Corporations Outline- Blair (Fall 2010)

I. Chapter 1: Economic and Legal Aspects of the Firm

A Basic Concepts and Terminology 1 The Classical Firm business owned and managed by one person; sole proprietorship a Coase identifies a "firm" as the antithesis of the market with respect to the means by which economic resources are allocated. i Resources are allocated pursuant to conscious order or directions from the entrepreneur to her employees the essence of the firm is the entrepreneur's management and conscious direction of resource allocations decisions 2 The Business Association jointly owned firm (partnership, corporation, limited liability company) a Very small number of owners "closely held" b Firms with thousands of owners "publicly traded" 3 The Modern Corporation and the Berle-Means Critique a The modern corporation was characterized by a complete separation of ownership from control b The firms managers did not own a controlling amount of the corporation's stock i Great majority of the stock was in the hands of a large number of passive, geographically dispersed shareholders, who had neither the means nor the will to monitor managers or engage in the process of electing the corporation's directors ii Berle and Means's view was that the modern corporation destroyed the theoretical underpinnings of the free enterprise system 4 The Return of Free Market Ideology: The Firm as a Nexus of Contracts a Emphasis on the contractual nature of the firm rather than the distinction between the firm and the market i A firm is described as a nexus of contracts between the various claimants to a share of the gross profits generated by the business 5 Separation of Ownership and Control and Agency Costs a Understanding the relationship between passive shareholders and managers: i Shareholders are the principals; managers are the agents of the shareholders In law principals have legal rights of control and direction and agents have legal obligations of obedience ii Agency-cost-limiting devices: 1) direct monitoring of managers' actions 2) bonding agreements by managers that will result in the imposition of penalties or other costs if certain objectively verifiable events do or not occur 3) incentive schemes to align managers' interests with those of shareholders 6 The New Millennium: Corporate Scandal, Financial Crises, Corporate Governance, and Government Regulation a The modern corporation does not have a traditional entrepreneur/owner B Organizing the Firm: Selecting a Value-Maximizing Governance Structure C The Firm and the Law of Agency 1 Agency Law and the Choice of Sole Proprietorship Form Restatement (Third) of Agency 1.01, 1.02, 1.03 a A firm is created simply by unifying the ownership and control of the team in the hands of one or more owners, referred to in agency law as the principal, while other team members agree to serve as employees, generally referred to as agents. 1

Corporations Outline- Blair (Fall 2010) i So long as the relationship exists, the agent is subject to the principal's control with respect to the services that the agent has agreed to perform. ii The law of agency imposes a fiduciary duty on agents, and other legal doctrines impose some limits on the principal's right to discharge an employee b Fiduciary Limits on Agent's Right of Action i Fiduciary duty substitutes for an express contractual specification of exactly what an agent may or may not do. ii Community Counseling Service, Inc. v. Reilly: The law provides the framework for fiduciary duties, if you don't like these default rules you can contract around them iii Hamburger v. Hamburger: arranging financing and leasing space while still employed is not illegal an employee is free to make logistical arrangements while still an employee; an employer who wishes to restrict the post-employment competitive activities of a key employee, where the activities do not entail misuse of proprietary information, must protect that goal through a non-competition agreement. c Limits on the Firm's Right to Discharge an Employee at Will i Foley v. Interactive Data Corp: absent any contract, however, the employment is "at will," and the employee can be fired with or without good cause; this right is still subject to limits imposed by public policy (otherwise the threat of discharge could be used to coerce employees into committing crimes, concealing wrongdoing, or taking other action harmful to the public); presumption of at-will employment can be overcome by evidence of contrary intent d Agency Law and Relations with Creditors Restatement (Third) of Agency 2.01-2.06, 3.01, 3.03 i The decision to operate as a firm creates a need for rules allowing creditors and others to know with whom they are dealing ii Traditional common law rules are designed to protect a principal's property interests a third party who deals with an agent does so at his peril the agent's actions will bind the principal only if the principal has manifested his or its assent to such actions iii Manifestations of consent can take two forms: Actual authority: occurs when the principal manifests his consent directly to the agent Consent may be expressly manifested (like in writing or orally) Consent can be implied from the conduct of the principal If actual authority exists, the principal is bound by the agent's authorized actions, even if the party with whom the agent deals in unaware that the agent has actual authority, and even if it would be unusual for an agent to have such authority Apparent (ostensible) authority: arises when an agent is without actual authority, but the principal manifests his consent directly to the third party who is dealing with the agent May be created expressly or impliedly A third party will be able to bind the principal on the basis of apparent authority only if the third party reasonably believed that the agent was authorized 2

Corporations Outline- Blair (Fall 2010) iv The result of this struggle to protect third parties was both an increasingly flexible application of the concept of apparent authority and the growing recognition of a new category of authority Inherent authority: does not arise from manifestations of consent of the type contemplated by traditional common law authority rules, but rather springs from a desire to protect the reasonable expectations of outsiders who deal with an agent Gap-filling device used by courts to achieve a fair and efficient allocation of the losses from an agent's unauthorized actions Two types of inherent authority case: 1) An agent exceeds her authority in an attempt to further the interests of the principal 2) totally opportunistic action, where the agent intentionally misleads both the principal and the third party Blackburn v. Witter FACTS: Long advises widow to invest in American Commercial Investment Company. Long gives her receipts for the transactions but these are not the standard investment receipts she had previously received. He gives her promissory notes saying "I.O.U." from himself. When she inquires about the abnormalities, Long tells her not to worry. COURT: The court held the investment company liable under ostensible authority; Dean Witter had the responsibility to inform clients of the scope of Long's employment and at the point of his discharge had a duty to notify clients Sennott v. Rodman & Renshaw: The difference between this case and Blackburn is that in this case, the third party knew the purported "agent" was not acting as an agent to the "principal" Rodman & Renshaw.

II. Chapter 2: Partnerships

A Traditional Non-corporate Business Associations 1 The General Partnership UPA (1997) 103, 202, 301, 306, 401, 601, 801 a The association of two or more persons to carry on as co-owners a business for profits creates a partnership i Can come into existence by operation of law, with no formal papers signed or filed ii Any partnership is a "general" one unless the special requirements for limited partnerships are complied with. b Equal sharing of ownership and management functions i Each partner is a residual claimant, has a full and equal right to participate in management of the firm, and has an equal right to act as an agent of the partnership ii Each partner has an equal share of profits and an equal responsibility for losses c Individual partner's adaptability to changed circumstances favored over firm's continuity and adaptability i If the partnership wishes to terminate its association with a partner, it may do so only by dissolving the partnership and paying the expelled partner the value of her interest in case. ii Adaptation of partnerships comes with lack of stability and continuity d Unlimited personal liability 3

Corporations Outline- Blair (Fall 2010) i All partners are jointly and severally liable for all obligations of the partnership and there is no limit on this potential personal liability e Fiduciary duty i Each partner owes a fiduciary duty to the other partners 2 Joint Ventures a A less permanent and less complete merging of assets and interests than does the label "general partnership" i Perhaps the greatest current use of joint ventures is by larger corporate firms that unite for a single purpose 3 The Limited Partnership ULPA (2001) 102(8)-(13), 107, 301-303, 401-404, 603, 604 a A business association composed of one or more general partners and one or more limited partners and that is formed by filing a certificate of limited partnership with the secretary of state in the jurisdiction chosen by the parties in control of the limited partnership b Separation of ownership and management functions i Limited partners have essentially no management power and no authority to act as agents in carrying out the partnership's business ii General partners are the active participants in the firm, empowered to make and carry out the firm's business policies c Limited liability i Limited partners are not personally liable for the limited partnership's obligations ii General partners are jointly and severally liable for the firm's obligations d Firm's continuity and adaptability to changed circumstances favored over individual's adaptability i General partners may withdraw from the partnership at will, but limited partners may not Such withdrawal does not automatically or necessarily trigger dissolution and liquidation of the limited partnership B Emergence of Additional Limited Liability Entities as the Norm 1 Impetus for New Forms a Concern for vicarious liability, coupled with the unsuitability of existing limited liability entities, led planners and policy makers to search for alternative means to provide the favorable tax treatment of general partnership form while avoiding its unfavorable limited liability rules 2 The Limited Liability Partnership UPA (1997) 306, 1001; ULPA (2001) 102(9), 404(c) a Limited Liability Company was authorized in the 1990s i If an LLC were unable to satisfy its obligations, its owners would lose only the capital they had actually invested in the company; are not personally liable for the debts and obligations of the LLC that could not be satisfied out of the firm's assets b Limited Liability Partnership and Limited Liability Limited Partnership i Limited liability as an opt-in default rule for firms operating as a general or limited partnership ii To become an LLP or LLLP , an existing or newly created general partnership simply registers with the secretary of state as an LLP or LLLP General partnership law governs an LLP in all respects except for special statutory

Corporations Outline- Blair (Fall 2010) liability and asset-distribution-limiting provisions designed to protect third parties Limited partnership law similarly governs an LLLP C Determining the Legal Nature of the Relationship UPA (1997) 202, 203 1 Byker v. Mannes a ISSUE: does partnership law require a subjective intent to form a partnership or merely an intent to carry on as co-owners a business for profit? b COURT: in ascertaining the existence of a partnership, the proper focus is on whether the parties intended to, and in fact did, "carry on as co-owners in a business for profit" and not on whether the parties subjectively intended to form a partnership. 2 Hynansky v. Vietri (Delaware) a ISSUE: whether a partnership was created. b COURT: The creation of a partnership is a question of intent. To prove the existence of a partnership, one must show the intent to divide the profits of the venture. i The acts, dealings, conduct, admissions, and declarations of the purported partners, in addition to other direct evidence, may be utilized. D Sharing Profits and Losses UPA (1997) 101(11), 401 1 In the archetypal general partnership, where two persons each contribute equal amounts of money and services to the business, the default rules are consonant with what most persons would presumably have bargained for-- an equal sharing of profits and losses 2 Kovacik v. Reed a ISSUE: Plaintiff seeks to recover from the defendant one-half the losses of a venture in which the parties agreed that plaintiff was to supply the money and the defendant supply the labor to carry on the venture. b COURT: In the absence of an agreement to the contrary, the law presumes that partners and joint adventurers intended to participate equally in the profits and losses of the common enterprise irrespective of any inequality in the amounts each contributed to the capital employed in the venture, with the losses being shared by them in the same proportion as they share the profits. i However, where on party contributes money and the other contributes services, then in the event of a loss, each would lose his own capital, the one his money and the other his labor. 3 Shamloo v. Ladd a COURT: Absent an agreement, a partner is not entitled to compensation for rendering services for the partnership other than profits. A partner is only entitled to compensation where the evidence discloses an express or implied agreement that such partner will be compensated.

III. Chapter 3: The Corporate Form and the Specialized Roles of

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Corporations Outline- Blair (Fall 2010)

Shareholders, Directors, and Officers

A The Corporate Form 1 Overview MBCA 2.06, 8.01, 8.40, 10.01-10.04, 10.20; DGCL 109, 141(a), 142, 242 a The archetypical corporation separate ownership and management functions into three specialized roles: i Shareholders provide capital and elect directors ii Directors make major policy decisions iii Officers execute those policies and provide day-to-day management b The corporate form provides a hierarchical form for decision-making that permits the enterprise to adapt easily to changed circumstances. i All corporate powers are exercised by, or under the authority of, a centralized group board of directors ii Day-to-day management operations are delegated to the corporation's officers and other agents iii No direct management role is left to the shareholders 2 Directors locus of all legal power and authority exercised by the corporation DGCL 141; MBCA 8.01 a Determine basic corporate policies, appoint and monitor the corporate officers, and determine when and if dividends (periodic distributions of profit) are to be paid to shareholders b Entitled to compensation for their services, but do not share in the firm's residual profits (except by virtue of any shares they may own in their personal capacity) c Law imposes constraints on director behavior to the extent that directors owe fiduciary duties to the corporation and its shareholders d Who are directors? i In a closely held corporation: the major shareholders generally comprise of the board of directors ii In a publicly traded corporation: the size of the board ranges up to the upper teens and occasionally even larger The typical publicly traded corporation thus has a few "inside" directors (generally the chief executive officer and her principal subordinate officers) and a balance of "outside" directors (who usually are employed full time as chief executives or financial officers of other corporations, or are lawyers, accountants, or investment bankers, and therefore have the skill, integrity, and political insight to oversee the business and affairs of their corporations.) 3 Officers responsible for day-to-day operation of the corporation's business affairs, although most statutes are remarkably silent about duties MBCA 8.40; DGCL 142 a Considered agents and the corporation as principal (acting through its board of directors) and leaves it to the board to work out the oversight that it desires b Receive compensation for services they perform, but do not share in the corporation's residual profit unless they also own shares c Modern statutes allow corporations to have the officers specified in the bylaws or determined by the board 4 Shareholders corporation's risk bearers and residual claimants a Have power to annually elect the corporation's directors and to approve fundamental 6

Corporations Outline- Blair (Fall 2010) changes in the corporation's governing rules or structure i An individual shareholder has very limited rights or power to participate directly in the management or operation of the corporation's business b (Normally) shareholders have no obligation or liability to the corporation or its creditors beyond the amount paid for the shares "limited liability" c Shareholders do three things: vote, sell, and sue B The Formation of the Corporation and the Governance Expectations of the Initial Participants 1 Where to Incorporate: State Corporation Laws as Competing Sets of Standard Form Rules a "Internal affairs doctrine" courts look to the laws of the incorporating state to determine the basic rights and duties applicable to a particular corporation i Most states base their corporation code on, or draw heavily from, some version of the MBCA ii Delaware does not follow the MBCA, but is the preeminent American corporate law jurisdiction iii There is substantial uniformity in the so-called "common law of corporations" 2 Formation: The Articles of Incorporation MBCA 2.01-2.06; DGCL 101, 102 a The process is fairly simple i Participants complete the articles of incorporation and file them with the appropriate state official in the chosen state State requirements are minimal: corporation's name, its registered office and agent for service of process, and the number of shares it is authorized to issue ii Initial organization meeting at which directors are elected, shares are issued in exchange for consideration that the corporation receives to undertake its business, and bylaws governing corporate procedures are adopted 3 Determining Shares to Issue MBCA 6.01; DGCL 151 a A corporation may have several types or classes of shares with characteristics as specified in the articles of incorporation. i Norms specify that there must be a class of shares that carry authority to elect directors and exercise all other shareholder voting rights There must also be a class that entitles the bearer to receive the corporation's net assets upon dissolution "Common shares" combine both residual claimant status and voting rights All shares of a given class shall be fungible (have identical rights, preferences, and limitations) b When there are different groups of investors with risk preferences that require a different set of incentives in order to get the investors to part with their money, the corporation may issue other classes of stock with different rights i "Preferred shares" might be granted a dividend or liquidation preference over common shares This preference is usually coupled with a limitation or denial of voting rights 4 Determining Voting Rights: Using Articles and Bylaws to Change Legal Norms a The corporate default rules can be changed by inclusion of the preferred rule in the articles of incorporation or bylaws: i Articles of incorporation public documents that can be changed only by action of a corporation's directors and shareholders ii Bylaws often can be changed by the directors alone and are not publicly filed

Corporations Outline- Blair (Fall 2010) documents b Overview of Normal Rules of Shareholder Voting for Election of Directors: Straight Voting MBCA 8.04, 7.21, 7.28; DGCL 141(d), 212(a), 216 i Default rule: Directors are annually elected by plurality vote, according to votes casted on a one vote per share basis Straight-voting candidates receiving the most votes will be elected (shareholders vote their shares for each open directorship) Practical effect: a shareholder with 51% of the votes will be able to elect 100% of the board seats, a result that reflects the majoritarian preference of the default rules in the corporation's codes c Cumulative Voting i A shareholder can cast a total number of votes equal to the number of shares multiplied by the number of positions to be filled, and these votes can be spread among as many candidates as there are seats to be filled or concentrated in as few as one candidate Purpose of cumulative voting is to permit some minority shareholders to have a place on the board (only applies to voting on directors, not on other matters) Maximum voting power of a given block of shares can be determined by: To elect X number of directors, a shareholder must have more than SX (D + 1) shares, where S equals the number of shares voting and D equals the number of directors to be elected d Class Voting, Including Dual-Class Voting Schemes i Default rule: power to elect directors rests with the voting shareholders as a whole Class voting: A corporation may divide its shares into classes and permit each class to select a specified number of directors "Dual class common" mechanism: separates shareholders into two classes and gives one class disproportionate voting power as compared to their capital contribution to the corporation might be desirable for a corporation going public e A Classified Board with Staggered Terms- Adaptability Versus Stability i MBCA 8.06; DGCL 141(d) ii Default rule: directors shall be elected annually Corporations can adopt longer and staggered terms for directors (if adopted in the articles or the bylaws) [avoids minority representation on the board] Theoretically ensures that a corporation will always have experienced directors in office [assures greater continuity] Operates as a constraint on the majority shareholders' ability to adapt to changed circumstances by quickly naming new directors [discourages takeovers because replacing the board is harder] 5 Looking Ahead: Shareholder Action After Electing Directors a The Annual Meeting and Other Forums for Shareholder Action i MBCA 7.01-7.07, 7.21; DGCL 211-213, 216, 222, 228 ii The corporate default rules promote adaptability to changed circumstances. To minimize the risk that directors will act unfairly, corporation statutes specify in detail the substance of shareholders' voting and meeting rights, as well as the procedural rules that safeguard the shareholders' exercise of these rights.

Corporations Outline- Blair (Fall 2010) Annual meeting and election of board of directors paramount (immutable) shareholder function Special shareholders' meetings to address issues expressly identified in the meeting notice (purpose of meeting must be stated) Delaware: directors or whoever listed in the charter can call special meetings MBCA 7.02: authorizes holders of 10% or more of a corporation's stock to call a special meeting NOTICE: shareholders entitled to timely written notice of annual and special meetings [this including time, location, sometimes summary of the matters to be discussed] Action by written consent in lieu of a meeting MBCA: (more restrictive rule) action by written consent only by unanimity, which effectively limits its use to small corporations with few shareholders Delaware: permits written consent by the vote of the number of shareholders otherwise required by corporate action (a majority) Record date: determining shareholders entitled to vote the shareholders who are entitled to participate and vote at a meeting are not necessarily the shareholders who own shares on the date of the meeting In publicly traded corporations: the shareholders owning shares on the "record date" specified by directors are entitled to vote [normally anywhere from 60 to 10 days before the meeting] shareholders of record Hoschet v. TSI International Software, Ltd (Delaware) ISSUE: Whether shareholder written consent action, which was taken pursuant to 228 of DGCL after the filing of the complaint, and that purported to elect directors for TSI, satisfies the requirement to hold an annual meeting and moots the claim stated in the complaint. COURT: Absent unanimous consent, the mandatory language o 211(b) places a legal obligation to convene a meeting of the shareholders to elect directors pursuant to the constitutional documents of the firm. b Removal of Directors and Other Midstream Private Ordering i MBCA 8.08-8.10; DGCL 141(k), 223 ii Directors are elected to serve a term that normally runs from one annual meeting to the next, but staggered terms can cover a three-year span. At common law, directors had a vested right to serve their full term, and shareholders could remove directors only for good cause. Pilat v. Broach Systems page 176 Statutory default rule: shareholders allowed to remove directors before the expiration of their term in office, with or without cause, by simple majority vote MBCA approach: no restrictions on shareholders' power to remove directors if the corporation has staggered terms; if the corporation has cumulative voting, shareholders cannot remove a director if the votes casted against removal would have been sufficient to elect that director; if a director is elected by a particular class of shareholders (class voting), that director can be removed only by a majority vote of that class These rules are immutable (but judicial removal is allowed under 8.09)

Corporations Outline- Blair (Fall 2010) Delaware approach: adds members of staggered boards to the list of directors protected from removal (can only be removed for cause, a powerful insulation for the boards of such companies); preserves the shareholders' power to remove even protected directors if done for cause; majority retains the ability to change the default rules and thereby permit removal in any of these situations by amending the articles to permit a without cause removal for a staggered board or to remove cumulative voting itself "For cause" is a fact-dependent analysis used as a last resort Campbell v. Loew's, Inc.(Delaware) page 177 [stockholders have inherent power to remove directors for cause even if elected under cumulative voting scheme; when removed for cause must be served with specific charges, adequate notice, and full opportunity to address the accusation] iii Adlerstein v. Wertheimer (Delaware) ISSUE: Whether the board of directors, acting as the board, could remove a director when the charter designates this as a function of the shareholders COURT: Procedural rules must be followed; you cannot do by deceit what you would not be able to without it c Protecting Changes Made to the Statutory Default Rules i Thoughtful drafting is necessary to ensure that courts will not find a loophole that allows majority shareholders to avoid the agreed upon changes to the default rules Centaur Partners, IV v. National Intergroup, Inc. (Delaware) COURT: a charter or by-law provision which purports to alter this principle of majority must be "positive, explicit, clear, and readily understandable; courts must give effect to the intent of the parties as revealed by the language of the certificate and the circumstances surrounding its creation and adoption; the bylaws may contain any provision, not inconsistent with law or with the certificate of incorporation (nullity) 6 Initial Issuance of Securities a The Securities Act of 1933 and Its Requirements Securities Act 5, 11, 12, 17 i If the financing of the corporation includes the public offering of securities, the corporation and its lawyers will have to comply with federal and state securities laws. State laws "blue sky laws" ii Securities: intangibles, pieces of paper that have no intrinsic value in themselves; their value comes because they represent an interest in something else Full and fair disclosure of material facts concerning securities (to tell investors what stands behind the paper) truth in securities Securities are created, not produced (can be issued in unlimited amounts, which increases the possibility of manipulation) b What transactions are covered? i Securities and Exchange Commission v. Edwards (Supreme Court) ISSUE: whether a moneymaking scheme is excluded from the term "investment contract" simply because the scheme offered a contractual entitlement to a fixed, rather than a variable, return. COURT: Congress' purpose in enacting the securities laws was to regulate investments in whatever form they are made and by whatever name they are called; broad definition of "security" was enacted; investment contract test:

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Corporations Outline- Blair (Fall 2010) whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others. c Exemption from Registration Securities Act 3, 4; SEC Rules 147, 501-508 i Securities and Exchange Commission v. Ralston Purina Co. (Supreme Court) ISSUE: Whether offerings of treasury stock to "key employees" fits within the registration exemption of 5 that exempts transaction by an issuer not involving any public offering. COURT: Since exempt transactions are those as to which there is no need for the application because the class affected doesn't need the protection, an offering to those who are shown to be able to fend for themselves is a transaction "not involving a public offering"; the focus of the inquiry should be on the need of the offerees for the protection afforded by registration. ii Regulation D is a series of rules (501-508) that establishes three exemptions from the registration requirement of the 1993 Securities Act. Rules 501-503 provide definitions and conditions that apply generally throughout the regulation 1) Rule 504 (small offerings subject to state blue sky laws): provides that sales of securities not exceeding $1 million in one year can be exempt from the registration requirements of the federal act, without any required disclosure 2) Rule 505 (medium-sized offerings subject to SEC conditions): provides an exemption for sales of securities that do not exceed $5 million in any 12-month period. The offer under this exemption can only be made to a maximum of 35 unaccredited investors. 3) Rule 506 (private offerings subject to SEC safe-harbor conditions): most used; is available to all issuers for offerings sold to not more than 35 unaccredited purchasers requiring an issuer to make a subjective judgment that each purchasers meets certain sophistication standards, but narrows the reach of previous rules that applied that standard to all offerees as well as purchasers. Accredited investors: include institutional investors, big organizations, key insiders, millionaires, fat cats, venture capitalists, and sophisticated trusts iii Intrastate exemption of 3(a)(11) and SEC Rule 147 Permits sales by a local company to local investors for local use without having to register under the 1993 Act iv Regulation A Permits companies to raise a limited amount of money (up to $5 million) subject to fewer regulatory restrictions C Shareholder Investment and Governance in Publicly Held Corporations and the Impact of Federal Law 1 How Publicly Held Corporations Differ a The Market for Shares and the Efficient Market Hypothesis i Securities markets provide three important services to publicly traded corporations and their shareholders liquidity, valuation, and the monitoring of managers Physical and Electronic Markets for Shares Two major markets for stocks in the US 1) New York Stock Exchange 2) NASDAQ

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Corporations Outline- Blair (Fall 2010) The Efficient Market Hypothesis If shares are traded in widely traded public markets, market prices will reflect the true underlying value of the stock in the sense that it will have already taken into account all the relevant factors (informationally efficient) b The Shareholder Census: The Emergence of Institutional Investors i "Small-stake," geographically dispersed, passive investors who simply rubber-stamp the officers' wishes, electing those directors aligned with management ii Large institutional investors (mutual funds, private/public pension funds, union funds) Own more than a quarter of all stock in public corporations iii Arbitrageurs seek out companies whose stock is in play and seek to encourage the trends that will make them money iv Value investors are those who actively seek to influence corporate management so as to produce higher share value from underperforming companies v Relational investors purchase large blocks in particular companies and seek a longterm relationship with management vi Social investors give explicit priority to social needs in guiding investment decisions vii Hedge funds have become large investors; turn corporate governance activism as their business plan to produce above average returns c Proxy Voting i Provides a means for institutional or other significant investors to collect voting power from smaller investors or each other in advance of an actual election, and thus is valuable tool even for the active shareholder. [creates an agency relationship] Process is federally regulated d Federal Regulation of Public Held Companies i Federal law requires disclosure in five contexts: 1) issuing securities 2) proxy solicitation 3) tender offers 4) insider trading 5) periodic reporting ii Regulation Via Disclosure Tied to Periodic Reporting Seeks to ensure that traders in those markets will have sufficient information as they buy or sell Primarily aimed at shareholders engaged in the selling (or buying function) rather than voting, iii Disclosure and Other Regulation Triggered by the Proxy Solicitation Process and Shareholders Voting 1934 Exchange Act Rules 14a-3, 14a-4, 14a-5, 14a-9 Rule 14a-3 prohibits any proxy solicitation unless the person solicited is first furnished a publicly filed preliminary or final proxy statement containing the information specified in Schedule 14A of the Exchange Act rules Rule 14a-5 regulates the form of the proxy statement * Readability is key Rule 14a-4 regulates the form of the proxy that solicitors ask shareholders to

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Corporations Outline- Blair (Fall 2010) execute * Proxy card Rule 14a-9 Catchall provision designed to supplement and reinforce the specific disclosure mandates 2 Shareholder Governance in the Public Corporation Setting a Introduction page 222 b Federal Rules Providing Shareholders Access to Persuasive Communication: Rule 14a-8 i Permits a "qualifying shareholder" to insert a proposal into the company's proxy for the annual meeting, the most common way that voting takes place in public corporations Shareholder proposal recommendation or requirement that the company and/or its board of directors take action, which you intend to present at a meeting of the corporation's shareholders Qualifying shareholder person who, at the time she submits her proposal, owns a minimum stake of the shares for a minimum holding period and continuously owns such stock through the date of the meeting ii Exceptions (allowing refusal of proposals placement on the agenda proposals that interfere with the traditional structure of corporate governance): "Not proper subject for shareholder action under state law" "Economic irrelevance": omission of proposals that relate to operations accounting for less than 5% of a corporation's total assets, gross sales, and net sales if the proposal "is not otherwise significantly related" to the company's business "Ordinary business": exclusion of proposals relating to the "ordinary business" of the company iii "Socially significance limitation on corporation's ability to exclude shareholder proposals Lovenheim v. Iroquois Brands, Ltd. ISSUE: applicability of the Rule 14a-8(c)(5) exception COURT: court found that the language of the exception allowed for "otherwise significant" proposals noneconomic test of significance used c Persuasive Communication with Punch: Rule 14a-8 Proposals Linked with Use of Shareholder Authority to Elect/Remove Directors i Directors are more willing to implement or respond positively to persuasive proposals because institutional shareholders are more willing to use their power to vote directors out d Using Shareholder Authority to Change the Bylaws i Shareholder Power to Amend Bylaws DGCL 109, 112, 113, 141; MBCA 2.06, 8.01, 10.20 ii CA, Inc. v. AFSCME Employees Pension Plan (Delaware) ISSUES: whether the bylaw is a proper subject for shareholder action may it be proposed and enacted by the shareholders without the concurrence of the company's board? COURT: the shareholders of a Delaware corporation have the right "to participate in selecting the contestants" for election to the board; entitled to facilitate the exercise of that right by proposing a bylaw that defines the process and procedures by which business decisions are made

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Corporations Outline- Blair (Fall 2010)

IV. Chapter 4: Fiduciary Duty, Shareholder Litigation, and the Business Judgment Rule
A Introduction to the Role of Fiduciary Duty and the Business Judgment Rule 1 Overview MBCA 8.01, 8.31, 8.32, 8.41, 8.42 a The fiduciary duty of loyalty operates to constrain directors and officers in their pursuit of self-interest. (Duty of good faith is a subset of the duty of loyalty) i An actionable wrong for an officer or director to compete with her corporation or divert to personal use assets or opportunities belonging to the corporation. Cant serve two masters; obligated to act in the best interests of the corporation ii Applies similarly to the officers and directors of both closely held and publicly held corporations b The fiduciary duty of care is a directors' official conduct in directing and managing the business and affairs of the corporation. (Duties run to equity shareholders) i Directors have the power, authority, and responsibility to manage the business and affairs of the corporation (corporate structure separates the risk-taking of the investors and the decision-making of the specialized managers) ii Most of the case law involves publicly traded firms c Business judgment rule: a judicial presumption that the directors have acted in accordance with their fiduciary duties of care, loyalty, and good faith [have carried out functions in good faith, after sufficient investigation, and fore acceptable reasons] i Greater pleading and evidentiary burden placed on plaintiffs-seeking to hold directors liable for breach of fiduciary duties (deters frivolous lawsuits) ii Rule is a rebuttable presumption that directors are better equipped than the courts to make business judgments and that the directors acted without self-dealing or personal interest and exercised reasonable diligence and acted with good faith. d (In some circumstances) a director's fiduciary duty is owed directly to the shareholders i Duty of disclosure, when recommending shareholder approval of a merger favored by the directors This duty can be enforced by individual action against the directors (direct action) or by a class action on behalf of all similarly situated shareholders e Generally, a director owes fiduciary duties to the corporation and to the shareholders collectively i This duty can be enforced in two ways: An action brought by the corporation at the behest and under the direction of its directors Normally it is the directors' responsibility to litigate against another director for breach of fiduciary duties; this is rare because those who abuse their control are unlikely to sue themselves Derivative suit (brought on behalf of the corporation by one or more shareholders)

2 Discretion to Determine General Business Policies a Shlensky v. Wrigley 14

Corporations Outline- Blair (Fall 2010) i ISSUE: Stockholder suit against the directors for negligence and mismanagement; is this a valid cause of action or can derivative suits only be based on fraud, illegality, and conflict of interest? ii COURT: Defendant's conduct must at least border fraud, illegality, or conflict of interest, otherwise, the court cannot interfere. It is not the function of courts to resolve for corporations questions of policy and business management. 3 Discretion to Consider Interests of Non-Shareholder Constituencies a Statutes provide that in determining the best interests of the corporation, directors may consider the interests of suppliers, employees, customers, and affected communities. i Could possibly be interpreted to insulate directors from lawsuits when directors in good faith advance other constituencies' interests to the financial detriment of shareholders b Dodge v. Ford Motor Co i ISSUE: whether it is a breach of fiduciary duty for directors to employ corporate policies that are intended to bestow significant benefit on non-shareholder constituencies (customers) arguably at great cost to shareholders. ii COURT: Theory of Shareholder Wealth Maximization The ultimate question should be whether it appears that the directors were not acting for the best interests of the corporation. The acts of the directors were within their lawful powers and were not to sacrifice the interests of the shareholders and therefore it is not the court's place to interfere. B The Fiduciary Duty of Loyalty 1 Introduction a Two classic settings: i Circumstances in which a director personally takes an opportunity that the corporation later asserts rightfully belonged to it (corporate opportunity usurpation) ii Transactions between the corporation and the director (conflicting interest transactions) b A director should favor the corporation's interests over her own whenever those interests conflict. i There is a duty of candor aspect to the duty of loyalty Has the director been completely candid with the corporation and its shareholders? 2 The Corporate Opportunity Doctrine (subset of duty of loyalty) a The American Law Institute and MBCA Approaches ALI, Principles of Corporate Governance 5.05; MBCA 8.70 i Northeast Harbor Golf Club, Inc. v. Harris ISSUE: whether the director breached her fiduciary duty by purchasing lots adjacent to the corporate property without providing notice and opportunity for the corporation to purchase the property and by subdividing the lots for further development. COURT: Corporate fiduciaries must disclose and not withhold relevant information concerning any potential conflict of interest with the corporation. They must refrain from using their position, influence, or knowledge of the affairs of the corporation to gain personal advantage. Line of business test: Guth v. Loft (Delaware); if there is presented to a corporate officer or director a business opportunity which the corporation is 1)

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Corporations Outline- Blair (Fall 2010) financially able to undertake, 2) is, from its nature, in the line of the corporation's business and is of practical advantage to it, 3) is one in which the corporation has an interest or a reasonable expectation and, 4) by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity for himself unless consent is obtained. Whether the opportunity was so closely related with the existing business activitiesas to bring the transaction within that class of cases where the acquisition of the property would throw the corporate officer purchasing it into competition with his company. Lower court followed this test; intensely factual and broad (decided by reasonable inferences from objective facts) Fairness test: Durfee v. Durfee & Canning, Inc.; the true basis of governing doctrine rests on the unfairness in the particular circumstances of a director, whose relation to the corporation is fiduciary, taking advantage of an opportunity [for personal profit] when the interest of the corporation justly calls for protection. Broad-ranging, intensely factual inquiry (no practical guidance to the corporate officer or director seeking to measure obligations) Two-step analysis: Miller v. Miller; 1) determine whether a particular opportunity was within the corporation's line of business, 2) scrutinize "the equitable considerations existing prior to, at the time of, and following the officer's acquisition." Combination the line of business test with the fairness test ALI 5.05 disclosure-oriented test: (central feature) strict requirement of full disclosure prior to taking advantage of any corporate opportunity; 1) director must have offered the opportunity and disclosed his conflicting interests and 2) the board or shareholders must have rejected the opportunity. Broad definition of "corporate opportunity" closely related to a business in which the corporation is engaged; any opportunities that accrue to the fiduciary as a result of her position within the corporation this court followed the ALI test ii ALI definition of "corporate waste if the transaction involves an expenditure of corporate funds or a disposition of corporate assets for which no consideration is received in exchange and for which there is no rational business purpose, or, if consideration is received in exchange, the consideration the corporation receives is so inadequate in value that no person of ordinary person of ordinary sound business judgment would deem it worth that which the corporation has paid. Waste is treated as a void rather than voidable act

b The Delaware Approach DGCL 122(17) i Broz v. Cellular Information Systems, Inc. (Delaware) ISSUE: Director acquired cell phone license at time cash-strapped corporation was being acquired by another, better-financed company interested in the license. 16

Corporations Outline- Blair (Fall 2010) Application of the doctrine of corporate opportunity in Delaware. COURT: A corporate fiduciary agrees to place the interests of the corporation before his or her own in appropriate circumstances. Guth test: 1) the corporation is financially able to exploit the opportunity, 2) opportunity is within the corporation's line of business, 3) corporation has an interest in the opportunity, and 4) by taking advantage of the opportunity, fiduciary is placed in a position contrary to his duties to the corporation. 3 Conflicting Interest Transactions a At common law i Most common law courts no longer viewed conflict of interest transactions as automatically void or voidable; instead conflicting interest transactions were voidable only if the transaction or the conduct of conflicted directors was unfair to the corporation. Two categories of self-interest: direct (corporation and director are parties to the same transaction) and indirect (when the corporate transaction is with another person or entity in which the director has strong personal or financial interest) ii Globe Woolen Co. v. Utica Gas & Electric Co. COURT: The trustee is free to stand aloof, while others act, if all is equitable and fair. He cannot rid himself of the duty to warn and to denounce, if there is improvidence or oppression, either apparent on the surface, or lurking beneath the surface, but visible to his practiced eye. Substance plus process: self-dealing is okay if the transaction was fair on the merits and was approved by a majority of disinterested directors. b Transactions with a Controlling Shareholder or Director i In circumstances constituting "self-dealing", transactions between the corporation and the controlling person were subject to heightened judicial scrutiny to protect the interests of the corporation and its non-controlling shareholders. A controlling shareholder has sufficient voting shares to determine the outcome of a shareholder vote ii Sinclair Oil Corp. v. Levien (Delaware) COURT: Simply having a conflicting interest is not a breach of fiduciary duties. Standard of intrinsic fairness (as oppose to the business judgment rule): high degree of fairness and a shift in the burden of proof; situations that involve a parent and a subsidiary, with the parent controlling the transaction and fixing the terms only applied when it is accompanied by self-dealing (when parent causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment of, the minority stockholders of the subsidiary)

c The Intersection of the Common Law and Conflicting Interest Statutes DGCL 144; MBCA 8.60-8.63 i Delaware: no conflicting interest transaction shall be void or voidable solely by reason of the conflict if the transaction is 1) authorized by a majority of the disinterested directors, or 2) approved in good faith by the shareholders, or 3) fair to the corporation

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Corporations Outline- Blair (Fall 2010) at the time authorized Requires complete candor and fair dealing by requiring disclosure of material facts Leaves significant gaps burden of proof, what constitutes a conflict, standard of judicial review, and what constitutes disinterestedness ii MBCA: Subchapter F (not yet adopted by a majority of the states) emphasized certainty and predictability rather than judicial oversight (review limited to approval process) 8.60 defines conflicting interest 8.61(a) instructs courts that transactions falling outside the definition in 8.61 do not expose an "interested" director to any special duty of candor or fair dealing and therefore relief cannot be granted based on a violation of that duty 8.61(b) provide that a conflicting interest transaction may not be voided as a result of such conflict if the transaction is 1) ratified by "qualified directors" (8.62) or 2) by the vote of "qualified shares," (8.63) or 3) is fair to the corporation. (8.61) iii Shapiro v. Greenfield ISSUE: determination of who are interested directors. COURT: Expressly defined in the statutes: ALI 1.23(a): if director is either 1) a party to the transaction, 2) has a business, financial, or familial relationship with a party to the transaction AND that relationship would reasonably be expected to affect judgment, 3) director has a material pecuniary interest AND that interest would reasonably be expected to affect judgment, or 4) the director is subject to controlling influence by a party to the transaction AND that influence could reasonably be expected to affect judgment. MBCA 8.60(1)(i): 1) if director knows at the time of commitment that he or a related person is a party to the transaction or has a beneficial financial interest to the transaction that the interest would be reasonably expected to exert an influence on the director's judgment directors are required to avoid only those self-interested actions which come at the expense of the corporation or its shareholders; transaction can still be approved by a neutral decision making body d The Special Problem of Director's "Self-Compensation" DGCL 141(h), 157; MBCA 6.24, 8.11 i Directorial self-compensation decisions lie outside the business judgment rule's presumptive protection, so that, where properly challenged, the receipt of selfdetermined benefits is subject to an affirmative showing that the compensation arrangements are fair to the corporation. Most common form of self-dealing One solution is to seek shareholder ratification or to place the compensation decision in the hands of independent (do not have an employment relationship) and disinterested directors. ii Stock options contract between a corporation and the optionee, giving the optionee a right to purchase, at some future date, a specified amount of the corporation's stock. Strike price: price at which the optionee may purchase stock pursuant to the option

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Corporations Outline- Blair (Fall 2010) usually determined by reference to the fair market value of the company's stock at the time the option is granted Typically subjected to heightened judicial scrutiny Delaware's two-prong test: 1) Plan must involve an identifiable benefit to the corporation. 2) The value of the options must bear a reasonable relationship to the value of the benefit. C The Fiduciary Duty of Care 1 Policy Arguments for Limiting the Ready of the Duty of Care MBCA 8.30(b) a (In some states, including Delaware) the duty of care is defined solely by judicial doctrine Facets of the duty: 1) good faith (honest, no conflict, doesnt condone wrongful/illegal activity); 2) reasonable belief (related to furtherance of corporate interests; no waste: rational business purpose); 3) reasonable care (informed in making decisions and monitor and supervise corporate activities.) b Liability for breach of duty of care has always been rare and occurs in situations when the director's conduct was egregious To challenge must show that board failed to act: 1) in good faith, 2) in honest belief that the action taken was in the best interest of the company, or 3) on an informed basis. c MBCA: "a person in a like position would reasonably believe appropriate under the circumstances" informed in performing their decision-making and oversight duties; discharges duties in good faith and act in a manner he reasonably believes to be in the best interest of the corporation i Should not be conceptualized under tort principles d Joy v. North i Rational basis behind business judgment rule: 1) shareholders entered business knowing it was risky 2) after-the-fact litigation is not a good way to evaluate the quality of a business judgment 3) don't want to dis-incentivize risk because potential profits often correspond with potential risk ii The business judgment rule does not apply to cases in which 1) the corporate decision lacks a business purpose 2) is tainted by a conflict of interest 3) is so egregious as to amount to a no-win decision, or 4) results from an obvious and prolonged failure to exercise oversight or supervision 2 Duty of Care in the Decisional Setting MBCA 8.30, 8.31 a (In a decisional setting) directors consider whether to authorize a particular course of action, activity, or transaction i Inside directors: key management employees who also serve as directors; invaluable source of information about the corporation's business; may have blind spots concerning their own business policies and may not always be objective or candid ii (In publicly traded companies) outside directors: must of the detailed information they need may be possessed by directors who are committed to a particular course of action;

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Corporations Outline- Blair (Fall 2010) b Smith v. Van Gorkom (Delaware) i ISSUE: whether the directors have informed themselves "prior to making a business decision, of all material information reasonably available to them." ii COURT: Under the business judgment rule, there is no protection for directors who have made "an unintelligent or unadvised judgment." Aronson gross negligence standard "Directors are fully protected in relying in good faith on reports made by officers" but not if they act in "blind reliance" "where a majority of fully informed stockholders ratify action of even interested directors, an attack on the ratified transaction normally must fail" Directors owe stockholders a duty to disclose all "germane" facts to the transaction 3 Statutory Exculpation Provisions MBCA 2.02(b)(4); DGCL 102(b)(7) a Corporations are allowed to limit or eliminate directors' liability for breach of fiduciary duty b Malpiede v. Townson (Delaware) i Corporation precluded money damages against the directors for any breach of the board's duty of care. ii COURT: 1) The shield from liability provided by a certificate of incorporation provision adopted is in the nature of an affirmative defense. 2) Where the factual basis for a claim solely implicates a violation of the duty of care, this court has indicated that the protections of such a charter provision may be invoked and applied. [Plaintiffs have the burden to allege well-pleaded facts that the conduct falls within the exceptions of the statute] The purpose of the statute was to free directors of personal liability in damages for due care violations, but not duty of loyalty provisions, bad faith claims, and certain other conduct (bars claims that only state a due care violation) 4 The Intersection of the Fiduciary Duties of Care and Loyalty (Including the Duty of Good Faith) a Introduction i Under DGCL 102(b)(7), a corporation may not provide exculpation for breaches of the duty of loyalty, or "for acts or omissions not in good faith." b Care, Good Faith, and Directors' Oversight Responsibilities MBCA 8.30, 8.42 i "the business and affairs of the corporation shall be managed by or under the direction of, and subject to the oversight of, its board of directors."

ii In re Caremark International, Inc. Derivative Litigation (Delaware) In order to show that the directors breached their duty of care by failing to adequately control the employee, plaintiffs would have to show either 1) the directors knew or 2) should have known that violations of law were occurring and, in either event, 3) that the directors took no steps in a good faith effort to prevent or remedy that situation, and 4) such failure proximately resulted in the losses

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Corporations Outline- Blair (Fall 2010) complained of "Oversight liability" c The Role and Nature of Substantive Review i Fail-safe mechanisms by which courts could intervene if a challenged substantive decision was sufficiently beyond the pale Waste has long been a doctrinal vehicle for entertaining such challenges Allows courts to find directors liable where direct proof of lack of care or loyalty is lacking, but the substantive decision seems explainable only as a product of the director's failure to carry out their fiduciary responsibilities Saxe v. Brady (Delaware): examination of the facts limited solely to discovering whether what the corporation has received is so inadequate in value that no person of ordinary, sound business judgment would deem it worth what the corporation has paid. Procedural due care (an informed decision) and substantive due care (purchase terms) ii Brehm v. Eisner (Delaware) Derivative action where shareholders seek to take action on behalf of the corporation; only raised duty of care claim for which there was an exculpation clause Repackaged process due care claims as bad faith claims after a books and records demand by the shareholders. iii In re Walt Disney Company Derivative Litigation (Delaware) Standard for bad faith: intentional dereliction of duty, a conscious disregard for one's responsibilities 1) Subjective bad faith: actual intent to do harm 2) Lack of due care: gross negligence and without any malevolent intent Gross negligence without more cannot constitute bad faith 3) Intentional dereliction of duty, a conscious disregard for one's responsibilities Falls on the spectrum in between the first two D Special Aspects of Derivative and Direct Litigation 1 Derivative Litigation and the Demand Requirement MBCA 7.42,7.44; ALI 7.03 a Shareholder Derivative Suit i Actually involves two actions: 1) against the corporation for failing to bring a specified suit and 2) on behalf of the corporation for harm to it identical to the one which the corporation failed to bring ii Usurps the directors' normal power to manage the corporation Many jurisdictions (including Delaware) require a shareholder to make pre-suit demand on the board, explaining the claims that he wishes investigated and remedied [MBCA makes demand universal, must then wait 90 days to file suit] If the board reaches a decision to not pursue the claim via litigation, the shareholder may challenge the directors' decision as a breach of fiduciary duty, but has no right to directly pursue the original claim that was the subject of his demand, unless the directors' action in refusing to institute litigation is found not to be protected by the business judgment rule. Where demand would be futile, shareholders need not make demand b Aronson v. Lewis (Delaware) 21

Corporations Outline- Blair (Fall 2010) i ISSUE: when is a stockholder's demand upon a board of directors, to redress an alleged wrong to the corporation, excused at futile? ii COURT: Demand futility is inextricably bound to the issue of business judgment and the standards of that doctrine's applicability. Only disinterested directors can claim business judgment rule protections If director interest is present and the transaction is not approved by a majority of disinterested directors, business judgment rule has no application in determining demand futility. Directors have a duty to inform themselves prior to making a business decision of all material information reasonably available to them. They must then act with the requisite care (gross negligence standard) Demand futility: where officers and directors are under an influence, which sterilizes their discretion, they cannot be considered proper persons to conduct litigation on behalf of the corporation. Reasonable proof that1) the directors are neither disinterested nor independent OR 2) that the challenged transaction was not the product of a valid exercise of business judgment (by showing a conflict of interest, bad faith, grossly uninformed decision-making, or a significant failure of oversight). Plaintiff must point to specific facts that point to either prong; heavy burden on derivative plaintiffs 2 Fiduciary Duty and Aronson's First Prong a In re The Limited, Inc. Shareholders Litigation (Delaware) i COURT: Under the first prong of Aronson, plaintiff must plead particularized facts sufficiently demonstrating: 1) Defendant directors had a financial interest in the challenged transaction 2) that they were motivated by a desire to retain their positions on the board or within the company (an entrenchment motive), OR 3) that they were dominated or controlled by a person interested in the transaction Director Disinterestedness: interest exists whenever divided loyalties are present, or a director either has received or is entitled to receive, a personal financial benefit from the challenged transaction which is not equally shared by the stockholders. Director Independence: decision is based on the corporate merits of the subject matter before the board, rather than extraneous considerations or influence by interested party Subjective "actual person" test: whether a particular director lacks independence because of control by another 3 Demand Futility Under Aronson's Second Prong or Under the Rales Test a Ryan v. Gifford (Delaware) i COURT: Failure to make demand can be excused if a plaintiff can raise doubt that 1) a majority of the board is disinterested or independent or 2) that challenged acts were the product of the board's valid exercise of business judgment [Aronson] The analysis is different however where the challenged decision is not a decision of the board in place at the time the complaint is filed.

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Corporations Outline- Blair (Fall 2010) Rales test: the absence of board action makes it impossible to perform the essential inquiry contemplated by Aronson; where the challenged transaction was not a decision of the board upon which plaintiff must seek demand, plaintiff must create a reasonable doubt that, as of the time the complain is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to demand Where at least one half or more of the board in place at the time the complaint was filed approved the underlying challenged transactions, which approval may be imputed to the entire board for purpose of proving demand futility, the Aronson test applies A board's knowing and intentional decision to exceed the shareholders' grant of express (but limited) authority raises doubt regarding whether such decision is a valid exercise of business judgment and is sufficient to excuse a failure to make demand. 4 Demand Futility in the Context of the Caremark Claims a Stone v. Ritter (Delaware) i In the absence of "red flags," good faith in the context of oversight must be measured by the directors' actions "to assure a reasonable information and reporting system exists" and not by second-guessing after the occurrence of employee conduct that results in an unintended adverse outcome." 5 Dismissal of Derivative Litigation at the Request of an Independent Litigation Committee of the Board MBCA 7.44 a Corporations can appoint a committee made up of directors who were not involved in the first suit and assert for this committee the right to claim the board's power to control derivative litigation i Three views: 1) Auerbach v. Bennett: a court would inquire into the committee members' disinterestedness, into the reasonableness of the procedures used in their deliberations, and into their good faith (before applying business judgment rule for the decisions of the committee) No inquiry into the substance of the special litigation committee's decision 2) Miller v. Register and Tribune Syndicate, Inc: the recommendations of a special litigation committee that a derivative litigation be dismissed would be entitled to no more business judgment deference than would a recommendation made directly by the interested board. Structural bias would prevent the committee from exercising impartial business judgment 3) Zapata Corp. v. Maldonado (Delaware) COURT: after an objective and thorough investigation of a derivative suit, an independent committee may cause its corporation to file a pretrial motion to dismiss; each side should have an opportunity to make a record on the motion; the court then applies a two-step test: 1) (Procedural) inquiry into the independence and good faith of the committee and the basis supporting its conclusions

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Corporations Outline- Blair (Fall 2010) Corporation has the burden of proving independence, good faith, and a reasonable investigation 2) (Substantive) the Court may then proceed, in its discretion, to determine, (applying its own independent business judgment) whether the motion should be granted. Intended to thwart instances where corporate actions meet the criteria of step one, but the result does not appear to satisfy its spirit or where the corporate actions would simply prematurely terminate a stockholder grievance deserving of further consideration in the corporation's interest. E Indemnification and Insurance MBCA 8.50-8.59; DGCL 102(b)(1), 145 1 Insurance and indemnification are devices that limit directors' risk of bearing personal financial losses as a result of serving on a board a Under general agency law principles, a principal is required to indemnify an agent either 1) pursuant to the terms of their indemnity agreement, if any, or 2) whenever the agent suffers a loss that, because of the relationship, should fairly be borne by the principal i Delaware: requires a corporation to indemnify its officers and directors if they are "successful on the merits or otherwise in defense of any action, suit or proceeding" related in any way to their services as an officer or director" Held to require indemnification for partial success also ii MBCA: indemnification mandatory only if the defendants are wholly successful on the merits or otherwise. b The first insurance policies designed to protect directors and officers from unwarranted apprehension of liability initially were written on a policy form having two parts: i Part 1: Corporate Reimbursement Liability covered a corporation's liability to indemnify its employees, whether such liability arose from contract or was imposed by law ii Part 2: Director and Officer Liability insured named officers and directors against insurable acts for which the corporation did not provided indemnification Specifically excluded were acts of willful misconduct, dishonest acts, or actions involving receipt of improper personal benefit 2 Owens Corning v. National Union Fire Insurance Co. a Two basic types of indemnification: i Mandatory: defense expenses occurred when the director is "successful on the merits or otherwise" in defense of the action brought against him ii Permissive: may occur, if the corporation so chooses, for the costs imposed on directors who have been determined to have acted in good faith. b Rebuttable presumption of good faith remain consistent with public policy and the controlling corporate law (can be made subject to presumption in the corporate by-laws)

V. Chapter 7: The Corporation as a Device to Allocate Risk

A Introduction 1 Creditors often require personal guaranties from individuals before extending credit to a noasset corporation, insist on contractual protection preserving the shareholder equity capital already contributed, or raise their price for taking additional risk 2 Unlimited liability has disappeared as a legal requirement in corporations statutes

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Corporations Outline- Blair (Fall 2010) a limited liability companies (LLCs) and limited liability partnerships (LLPs) B Corporate Law Rules Specifying an "Equity Cushion" 1 Historical Overview a (In the early years) a majority of court decisions treated shareholders' limited liability as a legally unavoidable by-product of recognizing a corporation's separate legal identity. A corporate participants liability for corporate obligations is limited to that persons investment in the corporation (limited liability as default rule) b Permanent capital ("capital stock" "legal capital" "stated capital" "stated capital" or "capital") served as equity cushion reducing the riskiness of extending credit to corporations. i Codified in the so-called legal capital rules "Par value" price at which a corporation's shares were to be sold 2 Statutory Rules Governing the Equity Cushion a Minimum Initial Capitalization Requirements MBCA 6.21; DGCL 153, 154 i A corporation's initial issuance of shares would automatically produce an equity cushion that creditors could easily calculate. (Law and custom changed, no necessary connection between par value and issue price) now corporation codes allow there to be no par value ii Corporation codes that retain legal capital restrictions now define the required "equity cushion" in a way that allows corporations to choose to avoid having such a cushion. Delaware: permanent capital termed "capital"; directors may specify by resolution what amount of the consideration paid for shares shall constitute capital. Capital cannot be less than an amount equal to the aggregate par value of issued shares having a par value Requires shares with par value to be sold for at least that amount MBCA: allows corporations to create shares with par value (doing so has no legal significance); no provision that prohibits issuance of shares at a price below par value No concept such as "capital" or "legal capital" that is used to restrict distributions to shareholders b Quality and Valuation of Consideration MBCA 6.21; DGCL 152 i A central concern of legal capital statutes is the quality of consideration paid by shareholders Creditors must be convinced that the consideration paid by shareholders was worth par value The DGCL and the MBCA leave to the discretion of each corporation's board of directors the determination of what type of consideration is acceptable. ii Directors and shareholders face potential liability if shares are sold for insufficient consideration Directors: only if their actions constitute a breach of fiduciary duties Shareholders: absent fraud, face no liability for purchasing stock at bargain price If they pay less than the entire agreed purchase price, then they remain liable for the remainder c Limits on Distributions to Shareholders MBCA 6.40; DGCL 154, 170, 244 25

Corporations Outline- Blair (Fall 2010) i General corporation codes have placed restrictions on corporations' power to distribute money or property to shareholders with respect to their shares Most common forms of distribution: 1) dividends 2) payments for share repurchases MBCA: restricts corporation's power solely by reference to two insolvency rules: equity and bankruptcy insolvency tests A corporation is permitted to distribute assets to shareholders so long as after such distribution the corporation 1) will be able to pay its debts in the ordinary course of business (will be solvent in the equitable sense) and 2) will still have assets equal to or in excess of its liabilities (solvent in the balance sheet/bankruptcy sense) Delaware: imposes greater restrictions on distributions Distributions are only authorized to shareholders after surplus If distributions are authorized only out of surplus that means one cannot touch capital Earned surplus: a corporation's net undistributed profits (retained earnings) Capital surplus: the consideration paid for the shares not designated as capital ii Klang v. Smith's Food & Drug Centers, Inc. (Delaware) No corporation may repurchase or redeem its own shares except out of "surplus" as statutorily define, or except as expressly authorized by provisions of the statute not relevant here Balance sheets are not conclusive indicators of surplus or a lack thereof Directors have reasonable latitude to depart from the balance sheet to calculate surplus, so long as they evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud C Piercing the Veil 1 Introduction a "Piercing the corporate veil": suits by creditors seeking to impose personal liability for corporate obligations on shareholders [exception to limited liability] i Black letter law the separateness of the corporate entity is normally to be respected. However, a corporation's veil will be pierced whenever corporate form is employed to evade an existing obligation, circumvent a statute, perpetrate fraud, commit a crime, or work an injustice.

Courts more likely to pierce the veil: 1) Closely held corporations a. No cases of piercing has ever involved the shareholders of a publicly traded corporation 2) Plaintiff is an involuntary creditor a. Cant easily protect themselves contractually, nor do they 26

Corporations Outline- Blair (Fall 2010) knowingly assume the risk 3) Enterprise liability doctrine a. Defendant is a corporate shareholder as opposed to an individual 4) Insiders failed to follow corporate formalities a. Theory that corporation is being used as an alter ego or conduit for personal affairs 5) Insiders co-mingle business assets and affairs with individual assets and affairs a. Creditors have a valid expectation that business assets will be available to meet their claims 6) Insiders did not adequately capitalize the business a. Simply organizing or running a business that has little or no capital, standing alone, is generally not sufficient 7) Defendant actually participated in the business a. Shareholders who are not active in the business and have not acted to disadvantage creditors are less likely to be personally liable than those whose actions resulted in a depletion of assets 8) (Most critical factor) Deception a. Piercing is near certain if the creditor is deceived into believing that the corporation is solvent. ii Powell's three-part test (for parent/subsidiary corporation but used in modern cases): to pierce the veil: 1) the parent completely controlled and dominated the subsidiary, 2) the parent's conduct in using the subsidiary was unjust, fraudulent, or wrongful toward the plaintiff, and 3) plaintiff actually suffered some harm as a result. 2 Piercing the Corporate Veil to Reach Real Persons a Contract Cases i Officers who sign contracts on behalf of the corporation are not personally liable if the corporation does not pay ii Consumer's Co-op v. Olsen Neither inadequate capitalization nor disregard of corporate formalities will independently justify piercing the corporate veil instrumentality or alter ego doctrine Must prove: 1) control (complete domination); 2) control used to commit fraud or wrong, AND 3) control and breach of duty were proximate cause of injury Undercapitalization: obvious inadequacy of capital "measured by the nature and magnitude of the corporate undertaking iii K.C. Roofing Center v. On Top Roofing Inc. A court may pierce the corporate veil or disregard the separate legal entity of the corporation and the individual where the separateness is used as a subterfuge to 27

Corporations Outline- Blair (Fall 2010) defraud a creditor Actual fraud is not necessary b Tort Cases i The corporate entity has never provided insulation for an individual committing a tortious act even if the individual purported to be acting as an officer or otherwise in the name of a corporation. They are liable as a result of agency law ii Western Rock Co. v. Davis The corporation in this case was a "shell corporation" which had no assets and was in financial difficulty. Obviously used to insulate the directors from personal and financial liability from their tortious acts. iii Baatz v. Arrow Bar Factors that indicate injustices and inequitable consequences and allow a court to pierce the corporate veil are: 1) fraudulent representation by corporation directors; 2) undercapitalization; 3) failure to observe corporate formalities; 4) absence of corporate records; 5) payment by the corporation of individual obligations; or 6) use of the corporation to promote fraud, injustice or illegalities. 3 Piercing the Corporate Veil to Reach Incorporated Shareholders a More complicated when the shareholder behind the corporation is another corporation instead of an individual. b Craig v. Lake Asbestos i Three-part test plaintiff must demonstrate: 1) control by one corporation of another, which is used 2) in a way that results in fraud or injustice, and which 3) is the proximate cause of plaintiff's alleged injury ii Control must be that the parent so dominated the subsidiary that it had no separate existence but was merely a conduit for the parent. Factors to consider: gross undercapitalization; "failure to observe corporate formalities"; non-payment of dividends; the insolvency of the debtor corporation at the time; siphoning of funds of the corporation by the dominant shareholder; non-functioning of other officers or directors; absence of corporate records; and the fact that the corporation is merely a facade for the operations of the dominant stockholder(s). c United States v. Bestfoods i The corporate veil may be pierced and the shareholder held liable for the corporation's conduct when the corporate form would otherwise be misused to accomplish certain wrongful purposes, most notable fraud, on the shareholder's behalf.

VI. Chapter 8: Mergers; Friendly Change of Control Transactions

A Introduction 1 "Friendly transactions": supported by the directors of the corporation experiencing the change in control. a Statutory merger principal legal form used to carry out friendly transactions. 28

Corporations Outline- Blair (Fall 2010) B The Statutory Template 1 Merger MBCA 11.01, 11.02, 11.04, 11.05, 11.07; DGCL 251, 253, 259-261 a A transaction whereby two or more corporations are combined into one of the corporations, usually referred to as the surviving corporation i The legal existence of all constituent corporations, other than the surviving corporation, ceases. ii The assets and liabilities of all constituent corporations pass to the surviving corporation. Technique used for merger can effect: 1) protections available to shareholders, 2) taxation of corporation/shareholders, 3) liabilities of the resulting entity. b statutory template for a merger: i There must be a plan or an agreement of a merger between the constituent corporations. (Plan of merger) ii The directors of each constituent corporation must adopt that plan. (Bound by fiduciary duties of care and loyalty) iii The merger must be approved by the shareholders (subject to various exceptions target company always gets vote; acquiring company only gets to vote sometimes) iv The approved merger must be filed with a state official v Sometimes there is a right to judicial appraisal in lieu of amount provided in the merger agreement. c Directors cannot complete a merger by themselves. i Shareholders normally do not have the right to get cash from the corporation in exchange for their shares. d Hewlett v. Hewlett Packard Co. (Delaware) i Judicial suspicion of vote-buying agreements is difficult to reconcile with corporate statutes explicit validation of shareholder agreements. 2 Dissenter's Rights MBCA 13.01(4); 13.02, 13.24; DGCL 262 a If a shareholder dissents when asked to approve a merger or other covered transaction, and if the transaction nonetheless obtains the requisite shareholder approval, the dissenting shareholder may demand that his shares be repurchased by the corporation for fair value. i Dissenter (or appraisal) rights permit each shareholder to avoid being forced to continue in an enterprise dramatically different from the one in which that shareholder that invested. Generally, shareholders of the target corporation (not the acquiring corporation) have appraisal rights. MBCA shareholders of the target corporation entitled to vote on a merger or in a compulsory share exchange have appraisal rights; shareholders of the acquiring corporation do not have appraisal rights, even if they have voting rights Delaware all shareholders of the target corporation have appraisal rights; shareholders of the acquiring corporation have appraisal rights, except when it is a whale-minnow merger or the market-out exception is applicable. b Delaware: the shareholder will receive judicially determined fair value, plus interest, even if that amount is less than what the corporation offered to shareholder as part of the

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Corporations Outline- Blair (Fall 2010) terms of the merger. c MBCA: requires corporations to make payment to the dissenter as soon as the corporate action is consummated (good faith judgment as to the fair value of the dissenter's shares); if the court finds a higher fair value in the appraisal proceeding, the dissenting shares will receive the difference. d When should appraisal rights be available? i Most statutes provide that appraisal rights exist only when voting rights exist Important exception: in a short-form merger, shareholders merged out of existence will still receive appraisal rights even though they dont have voting rights Short-form mergers allow a corporation that owns 90%+ of the shares of another corporation to merge with that subsidiary by director action alone. Two levels of protection: fiduciary rules apply and appraisal rights are automatic. De minimis change exception: denies voting rights to shareholders of the surviving corporation in a merger having terms that will not significantly affect the pre-merger shareholders' voting or equity rights, nor require a change in the corporation's articles of incorporation. e Market-out exception: i Delaware: denies appraisal rights for most publicly traded shares, if the merger consideration received in exchange is also publicly traded stock. Shareholders retain access to appraisal rights in cash-out mergers ii MBCA: exception does not apply to a corporate transaction that is an interested transaction as defined in 13.01(5.1). C Contracting Around Appraisal and Voting Rights 1 Use of Alternative Transactional Forms a Introductory Note i Alternatives to the statutory merger: 1) asset sale, 2) the sale of a control block of stock, and 3) "triangular merger" Significant tax, accounting, and liability reasons to consider choosing between the traditional merger form and one of these alternative forms b Sale of Assets MBCA 12.01, 12.02; DGCL 271 i Conveyance of title by one or more bills of sale a business is no more than the sum of its tangible and intangible assets, selling all assets effectively transfers control ii Differs from statutory mergers: 1) The corporation selling assets does not automatically go out of existence upon consummation of the sale (although it can by following the asset sale with a dissolution) becomes a shell or a holding company; its only assets are sale proceeds 2) The selling corporation need not transfer all of its assets substantially all 3) The liabilities of the selling corporation will not necessarily pass to the purchasing corporation by operation of law there may be need for consent iii Can be structured to achieve the same substantive result that would occur via a merger (and garner the same protections: board approval, shareholder ratification, appraisal rights for target company shareholders) iv If the directors of a (acquired) corporation wish to sell substantially all of the corporation's assets (other than in the ordinary course of business), they must obtain

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Corporations Outline- Blair (Fall 2010) shareholders approval (majority vote). Delaware: shareholders get a vote, but not appraisal rights The shareholders of the acquiring company do not have a right to approve or disapprove the transaction. v If less than all of a corporation's assets are to be sold, corporate planners must determine whether the transaction is qualitatively and quantitatively significant enough to require approval by the selling corporation's shareholders. Test for substantiality: (Oberly v. Kirby); measured not by the size of the sale alone, but also by its qualitative effect upon the corporation; it is relevant to ask whether a transaction is out of the ordinary and substantially affect the existence and purpose of the corporation. c Triangular Mergers i Forward triangular merger: the acquired corporation merges into the acquiring subsidiary. ii Reverse triangular merger: the acquiring subsidiary merges into the acquired corporation. iii The principal reason to eliminate the voting and appraisal rights that the shareholders of the acquiring parent corporation would otherwise have. d Compulsory Share Exchanges MBCA 11.03; 11.04 i Relatively less-used proceeding that permits one corporation to acquire all the shares of another while leaving the acquired corporation in existence; acquiring corporation can force the acquired companys shareholders to exchange their shares for consideration offered by the acquirer. Can be accomplished by a simple majority vote of shareholders of the acquired corporation (who get appraisal rights), but only need board approval of the acquiring corporation. 2 "De Facto" Mergers a Shareholders, denied voting or appraisal rights, may ask courts to intervene and recharacterize the transaction as a merger in order to regain these protections under the de facto merger doctrine b Farris v. Glen Alden Corp.: when a corporation combines with another so as to lose its essential nature and alter the original fundamental relationships of the shareholders among themselves and to the corporation, a shareholder who does not wish to continue his membership therein may treat his membership in the original corporation as terminated and have the value of his shares paid to him. i "de facto" merger or "substance over form" doctrine: if asset sale has the effect of a merger shareholders receive merger-type voting and appraisal rights. Delaware: supports a competing doctrine each provision of the corporation code has independent legal significance and is entitled to equal judicial respect. c Applestein v. United Board & Carton Corp. i ISSUE: All factors of a merger were present in this "exchange of shares". ii COURT: whether a merger is de jure or de facto, the reason for protecting the dissenting stockholders applies equally, whether they are stockholders of the acquired or acquiring corporation. Stockholders should not be forced against their will into something fundamentally different from that for which they bargained when they acquired their shares.

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Corporations Outline- Blair (Fall 2010) d Hariton v. Arco Electronics, Inc (Delaware) i COURT: Sale of assets statute and the merger statute are independent of each other; reorganization plan may resort to either type of corporate mechanism to achieve the desired end. "Doctrine of independent legal significance" (form trumps substance) D The Intersection Between the Appraisal Remedy and Fiduciary-Duty-Based Judicial Review 1 Cash-out Mergers and the Business Purpose Test a Statutory authorization for the use of cash as consideration in a merger became the norm; interpreted as not requiring the same consideration for all shareholders controlling shareholders were able to directly force minorities out of the enterprise via merger or other fundamental change by specifying that the controlling shareholder would get equity in the merged enterprise and the minority shareholders would get cash. i Minority shareholders sought to challenge cash-out mergers via class action which lead to the adoption of the business purpose test. b Singer v. Magnavox (Delaware): a merger made for the sole purpose of freezing out minority stockholders, is an abuse of the corporate process. i Required controlling shareholders to prove a valid business purpose for a cash-out merger little substantive protection (later abandoned) c Coggins v. New England Patriots Football Club, Inc. i Judicial scrutiny should began with recognition of the basic principle that the duty of a corporate director must be to further the legitimate goals of the corporation. Freeze-out (squeeze-out) merger: elimination of public ownership in the corporation; controlling shareholders rid themselves of minority shareholders (often the second step in a hostile takeover, once the bidder has successfully made a tender offer for control) [when the minority shareholders receive cash, this is called a cash-out merger] ii The court should then proceed to determine if the transaction was fair by examining the totality of the circumstances. Cash-out mergers terminate shareholder investment without their consent; Defendant has the burden of proving 1) that the merger was for a legitimate business purpose and 2) that the totality of the circumstances show it was fair to the minority shareholders. 2 The Weinberger Approach a Lynch v. Vickers Energy Corp. litigation: application of the Delaware block method which requires the court to determine the corporation's asset, market, and earnings values, appropriately (arbitrarily) weigh these values, and then add the weighed values together to arrive at a "fair value". b Weignberger v. UOP, Inc. (Delaware) i Overruled Lynch v. Vickers to the extent that it purports to limit a stockholder's monetary relief to a specific damage formula; reconsidered the business purpose rule (no longer the law of Delaware); two-prong entire fairness test ii The concept of fairness has two basic aspects: fair dealing and fair price Fair dealing: questions of when the transaction was timed, how was it initiated, structured, negotiated, disclosed to the directors, and how the approvals of the

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Corporations Outline- Blair (Fall 2010) directors and stockholders were obtained. Duty of candor (one possessing superior knowledge may not mislead to any stockholder by use of corporate information to which the latter is not privy) Court recommended the subsidiary board form an independent negotiating committee of outside directors to act as a representative of the minority shareholders. Clarifications: 1) Negotiations by outside directors buttress procedural fairness, especially when the directors are well informed and negotiations are adversarial. a. This shifts the burden to the challenger to show lack of entire fairness. Kahn v. Lynch Communications 2) Parent need not disclose internally prepared valuations unless directors/officers of the subsidiary prepare them. a. Only when executives have overlapping roles must the parent show its cards. 3) Approval by minority shareholders (after full disclosure) buttresses (but does not guarantee) procedural fairness and shifts the burden to the challenger to show lack of entire fairness. Kahn v. Lynch 4) A squeeze-out merger, although its share price is within a range of fairness, may not purposely be timed by the parent to avoid an obligation to pay a higher contract price. Rabkin v. Hunt Chemical Corp. Fair price: fairness relating to the economic and financial considerations; including assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock. More liberal approach than the Delaware block approach; must include proof of value by any techniques or methods, which are generally considered acceptable in the financial community and otherwise admissible in court. Clarifications: 1) The price paid can be calculated by the Delaware block method if supported by a fairness opinion and asset valuations by outside experts. 2) Fair value can be based on opinions of the parents investment banker, even though the subsidiarys committee has received opinions of higher value from other investment bankers. Kahn v. Lynch (II) 3) Parent must share with the minority shareholders any financial, operational, or tax gains expected in the merger. Cede & Co. v. Technicolor, Inc. E Appraisal and Entire Fairness Review After Weinberger 1 Valuation Under Statutory Appraisal MBCA 13.01(4); DGCL 262(h) a After Weinberger appraisal remedy has taken on increased significance in controlling shareholder-dominated mergers i Weinberger: 1) instructed trial courts to use realistic valuation methods and 2)

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Corporations Outline- Blair (Fall 2010) diminished the attractiveness of other remedies Shareholders may challenge a transaction, even if appraisal is available, if either: 1) approval was fraudulent, 2) fiduciary duty of fair dealing is breached; or 3) noncompliance with formal approval requirements. b Cede & Co. v. Technicolor, Inc. (Delaware) i FACTS: Two-step transaction: tender offer to acquire control and then cash-out merger; question of appropriate appraisal value. ii COURT: In a two-step merger, to the extent that value has been added following a change in majority control before cash-out, it is still value attributable to the on-going concern; the dissenting shareholder's proportionate interest is determined only after the company has been valued as an operating entity on the date of the merger added value accrues to the benefit of all shareholders and must be included in the appraisal process on the date of the merger. 2 Appraisal as the Exclusive Remedy a In Delaware i Weinberger was not retroactive post-Rabkin: the remedies available to minority shareholders cashed out in a long-form merger appeared to be equally available to shareholders cashed out in a short-form merger. ii Glassman v. Unocal Exploration Corp. (Delaware) FACTS: Short-form merger under 253: no voting but there was appraisal rights. COURT: Absent fraud or illegality, appraisal is the exclusive remedy available to a minority stockholder who objects to a short form merger; affirmed Weinberger about the scope of appraisal fair value is based on ALL relevant factors, including damages and elements of future value, where appropriate. It would defeat the summary nature of the short-form merger procedure if the parent had to constitute a negotiating committee of subsidiary directors, hire independent financial and legal experts, and conduct an arms-length negotiation. iii Berger v. Pubco Corpo.: Four possible remedies when the fiduciary fails to observe its "duty of full disclosure" "Replicated appraisal" proceeding: duplicate the precise sequence of events and requirements of the appraisal statute. An entire fairness review: consequence of the fiduciary's adjudicated failure to disclose material facts would be to render Glassman inapplicable. A quasi-appraisal proceeding to which shareholders would be required to opt in and place a portion of the merger consideration in escrow in case the quasiappraisal proceeding resulted in a determination of a lower value. A quasi-appraisal with no opt-in or escrow required.

VII. Chapter 9: Changes in Control: Hostile Acquisitions

A The Market for Corporate Control 1 Potential opportunistic behavior: board, who acts as a gatekeeper deflecting offers it does not think are appropriate, may use authority in opportunistic fashion a Direct dealings between the shareholders and potential alternative management teams are 34

Corporations Outline- Blair (Fall 2010) one way to counter this opportunistic behavior. i A potential acquirer who seeks control without the consent of the current control group can 1) make a tender offer seeking to buy sufficient shares to gain control of the board OR 2) launch a proxy fight seeking the authority to vote sufficient shares to gain control of the board. 2 Securities Exchange Act of 1943: required disclosure to shareholders when their proxies are solicited to approve a merger | The Williams Act (1968 amendment) extended disclosure to shareholders faced with tender offers. Schedule 13D Disclosure: any person (or group) that acquires beneficial ownership of more than 5 percent of a public corporations equity securities must file a disclosure document with the SEC; alerts the stock market (and the target corporations management) of a possible change in control. a 14(d)(1) of the 1934 Act: a tender offeror must disclose its identity and background, the source and amount of funds to be used in making the purchase, and the purpose of the purchase, including any plans to liquidate the target or change its corporate structure b SEC Rules 14e-1(a): tender offer must remain open for 20 business days, blocking a bidder's effort to force a hasty decision by shareholders c 14(d)(6) of the 1934 Act: if more shares are tendered than the bidder sought to purchase, the bidder must buy a pro rata portion from each shareholder i prevents first-come, first-served strategy to pressure shareholders to tender d 14(d)(7) of the 1934 Act: bidder must pay the same price for all shares purchased 3 Explanations of the hostile takeover phenomenon: bidders are willing to pay high premiums for the stock of a target corporation a Disciplinary Hypothesis: the bidder believes that the assets of the corporation would be worth more, if they were managed in a different way (role of tender offer is to replace inefficient management) b Synergy Hypothesis: the value of the combined enterprise is expected to be greater than the sum of its separate parts as independent companies c Empire Building Hypothesis: less about greater efficiency more about having a "bigger badder company"; acquire companies to build an empire d Exploitation Hypothesis: exploitation of the target company's underpricing; possible to go in and buy the shares of the company and then be in a position to win when the share price goes back normal/higher 4 Glossary of Takeover Tactics: page 835- 837 B Judicial Review of Tender Offer Defenses 1 Traditional Review a Takeover defenses involve the directors' efforts to prevent shareholders from exercising their power to vote or to sell in the unfriendly takeover context. b Historically common defense: directors cause the corporation to purchase the outsider's stock, generally at a price above the prevailing market price of the corporation's shares i Cheff v. Mathes (Delaware) FACTS: The board authorized the purchase of 155,000 shares from Motor Products. [First example of "greenmail"] The price paid was in excess of the market price...derivative suit holding certain directors liable for loss allegedly resulting from improper use of corporate funds.

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Corporations Outline- Blair (Fall 2010) COURT: DGCL 160: A corporation is granted power to purchase and sell shares of its own stock. If the actions of the board were motivated by a sincere believe that the buying out of the dissident stockholder was necessary to maintain what the board believed to be proper business practices, the board will not be held liable for such decision, even though hindsight indicates the decision was not the wisest course. | If the board as acted solely or primarily because of the desire to perpetuate themselves in office, the use of corporate funds for such purposes is improper dominant motive analysis Incumbent board should point to a reasonable investigation (preferably by outside directors) into a plausible business purpose for the defense; absence of an entrenchment motive the challenger then bears the difficult burden 2 The Enhanced Scrutiny Framework a The Unocal Doctrine i Unocal Corp. v. Mesa Petroleum Co. (Delaware) ISSUE: the validity of a corporation's self-tender for its own shares which excludes from participation a stockholder making a hostile tender offer for the company's stock. Two-tier "front-loaded" cash tender offer. COURT: Board has an obligation to determine whether a pending takeover bid is in the best interest of the corporation and its shareholders if the board of directors is disinterested, has acted in good faith and with due care, its decision in the absence of an abuse of discretion will be upheld as a proper exercise of business judgment Board must prove: 1) [threshold inquiry] reasonable grounds for believing that a danger to corporate policy and effectiveness exists [must demonstrate good faith and reasonable investigation] and 2) that the defensive measure adopted was reasonable in relation to the threat posed (proportionality test). b Poison Pills MBCA 6.01, 6.02; DGCL 141, 151, 157, 160 i Name for various rights given to shareholders entitling them to additional securities of the company upon the happening of certain events. One of the most popular defensive tactics to deter hostile takeovers. Makes takeovers more difficult, time consuming, and expensive for an acquirer unless the acquirer negotiates with the target's board of directors Two Types of poison pills: 1) flip-in plan: directors cause the corporation to issue certain "rights" to all current shareholders, often issued as a dividend to these shareholders. At the time of issuance, the rights have very little value; rights triggered upon an event (like an acquirer obtaining 20% of the shares of the corporation OR making an announcement of tender offer when trigger occurs, each holder obtains the right to purchase additional shares of stock in the corporation | acquirers are excluded from this right (shares in the target become diluted) 2) flip-over: same principles, but the rights given to shareholders are to purchase shares (at discount) in any company into which the target company is merged (raider could avoid this poison pill by continuing to operate the target as a separate company). ii Moran v. Householder International Inc (Delaware)

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Corporations Outline- Blair (Fall 2010) FACTS: Board approved "Rights Plan" that triggered additional shareholder rights if a tender offer of 30% was made or if 20% of stock was acquired by one person ("flip over poison pill). The question was the applicability of the business judgment rule as the standard by which the adoption of the poison pill should have been reviewed. COURT: When the business judgment rule applies to adoption of a defensive mechanism, the initial burden will lie with the directors. [Unocal two-part test must show reasonable grounds for believing that a danger to corporate policy and effectiveness existed. "Good faith and reasonable investigation"/reasonable relation to the threat posed] Where the board consisted of outside independent directors acting in accordance with the foregoing Unocal standards, the burden shifts back to the plaintiffs, who must show a breach of director's fiduciary duties. Directors here were protected by the business judgment rule; poison pill plan is a reasonable response to threats because it established the boards preeminent negotiating position. c The Revlon Rule i Effect of Unocal and Moran was unclear: Unocal supported greater judicial scrutiny of takeover defenses than the preexisting Cheff standard | Moran applying Unocal upheld the validity of poison pill rights plans, giving management a powerful tool to prevent hostile takeovers. ii Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc (Delaware) FACTS: An asset lockup option conceded by Revlons board to a white knight bidder. The board had granted the option to the white knight to induce him to submit a high bid in response to a hostile takeover bid by another company. The question was the extent to which a corporation may consider the impact of a takeover threat on constituencies other than shareholders. COURT: Lock-ups and related agreements are permitted under Delaware law where their adoption is untainted by director interest or other breaches of fiduciary duty. Once it became clear that the company would be broken up, the directors' role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company. Favoritism to a "white knight" to the total exclusion of a hostile bidder might be justifiable when the latter's offer adversely affects shareholder interests, but when bidders make relatively similar offers, or dissolution of the company becomes inevitable, the directors cannot fulfill their enhanced Unocal duties by playing favorites with the contending factions.

d Refining Revlon and Unocal i Paramount Communications, Inc. v. Time, Inc. (Delaware) [The Time case] FACTS: Two weeks before the Time and Warner shareholders were to approve the merger, Paramount announced a cash offer for Times shares, conditioned on the merger not happening. The question was under what circumstances must

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Corporations Outline- Blair (Fall 2010) directors abandon an in-place plan of corporate development in order to provide its shareholders with the option to elect and realize an immediate control premium? COURT: Two situations which may implicate Revlon duties: 1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; 2) where, in response to a bidder's offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company. If the board's reaction to a hostile tender offer is found to constitute only a defensive response and not an abandonment of the corporation's continued existence, Revlon duties are not triggered, although Unocal duties attach. ii Paramount Communications, Inc. v. QVC Network, Inc. (Delaware) [The QVC case] FACTS: After Paramount announced its merger with Viacom, QVC offered a committing (unsolicited) two-step offer consisting of a cash tender offer and a second-step merger with like-valued QVC stock. (Offer was conditioned on the invalidation of the stock lockup.) COURT: The sale of control implicates enhanced judicial scrutiny of the conduct of the board under Unocal and Revlon. (In this context the director's object should be to secure the transaction offering the best value reasonably available for the stockholders) A board of directors is not limited to considering only the amount of cash involved must inform themselves of all material information reasonably available Key features of the enhanced scrutiny test: 1) a judicial determination regarding the adequacy of the decision making process employed by the directors, including the information on which the director based their decision and 2) a judicial examination of the reasonableness of the directors' action in light of the circumstances then existing. Directors have the burden for proving that they were adequately informed and acted reasonably.

C Judicial Review of Voting Contest Defenses 1 Judicial Limits on Inequitable Actions MBCA 7.01, 7.07; DGCL 211 a Schnell v. Chris-Craft Industries, Inc. (Delaware) i FACTS: Board advanced the date of the annual stockholders' meeting and selected an isolated town to hold the meeting in efforts to handicap the plaintiffs who were

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Corporations Outline- Blair (Fall 2010) dissatisfied with the board. ii COURT: Management has attempted to utilize the corporate machinery and the law for the purpose of perpetuating itself in office and to that end for the purpose of obstructing the legitimate efforts of dissident stockholders in the exercise of their rights to undertake a proxy contests against management. Inequitable purposes presumptive breach of fiduciary duty (do not become permissible just because it is legally possible) 2 Enhanced Review of Good Faith Actions a MM Companies, Inc. v. Liquid Audio, Inc. (Delaware) i FACTS: Board adopted defensive measures which changed the size and composition of the board's membership for the primary purpose of impeding the shareholders' right to vote effectively in an impending election for successor directors. ii COURT: Adopted approach from Blasius The deferential business judgment rule is inappropriate when a board acts for the primary purpose of impeding or interfering with the effectiveness of a shareholder vote; The action is not a per se invalid "heavy burden of demonstrating compelling justification" Then the Blasius test was applied within the Unocal standard: When the primary purpose of a board defensive measure is to interfere with or impede the effective exercise of the shareholder franchise in a contested election for directors, the board must first demonstrate a compelling justification for such action as a condition precedent to any judicial consideration of reasonableness and proportionately. 3 Testing the Limits of Pre-Planned Defenses b Carmody v. Toll Brothers, Inc (Delaware) i FACTS: Questions the legality of the dead hand poison pill. Provision operated to prevent any directors of the company who were not in office as of the date of the Rights Plants adoption (or their designated successors) from redeeming the Rights. ii COURT: The court invalidated the dead hand plan as creating less equal directors and disenfranchising shareholders who elect directors committed to redeeming the poison pill.

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