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- Assigning liability to the least-cost avoider (e.g., P, employer)


Formation: formal filing (MBCA 2)

Archbishops Piercing the veil (never works for public)


Is it a security? Economic reality Sale of securities (§ 5)

- SEC registration + approval


- Personal liability (Sea-Land)


Exempt transactions

Reduce total agency cost = monitoring + residual (fringe)


1) Unity of interest +

§ 4(1)



2) Sx injustice or fraud

Private offerings

P’s liability to 3P in K can come from A’s…

- Subsidiary as alter ego


Exempt securities

1. Express authority


Fact-based TOTC

- Material misstatement/omission

2. Implied authority


No respondeat superior

- Exchange Act disclosures

3. Apparent authority requires awareness of P

among subagents

- Tort action (e.g., products liability)

Insider trading silent about material fact?

- Insiders


DEFENSE: estoppel

Roles with director discretion


Temporary fiduciaries

by 3P

- Corporate gift giving


10b-5 policy vs. CL

4. Inherent agency power from

- Dividends

- Misappropriation

undisclosed P? P’s… Ratification P’s liability to 3P in tort

- GF business judgment (BJR)


Cady, Roberts duty to disc


vs. “while in possession”

Limited Liability Companies

CL vs. 10b-5

- Relationships in law, not labeled

- Apparent agency control

o Over “instrumentality”?

- Type of A

LP vs. GP see RULPA 303 liabilities

LLPs only covers negligence, pro service

LLCs best choice unless startup

- Member/manager managed?

- Tippees

Proxy fights

- S/h list right of inspection by s/h

o Conflicting state laws


- No personal liability

- Other corp records prove purpose

Employee? Respondeat superior


Agents disclose to avoid

Takeovers (t-offers) – “enhanced scrutiny”



Dissolve properly to avoid

- Revlon duties sale of control


IC (non-servant agent)? Not liable

- Generally, freedom of K

- Unocal duties if no Revlon duties

o Franchisee (hybrid)? Depends on purpose A’s liability to 3P in K can come from nondisclosure of unidentified P. Fiduciary duties of A to P

- Unjust enrichment

- Duty to inform (disclose/abstain)

- Loyalty, noncompetition, care, competence, diligence

- Loyalty, noncompetition, care, competence, diligence Partnerships Formation: Act like it Existence: 2+ co-owners

Partnerships Formation: Act like it Existence: 2+ co-owners

- TOTC to assess existence

- PCV same as corporations



Self-interest? Entirely fair

- Fid duties to LLC (ULLCA 409)


Concern for non-s/h?



Loyalty, care, noncompete


No discrim self-tender


Members can agree waiver


Poison pill OK


Ends upon dissociation


Board of Directors Duties

Corporate Litigation Derivative suits

- Demand requirement

BJR presumption (Π burden to rebut), unless uninformed (gross negligence std), fraud,


Rejected? BJR

dishonest practice, bad faith, irrational BP


Cannot bifurcate claims

- Rebut Δ burden “entire fairness”



- Dissent: directors always informed

- Demand excused? Litigation

Duty of care (hasty decision-making


SLC determination



2-step test for MTD


Partners vs. employees

- Informed? Gross negligence std

Indemnification & insurance (DGCL 145)


Partners vs. lenders

- Rely in GF on officer reports

- Rights must be consistent w/ statute


Profit sharing necessary,

- Merger duties: be informed, have

- Must indemnify: D/O successful

rebuttable presumption

adequate basis, disclose to s/h

- May indemnify: Pt in good faith

- Partnership by estoppel

Fiduciary duties of partners to ptship

- Loyalty: Act in best interest of ptship; disclose

- Care: Negl/careless/violate law

- Breach limited to “secret profits”?

- DGCL 102(b)(7) limits $ dmg

Duty of loyalty (self-dealing, COI + GF)

- Trumps BJR – ↑ scrutiny if COI

o Safe harbor EXCEPTION

- Corporate opportunity doctrine 4- part Broz test

- May pay suit expenses in advance

o Rsbl agreements enforced

- May maintain insurance

Close Corporations

Ways for minority s/h to get more power

- Dominant/controlling s/h’s duty


Shareholder agreement?

No specific possessory property rights. Vs. joint ventures


Self-dealing? “Fairness


By 100% shareholders?


Fact-dependent scope and effect

- Ratified by interested director s/h



City magistrate

- Same fiduciary duties as partners Rights of partners in management

Duties of care & loyalty

- Revlon (sale of control)

Fiduciary duty utmost GF and loyalty

- Minority squeezed out?

- 2-person ptrship

- Unocal (takeover defenses)


Mass. vs. Del.


Disagree on ordinary?

Duty of good faith (condition to loyalty)




Maj. in two-person ptship?

- More than gross negligence

- Terminating directors?


Who’s suing: 3P or ptr?

- In executive compensation

- Ad-hoc controlling minority?


Recover expenses by one?


Corporate waste?

- Both employee and s/h?

- Agreements very flexible, comes

with risks of disagreement

- In executive oversight

- BF necessary cond for liability


“Agency” indicates the relation that exists where one person acts for another. Specifically, an agency relationship results from assent by one person (principal) to another (agent) that the agent shall act on the principal’s behalf and subject to the principal’s control, and assent/consent by the agent so to act


Assent or intention manifests through words or conduct

o Dissent: Agency means more than mere passive permission. It involves request, instruction or command (Klee)

Control ex condition that coach drive it (or merely a natural precaution)

Control is NOT: characterization in agreement, context of industry, popular usage

o Not probative by itself: marital status, joint ownership

The principal is responsible for the acts of his agent. Where one undertakes to transact some business or manage some affair for another by authority and on account of the latter, the principal-agent relationship arises. (See R.3d 2.04, 7.07(2) respondeat superior)

Not necessary: K, compensation, business matter

A creditor (security holder) who assumes control of his debtor’s business may become liable as principal for the acts of the debtor in connection with the business. 1

Can show control in light of all the circumstances an active participant in the debtor’s business


A creditor becomes a principal when he assumes de facto (actual) control over the conduct of his debtor, whatever the formal K may say


If he takes over management of debtor’s biz in person/through agent and directs what K may/may not be made

NOT merely holding veto power over business acts of debtor

Buyer-supplier vs. principal-agent

Factors showing one is a supplier:


Receives fixed price for property regardless of price paid by him!


Acts in his own name and receive title to property


Has an indep biz (operations not financed by someone else like a buyer) in buying and selling similar property

Agent: One who contracts to acquire property from a 3 rd pt and conveys it to another, only if it is agreed that he is to act primarily for the benefit of the other and not for himself

Moral hazard: when someone knows he doesn’t have to bear the full costs of bad things that might happen if the decision turns out bad, changes his behavior, making losses likelier

Liability of principal to 3 rd parties in contract



Dutiful Agent

Rogue Agent

Imposter Agent

Actual Express

Authority through express manifestations to A


Actual Implied

Actual + incidental, necessary, and customary

But implied authority may be worth arguing


1 Cargill: Grain storage company (Warren) became insolvent and owed grain dealer (Cargill) $millions without having paid farmers for their grain. Cargill was found to be the principal of Warren because Cargill was an active participant in Warren’s operations rather than simply a financier, thus showing control in light of all the circumstances (the 9 factors together, some of which would be found in an ordinary debtor-creditor relationship).


Manifestations to 3 rd party traceable to P (holding out)

But not

Holding out unlikely & maybe agency required


necessary b/c actual


Negates unusual limitations by undisclosed principal

But not

Requires P


necessary b/c actual


Acceptance of results w/ intent

But not

necessary b/c actual


Carelessly allowing rogue or imposter agent

Just the way rule is written

Apparent easier b/c it’s not equitable

The liability of a principal to third parties for the acts of an agent may be shown by proof of:

Express, real, or actual authority that was definitely granted

a. What A believes

Implied authority (to do all that is proper, customarily incidental, reasonably appropriate to the exercise of the authority granted)

a. What A reasonably believes P would authorize A to do on P’s behalf

Apparent authority (where the principal by words/conduct has “held out” the person to be his agent)

a. What 3P reasonably believes (no direct communication b/w 3P and P required)

b. Requires awareness of P: 3P’s belief is traceable to P’s manifestations

Inherent agency power?

a. Liability of undisclosed P possible

Implied vs. apparent authority an agent can exercise (R.3d 2.01-03)

Implied authority is actual authority circumstantially proven which the principal actually intended the agent to possess. P can’t think of and articulate everything for A to do. Includes powers necessary to carry out the duties actually delegated


Determine whether A reasonably believes because of present or past conduct of P that P wishes him to act in a certain way or have certain authority


Existence of prior similar practices is one of the most important factors. Specific conduct by the principal in the past permitting the agent to exercise similar powers is crucial

Apparent authority is not actual authority but is the authority the agent is held out by the principal as possessing


Depends on principal’s manifestations: An agent has apparent authority sufficient to bind the principal when the principal (not the agent) acts (or refrains from acting) so as to lead a reasonably prudent 3 rd person to suppose that the agent had the authority he purports to exercise 2


An agent has the apparent authority as long as 3 rd parties lack knowledge to the contrary


P just has to bear the risk of A doing something P doesn’t want, if P wants A working for him (“agency costs”). Or fire A if he goes beyond scope of duty

Ways to protect oneself

1. Put a disclaimer in the document that only certain officers could sign on P’s behalf

2. Make explicit on form K. Could make compensation contingent to non-deviation

3. Doctrine of assigning costs to least-cost avoider (who can avoid loss at the least cost?)

2 370, 18: P: Ampex; A: Kays; T: Joyce. Joyce could reasonably expect that Kays spoke on behalf of the company when Joyce received Kays’ letter confirming delivery dates. Nothing in the document suggests that Kays didn’t have authority to sign on behalf of Ampex. Joyce indicated to Kays that he wanted all communications to be channeled through Kays. It is reasonable for 3Ps to presume that one employed as salesman has the authority to bind his employer to sell. There was no evidence of limitations being communicated to Joyce in any manner. Kays had apparent authority to act for Ampex.

Inherent agency power

R.2d 8A: Power of an agent derived not from authority, apparent authority or estoppel but solely from the agency relation and exists for the protection of persons dealing with an agent

R.3d threw out inherent agency

Liability of undisclosed principal 3


R.2d 194: An undisclosed principal is liable to 3 rd parties for an agent’s acts “done on his account, if usual or necessary in such transactions, although forbidden by the principal”


R.3d 2.06(1) covers Watteau: An undisclosed P is subject to liability to 3P who is justifiably induced to make a detrimental change in position by an A on P’s behalf and without actual authority, if P, having notice of A’s conduct and that it might induce others to change their positions, did not take reasonable steps to notify them of the facts

Rogue A doing things outside normal course of business that P doesn’t notify


R.3d 2.06(2)

Contracts w/ 3 rd parties (R.3d 6.01-03)

Agent for undisclosed principal (PAT all bound)


Principal is party to K, unless excluded by K

Principal (if party to K) and 3P have same rights against each other as if principal made K personally


Agent and 3P are parties to K

Agent for disclosed or unidentified principal

o Only principal and 3P are the parties to the K, unless agent and 3P agree otherwise

Ratification: The affirmance by a person of a prior act of another, whereby the act is given effect as if done by an agent acting with actual authority. Retroactively creates the effects of actual authority to act on P’s behalf (R.3d 4.01-02) and binds P.

To exist, ratification requires acceptance of the results of the act with an intent to ratify and with full knowledge of all the material circumstances 4


Must be done before any manifestation of intention by 3P to withdraw from the transaction


Receipt of benefits? Before this may constitute ratification, other requisites for ratification must first be there


Implied affirmance through

Silence about lack of real authority

Acceptance of benefits before P had opportunity to decline

Resulting in prejudice of innocent 3P (buyer who buys from an unauthorized agent a house that later burns before P could affirm the K), unless 3P assents to being bound

Estoppel (vs. apparent authority): T reasonably believes “A” has authority; P carelessly permits belief; T detrimentally changes position.

If a proprietor of a place of business by his careless neglect (e.g., not monitoring) enables one who is not his agent conspicuously to act to lead a person of ordinary prudence to believe that the impostor was actually the proprietor’s agent, then the proprietor may NOT defensively avail himself of the impostor’s lack of authority and escape liability for the customer’s loss 5

3 Watteau, 20: P: Watteau; A: Humble; T: Fenwick. Not apparent authority because that requires 3P to reasonably believe A had authority from P. Here, 3P didn’t even know about P.

4 Botticello, 24: Walter (with half interest of the property) was not acting as an agent on behalf of Mary. No apparent authority existed because Plaintiff never knew that Mary was a principal. There was no ratification by Mary for Walter’s conduct because she was unaware that the benefits she received from the agreement stemmed from a lease with an option to buy.

5 Hoddeson v. Koos Bros., 28: Impostor clerk at store took P’s money and never delivered. No apparent authority (there was appearance of authority, but P did not put him out as an agent).


No manifestation by P required. P need not have put him out as an agentjust careless holding out as agent such that a 3P could reasonably infer that the purported agent has authority to contract on your behalf


See R.3d 2.05: intentionally/carelessly caused belief of agency to 3P, or did not take reasonable steps to notify 3P of the facts

For P to win, show reasonable belief and GF that the impostor was real, that it’s reasonable that the non- agent’s behavior was reasonable

Cf. apparent authority (tracing back to P involved)

Agent’s liability (on K) under a partially disclosed / unidentified principal

Actual (or reasonably equivalent) knowledge is the test for liability: It is the duty of the agent to disclose (not the other pt to discover) not only that he is acting as a representative but also the identity of the principal, if he wants to avoid personal liability. 6 (If A wants to avoid liability, must disclose P’s identity)

Liability of principal to 3 rd parties in tort The relationship of the parties does not depend on what the parties themselves call it but rather in law what it actually is.



Actual control over details of the work E.g., McDonald’s

Limited agent (for contracts) E.g., Sun Oil

Looser affiliations E.g., franchisor

Actual Agency (vicarious liability/respondeat superior)

Employer/master liable for employee/servant torts in scope of employment

Apparent Agency

Holding out causing plaintiff to rely on skill and care of purported agent; reliance tricky to prove


Employee/servant principal liable

Independent contractor principal not liable

Degree of

A person employed to perform services in the affairs of another who with respect to the physical conduct in the performance of the services is subject to the other’s control or right to control (R.2d 220(1)).

Agent-type IC


Agrees to act on behalf of principal

NOT subject to principal’s control over method of accomplishing resultthe physical conduct of the task Non-agent IC

See also R.2d



Operates independently in arm’s- length transactions


Under the doctrine of respondeat superior: A principal is subject to liability to 3Ps for the torts of his employees committed while acting in the scope of their employment.

A principal is not liable for the torts of his ICs (non-servant agents).

6 Curran, 33: P: “Marketing Designs, Inc.” (not actually incorporated); A: Curran; T: Atlantic Salmon. Curran said the real principal was Marketing Designs, Inc. “Marketing director” for the ambiguously formed company was found personally liable.


The agent also remains subject to liability even though the actor acted as an agent or employee, with actual or apparent authority, or within the scope of employment (R.3d



Scope of

An employer will be held liable under respondeat superior if the actions of the employee arise out of the course of his employment.


2 tests for employee’s actions:

Intent (Restatement): plausible story for why e’ee was acting in e’er interest

Foreseeability: It is only required that an employer could perceive that harm could flow from actions of their employees related to work (activities “characteristic” of the business). The level of foreseeability in a respondeat superior issue is lower than in a negligence case. 7

Course of employment E’ee acts within scope of employment when performing work assigned by e’er or engaging in a course of conduct subject to e’er’s control.

NOT within scope of employment when it occurs within an independent course of conduct not intended by e’ee to serve any purpose of e’er. R.3d 7.07(2)

Control is an essential element of the relationship to distinguish employee and IC (and franchisee): Does the principal have the right to control the details of the day-to-day operation of the alleged employee/IC? Control or influence over results alone is insufficient. 8

Hoover (Sun) not liable (didn’t control hours of operation, less control over pricing…)

No bright line: More quality of analysis than conclusion on exam

Assigning liability to the least-cost avoider: Party with incentive to minimize losses is the one with biggest opportunity to profit, one who controls how the store is run, how employees are trained, variable fees, etc.

Can use to justify assigning liability to P/employer, who can better spread risk of losses (cost of doing business, distribute to customers)

Franchisor-franchisee relationship (E-IC hybrid)

Is the purpose of the franchise K to achieve system-wide standardization of business identity, uniformity of commercial service, optimum public good will, or benefit both parties?

Or is it to regulate day-to-day activities (control)daily maintenance, power to hire/fire employees, set standards for employee skills, or supervise work routine?

7 Bushey, 52: Lane, a U.S. Coast Guard seaman, returned to Plaintiffs drydock after a night of drinking. For some unexplained reason, Lane opened three water intake valves, flooding the drydock. The drydock and vessel were damaged by Lane’s actions. POLICY of economic incentives was not a basis; the fact that D is better able to afford damages is not alone sufficient to justify legal responsibility; there is a deeply rooted sentiment that a business can’t disclaim responsibility for accidents that may fairly be said to be characteristic of its activities. Here, Lane’s conduct was not so unforeseeable as to make it unfair for charge D with responsibility. Human expressions of fun making and emotional flare-ups are inherent risks in the working environment. It was foreseeable that crew members crossing the drydock might do damage, negligently or intentionally (pushing Pl’s employees or property into the water). The incident was not related to his domestic life but his seafaring activity. Cf. Clover, 55: SCOTUS said a jury could reasonably find that the employee had resumed his employment and that his deviation wasn’t enough to be a total abandonment of his duties, and that SJ shouldn’t have been granted in favor of the ski resort. SCOTUS remanded for trial, but the Utah court simply said that the foreseeability standard was not the applicable test in Utah.

8 Sun Oil, 40 (found to be IC); cf. Humble Oil, 36 (found to be employee b/c of degree of control exercised by corporate)

Tort liability 9


Apparent agency? If the franchise agreement goes beyond setting standards and allocates to

the franchisor the right to exercise control over the daily operations of the franchise, an agency relationship exists (and franchisor becomes subject to vicariously liability as effective “employers”) 10

3P must have relied on a manifestation of apparent principal, and it must have been that reliance that exposed 3P to harm

Vandemark focuses on control over “instrumentality” that caused the harm


Apparent authority would not work in tort cases! P would not authorize its agent to act


Tradeoff between taking on more legal risk from control and reputational risk from substandard service. Is there a way to eliminate both risks?


Try to control compensation structure


Try to end the relationship (drastic)

Fiduciary obligation (duty of loyalty, care) of agents Unjust enrichment: If an employee takes advantage of his service and violates his duty of honesty and good faith to make a profit for himself, and the principal’s assets and the employee’s position play the predominant (sole) part in enriching himself, then he is accountable for it to the principal. 11

P doesn’t need to be harmed as a result

Accountable to P for profit solely due to opportunity created by employee’s position, rank, facilities, etc.

o Law professors, war heroes, etc. generally not going to be a problem

“Disclose (& secure P’s assent) or abstain” duty to disclose/inform self-dealing in conflict with P: An agent has a duty to disclose to the principal what the principal should rightly knowmatters affecting the principal’s business. An agent cannot use the relationship to benefit his personal interest, except with the full knowledge and consent of the principal. 12


Duty to deal fairly and openly with the principal applies in all transactions between them. An employee’s independent enterprise cannot compete or contract with the employer without the employer’s full knowledge

Loyalty: An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected

with the agency relationship.

8.04 Non-Competition: Throughout the duration of an agency relationship, an agent has a duty to refrain from

competing with the principal and from taking action on behalf of or otherwise assisting the principal’s competitors.

9 Holiday Inns, 42: Holiday Inns was not given any power to control its licensee’s business expenditures, fix customer rates, or demand a share of the profits. It was given no power to hire/fire employees, determine wages or working conditions, set standards for employee skills or productivity, supervise employee work routine, or discipline employees. All such powers and responsibilities typically exercised by an owner were retained by the licensee. Thus, the regulatory provisions of the franchise K did not constitute agency control, in favor of defendant Holiday Inns.

10 Miller v. McDonald’s, 49: D had precise control methods, and P relied on common signs to believe that all McD’s restaurants were the same because she believed that one entity owned and operated all of them (or at least exercised enough control that the standards that she experienced at one would be the same as others).

11 Reading, 70: Sergeant took bribe to transport a lorry with cases of unknown contents without being inspected. The uniform and position of Pl were the only reasons he was able to get the money. He got the money by virtue of his employment, and must not be allowed to enrich himself this way.

12 Rash, 74: Breach of fiduciary duty by employee for subcontracting with his company. Even if his boss said he had no problem with forming a business that might contract with the employer, failing to inform specifically his ownership in his own company was a violation of fiduciary duty.

During that time, an agent may take action, not otherwise wrongful, to prepare for competition following termination of the agency relationship.

8.08 Duties to Principal to Act with Care, Competence, and Diligence:

Normally exercised by agents in similar circumstances

Normally exercised by agents with special skills or knowledge

8.09 Duty to Act Only Within Scope of Actual Authority and to Comply with Principal’s Lawful Instructions

8.14 Duty to Indemnify (Compensate) Agent


Agent makes a payment


w/in scope of actual authority


beneficial to the principal, unless the agent acts unofficially

Agent suffers a loss that should fairly be borne by principal









Ptrs pers liable


Double tax (C-corp)

Single tax

Single tax


Yes (C-corp)

No (no IPO; VC rare but possible)




Less important?

Not important

Separate ownership/ control?




Big differences between corporations?

Liability: Partners are personally liable for liabilities of partnership. Shareholders are not personally liableall they can lose is the money invested in the corporation

o Limited liability important for large corporations

Legal formality: Start a corporation by filing the appropriate documents with secretary of state. Start a partnership by acting like one (see the Uniform Partnership Act (1997), CA adopted)share profits and control

Term: Corporations are theoretically immortal (until dissolution). Partnerships by default (unless contracted) dissolve when one of the partners drops out

Taxation: Partners pay taxes on partnership profits as part of normal income. Corporation pays taxes, and then shareholders pay taxes on dividends

Partners are all agents and principals to each other (UPA 301). Often in a corp, the managers are agents, and shareholders are principals

Don’t need a board of director in a partnership

Partners share profits and losses in proportion (UPA 401(b))

A partnership is an association of 2+ persons to carry on a business for profit as co-owners. See also UPA § 101(6).

“business”: a series of acts directed toward an end, which includes every trade, occupation and profession (UPA § 202 comment 1, 101(1))

If partners want to modify the default statutory requirements, they need a written partnership agreement. The primary source of “partnership law” is the partnership agreement. Thus, much of the law of partnerships is K law: Was there an agreement? If so, what does it say about the issue in question?

Partners vs. employees: The sharing of profits (e.g., with an employee) is a necessary factor but does not alone create a partnership, despite the parties’ intentions or contract terms. 13

Partners vs. lenders: Creditors who are granted a share of profits and some management control are not necessarily deemed partners if other factors indicate contrary intent. 14

13 Fenwick, 79: Mrs. Chesire, a receptionist, is an employee despite respondent and Chesire’s agreement that termed her as a partner. The sharing of profits is but one factor in determining whether a partnership exists. The court looked at several other factors that did not indicate a partnership in this case, such as obligation to share losses, ownership and control, conduct towards third parties (didn’t hold out as partners), and rights of dissolution. When the court weighed this against parties’ intent and the sharing of profits, the scales weighed in favor of an employer-employee relationship. She got nothing from the agreement but a new method of compensation as an employee. It did not establish a partnership; she was an employee.

14 Martin v. Peyton, 84: Hall was a friend of respondents, and Hall’s brokerage business was suffering. Respondents discussed helping Hall and his business, but they needed to ensure that Hall’s business would discontinue their speculative, unwise investments. Respondents agreed to loan Hall $2.5M in securities for Hall to secure $2M in loans. In return, respondents received Hall’s more speculative collateral and would receive a percentage of Hall’s profits. Hall retained management over the firm. Respondents, as trustees, acquired the ability to review Hall’s books and veto speculative investments. The agreements did not establish a partnership b/c the controls they bargained for were to ensure that their investment was secure in the lender’s interest lender status.

The labels the parties assign to their intended legal relationship, while probative of (relevant to) partnership formation, are not necessarily dispositive as a matter of law. Its existence must be assessed under a TOTC test (factors that indicate the extent of the relationship). 15

Profit sharing creates rebuttable presumption of partnership, but rebuttal is not limited to list of exceptions in statute. Receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but no such inference is drawn if profits were received:


As a debt


Employee wages




Loan interest



Partnership by estoppel (cf. partners in fact) 16

If a person represents himself (or permits another to represent him) to anyone as a partner in an existing partnership or with others not actual partners + the 3P to whom such a representation is made relies on the actual or apparent partnership on the faith of such representation, then the first person is liable to the


Generally, partners are jointly and severally liable for everything chargeable to the partnership (UPA


o If two partners are partners by estoppel, one partner can be held jointly and severally liable for the negligent acts of the other partner

Fiduciary obligations of partners Each partner (or joint adventurer) in a partnership owes the other partners a fiduciary duty to act in the best interests of the partnership over the interests of the individual in matters concerning the partnership. 17

Disclose the deals, opportunity, information

Partnership requires money. Each partner contributes capital. Default rule is that partners share equally in profits and is chargeable with a share of the losses in proportion to the share of the profits (UPA 401). Account balance can be negative.

Fiduciary duties a partner owes to the partnership (UPA § 404)

Duties of loyalty to


Account to the partnership and hold as trustee for it any property, profit or benefit derived by the partner through the partnership


Refrain from dealing on behalf of a party with an interest adverse to the partnership


Refrain from competing before dissolution

15 Southex, 89: Whether a partnership was formed turns primarily on factual findings, reviewed for clear error. Given the highly deferential standard of appellate review, Southex (plaintiff who acquired SEM) did not provide sufficient evidence to prove a partnership relationship with RIBA (DC affirmed). Southex insists that the agreement contained ample indicia of partnership formation: sharing of profits, mutual control, contributions of property. BUT the agreement was not titled “Partnership Agreement,” and SEM never considered itself as a partner (simply the producer, disclaimed ownership interest). As far as their conduct post- agreement, the parties may have split the profits, but they never shared in tangible property; SEM was responsible for most management decisions; Southex did not hold themselves out as partners to third parties; nor gave the collaboration a separate name. See 91-93. No parternship.

16 Young, 93: Found no partnership by estoppel. No reliance by brochure in making the decision to invest the money that disappeared. No credit given in reliance on representations as to the existence of a partnership.

17 Meinhard v. Salmon, 97: π, Morton Meinhard, was a partner with Δ, Walter Salmon, in the leasing and operation of a hotel. Δ was the manager of the building. Four months prior to the expiration of the lease, Δ signed a new lease with the lessor that would encompass the hotel plus the surrounding area. The deal was between the lessor and a business solely run by Δ. It was a deal with a third party over the future of the hotel that was not disclosed to π. Shares owned by Δ awarded to π (half?).

Duties of care to refrain from engaging in grossly negligent or reckless conduct, intentional conduct or knowing violation of the law

Day implies breach of fiduciary duty is limited to cases of “secret profits” advantaging oneself at ptship’s expense: One partner is essentially stealing opportunity from partnership, kickbacks, contracting with another business, etc.

Joint ventures 18

A JV is similar to a partnership but is more limited in scope and duration, and principles of partnership law apply


Joint adventurers owe the same duty of loyalty as partners


JV vs. partnership is also arguable

For a business enterprise to constitute a JV, these must be present:


(1) contribution by the parties of money, property, time, or skill in some common undertaking, but the contributions need not be equal or of the same nature;


(2) a proprietary interest and right of mutual control over the engaged property;


(3) an express or implied agreement for the sharing of profits, and usually, but not necessarily, of losses; and


(4) an express or implied contract showing a joint venture was formed


There is, however, no fixed formula for identifying a joint venture relationship in all cases, and each case will depend upon its own unique facts

Partnership property: A conveyance of partnership property by one partner held in the name of the partnership is made in the name of the partnership and not as a conveyance of the individual interests of the partners. A partner does not personally own any specific property of the partnership (only possessory rights on the claims to profits/losses) and therefore cannot retain any rights to the partnership after conveyance. 19

Interest in a partnership is interest in “share of the profits” (and losses)

o A partner is not a co-owner of partnership property and has no interest in partnership property that can be transferred (UPA 501)

Like a hypothetical oil discovery on the partnership real property after transfer of a partnership interest with neither pt believing oil to be there: The interest in the real property remains in the partnership. The transferor wouldn’t have transferred his partnership interest had he known of the oil, but mutual ignorance wouldn’t warrant a reformation of the contract for sale of the interest nor a share of the value of the oil

o It might matter if there was a failure to disclose, though. Partners who convey interest in the partnership are not entitled to profits to a surprise discovery

The only transferable interest of a partner is his share of the profits and losses and the right to receive distributions. The interest is personal property (UPA 502)

A transfer of a partner’s transferable interest in the partnership does not by itself cause the partner’s dissolution or dissociation (UPA 503(a)(2))

o When there has been a dissociation (UPA 601), the partnership continues as to the remaining partners (UPA 701)

18 Sandvick, 106: A JV did exist in regard to the pts’ purchase, but LaCrosse and Haughton breached their fiduciary duties of loyalty by taking advantage of a JV opportunity when they purchased the top leases without informing Bragg and Sandvick. 19 Putnam, 123: Putnam and her husband owned one half of a business, Frog Jump Gin, with another couple. After Putnam’s husband died, the business became unprofitable, and Appellees offered to take Putnam’s share of the business. Putnam and the other partners would put $21,000 into the partnership and then Putnam would convey her share of the business. After Putnam conveyed her interest in the partnership and rights to partnership property, Appellee’s discovered that the former bookkeeper was stealing money from the business. The business collected $68,000, but Putnam asserts that Appellee’s share is rightfully the estate of Putnam’s because the misconduct happened while she was a partner. BUT she is not entitled to the money collected by the business. Although the dishonest bookkeeping occurred while Putnam was still a partner, Putnam signed over her undivided interest in the partnership to Appellees. If she had an interest in the money, then she had an interest in the partnership.

Court may charge the transferable interest of a judgment debtor to satisfy the judgment for a judgment creditor of a partner (UPA 504)

Rights of partners in management If there is a disagreement as to an “ordinary course of business,” the decision of the majority controls. An act outside the ordinary course of business and an amendment to the partnership agreement may be undertaken only with the consent of all of the partners (UPA 401(j)).

Nabisco: two-person partnership + claim from 3P (biased for first acting partner) 20

Partners are jointly and severally liable for the actions of the partnership

Buying bread from Nabisco was the status quo, need a majority to change this

What could Stroud have done to protect himself? He could have amended the partnership agreement. They could bring in a mediator they trusted. They could delineate areas of responsibility and provide one party with greater voice in certain areas (one gets to control bread buying). Tiebreaker is what is considered what is “ordinary course of business”

On the other hand, couldn’t the court view Stroud’s refusal of the deliveries as a decision within the scope of the business that cannot be overruled by Freeman’s consent? Is it less “ordinary” to refuse deliveries?

Two partners in conflict (biased for second acting partner)

A partner will not be permitted to recover expenses that benefit the partner individually (even fulfilling a K obligation) rather than benefiting the partnership 21

A way to resolve: Who’s suing, 3P or partner?

3P creditor who relied on 1 partner acting as agent? Then this partner bound the partnership (Nabisco)

If partners arguing about sharing costs incurred by 1 partner? Less likely to bind if clear other partner didn’t consent (Summers)

One person may have implied powers in one department as an implied term of the partnership agreement, but another may have power to override decisions as someone higher up.

Agreements can be very flexible: Partners are free to make any agreement it suits them, without concern about minutiae of partnership theory. 22 There are business risks of disagreements, which are not for courts to adjudicate.

In a ptrship, the default rule is that participation in the biz is the right of a partner.

20 Nabisco, 127: Partners are jointly and severally liable for the actions of the partnership. Since Stroud is only one half of the partnership, and not a majority, he is unable to prevent Freeman from exercising his rights. Freeman had actual authority (and maybe apparent authority) to authorize bread deliveries while Stroud specifically attempted to disclaim responsibility.

21 Summers v. Dooley, 129: π and Δ were partners who agreed that if either was unable to perform then that partner was responsible for paying a third party to work on his behalf. π should not be compensated by the partnership for the cost of the additional employee. The additional employee was brought on for the personal benefit of π and not the partnership. Δ repeatedly rejected the hiring. A decision to change the status quo (of paying for own employee) would also require a majority approval, and π’s one vote did not constitute a majority. Hiring an extra employee was seen as in the ordinary course of business.

22 Day v. Sidley & Austin, 131: Sidley & Austin (Δ) did not violate a fiduciary duty to Day (π) by their merger and subsequent title change for Plaintiff. The partnership agreement that Plaintiff signed authorized the executive committee to appoint members and chairpersons, so Plaintiff was aware of the possibility of a co-chair. Also, Defendants decisions were not made to personally profit at the expense of the firm, and their fiduciary duty does not extend to what Plaintiff proposes. Finally, even if Plaintiff was aware of the title change, his vote against the merger would not have affected anything because a proposed merger only requires a majority vote unless specifically stated otherwise in the partnership agreement.

In an absence of an agreement to the contrary, none of the partners is entitled to a salary. Can draw a return from the ptrship (like a salary) by agreeing that all partners do. Ptrs cannot pay themselves without paying others.

Any ptr can dissolve the ptship, forcing the others to buy him out.


Differences between partnerships and corporations



How to form

Act like it

File articles of incorporation with secretary of state

Must include name of corporation, which must include words like “corporation,” “company,” “incorporated” or abbrs.


Can bargain with creditors to limit liability, and buy insurance

C shareholders have limited liability, but not absolute (veil piercing)


Partnerships at will, can end at any time

Default is indefinite, but possible (rare) to limit term of corporation


Partner is an agent but can agree to the contrary

Centralized management

What rights do shareholders have?

Voting rights on who is on board of directors, big decisions (mergers)

Receive dividends

Be residual claimants, get paid whatever is leftover when a corp goes bust

Amendments to articles of incorporation (constitution), bylaws (statutes)

Limited liability



Encourages capital formation, risk taking


Reduces monitoring costs

Downside of limited liability


Negative externalities (co can’t absorb all costs)


Risks to creditors

Can incorporate in any state but most who hope to go public incorporate in Delaware.

Race-to-the-top theory: Delaware is the best place for shareholder benefits. Delaware won the race to the top

o Why would management choose this state?

Signal shareholders and not get removed from management

Network effect: Everyone else is using it, like MS Office. More efficient to have everyone operating by the same rules

Predictability to companies from precedents, want to know what the rule is

Business cases are tried in Delaware chancery, a highly experienced and specialized court that deals almost exclusively with business matters

Formation and limited liability Model Business Corporation Act

1+ person may act as the incorporator(s) of a corporation by delivering articles of incorporation to the secretary of state for filing (2.01)

Corporate existence begins when the articles of incorporation are filed, unless a delayed effective date is specified (2.03)

Pre-incorporation transactions: Jointly and severally liable for all liabilities created while appearing to act as / on behalf of a corporation while knowing there was no incorporation (2.04)

Bylaws may have any provision not inconsistent with law or AOI (2.06)

Shareholders are not liable to the corporation or its creditors except to pay the consideration for the shares (6.22)

o Shareholders are not personally liable for the acts/debts of the corporation except by reason of his own acts

A director who assents to a distribution to shareholders in excess of what may be authorized is personally liable to the corporation for the amount of the distribution that exceeds the art of inc/6.40(c) limit

An archbishop can be a corporation sole under CA Corp. Code with the same civil rights and duties as other corps (Sheffield).

Piercing the veil / “alter ego” (CA) theory NEVER works for public companies (can own AAPL and sleep soundly)! Only for private companies (usually smaller group of shareholders) OR wholly owned subsidiary of larger, public company.

An individual can be held liable for the acts of a corporation through the doctrine of respondeat superior only if it can be shown that the individual used his control of the corporation for personal gain rather than furthering the corporation’s business. 23

Makes a “parent” liable for the actions of a “subsidiary” which it controls, but it doesn’t mean that where a parent controls several subsidiaries each subsidiary then becomes liable for the actions of all other subsidiaries. There is no respondeat superior between the subagents! 24 Need something like enterprise liability

The veil of limited corporate liability will be pierced when the plaintiff proves that

o 1) not only does the corp appear to be influenced and governed by the individual, there is a unity of interest between the individual and the corporation such that the separate personalities of the corp and the individual no longer exist, and

Fail to respect the corporate’s separate existence

To determine whether a corp is so controlled by another to justify disregarding their separate identities, focus on 4 factors:

(1) the failure to maintain adequate corporate records or to comply with corporate formalities,

(2) the commingling of funds or assets,

(3) undercapitalization, and

(4) one corporation treating the assets of another corporation as its own

Not holding meetings, not keeping minutes

23 Walkovszky, 176: Plaintiff, John Walkovszky, was injured by a taxi owned by a corporation owned by Defendant, William Carlton. Plaintiff sought to hold Defendant personally liable for his injuries. Defendant would be held liable under the respondeat superior doctrine if he controlled the corporation for his personal benefit at the expense of the corporations benefit. Plaintiff did not offer proof to make that claim, and instead offered proof that the ten corporations operated as one large corporation. The fact that the corporations may have been one large corporation, however, does not prove that Defendant was controlling the corporations for his own behalf. The dissent argued that the corporations were undercapitalized (each cab had only $10,000 worth of insurance coverage, which is the statutory minimum) and the corporate entity was clearly used to simply escape liability. The dissent wanted to pierce the corporate veil to achieve a more equitable result, but the majority believed that it was the legislature’s responsibility to raise the mandatory insurance coverage. The majority and the dissent both regard the series of corporate entities set up by Defendant as a method of limiting Defendant’s liability, but the majority reasons that the legislature should be the one to correct the abuse.

24 Sheffield, 187: π filed suit in CA against the Roman Catholic Archbishop of San Francisco after a Roman Catholic order’s monastery in Switzerland failed to ship a St. Bernard dog after installment payments. Δ argued in support of MSJ (denied) that he was not a party to the contract, had no knowledge of the alleged tx, and was a distinct legal entity. Π countered that the Roman Catholic Church is one worldwide entity, not a composite of entirely separate entities as Δ claimed. Π didn’t contend that Δ was involved in the tx between him and the monastery argued under the “alter ego” theory. But π doesn’t meet either of the two requirements for alter ego because the issue is whether the Archbishop may be held liable. Π doesn’t show that the Swiss organization is an alter ego of the Archbishop or vice versa. Also it is not sufficient that π won’t be able to collect if the corporate veil is not pierced.

Not having an elected board

Treated as “mere instrumentality”

o 2) to allow the limited liability would promote an injustice (injured the party seeking to pierce

the veil) or sanction a fraud. 25

To afford creditor protection where some bad faith conduct makes it inequitable for the equitable owner of a corporation to hide behind its corporate veil

Not required to fully prove intent to defraud

Courts that have properly pierced the corporate veils to avoid promoting injustice found that some “wrong” beyond a creditor’s inability to collect would result, e.g.,

A corp would be unjustly enriched unless liability is shared by all

Usage of corporate facades to avoid responsibilities to creditors

NOT satisfied when an unsatisfied creditor is trying to collecting payment 26

General doctrinal approach: If shareholder observes formalities and “respects separate existence of corporation,” no PCV. Otherwise, may be liable—depending on jx, usually need to show some injustice for PCV, not just unhappy creditor.

Subsidiary as alter ego of parent

Fact based: TOTC must be evaluated in determining whether a subsidiary may be found to be the alter ego or mere instrumentalityof the parent corporation. 27 All jx require a showing of substantial domination. Factors to be considered in applying the doctrine:



Commingling of funds

Holding out by one entity that it is liable for the debts of the other

Identical equitable ownership in the two entities

Use of the same offices and employees

Use of one as a mere shell or conduit for the affairs of the other


In re Silicone

the parent and the subsidiary have common directors or officers

the parent and the subsidiary have common business departments

the parent and the subsidiary file consolidated financial statements and tax returns

the parent finances the subsidiary

the parent caused the incorporation of the subsidiary

the subsidiary operates with grossly inadequate capital

the parent pays the salaries and other expenses of the subsidiary

the subsidiary receives no business except that given to it by the parent

the parent uses the subsidiary's property as its own

the daily operations of the two corporations are not kept separate

the subsidiary does not observe the basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings.

25 Sea-Land Services, 181: First prong met. Corporate records and formalities have not been maintained; funds and assets have been commingled with abandon; PS, the offending corporation and perhaps others have been undercapitalized; and corporate assets have been moved and tapped and “borrowed” without regard to their source. Second prong not met. Π did not adequately offer evidence on the second point to be awarded a motion for summary judgment. Need more than simply an unsatisfied claim.

26 Sheffield, 190

27 In re Silicone, 195: 1) The fact-finder at a trial could find that the evidence supports the conclusion that many of these factors have

been proven: two of MEC's three directors were Bristol directors

establish some of the other factors listed above, would provide significant support for a finding at trial that MEC is Bristol's alter ego.

2) Delaware courts don’t necessarily require a showing a fraud if a subsidiary is found to be the mere instrumentality or alter ego of its sole stockholder. Even in jx that require a finding of fraud, inequity or injustice, MEC may have insufficient funds to satisfy the potential risks of π’s claim. Bristol also permitted its name to appear on breast implant ads and packages to improve sales by giving the product additional credibility. It would be inequitable and unjust to allow Bristol now to avoid liability to those induced to believe Bristol was vouching for this product. See also R.2d Torts 324A(c) (p.197).

(p.195). These facts, even apart from evidence that might

Tort actions To PCV in tort actions against corporations, a plaintiff needs to show that the corporation is a “mere instrumentality” of the stockholder, and there is no burden to prove fraud. 28

Where arguing to pierce the corporate veil, a decision based upon a totality of the circumstances, summary judgments will rarely be granted because the decision is so fact-based

Respect the corporate formalities to avoid liabilities! Have shareholder meetings, have a real board, let them keep money in their own bank account, and be careful with using corp name. Can retain control by selecting directors who know what’s expected of them, know who they need to please, and act formally as independent directors.

Roles and purposes Corporate gift-giving is an allowable method of increasing goodwill. Any corporation could cooperate with other corporations and persons in the creation and maintenance of community funds and charitable, philanthropic or benevolent instrumentalities conducive to public welfare, and could for such purposes expend such corporate sums as the directors deem expedient and as in their judgment will contribute to corporate interests. 29

Courts are deferential. “We think this will help us. We think this will create goodwill”

Limits? Barlow: The gift should be less than 1% of the capital stock and require approval if written objections were made by holders of more than 25% of the stock

Shareholder should know where the money is going. If anonymous, they won’t know and there is no good will built through PR

Dividends: The directors of a corporation, and they alone, have the power to declare a dividend of the earnings of the corporation, and to determine its amount. Courts of equity will not interfere in the management of the directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds, or refuse to declare a dividend when the corporation has a surplus of net profits which it can, without detriment to its business, divide among its stockholders, and when a refusal to do so would amount to such an abuse of discretion as would constitute a fraud, or breach of that good faith which they are bound to exercise towards the stockholders. The purpose of the corporation is to make money for the shareholders, and it cannot arbitrarily (lack of good faith) withhold money that could go to the shareholders. 30

28 In re Silicone Gel Breast Implants Products Liability Litigation, 191: Since the cause of action is a tort action, product liability, there is no burden on the plaintiffs to establish fraud because there was no element of a mutual bargaining position and therefore no consent by the plaintiffs to the corporate structure of Defendant and its subsidiary.

29 Barlow, 251: Plaintiff corporation, founded in 1896, had a history of donating minor sums of money to various charities and institutions. In 1956 Plaintiff voted to give $1,500 to Princeton University. Plaintiff instituted a declaratory judgment action after Defendant stockholders questioned the proposed gift. Although a state statute allows corporations to contribute to charities, Defendants assert that the corporation’s certificate of incorporation does not allow the gift, and the corporation was incorporated prior to the statute that authorizes the gift-giving. Where justified by advancement of public interest, reserved power of State to alter corporate charter may be invoked to sustain later charter alterations even though they affect contractual rights between corporations and its stockholders and between stockholders inter se. There is no suggestion that it was made indiscriminately or to a pet charity of the corporate directors in furtherance of personal rather than corporate ends. It was voluntarily made in the reasonable belief that it would aid the public welfare and advance the interests of the plaintiff as a private corporation and as part of the community in which it operates. It was a lawful exercise of the corporations implied and expressly authorized powers. The potentially infinite lifespan of corporations would lead to corporations a varying ages to live under various sets of laws.

30 Dodge v. Ford, 257: Plaintiff shareholders, Dodge bros., brought an action against Defendant corporation, Ford Motor Co., to force Defendant to pay a more substantial dividend and to change questionable business decisions by Defendant. Henry Ford, admitted that the price negatively impacted short-term profits, but Ford defends his decision altruistically, saying that his ambition is to spread the benefits of the industrialized society with as many people as possible. Further, he contends that he has paid out substantial dividends to the shareholders ensuring that they have made a considerable profit and should be happy with whatever return they get from this point forward. Instead of using the money to pay dividends, Ford decided to put the money into expanding the corporation. The court reversed the portion of the lower court’s injunction of the building the plant but upheld the portion ordering payment of a dividend. Defendant is arbitrarily withholding money that could go to the shareholders. However, the court will not question whether the company is better off with a higher price per vehicle, or if the expansion is wise, because judges are not business experts.

Business judgment rule: A court will not interfere with an honest business judgment as to the best interests of the corporation and the stockholders, absent a showing of fraud, illegality or conflict of interest, clearly not aligned with shareholder interest 31


Unless there’s evidence of fraud, illegality, or COI, courts will be deferential to company board- of-director decisions. Mention what is the best interest of s/h


As π, try to show action (e.g., night baseball) is profitable to director


As Δ, try to show action is not in conflict or is profitable to company

Limited-liability companies


General partnership

o Limited-liability partnership

Limited partnership (not as common anymore) Corporations

C corporation

S corporation

Limited-liability company (corporation x general partnership)

“Limited liability” only refers to the liability of the owners of the entity. Creditors may not reach the personal assets of the shareholders who own the corporation to satisfy corporate debts.

Limited partnership (not LLP): Partnership where there are one or more general partners who manage the business, and one or more limited partners who have virtually no management authority

Needs at least 1 GP who has unlimited liability and has management responsibility for the firm

Needs to file to create a LP

A limited partner shall not become liable as a general partner (i.e., have unlimited liability), UNLESS in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business. 32

Revised Uniform Limited Partnership Act

o 303(a): A limited partner is not liable for the obligations of a limited partnership, UNLESS the limited partner is also a general partner or in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business

31 Shlensky, 262: Defendant is president of the Chicago National League Ball Club, which is the company that owns the Chicago Cubs. Although every other major league team had installed lights, Defendant did not install them for the Cubs because he was concerned that night baseball would be detrimental to the surrounding neighborhood. Plaintiff, a minority stockholder, argued that the team was losing money, and that the other Chicago team, the White Sox, had higher attendance during the weekdays because they played at night. Therefore, reasoned Plaintiff, the Cubs would draw more people with weekday night games. In this stockholders’ derivative suit against the directors for negligence and mismanagement, Plaintiff asserts that Defendant’s first concern should be with the shareholders rather than the neighborhood. Π relied on Dodge, but Dodge did involve lack of bad faith. The court affirmed TC’s dismissal. The court cited some reasons why the light installation could be detrimental, such as lowering the property value of the park itself, a lack of proof on behalf of Plaintiff that financing would be available for lights and would be certain to be offset by increasing revenues. The court cites precedent that asserts that business decisions should not be disturbed just because a defendant can make a reasonable case that the policy chosen by the company may not be the wisest policy available. There was no evidence of any of illegality, fraud or conflict of interest. Why didn’t π try to sell shares like Dodge bros.? The point was they were unvalued because of this problem.

32 Holzman, 167: The evidence sufficiently shows that Russell and Andrews both took "part in the control of the business." The manner of withdrawing money from the bank accounts is particularly illuminating. The two men had absolute power to withdraw all the partnership funds in the banks without the knowledge or consent of the general partner. Either Russell or Andrews could take control of the business from de Escamilla by refusing to sign checks for bills contracted by him and thus limit his activities in the management of the business. They required him to resign as manager and selected his successor. They were active in dictating the crops to be planted, some of them against the wish of de Escamilla. This clearly shows they took part in the control of the business of the partnership and thus became liable as general partners.

If the LP takes part in the control of the business and is not also a GP, the LP is liable only to persons who transact business with the limited partnership and who reasonably believe, based on the LP’s conduct, that the LP is a GP

Mt. Vernon, 168

A LP acting substantially the same as a GP has unlimited liability regardless of π’s knowledge of his role

Unlimited liability for exercising less than a GP’s power if the fact that he acted as more than a LP was actually known to π

o 303(b): A LP does not participate in control solely by consulting with and advising a GP with respect to the business of the limited partnership

LLPs are general partnerships that permit general partners to limit their personal liability (by filing with the Secretary of State, statutory requirements, and revising the partnership agreement to provide for limited liability).

Most LLP statutes provide limited liability only for partnership debts arising from negligence and similar misconduct (other than misconduct the partner is directly responsible for), not for contractual obligations. A few statutes provide protection for both

Professional services firms only, e.g., law, accounting

LLLP? Limited-liability limited partnership. CA doesn’t have this.

Takes GP and extends LL to all partners

LLCs (corporation x general partnership)



Tax treatment of partnership: Investors are taxed only once on its profits as they are earned. Losses can “pass through” and be taken account on investors’ individual tax returns


Limited liability of a corporationLLC provides a liability shield for its members


Flexibility in developing rules for management and control

Professional services firms cannot be LLCs

Best choice unless a VC advising a startup firmincorporate as a normal Delaware C corp. Why? The ultimate goal of a startup is an “exit event,” which will be an IPO or a sale to another company. If a company buys you, prefer to buy as a C corp. If IPO, have to create transferrable, liquid shares, which only C corp can do. VCs also don’t take dividends; they want to profit by selling their shares and taking capital gains

Uniform LLC Act

103: All members of a LLC may enter into modified rules Members vs. managers

Member-managed LLC: Members are allowed to directly manage the business

o ownership + control

Manager-managed LLC: Members can elect one or more managers to manage the business

o ownership with less control

301. Agency of members and managers


(a) Each member is an agent of the LLC

Act of a member binds the company, UNLESS the member had no authority to act for the company + the person with whom the member was dealing knew or had notice that the member lacked authority

Act of a member which is not apparently for carrying on in the ordinary course of the company’s business binds the company, ONLY IF the act was authorized by the other members


(b) In a manager-managed company

A member is not an agent of the company

Each manager is an agent of the company

o (c) Any member or manager may sign and deliver any instrument transferring or affecting the

company’s interest in real property

303. Liability of members and managers

o A member or manager is not personally liable for a debt, obligation and liability

Debts, obligations and liabilities of a LLC are liabilities of the company

A LLC not observing usual company formalities or requirements is not a ground for imposing personal liabilities

UNLESS provided in articles of organization + written consent by a liable member to the adoption or to be bound by the provision

Agents of a LLC When a 3P sues a manager or member of an LLC under an agency theory, the principles of agency law apply notwithstanding statutory notice rules (i.e., filing of the articles of organization serve as constructive notice of a company’s status as a LLC). An agent who negotiates a contract with a third party can be personally liable for breach, unless the agent disclosed both the fact that he or she is acting on behalf of a principal + the identity of the principal. 33

LLCs: the operating agreement It is the policy of LLC statutes to give maximum effect to the principle of freedom of contract and to the enforcement of LLC agreements!

LLC statutes give broad deference to the LLC members’ freedom of contract, unless the terms overstep any of the mandatory statutory provisions. 34

The mere exercise of one’s K rights, by itself, cannot be a breach of the implied covenant: The implied covenant protects the spirit of what was actually bargained and negotiated for in the K. It is clear that a court should not use the implied covenant of good faith and fair dealing to fill a gap in a K with an implied term, UNLESS it is clear from the K that the parties would have agreed to that term had they thought to negotiate the matter. 35

Piercing the “LLC veil” For the purposes of piercing the corporate veil, there is no law or policy that would require treating limited liability companies (LLC’s) different from corporations. 36

Fiduciary obligation ULLCA 409 affirmative duties of loyalty and care and noncompetition

In a member-managed company, a non-manager member owes no duties

33 Water, Waste & Land v. Lanham, 269: During the negotiations, Defendants never notified Plaintiff that they were acting as agents on behalf of their LLC, Preferred Income Investors (P.I.I.). The only reference to P.I.I. available to Plaintiff was the initials “P.I.I.” on Defendants’ business cards. When Plaintiff tried to collect for the work performed, Defendants could not pay. Clark and Lanham asserted that they were not liable because Colorado’s statutes regarding LLC’s provided constructive notice to third parties by the act of incorporation. The county court found for Plaintiff (dismissing Clark as not personally liable and entering judgment against Lanham and the company). DC reversed, relying on the notice provision of the LLC Act. However, the missing link between the limited disclosure made by Clark and the protection of the notice statute was the failure to state that P.I.I.,the Company, stood for Preferred Income Investors, LLC.” The court reversed the district court and reinstated the findings for Plaintiff.

34 Elf Atochem v. Jaffari, 274: See brief.

35 Fisk Ventures v. Segal, 280: See brief.

36 Kaycee Land, 287: See brief.

Members of an LLC can agree to limit the scope of the fiduciary (of trust and confidence in another) duty they owe to the LLC. 37

ULLCA 603(b): Upon dissociation of a member…

Member’s duty of loyalty under 409(b)(3) (noncompete) terminates

Member’s other duties of loyalty under 409(b)(1)-(2), 409(c) (no grossly negligent conduct) continue only with regard to matters arising before member’s dissociation

Members of an LLC can be held (proportionately) personally liable for the debts of their LLC if they fail to properly dissolve the LLC under the relevant statutes. 38

Board of directors

Manager/director = agent  shareholder = principal

Business judgment rule: The business judgment rule posits a powerful presumption in favor of actions taken by directors in that a decision made by loyal and informed board will not be overturned by courts unless it cannot be attributed to rational business purpose. A shareholder plaintiff challenging a board decision has the burden at outset to rebut the rule's presumption. To rebut the rule, shareholder plaintiff assumes burden of providing evidence that directors, in reaching their challenged decision, breached any one of triads of their fiduciary duty--good faith, loyalty or due care. If shareholder plaintiff fails to meet evidentiary burden, the business judgment rule attaches to protect corporate officers and directors and decisions they make, and the courts will not second-guess these business judgments. If rule is rebutted, burden shifts to defendant directors, proponents of the challenged transaction, to prove to trier of fact the “entire fairness” of transaction to shareholder plaintiff. 39 BJR precludes attempts to measure the reasonableness of a board’s decision. Irrationality is the outer limit of BJR.

Duty of care Concerns directors’ decision-making process, not the substance of their decisions: There is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company, unless it was in gross negligence (VG).

A court will not interfere with the decision of a company’s directors unless there is evidence of fraud or dishonest practice. 40

Van Gorkom: Under the business judgment rule, a business judgment is presumed to be an informed judgment, but the judgment will not be shielded under the rule if the decision was unadvised (uninformed, without substantial research) (in gross negligence). 41

37 McConnell, 294

38 Haack, 303: Defendant LLC was not properly dissolved. Creditors have priority over former partners of the LLC for the assets of the dissolving LLC. Because Haack took assets of the dissolving LLC, and evidence showed that the assets could have covered the debt owed to Plaintiff, Haack personally owes Plaintiff the outstanding gas card balance.

39 Cede & Co. v. Technicolor, 634 A.2d 345, 361 (Del. 1993)

40 Kamin, 308: Plaintiffs, Howard Kamin et al., filed a shareholder derivative suit against Defendant corporation, American Express, classifying the directors’ decision as negligent decision-making. Plaintiff demanded that Defendants sell the stock on the open market and use the $25.9 million capital gains loss to offset other capital gains. The offset would save Defendant corporation $8 million in taxes. Defendant didn’t pursue this demand, reasoning that the significant loss would adversely affect the value of Defendant’s stock. Δ’s decision may have been an unwise judgment, but it is a judgment that is outside the scrutiny of the court.

41 Van Gorkom, 312: Δ directors failed to inform themselves before recommending a merger to the stockholders, which constitutes a breach of the fiduciary duties of care and disclosure and rebutted the presumptive protection of the business judgment rule. They based their decision on Van Gorkom’s representations, which did not constitute a report on which they could reasonably rely, and they did not seek documentation of either the merger terms or the adequacy of the proposed PPS. Was $55 a fair price? Van Gorkom’s 20- minute oral presentation of his understanding of the terms of the proposed merger agreement, which he hadn’t seen, does not qualify as a “report” under DE statute. The directors were grossly negligent in permitting the agreement to be amended in a way they had not

Leveraged buyout (LBO): Put down little equity and large debt load to buy a company (usually public)

Under the business judgment rule, there is no protection for directors who have made an unintelligent or unadvised judgment

The rule itself is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. The party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one


Informed? The determination of whether a business judgment is an informed one turns on whether the directors have informed themselves “prior to making a business decision, of all material information reasonably available to them”


The concept of gross negligence is the proper standard for determining whether a business judgment reached by a board of directors was an informed one

In a merger context


A director has a duty to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders. A director may not abdicate that duty by leaving to the shareholders alone the decision to approve or disapprove the agreement


A substantial premium may provide one reason to recommend a merger, but in the absence of other sound valuation information, the fact of a premium alone does not provide an adequate basis upon which to assess the fairness of an offering price


A director has a fiduciary duty of care and loyalty to disclose to shareholders all material facts bearing upon a merger vote 42

Directors are fully protected in relying in good faith (but not blindly) on reports made by officers


Information must be pertinent


The term reporthas been liberally construed to include reports of informal personal investigations by corporate officers

At a minimum (under DE law), a report must be pertinent to the subject matter upon which a board is called to act, and otherwise be entitled to good faith, not blind, reliance

Not oral statements

Dissent: The directors had many years of collective experience as directors and employees of the company. They were not taken into this multimillion-dollar corporate transaction without being fully informed and aware of the state of the company. They knew the company like the back of their hands and were more than well qualified to make on-the-spot informed business judgments concerning the affairs of the company including a 100% sale of the corporation

A legislative response to Van Gorkom DGCL 102(b)(7) limits $ damages for breach of duty of care (not loyalty): Directors will not be liable for monetary damages for any breach of fiduciary duty as a director, except the things BJR permits courts to go after. Can still seek an injunction.

Duty of loyalty (COI + GF) Directors and managers: A director has a fiduciary duty to support the corporation’s interest over his or her own conflicting interests, and any competing interests renders the business judgment rule inapplicable. The business

authorized. The directors breached their fiduciary duty to their stockholders by their failure to inform themselves of all information reasonably available to them (VG’s role, “intrinsic” value) and relevant to their decision to recommend the merger and by their failure to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the offer. The directors were liable for damages. 42 Technicolor, 323: Cf. Van Gorkom. The Technicolor board (Δ) quickly approved a deal after the CEO presented it to the board, without adequate information and deliberation. However, this case favored Δ because the CEO did a thorough job of investigation (was the most informed about the strengths and weaknesses of Technicolor as a business), bargained hard (sought the highest price for sale), and hired experts who did a thorough job in support of the fairness of the deal for Technicolor. The price was fair, so there was no harm and no cause of action. Δ met its burden of proving entire fairness, and the lower court dismissed the action.

judgment rule is trumped by the rule of undivided loyalty, to avoid the possibility of fraud and the temptation of self-interest. 43

Where a close relative of an executive officer of a corporation takes a position closely associated with a new and expensive field of activity, the motives of the directors are likely to be questioned (unless one director owns all or most the stock for example)

Business decisions that would not typically merit an analysis under the normal business judgment rule will undergo strict scrutiny when there is a conflict of interest: If there is any evidence or indication of unfairness or undue advantage, the transactions are subjected to rigorous scrutiny, and where any of their contracts or engagements with the corporation are challenged, the burden is on the director not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein

Safe harbor EXCEPTION 44 (DGCL 144(a)(1))


There is a safe harbor (under DE law) if the material facts as to the directors relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors, and the board in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors fall back to BJR


After approval by disinterested directors, courts review an interested transaction under the business judgment rule

Corporate opportunity doctrine 45 The corporate opportunity doctrine provides that directors, officers, and controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation. The corporate opportunity doctrine is one application of the fiduciary duty of loyalty.

It applies even if the corporation benefits from the transaction!

Rule. A corporate officer or director MAY NOT take a business opportunity for his own if:

(1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation's line of business if is of practical advantage to it; 46

An opportunity is within a corporation's line of business if it is an activity as to which the corporation has fundamental knowledge, practical experience and ability to pursue (3) the corporation has an interest or expectancy in the opportunity; and

A corporation has an interest or expectancy in a business opportunity if the opportunity would further an established business policy of the corporation

43 Bayer v. Beran, 334: πs filed a derivative shareholder action against Δ directors, contesting their decision to pay for radio advertising that employed a director’s wife. No breach of fiduciary duty by the directors. Her contract was on a standard form negotiated through her professional agent. Her compensation was in conformity with that paid of comparable work. She received less than any of the other artists on the program. She received no undue prominence.

44 Benihana, 339

45 Broz, 345; see Guth

46 In re eBay, Inc. Shareholders Litigation, 351: Goldman Sachs was hired to underwrite the initial public offering of eBay stock. In doing so, Goldman Sachs allocated shares of the initial eBay stock to eBay “insiders,” including members of eBay’s board of directors. Shareholders of eBay (plaintiffs) brought suit against the directors (defendants), alleging that the directors’ acceptance of the private allocations violated their fiduciary duty to eBay by usurping eBay’s corporate opportunity in that eBay could and would have purchased the stock that was allocated. It is undisputed that eBay could afford the stock financially and that it was in the business of investing in securities. Investing in various securities was held to be in a line of business of eBay despite the fact that eBay's primary purpose is to provide an online auction platform. Investing was in a line of business of eBay because eBay "consistently invested a portion of its cash on hand in marketable securities." The complaint suggested that investing was integral to eBay's cash management strategies and a significant part of its business. There is a reasonable inference that that the insider directors accepted a commission or gratuity that rightfully belonged to eBay but that was improperly diverted to them. This conduct placed the insider defendants in a position of conflict with their duties to the corporation. Even if this conduct does not run afoul of the corporate opportunity doctrine, it may still constitute a breach of the fiduciary duty of loyalty. Δ’s MTD denied.

(4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position adverse to his duties to the corporation (the self-interest of the officer or director will be brought into conflict with that of the corporation).

In this case, the officer/director needs the board to approve it!

TOTC: No single factor is dispositive. The court must balance all factors as they apply to a particular case. 47

Corollary. A director or officer MAY take a corporate opportunity if (in the absence of any countervailing duty):

(1) the opportunity is presented to the director or officer in his individual and not his corporate capacity; (2) the opportunity is not essential to the corporation; (3) the corporation holds no interest or expectancy in the opportunity; and (4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity.

See also MBCA 8.70.

Dominant shareholders Majority controlling? Yes Controlling majority? Not necessarily. Shareholders too spread out to coordinate. Different classes of shares. 20-30% holding generally considered controlling.

Generally, regular shareholders don’t have fiduciary duties to other shareholders.

But a parent owes a fiduciary duty to its subsidiary when there are parent-subsidiary dealings.

Self-dealing? A standard of intrinsic fairnesswill be applied in a situation that involves a parent- subsidiary dealing, with the parent controlling the transaction and fixing the terms, AND only when the fiduciary duty is accompanied by self-dealing. 48

The transaction will be self-dealing if the parent receives something from the subsidiary to the detriment to and exclusion of minority shareholders of the subsidiary

High degree of fairness (vs. just not grossly negligent under BJR) (could have gotten the same deal in an arm’s-length tx)

The majority shareholder has the right to control. But when it does so, it occupies a fiduciary relation toward the minority, as much as the corporation itself or its directors.

Difference in voting roles as a shareholder and director: When voting as a stockholder, he has the legal right to vote with a view of his own benefits and is representing himself only; but, a director represents

47 Beam v. Stewart, 353

48 Sinclair, 355: Defendant, as the majority shareholder of Sinven, caused Sinven to pay dividends that were so large that the amount exceeded the earnings of Sinven. The dividends provided cash to Defendant as well as minority shareholders, but it left no resources for Sinven to expand its operations. Defendant also neglected to meet the terms of the contract between them and Sinven. Plaintiff, a minority shareholder of Sinven, brought this action, claiming the dividends were excessive and that Defendant breached the contract with Sinven. The court held that Defendant did not engage in self-dealing by issuing large dividends, but it did engage in self-dealing when they breached the agreement. The minority shareholders of Sinven received a proportionate share of the dividends. Defendant complied with a Delaware statute authorizing payment of dividends, and Defendant’s motives are not a factor unless π can show improper motive. BJR should have been applied here. However, the contract breach was to the detriment of Sinven and its minority shareholders with the positive effect being exclusive to Defendant (Sinclair received the products from Sinven, and Sinven’s minority shareholders were not able to share in the receipt of those products), so the breach is self-dealing.

all the stockholders in the capacity of trustee for them and cannot use his office as director for his personal benefit at the expense of the stockholders. 49

o Directors may not declare or withhold the declaration of dividends for the purpose of personal profit or, by analogy, take any corporate action for such a purpose

See also MBCA 8.61-63.

Ratification by interested director shareholders (like safe harbor exception for s/h?) Shareholder ratification of a self-interested transaction between the corporation and an interested party (D/O) will NOT be legitimate if the majority of the shareholders are the interested parties. 50

Under Gottlieb, shareholder ratification of an “interested transaction,” although less than unanimous, shifts the burden of proof to an objecting shareholder to demonstrate that the terms are so unequal as to amount to a gift or waste of corporate assets. “[The] entire atmosphere is freshened and a new set of rules invoked where formal approval has been given by a majority of independent, fully informed [disinterested shareholders]


Shareholder ratification can be used to switch the burden of proof back to a plaintiff to prove that a transaction was not legitimate. It therefore can reset the standard back to the business judgment rule (safe harbor exception?)


Without ratification by majority of disinterested s/h or directors, transaction is subject to intrinsic fairness test (same as Sinclair)

See DGCL 144 (interested directors)

If director/officer fails to disclose his position, K is voidable regardless of proof of fairness.

Revlon (sale of control) and Unocal (takeover defenses) also implicate duties of care and loyalty.

Duty of good faith


subsidiary element of the duty of loyalty.


executive compensation

The law presumes that in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. 51

49 Zahn, 362: The company’s charter allowed for the redemption of Class A stocks, but the timing of it was suspicious because right after causing the redemption Δ liquidated the company (through the company’s board of directors). Π alleged that if Class A stockholders had been had been allowed to participate in the assets on liquidation and had received their respective shares of the asset, he and the other Class A stockholders would have received $240/share instead of $80.80. Π alleged that the redemption was made to appear as incidental to the business and then liquidated. Dismissal is reversed because if Π’s allegations were true, Δ as controlling stockholder had a fiduciary duty to minority Class A stockholders that was violated. Π entitled to equitable relief if, as Π maintains, the directors were acting on Δ’s behalf when they decided to redeem Class A shares. Δ is entitled as a shareholder to vote in favor of its own interest, but its capacity as director (if the directors are acting as an instrument of the majority shareholders, rather than independently calling the Class A stock) is limited because of the fiduciary duty owed to the other shareholders.

50 Fliegler, 366: Agau’s directors voted to exercise the option. A majority of shareholders voted the same way, but the directors also comprised a majority of shareholders. Plaintiff argued that Defendant directors usurped a corporate opportunity for their own individual benefit, and that the transaction was inherently unfair. Defendants responded that their voted was ratified by shareholders, thereby shifting the burden of proof to Plaintiff to prove that the transaction was fair (under Gottlieb). The burden of proof that the transaction was fair was still on the Defendant directors because the shareholder ratification was not legitimate: Defendants controlled a majority of the shares, and there was not enough proof that disinterested shareholders voted with the directors. However, Defendants did offer enough proof to demonstrate that the transaction was “intrinsically fair.

51 In re Walt Disney, 374: Eisner and Ovitz entered into a letter agreement that outlined the terms of Ovitz's employment, including a five-year term and a generous severance package, all of which was subject to approval by the board. The board granted its approval shortly thereafter, and Ovitz began his employment on the date the agreement was officially executed. It soon became clear, however, that Ovitz was a poor fit with other Disney executives. The Disney board approved Ovitz's termination without cause. Brehm (P),

Categories of “bad faith” fiduciary behavior (examples of conduct that would establish a failure to act in good faith)


Intentional dereliction of duty (between subjective intent to do harm to the corp & lack of due care) a legally appropriate, although not the exclusive, definition of fiduciary bad faith

A conscious disregard for one's responsibilities is an appropriate (although not the only) standard for determining whether fiduciaries have acted in good faith

Deliberate indifference and inaction in the face of a duty to act is conduct that is clearly disloyal to the corporation. It is the epitome of faithless conduct

Requires more than gross negligence (due care standard)


Subjective bad faith (also discussed in case but not followed)

Fiduciary conduct motivated by an actual intent to do harm

Intent to violate the law


Lack of due care (also discussed in case but not followed)

Fiduciary action taken solely by reason of gross negligence and without any malevolent


But gross negligence by itself cannot constitute bad faith


MBCA 8.31(a)(2)(iv): A sustained failure of the director to devote attention to ongoing oversight of the business and affairs of the corporation, or a failure to devote timely attention by making or

causing to be made appropriate inquiry, when circumstances of significant concern materialize that would alert a reasonably attentive director

Corporate waste (Even if BJR protected a director’s action, did it constitute waste?)


Π who fails to rebut the BJR presumptions is not entitled to any remedy unless the transaction constitutes waste


Standard is similar to con law’s rational basis (outer boundary is rationality, rational purpose):

To recover on a claim of corporate waste, Π must shoulder the burden of proving that the exchange was "so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration." A claim of waste will arise only in the rare, "unconscionable case where directors irrationally squander or give away corporate assets."

This onerous standard for waste is a corollary of the proposition that where business judgment presumptions are applicable, the board's decision will be upheld unless it cannot be "attributed to any rational business purpose"

Directors cannot act in bad faith without also violating their duty of care/loyalty.

Example where BF violated but may not violate care or loyalty: Delivery service where drivers allowed to double park and any fines are covered. It violates the law (BF) but is more cost effective for shareholders

o Duty of loyalty not violated? But acting in GF is condition to loyalty. Maybe duty of care not violated

Black’s dictionary on bad faith: A complete catalog of bad faith is impossible.

Disney shareholder, brought a derivative suit against Eisner (D) and other directors, claiming that the termination of Ovitz was corporate waste, and that the employment contract and termination were breaches of fiduciary duty and not entitled to BJR protection. No reasonably prudent fiduciary in the president's position would have unilaterally called a board meeting to force the corporation's chief executive officer to reconsider his termination and the terms thereof, with that reconsideration for the benefit of shareholders and potentially to the president's detriment. The decisions to approve the president's employment agreement, to hire him as president, and then to terminate him on a no-fault basis were protected business judgments, made without any violations of fiduciary duty. So it was unnecessary to reach the shareholders' contention that the directors were required to prove that the payment of severance was entirely fair. Because the shareholders failed to show that the approval of the no-fault termination terms of the employment agreement was not a rational business decision, their corporate waste claim failed. There was enough evidence showing that, at the time they approved the agreement, the compensation committee members were adequately informed of the potential magnitude of an early severance payout. The approval of the severance payout had a rational business purpose of inducing Ovitz to join Disney at what would otherwise be a considerable cost to him (in leaving CAA). Eisner only had the option to terminate Ovitz and thus pay for the non-fault termination as agreed. Eisner had breached no duty and had exercised his business judgment.

In executive oversight Directors are not expected to know, in minute detail, everything that happens on a day-to-day basis. Just understand the business and be informed about general operational activities.

Liability of directors where they are unaware of employee misconduct that results in the corporation being held liable 52

A director’s obligation includes a duty to attempt in good faith to assure that a reasonable corporate information and reporting system (which the board concludes is adequate) exists, and that failure to do so under some circumstances may render a director liable for losses caused by non-compliance with applicable legal standards

Only a sustained or systematic failure of the board to exercise oversightsuch as an utter failure to attempt to assure a reasonable information and reporting system existswill establish the lack of good faith that is a necessary condition to liability.

Board must:


1) Set up a system: Adopt rules and procedures to ensure lawfulness (follow the law)

File suspicious activity reports w/r/t financial tx, e.g., on money laundering


2) Monitor

Only the duties of care and loyalty, where violated, may directly result in liability. A failure to act in good faith may do so indirectly, as a subsidiary/conditional element of the duty of loyalty. Bad faith conduct violates the fiduciary duty of loyalty.

52 Stone v. Ritter, 391

Public company issues

Securities law ’33 Act Securities Act of 1933 (initial stage)

Regulates primary market when company itself issues shares, money goes to company

Disclose all relevant information about company and letting individuals decide


Material misstatements/omissions in the prospectus that would impact investor judgment generally strictly liable under 33 Act


If SEC is satisfied, can sell even risky vehicles

’34 Act Securities Exchange Act of 1934 (after issuance)

Regulates trading in 2° market after securities are out there

Most relevant to insider trading

What is a security? The way it’s defined in the 33 Act, which lists a bunch of things it considers a security. It also generally captures future instruments created (“investment contracts”).

SCOTUS definition of “investment contract”: a contract, transaction or scheme whereby a person

invests his money in a common enterprise with a reasonable expectation of profits primarily (not necessarily solely) from the entrepreneurial or managerial efforts of others (includes anything generally considered to be security kind of circular)

o Economic reality/features of the instrument: What matters more than the form of the investment scheme is the “economic reality” that it represents—whether an investor, as a result of the investment agreement itself or the factual circumstances that surround it, is left unable to exercise meaningful control over his investment (passive security) 53

Registration process (’33 Act) 33 Act § 5 prohibits the sale of securities unless the company issuing the securities has registered them with the SEC:

Securities may not be sold until the registration statement has become effective

The prospectus (disclosure doc) must be delivered to the purchaser before a sale

Strict liability for violation of § 5

SEC considers whether the registration statement contains the required disclosures, not whether the security would be a good investment. The core of the registration statement thus is the prospectus. Until the SEC has approved the disclosures, companies cannot sell the new securities.

Two ways to sell securities without registering them:

Exempt security


Need never be registered, either when initially sold by the issuer or afterward


Highly specialized, less likely to be encountered

Exempt transactions (more likely to encounter transactional exemptions)

o One-time exemptions: A buyer is not automatically free to resell a non-exempt security in an exempt tx, unless it is registered or another exempt tx is utilized

53 Robinson, 401: Glynn had a company trying to develop new phone tech. Robinson (bizman with no experience in the tech) and Glynn entered into an agreement to purchase interest in the company if field test was successful. Glynn lied about the field test. Does Robinson’s membership interest in the company, an LLC, count as a security? No. Robinson was an active and knowledgeable executive rather than a mere passive investor in the company (not primarily derived from others’ effort, contributed too much). Also, LLCs lack standardized membership rights or organizational structures, so they can assume an almost unlimited variety of forms. It becomes difficult to declare that LLCs possess or lack the economic characteristics associated with investment contracts. The parties’ invitation for a broader holding is declined.


§ 4(1): Tx by anyone if you are NOT an issuer, underwriter (buys security with a view to reselling, takes risk, middleman between issuer and investing public) or dealer careful: broad definitions


Non-public, private offerings (statutory affirmative defense): Absent a registration statement, factors that Δ has the burden to show to determine whether an offering is private include the…

1) Number of offerees and their relationship to each other and the issuer most critical! 54

Purpose of the Act was to protect investors by promoting full disclosure of information thought necessary to informed investment decisions. The exemption question runs on the knowledge of the offerees

The more offerees the more likely that the offering is public

o Few (1-8) aids Δ’s search for exemption

High degree of business or legal sophistication of offeree does not suffice to bring the offering within private exemption


Δ must demonstrate that all offerees, whatever their expertise, had available the information a registration statement would have afforded any prospective investor in a public offering, not just those who ultimately accepted (necessary but not sufficient)


Sophistication (education, net worth) is not a substitute for access to the information that registration would disclose. If the offeree did not have the requisite information, he could not bring their sophisticated knowledge of business affairs to decide whether or not to invest

2) Number of units offered

Small aids Δ’s search for exemption

3) Size of the offering

Modest financial stakes aid Δ’s search for exemption

4) Manner of the offering

Personal contact and free of public advertising or intermediaries (i-bankers, securities exchanges) aid Δ’s search for exemption

Civil liabilities from material misstatement/omission (§ 11) In a registration statement, if there is a material misstatement/omission, those who buy in that primary offering can sue for any losses they suffer as a result of the material misstatement/omission. The issuer (Δ) is strictly liable to make whole; it doesn’t matter if it were an inadvertent mistake. Issuer isn’t the only possible Δ; other Δ are individual directors, designated experts (e.g., accountants, underwriters).

Due diligence defense for directors and underwriters: Unlike issuer itself, they can defend themselves by proving they were not negligent.

If Π can make prima facie case, BOP shifts to Δ to show any losses Π suffered were not caused by material misstatement/omission.

Exchange Act disclosures & integrated disclosure

54 Doran, 410: Plaintiff was an educated investor with a degree in petroleum engineering. A broker contacted Plaintiff to propose a sale of a participant interest in an LLC Wyoming oil drilling operation from Defendants to Plaintiff. Eight other entities were offered an interest, and three declined. Plaintiff paid for his interests through a down payment and a promissory note to take over payments on a debt held by the LLC. Shortly after Plaintiff purchased an interest, the wells were closing down for almost a year, and the operation was never as profitable as it was prior to his investment. Plaintiff sought to rescind his obligations to the LLC, citing violations by Defendants under the Securities Exchange Act. Defendants countered that the investment was a personal (private, not public) offering that was exempt from the Act (rescission of K). Δ raised this affirmative defense under statute. Δ may have shown factors 2-4. As for factor 1, the 5 th Cir. remanded to find whether the offerees knew or had a realistic opportunity to learn facts essential to an investment judgment.

Publicly traded companies (and some large close corps) are required to file Exchange Act reports: Form 10 (initial), Form 10-K (annual), Form 10-Q (each of first 3 quarters of the year), Form 8-K (within 4 days after certain important events affecting the company’s operations or financial condition).

Insider trading (’34 Act) It’s an issue only if you are silent about a material fact. Affirmative misleading statements will lead to liability anyway.

Cady, Roberts affirmative duty to disclose when dealing in securities10b-5 violation occurs when there are:

1) The existence of a fiduciary relationship affording access to inside information intended to be available only for a corporate purpose

2) The unfairness of allowing a corporate insider to take advantage of that information by trading without disclosure (to make “secret profits”)

Duty is owed to shareholders by (i.e., the disclose or abstain rule applies to)

Officers, directors employees (“insiders”)

Tippees when insider breached duty in tipping

Temporary fiduciaries revealed legitimately to underwriter, accountant, lawyer or consultant working for the corp special confidential relationship given access to info solely for corporate purposes the corp must expect the outsider to keep the disclosed nonpublic info confidential, and the relationship at least must imply such a duty

Would-be misappropriators

Material nonpublic information? Insiders cannot act on material information (information that a reasonable person would deem important to the value of the stock) until the information is reasonably (to the point that the public would have had a reasonable opportunity to act on it), publicly disseminated. 55

Who are insiders? Employees, directors who have fiduciary duties to shareholders need to show possession of material nonpublic information

o Others (e.g., lawyers) can be liable for insider trading if they breached a duty as temporary fiduciaries

Insider would also be liable if these people breached a duty

Material? Would a reasonable person believe that the information would be relevant to the price of the stock? (sort of reasonable standard)

o Information classically considered material

Takeover is coming

Pharma drug is approved or disapproved by FDA

Publicly disseminated: If misleading PR, recklessness standard generally. Negligent in releasing press release can be liable

55 SEC v. Texas Gulf Sulphur Co. (TGS), 466: Defendants were officers, employees or were closely tied to employees of Texas Gulf. After a promising mining exploration, the trading activity and sample drilling prompted rumors in the industry of a significant find by Texas Gulf, and on April 12, 1964 Defendants sent out a misleading press release to calm the speculation. The press release misrepresented the actual results of the samples. Defendants decided to announce the results on April 15, although the news did not reach the public until April 16. Defendants still traded between April 12 and the announcement. Defendants claimed that the information was not material to the value of the company and therefore did not feel obligated to publicly disclose the information. They also argued that any trading after they released the news at midnight of April 16 was legitimate because technically the news was disseminated to the public. The 2d Cir. found that Defendants withheld information that was material to shareholders and therefore were acting on insider information when they purchased their shares and calls on Texas Gulf stock. The court looked at the conduct of Defendants as evidence that the information was material: They purchased a great deal of shares in Texas Gulf, they deliberately kept the information from others, and the timing of their purchases occurred during the period that they exclusively held the information. Further, Defendants should not act upon the information until the information is disseminated to the point that the public would have had a reasonable opportunity to act on it.

Does Δ have an advantage over anyone without the information?

Obligations of insiders possessing MNI: Disclose it or abstain from trading the security!

Rule 10b-5 policy: All investors should have equal access to the rewards of participation in securities transactions and be subject to identical market risks

o Under common law, silence between two market participants OK? Under 10b-5, can go after people who are silent! Not just misstatements but omissions

Other circumstances barring trading while in possession of MNI

Misappropriation by “outsider”


A person commits fraud in connection with a securities transaction (thereby violating § 10(b) and Rule 10b-5) when he misappropriates confidential info for securities trading purposes, in breach of a duty owed to the source of the information 56

Deception through nondisclosure is central to liability, which is premised on deception of the source of the info by a fiduciary who was entrusted with access to confidential information

Rule 10b5-2. Duty of trust or confidence exists for misappropriation theory where someone is in a position of trust or confidence with the source of the information

Someone agrees to maintain info in confidence

Two people have a pattern or practice of sharing confidence such that the recipient of the info knows or reasonably should know that the speaker expects the recipient to maintain the info’s confidentiality, or

Someone receives MNI from a spouse, parent, child or sibling

Misappropriator’s deceptive use of info must be “in connection with the purchase or sale

of [a] security”


Eavesdropping (instead of given) not liable under 10b-5

Some tippees must assume an insider’s duty of loyalty to shareholders because it has been made available to them improperly: Insiders are forbidden by their fiduciary relationship from personally

using undisclosed corporate information to their advantage, and they also may not give such info to an outsider for the same improper purpose of exploiting the information for their personal gain

o Insider breach of duty by tipping required: A tippee assumes a fiduciary duty of loyalty to shareholders not to trade on MNI only when the insider has breached his duty by

disclosing the info to the tippee, and the tippee knows or should know that there has been a breach 57

Whether disclosure is a breach turns in large part on the purpose of the disclosure. The test is personal gain, whether the insider personally will (tangibly) benefit, directly or indirectly, from his disclosure

Absent some personal gain, there has been no breach of duty to stockholders. Absent a breach by the insider, there is no derivative breach

But if the breach of fiduciary of duty is of care, then tippee is not liable!

Liability on those who trade “on the basis of” vs. while in possessionof MNI

56 O’Hagan, 487: O’Hagan, in breach of a duty of trust and confidence he owed to his law firm and to his client, traded on the basis of nonpublic info regarding the planned tender offer for common stock.

57 Dirks, 482: Dirks received MNI from “insiders” of a corporation with which he had no connection. He disclosed this information to investors who relied on it in trading in the shares of the corporation. Dirks did not violate antifraud provisions of the federal securities laws by this disclosure: He took no action that induced the shareholders to put trust in him; there was no expectation by Dirks’ sources that he would keep their information in confidence, nor did Dirks misappropriate or illegally get the info. Unless the insiders breached their duty to shareholders in disclosing the nonpublic information to Dirks, he breached no duty when he passed it on to the investors and the WSJ. The insiders did not breach their duty to shareholders by providing info to Dirks: They received no monetary or personal benefit for revealing the secrets, nor was their purpose to make a gift of valuable information to Dirks. They were motivated by a desire to expose the fraud. Without breach of duty by insiders, there is no derivative breach by Dirks. Thus, Dirks could not have been a participant after the fact in an insider’s breach of a fiduciary duty.


Common law (Adler and Smith)

Mere knowing possession of MNI by an inside trader is not a per se violation of 10b-5. Trading while in possession of such info merely raises a strong inference that the insider traded on the basis of that info. The insider can rebut that presumption by showing that he did not use such info in making trading decisions

In criminal case, gov’t must prove the insider used inside info as the basis for his trading activity


Cf. Rule 10b-5

Prohibition of insider trading is violated whenever someone trades “on the basis of” MNI, but one is deemed to have traded “on the basis of” MNI if one was aware of such info at the time of the trade (subject to narrow exceptions)

Effectively rejects Adler and Smith

Proxy fights

Because few shareholders of public corps attend the annual meeting (“rational apathy”), the outcome generally depends on which group has collected the most “proxies”—agents who attend the meeting and vote on their behalf. “Proxy fights” result when an insurgent group tries to oust incumbent managers by soliciting proxy cards and electing its own representatives to the board.

Courts will intervene only if illegal or unfair means of communication employed by the present management 58

If insurgents start a proxy fight, they won’t get reimbursed for costs unless they win 59 . Incumbents’ costs are reimbursable

Shareholder inspection rights

Insurgents want the shareholder list to try to convince major shareholders to support them, but incumbents will mail the materials for proxy solicitation rather than release the shareholder list (choices under Rule 14a-7). Federal proxy rules (14a-7) do not require the corp to give the shareholder list, but federal rules do not impair any rights under state law. Thus, battles for the shareholder list are fought under state laws.

MBCA 7.20: Shareholders’ List for Meeting


Alphabetical list of all shareholders who are entitled to notice of a shareholders’ meeting


Shareholders’ list for notice must be available for inspection by any shareholder


List of shareholders entitled to vote shall be made available at the meeting


If the corp refuses to allow a shareholder, his agent or attorney to inspect a shareholders’ list before/at the meeting, the court of the principal office’s county court may order the inspection or copying


Refusal or failure to make available a shareholders’ list does not affect the validity of action taken at the meeting

MBCA 16: Records 16.01: Corporate Records

Corp shall keep permanent records of


Minutes of all meetings of its s/h and board


Its shareholders in a format that permits preparation of a list

16.02: Inspection of Records by Shareholders

(a) A shareholder is entitled to inspect and copy any of the records in 16.01(e)

58 Levin v. MGM, 517: Plaintiffs and Defendants were fighting for control of MGM, and each was campaigning for their directors to be elected at the annual shareholder’s meeting. Defendants used resources of the company and hired outside assistance to promote their candidates. Plaintiffs did not allege any fraud or corruption. MGM limited the proxy solicitation budget to $125,000. The court did not find the amounts to be paid excessive or the method of operation disclosed by MGM management to be unfair or illegal. It doesn’t violate any federal statute or SEC rule. 59 Rosenfeld, 520

(c) A shareholder is entitled to inspect and copy any of the records in 16.02(c) (includes shareholder records) if the demand is made in GF and for a proper purpose (and other 16.02(d) requirements)

16.03: Scope of Inspection Right 16.04: Court-ordered Inspection

If a corp does not allow a s/h who complies with 16.02(a)

If a corp does not allow a s/h to inspect and copy other records within a reasonable time

A court may impose reasonable restrictions on use or distribution of the records by the demanding s/h

No absolute right of inspection A shareholder desiring to discuss relevant aspects of a tender offer is granted access to the shareholder list, UNLESS it is sought for a purpose other than the business (improper purpose adverse to the corp) or its stockholders. The manner of communication selected should be within the judgment of the shareholder. 60

1961 law: Access must be permitted to qualified shareholders on written demand, subject to denial if the petitioner refused to furnish an affidavit that the inspection is not for a purpose other than the business of the corp

There must be no improper purposes: Courts will look at not just whether there is a proper purpose but whether it’s the only purpose. Would be problematic if there were another improper purpose

If tender offer is announced, it could pass muster since purposes related to tender offers are proper. If no tender offer, really need to show proper purpose

o Spam mail not a proper purpose. Publicizing tender offer is a proper purpose

Conflicting out-of-court state laws: Even if the state of incorporation does not allow requesting shareholders to obtain stockholder lists, a party can inspect records under section 1315(a) of the New York Business Corporation Law through an agent as long as the elements of the statute are met. 61 NY amended law to DE: A corp is not required to obtain info then hand over info about beneficial owners not in its possession.

The shareholder must prove a proper (investment-related) purpose to inspect corporate records other than shareholder lists. Where it is shown that stockholding is only colorable (only looks bona fide) or solely for the purpose of asserting opinions to oppose management policy or maintain suits to compel production, the requesting stockholder cannot be said to be a person interested as a stockholder in return of investment. 62

Supplier list harder for s/h to argue it is within investment return purposes


The bidder contacts shareholders directly with tender offer. The goal is to get enough shares to be in control of the corp. Highlights from federal rules:

1. Anyone (singly or as part of a group) that acquires a 5 percent stake in a company must alert the company and the SEC within 10 days of their identity and intent (e.g., whether it intends to try to gain control of the company, any major changes it will implement in the company's strategy if it does gain control, etc.). (§ 13(d)(1))

60 Crane, 565: Crane wanted Anaconda’s list of shareholders as part of a tender offer deal. Crane owned no Anaconda stock at this time; Anaconda refused saying there was no basis for Crane’s request. 2M+ Anaconda shares were then tendered to Crane, making Crane Anaconda’s largest stockholder. Since it appears that Anaconda failed to sustain its burden of proving an improper purpose (and court below did not abuse its discretion), inspection should be compelled.

61 Sadler, 569

62 State ex rel. Pillsbury v. Honeywell, 566: Petitioner decided to purchase 100 shares of Honeywell for the purpose of requesting corporate documents, as a shareholder, in order to give himself a voice in Honeywell’s affairs so he could persuade Honeywell to cease producing bombs for the gov’t. Π said a stockholder who disagrees with management has an absolute right ot inspect corp records for purposes of soliciting proxies, that such solicitation is per se a “proper purpose.” Δ and court said “proper purpose” concerns investment return. It is important that only those with a bona fide interest in the corp enjoy the power to inspect (b/c it may be the power to destroy). Π was not interested in the long-term wellbeing of Honeywell or the enhancement of his share value. His sole purpose was to persuade the company to adopt his social and political concerns, irrespective of any economic benefit to himself and Honeywell. Affirmed denial of Π’s writ of mandamus.


Any acquirer must hold the tender offer open for 20 business days. (Rule 14(e)(1)))

3. Any acquirer who raises his/her price during the term of a tender offer must raise it for any stock already tendered. (§ 14(d)(7))

Sale of control + adoption of defensive measures? Having informed themselves of all material information reasonably available, the directors must decide which alternative is most likely to offer the best value reasonably available to the stockholders (Unocal, Revlon, QVC). 63

Requires some degree of effort by corp to make sure they’re getting a good deal. Perfection isn’t the goal; reasonable decision is

Revlon rule: Once it’s clear that the company is going to be sold off, the duties of the board change. No longer are they defenders, but auctioneers, to get the best price they can for shareholders. Revlon duties are to maximize short-term shareholder value, treat all other interested acquirers on an equal basis, and auction the company fairly, in a situation where 1) dissolution of the corporate entity is inevitable (e.g., bidder keeps increasing bid), 64 OR 2) the transaction causes a change in corporate control (QVC). In either case, directors are obligated (and are subject to enhanced judicial scrutiny) to seek the best value reasonably available to the stockholders. 65

Is there a pending sale of control? Implicated in at least two situations:

1. (clearer) When a corporation initiates an active bidding process seeking to sell itself or to effect a

business reorganization involving a clear breakup of the company

63 Paramount v. QVC, 789: QVC started bidding against Viacom’s offer, which forced Viacom to renegotiate with Paramount to raise their offer, although the defensive measures were never renegotiated. QVC raised their offer even further, but the Paramount believed that the offer was too conditional (similar to Viacom’s offer, it was two-tiered) and the board still felt that the merger was not in the company’s best interests. Therefore, the Paramount board turned down a QVC offer that could have been about $1 billion more than Viacom’s offer. In the lower court, QVC (Π) successfully enjoined Paramount (Δ) from carrying out the merger agreement. Directors’ obligation to seek the best value reasonably available to s/h arises because the effect of the Viacom-Paramount tx,

if consummated, would shift control of Paramount from the public stockholders to a controlling stockholder, Viacom. Since

Paramount directors decided to sell control, they had an obligation to continue their search for the best value reasonably available to the s/h. This continuing obligation included the responsibility to determine if, inter alia, the PVC TO could be improved. The Paramount directors decided that a strategic merger with Viacom was in the best interests of Paramount and its s/h. The directors’ process was not reasonable, and the result for the s/h was not reasonable under the circumstances: The Paramount board clearly gave insufficient attention to the potential consequences of the defensive measures demanded by Viacom. The stock option agreement had draconian provisions. The termination fee clearly made Paramount less attractive to other bidders. The no-shop provision inhibited the board’s ability to negotiate with other potential bidders, especially QVC, which had already expressed an interest in Paramount. QVC’s interest gave the opportunity for the board to seek significantly higher value for s/h than that being offered by Viacom. QVC kept showing its intention to meet and exceed Viacom offers and negotiate possible further increases. Under the circumstances at the time, it should have been clear to the board that original merger agreement impeded the realization of best value reasonably available to the Paramount s/h. However, the board made no effort to modify these counterproductive devices and instead clung to its vision of a strategic alliance with Viacom. It was paralyzed by its uninformed belief that QVC’s offer was “illusory.” The defensive measures, as a whole, were problematic. The injunction of the original merger between Paramount and Viacom was affirmed and invalidated.

64 Revlon, 761: TC concluded that Revlon directors breached their duty of loyalty by making concessions to Forstmann (who had access to certain financial data among other exclusive privileges), out of concern for their liability to noteholders, rather than maximizing the sale price of the company for s/h benefit. Forstmann made a $57.25 offer, which the board unanimously approved because it was higher than Pantry Pride’s $56, it protected the noteholders, and Forstmann’s financing was firmly in place. Revlon directors had concluded that Pantry Pride’s initial $47.50 tender offer was grossly inadequate. In this regard, the board acted in GF and on an informed basis with reasonable grounds to believe that there was a harmful threat to the corporate enterprise (complying with Unocal duties). However, when P.P. increased its offer to $50, then $53, it became apparent that the breakup of the company was inevitable. Here, the duty, role and objective of the board changed from preservation of Revlon as a corporate entity to maximization of the company’s value at a sale for s/h benefit, an auctioneer getting the best price for s/h at a sale. The whole question of defensive measures became moot. Thus, Revlon couldn’t make the requisite showing of GF by preferring the noteholders and ignoring tis duty of loyalty to s/hduty of loyalty breached. The principal benefit went to the directors, who avoided personal liability to a class of creditors to whom the board owed no further duty under the circumstances. The board’s action is not entitled to the deference provided by BJR.

65 Paramount v. QVC, 791: Viacom-Paramount tx, if consummated, would shift control of Paramount from the public stockholders to

a controlling stockholder, Viacom. Not a breakup scenario.


In response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the breakup of the company

o NOT triggered if board’s reaction to a hostile tender offer is found to constitute only a defensive response and not an abandonment of the corporation’s long-term plan for continued existence. 66 But Unocal duties (for defensive response) attach!

Unocal duties if Revlon duties don’t apply Burden to prove the following before BJR attaches to defensive actions of a board of directors:

Was there a legally cognizable threat (to shareholders adequate value, long-term plans)?

Was the board adequately informed of the potential benefits of the other offer?

Is the defensive response reasonable in relation to a perceived threat?


Not permissible if it is “draconian,” i.e., “coercive or preclusive”


Discretion of board to choose a defensive measure from among alternatives within the “range of reasonableness” (QVC)

Unocal burden/duty: When a board implements anti-takeover measures, there arises the suspicion that the board may be acting primarily in its own interests, rather than those of the corp and its shareholders. This potential for conflict places on the directors the burden of proving that they had reasonable grounds for believing there was a danger to corporate policy and effectiveness.

Enhanced scrutiny test” (QVC)—There are two elements to look at in a board’s exercise of corporate power (before the board is entitled to be measured by the BJR standard) to prevent a hostile takeover bid: 67

o Showing of good faith and reasonable investigation (as required by BJR)

There is a fiduciary duty to act in the best interests of the corp’s stockholders

Impeding a takeover should be motivated by disinterested, informed, GF concern for the welfare of the corp and its s/hfree of breach of fiduciary duty, such as fraud, lack of GF, being uninformed, primary purpose to entrench (perpetuating themselves in office), or other misconduct

66 Paramount v. Time (Time-Warner), 772: No substantial evidence that Time’s board, in negotiating with Warner, made the dissolution of the corporate entity inevitable like in Revlon. Π relied on subjective intent of Time’s directors that the Warner tx might be viewed as effectively putting Time up for sale. Π argued that certain agreements prevented s/h from getting a control premium in the immediate future and thus violated Revlon. Such evidence is insufficient to invoke Revlon duties. Π’s Unocal claim also failed:

Time board reasonably determined that inadequate value was not the only legally cognizable threat that Π’s all-cash offer could present. Other threats were posed—Time s/h might elect to tender into Π’s cash offer in ignorance of the strategic benefit of combining with Warner, the conditions to Π’s offer introduced uncertainty that skewed a comparative analysis, and the timing of Π’s offer was viewed as arguably designed to upset, if not confuse, Time s/h votes. Time board’s decision that Π’s offer posed a threat to corporate policy and effectiveness was not lacking in GF nor dominated by motives of either entrenchment or self-interest. Time board was also adequately informed of available entertainment companies, including Π, before determining that Warner provided the best strategic fit. Π didn’t serve Time’s objectives or needs. Time’s response was reasonably related to the threat because its goal was to carry forward a pre-existing tx in an altered form rather than “cramming down” on its s/h a management-sponsored alternative.

67 Unocal, 751: Π was a corporation led by a well-known corporate raider. Π offered a two-tier tender offer wherein the first tier would allow for shareholders to sell at $54 per share and the second tier would be subsidized by securities that the court equated with “junk bonds.” The threat therefore was that shareholders would rush to sell their shares for the first tier because they did not want to be subject to the reduced value of the back-end value of the junk securities. Δ directors met to discuss their options and came up with an alternative that would have Δ corporation repurchase their own shares at $72 each. The Δ directors decided to exclude Π from the tender offer because it was counterintuitive to include the shareholder who initiated the conflict. The court held that Δ could exclude Π from its repurchase of its own shares. The directors for Δ corporation have a duty to protect the shareholders and the corporations, and one of the harmful tactics that can befall a company is a takeover by a shareholder who is offering an inadequate offer. There was evidence to support that the company was in reasonable danger: The outside directors approved of their self-tender, the offer by Π included the junk bonds, the value of each share was more than the proposed $54 per share, and Π was well known as a corporate raider. The selective stock repurchase plan chosen by Δ is reasonable in relation to the threat the board rationally and reasonably believed as posed by Π’s inadequate and coercive two-tier tender offer. Under these circumstances, the board’s action is entitled to be measured by the BJR standards. Unless it’s shown by preponderance that the directors’ decisions were primarily based on perpetuating themselves in office, or some other breach of fiduciary duty such as fraud, lack of GF or being uninformed, a court will not substitute its judgment for that of the board.

Court would consider any intent was to tear the company down, sell assets, fire employees, etc.

Unless rationally related benefit accrues to s/h (Revlon)

o The element of balance: If a defensive measure is to come within the ambit of the BJR, it

must be reasonable in relation to the threat posed (in light of the circumstances then existing)

Inadequacy of the price offered

Nature and timing of the offer

Questions of illegality

Impact on non-s/h constituencies (creditors, customers, employees, general community)

Risk of non-consummation

Quality of securities being offered in the exchange

Basic s/h (including short-term speculator) interests at stake

Offer’s fairness and feasibility

Proposed/actual financing for the offer, consequences of this financing

Bidder’s identity

Bidder’s business plans for the corp, their effects on s/h interests

Where actual self-interest is present and affects a majority of the directors approving a tx, a court will apply even more exacting scrutiny to determine whether the tx is entirely fair to the stockholders 68

Concern for various corporate constituencies other than shareholders is proper when addressing a takeover threat, but this principle is limited by some rationally related benefit accruing to the shareholders 69

Look for a reasonable decision, not a perfect one

Rule 13e-4(f)(8): Discriminatory self-tenders are disapproved. Issuer tender offers other than those made to all shareholders are prohibited. However, it does not prohibit “poison pills,” which can have much the same effect.

Favoritism to the exclusion of a hostile bidder might be justifiable when the latter’s offer adversely affects s/h interests, but not when bidders make relatively similar offers or dissolution of the company becomes inevitable

What is a poison pill? Right that attaches to shares, defensive measure against hostile takeovers. “Rights” give all s/h except acquirer something cheap or free (e.g., stock split) dilutive effect

Trigger for right to exercise?



For example, if corporate raiders end up owning 20% (typically), causing threat of takeover

Has flip-in, flip-out and redemption provisions (management can buy out rights)

But if there is a PP in the first place, mgmt. probably doesn’t want to redeem it. How to make them?

Proxy battle to kick out mgmt.

Sue the board for violating duties, force them to redeem the pill

Brute force to buy


Irrational to trigger halts takeovers

What can it allow? For example, the 20% owner cannot exercise the right. Everyone else can get split shares. Everyone else has same value of stock, but 20% owner’s new value is shrunk. 20 out of 100 + 80 out of 100 20 out of 180 + 160 out of 180

68 Paramount v. QVC, 787 n.9

69 Revlon, 762: No such benefit found.

Corporate litigation

A shareholder derivative suit is an action brought by a corporate shareholder on behalf of the corporation (claim by corp) to enforce a corporate right that the officers and directors of the corporation have failed to enforce. In bringing a derivative suit, a shareholder is asserting that the corporation was harmed, that the corporate officers and directors failed to take action to redress that harm, and that the corporate cause of action has therefore accrued to the corporation’s shareholders in place of its directors.

Shareholders can bring direct (usually part of class action on behalf of all s/h) vs. derivative actions against directors. The distinction depends on the wrong alleged and any relief

Direct claims


Declaration of invalidity of the challenged tx


Abdication claim (no monetary recovery accrued to the corp as a result)


10b-5 claim

Derivative claims (primary harm & recovery to corp)


Breach of loyalty or due care, waste, excessive compensation claims


Director takes corp opportunity self-dealing


Compel it to sue a 3P by the corp?

Derivative claims: Requirement of Π’s pre-suit demand on the directors

Demand requirement: Prior to instituting a derivative action, a s/h must make a demand on the board of directors to redress his grievances. Once demand has been made and rejected, the burden is

on Π s/h to show why the directors’ decision not to take action should not be respected by the court


Or as a derivative Π, demand that the board litigate the alleged corporate claim


Generally go directly to court and say demand would have been futile

A s/h who makes a demand is entitled to know promptly what action the board has taken in response to the demand. But a demand, when required and refused (if not wrongful), terminates a shareholder’s legal ability to initiate a derivative action (and contest board’s independence w/r/t challenged tx)if a pre-suit demand is made and rejected, the board rejecting the demand is entitled to the presumption of BJR