Professional Documents
Culture Documents
General Gent(i)le(wo)manly advice: take income taxation, watch Wall Street with Gordon Gekko and be into midwestern sports
but not Michigan sorry Paiv
Capitalism = efficiency
Intuitively? Maximize output for given set of inputs, minimize waste
Formal?
Pareto efficiency
(p. 4 AKS) no reallocation of resources can make at least one person better off without making at
least one other person worse off
NEG:
fails to take into account the existing distro of resources
Impossible to satisfy
Kaldor-Hicks efficiency
(p. 5 AKS) at least one party would gain after all those who suffered a loss are fully compensated
Winners win more than losers lose
NEG:
No account for existing distro of resources
No account for distributional consequences
Pretty much everything is analyzed by Kaldor-Hicks where you just want the biggest pot/pie in the biz
law realm and max output, min waste
Agency, transaction, organization costs: who bears the cost and how do we minimize it?
Agency cost theory - EX. Gekko hunting and fishing trips, steak lunches, etc. (EX. Dean Diller (DD) donut
shoppe)
CONTROLLED BY K B UT there will always be a residual loss because the A will never work as
hard as the P/owner would work
Monitoring (timesheets, clocking in)
Bonding (commission, sales-based, like a bonus)
COSTS BORNE BY AGENT
Principal = engages A to act on his behalf
Principal pursues principals interests
Agent = engaged by P
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A pursues Ps interests + own
Transaction cost economics (Williamson)
Bounded rationality = limited information (asymmetric), cognitive limitations, limited time (we are not
nearly as rational as we think we are though)
Behavioral assumption = self-interest with guile (hazard of opportunism)
Actors pursue their own interest and lie in a calculated way
feasible Ks? Every K is incomplete (missing info due to self-interest) and difficult to enforce
BORNE BY PARTIES TO K in relation to . . .
Frequency of interactions, degree of uncertainty
+ extent of asset specificity (e.g. barriers to entry like proprietary software THINK - Oracle)
CONTROLLED BY GOVERNANCE STRUCTURES (e.g. ownership stake = incentive)
Ownership cost theory (Hansman)
Ownership structure minimizes transaction costs for owners by bearing ownership costs + non-owners
(employees/eees)
OWNING COST:
Monitoring activities
Collective decision-making
Risk-bearing
CONTRACTING COST:
Asymmetric info
Lock-in w/ specialized instruments
Market power
BORNE BY PATRONS COLLECTIVELY / OWNERSHIP COLLECTIVE
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AGENCY RELATIONSHIP
Questions: what is the liability of the principal? What are the duties owed to the P by A? What about 3P injury?
Rst (3d) 1.01:
Agency . . . fiduciary relationship when P manifests assent to A . . . and A consents so to act
Agency relationship involves delegating some decision making authority to A
Tomorrow? Let us go then, you and i, when the evening is spread out against the sky . . .
to CIRCUMSTANTIAL EVIDENCE v. intent
- J. Alfred Prufrock / Albert Einstein / Gents all around
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Agency costs: I will not work as hard for Dean Diller as I will for myself
Dean Diller will engage in monitoring & bonding (no pay w/o selling 100 donuts)
There will always be some residual loss
Minimized via contract
Transaction costs
Ownership costs
Promotes
Efficiency
Fairness
constrain self-interest through law imposition of fiduciary duties
lawyers bring suits to enforce fiduciary duties
Litigation
Suit by 3P to obtain damages to obtain damages from a (putative) principal
4
Hanson rule seems efficient b.c. if it was other way around, too much liability for universities. Clubs,
etc and schools would likely shut all those programs down
LIABILITY IN CONTRACT
5
Ct says: she has no actual authority to SELL the land; expressed authority to BUY the land (p. 15)
Blank check with signature indicates limited authority, but no evidence that White knowingly permitted/expected
Simpson to SELL
Thomas failed to ask about power of attorney and did not attempt to contact White
While the declarations of an alleged agent may be used to corroborate
LIABILITY IN TORT
Central question is CONTROL
Rst (3d) 2.04:
Respondeat superior - an employer is subject to liability
for torts committed by eees while acting within the scope
of their employment
Rst (3d) 7.07(3):
Eee = agent
Rst (3d) 7.07(2):
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Eee acts within scope of employment when
Work assigned by eor OR
Conduct subject to eors control [overseeing work, etc]
Franchise Agreement: Co. or indiv. (franchisee) sells product or services or operating business pursuant to license from
another co. or indiv (franchisor). -- Gas Station cases are franchise agmts.
7
Very little litigation surrounding this
Express authority - when P tells A to do something explicitly (go buy donuts)
Implied authority - A can do everything that is incidental to what P authorized
Apparent authority - communication from P to 3P; manifestation to 3P
White v. Thomas: how do we figure out what apparent authority is?
Court looks to the reasonableness of the 3P (EX: DD emails the farmer)
Problem here is communication from P to 3P is a little murky (blank check here)
Power of attorney that A says she has but isnt able to produce
Cant just assume that blank check grants authority to SELL something, not just buy
Necessity of 3P action - is it reasonable to require the 3P to take action to confirm the authority?
Inherent (agency power) authority - protecting innocent 3P
Gallant Insurance Co: no modifications unless Gallant has the check, Gallant had A make mods all the time
even before the P gets the check
Permissibility of 3P reliance on communications by the A
Look at EFFICIENCY [to classify differing court opinions]
Apparent authority - You dont want the P engaged in every transaction, the 3P shouldnt be going to the P to
check everything
Inherent (agency power) authority - is it reasonable to allow 3P to recover under circumstances that may
ultimately lower the cost? (lowers cost between contracting parties and society as a whole)
LIABILITY IN TORT
Question isnt authority, it is CONTROL
Respondeat superior: employer/employee relationship acts within the scope of the employment
Does the P control the As performance of the work?
Are As acts within the scope of the employment?
The agent is doing work assigned by the principal?
Operational requirements financial structure
Gas Station Cases
Humble Oil Co: finds an eor-eee relationship Humble Oil is liable for the torts of Schneider
was not named as a along with Humble Oil
Schneider didnt have any money because was JUST an eee
Made monthly reports
Sunoco (Sun Oil): independent Kor finding (Barone)
named as a along with Sunoco
Saw that Barone was essentially an independent Kor with title to all the goods for sale in
the gas station, had all the profit from the gas station; made sense to sue him
Who sets hours of gas station? Who determines what products are sold in the gas station?
No monthly reports
EFFICIENT?
Allocates liability consistent with the way the parties bargain for it (bargain of the parties) efficiently
Difference is in what the parties have negotiated
GOVERNANCE OF RELATIONSHIPS
Methods of governance
Exit rights - A will quit or P will fire
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Very little incentive to P or A to make investment in the Co., whole relationship could end for no reason
Contract - specifies hire, fire stuff
Will always be incomplete, limited and asymmetric information, both likely to behave badly
Fiduciary duties - law fills in the gaps of the Ks
Duty of obedience - like actual authority - little litigation around it
Duty of care
Duty of loyalty - most important
Duty of Obedience
Rst (3d) 8.07: act in accordance with the express and implied terms of any K between the A and the P
Very clear cut, very little litigation
Duty of Care
Rst (3d) 8.08: act with the care, competence, and diligence normally exercised by As in similar circumstances . . .
[including] . . . special skills or knowledge
Some litigation around duty of care most people try to go around the world acting like everyone else in
their field, so very little breach of this duty of care
Duty of Loyalty
Rst (3d) 8.01: act loyally for the Ps benefit in all matters concerned with the A relationship
EX: buy a scratch off lotto ticket and win? Its Ps. Everything done in A relationship belongs to P
UNLESS able to get P to consent
Rst (3d) 8.02: duty not to acquire a material benefit from a 3P in connection with . . . As position
Rst (3d) 8.06: conduct by an A doesnt constitute a breach of duty if the P consents to the conduct, provided
that:
(a) in obtaining P consent, the A
(i) must disclose
(ii) act in good faith (GF)
(iii) otherwise deals fairly with the P (fair dealing) [AND]
(b) Ps consent concerns either a specific act or transxn . . .that could reasonably be expected to occur in the
course of the A relationship
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Matters not even if P has suffered no damage at all or if transxn was profitable for him
Is the rule efficient?
Money had no impact on the P; S wouldve either paid A or kept the money; doesnt harm the P
Want to strip away the As incentive to take secret commissions, no way to police this
Fair not to let the A keep the secret commission, makes A more willing to get the deal done
FIDUCIARY DUTY
Rst (2d) of TRUSTS 203: trustee is accountable for any profit made by him through . . . the administration of the trust,
although the profit does not result from a breach of trust
Even if trustee didnt breach, profit still belongs to the P
Trust law largely mirrors agency relationship; trustee cant deal with property of the trust
In re Gleeson; p. 31-32
Mrs. Gleeson dies right before the farm season; worry is that the planting season is around the corner (around V-day) and
that the fields will lay fallow
1950-1951: Curtin partnership farmed it (one member was Holbrook); $6/acre
1951-1952:
Feb 1952: Gleeson dies and funeral
1952-1952: Curtin partnership rents again; $10/acre
Colbrook not just tenant, but also trustee for trust Gleeson left for her children
P (Mrs. Gleeson) is dead, cant really go to her for permission
Cant talk to the beneficiaries because, if they were competent and capable of
managing the land, then wouldnt have made this trust
Colbrook prob a good family friend, doing this for the benefit of the Gleeson children
Why was he willing in the last year to raise the rent that he was paying unilaterally from $6 to $10?
T. Gleeson (minor child)s attorney was forced to sue because the attorney had fiduciary duty and saw
the breach of the trust
Issue:
Is the trustee permitted to lease the farmland that is the subject of the trust?
Analysis:
Special circumstances re: lease of the land?
Mrs. Gleeson died right at the pivotal point, and field would lay fallow
2 weeks not enough time to find another group of farmers
Gleeson gets crops, children get $$$
Ct says: NO. you can never act in this way!
p. 32: no justification at all for dealing with the property
What must a trustee do to satisfy his duty of loyalty?
p. 32: must decide to either farm the land OR act as a trustee
Would be easier to find someone to act as a trustee
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PARTNERSHIP LAW
JOINT OWNERSHIP
Reasons for partnerships
Operational expertise (synergies)
Financial support (investments)
(incomplete) partitioning of assets and liabilities
Partners share liability of what is owed; also may divide up the decisionmaking/control
When people have money/capital at risk, they will demand control
Difficulties with partnerships
Agency costs:
Still quite large between partners and eees
eees not going to work any harder
Still have monitoring, bonding costs + residual loss
Among partners
In addition to shirking that you do, still shirking among partners themselves
Transaction costs:
Still when the eees interacting with 3Ps
When partners interact with 3Ps
Ownership costs:
Collective decisionmaking among partners
PARTNERSHIP FORMATION
UPA (1914) definition: NY still follows this instead of RUPA but always pull out the actual NY partnership law
6(1): An association of two or more persons to carry on as a co-owners a business for profit
7(3): Sharing of gross returns does not of itself establish a partnership
Eees share in gross returns though; partners get paid only after everyone else gets paid
all you have to do is carry on as business for profit, INTENT does not matter (similar to agency relationship like
Cargill - Cargill agreed to have Warren act as its agent - conduct of the parties only thing that matters)
If you carry on as business for profit, then you find yourself in partnership
Receipt of a share of the profits of a business is prima facie evidence that a person is a partner
7(4): UNLESS the profits were received in
payment of a debt,
as wages of an eee
or rent to a LL
or interest on a loan, through the amount may differ vary with the profits of the business
Consequences of Partnership (UPA)?
Share profits and also losses
AND
9(1): Partners are agents of the partnership
???: Partners liable as Ps
15: Partners are liable for debts of the pship
18(e): All partners share equally in control
If no pship agreement (which can be oral), then everything is split equally
Why do people sue over partnership?
Typically about $$$
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invests a bunch of money into growing a bunch of plants prior to the time that Sweet is paid
Sweet(promised) = 20% of net profits
Sweet(paid) = 20% of [net profits - cost of purchased inventory]
Realize hes only getting 20% of profit after the inventory is subtracted out
Sweet(sues) = 20% of the inventory = 20% of $293,665 = $58,733
Sweet claims that they are sharing in the profits, left after everyone else has been paid saying that
they were in a pship, wants pship dissolved so he can get his fair share
Ct says: INCENTIVES
Only reason to give 20% of profits is to incentivize Sweet to grow the business
Cts reasoning is somewhat circular because it says they share profits because they are in a pship and they are in
a pship because they share profits
Hypo: what if rather than Sweet suing Vohland to get 20% of profits Vohland sued Sweet to get 20% on a loan then the
court would likely not find a pship because they look at INCENTIVES not INTENT
September 1, 2016
(ASSIGNED: p. 4650, 10509, Jackson Accounting Handout)
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Legal structure
Pship decisions
UPA 18(h)
Any difference arising as to ordinary matters may be decided by a majority of the partners
No act in contravention of any agreement between the partners may be done without the consent
of all the partners - if Davidson decides that the donut company should also be growing apples
TERMINATION OF PARTNERSHIPS
Accounting
Purpose:
Organize financial information for any business
Compare financial performance across businesses
Evaluate actions of managers
Determine whether managers have satisfied fiduciary duties
Approach:
Use financial information for the business not the owners or any other stakeholders
Record monetary values in dollar amounts even when difficult to determine
Value of intangible assets is estimated
Contingent liabilities included based on probability
Extraordinary items
Match entries with time periodsall debts incurred while producing a product should be recorded in the
same period as the proceeds from the sales of that product (e.g. when produced in December and sold in
January sale should be recorded in December)
Balance sheet
Assets
Cash, accounts receivable, inventory, real estate etc.
Listed in order of liquidity
Recorded at lower of acquisition cost and current fair market value (e.g. Business school building
is recorded on Fordhams balance sheet as only $100,000 b/c they bought it in 60s)
Liabilities
Because loans are repaid regularly they remain pretty close to market value
Partners capital (shareholders equity)
equity=assets-liabilities
The balance sheet is just a photograph as of one day
Income Statement
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Revenues
Expenses
Net Income
revenues-expenses=net income
The income statement is like a movieit looks at net income over a 12 month period
On the income statement accountants consider depreciation instead of maintenance expenses
$12,000 asset lasts 12 yearswe record it as depreciating $1,000 per year out of convenience
even if it does not match the actual maintenance costs
Because of this net income may not match actual profit because it may record more or less
depreciation than there was actual maintenance costs
Statement of Cash Flows
Just constructed from the balance sheet and the income statement
Cash from operating+cash from investing+cash from financing
Partnerships dont pay taxespartners do
Prob #2 p. 50: total taxable income would be salary plus income from partnership
September 6, 2016
(ASSIGNED: p. 51-74)
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EX. building next door was 160k, now worth about 100M; many assets are worth more than
their fair market value because use of historical value
Liabilities less likely to have this problem - short period of time (3/5/7/10 years)
Income statement - measures value by net income (profit)
REVENUES - EXPENSES = NET INCOME
Compare biz across time and industries
Record non-cash items, depreciation rather than maintenance costs
Cash flow statement - measures value by cash
Pickes out changes in companys cash position over that same year
CASH =
Cash from operating activities +
Cash from investing activities + (e.g. repay mortgage, buy a new oven)
Cash from financing activities
Records the actual (cash) value of the company
PARTNERSHIP LAW
Termination of partnerships - who gets what
Duties of partners (fiduciary duties)
Modification of the partnership form
TERMINATION OF PARTNERSHIPS
Statutory provisions
Dissolution (breaking up)
Termination (winding up)
Distribution (payments)
Judicial oversight
Avoid a dissolution
Adams v. Jarvis
Initiate a dissolution
Page v. Page
STATUTORY PROVISIONS
Dissolution UPA 29:
Change in the relationship of the partners caused by any partner ceasing to be associated in the carrying on . . . of the
business
Winding up UPA 37:
Unless otherwise agreed, each of the partners . . . has the right to wind up the partnership affairs (including by the
court)
Sweet: recall nursery business case
Distribution of partnership property UPA 38(1):
Each partner . . . unless otherwise agreed, may have the partnership property applied to discharge its liabilities and
the surplus applied to pay in cash the net amount owing to the respecting partners
You contribute assets, you can only use it for partnership business; cant take it back
Held as partnership in tenancy
Here, you dont get your stuff back, you get your pro-rated share of the sale of that asset
Rules for distribution UPA 40:
(a) the assets of the partnership are
I. the partnership property
II. the contributions of the partners necessary for the payment of all liabilities specified in clause (b) of this
paragraph
You can sell shit (e.g. sell the table you contributed, but the table is the partnerships!)
Personal assets are added back to the partnership to cover liabilities
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(b) liabilities of partnership shall RANK order of payment as follows
I. those owing to creditors other than partners
Eees, suppliers, utilities, etc. if not enough to pay these people, then partners have to
contribute to pay them
II. those owing to partners other than for capital and profits
After all the other creditors have been paid, debts, etc. to individual partners
E.g. loans extended to them, salary
III. those owing to partners in respect of capital
WA square pharmacy
Amount that theyve earned over time in partnership
IV. those owing to partners in respect of profits
Net income for year that partnership was wound up in
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What limitations are placed on Dr. Jarvis (and the other partner)?
Fiduciary relationship = gap-filling duties good faith effort to collect on accounts receivable
consistent with good business practices
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DUTIES OF PARTNERS (FIDUCIARY DUTIES)
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loyalty
Many forms of conduct permissible in a workaday world . . . trustee is held to something stricter than
the morals of the market place
Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior
Punctilio > morals of the marketplace
Notion that you have to tell your partner and then compete silly Cardozo
Joint venture terms?
The never seen
Salmon = winner take all never see this winner take all of who gets opportunity gets to take it
Meinhard = same terms never see this
Court = competition in absence of written agreement, there should be competition never see this
CARDOZO employs this as clearly a penalty
Mr. Salmon actually breached his fiduciary duty
Avoid the penalty by writing your own agreement that makes sense
Wants people to go into business together, make an agreement that makes sense to you
or pay the penalty of competing each other
RIGHT OF FIRST REFUSAL - efficient solution
Cargill - grain elevator (recall!)
Whoever gets the opportunity, negotiates;
offers the opportunity in total to the partner OR
offers to split it
Make note about Andrews - we didnt even talk about it in class
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Pappas v. Tzolis; p.6972
Facts:
2006 investments
P+T=50,000
Infantopoulous: 25,000
2007 sale to T
P+I sell their shares to T for 1M
Asks to sign certificate saying that they have done their own due diligence and they know what it is worth and
that selling their shares for .5M is the right price and that they have consulted counsel and are not owed any
fiduciary duty by T
T manages to resell the building for 17M
Claims:
P+I sue saying that T breached fiduciary duty
Issue:
Can LLC members waive fiduciary duty?
Analysis:
P and I were sophisticated
Represented by counsel
Their own allegations make it clear that at the time of the buyout the relationship between the parties
was not one of trust
Reliance on Ts representations would not have been reasonable
They should have been suspicious when T offered to pay them 20 times the original price
BUT why permit members of an LLC to waive unlike the members of a partnership?
Is the rule efficient
The nature of the rule of loyalty is efficiency
Cardozo is flipping over in his grave
BUT they know when they sign that waiver that there is going to be some funny business and it
is their responsibility to do as much due diligence as they can
If T comes to you and says invest 100,000 in this business and waive your fiduciary duty you will give
less because of the risk associated with waiving it
*If T had lied in obtaining the waiver it wont be any good because of fraud
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CORPORATE LAW
September 8, 2016
(ASSIGNED: p. 75-82, 82-92, 95-98, 98-101)
(Dunkin Donuts case study)
(Pappas v. Tzolis)
CORPORATIONS
About 18% of business organizations in the US are corporations
About 8189% of business receipts are made by corporations
FORMATION OF CORPORATIONS
State incorporations statutes
Used to have to go to a state legislature and ask them to pass a bill allowing you to form a corporation
Most of these were corporations for the public good
Benefit was that the state knows what corporations are in it and has control over actions
By the 20th century we gave up on this and now have general acts of incorporation
You just file with SoS and can conduct business for any lawful purpose
The advantage of using this modern approach is that anyone who wants a corporation can form
The barrier to formation is much lower than in a special act model
Disadvantage is that states no longer have control over what these corporations are doing
Governance terms
Used to have a lot of mandatory terms about
Paying bills
Who was in charge
Who made decisions etc. etc. etc
Now this is all over
Corporation codes are simply enabling statutes
They say that unless it is specifically prohibited it is permitted
The courts have filled in the gaps in these statutes with fiduciary duties
The statutes no longer provide and real control
Headquarter vs. incorporation
California, New York and Texas have most headquarters
Delaware has 50% of incorporations
Choice of state of incorporation
Legal consequences
Doctrine of internal affairs
Anything related to governance of the corporation will be controlled by the statutes of the state of
incorporation
Practical consequences
You get to pick your law because you get to pick where you incorporate
Once you are incorporated as a corporation you get the power to act as a person
Since corporations are people they pay taxes like people
Also pay franchise taxes ( of DE budget)
Competition among the states
Race to the bottom (Cary)
Managers choose where corporations are incorporated and thus they will choose states with the
least regulation like Delaware because it allows them to take investors money more easily
Race to the top (Winter)
Race to the bottom cant be right because if everyone understands that the law in Delaware is
really good for the managers and really bad for the investors then no one would ever invest in
corporations that are incorporated in Delaware
Race in either direction depending on the topic (Bebchuk)
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Which theory is applicable really depends on what you are talking about
Executive compensation is race to the bottom
Shareholder voting is race to the top
Competition between DE and Fed. Gov.
We went for 75 years with no federal regulation
After the depression there were some statutes then none until the 70s and 2000s
Delaware has won but there must be some times when the federal government steps in because the
Delaware law is not working
WE ARE GOING TO FOCUS ALMOST EXCLUSIVELY ON DELAWARE LAW
Close Corporations
Shares are held by relatively few shareholders
Who actively manage the business and
No market for shares exists so shares are sold in private transactions
Controlled corporation
Has a majority owner or a very large minority owner
Or a group acting together
Public corporations
Controlled corporation
Shares are held by the public at large
Who don't manage the business
Shares easily traded
Majority owner very large minority owner
Group acting together
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Officers
What are the titles
What are the responsibilities
Administration of stock certificates
What happens if you lose it
What happens if someone steals it
Indemnification of directors and officers
Why have bylaws that are so sophisticated where the certificate of incorporation is so barebones?
If you would like to amend the certificate of incorporation 242(b)
Board of directors has to propose and approve
Shareholders have to approve
Then you have to file the amended thing with the state
In order to amend the bylaws
Can be changed by stockholders OR
By the board of directors
Much easier and more flexible to change than putting it in the certifiate of incorp.
ORGANIZATION OF CORPORATIONS
Dispersed ownership by shareholders
Where liabilities are greater than assets - corporation is bankrupt
Cant have negative equity like in a partnership
Benefits of limited liability
Reduction of agency costs
No need to monitor the managers
No need to monitor the other shareholders
Reduction in transactions costs
Shares are fungible
It is easy to buy and sell shares
Reduction in ownership costs
Focuses on profits (efficiency
Race to top
Favor shareholders and so efficiency
Race to bottom
Favor managers, engendering large agency costs
CERTIFICATE OF INCORPORATION
Required (form) provisions
statutory requirements
Customized (bespoke) provisions
Stockholders
Board of directors
By-laws
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Mechanics of meetings for stockholders, board of directors
Titles and responsibilities of officers
Administration of stock certificates
TYPES OF CORPS
Close corporation
Relatively few shareholders who actively manage the biz
Public corporations
Shares are publicly held traded among investors (on exchanges) without corporations involvement
BENEFITS OF TRANSFERABILITY
Reduces in agency costs (ease of replacing managers)
Reduces transaction costs (ease of buying and selling shares)
Reduces ownership costs (ease of diversification)
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Tells Jennings exec committee would surely go along with these terms that I say
Board of directors normally rubber stamps what exec committee approves
THEY DONT APPROVE OF IT
Jennings shouldve been paid a $30,000 commission, wanted to cut him out of the commission; trying to
take advantage of Jennings
Claims:
Jennings goes to court oh nonono, Egmore had apparent authority!
Recall White and auction of farm case White v. Thomas
Issue:
Does Egmore have apparent authority to auth Jennings?
Does Egmore have apparent authority to bind the Pittsburgh Mercantile Co. to the K with Jennings?
Analysis:
What is the significance of the nature of the sale and leaseback transaction?
These are quite extraordinary (if just one factory, then just one sale-leaseback every 20-30 years)
p. 100 unusual and unprecedented
Q: Authority to accept some type of extraordinary transaction?
Are the statements Egmore made regarding his role, and the role of the Exec Committee, sufficient?
p. 100: Agent cant by his own words best himself with apparent authority
Are the prior dealings between Egmore and Jennings sufficient?
You shouldve seen this coming and shouldve known Pittsburgh wouldnt want to pay commission
You are experienced real estate agent
(1) similarity + (2) repetitiveness required
Is Egmores position in the corporation sufficient?
VP/comptroller role not enough; need decision from BOARD
Why is the court concerned that recognition of authority would be detrimental to the board?
Want to make sure only board has the authority to manage business and affairs of the company
p. 100 finding Egmore had apparent authority greatly undercut role of board
Would hold board liable for actions of the officers when board hasnt had chance to consider
What could Jennings have done? should have gotten board resolution
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THEORIES OF VALUE
Firm foundation theory - Williams / Graham and Dodd (taught Warren Buffett)
Stream of ca$h
Value of any company is just the cash that it produces; value is the company itself and the cash it produces
Buffett method
Look at the stream of payments (cash flows) paid over time (in the future)
Castles in the air theory - Keynes
You select the baby that is the most beautiful
You buy a share of stock in dunkin donuts because you
think someone else is going to pay that much money in
the future
So then you can sell share of stock in the
future based on which some asset in the
company can be sold for in the future
Price at which asset (company)
can be sold (in the future)
H/O Ackman and Dalio, Two Hedge Fund Titans, Size each other
Dalio (Bridgewater) - mad AI - doing better
Ackman (Pershing Square) - qualitative - aint doing as hot as normal
Intuitive notion:
Receive money today
Deposit money in the bank
Earn interest, so have more money next year
Receive money next year
No money to deposit in the bank
Dont earn interest so have less money next year
$100 you get today is worth $100 to you
But if you have to wait a year to get that money, then its worth somewhat less
Agree to make investment (buy stock) only if
The price today (which is a present value)
Is equal to
The (future) cash discounted to present value
First fundamental principle:
$1 today is worth more than $1 tomorrow
a
PV = (1+r)n
r == P V
did a bunch of exercises using these formulas
FV = PV (1 + r) ^n
FV = a (1 + r) ^n, where a = amount
PV = FV / (1 + r) ^n
PV = a / (1 + r) ^n, where a = amount
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Downside losses weighted much heavier than upside gains = risk aversion
Declining marginal utility of wealth
RISK
Consequences of risk
Risk imposes costs on individuals, due to risk aversion
Individuals dealing with declining marginal utility of wealth
Downside losses weighed more than upside gaines
Investors must be compensated to bear the risk (risk premiums)
Second fundamental principle:
$1 for sure is worth more than $1 with risk
(Risky) Investments
Looking at bonds issued by the US govt w/ maturity of one year or less (avoiding the inflation problem) -- 1%
Essentially risk-less
Big companies -- 9%
VC companies -- 12%
Expected value (used that DD coin flip example)
FOUNDATIONAL PRINCIPLES
First principle: $1 today is worth more than $1 tomorrow
Due to opportunity cost
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FV = a (1 + r) ^n
PV = a / (1 + r) ^n
Second principle: $1 for sure is worth more than $1 with risk
Due to risk aversion (declining marginal utility of wealth)
Q: What is the expected value of the loan if the bank believes it has a 95% chance of being repaid in full and a 5% chance of
receiving $0?
INVESTMENT
Intuitive notion
Pay price today; no need to discount because paying today
Receive cash in the future; futur case must be estimated/projected by determining its expected value
Agree to make investment (buy stock) only if the price today (PV) is equal to expected value (E) of the future cash
(FV) discounted to PV
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Investors receive no comp for bearing diversifiable risk
Undiversifiable (systematic) (market) risk
Risks related to the entire economy
Compensation?
Investors are only compd for bearing undiversifiable risk
Because they cannot escape it
Firm Foundation Theory: value of any company is just the value of the stream of cash you receive in the future
(a)
PV = (1+r)n
Discount rate (r) time value of money + systematic risk
GENT: take corporate finance!
Efficiency of a market
Information and profits
For a given set of info
Profits from trading on that info are, on average, zero
Information and prices
Prices immediately (and correctly) reflect all info in the set
Profits from trading on that information are, on average, zero
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Semi-strong form - public information - most prevalent
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Mechanisms for protections of creditors
1) Capital Structure
a) Assets (current and fixed), liabilities (bank loans, bonds, and A/P), and equity (preferred then common stock).
i) Contract, interest, and principal. Secured v. unsecured debt- determined by k.
ii) Secured debt is debt with a form of collateral to where creditors can get something if you are unable to
meet your debt obligations.
iii) Equity: Preferred stock with liquidation amount and dividends before common stockholders get dividends
(in event of bankruptcy or issuance of dividends). This is why common stockholders have right to vote,
everyone knows they get paid less so to be Kaldor-Hicks efficient they get voting rights. In the event of
bankruptcy they get nothing so incentive to avoid it by electing competent board!!!
b) Why do we protect creditors outside of contract?
i) To prevent debtor misbehavior
(1) Donuts are boring so Ill just invest in biotech, take money back whenever (sorry not sorry),
debtor could also just keep lending money and dilute claims.
ii) Protection of other stakeholders (not shareholders)-- employees, suppliers and customers all just want to
keep doing what theyre doing and making $. Members of the community benefit too via property taxes,
lets protect everyone by siding with the creditors so that we can keep it going.
2) Mandatory disclosure- Dont do much; unlikely to come in time to do anything. WORTHLESS
a) Statutory requirements- federal and state law.
b) Speciality service providers (think FICO) or credit rating agencies to rate how likely company is to pay debts.
3) Capital regulation: How much in dividends can be paid?
a) DGCL 170 (a): (nimble dividend test): may pay dividends out of capital surplus + retained earnings, or net profits
in current or preceding fiscal year (whichever is greater).
i) We can pay out surplus and nothing else. Surplus= equity- stated capital or in other words surplus= capital
surplus +retained earnings. Surplus can be negative brah. [Eva Q: I thought net income can be neg, not
surplus???? HALP]
ii) Stated capital makes sure assets remain in corporation to satisfy creditors-- surplus by using that lower par
value can make it hard for creditors to have access to anything, corporation can just pay everything out in
dividends.
iii) No surplus?-- pay the net profit in dividends for this year or last year brooo. Delaware knows what youre
thinking. Reward those groupie shareholders, stand by yo man,
iv) See pg 110 for Alpha-- dividends can be paid as surplus = capital surplus + retained earnings.
300+500=800. Had surplus been 0 Alpha couldve paid out net profits from last yr ($400) or this yr ($120).
b) DGCL 154: stated capital is aggregated par value per share (stated capital= par value * # of shares). Capital
surplus= (price-par value) * # of shares. PAR VALUE is typically trivial, the rest appears in capital surplus and uses
the price based on firm foundation theories or comparable companies,
c) DGCL 173: dividends can be anything (cash, property, shares in corporations capital stock).
d) DGCL 174: Wilful/negligent in calculation then partners are personally jointly and severly liable.
e) RMBCA 6.40: fair market value test- may base dividends based on financial statements or on a fair valuation or
other method reasonable under the circumstances (so long as you can pay debts as they come due in regular course
of business or what is owed to creditors and preferred shareholders).
i) In ALPHA example would be significantly more-- DCF analysis values at 30k. OVER TIME: PAR
VALUE CHANGES HAVE MADE THESE SIGNIFICANTLY DIFFERENT-- WRITE IN K THAT YOU
WONT PAY DIVIDENDS.
4) Duties Owed to Creditors
a) By directors- may owe obligation to creditors not to render firm unable to meet credit obligations by making
distributions to shareholders or others w/out receiving fair mkt value in return.
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i) See Credit Lyonnais Bank: (pg 113) judgment for $51 million subject to appeal. Expected value
computation of judgment given %s of affirm, modified, reversed is $15.55 million. Company only has one
liability of $12m in bonds. Outstanding offers to settle for $12.5m and $17.5 but the shareholders probably
dont care about the expected value and want to go for it all ($51m).
(1) BLACK LETTER LAW: Board of Directors should accept settlement offers that are above the
expected value and reject those below it.
(2) Ensure adherence by conceiving corporation as shifting fiduciary duties of the directors to the
entire corporation when in the vicinity of insolvency.
(3) Highly scrutinized opinion: when are we in the vicinity of insolvency and what should the
directors actually do when they are in it?
b) By creditors to other creditors (fraudulent transfers).
i) UFTA (1984), Section 4: transfer is fraudulent when debtor 1) acts with actual intent to hinder, delay, or
defraud any creditor 2) without receiving reasonably equivalent value and the debtor i) FIX.
(1) Actual (1) or constructive fraud (undercapitalization or intent or belief that would incur debts
beyond ability to pay when due)
(2) Problem with severance and retention payments and trying to incentivize board not to leave.
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Protection of other stakeholders
Employees, suppliers, customers, community
SOURCES OF INFORMATION
Statutory requirements company can go bankrupt in a matter of days
Specialty service providers paid by corporations themselves, little incentive to provide negative reviews
Contractual provisions provisions providing for disclosure, at best 30d disclosure period
CAPITAL REGULATION
Point is to keep some money/capital in the company so always going to have that there
Problem is that fixed amount wont always be there
TYPES OF RESTRICTIONS
Distribution constraints
Nimble dividends test allows the company to pay out profits from last year
Net income; surplus, retained earnings (income retained and reinvested in the
business)
DUTIES TO CREDITORS
Duties of directors to creditors Credit Lyonnais Bank
Company in the vicinity of insolvency (this zone)
directors owe fiduciary duties to the corporation, not to any one constituency (notably not the shareholders)
Directors should (always) accept (settlement) offers with values > expected value
Duties of creditors
Creditors owe duties to one another?
Fraudulent conveyance reaches out to the creditors and unwinds the transactions to give back to creditors
Types of fraudulent transfers?
Actual fraud typically hard to find
Constructive fraud debtor transfers its assets for less than fair market value
(1) Less than reasonably equivalent value
(2) Unable to pay debts as they become due, or unreasonably small capital to operate
its business
Modern uses
retention/severance agreements
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MECHANISMS FOR PROTECTION (OVERVIEW)
DUTIES TO CREDITORS
Equitable subordination
Assets takes assets and sell them
Current, fixed assets
Liabilities
Accounts payable, bank loans, bonds
Equity
Common stock sell bonds
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Must the loans from the shareholders be subordinated to the loans of Fazio, Ambrose?
Analysis:
Court looks at the capital (amount of money) left in the corporation
p. 119 - elected to take all the money out of the company and convert it into debt; focus on
capitalization and taking all equity out of the company except $2000 to match Leonards position
$6000 left in the corp is 1/65th of the annual net revenue of last year
The more debt, the lower the net income
Converting equity to debt to avoid tax liability
acted to detriment of the corporation and its creditors (p. 120); remedy is to subordinate that debt and shove
it back down into the equity layer
When the claim is found to be inequitable, it can be subordinated to the claims of the other creditors
35
Pierce into Marchese through pepper source, and then back down to those other corps and check em out
p. 124 - Van Dorn test
(1) unity of interest and ownership that the separate personalities of the corpoation and the individual (or
other corporation) no longer exist
+ 4 factors:
Absence of good books, records
Commingling of funds/assets
Under-capitalization lack of money to operate the business (goes to first prong)
One corporation treating assets of another as its own
p. 125 - there can be no doubt that the shared control / unity of interest is met
(2) circumstances must be such that adherence to the fiction of separate corporate existence would
sanction a fraud or promote injustice
Intentional wrongdoing
p. 126 - sealand services hasnt alleged any particular wrongdoing on Marcheses part, all it
relied it upon is payment of its outstanding debt; court then references all of this stuff but says
claimant didnt claim an injustice
Appellate court says that this isnt enough; Marchese sucks but nothing suggesting
anything has happened other than that money hasnt been paid
p. 126 - need to show corporate fraud was used to avoid responsibilities OR one of the other
corporations will be unjustly enriched unless liability is shared by all
ON REMAND goes back to the trial court
Did the trial court rely on any of the examples in finding that the second Van Dorn prong has been satisfied?
They found tax fraud!
36
Walkovszky v. Carlton; p. 132-136
Facts:
Seon Cab Corporation - has ten cab companies
On each of the companies, has minimum
required insurance ($10,000)
Not enough to pay Walkovszky
Wants to pierce and bring together the
assets from all ten companies, the 20
cabs and the $200,000 worth of
insurance
Cant get up to Carlton; all have good
books
Issue:
What assets are available to Walkovszky outside of
what is available in Seon Cab Corporation (and reaching other 9 companies)?
Analysis:
p. 132 - New York test (more like Van Dorn)
(1) unity of interest
Same factors as Sea-Land
(2) prevent fraud or achieve equity
Putting those asset across those ten corps = fraud? Not enough to pierce the corporate veil; not
illegal to create lots of individual companies
Need some fraud among those companies, e.g. company needs to be a dummy
Seon cab corp is all paid by same accounts, same drivers; treating these companies as if operating as only one
Court allows Walkovszky to replead
So what role does inadequate cap play here?
p. 134 - it is not fraudulent for the owner-operator of a single cab corp to take out only the
minimum required liability insurance . . .enterprise does not become illicit/fraudulent merely
because of this
How does the Court of Appeals in NY fix this?
The problem isnt with the legal test, its with the insurance minimums
NY Court says: You need to take this up with the Legislature!
CORPORATE GOVERNANCE
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Company like Dunkin Donuts?
Shareholders electing the DD Board of Directors (staggered board)
Dunkin proxy card?
Shareholder voting very important yes to what board recommends, no to what board recommends, or
you abstain; there is no write-in for elections
DGCL 212(a) every statute works just like this
Unless otherwise provided in cert of incorporation every shareholder gets one vote per share
Any corporation in cert of incorporation can confer/grant . . power to vote . . . and also any other rights which
stockholder has . . .
DGCL 216(2)
Vote by affirmative vote . . of the majority of the shares present in person
DGCL 216(3)
Directors shall be elected by plurality of votes
Shareholder voting? 3 things
[ONE] DGCL 211(b) - election of directors
[TWO] Fundamental changes
DGCL 271 - sale of property and assets
DGCL 251 - merger with another corporation
[THREE] DGCL 242(b) - Amendment to cert of incorporation
Certificate of incorporation
Protection from takeovers v. vulnerable to takeovers
Q: How easy is it for someone to takeover a corporation? Getting the shers to agree with takeover?
DGCL 141(d) - staggered board of directors
Annual election of directors, but no need all directors
Directors can be divided into three classes
Takes two years to elect a majority of the board of directors
DGCL 211(d) - no shareholder ability to call special meeting
If cert of incorp specifies that shers cant call special meetings; then meetings are annual and
whenever directors call meetings
DGCL 228(a) - no shareholder action by written consent
If cert of incorp specifies no sher action by written consent
Initial directors on the board write the certificate of incorporation thus pretty much every cert precludes written
consent and the special meeting
Q: why would shareholders accept this type of shit?
Shareholders (and stakeholders) are willing to bear higher agency costs (makes board very hard to
be fired) to achieve lower transaction costs and lower ownership costs (if doing poorly, can just
sell shares)
DGCL 212(b)
Any stockholder entitled to vote at meeting . . . may authorize another person or persons to act for such stockholder
by proxy . . .
Ex: if board member brings in majority by proxy, board solicits the proxies
Insurgent shareholder can also solicit proxies but must prepare a proxy statement
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Claims:
Shers indignant that they are reimbursing themselves for their own proxy contest
Issue:
Who gets reimbursed for costs of proxy solicitation?
Analysis:
When can corporate funds be used by board of directors to protect their position as board?
p. 176 - as long as contest of policy and not . . . purely personal power contest
Incumbents are reimbursed as long as the argument is about policy
Directors have to believe that it is in the best interest of the corporation
For the purpose of persuading the shers of the correctness of their position and soliciting their
support
What about the insurgents?
p. 176 - practical matter, reimbursed when they win
Stockholders . . . successful contestants . . . for expenses incurred by them in any such policy
contest (if the shers elect you, they must prefer you)
Why not prohibit the reimbursement of all proxy solicitation expenses incurred by the incumbents and the
insurgents?
Want to protect incumbents from any hostile takeovers if they dont have the cash money
Why not reimburse all proxy solicitations?
Want to discourage stupid proxy contests, limits insurgents unless they have a good ass idea
DGCL 220(b) - sher can inspect ledger, books/records (companys financial statements), sher lists for proper purpose
Proper purse shall mean a purpose reasonably related to such persons interests as a sher
Stock list
Corporation bears burden of showing improper purpose
(Almost nothing is improper)
Books and records
Shareholder bears burden of showing proper purpose
(almost nothing is proper)
Board of directors manages the biz and affairs of the corporation (DGCL 141(a))
Competitor is more likely to want to see the books and records
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What is vote-buying? Does this loan to Jet Cap count as vote buying?
Court says: Yes. p. 191, just a voting agreement supported by consideration Jet Cap being bought out
vote-buying , despite its negative connotation, is simply a voting agreement supported by
consideration personal to the stockholder, whereby the stockholder divorces his discretionary
voting power and votes as directed by the offeror
This is a true agreement to vote one way b/c of exchange of consideration
What is the new standard for evaluating claims of vote-buying?
p. 193 - going to evaluate it on a case-by-case basis for its object or purpose
What types of arrangements (vote buying) will we prohibit?
Will prohibit those that are fraudulent (p. 193)
Rationale is that if shers are all voting yes based on a misstatement/fraud, they are
meaningless yes votes
What is the standard for assessing fraud/disenfranchising shareholders?
Intrinsic fairness -- vote-buying is so easily susceptible of abuse, it must be viewed as a voidable
Courts will determine intrinsic fairness based on the votes of the shers
Shers had all the information that they needed, and they still voted for it (in favor of
the transaction)
No reason for the court to set it aside
p. 194 - going to look at whether or not furthering the interest of all Texas Intl shers
Interest of all shers, not just Jet Cap
NEW MODERN RULE - vote-buying is not per se illegal, but voting agreements are fine as long as they are
intrinsically fair
Is this new rule efficient? Seems so, but also odd because if 65% of the shers voted for then why bother trying
to get Jet Cap in the beginning? Call their bluff
Gregs procedural question: If you wanted to sue w/ full disclosures, then you had to sue right after you
got all the proxy materials but before the vote
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Enforces the securities laws
Promulgates rules and regulations to implement those laws more effectively
Costs of voting
All investors hold diversified portfolios
Each investor bears all the costs of becoming informed
(???)
Mandated disclosures required by the 1934 Act and rules promulgated by the Commission reduce the costs of
becoming informed (and improve efficiency of the stock market)
Individual investors remain apathetic and sell their shares when they become disappointed and so they remain
passive investors (passive apathetic investors)
Recall that shers are residual claimants; so they have incentive to vote for directors that are most efficient
But also shers have a reason not to want to be invested at all
Institutional investors hold portfolios that are too large to allow sales of shares will maintaining diversified
portfolios and so they become active investors
Activist hedge funds seek to profit by purchasing shares in disappointing companies and then seeking to reduce the
(extreme) agency costs
Hedge fund managers get about 20% of the profit; incentive structure to make profits, very active
PROXY RULES
Reg 14A (R 14a-1 to R 14a-7)
Substantive regulation of
The process of soliciting proxies
Comms among shers
Schedule 14A
Specification of the information
To be disclosed in a proxy statement
Distributed by the corporation (incumbents) or any shareholder (insurgents)
Lengthy document; 120 pages or whatever
Rule 14a-1
Solicitation = any communication reasonably calculated to result in procurement of a proxy
Rule 14a-3
Prohibits soliciting proxies unless a proxy statement containing the info specified in Schedule 14A is, or has been,
furnished to the shers
1992 exemptions dont have to prepare the proxy statements; exempted from talking to shers
Rule 14a-2(b)(1)
By shareholders who do not intend to seek proxies
Rule 14a-2(b)(2)
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Solicitations to fewer than ten shers
Rule 14a-1(I)(2)(iv)
Announcements of intentions regarding vote (and reasoning)
Ex: p. 4 of DDs proxy statement listing everything that needs to be disclosed, need to talk all about the way the
company is governed, any transactions related to persons, disclosures re: executive compensation, all the proposals
Runs for about 100 pages and the type is pretty small
Rule 14a-4(d)(4) Short Slate Rule
All you have to do is identify who else you would keep on the board, cant force them to stay on the Board; just
running for 3 or 4 (asking for agreement)
SHAREHOLDER PROPOSALS
Rule 14a-8(a)
You can simply ask the board of directors to do something
Recommendation or requirement that the company and/or its board of directors take an action at sher mtg
All you have to do is send it to the board, and the board will put it in the proxy statement
Rule 14a-8(d)
The proposal, including any accompanying or supporting statement, may not exceed 500 words
Rule 14a-8(i)
Company may exclude the proposal from proxy statement if [13 statements]
(1) it is improper under state law
Ex: dictating where the company is going to (proposing what the company is going to do) is not
allowed under DGCL 141 (board runs the company rule)
(5) Relates to less than 5% of the operations
If the proposal relates to operations which account for less than 5 percent of the company's total
assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and
gross sales for its most recent fiscal year, and is not otherwise significantly related to the
company's business
(7) ordinary business operations
Salaries, loans, properly in purview of directors
Rule 14a-8(j)
Company must file its reasons with the Commission
Rule 14a-8(g)
The burden is on the company to demonstrate that it is entitled to exclude a proposal
Ex: If you exclude this proposal because its improper under state law, then no action will be taken (no
action letter)
TYPES OF PROPOSALS
Corporate governance proposals
Majority election of directors
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September 27, 2016
(ASSIGNED: AK 214-232,
239-244, 248-255)
FRAUD
Strong prohibitions because the entire system is disclosure-based
Rule 14a-9
Remember almost anything is solicitation (you getting proxy) and cant misstate material fact or omit material fact
Corrective disclosure >>>>>>>>>>> redo shareholder vote
Claim of fraud
materiality standard and what it means
(1) misstatement or omission
(2) of a material fact
(3) you need to be responsible, culpability
(4)
Majority: negligence
3d Cir: scienter
(5) reliance on statement, causation
Can be shown in ways like demonstrating the market price incorporates all info (fraud on market theory)
(6) harm
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VBI v. Sandberg; p. 216-222
Facts:
Bank wants to get rid of shareholders so combine banks so we have larger VA bank
Shareholders get $42/share
VA bank will still need annual, but now First Am owns 100% of the shares
Only 15% shares in market of First Am. Bank of VA; 85% owed by other company
First American Bank merged with VA bankshares
Shareholders given $42/share and First Am. Bankshares has 100% stake in VA bankshares
Claims:
Directors said $42 high price + fair value
says Rule 14a-9 (misstatement of material fact)
board says nah, just our OPINION, which isnt actionable, shareholder should have figured it isnt
fair price and figure out our own opinion
We cant have endless litigation about whether directors have basis or dont
Issue:
Does it matter if it is opinion?
Analysis:
TSC industries = federal standard
It is material if reasonable shareholder would reasonably consider it when deciding to vote
HOLD that statement is material
Court says must mislead on underlying facts
Must have evidence that directors thought it wasnt fair
Standard: they did not in fact believe the statement
Real estate equity is much higher, more like $60/share because market rate of real estate is much higher
Court knows for sure that directors did NOT believe $42/share was fair or high because they saw it as a
$60 value
Goes even further to say that statements of opinion lead shers to believe certain underlying facts are true when they are
not then this can be a misleading statement (e.g. we believe our conduct is lawful but havent consulted lawyer)
But could not prove reliance because would have to show that she read and voted yes because of statements
Also her vote did not matter because the parent company had 85% and therefore had the power to decide the vote
itself
Q: can it just be pure statement of disbelief? (pure statement of opinion basis for fraud claim)
A: your opinion is enough if a reasonable investor could infer that the opinion is based on facts that dont exist
Ex. we believe that our conduct is lawful
Implies that board has hired lawyers and was told that
44
would have to find written opinion (under bank shares) that they didnt believe what they said
was true
Here, Kagan says that the implication that you hired lawyers is enough for a fraud
claim
in VA could not have shown she relied on proxy statement -- dont rely on subjective state of mind of for notion of
causation of causation standard is Mills:
Vote has to be sufficient to matter to outcome
In this case, shareholder vote just formality (necessary not sufficient) because only 15% of the stock
Essential link = has to be necessary to the outcome
here cannot demonstrate the essential link (why she lost); she said that bank would have been
unwilling to proceed with merger if 15% voted; even though could have, reverse for publicity reasons
SCOTUS SAYS you dont know, we dont want to spend our time on endless litigation
Underlying facts of case . . . CLEAR evidence of fraud
Same is true for essential links; we want to know these matter instead of being driven by something else
DUTIES OF DIRECTORS
Duty of care
Requirements
ALI 4.01(a)
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Good faith,
Best interest of corporation (reasonable belief)
Reasonably prudent person
46
When Pritchard dies, sons take more and more money until company goes bankrupt
Issue:
Did Pritchard breach duty of care by failing to monitor?
Analysis:
Has to be proximate cause and here it is
Does not get the benefit of the business judgment rule
The court wants her to object and if they fail to correct their conduct then she should resign
The court expects her to make sure this bad conduct stops
E.g. reporting to insurance authorities
But whether other directors have further duties than to protest and resign is left to ad hoc basis
Chris-Craft (DE) inequitable action not permissible just because possible- move meeting VOTING IS SPECIAL
A. D
irectors and Officers (WTF on this section?)
Duty of Obedience Officers and Directors must comply with the charter and bylaws
o this is never litigated because this is black and white if its in the bylaws (you settle right away)
Duty of Candor honesty is required wherever directors communicate with shareholders
o usually litigated under federal securities anti-fraud law
o Exists but not terribly important b/c unlikely to result in any damages at all
1. D uty of Care
a. Requirements of the Duty (pg. 217-20)
Three requirements: The Director must act:
1) in good faith;
2) in a way she reasonably believes to be in the best interest of the corporation; and
3) the way a prudent person would act under the circumstances
(not evaluated based on expertise as in agency law) (i.e. lawyers held to skill of lawyer)
Articulated standard is ordinary negligence,
Liability is imposed only for gross negligence (if no reasonable person under the circumstance would have done this)
o Rationale we dont want directors to be more risk averse than they already are
o If they make a decision that makes sense at the time, and later turns out to lose money they shouldnt be liable
o Otherwise, if the transaction is good they get pro rata benefit, but if they lose they bare all the costs
o Otherwise, the shareholders would want the riskiest investments because if it wins the shareholders win big, but if it loses
the directors have to assume the loss in the form of a damages award for breach of duty of care
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Trifoods Intl while the articulated standard for the duty of care is negligence, because of the business judgment rule, liability is
only imposed for gross negligence, i.e., if no reasonable person under the circumstances would have authorized such a transaction in
good faith
o Justification: if they make a bad deal, their competitor will win so a well-diversified shareholder will not lose
o The idea is to overcome directors sub-optimal risk acceptance because they lose job and stock value if 0
o Under ordinary negligence, directors will never take risk that would go outside 8-12
o With BJR, directors can consider 0-20 game which the shareholders prefer anyway
Dismiss on pleadings if the business judgment rule applies, the case will not be considered on the merits
c. E
xtension of the Duty
i. Duty to Monitor
Board passivity if the directors failed to make any decision, they cant get protection of the business judgment rule
I f directors fail to act at all where a regular prudent person would act, they have violated the duty of care
Chris-Craft Industries
Inequitable conduct restricting the sher franchise is prohibited even though action permitted under corporation code
and charter (and bylaws)
That which isnt explicitly prohibited is not necessarily permitted
Duty of candor
Honesty is required whenever directors communicate with shareholders
Malone v. Brincat
State law is just corrective disclosure, usually
DIRECTORS
Duty of care
ALI 4.01(a): good faith, reasonable belief / best interests of the corporation, care of ordinarily prudent person
Essentially just a negligence standard
Business judgment rule:
ALI 4.01(c): make a decision not (financially) interested, (duly) informed, rationall believe decision is
in best interests of the corporation
Trifoods Intl
Overcome directors suboptimal risk acceptance by eliminating...
Unless no person could have authorized transxn while attempting in GF to meet their duty of care
American Express
directors may exercise their honest biz judgment on the info before them (rejecting more profitable alternatives) so long
as they act in GF
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Should have sold worthless stock and gotten discount on their taxes rather than paying that as sher dividend
Duty of care type claim is hard to bring, lots of protection under the business judgment rule
Failure to monitor? Proximate cause, but what does a company need to do for oversight?
49
1937 consent decrees against DOJ for price fixing where neither admitted/denied but promised never to break
antitrust laws ever again
Claims:
Shers say that you should have known based on 1937 decree
Issue:
Did the directors breach fiduciary duties by failure to monitor the corps business?
Is the red flag doctrine efficient?
Analysis:
The company is very big! Couldnt possibly know what is going on
31,000 eees, 24 plants, 145 sales offices, 5,000 dealers
Made and sold all over the place
Directors could not know personally all the companys employees (p. 258)
Decentralize by delegating authority to the lowest possible mgmt level capable of fulfilling the delegated
responsibility
Salespeople are the most likely to engage in price fixing (lowest level doing dis)
p. 258 - the very magnitude of the enterprise required the directors to confine their control to
the broad policy decisions
smaller decisions are delegated to those lower
What is the relevance of the 1937 consent decree? (court looks at the 3 directors)
Date became aware of consent decrees - all within 10 years of 1959 indictments
Satisfaction that never guilty now in compliance directors satisfied that the co. was never guilty
p. 257 knowing that the company did exactly this in 1937 doesnt matter; 3 directors
convinced themselves that co. no longer engaged in any of this bad conduct
Directors say not the same set of people and that they werent there in 1937
When does the DE supreme court hold that a duty to monitor arises?
Absent cause for suspicion there is no duty upon the directors to install and operate a corporate system
of espionage to ferret out wrongdoing which they have no reason to suspect exists (p. 258)
Nothing has changed at this company (still decentralized), so surprise in 1959 seems cray
RED FLAG DOCTRINE:
p. 258 directors are entitled to rely on the honest and integrity of their subordinates until something
occurs to put them on suspicion that something is wrong
Rationale:
If directors are held liable, then theyll put in compliance (corporate espionage)
programs
Shareholders pays the cost of compliance, but directors would bear the liability
Court is concerned about overcompliance
Would need to show that these eees now are engaging in this shit
Wells Fargo H/O: the WF case is brought by Consumer Finance Protection Bureau under Dodd-Frank Act; couldnt bring it under
Allis-Chalmers because there is no Red Flag here!
Stumpf remains CEO here, but stories from today is that he has forfeited all of his pay $44M for this year
50
Employee hotline
August 1994 (Minnesota), September 1994 (Ohio) breaches of ARPL (bribing docs law)
Issue:
Did these directors breach their duty of Care by failing to monitor the corps business?
Did they do enough?
Analysis:
Distinction between this case and Allis-Chalmers
This company surely had red flags
p. 269 - can it be said today, absent some ground giving rise to suspicion of violation of law, that
corporate directors have no duty to assure that corporate info gathering and reporting systems exists
which represents a GF attempt to provide senior mgmt and the Board with info respecting . . .
compliance with applicable statutes and regulations?
I certainly do not believe so
So what constitutes the duty to be informed? (in modern, complex companies)
The board of directors must exercise GF judgment that the corps info and reporting system is in
concept and design adequate to assure the board that appropriate info will come to its attention in a
timely manner as a matter of ordinary business operations (p.269)
Need reporting system
What is the relationship between this duty to be informed and the red flag doctrine?
p. 270 - generally where a claim of directorial liability for corporate loss is predicated upon ignorance of
liability creating activities within the corporation, . . . only a s ustained or systematic failure of the
board to exercise oversight . . . will establish the lack of good faith that is a necessary condition to
liability
Likely that directors will put this in place
Shareholders are the one to pay, directors trying to avoid liability
51
of the business judgment of directors
Not crazy that directors manage the business risk, its crazy that no one paid attention along the way
How does the court justify this approach?
Suboptimal risk assessment from the POV of the directors
p. 277 - want directors to maximize sher value without having debilitating fear of personal liability
Doctrine also means, however, that when the company suffers losses, shers may not be able to
hold directors personally liable
52
Suit for failure of Ford to pay dividends
Issue:
Analysis:
Ford doesnt want to pay dividends because wants to keep costs of car low so that everyone could buy a car; if paid
dividends, then would have to raise the cost of the car!
court says NAAAAH
p. 285 - it is not within the lawful powers of a board to shape and conduct the affairs of a corporation for the merely
incidental benefit of shareholders and for the primary purpose of benefiting others, and no one will contend that, if
the avowed purpose of the defendant directors was to sacrifice the interests of shers, it would not be the duty of the
courts to interfere
duty is owed to the shareholders
Facts:
Coast Oyster begins to struggle and needs cash
CEO Verne Hayes thinks the best thing to
do is to sell two of the oyster beds
Coast sells to Keypoint (50% is Engmans)
Claim:
Sue Verne for breach of duty of loyalty, standing on
both sides of the transaction
Negotiating for Coast as CEO; nego for
Keypoint as largest shareholder
Issue:
Verne 23% interest in Coast; 12.5% interest in
Keypoint
No incentive to cheat Coast
Analysis:
New managers have no complaints about the deal; only complaint is Verne is complaining about both sides
October 4, 2016
(ASSIGNED: AK 298-327; Shareholder Ratification Excerpt)
Caremark
Directors have duty to be informed
Directors must implement an info and reporting system sufficient to assure timely receipt of appropriate
information
Liability for failure to be informed
Directors must utterly faily to implement an information and reporting system consciously fail to monitor the
information and reporting system
53
Citigroup
Protection of business judgment rule, which may be rebutted by showing gross negligence or bad faith
Miller v. AT&T
BJR does not protect illegal acts (even if they benefit the corporation)
DUTY OF LOYALTY
Court are trying to tease out
Conflicted transactions
Not void
Not voidable
Due to conflict of interest
Facts:
Coast Oyster begins to struggle and needs cash
CEO Verne Hayes thinks the best thing to
do is to sell two of the oyster beds
Coast sells to Keypoint (50% is Engmans)
Claim:
Sue Verne for breach of duty of loyalty, standing on
both sides of the transaction
Negotiating for Coast as CEO; nego for
Keypoint as largest shareholder
They dont challenge that $250k was a fair
price for those oyster beds
No complaint about price
Issue:
Verne 23% interest in Coast; 12.5% interest in
Keypoint
No incentive to cheat Coast
Analysis:
New managers have no complaints about the deal;
only complaint is Verne is complaining about both
sides
What argument do Hayes brothers raise in their
defense?
Made sure Coast received fair price in those
oyster beds! Hayes has larger interest in
Coast than Key
Court says: absence of disclosure is unfair in
itself (p. 294)
Nondisclosure by an interested director or officer is, in itself, unfair
P. 294 owe undivided loyalty, and a standard of behavior above that of the workaday world
Recall Meinhard v. Salmon (Cardozos punctilio case)
Salmon running the hotel
Remedy?
Force Keypoint Oyster to take the stock that was previously held by Hayes Oyster and give it to Coast
Is this rule per se rule against non-disclosure efficient?
Incentivizing? (Recall Resop jukebox case)
54
DUTY OF LOYALTY (OVERVIEW)
Requirements of duty
Transaction cleansing
Disclosure
Safe harbor statutes
Requirements (for
cleansing)
Mechanisms (for
cleansing)
Special concerns
TRANSACTION CLEANSING
DGCL 144: no contract or transxn between a corporation and 1+ of its directors can cleanse the transxn
(1) by approval of disinterested directors, even though the disinterested directors be less than a quorum
(all the directors that arent standing on both sides of the transxn)
(2) by approval in good faith by vote of the [disinterested] stockholders
Courts have interpreted this as disinterested stockholders
(3) demonstrate to the court that the transaction is fair to the corporation
Intrinsic/Entire fairness
55
Showing in court; reserving to the court the final look of the transaction (right to take look to see if in
best interest of the corporation, see if directors really are disinterested)
What evidence supports the finding of fairness?
p. 304 No serious dispute that the four agreements in issue have all benefited the company as
demonstrated by its financial success
If company profitable, then can show GF, honesty, fairness
If unprofitable, doesnt mean that you CANT make that showing
What role does market value play in the fairness evaluation?
[DISSENT = worried about market test] p. 305 certainly Herrig is driver in success of company, this
does not mean the transactions were fair
Did not show the fair market value of his services or expense for freight, advertising, and
storage cost
courts in general reserve to themselves the ability to look into these transactions
56
themselves for their pay, and nego on behalf of Mattel on what to pay them
May shers ratify a transaction that constitutes waste?
Analysis:
How does sher ratification differ from the typical situation in which a P ratifies the act of her A?
Recall White v. Thomas (the farm and land auction bidding situation case)
p. 310 collective action problems
What is the rational thing for a sher to do when you get the proxy materials?
Bearing cost of gathering all the info, but only getting payout of their pro rata share
What about the case of waste?
p. 310 rule of unanimity
Every single sher must approve the transaction
Why need unanimous vote to ratify of a wasteful transaction?
p. 310 no one should be forced against their will to make a gift (of their money)
People get shares to get rich, makes no sense to just throw it all away
What is waste?
P. 311 a waste entails an exchange of corporate assets for consideration so disproportionately small as
to lie beyond the range at which reasonable person would be willing to trade.
Most often the claim is associated with a transfer of corporate assets that serves no corporate
purpose for which no consideration at all is received
standard for waste is very very very high
57
Sinclair v. Levien; p. 314-317
Facts:
Sinven paying out almost $38M in dividends than what it is
earning
Comes from the surplus
DGCL Section 170(a)
Surplus = capital surplus + retained earnings
Drawing all of the retained earnings out of the
company by paying dividends and driving the
surplus to almost nothing
Claims:
Violating duty of loyalty because drawing all of this money out
of this corporation; no retained earnings to repair the equipment
or purchase new equipment or anything
Issue:
What is the std of review for determining whether Sinclair Oil
Corp breached its duty of loyalty to its subsidiary, Sinclair Venezuelan Oil Co?
BJR or fairness
Analysis:
What is the basis for the claim of the minority shareholders?
Company getting rid of all the money
What constitutes self-dealing?
p. 315 when the parent company gets benefits that are detrimental to the other shers in Sinven
If the transaction involves self-dealing, then std of review is test of intrinsic fairness
FAIR PROCESS + FAIR PRICE
p. 316 Sinclair Corp gets nothing from the Sinven to the exclusion of the minority shers
What is the appropriate std of review?
When no benefit-detriment, then std of review is BJR (p. 316)
Context: at the time, Venezuela was seizing company assets and selling back to public
(nationalizing); wanted less left for the government
Facts:
Shers own about 49.5%; Signal Co. owns about 50.5%
Signal successful, so looks for investment alternatives
Buy the 49% of UOP that they dont already
own
Signal has majority of all the stock, bring in Crawford
Signal offers $21/share (merger price)
Market price was $14.50
56% of minority shareholders vote on the merger; remaining
shers essentially throw the proxy materials out; with 51% of this 56% voting in favor it; (so really only 13% of
total shares are in favor of the merger)
Claim:
Breach of duty of loyalty, that Signal Co. set price way too low
Issue:
What is the impact of shareholder ratification?
Analysis:
p. 322 secret Arledge + Chitiea
8 items that ONLY benefit the signal company
All of these eliminate potential conflicts of interest, etc. etc.
But Arledge and Chitiea work at UOP and sit on the board of directors of UOP
$24/share would be a good investment for the Signal co.
(CONTD BELOW)
58
October 6, 2016
(ASSIGNED: 330-342, 287-292, 343-355)
Cooke v. Oolie
Both sides of transxn as creditors
Approval of disinterested directors provides protection of business judgment rule (BJR)
(so long as no controlling shareholder)
Lewis v. Vogelstein
Definition of waste
Beyond the range of reasonableness (no rsble party would be likely to trade, difficult standard to satisfy)
Shareholder approval of a wasteful transaction must be unanimous
Wheelbrator Tech
Breach of duty of care
Sher approval extinguishes the claim
only need a majority (not unanimity)
Sher approval of a transxn
with a director provides the protection of BJR
What about if transxn with a controlling shareholder?
Shifts the BOP to the to show a LACK of fairness
FAIRNESS STANDARD
59
Otherwise (intrinsic) fairness is the std of review
Company paying out all $$$ in dividends, paying out 97% to private, 3% to the public sher; everyone was getting
their pro rata share though (which is rare)
Almost every instance the test will fail, court will find that there is a conflict, so intrinsic fairness is std of
review
Weinberger v. UOP
49.5% shers, 50.5% Signal co.s; board appoints Crawford UOP
Signal decides best thing to do is pay out the shers
$14.50 market price, Signal merger price proposed is $21.00
Bad thing is Signal was willing to pay up to $24/share
Also bad thing is most of work was done by two directors on UOP but part of
Signal; prepared report that listed all these benefits to Signal
56% of the minority shers vote on the merger, roughly 50% vote in favor of it
What is role of hte Arledge-Chitiea Report?
Used UOP data for the benefit of Signal Co
p. 322 UOP directors prepared, but for the exclusive benefit of Signal; didnt tell the other
directors not at Signal or even the shers that the $21 price was determined by best interest of the
Signal Co and not UOP
What is the role of Lehman Bros and its fairness op?
Report said $21/share was fair
After merger, only 1 company (Signal Co) and only 1 company to employ them (knew had to fudge
the financial$ a little bit)
Partner spends weekend skiing in VT
Underlings know that that financial data doesnt line up, so left the price per share was left [BLANK]
Partner just write in, by hand, $21
None of this is disclosed to sher or other directors; so everyone assumes Lehman is doing a good job
What does intrinsic fairness entail?
p. 323: concept of fairness has two aspects
FAIR DEALING + FAIR PRICE
Fair dealing = (p. 323) transaction timed, how initiated, structure, negod, disclosed to the
directors; how approvals of directors and shers obtained
Fair price = (p.323) all relevant factors [discounted cash flow analysis]
Assets, market value, earnings, future prospects, and any other elements that affect
the intrinsic or inherent value of a cos stock
Not a bifurcated test!
p. 323 all aspects of issue analyzed as WHOLE
A really fair/high price will overcome a very flawed process
How could the Signal Co avoided all of these problems?
p. 323 n.7 court wants to see some sort of arms length bargaining between the two parties
Independent negotiating committee of its outside directors to deal with Signal at arms length
Independent committees need to have some leverage, so bids just start lower
What is the purpose of a judicial determination (appraisal) of fair value of the shares purchased in a merger?
DE (DGCL 262), sher can come in and dispute this price
p. 325 proportionate interest in a going concern
Whats the value of a going concern?
Way to determine that is techniques/methods acceptable by financial community
Firm foundation theory (DCF); castle in the air theory (comparable companies)
60
Current stock price or rely on valuation of experts
We have: BUSINESS JUDGMENT RULE (no conflict, or conflict cleansed) v. FAIRNESS (fair process + fair price, intrinsic)
61
Makes sure that everyone gets a share of it
What benefit would a discretionary purchase of shares confer on a corp?
See this in the mktplace, usually a retirement or severance package in public cos, and now a lot of
closely held corps
If you dont have this, then CEO may be stuck because co doesnt have enough to pay everyone
Nixon v. Blackwell DE
P. 338 close corps provide similar insurance benefits to all shers
Follows EASTERBROOK instead of MA rule
62
USES OF CORPORATE PROFITS
EXECUTIVE COMPENSATION
Elements / trends (incentive pay)
Judicial review
TYPES OF COMPENSATION
Salary
whatever youre paid like annually or whatever
Incentive compensation
designed to reduce agency costs (monitoring/bonding costs) including suboptimal risk acceptance (residual loss);
subject to severe agency costs (ineffective monitoring and bonding) including greater sub-optimal risk acceptance
Bonuses
Annual cash payments in addition to salary or wages based on performance
Straight off income statements; revenues - expenses = net income; if revenues goes up by or net
income goes up, then heres your bonus
Restricted stock
Grants shares of stock that vest over time
Typically vesting is tied to tenure (continued employment) and occasionally vesting is tied to
performance (measured by net income earnings targets or product development)
Options
63
Review & Recap
Business Judgment Rule
Failure to monitor
Duty of loyalty
Special concerns
Close corporations
Rodd Electrotype - in a close corp, the fiduciary of loyalty duty is identical to the duty partners
owe to one another, and requires the corporation to purchase of shares pro rata (Massachusetts)
Springside Nursing Home (MA) - permits companies to buy shares on non-pro rata
basis as long as can prove no alternative way to achieve these ends
Nixon v. Fitzgerald (DE) - different rule
Minority sher
Atlantic Properties - minority sher blocking transxn; breach of the duty of loyalty is
determined on a case-by-case approach reasonable interpretation (utmost GF and
loyalty)
Charitable gifts
AP Smith Mfring - permitted charitable contributions not made indiscriminately to a pet
charity
Executive compensation
CEO pay not set by the market or arms-length bargaining
Incentive compensation: designed to reduce agency costs (including sub-optimal risk
acceptance); but subject to severe agency costs (including sub-optimal risk acceptance)
E.g. CEOs that are almost retiring and shit agency costs
Bonuses, (restricted) stock, (stock) options
INCENTIVE COMPENSATION
Bonuses
Annual cash payments in addition to salary or wages based on performance
Performance is typically measured by sales (revenues) targets or net income (earnings) targets
(restricted) stock precluded from selling it for X period of time
Grants shares of stock that vest over time
Typically vesting is tied to tenure (contd employment) and occasionally besting is tied to performance (measured
by net income (earnings) targets or product development)
Call options
Right to buy a share of stock at a specified price for a specified period of time
Specified price = exercise (strike) price
Usually stock price
Specified period of time = maturity date
Maturity date is usually 10 years
p. 347 - graph in yo book
64
Costs of voting
Efficient Capital Markets Hypothesis: Mandated disclosures required by the securities exchange act of 1934 and
rules promulgated by the Commission reduce the (transaction) costs of becoming informed and improve the
efficiency of the stock market
Regulatory responses
Proxy statement disclosure
1993 amendments
Compensation table
Narrative description of contracts and rationale
Graph comparing share price to indexes
2006 amendments
Computation of single compensation number
Description of perquisites (perks)
2010 (Dodd-Frank Act, Section 953)
Relationship between execs compensation and annual change in share price
Ratio of CEOs annual comp and the median employees annual comp
now thats about 400:1 ratio
Repayment requirements
2002 (Sarbanes-Oxley, Section 304)
2010 (Dodd-Frank Act, Section 954)
Clawback all incentive compensation paid to
Current / and former / exec officers
Within the past 3 years
Upon any restatement of the corporations financial statements
Say-On-Pay
2010 (Dodd-Frank, Section 951)
Non-binding sher advisory vote to approve exec compensation
Non-binding sher advisory vote on frequency of sher review
its advisory vote because DGCL 141a; board sets pay, not sher
JUDICIAL REVIEW
Almost like a duty of loyalty question, esp wrt what the directors grant to themselves for pay
If theres no conflict, no fraud or illegality, then board is entitled to business judgment rule protection
First shareholder, then director
65
In re the Goldman Sachs Group, Inc. Shareholder Litigation; p. 360--368
Facts:
~45% of net revenues is paid out in bonus to the employees
Hedge funds pay out half of this in comparison
2% of net revenues is paid out as dividends
Issue:
Shers dont think that payout is quite fair; excessive compensation
Whatis the std of review for evaluating (bonus) compensation plans for employees?
Analysis:
What specifically does the complaint allege?
p. 362 - (1) that a majority of the board was interested . . . when it approved the compensation scheme
(LOYALTY CLAIM)
(2) that the board did not otherwise validly exercise its business judgment (UNINFORMED
BOARD CLAIM)
(3) the boards approval of the compensation scheme constituted waste (WASTE
CLAIM)
Does the approval of the (bonus) compensation plan for employees involve a conflict of interest?
p. 362 - claims that various donations by the GS Foundation to institutions upon whose boards various
GS directors served were [insufficiently particularized] to render such directors non-independent of the
Goldman insiders who qualified for the incentive compensation payments [under the plan]
Does the approval of the bonus comp plan for eees involve BJR?
p. 363 - board is allowed to do this; this is what boards do
Recall American Express - the tax strategy case
Why is the information considered by the directors important?
p. 365 - board just needs to consider relevant info; BJR requires the board to reasonably inform itself,
it does not require perfection or the consideration of every conceivable alternative
What is the significance of the claim that approval of the (bonus) compensation plan constituted waste?
p. 365 - by pleading particularized allegations that overcome the general presumption of GF by
showing that the boards decision
What is the purpose of defining waste as reasonableness like Lewis v. Vogelstein?
p. 365 - Courts are ill-fitted to attempt to weigh the adequacy of consideration under the waste standard
or, ex post, to judge the appropriate degrees of biz risk
Recall Lewis v. Vogelstein the standard is setting money on fire
How does this rationale influence the way in which the waste standard is applied to a (bonus) compensation plan
for employees?
p. 366 - Looked at the 31,000 eees as a whole
Absent such facts, these decisions are the province of the board of directors rather than the
courts
What is the role of business risk in determining whether or not a bonus comp plan for employees constitutes
waste?
p. 367 - there should be no finding of waste. Even if factfinder would conclude ex post that transxn
was unreasonably risky. Any other rule would deter corp boards from the optimal rational acceptance of
risk (Lewis v. Vogelstein)
EFFECTIVELY NO JUDICIAL REVIEW OF SALARIES ON FED LEVEL; STATE LEVEL IS CHOKED BY BJR
Gent: there is a small ray of hope for when directors are paying themselves
66
What would be the applicable standard of review in absence of any action by the (disinterested) shers?
Intrinsic or entire fairness is left
p. 369 - review will look for fair process and fair price entire fairness of the restricted stock
awards as conflicted compensation decisions
What would be the applicable std of review in the event the (disinterested) shers effectively ratified the grants of
restricted stock?
Recall Wheelabrator BJR protection!
p. 373 - valid sher ratification leads to waste being the doctrinal std of review for a breach of fiduciary
duty claim
The affirmative defense of ratification is available only where a majority of informed,
uncoerced, and disinterested stockholders vote in favor of a specific decision of the board of
directors
p. 369 - company did not seek or obtain sher approval of any action bearing specifically on the
magnitude of compensation to be paid to its non-employee directors
ENTIRE FAIRNESS STD HERE
IT ALL TURNS ON THE STD OF REVIEW
INSIDER TRADING
Claim of fraud: misstatement or omission, materiality, culpability (neg or scienter), reliance (causation), harm
Recall VA Bank Shares - $60 as actual fair price of the share; reasonable sher and what they would consider as
important
67
shares of stock in his corporation
Without first seeking out the other actual ultimate party to the transaction and disclosing to him
everything . . . he then knew affecting the real or speculative value
What is the applicable std of review when directors purchase or sell shares in impersonal markets?
p. 620 - where a director personally seeks a sher for the purpose of buying his shares w/o making
disclosure of material facts, the transaction will be closely scrutinized and relief may be granted in
appropriate instances
Strong v. Repide (SCOTUS case)
Why are those circumstances important?
When Agassiz bought, didnt know who sold
When Goodwin sold, didnt know who was buying
p. 620 - Goodin was no novice. He was a member of the Boston Stock Exchange and had kept
a record of sales of Cliff Mining Co stock. He acted upon his own judgment
FEDERAL LAW
10b-5
It shall be unlawful
(a) device, scheme, or artifice to defraud.
(b) to make untrue statement of a material fact or omit to state a material fact necessary in order to make the
statements made in the light of circumstances in which they were may, not misleading, or
(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon
any person, in connection with the purchase or sale of any security
in connection with the purchase or sale of any security
We explore (a) and (c)
68
p. 634 - finally, a major factor in determining . . . was a material fact is the importance attached to the
drilling results by those who knew about it
Who is harmed by insider trading?
Judicial Review
Goldman Sachs incentive compensation for employees is a core function of the board of directors
Calma v. Templeton ratification requires the vote of a majority of informed, uncoerced, disinterested shareholders
(majority of a minority)
this sher assent grants the directors the protection of the business judgment rule
otherwise, the directors must show the entire fairness (R144a-3) of the compensation agreement
Insider Trading
Under common law, insider trading is just another species of fraud
Goodwin v. Agassiz directors owe their duties to the corporation (not individual shareholders)
Transactions in the market are impersonal affairs
Trades between directors and shareholders create no liability under state (anti-fraud) laws (absent appropriate
(special) circumstances)
Duty to disclose or abstain
Texas Gulf Sulfur Co. Anyone with material information must disclose the info to the investing public or
abstain from trading the corporations stock
69
Issue:
Violation of 10b-5?
Analysis:
p. 637 no indication that Congress meant to prohibit any conduct not involving manipulation or deception
p. 638 but we do not think Congress . . . meant to bring within the scope of 10(b) instances of corporate
mismanagement. . . in which the essence of the complaint is that shers were treated unfairly by a fiduciary
There must be DECEPTION wrt to duty to disclose or abstain
70
(3) any officer, director, partner, or employee of any other person acting on behalf of [the bidder or the
target]
To purchase or sell . . . any of such securities . . .
71
was their purpose to make a gift of valuable information to Dirks
What role did his profession (as a securities analyst) play in the decision of the SCOTUS?
SCOTUS supports semi-strong form of efficient capital markets hypothesis
p. 649 Imposing a duty to disclose or abstain solely because a person knowingly receives
material nonpublic information from an insider and trades on it could have an inhibiting
influence on the role of market analysts, which the SEC itself recognizes
Commonplace for analysts to ferret out and analyze information
p. 649, n.14 temporary insiders = people who are hired to do the deal
Lawyers, underwriters, accountants, consultants
Who has a relationship of trust and confidence giving rise to duty to disclose or abstain?
Classical theory: insiders and temporary insiders
If the tipper doesnt breach, no one in the chain is in trouble
72
Rule 10b5-2:
steps outside of classical tipping theory, gives tipper relationships leading to breach
Chestman case from notes (useless husband traded on the information from family; nothing happens under Dirks)
A duty of trust and confidence arises
(1) Whenever a person agrees to maintain information in confidence;
(2) Whenever the person communicating the material nonpublic information and the person to whom it is
communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information
knows or reasonably should know that the person communicating the material nonpublic information expects that
the recipient will maintain its confidentiality;
OR
(3) Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or
sibling;
73
b. Separate from classical and misappropriation theory; creates own relationship in and of itself
4. Misappropriation theory
Hypos:
What happens if company hires janitorial services? Is partner liable if she says to a janitor we are getting read to make a
big deal?
Janitor probably has requirement to never look at the trash
Absent this, probably really hard to prove
Partner tells son shes been working late because of launch, son is broker, is she liable here?
Basically unless you have a relationship of trust and confidence, you can trade info BUT DONT
DERIVATIVE ACTIONS
With insider trading its SEC. but who enforces when director pay too much?
We need someone to stand up for shers when directors breach fiduciary duty of loyalty or care
Shers dont have money or time to pursue litigation in these instances, so how do we neofrce?
Director action = your sher is harmed b/c the corporation is harmed
74
Fletcher v. AJ Industries; p. 380-382 (attorneys fees)
Facts:
bar brings suit (finds Fletcher to serve as named )
Shenanigans!
Employment agent elects 2/9 directors
Replaces 4 directors and hire new CEO (replace
Malone)
Arbitrate monetary claims (save $200k)
Analysis:
Can a lawyer get paid?
Isnt really a common fund
Problem = no $ came back to company (excessive compensation not yet paid)
Court adopts substantial benefit rule
Attorney can still be paid even if benefits non-pecuniary . . . as long as substantial benefits (p. 382)
Why have this rule?
We want attorney to take these cases because we assume these fiduciary duties mean something (no
sher will bring this suit)
Derivative suit is the only way to enforce fiduciary duty
1. Standing
a. FRCP 23.1:
i. has to be sher at time of disputed transaction
ii. Demand requirement: sher articulates actions she took to get board to sue itself (determining who to sue =
biz transaction)
1. Make requirement to board to sue itself OR reasons she didnt (e.g. futile to do so)
iii. Sher adequately represent interest of all shers
2. Judicial Oversight
a. Demand requirement: on board or state reasons not to (e.g. futile to do so)
75
Ross Perot case (i.e. Donald Trump of his time)
Sold company to GM in exchange he got shares (0.8%) but became largest sher and sits on board of directors
He thinks GM is run by idiots, regularly gives interviews stating that he knows managers are idiots
Board of directors buys his stock for $43M
Ross agrees to not compete or criticize the managers
bar sees this and says this is a loyalty breach for sure
You used our $$$ to buy his silence, standing on both sides of transaction!
Shers sue directors, board; sue yourselves, but shers SKIP demand step and sue
Board says, the sher didnt demand
Sher says fuck you, it would have been futile!
Issue:
How do we figure out if demand is futile?
Analysis:
Aronson Test - clarified by Levine
(1) whether director is disinterested or independence is rebutted by well-pleaded facts,
AND IF NOT
(2) whether complaint pleads particularized facts to create reasonable doubt that challenged transaction
was product of valid exercise of business judgment (BJR)
(loyalty)
Board either conflicted or
(care)
Uninformed or grossly negligent
What does sher need to plead?
Board interested in transaction or dominated by someone who is (loyalty)
Challenged transaction unlikely to receive BJR protection either because board is uninformed or
otherwise behaved in grossly negligent manner (care)
Transaction so egregious it is wasteful (overcomes BJR)
So the court becomes the referee who decides if the case goes on
Inserts court into process prediscovery [and pre board just writes a check] to make sure litigation is
based in some substance to see if board did manage breach of duty of care or loyalty
If you bring, you concede Board can evaluate demand and makes determination, acts on
informed basis, good faith, and no conflict (everything you conceded by making a demand)
The board is then afforded BJR
You conceded to the board to evaluate it
SO, screening function under Aronson means that basically no sher makes demands to board because of BJR
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Board has very strong incentive to settle
Plaintiffs attorneys also want to settle because theyre only paid out after
rely on the COURTS to control the litigation
Get rid of strike suits
Board will settle even if its non-meritorious suits
Standing requirements
When shers have been harmed because board of directors have operated in negligent way; easy to find
sher to satisfy standing reqs
Rule 23.1:
(1) Contemporaneous ownership
(2) Demand / demand futility
Levine v. Smith: (Aronson Test for futility of demand)
We the court will agree with you the complaining sher that the board of
directors is disabled, for some reason incapable of fairly evaluating this
demand whether to bring suit against corp or some subset of directors
Directors lack independence (financial interest in transaction,
conflicted by the transaction)
OR
Directors failed to exercise due care (reasonable doubt that the
transaction is protected by the business judgment rule; transaction
itself reflects that prior actions dont receive BJR protection)
(3) Fairly represent all shers
Facts:
Easco Hand Tools owned by Blasband; significant portion (52%)
owned by the Rales Brothers
Easco issues a bunch of bonds, claims to invest in the business;
excess into Treasury bonds
Instead, buy bonds in other companies to support Mr.
Millken
Claim is that breach is helping Millken
Rales brothers elects Danaher Corp Board, wants merger with
Easco
Blasband wants to sue Easco hand tools, but in merger
his shares were swapped for shares of Danaher Corp
Issue:
What is the appropriate standard for thinking about the futility of demand?
Is Blasband exvused from making demand on Board of Directors because it would be futile to do so?
Analysis:
What is a double derivative suit?
Double derivative suit; Blasband is suing Danaher to tell Easco to sue itself
p. 394 - a sher of a parent corp seeks recovery for a cause of the action belong to a subsidiary corp
Thus cannot use Aronson Test
Inapplicability of Aronson Test
When Blasband sues, hes suing Danaher; complaining about use of bonds to invest in other Milliken
offerings; Easco hand tools board was the one to make that
When court evaluates futility of demand, doesnt use the Aronson Test
What test is used to determine futility of demand?
p. 395 - not Aronson, because Board considering the demand didnt make the biz decision which is
being challenged in the derivative suit
A trial court must determine whether or not the particularized factual allegations of a derivative
sher complaint create a reasonable doubt that, as of the time the complaint is filed, the board of
directors could have properly exercised its independent and disinterested biz judgment in
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responding to a demand
How might (complaining) shers demo that the directors are interested and so incapable of properly exercising
their biz judgment in rejecting the demand?
Dont look at the transxn
p. 397 - A director is considered interested where he or she will receive a personal financial
benefit from a transxn that is not equally shared by the shers. Directorial interest also exists
where a corp decision will have a materially detrimental impact on a director but not on the
corp and the shers
the mere threat of personal liability for approving a questioned transxn, standing
alone, is insufficient to challenge either the independence or disinterestedness of
directors
Suit must be rejected because shers did not bring demand
78
on his corps behalf
p. 404 - we must be mindful that dirs are passing judgment on fellow dirs in the same corp and fellow
dirs, in this instance, who designated them to serve both as dirs and committee members
J. QUILLEN OP (Recall Gagliardi v. TriFoods - suboptimal risk)
79
a finding of liability
= EXPECTED VALUE OF BENEFITS
Is litigation just like any other decision?
Nada
Some of lit = strike suits, reputation ramifications is inconceivable!
Does Winters approach mean that trial court will mimic a loyal (committee of a) board of directors?
Should these types of decisions be left solely to a committee of the board of directors?
Probably why we relegate some authority for review by courts
Reductionist view = cant assume that special committee is completely independent
Benefits Benefits
Recovery to (change in) corporation Limited - Litigation expenses, negative publicity
Costs Costs
Very large Very little
Litigation expenses Most are nuisance settlements
Negative publicity Recovery to (change in) corporation
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(ASSIGNED: 427-440, 442-450)
indemnification insurance
Reimburse Reimburse
Directors and officers Corporation
Litigation expenses Payments to directors and officers
Settlement costs
Reimburse
Directors and officers
Litigation expenses
Settlement costs
When corporation is unable to pay
81
Plaintiff, Norman Waltuch, sought indemnification for unreimbursed legal expenses from his former employer,
Defendant Contcommodity Services, Inc., after he defended himself from investors and the Commodities Futures
Trading Commission (CFTC) for work performed while working for Defendant
Waltuch dude wants indemnification under 145 for expenses for private lawsuits
$35M settlements / $1.2M legal expenses
$100k fine / $1M legal expenses
Issue:
Is Waltuch entitled to reimbursement or legal expenses?
Analysis:
p. 236 - grant of indemnification rights cannot be inconsistent with the substantive statutory provisions
of 145, notwithstanding 145(f) [which provides that the right to indemnification under Section 145 is
not exclusive] . . .
DGCL Section 145(a)?
Gents favorite part ever
p. 236 - subsections (a) applies to 3P actions, and (b) applies to derivative actions
Both (a) and (b) require the office to have acted in GF
DGCL Section 145(c)?
p. 237 - unlike 145(a), which grants discretionary indemnification power, 145(c) affirmatively
requires corps to indemnify their respective officers and directors for the successful defense of certain
claims
no surprise that some number of suits against directors will be nothing more than strike suits
p. 238 - vindication, when used as a synonym for success under 145(c) does not mean moral
exoneration. Escape from an adverse judgment or other detriment, for whatever, reason is determinative
Here, Waltuch was sued, and the suit was dismissed without his having paid a settlement . . .
Once Waltuch achieved his settlement gratis, he achieved success on the merits or otherwise
This conclusion comports with the reality that civil judgments and settlements are
ordinarily expressed in terms of cash rather than moral victory . . .
82
p. 312 - fiduciary conduct that is motivated by an actual intent to do harm constitutes classic, quintessential bad faith
p. 312 - conduct that involves an intentional dereliction of duty, a conscious disregard for ones responsibilities . . . is
properly treated as a non-exculpable, non-indemnifiable violation of the fiduciary duty to act in good faith.
TRANSACTIONS IN CONTROL
Efficiency enhancements
Private benefits of control
When control changes hands, about a 30% premium, up to 100% or more
MARKET RULE
83
Virtually no oversight you negotiate with the controlling position
84
Peculiar situations?
When Im trying to sell my corporate office (p. 448)
Directors currently in power can appoint new directors to fill vacancies
If you surveyed all of these cases, youll find that the court determination doesnt turn on size of premium, but it turns on
what happens next (e.g. replacement of officers)
CEO had 10% block for a very small premium (less than 5%) CEO had 4% block and sold at a 35% premium
Old directors resign, appoint buyers designees as directors Appoint buyers designees, CEO, two directors
New directors re-elected CEO fired
NOT A SALE OF OFFICE, allowed transxn to stand WAS SALE, court didnt allow transxn to stand
November 1, 2016
(ASSIGNED: 450-452, 459-464,
469-478, 487-491)
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Perlman v. Feldmann: controlling shers ower the same fiduciary duties as directors
Punctilio of an honor the most sensitive (remember seeing that in closely held corps)
When a market shortage creates an unusually large premium
A controlling sher may not take the value of premium for himself (must share)
Trick here is that the Ct is explicit that its not overruling the MARKET RULE
In most cases, controlling sher can sell at premium without sharing premium
UNLESS market shortage that creates unusually large premium (e.g. price controls,
going to war in the U.S.)
Feldmann plan designed to get money it needed to maintain/modernize its facility
Recall Wilport only wanted steel concern of the court is that what Wilport co. was
going to do was essentially run Newport Steel into the ground
Sale of Office small stake, like 10% or less
Carter v. Muscat / Brecher v. Gregg
Determined by reference to size of block (how big it is compared to controlling position), amount of
premium, subsequent treatment of new directors and officers (what happens next - dirs must stand for
reelection after appointment in next annual meeting)
Court finds illegal sale of office when dirs arent retained; just a sale of stock when dirs are
retained)
Sale to Looters taking all the money of a corp, bankrupt it
Controlling shareholder owes duty of care not to sell to looters
Perlman v. Feldmann / Harris v. Carter
Recall like the red flag doctrine under Allis v. Chalmers (cause for suspicion)
If theres something that gives controlling sher cause for concern that person buying is going to loot the
corporation, then has affirmative obligation to not sell to that looter
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protection against differential merger consideration . . . paid a higher price for their shares
Shers prob paid for the protection in that charter
How does DE treat charters?
Like a contract
p. 447 - Our Supreme Court has stated that a corporate charter, along with its accompanying bylaws, is
a K between the corps shers. Inherent in any Kual relationship is the implied covenant of GF + FD
Did Rosekranz violate that covenant?
p. 447 - Presumably, Rosenkranz, clear of any impending sale, could have purchased the right to a
control premium back from the [Class A] shers through a negod vote in favor of a charter amendment.
But to . . . allow him to coerce such an amendment here would be to render the charter rights illusory
Clear coercion!
p. 447 - Plaintiffs are reasonably likely to be able to demo at trial that in negotiating for
disparate consideration and only agreeing to support the merger if he received it, Rosenkranz
violated duties to the shers
What is the remedy?
Stick with Rosenkranz or not get this money at all!
If shers make fully informed vote, then DE court will not overrule
Court falls back on this shers get to vote excuse
It takes a lot to set aside a sher vote on an informed basis
p. 447 - It is preferable to allow the shers to decide whether they wish to go forward with the merger
despite the imperfections of the process leading to its formulation
WILLIAMS ACT
Acquisition of 5% (10%) Block (Section 13(d))
Disclosure and amendment requirements
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Gives loyal board of dirs to hire investment advisors, maybe get a bank loan to launch its own tender offer, etc. to
defend against this sort of corporate raider (Gekko)
Tender Offer (Section 14(d) / Section 14(e))
Disclosure and amendment requirements TO; if borrowing money, etc.
Substantive requirements
Time period / withdrawal periods (about a month)
Allows for the board of dirs to start making investor calls after notice that Gekko got himself 5%
of the shares, gives them a month to come up with an alternative plan
Equal treatment of shers
designed to make sure that the market knows what is happening
only part of federal securities whatever with regulation
DGCL 271:
(1) board approves sale of assets,
(2) shareholders have to vote to approve it
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Corp attempted to sell assets that constituted more than 51% of the corps total assets and generated about 45%
of the net sales; when the directors did not hold a shareholder vote to approve the sale, the shareholders who
were opposed to the sale sued to stop the sale
Issue:
What constitutes substantially all?
Analysis:
Shers claim this is substantially all - say this deal is shit, because Universal is offering more to shers
Volcan probably offered the directors jobs or something like that (which would explain why they are
going with worse deal)
Making plastic drums is a radical departure from making steel drums according to the court
So preliminary injunction with going forward with action until shareholder vote
based on 271(a), an asset sale of this magnitude required a shareholder vote.
Problem:
Delaware law says more than 50% assets is substantially all
Ways to fix it:
(1) Thorpe v. Cerbco: SCOTUS says substantially all transaction on quality in addition to
quantity (is transaction out of ordinary) AND substantially affects existence and purpose of
corporation
SCOTUS FIXES THE FUCK-UP; takes into account qualitative effects
(2) Hollinger Intl v. Black: (STRINE opinion)
p. 473 - A fair and succinct equivalent to the term substantially all would be
essentially everything.
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November 3, 2016
(ASSIGNED: 502-529)
Combinations of Companies
Efficiency enhancements society want Ct to select out
operations/financing/management
Wealth transfers society no care about this really
From stakeholders to shareholders (e.g. employees)
Mistakes (value destruction)
Integration failures / empire building (e.g. expanding the company)
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RATIONALES/ INFLUENTIAL FACTORS
Determine how to merge
What do the acquired cos shers get? Give them cash AND/OR stock AND/OR bonds
Then you are required to disclose (certificate of merger)
Technique
Negotiate agreement
to see which corporation will be the surviving corporation
Representations and warranties about what is true about company, etc.
Conditions to completing the transfer (closing)
Price (discounted cash flows)
Obtain approvals
Board of dirs and shers
Regulators
E.g. antitrust review
File certificate of merger
Make commercial and regulatory filings
Significant Risks
Minimal transaction risk (that shers will vote against you) very small risk because there is a significant premium
50% of shers voting (usually the target company is the shers that vote)
As opposed to a tender offer, shers may decide not to tender, e.g. want to buy 90% of the company and 20% decide
not to tender, then you wouldnt get 90%
Clear advantage is that:
You can do whatever you want to do
And minimal transaction risk
Unexpected business risk that merger doesnt work the way it should work
DGCL 251:
(a) any 2 or more corporations . . . may merge into a single corp, which may be any 1 of the constituent components, or one
that you make up
(b) board of dirs each corp most approve and recommend to shers
(c) when the transxn is big enough, both sides of shers must agree (unless not huge; e.g. Facebook buying WhatsApp, then
only WhatsApp shers voted)
once cert of merger is adopted, thats the end of the merger and the two companies are now one
SHORT-FORM MERGER
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More likely the sher doesnt know that they have the shares (e.g. death in fam, unsure when to tender, very short
time period to tender)
Merger! YAS YAS YAS
If merger consideration is cash, then theyre done - whenever they realize they have shares, you just pay off
CREATE an acquisition company
Elects board of dirs, merges DD into this one
Pays cash
51% of shers approve measure; doesnt matter what other 91% want
Anything above 90% is none as SHORT FORM MERGER under DGCL 253
Can skip the sher vote
Squeezing out minority sher
Because sher vote is expensive
Just tell everyone what youve done
DGCL 253: (SHORT FORM MERGER)
(a) you just tell shers what youve done prepare a disclosure statement that tells them the terms and
conditions of the merger, dont bother wih a vote
File with Secretary of State - hello shers, your shers are now worth $14/share in cash, please
come and collect
Challenges
Claim of inadequate (unfair) price (appraisal proceeding)
If price is found unfair, then you get the difference, not the other shers
DGCL 262: (APPRAISAL STATUTE)
(a) any sher . . . who holds shares of a stock on the date of the making od a demand . . . .
who continuously holds such shares thorugh the effective date of the merger or
consolidation, . . . and who has neither voted in favor of the merger or consented
Cant vote in favor of merger
complaining sher will have your own experts, etc. to testify re: fair value of the
shares (DCF - under firm foundation, comparative analysis - castle in the
air/sky)
Court will decree where fair price is $X
(b) appraisal rights only in 251 merger or 253 merger (quasi-appraisal proceedings)
You dont get them in sale of ALL assets
(1) dont get appraisal rights if stock is liquid
(i) traded on exchange
E.g. widely traded? You can just sell them on the exchange?
(ii) held of record by more than 2,000 holders
(2) you get appraisal rights if you are paid cash
The only time you get to obtain value from the company as a
participant
ADVANTAGE: Limited remedy where courts will determine fair value of shares, your
only complaint needs to be PRICE
DISADVANTAGE: you are financing the litigation and shit is $$$ EXPENSIVE $$$
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Claims of breach of fiduciary duty very rare, because shers paid for all of these lawyers, audit, etc.
Duty of care
Duty of loyalty (including claims of bad faith)
METHODS / CLASSIFICATIONS
separate ways of combining businesses (assets/liabilities, stocks, mergers)
most of that is tax driven
Recall UOP, Inc.:
56% of the minority shers vote on the merger, with 51% of
this group voting in favor of it
Ct said: of course this is breach of duty of loyalty - different
if company had created a special committee
Entire or intrinsic FAIRNESS
Fair process + fair price
fair price can overcome deficiencies in
fair process
Conflicted transactions, intrinsic fairness is std of review
Fair process (special committee) and fair price
93
Compagnie Generale dElectricites (CGE) (defendant) indirect subsidiary, Alcatel U.S.A. Corporation (Alcatel)
(defendant) held 43.3 percent of Lynch Communication Systems, Inc. (Lynch) (defendant).
Alcatel selected five of Lynchs directors. Lynch wanted to acquire Telco Systems, Inc. (Telco). Alcatel
pushed Lynch to acquire Celwave Systems, Inc. (Celwave), another CGE subsidiary, instead.
Lynchs directors wanted the Telco deal, but Alcatels designated directors on Lynchs board refused,
saying, We are 43 percent owner. You have to do what we tell you.
Lynchs board created an independent committee to negotiate with Celwave. The committee balked after
Alcatels investment bank suggested an unacceptable ratio for a stock-for-stock merger. Alcatel then
offered to acquire the rest of Lynch for $14 a share.
The same committee was charged with negotiating the cash-out merger. The committee
countered and got Alcatel up to $15.50, but Alcatel threatened to make a tender offer. The
committee felt it had no choice but to approve, though it believed the price unfair.
Lynchs board approved, with Alcatels designated directors abstaining.
Issue:
What is the std of review?
BJR
Or Weinberger entire fairness rule
Analysis:
What metric is used to determine whether or not sher is a controlling sher?
p. 507 - ct says you get to set compensation
At the August ` meeting, Alcatel opposed the ernewal of compensation contracts for Luynchs
top 5 mgrs . . . minutes reflect dirs left room . . . and the remaining board members then boted
not to renew the Ks
Alcatel can set compensation
p. 507 - At the same meeting, alcatel . . .
What is the std of review?
p. 508 - entire fairness
SCOTUS HERE MAKES EXPLICIT WHERE THE BURDEN LIES (so it goes with Weinberger and isnt
redundant)
Burden lies with the corporation to satisfy entire fairness
p. 507 - the initial burden of establishing entire fairness rests upon the party on both sides of the
transaction
Kahn represented by a plaintiffs attorney who has to finance the costs of a litigation
How can the burden be shifteD?
Can shift it onto the complaining sher
p. 508 - have an independent committee that satisfies its duties OR transxn is approved by
majority of minority shers
However, an approval of the transxn by an independent committee of dirs or an
informed majority of minority shers shifts the BOP on the issue of fairness from the
controlling or dominating sher to the challenging sher-plaintiff
By forcing burden onto complaining sher, gonna have many fewer suits, because of this burden
p. 508 - First, the majority sher must not dictate the terms of the merger . . . Second, the special committee must
have real bargaining power that it can exercise with the majority sher on an arms length basis
Alcatel (in future) would start at low end of the range, make it look like special committee had real
bargaining power, then shift burden onto complaining sher to eliminate most of the suits
94
The transaction was subject to two stockholder-protective procedural
conditions:
(1) the approval of a special committee to be appointed by the MFW
board of directors, and
(2) the approval of a majority vote of MFW minority stockholders.
The MFW board established the special committee, which approved the
transaction.
The minority stockholders voted to approve the merger. Kahn, et al.
(plaintiffs) brought suit, arguing that even both protections combined
are inadequate to protect minority stockholders, because directors on
the special committee may be inept or timid and MFW minority
stockholders may be subject to improper influence.
The plaintiffs claimed that the entire fairness standard should apply to the merger. In addition, the
plaintiffs alleged that the special committee was not independent because of various relationships
between members of the special committee and M & F.
Issue:
What is the std of review for evaluating cash out mergers undertaken by controlling shers that provide procedural
protections to minority shers?
Analysis:
Comparison to Lynch Comms
p. 515 - In Lynch, dirs can shift burden if:
(1) well functioning committee of independent dirs, OR
(2) transxn approved by majority of minority shers
in squeeze out merger, can get BJR
So how can controlling sher avoid an entire fairness review altogether (and receive protection of BJR)?
p. 518 - In controller buyouts, the biz judgement std of review will be applied IF AND ONLY IF:
(i) the controller conditions the procession fo the transcn on the approval of both a special
committee of dirs and a majority of the minority shers
(ii) special committee is independent
basically Weinberger
(iii) special committee is empowered to freely select its own advisors and to say no definitively
(iv) special committee meets its duty of care in engoing a fair price
(v) the vote of the minority is informed, AND
(vi) there is no coercion of the minority
if youve done none of these things, then you as corporation bears the BOP
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intrinsic/entire fairness is the standard of review
Fair process (special committee - nego at arms length),
AND
Fair price (how much paid for shares v. mkt price; can overcome a flawed process)
UOP shers have right to receive just the merger consideration
Problem is that this is very expensive
Lynch Comms
cash out merger (squeeze/freeze)-out merger force minority shers to accept case
In a cash out merger by a controlling sher, std of review is entire fairness
But controlling sher can shift burden to complaining sher to show lack of fairness, if the
controlling sher can show the following:
Approval of an effective special committee
OR
Approval of a majority of the minority shers
Plaintiffs attorneys are financing the litigation themselves; will have to show fair process and fair price,
and need gather further material
M&F Worldwide
In a cash out merger by a controlling sher, the std of review can be business judgment
If the controlling sher
Ab initio conditions
We will not go further with this merger UNLESS
approval of effective special committee
AND
the approval of a majority of the minority shers
Now plaintiffs attorneys needs to demo flaw in one of those two things (e.g. directors werent
independent, or that the approval of maj of min was somehow defective/uninformed)
Issue:
What is the std of review for evaluating tender Os by controlling shers (followed by short ferm mergers) to cash
out minority shers?
Analysis:
Does a person/corp making a tender O have a (state law) (fiduciary) duty to pay a fair price?
p. 524 - Solomon the rule tha ta tender Oor has no duty to provide a fair price. But Solomon II did
not involve a freeze-out [of minority stockholders by a controlling stockholder].
... therefore does not hold that controllers never owe fiduciary duties when making tender Os,
nor does it eliminate the possibility of entire fairness for a two-step freeze-out transaction
What is the unified framework (under Cox Comms) for evaluating cash out transxns by controlling shers that
take the form of a tender O after a short-ferm merger?
p. 525 - essentially same framework as M&F Worldwide
If a first-step tender O is both (i) negotiated and recommended by a special committee of
independent dirs and (ii) conditioned on the affirmative tender of a maj of the min shares, then
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the business judgment std of review presumptively applies to the freeze-out transaction
p. 525 - as with a merger, if both reqs are not met, then the transaction is reviewed for entire fairness
Did the cash-out of the public shers of CNX satisfy this standard?
p. 525 - First. . . the Special Committee did not recommend in favor of the transaction
Second, the Special Committee was not provided with authority comparable to what a board
would possess in a third-party transaction
Third, the plaintiffs have raised sufficient questions about the role of T. Rowe Price to
undercut the effectiveness of the maj of the min tender condition
Aka TRP here is sketchy
Whats so special about T. Rowe Price?
p. 525 - economic incentives matter, particularly for the effectiveness of a legitimizing mechanism like
a maj of the min tender condition or a sher vote
Has peculiar economic incentives
Stake in CONSOL is same as stake in CNX
Relying on TRP is prob wrong thing to do had relatively equal stake in CNX and CONSOL
p. 526 - TRPs roughly equivalent equity interests leave it fully hedged and
indifferent to the allocation of value between CONSOL and CNX
p. 526 - TRP has materially different incentives than a holder of CNX, thereby calling into question the
effectiveness of the maj of the min condition
Significant transactions
Transactions in control (blocks/positions)
Combinations of companies (M&A)
Control contests (hostile bids/takeovers)
Market for corporate control
Defending against takeovers
Managing takeovers
Icahn Effect stock goes up about 3% when hes interested in a stock (Hertz articles)
97
Board of dirs (monitoring + bonding)
Hostile bid/ takeover (proxy contest)
people like Icahn wait for that significant price drop, so takeover offer is premium to the current market
price
Henry Manne (mergers and market for corporate control 1965)
Bad management share price will decline relative to other companies in the industry
Tender offer
Other corporation (acquiror/bidder)
Against opposition from board of directors (hostile)
Here, just tenders for the majority of the shares (not all the shares)
Management response
Acquiesce many bids at low prices
Defend few bids at high prices
1.
3.
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4.
Issue:
What is the std of review for evaluating defensive measures adopted to thwart a hostile bid (takeover)?
Analysis:
p. 537 - the subordinated securities to be exchanged for Mesas squeeze out of the remaining shers in
the back-end mergers were junk bonds worth far less than $54. It is now well recognized that such
offers are a classic (structurally) coercive measure designed to stampede shers into tendering at the first
tier, even if the price is inadequate out of fear of what they will receive at the back end of the transxn
In what ways is Unocals Corp defensive self-tender offer coercive?
Court isnt concerned about Unocal offer (which is now not to tender)
Why are the dirs not entitled to B JR protection?
99
p. 536 - Because of the omnipresent specter that a board may be acting primarily in its own interests,
rather than those of the corp and its sher there is an enhanced duty which calls for judicial examination
at the threshold before the protection of the BJR may be conferred
(HIGHER LEVEL OF SCRUTINY)
Intermediate scrutiny / enhanced BJR
In order to get protection of BJR, board must show some stuff
Threat to corporate policy
Defensive measure is reasonable in relation to the threat posed
p. 537 - a further aspect
p. 538 - unless it is shown by a preponderance of the evidence that the dirs decisions
were primarily based on perpetuating themselves in office, or some other breach of
fiduciary duty such as fraud, overreaching, lack of GF, or being uninformed, a court
will not substitute its judgment for that of the board.
What factors may a board use to determine?
p. 537 - inadequacy of price offered, nature and timing of the offer, questions of illegality, the impact
on constituencies other than shers (i.e. creditors, customers, eees, and perhaps even the community
generally), the risk of non-consummation, and the quality of securities being offered in the exchange
November , 2016
(ASSIGNED: idk some shit)
100
then go to 3rd prong defensive measure is reasonable in relation to the
threat posed?
Yes? Then BJR protection
Between BJR and entire fairness is this thing called Revlon
WILLIAMS ACT
Acquisition of 5% (10%) Block section 13(d)
Disclosure + amendment requirements
Tender Offer (Section 14(d) / Section 14(e))
Disclosure + amendment requirements
Substantive requirements
Time period / withdrawal rights
Equal treatment of best price to shers
Prohibition against discriminatory tender offers
101
Poison pill = shareholders rights plan (invented by Lipton of Wachtell Lipton) usually about 10-15 pages
TRIGGER: Acquiring person becomes the beneficial owner of 15% or more of the companys common shares (trigger
usually around 10-20%)
At 15%, courts will definitely approve the poison pill
FLIP IN: everyone else can buy common shares having a total value equal to TWO TIMES (dilution price) purchase price
EXCLUDE BIDDER: other than the rights beneficially owned by the acquiring person
Board has power to redeem the pill
Avoid poison pill by conditioning offer on redemption or invalidation of the pill
Poison pill
15% trigger Buys 15 shares
$50 purchase price (price $10, buy 5 shares; 2-for-1 discount) Pays $300 (15 x $20)
85 right exercisable
Buy 425 shares (85 x 5)
Pay $4,250 (85 x $50)
Only been one instance where the bidder took over and tripped the pill
Recall Lynch Communications
Moran v. Household Intl -- can adopt this rule on a clear day GF, etc. requirements
Otherwise Unitrin (not draconian or preclusive defensive measure?)
Triggers at 15%, what if tender offer was conditioned on getting 95% of the outstanding shares? Then the dilution would be
very small
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evidence showing how Van Gorkom came up with this value other than Trans Unions market price at the time of
$38 per share. Subsequently, Van Gorkom called a meeting of Trans Unions senior management, followed by a
meeting of the board of directors (defendants). Senior management reacted very negatively to the idea of the
buyout. However, the board of directors approved the buyout at the next meeting, based mostly on an oral
presentation by Van Gorkom. The meeting lasted two hours and the board of directors did not have an
opportunity to review the merger agreement before or during the meeting. The directors had no documents
summarizing the merger, nor did they have justification for the sale price of $55 per share. Smith et al. (plaintiffs)
brought a class action suit against the Trans Union board of directors, alleging that the directors decision to
approve the merger was uninformed. The Delaware Court of Chancery ruled in favor of the defendants. The
plaintiffs appealed.
Issue:
What must dirs do to satisfy duty of care when selling the corporation?
Analysis:
Why does the DE supreme court find that the board of dirs acted grossly negligently in approving the transaction
with the Marmon Group?
p. 551 - On this record . . . we must conclude that the board of directors did not reach an informed
business judgment [in approving the transaction] . . . without any documents before them concerning the
proposed transaction, the members of the board were required to rely entirely upon Van Gorkoms
20-minute oral presentation of the proposal.
p. 549 - 4 CEOs, dean of UChicago biz school, none was investment banker or trained financial analysts
Why is their status as successful business people with detailed knowledge about the company insufficient?
p. 551 - The Board had no other information on which to base a determination of the intrinsic value of
Trans Union as a going concern
p. 551 - simply looking at the premium over the current stock price isnt quite enough (in DE courts)
Why does the DE SCt find the market test to be ineffective for confirming the reasonableness of the dirs decision
to approve the transaction with the Marmon Group?
p. 551 - merger agreement did not give Board of Dirs the freedom to put Trans Union up for auction
sale to the highest bidder and a public auction was in fact not permitted to occur
BREACH OF DUTY OF CARE
CONTROL CONTESTS
Defending against takovers
Different if sher voting
Blasius Industries expansion of board from 7 to 15 members, precluding hostile bidder from launching a
proxy contest
Not BJR, not enhanced scrutiny, not entire fairness
COMPELLING JUSTIFICATION STD!
103
If the defensive measure thwarts a vote of the shers, dirs must show a compelling justification
for their action
CERTAINTY OF SALE
Smith v. Van Gorkom: to satisfy its duty of care a board of Dirs must draw upon information about the transaction (not
only their knowledge of the business)
To be effective, a MARKET TEST
MANAGING TAKEOVERS
104
there are rationally related benefits accruing to the stockholders
However, such concern for non-stockholder interests is inappropriate when an auction among
active bidders is in progress, and the object no longer is to protect or maintain the corporate
enterprise but to sell it to the highest bidder
Need to protect the interests of the stockholders (getting the best price for them)
When are crown jewels lock-ups permissible?
p. 557 - While these lock-ups which draw bidders into the battle benefit shers, similar measure which
end an active auction and forclose further bidding operate to shers detriment [and so are
impermissible]
This was the showstopper - Gent
ECMH - market reflects all available information
MANAGEMENT RESPONSE
Acquiesce
Many bids (at low prices)
Defend
Few bids (at high prices)
Do you want to be shers in a company with lots of opportunities for control premiums, or few offers (that
are high)?
Revlon it was clear the company was going to be sold and Fortsmann and Perelman were offering these huge premiums; what if the
board had put in place a poison pill and refused to do a deal with anyone? Would have stood for reelection and been fired. Thus, even
if Revlon allowed board to shut the whole thing down, the company would have been sold because the premium was so high. The
shers would have never re-elected them.
Inevitable sale in Revlon
Problem is that no one is really that crazy to bid at $50+ when market price is $20ish
105
consider this merger as a sale of Time, and therefore Times board enacted several defensive tactics, such as a
no-shop clause, that would make them unattractive to a third party.
In response to the merger talks, Paramount made a competing offer of $175 per share which was raised
at one point to $200. Time was concerned that the journalistic integrity would be in jeopardy under
Paramounts ownership, and they believed that shareholder s would not understand why Warner was a
better suitor.
Paramount then brought this action to prevent the
Time-Warner merger, arguing that Time put
itself up for sale and under the Revlon holding
the directors were required to act solely to
maximize the shareholders profit. Plaintiffs also
argued that the merger failed the Unocal test
because Times directors did not act in a
reasonable manner.
(Wasserstein, Perella & Co) = financial
firm $189-212 merger valuation; come
back with valuation of merged company $106-188 (big range)
Issue:
Under what circumstances are defensive measures adopted to thwart a hostile bid (takeover) evaluated under
Revlon - when is sale so inevitable?
Analysis:
p. 564 - first, and clearer one, is when a corporation initiates an active bidding process seeking to sell itself or to
effect a business reorganization involving a clear breakup of the company
Revlon duties may also be triggered where in response to a to a bidders offer, a target abandons its
long-term strategy and seeks an alternative transxn also involving the breakup of the company
How are defensive measures evaluated when these circumstances are not present?
p. 564 - a board of directors reaction to a hostile tender offer is found to constitute only a defensive
response and not an abandonment of the corps continued existence, Revlon duties are not triggered,
though Unocal duties attach
p. 564 - we premise our rejection of the Revlon claim on . . . the absence of any substantial
evidence to conclude that Times board in negotiating with warner made the dissolution or
breakup of the corporate entity inevitable as was the case in Revlon
How does the DE SCt characterize the analysis under Unocal of the threat posed by a takeover bid?
p. 565 - the open-ended analysis mandated by Unocal is not intended to lead to a simple mathematical
exercise: that is of comparing the discounted value of Time Warners expected trading price at some
future date with Paramounts offer and determining which is higher
What is the open-ended analysis?
p. 565 - the court shouldnt determine what this value is defer to business judgment
of the board of directors
Indeed, in our view, the precepts underlying the BJR militate against a
courts engaging in the process of attempting to appraise and evaluate the
relative merits of a long-term v. short-term investment goal for sh;ers
Wo what is competent to determine the length of time used to eval business/investment decisions?
p. 563 - board gets to pick the corporate action, but also time in which considering that action
The broad mandate of DGCL 141(a) includes a conferred authority to set a corporate course
of action, including the time frame, designed to enhance corporate profitability
141(a) is Gents favorite
106
p. 563 - thus, the question of long-term v. short-term values is largely irrelevant because directors,
generally, are obligated to charter a course for a corporation which is in its best interest without regard to
a fixed investment horizon
Whats the threat?
p. 565 - The time board reasonably determined that inadequate value was not the only legally
cognizable threat that Paramounts all-cash, all-shares offer . . . presented
p. 565 - Time shers might elect to tender into Paramounts cash O in ignorance or a mistaken belief of
the strategic benefit which a business combo with Warner might produce
Substantive coercion - shers might be confused about value of their shares
p. 566 - Dirs are not obligated to abandon a deliberately conceived corporate plan for a short-term sher
profit unless there is clearly no basis to sustain the corporate strategy
Opportunity loss - promised to protect the Time culture/integrity of the Time editorial process
Recall Feldman - Feldman had plan to make Newport Steel Co. modernized, wanted
interest-free loans for company to modernize
When Wilport came along, wasnt interested in Feldman plan, really just
wanted the steel stock
Gent: No reason to expect Paramount would destroy Time culture threat to the time
culture here is enough to satisfy the first prong!!! Bizarre to think that one bidder would choose
to protect an asset that another would destroy
Whats reasonable in relation to the threat posed? (Times restructuring of Time-Warner combo reasonable?)
p. 566 - Times responsive action to Paramounts tender offer was not aimed at cramming down on
its shers a mgmt sponsored alternative, but rather had as its goal the carrying forward of a preexisting
transxn in an altered form. Thus, the response was reasonably related to the threat
The revised transxn did not preclude Paramount from making an O for the combined TW co.
Thus the response was proportionate
Paramount could wait, and then buy the combined TW
almost anything is a threat,
anything reasonable in relation to that threat,
nothing is draconian
Significant Transactions
Transactions in control (blocks/positions)
Combinations of companies (M&A)
Control costs (hostile bids/takeovers)
Unocal/Unitrin
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Revlon
NOTE: Revlon also bleeds up into M&A
Control contests (hostile bids/takeovers)
Market for corporate control
Defending against takeovers
Managing takeovers
Certainty of sale
Uncertainty of sale
Negotiated (friendly) sales
108
How might dirs seek best value reasonably available to stockholders and so satisfy their fiduciary duties when
selling the corporation?
p. 573 - auction, canvas the market, etc. DE law recognizes that there is no single blueprint that dirs
must follow
p. 573 - key features of an enhanced scrutiny test are: (a) judicial determination regarding the adequacy
of the decisionmaking process, employed by the dirs, including the info on which the dirs based their
decision; and (b) a judicial examination of the reasonableness of the dirs actions in light of the
circumstances then existing
Directors have the BOP that they were adequately informed and acted reasonably
Why does DE find that merger would result in a change of corporate control?
Redstone has control of Viacom
p. 572 - public stockholders (in the agg) currently own a maj of Paramounts voting stock. Control of
the corp is not vested in a single person, entity, or group, but bested in the fluid aggregation of
unaffiliated stockholders
In the event the Paramount-Viacom transxn is consummated, the public stockholders will
receive case and a minority equity voting position in the surviving corporation. Following such
consummation, there will be a controlling sher who will have the voting power to: (a) elect
directors, (b) cause a breakup of the corp, (c) merge it with another company, (d) cashout the
public shers, (e) amend the cert of incorporation, (f) sell all or substantially all of the corp
assets, or (g) otherwise later materially the nature of the corp and the public shers interests
Why DE find that deal protective measures in merger agreement were not a sufficient basis for dirs failure to
nego with QVC?
P. 576 - such provisions, whether or not they are presumptively valid in the abstract, may not validly
define or limit the dirs fiduciary duties under DE law or prevent . . . dirs from carrying out their
fiduciary duties under DE law. To the extent such provisions are inconsistent with those duties, they are
invalid and unenforceable
109
Revlon TRIGGERS CHART
All stock - transaction may not All cash - court likely to consider
constitute a sale (Time transxn as one in which there is a sale
Warner) (Revlon duties applicable)
Can pay a premium One and only time they get
for that stock that control premium
}
---------------------------------------- Consideration ------------------------------------------ competence
Merger of equals Whale/minnow Revlon
--------------------------------------- Size of the target ----------------------------------------
Size of acquiror
Only control
}
Widely held Controller
premium
------------------------------- Acquiror shareholders (QVC) --------------------------------
QVC
110
2006 offer to acquire Lyondell was rejected. A year later, an affiliate of Access filed a Schedule 13D disclosure
indicating its right to purchase more than eight percent of Lyondells stock from another company and
Blavatniks interest in Lyondell. Lyondells directors (defendants) called a meeting. Though the Schedule 13D
made clear that Lyondell was in play, the directors elected not to take any action at that time. Blavatnik
renewed his offer to Lyondell at $40 per share on July 9, 2007. Lyondells board had a series of meetings to
consider the offer. After negotiating with Blavatnik, the offer was increased to $48 per share. The boards
independent financial and legal advisers concluded that the offer was fair and a better deal was unlikely. On July
16, 2007, the board voted to recommend the merger to Lyondells shareholders. The shareholders almost
unanimously approved the merger. Ryan and others (plaintiff) filed a class action suit in the Court of Chancery
against Lyondell and its directors claiming breach of fiduciary duties regarding the negotiations and final merger
agreement. The trial court dismissed all claims except the claims that the merger negotiation process was
inadequate and the directors should not have agreed to the protection provisions.
Issue:
How do you satisfy duty of care or duty of loyalty under Revlon? (in negod friendly transxn)
Analysis:
Revlon
p. 587 - Revlon did not create any new fiduciary duties. It simply held board of dirs must perform its
fiduciary duties in service of specific objective: maximizing sher value
p. 589 - No court can tell dirs exactly how to accomplish that goal, facing a unique combo of
circumstances, many of which will be outside their control
111
Wrong time period! Once someone announces interest, your business judgment can be to wait & see
p. 589 - should have focused on the one week during which they considered Basells offer
What is std of review for evaluating the actions of dirs upon filing of Schedule 13D?
p. 589 - Basells Schedule 13D did put the Lyondell dirs and the market in general on notice that Basell
was interested in acquiring Lyondell
JUST A BUSINESS JUDGMENT!
p. 589 - the dirs responded by promptly holding a special meeting to consider
whether Lyondell should take any action. The dirs decided that they would neither put
company up for sale nor institute defensive measures to fend off a possible hostile
offer
Wouldve gone with Basell, lots of synergies, no one else would bid as much
for the company
p. 589 - Instead, [dirs] decided to take a wait and see approach that decision was entirely appropriate
exercise of the dirs business judgment
Court doesnt even consider Unocal/Unitrin - because there is NO omnipresent specter (not dirs seeking to
protect their own jobs rather than seeking to get best value for shers) threat to dirs position
At what point are actions of dirs subject to review under Revlon?
Once the dirs start negotiating with Blavatnik, then it becomes clear company will be sold
p. 589 - begins on a specific date
When the dirs began negotiating the sale of Lyondell = when its required to get highest price
for the stockholders
Lyondell dirs satisfaction of Revlon duties?
There is no blueprint! Yes, satisfied.
Intentional dereliction of duty (failure to act) is only thing they could be liable for
p. 589 - dont always have to conduct an auction or do a market check
Have to be able to demonstrate impeccable market knowledge of the value of the company
p. 590 - court recognizes standard is different when dealing with exculpation clauses
But if the dirs failed to do all that they should have under the circumstances, they breached
their duty of care. Only if they knowingly and completely failed to undertake their
responsibilities would they breach their duty of loyalty
112