Editing Business Associations

{{Infobox Outline
| subject         = Business Associations
| book_one        = Business Organizations: Cases, Problems, and Case Studies Smith, Williams
| book_two        = Business Associations, Cases and Materials on Agency, Partnerships, LLCs, and Corporations Klein, Ramseyer, Bainbridge
| book_three      =
| book_four       =
| related        = 
}}

==CHOICE OF ENTITY==
===Types of Entities===
#Sole Proprietorship
#General Partnership
#Limited Partnership
#Limited Liability Partnership
#Limited Liability Company
#Corporation

<u>'''6 Factor Analysis to think of clients'''</u>
#Liability- who's responsible for debts
#Management and control- who gets to call the shots
#Transferability- How easily can you get out
#Continuity of Existence (Duration) How long can entity last
#Taxation
#Raising Capital

<div>'''SOLE PROPRIETORSHIP'''</div>
* <u>'''SP & 6 Factors </u>(Doesn't make out too well)'''
** '''1. Liability'''
*** Unlimited personal liability because there's no distinction or separation between the sole proprietor and the business
** '''2. Management and control'''
*** SP gets to call all the shots
** '''3. Transferability'''
*** By necessity, you must sell the assets if you want to sell it (Asset Deal)
** '''4. Duration'''
*** Last until the earlier of 5 things: 
**** Business is sold; 
**** Terminated; 
**** Takes on an equity partner; 
**** Bankruptcy; or 
**** Dies
** '''5. Taxation'''
*** Schedule C- Schedule to form 1040
**** Bottom line flows directly onto form 1040
***** Has dollar for dollar impact 
** '''6. Raising Capital'''
*** Only option is through borrowing money (incurring debt)

<div>'''GENERAL PARTNERSHIP'''</div>
* '''Association of 2 or more persons to carry on as co-owners, a business for profit'''
* Are consensual in nature
* Created by either expressed or implied agreement
** Typically controlled by '''''Written Partnership Agreement'''''
*** If issue not covered in written agreement, or there is no written agreement, you fall back on statutory provisions of state in question
**** Usually UPA or RUPA
* <u>'''GP & 6 Factors:'''</u>
** '''1. Liability (Big Drawback)'''
*** Joint and several liability
**** Can be sued collectively; or
**** Can be sued individually
***** If sued individually, they could sue their fellow partners for contribution, because a single partner is not responsible for all the unpaid debts of the company 
*** ''Martin v. Peyton''
**** Issue- Whether a D is a partner with joint and several liability, or rather a mere creditor, who's then is just like the P, who's just someone that has not gotten paid
**** '''Rule→ Generally, someone that gets a percentage of profits is presumed to be a partner'''
***** Someone who gets a percentage of profits through payment of a loan IS NOT considered a partner (lender can have a payment provision in loan doc that says creditor will get part of profits until they get paid back)
** '''2. Management and control'''
*** UPA 18(e)→ Partners have equal rights in the management and conduct of the partnership business, '''''unless''''' partnership agreement provides otherwise
**** It is often that partnership agreements DO provide otherwise (Ex: "Managing Partners" are delegated managerial and control attributes)
*** ''Lupien v. Malsbenden''
**** Set forth the connection between control and the concept of co-ownership
**** The term "co-owners" does not have to mean Joint Title to all the assets (although it could)
**** '''Rule→ It's the right to participate in the control of the business that is the essence of co-ownership '''
***** Ask yourself "Does the person in question of the right to manage and control that business?"
***** Do not need to exercise that right; Only need to have that right 
** '''3. Transferability'''
*** Partners can transfer financial attributes of the business, unless partnership agreement provides otherwise
**** Financial Attributes:
***** Right to receive distributions 
****** Actual cash outlays (checks sent to people)
***** Also to receive allocative share of profits or losses
*** Partners CANNOT transfer management and control attributes, unless all the remaining partners consent, OR whatever is set out in the partnership agreement (for example majority vote)
**** Until this happens, the original partner retains the management and control AND the joint and several liability, until that partner withdraws or disassociates themselves from that partnership
** '''4. Duration'''
*** Partnerships continue until 1 or more '''''events of dissolution''''' occur. 
**** When one of these events happen, the partners need to determine if they will ''wind up'' their affairs and terminate, or continue on in a slightly altered form (i.e. one partner is no longer with the partnership)
** '''5. Taxation'''
*** Partnerships are '''''flow through tax businesses'''''- Partnership itself does not pay entity level income tax
**** Partnership itself does not write a check and send it to IRS.
**** '''Instead''', it allocates, pursuant to partnership agreement (and if none, then pursuant to statute), to each and every partner, their share of allocative profits or losses at the end of each year
***** Partners themselves must report it on their tax return 
****** If Profit→ Then must pay taxes on that profit as income
****** If Loss→ Can offset other income that they might have (uncle sam helps pick up the tax a little bit)
** '''6. Raising Capital'''
*** Can bring in additional partners
**** Price for buying in is whatever
*** Can borrow money
**** Often if small partnership, bank may ask for personal guarantee

<div><u>'''NON-CORPORATE LIMITED LIABILITY ENTITIES'''</u></div>

<div>'''(1) LIMITED PARTNERSHIPS'''</div>
* '''Have 1 or more General Partners & 1 or more limited partners'''
* LP's are a creature of statute
** Must file a ''certificate of limited partnership'' in the state in question
*** If you forget to do this, then by default, you are a general partnership (joint and seval liability)
* <u>'''LP & 6 Factors→ Only distinguished from GP's by 2 factors'''</u>
** '''Liability & Management and Control (go hand in hand for LP's)'''
*** <u>General Partners </u>
**** Continue to have joint and several liabilities for the debts of the business that they cannot pay. 
**** In return, it is the General Partners are entitled to manage and control the business
*** <u>Limited Partners</u>
**** Traditionally—'''''Control Rule'''''
***** Under this rule, limited partners have to give up any meaningful say in management and control. 
***** In exchange for that, they get limited liability—only thing at risk is their actual investment in the company
****** Creditors cannot go after the limited partners for the money that is still owed (no joint and several liability)
***** However, If a limited partner exercises too much control (violates the control rule), it is possible for the limited partner to become a de facto general partner, with joint and several liability (''Gateway Potatoes'')
***** But, Limited partners can engage in certain activities without violating the control rule
****** Investor have a right to protect their investment
****** Old UPA 303(b)- Laundry list of things Limited Partners can do:
******* Attending meetings; Being an employee; Consulting 
** Many people, instead of having a general partner as a person, have a Limited Liability Entity & Corp/LLC in a partnership (Limited Partner = Corp/LLC; General Partner = Limited liability entity)
*** If LP goes belly up, and creditors seek the assets of the GP, then the GP is the limited liability entity. 
**** Only assets exposed are ones of the business
**** Only works against general creditors
**** ''In Re USA Café's ''
***** This doesn't work against claims by partners of the limited partnership
***** If fiduciary duties are breached, you cannot hind behind your entity

<div>'''(2) LIMITED LIABILITY PARTNERSHIP'''</div>
* '''Designed for professionals that could experience malpractice liability'''
* <u>'''LLP & 6 Factors</u>: (Only Liability)'''
** '''1. Liability'''
*** Partners are jointly and severally labile for all general obligations (lease payments; employee wages; light bills)
*** Partners ARE NOT responsible for acts of malpractice for your fellow partners
**** Entity itself is responsible (which is why many statutes require malpractice insurance)

<div>'''(3) LIMITED LIABILITY COMPANY'''</div>
* Creature of statute- must file '''''articles of organization''''' filed with secretary of state (of state in qs)
* Has some attributes of a corporation & many attributes of a partnership
* Owners = '''''Members'''''
* <u>'''LLC & 6 Factors</u>: (Makes out very nicely)'''
** '''1. Liability (Most corp. like attribute)'''
*** Members have limited liability
**** Can lose investment, but cannot be sued personally
***** Exception- Piercing Veil
** '''2. Management and control'''
*** All members get equal say in management and control, unless operating agreement provides otherwise (and many do provide otherwise through manager-managed LLCs)
**** '''''Manager-managed LLC'''''
***** Contractually put management and control in hands in one or more managers
** '''3. Transferability '''
*** Free to transfer financial attributes of membership interest, but not unless all other members consent 
**** Contract can provide otherwise, and often does
** '''4. Duration '''
*** LLC will have listed in its operating agreement, '''''events of disassociation'''''
** '''5. Taxation'''
*** "Check the Box Regulation" 
**** Taxed as Corp; or
**** LLC will be taxed as flow-through taxed entities
** '''6. Raising Capital (Corporate like)'''
*** Great flexibility

===THE CORPORATION===
* Artificial people
* Creature of statute- Must file Certificate/Articles of Corporation/Corporate Charter
* <u>'''Corporation & 6 Factors</u>: (Makes out very nicely)'''
** '''1. Liability'''
*** Quintessential limited liability entity (Exception- veil piercing)
** '''2. Management and control'''
*** Publicly Traded
**** Those who own the Corp (stockholders) are not often the people on board or officers
*** Privately Held
**** Stockholders wear all the hats
** '''3. Transferability'''
*** Stock is considered personal property, and is freely transferable, so long as there are no contractual restrictions
*** Public Corp
**** Securities laws can impede the ability to transfer stock freely
** '''4. Duration '''
*** Perpetual existence, but there can be an end date put in the corp. charter
** '''5. Taxation'''
*** <u>Election of Subchapter C</u>→ Double Taxation
**** Pays Corp income tax at entity level
**** If it distributes money through dividends, then shareholders must pay income tax on the dividend as well
*** <u>Election of Subchapter S</u>→ Flow-through tax entity
**** Each shareholder gets a Schedule K-1, allocating (not distributing) to them their share of profit or losses
***** Individual shareholder then has to report their own income on their own Form 1040
**** <u>'''Requirements to file under Subchapter S:'''</u>
***** '''1. Can only have up to 100 Shareholders'''
***** '''2. Identity of Individual '''
****** Each shareholder must be an individual (a person)
****** Individual must be a US Citizen or Resident Alien
****** Individual can be a qualified estate or trust
****** Another S Corp can also invest into your S-Corp. 
******* BUT a C-Corp cannot.
******** The moment a C-Corp invests into your S-Corp, you lose your S-Corp. election, and you'll be taxed as a C-Corp from that moment forward 
********* You can have a Stub-Accounting period (1<sup>st</sup> part of year you're taxed as S-Corp, and 2<sup>nd</sup> part of year you're taxed as C-Corp)
******* Anyone that is not in the US cannot invest into an S-Corp either (because US gov't doesn't care about them)
******** So, you can just form an LLC
******** Also, just because you start off as one entity, doesn't mean you cannot switch to a different entity (Many LLC's convert to the corporate form)
***** '''3. Capital Structure'''- S-Corp can only issue 1 type of stock (common stock)
***** '''4. Subsidiaries'''
****** S-Corp CAN own shares in other corporations (S or C corp)
******* If S-Corp. can own 100% of another C-Corp, that C-Corp is a "'''''wholly owned subsidiary"'''''
******* If S-Corp. can own 40% of another C-Corp, that C-Corp is a "'''''partially owned subsidiary"'''''
****** BUT C-Corp CANNOT invest into a S-Corp
***** <u>Policy Justification of S-Corps</u>—Gov't trying to promote entrepreneurialism, and the creation of new corporations
****** Foster new business, give it a tax break, and only when it becomes more successful (grows and succeeds), does it need to pay that double taxation to the government
** '''6. Raising Capital'''
*** Tremendous Flexibility
*** Can borrow money from a bank too, but typically issues securities
*** Issues <u>One or more of three types of Securities</u>
**** '''1. Debt Securities''' (Borrowed Money)
***** '''''(1) Bonds'''''
****** Long term IOU (30 years)
****** Also tend to be secured/collateralized
***** '''''(2) Debentures'''''
****** Also long term IOU (20-30 years)
****** NOT collateralized
***** '''''(3) Notes'''''
****** Short term (3-7 years)
****** May/may not be collateralized
***** Claims of debt security holders are CONTRACT CLAIMS
***** Also, upside potential is capped at the interest rate in the contract
**** '''2. Preferred Stock'''
***** Contract claimants
***** Del- Certificate of Designation sets out terms
**** '''3. Common Stock'''
***** Residual claimants (they get what is left)
***** Last in line if things go bad, BUT 1<sup>st</sup> in line when things are good


* <u>'''Corporations Balance Sheet (ASSETS = LIABILITIES + OWNER'S EQUITY)'''</u>
** '''ASSETS (left side of balance sheet)'''
*** '''''1. Current Assets'''''
**** Cash or assets that can be quickly turned into cash
*** '''''2. Fixed Assets'''''
**** Tangible assets that have long lives, that are typically consumed or used up over lengthy periods of time
***** Accounting rules require that you depreciate fixed assets over a period of years, to indicate that they do wear out and need to be replaced over time
****** So fixed assets are listed on the balance sheet typically Net of accumulative depreciation, to indicate overall wear and tear to your fixed assets
*** '''''3. Intangible Assets'''''
**** Non-physical assets (i.e. intellectual property
*** '''''4. Other Assets'''''
**** Assets that don't neatly fit into the other 3 categories 

* 
** '''LIABILITIES''' '''<nowiki>= debt owed from money borrowed from 3</nowiki><sup>rd</sup> parties''' '''(right side of balance sheet)'''
*** '''''1. Current Liabilities'''''
**** Amounts due within the next 12 months
*** '''''2. Long-term Liabilities'''''
**** Amounts due beyond 12 months

* 
** '''SHAREHOLDER'S EQUITY = amount sh's contributed to the business in exchange for ownership (right side of balance sheet)'''
*** '''''1. Capital Contribution''''' that owners put into the business
**** <u>3 sub-categories</u>:
***** '''(1) Common Stock '''
****** Dollar Value = (# CS outstanding shares) x (CS par value per share)
******* Del- this is called "Capital"
******* NY- this is called "Stated Capital
***** '''(2) Preferred Stock'''
****** Dollar Value = (# PS outstanding shares) x (PS par value per share)
******* Del- this is called "Capital"
******* NY- this is called "Stated Capital
***** '''(3) Additional Paid in Capital (APIC) or Capital Surplus'''
****** Overage of any additional consideration received for selling stock, over and beyond the par value of that stock
*** '''''2. Retained Earnings or Deficit'''''
**** Aggregate amount of money your corporation has made since its inception, that has not been distributed in the form of a dividend
***** If company makes money, you look at Income Statement (Profit and Loss Statement), and the money that is made flows into Assets, and offset is that that money flows into the Retained earnings
*** '''''3. Other Comprehensive Income or Loss'''''
**** Reflects gains or losses not relating to ordinary business operations
**** Ex: Lottery ticket

Hypos: Corp sells 1 share of common stock. The par value is $10/share. It sells to the investor for $1,000. How is this reflected in balance sheet?

{| align="center" cellpadding="10" cellspacing="0" border="1"
|- 
| '''ASSETS'''
|  '''LIABILITIES'''
|- 
|| Cash: $1,000
|| 
|- 
|| 
|| Common Stock: $ 10 (1 share x $10)
|- 
|| 
|| APIC: $990
|- 
|| Total Assets: $1,000
|| Total Liability + Owner's Equity: $1,000
|-
|}
Hypos: Corp sells 50 shares of common stock, par value $5/share and sells to shareholders at $100/share. Then corp. sells 10 shares Series A preferred stock, par value $20, sold for $20 a share.

{| align="center" cellpadding="10" cellspacing="0" border="1"
|- 
||  '''ASSETS '''

|| ''' LIABILITIES '''

|- 
|| Cash: $5,000 (50 shares x $100)
|| 
|- 
|| $200
|| ''' Owner's Equity '''

|- 
|| 
|| Preferred Stock Account: $200 (10 X $20)
|- 
|| 
|| Common Stock: $ 250 (50 x $5)
|- 
|| 
|| APIC: $ 4,750 (50 X $95)
|- 
|| ''' Total Assets: $ 5,200 '''

|| '''Total Liability + '''

'''Owner's Equity: $ 5,200'''
|-
|}
* <u>'''Par Value '''</u>
** '''<nowiki>= Minimum amount of money you can legally charge for your shares of stock</nowiki>'''
*** Par value is arbitrarily decided by the BoD, or more likely the lawyer that forms the company
*** <nowiki>**If you minimize par value</nowiki>→ you maximize the ability to make dividend distributions to stock holders (which is why they are set at a minimum amount)
** '''''Watered Stock'''''- If you sell for less than that, the stock is considered ''Watered Stock'', and thus is assessable and not fully paid
*** If you own watered stock, you can be assessed the remaining amount that you owe to bring it up to the full par value of the shares you bought
*** Also, if you try to transfer your shares (sell them to someone else) to someone with any sophistication at all, they won't buy your watered shares, because they want to buy fully paid and non-assessable stock (because they don't want to get stuck with that liability)
**** More of an issue for private corporations
** '''Par value, historically, was designed to protect creditors'''
*** There's an amount, known as '''''Legal Capital''''' that would not be available for payment of dividends to the Common Stock Holders (CSH shouldn't be 1<sup>st</sup> in repayment food-chain) 
**** A corporation is prohibited from giving money back to the stockholders if it would impair the corporations legal capital (amount of money that is set aside to be available to creditors should the business fail)
** '''Par value is also helpful to stockholders'''
*** In the sense that every stockholder knows that every other stockholder paid ''at least'' the par value for his/her shares (comforting thought)
** '''Problem with Par Value:'''
*** It's been largely made irrelevant by the choosing of very small dollar amounts for par values
*** Why? If you minimize par value→ you maximize the ability to make dividend distributions to stock holders (which is why they are set at a minimum amount)

* 
** '''''Zero (No) Par Value Stock'''''
*** Corporation can issue stock with 0 par value, but does this does not mean there is no value paid! 0 Par value shares doesn't mean that they are sold for no consideration. Rather, this means that there is no specified par value per share. 
**** Gives the BoD on an ''ad hoc'' basis to look at the aggregate consideration it is receiving for those shares and allows the Board to determine what will be deposited into the Common Stock account and what will go into the APIC. 
*** Note: If a board forgets to allocate these investments, then by default, it all goes into Common Stock, which will be advantageous to creditors b/c it increases to capital cushion from which creditors can collect on debts 
*** '''Hypo''': 100 shares common stock – no par value. It is sold to investors for $20 per share. We are selling for $2,000 total. By resolution, the BoD will state that a portion will go into common stock account and remainder to APIC. The Board could decide to allocate $1/share to common stock. That means that $100 would go to common stock and $1,900 into APIC. 

* <u>'''Legal Capital Rules'''</u>
** Designed to protect creditors
** Makes it illegal for BoD to declare and pay a dividend (or other any other distribution) at a time when the company has insufficient capital
** Concept in qs. = '''''Capital Cushion'''''
*** You cannot make distributions out of the capital cushion

* 
** <u>'''Delaware Legal Capital Rule—DGCL 170(A)'''</u>
*** '''Directors may declare and pay distributions on their capital stock out of:'''
**** '''(1) ''Surplus<nowiki>;</nowiki>''' ''or if there is no surplus then out of
***** '''Surplus = (Total Assets – Total Liabilities) – (Capital)'''
****** <u>Capital</u> = (#PS x PS Par Value) + (#CS x CS Par Value)
***** If the surplus is 0 or negative, then look to # 2
**** '''(2)'' Net Income of Current Fiscal Year AND/OR Previous Fiscal Year'''''
***** Can still pay dividend if there's a surplus in current or previous fiscal year
***** Maximum amount would be up to the surplus amount of both combined
****** If only 1 is positive, then amount that can be paid is up to that amount that is positive 
***** <nowiki>*If you do this, you are eating into the capital cushion when you make this payment. This is very anti-creditor, but, this is just how Delaware is</nowiki>
*** '''Liability of directors in favor of paying illegal dividends''': 
**** Directors who vote in favor or concur with an illegal dividend (pay more than what 170(A) says you can pay, are jointly and severally liable for the overpayment (the amount in excess)
***** However, this only applied to directors that do so ''willfully or negligently'' 
***** And, even those directors that are liable, can then seek ''contribution'' from the stockholder that takes the dividend knowing that it violated the legal capital rule

* 
** <u>'''NY Legal Capital Rule—NYBCL 510'''</u>
*** '''Directors may declare and pay distributions on their capital stock out the Corporation passes 2 tests:'''
**** '''(1)'' Equity and Solvency Test'''''
***** Says a NY Corporation cannot pay a dividend when it is Insolvent, OR as a result of paying a dividend will '''''Rendered''''' Insolvent 
****** <u>Insolvency</u> = A corporation that is unable to pay its debts as they become due in the usual course of a debtors business
******* Do you have enough assets to cover the liabilities? 
******** Assets should be > Liabilities
******** <u>Compare</u>:
********* Current Assets vs. Current Liabilities; or
********* Total Assets vs. Total Liabilities (for bigger picture)
***** Assuming that there is a dollar amount from which you can pay dividends (based on the Surplus Test), you then must ask yourself whether paying the maximum amount allowed under the surplus test would ''render the corp. insolvent ''
****** Great place to look to see if after the dividend payment, whether the Current Assets are still > Current Liabilities
******* Simply subtract out the dividend you are thinking of paying
**** '''(2)'' Surplus Test (DO THIS TEST 1<sup>ST</sup>!)'''''
***** Same as Delaware

* 
** 
*** '''Liability of directors in favor of paying illegal dividends''': 
**** Same as in Delaware, but is found in NYBCL 719

* <u>'''What is considered Valid Consideration for Stock?'''</u>
** Big Concern = Future Services
*** Until recently, Delaware did not recognize future services as valid consideration, however, now it does, so long as it is properly documented (i.e. part of a binding obligation)
** Pre-incorporation services 
** '''DGCL 152—'''Cash, Tangible Property, Intangible Property, Future Services (but future services really needs to be properly document)
***With respect to DGCL 153, it's up to the BoD's to value whether the non-cash consideration is equal to the Par Value 
**  NYBCL 504(a)—You can issue stock in the Services Rendered within the formation of the company (even before there's an entity) 

* <u>'''PREFERRED STOCK: '''</u>
** Not every company has preferred stock…most don't
** Is a hybrid security with some Debt-like features & some Common Stock-Like features 
*** <u>Debt-like features</u>
**** Has a stated dividend yield associated with it (interest rate)
***** This yield can be stated as an actual interest rate OR they can specify what the annual dividend is in terms of a dollar amount (implicit) 
**** Preferred stockholders are Contract Claimants 
***** They can take advantage of a written agreement delineated in the corporate charter
****** Normally doesn't appear in main charter document, but rather are generally added by amendment
******* Del—Certificate of Designation
******* NY—Certificate of Amendment
****** Charter itself will have a '''''blank-check preferred stock provision''''' which delegates to the BoDs the decision on whether (and if so, in what amount and what terms) the corporation sells preferred stock at any moment in time
******* It's a delegation from Shareholders to Directors to make that decision within certain parameters that are set forth in the charter itself

* 
** <u>'''2 Preferences of Preferred Stock:'''</u>
*** '''(1) ''Dividend Preference'''''
**** Until the dividend on PS is declared and paid, a corporation is prohibited from distributing ''anything'' to the common stockholders
***** Until the PSH receive what they are owed, a corp. cannot make a distribution to those lower down in the food chain
****** NY- Contractually prohibited
****** Del- Contractually & Statutorily prohibited 
*** '''(2)'' Liquidation Preference'''''
****  If the company goes bankrupt, preferred stockholders are paid (generally a fixed amount – the par value) before distributing any assets to its residual claimants (common stockholders).  
****  The preferred stockholders in essence would get their principal investment back.  
**** Cumulative preferred stockholders would be entitled to arrearage before any common Most PS is only sold to a handful of investors (few insurance companies; pension plans; institutional investors with ability to write a big check)

* 
** <u>'''Types of Preferred Stock'''</u>
*** '''(1) ''Cumulative Preferred Stock'' '''
**** If the board chooses to forego a dividend, then that dividend does not go away, but rather accrues into an '''''arrearage'''''
***** Until this arrearage + current quarterly dividend is paid off, the CSH cannot be paid dividends
**** If 6 quarterly dividends are missed, then the PSH can vote as a separate class and nominate 2 additional BoD's (where the topic of convo will usually always be dividends and arrearage)
***** These BoD's get to sit on the board until these dividends are paid of
*** '''(2) ''Noncumulative Preferred Stock'' '''
**** Missed dividend quarters do not accrue and the board cannot pay dividends for missed quarters even if it wanted to. 
***** When the board finally declares dividends it can only pay for that quarter. Why? — B/c it would be unfair for the common stockholders b/c this would be money that according to the contract, should have gone to the CSH
**** Note: 
***** Venture Capitalists prefer noncumulative preferred stock over common stock
****** They ask for <u>''convertible preferred stock''</u> – which gives the shareholder the option to convert the preferred stock into common stock Why? — Common stock might increase in value beyond the fixed dividend yield of the preferred stock and the venture capitalist would have the option to cash in on this, but have the protection of liquidation preference if the company does not do well.

Venture Capitals prefer noncumulative preferred stock over cumulative preferred stock  

Banks are reluctant to lend to young companies that have arrearage dividends building up.  

Young companies generally don't pay dividends anyway, so the stockholder is not missing out on anything by investing in noncumulative stock  

* 
** In a private corp. it's not unheard of to have 1 investor as a PSH
** '''<nowiki>**The attributes of a particular series of PS really depend on the </nowiki><u>negotiations</u> with your perspective investors. As a result of these negotiations, the Preferred Stockholder may receive:''' 
*** '''1''. Voting Rights''''' in addition to those specified by the statute 
**** Emerge contractually or in bylaws
*** '''2.'' Conversion Rights'''''
**** Ability to convert preferred shares into common stock
*** '''3.'' Participation Rights''''' (uncommon)
**** Gives PSH the right to not only receive a PS Dividend, but also to participate in a CS Dividend paid thereafter, as if their PS were CS
**** Ex: The dividend on preferred stock is $1/share and corp. wants to pay $0.25/share to common stockholders. If you have 20 shares of preferred stock that has participation rights, you would receive: 
***** ($1 x 20 shares) + ($0.25 x 20 shares) 
***** Result→ You would end up with $20 as a straight preferred stockholder but $25 if preferred stock with participation rights
*** '''4. ''Redemption Rights''' ''(Something the CORP usually negotiates for)
**** Right to call in (get rid of), the preferred stock at some point in the future for a specified redemption payment

* <u>'''COMMON STOCK:'''</u>
** Common Stockholders are '''ownership claimants''' on the assets of the corporation
** In a liquidation context, CSH claims are '''residual in nature''' 
*** Only after creditors get paid in full, and if there are PSH, then the PSH get their liquidation preferences + any unpaid and accrued dividends, will the CSH share ''pro rata'' in the remaining assets
** '''''Voting Rights''''' = CSH main source of power
*** '''1.''' Election of Directors
*** '''2.''' Charter Amendments
*** '''3'''. Fundamental Corporate Transactions (Mergers)
*** '''4.''' MAY get asked to vote on By-Law changes
**** This is often shared power with the Directors 
*** '''5.''' Dissolution
**** Whether or not to throw the towel in
** Common Stock normally entitles each holder '''1 vote per share '''
*** BUT under Del. & NY law, it is possible to issue a class of either:
**** '''''Non-voting Common Stock—'''''No votes at all
**** '''''Super-voting Common Stock—'''''Stock with more than 1 vote per share
*** Non-voting and Super-voting comes in handy when corp. is trying to bring in investment capital, but also maintain control within the hands existing, founding shareholders (family)
** CSH are '''normally NOT entitled to dividends'''
*** If a dividend is being considered, it's payable at the discretion of the directors + only out of funds legally available for the payment of dividends (legal capital)
*** Dividends do not have to be in cash, although they typically are 
** '''''Preemptive Rights'' (what can CSH do maintain our percentage ownership?)'''
*** Give CSH the right (not obligation) to purchase enough of a new offering of stock so that they maintain their percentage of ownership
**** Under both Del. & NY law a ''preemptive rights provision'' must be in the corporate charter, or the shareholders are deemed not to have it
***** Across the board→ In corp. charter
**** But, it's not unusual for an investor to say "by contract I want preemptive rights, so that I get preemptive rights and the other holders do not"
***** Individually→ Contractually 

==CORPORATE FORMATION AND LIABILITY ISSUES==

===CORPORATE GOVERNING DOCUMENTS AND THE INTERPLAY WITH CORP. FINANCE===

* <u>'''3 Main Corporate Governance Documents</u> (In order of supremacy)'''
** '''(1) Certificate/Articles of Incorporation or Corporate Charter '''
*** DGCL 102 & NYBCL 402 lay out what must be in corporate charter, and what cannot
*** <u>Specific NY Requirements under NYBCL 402</u>
**** '''1. Name of Corporation'''
*****  Can't mislead the public 

*****  Can't use the word "police" in your name 

***** It is possible to reserve a corporate name 
**** '''2. Business Purpose '''
***** Could be very specific (could lead to problems with ultra vires)
***** Could be very generic
***** Could be a mix of generic and specific
**** '''3. Class(es) of stock that you're authorized to issue'''
***** If there is a stated par value, then that must be in charter too
***** Corp. must have enough authorized but not issued stock
****** Ex: Corp. Charter can state that the corp. is authorized to issue 1 million shares of common stock with no par value per share, and 500 thousand shares of preferred stock, with $10 par value per share
******* The no par stock means the board will allocate some of the consideration into the common stock account, and the rest into APIC
******* That million shares of common stock is what the board is authorized to issue, up to the point where it has issued a million shares.
******** <nowiki>**Once it has reached the million shares, it has to amend the charter to increase the # to something higher if they want to issue more stock</nowiki>
***** Corps must also delineate what the rights of each series of stock
****** Ex: class A CS may allow voting rights and Class B may not. This must be spelled out in the corporate charter 

* 
** '''(2) Bylaws '''

Detailed day to day corporate governance procedures;

Voting procedures,

Notices for shareholder or director meetings

Names titles of officers and description of officers' functions

Shareholders may always amend the bylaws – this can create a power struggle between shareholders and BoD if the directors are given power to amend by laws – the shareholders will always win 

DGCL § 109(c) – By laws may be adopted, amended, or repealed by the incorporators by the initial directors if they were named in the cert. of incorp. Or before a corp. has received payment for any stock. After sales of stock, any amendment must be voted on by the shareholders

NYBCL §601(a) – Amending Bylaws – if the cert of incorp gives the BoD the ability to amend the bylaws, then the BoD can amend the bylaws w/o shareholder approval 

* 
** '''(3) Board of Director Resolutions'''

Written statements by the members of their resolve of particular actions. For example, refinancing a bank loan.

Often contained in the minutes of the board meetings to see what resolutions were adopted.

Whenever the corp. is going to take material action, it is best to have documented the BoDs approval of that action – the best way to evidence that is to have a resolution from the BoD that they agree it is in the best interest of the corporation

<div>'''ULTRA VIRES DOCTRINE (dgcl 124)'''</div>
* "Beyond a Corporations Power"
** Specifically the powers enumerated in the charter
** Also the powers granted to corporations pursuant to corporation codes (dgcl + nybcl)
* ''Goodman v. Ladd Estate''
** Court having lots of equitable power in this area
*** Is it fair or equitable to allow a corp. to escape from a k based on ultra vires grounds?
** '''Rule'''—'''If all the parties are part of the legal proceeding, a court ''could'' refuse to enforce the k based on ultra vires grounds, BUT, still requires some type of equitable relief to the 3<sup>rd</sup> party involved (put them back to the status quo ante)''' 
* <u>Distinction between: </u>
** Illegal Acts
*** By definition are always against the law, therefore always beyond the corporations power
**** All illegal acts are ultra vires
**** Not all ultra vires acts are illegal
** Unauthorized Acts by Officers
*** More of an approval concept (Agency Issue)
*** Did the person that did what he/she did have the requisite legal authority to do so on behalf of the corporation
**** If not→ can be sued by the corporation 
** Ultra Vires Acts

<div>'''OBJECTIVE AND CONDUCT OF THE CORPORATION (Purpose of a corporation)'''</div>
* Should corporations serve purposes other than maximizing profits for the stockholders?
** Virtually everywhere but Delaware says yes
* ''Dodge v. Ford Motor'' (one end of spectrum)
** Says the purpose of corporation is primarily to make money for the stockholders 
*** Anything else must be very minimal and ancillary
* ''AP Smith Manufacturing v. Barlow'' (other end of spectrum)
** '''MODERN LAW TODAY'''
** Facts:
*** Involved BoDs that decided to give a charitable donation to Princeton University
*** Certain stockholders decided to challenge this
** NJ Supreme Court:
*** Affirms lower courts conclusion that gift was valid, based on common law and statutory grounds
*** <u>'''Common Law Rule'''</u>:
**** Prohibits directors and officers from dispersing any corporate funds for philanthropic or other worthy public causes, UNLESS the expenditure is:
***** 1. Reasonable in amount; and
***** 2. Would benefit the corporation (contribute to profits) 
****** TODAY, the benefit does not have to directly contribute to profits, but CAN provide indirect or tangential benefit to the corporation
*** <u>'''NJ Statute: '''</u>
**** Corp. charity must be 
***** 1. Reasonable in amount
***** 2. Must satisfy 2 conditions:
****** (i) Cant be making donation to someone that dominates the company
******* Charity in question cannot own more than 10% of stock
****** (ii) Contribution cannot exceed more than 1% of capital or surplus, unless the stockholders affirmatively approve a larger gift 
*** Court recognizes the '''big danger''' of corporate charitable giving—CEO makes decisions on these big gives, and often have their "pet charities"
* '''Can NY and Delaware give Charitable Donations?'''
** Yes, both have Statutorily implied power
*** DGCL 122(9)→ Every corp. created under this chapter shall have power to make donations for the public welfare, or for charitable scientific educational purposes or in times of war for the aid thereof
*** NYBCL 202(a)(12)→ subject to any limitation in the chapter or cert of incorp shall have power in furtherance of its corp purpose to make donations to irrespective of the corp's benefit
** Reasons for corps to give gifts:
*** Does good in world
*** Branding and PR effects that work to advantage of the corporations
* '''Alternative to Corporate Gifts?'''
** Have the corporation simply give out the money to the stockholders in a form of an extra dividend 
*** Then shareholders can decided if they want to give any money to charity and if yes, then to which specific charity
* '''What if a stockholder does not agree with the charity the corporation chooses?'''
** If you have a large block of shares you might have some influence with the board, but if you are a little guy then your only option is basically to sell your shares
* '''Does Del. or NY law allow a board of directors to consider constituencies other than shareholders when making business decisions?''' 
** For example, you have plants around the US and you decide to close the one in Ohio, can you consider the economic impact on the community when making the decision
** '''NYBCL §717(b)''' – NY is more constituency friendly when a board takes action relating to a change of control they can consider
*** The short and long term interest of the shareholders and its impact on
*** Corps current employees
*** Retired employees
*** The corps customers and creditors
*** The employment opportunities and impact on he community 
** '''Delaware– there is no constituency statute. '''
*** All rules dealing with constituencies are from case law. They generally deal with hostile takeovers typically offer cash to buy their stock, moving corp headquarters. In a takeover context, boards can consider the needs of constituencies other than shareholders provided they bear some reasonable relationship to shareholder interests ''i.e.'' consider any constituency you want so long as it benefits the shareholders. Haas thinks this is funny. 

<div>'''PRE-INCORPORATION TRANSACTIONS BY PROMOTERS'''</div>
* Generally the entrepreneurs that are starting their own business
* Under both NY and Del. Law, pre-incorporation services are in fact valid consideration for stock
** In theory you can start your own business without putting any money, but this is not recommended because capitalization is a crucial factor with respect to veil piercing 
* '''Pre-Incorporation Contract = '''Contract entered into before the corporation even exists 

* <u>'''Liability for Promoters for Pre-incorporation Contracts:'''</u>
** <u>'''General Rule'''</u>- '''Promoter's are personally liable for all pre-incorporation contracts '''(''Goodman v. DDS'')
*** <u>'''Exception'''</u>- Where you're able to get the 3<sup>rd</sup> party to acknowledge that the corp. doesn't yet exist, but nonetheless agree to look solely to corp. once formed for performance. If this occurs, the promoter will be off the hook
**** Promoter is responsible for carrying the burden of proof on the exception
**** Evidence 
***** Best evidence = If it is in the pre-incorporation contract (that the 3<sup>rd</sup> party agrees to look to the corporation once formed)
***** Can also show from circumstances that make it reasonably certain that the 3<sup>rd</sup> party was looking to the corporation once formed for performance

* <u>'''3 Concepts of what a corp. could do</u> (Does the Corp, once it is formed, have to be bound by the Pre-Incorporation Contracts, and if it is bound, what does that mean for promoter liability?)'''
** '''(1)'' Adoption'''''
*** Once corp. is formed, it can adopt the pre-incorporation k. 
**** It doesn't have to….it can choose to reject it
*** Note that the corp. doesn't need to take formal action when adopting the k
**** Simply acknowledging that the contract exists and accepting the benefits of that contract would an '''''implied adoption''''' under the law 
*** <u>Liability</u>:
**** When a corp. adopts a pre-incorp. Contract, both the corporation & the promoter are on the hook, jointly and severally 
***** If the promoter wants to be off the hook, the promoter must have the 3<sup>rd</sup> party enter into a Novation

* 
** '''(2) ''Novation'''''
*** Mirror-image agreement of exact same contract; Substance hasn't changed
*** Simply substituting the corporation in exchange for the promoter
**** Switching out name of promoter for the name of the corporation
*** <u>Liability</u>:
**** If this happens, then the promoter is completely off the hook

* 
** '''(3) ''Ratification'''''
*** Agency Concept, which only has meaning if there is a principal and an agent 
*** If the corp. has not yet been formed, then there is no principal, and if there no principal, then there cannot be an agent
**** So it would be wrong to say that the corp. once formed ratified the pre-incorp. K
**** Rather, ratification only has relevance in ''post-incorporation'' contracts (Not pre)

<div>'''CONSEQUENCES OF DEFECTIVE INCORPORATION (Are there times where individuals who screw up the incorporation process, or who never even attempted to incorporate at all, deserve the benefits of the corporate form, specifically Limited Liability)'''</div>

* <u>'''3 Concepts in this area:'''</u>
** '''(1) ''De Jure Corporation'''''
*** Corporation that HAS been legally formed under the law
**** You know this because you receive back from the State a certified copy of your charter
*** If you are a De Jure corp., then you get the benefits of limited liability (exception-veil piercing)
** '''(2) ''De Facto Corporation'''''
*** This will shield the unintentional or inadvertent promoter from personal liability, even though she has messed up the incorporation process from everyone EXCEPT the State if the elements are met
**** Why doesn't de fact work with the State?
***** State is the one who grants the incorporation to begin with
****** So don't go arguing to the State, the one who grants limited liability in the 1<sup>st</sup> place, when they never granted the incorporation in the 1<sup>st</sup> place
**** <u>'''3 Elements</u>:'''
***** 1. Must have put together charter and have it executed
***** 2. Must have made a bona fide effort to file that charter with the State
***** 3. Lastly, thinking you were a corporation, you must have exercised corporate power (you act like a corporation)
** '''(3) ''Equitable Estoppel (Juxtaposed with de facto defense)'''''
*** Ultimate fallback. If you don't have a de jure corp., and can't satisfy the elements of a de fact corp., then, pull out estoppel
*** <u>Estoppel</u>- Denies 3<sup>rd</sup> parties who've dealt with the business thinking it's a corporation, from now arguing in court that it's not a corporation
**** These 3<sup>rd</sup> parties that dealt the business thinking it was a corp. never expected to be able to go after the owners if they can't get paid, are now estopped in court from asserting the lack of incorporation
*** '''<nowiki>**NOTE: Estoppel is not embraced in NY** </nowiki>'''
**** For same reason as in De facto corp., except estoppel is even worse because you 

===PIERCING THE CORPORATE VEIL===
(When should people be denied the benefit of limited liability?)
* Getting at the assets of the Stockholder-Owners
* ''Fletcher v. Atex (Delaware veil piercing)''
** Plaintiff's argued that Kodak should be held liable for the torts of its indirect wholly own subsidiary

* <u>'''Delaware Veil Piercing '''</u>
** '''You can pierce the corporate veil by either showing:'''
*** '''(1) Fraud—'''The corporation was formed for the purpose of defrauding the public (the corporate entity was the vehicle of fraud)
<div>'''OR'''</div>
*** '''(2) Alter-Ego—'''Show that the corporation in question is a mere alter ego of its shareholder-owners. 
**** <u>Must show the Parent Corp.''' '''and Subsidiary Corp:</u>
***** '''1. ''Operated as a single economic entity'''''
****** <u>'''Factors'''</u>:
******* '''(i) *Adequacy of capitalization<nowiki>* </nowiki>'''
******** Does the shareholder in question have a sufficient investment to lose?
******** Think about what the business is doing or planning on doing, and juxtapose it against other companies in that industry and what they've been capitalized with 
******* '''(ii) Insolvency '''
******** But, it's a given the company in question is insolvent, otherwise it would just pay the claim of the creditor
******* '''(iii) *Corporate Formalities*'''
******** Must maintain a documented separateness between parent corp. and its subsidiary 
******** Whether dividends were paid?
******** Corporate records kept?
******** Officers or directors functioned properly?
******** Corporate formalities observed – does the Board of the subsidiary meet, does the parent recognize shareholder approval before subsidiary action, does the subsidiary file its own taxes, etc.
******* '''(iv) Siphoning of Funds'''
******** Treating the company as your personal ATM machine 
***** '''2.'' Doing so resulted in some type of injustice or unfairness'''''
****** No conclusory statements 

* ''Walkovsky v. Carlton NY (veil piercing)''
** Plaintiff was hit by a cab owned by scion cab company
*** Goal was to get at the personal assets of Carlton by piercing the corporate veil
**** <nowiki>**Assets do include all the stock Carlton owns within the other 9 companies </nowiki>
** Carlton allegedly owned to stock of that cab company as well as 9 other cab companies 
*** To limit his liability, Carlton kept his assets to a bare minimum within each of his 10 companies 

* <u>'''NY Veil Piercing'''</u>
** '''Can pierce a NY corporations' veil when:'''
*** '''(1) Fraud''' (whenever necessary to prevent fraud)
**** '''OR'''
*** '''(2) Equity''' (to achieve equity)
**** <u>2 ways this can occur:</u>
***** '''1. ''Corporation is the mere dummy''''' for its individual shareholders, who in reality, are carrying on the business in their personal capacities for purely personal ends (rather than corporate ends)
****** <u>Look at:</u>
******* '''(i) Was corp. the SH's personal agent?'''
******** Did the shareholder in question (Carlton) treat the corporation as his personal agent, rather than as a separate entity with its own unique agenda?
********* Doesn't mention Capitalization, but it's implied that if the company has its own agenda, it'll likely need adequate capitalization so that it can pursue that agenda 
******* '''(ii) Commingling?'''
******** Was there any commingling going on between: 
********* Personal assets and personal business
********* Corporate assets and corporate business
******** This brings in the play of '''corporate formalities, control, and domination'''
***** '''2. ''Corporation is a fragment of a larger corporate combine''''' which actually conducts the business'''. '''
****** If this is the case then only the larger corporate entity would be liable and the shareholder would not be personally liable
* ''Minton v. Cavaney (California)''
** Interesting because the corporation in this case did not issue any stock 
** So if you're piercing the veil to get at the assets of the stockholders, and no one was ever issued stock, then whose assets do you go after?
** Court: 
*** Looked at the notion of '''''"Equitable/Beneficial Ownership'''''"- Someone not registered in the ledger, but is deemed to own, or have the rights of all beneficial attributes of stock
**** Distinguished from "record ownership"- which is a list of stockholders who are in the records of the corporation itself as stockholders (delineated in the corporate ledger)
*** '''''Equitable owners'' may in fact find themselves personally liable for debts of the corporation that the corp. cannot pay, <u>if they engaged in the following acts:'''</u>
**** '''1.''' Did they treat the assets of the corp. as their own personal assets?
***** Failure to maintain separateness
***** If there are no assets then this is impossible
**** '''2.''' Did they add or withdraw capital from the corp. at will?
***** Siphoning of funds
**** '''3.''' Did they hold themselves out as being personally liable for the debts of the corp.? 
***** If you pay bills with your own personal check, it seems to imply that you yourself are personally liable for those debts
**** '''4.''' Did you provide adequate capitalization?
**** '''5.''' Did you actively participate in the conduct of the corporation?

* <u>'''How to Avoid a piercing of your Corporate Veil'''</u>
** '''1. Do your Corporate Housekeeping'''
*** Keep minutes of meetings (which means you must have meetings, which also means you need a board of directors)
*** Treat corporation as a separate and distinct entity
**** Keep documented separateness 
*** ''Kinney Shoe Corp. (pg. 443)''
**** "Adhering to the relatively simple formalities of creating and maintaining a corporate entity is a relatively small price to pay for limited liability" 
** '''2. Do not commingle personal and corporate funds '''
*** Must have separate corporate bank account
*** Should not pay corporate bills with personal checks 
** '''3. Properly document monies paid to shareholders for what they are '''
*** If you're taking money out, it needs to fall into 1 of several buckets
**** (i) Salary or Bonus
**** (ii) Payment of a loan 
**** (iii) Dividend (make sure legal capital rules are satisfied)
** '''4. Adequately capitalize your corporation '''
*** Make sure your corporation has economic substance (not just form)
**** Must put in the minimal amount of capital customary for the type of business that you're running 
*** ''Kinney Shoe Corp.''
**** "When nothing is invested in the corporation, the corporation provides no protection to its owner; nothing in, nothing out, no protection."
* Note: 
** Limited Liability DOES NOT mean risk free investing. 
*** It's only limited in the sense that you can only lose your investment, unless your veil is pierced
** Do shareholders have a legal obligation to contribute more capital to a failing business (even one that initially was adequately capitalized, but now isn't)? 
*** No, because capitalization is important when you are setting up the business (when you're 1<sup>st</sup> engaged in business) 
**** There is no legal obligation to put more money in later on down the road 
**** Exception = Hedge Funds
***** The committed investor to the hedge fund, by contract, can make a "''capital call''"

<div>'''PIERCING THE LLC's VEIL'''</div>
* ''Kaycee Land and Livestock v. Flahive''
** <u>Held</u>- '''There is no reason to not allow piercing the LLC's veil if traditional corporate oriented factors exist:'''
*** Adequacy of capitalization 
*** Siphoning funds and Commingling money 
*** Holding yourself personally responsible for the debts of the company 
*** Formalities (but naturally much less than what's needed for a corporation)

<div>'''EQUITABLE SUBORDINATION OF SHAREHOLDER CLAIMS (Deep Rock Doctrine)'''</div>
* <u>'''Deep Rock Doctrine</u>- Doctrine that can come into play to punish controlling stockholders when they try to cut in line in the repayment food chain '''
** Many shareholders who control their corporations also lend money to their corporations 
** Equitable Subordination tells us that under the right circumstances, the creditor-claims of those controlling stockholders could be equitably subordinated to the claims of all other creditors + preferred stockholders (if there are any)
*** '''Court will do so based on its equitable power if it sees inequitable conduct, engaged in by the controlling stockholder, designed to give it some edge'''
* Much less drastic than veil piercing 
** Your claim as a creditor is simply put to the back of the line, but no one is going after personal assets 
* <u>'''3 Conditions to find Equitable Subordination is Appropriate'''</u> (''Benjamin v. Diamond'')
** '''''(1) Inequitable Conduct'''''
*** Stockholder must have engaged in Inequitable Conduct 
*** Does not have to rise to the level of fraud (although it could)
** '''''(2) Injury to Creditors'''''
*** Misconduct must injure the creditors, or confer some advantage to the stockholder in question
** '''''(3) Consistent with Bankruptcy Code'''''
*** Granting the remedy cannot be inconsistent with the Bankruptcy Code 
*** Ex: ''Costello v. Fazio''—equitable subordination came up when the corporation was already in bankruptcy 
**** In this case there was a partnership that was not doing well financially, that decided to convert to the corporate form
**** As part of the conversion process, 2 of the 3 partners took out "sizeable amounts" of their capital contributions made when the partnership was 1<sup>st</sup> formed 
***** They took it out in the form of Promissory Notes (IOU's)
***** Result- 2 of the partners were now also creditors 
****** They did this primarily to cut in line in the repayment food chain (because getting something as a creditor is better than getting nothing as a stockholder)
**** Bankruptcy Trustee saw right through this scheme
***** Disallowed the 2 promissory notes (viewed them as illegitimate creditor-claims) and the Court of Appeal agreed
***** Found:
****** Corp was grossly undercapitalized 
****** 2 shareholders only did what they did for personal benefit, at the expense of the legitimate creditors 
**** Result = 2 stockholder-creditor-claims were equitably subordinated below the claims of the legitimate creditors, thus they stood last in line amongst the common stockholders 
* ''Arnold v. Phillips''—situation where a party makes an equity investment + a loan to her corporation at inception, from day 1
** Court has the equitable power to decide that some or all of your loan should be re-characterized as equity if it finds the corporation was under-capitalized
*** Court can convert some of your loan into Common Stock investments (i.e. equity)
*** HOWEVER, once a corporation is deemed adequately capitalized (at inception), then later on, if an equity owner wants to put more money in her business in the form of a loan, there is nothing wrong with doing so 

==CORPORATE STRUCTURE==

===DISTRIBUTION OF CORPORATE POWERS===
(between shareholders, directors, and officers)
* Mostly statutorily based, but there is case law

* <u>'''General Rule'''</u>- '''The business and affairs of the corporation will be managed by, or under the direction of the Board of Directors (not shareholders)'''

* <u>ALI Principle's of Corporate Governance</u>- goes even further 
** Says that with a publicly traded corp., the business will be conducted by or under the supervision of the principle senior executive officers
*** Reflects the reality that it's the senior executives at the corp. day-to-day to call all the shots, whereas most BoDs of publicly traded company's are watchdogs

* '''''Business Judgment Rule''''' 

* '''Rebuttable legal presumption running in favor of defendant directors, stating that when they make a business decision, the presumption is that they have satisfied their fiduciary duties '''
** Up to Plaintiff-shareholders to overcome the presumption

* If you cannot overcome the BJR presumption, then the only thing the directors have to show is that what they have done is attributable to '''''any rational business purpose '''''

* '''''Compelling Justification Standard '''''

* '''Whenever directors take <u>unilateral</u> action that impinges or impedes shareholder voting, the directors must meet the compelling justification standard '''

* '''Without a compelling justification, it is a breach of duty of loyalty'''

* ''Schnell v. Chris-Craft Industry''—directorial action enjoined based on equitable grounds 

* Plaintiff-Shareholders sought to enjoin Management of Chris-Craft from moving up the date of the annual meeting
** Management wanted to do that to make it more difficult for the shareholders to successfully wage a ''proxy contest'' (a fight over who should be reelected as directors)
*** By moving up the meeting date, the shareholders would have less opportunity to mount the fight to put their nominees in place of the incumbents on the BoDs
* '''The power to amend the bylaws was, within the charter, shared between the BoDs and the shareholders (permissible under DGCL 109)'''
** So what the BoDs did was fine, because it was authorized by the stockholders by means of the charter provision
** '''HOWEVER, even though this was statutorily permissible under DGCL 109, it was nonetheless inequitable to do that'''
*** It's interfering with the shareholders ability to elect the directors of their own choosing
**** It's a group of directors that are putting their own personal needs to stay on the Board ahead of what might be in the best interests of the corporation
***** Breach of Duty of Loyalty! 

*''Blasius Industries ''
** '''Facts''':
*** Largest stockholder of Atlas Corp. was budding heads against the Defendant-Directors of Atlas Corp. 
*** Blasius owned about 9.1% of the outstanding shares
** He wanted to see the Management of Atlas engage in a Leveraged Recapitalization
****** '''''Leveraged Recapitalization'''''
***** Borrow as much $ as possible secured against the assets of the corporation
****** Take that big bag of money as Loan Proceeds and 
****** Distribute that money to the common stockholders in the form of a special cash dividend 
*** When management wasn't very keen on this idea, Blasius took matters into his own hands
**** Reached out directly his fellow shareholders to get their consent to specific action against the BoD's of atlas corp. 
*** Blasius consented to, and hoped other would consent to:
**** 1. Precatory resolution (because is not mandatory)
***** Recommending the board pursue a leveraged recap
**** 2. Amendment to Atlas Bylaws
***** To expand board from 7 to 15 members 
**** 3. Blasius has 8 nominees ready to be elected that would consent to leveraged recap
*** Blasius sues
*** Management-directors defended themselves on:
**** '''''1. Business Judgment Rule—''Rebuttable legal presumption running in favor of defendant directors, stating that when they make a business decision, the presumption is that they have satisfied their fiduciary duties '''
***** Up to Plaintiff-shareholders to overcome the presumption
**** '''''2. Unocal Defense—'''''That a leveraged recap being foisted upon us, against our desires, is a threat, and under Unocal, we are '''entitled to take defense legal actions designed to proportionally defeat threats that are posed '''
** '''Court:'''
*** '''''Compelling Justification Standard'''''—Whenever directors take <u>unilateral</u> action that impinges or impedes shareholder voting, the directors must meet the compelling justification standard 
**** Without a compelling justification, it is a breach of duty of loyalty

**<u>'''Rule'''</u>—Stockholders are allowed, by written consent, to anything they could do at a shareholders meets, but without actually having that meeting (DGCL 228)

*''CA, Inc.—''Dealing with bylaws and their importance to corporate governance
** Defines <u>'''Bylaws'''</u>- Rules and procedures that bind a corporations board and shareholders
** More and a process and procedural oriented set of governance rules (mechanical notion)
** In this case, a Union which held stock in CA, Inc., sought to include an amendment to the bylaws in CA's proxy materials for an upcoming meeting of shareholders 
*** As a publicly traded company, CA is required to follow the Federal Securities Laws, when it reaches out to shareholders about something the shareholders are going to vote on
** <u>'''General Rule'''</u>—Publicly traded companies must include shareholder proposal that is submitted in a timely fashion
*** <u>Exception</u>
**** If the shareholder proposal would be approved, would cause the company to violate state law 
** In this case, the amendment in question would have forced CA to reimburse any shareholder who nominated 1 or more directors to the board, if those nominees were elected 
*** Del. Sup. Ct. decided this would violate state law
**** B/c it could cause the directors of the company to pay out reimbursement in violation of their fiduciary duties in some instances 

*''MM Companies v. Liquid Audio''
** Liquid Audio's board, as a defensive response to the challenge posed to it by MM companies, decided to expand the board from 5 to 7 members, and fill those seats with management friendly nominees 
*** Did it in a way designed to stop MM Companies from putting on some of its own nominees
** <u>Del. Court noted</u>: That what the directors had done was in fact a defensive action, but such action impeded the shareholders ability to vote on directors of their own choosing
*** Thus, this implicated the '''''Compelling Justification Standard '''''& '''''Unocal''''' defensive strategy standard 
**** <u>'''<nowiki>**Meshing Blasius & Unocal**</nowiki>'''</u>
***** '''If the primary purpose of unilateral board action is to impede shareholder voting, and this is done for defensive purposes, then:'''
****** '''1<sup>st</sup> the directors have to show a compelling justification for doing what they did,'''
****** '''Assuming a compelling justification is shown, then the court will consider the defensive response under the 2 prong Unocal analysis'''
* ''Williams v. Ghier''
**  Inside Directors (management-directors)—Senior executive officers that sit on the BoD (CEO) 

Important to note that it's very typical that the inside directors will fall in line with the CEO (b/c ceo is their boss) 

Also includes anyone that is outside the company but can really be fired by the ceo 

Examples: Outside legal counsel or investment bankers 

**  Outside Directors (Independent Directors)—People that have no affiliation with the company except that they sit on the board 

Delaware courts give great deference to committees made up of only independent directors 

B/c these aren't board members that are really biased towards the BoD's proposals 

** If you want to provide information to shareholders of a publicly traded company for voting purposes, you have to follow the Federal Proxy Rules 
* '''What ability does a BoD's have NOT to file a shareholder approved charter amendment?'''
** Generally do not have this authority
*** <u>One Exception</u>- If the Board retains the authority to abandon an amendment, then it has the power to do so

===AUTHORITY IN GENERAL===
* Corporate directors and officers as agents of the corporation
* <u>'''Agent'''</u> – a person who acts on behalf of and subject to the control of another
** <u>General Agent</u> – authorized to conduct a series of transactions involving continuity of service. E.g. corporate officer
** <u>Special Agent</u> – authorized to conduct only a single transaction, or only a series of transactions not involving continuity of service – the agent is hired for a specific limited purpose

* <u>'''Principal'''</u> – a person on whose behalf and subject to whose control an agent acts
** <u>3 Types of Principals:</u>
*** '''''1. Disclosed Principal'''''
**** <nowiki>= The third paerson knows that the agent is acting on behalf of a principal and knows the principal's identity</nowiki>
*** '''''2. Partially Disclosed Principal'''''
**** The third person knows the agent is acting on behalf of a principal but does not know the identity 
*** '''''3. Undisclosed Principal'''''
**** The agent purports to the third party that he is acting on his own behalf. The principal is still subject to liability

* <u>'''Liability of Principal → 3<sup>rd</sup> Party '''</u>
** If the Agent has the '''''requisite legal authority''''', then the Principal will be bound to 3<sup>rd</sup> parties for the Agents' actions (Actual; Apparent; Agency by Estoppel; Inherent; Ratification)
*** <u>'''5 ways an Agent might have Requisite Legal Authority </u>(principal is responsible)'''
**** '''''1. Actual Authority '''''
***** <nowiki>= Agent reasonably believes the Principal has authorized her to so act on behalf of corporation</nowiki>
****** <u>Express</u> – "I authorize you to contract in my name and purchase 100 shares of Western Union stock at today's market."
****** <u>Implied</u> – the instructions are less precise. "I authorize you to sell my automobile." Express in this instruction is the authority to transfer title to the vehicle in exchange for money. But implied is the authority to extend credit or a payment plan, or to accept something in partial exchange.
******* <u>Incidental Authority</u> – an offshoot of implied authority. The authority to do incidental acts that are reasonably necessary to accomplish an actually authorized transaction. 
******** Ex: principal gives authority to sell something at auction. Law requires a license to sell at an auction. Getting the license is an act incidentally authorized by giving the authority to sell something at auction
**** '''''2. Apparent Authority '''''
***** <nowiki>= Based on what the 3</nowiki><sup>rd</sup> party perceives, in accordance with the Principal's ''actions or words'' as to whether or not the Agent had the authority to do what she did 
****** Importance of "'''Power Position'''"—By a Principal granting a position to the Agent in question, an outsider would believe that because you have that position, you thus have the power to do what typically goes hand-in-and with that position 
**** '''''3. Agency by Estoppel '''''
***** <nowiki>= Where a 3</nowiki><sup>rd</sup> party might change her position based on careless actions of the Principal (or alleged principal)
***** <nowiki>= OR, where the alleged Principal </nowiki>''knew'' the 3<sup>rd</sup> party was about to change her position, yet failed to take reasonable steps to notify her of the true state of affairs 
**** '''''4. Inherent Authority '''''
***** <nowiki>= Principal </nowiki>''should have foreseen'' that the Agent would engage in conduct that was not explicitly authorized, and in fact violated the Agent's direct instructions 
****** Covers the "overzealous and negligent" agent 
**** '''''5. Ratification'''''
***** <nowiki>= Where Principal, with knowledge of the material facts, either:</nowiki>
****** (i) Affirms the Agent's conduct by manifesting an intention to treat the Agent's conduct as authorized; or 
****** (ii) Engages in conduct that is justifiable ''only if ''the Principal had such an intention 
***** Ex: P authorizes A to sell a stove at a specified price w/o a warranty. A purporting to have the authority to do so, contracts with T for the stove at a lower price than specified and with a 2 year warranty. P receives the check given by T knowing all the facts. The k made between A and T is then affirmed. 
** '''''Acquiescence '''''
*** If the Agent performs a series of acts similar in nature, the failure of the Principal to object to them is an indication that the Principal consents to the performance of similar acts in the future under similar circumstances. 
**** The Principal's acquiescence gives rise to actual authority.
** <u>'''Termination of Agent's Authority '''</u>
*** A Principal has the power to terminate an agent's authority at any time, even if it means violating a contract between Principal and Agent. 
**** The agent could sue for damages under the contract, but the court will not force the Principal to allow the Agent to conduct business on his behalf
***** <u>Exception</u>: Agency coupled with interest 

* <u>'''Liability of 3<sup>rd</sup> Party → Principal '''</u>
** The 3<sup>rd</sup> Party is liable to the Principal if the 3<sup>rd </sup>Party enters into a contract with an Agent under which the Agent's Principal would be liable to the third person
*** <u>Exception</u>: If the Principal was undisclosed and the Agent or Principal knew that the 3<sup>rd </sup>party would not have entered into the contract had he known the Principal's identity 

* <u>'''Liability of Agent → Principal '''</u>
** If the agent had actual authority, he is not liable to the principal; 
** If the agent had apparent authority, she is liable for damages; 
** If the agent's actions were ratified, the agent is not liable 
** The agent is liable to the principal if he had no actual authority
** Example
*** Agent is selling Blackacre to the purchaser. The agent has ''apparent authority'', but the agent had no ''actual authority'', because the principal said "call me before you sell", and the agent sold without doing so. Result = the agent is liable to the principal.

====ACTION BY DIRECTORS (BoD)====
* <u>Modern Model of Corporate Governance</u>—Says that '''Directors DO NOT actually manage''' (certainly true in the publicly traded corporation context)
** Public BoDs have constraints on their time, as well as on the information that they receive
** Also, unfortunately very often, a corporations Board is made up of people that are either economically or psychologically tethered to the CEO of that corporation
*** Thus if you're expecting "free-spirited" debate for people to stand up for the principles they believe in…. don't hold your breath 

* <u>'''Staggered/Classified Boards of Directors'''</u>
** BoDs that broken up, typically into 3 classes
** In each class, the Directors come up for reelection in successive years (rolling election)
*** Key = Majority of Directors are NEVER up for reelection at the same time 
**** This operates as a very nice take-over defense, because usually, 1 strategy of the hostile party is to replace a majority of the incumbent directors of the target company with new directors who are open to doing a deal with the hostile party 
** DGCL §141(d) – a staggered board provision must be set forth in the cert of incorp or amendment by shareholder approval. Classes limited to a maximum of three.
*** The board itself cannot adopt a classified board 
** NY NYBCL §704(a) – Allows you to divide directors into as many as 4 classes. So in NY, it could take as many as 3 years for dissident shareholders to replace directors. 
*** It would take 3 annual meetings to take control of your directors

* <u>'''How do Directors take Legally Binding Action?'''</u>
** '''(1) Through ''Unanimous Written Consent'''''
*** What people follow if you don't want to have a meeting (don't have time for a meeting) OR if whatever the issue might be is not controversial, therefore it's not hard to get a Director to sign a document and send it back [DGCL 141(f)]
**** The key = Unanimous (So if you can't find even 1 director, then you must have a meeting)

* 
** '''(2) Have a ''BoD Meeting'' '''
*** Way to take action, deliberate issues, and propose resolutions (because generally, unanimous written consent is for non-controversial things)
**** '''1. Regular Meeting'''
***** Formal notice not required – the directors are already on notice of date/time/place. 
**** '''2. Special Meeting'''
***** Notice of date/time/place must be given to every director
*** Director's DO NOT have to attend the meeting in person (Can be telephonically or video)
*** <u>'''Within the meeting, you need 2 things in order to take legally binding action:'''</u>
**** '''1. MUST have a ''Quorum'' of Directors present at the meeting'''
***** <nowiki>= Legal requirement that a critical mass of the Directors be at the meeting (in person or telephonically), so that what they do binds the corporation and its shareholders </nowiki>
***** <u>'''Default Rule</u>→ Majority of entire authorized board (not just those entirely in office)'''
****** So if there are vacancies on the board, you may have a more time achieving a quorum 
****** <nowiki>*Both Del. & NY allow you to have a quorum threshold </nowiki>''higher ''than a majority 
****** <nowiki>*Both also allow you to have a quorum threshold </nowiki>''lower ''than a majority, but no less than 1/3<sup>rd</sup> of the entire authorized board 
**** '''2. Assuming there is a quorum of directors present at the meeting, you also need the ''Requisite'' ''Vote'' that is required to pass the measure '''
***** <u>'''Default Rule'''</u>→ '''A majority vote of the directors at a meeting, at which a quorum exists '''
****** You can increase the voting threshold to make it ''higher'' than a majority (this will make it harder for BoDs to take action), but you cannot decrease that threshold
**** Example:
***** Corporation has 9 directors, and it's charter allows for 1/3<sup>rd</sup> of the directors to equal a quorum
****** Quorum = 3 Directors must be present at meeting
****** Voting = Majority of quorum = 2 Directors are needed to bind the corporation

====ACTION BY SHAREHOLDERS====
* <u>'''How Shareholder's vote for Directors '''</u>(Type of Vote necessary to elect a director)
** '''''Plurality Voting''''' (majority of the time)
*** In a ''contested election'' scenario (more people running than there are open seats), the top vote getters will win the seats 
*** <u>'''Manner in which Shareholder's get to cast their votes:'''</u>
**** '''''Traditional/Straight Voting'''''
***** All or nothing
***** <u>'''Steps</u>:'''
****** '''1. Receive a # of votes equal to the # of shares you own'''
****** '''2.''' '''You then get to place ''that exact #'' on a number of nominees, equal to the number of open seats''' 
****** Ex: If there is 1 thousand shares of stock, you get to put 1 thousand votes on a number of nominees up to the number of open seats 
***** Note that if you are a majority shareholder, and the manner in which shareholders cast your vote is traditional/straight, you WILL control the board every time

Ex:  
* Majority has 501 shares 
* Minority has 499 shares 
* There are three openings on the board 
* A, B, C are nominated by the majority 
* We don't like A, B, C so we nominate X, Y, Z 
* We vote 499 votes EACH for X, Y, Z, 
* The majority nominees will get 501 votes each 
* We as the minority can never win  

**** '''''Cumulative Voting (Only for Directors + must be in Charter)'''''
***** Cumulative voting <u>only</u> comes into play in the context of electing directors (has no relevance in any other scenario)
***** MUST be in corporate charter 
***** <u>Purpose</u>→ This helps minority shareholders nominate and elect at least 1 representative to the board, so that he/she could then speak up for the needs of the minority
***** <u>'''Steps</u>:'''
****** '''1. First you determine the aggregate # of votes that you receive'''
******* '''(# shares you own) x (# votes per shares) x (# open seats)'''
****** '''2. You then get to take that aggregate # of votes, and get to split them up any way you want '''
******* Can put them all on just 1 nominee
******* Can split them evenly or unevenly over multiple nominees
****** The ability to concentrate your voting power is the big distinction 

* 
** <u>'''Do you have enough shares to nominate and elect a director?'''</u>
*** <u>'''Formula'''</u>: '''N = [(X) x (D+1)] / (S)'''
**** '''N''' = # of Directors '''you''' can/want to elect (must be a whole #)
**** '''X''' = # of shares you own
**** '''D''' = Total # of Directors to be elected 
**** '''S''' = Total # of shares that will be voted at the meeting all together 
***  Example 1: 

5 open seats on board; There are 1000 shares of common stock; You own 100 shares  

N= [(100) x (5+1)] / 1000  

N = .6 → This is less than 1, so we don't have enough shares to vote a person to the board 

***  Example 2: 

Instead of 100 shares, I own 300 shares 

N = [(300) x (5+1)] / 1000 

N = 1.8 → Have enough shares to ensure 1 director to the board, but not quite enough to ensure 2 

**  Can also figure out the fewest # of votes you need to elect (however many) a number of directors 

Example: There are 5 seats for grab; You want to elect 1 directors; there are 1000 shares CS. How many votes do you need in order to elect 1 directors? (solve for X…not N) 

1 = [(X) x (5+1)] / 1000 

X = 166.67 → MUST round up to 167 

* <u>'''Shareholder Meetings'''</u>
** '''''Quorum for Shareholder Meetings''''' (DGCL 216 & NYBCL 608)
*** You're not allowed to take action at a shareholder's meeting unless you have a critical mass of shares represented in either Person or by Proxy
**** Without a quorum present, anything that happens at that shareholder's meeting will NOT be legally effective 
*** <u>'''Default Requirement→'''</u> '''Majority of all the outstanding shares''' (unless you've altered the requirement either up or down)

* 
** '''''Shareholder Voting'''''
*** If you have a quorum present, both Del. & NY law tell you the percentage of votes you need to approve a particular action
*** <u>'''Default Rule'''</u>→ '''Majority vote of the shares at a meeting, in which a quorum is present''' 
**** Ex: If 51% of shares make up a quorum, the majority of that 51% is 26%. A 26% vote can bind the company. 
**** '''''Abstentions'' (decline to vote) can be considered for quorum purposes'''
***** '''Del→ counted as a NO VOTE '''
***** '''NY→ NOT counted at all'''
****** <u>'''Ex'''</u>: There are 500 shareholder votes at a meeting; There are 200 yes votes; 175 no votes; 125 abstentions
******* Del- Measure is NOT be approved, because the 125 abstentions are counted as No's.
******** 200 vote yes
******** 300 vote no (175 + 125)
******* NY- Measure IS approved, b/c the 125 abstentions are not counted
******** 200 vote yes
******** 175 vote no
*** Also, the DGCL & NYBCL have specific voting rules that apply in various contexts
**** Charter Amendments→ You need a majority vote of ALL the outstanding shares 
**** Election of Directors→ Plurality Voting

* <u>'''Proxy Voting ("absentee balloting")'''</u>
** Most shareholders of publicly traded company's who bother to vote at all, vote via proxy 
** <u>'''How it works:'''</u>
*** Under federal law, you receive disclosure materials on what you are about to vote on, and then traditionally receive a "'''proxy card"''' where you can fill in how you want to vote, and submit it to the "'''proxy holder"''' (typically a senior executive officer at the company). Then he/she will vote your shares <u>'''AS YOU'''</u> indicate 
** '''Proxies are effective until the date specified, unless you revoke it previously''' (like an offer)
*** NY→ Last no more than 11 months (1 annual meeting)—nybcl 609(b)
*** Del→ Lasts 3 years—dgcl 212
** '''''Irrevocable Proxy (Irrevocable until death)'''''
*** '''If you give the proxy holder an irrevocable proxy, you can't revoke it & the proxy holder gets to vote your shares as <u>HE/SHE</u> see's fit'''
*** <u>'''NY''' Irrevocable Proxy (nycl 609):</u>
**** (i) Must state on its face that it's irrevocable
**** (ii) Proxy card be given to a member of a statutorily prescribed group of people (laundry list)
***** Ex: Pledgee—If you pledge your shares as collateral for a loan, you are entitled under NY law to give an irrevocable proxy to the lender, and the lender can vote your shares until you pay back the loan (at which point the proxy would be terminated 
*** <u>'''Del'''. Irrevocable Proxy (dgcl 212):</u>
**** (i) Must say so on its face
**** (ii) Must be coupled with interest (with actual shares or with corp. itself)
***** You can't be the proxy holder unless you have some nexus to the corporation in question
****** Ex: Some of the shares given to you as collateral in exchange for a loan (Pledgee would have interest necessary to be an irrevocable proxy holder)

==CORPORATE FIDUCIARY DUTIES==

===DUTY OF CARE===
(Not common) (Specific to individuals involved at the situation at hand)'''

<div><u>'''''Basic Standard'''''</u></div>
* With power comes responsibility
* Directors are agents of the corporation & the agents of the shareholders of the corporation
** They have a duty to act responsibly, since essentially, they are entrusted with the money of people
* <u>'''Directorial Due Care (</u>Hindsight plays NO role …it's all about the process''')
** <nowiki>= Directors must discharge their duties in good faith and with that degree of diligence, care, and skill, which ordinarily prudent people would exercise under similar circumstances in like positions. </nowiki>
** '''NY Duty of Care [nycbl 717(a)]'''
*** '''(1) Objectively'''
**** You compare what the director has done, versus what an ordinarily prudent person would have done
*** '''(2) Subjectively '''
**** '''''1. Ordinary prudent person in like position'''''
***** You assume the ordinarily prudent person is in a ''like position'' 
****** Like position- Has ordinarily same skill set like the director in question, and sits on the same type of board or company
**** '''''2. In similar circumstances '''''
***** Additionally, look at the actions taken by the director in question to hypothetical action that the ordinarily prudent person would have taken ''under similar circumstances''
****** Meaning, if confronted by the same set of facts
******* The decision doesn't matter…the decision-making process does!
*** '''(3) Proximate Cause ('''from ''Francis'' case''')'''
**** The Director's negligence must lead to the injury suffered by the plaintiffs 
***** Negligence but have been a '''''Substantial Factor '''''to the injury suffered by the plaintiff-shareholders (doesn't have to be the only cause of injury)
****** Ex: Commingling or Conversion of funds; Dereliction of duty; Negligence; 
** '''Delaware Duty of Care—No Statute'''
*** <u>'''Standard'''</u> = '''Gross Negligence''' 
**** <u>Gross Negligence</u> = Whether the Directors have informed themselves of all material information reasonably available to them at that time
***** Plaintiffs burden of proving Directors acted with ''Gross Negligence'', despite the directors having the ''Business Judgment Rule'' (legal presumption in their favor) that presumes that when the directors were making their decision, they were in fact careful
***** <u>Limitation</u>→ '''Exculpatory Charter Provision (dgcl 102(b)(7)'''
****** 
* ''Francis v. United Jersey Bank''
** Mrs. Pritchard was 1 of 3 Directors on the board, along with her 2 sons
** Sons engaged in commingling of funds, and then conversion of funds in the form of shareholder loans
** Company was then involuntarily forced into bankruptcy, and the trustees in question went after Mrs. Pritchard 
** <u>Trustee Argued</u>→ dereliction of duty for failure to prevent the misappropriation of funds OR for when she 1<sup>st</sup> discovered it, to put it to a stop as soon as possible
** <u>Mrs. Pritchard Defense</u>→ She was grief stricken, old, drunk, and just not in a good mindset to pay attention
** <u>Court</u>- Rejected Mrs. Pritchard's defense stating that "Dummy figure head and accommodation directors are inacronysms with no place in NJ Law"
** <u>'''Rules:'''</u>
*** '''1) At a minimum, a director must have a minimum rudimentary understanding of the business of the corporation'''
**** If you have no clue what the company does, then don't sit on its board
*** '''2) Directors are under a continuing obligation to keep informed about the activities of the corporation '''
**** Specifically, you need to review on a regular basis, as they come out, the financial statement of the company 
*** '''3) If Directors notice that something smells funny or raises a red flag, you have a ''duty of inquiry'' '''
**** You have to go look into it
*** '''4) If you discover illegal conduct, you must object to that conduct to management'''
**** <u>If nothing is done about it, options are:</u>
***** 1. Bring a lawsuit against perpetrators 
***** 2. Resigning with noisy exit 
***** 3. Canvassing with fellow directors to try to get people on your side, to try to put an end it
* ''In Re Caremark Inc. Derivative Litigation (''Directors failure to monitor'')''
** Involved shareholder lawsuit against directors of Caremark, for failure to prevent wrongdoing, because the directors never realized the wrongdoing was going on in the 1<sup>st</sup> place 
** <u>'''Rule </u>-'' Failure to Monitor''''' (part of being careful, which plays into the duty of care)
*** '''To avoid liability, directors must have made a good faith judgment that their information and reporting system (in both design and operation), is adequate for the board to receive information in a timely manner'''
**** <u>Directors lack a "good faith belief" in their system if</u>:
***** 1. If directors don't have a system 
***** 2. If directors know there are glitches in the system, and you don't do anything to fix it, and then the problem arises 
****** Anything that might have gotten caught had the system worked during the time it was down, could lead to trouble for directors 

====Business Judgment Rule====
* ''Smith v. Van Gorkom (Del. 1985)'' (Pivotal case dealing with directors' duty of care)
** Dealing with Trans Union, a company whose board approved a merger 
*** Company controlled by Jay Prtizker (takeover artist)
** Pritzker would pay $55/share for each outstanding share of trans union common stock
*** This $55/share in cash would be merger consideration with respect to trans union shareholders voting to approve a merger with one of Pritzker's entities 
** 9/20—trans union BoD approved the merger at a meeting that only took 2 hours 
*** Van Gorkom gave the directors a 20 min presentation about Pritzker offer, HOWEVER, he DID NOT mention his personal role in starting this whole process moving, NOR did he mention that he (van gorkom) himself came up with the $55/share price
*** Van Gorkom also did not provide copies of the merger agreement to the directors for their review 
** Board STILL approved the transaction, and Van Gorkom signed the merger agreement later that evening while at a charity event 
*** On 10/8, that merger agreement was later amended to placate (make less angry) senior managers who were very upset about the $55/share price that Pritzker would be paying
**** Van Gorkom DID NOT review the amendments that Pritzker put together, NOR did the other directors, but nonetheless, they went ahead and approved Van Gorkom to have those amendments signed
** Before the meeting of shareholders to vote yes/no on the merger, two competing bidders showed up—KKR & GE Capital
*** Both were willing to pay substantially more money per share for the shares of Trans Union stock
**** Van Gorkom however, did not treat them warmly, and these bids faded away
** The Board met again, prior to the shareholder meeting, to consider the merger with Pritzker for a 3<sup>rd</sup> time→ they decided to go with it
** At the Shareholder Meeting, 69.9% of shares were voted in favor of the merger 
** <u>Plaintiff-Shareholders brought a lawsuit</u>→Saying that in approving the merger, the directors were not fully informed, and were careless, therefore they breach their duty of care 
** <u>'''Delaware Duty of Care '''</u>
*** '''Plaintiffs burden of proving Directors acted with ''Gross Negligence'', despite the directors having the Business Judgment Rule (legal presumption in their favor) that presumes that when the directors were making their decision, they were in fact careful'''
**** <u>'''''Gross Negligence'''''</u> = Whether the Directors have informed themselves of all material information reasonably available to them at that time
** <u>Directors Defense</u>→ Arguing that the court should look at not only what they knew, but also everything they learned after that (which was prior to the shareholder meeting)
** <u>Del. Supreme Court</u>→ Disagreed and broke issues into 2 Issues:
*** ''(1) Did directors make an informed decision on 9/20 – the 1<sup>st</sup> time they considered the merger''?
**** <u>'''Held'''</u>→ '''Directors DID breach their duty of care and did make a grossly negligent decision by acting in an uninformed manner when they made the decision approving the merger at the 1<sup>st</sup> meeting '''
***** Court highlighted that:
****** 1. Directors didn't figure out Van Gorkom's personal role in pushing this whole thing through, despite so many red flags that led to their '''duty to inquire''' further about it
****** 2. Directors also failed to have experts determine on their behalf actually figure out what Trans Union was worth 
*** ''(2) If they didn't make an informed decision, then was everything they did after 9/20 enough to cure the infirmity of their Negligent decision making''
**** <u>'''Held</u>→ Directors cannot cure their previous infirmities '''
***** Court looked at 10/8 amendments that were ''supposed to'' facilitate Trans Union's ability to find someone that was willing to pay more money, however, the court noted these amendments didn't really have much impact
****** Court pointed out that the '''PROCESS '''by which the 10/8 amendments were adopted and approved were incredibly flawed 
******* Van Gorkom's oral presentations as to what the amendments would say, he never actually read. Rather, Van Gorkom was just assuming what he thinks they were going to say. And, the Directors authorized the amendments that said 'X', meanwhile they said things a little differently 
******* '''Van Gorkom did not have ''actual authority (properly authorized)'' to sign the amendments that he signed '''
******** Nonetheless, the amendments he signed would still bind the corporation, because he certainly had apparent authority (power position as CEO)
** '''Note''': Had Van Gorkom not played "deal maker" and it would have been a level-playing field action, it's likely that the results would have been different

RESULT OF Van Gorkom = Until this case, the thought among directors was that no one could ever be grossly negligent to the point that courts would actually hold them liable. In the aftermath of Van Gorkom, board members were resigning left and right. 

Policy—However, In the Van Gorkom era, the state legislatures took almost immediate action. They passed legislation that limited a director's personal liability for director's breach of the duty of care (See limits below) 

====Limits on Liability====
* <u>'''Exculpatory Charter Provision</u> [dgcl 102(b)(7) & nybcl 402(b)] = Affirmative Defense by Directors'''
** '''Allows corporations that have these provisions IN CHARTER, to exonerate Directors for almost all breaches of the <u>duty of care</u> (NOT duty of loyalty or bad faith behavior)'''
*** <u>Exception</u> = Illegal dividend payment under legal capital rules 
** Note:
*** 1. This provision <u>won't</u> work against companies that do not have this provision
**** Ex: Van Gorkom would be alive and well to any company that does not have this provision in their charter 
*** 2. This provision <u>will not</u> stop plaintiff-shareholders from seeking injunctive relief against directors who either are or have been grossly negligent 
**** Only exonerates you for monetary damages 
* ''Malpiede v. Townson (Del. Supreme Ct.) ''(Exculpatory charter provision in action)
** Delaware basically said that if this provision exists, cut to the chase and put it into effect
** Case involved the merger of Fredrick's into Knightsbridge for $7.75/share merger price
*** Fredrick's BoDs passed on a $9/share offer from Veritas
** Fredrick's shareholders were displeased that they were losing out on $1.25/share
*** <u>Alleged</u> that the directors violated the Standards in ''Revlon'' (If you do put your company up for sale, you are charged with acting as an auctioneer at getting the best possible price for your shareholders)
**** Alleged that by not going after $9 deal, directors violated their Revlon duties 
** However, court noted that plaintiff-shareholders can't simply allege that directors violated "Revlon duties", because Revlon tells us how directors can satisfy their traditional duties ''in the context of selling their company…''So plaintiffs still have to allege a <u>traditional</u> fiduciary breach (care, loyalty)
*** Plaintiff's broke up their claim into Care and Loyalty sub-claims
**** <u>Breach of duty of loyalty</u>:
***** P's pointed out that 1 of the defendant-directors had a substantial conflict of interest that would lead him to favor the lower priced deal
****** HOWEVER, the P's were unable to show that there was more than 1 conflicted director, or that that 1 director dominated all other directors 
******* Rather, the Knightsbridge-lower priced deal was approved by a majority of the '''''Disinterested Directors'''''
**** <u>Breach of Duty of Care:</u>
***** P's asserted that the directors were grossly negligent, and that they failed to implement a routine defensive strategy ('''''Poison Pill'''''), which would have enabled them to have a stronger negotiating posture to a company like Knightsbridge, and thus ''could have'' resulted in them having the leverage to accept the $9 deal
** <u>'''Court'''</u>→ Exculpatory Charter Provision crushes the Duty of Care claim
*** <u>Policy</u>—Make directors feel comfortable; they wont lose everything if grossly negligent

<div><u>'''''Directors & Officers Liability Insurance (D&O Insurance)</u> = CLAIMS-MADE INSURANCE'''''</div>
* Premiums went sky high as a result of the Van Gorkom case
* <u>'''D&O Insurance = Claims-Made Insurance'''</u>
** '''A director is only covered for actions that occurred after a policy's retroactive date'''
*** Each year you renew the policy, at which point you get a retroactive date, back to the 1<sup>st</sup> date you got insurance 
*** <u>'''Requirements to be Covered:'''</u>
**** 1. The action had to occur sometime while you were insured

2. Then, the claim itself must have been brought during the pendency of the insurance 

Tail – Extended amount of coverage that covers everything within the statute of limitations. You can buy a tail that will cover prior acts, so that if your policy ends, you will be covered for prior malpractice  

Ex: Policy covers us from Sept 1, 2005 through September 1, 2007.  

The policy will only cover claims arising and brought during the coverage period. But, if you renew your insurance, you would still be covered for prior acts. 

* <u>'''D&O Insurance typically has 2 Components:'''</u> (1) Corporate Reimbursement  

Insures the corp. against potential liability for actions for which the corp. has indemnified the directors or officers (indemnification would be in the charter or by-laws) 

(2) Personal Coverage  

Insures directors and officers for acts for which the corp. does not or is unable to indemnify them  

Exclusions: 

Insurance does not necessarily cover all acts. Some duty of care claims might be excluded from coverage and there might be policy limits on the amount of coverage 

====DUTY OF GOOD FAITH====
(Bad Faith Conduct = Disloyal Behavior – Self Interest)
* <u>'''2 Types of Potential Bad Faith Conduct '''</u>(plaintiff-shareholders must overcome the BJR presumption)
** '''''(1) Subjective Bad Faith''''' [✔<u>]</u> Fiduciary conduct motivated by an actual intent to do harm (and hurt your own company) 

* 
** '''''(2) Intentional Dereliction of Duty (Conscious Disregard of Responsibility)''''' [✔<u>]</u>
*** Key = "dereliction of duty"—Someone who is guilty of something when skipping a meeting  Dictionary- "shameful failure to fulfill one's obligations" 

Does not involve traditional disloyalty, which really involves a director putting their own self-interest in the corporation 

Court says that you can act disloyal towards your company, even if you don't personally benefit as a result  

Disloyal behavior w/o Self-interest = Bad Faith Conduct  

* 
** '''''(3) Grossly Negligent without malevolent intent '''''['''X'''<u>]</u>
*** Rejected because in Exculpatory Charter Provision & Indemnification Provision, legislature clearly indicated that good faith and due care are separate and distinct concepts 

* ''In Re The Walt Disney Co. Derivative Litigation''
** Case involving ill-faded hiring, and then ultimate firing of Michael Ovitz, the super-agent
** Because Disney fired him without cause, it was required to pay him, pursuant to his agreement, around 130mm
** Shareholders were furious about that, and some bought suit against the Disney directors, alleging:
*** '''1. <u>Breach of duty of care'''</u>- 
**** That the directors decision making process in approving the Ovitz deal was flawed, b/c the directors compensation committee considered and approved an agreement with a no-fault termination provision, in manner that fell short of best practices 
***** Court did agree that best practices were not followed, but best practices was not the law, rather, gross negligence is. 
****** <u>'''Held'''</u>→ the documentation was still sufficient to show that Disney would owe Ovitz a lot of money should they terminate him without cause. Therefore, while the directors' decision making process was slightly flawed, it did not rise to the level of gross negligence 
*** '''2. <u>Breach of duty of good faith'''</u>- 
**** Plaintiff-shareholders must overcome the BJR presumption that the directors acted in good faith (must proffer particularized proof to overcome that presumption)
**** <u>3 Potential types of bad faith</u>:
***** '''''(1) Subjective Bad Faith'''''
****** Actual intent to do harm = bad faith→ Agreed 
***** '''''(2) Grossly Negligent Conduct without malevolent intent '''''
****** Breach of duty of care = Breach bad faith → Rejected 
******* In Exculpatory Charter Provision & Indemnification Provision, legislature clearly indicated that good faith and due care are separate and distinct concepts 
***** '''''(3) Intentional Dereliction of Duty without personal interest '''''
****** Director is not seeking to advance 
*** '''3. <u>Corporate waste-'''</u>
**** To succeed on a corporate waste claim, the plaintiff-shareholders have the burden of proving that the transaction in question is so one-sided, that no business person of ordinary sound judgment, can possibly that the corporation received adequate consideration 
***** Directors must be shown to have '''''irrationally squandered the corporate assets '''''
* ''Stone v. Ritter ''(Failure to Monitor/Oversight = Duty of Loyalty)
** <nowiki>***Clarified that in today's day, when bringing a case of bad faith, you do so within the claim of breach of duty of loyalty</nowiki>

"Lack of good faith is a subsidiary element, i.e., a condition of the fundamental duty of loyalty" (The duty of bad faith is a subset of the duty of loyalty) 

* 
** Court reaffirmed that the Oversight Standard is the one found in ''In Re Caremark'' 
*** "Where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation, only a systematic failure by the board to exercise oversight, such as an utter failure to attempt to assure a reasonable information and reporting system exists, will establish the lack of good faith that is a ''necessary condition'' to liability in this context"
**** The only way directors are responsible for failure of oversight, is to show that they have been operating in <u>bad faith</u> with respect to their information and reporting system that is designed to upstream information = Duty of Loyalty

====TRADITIONAL DUTY OF LOYALTY====
(Disloyalty + Self Interest)

<div><u>'''5 Factual Circumstances that Implicate the Duty of Loyalty'''</u></div>
=====Self-Interested aka Self-Dealing transactions=====
(MOST COMMON)
* Transactions between a director and her corporation 
**Concern- Fear that the director will want to get a good deal for herself, which comes at the expense of the corporation to whom the director owes fiduciary obligations  
***"Lop-sided Transaction"—Lop sided in favor of the director at the expense of the corporation 
* '''Dgcl 144'''
** '''§ (a)- <u>Defines what a Self-interested transaction is'''</u>
*** Says that a transaction that does within 144 '''shall not be void or voidable''' ''even if'' the interested director/officer is <u>present</u> at the meeting to consider the transaction or contract, OR ''even if'' the interested director/officer <u>votes</u>, '''so long as 1 of 3 cleansing processes occurs:'''
**** <u>Cleansing</u>- Process that filters out possible disloyalty, so that what is left is a pristine transaction that is not feared
***** '''(i)''' Full disclosure + Approval by majority of disinterested directors 
***** '''(ii)''' Full disclosure + Shareholder approval of the transaction
***** '''(iii)''' In court, show the transaction or contract in question is in fact objectively fair to the corporation 
** '''§ (b)- <u>Quorum Requirements</u> (directors cannot take action unless a quorum is present)'''
*** States that <u>interested</u> directors DO COUNT towards quorum'' '' The interested directors' presence CAN count towards quorum, but you CANNOT actually count their vote to fulfill cleansing  
* '''Nybcl 713'''
** <u>'''Very similar, but with 3 Distinctions from Dgcl 144'''</u>:
*** '''''1. Requires Substantial Financial Interest '''''
**** Before a contract between Corp. in question & 3<sup>rd</sup> party Corp falls within the scope of 713 due to a directors ''financial interest'' in that 3<sup>rd</sup> part Corp., such interest MUST be deemed SUBSTANTIAL 
***** Dgcl 144 doesn't have that "substantial" language, although courts tend to interpret it that way 
***** NY recognizes that the director needs to have a substantial interest in the other company for someone to be suspicious
*** '''''2. Disinterested Cleansing'''''
**** §713(a)(1)- The cleansing process requires that disinterested director approval EITHER:
***** (i) Comply with the normal approval process found in §708(d) (approval by a majority of the board at which a quorum is present) but only counting the votes of the disinterested directors
<div>OR</div>
***** (ii) The disinterested director vote must have been unanimous 
****** Del. requires majority all the time
**** Shows that NY takes a harder line when it comes to interested-director transaction cleansing '
*** '''''3. Procedure '''''
**** §713(b)- In NY, 
***** '''If you HAVE properly followed either of the cleansing processes''' (disinterested director or disinterested shareholder approval)→ Shareholder who dislikes the transaction cannot challenge it at court
****** Shareholder can still challenge the process. 
****** '''If you HAVE NOT properly followed the cleansing process'''→ The burden then falls on those that are interested in the transaction to prove that it IS FAIR to the corporation
****** Differs from Del. where based on case law, even if 1 or both of the cleansing processes have occurred, the plaintiff-shareholder can still challenge the transaction in court, BUT the plaintiff-shareholder has the burden of proving that it was UNfair (at least they get to try)
* <u>'''Examples of Approval under 708(d)'''</u>: We have a 15-member board 
** 708(d) says that board action must be approved by a meeting of a quorum.
*** Here the majority would be 8. So if 8 people show up that's a quorum. 
*** If 13 people show up at the meeting – we have a quorum. Any action must be approved by a majority of the quorum. A majority of the quorum is 7.
**** We need 7 of the 13 directors to approve action.
** <u>First Scenario</u>
*** Assume that of the 13 that show up, 4 are interested director; the other 9 are disinterested. Assume 2 of the 9 vote no. 7 vote yes. 
**** Tells us that up to 2 could vote NO, and still be cleansed under 708(d), b/c there is still a majority of the quorum 
**** Can we approve this under 708(d)? 
***** YES. 7 Disinterested directors is still a majority of quorum present
*** Let's say that it wasn't valid under 708(d), this deal would not be approved because it was not unanimous
** <u>Second Scenario </u>(Still 13 people show up)
*** Let's say we have 5 interested and 8 disinterested, and 2 disinterested vote no. 
*** Can we approve this under 708(d)? 
**** No, because a majority of the quorum did not vote yes & under 713 because it was not unanimous.
** <u>Third Scenario</u>
*** 13 people present, 9 are interest. Only 4 vote. 
**** We need 7 of the 13 to vote yes under 708(d). But we only have 4 voting. We can't get 7 yes votes, so the vote would have to be unanimous disinterested vote of 4 . 
=====Interlocking Directorates=====
(usually leads to a self-interested transaction under dgcl 144 or nycbcl 713)
** '''<nowiki>= Where 2 corporations transact business, and on the boards of each of those corporations sits some of the same people </nowiki>''' Ex: 1 or more of the directors that sit on the board of Corp. A also sit on the board of Corp. B, and then Corp. A & B do business together  

Concern- The common directors may have the ability to try to favor one of the corp.'s at the expense of the other 

The interlocking director(s) may have a greater financial interest in 1 of the coporation's, and may try to steer that corporation into a deal with the other corporation on who's board they sit in a lop-sided way that favors the corporation that the director has a great financial steak in, and that they make out that way  

**  Lewis v. S.L.&E. 

See below 

* 
** ''Lewis v. S.L.& E''
*** 2 companies- Tire Dealership & Company of Lessor of land of dealership
*** Plaintiff- Was ONLY a shareholder in Lessor Company 
**** Plaintiff complained that the lease arrangement was not reflective of current market terms, which led to:
***** Gross undercharging by the lessor to Tenant
***** Waste by not charging the going rate 
*** Directors- Owned stock in both Lessor Company and Tire Dealership (Lessee)
*** <u>Court</u>: Noted that normally, setting rents is well within the business judgment of the directors making the decision 
**** '''BUT, the Business Judgment Rule presupposes that there are NO conflicts of interest present'''
***** The mere fact that interlocking directorate exists does create a conflict, and it's worthwhile pursuing whether that conflict caused problems
****** COULD HAVE BEEN CLEANSED under nybcl 713, but there were no disinterred director votes, nor was it put to the shareholders
******* So, the burden fell on the Defendant-Directors to show that not charging the fair market rent was somehow fair and equitable to the Lessor Company corporation 
*** <u>Result</u>→ Directors were unable to prove it was fair, and plaintiff won 
=====Usurpation of Corporate Opportunities=====
(ALI) 

**  = Whenever a director learns about a business opportunity of the type tat could be pursued by her corporation, but instead, without offering it to her corporation, she pursues the opportunity by herself (for her own benefit)  

Concern—Director may be taking business away from the corporation for her own personal needs at the expense of the corporation  

Puts the director into direct competition with the corporation on who's board she sits  

**  TESTS: 

(1) Line of Business Test (Old School)  

If an officer or director is presented an opportunity that the corp. is financially able to undertake, and such opportunity is in the line of the corp.'s business and is of advantage to it, and it's one that the corp. has an interest or reasonable expectancy of attaining, then by embracing the opportunity the director/officer will be brought into conflict with that of his corp. and the law will not permit him to seize the opportunity for himself 

Weaknesses: 

It's hard to determine whether an activity was within the scope of the corp's business 

If financial ability is an element of an activity being in the corp's line of business, this creates an incentive for the directors to neglect the corp's financial well being  

(2) Fairness Test (Massachusetts)  

1. Director takes advantage of an opportunity for personal profit; and 

2. The interest of the corp. justly calls for protection  

Weakness- provides no guidance  

(3) Minnesota 2-step Test 

1. Del. Line of Business Test—First determine whether a particular opp was within the corp's line of business 

2. Fairness Test—Then scrutinize the equitable considerations existing prior to, at the time of, and following the officer's acquisition 

Weaknesses- same as above  

(4) ALI § 5.05(a) (principles of corporate governance) 

1. Offer it to Corp + Disclose your interest in it 

You cannot take a "corporate opportunity" unless you 1st offer it to the corporation, and disclose your interest in the opportunity, and what the opportunity is all about 

Corporate Opportunity: 

On the job - Any opportunity to engage in a business activity of which a director or officer becomes aware, either: 

(a) In connection with his function as director or officer, or under circumstances that should reasonably lead him to believe that the party making the offer expects it to be offered to the corporation; OR 

(b) Through the use of corporate information the director or officer should reasonably be expected to believe it would be of interest to the corporation (even just searching the web while at work); OR 

Off the job - Any opportunity to engage in a business activity of which an officer (not a director) becomes aware and knows it is closely related to a business in which the corporation is engaged or expects to engage 

2. Opportunity must be rejected by the corporation  

3. 1 of 3 things must occur 

(i) taking of the opportunity is proven to be fair to the corp. 

(ii) corp. rejects the opportunity in advance by disinterested director vote 

(iii) rejected in advance or ratified by disinterested shareholder vote  

Note- You can under the ALI approach consider the company's financial ability of the company to undertake the opportunity 

Lack of finances may be the reason the board decided to reject the opportunity 

**  Northeast Harbor Golf Club v. Harris 

*** Ms. Harris had the opportunity and did in fact purchase 2 parcels of land adjacent to the golf course, without 1<sup>st</sup> offering them to the golf course so that it can purchase them
*** Delaware Line of Business Test ''Guth v. Loft, Inc. ''
**** Could the Corporation pursue opportunity if presented?
**** Does the transaction involve the same line of business? Would the director put it in direct competition with its own corporation?
*** Massachusetts Fairness Test?
**** Too Vague – What is fair? 
*** Minnesota two step test
**** Line of Business
**** Too Vague – What is fair? 
*** Adopted ALI § 5.05
**** Won due to statute of limitations 

=====Entrenchment Activities=====
(Hostile Takeovers) 

Actions that have the effect of entrenching the director in office (keeping their jobs) 

Concern—There's nothing wrong with the directors trying to keep their jobs, UNLESS it calls for the director(s) to make a decision that's not in the best interest of the shareholders 

When directors decision is in their own interest b/c it helps them secure their positions at that company  

"Whenever a takeover defense is adopted, there is the wide threat of directorial entrenchment" 

B/c whenever a defense is successful, and the hostile party goes away, the directors continue to keep their jobs.  

Therefore, defenses have to be analyzed under Unocal's 2 part test to see if  

The directors are more concerned about keeping their jobs→ disloyal 

Or if directors are really trying to protect the corporation→ loyal 

Unocal 2 Part Test: 
#'''Reasonable Grounds Test''' 
#*The target board must demonstrate that it had reasonable grounds for believing that a danger to the corporations policy and effectiveness existed  
#**Based on boards good faith reasonable investigation that a threat exists  
#***Doesn't have to be an actual threat  
#***If majority of disinterested or Independent directors conclude there really is a threat, then defenses are automatically warranted (even better) 
#**Also, the conclusions drawn from the investigation must be reasonable as well 
#**Del. recognizes 3 threats 
#**#Structural Coercion (very rare)- Structure of the offer itself is designed to get people to sell their shares to the hostile party, based on the fear of being left behind 
#**#Lost Opportunity (very rare)- By tendering your shares, you obviously don't get to accept the 3rd parties offer, not to you get to partake in existing managements plan for the company…. you're getting out so your done 
#**#Substantive Coercion- Fear that target shareholders may tender (sell) their shares to an underpriced offer. 
#**#*Shareholders do so b/c they either disbelieve their own management as to what the intrinsic value of their shares is, or they're simply ignorant  
#'''Proportionality Test''' 
#*The defenses adopted in light of the threat that is perceived must be reasonable in relation to the threat posed  
#**Key = To ensure defense ARE NOT Draconian 
#***Draconian: 
#***#Coercive- to target shareholders (our own shareholders) 
#***#Preclusive- to hostile party achieving its goal of taking over the company 
#***#*Sometimes means that the tender offer of the hostile party cannot be successful no matter what hostile party offers in terms of money  
#***#*Courts do also look at whether a hostile party would've been successful in a hostile proxy fight to replace a majority of directors (Air Products) 

''Air Products and Chemicals v. Airgas'' 
*Products went after gas in a hostile takeover.  
*Gas had a staggered Board of Directors, and a poison pill in place  
*Products was successful of replacing 1 class of Gas's directors with incumbent ones  
*Court- Unocal 
**Air Products was successful in having its existing nominees be elected to the board (they won the 1st round) 
***So, question arose about whether they'd be able to win the next round when the next group of incumbents were up for reelection 
****The fact that they won the 1st reelection led the court to believe that they could very well succeed in the 2nd election, and therefore the hostile defenses were clearly not preclusive to Products' goal of replacing a majority of the directors  
**Court believes the defense were reasonable (relates to the nominees that were 1st reelected) 
***When a hostile party nominates you to the board, and you succeed at getting elected, it doesn't mean you can come in with your own agenda. Rather, it means you now have to take the best interests of the corporation and its shareholders when you make decisions  
****Court notes that the 3 Product directors that were elected at the 1st election all promised to take a fresh look at the situation, AND after they took a fresh look, they ultimately joined with the rest of the board in its determination that the defenses needed to stay in place!!! 

'''Defenses against Hostile Takeovers'''
#Greenmail 
#*Hostile party owning some of your stock (8-9%), comes to existing directors with 2 choices: 
#*#Can launch a hostile party takeover and buy the company and fire you; or 
#*#Offers the target company directors to take the corporations money and buy all their stock back at a premium price, and then hostile party will sign a standstill agreement to not attack target company for a certain amount of time  
#*##Essentially bribe hostile takeover to go away for 2 years while using the corporations money 
#*Dgcl 160(a)—it's legal! But, a company that pays greenmail is not entitled to deduct the excess payment paid to the greenmailer for tax purposes  
#*Nybcl 513(c)—Anti-Greenmail Statute—The only way you can conduct greenmail is if you get shareholder approval (which is nearly impossible) 
#Defensive Charter Provisions  
#*Provisions put in your charter to make it harder to be taken over  
#*#Classified or Staggered BoDs Provision 
#*#Super-Majority Voters Provision relating to business combinations 
#Crown Jewel Strategy 
#*Where the hostile party wants your company b/c you have one division of the company that they want. So, you contract with a friendly 3rd party to "sell" the best division of your business for a bargain-basement price 
#White-Knight Strategy (Revlon) 
#*If the company doesn't believe it will be a stand-alone independent party, it figures that it should sell their company to the person they like rather than the hostile party 
#Pac-Man Strategy 
#*After the hostile tender offer, you then turnaround and try to initiate a hostile takeover against the hostile party! 
#Golden Parachute Strategy 
#*Severance agreements with senior executives that are triggered if the company is taken over. These include massive payments that make the exit of the senior execs more palatable to them….hence the golden parachute  
#Poison Pill (See Revlon) 
#*Most Effective and potent takeover defense 

'''Revlon Duties (as Care or Loyalty)'''
*Defensive measures in a Sale process are really not appropriate, because they deter bidding (also for crown jewel lockup) 
**As a director, your obligations change to that of an auctioneer, charged with getting the highest price reasonably available from a responsible and reputable bidder  
***Triggered By→ an independent decision of the target board to abandon their existing strategy and to put themselves up for sale and seek out a buyer 
****A 3rd Party CANNOT trigger Revlon duties in a Target BoD 
*****The mere fact that someone launches a takeover of your company, DOES NOT mean your board is in Revlon mode 
***Defenses that go overboard and deter an active auction process are disloyal to your shareholders!  
***Thinking about the needs of a group of contract claimants (exchange note-holders), caring about them because they are threatening to sue you is disloyal to shareholders as well! 
*Court doesn't recognized "Breach of Revlon duties"-''Malpiede'',  
**You have to bring an allegation of Breach of Duty of Care (which may get squashed in terms of an exculpatory charter provision) or as a Breach of Duty of Loyalty 
***Revlon teaches how the directors can fulfill their existing fiduciary duties in the context of putting themselves up for sale  

''Revlon''
*Typical hostile takeover, where Ron Perlman's vehicle of choice—Pantry Pride—launched a hostile tender offer for the Revlon shares  
*Revlon had a variety of takeover defenses 
*#Self Tender Offer 
*#*To buy back some of its own shares. Useful from a defensive perspective by placing them into friendly hands (people that wouldn't tender to Ron Perlman) 
*#Poison Pill 
*#Exchange Offer  
*#*Designed to take more shares out of the marketplace so they can be used for defensive purpose 
*#**B/c Revlon didn't have a lot of money to buy stock, the issued Notes that contained features that would cause them to explode (immediately due and payable on the spot), if certain events occurred without the blessing of the independent directors of Revlon  
*#White Knight→ Puts company for sale 
*#*Search for anyone other than Perlman that would interested in buying Revlon 
*#*They found Forstman
*Pantry Pride tried to dismantle those takeover defenses, and was successful in acquiring Revlon 
*Forstman's deal with Revlon had a # of Deal Protection Measures- measures designed to keep these 2 parties locked in the deal until it's consummated & to persuade other people to go away 
*#Lock-up Option 
*#*Forstman would have the ability to buy key divisions of Revlon at a "bargain-basement" price should another party like Pantry Pride purchase more than 40% of Revlon stock (which it might do with the tender offer)
*#No-Shop Provision  
*#*Whereby Revlon would be prohibited from shopping itself around once it signed a deal with Forstman 
*#Cancellation Fee 
*#*25mm should anyone acquire more than 20% of Revlon stock 
*#Forstman's agreement to support the value of those exchange notes in the marketplace  
*#*The secondary market price plummeted once the market learned that Forstman would be incurring large amounts of debt secured by the assets of Revlon…which made those exchange notes much more risky investments. So people discounted the notes' value by factoring in that risk  
*#**Result—Forstman agreed to buy notes in the secondary market to prop up the price (to provide a floor that the notes' price couldn't fall below) 
*'''Court'''- Boards DO have duties in the context of hostile takeovers. Have to keep a watchful eye on takeover defenses 
**'''Unocal Standard'''  
**#Reasonable Grounds Test 
**#*Substantive Coercion- Pantry Pride started off at $47, and there was documented evidence that Revlon was worth in the mid $50's 
**#**BUT, ultimately Forstman offers $57.25, and Pantry Pride offers $58
**#**Odd situation as a BoDs where someone you dislike it offering more money than someone you like  
**#Proportionality Test 
**#*Well, once Pantry Pride got into the mid $50's, and started offering even more money, there is no substantive coercion anymore, so WHERE IS THE THREAT that needs to be defended? 
**Court said searching for a white knight is explicit recognition that you are for sale! 
***Defensive measures in a Sale process are really not appropriate, because they deter bidding (also for crown jewel lockup) 
****As a director, your obligations change to that of an auctioneer, charged with getting the highest price reasonably available from a responsible and reputable bidder  
*****Defenses that go overboard and deter an active auction process are disloyal to your shareholders!  
*****Thinking about the needs of a group of contract claimants (exchange note-holders), caring about them because they are threatening to sue you is disloyal to shareholders as well 

=====Class Favoritism=====
* '''Situation where there is more than one class of stock, and the directors decide to make a decision that benefits 1 group of shareholders at the expense of the other'''
** The disadvantaged class is owed fiduciary duties as well
*** Rare, b/c for example, preferred stock is a group of contract claimants, so if the contract doesn't say the directors can't do this, the directors can do whatever they want 
** Ex: A corp. has both common and preferred stock outstanding, and is approached by someone to be acquired, and the potential acquirer says to the target company, "we'll pay 200 million for your company, for all the common and preferred stock, and you the directors figure out how much of the 200 million goes to the common stockholders and how much goes to the preferred stockholders"
***The group that feels like they're on the short end of that stick will argue favoritism. Note that it's very likely that the directors that are making the decision only own common stock, and don't own any preferred, in which case if they favor the common, it looks like they're favoring themselves at the same time.  

===DUTIES OF CONTROLLING STOCKHOLDERS===
(towards minority stockholders)
* '''Self-Dealing'''→ '''Controlling shareholder using his power over the Corporation to extract ''some benefit'' that is not made available to everyone else simply b/c you can'''
** If self-dealing occurs, the '''BJR of the defendant-directors is disabled''' and the 
** '''Entire or Intrinsic Fairness''' would apply
*** Shifts the burden of proof to the Defendant-Directors & Controlling Stockholder to prove that what they did is intrinsically fair to the Corporation and its minority stockholders 
* 
* ''Sinclair Oil v. Levien—''Sinclair using its dominance over subsidiary
** Parent company (Sinclair) owned 97% of subsidiary-Sinven (minority owned remaining 3%)
*** If you own 97% of stock, you're in a position to nominate and elect ALL the directors to the subsidiaries board
** Rule- '''Self-Dealing'''
** '''Plaintiff had to show waste or improper motive'''
** <u>'''Claim 1-</u> Company's dividend payments were excessive (Legal Capital Rule – DGCL 170(a))'''
*** <u>'''Held'''</u>- Sinven's payment of allegedly excessive dividends DID NOT constitute self-dealing, even though it worked to the advantage of the parent controlling stockholder
*** Because the minority received their pro rata share of the dividend money, just like the controlling stockholder got its fair share
**** Since everyone was receiving money, the Business Judgment Rule was not disabled
**** IF you want to disable the Business Judgment Rule without a conflict of interest, simply based on allegations that the dividends are excessive, courts provides a fairly stiff test, and the Plaintiffs weren't able to overcome that test
** <u>'''Claim 2</u>- That the parent company prevented Sinven from pursuing its legal rights against a wholly-owned subsidiary, Sinclair International when it breached its contract with Sinven'''
*** <u>'''Held</u>-''' Because there is a conflict of interest, the <u>intrinsic fairness test</u> would apply 
**** It was up the defendant-directors of Sinven, and the Parent-Sinclar Oil to prove the intrinsic or entire fairness of not allowing Sinven to pursue its legal rights against another subsidiary of the parent (it was unable to do so)

* ''Zetlin v. Hanson Holdings''—controlling stockholder selling its stake to another party 
** Minority Stockholder wanted to participate in the '''''Control Premium''''' that Controlling Shareholder group was about to receive when they sold their controlling stake 
**  Rule- Minority shareholders are entitled to protection from abuse by controlling stockholders, BUT CANNOT inhibit other stockholders' legitimate interests. Shares of stock are personal property which could be sold to whomever you please, for whatever price you please  

***  For this reason, there is a Premium—The added amount an investor is willing to pay for the privilege of directly influencing the corporation's affairs (acquiring control) 

***  Exceptions- Contractual Provisions allow minority to piggy-back  

****  "Tag Along" Provision 

Minority shareholder gets to tag along with any sale by a controlling stockholder of its stake to some 3rd party 

They get to pro rate participate in that sale by contributing some of their shares to be sold  

****  "Drag Along" Provision 

***** Most time the 3<sup>rd</sup> party doesn't want to just buy the controlling stake, but rather want to buy everything
****** So it's not unusual to see this provision that says "if the controlling stockholder finds a 3<sup>rd</sup> party to buy its stake, contractually it can drag along all the minority stockholders and force them to sell as well at the same price the controller is receiving"
***** Always argue for what you don't ha

<div>'''FORWARD & REVERSE STOCK SPLITS'''</div>
* '''''Forward Stock split'' ''' Take one expensively priced share and break it into pieces that will decrease the price per piece.  

2-for-1 Stock Split—Ex: If you own 1 share valued at $100 – via the stock split you would have 2 shares worth $50.  

Purpose: 

1. Makes stock more affordable to public 

There is more demand for a slice of pizza than there is for a whole pie.  

This is good, because you don't lose anything and it makes it more affordable for people to buy stock and the company becomes better off financially.  

2. This is a good sign to the public  

People recognize that the company is doing so well that the value of your stock is so high and that you have to lower your stock price in order to make it more affordable 

*  Reverse Stock split (Negative symbol in the marketplace) 

**  Combining shares into one bigger, more expensive share  

8 slices of pizza that you want to put back together. Sprinkle cheese and put it back in the oven, the cheese melts and the slices become one.  

** <u>'''Purpose:'''</u>
*** '''1. Maintain listing on Index (Nasdaq; NYSE; S&P)'''
**** Your stock, due to poor performance, is selling very low. 
**** If you are listed on NASDAQ they don't allow pooly performing stocks like that to be listed and you will be delisted. So, you combine shares into one bigger more expensive share. 
**** Ex: If you have 3 shares of stock worth $2 each. After the reverse split you have 1 share at $6 

* 
** 
*** '''2. It looks better, and people think it's a better company'''
**** BUT a reverse stock split is a negative symbol in the market place – Your stock won't sell at $6, because people recognize that it is just smoke and mirrors and it will really only sell at $5.86 or something like that.
*** '''3. To squeeze out minority shareholders '''
**** Giving 1 share for every 10,000 shares would do this. For shareholders that have less than 10,000 shares would end up with less than 1 share. You can't own a fraction of a share so the minority shareholders get cashed out and squeezed out.
***** Ex: Assume a company has shareholder A, B, and C
****** A- 1000 shares
****** B and C- 100 shares each
****** Shareholder A can do a reverse sock split that gets rid of minority stockholders by doing a "1 for 1000 split"

==DERIVATIVE CLAIMS==
===THE DERIVATIVE LAWSUIT===
* <u>'''''Derivative Lawsuit'''''</u> –'''Lawsuits brought by shareholders on behalf of their corporations, designed to protect the corporation from harm, either caused internally by the BoD/Senior Executives themselves, OR perhaps by 3<sup>rd</sup> parties '''
** Since the corporation owns the claim and has the right to sue in the 1<sup>st</sup> instance, a shareholders derivative lawsuit is called "derivative" because it derives from the corporations right to bring that lawsuit 1<sup>st</sup> (Corp = Nominal Defendant)

Strike Suit- (Negative of Deriv. Lawsuits) Lawsuit brought on behalf of the corp., designed to exploit the nuisance value of the lawsuit in order to gain some sort of settlement  

Beneficiary of Strike Suit: 

Lawyer – b/c they get considerable fees 

Professional Plaintiffs – someone who owns only a few shares of stock in all 500 of the Fortune 500 companies and any time a stock price dipped, they would file a complaint alleging mismanagement or fraud. Who funds these stock purchases: Lawyers 

Loser of Strike Suit: 

Shareholders (Indirectly)—b/c now they owns stock in a company that has less money b/c it had to pay out the settlement  

***Strike Suits are All About Procedure 

Strike Suit Lawyer Goal→ Hopes to get beyond the corporation's motion to dismiss, b/c then it moves on to discovery and engage in a fishing expedition, causing the senior management a great deal of heartache  

The strike suit plaintiff does not have much to disclose.  

The corporation has lots to disclose – the  could request depositions of every employee 

Corporation doesn't want to deal with turning over docs and that they will just settle 

Corps' Goal→ Get the case dismissed at the Motion to Dismiss stage – if the motion is granted it could chill any other prospective strike suit plaintiffs from attempting a claim 

* 
** <u>'''Demand Requirement</u> - '''Under State Law, you MUST make a DEMAND on the BoD to try to get the board to initiate the lawsuit (since it belongs to the corporation 1<sup>st</sup>)
*** <nowiki>*Demand requirement helps preserve the discretion of the directors to manage the corporation without inappropriate outside interference by the shareholders (b/c part of managing the corporation is deciding when, if ever, the corp. should bring a lawsuit)</nowiki>
*** '''Nybcl 626(c)'''
**** In any derivative action, the complaint must set forth with particularity, the efforts of the plaintiff to secure the initiation of the action by the BoD, for the reasons for not making such an effort 
**** <u>Demand Requirements Serves 3 Purposes</u> (''Marx v. Akers'')
***** '''1. '''Relieves courts from deciding matters of internal corporate governance by providing corporate directors with the opportunity to correct alleged abuses 
****** Perhaps it wasn't aware it was a problem 
***** 2. Provides corporate boards with reasonable protection of harassment by litigation on matters clearly within the directors' discretion
***** 3. It discourages strike suits commenced by shareholders for personal gain, rather than for the benefit of the corporation 

* 
** 
*** <u>'''''Demand Futility''—Times when making a demand would be FUTILE (pointless)'''</u>
**** When BoD or senior managers themselves are the ones causing the harm, and thus are unlikely to sue themselves
***** In these cases the demand should be excused
***** Florida has adopted the Universal Demand Statute
****** Says you always must make demand futility, no matter what 
**** '''Delaware Demand Futility '''
***** The directors are disinterested and independent and;
***** The challenged transactions were otherwise the product of a valid exercise of business judgment.
**** '''NY Demand Futility:'''
***** Demand excused if the complaint alleges with particularity 1 of 3 things 
****** (i) It could allege that majority of directors is interested in the challenged transaction, and thus are obviously conflicted about whether they should bring a suit against themselves 
****** (ii) Could allege that directors didn't fully inform themselves about the challenged transaction to the extent reasonably appropriate under the circumstances 
******* Need particularized facts indicating that the directors were incredibly misinformed when making a decision that you are challenging, then how likely is it that they'd focus on your demand?
****** (iii) Could allege the challenged transaction was so egregious on its face, that it couldn't have possibly been a product of sound judgment by the directors 
***** If you can show 1 of these 3 things, then the need to make a demand would be excused, and you will rightfully be able to court IMMEDIATELY (BJR rule is disable with respect to the board's ability to not take action on your demand)
****** Doesn't mean you'll win in court
******* Must disable BJR
******* Fid. Duties, etc.

* <u>'''Derivative Actions vs. Direct Action'''</u>
** Derivative Action- Brought on behalf of corporations 
** Direct Actions- Brought by stockholders in their own right
** ''Tooley v. Donaldson''
*** <u>2 Part Inquiry to determine if action is Derivative or Direct</u>
**** '''1. Court must determine who suffered the alleged harm '''
***** Corporation or Suing Stockholders individually
**** '''2. Court must determine who should receive the benefit of any recovery '''
***** Corporation or Suing Stockholders individually
**** If Shareholder Suffered→ Direct action
**** If Corporation Suffered→ Derivative Action
*** Conditions were not ready yet so, claim isn't ready. Tender offer was not closed. 

Class Action Derivative Lawsuits based on Fraud set out in Federal Securities Laws

Note that these are Direct Claims, NOT Derivative Suits

Shareholders brought lawsuits against directors for their lies to the public under anti-fraud rule 10B5 of the SEC.  

In 1995, Congress got involved because it felt that these anti-fraud class actions brought by shareholders thinking that the directors must have lied when there was a stock drop 

In 1995 Congress passed the Private Securities Litigation Reform Act (PSLRA) which added § 27 of the 1933 Act & § 21D of the 1934 Securities Act which  

Says Plaintiff Must to Certify (Targeting Professional Plaintiffs): 

1. That you have read the complaint 

2. That you did not buy the stock of the company at the direction of your lawyer 

3. That you will not receive any compensation as a plaintiff other than your pro rata recovery or awarded by the court 

Court now appoints the lead plaintiff. 

The complaint needs to be explained. (state of mind, statements) 

4. You as a plaintiff have to supply a list of all other actions you have filed by the court in the previous three years 

==SHAREHOLDER INFORMATIONAL RIGHTS AND PROXY VOTING==

===INSPECTION RIGHTS; NEED FOR PROPER PURPOSE; RECORD DATE===
* <u>'''What can a Shareholder look at in terms of Books & Records under State Law '''</u>
** '''Tension '''
*** Shareholders→ natural desire to find out what's going on with his/her investment
*** Corporation→ understandable desire to keep its proprietary information from being exploited for non-corporate purposes 
** '''Under Common Law & most Statutes'''
*** Before a shareholder gets to see any books or records, shareholder needs a '''''Proper Purpose→'''''A purpose that relates to your interest as an investor 
**** 1. Traditionally it's far easier for a stockholder to get a look at a list of shareholders in the "Stock Ledger" than it is to get a list of other books and records 
**** 2. Communication amongst shareholders is almost always deemed to be a proper purpose 
***** <u>Del.</u>—If shareholder purpose is to look at the communication amongst shareholders, it's the CORPORATIONS BURDEN to prove that the shareholders purpose in that regard is not proper 

===PROXY CONTROLS UNDER STATE LAW===
(Voting Rights under State Law)
* <u>'''Record Date'''</u>
** Both NY & Del. allow corporations to pick a '''''Record Date''''' with respect to a particular shareholder meeting
*** Only shareholders as of the close of trading or business on the record date are legally entitled to vote at the shareholder meeting 
**** Remains the case even if shares are traded between the record date and the meeting date 
**** Only the shareholders that held the shares as of the record date get to vote 
*** Ex: Let's say that Mary owns stock on the record date. She sells her shares to Jim the day after the record date. The meeting is two weeks after she sells, but because she was the owner on the record date, she gets to vote. How can Jim get around this? He can purchase shares with an irrevocable proxy (So she gets to vote as she sees fit if (1) it states on its face that is irrevocable + (2) is coupled with interest)
**** Note that with a public corp, Mary will never know the Jim, b/c it would be a face-less transaction
** Boards also select '''''Dividend Record Dates''''' 
*** Need to decide who get the dividend check
*** All the stockholders of record, as of the close of business or trading, on a ''Dividend Record Date'' are entitled to the dividend check, regardless of whether they sell their stock between the dividend record date and the date the checks are cut
* <u>'''Fixing Record Dates '''</u>
** '''''1. Legal Notice'''''
*** Once a record date for a shareholder meeting has been fixed, Legal Notice must be sent out 
**** '''''10:60 Time Frame'''''→ '''No less than 10, but not more than 60 days before the date of meeting'''
***** If the board fails to fix a date, the default record date is the close of the business day before the day that notice was sent out.
****** Ex: Let's say notice is mailed on June 5, the record date would be June 4. The record date is the day before notice of meeting was sent out. 
***** Dividend record date cannot be more than 60 days prior to payment of the dividend. 
****** Ex: From the Mary/Jim example above, if Mary sold her shares a day after the dividend record date, she would get the dividend even if the payment of dividend is after she sold her shares to Jim. He will pay a slightly lower price for the shares taking into account that he won't get the dividend 
** '''''2. State Purpose'''''
*** State Law→Must state the purpose of the meeting if it's a Special Meeting
**** Don't need to state purpose for Annual Meetings, b/c it's assumed that the purpose is for the upcoming election of directors 
*** Federal Law→ Publicly Traded company ALWAYS has to state the purpose 

* <u>'''Treasury Stock'''</u>
** <u>3 Notions</u>
*** '''1. ''Authorized shares'''''
**** <nowiki>= Authorized by corporate charter. Just look at charter to see how many are authorized to be issued </nowiki>
*** '''''2. Issued shares'''''
**** <nowiki>= Actually issued, initially to investors, from the pool of authorized shares </nowiki>
**** The only time shares are issued but NOT outstanding is when the corporation buys them back→ '''''Treasury Shares''''' – '''any shares originally issued by a corporation and later bought back by the corporation.''' 
***** Treasury shares are authorized shares, but the corp. does not get to vote those shares, and they are not counted for quorum purposes.
****** '''''Reissued or Retired '''''
******* The corp is entitled to reissue them at a later date if they so choose. 
******* But if they buy them back and retire and cancel them, they cannot reissue them. 
*** '''''3. Outstanding Shares'''''
**** Shares in the hands of investors = issued + outstanding
**** Treasury Shares 
***** Shares bought back 
***** Not counted towards quorum 
** '''''Treasury Shares''''' – '''any shares originally issued by a corporation and later bought back by the corporation.''' 
*** '''''Reissued or Retired '''''
**** The corp. is entitled to reissue them at a later date if they so choose. 
**** But if they buy them back and retire and cancel them, they cannot reissue them. 
*** '''''Cannot be voted by the corporation at any shareholder meeting '''''
**** Treasury shares are authorized shares, but the corp. these shares cannot be voted at any meeting, 
*** '''''Cannot be considered outstanding for purposes of quorum '''''
**** Makes sense b/c these shares are issued but not outstanding 
**** So, if Corp. buys back its own stock, it does not may it tougher to achieve a quorum

===FEDERAL CONTROL OF PROXY SOLICITATIONS FOR PUBLIC CORPORATIONS===
* Federal laws are primary about disclosure so that purchasers have the info needed to make a wise choice. 
* The gov't was concerned about the quality and quantity of information disclosed to shareholders
* '''§ 14(a) of 1934 Securities Exchange Act '''
** Governs the solicitation of proxies

'''Rule 14a-2—Exceptions '''
** To capture as much activity as possible in the area, the SEC defined "Proxy" and "Solicitation" so broadly, that it has carved out a number of individuals and activated from proxy regulations
*** '''''Street Name exception'''''
**** The shares are registered in the name of bank or broker dealer (UBS or Merrill Lynch) and they keep on their books who truly owns the shares. You are in their computers as the owner, but Street name facilitates the electronic trading of shares. In the old days there were stock certificates and when you bought shares you would be sent a certificate and when you sold you had to mail the certificate to the buyer. Now we use computers.
**** Under state law, you are entitled to demand a stock certificate.

* 
** 
*** '''''Mutual Concern exception'''''
**** 
*** '''''Diminimus exception'''''
**** Solicitations to not more than 10 persons do not need to be filed with the SEC

'''Rule 14a-3'''
** You can't solicit a proxy from someone unless you have previously or simultaneously sent them sec-vetted proxy materials 
** The concern is that the person soliciting will give one sided info
** The process is to file your materials with the SEC under the cover of ''Preliminary Schedule -14A''
*** The SEC has 10 days to decide whether they want to review your materials. If they decide not to, you can file a '''''definitive Schedule 14A''''' and send the proxy materials to the shareholders 
*** '''Schedule 14A''' – requires that you give out general information such as:
**** Date, time, place of meeting
**** Specify the identity of the person making the solicitation of your vote? Is it existing management, a disgruntled shareholder
**** Specify who gets to vote – like if you have a multiple class corp. with common stock and preferred stock – depending on the issue, preferred stockholders might not get to vote
**** Identify any large shareholder and how that shareholder is going to vote if the corp knows how the shareholder is going to vote
**** If you are a public company that has cumulative voting – you have to tell the shareholders that they have cumulate voting and you must explain to them how it works.
**** State what the required vote is – like the percentage of votes required to pass the issue
**** State what the quorum requirements are
**** If electing directors, must give the background of the nominees
**** If amending the charter, must state why they want to change the charter

'''Rule 14a-7'''
** If you want to initiate a hostile takeover, 14a-7 says that the target company has to 
*** 1. Assist the hostile party by providing a list of shareholders, which includes the DTCs holding shares in street name, OR 
*** 2. You on behalf of the hostile party can mail out the materials and the hostile party will reimburse the target company for the expense of mailing out materials. 
* <u>Shareholder proposals not relating to the election of directors</u> – must a board include shareholder proposals in the board's proxy materials?
** Yes depending on what the topic is:
*** '''A. Social policy proposals must be included in the proxy statement''', such as
**** Stop apartheid in S. Africa
**** Stop building nuclear power plants
**** Stop manufacturing tobacco products
*** '''B. Corporate governance proposals''', such as
**** Redeem the company's poison pill
**** Repeal a classified or staggered board of directors
**** Stop paying the CEO so much money

'''''Precatory = wishful'''''

'''''How to make a proposal. '''''

'''''1% of company or $2,000's worth for least a year – hold stock until date of meeting. '''''

'''''Cannot exclude proposal unless certain exceptions. (ie: illegality, immaterial, impossibility '''''

'''''14a-8 '''''

'''Rule 14a-11'''** Allows shareholder or group of shareholders that hold 3% of public stock for at least 3 years to nominate members of board
*** Max number of nominees = up to 25% of board, but no less than 1 
*** Ex: 3 member board…can still vote for 1 person

==CLOSELY-HELD CORPORATIONS==

==="STATUTORY" CLOSE CORPS. vs. CLOSELY-HELD CORPS.===
<u>'''Attributes of Closely-Held Corporation ("Incorporated Partnership")'''</u>** '''Limited # of Shareholders '''
*** 5 and 10…but can be up to 499
** '''Difficulty in reselling shares '''
*** No liquid secondary trading market to transfer the shares
*** Contractual Restrictions in Shareholder Agreement that inhibit ability to transfer stock
** '''Fiduciary Duties resembles General Partnership'''
*** Have a detailed governing contract (shareholder agreement)
*** Relationship is one of '''''Trust, confidence and absolute loyalty (utmost good faith and loyalty)'''''
**** ''Donahue v. Rodd Electrotype''
***** Court admonished the controlling stockholder for using his leverage over the company to force the company to buy back some of his stock when a similar opportunity was not made available to the other shareholder 
***** <u>'''Rule</u>- Shareholders of a close-corporation owe one another substantially the same duties that general partners owe one another'''
****** '''Duty only applies when a shareholder takes action that is relative to the operation of the corporation'''
******* '''Using your power over the corporation to extract some benefit not made available to everyone else''' 
****** Rodd was causing the company to buy his shares (not a 3<sup>rd</sup> party) back, thus '''dictating how the corporation uses some of its cash in its operations'''
******* '''As a controller, if you want to force your company to buy some of your stock back, you need to force the company to give equal opportunity to all the other shareholders to sell shares back on similar terms '''

===MARKET-BASED & CONTRACTUAL BASED RESTRICTIONS ON SHAREHOLDER VOTING & TRANSFER OF SHARES===
<u>'''Legislative Responses</u>→ Provisions to allow Close-Corp, designed to allow closely-held non-public companies to take advantage of partnership-like governance structure''' ** '''Dgcl 341-356—(Opt-in)'''
*** If you qualify and opt-in, then you get the benefit of the Delaware provisions
*** Allows shareholders of closely held corps to enter into shareholder agreements that address how the business will be managed – govern the selling of shares, and govern the voting of shares
*** Allows corporations to conduct themselves as if they were a partnership

'''DGCL 202 – Statutory Close Corporation'''

<div>Affirmative election to become one. </div>

<div>ABC Inc., a close corporation.</div>

* 
** '''Nybcl 620—(Always available to you)'''
*** Allows NY corps to create agreements amongst the shareholders that allow them to be effectively governed like a partnership. They look a lot like partnership agreements. So there is no need to opt in to the regulatory framework – in contrast with Delaware
*** You can enter into shareholder agreements that govern the way you will vote your shares
*** You can put a provision in your cert of incorp that restricts the board to only one member – like a general partner 
*** These apply to any NY corp so long as the shares are not publicly traded

* <u>'''2 Closely Held Corp. Issues (Contractual Responses)'''</u>
** '''1. Control'''
*** All about voting…It's an important issue to closely held corps b/c there are many investors out there who will not buy stock in a business unless they know who is controlling the business. Many times they want representation on the board so they know what is going on with their investment. This is because there is a risk with small companies. So it is not unusual to see closely held corps giving voting rights when it needs the money from the investor
*** <u>'''3 Ways to get People to Vote the way you want to vote:'''</u>
**** '''''1. Voting Provision within Shareholders agreement '''''
***** Commit the shareholder to vote in a particular fashion. 
****** The shareholder gives up the right to vote. This could not happen in a publicly traded corp.
****** If shareholder does not vote the way he is supposed to—Specific performance. The court will force a revote
**** '''2. ''Irrevocable proxies'''''
***** If someone gives you an irrevocable proxy to vote. 
**** '''3. ''Voting Trust'''''
***** You get a group of people that want to vote collectively and they establish a trust, deposit their shares into the trust, and nominate a trustee. 
****** The trustee votes in accordance with the trust agreement, the shareholders that deposited the shares in the trust get the dividends and stuff.
***** In NY the voting trust can only last for ten years, with a multiple ten year term extension NYBCL 621
***** You have to file a copy of the agreement with the corporation DGCL 218
** '''2. Ownership '''
*** How we ensure the shares stay in the hands in those we want to own shares 
*** <u>'''2 Types of Provisions'''</u>
**** '''(1) <u>Transfer Restrictions''' </u>(Charter, By-laws, or shareholder agreements) 
***** '''''1. Right of First Refusal''''' 
****** <nowiki>= Shareholder cannot accept 3</nowiki><sup>rd</sup> party offer to buy shares until shareholder 1<sup>st</sup> makes that offer to the corporation and the other existing shareholders, & the corp. and shareholders refuse. 
******* NY—Permitted in NY. Del does: 
******* Del.— Must be in the shareholders agreement
***** '''''2. Right of First Offer''''' (uncommon) 
****** '''''<nowiki>= </nowiki>'''''Before you as a shareholder shop around for third party buyer (offers), you 1<sup>st</sup> have to offer your shares to the corp. and other existing shareholders, & only if they refuse can you solicit third party buyers. 
******* Terms are typically spelled out in advance in the shareholders agreement – the terms are fixed, the price is already set. 
******* Works more in the corporation's favor b/c the price fixed in the agreement might be less than market value. If they refuse you can then solicit offers at a higher price.
***** '''''3. Consent Restraint''''' 
****** '''''<nowiki>= </nowiki>'''''You must get the corp's permission before you can sell or transfer your stock to a third party (usually written consent is required)

* 
** 
*** 
**** 
***** 
****** Problems—Stock is considered personal property, and restraints on transfer of personal property is an issue. So, if the consent restraint is not properly worded, they may not be upheld
***** '''''4. Group Restrictions''''' – Y
****** '''<nowiki>= </nowiki>'''You can transfer your shares but only to a select group of people. 
******* Typically you would restrict transfer of shares to people within the same family and you would define family (parents, children, and current spouses)
******** Involuntary transfers
********* Group Restrictions do not bar creditors
********* 
**** NOTE:
***** 

* 
** 
*** 
**** '''(2) Force Resale Provisions'''
***** <u>Typical triggering events:</u>
****** '''''1. Termination of Employment '''''
******* Employee shareholders must sell back shares upon termination of employment
****** '''''2. Death of a shareholder '''''
******* Typically you will have in a shareholders agreement that the estate must be bound to sell the shares back if the shareholder dies – the estate gets what it wants – money – and the remaining shareholders get what they want – the shares back rather than falling into the hands of heirs that they do not want to be in control
****** '''''3. Incapacity of a SH'''''
****** '''''4. Bankruptcy of a SH'''''
***** '''Biggest Issue is→ what price are you going to pay?'''
****** '''A specific dollar amount is always listed in the shareholder agreement beforehand'''
******* '''(1) BV = (TA-TL)/(#outstanding shares)--'''Less than FMV
******** There are a number of problems with book value – it is a good number for the person who is writing the check (conservative value), but not necessarily good for the person receiving the check, b/c it does not reflect "going concern" value. 
********* Assets are listed at their historical cost, or at lower value if their value has been permanently impaired, so the BV does not recognize that assets (land/bldgs) go up in value. The land would still be listed at the price paid for it.
********* BV is a terrible measure for businesses that are not capital intensive – businesses that don't have a lot of tangible assets, like cars, trucks, equipment (like a law firm or doc's office where the main assets are the client relationships, the human capital and the customer list – these are not listed as an asset and they are the most valuable parts).
******* '''(2) Discounted Net Cash Flow''' – Try to predict the net cash flow going into the future to see what the profit will be
******* '''(3) Hire an Appraiser''' – hire people to appraise the corp. there might be a dispute as to who the appraiser will be

===DISSOLUTION FOR DEADLOCK===
(when shareholders of a Closely Held Corporation no longer get along? corporate equivalent to divorce)
* Severe disharmony can result in deadlock at either the BoD level or shareholder level, and can lead to oppression of minority shareholders by majority shareholders
** <u>Board of Directors Deadlock</u> is extremely severe because Board is unable to make a business decision 
*** In a board deadlock situation the corp. just treads water – half of the board disagrees with the other half
*** <u>Shareholder deadlock</u> is dangerous because they can't elect new directors 
**** Successive electors can never be elected because the shareholders can't agree on who to vote in
* '''Dgcl § 226—Court appointed Receiver or Custodian'''
** Allows Chancery Court to Appointment a '''''custodian''''' or '''''receiver''''' of corp. on deadlock 
*** The custodian takes over and runs the company, until such time that the disagreeing parties agree to something. Custodians job is not to dissolve the company, but rather just to run it.
**** 1. When the shareholders are so divided that they have failed to elect successors for directors whose terms have expired
**** 2. The business is suffering or is threatened with irreparable injury
**** 3. The corp has abandoned business and has failed w/I a reasonable time to take steps to dissolve, liquidate or distribute its assets
*** Any shareholder can request this of the court. 
* '''NYBCL § 1104(a)—Dissolution therefore much more harsh'''
** Holders of shares representing 50% of the voting power can petition a court for dissolution if:
*** 1. The directors are so divided that directors can't come to a vote on anything
*** 2. Shareholders are so divided that they can't vote on directors
*** 3. Factions of shareholders are so divided that it would be more beneficial

===DISSOLUTION FOR OPPRESSION===
(when controlling group engages in Oppressive conduct against the minority stockholders)
* ''In Re Kemp & Bailey, Inc. ''
** 2 employee shareholders both left the employ of the corp after 42 and 35 years of service. 
** Before these two men were forced out they received the vast majority of there earnings as salaries. 
*** So, stock ownership was basically a union card to be able to work there and they were a cohesive group of people at one time. 
*** There were also dividends paid and bonuses paid. 
**** This ultimately leads to a low profit for the corp, which is great because as a C-Corp you pay less tax. Although you have to pay employment tax, it is less than the profit tax would be. 
** When these two guys are forced out, they stopped paying dividends. 
** Before these two guys left there was a history of the corp buying back the shares of employees that would leave, but the corp did not do that with these two guys.
** These two guys file a <u>claim</u> of '''''oppressive conduct''''' 
*** B/c they own stock that is basically worthless because they are not getting dividends (the other stockholders are getting salaries and bonuses) 
*** They can't sell the stock because there is no one out there to buy it. It isn't worth anything.
*** They file a '''''petition for dissolution''''' on the basis of oppressive conduct under '''''1104-a''''' (different provision than 1104(a))
**** '''Under 1104-a a petitioner must own at least 20% of all the outstanding shares to file for dissolution for oppressive conduct. '''
***** If 2 or more people own more than 20% than that's okay
** '''Court defines "Oppressive Conduct" '''
*** '''''Reasonable expectation''''': the conduct of majority of controlling shareholders substantially defeats the reasonable expectations of minority shareholders in committing their capital to the enterprise in question 
**** You look objectively at the shareholder's expectations as a whole to see what the majority shareholders knew or should have known or the reasonable expectations of minority)
**** '''What is the reasonable expectation of a shareholder of a closely hold business?'''
***** Ownership and control and employment for himself—He might not anticipate a big return on his shares, he wants a salary – typically the investment return of a closely held corp is salary, retirement benefits. When you are fired you don't get these benefits.
** '''Remedy = ''Statutory dissolution''''' 
*** But courts are reluctant, so typically courts order a less drastic remedy. 
**** '''Before dissolution, court offers that the other shareholders buy out the oppressed shareholders shares at fair market value so as to avoid dissolution. '''
***** This is good for the oppressed shareholder – he wants money and it is good for the shareholders that want to keep the corp together – just without the oppressed shareholder's involvement
***** '''<nowiki>***If they can't agree on what fair value is, the court can decide for them under nybcl 1118(b). </nowiki>'''
****** What are the options if the oppressors are not willing to pay the FV? 
******* Dissolution

* '''Note: Why isn't the duty of care and loyalty enough to protect the oppressed shareholders in this case? Why do we need dissolution statutes? '''
** Business Judgment Rule as a legal presumption that presumes the board members were well informed
*** Stop paying dividends—BoD has wide discretion
*** Paying bonuses—Also boards wide discretion
*** Since all this fits well into the BJR, we end up having the oppression statutes