Corporations

- Court will put the opportunity through 5 tests:

(1) Line of business - Was it the same as the corporation's current or planned business activities? (2) Expectancy - Was it one that the corporation had already formulated plans or taken steps to acquire for its own use? (3) Appropriation - Was it developed by the director through the use of the corporation's property or personnel? (4) Capacity - Was it presented to the director with the expectation that the director would present it to the corporation for its consideration? (5) Financial Ability - Would the corporation be able to financially support the opportunity?

Safe Harbor Rule:

- Director must present the opportunity before acting on the opportunity - Director only has to reveal all material facts that, at the time when disclosure is made, are known to the director - An corporate opportunity that has been properly presented to and declined by the corporation may then be pursued by the presenting director without breach of the director's duty of loyalty - Must engage in this before becoming legally obligated - If the transaction has already taken place, the corporation has lost its chance—and it would be too complicated to un-do the transaction. - *once you become legally obligated, you must prove fairness*

Executive Compensation & Waste Doctrine

- Executive compensation is set by the board of directors, and in the typical closely held corporation, all of the directors also serve as officers of the company o Only the board of directors can set the salary for officers and top executive employees. - If there is a deadlock, the president (with check signing authority) can continue to pay himself under the last pay scale approved by the board, including any bonuses

Analyzing Discrete Decision

- Francis v. United Jersey Bank "drunk Mrs. Prichard case" o As a general rule, a director should acquire at least a rudimentary understanding of the business of the corporation. o obligation to keep informed about the activities of the corporation. Directors may not shut their eyes to corporate misconduct and then claim that because they did not see the misconduct, they did not have a duty to look. The sentinel asleep at his post contributes nothing to the enterprise he is charged to protect.

Officers Standards of Conduct §8.42

- Officer must observe the duties of obedience and loyalty and to act with the care that a person in a like position would reasonably exercise under similar circumstances - Agent --- subject to a duty to the principal to act with standard care and with the skill which is standard in the locality for the kind of work which he is employed to perform and to exercise any special skill that he has - Duties: o To keep superiors informed of material information within the officer's sphere of responsibilities o To inform the relevant superior of violations of law of breaches of duty that the officer believes have occurred or are likely to occur and are material to the corporation  This is a subjective belief that a breach actually or probably has occurred or is likely to occur

Dissolution §14.30

- The court may grant or order dissolution at the request of the state, a shareholder, a creditor, or a corporation o The court can take into account the number of shareholders and the nature of the trading market for the shares in deciding whether to order dissolution - A corporation may dissolve because of ... o Deadlock - the directors are deadlocked on a decision causing irreparable injury to the corporation or is preventing the affairs of the corporation from being conducted o Waste - Corporate assets are being misapplied or wasted o Oppression - the directors are acting fraudulently, illegally, oppressively, or otherwise in breach of their fiduciary duty to the shareholders

Conflicting Interests : Safe Harbor §8.62

- The fiduciary relationship between directors and the corporation imposes fundamental limitations on the extent to which a director may benefit from dealings with the corporation he serves. - Director has safe harbor if the transaction is approved by the affirmative vote of a majority of the qualified directors

Analyzing Conflicts: Director's Conflicting Interest Transaction §8.60

- When one stands on both sides of a transaction, he has the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts - if you cure, you get business judgment rule & cannot challenge the transaction

Stone v. Ritter

-directors are required to institute internal control systems to ensure that the corporation will not suffer loss because of failing to comply with the law/fraudulent activity. Additionally, directors must monitor the system, and respond to any issues.  directors can only be liable in situations involving a sustained or systematic failure of the board to exercise oversight

Promoters Contracts

1. A promoter is someone who helps to found and organize a corporation 2. A promoter may need to make contracts in the process 3. Corporation may adopt pre-incorporation contracts.

Ultra Vires Doctrine

1. Conduct outside of the purpose for which the corp exist is Ultra Vires 2. In 19th century Corps not liable for ultra vires acts 3. Today courts construe purpose broadly 4. only tends to be an issue when conduct does not benefit the corp in any way 5. Modern law has sharply restricted the ability to challenge ultra vires conduct. 6. Note 2 Pg. 318 Specific Purpose Clause - Protect minority shareholders a. Corporation confined to limited objectives - Majority cannot change the nature of the business in a way that the minority shareholders could not have foreseen when they initially invested. 7. Tainted Shares rule - Taint follows shares 8. Powers and Purpose note 3 pg318 Va stat 626 629 - Purpose vs. Powers a. Ends and Means b. Corps are assumed to have any lawful purpose unless limited c. Assumed to have powers 9. Every corporation incorporated under this Act has the purpose of engaging in any lawful business unless a more limited purpose is (i) set forth in the articles of incorporation, or (ii) required to be set forth in the articles of incorporation by § 13.1-620, or any other law of this Commonwealth. 626 10. Listed powers in 627

Board of Directors

1. Elected by initial incorporators or named in certificate 2. Approve bylaws and minutes

Preemptive Rights

1. Give existing shareholders the ability to subscribe proportionately to any new issuance of shares. 2. Shareholder must make further cash contribution 3. Katzowitz - Majority stockholders may not offer lower priced shares in order to force minority stockholders into tough situation of lower value or purchase.

Bylaws

1. Rules for meetings 2. # of directors 3. Methods of appointing and removing directors 4. board vacancy filling 5. committees of the board 6. rule for calling directors meeting 7. id of officers and duties 8. methods of electing/removing officers 9. indemnification to point allowed by statute 10. the advancement of expenses to directors and officers who are sued in connection with their duties 11. Purchase of directors and officers insurance 12. fiscal year 13. manner in which bylaws may be amended

Financing the corporation

1. Shares a. Number must be on certificate b. May class or label shares in any way i. Common Shares ii. Preferred Shares iii. dept c. Common Shares - Residual or ultimate ownership of a company d. Preferred Shares - many varieties - Typically have preference over common shares with concerns to dividends i. Normally have preffernce on liquidation ii. Often convertible to common shares iii. Usually carry no voting rights unless payments missed 2. Loan a. If secured by corps assets - The investors have purchased a bond b. If unsecured then they have purchased a debenture. c. either are often convertible into common shares d. Unlike preferred shareholders debt holders have an absolute contract right to receive principle and interest payments

Formation

A. First step is filing a certificate of incorporation 1. Existence commences upon filing 2. Statutory list of items that must be included (13.1 - 619) 3. Most Important provisions included: a. # of shares corp is allowed to issue b. # of shares per class or series of shares c. Terms of each class or series

- Corporate Opportunity

An opportunity, that in fairness and keeping in the duty of loyalty, the director should have offered to the shareholders before taking advantage of the offer - PL must show the D is a fiduciary & that the thing that was taken was a corporate opportunity -Controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation. Falls under fiduciary duty of loyalty. Corporate fiduciary should not serve both corporation and personal interests at the same time.

- Director's gain

Must be direct

Derivative Suits - Shareholder Litigation

Nature of Derivative Suit a. Corporation Fiduciary Duty is to corporation, not individuals b. Shareholder sues on behalf of corporation i. All recovery goes to corporation ii. Shareholders get reimbursed litigation fees c. Procedural restriction on derivative suits i. PL takes complaint to the board ii. PL verifies complaint iii. PL must wait 90 days before filing unless board rejects or corporation would suffer irreparable injury by delay. d. Special exception for close corporation i. Can bring direct suit to vindicate their corporate rights and the breach of fiduciary duty e. Standing i. Contemporaneous stock ownership suit

Maj and Min BJR Review

No review and waste

Burden of Proof

Plaintiff must prove that one of the factors is absent - Note 2: p. 434: o Directors' decisions will be respected by courts UNLESS the directors are interested or lack independence relative to the decision, do not act in good faith, act in a manner that cannot be attributed to a rational business purpose or reach their decision by a grossly negligent process that includes the failure to consider all material facts reasonably available. o A director or officer decision is presumptively valid UNLESS a plaintiff can rebut one or more of the rule's prerequisites or can establish irrationality.

Directors' Standards of Conduct §8.30

Standard of Care --- what a person in a like position and acting under similar circumstances would reasonably believe to be appropriate

Vertical veil piercing

a creditor seeks to hold a shareholder liable for corporate obligations

- Benefit Detriment Test:

a parent does indeed owe a fiduciary duty to its subsidiary when there are parent-subsidiary dealings. However, this alone will not evoke the intrinsic fairness standard. This standard will be applied only when the fiduciary duty is accompanied by self dealing-the situation when a parent is on both sides of a transaction with its subsidiary. Self dealing occurs when the parent, 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, pg 517 o Sinclair operates to impose duties on controlling shareholders to minority shareholders where the majority shareholder takes a benefit from the corporation to the detriment of the minority - Ratification: minority could ratify/approve the transaction, and therefore cure it.—this will not work because it only will shift the burden of proof back to the PL. (usually the D bears the burden of proof). - After benefit detriment, if you try to cure...you do not get back to BJR. You stay in intrinsic fairness, and the BOP is on the PL.

- Director's Conflicting Interest Transaction

a transaction effected by the corporation... o Director is a party, or o Director has knowledge and a material financial interest, or o Director knew that a related person was a party or had a material financial interest

- Business Judgment Rule

absent self-dealing or other breach of the duty of loyalty, director's conduct is presumed to satisfy all duties

Defective Incorporation De facto Corporation

allows the shareholders to retain their limited liability in suits by third parties a. Must be a statute that allows incorporation b. A bona fide attempt to incorporate and c. Some actual use or exercise of corporate privileges.

Planning: do we have a corporate opportunity? Litigation:

do we have a corporate opportunity? If so, was the safe harbor used? Defendant bears the burden of proof, showing the safe harbor was used—then they get BRJ If didn't use safe harbor rule, then D must show, that the transaction was entirely fair for the director to take the opportunity for himself.

• Equitable subordination

if a shareholder-creditor of a corporation engages in inequitable conduct, a bankruptcy court has the power to subordinate his claim to those of other creditors.

Controlling Shareholders

investor or group with the power to direct corporate affairs o Ownership of less than a majority may also control-when shares are widely scattered, as long as it's a large amount

Control shareholder - Only owes fiduciary duty if

majority owner, or exercise control over the corporation o A controlling shareholder's power to direct corporate affairs generally stems from its ability to elect and remove a majority of the board of directors o *control is a property right, and the controlling shareholder may sell-whenever to whoever, for whatever price, and not required to share proceeds with anyone else. - When a conflict involves parent and sub, the test of intrinsic fairness is applied

Duty of Good Faith

must perform in good faith and in a manner reasonably believed to be in the best interests of the corporation o This duty includes a duty...  of care  to become informed --- the process of gaining sufficient familiarity with the background facts and circumstances in order to make informed judgment  of inquiry  of informed judgment  of attention  of disclosure  of loyalty  of fair dealing  And... a general fiduciary duty

 Reliance

o Director is entitled to rely on information provided by other people as long as that reliance is not unwarranted and is reasonable conditioned upon a reasonable belief as to the reliability and competence of those who have undertaken the functions performed or who prepared or communicated the information presented • Factors to determine if the person is reliable... o Experience o Record and reputation for honesty, care and ability  director was or took steps to become familiar with the information in question o An evaluation of the reliance would include an evaluation of the director's good faith and reasonable belief that he is acting in the best interest of the corporation  Reasonable belief --- could a reasonable person in a like position and acting in similar circumstances have arrived at that belief - Duty of Fair Dealing

- Delegation of Duties

o Directors may not abdicate their responsibilities and avoid accountability simply by delegating authority to others o If delegatee's actions constitute a deficient performance, director is not liable as long as the board acted in good faith and complied with other standards of conduct in delegating the responsibility and appropriately monitored the delegatee's performance o Factors to consider in evaluating delegation of duties  Care used in the delegation to and supervision of the delegatee • Appraisal of the capabilities and diligence of the delegatee  Amount of knowledge available to the director regarding the particular matter

- Director is not liable, even if he has an interest in the transaction, if

o He gets approval by qualified directors (§8.62) o He gets approval by qualified shareholders (§8.63) o He proves that the transaction was fair to the corporation (§8.60(b))

- Standard of Care

o Includes a duty of attention --- participatory performance over a period of time o Requires every director to take steps to become informed about the background facts and circumstances before taking action o A decision that is outside the realm of reason, or is so unreasonable, that it falls outside the permissible bounds of sound discretion will not satisfy the standard of care

- Duty of Fair Dealing

o Normally discharged through disclosure of conflicting interests and any information known by the director to be material to the oversight or decision-making functions of the board  Can be through direct statements or through any other timely means  A duty of confidentiality may override, but director must inform board of existence and terms of the duty of confidentiality - Court focuses on the manner of performance, not the correctness of the decisions made - If the director's conduct is in question, the court will evaluate the conduct of the entire board o Deficient performance by a director may be overcome by acceptable conduct of other directors as long as the duty is ultimately performed (but duty of loyalty, fair dealing, and disclosure will be evaluated individually)

- If director cannot fully disclose because of a duty of confidentiality, he must

o Notify the qualified directors o Disclose all information required that does not violate the duty of confidentiality o Inform them of the nature of the duty of confidentiality (attorney-client privilege, duty to another corporation) - Exception for confidentiality is only available if the conflict is because of directors duty to another business or because director is a trustee, guardian, personal representative, or a fiduciary (allowed because of previous fiduciary duty)

Incorporators

o Power of Incorporators (DGCL §107): If the persons who are to serve as directors until the first annual meeting of stockholders have not been named in the certificate of incorporation, the incorporators, until the directors are elected, shall:  Manage the affairs of the corporation;  Do whatever is necessary and proper to perfect the organization of the corporation, including the adoption of the original bylaws of the corporation and the election of directors.

Shareholder's Action §8.63 - In advance of vote...

o Shareholders must be given timely and adequate notice of transaction o Director must disclose material information to qualified directors - Safe harbor is effective if a majority of all qualified shareholders approve - Exception for confidentiality is not available for safe harbor through shareholder vote

Litigating Challenges to Executive Pay: An Exercise in Futility? Problem 4-12

o Should the business judgment rule apply?  It is usually a matter of contract o Professor adds minority shareholders (D, E, F, G, H, each with 5% stake) o Fiduciary Duties Issue:  1) Discrete Decision? Yes, they are making a decision  2) Reasonable Decision Making Process? (need more facts) • What other executives are paid? • Get expert opinion? • Look at the minutes from meeting? • IRS allow it to be deductable, as reasonable?  3) Good Faith? Yes, they acted in good faith • Continuum: • intentionally violate the law(bad faith)---gross negligence(not bad faith) • acting with a purpose other than advancing the corporationbad faith • conscious disregard of their dutybad faith  4) No Conflict? NO~ it is a conflict of interest • Safe harbor? • (b)(1) material relationship • B&C are not qualified directors, therefore they cannot cleanse/safe harbor the transaction • If they can cure, they should • 8.63: cure by shareholders. o Present to shareholders, who are fully informed and disinterested • Next, if that doesn't work, go to intrinsic fairness. • **significant risk that it is a conflict of interest transaction, go through the "cure" or "safe harbor" (depending on facts). Then is it cost justified? If so, go through 8.62 to see if qualified, then go through 8.63

Analyzing Reasonable Decision-Making Process: - Smith v. Van Gorkum

o The Court found that the directors were grossly negligent, because they quickly approved the merger without substantial inquiry or any expert advice. For this reason, the board of directors breached the duty of care that it owed to the corporation's shareholders. As such, the protection of the business judgment rule was unavailable. o "The rule itself 'is a 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.' ...Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one." (at 872) o Is the shareholder is informed? "turns on the fairness and completeness of the proxy materials submitted by the management to the shareholders" o If the outside shareholders are independent and informed—and they vote and approve the merger, then you get back on track for BJR. (Cure) If not, you must go on to intrinsic fairness

 Bad faith

present where a transaction is authorized for some purpose other than a genuine attempt to advance corporate welfare or is known to constitute a violation of applicable positive law

Fair

the transaction as a whole was beneficial to the corporation o Director's dealings were fair o Terms were comparable to what would be present in an arm's length transaction - Required Disclosures --- o Existence and nature of the director's conflicting interest o All material facts that would reasonably be material in deciding whether to proceed with the transaction

. Failure to Observe Corporate Formalities

• Courts sometimes refer to the failure to observe formalities b/c shareholders have used the corporation as their 'alter ego' or 'conduit' for their own personal affairs

Veil Piercing:

• Factors that indicate the veil should be pierced: o "alter-ego" /alias, stooge, or dummy?  The owner is just using the corporation as an alter-ego to do what he wants o Inadequate capitalization? o Comingling funds? o Informalities? (are there director's meetings, minutes, filing formal papers) o Sham? o Naughty-ness (bad act) o *evade a personal obligation o *use the corporate form to commit fraud/injustice o *abusing the corporate form (not treating it like a separate entity) • Virginia: there must be evidence that the person has ignored the "separateness" of the corporation • It is very difficult to pierce the veil • Almost impossible to pierce the veil of a publically held corporation

Undercapitalization & Purposeful Insolvency

• Pierce when corporation is formed or operated w/o capital adequate to meet expected business obligations • Piercing also justified when purposeful insolvency results from shareholder's undisclosed siphoning of whatever corporate assets become available

Deception

• Presence of misrepresentation, courts will refuse to enforce 'no recourse' understanding

Active Corporate Participation

• Shareholders who are not active in the business and have not acted to disadvantage creditors are less likely to be personally liable than those whose actions resulted in a depletion of assets

Parent-Subsidiary Piercing

• To go after Parent, courts have required a showing that the parent dominated the subsidiary so that they acted as a single economic entity & recognizing corporate separateness would be unfair/unjust

3 categories of fiduciary behavior for "bad faith"

 1) subjective bad faith: fiduciary conduct motivated by an actual intent to do harm  2) lack of due care: fiduciary action taken solely by reason of gross negligence without any malevolent intent (failure to engage in a reasonable decision making process)  3) Chancellor's definition of bad faith: intentional dereliction of duty, a conscious disregard for one's responsibilities. The question is whether such misconduct is properly treated as a non-exculpable, non-indemnifiable violation of the fiduciary duty to act in good faith. It must be-bad faith

BJR Applies if three prerequisites are met

 If a director or officer decision is made: • 1) in good faith • 2) with reasonable decision-making process, and • 3) with no conflict of interest  Then a court will uphold the decision, so long as the decision can be attributed to a rational business purpose