompetent) and they end up hurting third parties, then you will be held liable
  • if you hire them to do an inherently dangerous activity, then you will be held liable


Public Policy

  • Why does the court focus on control in trying to determine whether or not the principal should be liable?
    • We want to place responsibility on the party that is in the position to prevent the harm from taking place in the first place
    • ex. now probably due to respondeat superior gas station attendants are not allowed to smoke anymore – b/c gas station owners will be liable


3. Scope of Employment


Two Views of Master Servant: [ON THE EXAM BRING UP BOTH]

  • Common Law
    • Motive test- under the common law, the way we decide whether a tort is within the scope of the agency is whether the tort was motivated by a purpose to serve the master.  If it was, then we will consider the master liable for the actions of the servant
      • This law has been really hard to implement (really nebulous)
      • Bushey overturned the common law
      • This would be the fairness approach—more concerned with the distribution of the pie
  • Modern Law
    • Forseeable- The employer should be held liable for expected risks, which arise out of and in the course of his employment of labor
      • Court relies on deeply rooted human sentiment that one should not escape liability for torts that you commit if it was forseeable by your employer
    • Ira S. Bushey & Sons, Inc. v. United States- Use a forseeability test.


  • **We want the pie to be bigger, by giving the government an incentive [EFFICIENCY]


Public Policy

  • Maybe making the gov. liable will give them incentive to better screen sailors before hiring them and we wont’ have these ships crashing into the dock. 
    • We should not expand “vicarious liability”
  • Judge Friendly says: It is not at all clear that making the gov. liable is the best way to grow the pie
    • The best way is to make the dock manager liable to give him an incentive to put locks on the valves—it will cost more to screen every sailor, then it will to put locks on the valves
    • They are more concerned with the broad social implications
  • Friendly had shown that the trial court’s view of what would be more efficient is completely “flippable”—can switch it either way
  • It is no more precise a doctrine than the common law doctrine


4. Statutory Claims

  • in order to impose liability on a D for the discriminatory actions of an employee, the P must demonstrate that there is an agency relationship b/t the D and the third party
  • General agency- a master is subject to liability for the torts of his servants which acting in the scope of their employment
  • Arguello v. Conoco, Inc.- blacks and Hispanics said they were discriminated against at the Conoco gas station.  Some of the gas stations are franchised (Conoco-branded) and some are owned by Conoco. 
    • To establish an agency relationship b/t Conoco, Inc. and the branded stores, the Ps must show that Conoco, Inc. has given consent for the branded stores to act on its behalf and that the branded stores are subject to the control of Conoco, Inc.  The agreement states that they are completely separate entities and that the Conoco-branded stores are not employees of Conoco—therefore there is no agency relationship b/t Conoco and the branded stores.
    • Conoco-owned Stores:  The question becomes whether Conoco is responsible for the actions of its attendant
    • Factors used to Determine Whether Action was Within Scope of Employment:
  • 1. The time, place and purpose of the act
  • 2. Its similarity to acts which the servant is authorized to perform
  • 3. Whether the act is commonly performed by servants
  • 4. The extent of departure from normal methods
  • 5. whether the master would reasonably expect such act would be performed


Public Policy

  • The best way to ensure that you can deter this behavior is by making Conoco liable, b/c they are in the best position to protect against these harms (by a screening process, etc.)
    • This would be pretty expensive for Conoco to screen deeply into the psychology of its employees, it might be better to put the responsibility on the customer to figure out which stores are racist and which aren’t
  • How do we value those elements for the purpose of doing a value analysis?
  • You can’t figure this out without talking about the pie (how we want the pie to taste?—how do we want human affairs to be in America? We want them to taste like justice and equity)


D. Fiduciary Obligation of Agents

  • Agency requires a fiduciary duty of good faith and loyalty (an agent has a fiduciary duty toward his or her principal)
    • This is default rule—meaning it applies in the absence of agreement
  • An agent has a duty to act solely for the master, and any profit earned while violating this duty belongs to the master
  • it doesn’t matter that a principal is a corporation rather than an individual
    • General Automotive Manufacturing Co. v. Singer- P agreed to pay D a salary and D agreed not to engage in any other business while working there and not to share any company information he learned while working there.  D started working against the company by bringing in clients, but keeping the profits for himself.  He brought in a lot of business b/c of his reputation and the company couldn’t do all of it so he did it himself.  P sues for breach of fiduciary duty.  P says this was inconsistent with D’s obligations as a faithful agent or employee.  He conducted activities under their name and without telling them about it.  As an agent to General Automotive, Singer owed them a duty of “utmost good faith and loyalty” (fiduciary duty).  D was liable for the amount of profits that he took from them


Review of Agency:

  • When will the principle be liable for the torts of the agent?
    • in the Master/servant relationship
    • It is not just any kind of tort, there must be some kind of conceptual framework
    • *justice friendly set the boundaries at what would be most efficient—forseeability
  • Liability of the agent:
    • The agent is always liable for his own actions in tort, in addition to the where the principal is liable
    • When is the agent liable for the contracts?  Is he bound by the contracts he enters into on behalf of the principle?
      • the agent is liable on the contract when the principle is not disclosed or is only partially disclosed (where third party knows that the agent is working on behalf of somebody, but the agent does not know who that person is)


II. Partnerships

  • a form of business enterprise organized by two or more people for a profit
  • a consensual arrangement, usually entered into mutually with consent
    • unlike a corporation, this can come into existence without filing formal paperwork
  • an arrangement where individuals agree to share in profits in losses—the law will consider this a partnership
  • where these elements are evident, a partnership will be found to exist, but even where they are not evident, the law may find that they are still partners, also even if people say that they are in a partnership, absent these elements, the law may find that they are not actually partners
  • all partners are agents of partners, and are liable for each others torts
    • all partners are liable personally for all of the debts and liabilities of partners (no matter which one caused them)
    • each partner is liable for all the debts of the partnership
    • In partnership arrangements, you are responsible for all of the losses of your partner—you don’t want your partner screwing up (malpractice, etc.)
      • You have to make sure that your partner is not going screw you over
  • a partnership is not taxed as an entity as corporations are, but money earned by the partnership is taxed individually as income tax by both of the parties
  • one of the most important parts is that it gives rise to a fiduciary duty
  • NOTE: the law of partnership is a branch of the law of agency
    • Partners are considered agents of the partnership with power to incur obligations on behalf of the partnership—all partners are liable, as principals, for partnership obligations
    • Any partner can incur debts for which the other partners will be liable


A. What is a Partnership? Who Are the Partners?


1. Partners Compared with Employees

  • Elements Required For Partnerships:
    • 1. intent of the parties
    • 2. the right to share in profit
    • 3. obligation to share in losses
    • 4. the ownership and control of the partnership property and business
    • 5. community of power in administration, and the reservation in the agreement of the exclusive control of the management of the business
    • 6. language in the agreement
    • 7. conduct of the parties toward third persons
      • filing partnership income tax, holding yourself out as partners to third parties, etc.
    • 8. the rights of the parties on dissolution
  • It doesn’t matter what the parties intend to label the person—the intent is based on the type of relationship they intended to enter into with each other
  • Profit-sharing alone does not alone create a partnership, despite the party’s intentions
  • NOTE: one of the key elements of a partnership is “complete control and management” of the business
    • The Court looks to the totality of the circumstances to see who maintains day-to-day control of the business


2. Partners Compared with Lenders

  • State law normally presumes that partners share equally or at least proportionately in partnership losses
  • the labels the parties assign to their intended legal relationship, while probative of partnership formation, are not necessarily dispositive as a matter of law, particularly in the presence of countervailing evidence
    • Evidence of profit-sharing does not necessarily create a partnership formation
      • Just b/c they were sharing profits it is not enough to overcome the other evidence of no partnership
  • Even if the agreement uses the term “partner,” this alone is not enough to find a partnership
    • Southex Exhibitions v. Rhode Island Builders- where RIBA had an agreement with SEM (which was acquired by Southex).  Southex and RIBA thought they were partners.  In the agreements, they called themselves partners.  They shared control over the selection of location, timing of the shows, etc.  RIBA didn’t like Southex’s performance, so they entered into a contract with another producer.  Southex sued saying there was a partnership by estoppel (due to RIBA’s silence).  The Court says there was no partnership.  The court looks beyond the sharing of profits, etc. and said that Southex alone bears the loss of profits. If they don’t share a loss of profits, they are not a partnership.  The court also sees that the agreement is only called “Agreement,” not “Partnership Agreement.”  There is not much indication of the intent to form a partnership.  There is a lack of mutual control over business operations, failure to file partnership tax returns, failure to set up loss-sharing.  Also, Southex never conducted business in the alleged “partner’s” name—it conducted business under its own name.
  • NOTE: “partnerships can be created absent any written formalities whatsoever, its existence normally must be assessed under a “totality-of-the-circumstances” test


3. Partnership by Estoppel

  • General Rule: partners are jointly and severally liable for everything chargeable to the partnership
  • persons who are not partners as to each other are not partners to third persons
  • even if two people do not intend to be partners, they can be found to have created a partnership “by estoppel” if they represent to the outside world that they are in a partnership
    • they will be liable to any person to whom such a representation is made who has, on the faith of the representation, given credit to the actual or apparent partnership
  • If a third party has reasonably relied on the partnership, based on the representation of one partner, then the parties are partners by estoppel


B. Fiduciary Obligations of Partnerships


1. Introduction  

  • joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty
  • “A trustee is held to something stricter than the morals of the marketplace.”—Cardozo
    • Honesty alone is not enough
  • Each partner in a partnership owes the other partners a fiduciary duty to act in the best interests of the partnership over the individual in matters concerning the partnership
    • Meinhard v. Salmon– Salmon leased the Hotel Bristol for a 20 year term.  Salmon (lessee) changed the hotel into shops and offices.  He didn’t have the money, so he partnered with Meinhard (P), who funds the remodeling.  This was a joint venture and they agreed to split the money to construct it, then split the profits and split losses equally.  Salmon had the sole power to manage.  They both had fiduciary duties, but Salmon had the heavier one b/c he had to manage.  Salmon was then approached by the owner of the land to engage in a longer term project.  He enters into the new deal, and doesn’t tell Meinhard anything about it.  The Court says: “Salmon excluded his coadventurer from any chance to compete, from any chance to enjoy the opportunity for benefit that had come to him alone by the virtue of his agency.”  Meinhard assumed from D’s silence that D would have wanted to extend the lease, as it was ending.  Salmon wasn’t acting in bad faith, he was not trying to defraud.  The Court found that he breached his fiduciary duties to P.
    • Dissent: Justice Andrews
      • They were partners and that relationship requires trust and confidence to a high degree. Where parties engage in a joint enterprise each owes to the other the duty of the utmost good faith in all that relates to their common ventureThey are in a fiduciary relationship.  But the venture had a limited time and objectiveMeinhard had an interest, but this interest terminated when the joint adventure terminatedSalmon fulfilled his duties to Meinhard when the lease was overTheir adventure together ended on a specific date


Public Policy

  • Do we construe the fiduciary duty narrowly like Judge Andrews would have us do?
    • Andrews agreed there was a fiduciary duty, but said that it ended when the lease ended
  • Do we construe it broadly like Cardozo?
    • If we are going to construe these fiduciary obligations as broadly as Cardozo wants, we may deter the Salmon’s of the world from entering into these contracts
  • Why do we have this rule of fiduciary obligation?—they didn’t specify how much of themselves they each owed the other one
    • It comes from the law—the background law that governs situations where the parties don’t specify what they owe to each other
    • Fiduciary obligation is efficient and makes more pie for us all
    • Meinhard is an investor—he likes to play golf and sleep late, if they didn’t have this agreement he would have to get up early and go to work, instead the law is monitoring Salmon so he doesn’t have to
    • We want Salmon’s mind to be focused on the business of the partnership


Types of Partnership Law

  • default rules
    • * default laws are going to be laws that most people would want
    • two views on default rules:
      • 1. Majoritarian
        • the default laws exist so that the Salmons of the world don’t have to sit around listing the things that they would want to be rules in their agreements
      • 2. Penalty
        • Opposite of majoritarian
        • This view says that we should make the default rules really bad so that people will sit down and list what they want out of the agreement
  • Common law
  • Statutory law
    • U.P.A. (1914)
      • Uniform Partnership Act (most states have this law)
    • R.U.P.A. (1997)—Revised Uniform Partnership Act
      • This is just an improvement on UPA based on changing business practices and the difficulties found in applying it
    • California
      • Similar to RUPA, but has some of its own idiosyncrasies
      • RUPA is relatively new, so some states are still on the UPA track and others have moved on to RUPA
  • Agreement
    • All of the above laws can be modified by agreement of the parties


§ 404—General Standards of a Partner’s Conduct (p. 115)

  • Fiduciary duties owed by a partner to a partnership are the duty of loyalty and the duty of care
  • Should not have any interests adverse to the partnership
  • Refrain from competing with the partnership
  • Refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law
  • a partner’s duty of loyalty is limited to the partnership
  • a partner doesn’t violate this section solely because his actions further his own interests


Duties When Leaving a Partnership

  • partners owe each other a duty of utmost good faith and loyalty
  • As a fiduciary, a partner must consider his/her partners’ welfare and refrain from acting for purely private gain
  • A partner has a duty to render on demand true and full information of all things affecting the partnership to any partner


C. Partnership Property


Rights of a Partnership (under Uniform Partnership Act)

  • 1. rights in specific partnership property
    • This is the partnership tenancy possessory right of equal use or possession by partners for partnership purposes
    • This right doesn’t exist without the partnership
  • 2. interests in the partnership; and
    • This is the partners interest in the partnership which is defined as “his share of the profits and surplus and the same is personal property”
    • NOTE: the partnership owns the property or the asset—a co-partner owns no personal specific interest in any specific property or asset of the partnership
      • Similar to the right of a co-tenant (the partner is a co-tenant in all partnership property)
  • 3. right to participate in mgmt


General Rule- a conveyance of partnership property held in the name of a partnership is made in the name of the partnership and not as a conveyance of the individual interests of the partners

  • A partner doesn’t own any part of the partnership, so once he/she transfers his interest to another, he/she has no interest in anything that happens later
    • Putnam v. Shoaf– where P transfers her interest to another and then wants to retain part of the lawsuit settlement b/c the thing they were suing over occurred while she was there.  The court said since she fully intended to convey her interest, she had no right to the proceeds from the lawsuit.


D. Partnership Dissolution


Ending of a Partnership

  • dissolution– an event that triggers a series of events that conclude the partnership
    • ex. death of a partner
    • ex. bankruptcy
    • ex. expiration of a stated term within the agreement
    • ex. withdrawal of a partner from the partnership
    • You always have the power to breach a contract (and once you do, you are not bound by any of the contract terms)
      • But there is a difference b/t the power to dissolve it and the right to dissolve it
    • There is judicial dissolution of a partnership
  • wind up
    • it can take months or even years for a partnership to complete its windup
    • contributions are paid out (initial payments that each partner put in are paid back to them)
    • profits are divided up according to each partner’s share in the partnership
    • it is during the “wind up” period where partners are most likely to breach their duties to the other partners
  • termination
    • this refers to a completed “wind up”

NOTE: these can vary by state, so you need to look at the specifics of each state’s laws


General Rule- a partner can move to dissolve a partnership if another partner’s conduct undermines or breaches the partnership agreement

  • A partner may move for a dissolution of the partnership if another partner’s conduct:
    • negatively affects the business; or
    • repeatedly breaches the partnership agreement
  • Court will NOT dissolve the partnership for:
    • minor differences or grievance which involve no permanent mischief
  • They will issue one where:
    • There are quarrels and disagreements of such a nature and to such extent that all confidence and cooperation b/t the parties has been destroyed; or
    • where one of the parties  by his behavior materially hinders a proper conduct of the partnership business”


§ 2426 of the Civil Code [U.P.A. §32]

  • A court will issue a dissolution if:
    • A partner becomes in any other way incapable of performing his part of the partnership contract
    • A partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business
    • A partner willfully or persistently commits a breach of the partnership agreement, or otherwise conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him


Dissolution by the Partner at Fault for the Problems

  • a partner does not have a right to dissolve the partnership when his own conduct is the only conduct that is adversely affecting the business
  • if the party trying to dissolve the partnership is the only party who is not abiding by the partnership agreement, he cannot dissolve it


Dissolution When Time is Not Specified

  • unless specified, a partnership may be dissolved at will by any partner, provided the partnership is exercising good faith
    • a partner may not dissolve a partnership to gain the benefits of the business for himself, unless he fully compensates his co-partner for his share of the prospective business opportunity
    • if it is proved that the partner wanting to dissolve the partnership was acting in bad faith and violating his fiduciary duty by attempting to take the new profits for himself, without adequately compensating his partner, the dissolution is wrongful and the partner would be liable for violation of the implied agreement not to exclude his partner wrongfully from the partnership business opportunity.
      • Ex. Page v. Page– where it was alleged that the brother was trying to dissolve the partnership when the business started making a lot of money, so that he could hog all of the profits and not give them to his partner.
  • if there is no definite term specified, the partnership can be dissolved a the express will of any partner
  • Implied agreements
    • Partners can impliedly agree to end the partnership as soon as loans are paid, or until a certain amount of money is earned, etc., but there must be evidence of this agreement
  • NOTE: a partner’s duty to act in good faith overrides their freedom to dissolve the partnership


The Consequence of Dissolution

  • After a party has terminated the partnership wrongfully, he is entitled to the value of his interest in the partnership, minus any damages caused to the partnership by the dissolution, but good will should not be included when calculating it.
  • A party who caused the dissolution of the partnership is not entitled to collect for the value of good will at the time of dissolution


The Sharing of Losses

  • in the absence of any agreement to the contrary, partners participate equally in the profits and losses of the business, regardless of any inequality in the amounts each contributed to the capital employed in the venture, with the losses being shared by them in the same proportions as they share profits
    • This is different when each contribute one part (money and work)—in that case, neither is liable to the other for contribution for any loss sustained
  • when one partner contributes the money and one contributes capital and other labor, the partner contributing the money cannot hold the other partner responsible for money lost, just as the partner responsible for services, cannot hold the other partner responsible for any losses he suffered
    • ex. Kovacik v. Reed- they were sharing profits equally, but hadn’t said anything about the losses, so the Court held that they were each liable for their own losses.  Therefore, the partner with the money was not entitled reimbursement from the other partner—this way they each contribute to the losses
  • the losses are shared by the partners as they agree, or if there is no agreement, it will be proportionate to their profits percentage


Buyout Agreements

  • buyout/sellout agreement- an agreement that allows a partner to end his/her relationship with the other partners and receive a cash payment, or series of payments, or some assets of the firm, in return for his/her interest in the firm
    • agreement usually includes:
      • what events trigger the buyout
      • obligation to buy v. option to buy
      • price
      • method of payment
      • procedure for offering to buy or sell
  • until a court has decreed a dissolution, it has not taken place and the partners can still take advantage of any buyout provisions under the agreement (even if they have petitioned the court for dissolution)
    • ex. G&S Investments v. Belman– where they had filed for a dissolution and a buyout of the bad partner’s shares, but it never was official, therefore they could still use the buyout provisions.
  • Upon death, retirement, insanity or resignation of one of the general partners, the surviving or remaining general partners may continue the partnership business
    • If they decide to do so, the remaining partners must purchases the interest of the retiring or resigning general partner
  • Buyout amount = amount of the resigning/retiring partner’s capital account (calculated on a cost basis) + the average of the prior three years’ profits and gains actually paid to the general partner (or as agreed upon the general partners)
    • As long as this sum does not exceed the calculated sum in dollars


Law Partnership Dissolutions

  • in law practice partnerships, in the absence of a contrary agreement, the UPA requires that any fees paid to the partners for cases in progress during the dissolution should be allocated to the former partners according to their rights to fees during the partnerships
  • a dissolved partnership continues until the winding up of unfinished partnership business
  • Two Fiduciary Duties:
    • 1. each former partner has a duty to wind up and complete their unfinished business of the dissolved partnership
      • Ex. a partner can’t refuse to work on the case and then get the benefits of the other partner’s hard work
    • 2. no former partner may take any action with respect to unfinished business which leads to purely personal gain
  • The former partners will be entitled to reimbursement for reasonable overhead expenses (excluding partner’s salaries) attributable to the production of postdissolution partnership income


Removing Cases

  • Partners in law firms cannot participate in an agreement that restricts the right of a lawyer to practice law after the termination of a relationship created by the agreement
    • The strong public interest in allowing clients to retain counsel of their choice outweighs any professional benefits derived from a restrictive covenant
    • Ex. Meehan v. Shaughnessy– where the lawyers left the firm and took the clients.  The Court said the firm was not allowed to restrict a departing partner’s right to remove any clients who freely choose to retain him or her as their legal counsel.
  • Any case can be removed, regardless of whether the case came to the firm through the personal efforts of the departing partner


Dividing the Firm’s Assets

  • Capital account- the partner’s initial investment of cash or property, increased by any later such contributions, increased by profits over the years, decreased by losses and decreased by amounts withdrawn.
  • The statute allows partners to design their own methods of dividing assets and, provided the dissolution is not premature, expressly states that the partners’ methods controls
  • A partner must account for any profits which flow from a breach of fiduciary duty
    • Ex. Meehan v. Shaughnessy– where the lawyers breached their fiduciary duty to the law firm.  If certain clients left the firm because of this breach, then the former partners must account to the partnership any profits they receive on these cases.  The partners at the original firm are entitled to their portion of the fair charge on each of the unfairly removed cases and to the amount of profit they would have enjoyed that the former partners handled the case at the old firm.


E. Limited Partnerships


Statutory Framework

  • statutory laws—you must say “we are forming a limited partnership”
    • they are created by filing a formal document with a state official
    • there must be a written agreement among the partners
  • Not dissolved by the withdrawal or death of a limited partner



  • two kinds of partners:
    • 1. general partners- each liable for all the debts of the partnership
    • 2. limited partner- not liable for the debts of the partnership beyond the amount that they have contributed to the partnership
  • Limited partners do not participate in the management of the partnership
  • a limited partner will be held liable as a general partner if the limited partner acts to take part in the control of the business
  • even if you aren’t listed as a general partner, your actions can make you liable as a general partner
    • If you do not want to be held liable as a limited partner, you must not control the partnership or any of its day to day activities—if you do, you will be held liable
    • Ex. Holzman v. DeEscamilla- where the limited partners took part in the control of the business, so they became liable as general partners to the creditors of the partnership.  They all discussed which crops to plant and all agreed before it was done; they also came to the farm to check on it twice a week and signed the business checks.  The general partner had no power to withdraw money without the signature of one of the limited partner.
  • A limited partner shall not become liable as a general partner, unless in addition to the exercise of his rights and powers as a limited partner, he takes part in control of the business.
    • This must be more than merely advising the general partner on the business of the limited partnership
  • RUPA §303(a) changes this rule and says you can have a limited partnership, and you are not necessarily liable just by taking a part in controlling the day to day activities of the partnerships—you will only be liable if you hold yourself out to third parties as being a limited partners
    • You will be liable if a third party reasonably believes, based on the limited partner’s conduct, that the limited partner is a general partner


III. Corporations


A. In General

  • two biggest advantages:
    • 1. limited liability– shareholders are only liable for the amounts they put into the corporation, so if the corp. runs up large debts, they are not responsible
    • 2. free transferability– ownership interests in the corp. are freely transferable b/c they are represented by shares, which can be bought and sold easily.


General Set Up

  • shareholders:
    • they have the power to elect directors by voting for them once a year at the annual meeting
    • shareholder’s do not have the power to conduct business on behalf of the corporation or to bind the corporation by their actions
    • shareholders cannot give orders—they cannot order the board to take specific action
      • but they can use shareholder resolutions to influence the Board by recommending certain actions
    • they can vote to remove directors
    • they can approve or disapprove major actions contemplated by the board that would lead to fundamental changes
    • they cannot remove an officer
  • directors
    • typically they are up for reelection every year at the annual meeting
    • their main function is to set the policies of the corporation
    • authorize the making of important contracts
    • they declare dividends
    • most directors are now complete outsiders (meaning they have no ties with the company—they are not officers, employees, lawyers or accountants for the corp.)
    • they can appoint and remove the officers (with or without cause)
    • they cannot remove a fellow director even for cause, unless the bylaws say they can
  • officers
    • they are appointed directly by the Board of directors
    • they serve at the will of the Board of directors
    • carry out “day to day activities”
    • the officers are agents of the corporation
      • to bind the corporation, the officer must have the authority (actual, implied or apparent) or the corporation may be liable by ratification
      • ex. inherent agency- there is common knowledge that the CEO can sign non-extraordinary contracts on behalf of the corporation (ex. for supplies)


B. The Corporate Entity and Limited Liability

Public Policy: Reasons for Limited Liability

  • without LL, investors would have to limit their investments to one or two that they could watch very carefully
  • it encourages diversification in various kinds of enterprises
  • so-called “unsophisticated” contracting parties may not know that they are dealing with corporations or may not know the consequences of dealing with corporations
  • limited liability allows companies to externalize costs


1. Piercing the Corporate Veil

  • the Court will pierce the corporate veil whenever necessary “to prevent fraud or to achieve equity”
  • The court is more willing to pierce the veil in tort cases
    • b/c in contract cases, the P entered into relations with the corporation voluntarily
  • an individual can be held liable for the actions of a corporation through the doctrine respondeat superior if it can be shown that the individual used his control of the corporation for his personal gain (to further his own, rather than the corporation’s business)

Van Dorn Test

Corporate Veil will be Pierced if P proves:

  • 1. there is a unity of interest b/t the individual and the corporation (the separate personalities of the corporation and the individual no longer exist); AND
  • 2. to allow the limited liability would promote an injustice or sanction a fraud
    • Either one (injustice or fraud) will suffice to satisfy this element


Four Factors used in Determining the “Unity of Interest”

  • 1. failure to maintain adequate corporate records or to comply with corporate formalities
  • 2. the commingling of funds or assets
  • 3. undercapitalization
  • 4. one corporation treating the assets of another corporation as its own


Injustice—the Second Prong

  • MUST SHOW: some wrong beyond a creditor’s inability to collect would result
  • Examples of Injustice:
    • The common sense rules of adverse possession would be undermined
    • Former partners would be permitted to skirt the legal rules concerning monetary obligations
    • A party would be unjustly enriched
    • An intentional scheme to put assets in liability-free corporations while heaping assets upon an asset-free corporation would be successful


2. Parent Corporations and Subsidiaries

  • The parent like any other shareholder, is not liable for the debts of the subsidiary, so the parent can undertake an activity without putting its own assets at risk, beyond those it decides to commit to the subsidiary
  • the creditors of the subsidiary may be able to pierce the corporate veil of the subsidiary
  • The parent also must be careful not to become directly liable by virtue of its participation in the activities of the subsidiary.


Parent Corporations Are Not Liable If:

  • 1. proper corporate formalities are observed;
  • 2. the public is not confused about whether it is dealing with the parent or the subsidiary
  • 3. the subsidiary is operated in a fair manner with some hope of making a profit; AND
  • 4. there is no other manifest unfairness


Burden in Tort Actions

  • the burden of proof is lower in tort cases
    • P did not choose to enter into relations with the D corporation
  • P needs to show that the subsidiary corporation is an instrument of the (parent corporation) stockholder, but there is no burden to prove fraud
    • a totality of the circumstances test is used to see if there is “substantial domination”


Factors Used in Totality of the Circumstances Test:

  • The parent and subsidiary have common directors and officers
  • Common business depts.
  • File consolidated financial statements and tax returns
  • Parent finances the subsidiary
  • Subsidiary operates with grossly inadequate capital
  • Parent pays the salaries and other expenses of the subsidiary
  • Subsidiary receives no business except that given to it by the parent
  • Parent uses the subsidiary’s property as its own
  • Daily operations of the two corporations are not kept separate
  • Subsidiary does not observe the basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings



3. Limited Partnerships w/ Corporation as Sole General Partner

  • Limited partners do not incur general liability for the limited partnership’s obligations simply b/c they are officers, directors, or shareholders of the corporate general partner
  • in limited partnerships, only the general partners are liable for the losses, and the limited partners are not
  • a limited partner will be held liable if, for personal gain, he takes control of the business over and above his normal rights as a limited partner
  • When shareholders of a corporation, who are also the corporation’s officers and directors, conscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or injustice is done upon third persons who deal with the corporations, the corporation’s separate entity should be respected


C. Shareholder Derivative Actions

  • Shareholder derivative suit- where shareholder sues the corporation nominally, but really the managers of the corporation, to recover some opportunity that belongs to the corporation
  • This is a way to enforce the fiduciary duties of the directors


Public Policy:

  • Shareholders turn over the managing of the firm to agents, directors and employees
    • opportunity exists for directors to exploit the firm that they are charged with running for their own personal gain
  • Directors did not have a lot of accountability, so they could easily profit personally at the expense of the corporation
  • now shareholders can “step in the shoes of the corporation” and seek a right to the restitution that they couldn’t get on their own
  • But, the flip side, is what if the director is innocent and these frivolous suits keep coming in, then he will be spending all of his time in court and no one is going to be running the corporation, like he was hired to do
    • If we are going to allow minority shareholders to sue for these transactions, this would be quite an interference with managing the main company
      • These suits can be a great distraction, so we give them the opportunity to dismiss these suits, by requiring a security regarding attorney’s fees


Security Requirement

  • As a result of these suits, a whole industry has developed of lawyers and law firms who deal with these suits
  • sometimes states require that P provide a security for the D’s litigation costs that the P will have to pay the costs of litigation if it turns out that these suits are without merit
    • theses laws on security vary depending on the facts


Laws of Derivative Suits

  • product of state law
  • a shareholder’s derivative suit will follow state substantive law (non-procedural) laws regarding the derivative suits when possible
  • state laws will not be upheld if they are procedural and preempt (conflict) with federal laws

Defining Derivative Suits

  • Suing for “injury to the corporation” = derivative suit
  • Suing for “injury to the P as a stockholder and to him individually” = individual suit
    • suit may take the form of a representative class action
  • when the injury suffered was personal, rather than an injury of the corporation, the suit will not be considered derivative for the purpose of requiring a posting of security for opposing legal expenses


  • “Special Injury” Test (NY law)
    • a special injury is one that is separate and distinct  from that suffered by other shareholders, or a wrong involving a contractual right of a shareholder, such as the right to vote, or to assert majority control, which exists independently of any right of the corporation
  • Two Prong Test: (DE law)
    • 1. Who suffered the alleged harm, the corporation or the suing stockholders individually?
    • 2. Who would receive the benefit of any recovery or other remedy—the  corporations or the stockholders, individually?


Public Policy on Settlements and Attorney’s Fees

  • if a derivative action is settled before judgment, the corporation can pay the legal fees of the P and of the Ds
  • If a judgment for money damages is imposed on the Ds, except to the extent that they are covered by insurance, they will be required to pay those damages and may be required to bear the cost of their defense as well
    • if they are sued in court and lose, they have to pay out of their own pockets
  • The corporation can pay the D’s expenses only if the Court determines that “despite the adjudication of liability but in view of all the circumstances of the case, the D is fairly entitled to indemnity”
  • the real party in interest in a derivative suit is the attorney b/c the corporate managers will be relieved of liability, if the corporation pays big attorney’s fees to get the P to settle
    • Attorneys will often accept the money for the settlement either to avoid litigation or b/c they are being paid so well
  • The Court has to approve the settlement, but most busy judges will not challenge one
  • NOTE: Sometimes the Court will pay the P individually, b/c if it allows the corporation to recover the money, it would be returning the funds to the control of the wrongdoer


D. Shareholders, Directors and Officers

  • The purpose of a business corporation is to make profits for its stockholders
    • Directors are hired for this purpose
    • Directors should use their discretion in choosing how to attain this end
    • They do not have discretion over:
      • the actual goal itself
      • the reduction of profits, OR
      • the nondistribution of profits among shareholders in order to devote them to other purposes

General Rule

  • A business corporation is organized primarily for the stockholders!!!
    • directors owe a fiduciary obligation to the shareholders
      • this looks a little different than the traditional principle agent relationship
  • shareholders have an interest in the residual profits of the firm
    • these profits are paid to them in dividends
  • NOTE: shareholders are the principal, and the directors are working for them as agents


Two different kinds of directors

  • outside
    • committees and officers inform them about what is going on with the company
    • they set broad policy
  • inside
    • these directors have some relationship to the corporation (employees, officers, lawyers, etc.)
  • NOTE: it is better to have outside directors sitting on the board b/c they will have a more objective viewpoint



E. The Role and Purposes of a Corporation

  • corporate gift-giving is an acceptable method of increasing goodwill, but the gift should be less than 1% of capital and surplus and directed to an institution owning no more than 10% of company stock
  • only directors of the corporation have the power to declare a dividend of the earnings of the corporation and to determine its amount
  • Courts will not interfere in the mgmt of the directors unless it appears that:
    • they are guilty of fraud or misappropriation of the corporate funds
    • refuse to declare a dividend


Business Judgment Rule

  • courts will show great deference to the business to when make decisions on issues that pertain to the running of their business
  • The Court will not inquire into the motives of the board members, as long as their acts are within their lawful powers
  • A Court will not interfere with an honest business judgment (issues of policy and business mgmt) absent a showing of fraud, illegality or conflict of interest
  • NOTE: If a shareholder is unhappy with the way the board is running the business, why doesn’t he just get out, and go invest in some other business?  Why is he bothering the directors with his complaints if he has the opportunity to exit?
    • The exit is a limited strategy for the shareholders
    • The shares should be worth more than they are, so he can’t exit without taking a loss that he shouldn’t have to take


Public Policy on Derivative Suits v. Class Actions

  • there isn’t much incentive for any shareholder to bring a claim against the director
  • now people will only bring suit if they have an important claim
  • Problem—there is a war b/t shareholders and directors and we are desperate to find a mechanism to end this war
    • The directors have an unfair advantage in this war b/c they are trained and experienced and they have their hands on the lever—they have the key to the safe
  • The one solution is derivative suits, but this is not very effective
    • the agency (monitoring) problem is not solved; it’s an ineffective mechanism
  • Lawyers:
    • the real party in interest is the lawyer b/c doesn’t have to share his piece with anyone, while any result from the lawsuit is spread out among all shareholders—the lawyer has the real incentive
    • now there are too many lawyers and too many law firms bringing suit


IV. The Duties of Officers, Directors and Other Insiders


Public Policy: War B/t Directors and Shareholders

  • battle on the one hand to hold directors accountable to shareholders
    • to make sure they are putting the company’s best interest in front of their own best interests
  • one weapon that shareholders might have is the shareholders derivative suit
  • but directors counter with the business judgment rule
  • shareholders derivative suits become quite weak compared to the business judgment rule
  • before you bring a derivative lawsuit, you have to raise your complaint with the board of directors first
    • under the statute, you have to make that demand first before you bring suit
    • if the director disagrees with the shareholder, he can go on with the suit


A. The Obligation of Control: Duty of Care


Business Judgment Rule:

  • DE law—the business and affairs of a DE corporation are managed by or under its board of directors
  • a court will not interfere with the decisions of a company’s directors unless there is evidence of fraud or dishonest practice
    • mere errors in judgment are not sufficient as grounds for equity interference
  • more than imprudence or mistaken judgment must be shown for the court to interfere


Public Policy:

  • the business judgment rule really scares off shareholders b/c it holds them to a much higher standard—now they have to show that the company had a duty of care and breached it
  • hindsight bias- when we know that an outcome has happened, we are much more likely to overestimate their predictability (similar to “hindsight is 20/20”)
    • in corporate law, when the director makes a bad decision and the deal goes bad, judges and juries are much more likely to say: it was so obvious that it was going to go wrong, and award damages


Duty to Make Informed Decisions

  • “presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company “
    • The party claiming that a board decision is uninformed, must rebut the presumption that its business judgment was an informed one
  • Informed decision: It all depends on whether the directors have informed themselves “prior to making a business decision, of all material reasonably available to them”
  • STANDARD: gross negligence—standard for determining whether the business judgment reached by the Board was an informed one


Smith v. Van Gorkom—LANDMARK CASE

  • the decision made by the Board must be researched and informed
  • Directors are fully protected if they relied in good faith on reports made by officers
    • But these have to be substantial and relevant to the issues before the board
    • The director cannot just blindly rely on the reports—they must exercise good faith
  • During a proposed merger, a director has a duty, along with his fellow directors to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders.
  • now a Board of directors cannot make a decision like this without many, many court documents to insulate them from the threat of liability
  • this case says there is still the business judgment rule but you don’t get it with out earning it—going through lots of legal protections
    • Van Gorkom and the directors were not entitled to the business judgment rule
    • b/c the BJ rule assumes that they were acting in good faith
  • any “business judgment” the Board makes must be informed and in good faith
    • the court provides no protection for directors that make an uninformed judgment that is not made in good faith


Insurance Against Liability for Directors

  • Part of the settlement from Van Gorkom came from the insurance covering the directors
  • After this verdict, many corporations adopted provisions limiting the liability of its directors
  • Delaware corporate law permits firms to insure directors against liability for negligence


DE Corporate Law §102(b)(7)

  • allows any corporation to include in its certificate of incorporation:
    • “a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director:
      • 1. for any breach of the director’s duty of loyalty to the corporation or its stockholders;
      • 2. for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;
      • 3. under §174 of this title (relating to payment of dividends)
      • 4. for any transaction form which the director derived an improper personal benefit


Public Policy on Insurance

  • Directors are liable for breach of fiduciary duty
    • now DE responds to the holding in Van Gorkom by saying that directors can opt out of this rule by having insurance against liability
  • Reasons against insurance:
    • Why would firms decide not to take advantage of this opportunity and say, we will go with the default rule?
      • b/c it could deter investors—why would you want to invest in a firm that has waived liability?—you wouldn’t
      • shareholders would be walking into a company that they know they have no legal protection against
    • moral hazards problem– if directors know they are insured, they will be careless
  • Reasons for insurance:
    • you would want to insure the company so that the firm is protected b/c they could have to pay a lot of money
    • you aren’t going to get the big people to be directors unless they are insured against liability


Delaware Corporate Law:

  • A corporation can incorporate in any state it wants
  • internal affairs doctrine- the internal affairs of the corporation are governed by the state they are incorporated in, not the states in which it does business


Two competing views of why Delaware has the most corporations:

  • 1. race to the bottom
    • Directors are powerful, shareholders are weak
    • Directors are smart and can take advantage of shareholders (one way they do this is by choosing law that is beneficial to them, choosing law that allows them to opt out of negligence suits, etc.)
      • Directors can decide where to incorporate—the states get some advantage from having corporations incorporate in their state (there is a fee, etc.)—so there is a competition among states to get corporations to incorporate there, and the way the states convince these corporations is by making law that favors directors
    • So there is a race to the bottom to get the worst corporate law possible
      • worst for the environment, shareholders, and consumers
      • but the best for the people in charge: the directors
      • Delaware sucks and has nothing going on, so they have the worst laws, but the laws attracts directors
  • 2. race to the top
    • This view says shareholders have the money and get to choose where they invest, they are only going to invest in a firm that has laws beneficial to them
    • They are going to invest in companies with laws that give them greater protection
    • It says Delaware is the best and has produced the best laws
      • the DE law limiting negligence for directors, attracts the best directors that will do the best for the company, so shareholders want to invest in these firms
  • Another view is that no one can understand why everyone incorporates there, but everyone else is doing it, and it is just the thing to do


B. Duty of Loyalty


1. Directors and Managers

  • a director has a fiduciary duty to support the interests of the corporation over his own conflicting interests
  • generally when applying the BJ rule, courts don’t look at substance, but if there is an alleged conflict of interest, then they will


Enhanced Business Judgment Rule

  • when there are competing interests, the BJ rule will still apply, but the Court will use heightened scrutiny
  • Any transactions by directors to involving the corporations that may produce a conflict between self-interest and fiduciary obligation, are examined with heightened scrutiny
    • Transaction will be voided if:
      • there is any evidence of improvidence or oppression; OR
      • any indication of unfairness or undue advantage


Business judgment rule:

  • matters left to the discretion of the Board of Directors:
    • Questions of policy of management
    • expediency of contracts or action
    • adequacy of consideration
    • lawful appropriation of corporate funds to advance corporate interests
  • these are left solely to their honest and unselfish decision
  • they will only be questioned if the results show that what the Board did was unwise or inexpedient
  • The business judgment rule yields to the law of undivided loyalty—the law is designed “to avoid the possibility of fraud and avoid the temptation of self-interest”


Burden in “Conflict of Interest” Cases

  • the BJ Rule places a heavy burden on shareholders
  • the BJ rule presupposes that there is no conflict of interest, so the burden shifts when the directors have a conflicting interest (other than as directors of the corporation)
  • Burden on director:
    • the burden is on the director to prove:
      • 1. the good faith of the transaction; AND
      • 2. to show its inherent fairness form the viewpoint of the corporation and those interested in it
  • Director must prove that his actions were fair and reasonable to the corporation


2. Corporate Opportunities


War Between Accountability and Authority of Directors:

  • we are exploring this Pentium between authority and accountability for the directors
    • we want them to act on behalf of the shareholders, but we need to give them the authority to do so
    • for the most part, directors are given substantial authority to run the company
    • they must treat the corporation as a reasonable person would treat his/her own property
  • When a director makes a decision where he has an interest, the loyalty question is implicated, then the analysis is quite different
  • Where loyalty is involved, we will do a searching inquiry and we will look at the substance


Public policy:

  • General Rule:
    • a corporate fiduciary agrees to place the interests of the corporation before his/her own in appropriate circumstance
  • the director has put himself in a situation where he has a duty to put the interests of his shareholders above his own interests
  • burden: now the director must affirmatively come forward and demonstrate the fairness of the transaction
  • We want directors to deal with their firms sometimes
    • As in Broz, the thought is that this would deter directors from sitting on boards b/c they would be declining too many opportunities in their own personal lives


Doctrine of Corporate Opportunities (Broz test)

  • an officer/director cannot seize a business opportunity for himself if:
    • 1. the corporation can financially undertake it
    • 2. it is in the line of the corporation’s business and would be advantageous to it
    • 3. is one in which the corporation has an interest or reasonable expectancy in the opportunity
  • If theses elements are present, the director must turn the offer over to his firm
  • NOTE: it is not necessary that the director/officer present this opportunity to the board before taking it for himself
  • this only comes into play where the self-interest of the officer/director would conflict with his fiduciary duty to the corporation
  • Applying the Broz test


Tender offer

  • an offer to buy shares of stock from shareholders, who are invited to tender their shares to the offeror for purchase at a specified price within some specified period of time
  • Often the completion of a transaction is made contingent on the offeror receiving some specified number of shares, sufficient, for example, to give it control of the target corporation


3. Dominant Shasreholders

  • where a shareholder own a controlling majority in the company, he has a fiduciary duty to the minority shareholders
  • When the situation involves a parent and a subsidiary, a standard of intrinsic fairness will be applied, and the parent corporation’s majority ownership controls the transaction and fixes the terms
    • this means the burden shifts to the parent company to prove, subject to careful judicial scrutiny, that its transactions with the subsidiary were objectively fair
  • The parent corporation has a fiduciary duty, but there must also be self-dealing involved to invoke the intrinsic fairness standard
    • Self dealing- the situation where a parent is on both sides of a transaction with its subsidiary, and by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary
  • if the parent corp. does something that benefits them but not at the expense of the minority shareholder, then the court will use the business judgment rule
  • majority shareholders are held to a different standard than officers or directors
  • Unlike a director, a shareholder (majority or minority) is entitled to vote in a manner that is most beneficial to his/her interests
  • The majority shareholders have a fiduciary relation toward the minority
  • Big difference b/t when a stockholder is voting strictly as a stockholder and when voting as a director
    • when voting as a stockholder, he may have the legal right to vote with a view of his own benefits and to represent himself only
    • but when he votes as a director he represents all the stockholders in the capacity of a trustee for them and cannot use his office as a director for his personal benefit at the expense of the stockholders


Ratification of an Interested Transaction

  • shareholder ratification of a transaction b/t the corporation and an interested party will not be legitimate if the majority of the shareholders are interested parties
  • Where shareholders ratify, or approve of, an interested transaction, that clears the transaction
  • generally, shareholder ratification of an “interested transaction” shifts the burden of proof to an objecting shareholder to demonstrate that the terms are so unequal that they amount to a gift or waste of corporate assets


DE §144- Interested Transactions

  • (a) No contract or transaction b/t a corporation and 1 or more of its directors or officers, or b/t a corp. and any other corp., partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose, if :
    • 1. the material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; OR
    • 2. the material facts as his relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by votes of the shareholders; OR
    • 3. the contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee, or the shareholders.


V. Limited Liability Companies

  • Combines corporation and general partnership:
    • provides participants with the limited liability (the liability shield) that the corporation provides, but more flexibility in management and control
      • Limited liability protection of a corporation, together with a single-tier tax treatment of a partnership, along with considerable flexibility in mgmt and financing
      • No member can be liable for anything other than the amount of his investment in the LLC, regardless of how involved that member is in the daily operations of the business
  • Management:
    • the LLC can be managed by either:
      • all its members (as in a partnership); OR
      • by managers, who may or may not be members (as in a corporation)
        • The investors are called “managers”
  • Taxes:
    • the LLC has better tax treatment than the corporation
    • the IRS treats LLC’s as partnerships for tax purposes, instead of like a corporation
    • investors in an LLC are taxed, like partners, only once on its profits, as those profits are earned
    • LLCs also allow greater freedom than a corporation in allocating profit and loss for tax purposes
  • Dissolution parallels that of partnerships
  • LLC members do owe to each other fiduciary obligations of loyalty, as in the corporate context
  • Benefit of a Corporation Compared with LLC:
    • It is much easier to alienate your interests in a corporation, than it is to sell them in an LLC


DISTINGUISH: Limited Liability Partnership (LLP)

  • Limited liability for:
    • Partnership debts arising from negligence and similar misconduct (other than misconduct for which the partner is directly responsible)
      • No partner will be liable for the partnership’s obligation, just by virtue of being a partner
    • *Not for contractual obligations
      • But some provide limited liability for both contract and tort liabilities
  • Monitoring function of partnerships: They look out for each other’s partners’ clients which benefits the legal profession
    • One thing clients want is predictability
    • With LLC, you aren’t sure how things are going to play out in actual facts
  • NOTE: LLPs have to use the initials, LLP, in their names
    • This is so the public will know that individual partners won’t be liable
  • Now that LLP is implicated, they don’t have to worry too much about other partners b/c you aren’t liable for them
    • It used to be that the size of law firms had to be smaller b/c you were liable for each and every member’s actions
  • Partners in LLPs can participate in the management of the firm without having to worry about becoming liable as a general partner




A. Formation

  • LLC statute: by filing “articles of organization” you are giving notice to any party that the company is an LLC
    • This does not apply to agency
    • This statute does not relieve the agent of an LLC of the duty to disclose its principal’s identity to avoid personal liability
    • LLCs have to use the initials, LLC, in their names
  • Once the third party is on notice that you are an LLC, then they have to abide by all the elements of an LLC



  • principal not fully disclosed = agent is personally liable on a contract
    • An agent who negotiates a contract with a third party can be sued for any breach of the contract unless the agent discloses both the fact that he or she is acting on behalf of a principal and the identity of the principal
  • If both the existence and identity of the agent’s principal are fully disclosed to the other party, the agent does not become a party to any contract which he negotiates
  • Partial disclosed principal doctrine:
    • where the principal is partially disclosed (where his existence is known but his identity is not), it is usually inferred that the agent is the party to the contract


Agency in LLCs

  • When a third party sues a manager or member of an LLC under an agency theory, the principles of agency law apply
  • State statutes providing notice to third parties when an LLC has been incorporated do not extend to agency law, where the agent does not disclose the principal
    • Water, Waste and Land, Inc. (dba Westec) v. Lanham- where one party didn’t know that the other party (Clark) was acting for an LLC, except for a small indication on his business card.  Typically, according to the LLC Act, the filing of the articles of organization serves as constructive notice of a company’s status as an LLC.  However, the Court held that the statutory notice provision applies only where a third party seeks to impose liability on an LLC’s members or managers simply due to their status as members or managers of the LLC—not as agents.


B. Piercing the LLC Veil

  • there is no law or policy that says to treat LLCs different from corporations when piercing the veil
    • This will be allowed for maintenance and formality and some kinds of injustice
  • piercing the corporate veil was created to make sure that justice was served when a company had no assets
    • Kaycee Land and Livestock v. Flahive- D’s company screwed over P, but has no assets so P wants to “pierce the LLC veil” and go after D personally.  The court says there is no reason to treat LLCs different than corporations.  As such, if the members and officers of an LLC fail to treat it as a separate entity as contemplated by statute, they should not be immune from individual liability for the LLC’s acts that cause damage to third parties.


C. Dissolution

  • members of an LLC can be held personally liable for the debts of their LLC if they fail to properly dissolve the LLC under the relevant statutes
  • a dissolved LLC may “dispose of known claims against it” by filing articles of dissolution, and then providing written notice to its known creditors containing information regarding the filing of claims.
    • New Horizaons Supply Cooperative v. Haack- where D and her brother ran a company and D kept promising to pay P, but never did.


VI. Securities


Background on Federal Laws

  • tension between accountability and authority
    • directors must be operating on behalf of shareholders, while at the same time being able to exercise their authority to run the company
    • there are a lot of reasons why directors might be winning this war
      • we have talked about the race to the bottom
  • we begin with a broad structural problem
    • lots of opportunities for directors thrive at the expense of shareholders
    • there are some cases that suggest that directors are taking advantage of this structure to exploit shareholders
  • but, there are other institutions engaged in this war, including the Federal Securities Board
  • so far, we have been talking about state law, but after the Great Depression, awareness rose that corporate law was not responsive to the power of corporations
  • the Federal Securities Law was in response to the stock market crash in the 1920s, but also as an intervention (getting the federal gov. involved)
    • The federal gov. is not going to get involved in the substantive aspect—they don’t care about the structure of the company
      • Legislators are no better at making substantive business decisions than our judges
    • But they will get involved in the idea of “full disclosure”
    • Consumers should have all the information they need to make an informed decision of whether or not to invest in a company


Public Policy

  • Federal laws are not supposed to regulate substance, just procedure
  • If you are requiring firms to disclose in a particular form, then you are limiting the substantive leeway that they have


A. Disclosure and Fairness

  • trading corporate securities, such as stocks and bonds, takes place on two basic types of markets:
    • 1. the primary market
      • where the issuer of the securities (the company creating the securities) sells them to investors
        • ex. an initial public offering by a corporation takes place here
    • 2. the secondary market
      • Where investors trade securities among themselves without any significant participation by the original issuer
        • Ex. the NY Stock Exchange—very organized and regulated


Important Legislation

  • Securities Act
    • Concerned with the primary market
    • Two main goals:
      • 1. mandating disclosure of material information to investors; and
      • 2. prevention of fraud
    • It mandates disclosures by issuers in connection with primary market transactions
  • Securities Exchange Act
    • Concerned with secondary market transactions
    • Regulates:
      • insider trading and other forms of securities fraud
      • short-swing profits by corporate insiders
      • regulation of shareholder voting via proxy solicitations
      • regulation of tender offers
    • requires periodic disclosures by publicly held corporations
    • created the SEC (Securities and Exchange Commission) as the primary federal agency charged with administering the various securities laws


1. Definition of a Security

  • it is important to know whether or not the particular type of instrument or investment will be deemed a security
    • if it is a security then you would need to go through the registration process
  • P’s have a much easier time when they bring suit under the securities laws then they would if they had to bring suit under state common law fraud rules
    • The elements of federal securities fraud are less demanding and easier to prove
  • Definition of a Security in § 2(1) of the Securities Act:
    • 1. a list of rather specific instruments, including “stock, notes, bonds, treasury stocks, security future, debenture”
    • 2. a list of general, catch-all phrases, such as “evidence of indebtedness,” “investment contracts” and “any instrument commonly known as a ‘security’”
      • Investment contracts- a contract where you invest money in somebody, expecting profits to come through the services of others—you are not going to be involved in the actual business
        • one vulnerability is that shareholders/investors are not involved in the business that their money is involved in
  • it is the “economic reality” of a particular instrument, rather than the label attached to it, that determines whether it falls within the reach of the securities laws
    • just because an agreement labels the instrument a security, that is not enough to show that it falls under the federal securities laws


Claims Under Rule 10b-5

  • P must prove fraud in connection with the purchase of securities
  • Investment contract- a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of a promoter or third party
    • Ex. Robinson v. Glynn- where P invested in D (a cell phone company) and became the company’s treasurer. 


  • Characteristics of a Stock
  1. the right to receive dividends contingent upon an apportionment of profits
  2. free negotiability
  3. the ability of the interest to be pledged or hypothecated
  4. The conferring of voting rights in proportion to the number of shares owned
  5. the capacity to appreciate in value


Public Policy

  • If we are really so concerned about disclosure, why don’t the requirements of disclosure match up?
    • Even most lawyers would not understand these disclosures
  • Corporations say if consumers really wanted these disclosures, they would provide it
    • Since it is not being provided, the companies say this means that investors don’t want it
    • Are securities laws making companies/investors pay for something that they don’t need?
  • Consumers are actually vulnerable (for structural and legal reasons)
  • Whether or not you think securities laws are a good idea (necessary), goes to your view of whether or not investors are vulnerable (both structurally within the law, and as regular people)



2. The Registration Process


Securities Act:

  • prohibits the sale of securities unless the company issuing the securities has “registered” them with the SEC
  • Three Basic Rules of Section 5:
    • 1. a security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed with the SEC;
    • 2. securities may not be sold until the registration statement has become effective
    • 3. the prospectus (a disclosure document) must be delivered to the purchaser before a sale
  • Section 4: The provisions of §5 do not apply to:
    • 1. transactions by any person other than an issuer, underwriter, or dealer
    • 2. transactions by an issuer not involving any public offering



  • to register a security, the issuer must give the Commission extensive information about its finances and business
  • issuer- the company issuing the securities
  • a large company about to sell its stock to the public for the first time will need to file a registration statement that can easily exceed a hundred pages
  • when the SEC reviews a registration statement, it does not ask whether the security would be a good investment
    • instead, it asks whether the registration statement contains the disclosures required by the statute and the SEC rules thereunder and whether that information appears to be accurate
  • the core of the registration statement is the “prospectus”—the disclosure document that issuers are required to give prospective buyers under the Securities Act
    • until the SEC has approved the disclosures made in the prospectus, companies cannot sell the new securities
  • price of the security is another requirement in the registration statement
    • most issuers don’t know the price very far in advance, so issuers wait to sell their stocks until the SEC finds the registration satisfactory
    • then they price the security, amend the registration statement to incorporate that price and ask the SEC to make the amendment active immediately


Exemptions from Registration Requirement:

  • Exemptions:
    • It exempts some securities entirely
      • Exempt securities never need to be registered
    • It exempts some transactions in securities that would not otherwise be exempt
      • Exempt transactions are a one time exemption
  • Examples of Exemptions:
    • “private placements” under § 4(2) (Doran)
    • “transactions by any person other than an issuer, underwriter or dealer”
  • A private offering is exempted from the registration requirement, under §4(2) of the Securities Act of 1933
    • Condition of “Private Placement” Offerings:
      • each offeree has been given information about the issuer (that a registration statement would have disclosed); OR
      • each offeree had effective access to such information
        • if this is relied on, the privileged status of the offeree (his relationship with the issuer) must be proved
  • Factors the Court Found Important:
    • §5 says that if there is no registration statement, it is unlawful for a company to sell the security in interstate commerce (or use interstate communication or transportation to sell it)
      • the D sold or offered to sell these securities, and that the D used interstate transportation or communication in connection with the sale or offer of sale
        • this moves the burden to the P to show a prima facie case for a violation of federal securities laws
    • whether P had access to the kind of information that would be included in a securities disclosure, as required by the FSC
      • all offerees, whatever their expertise, had available the information a registration statement would have afforded a prospective investor in a public offering
      • there must be sufficient basis of accurate information upon which the sophisticated investor may exercise his skills
      • The Court says P was sophisticated and had access to the information, but the rest of the offerees did not
    • NOTE: sophistication is not a substitute for access to the information the registration would disclose


Burden of Proof

  • P has the burden of proving that it’s a security
  • Once the P has made out a prima facie case, the D has the opportunity to make an affirmative defense, such as “the transaction is exempt”
  • Then D has the burden to prove that the security was exempt from the federal laws
    • Doran – P proves it’s a security. D raises affirmative defense—it was exempt b/c it is not a “public offering.”  D then has the burden of proving it was “private.”


Four Factors to Decide Whether an Offering Qualifies for an Exemption:

  • 1. number of offerees and their relationship to each other and the issuer
    • Personal contact with the issuer and offerees (no public advertising or intermediaries, such as investment bankers or securities exchanges), then it is more likely to be a “private” transaction
    • The number of offerees shows the knowledge of each person involved
      • The more offerees, the more likely the transaction is public
    • NOTE: it is the number of offerees, not the number of purchasers that is relevant
    • Relationship b/t the offeree and the issuer
      • Shows how much info was available
      • “availability of info”- means either disclosure of, or effective access to, the relevant information
  • 2. number of units offered
    • The smaller the number of offering, the more likely it is exempt
  • 3. the size of the offering; AND
  • 4. the manner of the offering


Deciding Whether a Transactions is Exempt

  • Court will look to the statutory purpose:
    • exempt transactions are those where there is no practical need to apply the Act
    • deciding to apply §4(2) should turn on whether the particular class of persons affected need the protection of the Act
    • The purpose of the Act was “to protect investors by promoting full disclosure of information thought necessary to informed investment decisions”
  • The exemption question turns on the knowledge of the offerees


NOTE: the Securities Act focuses on facts:

  • facts disclosed by issuer;
  • facts known to offeree; OR
  • access to facts


Regulation D Exemptions:

  • if an issuer raises less than $1 million through the securities, it generally may sell them to an unlimited number of buyers w/o registering the securities
  • if it raises less than $5 million, it can sell the securities to up to 35 buyers
    • if it raises more than $5 million, it can sell to no more than 35 buyers, and each buyer must pass various tests of financial sophistication
  • NOTE: in all of these cases, the issuer:
    • cannot widely advertise the security; AND
    • must file with the SEC a notice of the sale shortly after it issues the securities
  • NOTE: the limits on the number of buyers, does not apply to “accredited investors” (banks, brokers and other financial institutions and wealthy buyers)
  • Regulation D only exempts the first sale—if the buyers re-sell it they have to find another exemption or it must be registered
    • Ex.  if the buyer is not “an issuer, underwriter, or dealer,” he or she will be able to rely on §4(1) for the exemption
  • Issuers can protect the exemption by using “reasonable care” to make sure the buyers are planning to hold the stock themselves
    • This requires that issuers:
      • 1. exercise “reasonable inquiry into the buyer’s plans,
      • 2. disclose to the buyers that the stock is unregistered and subject to various resale restrictions; AND
      • 3. print those restrictions directly on the stock
  • Rule 144- subject to various qualifications, the rule allows buyers to resell stock they acquire in a Regulation D offering, if they first hold it for one year and then resell it in limited volumes


Securities Act §11

  • this is the main cause of action directed at fraud committed in connection with the sale of securities through the use of a registration statement
  • this can’t be used with an exempt offering b/c the misrepresentation or omission must be in the registration statement
  • Strict liability to the firm itself for misstatements
  • NOTE: People can be liable whether or not they signed the registration statement


Burden of Proof in §11 Causes of Action

  • P does not have to prove reliance or causation in his/her prima facie case (they are not elements)
  • D has the burden of proving that its misconduct did not cause P’s damages


Section 11(a)

  • if any part of the registration statement contained an untrue statement of material fact or omitted a material fact required to be stated therein, or necessary to make the statements therein not misleading, any person acquiring such security (unless he knew of the untruth or omission at the time he acquired the security), may sue:
    • 1. everyone who signed the registration statement, which by statute must at least include the issuer, its principal executive officers, and a majority of its board of directors
    • 2. every director of the issuer at the time the registration statement became effective, including directors who did not sign the registration statement
      • It does not matter whether they read it or even understood it
    • 3. every person named in the registration statement as someone about to become a director
    • 4. every “expert” names as having prepared or certified any part of the statement, or as having prepared any report or valuation used in connection with the statement; AND
      • Accountants, engineer, appraiser 
    • 5. every underwriter involved in the distribution
  • NOTE: the long list of D’s in securities actions
    • no privity requirement, so there can be a long list of Ds
  • once P makes out his prima facie case, the issuer is strictly liable
    • the issuer can be held liable even if the misrepresentation or omission was an unintentional mistake


Section 11 (b) (p. 437):

  • as for D’s other than the issuer, the degree of fault required is essentially a negligence standard
  • D has the burden to prove that he was not negligent in preparing the registration statement:
    • Must show after a reasonable investigation, he had reasonable grounds to believe and did believe, at the time of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact that was required to be stated therein or necessary to make the statements not misleading
    • After reasonable investigation, he must also believe (or had reasonable ground to believe) that the statements were true and there was no omission to state a material fact


Section §11(c)- reasonable investigation

  • The standard of reasonableness should be that required of “a prudent man in the management of his own property”


The “Due Diligence” Defense

  • usually due diligence is the only viable defense to a §11 claim
    • Due diligence is usually the lawyer’s job, but if he fails, any D’s who delegated that responsibility to the counsel will lose that defense
  • D’s can escape liability, ifthey did the following:
    • He had, after reasonable investigation, reasonable grounds to believe, and did believe, that the registration statements were true or that there were no omissions
      • This is a pretty expansive defense
  • NOTE: The company itself does not have this defense, they are strictly liable


Public Policy Behind §11

  • this is not available under state law
  • in common law fraud, you are liable for misstatements, but not omissions, so this is a big deal on behalf of consumers
  • there is a wide range of potential D’s
    • you can sue lots of people—anybody to signed the statement, anyone who was a directors even if they didn’t sign the registration statement, any underwriter,


Securities Act §12


  • imposes strict liability on sellers of securities for offers or sales made in violation of §5
    • ex. where the seller improperly fails to register the securities
    • ex. where a seller registers, but fails to deliver the disclosures
  • main remedy = rescission– the buyer can recover the consideration paid, plus interest, minus income received on the security
    • if the buyer is no longer the owner of the securities, he/she can recover damages comparable to those which would be provided by rescission


  • imposes civil liability on any person who:
    • offers or sells a security in interstate commerce,
    • makes a material misrepresentation or omission in connection with the offer or sale, AND
    • cannot prove he did not know of the misrepresentation or omission and could not have known even with the exercise of reasonable care


P’s Prima Facie Case for Violations of Securities Act §12:

  • 1. the sale of a security
  • 2. through instruments of interstate commerce or the mails
  • 3. by means of a prospectus or oral communication
  • 4. containing an untrue statement
  • 5. by a D who offered or sold the security; AND
  • 6. which D knew or should have known of the untrue statement
    • if P pleads D’s knowledge, the burden of proving no knowledge shifts to the D
  • NOTE: P does not have to prove reliance
  • NOTE: liability under §12(a)(2) only arises with respect to material misrepresentations or omissions made in written documents or oral communications used in connection with public offerings.
    • Liability under this section does not arise in secondary market transactions or private placements


Debentures (a form of security)

  • Companies can sell debentures to the public, which are basically IOU’s
  • These shareholders then have equity interest in the firm—they get what is left after all the predators got their share
  • If it is looking like the company is going to be very profitable, then people don’t mind standing at the back of the line and waiting for the profits to come to them
  • But if the company goes belly-up, the debentures get paid before the shareholders get anything
  • At the auction of the holder of the debenture, they can turn it in for stock


Misrepresentations and Omissions

  • the misstatement or omission must be material enough to cause the investor to rely on the registration statement, when they otherwise would not have
  • material- those matters that an average prudent investor should reasonably be informed of before purchasing the security registered
    • matters that an investor would want to know before he can make an intelligent, informed decision whether or not to buy the security
    • facts that have an important bearing upon the nature or condition of the issuing corporation or its business
  • Escott v. BarChris Construction Corp.- Ps are holders of the debentures and they sue when the company goes bankrupt, saying that the registration statement contained material false statements and misleading omissions. The Court says the company must look at the registration statement with which a person of reasonable prudence would, using due diligence.



If an average prudent investor had known the real information would it have deterred him from purchasing the debentures?


Integrated Disclosure and Exchange Act Disclosures

Old System:

  • Securities Act:
    • Requires disclosures with respect to particular transactions, such as new issues of stocks or bonds to the public
  • Exchange Act:
    • Imposes a system of periodic disclosures on certain companies
    • Most importantly, the obligation to file annual and quarterly reports


Integrated Disclosure System:

  • An issuer planning a registered offering first looks to the various registration statement forms to determine which form it is eligible to use
  • Must file reports required under Exchange Act
  • All publicly traded companies, as well as some large close corporations, are required to file Exchange Act reports
  • Covered corporations must register with the SEC by filing an initial Form 10
  • NOTE: there is a difference b/t registering a class of securities under the Exchange Act and registering an offering of securities under the Securities Act
    • A company that has registered a class of securities under the Exchange Act will still have to register a particular offering of securities of that class under the Securities Act
    • the Exchange Act registers companies; the Securities Act registers offerings


C. Rule 10B-5

  • courts sometimes find a private right of action even if not specified in the statute
  • the most important in securities law, is the private right of action under Exchange Act § 10(b) and Rule 10b-5
  • §10(b) (p. 449)
    • Makes it unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, to use or employ, in connection with any registered or unregistered security, any manipulative or deceptive device in contravention of such rules and regulations that the SEC thinks are necessary to protect investors
    • This applies to any securities, including securities of closely-held corporations that are generally not subject to the Exchange Act, and to transactions in government securities


Rule 10b-5

  • Unlawful for any person, by the use of any means or instrumentality of interstate commerce or of the mails:
    • (a) To employ any device, scheme, or artifice to defraud;
    • (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) 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.


NOTE: reliance is an element of a 10B-5 cause of action

  • reliance provides the requisite causal connection between a D’s misrepresentation and a P’s injury


1. Materiality of Misleading Statements

  • misleading statements during merger discussions will be material under Rule 10B-5 if the misstatements would have changed the view of the total information by a reasonable investor
  • NOTE: silence, absent a duty to disclose, is not misleading under Rule 10b-5
  • USSC definition of materiality– an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote
    • “there must be a substantial likelihood that the disclosures of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available”
    • It all depends on the significance the reasonable investor would place on the withheld or misrepresented information



  • When the event is speculative in nature, like a merger, it is hard to decide whether the reasonable investor would have considered the omitted information significant at the time.
    • Test for Speculative Events:
      • Balance the indicated probability that the event will occur and the anticipated magnitude of the event given the totality of the company activity
  • Whether merger discussions are material in a certain case, depends on the facts of the individual case
    • Basic Inc. v. Levinson- where P sold their shares after the company had publicly denied a merger (which made the market value go down) and then the merger occurred.

2. Public Accessibility of Information

  • According to standard finance principles, the price of a given stock will change whenever investors (the large investors who control enough funds to affect prices) acquire new information about the stock
    • The large investors have access to the very best securities analysts
  • a fraudulent statement needs to be made publicly accessible in order for P to claim that the statement caused a loss on the investment


Burden of Proof:

  • P has to demonstrate that he relied on the misstatement
    • Once we have a material statement, the burden shifts, b/c we will presume that the P relied on that misstatement
  • then D has to affirmatively rebut this reliance by showing that the particular seller wasn’t relying on the market at all
    • if D can demonstrate the P sold off his stock for some other reason than the falling stock prices, then he is off the hook


“Fraud on the Market” Theory

  • The market price of shares (traded on well-developed markets) reflects all publicly available information, and hence, any material misrepresentation
    • It may be presumed that individuals rely on the integrity of the market price
  • B/c most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentation, therefore, may be presumed for purposes of a rule 10b-5 action
  • most consumers are not looking at the disclosure statement—they are relying on the integrity of the stock prices
    • in the market setting, the market transmits information to the investor in the processed form of a market price, so the market is performing a substantial part of the valuation process (which is usually performed by an investor  in a face-to-face transaction)
    • the market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price
  • Justice White’s Dissent (in Basic):
    • Isn’t it true that you buy a stock because you think the market price is wrong—b/c you think that the stock is more valuable than the stock market says it (and you sell the stock b/c you think it is going to go down—that the market is wrong)


Public Policy on Disclosures

  • We saw that shareholders don’t read the disclosure statements—shareholders aren’t paying attention to what directors say and every move the directors make
    • consumers/investors are relying on the market
    • We know that shareholders don’t listen to the directors and aren’t listening to the statements, so it is hard so show that they relied on these statements
  • When directors falsely deny that there is going to be a merger, the market takes that information and the stock price decreases, making the stock less valuable than it really is
    • Consumers are relying on the price, not the statement
  • Even the small possibility of this big event might be relevant to some shareholders
  • Cons of Federal Laws:
    • the security fraud laws are unnecessary b/c if investors wanted the disclosures, then the directors would provide it
      • investors invest in firms anyway without researching the disclosures
  • Pros of Federal laws:
    • the fed gov. responds by saying that this may be true in regards to sophisticated investors, but not to uninformed and amateur investors
    • sophisticated shareholders really do read the registration statement and take it into consideration


Rule 10(b)-5 Does Not Extend to Breach of Fiduciary Duty

  • Rule 10(b)-5 will apply only if there is conduct involving “manipulation or deception”
    • Manipulation refers to practices that are intended to mislead investors by artificially affecting market activity
  • The securities laws were not meant to federalize state law
    • they were meant to enforce disclosure (absent a clear congressional intent, the Court is reluctant to regulate areas that are typically under state law)
  • Santa Fe Industries, Inc. v. Green- where a short form merger took place.  In DE corporate law §253, when a parent company owns over 90% of the subsidiary company, they have to inform the 10% of minority shareholders if they are buying them out.  They don’t have to ask the minority shareholders or get their approval, they just tell him.  All the majority has to do is pay the minority shareholders a fair price.


VII. Insider Trading

  • a buyer of stock on the market does not owe a fiduciary duty to a seller to disclose the information that the buyer may know, even if the buyer is in a position that provides insider information
  • federal securities laws were passed in an effort to protect shareholders from directors’ opportunities to exploit them
    • to protect shareholders in their vulnerabilities


Stock Options

  • they are a type of securities, so they are covered by securities law
  • they are simply a contract


Two Types of Options:

  • Call Option:
    • Gives you the option to buy a stock at a certain price at a certain time
    • This is a contract that says you have the right to buy a certain stock, how much the stock will be and when you can buy it
  • Put Option:
    • I pay $1 for the right to sell you ACME at $20 on or before April 1st
    • If on April 1st, Acme is selling at $15, you Exercise your Option
  • Short Sale
    • Borrow ACME today ($20), return it to you on April 1st
    • Sell ACME today, hope and pray that it falls by April 1st


Material Information

  • insiders cannot act on material information (information that a reasonable man would deem important to the value of the stock) until the information is reasonably, publicly disseminated  



Would a reasonable person think that the information would be relevant to the price of the stock?



Does the trader have an advantage over those without the information?


Public Policy Behind Rule 10(b)-5

  • Congressional intent:
    • prevent inequitable and unfair practices; and
    • insure fairness in securities transactions generally, whether conducted face-to-face, over the counter, or on exchanges
  • expectation of the securities marketplace:
    • all investors trading on impersonal exchanges have equal access to material info
    • All of the investing public should be subject to identical market risks
  • Anyone trading in the securities of a corporation who has “access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone” may not take “advantage of such information knowing it is unavailable to those with whom he is dealing” (i.e. the investing public)
  • Insiders, as directors or management officers are, of course, by this Rule, precluded from so unfairly dealing, but the Rule is also applicable to someone processing the info, who might not be termed an “insider”
  • Anyone in possession of material inside information must either:
    • 1. disclose it to the investing public; OR
    • 2. if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, MUST abstain:
      • (a) from trading it; AND/OR
      • (b) recommending the securities concerned


Inside Information

  • an insider is not always foreclosed from investing in his own company merely because he may be more familiar with company operations than are outside investors
  • an insider’s duty to disclose information or his duty to abstain from dealing in his company’s securities arise only in “those situations which are essentially extraordinary in nature and which are reasonably certain to have a substantial effect on the market price of the security if the extraordinary situation is disclosed”
  • an insider is not obligated to confer upon outside investors the benefit of his superior financial or other expert analysis by disclosing his educated guesses or predictions
  • any material fact must be disclosed to the investing public prior to the commencement of insider trading in the corporation’s securities
  • material facts:
    • information disclosing the earnings and distributions of a company
    • those facts which affect the probable future of the company
    • those facts that might affect the desire of investors to buy, sell, or hold the company’s securities


A. Theories of Insider Trading


Classical theory

  • A corporate insider in possession of material nonpublic information must abstain from trading in the shares of that corporation OR disclose all material insider information known to him
    • This focuses on the duty to shareholders with whom the insider transacts
  • This duty arises out of the relationship of trust and confidence b/t a corporation’s shareholders and its employees (those insiders who have the information based on their position with that company)
  • Now, we are saying that an insider must disclose or abstain, but this duty to disclose resides in the fiduciary relationship b/t the insider and the shareholders of that firm
  • Duty of loyalty—the insider can’t take advantage of any asset of the firm for his/her own benefit—he has to turn it over to the firm’s owner (his principal)


Misappropriation Theory

  • A person commits fraud in connection with a securities transaction, and thereby violates §10(b) and Rule 10b-5 when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information
  • an outsider who misappropriates confidential information for his own personal benefit violates §10(b) because there is deception in connection with the purchase or sale of a security (it defrauds the person of the exclusive use of that information)
    • this theory focuses on the duty owed not to a trading party, but to the source of the information
  • The nexus to the deception is disclosure (D did not disclose)
    • If O’Hagan had told Grand Met that he intended to misappropriate the information and trade on it in Pillsbury, then he wouldn’t be violating federal law (this would never happen in real life)
      • He would still be liable in state law for violating fiduciary duty


“Tippee” Theory

  • SEC: when someone comes into possession of corporate information, that they know is confidential and know came from a corporate insider, they must either publicly disclose that information or refrain from trading
  • a non-fiduciary in possession of material nonpublic info necessarily inherits the duty from the “tipper”
    • In the absence of a breach of duty to the shareholders by the insiders, there was no derivative breach by Dirks
  • Where a fiduciary has violated his fiduciary obligation and benefited personally from that violation in connection with the tipping of an outsider, then the outsider will be held to the disclosure or abstain standard (like if Secrist got something out of “tipping” Dirks, then Dirks would be held liable)


Tippee Responsibility

  • Two elements of 10b(5) violations:
    • 1. the existence of a relationship affording access to inside information intended to be available only for a corporate purpose;
    • 2. the unfairness of allowing a corporate insider to take advantage of that information by trading without disclosure
  • There is no general duty to disclose before trading on material nonpublic information
    • “a duty to disclose under §10(b) does not arise from the mere possession of nonpublic market information”—it only arises from a fiduciary duty
    • Not all breaches of fiduciary duty—only where there is “manipulation or deception”
  • An insider will be liable only under Rule 10b-5 for inside trading only where he fails to disclose material nonpublic information before trading on it and then makes “secret profits”
  • A tippee (like Dirks) assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee “knows or should know” that there has been a breach
  • **what the tippee knows about the tipper’s motivations is very relevant


TEST for Tippees:

  • 1. Did the insider’s (the tipper’s) tip constitute a breach of the insider’s fiduciary duty?
    • Depends largely on the purpose of the disclosure (sometimes insiders mistakenly think that the info has been disclosed already)
  • 2. Will the insider (the tipper) personally benefit, directly or indirectly, from this disclosure?
    • Absent some personal gain, there has been no breach of duty to stockholders
    • Absent a breach by the insider, there is no derivative breach
  • If YES, the tippee has a fiduciary duty.


Public Policy:

  • The Court notes that the role of firms that analyze corporations (like Dirks’ firm) is a very important one and often that information cannot be made available to the public


Short-Swing Profits:


Section 16 of the 1934 Securities Exchange Act

  • prohibits directors, officers, 10% percent shareholders from buying and selling shares within a six month period—if they do buy or sell then any profits made (or any losses avoided) on the transaction are recoverable by the corporation
  • This is a “prophylactic” rule—it prohibits a lot of trades that aren’t really insider trading
  • Congress passed this b/c if insiders are trading with that frequently, then they are probably doing it based on some inside information (something the public doesn’t know)
    • But it doesn’t make a lot of sense, b/c you could be trading within those 6 months based on information that is public and everybody knows



  • Were you a 10% shareholder “at the time of the purchase”?
  • If YES, then you are covered under the statute
    • You are only covered by §16(b) if you are already a 10% shareholder and then you buy more—not if you just start at 0% and then buy 10%


VIII. Problems of Control


A. Proxy Fights



  • Directors control the corporation, but shareholders decide certain big decisions
  • Corporations hold annual meetings of shareholders for election of directors and for voting on all other matters
  • There are also special meetings for specific issues
    • ex. getting shareholders approval/disapproval of a merger
    • ex. whether to amend the articles of incorporation
    • ex. deciding to liquidate the firm
    • ex. to sell all or substantially all of the assets
  • Directors nominate themselves and ask the shareholders to vote for them at these meetings
    • Shareholders have to be given notice of the vote
    • Quorum- More than 50% of the shares must be present
      • either in person or in “proxy”
  • very few shareholders of public corporations actually attend these meetings
    • Instead they turn their votes over to a proxy that votes for them
    • They don’t vote b/c they feel that it doesn’t matter—one vote won’t effect the election, they have too much else going on, they don’t have enough stake in the outcome
  • Few shareholders own enough shares to make a difference at the meetings
    • Their stake is generally too small to affect the outcome at the meetings
    • But, in smaller firms, shareholders may actually attend the meetings and help decide the firm’s business strategy (b/c they have enough shares to affect the outcome of the vote)
      • The outcome of the votes usually depend on which group has collected the most “proxies
    • The shareholder with the most proxies wins the vote
    • Generally the incumbent mgmt will ask for the “proxy” (the document) directly from the shareholder, so the manager can vote on the shareholder’s behalf


Proxy Fights

  • these occur when an insurgent group tries to oust incumbent managers by soliciting proxy cards and electing its own reps to the board
  • this is basically a fight for control
  • they also use proxies to fight a defensive measures that the mgmt might hope to implement
  • proxy fights are subject both to the Securities Exchange Act of 1934 and state corporate statutes


Strategic Use of Proxies

  • The decision to continue with the present mgmt rests entirely with the stockholders—a Court may not override or dictate on a matter of this nature to stockholders
  • Proxy fights aren’t the best way to do this
  • They should just go out on the open market and buy up MGM, gain a controlling interest and take control of the firm
  • Courts will give quite a bit of latitude to directors who use these proxy fights
  • NOTE: proxy fights are an element of state law


Shareholder Proposals


§14(a) of Securities Exchange Act of 1934

  • If any security holder of an issuer notifies the issuer of a proposal for an upcoming meeting the issuer should allow it to go in the program and the security holder can present a statement of not more than 500 words in support of the proposal
    • the issuer must include the shareholder’s proposals in the proxy materials that they send out
    • provides the opportunity for shareholder’s to voice to their social concerns


Exceptions to Rule 14a-8

  • the proposal can be omitted if it relates to operations which account for less than 5% of its total assets at the end of the fiscal year or is not significantly related to the issuer’s business
  • now ethical and social concerns are part of that rule
  • ordinary business operations
    • Where proposals involve business matters that are mundane in nature and do not involve any substantial policy or other considerations they can be omitted
  • Even if the proposal does involve the way daily business matters are conducted, the statement may not be excluded if it involves a significant strategic decision as to those daily business matters (ex. one that will significantly affect the manner in which the company does business). 


NOTE: The Corporation has the burden of proving that the proposal falls in the exception if they want to exclude it from the proxy materials


Public Policy

  • now we have 14(a) that says we have to include it if it is significantly related to ethical and social concerns


Shareholder’s Proposal Process:

  • SEC referees the shareholder proposal process
  • If a corporation’s mgmt believes the proposal should be excluded from the proxy statement, it files a notice with the SEC that the firm intends to exclude the proposal
  • If the SEC staff agrees, it will issue a “no-action” letter, meaning the staff will not recommend that the Commission bring an enforcement proceeding against the issuer if the proposal is excluded
  • If the SEC disagrees (thinks it should be included in), the staff will notify the issuer that the SEC may bring an enforcement action if they exclude the proposal


C. Shareholder’s Inspection Rights


Section §14(a)-

  • requires directors to turn over shareholder’s lists to the proposer to allow him to send materials about the proposal out to the other shareholder’s
  • if they don’t want to give up the shareholder’s list, then they will offer to send the materials out for the proposer (and the proposer will foot the bill)


Shareholder’s List

  • if you don’t like the way a firm, that you own shares of, is being managed, you cannot require them to include your own slate of directors in the solicitation materials, so you will need to do your own proxy solicitation
  • usually you pay them to mail out your solicitation materials
  • you won’t send it to all shareholders—instead you will identify the holders of the large blocks of stock and spend most of your efforts trying to convince them to support you
  • federal proxy rules do not require the corporation to give it to you, but that does not impair any rights you have under state law


Inspection Rights

  • one of the most important rights shareholders have is the right to inspect the company’s books and their shareholder lists
  • inspection rights are a species of state law
  • a qualified shareholder is allowed, when in good faith, to inspect a corporation’s stock register in order to notify shareholders of exchange and solicitation offers for stock
  • A shareholder desiring to discuss relevant aspects of a tender offer should be granted access to the shareholder’s list, unless it is sought for a purpose contrary to the corporation or its stockholders.


Public Policy:

  • The pending tender of a large amount of the company’s stock may affect both the future direction of the corporation and the continued vitality of the shareholder’s investment
  • Inspection of the list should be allowed, so that shareholders can independently evaluate the situation
  • whenever anything happens to the company, the shareholders are affected
  • whenever the corporation faces a situation having potential substantial effect on its wellbeing or value, the shareholders are necessarily affected and the business of the corporation is involved (Section 1315 of the Business Corporations Law)


NY Business Law §1315:

  • 1. Inspection may not be requested for any other purpose than the business of the corporation; AND
  • 2. the shareholder requesting the information may not have participated in the sale of any stockholder list within the last five years


DE Law

  • DE law requires a “proper purpose” to view the shareholder list
  • Because the power to inspect is the power to destroy, it is important that only those with a bona fide interest in the corporation enjoy that power. 
    • It must be a proper purpose reasonably related to such person’s interest as a stockholder.


§14 of the Exchange Act

  • it appears to give voice to the shareholders about how firm should be run
  • it appears to provide a venue about ethical views, moral views
  • but when we look at the limitations that are placed on inspection rights under state law, it seems that they don’t really get these rights


Illusion of Shareholder Democracy

  • it is not the case that the mirage has no effect, that the consequence of the illusion of shareholder democracy is that there is no shareholder democracy
    • the mirage itself allows legislatures and policymakers to believe that there is no problem b/c if they wanted something different they would do something about it
  • this is what shareholder’s want, otherwise they would change it
  • there is no reason for the legislature to step in and say you need to stop producing weapons, or need to protect animal rights b/c shareholders could do it themselves and they are not doing this
  • the illusion of shareholder democracy gives coverage to this problem


D. Control in Closely Held Corporations

  • non-public corporations, owned by a small number of shareholders
    • stock is only rarely dealt
    • size is not determinative
  • absence of a readily available secondary market, through which shareholders can exercise exit if they are dissatisfied with the directors or the governing board
    • lack of any resale market
    • sometimes these firms have limitations on the alienability of the stock
    • many people who own a stake in a closely held firm get it from their employment—they get their foot in the door by being employed there
    • they don’t get dividends, so they are paid a salary
  • shareholders have more control over the firm
    • shareholders ability to influence the running of the firm is limited
    • shareholders in closely-held corporations are entitled to a lot of leeway
    • the shareholders have more experience in the firm, so they might take more interest in it
    • they have the opportunity to be informed and the incentive to be informed
    • there may be a greater non-pecuniary interest
      • b/c shareholders have a great stake in the corporation, they want a greater stake in control of the corporation
    • they have the access to the firm—they show up at the firm, they know what’s going on
      • they have knowledge and the desire to belong at the firm
  • corporate law is not designed to facilitate shareholder control, it is designed to facilitate directorial control
    • the directors will be benefiting from the policies they are implementing
  • jx varies widely and terminations are often made on the facts of specific cases
  • NOTE: if a family is the majority shareholders, then they would control the whole thing, but if one dissents and joins with the minority, then they have lost control


Limitations on Decisions by Shareholders

  • Stockholders may not, by agreement among themselves, control the directors in the exercise of the judgment to elect officers and fix salaries
    • Directors motives may not be questioned, so long as their acts are legal
    • The bad faith or the improper motives of the parties does not change the rule
    • Directors may not by agreements entered into as stockholders abrogate their independent judgment
  • Generally shareholders cannot form an agreement to control the decisions traditionally vested in the judgment of the directors of a company
    • McQuade v. Stoneham
      • McQuade Rule:
      • Shareholder agreements are perfectly acceptable with regard to the election of officers
      • Shareholders can sell their shares if they want to
      • Shareholders can compete with firms
      • Shareholders can vote for whichever person they think will allow them to benefit the most
    • **It is imp to note that the main issue in this case is the minority interest (in Clark, seen below, there is no minority—that’s why it is different)
      • *shareholders are allowed to be selfish—directors are not
  • a contract is illegal and void so far as it precludes the board of directors, at the risk of incurring legal liability, from changing officers, salaries, or policies or retaining individuals in office, except by consent of the contracting parties
    • the whole contract is void (you can’t split the baby)
  • where the directors are the sole shareholders, there seems to be no objection to enforcing an agreement among them to vote for certain people as officers
    • Clark v. Dodge- where they were the only two shareholders and they made an agreement that said they would elect each other as directors and later as officers of the firm.  The Court found that the contract was valid.
    • there was no invasion of the powers of the directorate under that agreement
    • there was no damage suffered by or threatened to anybody
    • *this it different than McQuade b/c Clark and Dodge were the only two involved
      • there are no minority shareholders, so they could look out for their own interests and it won’t hurt anyone
      • Therefore the purpose of the McQuade rule would not apply



  • if the firm is closely held, there is no complaining minority and the terms are reasonable, then the courts will uphold the shareholder agreement
  • the Galler rule is the current rule, but now there are closely held corporation statutes
  • NY still goes by McQuade


New York & Delaware Law (no difference)

  • they both permit shareholders in closely-held corporations to add a provision in the articles of incorporation that allows them to elect directors and officers


§141(a) of the Delaware Corporate Code

  • You are permitted to say that someone other than the board of directors is managing the company, but this must be in the certificate of incorporation
    • (this is the default rule, but you can change this in your agreement)
    • If there is a minority shareholder, then things change


§620 of NY Corporate law on p. 614

  • (a) An agreement between two or more shareholders, if in writing and signed by the parties thereto, may provide that in exercising any voting rights, the shares held by them shall be voted as therein provided, or as they may agree, or as determined in accordance with a procedure agreed upon by them
  • (b) A provision in the certificate of incorporation otherwise prohibited by law because it improperly restricts the board in its mgmt of the business of the corporation, or improperly transfers to one or more shareholders or to one or more persons or corporations to be selected by him or them, all or any part of such mgmt otherwise within the authority of the board under this chapter, shall nevertheless be valid:
    • (1) if all the incorporators or holders of record of all outstanding shares, whether or not having voting power, have authorized such provision in the certificate of incorporation or an amendment thereof,
    • (2) if, subsequent to the adoption of such provision, shares are transferred or issued only to persons who had knowledge or notice thereof or consented in writing to such provision.


Public Policy

  • Minority shareholders in a closely-held corporation are often at a disadvantage so they will make agreements to make sure he keeps his employment with the company and is allowed to participate in important business decisions
  • Contracts cannot place limits on the power of the directors to manage the business of the corporation
  • majority stockholders cannot compel the directors to act a certain way, but at the expiration of the term of office of the directors, the stockholders have the power to replace them with others whose actions coincide with the judgment or desires of the holders of a majority of the stock. 
  • the choice of directors lies with the majority stockholders and thus gives stockholders a very effective control of the action by the board of directors.
  • the DE court says:
    • basic dilemma of minority shareholders in receiving fair value for their stock as to which there is no market and no market valuation. 
    • A stockholder in a closely held corporation can make a business judgment whether to buy into such a minority position, and if so on what terms. 
    • he could bargain for definitive provisions of self-ordering permitted to a DE corporation through the certificate of incorporation or by-laws under state law.  In addition, a stockholder intending to buy into a minority position in a DE corporation may enter into definitive stockholder agreements to provide for elaborate earnings, buy-out provisions, voting trusts or other voting agreements.


Shareholder Agreements:

  • also called “pooling” agreements
  • they are designed to achieve similar objectives to those in McQuade v. Stoneham and Clark v. Dodge
  • shareholders agreements that commit them to electing themselves, or their representatives, as directors, are generally considered unobjectionable, and are now valid in many jx
  • as long they don’t interfere with the obligations of the directors to exercise their sound judgment in managing the affairs of the corporation
  • agreements that require the appointment of certain individuals as officers or employees of the corporation do deprive the directors of one of their most important functions
    • but now, these agreements are enforceable as long as they are signed by all shareholders


Voting Trust:

  • specifically authorized by the corporation laws of most states
  • shareholders who want to act in concert turn their shares over to a trustee
  • the trustee then votes all the shares, in accordance with instructions in the document establishing the trust
  • voting trusts are often used when a family or group wants to maintain control of a corporation by a family or group, when there is a fear that some members of the family or group might form a coalition with minority shareholders to shift control
  • these generally must be made public


Special Statutory Provisions for Closely Held Corporations

  • these provisions vary from state to state
  • they allow certain corporations to choose to have “close corporation status”
    • this is completely voluntary
  • this means that they will be managed by shareholders, not a board of directors
  • one advantage is the need for any corporate formalities


E. Abuse of Control

  • Stockholders in the close corporation owe one another the same fiduciary duty in the operation of the enterprise that partners owe to one another
    • This is a duty of “utmost good faith and loyalty”
    • This comes before their mgmt and stockholder responsibilities
  • shareholders in a closely held corporation owe each other a duty of acting in good faith
  • they breach this duty by terminating another shareholder’s salaried position, when the shareholder was competent in that position, in an attempt to gain leverage against that shareholder


Did the mgmt decision that severely frustrated a minority shareholder have a legitimate business purpose?


Burden of Proof

  • When a minority shareholder complains about being frozen out of a closely held firm by his fellow shareholders:
    • 1. the majority must come forward and demonstrate a “legit business purpose” for their actions (in freezing him out)
      • They don’t have to demonstrate complete fairness (as in the loyalty rule)
    • 2. Then the minority must show a “less harmful alternative” to pursue that legit business purpose without harming the minority shareholder


Employment in the Firm

  • absent an employment contract, an employee is an “at-will” employee when his shareholder agreement provides a buyback provision of his shares if they are terminated for any reason
  • a minority shareholder in a close corporation, by that status alone, who contractually agrees to the repurchase of his shares upon termination of his employment for any reason, acquires no right from the corporation or majority shareholders against at-will discharge.
  • NOTE: a corporation owes a duty to a minority shareholder as a shareholder, but there is no duty owed to him as an employee


F. Transfer of Control

  • Usually shareholders will come up a limit on the transferability of shares:
    • First option- the right to buy them at a pre-established price
    • Right of first refusal- the right to buy them by matching what the outside person is willing to pay
      • Rights of first refusal are to be interpreted narrowly
  • A agreement that gives the shareholder the right of first refusal does not convey the right to control the sale of assets or the liquidation of the company
  • NOTE: a sale of the majority block’s shares is not the same thing as a sale of either all or some of the holding company’s assets
    • Frandsen v Jensen-Sundquist Agency, Inc.– where P (a minority shareholder) had the right of first refusal if the company sold out to a third party.  The company was going to sell its shares to another company, but P wouldn’t sign the waiver, and said he wanted to buy out the shares.  President of the company didn’t want to sell to F b/c he was afraid that P would fire him and he would lose his job if P owned the majority. P sued for breach of shareholder agreement.  The Court says that the agreement only gives the right of first refusal if the shares were offered for sale.  They aren’t offered for sale if D is only selling some of its assets to become an investment company instead of a bank holding co.  The right of first refusal was only triggered by an offer; here, First Wisconsin didn’t want to become a majority shareholder—they just wanted the bank.  The original transaction was a merger, so there was no “offer” to buy the shares.  In this case, the shareholders would have received cash—their shares would have disappeared but not by sale, for in a merger, the shares of the acquired firm are not bought, they are extinguished—there would have been no D company after the merger and no shareholders in D.  A merger is different than a sale of shares. 


Premium Price

  • When someone buys so much stock that they now have a premium interest, they have to pay a premium price, so that they don’t take advantage of the minority shareholders. 
    • the premium is paid for control b/c the buyer wants to milk or loot the company
  • The premium is the added amount an investor is willing to pay for the privilege of  directly influencing the corporation’s affairs
  • Absent bad faith, a controlling shareholder is free to sell, and a purchaser is free to buy, the controlling interest at premium price
    • a party can purchase a controlling share of a corporation at a premium price without extending a tender offer to all shareholders.
  • Shareholders are entitled to sell their shares at a premium and they don’t have to share it with minority shareholders


Selling Control of Management

  • an agreement to sell control of the management, along with the sale of a substantial percentage of shares is not against public policy
  • it is fine for someone to come in a “buy” control of management” (paying for some directors to resign)


IX. Mergers, Acquisitions and Takeovers


Mechanisms of Gaining Control

  • one way is by owning a little bit of stock and then trying to get elected to the board of directors
    • but the proxy fight is an unlikely way
  • practical mergers
    • another way is to go on the market and start buying out stock until you receive a controlling interest
    • when the market starts seeing you buying all this stock, they will see that you know something that they don’t—so it might raise the stock value
  • statutory merger             
    • where you merge your firm with a “target” firm (the firm you are trying to gain control over) in a way that will leave you in a dominant position
    • certain states have different rules on mergers


A. Mergers and Acquisitions


Mergers in General

  • the shareholders in the company being “acquired” end up with stock in the acquiring corporation, so they have a continued stake in the newly-combined enterprise
  • the acquiring company then owns both companies
  • distinguish: in a sale-type deal—the shareholders of the “acquired company” end up with only cash and no stake in the new enterprise


Statutory Merger

  • one way to accomplish a combination of two companies
  • the procedure are set forth in state laws
  • the terms of the merger are spelled out in a document called a merger agreement
    • drafted by the parties
    • lays out the treatment of the shareholders of each corporation
    • how many shares go to the shareholders of each of the two corporations
  • shareholders and directors are required to approve the merger by voting
    • appraisal rights- shareholders who voted against the merger, would be paid by the acquiring company in cash, the fair value of their shares


Practical Mergers (other forms of mergers that do not use the statutory procedure)

  • buying shares from shareholders
    • buying enough of another company’s shares to gain control of that company
      • since this would be b/t the buying company and the shareholders of the selling company, no votes of shareholders or directors would be necessary
      • nor, would there be any appraisal rights
      • once the buying company gained sufficient control, it could use a special procedure, called a “short-form merger”
  • assets acquisition
    • buy all the assets of the company you want to acquire in exchange for shares of your own company (or for cash)
      • then you are dealing with the actual company instead of its shareholders
      • *here, the acquiring company does not take on liabilities of the acquired corporation, as it would under a statutory merger
    • State laws vary on whether this type of acquisition requires a shareholder vote and whether they get appraisal rights


Assets Acquisitions

  • a reorganization by a corporation to acquire the assets of another organization operates as a de facto merger if the consequences are the same (nature of the corporation is significantly changed and the shareholder’s interest is significantly altered)
    • Farris v. Glen Alden Corporation- P was a shareholder in D’s company (GA).  GA sold all of its assets to List, instead of actually merging the companies (“asset acquisition”) so P sued for his appraisal rights.  One of the companies was a PA company and one was a DE company—both states have different laws for mergers.  In PA, shareholders need to approve the merger and if they don’t, they get appraisal rights.  The Court found that the “assets acquisition” had the same effect as a de facto merger, so P should get the same rights.  The Court said it doesn’t matter what you call it, if it has the same result as the merger, then the shareholders have the same rights
  • Even if you try to get around the merger statute, the Court will impose the same rights on the shareholder
    • Asset sales statutes and merger statutes are independent of each other, and a corporation must comply with one or the other


Public Policy Behind the Market for Control

  • Now, most states have given up on the statutory merger and the de factor merger mechanism
  • modern view– we want to liberalize the market b/c it benefits shareholders and gets new blood into the board
  • Is it a race to the top?
    • Has DE found the best corporate laws for the best interest of shareholders?
  • Or a race to the bottom?
    • Has DE come up with the worst laws for the shareholders, but the best laws for the directors?
    • Competition among states to find the best laws for directors
  • Should the market for control be encouraged or discouraged?
  • You have to look at the reasons
    • Do they want it to exploit the firm?
      • Then you would want to increase the control
    • OR, Do they want it to grow the firm?
      • Then you would want to relax the control
  • Traditionally corporate law has been concerned about the market for control


B. Freeze-Out Mergers

  • Where the controlling shareholders take exclusive ownership of the corporation by finding a legal way to eliminate the outsides as shareholders
  • you usually have a big shareholder that owns ton of stock and then you have the minority shareholders that are coming along for the ride
    • often the best thing to do is to just get rid of them
    • you think that you are making a lot of money and every dollar that you are making you have to share with these minority shareholders who aren’t doing anything
    • if you get rid of them, then you would get to keep all of the money that you make


Cash out mergers

  • These are perfectly legal
    • The rule is that the majority who has prepared the merger deal has an affirmative obligation of good faith and fair dealing and the obligation to pay the minority shareholders a good price
  • a majority shareholders owes a fiduciary duty to minority shareholders to provide all relevant information that would pertain to a proposed “cash-out merger” (they have the same fiduciary duty that they have for “inside information”)


Burden of Proof:

  • 1. P attacking the merger, must demonstrate some basis for invoking the fairness obligation
  • 2. the majority shareholder must show by a preponderance of the evidence that the transaction is fair
  • NOTE: when a corporate action has been approved by an informed vote of a majority of the minority shareholders, the burden entirely shifts to the P to show that the transaction was unfair to the minority
    • But the burden remains on those relying on the vote to show that they completely disclosed all material facts relevant to the transaction


C. Takeovers


1. Tender Offers

  • When the acquiring company offers to buy each public holder’s stock directly
    • This can be carried out over the objection of the “target” company’s Board of Directors and managers
    • It is up to each individual shareholder to decide to sell their shares
  • This occurs when someone is not able to negotiate a merger, but still wants control
    • usually, they will condition it on getting at least 51% of the shares, so they have a majority
  • policy behind the two-tiered tender
    • if you have the $45 backend deal, you might think that its unfair, and you might think that you would win in court, but this would take so much time and so much money (for attorneys, etc) that you might just want to cut your losses and invest elsewhere
    • a $45 cash out for control in this firm might survive a challenge


Straight (One-Tiered) Tender

  • if Unocal stock is selling for $50/share on the open market
  • you want control of Unocal, but you cant negotiate with the directors b/c they don’t care about you and don’t want you in their company
  • so you say to the stockholders, “your stock is selling at $50, I will give $60 for the first 51% of shares that walk in the door”
    • as a minority stockholder, notice that if someone is willing to pay $60, then they must know something (that it is more valuable then that)
  • you won’t give it to any percentage under 51% b/c he wants control
  • **a straight tender offers threatens stagnation


Two Tiered Front-End Loaded

  • This is a coercive mechanism
  • You are still taking your chances that a court will say the back-end is a fair price
  • If you don’t tender, you are going to be stuck in the back end with the lower price
  • The question is: Do you want to empower boards to come up with defensive mechanisms to avoid this?
  • *the two-tiered front end loaded mechanism threatens a stampede
  • *most shareholders will tender b/c of the fear of being left on the backend


2. Development

  • directors have a duty to protect the corporation from injury by third parties and other shareholders, which grants directors the power to exclude some shareholders from a stock repurchase
  • business judgment rule- the court will not substitute their views for those of the board if the board’s decision “can be attributed to any rational business purpose”
  • when a board of directors uses corporate funds to remove a threat to corporate policy when a threat to control is involved, directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person’s stock ownership
    • this burden can be satisfied by showing good faith and reasonable investigation
    • this choice must be motivated by a good faith concern for the welfare of the corporation and its stockholders, which in all circumstances, must be free of any fraud or other misconduct
    • next, the Court has to balance—the action taken must be reasonable in relation to the threat posed


Enhanced business judgment rule

  • under some circumstances the Court will require that the director comes up with proof that their  response was reasonable in light of the threat


SEC Reaction to Unocal and Poison Pills

  • after Unocal, the SEC created rules against discriminatory self-tenders, prohibiting issuer tender offers other than those made to all shareholders
  • the SEC does not prohibit poison pills, which have the same effect
    • official name: “Shareholder Rights Plan”
  • warrant- a right that grants the holder the option to purchase new shares of stock of the issuing corporation
    • they give the holder the right to buy issuer common stock at a discount from the prevailing market price


Poison Pill

  • this is a defense mechanism to avoid hostile takeovers
  • a company offers its own shareholders a note in exchange for each of their shares
  • this puts the corporation in so much debt that no one would want to takeover the corporation
  • basically, you are threatening suicide of the company
  • the pill is typically adopted by the board of directors without any shareholder action
  • the pill’s flip-in element is triggered by the actual acquisition of some specified percentage of the issuer’s common stock
  • the pill causes the value of the stock to decrease
  • when a takeover is inevitable, the director’s duty is to get the best price for the shareholders
  • NOTE: once the director’s know that the corporation is going to be taken over, the duty to the shareholders outweigh the duty to the corporation
  • no defensive measure can be sustained when it represents a breach of the directors’ fiduciary duties
  • favoritism for a white knight to the total exclusion of a hostile bidder may be justifiable  when the latter’s offer adversely affects shareholder interests, but when bidders make relatively similar offers, or dissolution of the company becomes inevitable, the directors cannot fulfill their enhanced Unocal duties by playing favorites with the contending factions
      • Revlon v. MacAndrews & Forbes Holdings
  • Notes on Revlon:
    • The only duty left for the board of directors is to maximize price
    • There is nothing to discuss—the firm is going to be sold, not its just about how to maximize price for the shareholders
    • When they realized the company was going to be sold, they now become auctioneer

Paramount v. Time

  • It’s not BJ rule because this tender offer was consummated in response to the threatened takeover, so the court will apply the enhanced BJ rule.

Enhanced BJ Rule:

  • The court does a reasonable investigation and finds that Time isn’t being sold, but it merging with Warner and will continue to be a live entity
    • There is no auction, this is not like Revlon
  • Unocal Analysis: (discussed on p. 801)
    • 1. Has there been reasonable investigation to determine that there is a threat?
    • 2. Are they operating with good faith?
    • 3. Is the response reasonably related to the threat?
      • They are offering $70 above market
  • The reason it was allowed in Unocal was b/c it was structurally coercive
      • Here it was not structurally coercive
  • They were entitled to protect their shareholders from being confused
    • They should have not led them to think that $200 in their pockets now was better than being a part of the Time Warner Corporation
    • This was robbing them of the greater value of being part of this corporation


Public Policy

  • The Paramount ruling represents a major step in the authority direction in the war b/t accountability and authority
  • A major rebuff to Easterbrook and the passivity thesis

Passivity thesis-

  • says the proper response for a company in a hostile takeover is passivity—to do nothing
  • DE has not adopted the passivity thesis, it had endeavored to reach some middle ground
  • In short, it is nice to have an option in the Revlon contracts, and as a result of the option the shareholders might get $57 or more, but the only reasons the option was able to happen here is b/c PP originally came to the table and offered $45
  • Why should the PP’s of the world go out there and look for firms who might be underperforming?–they are only going to attract the Forstman’s of the world to the table?
  • Allowing firms to engage in the poison pill might be good now, but it will end up scaring the Forstman’s of the world awayIt will chill the market for control
  • Market for Control:
    • Does it provide an opp for outsiders to come into a firm and exploit opportunity?
    • Does the very knowledge that there is market for control available make directors become more careful not to exploit shareholders




Written by freelawschooloutlines

October 13, 2009 at 4:52 am

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