Business Organizations

Professor McClane – Spring 2018

University of Connecticut School of Law
Keyed to Allan, Kraakman: Commentaries and Cases on the Law of Business Oganization, 5th Edition

BASICS
Basic Problems of Business Law
1. Facilitating relationships among the owners of the corporation (shareholders & partners)
2. Facilitating relationships between the owners and outside partners (creditors)
3. Facilitating relationships between owners (shareholders) and managers (directors)

AGENCY
P A

When can an agent (A) bind a principal (P) to a third party (T)?

Formation

 Agency is the fiduciary relationship that arises when one person (P) manifests assents to another person
(A) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent
manifests assent or otherwise consents so to act. Restatement (Third) of Agency §1.01.
o (1) Mutual assent (both ways) (2) for agent to act on principal’s behalf and (3) subject to
principal’s control
 Assent can be explicit or implicit
 Agency relationships may be implied (see Jenson Farms Co. v. Cargill)

Types of Agents

Scope of Agency Disclosure of Agency Amount of Control

Special Agent Fully Disclosed Employee or “Servant”
(one act or transaction) (T knows A acts for P) (Control in detail)

General Agent Partially Disclosed Independent Contractor

(series of acts or transactions) (T knows A is an agent, but does (Less control. Only controls
not know the identity of P) generally, but defers to
skills/judgment)
Undisclosed
(T does not know A is agent)

Termination
 Authority terminates if the P or the A manifests to the other dissent to its continuance. Restatement
(Second) of Agency §118.
 At any time, unless otherwise specified
 Contractual claim for damages if principal “revokes” or agent “renounces”
Liability in Contract

Actual Authority Apparent Authority

That which a reasonable person in A’s position That which a reasonable third party would
would infer from P’s conduct infer from the actions or statements of P

- Express if communication was explicit See White v. Thomas

- Implied (or incidental) if A’s actions Restatement §8 & §27
were reasonably calculated to discharge
P’s explicit instructions

Also includes incidental authority, which is

the authority to do those implementary steps
that are ordinarily done in connection with
facilitating the authorized act

Forms of Authority

Agency by Estoppel Inherent Authority

P makes no manifestation that A has authority “Power derived from the agency relation and
or is an agent but: exists for the protection of persons harmed by
- P intentionally or carelessly causes T’s or dealing with a servant or other agent”
belief that A has authority; or Restatement §8A
- P has notice that T might believe A has
authority but does nothing about it Basically, A can bind P to an unauthorized
contract if A would ordinarily have the power
and T makes a detrimental change in position to enter such a contract and T does not know
in reasonable reliance on the belief that A has that matters stand differently
authority
See Gallant Insurance v. Isaac

Ratification: Accepting benefits under an unauthorized contract

Liability in Tort

 Principals are usually liable for torts committed by a class of agents, “employees,” but not for
independent contractors.
 How much control? Level of control:
o Branch network = control over where stores are, benefits of workers, micromanaging
o Franchise system = people use name and then are allowed to run their own stores
o Franchise is better because the owner will bear more risk, and it is more efficient. P is able to
align A’s incentives better and get A to work harder.
 See Humble Oil v. Martin, Hoover v. Sun Oil

Agent’s Duties

 Duty of Obedience: Duty to obey principal’s commands (Rule 8.09)

 Duty of Loyalty: Pervasive obligation always to exercise legal power over subject of the relationship in a
manner that the holder of the power believes in good faith is best to advance the interest or purposes of
the principal or beneficiary and not to exercise such power for a personal benefit. (Rule 8.01-03) (see
 Tarnowski v. Resop) [Duty to act in the best interest of the P, at least not without getting consent, giving
full disclosure and acting in fair dealing.]
 Duty of Care: To act, in good faith, as one believes a reasonable person would act, in becoming
informed and exercising any agency or fiduciary power. [Duty to act as you would if you were managing
your own affairs]
o Rule 8.08 – good faith requirement
o Rule 8.06 – conduct that would otherwise breach duty is not a breach if P consents with
disclosure. Must still be acting in good faith, disclose material facts and deal fairly.

Trustee’s Duties to Trust Beneficiaries

 Trustee is subject to terms of trust, which are fixed by the settlor. Not ordinarily subject to control of
beneficiary. (see In re Gleeson)

Agency Cost Problems

 Occur whenever you have more than one person working towards any given goal. Usually between a P
and an A and occurring whenever the A has a different incentive than the P and does things differently
than what the P wants. The difference between what the A &P want is the agency cost.

PARTNERSHIPS

- General agent of partnership, each partner binds the partnership by contracting usual course of business

 All partners are owners (principals)

 All partners are also general agents
 All general partners are jointly & severally liable for the debts of the business
 All partners share equally in control

Conflict Among Co-Owners:

- During enterprise, there is a fiduciary duty of loyalty to the other partners (see Meinhard v.
Salamon)

Formation:

o UPA §7(4): Receipt by person of a share of the profits is prima facie evidence that he is a partner
in the business. Lack of daily involvement is not per se indicative of absence of a partnership.
o UPA §6(1): A partnership is an association of two or more persons to carry as on co-owners of
the business for profit. (Don’t need to have money. Normally an agreement but not necessary)
o UPA §18(g): Need consent of all partners to be a member of the partnership
o UPA §13: Each partner is bound by other partners’ wrongful acts or omissions
o See Voland v. Sweet – The parties must have intent to form a partnership, but this means “an
intent to do those things which constitute a partnership,” rather than the specific intent to become
partners. Don’t need to be called a partnership. Received % of net profits, not gross profits.

Partnership by Estoppel
UPA §16: If a person represents itself as being a partner in an enterprise (or consents to others
making the representation) AND a third party reasonably relies on the representation (actual
reliance) and does business with the enterprise THEN the person who was represented as a
partner is personally liable on the transaction, even though that person is not in fact a partner.
Liability

 Third Party Relations

o Jointly liable = Everyone on the hook for everything
o Severally liable = Each person is liable for their share of the damages
o Jointly & severally liable = sue them all, let them sort out who pays
o Partners are jointly & severally liable for partnership property
o UPA §15: Partners are J&SL on partnership torts, and jointly liable of partnership contracts
o RUPA §306: Partners are J&SL on partnership torts and contracts
 But RUPA §307(d): Must exhaust business assets before pursuing personal assets

 Creditor’s Rights
o Who can creditors pursue?
 Creditors can go after partnership property
o When can an ex-partner escape partnership debts?
 Departing partners can escape existing creditors (a) if creditor agrees (UPA §36(2)); or (b) if
there is material alteration to terms with notice to creditors (UPA §36(3))
o How do partnership creditors fare in competition with personal creditors for assets when the partnership
and all of its partners are bankruptcy?

 Claims Against Departing Partners

o Generally, withdrawing partner is liable for obligations incurred prior to departure
o UPA §36(2) and (3): Withdrawing partner is released if Courts infer an agreement between the
continuing partners to release withdrawing partner (see also RUPA §703)

Governance

 See National Biscuit Co. v. Stroud (selling bread was ordinary matter connected with the partnership business.
Stroud could not restrict power/authority of Freeman. Freeman bound business and Stroud.)
o Analysis: Is it in the ordinary course of business? If no, §9.2 (needs unanimous authority under
§18(h)). If yes, §9.1 (individual can bind the partnership if it is not disagreed upon. If there is a
disagreement, then check §18(h))
o Same analysis under RUPA §401(j)
 Authority to Act
o UPA §9: Every partner is an agent of the partnership for the purpose of its business, and an act of a
partner which is not apparently for the carrying on of the business of the partnership in the usual way
does not bind the partnership unless authorized by the other partners
o UPA §18(h): Any difference arising as to ordinary matters connected with the partnership may be
decided by a majority of the partners BUT no act in contravention of any agreement between the
partners may be done rightfully without the consent of all the partners

Formation  Partner Leaves (or term ends)  Liquidating and/or distributing assets  End of P’ship
UPA §6-7; UPA§29 UPA §37, §38 and §40 UPA §30
RUPA §202 RUPA §802

Ending a Partnership

 Leaving partner is entitled to take share of assets distributed in a certain way (unless otherwise agreed) UPA
§38
 See Adams v. Jarvis
 Dissolution: UPA §29 – any change of partnership relations (the exit of a partner)
  Winding Up: UPA §37 – orderly liquidation and settlement of partnership affairs
 Termination: UPA §30 – partnership ceases entirely at the end of winding up

 Distribute based on what the partnership agreement says. If it doesn’t say anything then:
o Under UPA §§38, 40: Figure out residual value after payment to creditors, after paying amounts owed
to partners and capital accounts of partners then divide equally
o Under RUPA §701: Figure out residual value and buy out partner at higher of either the liquidation
value or the going-concern value
o See Page v. Page and Meinhard v. Salamon
o UPA §31(1)(b): Partnership can be dissolved by express will by any partner when no definite term or
particular undertaking is specified. If there is a term or undertaking, it can be terminated if both agree.

FORMS OF PARTNERSHIP
Sole Proprietorship  General Partnership  Limited Partnership  LLP  Corporation

o Limited Partnership (LP)

 One general partner incurs unlimited personal liability. Passive investors called limited partners.
Limited partners risk no more wealth than their contribution. The general partner might be a limited
liability entity such as an LLC. Pass-through taxation. Limited partners do not have control, only GP
does.
o Limited Liability Partnership (LLP)
 Limited liability only with respect to partnership liabilities arising from negligence, malpractice,
wrongful act, misconduct of another partner or an agent of the partnership not under the partners’ direct
control. Needs to be registered/filed. Pass-through taxation. Still liable for debts of the firm.
o Limited Liability Company (LLC)
 Members operate firm and serve as its agent, or elect managers to do so (like general partners.) Enjoy
limited liability even when they exercise control over the business in the same way that a general
partner would.

The difference between LPs and LLPs are that LPs provide unqualified limited liability to some partners; LLPs
provide qualified limited liability to all partners

Limited Liability

 Limited liability eliminates messy problems of personal liability. Owners have no liability. Creditors can only
rely on business assets
 Allow investors to enter and exit the firm. All they have to do is buy or sell shares
 Prevents minority investors from trying to hold up the firm by threatening to dissolve it
 Easy for 3rd parties who contract with the firm to know who they are dealing with as an unauthorized agent. All
they need is a board resolution.
 See Pappas v. Tzolis (forming an LLC)

Benefits of LL

 Reduces need to monitor agents – at least compared to GPs and LPs – and other owners (shareholders)
 Makes shares fungible (which also facilitates takeovers)
 Facilitates diversification
 Enlists creditors in monitoring managers (because creditors bear more downside risk)
 THE CORPORATE FORM
 The State of incorporation dictates which corporate law rules apply under the “internal affairs” doctrine

Types of Corporations
 Public Corporations: More buyers, less restrictive
 Closely Held Corporation: Privately held and incorporated for liability issues, non-capital raising.
Shareholders are managers and directors.
 Controlled Corporation: Single person or small group controls company
 “In-the-Market”: No individual controls the corporation

Incorporating
 Articles of Incorporation or Certificate of Incorporation (charter)
o Must state purpose, powers of corporation, define special features, file with designated public office,
identify corporation’s principal office within the state and identify agent in the state upon whom
process can be served
o In Delaware, corporate’s legal life begins with charter is filed
 First act of business = Elect directors at organizational meeting
 Must have corporate bylaws
 RMBCA §2.01-05: Incorporator signs documents, pays fees, drafts certificates/AOI, secretary of state issues
corporation’s charter, election of directors, adoption of bylaws, and appointment of officers

Charter and Bylaws

 Articles of Incorporation (or Charter)
o Must include the name of the company, address, purpose, capital structure and other miscellaneous
provisions

Transferable Shares
 Benefits: permits takeovers, disciplines management, allows shareholders to exit without disrupting business
and because of LL, shares are fungible which facilitates active stock markets, increasing liquidity

Board of Directors
 Set up by the Charter
 Elected annually (or staggered board)
 Represent shareholders but need not heed shareholders. Shareholders can vote only infrequently
 See Automatic Self Cleaning Filter and Jennings v. Pittsburgh Mercantile

Protection of Creditors

o Mandatory disclosure duty of corporate debtors

o Federal securities law imposes mandatory disclosure on public corporations but not for closely held
companies. Helps illuminate assets, liabilities, income, cash flow, etc... but it costs a lot of money for
corporations.
o Need mandatory disclosures like credit reports to determine credit worthiness. Financial statement, past
tax returns, etc... Many companies have these because they regulate securities controlled by the SEC. If
not, then you’re under state law. Most states don’t have MD requirements.
o Capital regulation requires business entity to hold a minimum amount of capital and restricts removal of
capital from the firm. Regulation of the capital committed to the corporation is a mean by which the legal
system might attempt to protect against some of the risks that creditors face.
o Distribution Constraints
 Nimble Dividend Test / Modified Surplus Test (DGCL §170(a)) : May pay dividends out of
capital surplus + retained earnings, or net profits in current or preceding fiscal year (if not
surplus). Refers you to DGCL §154.
 Capital Surplus = Excess of net assets over the par value of stock (§154)
  Net Assets = The amount by which total assets of exceed total liabilities (§154)
 A surplus is anything above stated capital once you subtract liabilities
 RMCA §6.40(c): May not pay dividends if you can’t pay debts as they come (c)(1); or assets
would be less than liabilities plus the preferential claims of preferred shareholders (c)(2) BUT
board may meet the asset test using a “fair valuation or other method that is reasonable in the
circumstances” (d)

o Financial Statement
o Two principal accounting statements:
 Balance Sheet – Represents the financial picture of a business organization as it stands
on a particular day
 Income Statement – Presents the results of the operation of the business over a specified
period

Corporation Balance Sheet

Assets Liabilities

Stock Holders’
Equity

o Fiduciary Duty Constraints

 Director Liability: Directors owe obligation to creditors not to render the firm unable to meet its
obligations to creditors by making distributions to shareholders or to others without receiving a fair
value in return
 Credit Liability: Fraudulent Conveyance (UFTA §4)
 Shareholder Liability: Piercing the Corporate Veil

o Fraudulent Conveyance & UFTA §4: Creditors may attack transfer of cash or benefits if transfer is made
with intent to hinder, delay, or defraud any creditors or without receiving a reasonably equivalent value in
exchange for the transfer and the debtor was:
o Engaged or about to engage in business transaction for which the remaining assets of the debtor were
unreasonable small; or
o Intended to incur or reasonable should have believed that he would incur debts beyond his ability to pay
as they came do
o Directors owe a duty to the corporation (see Lyonnais Bank). Creditors cannot sue by themselves, but
they could sue for breach of duty to the corporation (see N. Am. Cathloc Edu v. Gheewalla)

o Piercing the Corporate Veil

o Equitable device to set aside entity status of corporations and hold shareholders liable directly on
contracts/torts. Occurs when a Plaintiff attempts to hold shareholders personally liable on corporate
debts.
o Two Components:
 Evidence of “lack of separateness” (e.g., shareholder domination, thin capitalization, no
formalities/co-mingling of assets)
 Unfair or inequitable conduct (this is the wildcard in veil-piercing cases)
o There’s probably no piercing against public corporations, passive shareholders, or minority
shareholders if all formalities are observed and nothing funny with the accounts
 See Sea-Land Services v. The Pepper Source
 Van Dorn Test: (1) There must be such a unity of interest and ownership that the separate
personalities of the corporation and the individual no longer exists. (2) Circumstances must be
such that adherence to the fiction of separate corporate existence would sanction (a) fraud or (b)
promote injustice (has to be compelling public interest)
 Kinney Shoe Corp
  Laya Test: (1) Unity of interest and ownership such that the separate personalities of the
corporation and the individual shareholder no longer exists; (2) would an inequitable result
occur if the acts were treated as those of the corporation alone. (Potential third prong – D might
still prevail by showing an assumption of risk.)
 Walkovsky v. Carlton
o Tinkerbell Test: To be protected, shareholder must believe in the separation of corporation from
individual
o Lowendahl Test: Disregard the corporate form whenever recognition of it would extend the principal of
incorporation beyond its legitimate purpose and would produce injustice or inequitable consequences.
Requires that Plaintiff show the existence of a shareholder who completely dominated corporate policy
& uses her control to commit a fraud or wrong that proximately caused the Plaintiff’s injury. This is
the majority.

 Equitable Subordination
o A doctrine enabling creditors, and in some instances shareholders, to get ahead of others who are
making claims as creditors. As a result, the bottom line may be that a creditor may collect more money
on a debt owed by an insolvent corporation than otherwise might be the case. (See §501(c)(1) of the US
Bankruptcy Code)

ROLE OF THE SHAREHOLDER

 Default powers of shareholder are the right to vote, right to sell and right to sue
 Collective action problem  either one shareholder (voting become arbitrary) OR too many shareholders
(getting information out is costly)
 Incentive is to remain passive & not spend those costs “rational apathy”

The Voting System

 What do you vote on?

o Election of directors
o Organic or fundamental changes (e.g. mergers, sales, dissolution, etc...)
o Shareholder resolutions

 When do you vote?

o Annually, other than special meetings or written consent solicitations (see DGCL §211(b) and RMBCA
§7.01(a))
 Max 13 months (DGCL 211(c)) or 15 months (RMBCA 7.03(a)). Some states require more.
 Special Meetings: DGCL §211(d) allows board to call a special meeting
 RMBCA §7.02 allows board or 10% of shareholders to call a special meeting. Can be
changed up to 25%
 Notice: DGCL §211(b) and RMBCA §7.01(a) (may be waived)
 Quorum: Default is majority of shareholders (DGCL §216; RMBCA §7.25) can be changed but
no less than 1/3rd of shares in DE
 Action by written consent: DGCL §228 provides that any action that may be taken at a
meeting of shareholders may also be taken through written consent. RMBCA §7.07(a) requires
unanimous written consent

 How do you vote?

o Proxy voting system (DGCL §212 and RMBCA §7.22)
o Board sends a “proxy statement” to shareholders and requests that they vote a slate or request proxies to
vote
o A proxy is usually revocable because a proxy creates an agency relationship with the real owner; and
agency relationships are revocable. There are irrevocable proxies under RMBCA §7.22(d)
  How are votes tallied?
o Straight (first past the post): Each shareholder gets one vote per share
o Cumulative (RMBCA §7.28): Each shareholder gets votes equal to number of shares owned times
number of seats to be filled
 Improves likelihood of minority representation on the board

 Who do you vote?

o Either all the directors (unitary board) or 1/3rd of the directors (staggered board)
o DGCL §141(d): Staggered board
o Staggered boards can be used as a takeover defense

 How do you remove directors?

o For Cause: DGCL §141(k) & RMBCA §8.08(a) – common law
 If cumulative voting is in place, the only way to vote off a director is with the same number of
requisite votes needed to elect
o Without Cause: (Same as above) BUT DGCL §141(k) not if board is classified
 If cumulative voting, only with more than the requisite votes to elect
 Cannot do this kind of a removal if board is staggered
o How to remove an unfireable CEO:
 Amend certificate of incorporation (DGCL §242(a) & (b))
 Amend by-laws (DGCL §109)
 Increase the size of the board (DGCL §223(a)(1))
 Remove one or more directors (DGCL §141(k))
 Dissolve the company and distribute the assets (DGCL §275)
o See Campbell v. Loew’s Inc. (director entitled to due process rights when removed)
o State law in most jurisdictions bars directors from removing fellow directors for cause or otherwise
absent express shareholder authorization
o Can petition the court of competent jurisdiction to remove director
- Federal courts have authority when corporation is publicly traded and registered under SEA of
1934
Proxy Voting

o Proxy voting system is set up by DGCL §212

o Addresses the quorum requirements. Generally, proxies must record the designation of the proxy holder by the
shareholder and authenticate the grant of the proxy. Proxy holder is bound to exercise the proxy as directed, but
can exercise independent judgment.
o Can use e-communications. Makes it cheaper to run an insurgent slate because it reduces the cost of
distributing proxy materials, though take-up has been minimal thus far.
o Proxy holder bound to exercise proxy as directed
o Management expenditures for proxy contests are reimbursed. Winners also usually can get reimbursed
 See Rosenfeld v. Fairchild Engine – Management may look to corporate treasury for the reasonable
expenses of soliciting proxies in good faith to defend a position in a bona fide policy contest. Insurgents
only get reimbursed if they win.

Shareholder Information Rights

o Shareholders have a right to inspect company’s books and records for a proper purpose
o DGCL §220(c)
o RMBCA §16.02 (burden is on the shareholder) and §16.01(e)
o Stock list request
 Discloses identify, ownership interest, address of each registered owner of company stock
 Proper purpose is broadly construed and additional improper purpose not considered. (DE does not
need proper purpose but RMBCA does)
 Honeywell (asking to see shareholders because you think they are building a weapon: NO)
o Inspection of Books and Records of Corporation
  To uncover suspected wrongdoing
 Expensive, including proprietary information
 DE law requires shareholders to carry burden of showing a proper purpose

Rigging the Vote

 Dual class voting: Tool for entrenching certain controllers. A planner can attach all voting rights to the
fraction of shares that are assigned to the controller, while attaching no voting rights to the remaining shares
that are distributed to the public or other shareholders
 Vote buying: Hewlett Packard case. Per se illegal if purpose is to defraud or disenfranchise other stockholders.
If it is not to defraud, it is illegal if it is intrinsically unfair.
 See Schnell v. Chris-Craft Industries – Although the action by the board was not illegal, the inequitable
purposes could not stand because they stripped shareholders of their valid exercise of voting rights.

FEDERAL PROXY RULES

Federal Law
o Securities Exchange Act of 1934 (aka Exchange Act aka 1934 Act)
 Disclosure requirements and mandatory vetting regime, regulation of the process of soliciting proxies,
town hall meetings that permit shareholders to gain access to proxy materials, and general anti-fraud
provision
 Substantive regulation of the process of soliciting proxies from shareholders
- Must file Schedule 14A unless you have an exemption
- Town Hall Meeting Rule  §14a-2(b)(I) – “Any solicitation by any person who does not seek
directly or indirectly the power to act as proxy for a security holder and does not furnish or
otherwise request a form of revocation, abstention, consent or authorization. Provided that ...”
[The exemption does not apply to any person affiliated with the registrant, etc...
 Specialized town meeting provision  §14a-8: permits shareholders to gain access to corporation’s
proxy materials and thus gain a low cost way to promote certain kinds of shareholder resolutions
(shareholder proposals)
- Several grounds for keeping proposals off of the proxy
- Corporation response to shareholder proposal: get a no-action letter from SEC to confirm
rejecting proposal is okay

§14a-1 to §14a-7 Makes it unlawful for any person to contravene against any rule the commission adopts by
“soliciting proxy votes on registered securities.”
§14a-3 No one may be solicited for a proxy unless they are or have been furnished with a proxy
statement containing the information specified in 14a
§14a-4 to §14a-5 Form of proxy and proxy statement
§14a-6 Formal filing requirements. Subsection (g) list companies exempt from proxy rules
§14a-7 List-or-mail rule under which a company must either provide a shareholders’ list or
undertake to mail the dissident’s proxy statement and solicitation materials
§14a-8 Specialized town hall meeting provision
§14a-9 Anti-fraud provision: there is an implied private right of action against companies for
violating the Act.

MANAGEMENT OBLIGATIONS

Business Judgment Rule

 The BJR provides that, where a director is an independent person, there can be no liability for corporate loss,
unless the facts are such that no person could possibly authorize such transaction if he were attempting in good
faith to meet their duty
 A corporate director is required to form his functions:
o In good faith
 o In a manner he reasonably believes to be in the best interests of the corporation
o With the car that an ordinarily prudent person would reasonably be expected to exercise in a like
position and under similar circumstances

 ALI §4.01(c): A director or office who makes a business judgment in good faith fulfills the duty under this
section if the director or officer:
1. is not interested in the subject of the business judgment;
2. is informed with respect to the subject of the business judgment to the extent that the director or officer
reasonably believes is appropriate under the circumstances; and
3. rationally believes that the business judgment is in the best interests of the corporation

 See Kamin v. American Express and Smith v. Van Gorkom

 Creates a high bar to judicial review for breach of duty of care. Courts should not second guess good faith
decisions by independent and disinterested directors.
o However, Courts will look at BJ if there is (1) a violation of the duty of care; (2) if there is a violation
of duty of loyalty; (3) is made in judgment of good faith; OR if no one could have possibly made that
choice in good judgment
 DGCL §102(b)(7): Corporation may exempt directors (but not officers) from liability. Even if breach, directors
and officers might not be personally liable

The BJR and Corporate Non-Decisions

o See Francis v. United Jersey Bank and Graham v. Allis Chalmers Mfg. and In re Caremark and Stone v.
Ritter and In re Citigroup
o RMBCA §8.30(b)

 Two types of scenarios:

o Business Decisions (duty of care and BJR – Van Gorkom / Kamin)
o No Business Decision
 Failure to Act (duty of care only – Caremark / Allis-Chalmers)
 Failure to Monitor Business Risks (still get the BJR – Citigroup)

DUTY OF CARE
Duty of Care reaches every aspect of a director’s conduct since it requires these parties to act with “the care of an
ordinarily prudent person in the same or similar circumstances.”

Very hard to violate DOC because of the BJR

RMBCA §8.30(a): A director shall discharge his duties as a director, including his duties as a member of the
committee:
1. in good faith;
2. with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
3. in a manner he reasonably believes to be in the best interests of the corporation

ALI §4.01(a): A director or office has a duty to the corporation to perform

1. in good faith
2. in a manner that he reasonably believes to be in the best interests of the corporation; and
3. with the care that an ordinarily prudent person would reasonably be expected to exercise in a like position and
under similar circumstances

Generally, claims for duty of care must show a violation of:

1. financial disinterested directors or officers
2. is duly informed before exercising judgment
3. who exercise judgment in good faith effort to advance corporate interest
Duty to Monitor
 Courts look at what a reasonable person would have done
 Smith v. Van Gorkom – personal liability for grossly negligent decision because of lack of informed decision
 Francis v. United Jersey Bank – there is a duty to have a rudimentary knowledge of the industry and workings
of the business
 Graham v. Allis Chamlers – duty to monitor a company is entitled to deference, absent showing of “red-flags”
 In re Caremark – director oversight liability if: (1) director utterly fails to implement any reporting or
information systems or (2) having implemented the systems, consciously failed to monitor or oversee the
operations, thus disabling themselves from being informed AND imposition of liability requires showing that
directors knew they were not discharging fiduciary obligation

Red-Flags  if red flag comes up in the warning system, if they are fraudulent/criminal and you didn’t do anything
about it, it is almost necessarily indicative that warning system did not work BUT if the red flags are less than
fraudulent, it doesn’t mean that Caremark claim was valid.

DUTY OF LOYALTY
 Duty to Whom?
o Old law was that the duty is to the shareholders (see Dodge v. Ford Motor Co.)
o Duty to the Corporation: (Consistency Statutes) – Many states have enacted statutes that say directors
have power (but not obligation) to balance interests of shareholder constituencies and interests of non-
shareholders in setting corporate policy
 Question of loyalty arises when a board claims to advance a non-shareholder interest over
shareholders (like a public benefit)
 A board may decide to use retained earning to fund investment, price reductions, and increase
employee wages as a device to increase long-term corporate earnings

 When Does Duty of Loyalty Come Up?

o Presumption that BJR applies  P shows there is a conflict  D, corporation, has to prove there was
procedural fairness (safe harbor rule) or substantive fairness (entire fairness test)
o What Constitutes a Breach:
1. Self dealing w/ direct financial interest of party in transaction
 Self dealing occurs when a director, by virtue of his position in the corporation, causes
the corporation to act in such a way that the director receives something from the
corporation to the exclusion of, and detriment to, the minority of shareholders in the
corporation
 Intrinsic Fairness Test: A self-dealing transaction will be upheld if it is ultimately
deemed to be intrinsically fair to the corporation; that is, if there is evidence of the
earmarks of an arms length deal, then the transaction was probably fair to the
corporation
2. Interested transaction if director has indirect interest in transaction because he is not a party but
stands to benefit

o Entire Fairness Test: (DGCL §144(a); Weinberger) Once the plaintiff establishes that duty has been
breached, then director must establish fairness of transaction by showing
1. Fair dealings: Duty of corporation to completely disclose to the shareholders all relevant
information when transaction was timed, initiated, structured, negotiated, what was disclosed to
directors, how approvals were obtained
2. Fair price: Requires that price being offered for outstanding price be equivalent to price
determined by an appraisal. Economic and financial consideration, how deal affected intrinsic
value of assets.
 o Safe Harbor Statutes: DGCL §144: A director’s self dealing transaction is not voidable simply
because he is interested as long as it:
1. Disclosure and authorization by disinterested director OR
2. Disclosure and authorization by disinterred shareholder OR
3. The transaction is fair
o Seek to permit boards to authorize transactions in which a majority of directors have an interest
o Not voidable simply because it is interested OR such a transaction is not voidable solely because it is
interested so long as it is adequately disclosed an approved by a majority of disinterested directors or
shareholders or it is fair

 What Constitutes a Possible Interested Transaction?

o Self-Dealing Transactions: When the director has a direct financial interest in the transaction
o Interested Transactions: Director has an indirect interest in the transaction
 Interested directors may be voidable unless
 PROCEDURALLY FAIR
o Full Disclosure  See Hayes Oyster Co.
o Approval  Safe Harbor Statutes (DGCL §144(a))
 Assume the transaction is interested, and this interest is fully and
adequately disclosed. Transaction is NOT voidable solely because it is
interested if disinterested board approval OR shareholder approval, but
court still needs to do a fairness inquiry
 See Cookies Food Products
 Disinterested director approval: see Cooke v. Oolie

Type of DGCL 144 ALI 5.02

Approval
No board or SH Entire Entire Fairness
approval Fairness (D) (D)
Disinterested BJR (P) Reasonable
directors Cooke belief in
authorize fairness (P)
Disinterested BJR (P) Entire Fairness
directors ratify (D)

 SUBSTANTIVELY FAIR
 WASTE
o Must prove that corporation entered into transaction and got so little of a
consideration that it was basically a gift (see Lewis v. Voeglestein)

Effects of Shareholder Ratification

Types of Approval DGCL 144

Disinterested shareholders ratify BJR/Waste (P)
But: controlling shareholder Entire fairness (D)
Unless: Controlling shareholder, but majority of minority Entire fairness (P)

SHAREHOLDER LITIGATION
Direct v. Derivative Actions
 DIRECT
o P sues for direct injury, as an individual or as a class action
o Injury alleged is to a personal interest, can be brought individually or as a class action, and remedy is to
recover damages lost
 DERIVATIVE
 o P sues on behalf of corporation. The suit “derives” from a corporate injury
o Typically allege that directors failed to vindicate its claim because they were the wrong doers
o Remedy is often injunction

ASK:
1. Who suffers the harm?
a. See Tooley v. Donaldson Lufkin & Jenrette
b. The law to be applied henceforth in determining whether a stockholder’s claim is derivative or direct
[turns] solely on the following questions:
i. Who suffered the alleged harm (the corporation OR the suing shareholders); and
ii. Who would receive the benefit of the recovery or other remedy? (the corporate or the
shareholders?)

Standing
 P must be a shareholder for the duration of action and at the time of alleged wrong action or omission
o Fair and equitable representation of the class (FRCP §23.1 and DE)
o Contemporaneous ownership (FRCP §23.1 and DE, RMBCA §7.41, ALI §7.02)

Attorney’s Fees
 See Fletcher v. AJ Industries

Demand
 Aronson Demand Futility Test:
o Court must decide whether, under the particularized facts alleged, a reasonable doubt is created that:
1. The directors are disinterested and independent, and
2. The challenged transaction was otherwise the product of a valid exercise of business judgment
o The Court must make two inquiries, one into the independence and disinterestedness of the directors
and the other into the substantive nature of the challenged transaction and the board’s approval thereof
 Aronson/Levine Demand Futility Test:
o Plaintiff must:
1. Establish that the directors are interested or dominated and hence incapable of passing on a
demand; OR
2. Create a reasonable doubt with particularized facts, that the challenged transaction is protected
by the BJR
 DE uses Aronson/Levine test  P must establish either that directors are interested/dominated OR must allege
facts that create a reasonable doubt of the soundness of the challenged transaction
 RMBCA (and CT)  Must make demand and wait 90 days unless irreparable injury (§7.42) and if demand is
refused shareholder may continue by alleging with particularity that board is not disinterested (§7.44(d)) or did
not act in good faith (§7.44(a))
 ALI  Must make demand unless irreparable injury (§7.03) and if demand is refused and shareholder
continues, court will review board motions to dismiss derivative suits using a graduated standard: BJR for
alleged duty of care violations (§7.01(a)(1)) and reasonable belief in fairness for alleged duty of loyalty
violations (§7.10(a)(2)) except no dismissal if P alleges undisclosed self-dealing (§7.01(b))
 See Rales v. Blasband

BASICALLY in DE, demand is a requirement but you can request demand be excused for futility. There are some
states where you have to make demand no matter what. If you make a pre-suit demand, you’re automatically
conceding that the board is independent and disinterested with respect to the question to be litigated. The RMBCA &
CT require that you must make demand and wait 90 days unless there would be irreparable injury (see 7.42) and if
demand is refused, shareholder may continue by alleging with particularity that the board is not disinterested (7.44(d))
or did not act in good faith (7.44(a))
Special Litigation Committees
 Formed after litigation has begun and board needs to make a decision. Independent directors are used to figure
out whether to litigate or not. SLC have a fiduciary duty to corporation and the Court will not allow dismissal
if it would breach such duty.
 See Zapata Corp. v. Maldonado
o Two-Step Test (to see whether SLC breached fiduciary duty when dismissing suit):
1. The Court should inquire into the independence and good faith of the committee and the bases
supporting its conclusion ... the corporation should have the burden of proving independence,
good faith, and a reasonable investigation
2. The Court should determine, applying its own independent business judgment, whether the
motion should be granted
 14(a) and (c) give power to the board to delegate power to an SLC
 P doesn't make demand
P makes demand (Aronson/Levine Two Step
Test)

Board Refuses Demand Required (Levine) Demand Excused (Rales)

Relaxed BJR (Levine, Suit Dismissed. Must ask

Suit proceeds
Speigel) board

Board Does Not Refuse SLC No SLC

SLC recommends dismissal

Corporation brings suit Case continues
or settles

Zapata two-step

Case continues

 See In re Oracle Corp.

 Competing Approaches in Court’s Exercise of BJR:
o Zapata – The Court should, when appropriate, give special consideration to matters of law and public
policy in addition to the corporation’s best interests
o Joy v. North – “The court’s function is thus not unlike a lawyer’s determining what a case is worth for
purposes of settlement”

CHANGES IN CONTROL & STRUCTURE

Transactions in Control
 Acquisition can either be from (1) purchasing shares from numerous small holder (tender offer); OR (2)
purchasing controlling block from an existing controlling shareholder (seller demands a control premium)
 Acquisition of Control Block: Premium is added amount an investor is willing to pay for the privilege of
directly influencing the corporation’s affairs.
o Regulation of control premia is defined by The Market Rule (see Zetlin v. Hanson Holdings). The
common law rule is that seller receives whatever market will bear for control premia, absent looting of
corporate assets, conversion of corporate opp., fraud, etc...
 o Control premia is subject to disqualification (minority) under the equal opportunity rule (rarely) where
all shareholders are entitled to a part of the control premium (see Perlman v. Feldman – where an
unusually large premium and breach of fiduciary duty)

The Market Rule

 Common law rule, universal in the United States
 Controlling shareholder is entitled to sell control to anyone (except looters) and receive a control premium
without any obligation to minority shareholders
o The sale of control is a market transaction that creates rights and duties between the parties, and not
with minority SHs absent looting, conversion of a corp opportunity, fraud or bad faith (Zetlin v. Hanson
Holding)

Equal Opportunity Rule

 If a transaction looks like looting (for example, where the buyer is going to extract more than pro rata value),
the seller might have to share some of the profits
o Selling a corporate opportunity might be different than selling the ability to run the company (Perlman
v. Feldman)

Sale of corporate office

 Although you can sell corporate control, you cannot sell corporate office
 The 10% Block & Ratification rules: Case law generally distinguished between sales of control & sales of
office on the basis of:
 The % of shares sold; and
 Whether the other SHs ratify new the officers
 If you are a looter what do you really want?
o You want as small a stake as possible so that when the stock price goes down
you don’t lose too much on that end while looting
o The efficient buyer wants a large stake b/c they are adding value to the company
& want to benefit from that

REMEMBER: Sale of an office and sale of a controlling block look very similar, but courts treat them VERY
differently.

Tender Offers
 A premium public offer at fixed price, open for a set period. An investor who wishes to purchase a control
stake in a widely held company must do so by aggregating the shares of many small shareholders. The offer is
an offer of cash or securities to the shareholders of a public corporation in exchange for their shares at a
premium over the market price.
 Regulated by the Williams Act:
1) Early warning system (§13(d)): requires disclosure whenever anyone acquires more than 5% of the
stock.
 Must file w/in 20 days of acquiring. Qualified institutional investors and passive investors are
exempted.
2) General Disclosure: (§14(d)(1)): requires tender offeror to disclose identity and future plans,
including any subsequent going-private transactions.
3) Anti-Fraud Provision (§14(e)): prohibits any fraudulent, deceit, or manipulative practices in
connection with a tender offer.
4) Terms of Offer (§14(d)(4)-(7)): governs the substantive terms of tender offer must be open for 20
business days, must be made to all holders and all have to get same deal, bidder cannot buy outside the
tender offer.
 Hart Scott Rodino Act: must wait 30 days before closing transaction so the gov’t has time to assess it, must
wait 15 days for cash tender offers. Can be extended. Merging firms must file with the DOJ and DTC.
 MERGERS AND ACQUISITIONS
Statutory Mergers
 DGCL §251; RMBCA §11.03
 Allows two corporations to merge into one
 Acquiror (A) and target (T) negotiate the merger and adopt a resolution approving the merger and recommend
it to the shareholders. T’s shareholders vote. (A’s shareholders only vote is A’s outstanding stock will increase
by more than 20%.) If majority approves, T’s assets merge into A, T’s shareholders get A stock, and certificate
of merger is filed with the Secretary of State. Dissenting shareholders get appraisal rights.

Asset Sales
 DGCL §271; RMBCA §12.02(a)
 Acquire all or essentially all of the assets. T may continue by name but will just be a shell. Good when T has
liability or bad reputation
 A and T negotiate the merger, proxy materials and vote for T shareholders only, transfer assets, T liquidates
consideration received to shareholders
 Sale of substantially all assets require shareholder vote of T, but not A
 See Katz v. Bregman

Short Form Mergers

 DGCL §253
 Mergers of 90% owned subsidiary do not require a vote by the other 10% of shareholders

Compulsory Share Exchange

 Not available in DE
 RMBCA §11.03
  Offer negotiated with T board of directors that, after approval by the requisite majority of shareholders,
becomes compulsory for all shareholders
 Similar to statutory mergers but with a “forced” tender offer
 Accomplished in DE with triangular mergers
 Same tax implications of a tender offer without same time and minority shareholder issues

Two-Step Merger (in DE in lieu of Compulsory Share Exchange)

- T&A boards negotiate two linked transactions as one single package. Tender offer for most or all of T’s shares.
Merger between T and a subsidiary of A which followed tender offer and removes minority shareholders who
failed to tender shares.

Triangular Mergers (form of the two-step)

Start with three corporate entities (parent purchaser, subsidiary, target). If subsidiary mergers into T then it is a reverse
triangular merger. If T mergers into the subsidiary, then it is a forward triangular merger.

Duty of Loyalty in Controlled Mergers (Freeze-Out Mergers)

o Terms:
o Freeze-out tender offer: tender offer + short form merger
o Freeze-out/Cash-out Merger: existing controlling shareholder merges the companies together and
cashes out minority shareholders.
o Fiduciary Duty Claim
o Fairness Actions dominate b/c (1) appraisal right might not be available; (2) actions claiming breach
can be brought before merger is finished; (3) can be class actions.
o Wienberger Rule: if P alleges and shows transaction was between controller and the company, fiduciary
ahs burden to establish the transaction was fair in all respects to the corporation. (Check M&F
worldwide to prove dependency)
 Entire Fairness test: (1) shareholder ratification and (2) independent director approval.
 Can use Special Committee.
 If fiduciary can meet fairness test, P must show unfairness by questioning independant judgment
committee, unfair opinion, lack of real negotiation.
 o NEW LAW:
o Use BJR in controller buyouts if and only if:
 (i) the controller conditions the procession of the transaction on the approval of both a Special
Committee and a majority of the minority stockholders;
 (ii) the Special Committee is independent;
 (iii) the Special Committee is empowered to freely select its own advisors and to say no
definitively;
 (iv) the Special Committee meets its duty of care in negotiating a fair price;
 (v) the vote of the minority is informed; and
 (vi) there is no coercion of the minority.
o If not, use entire fairness review.

Shareholder Voting Rights in M&A

Statutory Merger Asset Acquisition Share Exchange

(DGCL 251; RMBCA (DGCL 271; RMBCA (RMBCA 11.03)
11.02) 12.01-12.02)
T Voting Rights Yes – need majority of Yes, if “all or Yes – need majority of
shares outstanding substantially all” assets shares voted (RMBCA
(DGCL 251(c)), or are being sold (DGCL 11.04(e))
majority of shares voted 271(a)) or no “significant
(RMBCA 11.04(e)) activity” (RMBCA
12.02(a))
A Voting Rights Yes unless fewer than No Yes, unless less than 20%
20% new shares are being shares being issued
issued (DGCL 251(f), (RMBCA 11.04(g))
RMBCA 11.04(g))

Concerns by Lawyers

Barrier Lawyer Response

Different expectations about value of company Build in contingent payments: Earn out or Claw
backs
Different time preferences Negotiate timing and payment
Asymmetric information: the “lemons” problem Build in representations, warranties,
indemnification, and opinions
Imperfect information Negotiate to “seller’s knowledge” versus “to the
best of seller’s knowledge” versus “to the best of
seller’s knowledge and after diligent
investigation”

Appraisal Rights
 DGCL §262
 Anyone who had the right to vote on a merger and did not approve the merger will have a right to appraisal in
order to seek the fair value of their shares
o Process:
 SH get notice of appraisal right at least 20 days before SH meeting (§262(d)(1)).
 SH submit written demand for appraisal before shareholder vote, and then votes against (or at
least refrains form voting for) the merger (§262(d)(1))
 If merger is approved, shareholder files petition in Chancery Court within 120 days after merger
becomes effective (§262(e))
 Court holds valuation proceeding to demine the shares’ faire value exclusive of any elements of
value arising from accomplishment or expectation of the merger (§262(h)).
 No class action device available, but chancery court can apportion fees among plaintiffs as
equity may require (§262(j)).
 Statutory Merger Asset Acquisition Share Exchange
(DGCL 251; RMBCA (DGCL 271; RMBCA (RMBCA 11.03)
11.02) 12.01-12.02)
Appraisal Rights Yes if T shareholders vote Yes under RMBCA if T Yes unless stock market
unless stock market shareholders vote unless exception (RMBCA
exception stock market exception; 13.02(a))
No in DE unless provided
in charter

Market-Out Rule (§262(b))

 Exception to Appraisal Rights
 Don’t get appraisal rights if any of the following exist: (b)(1)
o If consideration is SHARES and your shares are market-traded
o Company has 2k shareholders
o Shareholders are not required to vote on the merger
 This means that if the compensation/consideration for the merger is CASH then you are ALWAYS going to
have appraisal rights. ((b)(2)). If it is a mix of cash and shares, then you only have appraisal rights to the cash.
If it is just shared, then no appraisal rights exist

Minority Freeze-Out Transactions

 If the transaction is challenged, DE courts apply entire fairness standard when reviewing minority freeze out
transactions
 Under entire fairness review, directors have the burden of proof to show that the transaction as a whole is fair
to minority SHs
 Burden is shifted to Plaintiffs if: (1) Properly functioning special committee (e.g. the SC must be comprised
solely of independent directors and have real negotiating power); and (2) approval of transaction by majority of
minority SHs (e.g. closing or merger or tender offer conditioned upon approval of a majority of the minority,
as well as other factors: Kahn v. M&F Worldwide)
 Using a special committee to negotiate
 The idea is to negotiate at arms length between the controlling SH and the acquirer. The
SC has the power to refuse, at least theoretically, the plan proposed by the controlling
SH if it is unfair. (Kahn v. Lynch)

OTHER IMPORTANT THINGS TO KNOW

Poison Pill
 PP was upheld under Unocal: (1) board ahs authority to adopt a poison pill under DGC 157 and 151g and (2)
adoption of a pill is a valid exercise of business judgment.
 Implementing Flip In PP:
o Step 1: Rights plan adopted by board vote. Shareholder vote not necessary as long as the board has
the requisite provision in the charter allowing it to issue blank check preferred stock.
o Step 2: Rights are distributed by dividend and remain “embedded” in the shares.
o Step 3: Triggering event occurs (it never does) when prospective acquirer buys > 10% of
outstanding shares. Rights are no longer redeemable by the company and soon become exercisable.
o Step 4: Rights are exercised. All rights holders are entitled to buy stock at half price – except the
acquirer, whose right cancelled.
 CASES
 Jenson Farms v. Cargill (Minn. 1981) (Formation of Relationship, Implicit Assent): Jenson sued Cargil
(food products conglomerate) and Warren (grain elevator) to recover losses when Warren defaulted on
contract. Warren is insolvent ($4 million in debt). Farmers are arguing that Cargill is a principal for Warren,
Cargill says that it has merely loaned Warren money. Issue: was there sufficient relations to hold Cargil liable
for Warren’s default? Holding: Yes: although there was no explicit agreement, a jury could find an agency
relationship b/c there were sufficient indicators of Cargill’s control over Warren. 9 factors listed on page 12 of
the book: Cargill made constant recommendations, had first right of refusal on grain, Warren needed Cargill’s
approval in order to enter into mortgages/purchase stock/pay dividends, Cargill had a right of entry onto
Warren’s premises to carry on checks and audits, Cargill criticized Warren’s finances, officers’ salaries and
inventory (correspondence), Cargill claimed that Warren needed “strong paternal guidance”, Cargill financed
Warren’s purchases of grain and operating expenses, and Cargill had the power to discontinue the financing of
Warren’s operations. Actions can equal assent even if not explicitly given. The parties conception of the
relationship does not control…can prove that a principal/agent relationship exists by the circumstantial
evidence between two parties.

 White v. Thomas (Ark. App. 1991) (Apparent Authority): White employed Simpson part time for two years,
instructed Simpson to attend auction and bid up to 250K on a farm. She overbid, wound up paying $327,500
and then negotiated to sell 45 acres of the property to Thomas in an attempt to make up for her mistake….she
signed the contract with Thomas as POA for White. White was unhappy and repudiated the deal. Thomas sued
White (as Simpson’s Principal) for specific performance. Court held that there was no apparent authority b/c
Thomas couldn’t have thought buying and selling were closely related. Thomas knew Simpson had POA to
buy, but it doesn’t mean he thought she had POA to sell. Blank check showed apparent authority for buying,
not selling…..Thomas could have followed up with the principal but he didn’t.

 Gallant Ins. Co. v. Isaac (Ind. App. 2000) (Inherent Authority): Gallant (principal) issued car insurance to
Isaac through Thompson Harris (independent agent). Thompson-Harris bound Gallant to new insurance
policies. Forms were changed by TH (without Gallant’s approval…application said that an agent can’t change
terms of the policy). Isaac got into accident during policy lapse. Court found that there was no actual
(implied/incidental) or apparent authority. Sua sponte addressed inherent authority. TH was left unsupervised
to develop this practice. Gallant knew it was going on and didn’t do anything to stop it. How was Isaac
supposed to know her insurance agent works with the overarching company? Therefore, inherent authority
existed……however, inherent agency power has fallen out of favor.

 Humble Oil v. Martin (1949 Tex.) (Employee v. Independent Contractor): Car parked at a gas station rolls
down a hill and injures Martin + kids. Martin sues the owner of the station (Humble Oil), the station’s operator
(Schneider) and the owner of the vehicle (Love). Schneider had commission agency agreement with Humble.
Martin attempted to make the case that Schneider was an agent of Humble Oil. Court held a relationship
existed b/c Humble established strict financial control and supervision over Schneider: use of docs, humble
owned everything, paid for most expenses, Schneider had to sell Humble products, rent owed to Humble was
based on the amount of products sold by Schneider….Schneider was a “glorified store clerk”. Humble failed in
its argument that Schenider should be considered an independent contractor.

 Hoover v. Sun Oil (1965 Del.) (Employee v. Independent Contractor): Hoover sued Sun and station operator
for negligence b/c his car caught fire (gas station attendant was smoking while filling up the car). Hoover
argued that the operator should be viewed as an agent of Sun Oil….wore a Sun Oil uniform, sold Sun Oil
products, Sun Oil employees inspected the station. **P-A relationship did not exist when an independent
contractor controls day-to-day operations of entity that is responsible for damages suffered by plaintiff.
Independent contractor was in change of day to day operations, could sell competing products, no
documentation…had more control in comparison to Humble Oil. From a public policy perspective, we want
the people in control to be held liable…they’re in a better position to monitor.

 Tarnowski v. Resop (Minn. 1952) (Profits to Principal): purchaser employed agent to investigate/negotiate
purchase of a business…perform due diligence on P’s investment (coin-operated money machines). Agent did
 not follow the principal’s directions and accepted a secret commission from the sellers. Purchaser sued to
recover secret commission. **All profits made by agent in course of agency belong to principal.

 In Re Gleeson (Ill. App. 1954) (Can’t self-deal as a trustee): Farm owner died, left land trust to children.
Trustee rented the land to himself…had his partnership farm the land because he didn’t want to miss a farming
season (wanted beneficiaries to get income). He even raised the rent the following year. There was still a
breach of loyalty (self-dealing) b/c trustee relationship is strict.

 Meinhard v. Solomon (NY 1928) (Duty of loyalty to co-owner): M and S entered into partnership for hotel
business. M was a passive investor and S ran everything. Did not work well together. When lease was about to
end, S and owner (Gerry) went into negotiations and made a new deal…M was left in the dark. M sued
because he believed it was his legal right to be involved in the new venture….demanded lease be held in trust
as an asset of venture. M wanted an option to renew (right of first refusal). Court held that the relationship and
duty of loyalty continue while the enterprise continues. S must inform M of any new opportunity. No longer
good law.

 Vohland v. Sweet (Ind. App. 1982) (Has a partnership been formed?): S worked for V’s father at nursery.
S’s status changed: V decided to give S a 20% share of net profits after all expenses….V viewed S as an
employee and thought this was a legit commission. S brought action for dissolution of partnership (wants to
wind-up) and won. V appealing. No partnership income taxes filed, V borrowed money in his own name, S &
V restocked nursery using part of net profits and therefore part of net shares. Holding that there was a
partnership created b/c prima facie case of profit sharing and sweat/equity investment. The parties must have
intent to form a partnership, but this means “an intent to do those things which constitute a partnership,” rather
than the specific intent to become partners. Look at control, risks, stakes each person has in the business.

 Nabisco v. Straud (Need majority): Straud and Freeman entered G.P. to sell groceries. Straud told Nabisco
that they didn’t want any more bread. Freeman wanted to order more bread and Nabisco sold the bread. The
bill didn’t get paid and the partnership dissolved. Under UPA, S wanted to make a decision in the ordinary
course of business so he needed a majority vote (which he didn’t have)…Stroud therefore did not have the
authority to remove Freeman’s authority. The partnership was obligated to pay for the bread.

 Adams v. Jarvis (Wis. 1964) (Can contract around UPA): GP of 3 doctors. One is leaving and says his
leaving constitutes dissolution and that the partnership must wind down. Other doctors do not want to wind
down. Trial court decided that plaintiff’s withdrawal was dissolution and assets would be liquidated and
divided according to UPA. Adams wanted to dissolve to get accounts receivable. But partnership agreement
was clear that partnership would continue even after withdrawal (“The incapacity, withdrawal, or death of a
partner shall not terminate this partnership”). Differing terms between termination and dissolution shouldn’t
default the agreement to the UPA standards. Agreement outlined that partners have duty to get accounts
receivable. Adams ended up getting 5/12 (leaving after 5 months) * 1/3 (3 partners) of the profits in the year of
his withdrawal. Everything in the UPA can be superseded by contract.

 Page v. Page (Cal 1961): oral partnership agreement, older Page (plaintiff) wanted to terminate after a few
years. Each contributed $43k. Loan for $47k by older Page that allowed him to make demand on any time.
Air force base came in and was more lucrative, older Page tried to dissolve. Younger Page argued that they
were in a partnership for a specific term…needed to repay debts…cited past partnerships with the older Page
that lasted for specific terms. Trial court ruled that it was a partnership term: long enough for partnership to
repay partnership profits. Appeal ruled that it was a partnership at will b/c every partnership is for profit.
However, the older Page still wasn’t allowed to dissolve the partnership just b/c it would be more profitable
solo. Dissolution must be done in good faith….need to fairly pay out debts and assets.

 Pappas v. Tzolis (NY Ct. App. 2012): 3 partners pooled money together. Tzolis obstructed the other two
partners from leasing the building to someone else, goes on to negotiate a great deal behind the back of the
other two partners. Tzolis bought the other partners out  got the great deal, other two partners are pissed.
Partners alleged a breach of fiduciary duty. Lower court  there was no fiduciary duty…cited a certificate
signed by the partners during negotiation process (“we haven’t relied on anything”). Appellate court reverses
  Tzolis’s duty of disclosure was not extinguished by the certificate. Tzolis has not proven that the agreement
allowed him to secretly negotiate the sale of the company’s only asset. Relationship is adverse. Highest Court
(Court of Appeals reverses again)  the fraud/misrepresentation claim is BS. The operating agreement
specifically permitted members of the partnership to engage in outside business, including competing business.
LLCs are very flexible….can contract around common law fiduciary duties….but the courts still get to say
what’s good faith and what isn’t.

 Sea-Land Services v. Pepper Source (7th Cir. 1991) (Van Dorn Test): SL shipped peppers for PS. PS did not
pay SL a freight bill. SL filed suit for $, but PS was already dissolved for failure to pay state franchise taxes.
SL got a favorable judgment but since PS was dissolved it was looking to reverse-pierce the corporate veil in
order to get the money. SL brought suit against Marchese as an individual and the 5 other business entities he
owned. SL believed these corporations were alter egos for each other and Marchese created for his personal use
and shield from liability. First prong of Van Dorn test (above) was met (no meetings of the corporations, no
articles of incorporation or bylaws, Marchese ran everything from one location, companies borrowed money
from each other interest-free). Second prong not satisfied because SL did not argue that a further injustice
would occur other than just losing money. Injustice can’t just be that counterparty cant get judgment, has to be
something beyond the fact that P cant get money out of the corporation. Reversed and Remanded to find if
there was an injustice other than that the plaintiff could not fully recover. Examples of what a further injustice
would be: unjust enrichment, escaping rules or liabilities, common sense rules of adverse possession,
intentional scheme going on. Second prong was ultimately satisfied (fraud).

 Kinney Shoe Corp. v. Polan (4th Cir. 1991) (Laya Test): Cabel County (parent) Kinney Shoe (sub)
Industrial (Parent 2/lessee) Polan (Sub 2/sub- lesee). Kinney seeking to recover rent owed on a sublease
between Kinney and Industrial, and Polan is sole shareholder of Industrial. Industrial went bankrupt, so Kinney
went after Polan personally. Other than this sublease, Kinney had no assets or bank accounts. Industrial only
had income from a sublease to Polan. Court said undercapitalization of Industrial was not enough, but
ultimately found that the two prongs of the test were satisfied. Industrial did not observe corporate formalities.
Those who get to benefit from limited liability should be able to do the few things required for creating and
maintaining corp (“you didn’t even try”).

 Walkovsky v. Carlton (NY 1966) (Lowendahl Test): Taxi case…this is wise corporate structuring. P injured
when hit by a taxi in NYC. Cab owned by Carlton’s corporation. Carlton also owned 9 other corporations with
2 cabs registered in their names. Corps. seemed independent but allegedly they operated as a single entity.
Carlton trying to limit his liability. Even though it could be argued that they were shell companies or fragments
of a larger company, the allegations themselves weren’t enough. Dissent  thinks 10 corps with no assets and
minimal capitalization is funny enough to pierce.

 Credit Lyonnais Bank (Del. Chancery Court): held that when a corporation is in the vicinity of insolvency, the
directors, in making business decisions, should not consider shareholders’ welfare alone, but should also
consider the welfare of the community interests that constitute the corporations…include the creditors
 N. Am. Catholic Edu. v. Gheewalla (DE 2007): Creditors cannot assert a direct claim (alleging injury to their
own interests as creditors) but do have standing to assert a derivative claim (alleging injury to the corporation)
against an insolvent corporation.
 Directors in the zone of insolvency “must continue to discharge their fiduciary duties to the
corporation and its shareholders by exercising their business judgment in the best interests of the
corporation for the benefit of its shareholder owners.”

 Kamin v. Amex (NY 1976): BJR applied to decision by AmEx. Amex bought shares of DIJ and lost $25M.
Amex wanted to distribute shares to shareholders as dividends, Kamin wanted them to sell the shares to offset
tax savings. No claim of fraud or self dealing. Court ruled that there was no claim b/c of BJR. Court will not
interfere unless a clear case is made out of fraud, oppression, arbitrary action or breach of trust. After Kamin
and until Van Gorkom, it was a given that a corporation would be protected by BJ rule.

 Smith v. Van Gorkom (Overcoming Business Judgment Rule): first time that court held financially
disinterested directors were personally liable for consequences of business decisions b/c they were grossly
 negligent by not making informed business decision. (Rare that courts apply this nowadays). Van Gorkom
called a special meeting of the board but did not give them an agenda and board approves the merger after two
hour meeting (20 min pres.). Meeting was egregiously sloppy, cannot agree to merger without any analysis and
examination of financials.

 Francis v. United Jersey Bank (NJ 1981) (Duty to Monitor): family owned reinsurance business. Sons took
“loans” for themselves. Ms. Pritchard, the other owner, was sued for passivity and held liable. BJ rule did not
apply because widow was not informed at all, she made no judgments when she could have done something
(stepped down, sued sons, stopped them). Directors must say something, get help, or resign.

 In re Caremark Litigation (Del. Ch. 1996) (Duty to Monitor, Pipeline): DOJ found a bunch of crimes. Civil
suit including duty of care claims. Court was reviewing and said there was a low probability that duty of care
violation happened. Rule (see above). Court looked at the warning systems in place for compliance (internal
checkmarks, PWC investigation, ethics manual). No evidence that showed evidence of violation. Caremark
had always had an ethics guidebook, an internal audit plan, and a toll-free confidential ethics hotline. A system
was in place to monitor….a pipeline to know what employees are doing

 Stone v Ritter (Del. 2006) (Reaffirming Caremark): new standard…see LR outline.

 Graham v. Allis Chalmer Mfg. (Del. 1963) (Duty to Monitor, Red Flags): AC was large decentralized corp.
that made electrical equipment. 1930’s was busted for price fixing and then in 1950. Defendant directors said
they had no knowledge of price fixing. Plaintiffs argued they should have known. Holding: duty to monitor is
entitled to deference, absent showing of red flags. Directors should be able to rely on info from employees and
compliance at face value

 In re Citigroup Shareholder Derivative Lit (Monitoring business risks): shareholders sued after subprime
issue under Caremark theory. Court held that BJR applied b/c there was no evidence of ill informed decisions,
just bad business decisions. Distinction between misconduct (Caremark) and business risk.

 Cookies v. Lakes (Self Dealing can be ok): Cookies Inc is formed to make BBQ sauce, Cookies enters into
distributship w/ minority shareholder (Herrig). Distributorship is successful and Herrig buys out Cook,
becomes controlling shareholder. He makes self-dealing contracts. Shareholders were pissed b/c they couldn’t
get dividends until loans were paid, loans wouldn’t be paid if he kept getting raise. Rule: directors must
establish they acted in good faith, honesty, and fairness in addition to requirements that any such transactions
must be fully disclosed and consented to the board of directors or shareholders. Holding: even though it was
self dealing, it was fine b/c he provided info and was consented.

 Hayes Oyster Co. v. Keypoint Oyster (Duty to disclose): Hayes is director, shareholder, and CEO of Coast
Oysters (public co). Hayes suggests to another Coast employee to form new corp. called Keypoint. Coast
faces cash flow problems and Hayes convinces board to sell two oyster beds to Keypoint. Hayes Oysters also
arranges to help Keypoint w/ financing in exchange for 50% equity. Hayes Oysters getting 50% happens after
Coast votes to sell but before Coast shareholders approve. Coast’s new mangaement discovers what Hays did
and brings suit. Holding: Hayes should have disclosed his self interest before he voted for the sale. Violation
of duty to disclose under duty of loyalty. Disclose or abstain.

 Cooke v. Oolie (BJ rule is appropriate when disinterested directors vote same as interested): O and S
were directors and creditors of company, voted to pursue an acquisition proposal that best protected their own
interest instead of accepting proposals for shareholders. But since disinterested directors voted to approve the
deal, O/S did not breach duty of loyalty b/c BJR applied. Court used DGCL § 144(a)(1). Disinterested voter
ratification cleanses the taint of interest. Their vote signals that the interested transaction furthers the best
interests of the corporation

 In re Wheelaborator Tech: WTI was bought in merger by WMI, which owned shares but not control. Four
WTI officers were WMI directors. WTI uninterested shareholders approved transaction. Other shareholders
claimed breach of duty under DGCL § 144. Rule: fully informed shareholder’s ratification does not extinguish
 duty of loyalty claim, but serves to make BJR the applicable review and shift burden to plaintiff to prove
waste. Holding: since transaction did not involve controlling SH, BJR applies.

 Sinclair Oil Corp. v. Levin: SOC was major SH of Sinven and nominated all members of board and controlled
the company. Minority SH (Levin) alleges SOC caused Sinven to pay excessive dividends. Rule: BJR applies
b/c there is no self dealing in a situation where the benefit is not exclusive to the majority shareholder
(dividends were distributed proportionately). Holding: entire fairness applies.

 Weinberger v. UOP: Signal owns 50.5% of UOP and holds 7/13 seats of UOP board. Signal board decides to
buy remainder of UOP to invest. Two directs of UOP and S perform study and pass along price of $24 as good
investment. Price study was shared with Signal board but not with overlapping UOP members. S offers $21 a
share (55% control premium) conditioned on getting approval from majority of minority UOP shareholders.
UOP non-overlapping board approves. Suit for duty of loyalty violation. Rule: apply fairness test. Holding: S
failed to disclose non-overlapping UOP board their study. Remand to determine price and other factors. One
party had superior knowledge, negotiations were done too quickly (3-4 days), the fairness reports were done in
a hasty manner so minority shareholder vote was not an informed one. A special committee could have solved
this problem if there was real deliberation.

 Fletcher v. A.J. Industries (Substantial Benefit Rule): formation of substantial benefit test. Settlement was
made and attorneys were granted fees.

 Levine v. Smith (Del. 1991) (Need to make demand unless doing so would be futile): makes Aronson
Disjunctive (or instead of and) and Broader. GM buys EDS from Ross Perot in a stock transaction that made
Perot GMs largest SH. Perot is on board and criticizes GM. GM pays Perot $742M in exchange for his stock,
notes, and agreement not to wage proxy contest or criticize GM. Deal is approved by subcommittee and then
22 other board members. Shareholders sue claiming breach of fiduciary duty. Argue that demand is excused
b/c it would have been futile. Court  management didn’t lack independence…valid exercise of the board
members’ business judgment…insufficient facts to support the shareholders’ argument

 Oracle Derivative Litigation: inquiry to independence of SLC is highly individualized. Court ruled that
members of SLC couldn’t make independent choice b/c of school ties to Stanford. Members of the same
church having coffee together. Court looked at where they went to school, different community service and
foundations the members were involved in, where they all live and the potential for social awkwardness as
indicators of interest.

 Perlman v. Feldman (2d Cir. 1955) (Equal opportunity Rule (rare)): Korean war had steel shortage, semi-
official price freeze and rationing of steel. Feldman (Director and CEO) controlled 37% of Newport Steel.
Sells stake to Wilport for $20 a share when stock was trading at $12. Feldman resigns and Wilport takes
control of the board. Court says he breached fiduciary duty by selling the goodwill of the company. Employs
equal opportunity doctrine and disperses the premium b/c company would have made money.

 In re Delphi (Del. Ch. 2012): Rosenkranz contributes 12% of capital and owns 49.9% of the votes o Delphi.
Equal opportunity rule for Class A and Class B for sale of company. Rosenkranz is adamant about receiving
control premium before voting for the sale to go through and gets amended charter to allow for some control
premium. Court thinks this is in violation of good faith and fair dealing b/c he agreed to forego those rights at
the time of purchase.

 Kahn v. Lynch Comm. (Del. 1994): shareholder owed fiduciary duty if owns majority interest or exercises
control over business affairs of corp. Alcatel owns 43.3% of Lynch Comm; Lynch wants to buy Telco, but
supermajority provision allows Alcatel to veto. Alcatel tells them to acquire Celwave (owned by Alcatel)
instead. Lycnh appoints special committee to negotaite with Celwave. Alcatel threatens to hostile takeover if
they don’t accept, special committee accepts. *Mere existence of spec. comm. doesn’t shift burden. They
must have real bargaining power and exercise it with majority shareholder at arm’s length. Threat of hostile
takeover meant no real choice.
 Kahn v. M &F Worldwide: defining independent v. controlling
o *To show that a director is dependent, a plaintiff must demonstrate that the director is beholden to
controlling party or so under [the controller’s] influence that [the director’s discretion would be
sterilized. Inquiry must be whether, subjectively, the ties were material in the sense that they would
affect the impartiality.

 In re Siliconix (Del. Ch. 2001): unilateral tender offer, followed by short form merger (aka freeze out tender
offer). Rule: freeze-outs executed via tender offer are not subject to entire fairness review.

 In re CNX Gas Crop. (Del. Ch. 2010): entire fairness applies to controlling shareholder tender offer that lacks a
special committee recommendation.

 Smith v. Van Gorkom: BJR did not apply b/c directors had been grossly negligent in failing to act informed
reasonable deliberation.