Corporations
a Law school outline by corbin dodge
for more outlines visit corbin-dodge.com
Fall 2013
Professor Joseph Leahy
South Texas College Of Law

Table of Contents

I. Intro to Business OrGs (Chapters 1-3)	4

Unincorporated Business Orgs – Sole Proprietorship, Agency & Partnership	4

Intro to Fiduciary Duties – Fiduciary Duties in Agency & Partnership	5

II. INTRO to the CORP (Chapter 4)	6

Types of Corps & Key Characteristics –Separate Legal Entity, Limited Liability, Freely Transferable Shares & Centralized Management	6

Corp Law Statutes	7

III. FormATION (Chap. 4)	9

Steps & Governing Documents	9

Issues Arising at Formation: Preemptive Rights	11

Issues Arising at Formation: Opting to be a Statutory Close Corp –Formation & Governance of Close Corps	11

TX Statutory Close Corps	11

TX Shareholder Agreements	11

Issues Arising at Formation: Restrictions on Transfer of Shares	12

A Closer Look at Boards & MGMT –	13

Relationships, Roles of Shareholders, Director & Officers	13

IV. Financing (Chap. 5 & 6)	16

Intro: Capital Structure	16

Intro to Valuation	17

	Time Value of Money	17

Risk & Return	20

Diversification	21

Discounted Cash Flow Analysis: Valuing Assets in the Real World	21

Protection of Creditors	22

Mandatory Disclosure + Capital Regulation (Capital Minimums & Capital Maintenance) 4 Ways to Protect Creditos	22

Capital Regulation (Dividend Restrictions)	23

Directors Duties in (or near to) Insolvency	25

Fraudulent Conveyance Norm	25

Veil-Piercing (Voluntary Creditors) K creditors!	25

Veil-Piercing (Involuntary Creditors) tort creditors!	27

Veil-Piercing (TX)	27

Veil Piercing in TX (p.110)	28

Hypo	28

V. Day to Day Governance (Chap. 7 & 8)	30

Voting System	30

Shareholder Voting & its Costs	30

Directors Elections & Annual Meetings	31

	Consents & Classified Boards	32

Election & Removal of Directors	33

Special Meetings	34

Problem: The Unfireable CEO	35

	Problem: The Unfireable CEO (Not req’d to own a majority a.l.a. the other owners own very little)	36

The Voting System	38

Class Voting	38

Shareholder Information Rights	39

Treasury Shares – Vote Buying & Circular Control	39

Vote Buying	40

Federal Proxy Rules WATCH THE VIDEO	40

Shareholder Proposals	41

Submitting a Shareholder Proposal	41

Exclusions	41

Duty of Care	42

Intro	42

Director Risk Aversion	43

Duty of Care – Limiting Liability for Duty-of-Care Violations	44

Indemnification & Insurance	44

The Business Judgment Rule	44

Van Gorkom & Waiver of DAS	45

Duty of Care – Board’s Passivity & Board’s Duty to Monitor	46

Board’s Passivity & Board’s Duty to Monitor	46

Knowing Violations of the Law	48

VI. Governing CONFLICTS (Chap. 9)	49

Intro: Duty of Loyalty	49

Self-Dealing	50

Intro	50

Disclosure Requirement	51

Safe Harbors & Disinterested Director Approval	52

Safe Harbor Statutes	52

Safe Harbors & Shareholder Ratification	53

Duty of Loyalty (Self-Dealing) – Special Situations	53

Controlling Shareholders	53

Minority Shareholder Oppression in a Close Corps	53

	Executive Compensation	54

Corporate Opportunity Doctrine	55

3 Tests: Whether the transaction was a corporate opportunity	55

VII. Suit on Behalf of the Corp (Chap 10)	57

Derivative Suits	57

2 Types of Shareholder Suits: Direct v. Derivative Claims	57

How Derivative Suits Work: Atty Fees + Settlement & Indemnification	57

Standing Doctrines	57

Demand Req’t	58

Special Litigation Committees	58

IX. Fundamental Changes (Chap 12)	59

Intro	59

Transactional Form	59

Asset Sale & Share Exchange	59

Transactional Form: Merger	60

Long Form Statutory Merger	60

Short Form Statutory Merger	61

The Appraisal Remedy	61

Appraisal Procedures	61

Cash-Out Mergers: Alternatives to Appraisal	62

De Facto Merger Doctrine	63

De Facto Merger: The Argument	63

State Anti-Takeover Statutes	63

Supplemental Required Reading	64

§ 145 Indemnification of D/Os, EEs, & agents; insurance	67

§240.14a-8 Shareholder proposals	69

Test Tips	72

Index	73

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I. Intro to Business OrGs (Chapters 1-3)

Agency Costs: Business costs of having employees, of having someone do it for you

Types of Agency Costs O’s expend

Loyalty Costs: To ensure agent loyalty	EX: Prevent ee from stealing-security cams

Due Care Costs: To ensure agents work diligently/skillfully	EX: Give bonus for better performance

Goal: Encourage efficiency by reducing agency costs = More $ for shareholders. This is a way to critique a BusOr

Problems	Answer
Agency Cost: The CEO & the Jet Plane, 11 CEO flys a lot & needs convenience to work while traveling. Leasing private jet costs $1.5 million vs. $500K to fly first class, same comfort/convenience.	There’s a $1 million difference in cost. The extra $1 million to fly on a private jet is the agency cost. If CEO owns 100% of the corp, it would cost her $1 million, but if she only owns .01% it would only cost her $1,000 - this is an agency cost. How can you govern them? Say don't do anything that's not in the shareholders best interest. Put it in the fiduciaries hands (the CEOs)
On what persons/groups concerns does bus. org. law focus? Whose does it ignore?	1) Shareholders (Owners) 2) Managers (Agents/Officers) 3) Directors (Board) 1) Employees 2) Consumers/Clients/Customers 3) Environment 4) Suppliers/Creditors sometimes 5) Municipality/gov’t 6) Competitors
Is bus org law unjust or unfair b/c it ignores their concerns? Can you argue how it’s not unfair for that reason?	No. Its amoral, it ignores them. Mergers can affect people- ex if factory shuts down, but they can seek remedies in other areas of law Environmentalists can seek remedies in environmental law, suppliers in K or bankruptcy law, employees in employment law, consumers in consumer law, competitors in anti-trust law
What is the primary underlying purpose of bus. org. Law? (i.e. what should the law promote and for whom?)	Foster shareholder wealth maximization (SW Max)
What are the agency costs? Why do they arise in businesses? Types of agency costs? If bus. org law is to efficiently serve its key purpose, should the law promote or combat agency costs?	The business cost of having employees, of having someone do it for you

Unincorporated Business Orgs – Sole Proprietorship, Agency & Partnership

Agency: Agreement + A acts on behalf of P + P controls A

Partnership: 2+ co-owners + in business + for profit

When might a bus org w/ joint ownership be superior (from the founders perspective) to a sole proprietorship?
A founder might bring in a co-owner b/c sometimes sharing the risk is cheaper than borrowing. But also must share profit

Intro to Fiduciary Duties – Fiduciary Duties in Agency & Partnership

Fiduciary Duty

A fiduciary acts in another’s best interest. In doing another’s business, a fiduciary must put the other’s interests aheard of her own. Thus, they must act in the best interest of a fictional legal person

2 Key Fiduciary Duties

Duty of Care targets due care costs	i.e. prohibits shirking

Duty of Loyalty targets loyalty costs

Meinhard	Most famous bizorgs case

Cardozo says it's the duty of “finest” loyalty

Beware your co-venturer, the duty of loyalty is strict !!!

If you think about shareholder wealth maximization, Cardozos rule encourages passive investment

Default rule favors investors over managers. So long as the rule is clear, the partner can negotiate

Holding: The opportunity to d business w/ Gerry belonged to the joint venture. Salmon couldn’t take for himself—he had to put the bus org first. He must share the opportunity w/ Meinhard.

Gerry’s opportunity is very diff from Meinhard and Salmon’s joint venture b/c it is larger, more expensive, and longer.

Tarnowski

When A took a secret commission from T, A breached his duty of loyalty to π. A must place π’s interests first and “can’t take a little for himself” π can recover A’s secret commission, even if π wasn’t damaged in the transaction

II. INTRO to the CORP (Chapter 4)

Types of Corps & Key Characteristics –Separate Legal Entity, Limited Liability, Freely Transferable Shares & Centralized Management

5 Key Corporate Characteristics

1) Legal personhood (personality w/ indefinite life)	i.e. corp = separate person from owners

2) Limited liability for investors (b/c they already invested in the corp)	i.e. 0 liability for investors (exception in chap 6)

3) Free transferability of share interests	i.e. can resell shares to anyone

4) Centralized management

Elected by shareholders

Board/officers make decisions	Exam Tip: Don’t say shareholders make the decisions !!!

In large corps Board may defer it to officers

5) Appointed by equity investors

Due to these characteristics, the corporate form is well-suited for raising large sums of capital from passive investors

Types of Corps

a) By Size

Close Corporations	Few shareholders

Public Corporations	Many shareholders

b) By Concentration of Ownership

Controlled Corporation

[1 person or a group acting together] consistently elects the board	Shareholder ownership !!!

Control is a factual question

Unless it’s legal control: 50% + 1 voting shares

Not Controlled (control in the market)

No single person/group can elect the board

Management has free reign b/c no group of shareholders looking over their shoulders

Corporate Types & Key Characteristics Questions, 37	Answer
What are the 5 key corp characteristics? Explain what they each mean. For EX, Is anyones liability really limited by the corporate form? Is the corps liability limited? Is a shareholders liability limited?	1. legal personality w/ indefinite life 2. limited liability for investors 3. Free transferability of share interests 4. centralized management 5. appointed by equity investors
Are these characteristics mandatory for all corps?
How do they complement each other?
Due to these characteristics, the corporate form is well suited for raising large sums of capital from passive investors. Explain.
What is a close corporation? What is a public corporation?	Close corp = few shareholders, i.e. you can’t buy shares Public corp = many shareholders, ie. NYSE
What is a controlled corporation? What does it mean for control of a corp to be in the market?
As a result of passive investors being rationally apathetic, who do you think actually makes critical decisions for a large corp where control is said to be in the market?

Corp Law Statutes

Types of Corporate Law §’s

Mandatory	“The board of directors shall…”

Permissive	“The board of directors may…”

Default	“Unless the charter or bylaws provide otherwise, the BOD….

Our focus: DGCL & TBOC (based on RMBCA)	TBOC: Title = hub Title 2= spoke

Enabling Acts

Enabling Corporation:

Regulatory Corporation:

Internal Affairs Doctrine

Choice of Law Rule (Internal Affairs Doctrine): Law of state of incorporations governs internal affairs (i.e. governance) of the corp

Internal Affairs: It’s everything we discuss in this class	TBOC § 1.105

Always look to the state of incorporation for the choice of substantive law	Exam Tip: He will try to trick us !!!

not where its headquarters are, not its principal place of business

Intro to TBOC & DGCL

Delaware General Corporation Law (DGCL)

Website: http://delcode.delaware.gov/title8/c001/index.shtml

SEC website for Federal Securities Laws: http://www.sec.gov/investor/pubs/securitieslaws.htm

Securities Exchange Act of 1934: http://tinyurl.com/cb9tzr3

TBOC § 1.002(18)

TBOC § 1.002(22)

Mandatory if: says may
Permissive if: says shall

What choice of law doctrine applies to disputes involving the internal operations of a corp? Explain how it works. Under this doctrine, when does TX law govern the internal operations of a corp?

What are some examples of the internal operations of a corp? What sorts of things don’t constitute them? In lawsuits not involving them, what choice of law rule applies?

Who is it important for lawyers practicing corp law in TX to learn DE corp law?

Familiarize yourself w/ TBOC.
Explain its hub and spoke structure. What title is the main hub? What title is the main spoke that governs for-profit corps?
What subjects are addressed in the main hub?
Where are the definitions located?

III. FormATION (Chap. 4)

Steps & Governing Documents

DGCL § 108 http://delcode.delaware.gov/title8/c001/sc01/index.shtml

Incorporating made easy

Books on amazon are 9.99 / websites like clickandinc.com

A form, anyone can do it, but a good lawyer can add value of/ good judgment

Choice of Entity

LLC	Most customizable	Pass-through taxation

LP

Corporation

Ask

Default structure or customizable (LLC)?

Will all O’s participate in mgmt?

“Double” or “pass-through” taxation?

2 Steps of Formation

in DE

1) File Certificate of Incorporation

2) File w/ Secretary of State

in TX

1) File Certificate of Formation

2)

When does the Corps life begin? Upon filing

Does there have to be an organizational mtg for the corp to exist? No

For a charter to be properly executed/filed, who must sign it? Incorporator

What else? Must pay fee

What happens at (step 2.5), the organizational mtg? Est bylaws, appoint directors (if not done before), appointing officers

What must go in a Charter?

In DE

1) Name

2) Office Address & Registered agent

3) Purpose

4) # *authorized* shares	State par value or no par value (fictional value of shares, i.e. 1/100th of a cent)

5) Incorporators name & address	TX: they’re called organizers

in TX Same + 6) DIRECTORS

Other stuff to expand on:

Name: Must include “Co. “Inc. “Corp” “Ltd” or similar to give notice of status as limited liability	TBOC Ch. 5

Purpose

Can’t suggest unlawful purpose	EX: Insurance Co or bank

Can’t be deceptively similar to another name

Ultra Vires (beyond the power)

Definition: Can’t perform acts outside its purpose - or specifically prohibited by charter

Irrelevant now (was on 2012 bar)

EX: State purpose is to sell lemonade → Can branch out & do more

DE: Pre-filled on the form to avoid ultra vires

TX: Prohibits lawsuits for ultra vires DAS or to void a past action (but allows injunctive relief)

Issues if defined too narrowly

Shareholder may bring an ultra vires action for an injunction (prevent corp from acting outside scope of its purpose)

But, TX: shareholders prohibited from bringing a suit for DAS against corp or to void a past action by corp

But action for DAS against an officer or director for exceeding his authority → Allowed

If you made a 1) good faith attempt to file & 2) attempted to use the corp powers → Ct will treat you as a corp ala no fraud/bad faith

DE, TX: Authorized Shares

Must have 1+ class of voting stock

Must list special characteristics in the charter	i.e. if they’re convertible to debt

Can call anything	i.e, banana stock

If incorporators want to create other classes of stock, like preferred stock → Must list

Usually must be detailed in charter

Exception: state board can decide

Incorporators

Must have capacity to K (<18)

Not req’d to be directors/shareholders

Questions on Formation, 45	Answer
What steps are necessary to incorporate a corp?	1) Filing the charter 2) Hold an organizational meeting
What are incorporators (organizers)? Who may be one?	Anyone w/ capacity to K (<18)
What is a charter? What’s the proper legal name for it?	Certificate of Incorporation (DE) Certificate of Formation (TX)
What info must appear in the charter?	DE 1) Name 2) Office Address & Registered Agent 3) Purpose 4) # *authorized* shares State your par value for shares or state there’s no par value (fictional value of shares, i.e. 1/100th of a cent) 5) Incorporators name & address TX: Same + Directors
What info may appear in it? Why might incorporators insert that optional info?	Anything lawful But can use to customize the corp w/ governance rules (size of the board, other classes of stock, terms of directors, customized voting rights, cumulative voting rights) …but usually charters are fairly bare bones To understand why, understand the alternative to the charter: the bylaws The charter is more fundamental than the bylaws. The charter is publicly filed; bylaws aren’t always filed publicly The charter is harder to amend; the bylaws are harder to amend If the bylaws offer more flexibility, then why place the following in the charter? Staggered board, Cumulative voting, “Blank check preferred” stock…which is put in place to prevent the takeover defense. ….the poison pill is the takeover defense. This is when if someone purchases a certain threshold of the corp (i.e. 10% of the stock)…so heading for a takeover, …so using blank check preferred stock in the bylaws, it allows a takeover rights plan that allows other shareholders to buy X amount of the big stockholder
Explain the hierarchical relationship b/w a state’s governing corp law §, a corps charter, and its bylaws. Use TX law: What are some impermissible names & purposes for a for-profit corp? What’s the filing fee?

Issues Arising at Formation: Preemptive Rights

Preemptive Rights: Allows existing shareholders to purchase the same percentage of the corp that they currently own, when new shares are sold. This allows the corp an opportunity to keep the same ownership percentage

Purpose: Keep same ownership %

Why might shareholders of a close corp value preemptive rights? Since close corps are smaller, shareholders would value preemptive rights in order to prevent a takeover, especially since the stocks are limited and it would be easier to takeover then a large public corp like apple

In DE: No preemptive rights by statute unless in charter

Reason: DE has lots of big companies. Shareholders don’t care about them

In TX: No preemptive rights by statute	§ 203

Shareholders and corps formed < 10 yrs ago still have preemptive rights	§ 204

Used to allow it b/c TX was mainly close corp

Hypo	Answer
Annie has 7 shares; Bob has 3 shares (10 total). If you are selling 10 more shares, what result?	Bob has the right to purchase 3 more shares; Annie 7

Issues Arising at Formation: Opting to be a Statutory Close Corp –Formation & Governance of Close Corps

TX Statutory Close Corps

General: TX has a concept of a §’ory close corp. Diff than a general close corp.

Requirement to Form	TBOC 3.003

State “This is a close corp” in charter

Stock certificates must disclose it’s a statutory close corp (plus other stuff).

Failure to comply doesn’t affect its status as a §’ry close corp

Benefits

Can eliminate BOD *Main (allows shareholders to manage shareholder)

Shareholder meetings replace BOD meetings

So all shareholders are treated by § like directors for liability purposes (fiduciary duties)

Avoid other formalities	i.e. no bylaws

Can limit decisions the board can make

§21.707

TX Shareholder Agreements

Requirements

In charter or bylaws OR signed by all, in writing & made known

To amend → All must agree

Benefits

Not restricted to close corps

But not effective if traded on a national securities exchange

Allows corp to opt out of some mandatory TBOC rules	eg eliminate board or restrict its discretion

Permitted for any corp (unless it’s traded on a national securities exchange)

Valid for 1 yr (unless a § close corp)

Requirements

Approved by all shareholders &

In charter/bylaws or
in writing signed by all shareholders & made known to the corp

Amendments

Can only be amended by all shareholders

Shareholder Agreements by Non-§ close corps (newer section)	TBOC § 21.101

What you can do with a §’ory close corp	TBOC § 21.714

Test Tip: Treat 21.101 and 21.714 as the same. Only 2’ish questions on exam

TX: A Shareholder Agreement is enforceable if

For how long, in a non-close cop is a shareholder agreement valid?

Test Tip: Skip DE close corps

How is a statutory close corp formed in TX?

What structural changes can the founders of a TX statutory close corp implement in order to make decision-making more informal? (i.e. what documents and/or governance structures can be eliminated?)

Why might owners of a close corp make a shareholder agreement? What are the benefits?

What sorts of issues may be the subject of a shareholder agreement made w/ respect to a TX corp? Examples? What TX corps may not be governed by a shareholder agreement?

What’s req’d in order for a shareholder agreement to be enforceable under TX law?

Issues Arising at Formation: Restrictions on Transfer of Shares

Default Rule for all corps: There are no restrictions on transfer

Exception: But state corp law might restrict the transfer of its shares !!!

Purpose of Restricting the Transfer of Securities

Restrictions on Transfer Questions, 47	Answer
Why might shareholders of a close corp wish to restrict the transfer of the corps stock?
What sort of restrictions on the transfer of a corps shares are permissible in TX? Examples?	In order to be valid, a restriction on trn of shares must be 1) reasonable, 2) conspicuously noted on the stock certificates, or, if there is no stock certificate) be in a notice sent to the holder as per the §. Absent such notice, restriction is ineffective against a transferee for value who has no actual knowledge of the restriction at time of trn, or against any subsequent transferee….that means you’re subject to the restriction if you have actual knowledge See 21.211(a) to see a list of things that you can do if they are reasonable, for example,… then 21.211(b) gives a list of things that are presumed reasonable (ex, like for a tax advantage.
What’s req’d in order for a restriction on transfer to be enforceable under TX law?

A Closer Look at Boards & MGMT –

Relationships, Roles of Shareholders, Director & Officers

Who selects whom?

By law: Shareholders annually elect → Board, technically selects* → Management

In reality: Mgmt selects the Board

Who makes the decisions for the corp?

The Law: The Board	TBOC § 3.003

In reality: The CEO (typically on the Board too)

Directors

TX: Directors don’t have to be TX Residents	TBOC 21.402?

TX: Directors don’t have to be shareholders (but it’s good for them to be, b/c personal interest)

TX # of Office Required: 2. Must have President & Secretary	TBOC 21.417

TX # of Officers Required: 1. Can hold 2+ offices

Director Independence

Types

Inside Directors: EE of the company (CEO or even a janitor)

Outside Directors (independent directors): No ties to the corp other than being on the Board

Truly Independent (Leahy’s Theory): Honorees w/ no connection, just for prestige

Advantage:

Disadvantage: May not have a full interest in the corp. May not have knowledge of the business.

Director Actions

Chairman of the Board may NOT (w/o the other board members):

Sell stock

Sell corps real estate

Buy office supplies

Initiate new business plan (not listed in §, but likely something a board does together)

Reason: Directors are not officers (AGENTS) of the corp !!!

Note: Boards act; Director’s don’t

Top officer (CEO) acting alone

Can’t sell stock in the corp

Can’t introduce new business plan (depends on corp structure)

Can’t sell Corp’s real estate

Can buy office supplies (he is an agent of the corp)

TX: CEOs authority must be expressly stated in the bylaws & strictly limits apparent authority.

Director Meetings	“The mere fact that directors are gathered does not a meeting make” Fogel

Must be a formal call to the meeting

Bylaws can include info as to what meetings/conditions constitute a “valid meeting”

TX, DE: BOD can unanimously agree to act by consent – (all agreed to an action to act on paper instead of a valid mtg)

i.e. written consent call to action to not have a mtg

Meeting Requirements

Proper notice (if req’d in bylaws)

Regular Mtgs: No notice req’d unless in bylaws

Special Mtgs: Require notice	e.g. ad hoc meeting

A “quorum” unless reduced by charter or bylaws	i.e. A majority of board

DE/TX: Can’t be less than 1/3 of the board (total # of directors)	DGCL §141(b); TBOC 21.413

21.416 (Committees of BOD)

Board Actions

Official action of the BOD requires approval of a majority of directors present

EX: Board has 9 directors, 5 are present at mtg → a decision approved by 3 directors is valid….assuming proper notice

Automatic Self-Cleansing Filter, 48

Facts: Controlled corp & controlling shareholder want to sell the corp. BOD rejects b/c they think it’s bad for the minority shareholders & corp. He argues that the BOD acts as his agents.

Holding: Directors aren’t agents → Can’t act w/ maj. Approval. [However he can alter the BOD makeup at the next mt]

Rule: BOD has a fiduciary duty to the corp

Protects minority shareholders

Knowledge of BOD fiduciary duties attracts minority shareholders to invest in corps & raise capital

If there was no minority shareholder protection, no one would want to be a part of a corp

Automatic Self-Cleansing Filter Syndicate (ASCF), 52	Answer
What does Art. 96 of the UK’s Companies Act, cited in the case, say about who makes normal day-to-day decisions for this corp under UK law? Is it consistent w/ DE & TX law?	Art 96: DE: TX:
DE & TX law don’t contain a supermajority override provision like the one in the charter of the ASCF corp. (However, such a charter provision presumably is permissible under DE & TX law) Would the case have turned out differently in the absence of the supermajority provision?	xx
Is the ASCF corp a controlled corp? Why/why not? Does it matter that McDiarmid & his cronies are unable to force the board to do their will in this instance?
What arguments does McDiarmid make to the Ct? And why does the Ct reject them? Which do you think is superior (majority or concurrence)?
What does this case tell us about to what or to whom a board’s fiduciary duties are owed?

Boards of Directors, 55	Answer
What’s a directors role in day-to-day governance of a corp? What is a shareholders role?	xx
Who’s eligible to be a director of a corp? Must directors be shareholders?	xx
How many directors must a corp have? How many may it have?	Must have President & Secretary, but can be 1 person
Are directors agents of the corp?	No.
When are directors actions considered an act of the corp?
What is a quorum? What business can be transacted at a board mtg in the absence of a quorum? What are the req’ts of a quorum at a board mtg?	A majority of the board.
When may directors take action on behalf of the corp w/o holding a board mtg?
What notice, if any, is req’d for a board mtg?
To whom are a directors (or officers) fiduciary duties owed?

Can a corp office also be a director of the corp?
What’s the difference b/w an outside director & an inside director? Is either type of director necessarily independent from the CEO? Which type best promotes shareholder wealth maximization?
Officers are agents. Directors are not. What is the practical effect of this distinction? (i.e. what sorts of things can officers do on their own, if authorized, that directors cannot?
How many offices (i.e. titles) must a corp have? How many officers (people) must a corp have?

IV. Financing (Chap. 5 & 6)

Intro: Capital Structure

Issuing Stock/Shares	DGCL § 152

Who can authorize the issuance of stock? BOD but can be delegated to a committee of the BOD. May hire an investment banker to sell shares

Charter lists a max amount of authorized shares that can be issued, but not yet issued to anyone for $

Charter doesn’t have to authorize issuance of debt (§ allows BOD to do it)

Consideration for Stock (Par Value)	DGCL § 153

Consideration Req’d: BOD must adhere to the par value (if in charter)

Limits on Authority: BOD wants to exceed that amount Charter must to be re-organized to allow it

Capital Structure = a mix of debt & equity

Issuance of Stock, 60	Answer
Who has authority to decide whether to issue stock of a corp? For what consideration? What are the limits, if any, on this authority?	BOD Par value <par value must re-organize charter

Series of Shares (Issuance, etc)	TBOC § 21.155

Equity/Common Stock

Owning stocks for a stake in business, which are part of corps residuary

Common Stock governed by statute

So non-negotiable as part of a “K” & only have rights given in statute

In theory, stockholders own “residual,” so strong incentive to maximize company value

No Set Repayment: Shareholders have no right to repayment if corp dissolves

Bankruptcy

One probably won’t get anything, even though they’re theoretically entitled to a % of what’s leftover after everyone else has been paid (only entitled to residuary, last in line)

No right to periodic payments

Dividends

Similar to interest, but they are NOT guaranteed

So no right to receive them unless board decides to hand them out (can’t demand dividends)

Have the right to vote to elect the board in proportion of your shares

Smart to pick members who know business & what will be profitable to make $

Preferred Stock (Equity)

Middle ground/hybrid b/w debt and equity

Contractual in nature w/ rights in the charter like debt, but still retains some statutory protections like equity

Guaranteed any dividends before common stockholders

Additional things are negotiable & can add benefits of the preferred stock in charter customize it

Usually doesn’t vote for BOD

Controlled by charter/bylaws

Debt	e.g. bonds

Loaning money to a corp as a creditor, but the creditor does not own the company itself

Caveat: There are no default/set/typical characteristics for debt purely contractual b/c every creditor and debtor negotiates their own terms (very flexible)

Will only negotiate enough control to ensure repayment

Lender/creditor makes decisions on what the principal, interest and maturity date are

Only have as much say as is written in contractual agreement Leverage to negotiate

Creditors don’t care about board elections or that business does well for shareholders

Principal: Amount given by the lender to the debtor

Interest: Amount you get by lending principal to the debtor

Interest Terms: When the interest accrues

Maturity Date: Time when the principal/repayment is due back

Creditor can sue if it fails to pay back principal and interest by date judicial right enforceable by the court

Tax Treatment

Corps can deduct interest amount it pays from its taxable income (b/c debt is a business expense to corp)

“Profits” are per se not taxed !!! (equity dividends are)

Liquidation: Creditors have right to be repaid first, and have legal remedies if they aren’t

Zero Coupon: Debt is repaid in one lump payment (more than originally loaned)*****

Debt gives control to creditors through…

Restrictive clauses in debt K

Agree not to take on additional debt

Senior debt *BEST (objective)

Debt to equity ratios

**On whole, prefer debt over equity b/c less expensive & leverage buyout**

*Repayment Order: Secured debt debt (notes) subordinated debt preferred stock common stock

Intro to Valuation

Time Value of Money

Present Value (PV) = FV / (1+r) n

The value today of money to be paid/received at some future point ($ you receive in the future)

Purpose: When BODs makes any financial decision, they need to evaluate these future payoffs in today’s $ b/c they’re interested in future payoffs

Applies: Whether to sell stocks/bonds | What products to make | What investments to take

Used to: Figure out which investment is a better deal	e.g., the investment w/ the higher PV

Always >FV unless there’s a positive discount rate or negative interest rate (unlikely)

Formula is used to: Increase PV based on interest as to compare we would have gotten somewhere else

Advantage: Tool for evaluating future payoffs

Disadvantage: Doesn’t take risk into account

# of Periods “n” - Assume interest is compounded yearly

Discount Rate “r”

Comparative rate that helps discount from PV to FV for other investments in the market market rate return for money

aka treasury bill rate or national bank interest rate

Used to compare our specific investment/loan to another potential investment in the market

NOT THE SAME AS THE INTEREST RATE

Future Value (FV) = PV x (1+i) n

The value in the future of money you receive today

The increased value of money in the future because of interest (ignore inflation***)

Disadvantage: Leaves out the chance investments won’t be paid off (risk)

The amount owed on a loan after “n” periods and the way you calculate interest

2 Uses

To calculate interest &

To convert b/w PV and FV (if you don’t have a specific investment in mind)

Instead of “i” use “r” and compare the 2 results

Interest Rate “i”

Amount you’re paid for lending $ or the rate by which your money grows	i.e. a bank’s interest rate on an investment

Problem	Answer
What is the PV of $1 one year from now if the discount rate is 5%?	PV = 1 / (1.05)1 = $0.95
What is the PV of $5 3 years from now if the discount rate is 4%?	PV = 5 / (1.04)3 = $4.44
What is the PV of $1 10 years from now if the discount rate for each of the ten years is 10%?	PV = 1 / (1.1)10 = $0.39
What is the FV in 3 years of $2 today if the interest rate is 9%?	FV = 2 x (1.09)3 = $2.59

Relationship: as discount rate (r) increases, PV decreases Negative relationship

The bigger the discount rate, the smaller that $ will be worth today

Question: NPV to whom? Is it positive or negative to that person? Make sure you have the right party for the answer !!!

NPVto investor = PV [EV all $ to be received (rtnd.)] – PV [all $ paid (invested)]

Used to: Evaluate investments b/c corps. want compare the $ investors put in and the $ that comes out (what that’s worth today) Risk neutral investors

NPV nets (subtracts) $ invested from $ earned

NPV compares $ invested in today’s dollars w/ $ earned in future dollars

NPV+ is a good investment & NPV- is a bad investment

Must ask, NPV to whom????

Loan repayment is money out (paid) to a borrower but money in (received) to the bank

Positive Investment: When $ spent in whole is less than all $ received in todays dollars

The higher the discount rate, the better the investment and the better chance of + return

Example, pg 68	Answer
Get a $10k loan, pay 8.5% interest yrly for 1 yr (so repay a total of $10,850). What is NPV if discount rate is 7%, 8.5%, and 10%?	DR = 7% What is the PV of 10,850 you must repay if discount rate is 7%? PV = FV/(1+r)n = 10,850 / (1+.07)1 = $10,140 NPV NPV = PV (Rec) – PV (Spent) = 10,000-10,140 = -140 BAD Investment DR = 8.5% What is PV if DR is 8.5%? PV = 10850 / (1+.085) = 10,000 NPV = 10000-10000 = 0 Neutral Investment What’s the point in making the investment then? DR = 10% PV = 9,864 NPV = 10000 – 9864 = 136 Good Investment
Get a $10k loan and immediately invest it into a stock w guaranteed return of 10% in 1 yr. NPV if discount rate is 8% of loan and investment?	Borrower NPV = PVreceived – PVspent What money will be spent? $10k invested today (already in PV) 8.5% interest on the $10k in a yr (must convert this into PV because it’s a FV) Use FV formula to determine interest owed = 10k (1+.085)1 = 10,850 Calculate the PV of the interest owed = 10,850/(1+.08)1 = 10,046 Total Spent = 10046 + 10,000 = 20,046 What money will be received? $10k from the bank today (already in PV) 10% return on $10k in a yr FV = 10k(1+.1) = 11,000 PV = 11000 / (1+.08) = 10,185 Total Received = 20,185 NPV = 20,185 – 20,046 = $139 (good investment)

Expected Value (EV)

Expected/future value of an investment is a weighted average of all projected incomes/returns b/c %s aren’t certain in the real world builds in risk to PV so it’s in the NPV

Is NOT a real value you necessarily expect to receive

Doesn’t take into account risk aversion

So take NPV formula and replace FV with EV on PV equation

Investment professionals calculate this figure in the real world

Compare the EV w/ the cost of the investment

If the cost of the investment is >EV May be a good investment (not considering risk = risk neutral)

($ value of Outcome 1) × (% chance of Outcome 1)

($ value of Outcome 2) × (% chance of Outcome 2)

+ ($ value of Outcome 3) × (% chance of Outcome 3), etc.

= Expected Value

Debt & Equity, 64	Answer
What is equity? What are its typical characteristics? What is the key source of law that governs the rights of equity holders? What is debt? What are its typical characteristics? What is the key source of law that governs the rights of debt holders? What control do equity holders have over a corp? What types of control do debt holders have over a corp? When might directors prefer to issue equity? Explain.

Risk & Return

Risk Neutral	MINORITY OF PEOPLE !!!

Someone who doesn’t care about divergent outcomes & pays up to the expected value b/c he only thinks that on average he’ll make money (only compares EV w/ the investment cost)

Risk Averse	MAJORITY OF PEOPLE !!!

Someone who will NOT pay up to the expected value (but close to it) b/c fears widely divergent outcomes

Need this bc EV doesn’t include risk aversion it gets built in to PV of $ paid in by reducing EV by our nervousness factor

These investors require a risk premium to take the investment

Certainty Equivalent (CE) = EV – RP

Realistic amount you’re willing to pay to feel comfortable (gut feeling) making the investment (future value to which we’ve built in risk and uncertainty) be able to calculate!

Risk Premium: Add’l amount a risk-averse investor demands to accept a higher-risk investment in the capital market (usually in FV) given on exam

Don’t build it into the price of an investment (b/c investors rarely pick the price they pay for investments)

Instead, it’s built into the PV of $ paid in

EX: $1000 coin flip, can buy it for $400. EV = $500, RP = $100, CE = $400

Risk Preferring: Person who pays more than EV for investment	i.e. gambling

Revised Formulas: What an investor will pay for an investment in future, depending on appetite for risk

A risk neutral person will pay the expected value reduced to present value	PV = EV / (1+r)n

A risk averse person will pay the certainty equivalent reduced to present value	PV = CE / (1+r)n

3-Step Approach

1) Calculate the CE based on the RP (in future dollars)	CE = EV – RP

2) Replace EV with CE when calculating the PV of $ paid in	PV = EV / (1+r)n

3) Apply final equation

if risk averse	NPV = PV (CE all $ to be received) – PV (all $ paid)

If risk neutral	NPV = PV (EV all $ received) – PV (all $ paid)

Leahy’s Approach

1) NPV to whom?

2) Identify and write down all $ in and $ out to the particular investor

3) Calculate the EV of all $ in

4) Is this investor isrisk averse, if so, convert EV to CE

5) Discount EV (or CE) to PV (only to $ that occur in the future)

6) Calculate value of $ paid out

7) Are these payouts in the future? For interest, use the FV formula

8) Discount future payouts to PV

9) Do the NPV equation with those #s

Problem, pg 72-73	Answer
See book. Use the above approach	NPV to whom = to the bank Bank pays $10M to receive $11.3M in 1 year 95% chance paid in full, 5% chance default EV = (.95 x 11.3M) + (.05 x 0) = $10.735M They are risk averse, so convert EV CE If risk neutral PV of EV rec = 10.735M / (1+.065) = 10,079,812 NPV = 10,079,812 – 10M = 79,812 (Good investment if risk neutral) Risk averse (has a $200k risk premium) CE = EV – RP = 10.735M – 200k = 10.535M PV of CE = 10.535M / 1.065 = 9,892,019 NPV = 9,892,019 – 10M = -107,981 (Bad Investment)

Diversification

The risk of the whole portfolio on average is lower than the risk of each investment in the portfolio by investing in many different things!

Advantages

Not putting all your eggs in one basket May reduce unsystematic risk

Making the variance smaller Allows risk averse investors to act risk neutral by

Assumption: Investors will diversify whenever they can

Some Risks Cannot be Diversified

Systematic Risk

Can’t be diversified away by investors, no matter how their portfolios constructed (b/c risk hits everyone)

i.e. risk the world will end

Unsystematic (idiosyncratic) Risk: Can be diversified away by investors	i.e. risk of a company going under

Explain: diversification, systematic risk, unsystematic risk, default risk. Which of these types of risks can diversified? Which cannot?

Discounted Cash Flow Analysis: Valuing Assets in the Real World

Discounted Cash Flow Analysis (DCF)

Large NPV calculation to determine corps value. It looks at ALL future investments a business will make

Requires a prediction of all future cash flows & a discount rate to bring those cash flows back to present to yield a NPV

Used to: estimate PVs based on an uncertain future. Takes all the corps potential cash flows and brings them down to PV

Values the whole corp by valuing all investments/cash flows (rather than just a particular investment)

Disadvantage: Great in theory, but in the real world it’s totally estimation so lots of room to fudge

Protection of Creditors

These rules mandate a corp to keep a certain amount of funds available for creditors in the event the corp becomes insolvent

Pros: bottom line, protecting creditors decreases the cost of borrowing $ to the shareholders

Focuses on limited liability of the shareholders b/c opportunity for misrepresentation in transactions with voluntary creditors

Creditors cannot go after the shareholder’s assets unlike an unincorporated business.

Makes it attractive to shift assets out of the corp after a creditor extends credit to the corp Shell game w/ their assets

Contracting their regulations wastes time and money (b/c they must hire lawyers to do it)

Default protections would reduce lender costs, thus reducing borrowing costs

Shareholder wealth maximization (encourages investment)

Cons

Creditors can build protection into the K

An astute corp creditor will secure the debt or if he doesn’t get security he should negotiate regulations in the K upfront b/c debt is contractual

Protects creditor b/c helps to ensure corp can pay its debt

***The more remedies there are for corp creditors more likely stockholders will be attracted to that corp for the lower cost of capital (lower risk via creditor protection = lower cost of debt for corp)

If there’s $ available to pay creditors, there’s probably $ to pay shareholders Less risk for all. Encourages investment

Mandatory Disclosure + Capital Regulation (Capital Minimums & Capital Maintenance)
4 Ways to Protect Creditos

4 Ways to Protect Creditors

1) Mandatory Disclosure to Creditors (not req’d in any state)

Telling creditors what is beyond the balance sheet

Unnecessary because the lender contract mandates what needs to be disclosed prior to giving $$$

Not common in U.S. but pretty easy to put in contract if creditor wants protection

Federal law requires disclosure to investors, not creditors

State laws don’t actually mandate disclosure to creditors

2) Capital Regulations (see below)

Purpose: requiring investors to contribute a minimum amount of capital from the firm to keep something in the corp. until the creditor is paid

Par value for paid stock tells you how much shareholders put into the “lockbox”

3) Capital Minimum Rules

Required minimum amount they must contribute at startup only

in DE: No capital minimum / not required

in TX: No capital minimum / not required (as of 2003)

Ineffective way to protect creditors bc can still shift assets around after first day, so corp. doesn’t have to have that minimum amount anymore

Between reporting periods, don’t actually know if the corp. has $

4) Capital Maintenance Rules

Corp must have a certain amount of §/capital in its bank account at any given time (outgoing capital) Protects creditors by having money on hand

Ds/Os dislike these b/c it’s capital they could be using elsewhere

Rare in U.S. (none in DE or TX) but common in Europe

US feels these rules are illusory (easy to shift around assets)

Restrictions on Distributions (below)

Main way to regulate corps.

Court-Enforced Duties on Directors/Officers (see below)

“Vicinity of Insolvency” Doctrine

“Fraudulent Conveyance” Norm

Equitable Subordination

Veil-Piercing

Busts through the limited liability wall to not just sue the corp, but allow shareholders to be sued subverting limited liability

Capital Regulation (Dividend Restrictions)

Distribution: Transfer of property, not including its shares, from the corp to its shareholders	§21.002(6)(a)

Applies to: dividends or repurchasing shares Corp buys already-issued shares

Authorized Shares: are possible shares - doesn’t exist yet b/c still inside company (authorized in the charter)

Issued Shares: bought from corp by public/stockholder for consideration

Is considered “outstanding” if owned outside of the corp

Repurchased “Treasury Shares”: from public/shareholders back to corp. for consideration; the corp’s own stock that the company has repurchased and holding

It’s considered an issued share, but it’s not outstanding

Cancelled shares: becomes an authorized un-issued share; act as if they never existed in the first place and can issue them again

NO distribution can be made that…	[Limits on Distribution]

Renders the corp insolvent, OR

Insolvent: unable to pay debts as they come due in the ordinary course of business (not necessarily a negative on your balance sheet)

Exceeds the relevant distribution limit

Share issuance

Accounting Categories

Calculating Key Categories

The Distribution Limits

3 Main Financial Statements

1) Balance Sheet “snapshot” on a specific day of 2 things

Assets: things the corp. has or owns (+)

Liabilities: obligations corp owes and are known (-)

Shareholder’s Equity (SE) = Assets – Liabilities

Shareholder’s Equity (“net assets”): theoretical residual that they own after selling assets and paying liabilities no right to these but what we want to maximize!

Not actual residual amount b/c doesn’t factor in current market value

2) Income Statement (The P&L)

Profits & losses (income) for a period of time depending on the financial statement

Earnings over a period of time” (not the entire company financial information)

3) Statement of Cash Flows	Not relevant for this class

Books and Records: Corps must maintain books and records	e.g., balance sheet, income statement, cash flow statement

Breakdown of “Shareholder’s Equity” (SE)

Stated Capital = SC

Capital Surplus = CS

Retained Earnings = RE

SE (net assets) = SC (“cap.”/”legal cap.”) + {CS (“paid-in surpl.”) + RE (earned surpl.)}

Stated Capital (SC) a.k.a. “legal capital” or “capital”

SC = ($ par value) x (# issued shares (incl. treasury shares))

Outstanding Shares: those that have not been repurchased

A repurchase of shares will not affect SC if the shares are held as “treasury shares” rather than cancelled bc treasury shares are issued but not outstanding

Par Value: minimum the stock can be sold for

NOT the same as expected sale price of stock need to pay dividends so want expected to be higher

A stock can be sold for more than par but NOT FOR LESS

Created in charter lower par value means more dividends paid flexibility

Most big corps. have par value at $1 or even lower b/c they want flexibility in future to raise/lower the price of the stock and don’t want to be constrained by the par value set very low penny stock

Par value not req’d no-par stock gives more flexibility

BUT, SC = Entire consideration received for stock when issued

Unless w/in 60 days of issuance, the board designates part of the consideration as surplus

Hypo	Answer
Corp’s charter authorizes 1000 shares of common stock with a par value of $1. Corp. sells 100 of those 1000 shares for $5.	What is SE after the sale of the stock? Assume it has no other assets and no liabilities. SE = A – L = $500 SC = $ par value x # issued shares = $1 x 100 = $100 What happens if corp repurchases 1 share and retains it as treasury stock? Doesn’t change SC because treasury share is an issued share What if corp cancels that share? SC would now be $99 In order for SC to be reduced by a repurchase, you must cancel the share b/c it’s still issued/sold and exists !!!

Capital Surplus (CS) “paid-in surplus”

CS = [($ price corp. rec’d when shares issued) – ($ par value)] x (# issued shares*)

*if there are no repurchases

Amount of money in excess of par received by corp. for its shares when originally sold

Doesn’t care about how much it was sold for on the market afterwards

Treasury shares don’t count towards the corp.’s assets (just paper shares)

TX law prohibits corps from counting repurchased shares as assets bc they are just pieces of paper

CS is reduced b/c corp. is paying out cash to get those shares back

Hypo	Answer
Same as above	What is Corp.’s CS from above? CS = [($5 - $1)] x 100 = $4 x 100 = $400

Retained Earnings (RE) “earned surplus”

RE = [net profits/loss all prior FYs(RE prior FYS ) + net profits/loss last FYs(RE last FYS )]

Earnings: income/profit to the corp. accumulated over time (can be negative)

Either retained or spent on dividends

2 steps to calculate RE as of 12/31/2010…

Start with RE as of 12/31/2009 (prior RE)

Then add RE for FY 2010 (current term)

Look to P&L

Distribution Limit/Lockbox

In TX: we can take distributions only from total surplus (CS + RE), not SC

Traditional Rule: SC is the lockbox set up by § to protect creditors b/c dividends are paid to shareholders purpose to restrict distributions

If no dividend, then you are done!

To pay dividends, a corp. must be SOLVENT!

Applies to dividends, repurchases, and liquidation of the corp.

Exceptions: special cases where dividends may be paid from net assets

EX. elimination of “fractional” shares when someone has 1/10 of a share and the corp. can buy them out

However, SC can be reduced with shareholder approval for no-par stock

TX doesn’t have a Nimble Dividend Rule

In DE: doesn’t have a universal “distribution limit,” but rather 2 parts

Retained earnings and capital surplus (total surplus)

Exception to the General Rule (unlike TX)

If no surplus, dividends can be paid from the net profits of current &/or previous year (found on balance sheet)

Nimble Dividend Rule: gives corp. 2nd chance to the lockbox from net profits

Policy: a corp., which has lost $ for a while so doesn’t have RE or CS, but has made $ in the last couple of years, ought to be able to award its shareholders modern, very permissive

Really robs the lockbox b/c if you don’t have any surplus, you have to “mortgage” the lockbox SC compromised

CHECK ONLINE SLIDES FOR EXAMPLE FROM BOOK P90

Directors Duties in (or near to) Insolvency

Vicinity of Insolvency Doctrine

Directors generally have to keep their duty towards shareholders

BUT with insolvency, directors’ duties to the corporation mean doing what is best for creditors bc they really make up the corp. so creditors have standing to sue (derivative lawsuits)

DE: This doctrine may apply to directors of corps that are “in the vicinity of” insolvency to keep an eye on directors when teetering near it 99% unenforceable

Equitable Subordination

In bankruptcy, a Ct may deem a “loan” by controlling shareholders as “equity” if the shareholder acted wrongfully

Shareholders know things are going badly and take all of their money out (equity) and put it all back in as a loan to ensure repayment manipulate by making themselves protected creditors

Ct will say they’re not protected and to go to the back of the line

Fraudulent Conveyance Norm

Fraudulent Conveyance Norm Rule

Creditors can safely assume/expect that $ lent to the corp will be available to repay the loan, subject to “normal wear and tear,” and won’t be shifted out of the corp via actual or constructive fraud

Creditors of an insolvent corp may “void” (put back) 2 types of transfers if the debtor made the transfer with either…

Actual Fraud, OR

Transfer made with intent to defraud, hinder or delay creditors of the debtor

Constructive Fraud

Transfer made w/o receiving a reasonable equivalent value IF the debtor is left with remaining assets unreasonably small in relation to its business or

Debtor intended, believed or reasonably should have believed he would incur debts beyond his ability to pay as they’re due or debtor insolvent after the transfer

Should have known you would bankrupt the corp when you took $ out

Can;t prove actual intent, just deceit

Veil-Piercing (Voluntary Creditors) K creditors!

Veil Piercing

Cts equitable power to set aside the entity status of a corp (pierce the veil) to hold its shareholders liable directly on K or tort obligations

3P Creditors pierce the limited liability corp veil to hold shareholders liable for corps debts

Exception to norm b/c shareholders are rarely held liable for corp. debts

You NEVER pierce the veil of a public company !!!

Most tests generally consist of…

Evidence of “lack of separateness”

Shareholder domination

Thin capitalization

Alter-ego/no formalities/commingling of assets

Unfair or inequitable conduct

Fraud

Avoiding liability

Veil Piercing Doctrines

Van Dorn/Alter Ego Test (IL, applied in Sea Land) must meet both !!!

Unity of interest and ownership that the separate personalities of the corp (or other corp) & the individual no longer exist (alter ego) &

Corp & person are one and the same and haven’t done anything to separate themselves

MOST CRITICAL prong!

Circs must show that adhering to the fictional separate corp existence would sanction fraud or promote injustice (something less than fraud)

Fraud > injustice > Inability to pay

Failure to repay debt is insufficient (b/c preserves corps limited liability benefit) Must show fraud or injustice

Undercapitalization alone is insufficient must show commingling of funds

Examples

Intentionally transferring assets into a liability-free corp while heaping liabilities on an asset-free corp

Unjust enrichment

Parent co. causes a sub’s inability to pay for its liabilities solely to escape from them

Kinney Shoe Laya Test (Kinney Shoe) Similar, must meet both !!!

Such unity of interest and ownership that the separate personalities of the corp & the individual no longer exist &

An inequitable result would occur if the acts were treated as those of the corps alone

Potential 3rd prong if both are met: ∆ can still prevail by showing assumption of the risk

Synthesizing the 2 Cases: There’s only 2 prongs. Cts will pierce only if there’s…

Lack of formality/separation (alter-ego/unity of interest) &

Some form of fraud/injustice

If a creditor doesn’t do his due diligence he assumed the risk so no injustice

Unity of Interest Factors (Sea Land)

Fails to maintain adequate corp records or comply w/ corp formalities

Commingles funds or assets

Undercapitalization

One corp treats assets of another corp as its own

Liability/Veil Piercing Never allowed for:

Public corps

If adhered to all corp formalities

Minority shareholders (very rare)

Passive shareholders (unless proves they caused corp to be used for the purpose of perpetrating & did perpetuate actual fraud)

Close corp shareholders (unless they had the right to vote/consent to the action or dissented from the action)

Reverse Veil Piercing

After creditors attack the shareholders, if a shareholder is part of any other entities (bystander/sister corps) they can pierce back & get compensated for that debt

Test: Same as Van Dorn test

Piercing party can become a creditor (instead of an equity holder) ahead of other creditors

Burdens and Review

BOP: Party trying to pierce

Test: Totality of the circs

Standard of Review: Clearly erroneous (only way to overturn findings of fact)

EQUITABLE REMEDY

Cases

Sea Land (reverse piercing)

Facts: Sole owner of 8 companies. They used all same $ and he didn’t have a personal account b/c he used all the corps $. They used all the same PPE, and then there was a last company where owned only ½ the stock, but he ran it

Holding: 1st req’t of the piercing was met b/c there was unity of corp and person. 2nd req’t wasn’t met b/c no severe injustice determined by DC. Remanded for the “promotes injustice” prong. Piercing party needed to show something more than a “wrong” beyond a creditor’s inability to collect.

Leahy: It was a shell game

Kinney Shoe

Facts: ∆ created a shell company for his main shell company. Doesn’t pay debt. TC used a 3-prong test

Holding: Reversed. Threw out the 3rd prong so ∆ wouldn’t get away by skipping the bare minimum of a corp

Leahy: Undercapitalization was the underlying problem. Says case decided wrong.

Veil-Piercing (Involuntary Creditors) tort creditors!

General

K creditors pierce more often than tort creditors

Tort creditors, unlike K creditors, generally can’t protect themselves in advance

e.g. via due diligence or negotiating contractual protections

Hard to show fraud or injustice when the only way you become a creditor of the corp is that you got hit by a cab (tort)

Walkovsky

Applies Single Business Entity Theory to make all the individual cab co’s liable together, but doesn’t make the owner individually liable

Cabs would be individually incorp. & carry the min. insurance to shield itself from tort liability. 1 person could own 10 different “corps” (10 cabs). Ct said no $ from other cab companies π failed to satisfy his injustice prong burden. ∆ Carlton was dismissed. The companies didn’t break any laws,were incorporated properly, so petition the legislature to change the law if people disagree

Test

Alter ego/not following formalities

Unethical/fraud

Veil-Piercing (TX)

Allowance of Constructive Fraud

Castleberry	pre-’86, but still applies to tort creditors !!!

TX Cts Pierce in 2 Familiar Situations

Corp fiction was used to perpetuate fraud &

Alter Ego: Corp was organized & operated as a mere tool or business conduit of another corp

Applies: When there’s such unity b/w a corp and an individual that the separateness ceased, so holding corp liable would be unjust (same as Sea Land/Kinney Shoe)

Can pierce when “unity b/w corps & individual…separateness ceased, soholding corp liable would result in injustice.”

Holding: Constructive fraud was enough for injustice

§ 21.223 and § 21.729-.730 only applies to K creditors (voluntary)

[Prong 2] Now must show actual fraud (not just constructive fraud)

In a tort case Constructive fraud s sufficient

Inadequate capitalization, alone, is not an adequate basis for disregarding the corp form (what Kinney Shoe got wrong)

[Prong 1] (lack of formalities) eliminated as a way to pierce the corp veil, no matter what the corps size major change to CL

Got rid of the single-business entity doctrine

§ only says what isn’t enough to pierce. It doesn’t give a test but it seems to be just one test:

Tort cases Constructive fraud is sufficient

K cases Actual fraud

Must receive a personal benefit

Constructive fraud not enough

SSP Partners

Rejects the single business enterprise doctrine b/c doesn’t require fraud inconsistent w/ TBOC

When corps act as the same business, each constituent corp may be liable for debts incurred in pursuit of that business purpose

TX: Must do a veil piercing test to reverse pierce

Reverse piercing is disfavored in TX unless the other corps owner is the sole owner

Hypo, pg 117
What role does lack of formalities go? Prong 1 Does it apply in TX? No Can A be pierced in TX? No b/c no actual fraud Can B be pierced since he engaged in actual fraud? No b/c he received NO personal benefit

Veil Piercing: Holding shareholder liable for corp debt

Reverse-piercing: Piercing back into corps that are also owned by an already-pierced shareholder

Sea-Land Test !!!

1) Unity of interest (aka alter ego) &	Does the corps formalities act like a corp exists?

2) Fraud or injustice

Usually requires a mistake

Injustice is in the middle: Fraud - Injustice - Inability to pay

Requires more than that the π wasn’t paid

Engaged in a shell game May be able to pierce under the injustice prong

Use Sea-land test for both veil piercing & reverse veil piercing

Veil Piercing in TX (p.110)

Modern

Required: Actual fraud (eliminated constructive fraud)	§ 21.223

Rule: Actual fraud is req’d as the basis for piercing. Other theories won’t help pierce the veil

Exception: A tort claim (involuntary creditor) → Can sue on actual or constructive fraud

§ 21.223(a)(2) where it states “contractual obligations”

However, hard to prove constructive fraud in a tort claim

Single Business Enterprise is rejected in TX	§ 21.223

SBE theory was in Walkovszky back when it was TX law

Hypo

Requirements

1) Lack of Formalities

Insufficient alone to pierce the corp veil	§ 21.223(a)(3)(A)-(B)

Facts must say it’s a statutory close corp to get protection (Statutory=must be in charter)	§ 21.730

2) Actual Fraud for primarily a direct, personal benefit of the shareholder being pierced	§ 21.223(b)

If statutory close corp Shareholders who dissented from action won’t be held liable	§ 21.729 & 21.730

New Test in K Cases: Actual Fraud

Test in Tort Cases: Actual or Constructive Fraud

V. Day to Day Governance (Chap. 7 & 8)

Voting System

Shareholder Voting & its Costs

2 Major Components of Day-to-Day Governance: How Shareholders can Discipline Mgmt

1) Shareholders vote to elect directors	Chap. 7

2) Shareholders sue to hold directors to their fiduciary duty of care	Chap. 8

3) Shareholders sell their shares	Add’l point

(Hostile) Takeover: Lowers the price of the shares & outsider can buy all of them to take control of the corp & kick out mgmt.

Proxy System

In ordinary corps (not close corps), BOD is responsible for the day-to-day decisions (not shareholders)

Default Rule: Shareholders elect the BOD at annual shareholder mtgs.

It’s the only time they might affect day-to-day decisions but most don’t show up

Collective Action Problem

Lots of shareholders, their vote is small & benefit not worth travel costs

This is the concern of corps--that no one would come

So we have proxy voting

Solution: Proxy Voting

Proxy: Authorizes another to vote for you

An agency relationship (so that mgmt can vote for yo)u

Mgmt sends the proxy voting forms to all shareholders & solicits them for proxy votes

Fundamental to corp governance in publicly financed corps.

Designating a Proxy

Proxies must record the designation of the proxy holder by the shareholder and authenticate the grant of the proxy.

Electronic proxies ok	§212(c)(2), TBOC 21.367

Advantage: Lowers the cost of attending mtgs for all shareholders, still allows them to vote, & allows annual mtgs

Revocable unless holder K’d for the proxy to protect a legal or property interest, such as an interest in the shares themselves DGCL §212(e)

1+ persons incur the initial proxy solicitation expenses

Substantial cost so shareholders face a serious impediment to collective action

Proxy Voting from Shareholders Perspective

Est by state corp law & legal structure in which proxies are given, exercised, and revoked	DGCL §212(b)

Scenarios

If shareholder wants to vote for the mgmts slate of directors → Mail it

If shareholder doesn’t want to vote for mgmts slate of directors

Trash it

Mgmt not req’d to accept your proxy if you want to vote against their will (use state law)

If shareholder wants to affirmatively vote for a different slate of directors

Can sign a form circulated by the shareholders

Find another proxy b/c mgmt will vote their way. So find someone else who is soliciting you & voting w/ you

If shareholder wants to nominate his/her own slate of directors

Mail your own proxy solicitation to try to get others to join you

They give you proxy authority to vote for them

….thus there is no universal ballot

Form of Proxies: Can be written or electronic	TBOC 21.367; DGCL 212(c-d)

Proxies are Valid for

DE: 3 years	DGCL §212(b)

TX: 11 months	TBOC §21.368

Generally: Proxies can be revoked at any time

Unless

1) Explicitly says so &

2) Coupled w/ an interest that is sufficient to support irrevocability	TBOC §21.369, DGCL §212(e)

Cost of Proxy Contests

Expensive in large corps (b/c mailing & printing costs)

Can do it online, but must still mail notice

However, if it is cheaper to do, this might result in more proxy contests

Who Pays for Proxy Contests? In a policy contest (vs. purely personal power contest) Rosenfeld v Fairchild Engine & Airplane 121

1) Management can incur the expenses whenever

Mgmt can pay reasonable expenses out of the corp treasury !!!

Corp directors have the right to make reasonable & proper expenditures, subject to Ct scrutiny when challenged, from the corporate treasury for the purpose of persuading the stockholders of the correctness of their position and soliciting their support for policies which the directors believe, in all good faith, are in the best interests of the corp.

Limits on Proxy Expenditures for: 1) personal power, 2) individual gain, or 3) private advantage (Ct will disallow)

2) Insurgents are reimbursed only if they win a proxy battle

Ct says the shareholders can approve the expenses, but in reality they’ll only approve them if they win

Insurgents can be reimbursed if there’s ratification

Effect: Mgmt gets reimbursed & insurgents only get reimbursed if they win

Directors Elections & Annual Meetings

BOD Elections

Every corp must have a BOD (TX: BOD can be eliminated by shareholders)	DGCL 141(a), TBOC 21.401(a)

1+ class of voting stock	DGCL 212(a), TBOC 21.152(d)

Annual election of some directors	DGCL 141(d), TBOC 21.408

Who votes: Holders of record

Annual meetings

TX, DE: Must be held every 13 months !!!	TBOC 21.351

Not req’d to be held in state of incorp (unless charter specifies otherwise)	TBOC 6.001

Shareholders can sue to enforce 13 month rule

1) NOTICE re: Annual Meetings

Written notice 10- 60 days before the mtg !!!	DGCL § 222, TBOC 21.353

Electronic OK if you consent

Record date

Usually set, but if not, the defaults are

TX: Date of the notice

DE: Day before notice sent

Waiver of Notice	TBOC 6.052

Default Rule: 1 vote per share of stock

If charter silent → Default rule is that preferred stock votes

To restrict voting rights → Must be in charter

To delegate <1 vote/share → Must be in charter

If BOD doesn’t fix the record date → Default record date is the notice date (TX)	TBOC 6.101

2) A QUORUM

Quorum Requirements

Must have a quorum present in order to officially vote on business (the “threshold”) !!!

TX: Majority of voting shares must be “present” at a mtg to establish a quorum	!!!	TBOC 21.358

Can be done through proxy

TX, DE Minimum req’d %: Can raise or lower in charter, but not less than 1/3 of total shares

Vote % Needed to Win

Voting on Directors	TBOC 21.359

Default: Plurality (who gets the most votes)	Majority not req’d

Can change in charter or bylaws

EX: 9 board open positions → Win if in top 9 of vote-getters

Voting on Normal Resolutions (Stuff other than Directors)

DE: Simple majority of voters present	TBOC 21.363

i.e. 500 present → need 251 votes

Step outside and you don’t vote → vote counted ???

TX: Majority of those voting

We don’t count implicit abstainers	i.e. You leave the quorum → Votes not counted

Voting for Special Rules (fundamental changes)

TX: Absolute super-majority of all eligible voters→ 2/3rds of all voting shares

Can change in charter or bylaws, minimum is 50%

DE: Absolute majority → 50% of all voting shares

Vote Counting

TX, DE Default Rule: 1 vote per share owned !!!	aka straight/regular voting

Can change in the charter !!!

TX Pre-2003: Cumulative voting was the default rule	TBOC 21.362

But charter could have changed to straight voting

Vote Casting

TX Default: Straight voting unless incorporated pre-2003 (then cumulative, unless charter said straight)

DE Default: Straight voting

Both: Can be changed in charter

Straight vs. Cumulative Voting

Formula: 1Vote X xShare X xOffices = Total # of Votes

Straight Voting

1 vote per share per person

EX: If there’s 9 directors → You’d get 9 votes (but they can’t be all for the same person)

EX: If you have 10 voting shares you use up to 10 votes to 1 individual, but not more

Cumulative Voting	TBOC 21.361

Can take your 1 vote & cumulate your 9 votes (9 director slots) & give all 9 to 1 open spot (one individual)

EX: If you have 10 shares → Can vote all 100 votes to 1 individual

Advantage: Prevents majority owner from electing the entire board

Hypo, Proxy Contest	Answer
Proxy Contest. Corp. X has 100 voting shares. You own 51, I own 49. You vote for 9 different people than me.	Under straight voting how many directors will you elect with your 51 votes? You can elect 51 votes per open board spot. Under straight voting how many directors will I elect with my 49 votes? I will be able to vote 49 votes per open board spot. Whomever gets 51 will control the board
What about under cumulative voting? Difficult to know unless you use cumulative voting formulas that uncover the best use of your votes, compared person w/ 49 votes. (Formula not req’d on exam). There’s the possibility of strategic voting (i.e. instead of voting 51 votes on each director, you could do 50 on one, 52 on another) If you assume both maximize their strategic voting potential → Person w/ more votes wins So large majority voters get a bigger voice In DE: a large minority shareholder could use it to get better representation Just know on exam that you’d need a formula to figure this out

Consents & Classified Boards

Classified Board

Like a staggered board, where diff directors are given diff terms

Effect: Causes the board members to not all get voted out each year, but rather changes, in multiple years.

TX, DE: Max 3 classes allowed	TBOC 21.408(a); DGCL 141(d)

i.e. 9 directors, divided into 3 classes (so 3 directors in each class) → The classes can then be elected on alternating years, a group of 3 directors would go up for election each year → Effect? So they would each have a 3 year term

Cumulative voting & classified board is a great defense to a take-over. Delays the inevitable.

Cumulative voting must be stated in the charter (not bylaws)

In order for the bylaw classifying the board to be valid, it has to be a shareholder approved bylaw.	TBOC 21.408

TX Note: If there’s fewer than 9 board spots Can’t have cumulative voting

If you are able to amend the charter, you can do anything you want w/ the bylaws, b/c the charter trumps the bylaws.

Can you amend the bylaws?

TX: Can amend (unless charter says otherwise)

DE: Can’t amend once shares are sold (unless charter amended)

DE: Need only a majority of shareholder votes to amend the charter

However, a proposal from the board is req’d first

So, even w/ a majority of the votes, mgmt. must support you

2-step process:

1) Board proposes amendment

2) Shareholders adopt	DGCL 242(b)(1)

TX:

Need board proposal & the adopted resolution

To amend charter → need 2/3 (super majority)	TBOC 21.364

Bylaw amendments don’t help you circumvent cumulative voting b/c charter ranks higher

But you can eliminate the classified board

therefore you would (if you have a majority of shares) be able to get 5 of the 9 board members at election time.

DE: Can’t divest stockholders of the power to adopt, amend, or repeal the bylaws	Last sentence DGCL 109(a)

TX: Need a shareholder-approved amendment in the charter to allow shareholders to lose their power	TBOC 21.057-058

To Amend Bylaws

TX Board starts out w/ ability to amend the bylaws

DE: Shareholders have to grant that power to the board

The board alone…

TX: Can amend the bylaws in TX (unless charter says otherwise)

But they have to do it with shareholder help, or at a meeting with the board elected???

DE: Can’t amend the bylaws in DE (unless charter says otherwise)

If they change the charter to allow amendments to the bylaws → Shareholder approval is req’d

Election & Removal of Directors

Board Basics: Every Corp Must Have…

BOD

TX: except if you have a shareholder agreement or close corp

1+ class of voting stock

Annual election of some directors

Annual Meeting Scheduling

TX, DE Must hold every 13 months (but not necessarily in those states)

DE: If mgmt refuses to hold it w/in the proper timeframe → Shareholder can file suit	DGCL 21.351(b)

DE: 50%+1 of voters can decide to NOT have a mtg (basically a quorum)

Notice: TX—Written Notice unless changed, 10-60 days before the mtg, can waive bad notice by attendance

Vote Counting

TX,DE Default: Straight Voting

1 vote/per share/per person/per open office

Preferred by mgmt. (b/c less turnover & promotes collegial boards (vs. divisive boards))

Preferred Stock: Standard default is 1 vote & charter must specify preferred stock doesn’t have voting rights

Shareholder of Record: Shareholder who’s on record on the notice date. Day notice is given=Record Date

Problem:	Answer
9 director positions are available & you have 1 voting share. How many votes can you cast and for which directors?	You may cast up to 9 votes total, 1 vote per open director seat. But you can’t cast all of those votes for 1 person (no accumulation allowed)
100 total voting shares in the corp. You own 51, I own 49.	You vote for 9 diff people than me. You’ll beat me 51-49 every time

Alternate Method: Cumulative Voting

Rule: One vote per share per office !!!

Each share gets a vote for each director

EX: 5 votes for one person, 4 for another; or 3 votes each for 3 diff people !!!

Effect

Can cumulate these votes & put them all towards one instead of splitting them amongst each position → only if in charter! (total # of votes can go to 1 person)

All can be put towards one person or split them up b/w diff people

Allows minority shareholders to pool all their votes to possibly elect a director. Requires formulas

Use: Rare, usually only in small corps

TX Default pre-9/1/2003 (>9 years old): Charter can change it

Formulas

Ns = [S / (D+1)] +1

Ns = # voting shares required to elect one director

S = total # voting shares outstanding

D = total # directors up for election

Nv= [V / (D+1)] +1

Nv = # votes needed to ensure election of one director

V = # votes to be cast in election

D = total # directors up for election

Nd = [(Sn – 1) x (D+1)] / S

Nd = # directors one can elect with the specified # shares

Sn = specified # shares one controls

D= total # of directors up (class or straight)

S = total # of voting shares outstanding

STAGGERED BOARD = GOOD TAKEOVER DEFENSE

STAGGERED BOARD + CUMULATIVE VOTING = GREAT TAKEOVER DEFENSE

Special Meetings

Definition: Mtgs, other than the annual mtg, called for special purposes

DE: Special mtgs may be called by BOD or by someone designated in the charter or bylaws	§ DGCL 211(d)

TX: Anyone with <10% of shares can call a special mtg	§ TBOC 21.352

Problem: The Unfireable CEO

Facts: Before Kagan comes along, Revesz Vd:

1) Proposes a charter amendment that:

a) Power to amend the bylaws is vested exclusively in the Board

b) implements cumulative voting	Shareholders ratify this amendment

2) Amends bylaws to:

a) fix # of Ds at 9

b) classify bd 3 classes

Strategy #1 for Kagan to take over: Amending the Charter

Can Kagan amend the charter?

Kagan would need to eliminate the classified board to take over at the next meeting (not cumulative voting)

The classified board is in the bylaws

Can Kagan eliminate the classified board by amending the charter?

Yes, b/c charter trumps bylaws

To the extent shareholder votes are necessary to amend the charter, can she amend the charter in…

In DE?

The requirements to amend the charter in DE are

1) Shareholder ratification

2) Board proposal

She has 51%, so she has enough shareholder votes to amend the charter in DE. But votes aren’t enough, she would also have to have a board proposal

in TX?

Req’t to amend the charter is a 2/3 super majority shareholder vote

No, she couldn’t amend the charter b/c she doesn’t have enough votes

Strategy #2 for Kagan to take over: Amending the Bylaws

Can Kagan amend the bylaws…

in DE?

Does she have enough shareholder votes to amend the bylaws?

Under § 109 Bylaws, the § says that even if the board is given the power to change the bylaws BUT that power CAN’T be taken away from the shareholders

This means that pt 1 in the charter amendment is void, b/c § trumps charter

Will her amendment succeed? Yes

in TX?

Does she have enough shareholder votes to amend the bylaws?

Shareholders can amend the bylaws, regardless of whether the corps directors can too	TBOC 21.058

Will her amendment succeed? No

But let’s assume that she can amend the bylaws in TX….

And now assume that she wants to take over the company right now, before the next annual mtg.

Can Kagan call a special mtg…

…in TX?

Yes. The president, the BOD, anyone who’s listed in the bylaws, or 10% holders can call a special mtg	TBOC 21.352

…something about 10-50% in	TBOC 21.352(a)(2)

TX is easier on special meetings

…in DE?

No, b/c on the board can call a special mtg	§ 208

Could Kagan cause the shareholders to vote on her proposed bylaw amendment, w/out holding a mtg? [aka consent]

…in DE?

“not less than the min # of votes that would be necessary to authorize

treat consents as if the quorum is everyone & you must have an absolute majority

DE is easier on consents

…in TX?

No, b/c TX requires unanimous written consents and she doesn’t have that

Will her bylaw amendment be successful?

Strategy #3 for Kagan to take over: Increasing the size of the board

If Kagan only increases the size of the board…

in DE? Yes, she could takeover by amending the bylaws to increase the size of the board

in TX? Yes, the board or the shareholders can increase the size of the board, but it can’t exceed 2, per….

So Kagan successfully amends the bylaws and she increases the board size and states that shareholders elect the new directors. Remember that all 9 directors are loyal to Revesz.

So how many seats must Kagan add?

If she adds 10 more seats to the board, will she be able to take over? No, b/c the amended charter says they use cumulative voting. So you’d have to use a cumulative voting formula, which we don’t need to know for the exam.

But just for an example… With 75% of the votes, Kagan must add 20 new directors to take over now.

Thus, just b/c you add directors doesn’t mean that you’ll get them all

Strategy #4 for Kagan to take over: Removing the Board

What’s the general rule for removing a director…

In TX?

In DE? The BOD may be removed w/ or w/out cause, by a majority shareholder vote at an election of directors, BUT if there’s a classified board, they can only be removed with cause. Here, the charter states that it is a classified board, so she can’t remove the board b/c there isn’t cause. But she could amend the charter and declassify the board, which would allow her to eliminate the board w/out cause.

Let’s say she removes a majority of the board (5 directors)…can she take over now? No, she can’t even remove 5 b/c § 141(k)(2). She’ll have to remove the whole board.

Kagan has enough votes to amend the bylaws. She couldd use consents (DE) or a special mtg (TX) to get a vote on any proposal she makes.

Can she directly take over by passing a bylaw, which requires the board to hire her as a CEO?

Can’t blatantly say “hire me”

But can amend bylaws to say “shall consider women & minority candidates”

Remember, CEP Rev & “his” board amended the charter & bylaws to entrench themselves--attempting to defeat her takeover.

Can he do this? No

Rule: An attempt by mgmt. To entrench themselves is a breach of fiduciary duties (even if complies w/ §)

Problem: The Unfireable CEO (Not req’d to own a majority a.l.a. the other owners own very little)

1) Before Kagan buys 51% of the voting stock Rev controls the Bd, but he owns only 25% of the voting stock.

Can one be a controlling shareholder w/ less than a majority of voting shares? Yes, chapter 4

In order for Rev to control the board, what must be true about the % of shares owned by all the other stockholders? It must be that all the other shareholders are pretty small. Remember, a plurality is allowed, and thus we call it de facto control.

2) Here, the proposals by Revs board basically disenfranchised the shareholders in several ways.

Is this realistic? In theory, the 25% that Rev holds is enough b/c it’s possible 10% of shareholders won’t vote.

Classes of Board Members

DE/TX: Max 3 classes. Board turns over every 3 years

TX: Must have 9+ directors to classify

General: Effective takeover defense

Amending Charter (cumulative vote must be in the charter)	CHARTER TRUMPS BYLAWS

DE/TX: Board must propose the amendment & not via proxy

Shareholder vote % (approval/ratify)

DE: if there are shareholders, it must be approved by them (majority)

TX: if there are shareholders, it must be approved by them (2/3 supermajority)

TX: Fewer than 9 Directors → Can’t have cumulative voting (where to put this???)

Amending Bylaws (Classify the board. Must be shareholder approved)

Amendments by BOD

Default: BOD can amend

TX: Can amend from the start as a default (concurrent power)

Before they get their stock→ Can amend	§ 109(a)

After they get their stock → Must propose to shareholders to amend b/c don’t have that ability on their own

Can add to the charter to get concurrent power

Amendments by Shareholders

Default: Shareholders can amend in either state

DE: Inalienable right to amend bylaws → Can’t give up ability to amend *mandatory rule* (majority%)

Exception: Can eliminate their right to change bylaws w/ majority % shareholder approval	§ 21.057

Mergers

DE: Must be proposed by board

Special Meetings

May be called by…

DE: BOD	Charter can authorize other people too

TX: BOD or holders of 10% of stock

Controlling shareholders should be able to call them

Charter trumps these default rules

Written Consent in Lieu of Meeting

TX: Requires unanimous consent from all shareholders

DE: Requires an absolute majority (51%)

DE Quorum Req’t:

Can consent to…	Can’t consent to…

Removal of all directors	Amending charter

Allow “veil piercing”	Merger

Amend the bylaws

Dissolve – must be unanimous consent

Board Vacancies (increasing # of directors creates vacancies)

DE: Board fills vacancies	Can change in the charter

TX: Shareholders may fill in annual or special meetings, or majority or remaining board

Removal of Directors

Modern Rule: Directors can be removed/fired for any reason with a majority vote

Poor business judgment w/out additional fault is not cause for removal

Directors can’t be removed by fellow directors

Classified/Staggered Board

Default Rule (TX/DE): Can only remove director “for cause”

Cumulative Voting

Default Rule:

If removing the whole board:

Need a simple majority to say get rid of whole board

i.e. need 50%+ to remove board, then cumulative vote for new directors

If removing less than entire board:

If the votes against removal are enough to elect that director under cumulative voting, then must have cause to remove that director

Enough to elect is enough to protect. Protect those he could elect. Then vote

Vote not to remove, 6 board members removed, CEO can protect 2 votes & then vote on the other 4 w/ his votes

i.e. if 15% of votes were needed to elect director, need 86% to remove w/o cause

Non-Classified Board: can be removed with or without cause (TX & DE)

Can someone force the board to hire a person as the CEO?

No, they have a fiduciary duty to do what’s right for the corp (bylaws can’t eliminate it)

These duties overly the §

DE: Classified board may appear in the bylaws only if the shareholders approve	408(d)

TX: Classified board may appear in the bylaws if shareholders approve or if bylaws are amended at a mtg where directors are elected

The Voting System

Class Voting

General Rule: All classes vote together and they are lumped together

Class Voting: Each class votes separately. A specified % of each class…

Advantages: ???

Disadvantages: ???

Avonex Problem, 136

Preferred stock gets special rights, but typically don’t vote

Senior: Newly released preferred stock takes a senior position (get dividends first) over the existing preferred stock holders.

% mark is representative of some aspect of the dividend

Here, the 11% are getting more than the 6% group

Risk: Avonex is a struggling company.

If it doesn’t reach a profit, they may not be able to pay the dividends

If they can pay a limited dividend, then the senior preferred holders may get the only dividend distribution.

De we need a class vote?

DE: Not very protective	DGCL § 242(b)(2)

No right to a class vote here b/c the existing rights of the 6% group aren’t being changed or altered in any way. The corp is only adding a new class.

NY: More protective when you add a new class of stockholders	§ 804

TX: Like NY	TBOC § 21.364(d)

Adding add’l shares of the same 6% preferred at a discount (see facts) dilutes the ownership power of the existing shareholders of this class (6% preferred)

If you increase or decrease the aggregate # of authorized shares….

DE: Does protect	(the class can vote)	DGCL 242(b)(2)

NY: Doesn’t protect existing 6% preferred stockholders. They don’t include the increase/decrease of a similar or same series of stock.	§ 804

TX: Like DE	TBOC § 21.364(d)(1)

Can amend charter to increase protection

Example 1

X corp has 4 classes of voting stock, 2,000,000 of common vote yes / 200,000 of class a / 20,000 of preferred B / $2,000 of preferred C

If No class voting (default)…

But under class voting…

Each preferred class will vote separately, in addition to the whole

1,999,998 shares of common must vote yes

2,0001 shares of preferred A must vote yes

21 shares of pref b must vote yes

1 share of preferred C must vote yes	IF THE 1 SHARE VOTED NO → RESOLUTION FAILS

Example 2

A corp has 3 classes of stock:

100,000 shares of common stock

1,000 shares of preferred A

10 shares of preferred B (Charter: Preferred B doesn’t vote)

Scenario 1 (DE): Assume there’s no class voting. Which shares must votes yes for a charter amendment to pass?

Absolute majority for 100,000 = 50,001

Simple majority for 100,000 =

Scenario 2 (DE): Assume there is class voting for all classes of stock. Which shares must vote yes for a charter amendment to pass?

Class voting requires that there must be an absolute majority for each class voting.

50,0001 for C

501 for A

6 for B

Keep in mind that if the § requires class voting, the charter can’t change that (b/c charter trumps §)

Scenario 3 (TX): ????

Shareholder Information Rights

Financial Statements

TX: Must provide written statements upon request (last fiscal yr + interim statements)	TBOC 21.218

DE: No obligation to send it to shareholders (This is only under state law)

Other States

In 15 states, corp must provide them to shareholders annually

In 25 states, corp must provide them to shareholders who request it in writing

In some states, corp never has an obligation to provide them (circs irrelevant)

Inspection by Shareholders

In all states, shareholders may ask to inspect:

1) the Stockholder list	TBOC 21.354

2) The Books & Records

This is a detailed record of all financial transactions

A person may want to see this to ensure against any wrongdoing by the corp’s mgmt.	DGCL 220

Requirement to Inspect the Stockholder List (Request for examination of records)

DE:	DGCL 220

Written request (under oath) &

Proper purpose

Proper Purpose: Reasonably related to your interest as a shareholder

i.e., Run a proxy battle to unseat current mgmt

Soliciting shareholders to join a derivative suit against BOD

BOP: Corps (to show it’s not proper)	DGCL 220(c)

Once a proper purpose stated Ct won’t look at an add’l improper purpose stated

Mgmt may attempt to show it’s a lie

TX:	TBOC 21.218

Written request (under oath) &	[same as DE]

Proper purpose &	[same as DE]

Held shares for 6 months &

Hold <5% of outstanding shares

BOP: § implicitly, probably corp

Takes a refusal to share the shareholders list very seriously. Can result in liability for costs to obtain the list TBOC 21.222

§ mandate that a corp provide financial statements to its shareholders at the annual meeting	TBOC 21.372; DGCL 219

Both require notice TX: 11 days ; DE: 10 days) before the mtgs of the stockholders.

Treasury Shares – Vote Buying & Circular Control

General Rule: Treasury stock doesn’t vote & it’s not counted for quorum purposes	DGCL 160(c); TBOC 6.152

Corp (i.e. board or mgmt.) is prohibited from voting treasury shares

Policy: Keep mgmt from buying stock, placing it in the treasury, then controlling the stock, which would keep the votes to keep themselves in power, i.e., entrench themselves in power positions

There’s too much control w/ mgmt to buy treasury stocks

Shares of a Parent of Subsidiary	TBOC 1.002(85)

DE/TX: Shares of P held by a majority owned S are not voted

Since P (via mgmt.) elects S’s board, allowing S to vote P’s shares would present the same entrenchment problem as allowing P to vote its own treasury shares

Yet, the § doesn’t explicitly prevent S from voting P’s shares if P controls S w/ less than a majority of S’s stock

Definition: An org for which another org, either directly or indirectly through or w/ 1+ of its other subsidiaries:

A) owns at least 50% of the outstanding ownership or membership interests of the org or

B) possesses at least 50% of the voting power of the owners or members of the org

Circular Control

EX: CorpP controls CorpS. CorpS owns CorpP stock.

So the effect is that CorpP votes shares to elect CorpS BOD, etc

TX:	TBOC 1.002?

It depends on whom the majority votes

50% or more is a bar to control (so can’t)

DE:	The Bright-Line Test	DGCL 160(c)

But Cts might apply § when P controls S w/ less than a majority if π proves P dominates S’s board

Vote Buying

CL: Vote buying is illegal per se ‼!

Shareholder can’t sell her vote (other than as part of a transfer of the underlying share)

Who is the buyer: An outsider

Who is harmed by it? Shareholders

Why? Vote buyer might not act in the corps best interest	i.e. sell for .01/share vs. $1/share

Ct of equity will be inclined to require a transferor, who sells stock after a record date, to give his transferee a proxy to vote the stock – unless transferor specifically retains voting right to protect a legal interest in stock or corp strong enough to support the grant of an irrevocable proxy

Schreiber v. Carney, 145

Rule: Must be full disclosure (of all material facts) & ratification by all disinterested shareholders & deal was intended for corps benefit

Holding

An agreement involving the transfer of stock voting rights w/o the transfer of ownership → Not necessarily illegal.

Examine each arrangements object or purpose

Helps that it was approved by disinterested committee

Approval from disinterested shareholders → Not subject to the voidable per se, rule

DE: Vote buying is voidable (must be fully disclosed & ratified)	vs. void per se

DE: Vote buying is only per se illegal if fraud, etc

No ratification → Do an entire fairness analysis	see entire fairness below

TX: n/a

What if there wasn’t ratification in Schreiber? Ct would have considered whether it was fair to the corp (intrinsic/objective fairness)

Federal Proxy Rules WATCH THE VIDEO

Securities Exchange Act of 1934 (Town Meeting Rule)	§14a-4(d)(1)

No proxy shall confer authority: to vote for the election of any person to any office for which a bona fide nominee is not named in the proxy statement

4 Major Elements

1) Disclosure reqt’s & a mandatory vetting regime

Permits SEC to: assure relevant info is disclosed & protects shareholders from misleading communications

Must file proxies on a Schedule 14A

Must file the proxy materials

Anyone who solicits a proxy must file the req’d proxy materials w/ SEC before providing to shareholders (unless exempt)

Solicit: asking other shareholders to join a request for a stockholder list	Studebaker

2) Substantive regulation of the proxy solicitation process

If electing directors: proxy card must allow shareholder to w/hold vote from 1 or all directors	14(a)-4(b)(2)(ii)

If normal proposal: proxy card must allow shareholder to vote for, against or abstain for each proposal 14(a)-4(b)(1)

List or mail rule: if an insurgent wants to start a proxy battle, mgmt must:

1) Provide list of shareholders or

2) Mail shareholder’s material for him (at shareholder’s expense).

Rule 14(a)-7

Internet availability

May put materials online except for certain propsals (i.e. mergers) &

Mail notification to shareholders (1 pg notice about the online posting)	14(a)-6

Short Slate Rule

Bona fide nominee rule (traditional)	14(a)-4(d)(4)

Shareholder can’t nominate a person for director unless they consent to be on proxy & agree to serve if elected

Short slate exception to the traditional rule

Shareholders may solicit proxies for

A minority slate of their own directors nominees +

A majority of mgmt’s director nominees

But insurgents may only state which mgmt directors they won’t support

3) A specialized town mtg provision (14a-8) that permits shareholders access to corp’s proxy materials (low-cost way to promote certain shareholder resolutions) &

4) A general anti-fraud provision (14a-9) that allows Ct to imply a private shareholder remedy for false or misleading proxy materials

Federal proxy rules created to cover areas where state law doesn’t have any rules or unclear

Applies: Only to large corps or “reporting” corps (DE has lots)

Corp is a reporting corp if

1$0 Million in assets & 500+ shareholders, &

Traded on the national exchange (NYSE)

Shareholder Proposals

§14a: Provides specific grounds to permit corps to exclude shareholder-requested matter from the corp’s proxy solicitation materials

CD: permits shareholders to make proposals on mgmt’s proxy

Applies: BIG companies

Submitting a Shareholder Proposal

Requirements

State shareholders identity	14a-8(b)(1)

# of proposals	14a-8(c)

Length of supporting statement	14a-8(d)

Subject matter of proposal	14a-8(i)

Standing to submit: Shareholders w/ min $2,000 in total market value (voting stock) or 1% of securities	14a-8(b)(1-2)

Format: 500 words or less	(proposal + supporting statement)	14a-8(c)

Timing: 120 days before mgmt releases proxy materials for annual mtg

Exclusions

BOP Mgmt (corp) to demonstrate it’s entitled to exclude a proposal	14a-8(g)

Effect: Your proposal excluded from the corps proxy materials

Improper Subject Matter	14a-8(i)

1) Improper under state law !!!

2) violation of law

3) violation of proxy rules

4) Personal grievance !!!

5) Irrelevant (less than 5% of the business)!

6) Absence of power/authority

7) Mgmt functions (ordinary business) !!!

SEC won’t automatically allow its exclusion if it also relates to a significant social policy issue

Instead, SEC will allow exclusions on a case-by-case basis if the proposal seeks to micromanage the corp or

deals w/ complex issues that shareholders aren’t qualified to make informed judgments

e.g. climate change

8) Relates to current election !!!

Can’t make a board proposal that says you should elect a certain director for this election

Reason: Allows shareholder to propose a procedure for a future director election

But can’t propose on mgmts. Own proxy that certain directors should be elected

9) Conflicts with mgmt’s proposal !!!

10) substantially implemented

11) duplication

12) resubmissions

13) specific amount of dividends

Policy re SEC’s Involvement

Shareholders can have opinions about social issues &

Can shareholders be well informed?

Well-Informed: Consider depth of complication and/or details (case-by-case analysis)

Well-informed → Unlikely to exclude proposal

Not well-informed (material too in-depth) → Likely to exclude proposal (b/c best left to mgmt)

A 14a-8 proposal must focus on

Significant social policy issues &

Not seek to micromanage the business (to comply w/ ordinary business exclusion)	p.163

Duty of Care

Before we were studying specific rules in statutes, but now these are more murky judicially created rules

Intro

Duty of Care

Directors/officers must act w/ the care of an ordinarily prudent person (in the same or similar circs)

Litigated less than the duty of loyalty

b/c law insulates them from negligence liability (vs. knowing misconduct) to avoid inducing risk-averse mgmt of the firm

What is the standard of the Duty of Care? Negligence standard (prohibits d/o malpractice)

What does it prohibit? Malpractice

….but in practice we don’t really deal w/ the duty of care in corps, b/c it protects directors

Is there a reason shareholders might not want Directors to be held liable for negligence? b/c they wouldn’t take risky investments

Duty of Obedience

A fiduciary must act consistently w/ the legal documents that create her authority

i.e. a director must comply with the tasks that he’s given from the charter otherwise face liability

Duty of Loyalty

Requires corp fiduciaries to exercise their authority in a good-faith attempt to advance corp purpose

Bars officers and directors from

Competing w/ corp

Appropriating corp property, info, or business opportunities

Transacting business w/ it on unfair terms.

Director or officer is req’d to perform his or her functions:	ALI’s Principles of Corp Governance

1) in good faith

2) Reasonable belief it’s in corps best interest &

3) w/ care of an ordinarily prudent person would reasonably be expected to exercise in a like position & under similar circs

The duty of care is not just another negligence rule, however

Policy reason why a business loss can’t be analogized to a traffic accident or a slip on a banana peel

Policy

Corp d/o’s invest other people’s $

They bear the full costs of any personal liability, but receive only a small fraction of gains from a risky decision

Mgmt = Risk Averse vs, Investors (shareholders) = Risk Neutral

Shareholders can easily diversify, b/c they can invest in many companies, so they’re impliedly risk averse

i.e. they’re protected by their diverse portfolio b/c their diversified investments help offset the risk

Whereas d/o’s are dealing with one company

Gagliardi v. Trifoods International, Inc., 169

A corp d/o isn’t legally responsible to corp for losses suffered, that result from an Os decision or Ds authorized in good faith

Director Risk Aversion

4 Ways Corp law protects directors from malpractice	bottom of p170

1) Indemnification by Corp	DGCL 145

Definition: Corp will reimburse a manager/director for expenses, fees, etc, if they’re held liable for a wrong

Types

Mandatory indemnification: Corp MUST indemnify a d/o of the corp (b/c § requires it)

Permissive indemnification: Corp MAY indemnify a d/o of the corp

Charter, bylaws or an employment K may entitle a d/o to indemnification

So look to the levels of req’t to see what trumps what	i.e. Statute > Charter > Bylaws

if statute says may, charter says must, and bylaws say may → You must b/c charter says so

Waltuch v. Conticommodity, 172

Permissive Indemnification

DE&TX

Type of expenses the corp can reimburse depends on the type of lawsuit that was filed against the d/o

1) Suits brought on the corps behalf

Judgments, settlements No

Reason expenses Y e.g. atty fees

But DE nuance: Can’t indemnify any expenses for any claim d/o was adjudged liable

2) All other types of lawsuits	(i.e. public, private suits)

Judgments, settlements Allowed

DE:	DGCL 145(a)&(b)

D/O will receive indemnification if…

the person acted in good faith &

reasonably believed expenses were in best interests of the corp

Payments for settlements and judgments Allowed	DGCL 145 (a)

Applies: Action brought by or for corp against a D/O	DGCL 145(b)

Doesn’t apply: Action by the corp	DGCL 145 (a)

DAS

Expenses + atty fees

Mercy judgment and get indemnification (judges discretion)

Criminal law action → Must show you had no reason to know it was unlawful

Procedural Issues: Who decides whether to give out permissive indemnification?

An independent, disinterested person must decide whether the § permits the corp to indemnify a D/O (even if charter says it must indemnify )

Court

Majority of Independent/disinterested D’s

Or majority of a committee of such Ds (D/O committee)

Special Counsel (TX)

What if Waltuch proved he acted in good faith (and in a manner he reasonably believed were in the corps best interests)? AND

He personally paid to settle some of the underlying actions + was found liable & paid judgments in others. Could he be indemnified?

Per 145 (b) What if he was adjudged liable and paid the judgments himself, but he’s not asking for indemnification for the judgment; he only wants reimbursement for Yes,

TX: Very Similar	TBOC 8.101-.104

The only diff in TX is that 1456(b) except or unless clause → You don’t have to go to ct

Mandatory Indemnification

DE	DGCL 145(c)

If agent or officer is [wholly] successful on the merits or otherwise in defending the suit→ “shall be indemnified against expenses (including atty fees) actually and reasonably incurred”

Settlements are considered a “win”

Success = Not having to pay any penalty !!!

Settlement vs. Vindication

Settlement:

Vindication:

TX: Very similar	TBOC 8.101-.104

Difference: “Wholly” was added

Effect: Must be completely successful in the entire suit!

Angry shareholder can’t petition BOD to change the charter (b/c § always trumps charter)

Mandatory = charter amendment contrary to statute = not possible

Permissive = charter amendment contrary to statute = likely possible

Who must decide if the § permits corp to indemnify a d/o (even if charter says it must)?

1) Ct	TBOC 8.103

2) An independent D/O Committee

3) Special Counsel (TX or DE if no Independent Dir. Committee available)

4) Shareholders (TX: All shareholders, or a majority of disinterested shareholders)

5) DGCL 145(d)

Indemnification Review: Success doesn’t require exoneration. It’s getting away intact.

Duty of Care – Limiting Liability for Duty-of-Care Violations

4 ways corp law protects D/Os from malpractice liability

Indemnification

Insurance

BJR (main)

Waiver of DAS

Indemnification & Insurance

DE, TX: Ability to insure D/O is broader than its ability to indemnify D/Os

Corp can pay to insure D/O’s against settlements/judgments brought on behalf of corp

DE: Ability to insure D/O is broader than its ability to indemnify D/Os	DGCL 145(g)

Allows insurance to protect against any liability

What’s the issue with this? Insurance Co’s

What things can a DE corp insure but not indemnify?

Bad faith and fraud (I think)

Derivative suits (brought on behalf of the corp)

Judgments & Settlements

Allows insurance against ANY LIABILITY, but issue is, will an insurance company insure against any liability? Likely not.

TX: Allows self insurance against lawsuits (broader b/c offers add’l feature)	TBOC 8.151

Potential loophole to Indemnification Limits: b/c power to insure is broader than the power to indemnify

But the § allows it

Test: in TX you can do it & it’s not typically available in other states.

The Business Judgment Rule

Overview

The key way D/Os are protected from malpractice liability

Interacts with the duty of care standard

Ct-created doctrine w/ many formulations

Suits not robes

Threshold Requirement: Only protects conduct made based on a business judgment or decision !!!

BJR Presumption

When D/Os make a business judgment, the BJR demands that Cts presume:

1) Directors were disinterested

2) Duly informed	π only must prove 1 was violated !!!

3) Acted in good faith

4) Rationally believed it was in the best interest of the company

5) No Gross Negligence added by Van Grokom, removed by §

Standard for which D/Os are held: Usually held to the BJR (not duty of care standard)

Protects: D/Os who make a good faith, disinterested decision

BOP: To overcome the BJR the π must prove they were not 1-4 above

Can’t use negligence to overcome the BJR

Depending on what π’s prove, D/Os may have to show the transaction is fair (Chapter 9)

Policy

Who’s best to make business decisions? Directors

BJR prohibits Ct from 2nd-guessing good-faith decisions made by independent and disinterested directors

BJR means Ct won’t decide (or allow a jury to decide) whether the boards decisions are either substantively reasonable by the “reasonable prudent person” test or sufficiently well informed (same test)

If π loses in an attempt to overcome the BJR → they’re barred from bringing a negligence claim

If π wins D/Os aren’t necessarily liable → They have a chance to defend their actions/decisions

Kamin v. American Express Co.	p179

Rule: Ct will back the board a.l.a. the board is honest & minimally careful

Mere errors of judgment are not sufficient, as grounds for equity interferences, for the powers of those entrusted w/ corp mgmt are largely discretionary

Watch for where a D/O “have acted or are about to act in bad faith and for a dishonest purpose”

Policy: Directors are in the best position to make these decisions so Ct won’t interfere

Reasons for the Special BJR

1) Procedural: Converts question of fact into a question of law for Ct to decide

2) Substantive: Converts question of “was the standard of care breached?” into:

Whether the directors were truly disinterested and independent &

Whether their actions weren’t so extreme, unconsidered, or inexplicable as not to be an exercise of good-faith judgment

Disinterested: Won’t receive a personal financial benefit from a transaction that isn’t equally shared by the stockholders

Independent: Can decide w/out being beholden to another – lack of influence from another.

DE Cts: Mere social relationships are not enough to create independence

Independence req’s some sort of dominance

If friends play golf together Insufficient

If friends play golf together & then threaten you with tire irons if you don’t comply Independence

However, if π’s overcome the BOP BOP shifts to the D/Os to defend themselves before they incur liability

e.g. if the Ps’s est the DO’s were interested, then….???

Possible loophole in the BJR: Π’s could allege that the ∆ directors…

How can directors avoid liability despite performing inadequate research, if the board makes a negligent decision b/c:

1) Outside expert they hired made an error (unknown to the board)

2) Faced a deadline and acted too fast

3) More research was too costly

Duty of Care changes a Cts focus

Under BJR, rather than look at the quality of the board’s decision (i.e., was it negligent) to – the integrity of the decision making process (i.e., was the decision made in good faith by uninterested, independent, and duly informed directors?)

Van Gorkom, 187

1st time in DE that directors who made good faith decisions weren’t protected under BJR

π’s only argument was that directors failed to adequately informed themselves

Holding: Directors were grossly negligent & couldn’t claim BJR protections

Gross negligence was new to corp law b/c it wasn’t a part of the BJR elements

Gross negligence (DE) means “very negligent” (not bad faith)

Est. way to overcome the BJR = Gross Negligence.

New element still requires judges to look at the directors decisions & the quality of the decision

SO…..Enacted DGCL 102(b)(7) which changed this. It protects directors from Van Gorkom

Van Gorkom & Waiver of DAS

TX, DE: Waiver of DAS	DGCL §102(b)(7); TBOC 7.001

Charter amendments are valid if they provide directors aren’t liable for losses caused by transactions / when they had no conflicting financial interest / or otherwise was alleged to violate a duty of loyalty

i.e. “allows a corp to amend its charter to waive DAS in lawsuits brought on behalf of corps” !!!

Thus, waiver of DAS allowed for some types of wrongdoing

Permissive. Implement by adding in charter

Gets rid of Van Grokom

No business decision -> SOC=Negligence ; Business Decision=Gross Negl (but § 102(b)(7) rejects)

Purpose: Stop frivolous lawsuits

Permits waiver of DAS claims for breach of the duty of care…In particular for claims D/Os were grossly negligent

BJR protects us from regular negligence. Therefore, waiving duty of care DAS → waives DAS for gross negligence

A claim for DAS alleging gross negligence is the only type of claim
that would overcome the BJR but would be waived under the §…

Can’t waive DAS for	…b/c these exclusions in the § essentially attacks gross negligence

1) Breach of Duty of Loyalty

2) Bad faith

3) Intent to do harm

4) Improper benefits

5) Knowingly violating the law

Procedure upon Motion to Dismiss

If π files only a duty of care claim for DAS & corp has a 102(b)(7) charter provision → Claim dismissed

But if π also alleges (on particularized facts) a claim that’s not waived → Suit continues

EX: π alleges a non-frivolous Duty of Loyalty claim along w/ Duty of Care claim → Claim dismissed

Duty of Care – Board’s Passivity & Board’s Duty to Monitor

Board’s Passivity & Board’s Duty to Monitor

Boards passive decision to not set up a monitoring system > Same rules still apply. Must overcome BJR	i.e. do nothing

Can still get § 102(b)(7) protection for failure to make a business decision

Remember, the § must be enacted in the charter

Minimum Objective SOC for Directors (Majority)	Francis v. United Jersey Bank, 194

Negligence. Directors can’t abandon their office but must make a good-faith attempt to do a proper job

Minimum Standards for Directors Include:	…otherwise unqualified to be a director

Rudimentary understanding of the business of the corp

Familiar w/ fundamentals of the business

Attend board mtgs

Familiarity w/ corp’s financial status (occasionally review)

Not req’d to inspect day-to-day activities in detail, but oversight & occasional review is req’d

Keep informed about corp’s activities

Other stuff about the case

BJR not applied b/c there wasn’t a business decision. Thus, negligence, gross negligence, irrelevant here

Not req’d to describe conduct

If BJR NOT applied > SOC falls back to negligence

Her actions worse than Van Gorkom

Failure to act → Corruption continues

Getting outside counsel involved → Also a deterrence to corrupt behavior w/in corp

Blowing the whistle → Would have been better than willful ignorance

Graham v. Allis-Chalmers Manufacturing Co., 198

Facts: Directors had no actual knowledge of the anti-trust activity. π contends directors should have put a monitoring system in place to catch wrongdoing

Standard: BJR doesn’t apply

Holding: Absent an actual suspicion, there wasn’t a duty to set up such a monitoring system. Only must watch for red flags

The “Red Flag” doctrine

Absent cause for suspicion, you should be able to trust your employees (something must occur to create suspicion)

“it appears directors are entitled to rely on the honesty and integrity of their subordinates until something occurs to put them on suspicion that something is wrong.”

What is a red flag?

Recklessly reposed confidence in an obviously untrustworthy employee &

Refused or neglected cavalierly to perform duty as a director or
Willfully or inattentively ignored obvious danger signs of EE wrongdoing	…then director is liable

SOC

BJR not applied > SOC defaults to negligence

Negligent failure to follow up on a red flag → should be liable b/c no BJR protection

Note: BJR doesn’t apply > SOC is negligence

Business decision to not follow up on a protected procedure BJR applies

If there is a business decision & DGCL 102(b)(7) in charter SOC increases even higher to keep gross negligence from getting at the directors

If there isn’t a business decision & DGCL 102(b)(7) in charter Including the waiver of DAS § in the charter raises the SOC > Can’t be found guilty of negligence or gross negligence

However, still liable for

1) Breach of Duty of Loyalty

2) Bad Faith

3) Intent to do harm

4) Improper Benefits, Knowingly violating the law

§ 102(b)(7) applies to more than business decisions. It applies even when there’s no decision. It also eliminates DAS (even though not expressly written in it)

In Re Caremark International Inc. Derivative Litigation, 203

Facts: Involves illegal kickbacks where directors unaware of the wrongdoing

π’s alleged wrongdoing b/c directors failed to implement a monitoring system

Holding: Directors should have (req’d to have) a monitoring system in place (vs. Graham)

Doesn’t overrule Graham

It’s diff b/c of changed circs

Monitoring system allows for an improved efficiency w/in a corp &

Sentencing guidelines offer support for improved monitoring

“the potential impact of the federal org’l sentencing guidelines on any business org. Any rational person attempting in good faith to meet an org’ governance responsibility would be bound to take into account this development + the enhanced penalties + the opportunities for reduced sanctions that it offers.

Rule: Corps must now have a monitoring system to ensure the board gets info in a timely manner (must be reasonable) to help directors fulfill their responsibility. Especially applies to large corps

Issues	Graham	Caremark

Alleged wrongdoing by corp EEs	Antitrust violations	Kickbacks

D’s know/should have known about wrongdoing	No	No

Πa allege Ds breached their fiduciary duties	failed to implement monitoring system	“ “

Holding	No monitoring system req’d	Monitoring system req’d

Problem:	Answer
X corp. BOD has a mtg to decide what sort of monitoring system to create. They implement a careful monitoring system, including a fraud hotline, intending in good faith to satisfy Caremark. But, board decides an 800 # is too costly, so they implement a toll hotline. Shareholder sues alleging the system is inadequate	SOC = BJR b/c Caremark only req’d you to put in a monitoring system, & Cts won’t question BOD’s decisions re: actual efficiency of the monitoring system

Stone v. Ritter

It’s bad faith to not have any monitoring system

If you act in bad faith You violated the duty of care (& therefore the duty of loyalty)

Caremark is a bad faith case

Disney Synthesized

Mere director negligence doesn’t give rise to liability

Lacks the degree of attn a reasonable person in the same or similar circs would be expected to give a decision

Holding: BJR forecloses liability & generally permits a Motion to Dismiss

1) Rule: Est. gross negligence may (like Smith v. Van Gorkom) be the basis for a breach of duty finding & create liability for any resulting losses

2) However, such liability for gross negligence alone can be waived	§102(b)(7)

& has been waived in most public corps) thru a shareholder-approved charter amendment

3) but the waivers may not waive liability that rests in part upon breach of the duty of loyalty &, under the §’y language, that inability to waive DAS extends to acts (or omissions) not done in “good faith.”

Director’s intent is so profound that Ct concluded they lacked good faith

Neither BJR nor the waiver authorized §102(b)(7) waiver protects ∆ from liability

Knowing Violations of the Law

Cts don’t apply BJR to knowing violations of the law (even if violation benefitted corp)	Miller v. AT&T

i.e. Bd decides it benefits the corp financially to violate law > No BJR protection

Leahy: thinks it’s more an issue of duty of loyalty

VI. Governing CONFLICTS (Chap. 9)

Intro: Duty of Loyalty

Who owes it

Directors

Officers

Controlling shareholders

Doesn’t Owe it: Ordinary & minority shareholders

Persons Who Owe the Duty of Loyalty

Fiduciaries	i.e. D/Os, controlling shareholders !!!

Ordinary shareholders are not fiduciaries (in large corps)

If you’e a controlling shareholder, you have a fiduciary if you have power to elect the board (fact question)

Especially if you’re a 50%+ shareholder

Duty of Loyalty is owed to the corp, but corp is a mix of people such as stockholders, creditors, EEs, suppliers, & customers

Duty of Loyalty is more exacting than the Duty of Care

It’s about putting the corps interests ahead of your own

2 Critical Situations

1) Conflicted Transactions

2) Fundamental Transactions

1) Schnell

2) Self-Dealing

3) Corp Opportunity

Normal Governance (Fiduciary Duties)

Duty of Loyalty requires a corp D/O, or controlling shareholder to exercise her institutional power over corp processes or property (including info) in a good-faith effort to advance the interests of the company

Thus, corp D/Os, & controlling shareholders may not deal with the corp in any way that benefits themselves at its expense

Schnell v. Chris-Craft Industries, Inc., 227

Facts: D’s moved up the annual board mtg date to get past an attempt by disgruntled shareholder to vote them out by proxy

Rule: Mgmt can’t act w/ an inequitable purpose.	i.e. it can’t intend to harm the corp or its shareholders

Holding:

Inequitable action doesn’t become permissible simply b/c it’s legally possible

A fiduciary can’ intentionally harm the corp, its shareholders – this blatantly violates the duty of loyalty.

Remember, fiduciary duties can (and are) be separate from statutory duties

Remember, the Unfireable CEO problem – the director using the defense to take over mechanisms should have been sued for breaching the duty of loyalty

He would’t have been able to do those things without facing liability for purposefully harming shareholders.

Dodge v. Ford, 221	Pretty much overruled by Smith

Facts: Dodge bros own a big part of Ford. Dodges want to start building cars w/ their Ford shareholder dividends. Henry Ford devised a plan to use it to benefit the public, thereby preventing the Dodge bros from getting it. Ct holds for Dodges b/c shareholder wealth maximization underlies the duty of loyalty

Rule: The duty of loyalty requires you to benefit the shareholders before you try to benefit others

Today, CEO would say we’re lowering prices to crush the competition & therefore improve shareholder wealth over time.

CEO must favor shareholders, not the public

Duty of loyalty = maximizing wealth for shareholders

Protected by BJR

Subsequent History: Constituency Statutes

TX/DE: Don’t have

Background: Hostile takeover wave of the 1980’s--Some states rejected Dodge by enacting “other constituency statutes”

Effect

Permits mgmt/BOD to make decisions (e.g. refuse merger) based on what’s best for the stakeholders, not only shareholders (e.g. workers, community, etc.)

Gives board lots of flexibility (+), but allows it to hose down shareholders (-)

AP Smith Manufacturing v. Barlow, 223

Modern approach to Dodge

Broader to escape duty of loyalty

Facts: Corp. donated to Princeton but some shareholders argued it took money from the shareholders’ pockets.

Rule: Mgmt’s decision to donate $ is protected by the BJR ala it’s in the corps best interest	e.g. indirect long-term benefit

Requirement: Must be in good faith & disinterested Protected by BJR

Standard: BJR

NJ: Corp can donate $ to a charity (aside from duty of loyalty)

Holding:

vs Dodge: Broadly construed, if you can argue the $ given away will come back to you & benefit the corp, then it will be permissible

vs NJ Statute: Via the reserved power doctrine, the legislature can alter, suspend, & repeal corp charters if they want

DE,TX (Modern): Cts apply a standard where they look at the long term interest in the corp & benefit to the shareholders	DGCL___; TBOC 21.401(b)

Reserve Powers Doctrine

States reserve the right to edit/update charters w/ subsequently passed §’s

i.e. Old charters can’t be grandfathered to trump §

Self-Dealing Transactions

D/O is on both sides of the transaction or where the fiduciary has a material financial interest.

Engaged for the corp, on behalf the corp, with yourself, or your family, etc. on the other side.

Long ago, these transactions were void per se

It was prohibited b/c it left too much chance to harm shareholders and possibly the corp as a whole.

TX: Self-Dealing	TBOC 21.418 see defs. § for 1)affiliates, & 2) associates

A transaction between a corp and:

1) 1+ of its D/Os, or 1+ affiliates or associates of 1+ of its D/Os or

2) an entity or other org in which 1+ of its D/Os, or their affiliates or associates of 1+ D/Os of the corp:

A) is a managerial official; or

B) has a financial interest

Every State: Self-dealing transactions shifted from void per se to voidable

For self dealing transactions to be upheld (not voidable), the transaction had to be:

1) Objectively fair to corp &

2) Approved by a board compromised of a majority of disinterested Ds

Safe Harbor Rules

Why would a rational shareholder (not engaged in self-dealing) want to allow mgmt to engage in some self-dealing?

There might be a benefit for the corp that might only come through one of the D/Os

Self-Dealing

Intro

Self-Dealing

Definition: A transaction in which a fiduciary has a material financial interest (not shared by SH generally) i.e. any transaction b/w:

1) Corp &

2) Fiduciary or a proxy for the fiduciary (on the other side) or close relative of the fiduciary or entity controlled by F

TX (Narrower): Spouse or blood relative who lives w/ fiduciary or

Applies: D/O is on both sides of the transaction or fiduciary has a material financial interest.

Engaged for the corp, on behalf the corp, with yourself, or your family, etc. on the other side.

TX: Self-Dealing	TBOC 21.418 see defs. § for 1)affiliates, & 2) associates

A transaction between a corp &

1) 1+ of its D/Os, or 1+ affiliates or associates of 1+ of its D/Os or

2) an entity or other org in which 1+ of its D/Os, or their affiliates or associates of 1+ D/Os of the corp:

A) is a managerial official; or

B) has a financial interest

Every State: Self-dealing transactions shifted from void per se to voidable

For self dealing transactions to be upheld (not voidable), the transaction had to be:

1) Objectively fair to corp &

2) Approved by a board compromised of a majority of disinterested Ds

Safe Harbor Rules

Why would a rational shareholder (not engaged in self-dealing) want to allow mgmt to engage in some self-dealing?

There might be a benefit for the corp that might only come through one of the D/Os

2 Key Issues !!!

1) Was the transaction disclosed?

2) What’s the effect of disinterested approval of a (disclosed) self-dealing?

Material financial interest that isn’t shared w/ other shareholders

Self-Dealing: when a fiduciary [D/O/Controlling shareholder] facilitates a K or transaction that materially helps his personal interests or another company he owns

Materially: no one will argue that a fiduciary of one corp. who owns one share in another big company will have a material effect on a transaction that looks like it involves self-dealing Must raise a material financial interest

Any transaction b/w: Corp & Fiduciary or a proxy for fiduciary (other side) ..implicates the financial interests of the fiduciary

Applies: Close relative of fiduciary, Entity controlled by fiduciary (another corp of theirs) Proxies

History: These transactions were void per se (b/c believed high possibility it would harm shareholders & corp)

Early CL: Self-dealing void per se. Strictly prohibited b/c shareholders worried a D/O would take advantage/steal

Either a fiduciary gets a reduced price or a bigger price on something he sells to corp.

Later CL: Voidable

To uphold a transaction (i.e. not voidable), Cts req’d the transaction be…

Objectively fair to corp &

Approved by a board comprised of a majority of disinterested Ds after disclosure of all material facts

If only one was satisfied, it was merely voidable

Modern: Self-dealing isn’t void per se anywhere !!!

A rational shareholder might allow mgmt to engage in some self-dealing if mgmt can get corp. a better deal/price + they know the needs of the corp better (will spend less time researching)

Temptation of self-dealing is getting a better price. Thus, it depends whether you trust the insiders to not steal

More recently, all states enacted safe harbor §’s

Definition of Self-Dealing

TX

Transaction b/w a corp &

1+ of its D/Os or 1+ of affiliates or associates of its D/Os OR
Entity or other org where [same] is a managerial official or has a financial interest

Hypo	Answer
John controls a general construction contractor business, House Inc. John’s friend, Nancy, is a minority shareholder. John’s brother, Mitch, owns a roofing business called The Upper House. John hires Mitch to do the roofing on a project. The market rate for the roofing project is $20k. Mitch charges the corp. $40k and John approves the charge. Mitch does an average job that is worth the market rate.	This is stealing. The nature of the transaction is the issue

Disclosure Requirement

Hayes Oyster v. Keypoint, 231

Facts: πs alleged ∆ CEO breached his fiduciary duty by self-dealing w/ another oyster corp when π discovered the secret transaction after it occurred.

Holding: Price was fair but transaction was unfair b/c non-disclosure is per se unfair.

Rule: Non-disclosure is unfair and thus, void per se

Even if board approves the transaction, it also must approve self-dealing

Fiduciary can’t argue an undisclosed transaction was objectively fair (in most jrds., including TX)

MUST disclose all material info BEFORE the transaction (not during litigation)

Any Material Info Must be Disclosed

2 Questions for disclosed self dealing:

1) Is the transaction permissible if disinterested Ds (or shareholder) approve/ratify the transaction?

2) Does disinterested director/shareholder approval automatically sanitize the deal, or is Ct review still req’d?

Safe Harbors & Disinterested Director Approval

No K or transaction b/w a corp & 1+ of its D/Os or b/w corp and any other corp IS void or voidable if…

Material facts as to the D/Os relationship or interest and as to the contract or transaction are disclosed or are known to the board, OR [same] shareholders, OR

K or transaction is fair to the corp when authorized by the BOD as a committee or shareholder

Must HAVE DISCLOSURE!!

Cookies Food disclosed self-dealing transaction approved by the board (majority)

Ct applied “Safe Harbor” § & said § satisfied b/c the transaction approved to contain self-dealing was approved by the directors (“or” means or!) and only need one of those for self-dealing to be approved. Ct read § as codifying the CL.

Iowa Ct said that at least one of the first two approvals must be satisfied AND there has to have objective fairness at the time it is authorized most states agree

Policy

If safe harbor § is read to require both disinterested approval AND entire fairness Cts judgment re: fair price may override judgment of the disinterested directors

But as policy, we might prefer the TX approach where either disinterested approval or fairness is sufficient

b/c gives deference to the disinterested directors	i.e. suits not robes should prevail

Safe Harbor Statutes

Even though the statutes all say “or,” they are each read differently. In most states, even if a self-dealing transaction is approved, the Cts will still look at whether it is fair. But consider, that if the Ct balances fairness every time, it isn’t much of a safe harbor

DE	DGCL §144

A director’s self-dealing transaction is not voidable solely b/c it is interested, a.l.a it’s

a) Disclosed & approved by a majority of disinterested directors or

b) “[same]” shareholders or

c) Fair

More of a hybrid jsd

TX: Any 1 of the 3+ means the self-dealing transaction is valid (not voidable)	TBOC 21.418

1) Disclosed & approved by a majority of disinterested directors or

2) Disinterested shareholder approval or

3) Fair	*obviously, must be disclosed in the first place.

Recognized the “or” from the DGCL and only requires 1 of the 3

Diff than DE or anywhere else ??? b/c it has the second “or” and really utilizes it

More of a safe harbor

Cookies Food v. Lakes Warehouse: Most states now require one of the two:	MAJORITY

BOTH APPROVAL (by a majority of disinterested Ds/SHs) &

FAIRNESS	but fairness can be enough

Entire Fairness

2 Factors: Is a Deal entirely Fair?	Weinberger v. UOP, Inc., 247

1) Fair Price (for an arms-length deal)

Did corp pay or receive FMV in the transaction?

Economic & financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, & other elements that affect the intrinsic or inherent stock value

2) Fair Dealing

Was the deal done in the right way?	i.e., Full disclosure; without coercion or undue pressure

Consider: When transaction was timed, how it was initiated, structured, negotiated, disclosed to Ds, and how the approvals of the Ds and the stockholders was obtained.

Examine as a whole

BOP: Fiduciary engaging in the self-dealing (the director)

Disinterested: Approver has no direct or indirect (e.g., no subsidiary) material financial interest in the challenged transaction

Who must be disinterested?

DE, TX

Director approval prong of the safe harbors require approval of a majority of disinterested directors

Shareholder approval prong is silent on the issue of disinterest

DE: Many Cts think it requires disinterested shareholder approval	Read it into the §

Director/Shareholder Independence

Independence: Approver isn’t dominated by or beholden to the interested fiduciary	e.g., Not an EE of interested person

Issue: Whether persons approving the transaction must be independent as well as disinterested

TX,DE: Safe harbors don’t mention independence

DE: Many Cts think it requires approving directors or shareholders be both disinterested and independent (treat as rule)

Friendship

DE

Friends independent unless π shows otherwise

A director isn’t beholden just b/c he has a social relationship w/ a self-dealer

BOP: Must show more than friendship. Must show the director is beholden to them

i.e., CEO engages in self-dealing & other directors are her long-time friends, but none work for the company

Approaches to Safe Harbor Statutes

DE: Sliding-Scale Approach	See Leahy’s Chart on DE Sliding Scale

If a non-controlling director self-deals & disinterested directors approve BJR applies (defers to disinterested Dir’s)

But, if a controlling director self-deals & disinterested directors approve Fairness Standard Applies

More control = More scrutiny

TX: Similar. Ct defers to the Directors and does not assess whether the transaction was fair

BUT When a non-controlling D/O self deals and disinterested shareholders approve Ct will defer EVEN MORE

It will apply the WASTE STANDARD

Waste

Sort of like BJR

Effect of transaction is so disproportionately small that no one would bother w/ it (unless just wasting $)

High BOP for π

i.e. consideration received is so small no reasonable person would agree to it	i.e. was transaction burning $?

Safe Harbors & Shareholder Ratification

Duty of Loyalty (Self-Dealing) – Special Situations

Controlling Shareholders

Controlling Shareholder

Duty: Controlling shareholders owe a fiduciary duty to corp & minority shareholders

Applies: Only when acting as controllers

e.g., Voting on a proposal CSH not req’d put the interest of the minority ahead of theirs

Not all transactions b/w a controlling shareholder & a corp are self dealing

Discussed Donahue Equal Opportunity Rule (below)

TX* , DE	*probably

Whether a fiduciary duty is owed depends on whether there is a relationship of trust & confidence

Neither follows Donahue

But if a repurchase is self-dealing, it must nonetheless be entirely fair	i.e. have a legit business purpose

Threshold Test for Self-Dealing (only used in the context of dividends)	Sinclair, 257

A dividend paid to a controlling shareholder is self dealing only if controller receives a benefit to the exclusion of the minority

Thus, pro rata dividends≠ self-dealing

Minority Shareholder Oppression in a Close Corps

The Duty of Loyalty is applied more aggressively in close corps to protect minority shareholders.

Purpose: Minority shareholders need more protection in a close corp (vs. a large corp) b/c they have limited opportunities to sell their share (smaller market)

How a Shareholder can Control their Situation

1) Vote	but minority shareholders can’t vote

2) Sell	but can’t sell if market is small or nonexistent

2) Sue	*the only real protection

How Majority Shareholders can take Advantage of Minority Shareholders in a Close Corp

Sell your shares back to the corp (repurchase)

Can try to pay yourself dividends w/o paying minority	[Doesn’t work]

Must Show: Entire fairness

Rule: Dividend must be paid pro-rata. Can’t pay yourself a big dividend & not pay the minority shareholder	Sinclair

Executive Compensation

Rule: Loans are ok if expected to benefit the corp

Take out a corp loan below market rate

Engage in transaction w/ corp for goods/services & overcharge

Goods/Services Transaction Must show the transaction was done at a market price & is consistent w/ what an average K/service provider

Repurchase

Requires entire fairness (corp must offer to purchase shares from all shareholders at the same price) (equal opportunity)

Majority: Equal Opportunity: If a close Corp repurchases shares from any shareholder, all shareholders have an equal opp. to resell pro rata at the same price

Minority Exception: MA Only

Corp can repurchase shares non-pro rata for a legitimate bus purpose unless minority shows there was a less harmful way.

Donahue

All shareholders (whether or not controlling) owe eachother a duty of utmost loyalty. Requires good-faith & loyalty

An agreement to reacquire stock is enforceable, but purchase must be made in good faith & w/out prejudice to creditors & stockholders

If stockholder whose shares were purchased was a member of the controlling group controlling stockholders must cause the corp to offer each stockholder an equal opportunity to sell a ratable # of his shares to the corp for same price

Only for close corps (b/c you can use the market to sell your shares)

TX, DE Rule In Sum: Self-dealing (not really equal opportunity) transactions must be fair

Issue: Difficult to prove a close corps stock s market value (b/c no market)

Must go through the books to prove right or wrong, the value of the shares

DE: Not the same rule

Uses a balancing test that recognizes the controlling shareholder’s right of “selfish ownership”

If controlling shareholder can demonstrate a “legitimate business purpose” for its actions – then there is no breach of fiduciary duty.

TX: Co-shareholders in a close corp don’t owe fiduciary duty to co-shareholders. Consider circs to determine if duty exists

Salary & Benefits

Normal EEs BJR

Top officers Sometimes BJR, despite being self-dealing; Sometimes Cts apply safe harbor rule

Less scrutinized b/c paying them is necessary, so a little bit of a benefit, like paying themselves an unfair dividend is less likely to be scrutinized by the Cts

Even if you get outside directors to approve the salary, they will be approved under either standard.

DE: If disinterested directors approve an executives salary, DE Cts generally will usually allow it unless it constitutes waste

Can you pay yourself a large salary?

Yes, even if the approving board members are friends, you must prove they are beholden to you before the Ct questions it (b/c BJR)

Safe Harbor: You’re safe if you have disinterested approval

Ct only looks for waste (high BOP)

Shareholder Oppression

DE: Doesn’t bother with it

TX: When the shareholders reasonable business objective for joining the corp is substantially defeated or other wrongful or deceitful conduct

May be scrutinized under this standard if you paid yourself an egregious salary. So, pay yourself a slightly excessive salary

Loans to D/Os

DE,TX: You can loan money to D/Os if it reasonably benefits corp	DGLC 143; TBOC 2.101(13)

Must have board approval	so pack the board w/ your golf buddies

This is a possibly viable way and will likely be BJR

Note: Only for close corps. Fed law prohibits loaning money to D/Os in publicly held corps

Corporate Opportunity Doctrine

In addition to unfair (or unapproved) self-dealing,
one can breach the duty of loyalty by stealing a corporate opportunity

Corporate Opportunity: 3P transaction which results in an opportunity being stolen from the corp

Corp Opportunity vs. Self Dealing Differ b/c: Parties involved in the challenged transaction are diff

Self Dealing = Fiduciary + Corp

Corp Opportunity = Fiduciary + 3P

2-Step Approach

1) Rule of Recognition: Was the transaction at issue “a corp opportunity?”

i.e., did it deal belong to the corp?

Not every transaction that involves a 3P is a CO

2) Defenses: If a corp opportunity was taken, does the fiduciary have a defense?

i.e., is there a legitimate excuse for the fiduciary taking this corporate opportunity?

BOP of Defense: ∆

BOP: Starts out on π who is the person trying to show that the opportunity belonged to the corp

3 Tests: Whether the transaction was a corporate opportunity

There are really just 2 tests, and a Ct that applies either test (particularly the DE LOB test) may ask 2 fairness questions/factors:

1) TX: Expectancy or Interest Test	[Narrower]

Must grow out of an existing legal interest, and the appropriation of the opportunity will in some degree “balk the corp in effecting the purpose of its creation.”

The business opportunity arises where a corp has a legitimate interest or expectancy in and the financial resources to take advantage of a particular business opportunity, 279

2) DE: Line of Business Test	[Broader]

Classifies any opportunity falling w/in a company’s line of business as a corp opportunity

i.e. anything a corp could be reasonable expected to do = corp opportunity

Factors

1) How this matter came to the D/O/EE’s attention?

2) How far removed from the “core economic activities” of the corp. opportunity lies?

3) Whether corp info is used in recognizing or exploiting the opportunity

2 Fairness Questions

1) Where did the opportunity “knock?”	i.e. at work, while fiduciary was working?

2) Was corp info used to take advantage of the opportunity?	i.e. at work, did they use company property

to come up with the opportunity?

3) Fairness Test

Factors

How manager learned of the disputed opportunity

Whether he or she used corporate assets in exploiting the opportunity

Other facts specifically indicating of good faith and loyalty

Leahy: Beefed up version of the Line of Business Test

How do the line of business and expectancy test differ?

An expectancy or interest: Something corp already had a contractual right to	i.e. corp owns option to buy land

Modern

Landon, 278, “the opportunity to extinguish a corp’s indebtedness to a creditor clearly constitutes a business opportunity in which the corp had a legitimate interest or expectancy.

The interest or expectancy in Landon was A NOTE

Broader than a k’ual right more like something they had in its horizon

Line of Business

Looks at the corp’s type of business, generally

E.g., in Guth, Loft Inc. sold soft drinks. It was unsatisfied with its main product (Coke)

CEO Guth personally bought a then little known company (Pepsi’s predecessor). He made a killing.

Loft Inc. alleged that the opportunity to buy & produce Pepsi belonged to it. – Ct agreed

Defenses to Stealing a Corp Opportunity

1) Corp is financially unable to take the opportunity, or

Commentators think it makes little sense for NPV positive opportunity b/c NPV takes into account the $ you’ll bring in from a project & your borrowing costs

2) Corps abandonment of the opportunity	i.e., declines the opportunity

Most Cts accept a board’s good faith decision not to pursue an opportunity as a complete defense to a suit challenging a fiduciary’s acceptance of a corporate opportunity on her own account

Presentation to the board is not a necessary prerequisite to a finding that a corp opportunity had been usurped.

i.e. no req’t that you have to take the opportunity to the board

Presenting to the board simply provides a kind of “safe harbor” for the director, which removes the spector of a post hoc judicial determination that the D/O has improperly usurped a corporate opportunity”

i.e. fiduciary fails to disclose it They’re not prohibited from taking it

DE: Explicitly authorizes waiver in corps charter opportunity constraints D/Os, or shareholders DGCL § 122(17)

Leahy: More likely to look at that the opportunity was NPV+ and “go borrow the $”

TX: Technically available

VII. Suit on Behalf of the Corp (Chap 10)

Derivative Suits

2 Types of Shareholder Suits:
Direct v. Derivative Claims

…because we can assume the board is not going to sue itself…

Direct Actions

Usually class actions

Gathering together of many individuals or direct claims that share important common aspects.

Claim is to recover DAS suffered by individuals directly (or to prevent injury to them b/c they’re a shareholder)

Like Van Gorkam

Derivative Actions

Brought on behalf of the corp by the shareholder only (b/c they’re an owner of the corp)

Shareholders bring this suit against the board – this is why the board doesn’t get involved (they’d be the ∆s)

Applies: Duty of Care is typically a classic derivative lawsuit

How they Differ: Who’s rights are being enforced?

Tooley Test

1) Who suffered the harm?

2) Who would receive the recovery/remedy?

Derivative suits come from things that affect the corps well being, w/ shareholders indirectly harmed

Direct suits are for things that affect shareholders voting rights (or a control transaction (-)), etc (that directly affect shareholder’s well-being)

How Derivative Suits Work: Atty Fees + Settlement & Indemnification

Atty fees drive the derivative litigation system (not πs)

πs attys are like bounty hunters – go after the claim to get the fees.

The rule that tells cts whether to award fees in a derivative suite is critical part of the system of enforcing FD’s.

A bad rule will lead to many meritless strike suits, while a good rule might prevent such suits

TX: Attorney’s fee rule are “procedural”	TBOC 21.562(a)

Historical/Traditional Rule: Common Fund Doctrine

There had to be a pot’o $

Fees were only granted if the litigation led to a common recovery fund

Modern Majority Rule: Substantial Benefit Rule

Ct can award atty fees (even if there’s no pot o money)

Fees may be awarded if suit resulted in a substantial benefit to corp, even if there’s no common recovery fund (pot o’ $)

TX adopted by §

Intro Hypo	Answer
If you own 100 shares of Exxon and you believe the CEO’s disloyalty cost the company $, do you hire an atty?	No, it’s the collective action problem

Standing Doctrines

3 Traditional Rules

1) Contemporaneous Ownership Rule: You’re the beneficial contemporaneous owner

π can’t buy a lawsuit by buying stock

On 9-1-11 TBOC was amended to say that if the shareholders stock is exchanged for cash or shares of another corp, she still has standing to sue if she had….

2) “Fairly represent” interests of corp

3) Make “demand” on board	MAIN

A letter to board, specifying the alleged wrongdoing in detail & asking that the board sue the wrongdoer (or else π will)

General: Cts screen lawsuits by requiring demand (b/c πs lawyers have an incentive to ..)

Demand Req’t

DE: Π’s can either:

1) Make demand, or

π treated as having conceded that the current board was sufficiently independent & disinterested to pass on the demand.

So the only thing left to challenge is whether BJR otherwise protects the board’s decision (not gross neg or bad faith).

2) Not make demand

Attempt to show demand is excused as futile.

Aronson, if the current board made the decision that is being challenged:

π must raise a reasonable doubt &

Plead particularized facts showing that either:

1) the board is dominated/interested and can’t objectively evaluate demand* or

2) underlying decision isn’t otherwise protected by BJR*	i.e., bad faith/gross negligence

* either one of these is enough to show that demand is futile

But DE is really a rule of “universal non-demand” Basically the rule encourages π’s lawyers not to make demand. And they don’t. Makig Demand is uncommon in DE

Rales

A director is not independent if beholden or So under influence – discretion is sterilized.

A director is not disinterested if personal financial benefit from transaction.

TX:	TBOC 21.553

A demand is req’d & Can’t sue until 91 days after you made demand.

Reparable harm > must still make demand

But you don’t always have to wait 91 days you could make demand and then get an injunction

We make demand all the time

A Ct must disimiss a derivative suit if:

1) a maj of disinterested// independent directors or

2) an independent/disinterestes committee (….etc…) HE’LL POST IT

Special Litigation Committees

Definition:

IX. Fundamental Changes (Chap 12)

Intro

Fundamental Transactions (Changes) to the Corp

Usually require shareholder approval

May permit dissenters to opt out

Key Fundamental Changes

1) Charter Amendment

2) Dissolution

3) Merger/Sale of “Substantially all Assets”

Key Issues – Most fundamental changes require:

Board Proposal &

Approval by at least some shareholders

Some Fundamental Changes also Allow

A dissenters right to opt out of the change:

Ct determines the “fair value” of the dissenting shareholder’s share &

Corp pays fair value to the dissenter in exchange for his shares

Voting for Fundamental Changes: Voting

If a fundamental change requires voting, the % of votes necessary to approve differs:

DE: An “Absolute” majority of voting shares must approve the change

i.e., a majority of all outstanding voting shares

TX: An absolute 2/3 super-majority must approve the change	TBOC 21.364(a) or 21.457(a)

i.e., 2/3 of all outstanding voting shares

Class Voting

If fundamental change requires voting:

Normal class voting rules apply – therefore, shares don’t vote as a class unless a class vote is required by:

Applicable § or	DGCL 242(b)(2); TBOC 21.364(d) &

Corp’s charter	TBOC 21.458

Charter Amendments

All holders of voting shares vote	DGCL 242(b)(1); TBOC 21.364(a)(1), (b)

Are dissenters’ rights available? No – compare	compare DGCL 262(b); TBOC 21.460

DE: Unless the charter so requires	DGCL 262(c)

Dissolution (“Winding up” in TX)

Who votes? All holders of voting shares (no class voting)	DGCL 275(b); TBOC 364(a)(2), (b)

Are dissenters’ rights available? No	compare DGCL 262(b);TBOC 21.460

A corp’s existence is perpetual by default

Therefore, dissolution never occurs automatically – we would need action by board & shareholders

What happens to limited liability when corp dissolves?	DGCL 78, 280, 281, 282

Follow procedures to pay claims (in code);

If followed, shareholder receiving $ back after the winding up not liable for more than they received as payment when the corp winds up (not liable for anything more than the $ you got back)

Transactional Form

Asset Sale & Share Exchange

M&A or Merger/Sale of “Substantially All” Assets

Normal Asset Sale

Acquiring Corp. & Target Corp.

A Corp has Money & T Corp has Assets (building, etc)

Cash is exchanged for assets	or A Corp. could exchange stock to purchase of the assets

Normal Asset Sales are governed by: the BJR !!!

Shareholders have no voting/dissenting rights

For a sale of “Substantially All Assets” looks virtually the same, however

The §’s in all states are governing and get shareholders involved

What does “Substantially All” mean?

…in DE?

Katz	Outlier Case

Sale of 51% of assets, 45% of revenues & 52% of its operating income, with intent to shift to a different line of business, was “substantially all” assets. So, half of company was deemed “substantially all

Still good law in DE, but an outlier

Hollinger	More typical case

Facts: The Daily Telegraph and related newspapers constituted 57% of Hollinger Inc.’s value

Holding: This was not “substantially all” of Hollinger Inc’s assets. The company still owned <100 Chicago newspapers, including the Sun-Times!

Note: It could be said that value and assets are different

See DGCL 271

Cts didn’t like Katz

Approx 80-90% of company needs to be sold in order to be a “more typical case”

CERBCO

Looked at qualitative effect: Was transaction “out of the ordinary course” & did it substantially affect the corps existence and purpose?

In Hollinger, the sale didn’t cause them to change the purpose or existence of its business (it had multiple papers)

But if NY Times Co. sold the NY Times newspaper (although it still has assets beyond newspapers) – under the DE cases, if it was <65%, Cts would likely diverge from Hollinger and determine that the NY Times paper was such an important asset, that selling it would change the companies character

Therefore, it’s likely a factual determination depending on what happens to the corp’s assets & character if sale proceeded

…in TX?

More objective approach. TX outright rejects Katz

“Substantially All” doesn’t include	TBOC 21.451(1)

Continuing to engage in 1+ businesses or

Portion of consideration received (in the transaction) applied to a continuing business

Commentary: Shareholders only get involved when questioned disposition ends corp’s existence

What’s the result of a sale of Substantially All Assets?

Who votes?

All holders of Target Corp.’s voting shares	DGCL 271(a); TBOC 21.455(f) & 21.457(a)

Holder shares in Acquiring Corp don’t vote

Are dissenters’ rights available?

DE: No, not even to holders of Target Corp.’s voting share unless T’s charter so requires	DGCL 262(c)

TX: Yes, for some of T’s Shareholders…but, only to holders of T’s voting shares	TBOC 21.460, 10.354(a)(1)(B), (b)

Transactional Form: Merger

Long Form Statutory Merger

Who votes?

Holders of voting shares of T always vote	DGCL 251(c); TBOC 21.452(e), .457(a)

Holders of voting share of A only vote if:

Total # of A’s voting shares are increased by 20%+ in the merger (aka whale/minnow merger) or

A’s charter is amended or A’s shares are exchanged/altered in the merger DGCL 251(c), (f); TBOC 21.452(e), .457(a), .459(a)

Are dissenters’ right available (T)?

DE: Yes, for all T shareholders (even holders of non-voting T shares) unless the “market out” rule denies appraisal DGCL 262(b)

TX: Yes, for holders of T voting shares, unless the “market out” rule denies appraisal TBOC 21.460, 10.354(a)(1)(A), (b)

How they differ: All shares in DE can vote. Only voting shares in TX can vote!

Are dissenters’ rights available (A)?

DE, TX: Yes, for voting A shares unless the “market out” denies appraisal	DGCL 262(b)(1); TBOC 21.460 & 10.354(a)(1)(A), (b)

Short Form Statutory Merger

Parent/Subsidiary Merger

T Corp. shareholders own 10% or less of T Corp (so A must already own 90% or more of T)

If you meet this criteria Can do a short form merger

Who Votes on a short form merger?	DGCL 253(a); TBOC 10.006(a), (b)

Nobody (neither holders of T’s voting shares nor holders of A’s voting shares)

Are dissenters’ rights available?

DE, TX:

Yes, for all holders of T’s shares, even T’s non-voting shares	DGCL 253(d), 262(b)(3); TBOC 21.460, 10.354(a)(1)(E), (b)

A’s 90% shareholders of T Corp don’t get a vote

No, for all A shareholders	DGCL 262(b); TBOC 21.46, 10.354(a)(1)(A), (b).

Triangular Merger

Definition: A different way of doing a long form or short form merger. A & T don’t merge. T merges w/ a subsidiary of A

EX: A Corp sends stocks to T Corp and the subsidiary of A Corp mergers w/ T corp (forward triangular merger)

So A still has A Corp stock

T now has A Corp stock

&, Subsidiary has T Corp’s Assets

Reason, if T has some liability that A doesn’t want, you can effectively use subsidiary as a veil – protect A from T’s liability.

Reverse Triangular Merger

Most common type of merger today– Allows A & T to remain separate

EX: T Corp becomes a subsidiary of A Corp. Then, T Corp (owned by A Corp) mergers w/ Subsidiary company owned by A Corp

Result: A Corp is a separate company from T Corp, but T’s now a subsidiary of A Corp

Stock for Stock Mergers vs. Stock for Cash Mergers

EX: As part of the merger, A gives T shareholders A-stock in exchange for T stock. T stock is then done away

Stock for Cash Merger

Minority shareholders of T get cash instead of stock.

aka Cash Out or Freeze Out

Freeze Out: Reverse Triangular Merger

Cash Out: Same as reverse triangular merger, but instead, T Corp shareholders get cash (instead of stock) and are free to go their way (Cashed out)

Amount of cash is decided by: BODs of both corps

Can lead to: A low-ball “cash out” offer (that’s less than favorable)

Especially if A owns T

Can be done through A’s ability to elect T’s BOD (depends on the amount of stock they own)

How Cts have tried to protect shareholders from this situation

1) through appraisal &

2) Cts protecting shareholders

The Appraisal Remedy

Appraisal Rights

General Rule: aka dissenter’s rights b/c shareholders typically are allowed appraisal only if they can vote on a transaction

DE, TX: Exceptions

For short-form mergers	Shareholders have the right to appraisal but no right to vote

For charter amendments & dissolution	Shareholders have the right to vote	but no right to appraisal

Appraisal Procedures

To Obtain Appraisal, Shareholders Must…

…in DE	DGCL 262(d)

File notice of dissent w/in 20 days before shareholders vote on the merger

Not vote for the merger & File a petition for appraisal w/in 120 days after merger becomes effective

Can be expensive b/c:

Shareholders pay their own litigation costs unless court grants costs	DGCL 262(j)

Class actions appraisal unavailable

…in TX	TBOC 10.356

1) File a properly formatted notice of dissent:

Before the merger is considered (if it’s considered at a shareholder mtg)

Max 20 days after notice of the merger is sent (if the merger is undertaken on written consent) or

Max 20 days after notice is sent that the merger occurred (for a short-term merger)

2) Vote against merger (or not consent in writing) &

3) Submit shares to corp, max 20 days making demand (unless good cause is shown)

Fair Value

Traditional Approach: Many Cts imposed a specific formula – the “Delaware Block Method”

Modern: Generally allow any well-accepted method of financial valuation

May include:

A DCF calculation or

An analysis of comparable companies

Cash-Out Mergers: Alternatives to Appraisal

Default Rule, Chap 9 (absent any §’ory safe harbor): Controlling shareholder must show a self-dealing transaction is entirely fair

If A controls T, then a “cash-out” merger b/w A & T is a self-dealing transaction: A, the controller of T, is forcing a merger b/w itself & T

When A controls T, can soon-to-be cashed out shareholder of T sue A & require A to prove that the amount of cash consideration is entirely fair?

DE: Depends on the type of merger

In a long-form cash-out merger:

DE: In addition to seeking appraisal, a minority shareholder can file a class action to force the controlling shareholder to show that the cash-out merger was entirely fair	Weinberger

In a short-form cash-out merger:

DE: Appraisal is the only option (An entire fairness action is not available, Glassman)

TX: Similar

Appraisal is, absent fraud, the exclusive remedy for a dissenting shareholder	TBOC 10.368(a)

But it doesn’t purport to preclude breach of duty lawsuits for self-dealing

So, it may permit a shareholder to recover DAS from a controlling shareholder who fails to show a freeze-out is entirely fair to the corp (regardless of the type of merger)

“Market Out” Rule

Consists of

1) an exception that denies appraisal in some circs &

2) an exception to the exception that restores appraisal (despite the applicability of the exception) in certain circs

Thus, you can be denied appraisal & then have it given back

The “Exception”	DGCL 262(b)(1); TBOC 10.354(b)(1)

Dissenting shareholders (of either A or T) who otherwise qualify for appraisal are denied appraisal if:

Their current shares (A or T) are traded on a national exchange or	e.g. NYSE

Their current corp (A or T) has at least 2,000 shareholders

Plus, A’s shareholders are denied appraisal if they don’t vote

Policy: if you sell your shares in the market or if you have a lot of other shareholders to sell to you don’t get appraisal

The “exception to the exception”

Dissenting shareholders (of T) who would be denied appraisal are nonetheless granted appraisal if the consideration they receive in return for their shares (of T) is anything other than:

in DE:	DGCL 262(b)(2)

Shares of the surviving corp (A) or

Shares of another corp that trades on an exchange or has 2,000+ shareholders or

Cash in lieu of fractional shares (or any combo of the 3)

in TX	TBOC 10.354(b)(2) slightly diff from DGCL

Any consideration different than shares of same class or

Shares of another corp that trades on an exchange or has 2,000+ shareholders or

Cash in lieu of fractional shares (or any combo of the 3)

Summary: General Rules Based on the “market out” rule & the “exception to the exception”

1) If a constituent corp to a merger is not publicly traded that corps dissenting shareholders will always receive appraisal (to the extent they’re eligible for appraisal)

“Market out” exception won’t apply b/c they’re not publicly traded (they don’t have a market out)

2) If a constituent corp to a merger is publicly traded whether its dissenting shareholders receive appraisal depends on the type of consideration they receive: (if they’re eligible for appraisal)

If the shareholders entire consideration is either stock in A or stock in another exchange-traded/2000+ shareholder corp No appraisal

3) If T shareholders are “cashed out” in a merger Always granted appraisal

Regardless of whether: they hold voting shares / they vote on the merger / type of merger

De Facto Merger Doctrine

Definition

An Asset sale where T is liquidated immediately after the sale:

If T shareholders receive stock result looks exactly like a stock-for-stock merger

If T shareholders receive cash result looks exactly like a stock-for-cash merger

But in each case there’s a key diff b/w the asset sale & the merger:

DE: Ts shareholders don’t receive appraisal for the asset sale	DGCL § 271

De Facto Merger: The Argument

“De Facto merger” is an argument that shareholders (of T) make (in an asset sale). They argue:

1) If the result of a transaction is effectively the same as would occur in a merger

2) Then T shareholders should receive the same protections as they would in a merger

Is this Argument Accepted?

Some states recognize this doctrine and provide merger protections in transactions look like a merger

DE: Rejects the de factor merger doctrine	Hariton

TX: Doctrine is unnecessary

b/c TX generally provides the same protections for diff transactions that have the same result

e.g., TX provides appraisal to shareholders of T in a sale of substantially all assets	TBOC 103.54(a)(1)(B)

State Anti-Takeover Statutes

Definition:

Supplemental Required Reading

Background and Structure of the Texas Business Organizations Code (TBOC)

PowerPoint was created by the Texas Secretary of State's Business and Public Filings Division and abridged by Joe Leahy

To download the entire presentation: http://www.sos.state.tx.us/corp/forms/boc/structure_effective_dates.pps

Code Structure

Provisions common to most forms of entities are placed in a single title // Provisions specific to entity type placed in separate titles

Title 1. General Provisions	- Title 5. Real Estate Investment Trusts

Title 2. Corporations	- Title 6. Associations

Title 3. Limited Liability Companies	- Title 7. Professional Entities

Title 4. Partnerships	- Title 8. Miscellaneous and Transition Provisions

General Provisions

Title I “The Hub”

Provisions applicable to most entities

Contains 12 chapters pulling together similar or overlapping provisions found in prior law

Intent: to standardize, organize, and simplify

Hub Chapters

Chapter 1: Definitions	(key chapter)

Chapter 2: Purposes and Powers of TX entities	(Prohibited Purposes)

Chapter 3: Formation and Governance

Subchapter A—Req’ts for certificates of formation for all entities

Subchapter B--Amendments and restatements

Chapter 4: Filings

Subchapter A--General provisions re: signatures, liability for false filing instruments, fax copies

Subchapter B--When Filings Take Effect

General Rule: On Filing

Delayed effective dates and conditions

Abandonments before effectiveness

Subchapter C: Certificates of correction

Subchapter D: FILING FEES!

All Entities 4.151

For-Profit 4.152

Nonprofit 4.153 etc

Chapter 5: Names of Entities; Registered Agents and Registered Offices

Subchapter B: Names

May use assumed name

Unauthorized purpose in name prohibited

May not be same as or deceptively similar

Subchapters C & D: Name reservations

Also

Organizational identifiers for all names

Professional entity names must not be contrary to regulatory statute

Cannot use “Lotto” or “Lottery”

Unauthorized use of certain words in veterans orgs

Subchapter E: Registered Agents & Offices

Designation of agent and office

Changes to registered agent/office

Change by a registered agent to name or address

Resignation of registered agent

Chapter 9: Foreign Entities

Foreign entities required to register	- Name changes

Permissive registration	- Withdrawal of registration

Registration procedures

Chapter 10: Mergers, Interest Exchanges, Conversions and Sales of Assets

Subchapter A--Mergers	- Subchapter D--Certificates filed with the SOS

Subchapter B--Exchanges of Interests	- Subchapter E--Abandonment of Merger, Exchange, or Conversion

Subchapter C--Conversions

Chapter 11: Winding up and Termination

The new dissolution provisions	- Reinstatement procedures

Includes voluntary & involuntary terminations

Title 2 through Title 8 “The Spokes”

Chapter 12: Administrative Powers of SOS and OAG

Adoption of procedural rules

Interrogatories

Appeal from SOS decisions

Title 2: Corporations

For-Profit

Nonprofit

Special-Purpose Corporations

Lodges

Title 3: Limited Liability Companies

Title 5: Real Estate Investment Trusts

Title 4: Partnerships

General Partnerships

Limited Liability Partnerships

Limited Partnerships

Title 6: Associations

Cooperative Associations

Unincorporated Nonprofit Associations

Title 7: Professional Entities

Professional Associations

Professional Corps

Professional LLCs

Title 8: Misc and Transition Provisions

When the Code takes effect

When it applies to entities already in existence

What happens to the TBCA and other existing laws

Navigating the BOC

Look to Title 1 for the general provision

Then look to the specific title governing the entity--The “spoke”	e.g., corporations--Title 2

If a Title 1 provision conflicts w/ a provision in the specific title governing the entity Use specific title provision

Short Titles for Spoke Provisions

Texas Corporation Law Title 2 and Title 1 to the extent applicable to corps

Texas For-Profit Corporation Law Chapters 20 and 21 and Title 1...

Foreign Entity - an org formed under, and the internal affairs of which are governed by, the laws of a jrd other than TX

Foreign Filing Entity - a foreign entity that registers or is req’d to register as a foreign entity under Chapter 9 of the BOC. (Includes out-of-state business trusts/REITs.)

Foreign Nonfiling Entity: a foreign entity that is not a foreign filing entity. (Includes foreign LLP.)

Domestic Entity - an org formed under or the internal affairs of which are governed by the BOC. (Doesn’t include banks, insurance companies, telephone cooperatives, or other corps formed under a TX law other than the BOC)

Non-filing Entity - a domestic entity that’s not a filing entity (Includes unincorporated non-profits & domestic general partnerships)

Filing Entity - a domestic entity that is a corp, LP, LLC, PA, cooperative, or REIT. (Doesn’t include LLPs.)

Governing Authority - a person or group of persons who is entitled to manage and direct the affairs of an entity under the BOC and the entity’s governing docs.

Includes

BODs of a corp

General partners of a general partnership or LP

Managers or managing-members of LLC.

Does not include: an officer

Governing Person - a person serving as part of a governing authority.

Officer - an individual elected, appointed, or designated as an officer of an entity by it’s governing authority or it’s governing docs

Managerial Official - officer or governing person

Individual - a natural person. BOC clarifies that officers and directors must be individuals.

Owner

In a domestic or foreign corp (or REIT) a shareholder

In a foreign or domestic partnership a partner

In a foreign or domestic LLC or PA a member

In any other foreign or domestic entity an owner of an equity interest in the entity

Governing Documents For domestic entities:

its certificate of formation (or any other document or agreement under which it was formed); PLUS

other docs or agreements adopted by the entity under the BOC to govern the formation or the internal affairs of the entity.

Upon filing a certificate of formation, the SOS will issue:

an “acknowledgment” - conclusive evidence of the entity’s formation, existence, & authority to transact business in TX

a letter of acknowledgement &

a certificate evidencing filing.

§ 145 Indemnification of D/Os, EEs, & agents; insurance

THIS IS PERMISSIVE INDEMNIFICATION

(a) A corp SHALL have the power to indemnify any person

who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, (civil crim etc irrelevant) other than an action by or in the right of the corp [CD: which is more limited] by reason that the person is or was a director, officer, employee or agent of the corp, or is or was serving at the request of the corp as a director, officer, employee or agent of another corp, partnership, joint venture, trust or other enterprise,

against expenses (including atty fees), judgments, fines & amounts paid in settlement actually & reasonably incurred by the person in connection w/ action, suit or proceeding

when person acted in good faith &

in a manner the person reasonably believed to be in best interests of the corp

In a criminal action or proceeding→ no reasonable cause to believe what they did was unlawful

The termination of any action, suit or proceeding doesn’t alone create a presumption they didn’t act in good faith & in a manner which the person reasonably believed to be in or not opposed to the best interests of the corp, and, w/ respect to any criminal action or proceeding, had reasonable cause to believe that the person's conduct was unlawful.

(b) A corp SHALL have the power to indemnify any person

who was or is a party or is threatened to be made a party to any action/suit by or in the right of the corp to procure a judgment in its favor by reason of the fact that they are/were a director, officer, employee or agent of the corp, or is or was serving at the request of the corp as a director, officer, employee or agent of another corp, partnership, joint venture, trust or other enterprise against expenses (including atty fees) actually & reasonably incurred by the person in connection w/ the defense or settlement of such action or suit

if the person acted in good faith &

in a manner they reasonably believed to be in or not opposed to the best interests of the corp

except no indemnification shall be made in respect of any claim, issue or matter where they’ve been adjudged to be liable to the corp

unless & Ct where suit was brought determines that, despite the adjudication of liability but in view of all the circs of the case, such person is fairly & reasonably entitled to indemnity for such expenses Ct thinks proper

(c) To the extent that a present or former director or officer of a corp has been successful on the merits or in defense of any action, suit or proceeding in (a) & (b), or in defense of any claim, issue or matter therein

→ such person shall be indemnified against expenses (including atty fees) actually & reasonably incurred

(d) Any indemnification under (a) & (b) (unless ordered by a court) shall be made by the corp only as authorized in the specific case upon a determination that indemnification of the present or former director, officer, employee or agent is proper in the circumstances because the person has met the applicable standard of conduct in (a) & (b). Such determination shall be made, w/ respect to a person who is a director or officer of the corp at the time of such determination:

(1) By a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum; or

(2) By a committee of directors designated by majority vote of such directors, even if less than a quorum; or

(3) If there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion; or

(4) By the stockholders.

(e) Expenses (including attorneys' fees) incurred by an officer or director of the corp in defending any civil, criminal, administrative or investigative action, suit or proceeding may be paid by the corp in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the corp as authorized in this section. Such expenses (including attorneys' fees) incurred by former directors & officers or other employees & agents of the corp or by persons serving at the request of the corp as directors, officers, employees or agents of another corp, partnership, joint venture, trust or other enterprise may be so paid upon such terms & conditions, if any, as the corp deems appropriate.

(f) The indemnification & advancement of expenses provided by, or granted pursuant to, the other subsections of this section shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in such person's official capacity & as to action in another capacity while holding such office.

[CD: Basically the corp has power to indemnify, but that the charter can modify it….but really it comes down to the 2 main elements in (a)]

A right to indemnification or to advancement of expenses arising under a provision of the certificate of incorp or a bylaw shall not be eliminated or impaired by an amendment to the charter or the bylaws after the occurrence of the act or omission that’s the subject of the civil, criminal, administrative or investigative action, suit or proceeding for which indemnification or advancement of expenses is sought, unless the provision in effect at the time of such act or omission explicitly authorizes such elimination or impairment after such action or omission has occurred.

(g) corp has power to purchase & maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corp, or is or was serving at the request of the corp as a director, officer, employee or agent of another corp, partnership, joint venture, trust or other enterprise against any liability asserted against such person & incurred by such person in any such capacity, or arising out of such person's status as such,

whether or not the corp would have the power to indemnify such person against such liability under this section.

(h) here "the corp" shall include, in addition to the resulting corp, any constituent corp (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power & authority to indemnify its directors, officers, & employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent corp, or is or was serving at the request of such constituent corp as a director, officer, employee or agent of another corp, partnership, joint venture, trust or other enterprise, shall stand in the same position under this section w/ respect to the resulting or surviving corp as such person would have w/ respect to such constituent corp if its separate existence had continued.

(i) For purposes of this section, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person w/ respect to any employee benefit plan; & references to "serving at the request of the corp" shall include any service as a director, officer, employee or agent of the corp which imposes duties on, or involves services by, such director, officer, employee or agent w/ respect to an employee benefit plan, its participants or beneficiaries; & a person who acted in good faith & in a manner such person reasonably believed to be in the interest of the participants & beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the corp" as referred to in this section.

(j) The indemnification & advancement of expenses provided here shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent & shall inure to the benefit of the heirs, executors & administrators

(k) The Court of Chancery is hereby vested w/ exclusive jurisdiction to hear & determine all actions for advancement of expenses or indemnification brought under this section or under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. The Court of Chancery may summarily determine a corp's obligation to advance expenses (including attorneys' fees).

§240.14a-8 Shareholder proposals

(you=shareholder submitting it)

Purpose: When a company must include a shareholder's proposal in its proxy statement & identify the proposal in its form of proxy when the company holds an annual or special mtg of shareholders

Summary: To have your shareholder proposal included on a company's proxy card, & included along w/ any supporting statement in its proxy statement, you must be eligible & follow the procedures.

Companies can sometimes EXCLUDE your proprosal but ONLY AFTER submitting its reasons to the Commission.

(a) Question 1: What is a proposal?

A shareholder proposal is your recommendation or req’t that the company and/or its BOD take action, which you intend to present at a shareholders mtg.

It should clearly state the course of action you believe the company should follow.

If your proposal is placed on the co’s proxy card co. must provide an option to vote approve/disapprove/abstentation by proxy

“Proposal” = your proposal, & to your statement in support of your proposal (if any).

(b) Question 2: Who is eligible to submit a proposal, & how do I demonstrate to the company that I am eligible?

(1) Must have continuously held at least $2,000+ in market value, or 1%, of the co’s securities entitled to be voted on the proposal at the mtg
for at least 1 yr by the date you submit the proposal.
Must hold those securities through the date of mtg

(2)

IF YOU ARE the registered holder of your securities (your name’s in the company's records as a shareholder)

- company can verify your eligibility, but you still must to provide the company a written statement you intend to continue to hold the securities thru the date of the mtg

IF YOU ARE NOT a registered holder, the company likely does not know that you’re a shareholder, or how many shares you own. Must prove your eligibility to the company. 2 ways:

(i)Submit to the company a written statement from the “record” holder of your securities (broker or bank) verifying that, at the time you submitted your proposal, you continuously held m for < 1 yr. & that you intend to continue to hold the securities through the date of the mtg of shareholders; or

(ii) Applies only if you have filed a Schedule 13D (§240.13d-101), Schedule 13G (§240.13d-102), Form 3 (§249.103 of this chapter), Form 4 (§249.104 of this chapter) and/or Form 5 (§249.105 of this chapter), or amendments to those docs or updated forms, reflecting your ownership of the shares as of or before the date on which the 1-yr eligibility period begins. If you filed 1 of these docs w/ the SEC, you may demonstrate your eligibility by submitting to the company:

(A) Copy of the schedule and/or form, & any subsequent amendments reporting a change in your ownership level;

(B) Your written statement that you continuously held the req’d # of shares for 1-yr as of the date of the statement; and

(C) Your written statement that you intend to continue ownership of the shares thru the annual or special mtg.

(c) Question 3: How many proposals may I submit? max 1 proposal per shareholder to a company for a shareholders' mtg

(d) Question 4: How long can my proposal be? Max 500 words, including any accompanying supporting statement

(e) Question 5: What is the deadline for submitting a proposal?

(1) FOR THE ANNUAL MTG

Look to last yr's proxy statement or
quarterly reports (if didn’t have one last yr, or this yrs mtg is < 30 days from last yr's mtg), or

in shareholder reports of investment

CAN SUBMIT Elec if proves date delivered

(2) FOR A REGULARLY SCHEDULED ANNUAL MTG

The proposal must be received at the company's principal executive offices within 120 days before the proxy statement released to shareholders in connection w/ the previous yr's annual mtg.

<30 days from last yr's mtg reasonable time before the company prints & sends proxy materials.

(3) FOR A SHAREHOLDER MTG NOT REGULARLY SCHEDULED reasonable time b4 company prints & sends proxy materials

(f) Question 6: What if I fail to follow 1 of the eligibility or procedural reqt’s in Questions 1-4?

(1) The company may exclude your proposal, only after it has notified you of the problem, & you failed adequately to correct it. W/in 14 calendar days of receiving your proposal, the company must notify you in writing of any procedural or eligibility deficiencies, as well as of the time frame for your response. Must postmark or e-send your response, no later than 14 days from the date you received the company's notification. A company need not provide you notice of a deficiency if the deficiency can’t be remedied (i.e. you fail to submit a proposal by the deadline). If the company intends to exclude the proposal, it will later have to make a submission under §240.14a-8 & provide you w/ a copy under Question 10 below, §240.14a-8(j).

(2) If you fail in your promise to hold the req’d # of securities through the date of the mtg of shareholders, then the company will be permitted to exclude all of your proposals from its proxy materials for any mtg held in the following two calendar yrs.

(g) Question 7: Who has the burden of persuading the Commission or its staff that my proposal can be excluded?

The company has the burden to demonstrate that it is entitled to exclude a proposal (unless otherwise req’d)

(h) Question 8: Must I appear personally at the shareholders' mtg to present the proposal?

(1) You or your representative (qualified under state law) must attend the mtg to present the proposal. Your responsibility to ensure compliance w/ state law procedures for attending the mtg and/or presenting your proposal.

(2) If the company holds its shareholder mtg in whole or in part via electronic media, & the company permits you or your representative to present your proposal via such media, then you may appear through e- media

(3) If you or your qualified representative fail to appear & present the proposal, w/out good cause, → company permitted to exclude all of your proposals from its proxy materials for any mtgs held for 2 yrs.

(i) Question 9: If I have complied w/ the procedural reqt’s, on what other bases may a company rely to exclude my proposal?

(1) Improper under state law: If proposal is not a proper subject for action by shareholders under the laws of the jsd of the company's org;

Note: Depending on subject matter, some proposals aren’t proper under state law if they would be binding if approved by shareholders. In our experience, most proposals that are cast as recommendations or requests that the BOD take specified action are proper under state law. Assumed proper unless company shows otherwise.

(2) If proposal Violates law: If implemented proposal would cause the company to violate any state, federal, or foreign law to which it is subject;

Note: Proposal won’t be excluded if it would violate foreign law if compliance w/ the foreign law would violate any state/fed law.

(3) Violation of proxy rules: If the proposal or supporting statement is contrary to any of the SEC’s proxy rules, including §240.14a-9, (prohibits materially false or misleading statements in proxy soliciting materials)

(4) Personal grievance; special interest: If the proposal relates to the redress of a personal claim or grievance against the company or any other person, or if it is designed to result in a benefit to you, or to further a personal interest, which is not shared by the other shareholders at large;

(5) Relevance: If the proposal relates to operations which account for less than 5% of the company's total assets at the end of its most recent fiscal yr, & for less than 5 % of its net earnings & gross sales for its most recent fiscal yr, & is not otherwise significantly related to the company's business;

(6) Absence of power/authority: If the company would lack the power or authority to implement the proposal;

(7) Management functions: If the proposal deals w/ a matter relating to the company's ordinary business operations;

(8) Director elections: If the proposal:

(i) Would disqualify a nominee who is standing for election;

(ii) Would remove a director from office before their term expired;

(iii) Questions the competence, business judgment, or character of 1+ nominees or directors;

(iv) Seeks to include a specific individual in the company's proxy materials for election to the BOD; or

(v) Otherwise could affect the outcome of the upcoming election of directors.

(9) Conflicts w/ company's proposal: If the proposal directly conflicts w/ 1 of the company's own proposals to be submitted to shareholders at the same mtg;

Note to paragraph (i)(9): A company's submission to the Commission under this section should specify the points of conflict w/ the company's proposal.

(10) Substantially implemented: If the company has already substantially implemented the proposal;

Note to paragraph (i)(10): A company may exclude a shareholder proposal that would provide an advisory vote or seek future advisory votes to approve the compensation of executives as disclosed pursuant to Item 402 of Regulation S-K (§229.402 of this chapter) or any successor to Item 402 (a “say-on-pay vote”) or that relates to the frequency of say-on-pay votes, provided that in the most recent shareholder vote req’d by §240.14a-21(b) of this chapter a single yr (i.e., 1, two, or three yrs) received approval of a majority of votes cast on the matter & company has adopted a policy on the frequency of say-on-pay votes that is consistent w/ the majority vote of the most recent shareholder vote req’d by §240.14a-21(b) .

(11) Duplication: If proposal substantially duplicates another proposal previously submitted to the company by another prop1nt that will be included in the company's proxy materials for the same mtg;

(12) Resubmissions: If proposal deals w/ substantially the same subject matter as another proposal(s) that has or have been previously included in the company's proxy materials w/in the preceding 5 calendar yrs, a company may exclude it from its proxy materials for any mtg held w/in 3 calendar yrs of the last time it was included if the proposal received:

(i) Less than 3% of the vote if proposed 1x w/in 5 calendar yrs;

(ii) Less than 6% of the vote on its last submission to shareholders if proposed 2x w/in 5 calendar yrs; or

(iii) Less than 10% of the vote on its last submission to shareholders if proposed three times or more previously w/in the preceding 5 calendar yrs; and

(13) Specific amount of dividends: If the proposal relates to specific amounts of cash or stock dividends.

(j) Question 10: What procedures must the company follow if it intends to exclude my proposal?

(1) Must file Reasons w/ SEC w/in 80 calendar days before it files its definitive proxy statement & form of proxy w/ the Commission. Must provide you w/ a copy of its submission. SEC may extend deadline if good cause shown

(2) TMust file 6 paper copies of::

(i) The proposal;

(ii) Explanation of why the company believes it may exclude the proposal, (if possible, it should refer to the most recent applicable authority (such as prior Division letters issued under the rule); and

(iii) A supporting opinion of counsel (if reasons based on state or foreign law)

(k) Question 11: May I submit my own statement to the Commission responding to the company's arguments?

Yes, you may submit a response, but it is not req’d. You should try to submit any response to us, w/ a copy to the company, as soon as possible after the company makes its submission. This way, the Commission staff will have time to consider fully your submission before it issues its response. You should submit six paper copies of your response.

(l) Question 12: If the company includes my shareholder proposal in its proxy materials, what information about me must it include along w/ the proposal itself?

(1) The company's proxy statement must include your name & address, as well as the # of the company's voting securities that you hold. However, instead of providing that information, the company may instead include a statement that it will provide the information to shareholders promptly upon receiving an oral or written request.

(2) The company is not responsible for the contents of your proposal or supporting statement.

(m) Question 13: What can I do if the company includes in its proxy statement reasons why it believes shareholders should not vote in favor of my proposal, & I disagree w/ some of its statements?

(1) Company may elect to include in its proxy statement reasons why it believes shareholders should vote against your proposal. Company allowed to make arguments reflecting its own point of view, just as you can in your supporting statement.

(2) However, if you believe the company's opposition to your proposal contains materially false or misleading statements that may violate our anti-fraud rule, §240.14a-9 → you should promptly send a letter to the Commission staff & the company explaining the reasons for your view, along w/ a copy of the company's statements opposing your proposal. To the extent possible, your letter should include specific factual info demonstrating the inaccuracy of the company's claims. Time permitting, you can try to work out your differences w/ the company by yourself before contacting the Commission staff.

(3) Company req’d to send you a copy of its statements opposing your proposal before it sends proxy materials Purpose: bring to our attention any materially false or misleading statements, under the following timeframes:

(i) If our no-action response requires you make revisions to your proposal or supporting statement as a condition to requiring the company to include it in its proxy materials → Company must provide you w/ a copy of its opposition statements <5 days after the company receives a copy of your revised proposal; or

(ii) I<30 calendar days before its files definitive copies of its proxy statement & form of proxy under §240.14a-6.

Test Tips

Class Website on Moodle: http://online.stcl.edu/course/view.php?id=3152

Contact Info:

Exam Date:

Exam Format:

Don’ts:

Panel A is last names A-L - MON; Panel B is last names M-Z –WED

Index

A

Annual Meeting

Scheduling · 1, 29, 31

Annual Meetings · 1, 29

Appraisal · 2, 59, 60

Cash-Out Mergers · 2, 60

Cash-Out Mergers · 2, 60

Procedures · 2, 59

Procedures · 2, 59

B

Balance Sheet · 21

Board of Directors · 5, 21, 23, 47

Classified Boards · 1, 30

Consents · 1, 30

Duties · 1, 5, 21, 23, 47

Elections · 1, 29

Removal · 1, 31, 35

Business Judgment Rule · 2, 42

Bylaws · 12, 31, 33, 35, 41

C

Capital Regulation · 1, 20, 21

Cases

AP Smith · 48

Cookies Food · 50

Dodge · 47, 48

Gagliardi · 41

Katz · 58

Kinney Shoe · 24, 25, 26

Schnell · 47

Schreiber · 38

Sea Land · 24, 25, 26

SSP Partners · 26

Tarnowski · 5

Walkovsky · 25

Charter · 8, 9, 10, 11, 12, 16, 21, 27, 29, 37, 39, 44, 52

Incorporators · 8, 9

Purpose · 8, 9, 10, 11, 16, 21, 37, 44, 52, 67, 69

Requirements · 10, 11, 12, 27, 29, 39

Ultra Vires · 8

Choice of Entity · 8

Collective Action Problem · 28

Constituency Statutes · 47

Corp · 4, 6, 7, 8, 9, 10, 11, 12, 41, 55, 62

Characteristics · 1, 6

Formation · 1, 8, 9, 10, 11, 62

Types · 1, 2, 4, 6, 7, 12, 41, 55

D

Damages · 2, 29, 42, 44

De Facto Merger Doctrine · 2, 61

Derivative Suits · 55

Derivative Claims · 2, 55

Derivative Claims · 2, 55

Director Risk Aversion · 2, 41

Discounted Cash Flow Analysis (DCF) · 20

Diversification · 1, 20

Dividends · 11, 21

Restrictions · 1, 11, 21

Doctrine

Corporate Opportunity Doctrine · 2, 53

Merger · 2, 61

Vicinity of Insolvency · 23

Duty of Care · 2, 5, 40, 42, 43, 44, 47, 55

Duty of Loyalty · 2, 5, 40, 44, 45, 47, 51, 52

Duty to Monitor · 2, 44

E

Enabling Acts · 7

Equitable Subordination · 21, 23

F

Fraudulent Conveyance Norm · 1, 23

I

Income Statement · 22, 23

Indemnification · 2, 41, 42, 55, 65

Insurance · 2, 8, 42

Internal Affairs Doctrine · 7

K

Knowing Violations of the Law · 2, 46

M

Merger · 60, 61

Cash-Out · 2, 60

Cash-Out · 2, 60

De Facto · 2, 61

N

Nimble Dividend Rule · 23

P

Preemptive Rights · 1, 10

Preferred Stock · 15, 31

Proxy System · 28

Q

Quorum · 29, 35

R

Repayment Order · 16

Repurchase · 52

Reserve Powers Doctrine · 48

Risk

Risk Averse · 18, 40

Risk Neutral · 18, 40

Systematic Risk · 20

S

Safe Harbor Statutes · 2, 50, 51

Self-Dealing · 2, 47, 48, 49, 51, 52

Shareholder

Agreements · 1, 10, 11

Amendments · 11, 35, 57

Controlling · 2, 35, 47, 49, 51, 60

Controlling · 2, 35, 47, 49, 51, 60

Exclusions · 2, 39

Information Rights · 2, 37

Majority · 29, 30, 41, 44, 52, 55

Majority · 29, 30, 41, 44, 52, 55

Minority · 2, 25, 52, 59

Minority · 2, 25, 52, 59

Proposals · 2, 39

Ratification · 2, 51

Ratification · 2, 51

Shareholder Ratification · 51

Shareholder(s) · 1, 10, 11, 25, 28, 29, 30, 31, 32, 35, 36, 39, 47, 49, 51, 52, 57, 59, 60

Shareholders

Exclusions · 2, 39

Shareholders Equity

Capital Surplus · 22

Retained Earnings · 22, 23

Stated Capital · 22

Shareholders(s) · 39

Special Litigation Committees · 2, 56

Special Meetings · 1, 32, 35

Stock · 15, 16, 22

Common Stock · 15

Par Value · 15, 22

Preferred Stock · 15, 31

T

Treasury Shares · 2, 21, 37

V

Valuation · 16, 18

CV · 19

Discount Rate · 16

EV · 17, 18, 19

Future Value · 16

FV · 16, 17, 18, 19

Interest Rate · 16

NPV · 17, 18, 19, 20, 54

PV · 16, 17, 18, 19, 20

Veil-Piercing

Involuntary Creditors · 1, 25

Voluntary Creditors · 1, 24

Vote Buying · 2, 37, 38

Voting

Class Voting · 1, 36, 57

Class Voting · 1, 36, 57

Costs · 1, 4, 28

Costs · 1, 4, 28

Cumulative Voting · 30, 32, 35

Straight Voting · 30, 31

Vote Buying · 2, 37, 38

Z

Zero Coupon · 16