Corporations

In re Citigroup Inc. Shareholder Derivative Litigation

BJR case Rule: Under the business-judgment rule, corporate directors will not be held personally liable for failure to manage the company's business risk unless their conduct rose to the level of gross negligence. o Court says Caremark established director oversight liability and either there were no controls/reporting systems or there were such systems and the directors did not monitor/oversee them § This means the directors demonstrated a conscious disregard for their duties and therefore breach the duty of loyalty by failing to discharge their fiduciary obligations in good faith. This means the plaintiff must show the directors KNEW they were not doing their duties - this test rooted in bad faith o Therefore, P must show bad faith as a necessary condition to director oversight liability · PROCESS o BJR is the presumption - always start there. Difficult to rebut with gross negligence. Even more difficult to show bad faith o Plaintiff does not have those particularized facts needed in Citigroup, there were just red flags o Courts cannot step in and impose liability just because a board made a wrong business decision o This would create all sorts of issues, where court is judging decision and not the process o Also BJR allows directors to maximize shareholder value by taking risks without the debilitating fear that hey will be personally liable if the corporation suffers losses · The Waste Caveat o Unless its presumption is rebutted, the BJR precludes judicial review of the underlying substance of the decision regardless of clear demonstration of error or bad judgment o A claim of waste will only arise in the rare, unconscionable case where directors irrationally squander or give away corporate assets. The board's decision will be upheld unless it cannot be attributed to any rational business purpose

LLC Dissolution

An LLC can be dissolved by (1) the occurrence of some event stipulated in the LLC agreement, (2) vote of the (non-dissociated) members, or (3) judicial decree. o Dissolution is a technical term. It does not end a company's existence, but instead changes the purpose of that existence. It no longer exists for the purpose of conducting business as a going concern, but instead for the purpose of winding up affairs. o RULLCA Section 701 (Events Causing Dissolution): (a) A limited liability company is dissolved, and its activities and affairs must be wound up, upon the occurrence of any of the following: § (1) an event or circumstance that the operating agreement states causes dissolution; § (2) the affirmative vote or consent of all the members; § (3) the passage of 90 consecutive days during which the company has no members unless before the end of the period o RULLCA Section 702 (Winding Up): (a) In winding up its activities and affairs, an LLC: (1) shall discharge the company's debts, obligations, and other liabilities, settle and close the company's activities and affairs, and marshal and distribute the assets of the company

Derivative Suit Indemnification Statute

DGCL 145 § § 145(a): Permissive Indemnification in Non-Derivative Suits · Permits indemnification for expenses (including attorneys' fees), judgments, fines, and settlements in suits other than derivative suits subject to certain statutory criteria, including a "good faith" requirement § § 145(b): Permissive Indemnification in Derivative Suits · Permits indemnification for expenses incurred for defense or settlement in derivative suits subject to certain statutory criteria § § 145(c): Mandatory Reimbursement · Requires reimbursement of expenses if the defendant was successful on the merits or otherwise § § 145(e): Permissive Advancement · Permits advancement of defense costs and expenses § § 145(f): Non-exclusive Indemnification Rights · Allows indemnification agreements or bylaws that provide greater protection than does the statute by itself § § 145(g): Insurance Procurement · Authorizes procurement of D&O insurance · Most states, including DE, have detailed statutory provisions covering indemnification · Most of the provisions are permissive o Permissive provisions permit a corporation to indemnify directors and officers in certain situations if they can satisfy certain statutory criteria (see DGCL Section 145(a), (b), (e), (f), (g)) · However, some provisions are mandatory o Mandatory provisions require the corporation to indemnify directors and officers in specific situations o e.g., DGCL Section 145(c): the corporation must reimburse the defendant director's expenses if the defendant was successful on the merits or otherwise.

Francis v. United Jersey Bank (New Jersey)

Duty of Care Case Old Dumb Drunk Housewife Case Rule: A director has a duty to know generally the business affairs of the corporation. § The business judgment rule protects director action so long as, among other conditions the director acted "on an informed basis." This implies that if a director did not act on an informed basis, the rule would be rebutted. The duty of care requires that when directors act, they must act informedly, lest they breach the duty of care. § For financial institutions, have senses heightened that there is more scrutiny § This company didn't segregate funds. When you have money coming in, you have to segregate the funds that the people want for use in your company § Mrs. P knew nothing of P&B; went there once; never paid any attention; never read the financial statements; husband (Charles Senior) warned her about son Charles Junior; never attempted to discharge her duties as director at all; died in 1978 during these proceedings Duties of a director: o Should understand business, or learn to o Should be informed as to the activities of the company o Should attend board meetings o Should be familiar with financial condition of company o May need to seek outside counsel o CANNOT HIDE BEHIND A DUMMY DIRECTOR - no such thing as a fake director. You have actual responsibilities and if you can't live them out, you can have liability o Mrs. P gave zero effort, abdicating her duties and this showed a breach of care · Takeaways: o Court says there is no reason the average housewife could not adequately act as a director, even without proper business experience, if she gave the job reasonable attention o Problem is not that she was a housewife but that she made zero effort

Smith v. Van Gorkom

Duty of Care case · Directors need to be informed by all the material reasonably available to them. Standard comes from Aronson that gross negligence determines whether directors made an informed decision · Directors have duty in a merger situation to make an informed decision before passing the proposal to shareholders · Directors did not make an informed decision September 20th. o They were not adequately informed about Van Gorkom's role in pushing the sale or where the price came from o Were uniformed as to the intrinsic value of the company o Given above, were indeed grossly negligent in approving a sale in 2 hours without prior notice or any triggering crisis o Also, counsel was clueless, senior management mostly missing and no one had any prior knowledge that this was the purpose of the meeting except van gorkom and Chelberg · Also had no documentation! - not a dealbreaker but still not good. · No one asked questions in Van Gorkom about anything - like valuation, etc. · What the Board knew o Pritzker was willing to pay a $17 premium over the prevailing market price § BOD doesn't know how Van Gorkom set the price § BOD doesn't know price based on study of feasibility rather than value · Does a firm have an "intrinsic value"? § BOD doesn't know what control is worth to Pritzker § Board's failure · No effort to determine how much control would be worth to Pritzker o Absent such a determination, no basis for deciding whether the price was a fair one o The feasibility study was prepared internally by somebody who doesn't do financing studies for a living and it showed only whether it would be feasible to finance the purchase, not how much the company was actually worth o Board should have hired someone to do a valuation study

Nixon v. Blackwell (DE)

ESOP Case § Rule: Under Delaware law, corporate directors owe a fiduciary duty of fair, but not necessarily equal, treatment to all shareholders. Barton created Employee stock ownership plan (ESOP) which held B shares, and would repurchase employee shares for cash on termination of employment § Barton also caused the company to buy "key man insurance" to fund corporate repurchase of shares from employees at their death § All of this was approved by the board of directors, all of whom are employee-stockholders. The company was profitable but paid low dividends o Delaware is different: shareholders of closely held corporations have NO fiduciary duty to one another o Plaintiffs who were non-employee Class B stockholders, claimed defendants had treated them unfairly by establishing an ESOP that favored employee, Class A stockholders over plaintiffs

Meinhard v. Salmon

Facts: Salmon entered into a lease for a hotel which he was to convert into shops and offices. To fund the remodel, he entered into a joint venture with Meinhard to pay for half of the costs. In return, he would receive half of the profits, and Salmon would have the sole power to manage the building. 4 months before the end of the lease, the owner of the building approached Salmon about increasing the structure size by clearing several neighboring lots. He agreed and signed a new lease that did not include his business partner Meinhard. Issue: As co adventurers in joint business venture, the sole managing partner has a duty to the other to communicate if they have the opportunity to acquire any benefit. Decision: The court ruled in favor of the plaintiff because Salmon had violated his fiduciary duty as a partner. · Rule: Co-adventurers, like partners, have a fiduciary duty to each other, including sharing in any benefits that result from the parties' joint venture. · Does a new opportunity arising from partnership activities belong to the partnership as a whole or to the individual partner who finds and exploits the opportunity first? o Court says here the new lease opportunity belonged to the partnership. Salmon must therefore share it with Meinhard on terms similar to the original partnership agreement. Duty included any proceeds from partnership · Fiduciary duty is the default rule - "Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior." - Cardozo. · You can eliminate some fiduciary duties in a written partnership agreement, but you can't eliminate duty of loyalty. Good example is ability to compete with each other. You can have this in agreement and would carve out some kind of allowable behavior without eliminating duty of loyalty

McConnell v. Hunt Sports (Ohio)

Hockey LLC Case § Rule: An LLC operating agreement may limit the scope of the fiduciary duties of its members. § Contract/Operating Agreement here was clear and unambiguous and therefore enforceable. The contract said that members are not prohibited from owning or engaging in any other businesses that might compete with CHL · Test for ambiguity is that common words are given their ordinary meaning unless o That would produce absurd results, or o Some other meaning is clear from the face of the contract · Once there is an ambiguity then the courts will consider extrinsic evidence § Implication here: as long as the contract unambiguously allows the activity here, the courts will refuse to take into account any implicit understandings that might have existed between the parties § Holds for McConnell - language didn't take on meaning "other" that Hunt argued for. Because it could be competitive and of any nature, McConnell could do this § Contractually, ppl are able to alter operating agreement § Fiduciary duties in LLCs (application) · Like a partnership, an LLC involves a fiduciary relationship · Ordinarily, such a fiduciary relationship would preclude direct competition between members · Here, you have to look at what the Operating Agreement says. The OA allowed competition in this case and allowed McConnell to go and do what he did o Delaware Approach: DE is different § DE permits the COMPLETE ELIMINATION of fiduciary duty of members and managers through contracting, provided that the LLC agreement may not eliminate the implied contractual covenant of good faith and fair dealing (Delaware Limited Liability Company Act Section 18-1101(c)) § NV too § It doesn't matter which type of business entity, there is still a nonwaivable and mandatory subject to good faith and fair dealing

Haley v. Talcott (DE)

LLC Dissolution case §Rule: A court may dissolve an LLC when the exit mechanism in the operating agreement isn't sufficient and it isn't reasonably practicable to carry on the business § Impasse - 2 50/50 shareholders and the OA didn't contemplate the personal guarantee needed for the mortgage so even if they follow the contractual separation in the LLC agreement, the guarantee would still be in place § Impasse as Haley wants Talcott out of the LLC and Redfin, Talcott wants to buy Haley out of the LLC and keep the Redfin Grill § Court looks to DGCL Section 273. This has 3 requirements: (1) Corporation must have 2 50% stockholders; (2) the stockholders must be engaged in a joint venture; (3) they must be unable to agree on whether to continue business or how to dispose of the assets § A 3 conditions are met here but this is an LLC with a detailed exit provision in the agreement. DE however prioritizes freedom of contract § While an exit mechanism in a friendly dissolution of an LLC, it does not work in a contested dissolution when it does not equitably separate the parties § Court ordered solution · Would not be fair to utilize exit mechanism and give Haley the downside of the personal guaranty existing with zero upside. Court thus orders dissolution with a plan to sell the property (courts usually don't like to shut down running businesses)

LLCs

Limited Liability Company - a hybrid form of business with limited liability for the owners with the advantage of not paying corporate income tax. o New kind of business entity with lots of flexibility (hybrid between a corporation and a partnership) o Ex: a large corporation wishes to conduct part of its business through a wholly-owned entity. It could create a corporation in which it is the sole shareholder, or it could create and LLC in which it is the sole member. o Limited Liability requires state filing o Equity holders called members - one advantage of an LLC over a partnership is that an LLC requires only one member whereas a partnership requires at least 2 partners

Kinney Shoe Corp. v. Polan (WV case)

PCV - Contract Creditor § Fact Pattern: Lincoln M. Polan (defendant) incorporated Industrial Realty Company (Industrial) and Polan Industries, Inc. (PI) under the laws of West Virginia. Polan made no capital investment into either company. Further, Polan did not hold initial meetings or elect directors, and no stock was ever issued. Kinney Shoe Corporation (Kinney) (plaintiff) had a long-term lease on a building, which Kinney subleased to Industrial. Industrial then subleased a portion of the building to PI, with Polan signing the relevant documents. Polan made a single rental payment to Kinney from his personal account before Industrial defaulted on the lease. Kinney sued and obtained a judgment of $166,400 against Industrial. Kinney then sued Polan personally. The district court concluded that Kinney had "assumed the risk of Industrial's undercapitalization" and refused to pierce the corporate veil. Kinney appealed to the United States Court of Appeals for the Fourth Circuit. § Issue: May a shareholder in a corporation ever be held personally liable for corporate obligations? Court says yes. § Rule: A shareholder in a corporation may be held personally liable for corporate obligations once the corporate veil is pierced to prevent injustice. § Red flags: undercapitalized, no corporate formalities § Assumption of risk: when we have a contract creditor, they should have known better and could have protected themselves better in the contract

OTR Associates v. IBC Services (NJ)

PCV Blimpie Case (alter ego) § Rule: The corporate veil of a parent corporation may be pierced if the parent: (1) dominates and controls the subsidiary and (2) abuses the privilege of incorporation by using the subsidiary to commit a fraud or injustice. § Important case because parent-subsidiary relationship. This is typical · IBC dominated and controlled by Blimpie · Blimpie used IBC to commit fraud/wrongdoing · IBC was created only to insulate Blimpie § Have to be careful of parent-subsidiary relationship when looking to pcv. There has to be significant wrongdoing for veil to be pierced.

Freeman v. Complex Computing (2nd Circuit)

PCV case § A court may not pierce the corporate veil if it finds that a shareholder dominated and controlled a corporation in the absence of a showing that the shareholder control was used to commit a fraud or other wrong. freeman has to pierce corporate veil to get to Glazier. However, Glazier is not a shareholder . § Glazier found to be controlling person of C3 (he had it on his resume!)

Daily v. Ayers Land Developent LLC (WV)

PCV in LLCs § Fact Pattern: James Dailey and others (collectively, Dailey) (plaintiffs) sued Ayers Land Development, LLC, RJM Holdings, LLC (RJM), and certain other corporations and limited-liability corporations (collectively, RJM) (defendants). Dailey also sought to pierce RJM's corporate veil to hold RJM's shareholders, Jerry Ayers, Roger Ayers, and Michael Frye (collectively, shareholders) (defendants) personally liable for RJM's debts and obligations. Per Dailey, it was appropriate to pierce RJM's corporate veil because RJM and the shareholders had no operating agreement regarding their shared use of employees, office space, equipment, phone lines, or marketing material and because the shareholders paid RJM's expenses. RJM and the shareholder moved for summary judgment, which the circuit court granted. Dailey appealed. § Issue: Will summary judgment rarely be appropriate with respect to whether a court should pierce a corporate veil? § Rule: Summary judgment rarely will be appropriate with respect to whether a court should pierce a corporate veil. § Charges of fraud so P wants to pierce veil to get to 3 guys

Walkovszky v. Carlton (NY)

Piercing Corporate Veil case (Tort Creditor) William Carlton (defendant) owned a large taxicab business. Carlton was a controlling shareholder of 10 different corporations, each of which held title to two cabs and no other assets. Each cab carried $10,000 in car liability insurance, which was the minimum required by state law. John Walkovszky (plaintiff) alleged that he was struck and injured by a cab owned by Seon Cab Corporation (defendant), one of Carlton's entities. Walkovszky sued Carlton, Seon Cab Corporation, and each of Carlton's other cab corporations, arguing that they all functioned as a single enterprise and should be treated accordingly. Carlton moved to dismiss the complaint as to him personally for failure to state a cause of action. The trial court granted the motion. Walkovszky appealed, and the appellate court reversed, reinstating the complaint as to Carlton. Carlton appealed. § Issue: May a party maintain a cause of action to pierce the corporate veil without alleging that a shareholder used the corporate form to conduct business in an individual capacity? Court says no. § Rule: In order to maintain a cause of action for piercing the corporate veil, the plaintiff must allege that a shareholder used the corporate form to conduct business in his individual capacity. § Easily foreseeable risk to own taxi company and to have car wrecks § Carlton technically did nothing illegal because you could structure a company the way he did with 10 subsidiaries § Plaintiff here was looking beyond the surface · Argues that all 10 companies are a single company § Court says company structure is legal and that this isn't an issue for the courts. All companies were compliant with insurance requirements

In re Ebay Shareholders Litigation

Pre-suit demand case. See notes for facts Rule: (1) Shareholders are not required to make a pre-suit demand on a corporation's board of directors prior to bringing a derivative action if the independence of a majority of the board's members is reasonably questionable. § (2) Directors of a corporation are not permitted to personally accept private stock allocations in an initial public offering of the corporation's stock when the corporation itself could have purchased the stock. o Only 7 directors including 3 defendants § All 3 clearly with an interest § Skoll owns 13%, co-founder and former director § Other 4 independent directors · P argues they are not independent and therefore demand is futile o Close business ties and cannot exercise objective judgment o All make a lot of money as directors and owe their positions to the 3 spinners o All getting options worth millions they won't get unless they stay directors o Takeaways § Court found that Board was not independent and demand was futile § 3 of 7 directors interested in the challenged transactions § At least 1 (but court says that's enough) raises a reasonable doubt as to his independence given the material benefit to him to remain director

SEC 14a-8(h) and (i)

Procedural requirements (Rule 14a-8(b)-(e)). Under 14a-8(h), proposing shareholder or his representative must appear at shareholder meeting · Shareholder proposals (Rule 14a-8(i)) Grounds for Company's exclusion of the proposal include: o Proposal is not proper subject for action by SH under state law o Proposal, if implemented, will cause company to violate a law/proxy rules o Proposal relates to the redress of a personal claim/personal benefit o Proposal relates to operations accounting for less than 5% earnings/gross sales o Company lacks power/authority to implement the proposal o Proposal deals with a matter relating to company's ordinary business operations o Proposal relates to BoD election or conflicts with the company's proposal o Resubmission: certain restrictions on the ability to repeat same proposal § Can resubmit proposal every year but there are some restrictions (see cracker barrel) · The SEC has become referee in shareholder proposal issues. If board believes a proposal can be excluded from proxy statement, it files notice with the SEC · If the SEC staff agrees, it issues a NAL indicating that SEC will not take enforcement action against this decision · IF the SEC staff disagrees, it tell company that it may take enforcement actions if the proposal is excluded. The company then ordinarily will include the proposal in the proxy statement. · SEC may also take an intermediate position (proposal as it stands is excludable, but can be rephrased to be non-excludable). · If either BoD or proposing SH is unhappy with SEC staff's decision, they can appeal to the commissioners, then appeal that to the DC Circuit. · Practically, such appeals are rare. If proposing SH loses, he alternatively may sue for an injunction in a federal district court, challenging the company's decision rather than the

Trinity Wall Street v. Wal-Mart Stores, Inc.

Rule: A company cannot exclude from a proxy statement a shareholder proposal that focuses on a matter of significant social policy related to the company's day-to-day business operations if the policy issue transcends those operations. o Even if a proposal involves the company's ordinary business operations, the company cannot exclude the proposal if its focus is a matter of significant social policy that goes beyond the company's day-to-day business operations. § The social policy does not transcend Walmart's day-to-day business operations. § SEC said in NAL that Walmart can exclude the Trinity proposal since it relates to ordinary business operations of Walmart o Court uses 2 part test looking at exclusion § What is subject matter of trinity's proposal? o Trinity says this is not ordinary business because it is dealing with higher level issues o Ct says if Walmart adopted Trinity's proposal it would shape what products might be sold...and that is ordinary business matters § Does the subject matter relate to Walmart's ordinary business operations? · Alleged inconsistency · Yes it does relate · Trinity's proposal tries to have the board committee change policies that might change their product mix o What constitutes ordinary business operations? § Argument that should be left to business judgment - this is at the core of what a retail store does. § Even though there's a huge social issue, the business does decide how to conduct its operations o Trinity lost the case here but policy changed anyway. This is a way shareholder proposal can make a difference

Einhorn v. Culea (WI)

Rule: A corporation may create a special litigation committee composed of independent directors to determine whether a derivative action is in the best interests of the corporation. o If the independent special litigation committee acts in good faith, engages in a reasonable inquiry, and decides that the derivative action is not in the best interests of the corporation, the circuit court shall defer to the business judgment of the special litigation committee and dismiss the derivative action. o Whether directors are independent is determined by an objective test based on the time they were appointed to the special litigation committee. The test is whether a reasonable person in the position of a director on the special litigation committee can base his decision on merits of the issue without other influences The factors to consider for director independence include o (1) whether the director is a defendant or has potential liability, (2) if the director participated in or approve the challenged transaction (3) whether the director has business relations with individual defendants, (4) whether the director has personal relations with individual defendants, (5) if the director has business relations with the corporation, (6) the number of directors on a special litigation committee, and (7) whether the counsel retained by the committee has represented individual defendants or the corporation in the past.

United Food et al v. Zuckerberg

Rule: A presuit demand in a shareholder-derivative suit should be excused only if the shareholder raises a reasonable doubt that a majority of the directors would be unable to impartially apply their business judgments to a demand. 3 step approach to futility - replaces Aronson o BJR would not apply because of the shareholders here - more focus on the intent of the Board. o Cannot exculpate loyalty, but you can exculpate care o Also did not show board was beholden to Mark or lacked independence o Have to balance Board's decision-making abilities with a path for shareholders to file derivative lawsuits o Friendship was not enough, needed something more o Takeaways: 3 prong test The court says you cannot say demand would be futile just because there is an exculpation clause - you actually have to go through new 3 prong test. IF any of those 3 prongs are proven, then demand is futile and excused · Majority of directors on board at time of breach received a material benefit from alleged decisions · Director would face a substantial likelihood of liability Director lacks independence from someone with a material benefit or who would face a substantial likelihood of liability

Tooley v. Donaldson, Lufkin & Jenrette

See notes for fact pattern Difference between direct and derivative action · Rule: To constitute a direct shareholder claim, as opposed to a shareholder derivative claim on behalf of the corporation, the plaintiff's claimed direct injury must be independent of any alleged injury to the corporation. o The plaintiff must be able to demonstrate that he can prevail in the lawsuit without showing any harm to the corporation. The crucial inquiries are thus: (1) who suffered the harm (i.e., the shareholder-plaintiff, individually, or the corporation) and (2) who would receive the benefit of any judgment. § Under the Tooley test, quintessential derivative claims are: · Court says decision an be outcome determinative · Court says must be decided solely on 2 questions o (1) Who suffered the alleged harm (the corporation ort the suing shareholders) o (2) Who would receive the $$ or other remedy (the corporation or the suing s/holders, individually)? Allegations of mismanagement · Breach of fiduciary duty (including claims for self-dealing by directors and officers) · Claims challenging executive compensation, asset sales or purchases, and payment of special dividends § Direct claims arise when the "structural relationship" between the corporation and shareholders is harmed by managerial actions · DGCL establishes a structural relationship between the corporation and its officers, directors, and shareholders · If a corporate officer acts in a manner that the DGCL prohibits, the officer has violated this structural relationship by disregarding the specific restraints placed on him by the shareholders.

AmerisourceBergen Corp v. Lebanon Countee Employees' Retirement Fund

See notes for fact pattern: DGCL 220 case · Rule: A stockholder seeking to inspect corporate books and records to investigate possible corporate wrongdoing is not required to specify the intended objectives of inspection in the inspection demand. · Retirement fund used "tools at hand" DGCL section 220 to request books and records to see if there are breaches of fiduciary duty o Need proper purpose for Section 220 · DE has low bar, but need credible basis · COMMON THEME: Need to evaluate whether directors are interested/disinterested/beholden, etc. · Wrongdoing can be a factor but not required - can satisfy threshold by presenting evidence · Bar can't be lowered to allow fishing expeditions - can't use section 220 to see if there's any wrongdoing. There must be credible basis of wrongdoing

Gantler v. Stephens

The Company represented that there had been careful deliberations regarding the "first place merger proposal" when there were not. If you state you "carefully deliberated" you need to give the details. The shareholders need to know how the vote split etc. so that when they decide to ratify etc., they have an idea of the background. In the context of an action when you're seeking approval you must disclose all material facts. Material facts are defined as those that a reasonable investor would want to know in making the vote. o Rule: A complaint challenging a board's decision to reject a merger proposal must allege other facts beyond a self-entrenchment motive in order to adequately state a claim that the directors acted disloyally. o Bank is in OH but incorporated in DE o Board didn't discuss or deliberate issue o Shareholder ratification will often serve as a remedy o Careful non-deliberations § The proxy statement was misleading and false because there was no deliberation § Is this material? · Lower court said immaterial but this was reversed. Even if transaction was fair, the Board has a duty to disclose § It's okay to reject the merger but not okay to say that the Board carefully deliberate it · Causation o In order for a misstatement or omission to be actionable under the proxy rules, it must not only be material, but it must cause some harm to the complaining shareholders.

Malone v. Brincat

The company was not seeking shareholder action when they made a materially false disclosure/ filing. The shareholders sue because they were damaged by the resulting 2 million dollar loss. They would have gotten out had they known the status of the co. Rule: Under Delaware law, there is no corporate law duty upon board to keep shareholders informed if they not asking for action. That comes from federal securities law. However, ONCE YOU MAKE A DISCLOSURE, it must be ACCURATE (this true under state law too). Shareholder duty to investigate o Plaintiff is arguing that directors have made material false statements in disclosures to shareholders overstating earnings, etc. o Constant duty to disclose (not intermittent) o Duties of Directors § Disclosure part of director general duties (along with duty of care/loyalty) § Problem here is that usual way is a federal case but must buy or sell securities to use Rule 10b5 § Takeaway: Directors must tell the truth! · Advantages of using SEC rules is advantage of using federal law over state law

In re USACares LP Litigation (DE)

USACafes, L.P. (the Partnership) was a limited partnership consisting of USACafes General Partner, Inc. (the General Partner) (defendant) and a large group of limited partners who owned partnership units (the Unitholders) (plaintiffs). In 1989, Metsa Acquisition Corp. (Metsa) (defendant) purchased substantially all of the Partnership's assets. The unitholders sued the General Partner, the directors of the General Partner (the Directors) (defendants) and Metsa, alleging that the asset sale price had been unfairly low. They claimed that Metsa made side payments to the Directors to induce the Directors to cause the General Partner to accept the low price. The Unitholders alleged that the General Partner and its Directors had breached their duty of loyalty to the Unitholders by failing to obtain the best price, and that Metsa had induced the breach by offering the side payments. The Directors moved to dismiss the charges against them for failure to state a claim, asserting that while the General Partner owes a duty of loyalty to the Unitholders, the Directors themselves do not. · Rule: A director of a corporate general partner owes fiduciary duties to the other partners and to the partnership, in addition to the duties owed to the corporate general partner. · Where a corporation acts as a general partner, the individual directors of the corporation owe duties to the limited partners and limited partnership · Here, the GP and its directors had a duty of loyalty to seek out the best price for the partnership's assets. They couldn't use their positions to benefit themselves · In DE, so maximum effect to contract · Takeaways o GP owes fiduciary duties to LP § Unless eliminated in partnership agreement and in DE

Closely held corporation voting arrangements (3)

Voting trust - shareholders create a voting trust by conveying legal title to their stock to a voting trustee pursuant to the terms of a trust agreement. o Disadvantages: SH lose control over the shares. Requires a lot of trust in the trustee; Many statutes limit duration of voting trusts. MBCA 7.30 limits them to renewable 10-year terms; Voting trust must be made public in many states (DGCL section 218). Might solve deadlock but not oppression Irrevocable Proxies - o The ordinary proxy, like any agency power, may be revoked at the will of the principal, and the proxy holder remains subject to the control of the principal. o Proxies are usually revocable, but can be made irrevocable if attached to an interest (MBCA 7.22(d)). In some situations, there may be reasons to make a proxy irrevocable, perhaps with directions to vote in a particular way or subject to some future contingency § Irrevocable proxies can be seen as separating the voting right from the stock § This raises policy concerns because it can give the right to vote to someone with no economic stake, who may use the vote arbitrarily or for a motive other than the corporation's best interest. Therefore, both MBCA and DGCL require to be "coupled with an interest" because otherwise voter may have no economic interest in the business o Being a party to a voting agreement is considered an interest (MBCA 7.22(d)(5)) o Disadvantages: Require an interest - Irrevocable can be just that · Voting Pooling Agreements o Just another agreement with parties to combine their votes; Agreement may provide its own enforcement mechanism; Enforcement/remedies can be tough

Cortez v. Nacco Material

Worker injured - application of limited liability in LLCs Rule: A member or manager of a limited liability company is liable for his or her acts or omissions to the extent those acts or omissions would be actionable against that person in an individual capacity. o An LLC's members and managers may be held liable for acts and omissions taken in their official capacities if they could be held liable for those same acts and omissions if acting in a personal capacity. o Although members/managers may not be held vicariously liable for company's obligations and liabilities, they may still be held personally liable for acts performed in official capacities if performing same acts in personal capacity that would make them liable o Just because you're a member/manager doesn't mean that liability attaches o No personal liability just because you're member/manager. However, question of whether acting or being plays a role? Court here says these are synonymous. o If you're a member/manager of LLC and you're responsible for a specific type of conduct, this OR law will not preclude liability o Negligence not found but Swanson liable under ELL § Negligence cases in OR say that corporate officers/directors not liable for negligence of employees just because they are officers/directors and even though they still have right to control/supervise employees § Same standard applied for Swanson as member of Sun Studs LLC o OR employers liability law cases show if you retain the right to control the activities - if risk taking activities, then you can be held liable o Any time you see a parent company having a subsidiary, you have to see whether structure is there to protect themselves? How active is parent company in controlling subsidiary?

Fiduciary Duties

o A fiduciary duty exists when one places special trust in and reliance on the judgment of another where one person has a special duty to protect the interests of another. o Fiduciary duties do not stand in a transactional relationship, but must consider the interests of those with whom they have a special relationship. o Not all persons in a firm owe fiduciary duties. The law imposes duties on those persons who occupy a special position in the firm - a position that empowers the to exercise the levers of control and management. § Duty of care: a duty that directors owe to act in the corporation's best interests and to exercise reasonable care in making decisions and in overseeing the corporation's affairs. § Duty of loyalty: a duty that requires directors to act in the god faith belief and in the best interests of the corporation and its stockholders rather than in their personal interest. o These are discrete concepts but the line between them is often blurry - application is often contextual o Directors and officers owe fiduciary duties of care and loyalty. o Shareholders with small stakes (most shareholders in public corporations) do not owe fiduciary duties to the corporation or other shareholders. o Since the exercise of the powers of controlling shareholders may result in their deriving an unfair benefit at the expense of minority shareholders, they also owe the fiduciary duty of loyalty to the corporation and its minority shareholders o Outside directors are almost never required to pay damages for breaching their duty of care o Business judgment rule precludes liability unless directors have been grossly negligent o Corporate fiduciary duties are mandatory and nonwaivable.

Shareholder Meetings

o Annual meetings (per bylaws), can participate electronically ("on the call") (required, MBCA 7.01) o Notice - need to let shareholders who can vote know o Quorum - majority of shareholders must be present or represented by proxy for an action taken at the meeting to be effective (unless the bylaws provide otherwise) o Action by written consent: both MBCA and DGCL allow shareholders to act in writing BUT DIFFERENT § MBCA section 7.04(a) requires consent in writing of ALL shareholders § DGCL section 228 requires majority of shareholders o Every share = 1 vote (unless articles provide differently) § May vote by proxy § Can be supermajority if in A/I o Special Meetings § MBCA 7.02: called by board or authorized officer or by shareholder owning together a 10% (AoI/bylaws may modify this percentage up or down, but it may not exceed 25%) § DGCL section 211(d): no right for shareholders to call meeting unless AoI/bylaws specify such right § NEED NOTICE!

3 standards of review for breach of fiduciary duty

o BJR o Enhanced scrutiny: Often applies when there is an appearance of conflict of interest o Entire fairness (highest standard of review in DE) : must have fair dealing and fair price § DGCL Section 102(b)(7): enables the exculpation of director liability for a breach of the duty of care. (MBCA Section 2.02(b)(4) has a similar provision). · Exceptions are: Duty of loyalty; acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; for any transaction from which the director derived an improper personal benefit · Section 102(b)(7) permits the exculpation of liability for money damages for a breach of the duty of care only. o It does not preclude a shareholder from seeking nonmonetary remedies like an injunction or recission for breach of duty of care. (E.g., would not preclude from seeking an injunction against a merger). CAN ONLY EXCULPATE DUTY OF CARE NOT DUTY OF LOYALTY

PCV Takeaways

o Depends on totality of circumstances (could depend on jurisdiction) o PCV is exception to limited liability o Court won't hold innocents liable - look for fraud or wrongdoing o Look to see if there is no clear separation between the company and the owners (i.e., business pays personal expenses/commingling assets, no business formalities followed like meeting minutes, etc.) o Look for initial undercapitalization - business didn't have the money that it should've had at the beginning. Need cushion for foreseeable risks

Entity Theory of Representation

o Entity theory of representation o Model rule 1.13 o Lawyer represents the entity (the legal person) and not the officers, directors, owners, employees, etc. though with informed consent, the lawyer may also represent them. (see Jesse by Reinecke v. Danforth (WI))

3 tools/layers to provide protection for Directors

o Exculpatory clauses (DGCL Section 102(b)(7)) o Indemnification Clauses o D&O Insurance o All 3 provide protection but there are slight differences § Exculpation - prevents liability attaching to directors in the first place (except cannot exculpate duty of loyalty, "acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law" or transactions where the director derived an improper personal benefit Indemnification & D&O insurance - compensate and hold directors and officers harmless when they have incurred liability or are faced with defending liability claims

IE Test LLC v. Carrol (New Jersey)

o Fact Pattern: Kenneth Carroll (defendant), Patrick Cupo, and Byron James were the members of IE Test, LLC (IE) (plaintiff). The members discussed signing an operating agreement, but Cupo and James rejected Carroll's proposed agreement. An impasse ensued. IE filed suit seeking authorization to dissociate Carroll from IE. IE claimed that despite increasing revenues, it could not obtain a line of credit without an operating agreement. New Jersey's Limited Liability Company Act authorized a member's dissociation from an LLC if the member engaged in conduct making it not reasonably practicable to continue the business with the member. The trial court granted IE summary judgment. The appellate court affirmed. The Supreme Court of New Jersey granted Carroll's petition for certification. o Issue: Does a disagreement among LLC members over the terms of the LLC's operating agreement necessarily compel the dissociation of a dissenting LLC member? Court says no. o Rule: A disagreement among LLC members over the terms of the LLC's operating agreement does not necessarily compel the dissociation of a dissenting LLC member. o Here, there was no operating agreement o Look to statute but look to default rule where statutes are silent o 2 theories in statute § 3a: "wrongful conduct that adversely and materially affected the LLC's business" § 3c: "not reasonably practicable to carry on the business with the member in the LLC" o Used principle of judicial expulsion. Lower courts let them kick Carroll out, with a payment for 1/3 of the company

Partnership Highlights

o For limited partnerships: need a GP and an LP o Joint venture is a technical term which describes an agreement between 2 or more parties on a specific product or goal. (Partnership usually lasts longer and can be formed without intent) o Good faith and fair dealing § Concept of good faith and fair dealing is not a default rule; it is mandatory § Therefore, no matter what, partners may not eliminate good faith and fair dealing by contract o RUPA provides that the only fiduciary duties that attach to partners in a general partnership are the duties of care and loyalty § While not designating good faith and fair dealing as a "duty", RUPA provides that partners must "exercise any rights consistently with the obligation of good faith and fair dealing" o Kinds of behaviour that can be carved out from duty of loyalty § Ability to compete § Taking of a corporate opportunity in certain situations (like lease of a different building) § One could allow a partner to use the partnership name for their own private interests

Problems with closely held corps

o Huge liquidity issue with closely-held corporation because there is no ready market for people to buy shares. Therefore, close corporations are typically illiquid § Issue to spot: easily foreseeable risks that getting out/selling shares in company will likely be an issue § Difference in liquidity in close corporatio is so important because: · Investors in a close corporation cannot be passive (normally employed by company and must participate in control or at least monitor) · Difficult to exit or sell interest · Compensation given to officers/shareholders often replaces dividends to avoid double taxation · Important for shareholder agreement to think about foreseeable risks. How do we have agreements in place to deal with situations that might occur · Biggest disadvantage is that business and business owner are the same § Incorporating is expensive; there are also legal barriers: raising capital, shareholders · Includes federal and state law compliance

Reasonable Expectations Test

o If a lawyer leads a person or an entity to think they are a client and that is a reasonable belief, an attorney client relationship is created, even without a formal retainer agreement o Difficult especially with close corporations, as thorny given founders, owners, managers can all be the same person who think the lawyer is acting on their behalf o Payment of fees not proof positive o Risk of transferability (easy in a corp, unless close corp)

Piercing the Corporate Veil

o In some circumstances, courts will find that limited liability does not apply and will allow the corporate veil to be pierced for plaintiffs or debtors to recover damages from the personal assets of the corporation's owners. o Generally, the corporate veil may be pierced if the company was just a shell for the owners' individual acts or the owners intentionally used their business to commit a wrongful act o PCV is a state law and each state has its own rules for applying this doctrine o There is no brightline rule for deciding when courts will pierce - usually happens with close corporations (i.e., not publicly traded companies with a lot of shareholders) o Things to look for in piercing questions § Look to see if there is no clear separation between the company and the owners (i.e., business pays personal expenses/commingling assets, no business formalities followed like meeting minutes, etc.) § Look for INITIAL undercapitalization (i.e., the business could never really stand on its own) § Corporate formalities (this is under the corp's control. This is easy!) · Need to have board · Need to have board meetings/minutes from the meetings, etc. § Nature of plaintif's claim · Contract vs tort § Nature of defendant · Whether the defendant is a passive shareholder of close corporation. If the defendant is not and is engaging in objectionable conduct, this could be a reason to pierce · Unfair injury to random person § DE/NY tougher to pierce § Is it a contract or tort case? Important because contractor assumes risk when dealing with corporation (i.e. you have a contract) § Want to make sure that company is properly capitalized from the beginning o PCV exists to allow courts to provide an equitable remedy to get around limited liability o Remember most big corps don't get veil pierced...

ESG Investing

o Investors consider environmental social and governance factors of a company o Environmental: looks at the impact a company has on the environment § Criteria include air and water pollution, carbon emissions, green energy initiatives, deforestation, water usage, and waste management o Social: Looks at a company's social impact both inside the company and within the broader community § Criteria include company sexual harassment policies, employee gender and diversity, customer satisfaction, data security, local and global human rights, and fair labor practices o Governance: Looks at how policies and actions of a company's management and board of directors drive positive change § Criteria include political contributions, executive pay, diversity of board members, transparency and disclosure, and internal corruption. o ESG and activist investors § Helped to make boards more accountable

LLPs and LPs

o LLPs (Limited Liability Partnerships) § Except the liability of partners and related issues such as dissolution and wind up, all the rules of general partnerships in RUPA apply to LLPs (RUPA 306(c)). § All 50 states permit LLPs · But requires filing with the state § All rules of GPs under RUPA apply to LLPs except liability issue § GPs where the partners get the benefit of limited liability o LPs (Limited Partnerships) § Require 2 different partners: at least 1 GP and 1 LP § Limited partners enjoy limited liability but not the general partners · GP manages limited partnership; LP is the passive investor who might give money § Each general partner is an agent of the limited partnership for the purposes of its activities and affairs (ULPA 402(a)). § LPs can't be formed accidentally like a general partnership, must proactively file with the state

Partnerships

o Marvin Gaye song "it takes two to make a thing go right" o Governed by statutory state law o RUPA Section 102(11) Definition: An association of 2 or more persons to carry on as co-owners a business for profit. § Doesn't matter if you're a living breathing person or a legal person. Just need at least 2 person. Can be any combo o Formation of a Partnership § RUPA Section 202: (a) the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership · (c) in determining whether a partnership is formed, the following rules apply: o (2) the sharing of gross returns does not by itself establish a partnership, even if the persons sharing them have a joint or common right or interest in property from which the returns are derived o (3) a person who receives a share of the profits of a business is presumed to be a partner in the business unless the profits were received in payment. o Co-owner means § Shared control of the business § Shared profits of the business o No formal creation requirements. Doing business as co-owners results in creation of partnership by operation of law. No intent needed o You can accidentally form a partnership o RUPA Section 306(a): all partners are liable jointly and severally for all debts, obligations, and other liabilities of the partnership § When a creditor is not paid by a debtor, it may seek payment from a third party on the grounds that the debt was owed by a partnership between the debtor and the third party who was liable for the partnership's debts

Primary benefit for closely-held corps

o Primary benefit for closely held corps: § There is limited liability for its owners and shareholders § Integrated where a small group of ppl manage the business (A sole proprietorship is not legally distinct from its owner) § In a closely held corporation, the corporation and not the corporate shareholders, is responsible for paying off debts · However, PCV can apply if a creditor proves that the shareholder and the corporation are one and the same "person" and that it would be inequitable not to hold the shareholder personally liable (fact-dependent analysis)

Partnership provisions

o Private Ordering and Mandatory Provisions § The private ordering of the partners is set forth in the partnership agreement. This provides a template for ordering the internal affairs of the partnership, but one of the principal purposes of drafting a partnership agreement is to modify some of the default statutory provisions and provide additional provisions as needed to establish economic and management relationships desired by the partners o RUPA Section 105(a) § The partnership agreement governs: · The relations among partners as partners and between the partners and the partnership · The business of the partnership and the conduct of that business; and · The means and conditions for amending the partnership agreement o RUPA Section 105(c)-(d) § A partnership agreement may not · Unreasonably restrict the right of access to books and records · Eliminate the duty of loyalty, but the partnership agreement may alter or eliminate certain aspects of the duty if not manifestly unreasonable · Eliminate the obligation of good faith and fair dealing, but the partnership agreement may prescribe the standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonable · Eliminate the duty of care, but the partnership agreement may alter the duty of care, if not manifestly unreasonable and does not authorize conduct involving bad faith, willful or intentional misconduct, or knowing violation of law · Vary the right of a court to expel a partner or dissolve a partnership for reasons stated in the statute o Nonwaivable provisions § Cannot eliminate duty of loyalty · Partnership agreement can specify certain behaviors are OK if not manifestly unreasonable

RBC Capital Markets v. Jervis

o Rule: A party may be guilty of aiding and abetting a director's breach of a fiduciary duty if the party knowingly participated in the breach. § Chancery Court found RBC liable for aiding and abetting the Board's breaches of fiduciary duty (Moelis settled) · Putting the Company in play without Board authorization · Providing false and materially misleading information to the Board, and · Having an undisclosed conflict of interest in the transaction § Also held that an exculpatory provision Section 102(b)(7) only covered the Rural directors and did not extend to the Board's advisors § Later decided to set the amount of RBC's liability at $75 mm as RBC responsible for 83% of the $91 mm in total damages shareholders § For our purposes, RBC aided and abetted the Board's breaches of fiduciary duty, agreeing with the trial court's "narrow holding" that "[i]f [a] third party knows that the board is breaching its duty of care and participates in the breach by misleading the board or creating [an] informational vacuum, then the third party can be liable for aiding and abetting."

Shlensky v. Wrigley (IL)

o Rule: As long as a corporation's directors can show a valid business purpose for their decision, that decision will be given great deference by the courts. § Courts are willing to uphold business decisions on the slimmest of justifications § Shlensky here failed to state a cause of action here § Court doesn't even allow Shlensky to argue about profits because there was no evidence of fraud, illegality, or conflict of interest, so the court does not second guess Wrigley's judgment despite evidence Shelsky wants to present showing that night game profits will increase profits § As the court concedes, its evaluation of the possible benefits and cost of lights is irrelevant. THE KEY IS THAT THIS IS FOR THE BOARD TO DECIDE § What Shelsky could have argued: instead of arguing for a lack of business justification (in the face of the BJR) Shlensky might have been better off trying to argue that Wrigley refused to investigate option of night games and thus it not make an informed business decision o If Shlensky was unhappy with the way Wrigley wanted to operate, why did he not jut sell his shares? § He would have to sell for a price reflecting the poor business decision § Free transferability of shares (if you don't love it leave it) doesn't solve the problem of oppression for minority shareholders o Key takeaway: board's decision to make and it was their decision to not have lights. BJR HOWEVER DOES NOT PROTECT AGAINST FRAUD, ILLEGALITY, OR CONFLICT OF INTEREST (e.g., bad faith).

SEC Rule 10b-5

o SEC Rule 10b-5 "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, o (a) To employ any device, scheme, or artifice to defraud, o (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 o (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." o Standard of materiality: "...whether there is a substantial likelihood that a reasonable shareholder would consider the fact important" [TSC Industries, Inc. v. Northway, Inc.] o Materiality depends on a balance between probability and magnitude [Basic, Inc. v. Levinson]. Even if you know with certainty that the printer in Building 26 got jammed (or something else minutia like), you don't need to report that. Materiality should always be resolved in favor of disclosure

Federal Proxy Regulations (Shareholder Proposal Rule)

o SEC Rule 14a-8 gives shareholders access to the company proxy § must meet ownership requirements § must be a proper subject matter o Used by shareholders for social responsibility, corporate governance issues o the company usually recommends shareholders vote against the proposal (if even included) o Company has a lot of ways to exclude from SEC Rule 14a-8(i) o Company asks SEC if it's okay to exclude SEC issues NAL o Shareholders can try to nominate their own director(s) but this is difficult to do, DE law now allows this explicitly since SEC rulemaking basically failed

Mills v. Electric Auto-Lite Co.

o See notes for fact pattern o Rule: Where an omission in a proxy statement is determined to be material, the shareholder has established sufficient causation between the violation of Section 14(a) and his injury. o Elements of the action (prof doesn't like this but might be helpful) § Violation (misleading statement or omission) § Materiality § Causation § Damages o Mention of word "fairness" - not to be equated with fairness standard (highest level of review that DE courts use to look at actual conflict of interest) o If the proxy solicitation was essential to approve vote, the issue becomes material re the misleading statement/omission. Here, the disinterestedness of the board was relevant, because a disclosure of the relationship would have caused shareholders to be on their guard o Plaintiff shows materiality and thus causation if he demonstrates that the defect has a significant propensity to affect the voting process. This wouldn't affect trivial or unrelated defects. No need to show effect on vote, if, as here, the defect was "an essential link in the accomplishment of the transaction." This should be a more administrable doctrine o Rule: If a statement is material, do not need to show exactly what votes would be just that it could have affected outcome

Lovenheim v. Iroquois Brands

o See notes for fact pattern. o Rule: The meaning of "significantly related" in the SEC rule for omissions in proxy statements is not limited to economic significance. o The meaning of "significantly related" in the SEC rule for omissions in proxy statements is not limited to economic significance. o Therefore, because of the ethical and social significance of Lovenheim's proposed resolution, Lovenheim has shown a likelihood of prevailing on the merits in that his proposal is "otherwise significantly related" to Iroquois business. The proposal therefore may not be excluded from the proxy statement being distributed. o Even though the loss was such a small part of the business, there was a social part of this that made it difficult for shareholders to comply

Aronson v. Lewis

o See notes for facts Rule: A court may dismiss a shareholder's derivative action if the shareholder has failed to make a demand on the board or allege facts sufficient to demonstrate that such a demand would be futile. o Waste is a hard argument to make · Remember BJR only applies when the director is disinterested and has NO conflict of interest (real of even perceived) - also has to be a decision made for this to apply · Directors must be informed! If not, could be gross negligence and BJR does not apply · Only applies if there is an actual board decision o If a demand was made and refused, courts would apply the BJR to the board's refusal because it was a business decision, thus creating a strong presumption in favor of the board's decision not to pursue the litigation o The stockholder's only recourse is to rebut the presumption of the BJR by demonstrating that the board rejected his demand without informing itself of the issues or that the board relied on attorneys who also represented or had represented the alleged wrongdoer · The plaintiff shareholder is permitted to pursue the derivative suit without making a demand if a demand would be deemed futile. The failure to establish demand futility in the complaint usually signals the death of a derivative suit · Demand Futility Doctrine: "a reasonable doubt is created that (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." o The Aronson standard should not be applied for demand futility where the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit.

Shareholder Litigation

o Shareholders can bring an action to inspect the corporation's books and records. They can also sue in their individual capacities or bring an action on behalf of the corporation in a representative capacity. o Inspection of Books & Records § Shareholders have the right to inspect books and records with a proper purpose § Every state has this right but lots of variation - focus on DE · Some states limit shareholders of 5% or more, 6 months or longer · DE courts urge shareholder plaintiffs to use Section 220 before filing derivative actions so they can provide "some" evidence as to why demand is futile o DE specifically tell plaintiffs to use tools at hand - can give some of the evidence needed to show that demand is futile § MBCA Section 16.02 (a)-(c): Shareholders can readily inspect the articles of incorporation, bylaws, minutes of shareholder meetings and like documents. The other category of records includes minutes of board meetings, financial statements, accounting records, and the list of shareholders. The following conditions must be met · (1) The shareholder's demand is made in good faith and for a proper purpose · (2) The shareholder's demand describes with reasonable particularity the shareholder's purpose and the records the shareholder desires to inspect, and · (3) the records are directly connected with the shareholder's purpose See also DGCL 220!

Shareholder Powers

o Shareholders do not manage the corporation - the board of directors does. Shareholders keep the board accountable o Shareholders elect the board but do not nominate them o Typically vote on big transactions (mergers, sale, voluntary dissolution) and any amendments to the A/I as well as amending by-laws o Can vote when the board seeks their vote for items like appointment of auditors, management compensations plans, etc. o Cannot vote to have the board take certain actions, except maybe non binding recs o Voting in DE vs MBCA : Assuming quorum, the general principle governing shareholder voting on questions other than the election of directors is majority rule § MBCA says that votes AT meeting matters if 100 shares of company, but only people or proxies representing 60 shares at meeting, then need majority of those voting. Could be less than 60 if abstentions § DGCL says for votes other than for Directors, need majority of votes there. So would need 31 no matter what. § Practically, anyone there or who has given proxy usually votes o However, voting for Board of Directors and mergers, some states incl DE, need a majority of shares outstanding DE: other than directors, need majority of votes that are at the meeting

Closely held corps (highlights)

o Small number of shareholders, like a partnership in terms of functionality o Active investors involved in management o Illiquid no ready mkt for shares so exit is an issue o Look for oppression of the minority shareholder

BJR Post Van Gorkom

o Standard of liability: directors may be held liable for gross negligence in failing to make an informed decision o a rule of abstention § will court review substance of BOD decision? No - court will examine decision-making process to the extent to which BOD made an informed decision · What do boards do today? o They obtain expert opinions on virtually all transactions o Is there a potential inefficiency from this § Sure, it's harder to get work done, and it means that board members may not rely on own expertise as much o Why is it in directors' interests to be so careful even if it isn't in the corporate interest § Because the directors pay the judgments at least after D&O insurance is exhaustive o What about interest of lawyers who advise boards on their deliberative process? § More process is good for lawyers, both helping them avoid potential malpractice like generating greater fees · Issues relating to the duty to be informed o Reliance § Especially important for outside directors who may not know ins and outs of specific business § Can rely on reports, opinions, advice, etc. but should read or be present at the meetings discussing it o Causation § Nonfeasance - Francis and Caremark cases, if directors would have done their job, they could have prevented a loss § Misfeasance - deficient decisions like Van Gorkom, if directors would have been fully informed they would not have approved.

How a shareholder can get control of a compahy

o Tender offer § Purchase sufficient shares from other shareholders to own a controlling interest, then replace board with directors who agree with your views (e.g., Elon Musk & Twitter) § Usually when you see a tender offer, you see a proxy battle o Proxy Solicitation § Like a media campaign - make them vote how you want them to vote § Campaigns your idea(s) to other shareholders, asking them to vote their shares according to your recommendations (i.e., to replace the directors with your candidates) o Shareholder proposals not about control, but pushing change § Solicit shareholders to vote on a specific issue, without replacing the board § This is similar to voting on referendums in state elections

Materiality

o The overarching philosophy of securities law is disclosure. For public companies, federal law requires disclosure, including annual audited financial statements, quarterly unaudited financial statements, and proxy statements. o Rule 14a-9: only material misstatements and omissions will result in liability for proxy fraud.

Why make a partnership?

o Unlimited Liability § General partnerships do not offer limited liability to partners. They are liable for the remaining debts and obligations of the partnership if the partnership's assets are insufficient to satisfy all creditors. (RUPA 306(a)). § Reasons for making a partnership · If limited liability is not a concern for partners · Partnerships can be formed accidentally if the partners intend to co-own a business for profit even if they are unaware that they have formed a partnership

Derivative Suits

o Usually when shareholders claim a breach of fiduciary duty by directors, officers or controlling shareholders § Courts created derivative suits to allow shareholders to step into the corporation's shoes and sue on its behalf. § In a derivative action, the injured party is the corporation, and a shareholder acts as a representative who pursues an action on behalf of the corporation. § The shareholder asserts rights belonging to the corporation on its behalf because the board of directors has failed to do so. § A derivative action consists of two elements: · (1) an action to compel the corporation to sue the wrongdoers, typically managers; · (2) an action by the corporation, asserted by a shareholder, in its own right to seek redress, typically against managers. § Any amounts recovered belong to the corporation, not the plaintiff shareholder § Against a 3rd party § Shareholder brings a claim on behalf of the company in which they own stock § Hardly ever go to trial § Adequtate Plaintiffs · Requirement in FRCP that the named Plaintiff be capable of ADEQUATELY and fairly representing the interests of the shareholders · Most states have similar requirements · Most courts have decided that as long as there is a qualified lawyer MBCA Section 7.41 limits standing to shareholders

Virginia Bankshares v. Sandberg

oSee notes for fact pattern Rule: (1) A proxy statement using conclusory terms to explain corporate directors' recommended actions is materially misleading. (2) A party cannot demonstrate causation of damages compensable under Section 14(a) of the Security Exchange Act by a member of a class of minority shareholders, whose votes are not required by law or corporate bylaw, to authorize the transaction proposed by the proxy statement. o 2 big issues: § Can a false/misleading OINION be considered a false/misleading statement? § If approval by shareholders is not necessary, then is a proxy essential for purposes of showing an injury to shareholders? o First Virginia Bank merged into its parent Virginia Bankshares. VB held 85% of the shares before this happened, so the merger was a "freeze out" o Because they had overwhelming majority, no need for approval from the minority 15%. Bank decides to solicit proxies anyway. This is different from Mills because in that transaction the majority owned 50% but needed 2/3 approval from all s/holders o Defendant argument: Alternatively, there was a conflict of interest as one Director also owned shares and approved, so the proxy solicitation of all the minority (15%) s/holders would help insulate the merger from being voided because of this conflict o SCOTUS doesn't want to expand the case law from what it is o Shareholders still have state remedies if there is a conflict of interest, issue was not disclosed

Contract Creditors

§ A contract creditor can do the following to mitigate risk of defaulting · Investigate corporation's credit-worthiness; require personal guarantees · Require higher interest to compensate for higher risk § Prof: Is contract creditor harmed by undercapitalization? Maybe, § Prof: Is contract creditor harmed by failure to abide by formalities? Not really, so long as company holds up their end of the contract. Fraud? Same

LLC Management

§ Because it is entirely a creature of contract, the management structure of an LLC is highly malleable § RULLCA recognizes 2 forms of management structure in an LLC · Member-managed company (resembles a general partnership) - each member has an equal right in the management of the LLC o Issues decided by majority vote, except for matters specified in ULLCA, which require unanimous consent · Manager-managed company (resembles a limited partnership or a corporation) o Managers elected/removed by majority vote of members o Managers decide all matters except those specified in ULLCA which require unanimous consent of the LLC members o Members have no management rights except for those retained in Articles of Operation/Operating Agreement, and those specified in ULLCA · The cost of flexibility is lack of specificity. Articles of Operation/Operating Agreement need to create detailed arrangements

Fiduciary Duties in Closely-Held Corp

§ Board has duties generally. If there's no board then DGCL and MBCA say shareholders or those that have duties the board should have, have fiduciary duties · Subject to all liabilities of directors § A shareholder's duty most clearly arises when minority shareholders condition their investment in a close corporation on a governance structure that gives them a veto over some or all decisions of the majority. · The question is whether a minority shareholder who exercises veto power can be deemed to have violated her fiduciary duties (question can be one of degree) § A "deadlock" arises when relations among shareholders or directors has deteriorated to the point that virtually no action is possible § IN DELEWARE, CLOSE CORPORATION SHAREHOLDERS HAVE NO FIDUCIARY DUTIES TO EACH OTHER

Smith v. Atlantic Properties (Massachusetts).

§ Close corporation dividends case § Rule: A minority stockholder in a close corporation that requires a unanimous vote for corporate action may not repeatedly vote against an action for personal reasons if the action would be in the best interest of the corporation. § Company has minority blocking right (4 ppl who each have 25% share). Provision that need 80% provision to proceed § Wolfson had duty of utmost faith and loyalty § Takeaways: minority shareholders in a close corporation owe fiduciary duties to other shareholders in some states (not DE) · If minority shareholder has veto power and exercises it to damage the corp deliberately § When Dr. W bargained for veto power to prevent the majority from ganging up on him, this raises a question of how far he can go in exercising this power without violating his fiduciary duty · This was the problem here because the company was doing so well and not returning a sufficient amount of capital

Corporate bylaws

§ Corporate bylaws structure corporation · Describe how the company is operated along with the rights and obligations of the shareholders. · Any info concerning regulations about the management of the company · The shareholders' relationship, the ownership of shares · What happens to shareholders' interest if he leaves the business · Shareholder privileges · Bylaws are not filed with state agency and only serve internal users · Shareholder agreement may include a provision that restricts a shareholder's ability to transfer his shares to a third party. However, all restraints must be reasonable to be enforceable o To determine reasonableness, court considers the size of the corporation, the extent of the restraint, the length of time the restraint is in place, and whether the restraint serves valid corporate goals.

DGCL 220

§ DGCL§ 220: Shareholders are granted the right to inspect books and records for "any proper purpose." - 1st step to acquire books and records · A proper purpose shall mean a purpose reasonably related to such person's interest as a stockholder. (DGCL§ 220 (b)). · Demand futility requirement must be satisfied in order to bring a Section 220 derivative action. o Court of Chancery Rule 23.1: To show demand futility, a stockholder plaintiff in a derivative suit must allege with particularity why the stockholder was justified in having made no effort to obtain board action. By first prosecuting a section 220 action to inspect books and records, the stockholder plaintiff may be able to uncover particularized facts that would establish demand excusal in a subsequent derivative suit. · Takeaways for 220 o No fishing o Need a credible basis (lowest possible standard other than no standard or mere suspicion) o Can potentially get third party docs o Can get docs from a sub if the parent has them o When you bought stock may not be limited o Do not need the suspected wrongdoing to be actionable o Sole purpose can be for litigation

LLC Fiduciary Duties

§ Depends on mgmt. structure; also statutes allow flexibility to define/limit in the operating agreement § FIDUCIARY DUTIES ATTACH TO INDIVIDUALS WHO CONTROL THE ENTERPRISE § In a manager-managed LLC · Managers owe fiduciary duties (RULLCA Section 409(a)-(c)) · Usually, members do not owe fiduciary duties to the LLC or its members by reason of being members § In a member-managed LLC · All members owe fiduciary duties (RULLCA Section 409(i)(1)) § Standard for fiduciary duties set in RULLCA Section 409 (p. 327) o IN EVERY BUSINESS ENTITY (CORPS, PARTNSHIPS, LLCS), MANAGERS/MEMBERS ARE ALL SUBJECT TO GOOD FAITH AND FAIR DEALING (NONWAIVABLE AND MANDATORY) - SEE PARTNERSHIP SECTION ON THIS ALSO o Contracting for Fiduciary Duty § The purpose of contracting for fiduciary duties is to change the default rules to the specific circumstance of the parties of interest § Good faith and fair dealing cannot be eliminated by contract (RULLCA Section 409(d))

Difference between interest and independence for a BOD

§ Interest: manifests in 2 different ways · DE defines a disabling interest as o When a director personally receives a benefit or suffers a detriment o As a result or from the challenged transaction o Which is not shared/suffered by other shareholders in the corporation o And the benefit/detriment is material enough to question whether the director could objectively vote on the transaction · When a director is on both sides of the transaction o Involves the first 3 situations above, and once on both sides then materiality not even relevant § Independence: not about benefits/detriments but about control · Can be dominated by another party o Through personal relationships o Through family relationships o Through force of will o can be beholden to another party if the controlling party has the power to decide if that director receives a material benefit that the loss of that benefit questions whether that director can objectively vote

LLC Dissociation

§ Express will: Partner's express will to withdraw/Desire to leave § Per the partnership agreement: event agreed to in the partnership agreement, or expulsion pursuant to the partnership agreement § Expulsion by partners: Partner's expulsion by the unanimous vote of the other partners if (i) it is unlawful to carry on the partnership business with that partner; (ii) there has been a transfer of all or substantially all of that partner's transferable interest in the partnership; or (iii) partner that is a legal person has or will dissolved (but for a good reason) § Expulsion by court: On application by the partnership or another partner, the partner's expulsion by judicial determination because: (i) the partner engaged in wrongful conduct that adversely and materially affected the partnership business; (ii) the partner willfully or persistently committed a material breach of the partnership agreement or of a duty owed to the partnership or the other partners; or (iii) the partner engaged in conduct relating to the partnership business which makes it not reasonably practicable to carry on the business in partnership with the partner (also for a good reason) § Death, dissolution or bankruptcy: Parner's bankruptcy, receivership, liquidation, death, incapacity, or termination o All of the above are default terms and can be modified in the partnership agreement. The rules for limited partnerships and LLCs are derived from these o A partner has the power to dissociate but does not have the right to do so if the dissociation is wrongful (RUPA Section 602(a)-(b); RULLCA Section 601-602; ULPA Section 601-602 (LPs) and 603-605 (GPs)). o Why people would want to dissociate: § People die or become disabled § Entities dissolve, become bankrupt, or are merged out of existence § Owners may want to retire or exit for

o Jesse by Reinecke v. Danforth (Wisconsin)

§ Fact Pattern: Drs. Danforth and Ullrich (defendants) wanted to form a corporation. The doctors contacted Douglas Flygt, an attorney with DeWitt, Porter, Huggett, Schumacher & Morgan, S.C. (DeWitt). With Flygt's help, the doctors formed a corporation called MRIGM. The doctors were shareholders of the corporation. Jean Jesse (plaintiff) sued the doctors for medical malpractice for conduct occurring prior to MRIGM's formation and otherwise unrelated to MRIGM. Jesse retained Eric Farnsworth, also an attorney with DeWitt, for the lawsuit. The doctors filed a motion to disqualify DeWitt from the case for a conflict of interest. § Issue: In the context of a lawyer who assists individuals in forming a corporation, does the entity rule of representation apply retroactively to make the lawyer's pre-incorporation representation relate only to the corporation, and not to the individuals who formed the corporation? Court says yes. § Rule: In the context of a lawyer who assists individuals in forming a corporation, the entity rule of representation applies retroactively to make the lawyer's pre-incorporation representation relate only to the corporation, and not to the individuals who formed the corporation. § Court develops helpful guidelines in applying Entity Theory of Representation · If a person hires a lawyer for the purpose the lawyer's involvement with that person is related to the incorporation, and if the entity is incorporated, then the entity rule applies retroactively and the lawyer's involvement with the person is deemed to be a representation of the entity and not the person

TSC Industries, Inc. v. Northway, Inc.

§ Fact Pattern: In 1969, National Industries, Inc. acquired 34 percent of the stock of TSC Industries, Inc. (defendant). Several executives from National were then placed on the board of directors of TSC. Later that same year, National and TSC planned to merge. A joint-proxy statement was issued to shareholders. Northway, Inc. (plaintiff), a TSC shareholder, brought suit against TSC, alleging that TSC committed fraud by not disclosing the fact that National was already highly involved in TSC in its proxy statement. The district court denied Northway's motion for summary judgment. Northway appealed to the court of appeals, which granted partial summary judgment. TSC then petitioned for certiorari to the United States Supreme Court. § Rule: A fact is material pursuant to Section 14 of the Exchange Act if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. § Definition of a material omission § Shareholder sued under SEC Rule 14a-9 that the proxy did not specifically state the control that National had § Reasonable investor standard: an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote · Must POTENTIALLY change how a shareholder might vote § A fact is material pursuant to Section 14 of the Exchange Act if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. § The fact will be considered important if it would significantly change the "total mix" of information available, as viewed by a reasonable investor. In this case, the court of appeals applied a much more lenient standard concerning materiality.

Partnership dissolution and winding up

§ First, assets are marshalled and sold in a liquidation § Second, creditors are always paid first before equity holders because they hold the priority financial position. § Third, if the assets net of liabilities paid are positive, the equityholders distribute these net assets among themselves according to some formula in the statute or in the charter document.

Duty of Care

§ Focuses on board decision making where director interests are aligned with those of the corporation. § Duty of Oversight · BJR implies that action taken is presumed to be informed, in good faith, and in the best interest of the corporation · Rule protects actions and intended omissions but not neglectful omissions o Protects directors when they exercise their managerial authority granted under corporation law § MBCA Section 8.30: "...the standard of care entails primarily a duty of attention."

Obligation of Good Faith and Fair Dealing for partnerships & LLCs

§ Good faith and fair dealing is different from fiduciary duties for noncorporate business entities including partnerships and LLCs. · Good faith definition (see Stone v. Ritter): A failure to act in good faith may be shown (1) where the fiduciary intentionally acts with a purpose other than that of advancing the best interest of the corporation, (2) where the fiduciary acts with the intent to violate applicable positive law, or (3) where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.

Alternative Aggregate Theory

§ Instead of representing the shareholders individually, the lawyer represents all of the owners individually in addition to the entity. Lawyer can represent joint constituents collectively, as joint clients, during formation · Unlike the entity theory, under the aggregate theory, a lawyer has no duty to keep information confidential among the owners if the information relates to the representation, nor does the attorney-client privilege obtain if there is litigation between the owners. § Once company is incorporated, the clients determine if the lawyer will represent the entity only or all the constituents and the entity

LP Fiduciary Duties

§ Limited Partnership Fiduciary Duties · Same concepts as with RUPA, partnership agreement cannot completely eliminate fiduciary duties but can specify some actions that do not violate duty of loyalty if not manifestly unreasonable, etc. · A general partner in a limited partnership owes fiduciary duties to the limited partnership and its limited partners · Delaware is different o DE gives maximum effect to contract of partnership agreements o Can eliminate/restrict much more than in other states in the partnership agreement as long as the partnership agreement does not eliminate the implied contractual covenant of good faith and fair dealing o Partnership agreement can do more to eliminate duty of loyalty in DE - so long as it doesn't violate implied contractual covenant § Default rule for LPs is different: more like a corporation. What you put in will be what your share is. Profits and losses are allocated on basis of contributions of each partner

Closely held corp minority protection devices (3)

§ Minority Board Representation § Minority Veto Power § Dispute Resolution or Exit Options § A close corporation can be structured to provide minority shareholders with some degree of protection. § Other voting agreements · Supermajority voting (requiring more than 50%). Another approach can be to require unanimous approval. · Class voting o Company issuing different classes of sharesrisk of deadlock · Cumulative voting: allows shareholders to elect directors in proportion to their ownership (stops a majority from automatically electing all directors) o Available in most states if the parties opt in the articles of incorporation

LLC Contracting

§ Operating agreement just like partnership agreement for partnerships - established rules of governance and internal affairs, therefore called "creatures of contract" · Whenever we have LLC case - want to see what the operating agreement says. If it's silent on specific terms, we use default. In that case, we need to know what state we're in § LLC chief advantage is its flexibility. · It requires only one owner, like a corporation and unlike a partnership. · It provides limited liability to all members and managers, like a corporation and unlike a partnership. · It can allow flow-through taxation (no tax at the entity level), like a partnership and unlike a corporation. · It permits a flexible management structure more like a partnership than a corporation

PCV in LLCs

§ Piercing the LLC Veil · MBCA Section 6.22(b): Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct. · RULLCA Section 304: A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager. · No explicit exception that opens the door to piercing the veil o Minnesota example: similar to other states. Some states will say that what's good for piercing corporate veil is good for piercing LLC veil · Failure of a LLC to observe formalities relating to the exercise of its powers or management of its activities and affairs is not a ground for imposing liability on a member or manager for a debt, obligation, or other liability of the company (RULLCA Section 304(b)). o All members and managers of an LLC get limited liability § RULLCA Section 304(a): The debts, obligations, and liabilities of an LLC, whether arising in contract, tort, or otherwise: · Are solely the debts, obligations, and liabilities of the LLC and · Do NOT become the debts, obligations, and liabilities of a member or manager solely by reason of the member or manager acting as a member or manager § No difference between member-managed or manager-managed LLC for this

Tort Creditors wishes

§ Prof: Does a tort creditor care about shareholder's respect for formalities? Not really, they just want to be compensated for their loss § Prof: Do they care about corporation's undercapitalization? Probably more so, because they want money to pay back what happened to them

Limited Liability Rationales

§ Promotes capital formation by encouraging small, passive investors § Permits investors to diversify § Encourages risk taking (because you're only liable for what you invest) § Promotes liquidity by making shares fungible § Reduces monitoring costs for investors § In large firms, creditors would find it prohibitively expensive to collect from many shareholders § In small firms, voluntary creditors can protect themselves by contract Increased equity cushion benefits creditors

Basic Inc. v. Levinson

§ Rule: (1) Company statements about preliminary merger negotiations can be material under Section 10(b) and Rule 10b-5. (2) Based on a fraud-on-the-market theory, there is a rebuttable presumption that individual members of a plaintiff class of investors relied on false statements affecting the price of the company's shares. § Generally, the materiality of a statement about a prospective event depends on the probability that the event will occur and the importance of the event to the company. Thus, because mergers can be the most important event in a company's existence, misstatements about merger negotiations can be material statements of fact. § Whether they are or not depends on the facts of the case, and specifically the significance that a reasonable investor would place on the withheld or misrepresented information. § Has to be probability that the merger is going to happen: There must be a "substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available § Materiality depends on a balance between probability and magnitude: materiality in a merger context depends on probability that transaction will be consummated, and its significance to issuer of securities (thus, materiality depends on the facts and is to be determined on a case-by-case basis) · Even preliminary negotiations may be material. The Court rejects an agreement-in-principle test, which is motivated partly by a desire to allow preservation of confidential merger discussions. § After decision in Basic, a company asked about merger negotiations and falsely denying them may violate Rule 10b-5

Martin v. Peyton (New York)

§ Rule: In order for a creditor to be a partner in a firm, the creditor must be closely enough associated with the firm so as to make it a co-owner carrying on the business for profit. A lender becomes a partner only if the lender and the owners of the business carry on the business for profit together as co-owners. § Court noted that a lending relationship has to be considered in its entirety. The combination of the loan's various provisions might make a loan into a partnership interest. However, question is a matter of degree. If a lender takes control of the partnership's affairs and participates in the profits and losses, the lender becomes a partner. § Want securities that easily raise capital § KNK was using marketable securities to get loans from bank and bank wouldn't accept speculative securities § KNK is playing with other ppl's money. Risk for them is huge § PPF probably knows that this is a risky deal and they want · High return/compensation · Dividends · 40% of profits · Option to buy into the firm § Court rules not a partnership § Reminder: can have a partnership without ever callning it that, filing anything. · Argue elements of control § What PPF did was take prudent normal business practices to protect themselves, not about being partners. They had some control, but it was not to actually manage the business.

o Energy Transfer Partners LP v. Enterprise Products Partners LP (Texas)

§ Rule: Parties may create contractual conditions precedent to the formation of a partnership. § Parties explicitly said that neither party was going to be bound to proceed with the pipeline until each company's board approved the execution of a formal contract and a final agreement was reacted with terms and conditions of the transactions finalized § TX code says you can form a partnership without intending to or calling it a partnership § Several factors that indicate a partnership has been formed · Right or receipt to receive a share of profits of the business · Expression of an intent to be partners in the business · Participation or right to participate in control of the business · Agreement to share or sharing losses of the business or liability for claims by third parties against the business · Agreement to contribute or contributing money or property to the business § Takeaways: TX supreme court held that parties can conclusively negate the formation of a partnership through contractual conditions precedent

Partnership dissociation

§ Under RUPA, the departure of a partner results in the dissociation of the partner from the partnership. A partner always has the power to dissociate but may not have the right to depart. A wrongful dissociation occurs when by doing so the partner breaches the partnership agreement or leaves earlier than an agreed time § If you don't have a partnership agreement or if the partnership agreement fails to include/address any terms/risks, the default rules apply

Direct vs. Derivative Actions

· A direct action is one in which shareholders sue directly on their own behalf to vindicate their individual rights, rather than the corporation's rights. o In public corporations, direct actions are often brought as class actions · Direct actions are attractive because they avoid the procedural hurdles that apply to derivative actions · Derivative suits are dismissed if they do not comply with certain requirements including: o Shareholder needs to post bond to cover corp's legal costs in case of frivolous suit

Entire Fairness Standard

· An inquiry into whether, despite the rebuttal of the BJR, the defendant and the conduct in question in fact resulted in inequity to the corporation and its shareholders. · When a plaintiff shareholder rebuts the presumption of the BJR by demonstrating under the procedural and evidentiary standards that the defendants breached their fiduciary duty (either duty of care or loyalty) then the Entire Fairness Standard applies. o Under this standard, the defendant directors must establish to the court's satisfaction that the transaction was the product of both fair dealing and fair price. Further, in the review of a transaction involving a sale of a company, the directors have the burden of establishing that the price offered was the highest value reasonably available under the circumstances. o Under the entire fairness standard of review, courts do not defer at all and instead conduct an independent, thorough review for fairness. o Defined to mean both fair price and fair dealing. MUST SHOW THIS § Fair price · Economic and financial considerations § Fair dealing · All about the transaction process: how it was structured, negotiated, disclosed and approved o Entire fairness means both matter but at the end of the day price may have a little bit more weight if there is a fair price but the process was flawed o Sometimes if you get to a fair price, courts might look the other way if there's something wrong with the dealing § How to know when to use entirety of entire fairness? · Start with BJR and if there's a process that's flawed, go with entire fairness as defense

Exculpation Clauses for Liability

· DE Section 102(b)(7) clauses allow companies to exculpate duty of care - directors might breach their duty of care but the companies have a clause that says it's okay DCGL Section 102(b)(7) and MBCA Section 2.02(b)(4) permit insertion of provisions in the charter that may exculpate directors from money damages for a breach of the duty of care · They do not however permit modification of or exculpation from breaches of the duty of loyalty

Election of Directors and Say on Pay

· Election of Directors and Say-On-Pay o Under state corporation law, all directors are elected at the annual meeting unless the articles of incorporation provide for staggered terms, in which case shareholders elect directors for terms of 2 or three years. § The shareholders' power to elect directors is exclusive except when a board seat is vacant. In this event, the vacancy can be filled either by shareholders or by the remaining directors, unless the articles provide otherwise. o Shareholders vote as many times as there are open seats. o Say-On-Pay Voting: Dodd-Frank requires this for public companies. This is a non-binding advisory vote on the company's executive compensation scheme. Under SEC Rule 14a-21, companies must include a resolution in their proxy statements at least once every 3 years asking shareholders in a non-binding vote, to approve the compensation of the top executive officers listed under Item 402 of Regulation S-K. § Theory behind this is that giving shareholders a periodic referendum on executive compensation will decrease the likelihood that overly generous compensation packages will be paid to senior executives.

Gerber v. Enterprise Products (DE)

· Fact Pattern: Joel Gerber and other limited partners (plaintiffs) in a partnership brought a class action suit against the partnership's general partner and others (defendants). Gerber alleged a breach of the partnership agreement, as well as a breach of the covenant of good faith and fair dealing implied in the partnership agreement. The Court of Chancery granted the general partner's motion to dismiss, and Gerber appealed. · Issue: Does a party breach the implied covenant of good faith and fair dealing if it is clear from the agreement that the parties would have agreed to prohibit the challenged conduct had they thought to negotiate with respect to that conduct? Court says yes. · Rule: A party breaches the implied covenant of good faith and fair dealing if it is clear from the agreement that the parties would have agreed to prohibit the challenged conduct had they thought to negotiate with respect to that conduct. · Court holds that a party breaches the implied covenant of good faith and fair dealing if it is clear from the agreement that the parties would have agreed to prohibit the challenged conduct had they thought to negotiate with respect to that conduct.

Wilkes v. Springside Nursing (MA)

· Fact Pattern: Wilkes (plaintiff), Riche, Quinn, and Connor were the four directors of the Springside Nursing Home, Inc. (Springside) (defendant), each owning equal shares and having equal power within the corporation. Eventually the relationship between Wilkes and the other three directors (defendants) soured. When Springside became profitable, the defendants voted to pay out salaries to themselves, but did not include Wilkes in the group to whom salary would be paid. Then, at an annual meeting, Wilkes was not reelected as director and was informed that he was no longer wanted in the management group of Springside. Over the course of these events, Wilkes faithfully and diligently carried on his duties to the corporation. Wilkes brought suit against the defendants for breach of their fiduciary duty owed to him. The lower court dismissed Wilkes's complaint. He appealed. · Issue: Are majority shareholders in a close corporation liable for breach of a fiduciary duty to a minority shareholder if they remove him from office and cut off his salary without any showing of misconduct? Court says yes. · Rule: Majority shareholders in a close corporation owe minority shareholders a strict duty of the utmost good faith and loyalty, unless a legitimate business purpose can be demonstrated to justify a breach of that duty. · We know this is a close corporation because there are 4 shareholders · In MA here and Donahue applies · "Freeze out" - what happens when you oppress minority shareholders · Wilkes sues for damages based on breach of fiduciary duty · There was no legitimate business purpose to get rid of Wilkes · Classic case of majority ganging up on minority · "When people use their power in a corp to harm other ppl's interests selflishly and harmfully, there will be a problem"

Qualification of Shareholder Plaintiff

· Federal Rules of Civil Procedure 23.1: The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of shareholders or members who are similarly situated in enforcing the right of the corporation or association. The complaint must: o (1) Allege that the plaintiff was a shareholder or member at the time of the transaction complained of, or that the plaintiff's share or membership later devolved on it by operation of law o (2) allege that the action is not a collusive one to confer jurisdiction that the court would otherwise lack; and o (3) state with particularity § (A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and § (B) the reasons for not obtaining the action or not making the effort · Delaware Court of Chancery Rule 23.1 (Derivative Requirements): o Shareholder must § Hold shares throughout the litigation § Make pre-suit demand on the board § Obtain court approval of any settlement · MBCA Section 7.41: "A shareholder may not commence or maintain a derivative proceeding unless the shareholder o Was a shareholder of the corporation at the time of the act or omission complained of or became a shareholder through transfer by operation of law from one who was a shareholder at that time and o Fairly and adequately represents the interests of the corporation in enforcing the right of the corporation

How do shareholders keep board accountable?

· How do shareholders keep board accountable? o In closely-held corp: other shareholders regularly monitor firm and can vote out directors · In a publicly -held corp o More shareholders with smaller stakes lead to rational apathy § Incentive to monitor directors is very small · Bad decisions have minimal financial impact on a shareholder with a small interest in corporation · Each shareholder has little voting power, so heir ability to oust directors is small o But, public corps have easily transferable shares and provide more information to the general public, so third party investors (who are not SH) may keep BoD accountable § If board performs badly, the firm's stock price will be low making the firm an attractive target for a takeover (incentive for board to keep stock price high) § 3rd party investors have an incentive to monitor firms and identify poor performers, then take control of them · Can be target for activist investors § Problem: these investors are likely to focus on short term profits · No tenure for directors: Must be re-elected (happens often - especially with apathetic shareholders). Can be removed (even without cause unless the A/I say only for cause)

Special Litigation Committee

· In response to a derivative suit, corporations often form a special litigation committee (SLC) to consider whether it is in the best interest of the corporation to take over the suit, allow it to continue, or move to dismiss. · It is usually composed of independent directors selected specially to serve on the committee for the disposition of the derivative suit · SLC formed by a corporation: 2 or more independent directors o Appointed by a majority of independent directors o Overall, derivative lawsuits do not have positive effect on stock prices or bring in money for the company o So why have them? They make directors care about their reputation and duties for the company o Settlement and Attorney Fees § Settle so lawyers get contingency fees paid § Court has to approve settlement according to FRCP and state statutes, but busy courts basically given fait accompli § Evaluation as to whether settlement is fair but allow courts to make their own judgment

Elements for Aiding and Abetting Breach of Duty

· Not just directors who can be held liable - 3rd parties can also · (1) The existence of a fiduciary relationship · (2) The fiduciary's breach of duty · (3) The defendant's knowing participation in that breach and · (4) damages proximately caused by the breach See RBC Capital Markets v. Jervis

Business Judgment Rule

· Presumption that in making a business decision that the directors of a corporation acted on o [1] an informed basis - (duty of care) o [2] in good faith and - (good faith) o [3] in the honest belief that the action was taken in the best interests of the company. (Self-dealing, conflict of interest, and usurping business opportunity) · Scope of the BJR o The duty of care and BJR are closely linked § Whereas the duty of care imposes potential liability for a breach of the duty, the BJR requires that, in determining whether there has been a breach, courts defer to the informed, good faith judgment of a board in making the decision being challenged o Traditionally, the BJR has operated as a shield to protect directors from liability for their decisions. If the BJR rule applies, courts will not interfere with or second-guess directors' decisions o The BJR creates an initial rebuttable presumption that directors acted in accordance with their duties o The rule also presumes an action, which is then subject to the protection of the presumption. It does not apply when there has been no exercise of judgment resulting in a decision. o Intentional omissions, being deliberate inactions, are protected, but neglectful inactions are not protected o Cout defers to the Board's decisions unless: § Directors breach their Duty of Loyalty, because their decision is tainted by fraud, illegality, or conflict of interest § Directors breach their Duty of Care, because they do not conduct sufficient investigation or deliberation to make a business judgment

Universal MBCA Approach for Shareholder Litigation

· Requires demand in all cases and does not recognize demand futility · MBCA Section 7.42: No shareholder may commence a derivative proceeding until o (i) a written demand has been made upon the corporation to take suitable action and o (ii) 90 days have expired from the date delivery of the demand was made unless the shareholder has earlier been notified that the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting for the expiration of the 90-day period. Seminal case: Einhorn v. Culea

Indemnification and Insurance for Derivative suit

· Scope of Indemnification o Generally covers damages that officers and directors might incur in connection with their corporate activities o Indemnification also covers litigation expenses and defense costs associated with the defense of officers and directors · Insurance o Corporations can purchase Director & Officer ("D&O") Liability Insurance to cover damages and expenses of defense

In re Fuqua Industries Shareholder Litigation

· Standing is limited generally to those with an equity interest in the corporation o Fact Pattern: Virginia Abrams (plaintiff) and Alan Freberg (plaintiff) were named plaintiffs in a shareholder derivative action against Fuqua Industries, Inc. (Fuqua) (defendant). Abrams had been a substantial shareholder of Fuqua for over 30 years. Abrams made her investment decisions jointly with her husband, who was a lawyer, including the decision to sue Fuqua. When she and her husband became dissatisfied with Fuqua's management, Mr. Abrams wrote letters to Fuqua's board. The letters were ignored. Abrams was ill, and her memory suffered. In a deposition, although Abrams was able to provide a general understanding of her claim, she was unable to give any details, and she was confused about the basic facts of her lawsuit. The other named plaintiff, Freberg, owned 25 Fuqua shares. Freberg's deposition testimony showed that his knowledge about the case was minimal. Contrary to Fuqua's allegations, Freberg did understand the basic nature of the derivative action and numerous other, unrelated derivative actions brought in his name. Fuqua alleged that Freberg was just a "puppet" for his lawyers. Fuqua moved to disqualify Abrams and Freberg as representative plaintiffs in this action on the ground of inadequacy. o Rule: A plaintiff who understands the basic nature of a shareholder derivative action brought in her name, but is unfamiliar with the facts and exercises little control over the case, is nevertheless an adequate representative of the shareholder class. o Policy issue: Should we let lawyers file these kinds of lawsuits with plaintiffs that are just for show?

Derivative Suit Incentives

· The plaintiff shareholder receives no direct pecuniary benefit from the successful litigation. In theory, benefit comes from an increase in the corporation's stock price attributable to the recover, if damages are the remedy. o Any money recovered belongs to the corporation (and not to the shareholder who initiates the lawsuit) · A plaintiff shareholder would want to maximize the size of recovery because it is an interest shared by the corporation itself · The defendants, usually senior officers or directors, seek to minimize cost, which would consist of any monies paid in judgment or settlement, plus attorneys' fees. · Plaintiff's counsel will receive a fee if the suit results in a favorable judgment or a settlement, whether involving monetary damages or some other benefit to the corporation. He earns nothing if the plaintiff loses. · Derivative suits are not a zero-sum game because both a plaintiff and a defendant can recover many litigation costs from the corporation. · Lawyers often seek out plaintiffs as lawyers have most to gain - popular targets for lawyers o Restrictions therefore to try and guard against frivolous/strike derivative lawsuits

Demand in Derivative Suits

· Traditional (DE) o Need to know if shareholder plaintiff is required to demand to the board to remedy the alleged wrong or whether demand is not really possible so therefore excused o Use Aronson case § Delaware Rules of the Court of Chancery: Rule 23.1 (Derivative Actions by Shareholders) · "...The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort."