NATURE OF BUSINESS ORGANIZATIONS...................................................

10
1. New Mexico oil delivery case Rainbow (agent) entered into a contract with
Morris (no idea Dawn existed) w/o the authority of Dawn = creation of an
undisclosed agency, court finds liability – when an undisclosed principal
entrusts an agent, the undisclosed principal is bound to agreements made
by the agent w/third party, even when agreements are outside the scope of
business. ...............................................................................................13
2. Where the undisclosed principal retains the benefit or proceeds of
agreements reached by an agent, with knowledge of material fact, it ratifies
the agreement made by agent. ................................................................13
iii. Redding v. Attorney General................................................................13
4. General, asked to assist in running of whisky, by riding in his army
uniform in the truck, assuring that the truck would not be hijacked or
inspected. Redding received 20,000 pounds. ............................................13
5. British gov’t received these funds on the grounds that the money was
paid to Redding as they were paid while he was falsely representing the
government during military duties. .........................................................13
6. Court – if a servant takes advantage of position that he enjoys, or
opportunities that it provides, agent is responsible to the principal for
benefits gained. .....................................................................................13
7. Even through action was a criminal act, the British army had the right to
take his profits........................................................................................13
VIII. PARTNERSHIP...................................................................................15
9. People can become partners even when facts show that they have no
intention of doing so, intent is not enough. ..............................................16
j. §9 is really saying that every general partner has the agency powers of a
general manager, but it is still left to the courts to determine on a case-by-
case basis the extent of this power..........................................................18
k. Distinguishable by the narrowness of purpose. .....................................19
12. Establishes that a partnership at will does not require justification to
dissolve the partnership, even if it is in contravention of the agreement, a
partnership can be dissolved under the UPA. ...........................................21
13. This case contributes to the development of the RUPA. Avoids the
harshness of the UPA where there is a fire sale. It allows the remaining
partners to buy out the leaving partner’s estate. Valuation is taken on the
date of the partner’s death. ....................................................................21
14. *Fishman thinks that this is a bad result – Clark may not have the ability
to pay for the entire share. Or Joan would get less than she would have if the
property was sold on the market. ............................................................21
XV. ALTERNATIVE FORMS OF BUSINESS ORGANIZATIONS...........................23
xvi. Megadyne Information Systems v. Rosner, Owens & Nunziato, LLP......27

1
17. P has a claim, but the statute of limitations has expired, served one year
after SOL has run. P claims that D has breached duty, paid for worthless
services..................................................................................................27
18. I – if it had been shown if the other partners had discussed this re: the
handling of the matter, then issue of fact, meaning the other partners could
be sued...................................................................................................27
XIX. CORPORATE FORM............................................................................27
t. Name has to be reserved with the secretary of state, can use own name,
unless it might confuse people. Cannot use if it is not personal name.
Corporation can file in one name, then can file as a DBA. ..........................28
xxi. Generally courts have held that if a promoter is liable under a
contract, the mere formation of the corporation is still left on the hook. If
the corp is not formed, promoter still not off the hook, the only way is
through a novation, through which all parties agree that the corporation
assumes the liability. (or the agreement is like Pottery Warehouse, stating
that the agreement is with a corporation to be formed).............................31
22. NY B.C.L. §202(a)(12) is applicable. ....................................................32
xxiii. Philanthropy – ................................................................................33
24. What happens when it has no benefit or relation to shareholders, but
management is interested in?..................................................................33
XXV. CORPORATE STRUCTURE..................................................................34
26. Key to corporate governance – “an effective board”, assumed for good
corporate performance. ..........................................................................35
xxvii. Senior management will call the real shots for a corporation (Directors
often cannot oversee top management)....................................................35
28. Fishman details 13-d filing – tender offers regulated under SEC act –
whenever a person or corporation acquires 5% of the stock of a public
company, within 10 days of that acquisition, it must send to the issuer (the
corporation) and the SEC certain information. ..........................................38
29. In most cases, the question of whether the board’s actions are preclusive
is hotly contested....................................................................................38
30. Bylaws - may authorize directors to appoint committees. C should
generally operate through a committee structure.....................................39
ee. Executive committee – important when there is a large board composed
of non management personnel.................................................................39
ff. Finance committee – typically principle financial officers of the corp......39
gg. Compensation committee –determines the compensation of sr.
management...........................................................................................39
hh. NY a committee can have one or more members. 712(a) – a committee
has no authority to submit to the shareholders a motion that must come
from the full board. Cannot amend the bylaws. ........................................39
ii. Delaware – no such restrictions, BUT cannot authorize a dividend or issue
stock, UNLESS bylaws authorize...............................................................39
2
36. Delegation of Authority......................................................................39
kk. Boards may override any committee decision, but can delegate authority
to committees.........................................................................................39
ll. Boards can delegate authority to outside companies to manage certain
facet of business, frequently used by smaller companies. These contracts
must be approved annually by the board of directors, and can be ended at
any time. ...............................................................................................39
xxxix. Board can be classified – stagger the election of directors. (board size
can also be decreased to achieve same result) .........................................43
xl. Replace board meetings with informal discussions. ..............................43
xli. Use of committees by which the minority issues are not on the table. . .43
42. States that are mandatory have gone both ways whether these actions
can be taken to mitigate the effect of cumulative voting. .........................43
xliii. Classification of stock in NY – Can be in the bylaws § 707. ..................43
xliv. Removal of directors elected by cumulative voting requires the same #
of votes used to elect them. ....................................................................43
xlv. Most corporations do not like to use it since it gives up some control ..43
tt. Agency law will impose liability on parent corporations – because it is a
principal, not a corporation whose veil has been pierced. .........................44
47. Even if a corporation is pierced, generally only hold liable those who are
active in managing the corporation are held liable. ..................................44
xlviii. Corporate subs or divisions - A parent corporation may operate a
business either as a sub or a division within the corporation itself. ...........45
49. Parent is usually liable for the operations of the division, there is no
separation..............................................................................................45
50. If operated as sub, parent is normally not obligated for sub’s liabilities.
..............................................................................................................45
51. Limitation of parent liability is not the dominant factor in choosing
between sub/division, usually it is an operational choice. (management
decision) ................................................................................................45
52. Parent may make use of the assets of a sub, to get better interest rates,
to ensure that the sub is not wasting money. ...........................................45
aaa. Fletcher v. Atex – ............................................................................45
bbb. Walkovszky v. Carlton – ...................................................................45
lv. **Court views that holding minimum insurance as not fraudulent.
Corporate form will not be discarded just because corporate assets are
insufficient to make P whole. .................................................................45
ddd. Minton v. Cavaney – Outer limits of piercing doctrine.........................45
57. Here the basis for piercing is – ...........................................................45

3
fff. Arnold v. Browne – “Evidence of inadequate capitalization is, at best,
merely a factor to be considered by the trial court in deciding whether or not
to pierce the corporate veil”....................................................................45
ggg. Slottow Fidelity Federal Bank v. American Casualty Co – piercing in a
parent/ sub organization holds the parents liable, but not the shareholders
of the parent company. ...........................................................................45
hhh. Radaszewski v. Telecom Corp. – Subsidiary was adequately capitalized
due to insurance policy, even if undercapitalized......................................45
iii. Sea-Land Services v. Pepper Source – .................................................45
lxii. When will the corporate veil be pierced? ...........................................46
lxiii. The nexus of fraud was that he knew he would be unwilling/unable to
pay. D was found personally liable, and all corporations were pierced
(reverse pierced) D was the dominant force behind all the corporations. D
and all his subsidiaries were held liable. ..................................................46
64. Fraud is still an independent basis for liability, but must prove reliance
on fraud. Some cases hold that reliance does not need to be shown. ........46
mmm. Kinney Shoe v. Polan – Court set forth a 3rd prong to corporate veil
test, apply to contract creditors only:.......................................................46
lxvi. Poland was pierced because if they wanted the protection of
formalities, proper corporate formalities should have been followed. Nothing
invested in corporation therefore no protection to owner. ........................46
LXVII. SHAREHOLDER’S RIGHTS................................................................46
ppp. Derivative suit – where a shareholder or director brings suit on behalf
of a corporation, where the recovery goes to the corp...............................47
qqq. Direct suit – where shareholder sues on behalf, and recovery goes to
plaintiff (& other shareholders)................................................................47
rrr. Request cannot be too sweeping, cannot cover preliminary profit/loss
statements, monthly profit analysis, detailed balance sheets, or other
confidential information..........................................................................47
sss. Once establishing a proper purpose, secondary improper purposes will
not defeat access....................................................................................47
72. Illegal proposals that violate any law, including of SEC........................53
73. Proposals based on personal grievances. ...........................................53
74. Proposals that are moot/beyond corporation ability ............................53
lxxv. If proposal passes all these hurdles, management must include for SH
vote, if failing to do this, SH can seek SEC declaration that rules are being
violated, or bring a private action in court. ..............................................53
LXXVI. CLOSE CORPORATIONS..................................................................55
77. Test – must be equal opportunity for each shareholder to participate,
subject to being in good faith, to equal creditors and then shareholders.
Controlling group cannot use their control to obtain special advantages. ...55

4
lxxviii. §212(e) – A duly executed proxy shall be irrevocable if it states that it
is irrevocable and if, and only as long as, it is coupled with an interest
sufficient in law to support an irrevocable power, a proxy may be made
irrevocable regardless of whether the interest with which it is coupled is an
interest in the stock itself or an interest in the corporation generally.........56
lxxix. Not seller’s agent, stock can be voted as wanted, owe nothing to other
party, called proxy only because the form is given in traditional matter.....56
lxxx. Power given by a SH, allowing the proxy holder to vote independently.
Seller is still listed as the owner on the company books. ..........................56
lxxxi. Typical situation is as a means of securing a debt. Company extends
funds, and receives irrevocable proxies sufficient to elect members of the
board of directors. Holder of the proxy does not have the duty to act for the
giver of the power, nor subject to the giver’s control. ...............................56
lxxxii. Another example – one extends credit to a corporation, and can be
given irrevocable proxy in order to vote to protect the loan. Here the
interest is in the corporation (not in the stock).........................................56
lxxxiii. Another example – employee can bargain for a proxy (interest is in
the corporation)......................................................................................56
84. SCOTUS – arbitrator’s duty was to decide if there was a disagreement
between parties, not be a trustee. The agreement contained no protections
against Haley shifting allegiance to North, parties only bound to each other,
no explicit proxy provision. Here one party could not exercise the voting
rights of another, enforcement mechanism was flawed, Haley’s failure to
exercise voting rights in accordance with agreement was a breach of K.
(SCOTUS doesn’t count Haley’s vote, leaving one vacancy) Power of the
arbitrator is not independent of the decision making of the two SH, court
finds that the agreement to use an arbitrator is merely a deadlock breaking
device. The agreement is legal, but cannot be enforced. ...........................56
85. Statute allows whatever capital structure wanted. ..............................57
hhhh. So shareholders assume fiduciary liability.......................................58
iiii. They assume liability for results of their control. (no longer on directors)
..............................................................................................................58
jjjj. 620(a) & (b) (mostly) is used to overrule – provides that management
powers of the board can be restricted, but this provision must be in the
certificate...............................................................................................58
kkkk. Careful lawyer should always recommend various ancillary agreements
(voting, buy/sell, employment) to serve as shareholder protection. ...........59
llll. Here formalities were ignored, but nobody was injured by it. ..............59
91. Possible solution - Put in Berezofhsky clause – ct of appeals case – in the
event any provisions of the agreement shall be deemed illegal or against
public policy, the legality and validity of the remainder shall not be affected.
However if any illegality or validity issue can be solved by amending the
certificate it will be done. .......................................................................59

5
92. Narrows Donahue v. Rodd – strict good faith standard owed to minority
SH, ct is concerned that strict good faith standard will result in limitations
on legitimate actions by a controlling group in a close C. Majority has certain
rights of selfish ownership that needs to be balanced against the fiduciary
rights of the minority. .............................................................................61
oooo. Shareholders have a legitimate interest in controlling the transfer of
stock......................................................................................................62
pppp. Stock is personal property of the holder, should have the right to
dispose of the personal property as desired..............................................62
qqqq. Share transfer agreements can be used to:.....................................62
rrrr. This is an important area for lawyers. First a contract is created
between the parties, the bylaws are created to reflect the agreement in the
bylaws. Here precise drafting is needed. ..................................................62
97. No wrongful discharge, no cause of action because Wis. wrongful
discharge is limited to discharges that violate public policy.......................64
tttt. BUT buyback price was low, benefitting remaining SH. Did not deal
fairly with minority SH. Conflict of interest, device to cut out one of the SH.
..............................................................................................................64
99. Minority shareholders have equitable right to dissolution if majority have
committed fraud or other illegal or wasteful conduct. Otherwise must remain
in corp....................................................................................................64
100. 1104(a) – need 20% of votes of all shareholders.................................64
101. 1104(b) – only used for non-publically traded corps. ..........................64
102. Ct is supposed to take into account if liquidation is only feasible means
for minority shareholders to obtain a return on investment.......................64
103. 1104(a) leads to hearing, if under §1111 dissolution is ordered, brought
by AG – interests of the public is paramount, if brought by shareholder, their
interests are paramount..........................................................................64
civ. Advice – SH agreement should contain clauses defining expectations of
parties, then if disagreement should include buy/sell agreement. Basic idea
of this chapter.........................................................................................64
aaaaa. Relief given in these cases where majority tries to freeze out minority
SH. – try to restore a minority shareholder to the position as closest possible
as to where minority shareholder would have been if there were no
wrongdoing. (look at what ct is granting, eval what factors apply in relief
granted).................................................................................................65
cvi. Donahue – maj SH Caused C to purchase min SH stock at favorable price,
while denying Euphemia the same opportunity. Ct orders rescind sale of
stock to C or in alt. Give Euphemia same price..........................................65
cvii. Wilkes – expectations of employment – ordered damages for loss of
employment as well as the value of his shares, attempt to reset balance
between maj. Right of selfish ownership and min. rights of reasonable
expectations of employment....................................................................65

6
cviii. Galler – ct. specifically enforces agreement for both sides to receive the
same amount (retrospect -would have been much better to buy Emma out)65
cix. Kemp – reasonable expectations leading to buyout.............................65
CX. DUTY OF CARE...................................................................................66
111. Director should consult outside advice if necessary...........................66
112. Directors owe a duty to SH, creditors (only as C is dipping towards
insolvency), the C....................................................................................66
113. Directors should exercise their duty in good faith and skill. ...............66
114. Director can fail to discharge the duty by;.........................................66
115. Directors can rely on repots from other employees, counsel, etc, but it
must be in good faith, and must have reasonable belief that the report is
true. ......................................................................................................66
116. Director can rely on a committee of the board if acting in good faith,
and believes reliance on a committee is warranted, but must read the report
in order to rely on it................................................................................66
117. Director can rely on competent outside experts, relying on relevant skill
and experience........................................................................................66
118. BJR protects directors from imposition of liability based on hindsight.
Also helps to encourage D to take risks so that they are not found liable for
hindsight bias. Decision turned out badly v. bad decisions. .......................67
119. If the courts did not abide by the business judgment rule, they might
well penalize the choice of A in each such case and thereby unknowingly
injure shareholders generally by creating incentives for management always
to choose b (less risk, less reward)...........................................................68
120. BJR encourages managers to take good risks, and they will be rewarded
for this. ..................................................................................................68
qqqqq. Gross negligence is the standard that will lead to director liability.
SH did not know that decision was reached without adequate information by
the board. ..............................................................................................68
rrrrr. Heightened decision-making is now required for life/death decisions re:
corporation. ...........................................................................................68
123. F - Directors killed deal to benefit selves, issued fraudulent proxy
statement to shareholders.......................................................................68
ttttt. SH ratification by disinterested SH will cleanse a board decision
making process if board is questionable IF SH RATIFICATION IS NOT LEGALLY
REQUIRED (not necessary) (DELAWARE)....................................................68
cxxv. Previously disinterested majority of SH ratified action of board directly
therefore, even if board breach duty of care, was ok.................................68
126. Board’s deceitful activity isn’t cleansed by SH ratification..................68
cxxvii. IE. Board wants to proceed with action, not required to get SH
approval but do so anyway, it cleans the impure decision-making process.
SH must be fully informed. ......................................................................68
7
cxxviii. Then Board can use Biz Judgment Rule as defense.........................68
yyyyy. “Subjective bad faith” - conduct of directors motivated by an actual
intent to do harm to the corporation. This type of conduct as “classic,
quintessential bad faith.” .......................................................................69
zzzzz. “Intentional dereliction of duty, a conscious disregard for one's
responsibilities.” ....................................................................................69
cxxxi. Failure to act in good faith may be shown, for instance, where the
fiduciary intentionally acts with a purpose other than that of the best
interests of the corporation, where the fiduciary acts with the intent to
violate applicable positive law, or where the fiduciary intentionally fails to
act in the face of a known duty to act, demonstrating a conscious disregard
for his duties...........................................................................................69
132. Cant be indemnified or exculpate......................................................69
cccccc. §107 – duty of care does not apply if there is a breach of duty, but
doesn’t work if there is a lack of good faith duty of loyalty. Caremark
decision is reclassified (to good faith duty of loyalty) Standard in Caremark
is sustained or systematic failure of the board to assure oversight. If this
fails, then establishes a lack of good faith. Draws heavily upon concept of
director failure to act in good faith, differs from the breach of duty of due
care. ......................................................................................................70
CXXXIV. DUTY OF LOYALTY......................................................................71
cxxxv. In terms of complying with statute – 3 approaches..........................72
ffffff. Theory – outstanding performance is warranted. Stock options are
supposed to provide an all or nothing payoff............................................73
gggggg. Reality – even if the investor loses, executives can still win. Options
have strike price reset.............................................................................73
hhhhhh. Until recently federal tax and options policy kept them tax-free. ..73
iiiiii. Excess of options has led to – ...........................................................73
jjjjjj. Cannot issue options below the fair market value of the stock therefore
it is a breach of fiduciary loyalty to the shareholders. ...............................73
kkkkkk. Bad faith – intentional violation of shareholder approved options
plan, plus intentional misinformation on disclosures. ...............................73
llllll. Board was not completely honest, and SH were owed candor from the
directors even after the plan was approved..............................................73
mmmmmm. This was disloyalty and directors cannot rest defense on BJR...73
cxliv. In re eBay Inc. Shareholders Litigation (2004)..................................75
145. IPO case, Goldman bribed fiduciaries of corporations for whom it was
doing business. They got further business as a result of the granting of
stocks at IPO prices. ...............................................................................75
146. Ebay’s agents were under a duty to account for the profits from the
transactions that related to his/her company. The benefits of the IPO
belonged to the corporations. .................................................................75

8
147. This isn’t really the taking of corporation’s property, but kind of a use,
the taking of good will of eBay’s charity...................................................75
148. Raise many of same conflict of interest concerns as arise between
directors and corporations.......................................................................75
ssssss. In this case an independent committee (plus resigning from the
board) may have helped Feldman’s case here. .........................................77
tttttt. If Feldman was a minority shareholder – he could probably sell his
shares. ..................................................................................................77
uuuuuu. Recovery against Feldman – Feldman had to account to
shareholders the premium he was paid – the opportunity was distributed to
the other shareholders............................................................................77
vvvvvv. Pearlman could be read – control cannot be sold at a premium to
those who would injure the corporation by failing to maximize profits. .....77
CLIII. INSIDER TRADING............................................................................78

9
NATURE OF BUSINESS ORGANIZATIONS
a. Business Organizations:
i. Sole Proprietorship - a business organization that is owned by a single individual, and is not cast in
a special legal form of organization, such as a C, that can be utilized only by filing an organic
document with the state pursuant to an authorizing statute
1. Has no separate identity from its owner
2. Individual who owns SP has unlimited personal liability for obligations incurred in the conduct
of the business
3. May hire employees, keep records, take out loans, etc.; but keep business aspect separate from
personal property
ii. Corporation - a type of legal institution that defines legal relationships between people; it is a
method of organizing business; it is a legally recognized fiction.
1. Public (open) – a corporation that is listed on a stock exchange or “over the counter market”
(computerized trading system; means they are publicly held by individual owners, SH, and
publicly traded)
2. Close corporation (private) – not listed on an exchange and privately held
3. Members of a Corporation:
a. Board Members – oversee the corporation
b. Shareholders – are the owners of the corporation
c. Bondholders – are people that lend money to the corporation
d. Managers – run the corporation
e. Hedge Funds – large bodies of privately held capital
iii. General Partnership – any association of two or more people who carry on a business as co-owners;
can be established by operation of law w/ no formal papers filed; any partnership is general unless
comply with special requirements for limited partnerships
iv. Limited Partnership – can only be created where:
1. there is a written agreement among the partners, and
2. a formal document is filed with state officials
v. Limited Liability Companies – is neither a corporation or a partnership, but incorporates a little of
each
b. Corporations Theories:
i. Entity Theory: a corporation may be viewed as an artificial entity used to conduct a business. The
entity can conduct business in its own name (pays taxes, sue, buy land). This entity is formed by a
grant of authority by the state. This is done by a document called a certificate of incorporation.
Individuals and the state know this corporation as a separate entity. Real people actually conduct the
business; these are the corporation’s agents.
ii. Concession Theory: because a corporation is a grant or concession of the state, and therefore the
state can impose restriction on corporate behavior. Today this really does not exist because the state
has no control over the corporation, no decision making power.
iii. Contract Theory: the charter/certificate of incorporation represents a contract between the state and
the corporation or the corporation and the shareholders or a contract between the SH’s of the
corporation. This contract theory emerges today in disputes between different classes of
shareholders.
iv. The Nexus of Contract Theory: this theory rejects the notion that shareholders are ultimate owners
of corps, but rather it views SHs as investors of capital that get periodic returns. A nexus of Ks that
come together. Under this theory the corp is not an entity, it is a group of individuals that work
together for a goal. The proponents of this theory do not believe in corp regulation because it is just
v. *NOTE - State vs. Federal Law: Traditionally corporations regulated by states; since Depression
federal gov’t started to regulate, including issuance & trading of securities.
c. Agency and Authority: If there is authority, the agent has the power to bind the principal to an agreement
with a third party.
i. Agency - is the fiduciary relationship that arises when one person (a principal) manifests assent to
another person (an agent) that the agent shall act on the principal’s behalf and subject to the
principal’s control, and the agent manifests asset or otherwise consents so to act (RS 3rd § 1.01)
1. Elements for an agency relationship:
a. Manifestation by the principal that the agent shall act for him
b. Agents acceptance of the undertaking
c. Understanding of the parties that the principal is to be in control of the undertaking
10
 2. Although agency is a consensual relationship, how parties label any given relationship is not
dispositive
ii. Agency Law – this area of law governs:
1. The relationship between agents and principals
2. The relationship between agents and third persons with whom an agent deals, or purports to
deal, on a principal’s behalf
3. The relationship between principals and third persons when an agent deals, or purports to deal,
with a third person on the principal’s behalf
iii. Agent – Person who by mutual assent acts on behalf and subject to the control of another, the
principal
1. General Agent – an agent who is authorized to conduct a series of transactions involving
continuity of service
2. Special Agent – an agent who is authorized to conduct only a single transaction, or only a
series of transactions not involving continuity of service
iv. Principal – person on whose behalf and subject to whose control an agent acts
1. Disclosed Principal – when an agent and third party interact, and the third party has notice that
the agent is acting for a principal and has notice of principal’s identity
2. Partially Disclosed Principal – (or unidentified) when an agent and third party interact, and
the third party has notice that the agent is acting for a principal but doesn’t have notice of the
principal’s identity (cases split whether principal is liable in this situation)
3. Undisclosed Principal – when agent and third party interact, and third party has not notice that
agent is acting for a principal
v. Jensen Farms v. Cargill –
1. P – When a creditor maintains de facto control, the creditor relationship becomes an
agency relationship. Case ex. of how A can be found if P exercises de facto control.
2. F – W operated grain elevator and sold grain; C buys grain from W and sells to other
companies; C acts like a bank to W and is given right of first refusal; W owes $2 million to
farmers, which means C is jointly liable with Warren and farmers can sue C directly.
3. H – C is liable b/c he manifested consent of agency relationship by directing W to implement
his recommendations. *Key – factor was C’s (creditors) ability to control W (debtor). Factors
to look at:
a. Nature of business
b. Purpose of relationship
c. Amount of financing, and
d. Control of the parties

d. Liability:
i. Vicarious Liability of Principal – RS 3d § 7.07(1), (2)
1. An employer is subject to vicarious liability for a tort committed by its employee acting within
the scope of employment
2. An employee acts within scope of employment when performing work assigned by the
employer or engaging in a course of conduct subject to the employer’s control. An employee’s
act is not within the scope of employment when it occurs within an independent course of
conduct not intended by the employee to serve any purpose of the employer.
3. RS 2nd (master (p) / servant (a)); RS 3rd (employer (p) / employee (a))
ii. Liability of Principal to 3rd Person – a Principal becomes liable to a third person as a result of an act
or transaction by an agent on the principal’s behalf, if the agent had the actual, apparent, or inherent
authority to act on the principal’s behalf in the way that he did, or was an agent by estoppel, or if the
principal ratified the act or transaction
1. Actual Authority – A has actual authority to act on behalf of P if P’s words or conduct would
lead a reasonable person in A’s position to believe that P wishes A so to act.
a. Express / Real – P directs A to perform some act
b. Implied – including incidental authority, which is authority to do incidental acts that
are reasonably necessary to accomplish an authorized transaction or that usually
accompany that type of work
2. Apparent Authority – if manifestations of P to T would lead a reasonable person in T’s
position to believe that the principal had authorized the agent to so act.

11
 a. Power of Position – type of apparent authority that is created by appointing a person
to a position (ex. manager) that is generally recognized as having certain duties or
authority
3. Agency by Estoppel – person who has not made a manifestation that an actor has authority as
A and who is not otherwise liable as a party to a transaction purportedly done by the actor on
that person’s account is liable to T who is induced to make a detrimental change in position b/c
the transcription is believed to be on the person’s account if
a. 1 – the person intentionally or carelessly caused such belief, or
b. 2 – having notice of such a belief and that it might induce others to change their
positions, the person did not take reasonable steps to notify them of the facts
c. *This is very similar to apparent authority
4. Inherent Authority – derives solely from agency relationship and exists for the protection of
persons harmed by or dealing with an A; ex. A may bind P in certain cases even when A had
neither actual nor apparent authority.
5. Ratification – even if A had neither actual, apparent, or inherent authority, P will be bound to
T if A purported to act on P’s behalf, and P, with knowledge of material facts, either:
a. (1) affirms A’s conduct by manifesting an intention to treat A’s conduct as
authorized, or
i. Manifesting an intention or Express ratification
b. (2) engages in conduct that is justifiable only if he has such an intention
i. Engaging in conduct or Implied ratification
c. *Ratification doesn’t need to be communicated to T to be effective, it only needs to
be objectively manifested

6. Acquiescence – if A performs a series of acts of a similar nature, the failure of P to object to

them is an indication that he consents to the performance of similar acts in the future under
similar conditions
7. Termination of Agent’s Authority – G/R P has the power to terminate A’s authority at any
time, even if doing so violates a contract between P and A, and even if it had been agreed that
A’s authority was irrevocable.
a. Even thought P can terminate A’s authority, A can still sue P for damages for
wrongful termination or breach of contract.
iii. Liability of 3rd Person to Principal:
1. G/R – if A and T enter into a contract, and A’s principal is liable to T under the contract, then
T is liable to P.
2. Exception – T is not liable to an undisclosed principal if A or P knew that T would not have
dealt w/ P if he had known P’s identity
iv. Liability of Agent to 3rd Person – where A has entered into a contract with T on P’s behalf, A’s
liability to T depends on whether P is bound under the contract
1. Where principal is bound – where A has actual, apparent, or inherent authority, so that P is
bound to T, A’s liability to T depends on whether P was:
a. Disclosed Principal – A is not bound to T
b. Undisclosed Principal – A is bound even though P is also bound
i. Majority rule – if T obtains a judgment against either P or A, the other
party is dismissed
ii. Minority rule - neither A or P are discharged by T’s judgment against the
other
c. Partially Disclosed Principal – A and P are bound to T
2. Where principal is not bound – A is liable to T
v. Liability of Agent to Principal – If A takes an action that he has no actual authority to perform but P
is still liable b/c A had apparent authority, A is liable to P for any resulting damages to P
1. Liability not clear for when A acts with inherent authority and binds P
vi. Liability of Principal to Agent – If A acts with actual authority, P is under a duty to indemnify A for
payments A made that were authorized or made necessary in executing P’s business. This includes:
1. Authorized payments made by A on P’s behalf;
2. Payments made by A to T under contracts which A was authorized to make himself liable (P
partially or undisclosed);

12
 3. Payments of damages to T that A incurs b/c of an authorized act that constituted a breach of
contract for which A was liable to T;
4. Expenses in defending actions brought against A by T b/c of A’s authorized conduct
vii. Morris Oil v. Rainbow Oilfield Trucking
1. New Mexico oil delivery case Rainbow (agent) entered into a contract with Morris (no idea
Dawn existed) w/o the authority of Dawn = creation of an undisclosed agency, court finds
liability – when an undisclosed principal entrusts an agent, the undisclosed principal is bound
to agreements made by the agent w/third party, even when agreements are outside the scope of
business.
2. Where the undisclosed principal retains the benefit or proceeds of agreements reached
by an agent, with knowledge of material fact, it ratifies the agreement made by agent.
1. Dawn could have protected itself by ensuring that Morris knew of Rainbow’s lack of authority.
e. Agent’s Duty of Loyalty:
i. RS Agency § 8: Duties of A and P to Each Other
1. § 8.01 – General Fiduciary Principle
2. § 8.02 – Material Benefit Arising Out of Position
3. § 8.03 – Acting as or on Behalf of an Adverse Party
4. § 8.04 – Competition
5. § 8.05 – Use of Principal’s Property; Use of Confidential Information
ii. Tarnowski v. Resop –
1. P - A has utmost duty of loyalty and if he has been disloyal he must turn over all profits
to P; Agents are fiduciaries and are required to act unselfishly; person is obligated to
renounce any personal furtherance or interest.
2. F – P hired D as his agent to investigate and negotiate for the purchase of coin-operated music
machines. Agent took commissions from seller and made misrepresentations to principal
(buyer).
3. L - All profits made by an agent in the course of an agency belong to the principle, whether
they are legit or not. Principal can squeeze all profits out of the transaction even if he suffered
no loss (attorney fees consequence of misrepresentation).
4. H - If an agent has received a benefit as a result of violating his duty of loyalty, the principle is
entitled to recover from him what he has so received and also the amount of damage thereby
caused. The right to recover profits made by the agent in the course of the agency is not
affected by the fact that the principle, upon discovering a fraud, has rescinded contract and
recovers his $.
iii. Redding v. Attorney General
4. General, asked to assist in running of whisky, by riding in his army uniform in the truck,
assuring that the truck would not be hijacked or inspected. Redding received 20,000 pounds.
5. British gov’t received these funds on the grounds that the money was paid to Redding as they
were paid while he was falsely representing the government during military duties.
6. Court – if a servant takes advantage of position that he enjoys, or opportunities that it
provides, agent is responsible to the principal for benefits gained.
7. Even through action was a criminal act, the British army had the right to take his profits.
iii. Tarnoski – tells us that agents are fiduciaries
1. Few agencies have the power such as the fiduciary obligation.
2. Obliged to act unselfishly

3. Has to act for another, provide skill.

4. Black letter – fiduciaries are to avoid self interest

5. Duties vary in different context (as does justification for imposing limitiation)

6. Is a person who undertakes to act in the interest of another person.

7. Many fiduciary norms are very general. Also many beneficiaries as principals are liable to
misconduct to fiduciaries.
8. Courts have a difficulty in applying these norms.
f. Introduction to Financial Statements:
i. Fundamental Equation: Assets = Liabilities + Owner’s Equity
ii. Double-Entry Bookkeeping:
13
 1. Any transaction firm enters into, is going to be entered in two places (assets and liabilities)
2. Basis for this is the fundamental equation
iii. Balance Sheet – left side of sheet must always equal right side of sheet
1. Doesn’t necessarily reflect real or market values; usually just reflect book value (original cost
of asset – depreciation)
2. Depreciation – determined by a formula, such as straight line depreciation where item
decreases 5% from cost for each year in existence
3. Debits – left side entry
4. Credits – right side entry
iv. Assets & Liabilities:
1. Assets – are resources that are based on past transactions
a. They are listed in the order they can be turned into cash
b. Listed at the cost to obtain them, rather then present value
c. When lists assets also lists their sources (balance sheet)
2. Liabilities – debts and obligations owed by the company
a. They are the reverse of assets b/c they are claims on firm’s resources
b. Current liabilities, listed in order they are due – must be reduced to cash w/in a year
c. Long Term Liabilities
v. Net Worth = Assets – Liabilities
1. Net worth is the owner’s interest in the enterprise after recognizing the interest of the creditors
2. Owner’s Interest includes:
a. Capital paid into the company – original stake in the business; money originally
invested in company
b. Accumulated profits or retained earnings – Companies distribute their profits in form
of dividends, but some money is kept in treasury to be used by company
vi. Income Statement – a statement for a period of time, giving a summary of earnings between balance
sheet dates
1. Also known as Earnings report or Profit and Loss sheet
2. The income statement matches the amount received from selling goods vs. costs to operate
company, the result is profit or loss for the year; Any profit rolls over into Retained earnings –
any dividends paid out
3. Revenues = Revenues Realized – Expenses Incurred
4. *Note – a balance sheet speaks as of a particular date, an income statement covers a period of
time between successive balance sheets
5. To figure out financial health of a firm look at 2 to 10 years of income statements
vii. Agency Costs – the sum of:
1. Monitoring expenditures by the principal
2. Bonding expenditures by Agent
3. Residual Loss – dollar equivalent of the reduction in welfare experienced by the principal due
to this divergence

14
VIII. PARTNERSHIP
g. Partnership Formation:
i. UPA § 6 – Partnership Defined
ii. UPA § 7 – Rules for Determining the Existence of a Partnership
iii. General Partnership – any association of 2 or more people who carry on a business as co-owners;
can be established by operation of law w/ no formal papers filed;
1. Any partnership is general unless comply with special requirements for limited partnerships
2. PN are default relationship
3. Businesses must be For-Profit
4. Two types of Partnerships:
a. At-Will – ended by the express will of the partners or a specific event; don’t have to
give a reason for dissolution
b. For a Term – if dissolve prior to ending of term, can be subject to damages
iv. Limited Partnership –
1. Can only be created where:
a. There is a written agreement among the partners, and
b. A formal document is filed with state officials
2. Two types of partners:
a. One or more “general” partners, who are EACH liable for all the debts of the
partnership
b. One or more “limited” partners, who are NOT liable for the debts of the PN beyond
the amount they have contributed
v. Limited Liability Partnership – the liability of partners in a PN depends on whether the PN is
“general” or “limited”
1. General – all partners are individually liable for the obligations of the PN
2. Limited – general partners are personally liable but limited partners are liable only up to
amount of their capital contribution; but a limited partner will lose this limit on liability if he
actively participates in the management of the PN
vi. Formalities:
1. General Partnerships – can be organized with no formalities and no filing; whether there is a
PN depends on factual characteristics of relationship between people, not whether they think of
themselves as having a PN
2. C, LP, LLP, and LLC – all require certain formalities to be complied with and a filing made
with the state
vii. Basic Partnership Law Norms: UPA provides default rules to govern situations PN agreement fails
to cover, but allows owners to contract for different rules; these are basic rules absent a contrary
agreement (*UPA is law in NY)
1. Internal Governance –
a. All partners have equal rights in management and conduct of PN
b. Differences among the partners as to ordinary matters connected with the PN are
determined by a majority of the partners, but matters that are outside the scope of the
PN, or that would be in conflict with the PN agreement, require unanimous approval
2. Authority – any partner has power to bind PN on a matter in the ordinary course of business;
even if partner lacks actual authority under PN agreement, so long as T didn’t know that P
lacked actual authority
3. Distributive Shares – PN profits are shared per capita, and no partner is entitled to a salary
4. Transferability – no person can become a member of a PN w/o consent of all the partners
5. Term – PN are normally created for a limited term – frequently a relatively short term – and
dissolution is easy;
a. If PN is not for a specified term (express or implied) any partner may cause
dissolution at any time;
b. If PN is for a specified term, dissolution occurs at tend of term
6. Fiduciary Duties – Partners stand in a fiduciary relationship to each other
7. Liability – Partners in general PN are individually liable for PN’s obligations
viii. Rules for Determining whether a Partnership:
1. Facts and Circumstances Test – to determine whether there was intent to do business as co-
owners for profit
15
 a. Who makes management decisions – Joint management
b. Intent of Parties – Did they intend a PN
c. How did parties hold themselves out to each other
d. Amount of services contributed by each party
e. Is there the existence of another motive, other than PN, to explain the transaction
f. Capital contributions
g. Profit Sharing
h. Is there any intent to evade a regulation or tax statute
i. Is there any purpose to avoid tort liability
2. PN can be express or implied - Doesn’t matter if parties expressly agree to a PN or whether
they specifically deny a PN – facts determine relationship
a. *Note – in a close case, court will respect the agreement / intention of the parties if
the agreement / intention is clear
3. Need to distinguish between creditor making loan and lender entering PN
ix. The 4 Element Test – (departs from UPA § 6 statutory test)
1. An agreement to share profits
2. An agreement to share losses
3. A mutual right of control or management of the business
4. A community of interest in the venture
x. Martin v. Peyton –
1. F – Lenders investing in a near bankrupt PN were granted profit sharing and some
management rights until they were repaired. When PN defaulted on debts, a creditor sued the
lenders, contending their rights made them partners and personally liable for PN debts.
2. H – Creditor/Debtor relationship, NOT a PN; helped bail out co, a loan; they had negative
controls to protect their securities, not affirmative decision making authority or ability to
initiate a transaction or bind co.
3. R – Even PN creditors who are granted a share of profits and some management control
are not necessarily deemed partners if other factors indicate contrary intent.
i. In a close case, courts will respect parties’ intentions, in cases where relationship is clear.

ii. Also – look at what are the motives of the parties in favor of or opposed to the
relationship.

iii. Is there an attempt to evade or benefit from some statute?

xi. Lupien v. Malsbenden –

1. F – A business defaults on a customer’s order, the customer sues its financier, contending
financier managed business himself, thus became a partner.
2. I – Is a business creditor involved in managing the business liable as PN?
3. H – Yes; did more than a loan, no set payments to repair $, affirmatively involved in decision
making, pooled resources together (capital & auto skills).
4. R – A creditor who actively manages its borrower’s business may be liable as the
borrower’s partner; was joint management and profit sharing.
9. People can become partners even when facts show that they have no intention of doing
so, intent is not enough.
h. Legal Nature of a Partnership:
i. UPA § 6 – Partnership Defined
ii. Entity v. Aggregate – common law PN was not an entity, but merely an aggregate of its members;
more like a friendship
1. PN as an entity means that it can sue, be sued, hold property, etc.; there isn’t much difference
regarding liability
iii. UPA – defines PN as an association of 2 or more persons to carry on as co-owners a business for
profit; applies a hybrid approach
iv. Other Statutes – issues arise as to whether states that adopt UPA, but have other statutes, should
treat PN as an entity or in aggregate; most define as an entity
v. RUPA – confers entity status on PN
i. Ongoing Operation of Partnerships:
i. UPA § 18 – Rules Determining Rights and Duties of Partners
1. PN Agreement - very important b/c you can draft away most UPA provisions
16
 2. Disputes – If partner has dispute against one another can file suit for an accounting under § 21
or can sue for dissolution
3. Dissolution § 18 – order of payout under dissolution
a. Creditors
b. Partners Advanced (excess contributions)
c. Partners capital contributions
d. Profit (if any left over, according to agreement)
ii. UPA § 19 – Partnership Books (Cannot draft around)
iii. UPA § 20 – Duty of Partners to Render Information (Cannot draft around)
iv. PN Liability – Partners are individually liable to PN creditors for PN obligations, but only liable for
their share which is based on the partners capital contributions
1. Indemnification - each partner is liable for his share of the PN obligations – thus if one pays
of more than his share of the debt, he is entitled to indemnification from the PN for the
difference between what he paid and his share in the liability
a. Obligation to indemnify a partner is a Partnership liability
2. Contributions – Partnership has a right, if they indemnify a partner, to require contribution
from one or more partners; Contribution can also be required for paying off creditors or
equalizing capital losses
a. Obligation to make contribution is a liability of a partner
v. Summers v. Dooley:
1. F – After one partner hires an employee over the other partner’s objection, he demands the PN
reimburse him for paying the employee’s wages.
2. H – Not obligated to pay; partners have equal rights to manage PN business, so disagreements
must be decided by a majority of partners.
3. R – If a partner incurs expenses for the PN, the PN need not reimburse them unless those
expenses were authorized by a majority of partners, absent contrary agreement or later
ratification.
4. *Note – under UPA § 18(h) need a majority vote to make such a change; but need to actively
object, can’t be silent.
vi. Sanchez v. Saylor:
1. F – Were partners and T was considering lending PN $ to restructure PN debt, but wanted
Sanchez’s personal finances; Sanchez refused and Saylor brought suit claiming breach of
fiduciary duty.
2. H – Held for Sanchez. Remedy is dissolution under Covalt Rule.
3. Covalt Rule – All partners have equal rights in a PN, but neither partner can impose his or her
will on the other partners; matters must be decided by a majority (51%)
4. Covalt Remedy - Absent an enforceable agreement covering such circumstances of
disagreement, when both partners in a two-partner partnership disagree it is dissolution, not an
action for breach of fiduciary duty, that is the appropriate avenue of relief.
j. Authority of a Partner:
i. UPA § 3 – Interpretation of Knowledge and Notice
ii. UPA § 9 – Partner Agent of Partnership as to Partnership Business
iii. UPA § 10 – Conveyance of Real Property of Partnership
iv. UPA § 11 – Partnership Bound by Admission of Partner
v. UPA § 12 – Partnership Charged w/ Knowledge of or Notice to Partner
vi. UPA § 13 – Partnership Bound by Partner’s Wrongful Act
vii. UPA § 14 – Partnership Bound by Partner’s Breach of Trust
viii. Partner’s Authority:
1. Each partner is an agent of the PN for the purpose of its business
2. A partner has authority to bind the PN by any act “for apparently carrying on in the usual way
the business of the PN of which he is a member”
a. Not clear whether this means an act w/in the course of business as carried on by the
partner’s firm or the course of business of other firms in the same local engaged in the
same line of business
ix. Northmon Investment Co. v. Milford Plaza:
1. F – Milford challenged a long-term lease (99 yr) entered into by partners in its PN
2. I – May a partner challenge the actions of another partner as outside the scope of its authority?

17
 3. H – Yes; partner may bind PN by transaction made in ordinary course of business, but partners
may object to unauthorized transactions in assertion of their equal rights in the management
and conduct of PN business.
4. R – Can bind in ordinary course of business (§9) by a majority vote (§ 18) but this was
extraordinary leasing sole asset for longer than PN. Unanimous consent required by §9(2)
5. Application of UPA §9, NY = §20
j. §9 is really saying that every general partner has the agency powers of a general
manager, but it is still left to the courts to determine on a case-by-case basis the extent
of this power.
k. Liability for Partnership Obligations:
i. UPA § 9 – Partner Agent of Partnership as to Partnership Business
ii. UPA § 13 – Partnership Bound by Partner’s Wrongful Act
iii. UPA § 14 – Partnership Bound by Partner’s Breach of Trust
iv. UPA § 15 – Nature of Partner’s Liability
1. All partners are liable jointly and severally for everything chargeable to PN under §§ 13 and 14
a. §9, 13, 14 make partners liable, but UPA does not authorize such lawsuits.
2. All partners are liable jointly for all other debts and obligations of PN
3. *Note – w/o an agreement otherwise, losses and profits are shared equally
v. UPA § 16 – Partner by Estoppel
vi. UPA § 17 – Liability of Incoming Partner
vii. UPA § 36 – Effect of Dissolution on Partner’s Existing Liability
1. Dissolution does not of itself discharge existing liability
2. A partner is discharged by an agreement between himself, the creditor, and the person
continuing the business
viii. Davis v. Loftus –
1. F – Firm had two different kinds of partners (equity and income); Income partners put in
capital that they got back when they left, as well as salary; Action brought against firm for
malpractice.
2. I – Whether income partners are liable for the malpractice?
3. H – Income partners do NOT qualify as partners under UPA, so they are not liable for the
malpractice; they had not right to vote on the management or conduct of PN, no profits, got
separate salary, not likely to have been involved in the decisions that caused the malpractice.
4. TEST – Look at the Substance and not the Form of a business relationship to determine
whether the relationship qualifies as a PN.
l. Partnership Interests and Partnership Property:
i. UPA § 8 – Partnership Property
ii. UPA § 18 – Rules Determining Rights and Duties of Partners
iii. UPA § 22 – Partner Has a Right to an Accounting
1. Can not be changed by agreement
iv. UPA § 24 – Extent of Property Rights of a Partner
v. UPA § 25 – Nature of a Partner’s Right in Specific Partnership Property
vi. UPA § 26 – Nature of Partner’s Interest in the Partnership
vii. UPA § 27 – Assignment of Partner’s Interest
viii. UPA § 28 – Partner’s Interest Subject to Charging Order
ix. Partnership Property:
1. Under UPA PN can own Property - sets forth rules that effectively treat PN as if it were an
entity
a. G/R – individual partners own the partnership property in theory, but in practice all
the incidents of ownership are vested in the PN, so that the “tenancy in partnership”
rule of UP has no real-world significance
b. § 8 – real property can be held in PN’s name
c. § 25(1) – PN property is owned by partners, as tenancy in partnership, but § 25(2)
takes away individual partners ownership of the property
2. Property used by a PN may be either:
a. PN property or
i. This property can be transferred by the PN
ii. Upon dissolution this property must be sold or valued along with other PN
assets and proceeds of sale or value of asset must be distributed amongst
partners
b. Property of a partner that is loaned by the partner to the PN
18
 i. This property can NOT be transferred by the PN
ii. Upon dissolution, the property must normally be returned directly to the
loaning partner
3. This distinction is important:
a. For determining who has the power to transfer the property
b. If creditors of PN are competing w/ creditors of individual partner
c. If partnership is dissolved
x. Partnership Interests:
1. Partner’s Interest in the PN – Partner does own his interest in PN or his share of the PN;
creates a 2-level structure of ownership
a. 1 – Partnership owns the partnership property
b. 2 – Partner owns his interest in the partnership
2. Assignment – although a partnership interest is assignable, a partner cannot make an
assignment of his PN interest that would substitute the transferee as a partner in the
transferor’s place b/c no person can become a partner w/o the consent of all the partners
a. When PN interest is assigned, the assignment is not a full transfer of the interest
b. Instead, it is a transfer to secure a debt that the assignor-partner owes to the assignee-
creditor
c. Assignee only becomes partner if all the other partners consent and has no right to
information about PN, and no right to inspect books
d. Assignee has a right to receive the distribution which the assigning partner would be
entitled, and upon dissolution has right to recover assigning partner’s interest
e. A partner who assigned her PN interest remains a partner, but other partners can
dissolve PN
3. PN Creditors – If a partner’s individual creditor gets a judgment, he can get a Charging Order
on partner’s PN interest
a. Creditor can get partner’s distributions under PN
b. Creditor can foreclose on PN interest under § 28 and cause its sale; Buyer of the
interest has right to compel dissolution if:
i. The term of PN has expired, or
ii. The PN is at will
c. Creditor may put individual partner into bankruptcy, which results in dissolution of
PN under § 31(5)
m. Partner’s Duty of Loyalty:
i. UPA § 20 – Duty of Partners to Render Information
ii. UPA § 21 – Partner Accountable as a Fiduciary
iii. Fiduciary –
1. Partners are fiduciaries
2. Duty of loyalty is fiduciary - partners as fiduciaries owe each other the very highest standard of
loyalty, honesty, and honor.
3. Partners have a fiduciary duty to share business opportunities, or at least give notice to partners
of business opportunities in same area.
4. *Note – fiduciary rules are default rules in the absence of a PN agreement
iv. Meinhard v. Salmon –
1. F – When a PN is offered a profitable lease, one partner accepts it for himself, prompting the
other to demand participation.
2. H – S breached his fiduciary duty; S had a duty to inform M of the lease offer to at least allow
him a chance to compete for it.
a. NO fraud in this case, S acted in good faith.
b. Holding may be different if opportunity unrelated to S’s position in PN
3. R – Partners’ fiduciary duties of loyalty forbid appropriating opportunities offered to the
PN.
4. This decision has helped to enable venture capital due to the high fiduciary duty owed to
financers. What is the difference between a venture and a partnership?
k. Distinguishable by the narrowness of purpose.
a. Partnership is ongoing, venture = “one night stand”

b. Venture is a single undertaking or a short series of undertaking, not expected to

exceed a certain period.

19
 c. Dispute as to whether joint venture is covered by partnership law. 18(a) might be
unfairly applied.

n. Dissolution by Rightful Election:

i. UPA § 29 – Dissolution Defined
1. A dissolution is merely a change in the relation of the partners, not an end of the relationship
ii. UPA § 30 – Partnership not Terminated by Dissolution
1. Says that the relationship changes, but changes scope
iii. UPA § 31(1) – Causes of Dissolution: W/o violating Agreement
iv. UPA § 38 (1) – Rights of Partners to Application of Partnership Property
v. UPA § 40 – Rules for Distribution
vi. Types of Partnerships:
1. At will – ended by express will of parties at any time or specific event, but only as long as
ended in good faith
a. Wind up – pay off any liabilities and surplus paid to partners
b. No longer have to liquidate – it is a forced sale where you frequently get less then the
real value
2. For term – intended to last for a specified duration or until a specified project is completed;
cannot be dissolved at will; can be subject to damages for dissolving early

vii. Three Phases to Terminating a Partnership:

1. Dissolution – this is an event which sets the termination in motion
a. It describes a change in the legal status of the partners and PN
b. It is NOT an end to the relationship, relationship continues until the winding up of
PN’s affairs is completed
c. Upon dissolution very little happens except the PN scope of business narrows; you
don’t take on new business, but PN may be required to continue during dissolution in
order to maintain assets
d. Partner liability doesn’t end until winding up is completed
2. Winding Up – process of actually terminating partnership’s business
a. Describes economic event of liquidation that follows dissolution
b. Includes paying off debts, settling contracts, selling assets, etc.
3. Termination – consists of completing the wind up and ending PN
4. *Note – UPA doesn’t adequately distinguish between a departure that triggers a winding up of
a business and a departure due to a Buyout or a Continuation Agreement
viii. Consequences to Dissolution:
1. Consequences Among the Partners –
a. G/R - Unless otherwise agreed, PN must sell its assets for cash and distribute
proceeds of sale among partners, OR make a cash payment of the value of a partner’s
share of PN or an in-kind distribution
b. Wrongful Dissolution – § 38(2)(b), although dissolved the remaining partners can
continue PN business by
i. Pay X value of his PN interest – any damages cause by the dissolution, OR
ii. Put up a bond to secure such a payment and indemnify X against present
and future PN liabilities
c. Continuation Agreement – can enter into an agreement whereby remaining partners
can continue PN’s business after dissolution; these agreements usually include terms
of dissolution and amount of compensation to leaving partner
2. Effect of Dissolution on Relationship between PN and 3rd Parties –
a. If PN dissolved and deemed a new partnership for legal purposes, still have to transfer
leases, licenses, franchises, etc. to new PN
b. Can’t draft away dissolution - § 31 expressly states that dissolution is caused by
w/drawl of a partner
3. Tax Consequences –
a. IRC § 708 – PN”s existence doesn’t terminate for tax purposes until:
i. A – no part of any business, financial operation, or venture of PN
continues to be carried on by any partners in PN, OR

20
 ii. B – within a 12 month period there is a sale or exchange of 50% or more
of the total interest in PN capital and profits
b. Dissolution generally a non-event for tax purposes
ix. Girard Bank v. Haley –
1. F – General PN / at-will; partner sought to dissolve PN by sending a letter to 3 partners.
2. Lower court - partner didn’t dissolve PN b/c she didn’t give a reason.
3. H – REVERSED; this was an at-will PN and you don’t have to give a reasons for dissolving.
If this was a PN for a term, you would have to give a reason and could possibly be subject to
damages.
12. Establishes that a partnership at will does not require justification to dissolve the
partnership, even if it is in contravention of the agreement, a partnership can be
dissolved under the UPA.

x. Creel v. Lilly –
1. F – After the death of a partner, widow sued the surviving partners for liquidation of PN assets.
Wife claims that instead of winding up PN, they continued PN under another name.
2. H – This was a new PN / successor PN; surviving partners did wind up old business, did an
accounting, and gave $ to estate; Winding up does NOT mean to liquidate – you just have to
be able to pay estate what is owed.
3. R – When remaining partners wind up PN in good faith and provide an accurate
accounting of PN’s value, the departing partner has no right to compel liquidation b/c
PN”s value can be determined w/o liquidation.
4. *Note – Should have had a PN agreement with a continuation clause for PN to continue even if
one partner dies.
13. This case contributes to the development of the RUPA. Avoids the harshness of the UPA
where there is a fire sale. It allows the remaining partners to buy out the leaving
partner’s estate. Valuation is taken on the date of the partner’s death.
xi. McCormick v. Brevig -
1. I – When dissolution is ordered by judicial degree, is liquidation required?
2. H – when a partnership dissolution is court ordered, the partnership assets must be reduced to
cash in order to satisfy the partnership obligation, and any additional funds are dispersed to the
partners
14. *Fishman thinks that this is a bad result – Clark may not have the ability to pay for the entire
share. Or Joan would get less than she would have if the property was sold on the market.
xii. Page v. Page –
1. F – P and D entered into an oral partnership agreement w/ each contributing $43k for purchase
of land, machinery, and linen to start business. Major creditor of business was a corporation
owned by P. P claimed business was losing $ and wanted to dissolve; D claims P was acting in
bad faith by using his superior financial position and now that business was doing better.
2. I – Whether PN was at will or for a term, and can partners dissolve, what were PN terms?
3. H – This was an at-will PN, but can’t be dissolve if in Bad Faith; case was remanded to
determine if done in Bad Faith.
o. Dissolution by Judicial Decree & Wrongful Dissolution:
i. UPA § 31(2) – Causes of Dissolution: In contravention w/ Agreement
ii. UPA § 32 – Dissolution by Decree of Court
iii. UPA § 38 – Rights of Partners to Application of Partnership Property
iv. Drashner v. Sorenson –
1. F – After an irresponsible partner wrongfully dissolved the PN, he demanded a share of the
PN’s good will.
2. H – When a partner causes the PN’s dissolution wrongfully by making it impracticable to
remain in the PN, the other partners may continue PN and the wrongfully dissolving partner is
not entitled to share in PN’s good will, § 38(2).
v. Wrongful Dissolution – (Illustrated by Drashner)
1. A partner that wrongfully dissolves PN can be subject to:
a. Damages;
b. A valuation of his interest that does not reflect the real value of the interest b/c
goodwill is not taken into account; and
c. A continuation of the business w/o him

21
2. Consequences- There is risk to dissolving a partnership at will since, if you are wrong about
whether PN is a term or at-will and you proceed with dissolution, you can suffer these
consequences.
3. Options for innocent partners:
a. Wind up and seek damages against wrongful dissolver
b. Continue PN and bring in another partner
c. Continue PN and seek damages against wrongful dissolver

22
XV. ALTERNATIVE FORMS OF BUSINESS ORGANIZATIONS
p. Taxation:
i. Taxation is a major issue in choosing a business form
ii. 2 Basic Patterns of Taxation under IRC:
1. Firm Taxation or Double Taxation:
a. Firm is taxed on its income
b. If firm has income or expenses, gains or losses, those go into firm’s taxable income,
not the taxable income of the owners
c. If firm makes distributions to its owners from after-tax income, the owners pay taxes
on those distributions
2. Flow-Through Taxation:
a. Firms is not subject to taxation
b. All of firm’s income and expenses, gains and losses, are taxable directly to the firm’s
owners
c. Distributions are not taxed, so there is no double-tax effect
d. If firm has losses, owners can use them to offset other income
iii. Selecting Taxation - IRS has adopted a “check the box” method whereby any domestic
unincorporated business that constitutes an eligible entity can elect either flow-through or firm
(corporate) taxation;
1. *Note - If there is only one owner, the entity’s income, etc. will be attributed to that owner
iv. Eligible Entity – is any business entity other than (1) a corporation, or (2) a business entity that is
specifically made taxable as a corporation under IRC
1. Generally publicly traded limited partnerships are taxed as corporations
q. Limited Partnerships:
i. ULPA § 101 – Definitions
ii. ULPA § 201 – Certificate of Limited Partnership
iii. ULPA § 303 – Liability to Third Parties
iv. ULPA § 403 – General Powers & Liabilities
v. Basics:
1. Generally- is a statutory creature and must comply with ULPA; LP may only be created by
filing a certificate w/ SOS; There also must be a written agreement between the partners; LP’s
serve an economic function by financing assets used in someone else’s business
a. Issue – should LP be taxed as a PN or Corp
2. Two types of partners –
a. General Partner – each liable for all debts of PN
i. Corporations can be general partners; whether officers of Corp as general
partners may be liable depends on their role and actions in PN and whether
they fail to maintain their corporate identity in conducting PN affairs
b. Limited Partner – one or more partners who are NOT liable for the debts of the PN
beyond the amount that they have contributed to the PN
3. Compensation – they have no role in the conduct of the business and their profits are
stipulated under their agreement w/ general partners; have lots of options in how profits and
losses can be allocated
a. GP – may have insignificant interest in LP, but has exclusive right to manage and
control business interest
4. Liability – liability is only up to the value of his investment, but can’t participate actively in
the management of PN
a. *Key – is determining how much say LP can have in the business before they lose
their limited liability
5. LP Classification – characterized as securities under state and federal securities regs and must
be registered under SEA
6. Fiduciary Relationship – generally there is a duty of LP and GP to have fiduciary duties and
fairness, and in most states can’t contract around that
a. DE – court said LP agreement can eliminate, expand, or constrict fiduciary duties
vi. Gateway Potato Sales v. GB Investment:
1. F – When a limited PN defaults, its unpaid supplier sues a limited partner, contending it
actually controlled the PN.

23
 2. H – Court applies the “substantially the same” test and finds that if they can show at trial that
the limited partner controlled the PN, the limited partner can be personally liable for PN debts;
court found it was enough that E told G that LP was controlling the business.
3. TEST – Is LP’s control of the business is substantially the same as the exercise of the powers
of a GP, if so then liability applies even if not dealing with 3rd parties. (Actually - The LP’s
participation in the control of the business is not substantially the same as GP, he is liable only
to persons who transaction business with the LP with actual knowledge of his position and
control)
4. *NOTE – In NY it is NOT enough for creditor to be told by someone that LP is in control of
business; Creditor has to be in direct contact with LP
vii. Gotham Partners – no longer good law in Del.
1. F – LP sued GP, directors, parent C, for breach of fiduciary duty and partnership agrmt, and
consummating series of T that increased their control of LP
2. I – whether there are same kinds of fiduciary duties that are found in a C
3. H – SC Del – T subject to GP’s contractual obligation of entire fairness to LPs. Joint & several
liability for parent & directors (with LP) due to aid & abetting of breach of fiduciary duty.
4. R – LP may provide for contractually created fiduciary duties that are substantially the same
found in C law. Here LP agreement provided this. Under Del. State parties to a LP do have the
power to draft around normal rules. Any claim of fiduciary duties must be analyzed in light of
the LP agreement.
r. Limited Liability Companies:
i. ULLCA § 101 - Definitions
ii. ULLCA § 103 – Effect of Operating Agreement: Non-waivable Provisions
iii. ULLCA § 201 – LLC as Legal Entity
iv. ULLCA § 202 - Organization
v. ULLCA § 203 – Articles of Organization
vi. ULLCA § 301 – Agency of Members
vii. ULLCA § 302 – LLC Liable for Member’s Actionable Conduct
viii. ULLCA § 303 – Liability of Members
ix. ULLCA § 404 – Management of LLC
x. ULLCA § 405 – Sharing of & Right to Distributions
xi. ULLCA § 408 – Member’s Right to Information
xii. ULLCA § 409 – General Standards of Member’s Conduct
xiii. Basics –
1. LLCs – are noncorporate entities that are created under special statutes that combine elements
of corporation and PN law;
a. No limit on # of SH – but usually establish by family business w/ few investors,
accounts, doctors, lawyers, etc.; Not practical for corp with many SH or owners
b. Benefits - can adopt PN style management and control but maintain corp liability, and
have contract-based flexibility that corps don’t have
c. Like Corp law –
i. Owners of LLCs have limited liability
ii. LLC is an entity, so it can hold property and sue and be sued
d. Like PN law –
i. LLC has freedom to structure internal governance by agreement
ii. Can be taxed as PN or Corp (check box)
2. 2 Types of LLCs –
a. Member-Managed LLC – managed by their members (default)
b. Manager-Managed LLC – managed by managers who may or may not be members
c. *Can have non-resident alien shareholders
3. Formation –
a. Formed by filing articles of organization w/ SOS
b. All statues allow LLCs to be formed by a single person
c. Articles include: name of LLC, address of principal place of business or office in
state, name and address of registered agent
d. Some states require:
i. Purpose of LLC
ii. If LLC is manager-managed, names of initial managers; If member-
managed, names of initial members
24
 iii. Duration of LLC or latest date on which it is to dissolve
4. Operating Agreements – an agreement among members concerning the LLCs affairs; typically
provides for governance of LLC, its capitalization, admission and w/drawl of members, and
distributions
5. Management – almost all LLC statutes provide as a default rule, that an LLC is to be managed
by its members (so members cannot bind LLC with third party agreements)
6. Voting by Members – voting is per capita (one vote per member) unless otherwise agreed
7. Agency Powers –
a. Member-managed LLC – each member has power to bind LLC for any act that is for
apparently carrying on the business of the LLC in the usual way or ordinary course
b. Manager-managed LLC – typically only managers have apparent authority to bind
firm; members have no apparent authority to bind
c. DE statute – § 18-402 of DE LLC Act provides “unless otherwise provided in a LLC
agreement, each member and manager has authority to bind the LLC”; But DE also
has a rule that you are bound by GF and fair dealing, so not clear if can actually
contract out of (but is harder to prove BF then breach of fiduciary duty)
8. Inspection of Books and Records – members are entitled to access books and records
9. Fiduciary Duties – fiduciary duties of managers and members are largely unspecified in
statutes; probably like corporate statutes
10. Derivative Actions – members of LLC can bring derivative actions on LLC behalf based on a
breach of fiduciary duty
11. Distributions – in the absence of an agreement to contrary, distributions to members are to be
made pro rata according to members’ financial contributions
12. Members’ Interests – member can have both:
a. Financial rights –
i. Right to receive distributions
ii. Member can transfer rights by transferring interest in LLC
b. Governance rights –
i. Right to participate in management, to vote on certain issues, and to be
supplied with information
ii. Generally member can only transfer rights with unanimous consent of
members, unless agreement says otherwise
iii. *Not clear whether if you assign financial rights, you still retain
governance rights
13. Liability – every members’ liability is limited to their investment; members and managers are
not liable for LLC’s debts, obligations and other liabilities; but members may become liable if
conditions for piercing veil are satisfied (use corporate piercing standards)
14. Dissociation – is termination of a member’s interest in an LLC other than by member’s
voluntary transfer of her interest; statutes differ on requirements for this (pay out $, don’t need
notice, by judicial decree)
xiv. Zolus v. Wolf
1. F – P owns 25% of membership in LLC, claim individual and on behalf of LLC that those in
control arranged to lease LLC’s principle asset (building) for below mkt value, that lease
unlawfully assigned, company fiduciaries benefitted personally from the sale
2. I – is a derivative suite allowed on behalf of LLCs, statute does not address.
3. H – directors analogized to be a trustee of a trust, SH are a trustee. There is an equitable right
to bring a derivate suit on behalf of LLC where GP is fiduciary and LP is beneficiaries.
xv. Salm v. Feldstein –
1. F – P and D were members of LLC, w/ D as managing member. D purchased P’s membership
interest in LLC and later sold it for 4X more to a 3rd party. P brought action for breach of
fiduciary duty and fraud, claiming that D misrepresented the value of the company and failed
to disclose that T had made a firm offer to purchase business for $16million.
2. H – As managing member of LLC and as co-member with P, D owed P a fiduciary duty to
make full disclosure of all material facts.
xvi. Phelpstien
1. F – D, managing member bought out LLC for 3.7m then sells for 16m, Summary judmt
granted by lower ct.

25
 2. Ct finds that there is a fiduciary duty for LLCs, most jurisdictions have adopted corporate
model for LLC.
xvii. Matter of 1545 ocean ave
1. F - 2 member LLC, member managed. Ocean Suffolk, crown royal. Reached agreement to
solicit bids to perform demolition and construction work to complete project. Managers
disagreed on construction work and hiring of manager owned construction business to
complete the work, There were no management meetings held.
2. I - Two managers have a dispute, one, King, wants LLC dissolved. But court allows LLC to
continue, as the dispute did not hamper the ability of the LLC to continue.
3. H – Court says the LLC can be dissolved when it is no longer reasonably possibly to carry out
the business in accordance with the organization agreement.
a. Management has become dysfunctional (each could make independent decisions)
b. Voting deadlock
4. Test to dissolve LLC – whether it is reasonably practicable to carry on the business of the
LLC (not whether it is impossible)
a. Court looks at operating agreement, then looks to see if it is reasonably possible to
carry on the business, essentially a contract based analysis.
xviii. S Corporations – enables owners of corporation to elect a special tax status under which corp and its
SH receive flow-through taxation that is comparable to PN tax; taxable income of S corp is computed
as if corp were an individual;
1. To Qualify as S Corp:
a. Corp may not have > 100 shareholders
b. Corp may not have > 1 class of stock
c. All shareholders must be individuals or qualified estates or trusts
d. No shareholder may be a nonresident alien
e. Has a max of 80% of another corporations stock that it can hold
f. Must have at least one general partner with unlimited liability (may get around this by
having general partner be a corporation
s. Limited Liability Partnerships:
i. LLPs - allows a general partnership to adopt some form of limited liability
1. Core difference – the liability of general partners of a LLP is less extensive than the liability of
a general partner
2. Ancillary difference – LLPs must be registered with the designated state office
3. *Note – NY and CA only permit professional firms to be LLPs
4. Neither ownership or control determines how profits are distributed, that is K.
ii. Liability under LLP:
1. Limited liability:
a. Extends to all creditors, debts and obligations of PN;
b. Partners are not liable for wrongful acts or negligence of other partners or employees,
2. Liability:
a. Liable for negligence that YOU have engaged in
b. Can be liable for acts that people you supervise have engaged in
c. Most jurisdictions you are still liable for contractual obligations of LLP
d. Partnership is still vicariously liable for partners acts
iii. New York LLP Statute –
1. Broadest LLP statute in country
2. LLP status only available to professionals practicing as a general partnership
3. Not liable for contractual obligations of LLP
4. BCL §303(b) (p.760-761) – variety of safe harbors that allow LP to engage in aspects of
business w/o being classified as a GP.
iv. LLLP – Limited Liability Limited Partnership, which the liability of the general partners in a limited
partnership is limited
v. Ederer v. Verstien. (2007)
a. Law firm collapses, (LLP later took on new partners, alleged not party to the earlier
agreements) Withdrawal agreement - 1 partner would stay on for term of one case, be
compensated, then would have access to his cases and books/records following his
withdrawal. Two initial partners failed to draft a written partnership agreement amongst
themselves. P demands an accounting, alleging breach of k

26
 b. I - §15 deals with joint and several liability for partners charged – says that partners are
jointly and severably liable of the debts and obligations of the partnership. (torts and
breaches of trust)

a. Court reiterates – partnership is based upon the law of principal and agent, each
partner is personally liable for the acts of other partners in the ordinary course of
business. (acting in this capacity each partner has authority to bind the P)

b. §26(b) (UPA15)– partner no longer liable for the acts of his fellow partners, no
requirement for indemnification or contribution from other partners who did not
cause the liability. Does this apply?

c. H - P is entitled to an accounting. §26(b) does not shield partners from liability to each other,
only to third parties. Not to any debts among the partners
xvi. Megadyne Information Systems v. Rosner, Owens & Nunziato, LLP
17. P has a claim, but the statute of limitations has expired, served one year after SOL has run. P
claims that D has breached duty, paid for worthless services
18. I – if it had been shown if the other partners had discussed this re: the handling of the matter,
then issue of fact, meaning the other partners could be sued.
1. H - This is sufficient to create a triable issue of fact – whether the firms partners were
personally involved in the firm’s breach of fiduciary duties
XIX. CORPORATE FORM
t. Introduction and Characteristics of Corporation:
i. BCL § 201 – Corporate Purposes
ii. BCL § 401 – Formation: Incorporators
iii. BCL § 402 – Formation: Contents of Certificate of Incorporation (Required Elements)
iv. BCL § 403 – Formation: Effect of Certificate of Incorporation
v. BCL § 404 – Formation: Organization Meeting
vi. BCL § 601 – Shareholders: Bylaws
vii. BCL § 615 (c) – Shareholders: Written consent w/o a Meeting
viii. BCL § 1317 – FN: Liabilities of Directors and Officers
ix. BCL § 1318 – FN: Liability for failure to disclose required information
x. BCL § 1319 – FN: Applicability of other provisions
xi. BCL § 1320 – FN: Exemption from certain provisions
xii. Publicly held Enterprises – corporate form traditionally preferred by publicly held business
enterprises
1. Limited Liability –
a. SH have limited liability and are not personally liable for C obligations
b. Mangers are normally not personally liable for C obligations, as long as act on C’s
behalf and w/in their authority, they are treated as agents
2. Free Transferability of Ownership Interests – ownership / equity interests are represented by
shares of stock and are freely transferable; rapid liquidity
a. PN – can’t transfer w/o approval by all partners
b. Close Corp – usually have shareholder agreement that prohibits transfer of shares w/o
consent of other SH
3. Continuity of Existence – legal existence of C is perpetual, unless shorter term stated in COI
4. Centralized Management – normally managed by or under direction of a board of directors;
SH have no right to participate in management; set up facilitates specialization of roles b/c
investors and managers don’t mix
a. Hierarchical structure of authority. Management is in charge, shareholders have very
little say. Board members have at best observation.

5. Entity Status – C is a “legal person” or “legal entity”; C can exercise power and have rights in
its own name (sue, be sued, hold property) Also must pay taxes.
xiii. Privately held Enterprises – if enterprise is privately held, may prefer to be a close corporation,
general PN, LLP, limited partnership, or LLC
u. Selecting State of Incorporation & Organizing Corporation: If choosing to incorporate:
i. Selecting a State of Incorporation – firm can incorporate wherever it chooses and C’s internal
affairs are governed by law of its state of incorporation, even if C has no business contacts w/ that
state
27
 1. Close corporation – usually incorporate locally in state where it has its principal place of
business, often has restriction on the transfer of shares.
2. Public corporation – usually incorporate in DE b/c the law of the state of incorporation
normally governs internal corporate affairs
3. Doing Business Tax – tax for states you do business in
4. Franchise Tax / Incorporation Tax – tax for state where you are incorporated, even if C
doesn’t do business in that state
5. Note Elements of both taxes may overlap, may benefit corporations incorporated and operating
in the same state (reducing taxes)
ii. Organizing a Corporation –
1. Select a Corporate Name
t. Name has to be reserved with the secretary of state, can use own name, unless it
might confuse people. Cannot use if it is not personal name. Corporation can file in
one name, then can file as a DBA.
2. Draft Purposes Clauses of Corporation – usually any lawful purpose is ok
a. Corporate Power – devices used to effectuate corporate purposes; not put in bylaws
b. Corporate Purposes – reasons for which corporation are organized; put in certificate
c. Draft bylaws – internal rules for the corporation (not public); these guide management
and board of directors for what they need to do; Directors can amend bylaws w/o
shareholder approval (NY)
3. Subscription Agreement – contract with participants thru a promoter to buy shares of C once it
is incorporated; this raises $ for C
4. File w/ SOS - Once SOS accepts COI you are incorporated
a. NY – Certificate of Incorporation
b. Other States – Articles of Incorporation or Charter
5. Hold an organization meeting to elect directors, adopt corp. seal, set salaries, issue shares.
6. Managers are different than the owners, but bylaws provide for maximum indemnification
out of corporate assets. Confers as many powers as the laws allow on the record. Shareholders
as owners have a very limited power.
iii. Corporate Finance –
1. Ownership of C described in 3 different ways:
a. 1 – power to exercise control over management
b. 2 – right to receive income from operations of C
c. 3 – right to share in the assets at some rate upon dissolution of C
2. Common Stock – ownership or equity interests in C
a. Greatest Risk - if C goes bankrupt SH is last to receive $ if any left
b. Greatest Gain - have potential for greatest gain
c. Benefits - have voting rights; Elect the directors
d. *In NY, BCL § 501, all C’s have to have one class of common stock
3. Bonds – generic term for all long term debt securities, which are typically obtained from
public investors
a. Least Risk – in case of bankruptcy you have first claim in liquidation
b. Normal Gain – Right to receive fixed interest payments, but no more; right to receive
a return on principal, but no more
c. Few Benefits – NOT an owner; you are a creditor, so you don’t get a right to vote
4. 2 Types of Securities:
a. Debt – a fixed obligation to repay principal amount of the security, as well as interest
i. Trade debt – amounts C owes for goods and services at any point in time;
payment usually not due for 30, 60, 90 days; Accounts Payable
ii. Bank debt – bank loans; Loans Payable
iii. Notes – may be long term or short term, but often issued pursuant to
indentures as unsecured long term obligations; tend to be for less time
them debentures
b. Equity – rights of the common stock holder are to the residual income and assets after
everything is paid to the bond holder
5. NY - §501 All corporations in NY must have a class of common stock.
a. Can be dived into classes that have varying voting rights.
28
 b. One class of common stock must have a right to vote.

c. Participation takes the form of dividends that the corporation has been earned, but can
only be paid after obligations have been paid off. Remainder belongs entirely to
common stock class.

d. If declaring dividends tend not to declare all that could, retains some in order to invest
in corporate activities.

e. Shareholders hope that values of shares go up, then will make money on sale.
iv. Authorized / Issued Stock –
1. COI designates the classes of stock and number of shares of each class that C is authorized to
issue; If want to issue more shares, have to amend the COI
a. Seniority of shareholders arises out of provisions in the COI. Typically will be in a
dollar amount.

2. Common Stock – have right to vote, receive dividends, and if C dissolved and profitable, you
have right to receive a pro rata share of assets (Greatest Risk)
3. Preferred Stock – usually cumulative, stock that carries a preference as to dividends, on
liquidation, or both, over common stock; normally don’t have right to vote (unless on changes
that effect preferred shareholder rights or if haven’t declared dividends in > 2 years); COI must
either
a. Designate terms of each class, or
b. Authorize the board to issue portions of authorized class in series from time to time
and to designate the terms of each series as it is issued
4. Convertible Stock – contract between preferred SH and C, gave preferred SH right to convert
into common stock; might want to do this if the amount of your dividend for preferred stock
(which is set) is less then the amount of dividends for common stock
5. Issuance of Stock – sale of stock by C; only stock that has been authorized in COI can be
issued
a. Authorized but Unissued - Stock that is authorized but unissued
b. Issued Stock or Outstanding stock – authorized and issued stock
c. Treasury Stock or Authorized & Issued but not outstanding stock – stock that C
repurchases that has previously been issued
6. Board decides whether to authorize stock and what price to issue it
a. Use to have preemptive rights – at common law each existing SH had right to
subscribe to her proportionate part of a new issue of stock of the class she held; no
longer do this
b. Quasi-preemptive right – right to prohibit a non-pro-rata stock issuance for an
improper purpose, such as for purpose of reallocating or perpetuating control; board
can’t issue stock to directors at an unfairly low price b/c breach of fiduciary duty
v. Bonds –
1. Bond holders generally receive semi-annual interest payments. Holders are third party
beneficiaries – cannot bring suit (left to trustee, to oversee the corp, and interests of the
bondholder), have no voting rights (usually), traditionally secured by a mortgage

a. Debentures – used interchangeably.

b. If a bond is issued, an indenture will also be issued

2. Complex contract that fixes the term of the security (bond), All issues determined by contract.
3. If bonds are sold to the public, they take the form of a trust agreement with the corp issuing the
bond and the public. Distinction between bonds and indenture.

4. Trust agreement between corp and bondholders, as well as corp and an indentured trustee
(usually a bank – essentially administers the bond issued, pays the interest)

a. If corp misses an interest payment, the whole thing is due, and then is in default on
the loan and may be thrown into bankruptcy.

29
 5. Covenants or negative covenants – company agrees not to issue dividends or repurchase shares
unless meeting certain conditions (usually of solvency)

6. Collectable at the option of the company at a fixed price.

a. Sometimes bonds are convertible into common stock.

vi. Initial Directors –
1. Problem - When C established its Board of Directors is elected by SH, but C has no SH until
stock is issued, and function of issuing stock is job of Board
2. NY – C’s incorporators have powers of SH until stock is issued, and powers of directors until
directors are elected
3. DE – initial directors can be named in C’s COI and the functions of the incorporators pass to
directors when COI is filed
vii. Subscription for Shares –
1. Normally – stock issued by C in a simultaneous exchange for cash or property
2. Subscription Agreement – would be SH enter into agreement to purchase C’s stock when it is
issued to him at some future date
3. Pre-Incorporation Subscription Agreements – those made prior to C being incorporated;
a. DE law – these are irrevocable for a specified period of time unless all subscribers
consent to a revocation, or the agreement otherwise provides
viii. VantagePoint Venture Partners v. Examen –
1. F – VP is seeking a class vote of preferred stock SH so that it can have an opportunity to block
E’s merger. If C is CA (or NY) then preferred SH could vote as a class and block merger; if C
is DE then preferred are lumped with general SH and wouldn’t be able to block.
a. CA Law – creates a quasi-CA corporation even if incorporated elsewhere b/c C has
significant contacts with CA and > half of voting shares are held by CA residents
b. Internal Affairs Doctrine – chose of law principle that recognizes that only one state
should have authority to regulate internal affairs of C and that is the state of
incorporation
2. I – Whether this is a DE or CA corporation?
3. H – DE corporation; Problem w/ CA law is as amount of CA SH change, so would what state
law governs your C; You need uniformity for intra-C matters and matters regarding right to
vote fall within internal affairs doctrine; If you incorporate in a state, should expect that state’s
laws to apply.

ix. Friese v. Superior Court –

1. F – Case involving insider trading in which C changed their accounting method so that D could
begin selling C’s stock at an artificially inflated price; their product was flawed and wasn’t
selling so C had to file for bankruptcy. Statute at issue is a CA insider trading law; C is a DE
corporation.
2. I – Whether CA statute applies to a non-CA corporation.
3. H – CA law applies and internal affairs doctrine doesn’t; a statute regulating securities (sale or
transfer) is not part of the internal affairs of the C; a foreign corporation must conform to the
securities regs of CA.
4. P – State securities regulations do NOT have to give way to the internal affairs doctrine;
these matters are outside the scope of internal affairs doctrine.
v. Pre-Incorporation Transactions by Promoters:
i. Promoter – person who transforms an idea into a business by bringing together the needed persons
and assets, and superintending the various steps required to bring the new business into existence
1. Liability of the Promoter – G/R is that when a promoter makes a contract for the benefit of a
contemplated C, the promoter is personally liable on the contract and remains liable even after
C is formed
a. Exception – if the party who contracted w/ promoter knew that C was not in existence
at time of contracting, and nevertheless agreed to look solely to C for performance;
can be expressed or implied (novation)
2. Liability of the Corporation –a C that is formed after promoter has entered into a contract on
its behalf is not bound by the contract, without more; reason is that C wasn’t in existence when
contract made and couldn’t have authorized it; Once C is formed, it may be bound
30
 a. P and C can be jointly and severally liable for contract
ii. Goodman v. Darden
1. F – Darden knew that C did not exist entered into contract with promoter (Goodman)
2. I – Is the promoter, a party to pre incorporation agreement, have to take part in an arbitration,
was he liable for putting his signature on agreement.
3. GR – promoter is bound unless the contracting party knows that C is not in existence but
nevertheless agreed to look only to C for payment.
4. H –evidence did not show that DDS intended to contract only with the corporation.
iii. Company Stores Development v. Pottery Warehouse, Inc.
1. F – Lease to Potter Warehouse for 5 years, not yet incorporated, president did not sign in
individual capacity, but as president of a future C to be formed.
2. H – No liability to promoter as Plaintiff knew that C was not yet formed, but intended to look
solely for the corporation for satisfaction of the agreement. K identified C as a C to be formed.
xxi. Generally courts have held that if a promoter is liable under a contract, the mere formation of the
corporation is still left on the hook. If the corp is not formed, promoter still not off the hook, the only
way is through a novation, through which all parties agree that the corporation assumes the liability.
(or the agreement is like Pottery Warehouse, stating that the agreement is with a corporation to be
formed)
iv.
w. Consequences of Defective Incorporation:
i. De Jure Corporation – a C organized in compliance with the requirements of the state of
incorporation; C’s status can’t be attacked by either private parties or the state
1. Must have substantial compliance with statutory requirements, which is determined on a case-
by-case basis
2. Some states say must have exact compliance with all Mandatory requirements but failure to
comply with Directory requirements is okay; the distinction in the requirements is subject to
statutory interpretation
ii. De Facto Corporation – a C that is said to exist when there is insufficient compliance to constitute
de jure C if challenged by the state, but steps taken toward forming C are sufficient to treat it as a C
with respect to 3rd Parties (almost unimportant today due to ease of incorporation)
1. 3 Requirements –
a. A statute in existence by which incorporation was legally possible
b. A colorable attempt to comply with the statute, AND
c. Some actual use or exercise of corporate privileges
2. State can invalidate C, but creditors or other persons dealing with C can’t
iii. Estoppel – if neither a de jure or de factor C has been formed, courts have still held that a party who
has dealt with an enterprise on the basis that it is a C is estopped from denying the enterprises
corporate status; Examples of cases:
1. Denial of corporate status by would-be shareholders – true estoppel case where T relied on
initial claim of corporate status
2. Technical contexts –cases where question of corporate status is raised in a technical or
procedural context; ex. a would-be C sues P and P claims not a C

3. Liability of would-be shareholders – cases where T has dealt with an enterprise on the basis
that it is a C, seeks to impose personal liability on would-be SH, who in turn raise estoppel as a
defense. Issue becomes whether as a matter of equity, the claimant having dealt with
enterprise as if it were a c, should be prevented from treating it as anything else
iv. Who May be Held Liable – if C is none of the three, courts are divided on whether would-be SH
may be held personally liable for debts incurred in C’s name
1. Old cases - did impose liability on theory that if not a C, than it was a PN
2. New cases - imposes personal liability only against those owners who actively participated in
the management of the business, and are held liable as if they were partners
3. MBC Act § 2.04 – only persons acting as or on behalf of C who know there was no
incorporation are jointly and severally liable for C’s liabilities
x. Classical Ultra Vires Doctrine: has almost become unimportant.
i. Ultra Vires Doctrine – C is regarded as a fictitious person, endowed with life and capacity only
insofar as provided in its charter, which sets forth what activities C can permissibly engage;
Transactions outside that sphere were characterized by courts as Ultra Vires (beyond C’s power) and
unenforceable (against C and by C)
31
 1. Today – doctrine exists only to protect SH from C’s activities that are beyond the scope of C’s
charter; also affords state some limited control over C by knowing what C’s purpose clause has
designed it to do
2. BCL § 203 – Ultra Vires Statute; only applies to actions between C and SH, cannot otherwise
be applied to actions of a party in contract.
a. If ultra vires for other purpose today it is probably grounds for malpractice.
ii. Powers & Purposes – UV doctrine applicable in two different situations:
1. Where C acted beyond its purposes; did it engage in a type of business activity not permitted
under its certificate
2. Where C exercised a power not specified in its certificate
iii. Recurring Problems – under UV doctrine several recurring problems
1. Power of C to guarantee a third party’s debts; today C’s can make guarantees
2. Power of a C to be a general partners; today C’s can become partners
iv. Limitations on Ultra Vires Doctrine –many thought doctrine was unsound
1. Courts view C’s powers as both implied as well as explicit, and incidental
2. UV doctrine didn’t apply to corporate tort, criminal liability, or reverse completed transactions;
only really effected executory contracts
3. Didn’t always work as a defense when partial performance or one party had already performed
4. Unanimous SH approval barred UV defense unless creditors would be injured
5. COI has decreased in its significance as a limit on C’s purpose and power; many COI’s today
state that C can engage in any lawful business and setting forth a laundry list of powers
6. Several states passed statutes that almost abolish doctrine, including DE
v. Goodman v. Ladd Estate –
1. F – A C’s ultra vires guaranty agreement was held enforceable.
2. R – SH who participated in an ultra vires act can’t later attack it as ultra vires.
y. Objective & Conduct of Corporation:
i. BCL § 202(a)(12) – Corporate Purposes: General Powers
ii. BCL § 717 – Directors: Duty of Directors
iii. ALI §§ 2.01, 6.02 (*NOT law – these are persuasive authority only!)
iv. Generally:
1. Corporate Principle - is that a Corporation is to be primarily run for the pecuniary benefit of
its shareholders; Profit motivated.

a. Test for Issuance of Dividends – Bad Faith; company has right to decide whether or
not to declare dividends
2. Common Law – C couldn’t expend C $ for philanthropic purposes unless it benefited C
3. Today – C contributions have very important role and impact on society
4. NY Law – specifically says C contributions don’t have to benefit the C
v. Dodge v. Ford –
1. F – Ford decided not to declare dividends, but to put $ back into company; Dodge brothers
were SH and brought suit to compel the issuance of dividends.
2. H – Court ordered Ford to declare dividends b/c purpose of a business is primarily for the
profit of SH and decision by Ford appears to be arbitrary.
3. R – Director’s responsibility is to increase earnings and benefit SH and powers of
directors are employed to that end. The object of a corporation is to make money and
cannot be run for the incidental benefit of the shareholders
vi. A.P. Smith Co. v. Barlow –
1. F – Stockholders challenged a donation by C to Princeton University.
2. I – Can a C make a charitable donation that is not expressly authorized by its COI?
3. H – Yes. President thought contribution was a sound investment that would create good will
for the company and a favorable environment for the C. Court found donation was for a
modest amount and no evidence it was inappropriate, for President’s pet charity, or his own
benefit; donation was w/in C’s implied and incidental powers..
4. R – Reasonable charitable donations can be made by a corporation even if not expressly
authorized by its articles of incorporation.
22. NY B.C.L. §202(a)(12) is applicable.
vii. Charitable Contributions by Corporations – Virtually all states have adopted statutes relating to
corporate contributions (like DE law) that carry an implied limit of reasonableness
32
 1. G/R – donations should be reasonable in amount in the light of the corporation’s financial
condition, bear some reasonable relation to the corporation’s interest, and not be so “remote
and fanciful” as to excite the opposition of shareholders whose property is being used. Direct
corporate benefit is no longer necessary, but corporate interest remains as a motive.
2. C’s contributions cannot exceed 1% of capital and surplus, institution receiving the money
cannot own more than 10% of company stock
3. C’s don’t have to disclose their charitable contributions unless they start another C for a
specific charitable purpose
viii. Constituency Statutes – provides that a board must consider the impact of C’s decision on other
constituencies, not just SH
1. G/R – Directors owe a fiduciary duty to C and its SH, so SH’s interests are its primary
responsibility when making a C decision
2. These statutes enable directors to consider other factors when making a decision, w/o being
subject to a lawsuit by SH
3. NY Constituency Statute 17(7)(c) – provides that a board must consider the impact of C
decision on other constituencies, not just SH; typically this is applied when C is changing
control
4. DE – does NOT have a constituency statute; SH interest is paramount
xxiii. Philanthropy –
24. What happens when it has no benefit or relation to shareholders, but management is interested
in?
a. Basically a business decision and the shareholders have no rights.

b. Fear that the corporations would be held hostage to special interest groups rather than
endure bad publicity

c. Donations should be reviewed with ALI test should be the reasonableness of the
institution. This is a hard test to apply as it assumes that Cs are comparable.

33
XXV. CORPORATE STRUCTURE
z. Basic Structure of a Corporation:
i. Corporation - a type of legal institution that defines legal relationships between people; it is a
method of organizing business; it is a legally recognized fiction.
1. Public (open) – a corporation that is listed on a stock exchange or “over the counter market”
(computerized trading system; means they are publicly held by individual owners, SH, and
publicly traded)
2. Close corporation (private) – not listed on an exchange and privately held; similar to a
partnership
3. Members of a Corporation:
a. Board Members – oversee the corporation
b. Shareholders – are the owners of the corporation
c. Bondholders – are people that lend money to the corporation
d. Managers – run the corporation
e. Hedge Funds – large bodies of privately held capital
aa. Shareholders in Publicly Held Corporations:
i. Traditional Model – inverted pyramid w/ SH at top who owned C, elected board of directors, and
whose approval required for major or fundamental C actions
ii. Modern Corporation – separates ownership and control, but creates conflicts
1. SH owning tiny amount of stock is rationally apathetic b/c not cost effective to spend a lot of
time on C’s affairs; if all SH own few shares, all are apathetic
2. When SH all over country, voting must be done by proxy rather than in person; hard to
organize and coordinate efforts; dissatisfied SH will usually exit or sell instead of fight
management; when C has great # of SH that are highly dispersed, management will normally
control
iii. Institutional Shareholders – frequently there are conflicts of interest between these SH and
management and SH tend to vote in accordance with management.
a. Private Pension Plans
b. Public Pension Plans
c. Banks
d. Investment Companies
e. Insurance Companies
f. Foundations
2. Can meaningfully assess corporate governance structures, playing an important role in kicking
out poorly performing management where individual shareholders could not
3. They can consult with management and share concerns, can vote and will count (due to
holding so many shares)
iv. Forms that Institutional SH in Corporate Governance may take:
1. Simplest –Take an active posture in voting on management or SH proposals
2. More Aggressive – Not only vote on SH proposals, but make SH proposals
3. Consultation – consult management on matters; usually more done this way
bb. Allocation of Power between Management and Shareholders:
i. BCL § 601 – Shareholders: Bylaws
ii. BCL § 602(b) – Shareholders: Meetings
iii. BCL § 615(b) – Shareholders: Quorum & Vote
iv. BCL §616(b) – Shareholders: Supermajority Provision
v. BCL § 701 – Directors: Board
1. Power granted to directors except as otherwise indicated in the Certificate of Incorporation.
vi. BCL § 702 – Directors: Number of Directors
vii. BCL § 703 – Directors: Election and Terms
viii. BCL § 704 – Directors: Classification
ix. BCL § 705 – Directors: Newly created Directors & Vacancies
x. BCL § 706 – Directors: Removal
xi. BCL § 712 – Directors: Committees
xii. BCL § 801 – Amendments: Right to Amend COI
xiii. BCL § 803 – Amendments: Authorization to Amend
xiv. BCL § 804 – Amendment: Class Voting
xv. BCL § 903 – Merger: Authorization by Shareholders

34
 xvi. BCL § 909 – Merger: Disposition of Assets
xvii. Power of Shareholders –
1. SH have passive role –
a. Own C, but don’t manage it
b. SH can NOT control directors in exercise of their official judgment
c. BUT SH can influence C – can’t bind C by their own direct actions, they must act
thru their control of the board
i. Elect and Remove Directors
ii. COI and By-laws – SH can approve / disapprove of changes to these
documents and thereby influence the allocation of power among
themselves, directors, and officers
iii. Fundamental Changes – SH have right to approve / disapprove of
fundamental changes not in the ordinary course of business
iv. Void or Voidable Transactions – some transactions by officers or
Directors are void/voidable unless ratified by SH vote
1. Ex. Transactions between C and Director or Officer are voidable on
grounds of self-dealing unless SH ratify transaction by voting to
approve it
2. Duties –
a. Elect Directors
b. Amend by-laws (Recognized by BCL §601)
i. By-laws – internal operating rules of C
ii. This is a contract between those that own C
iii. *Even if power to amend is given to Directors, SH still maintain right to
amend them
c. Can take action at SH meeting if there is consent
3. SH Meeting –
a. Main purpose of meeting is to elect Directors
b. Date of annual meeting is set forth in C by-laws
c. Proxy can allow written consent for action. BCL §615 requires unanimity for any
action taken absent a meeting, but can be drafted around.
d. Failure to hold shareholder meeting doesn’t void actions taken by directors, who
remain in office after the expiration of their terms per BCL §602(b)
4. SH Primary Protections against Poor Performance –
a. Sell their Stock (“Wall Street Walk”)
b. Vote to replace the Board
c. Derivative Suit - Difficult to sue C for breach of fiduciary duty b/c of procedural
hurdles
i. Must make a demand request
ii. If board says no, there denial is subject to judicial review under BJR; the
demand will be dismissed if futile
26. Key to corporate governance – “an effective board”, assumed for good corporate performance.
xviii. Power of Officers – Most C statutes provide that the officers are essentially the agents of the board
of directors
xix. Power of Directors –
1. Two Types of Directors:
a. Inside Directors – employees of corporations (full-time employees)
b. Outside Directors – not full time employees, but not necessarily independent
2. Directors are fiduciaries of C –
a. They are not like employees, more like public officials; they are elected for a period
of time and have a fiduciary duty to C / SH as a whole
b. Bound to use ordinary care and diligence in the management of C
c. Today they are at best answerable for gross negligence
d. Usually don’t get involved in day-to-day affairs; that is the job of senior management
xxvii. Senior management will call the real shots for a corporation
(Directors often cannot oversee top management)
3. D have control over officers and agents -
a. Hire / Fire officers
35
 i. BCL §705(a) –Vacancies occurring in the directors term of office may be
filled for the unexpired term by the remaining directors. This does not
preclude SH from filling vacancies, depends on C bylaws.
b. Set Compensation
c. Must meet regularly
4. Business Judgment Rule –
a. Most Lenient Standard for judging conduct of Directors & Officers
b. If Director exercises due care, is informed about the decision, has no interest, and acts
in good faith – court won’t second guess that decision
c. If certain conditions are satisfied, a director or officer will not be liable for the
consequences of a decision unless the decision was irrational
d. Rule does NOT apply in cases dealing with the allocation of power between Board
and SH
xx. Organic Fundamental Change –
1. Special events that if C is going to do it, SH must participate in procedure to approve these
types of changes
2. Standard Procedure:
a. Board adopts proposed change
b. Proposal submitted to SH at annual or special meeting (All jurisdictions, but most
states allow C to amend COI in any way “so long as its COI as amended would
contain only such provisions as would be lawful and proper to insert in an original
COI if filed at the time of the filing of the amendment”)
c. Proposal will have to be approved by a requisite # of shares, and subsequently the acts
of such action will be filed with SOS w/ supporting documents stating what has
occurred
d. *NY – today need 51% of vote to approve an organic change (Except under BCL
§905 i.e. C owns 90% of sub & seeks to merge into parent, SH vote not required)
3. Ex. Merger, Dissolution, Disposition, Sale of Assets; Most states require SH approval for
amending COI
xxi. Removal of Directors –
1. Removed by SH –
a. Cause - SH can remove a director for cause, even w/o a statute
b. Without Cause – SH can NOT remove a director w/o cause unless it is permitted in a
statute, COI, or by-laws
c. NY BCL § 706(b) – Only SH can remove director w/o cause if COI or by-laws
provide for it (Cause – dishonest, not attending meetings, etc)
2. Removal by Board –
a. Unless there is a statute, board cannot remove a director with OR without cause
b. Some states say board can do it for cause if in COI
3. Removal by Court –
a. Cases split whether Court can remove directors for cause
b. Some statutes permit Court to remove a director for specified reasons, ex. fraudulent
or dishonest acts
xxii. Takeovers –
1. Old Way – hard to oust incumbent management of a publicly held C; had to wage a proxy fight
to get rid of them
2. Hostile Takeovers – mid 1960s this became a way to oust incumbent management and effect
acquisitions
a. A makes a public offer – bid or tender offer – to purchase stock of B up to a stated
amount and subject to certain conditions
b. Tender offer is made to B’s shareholders, not to B; the price of the tender offer is
usually well above the market price for B’s stock
c. Because offer made to B’s SH, rather than to B, the approval of B’s board is not
required; despite this, management tends to fight it
d. Unocal Test – (applied for hostile takeovers) if board wants to take defensive actions
against takeover, it must satisfy enhanced business judgment rule (or intermediate
standard of review).
i. Intermediate Standard of Review – greater than BJR standard and less then
the high standard under duty of loyalty
36
 ii. 1st – Board must show that it had reasonable grounds for believing that the
tender offer presented a danger to corporate policy and effectiveness
1. Burden met by showing Good faith and reasonableness
iii. 2nd – Board must then satisfy a proportionality test: the defensive action
must be reasonable in relation to the threat posed
1. Board’s defensive action must not be either preclusive or coercive
(draconian in nature), and
2. Must be within a range of reasonable responses to the threat posed
by the tender offer
xxiii. Weighted Voting in Publicly Held Corporations –
1. Only common SH have voting rights; each share of stock carries 1 vote
2. Voting rights can be conferred on Preferred Stock or Bonds
3. Dual Common Stock – when there is more than one class of common stock, one of which has
a greater weight than the other; usually stock with greater weight given to directors or
managers
a. DE Law – one share = one vote, unless COI provides otherwise
b. G/R – difference between classes of stock will normally be upheld b/c when you buy
stock you know what you are getting into and if it is allowed, then it is legal
xxiv. Charlestown Boot & Shoe v. Dunsmore –
1. F – SH of CBS brought suit against its directors claiming the directors should have done what
the SH wanted them to do.
2. I – May SH of C force directors to take certain actions on behalf of C?
3. H – No; C structure provides that business of C is managed by directors subject only to the by-
laws and votes of C; SH are not authorized to compel directors to act a certain way; Court sets
boundary between SH and D.
4. R – SH have no power over the management of C and cannot order the directors to take
particular actions in managing the business of C. Old rule, now directors are only held
liable for gross negligence. SH can vote out the board, but cannot give instructions.
xxv. People ex rel Manice v. Powell
1. I - Is the board board the agent of the shareholders?
2. H – Board members are more than just agents, relationship is like that of a trustee and
beneficiary. Powers of the board are original and un-delegated.
3. R - Shareholders as a group own the property, but directors in the course of their duty
direct it and act as if they own it for the term of their position. Directors are not at the
beck and call of the voters of individual things.

xxvi. Schnell v. Chris-Craft Industries –

1. F – Directors advanced the date of the annual SH meeting in an attempt to stifle a proxy fight.
2. H – By-laws of C set the date for the annual meeting; Management can’t advance the date to
gain an advantage; this was an inequitable purpose. Inequitable action does not become
permissible simply because it is legally possible
3. R – Even if authorized by statute, Directors of a C can NOT advance the date of SH
meeting when this action would effectively eliminate the chances of a successful proxy
fight. Can’t use corporate machinery to thwart corporate democracy.
4. *Note – this action was legal under DE law; court said an inequitable action or decision
doesn’t become permissible just because it is legally permissible
xxvii. Blasius Industries v. Atlas Corp –
1. F – The incumbent board of Atlas sought to prevent Blasius from gaining control of C by
increasing the number of board members.
2. H – Board may not interfere with SH vote; BJR doesn’t apply b/c dealing with allocation of
power between Board and SH.
3. TEST – (“Compelling Justification” standard) Once a showing has been made that a board
acted for the primary purpose of thwarting a SH vote, Board bears the heavy burden of
demonstrating a compelling justification for its action. (quite onerous and rarely applied)
4. R – Actions by Directors made for the primary purpose of interfering with a SH vote are
improper, even if made in good faith. Improper actions not defended by BJR.
5. *Note – usually by-laws will provide that directors can expand number of directors in between
the annual meeting.

37
 6. Staggered board – makes it more difficult to oust incumbent management & board. May not
be a sufficient defensive tactic to prevent hostile removal of board members. Will also need
provisions preventing the by laws to be amended to increase the number of directors as this
undermines the tactic of staggering.
28. Fishman details 13-d filing – tender offers regulated under SEC act – whenever a person or
corporation acquires 5% of the stock of a public company, within 10 days of that acquisition, it
must send to the issuer (the corporation) and the SEC certain information.
a. Facts about the identity and background of purchaser

b. # Of shares held

c. Where the funds were sourced from

d. If the purchaser intends to take control, must disclose plans.

29. In most cases, the question of whether the board’s actions are preclusive is hotly contested.
e. The line between board actions which influence in legitimate dates vs. actions that
preclude shareholder action are not always clear.

f. The way a court looks at board’s actions may influence the standard of review that
will be applied to it

g. Later cases says that the invocation of the Blasius standard usually indicates the board
action will be invalidated, failure to invoke Blasius indicates that the board action will
survive review.

7. If management opposes tender offer, how far can they go? Delaware follows Unocal case, with
an intermediate standard of review. Board must show that they had reasonable grounds for
believing the tender offer was harmful to the company.

a. Must show it was reasonable

b. Defensive action by management must be proportional to threat. Must be within a

range of reasonable responses.

8. There has been some erosion of this rule. Here Atlas was too ‘ham fisted’ in attempting to
thwart the Blasius plan.
cc. Legal Structure of Management:
i. BCL § 707 – Directors: Quorum
ii. BCL § 708 – Directors: Actions by Board
iii. BCL § 709 – Directors: Greater Requirement for Vote
iv. BCL § 712 – Directors: Committees
v. BCL § 715 – Directors: Officers
vi. BCL § 716 – Directors: Removal of Officers
vii. ALI § 3A.01 to § 3A.05
viii. Modern Corporate Practice – traditionally the board managed the business of C; today the board
still has central legal role in C, but today the management function is ordinarily role of executives and
CEO; Board’s role is limited due to constraints:
1. Constraints of Time
2. Constraints of Information
3. Constraints of Composition
ix. Monitoring Board – recently there has been a shift to having the board act as a monitor, rather than
manager; this model recognizes that senior management runs C and recognizes that Board sets
compensation, replaces senior executives, monitors conduct of business, and reviews major corporate
plans and policies; for this model to be effective the Directors of the board need to be more
independent form senior execs
1. CEO – Chief Executive Officer / President
2. COO – Chief Operating Officer / Vice President
x. Committees

38
 30. Bylaws - may authorize directors to appoint committees. C should generally operate through a
committee structure.
ee. Executive committee – important when there is a large board composed of non
management personnel
ff. Finance committee – typically principle financial officers of the corp
gg. Compensation committee –determines the compensation of sr. management.
hh. NY a committee can have one or more members. 712(a) – a committee has no
authority to submit to the shareholders a motion that must come from the full board.
Cannot amend the bylaws.
ii. Delaware – no such restrictions, BUT cannot authorize a dividend or issue stock,
UNLESS bylaws authorize
36. Delegation of Authority
kk. Boards may override any committee decision, but can delegate authority to
committees
ll. Boards can delegate authority to outside companies to manage certain facet of
business, frequently used by smaller companies. These contracts must be approved
annually by the board of directors, and can be ended at any time.
xi. Authority of an officer to act on a corporations behalf – depends on the title
1. Apparent authority – third party assumes customarily vested authority by person holding
position (title)

2. Modern rule – Lee v. Jenkins – President only has the authority to bind his company by
acts arising in the usual and normal terms of business.

a. Courts all over the line on this issue, depends on facts case and attitude of the court.

3. Declaration of dividends - can only be done by the board of directors.

4. Elements to consider if things are extraordinary (thereby outside of apparent authority)

a. Economic magnitude of the decision in relation to earnings

b. Amount of risk involved

c. Time spent on the result of the actions

d. What is the cost of reversing the action

5. Courts look at the significance of the decision on the structure of the business

6. An officer can have certain authority if the board gives specific permission. It is good to ask
if the person has the authority to speak/act on behalf of the corporation.
xii. Sarbanes-Oxley Act (“SOX”) - establishes the framework for a new requirement of accountability
by public companies in the areas of financial reporting, disclosure, auditing, conflicts of interest, and
governance; Statute primarily about disclosure
 Public Accounting Oversight Board – regulates the accounting profession and overseas the audit
of public companies to protect public interest and board is subject to SEC oversight; establishes
rules for audits and can adopt standards suggested by professional accounting orgs;
 Key aspect is Auditor Independence – an important part of an audit is to test the reliability of
company information systems; problem with Enron is that auditors were setting up the system, and
then the same auditors were saying that the system was great – these companies were not
independent, but rather were consulting too;
• SOX – prohibits auditors from providing most auditing services
• Something – must change every 5 years, to avoid the look that the head auditor’s alliance
is with the company and not independent; These auditors can’t accept any type of
compensation or perform consulting; they do have a salary, but can’t have other kinds of
compensation
• Audit committee – establishes procedures for receipt and retention of complaints, provide
a channel where confidential and anonymous submissions by employees can be rec’d and

39
 employee won’t be fired for being a whistleblower. Committee has ability to retain
independent counsel.
o One person on audit committee has to have financial experience, such as
accounting
o Officers of corporation can’t try and influence audit committee
• X – must say they investigated internal financial information and are confident that figures
are accurate; and then the head of each department has to also sign off on this – this way
all heads are on the line
• SEC sets out what they want to know about different corporate controls
 Result of SOX – was a slew of restatements of accounting and financial results; tons of companies
after SOX’s had to re-state their financial results b/c they were cooking the books
• SOX requires that if the restatement of financial results was b/c of misconduct by
mismanagement, the CEO and COO or CFO have to reimburse company for difference
o CEO & CFO required to certify the accuracy of financial statements
• Companies – have to have code of ethics, policy on conflicts of interest, can’t give loans
to directors of corporation
• Act requires lawyers to report evidence of material violations of security laws, to
appropriate enforcement agencies
• Material Changes have to be disclosed very rapidly under SOX, off balance transaction
sheets must be mentioned, and there are whistleblower protections under SOX as well
• *Smaller firms with less than $75 million in corporate assets – have more time to comply
with SOX
• SOX – only applies to publicly traded companies
• Audit Committee is sub-committee of board of directors and are suppose to be
independent members of the board; Job of audit committee is to ensure that there are
financial controls in place and that the numbers that go up to the board are accurate – they
can hire independent accountants and lawyers to ensure that these controls are working
• Criticism of SOX is that it is overkill – now every company that is listed has to comply
with SOX, as opposed to # of companies actually involved. Problems still exist.
dd. Formalities Required for Action by the Board:
i. BCL § 708 – Directors: Actions by Board
ii. BCL § 709 – Directors: Greater Requirement for Vote
iii. BCL § 710 – Directors: Place & Time of Meetings
iv. BCL § 711 – Directors: Notice of Meetings - during a regular meeting of the board, specific items
to be discussed do not need to be disclosed.
v. Governing Rules:
1. Meetings –
a. A single D normally has no power; instead Ds can only act as a body
b. Usually must act at a meeting where quorum present;
c. Can conduct meetings via conference call
d. Can act w/o a meeting if unanimous written consent
2. Notice –
a. Regular Meeting - formal notice not required b/c already on notice
b. Special Meeting – every D must be given notice of date, time, and place; don’t have
to state purpose unless COI provides
c. Waiver – notice can be waived in writing before or after meeting
3. Quorum –
a. Quorum of a board consists of a majority of the Full Board (the authorized number of
directors); not just majority of # in office b/c there could be vacancies on the board
b. COI or Bylaws can allow for a lesser amount, but usually no less 1/3
4. Voting –
a. The affirmative vote of a majority of those present (not simply a majority of those
voting) is required for action
b. COI or bylaws can require a greater-than-majority vote for board action
vi. Consequences of Non-Compliance – for publicly held C failure to comply will render board
action ineffective

40
 1. Unanimous explicit, but informal, approval – for close corps, most courts would hold that
explicit but informal approval by all the directors is effective where a person who has
contracted with a corporate officer has been led to regard his transaction with the corporations
as valid an all SH either are directors or have acquiesced in the transaction or in past practice
of informal board action
2. Explicit approval by a majority coupled with acquiescence by remaining directors – when
majority of directors explicitly approve transaction and the rest know of the transaction but
take no action, most courts will uphold the transaction
3. Majority approval or acquiescence – if majority of directors approve a transaction, but the
remaining lack knowledge of the transaction, some courts have refused to uphold the
transaction; others will hold C liable if the SH acquiesced
vii. Committees – Boards of Publicly held C do most of their work thru committees
1. Committees can be advisory, or board can delegate decision making power to a Committee on
a specific matter or range of matters
2. Some statutes list matters that can NOT be delegated to a committee
3. C can delegate authority to outside corporations, such as corporations w/ specific expertise;
problem is lack of accountability
4. Rules governing board procedures (notice, quorum, voting) are applicable to committees
5. Compensation Committee – determines salaries and hire a consultant to tell them who should
be paid what
6. § 712 – NY Committees
a. Committee can have one member
b. Have no authority to submit matters to SH for signature
c. Board can override any cmt decision
7. DE Committees – no restrictions, in DE committees can run whole corporation
ee. Authority of Corporate Officers:
i. BCL § 715 – Directors: Officers
ii. President –
1. Apparent Authority – P has apparent authority to bind company to contracts in the usual and
regular course of business, but NOT contracts of an extraordinary nature
a. Extraordinary Matters - decisions that would make a significant change in the
structure of the business enterprise, or in the structure of control over the enterprise
b. P can NOT bind C –
i. In declaration of dividends b/c must be decided by Board
ii. On matters that need Board and SH approval
2. Actual Authority – P’s actual authority is in COI, by-laws, or Board resolutions, or may derive
from a pattern of past acquiescence by the Board, or from Board’s ratification of a specific
transaction
iii. CEO – Chief Executive Officer; usually holds a second title of either Chairman of the Board,
President, or Both; COO or Chief Operating Officer is usually also President
iv. Chairman of the Board – frequently held by CEO
v. Vice President – has little or no apparent authority
vi. Secretary –has apparent authority to certify records of C, including resolutions of the board; no
apparent authority for matters other than certification
vii. Treasurer – has no apparent authority
viii. Closely Held Corporations – if P has been exercising absolute authority over C’s affairs, and board
has never questioned, altered, or rejected his decisions, P will have extremely wide actual and
apparent authority
ix. Ratification –
1. Even if an officer lacks both actual and apparent authority, C may be bound by officer’s act in
entering into a contract or other transaction on its behalf, if the board later ratifies the officer’s
act
2. Ratification may occur where C, knowing all of the facts, accepts and uses the proceeds of an
unauthorized contract executed on its behalf
ff. Formalities Required for Shareholders Action – Cumulative Voting:
i. BCL § 602 – Shareholders: Meetings – requires annual meetings, 602(c) re: who can call special
meetings and procedure to do so.

41
 ii. BCL § 603 – Shareholders: Special meeting for elections
iii. BCL § 604 – Shareholders: Fixing Record Date
iv. BCL § 605 – Shareholders: Notice of Meetings
v. BCL § 606 – Shareholders: Waivers of Notice
vi. BCL § 607 – Shareholders: List of Shareholders at Meetings
vii. BCL § 608 – Shareholders: Quorum
viii. BCL § 609 – Shareholders: Proxies
ix. BCL § 612 – Shareholders: Qualification of voters
x. BCL § 613 – Shareholders: Limitations on right to vote
xi. BCL § 614 – Shareholders: Vote
xii. BCL § 615 – Shareholders: Written consent w/o a meeting
xiii. BCL § 616 – Shareholders: Greater requirement for vote
xiv. BCL § 617 – Shareholders: Voting by Class
xv. BCL § 618 – Shareholders: Cumulative Voting
xvi. BCL § 704 – Directors: Classification
xvii. BCL § 706(c) – Directors: Removal
xviii. Formalities Required for Shareholder Action:
1. Meeting and Notice –
a. Annual Meeting – must provide notice of place, time, and date
i. Federal Proxy Rules and some State Laws – require a description of
purpose in the annual meeting
ii. Date is set by the by-laws
b. Special Meeting – must provide notice of place, time, and date; must describe the
purpose for which the meeting is called
i. ONLY business that can be transacted at a special meeting is that which is
set froth in the notice of the meeting
c. Who Notices are Sent to:
i. Notice of a Meeting is given to those persons who are SH of record on a
designated record date prior to the meeting
1. Record Owners – persons who are listed as shareholders on C’s
records - BCL § 604
a. This is NOT necessarily the same as those persons who are
owners of the stock on the date of the meeting
b. Only persons who were record holders on the record date
have right to Notice of meeting and are entitled to vote at
the meeting
2. Beneficial Owners – persons who actually own C’s shares
3. Notice of meeting usually given a month before the meeting
ii. Record Date – normally fixed in the by-laws, or by the board; or if date
not fixed, statutes usually provide that it be the day of or day preceding the
day on which the meeting notice is sent; date is used to determine SH
entitled to vote at the meeting
iii. Waiver – SH can waive notice by showing up at meeting
2. Quorum – a majority of shares entitled to vote is necessary for a quorum, unless COI sets a
higher or lower number - BCL § 608
a. Some laws - quorum can’t be lower than 1/3 of shares entitled to vote
b. Other laws – set no minimum
3. Voting -
a. Ordinary Matters – affirmative vote of a majority of shares represented at a meeting is
required
i. If need affirmative vote of majority present, then an abstention counts as a
negative vote
ii. Requirements can be changed by COI
b. Fundamental Changes – often require approval by a majority or 2/3 of the outstanding
voting shares, rather than a majority of those present or voting at the meeting
c. Election of Directors – need a plurality vote, the candidates who receive the highest
number of votes are elected

42
 d. Written Consent – generally SH are permitted to act by written consent in lieu of a
meeting
xix. Cumulative Voting:
1. Straight Voting – a SH can cast for each candidate for election to the board, a # of votes equal
to her number of shares
a. Ex. S owns 100 shares and 7 directors are up for election; S can cast a total of 700
votes, but no more than 100 per candidate
b. Under this method, a minority SH can never elect a director to the Board over the
opposition of the majority
2. Cumulative Voting – a SH can cast for any candidate a number of votes equal to the number
of shares she holds X the number of directors to be elected
a. Ex. S owns 100 shares and 7 directors are up for election; S can cast 700 votes for one
candidate, or 350 votes for 2, or 300 for 2 and 100 for a third candidate, etc.
b. Under this method, minority or majority can vote in a candidate; it protects the
interests of minority SH
3. Mandatory Cumulative Voting – % of stock that minority SH must hold to elect at least 1
director under cumulative voting varies inversely w/ the # of directors to be elected; problem is
that SH or Boards can undermine it
a. In NY and DE – cumulative voting is permissible, but it can be ignored. Some states
are mandatory. (then the issue is can steps be taken to dilute the effects)
xxxix. Board can be classified – stagger the election of directors. (board size can
also be decreased to achieve same result)
xl. Replace board meetings with informal discussions.
xli. Use of committees by which the minority issues are not on the table.
42. States that are mandatory have gone both ways whether these
actions can be taken to mitigate the effect of cumulative voting.
xliii. Classification of stock in NY – Can be in the bylaws § 707.
1. Can have up to four classes, and each need to be as close to each
other as possible.
xliv. Removal of directors elected by cumulative voting requires the same # of
votes used to elect them.
xlv. Most corporations do not like to use it since it gives up some control
4. Mathematics of Cumulative Voting –
a. Minimum # of shares needed to elect a particular number of Directors:
i. X = (S x N) + 2
D+1
ii. X = minimum number of shares needed
iii. S = total number of shares that will be voted at meeting
iv. N = number of directors desired to elect
v. D = total number of directors to be elected
b. How many Directors can be elected by a group controlling a particular number of
shares:
i. N = (X) x (D+1)
S
ii. N = number of directors that can be elected
iii. X = number of shares controlled
iv. D = total number of directors to be elected
v. S = total number of shares that will be voted at meeting
gg. Limited Liability:
i. Limited Liability –
1. No-Liability Rule: SH ordinarily have NO liability for corporate obligations
2. SH’s risk is ordinarily limited to her investment – the most a SH stands to lose if C fails, is the
amount that she paid for her shares
3. Corporate managers and SH are ordinarily not liable for C obligations
a. SH – are not liable by statute
b. Managers – are not liable under agency principles; but they are liable for their own
tortious acts or those that they direct to be done

43
 c. Vicarious Liability – a tort by a corporate employee that injures a 3rd party, normally
will not cause a manger to be vicarious liable, even if employee was a subordinate to
the manager
4. Exception – Piercing the Corporate Veil
ii. Piercing-The-Veil Doctrine –
1. This is an equitable concept, courts will pierce corporate veil whenever necessary to prevent
fraud or achieve equity
2. Doctrine is applied to all corporations, but primarily close corporation or a parent corporation
and subsidiary; no case has held SH of public C liable
a. If veil has been pierced, only those that have been personally involved in the
management of the C are usually held liable
b. Courts have generally held that PV doctrine can be applied to LLCs
c. BCL §630 – Unlimited liability survives, 10 largest shareholders of a close
corporations are liable personally for the wages of employees if a corporation
becomes insolvent
tt. Agency law will impose liability on parent corporations – because it is a principal,
not a corporation whose veil has been pierced.
i. Did the party deal with the corporation voluntarily, or was it imposed (tort
situation = involuntary creditor)

ii. As a creditor a due diligence investigation should be done, additional

guarantees can be required.
3. Typically veil will be pierced when:
a. (1st prong) There has been some disregard of corporate formalities, or
b. (2nd prong) If the facts are treated as of the C alone and an equitable result would
follow (It would be unfair/unjust to acknowledge corporate form.)
47. Even if a corporation is pierced, generally only hold liable those who are active in managing
the corporation are held liable.
iii. Alter Ego Theory – basically arguing that the alter ego virtually ignored the corporate form, and
operated the subsidiary corporation as if it were the parent, and that it would be unfair to not pierce
the corporate veil of the sub
1. 1st Prong - P must show that the parent and the subsidiary “operated as a single economic
entity” and
a. A parent C approving major decisions of sub doesn’t mean two Cs are a single
economic entity
2. 2nd Prong - that an element of injustice or unfairness is present
a. It is not necessary that their be a showing of fraud
3. Factors for court to consider:
a. Whether C was adequately capitalized
b. Whether C was solvent
c. Whether C records were kept and other formalities observed
d. Whether a dominant SH siphoned corporate funds
e. Whether, in general C simply functioned as a facade for dominant SH
f. *Note – courts generally refuse to find alter ego liability where a cash management
system is used
iv. Equitable Subordination –
1. Under this doctrine, when a C is in bankruptcy, debt claims that a controlling SH has against
the C may be subordinated to the claims of other persons, including the claims of preferred
shareholders, on various equitable grounds
a. Also referred to as the “Deep Rock” doctrine (Taylor v. Standard Gas & Electric)
2. This is NOT piercing; you are knocking down some of the creditors to a less preferred status;
this is much less drastic than piercing veil which undermines the essential premise of limited
liability - that a SH risk is limited to the amount of his investment
3. This usually happens where there is not enough capitalization, usually must more common
thatn piercing.

44
 xlviii. Corporate subs or divisions - A parent corporation may operate a business either as a sub or a
division within the corporation itself.
49. Parent is usually liable for the operations of the division, there is no separation
50. If operated as sub, parent is normally not obligated for sub’s liabilities.
51. Limitation of parent liability is not the dominant factor in choosing between sub/division,
usually it is an operational choice. (management decision)
52. Parent may make use of the assets of a sub, to get better interest rates, to ensure that the sub is
not wasting money.
aaa.Fletcher v. Atex –
v. F – F was allegedly injure by an Atex keyboard and sought to pierce corporate veil to hold Atex’s
parent company, Kodak, liable.
vi. H – P failed to satisfy either prong of the alter ego theory test.
vii. R – Corporate veil can be pierced if the Corporation and the SH operated as a single economic
entity and there was an overall element of unfairness present.
bbb. Walkovszky v. Carlton –
viii. F – W hit by a taxicab and sought to hold SH personally liable for his injuries. The cab companies
were intentionally undercapitalized by Carlton by providing the bare minimum liability insurance.
ix. H – Case dismissed for failure to state a claim; P failed to show that the corporation was a dummy for
its SH who were actually carrying on the business in their personal capacity for personal rather than C
ends.
x. R – For personal liability to attach to SH, it must be shown that the SH were actually carrying
on the business in their individual capacity for personal rather than corporate ends.
xi. Note – When case was dismissed for failure to state a claim, W re-filed case and alleged that Carlton
conducted the business in their individual capacities.
lv. **Court views that holding minimum insurance as not fraudulent. Corporate form will not be
discarded just because corporate assets are insufficient to make P whole.
ddd. Minton v. Cavaney – Outer limits of piercing doctrine
xii. F – M’s daughter drowned in a pool owned by S. M sought to hold S’s director liable for her death.
xiii. H – Corporate veil should be pierced b/c there was no attempt to adequately capitalize C; but S can’t
be held liable since not a party to original action so need to re-litigate.
xiv. Factors for when SH should be held personally liable:
1. When they treat the assets of the C as their own
2. When they hold themselves out as personally liable, OR
3. When they provide inadequate capitalization and actively participate in the conduct of
corporate affairs
57. Here the basis for piercing is –
a. Inadequate capitalization – trivial to the business to be done and the risks involved.

b. Ignorance of corporate formalities –

i. Amount of directors (was only one)

ii. Corporate records kept in personal office

iii. Shares never dispersed.

xv. R – Corporate veil can be pierced where SH undercapitalize the corporation and actively
participate in the conduct of corporate affairs..
1. BUT undercapitalization alone is still not sufficient to pierce.
2. Corporate formalities must be followed
fff. Arnold v. Browne – “Evidence of inadequate capitalization is, at best, merely a factor to be considered by the
trial court in deciding whether or not to pierce the corporate veil”
ggg. Slottow Fidelity Federal Bank v. American Casualty Co – piercing in a parent/ sub organization
holds the parents liable, but not the shareholders of the parent company.
hhh. Radaszewski v. Telecom Corp. – Subsidiary was adequately capitalized due to insurance policy, even
if undercapitalized.
iii. Sea-Land Services v. Pepper Source –
xvi. F – After losing on remand, D appealed the court’s finding that injustice would result if the corporate
form was respected.

45
 xvii. H – S satisfied the 2nd prong of the test by showing that in addition to the inability to collect on a
judgment, D was unjustly enriched and manipulated the corporations to avoid creditors. D had used
C funds to pay personal expenses and expenses of his other Cs; he left C with insufficient funds to
pay its creditors causing bankruptcy; he violated lots of tax laws.
xviii. R – Unjust Enrichment and Manipulating corporate funds are sufficient “wrongs” to pierce the
corporate veil of (here ofalter ego corporations)
lxii. When will the corporate veil be pierced?
1. Failure to maintain adequate corporate records or comply with corporate formalities

2. Commingling of funds or assets

3. Undercapitalization

4. One corporation treating the assets of another corporation as its own.

lxiii. The nexus of fraud was that he knew he would be unwilling/unable to pay. D was found
personally liable, and all corporations were pierced (reverse pierced) D was the dominant force
behind all the corporations. D and all his subsidiaries were held liable.
64. Fraud is still an independent basis for liability, but must prove reliance on fraud. Some
cases hold that reliance does not need to be shown.
hh. US v. Bestfoods and Direct Liability – case stresses formalities of corporate formality.
i. I – Whether the Parent CPC was liable as the owner/operator of a plant owner by a subsidiary for a
toxic cleanup under CERCLA.
ii. Cases in which parent is sought to be held liable w/o piercing the subsidiary’s veil, on the ground that
the parent directed the subsidiary’s operations, or some relevant portion of those operations, and is
therefore directly liable as a primary wrongdoer for wrongs that were committed in the course of
those operations
iii. Key Question (TEST) – Whether in degree and detail, actions directed to the facility by an agent of
the parent alone are eccentric under accepted norms of parental oversight of a subsidiary facility.
iv. Under CERCLA a parent may be liable under traditional piercing situations, but also for directly
participating where agents participate or directly operate a hazardous waste site. The fact that there
are employees of parent present is not sufficient to pierce, parent must conduct activities specifically
related to pollution for liability
mmm. Kinney Shoe v. Polan – Court set forth a 3rd prong to corporate veil test, apply to contract
creditors only:
v. When it would be reasonable for a creditor entering a contract with C, to conduct an investigation of
the credit of C prior to entering into the contract, the creditor will be assumed to have knowledge that
a reasonable credit investigation would disclose.
1. If the investigation would disclose that C is grossly undercapitalized, the creditor will be
deemed to have assumed the risk of gross under capitalization and will not be permitted to
pierce corporate veil.
vi. Basically – Incorporates who actively participate in the operation of the business are not entitled to
personal immunity, when they fail to provide the quid pro quo for such immunity, specifically, a
reasonably adequate capital fund to which creditors may resort
lxvi. Poland was pierced because if they wanted the protection of formalities, proper corporate formalities
should have been followed. Nothing invested in corporation therefore no protection to owner.
1. Fishman thinks case allowed Kenny to be reckless and do no due diligence. But court says that
it would be inequitable to allow Poland to walk away from sublease. Not a normal result.
LXVII. SHAREHOLDER’S RIGHTS
ii. Shareholder Information Rights under State Law:
i. Rights to Inspect Books and Records:
1. BCL § 624 – Shareholders: Inspect Books
2. BCL § 1315 – FN: Record of Shareholders
3. Common Law – SH acting in good faith for purpose of advancing the interest of C and
protecting his own interest as a SH has a right to examine the corporate books and records at
reasonable times
a. Burden of Proof – SH bears burden of alleging and proving good faith and proper
purpose
4. Statutory Limitations on Inspection –
a. Only certain kinds of SH; ex. SH of at least 5% of stock

46
 b. Only certain kinds of books or records
5. Today – Statutes supplement the common law, so that a suit for inspection that does not fall
within the relevant statute can still be brought under common law
ppp.Derivative suit – where a shareholder or director brings suit on behalf of a
corporation, where the recovery goes to the corp.
qqq. Direct suit – where shareholder sues on behalf, and recovery goes to plaintiff
(& other shareholders)
rrr. Request cannot be too sweeping, cannot cover preliminary profit/loss
statements, monthly profit analysis, detailed balance sheets, or other confidential
information.
6. Proper Purpose – courts have held that proper purposes for SH to exercise right of inspection
are: To determine the financial condition of the corporation; and To ascertain the value of the
petitioner’s shares
a. Purpose reasonably related to such person’s interest as a shareholder.
sss. Once establishing a proper purpose, secondary improper purposes will not defeat
access
b. Access limited to books needed to establish proper purpose, right to inspect does not
allow a mere fishing expedition.
7. Stockholder Lists –
a. Easy to get other stockholder lists and basic information
b. Harder to get internal data or contracts; Have to show the court a “specific and
plausible reasons why the information is needed”
8. Reporting Laws:
a. C with 500 or > shareholders = SEA requires C to report certain information to all SH
without specific SH requests
b. C with < 500 shareholders = Model Business C Act and some state statutes, require C
to furnish its SH annual financial statements, including a balance sheet and income
statement
i. *DE – doesn’t require C to furnish financial statements to SH even on
written request
9. Director’s Intent:
a. NY –director’s intent is irrelevant; director needs unqualified access to information to
perform his duties
b. DE – director’s intent is relevant on theory that his right to information presupposes
that he is not hostile to C
ii. Saito v. McKesson HBOC –
1. F – S as a SH sought to inspect books and records of HBOC to determine whether C was
engaged in any wrongdoing. S was seeking inspection of both parent and subsidiaries books,
including for the time before he was a SH.
2. I – Is a SH right to inspect C records and books limited by the date of the records or their
sources?
3. H – No; right of inspection is limited to review of those records necessary and essential to
accomplish stated purpose.
a. P in a derivative suit must be a SH at the time the transaction complained of
occurs
b. Books and records can pre-date P’s stock ownership, as long as they are reasonably
related to P’s interest as SH
c. If activities that occurred before stock purchase date are reasonably related to SH’s
interest as SH, then the SH should be given access to records necessary to an
understanding of those activities
d. 3rd party documents – must be reasonably related to SH’s interest and necessary to
establish SH’s proper purpose justifying inspection
e. A SH of a parent corporation ordinarily does not have a right of inspection of the
books and records of a subsidiary of which he is not a stockholder
4. R – SH has broad right to inspect corporate books and records; SH has right to make a
written demand to inspect corporate books and records for a purpose reasonably related
to such person’s interest as SH.
iii. Seinfeld v. Verizon –

47
 1. F – S brought suit under § 220 DE law to inspect the books and records of V relating to the
compensation of their 3 highest corporate officers. S claimed their compensation was
excessive and wasteful (corporate waste) but lower court said he didn’t meet his burden of
establishing a credible basis for waste.
2. I – Should a SH seeking inspection under §220 be entitled to relief w/o being required to show
some evidence to suggest a credible basis for wrongdoing?
3. H – No; A SH seeking inspection must present a preponderance of evidence to suggest a
credible basis from which a court can infer that mismanagement, waste or wrongdoing have
occurred; S failed to meet the credible basis standard to justify additional investigation.
a. “Credible Basis” standard – provides SH with access to records; and protects C
from requests based on suspicion or curiosity
jj. Shareholder Information Rights under Federal Law & Stock Exchange Rules:
i. Stock Markets:
1. Financial Market – is a way of bringing buyers and sellers together; debt and equity securities
are bought and sold
a. Equity Securities – issued solely by the corporations
b. Debt Securities – issued by both governments and corporations
2. Primary Market – refers to the original sale of securities by governments and corporations
a. C is the seller and transaction raises $ for C
b. C engages in 2 types of transactions:
i. Public Offering – selling securities to general public
1. SEC requires public offerings of debt and equity to be registered
with the SEC, which requires C to disclose a great deal of
information before selling any securities
ii. Private Placement – negotiated sale with a specific buyer
1. These sales do not have to be registered w/ SEC
3. Secondary Market – those in which these securities are bought and sold after the original sale
a. Involves one owner or creditor selling to another
b. This market provides means for transferring ownership of C securities
c. 2 Kinds of Secondary Markets:
i. Over the Counter / Dealer Markets – dealers buy and sell for themselves
at their own risk; most trading takes place OTC
1. Ex. National Association of Securities Dealers (NASD)
ii. Auction Markets – brokers and agents match buyers and sellers; this takes
place at a physical location (like Wall ST.)
1. Ex. New York Stock Exchange (NYSE); American Stock Exchange
(AMEX); and Pacific Stock Exchange
2. Street Name – stock frequently held in the name of a broker or a
bank, rather than the individual shareholder
3. Nominee Name – stock registered in the name of a bank nominee
account
4. *Note - Problem arises when C soliciting proxy votes b/c when
stock registered in street or nominee name, they don’t have a
beneficial interest in the vote, they are merely custodians of the
securities
d. Listing – stocks traded on an organized exchange are “listed” on that exchange; To be
listed firms must meet certain minimum criteria for asset size and # SH
i. NYSE – has most stringent requirements; must have a market value of at
least $100 million and a total of at least 2,000 SH with at least 100 shares
each
ii. SEC & Securities Exchange Act:
1. SEA § 12(a), (b), (g) – Registration Requirements for Securities
2. Securities Exchange Act: Rule 12g-1. Exemption From Section 12(g) - An issuer shall be
exempt from the requirement to register any class of equity securities pursuant to section 12(g)
(1) if on the last day of its most recent fiscal year the issuer had total assets not exceeding $10
million and, with respect to a foreign private issuer, such securities were not quoted in an
automated inter-dealer quotation system.

48
 3. Securities Exchange Act of 1934:
a. Created Securities and Exchange Commission
b. Empowers SEC w/ broad authority over all aspects of securities indus
c. Powers Include: to register, regulate and oversee brokerage firms, transfer agents, and
clearing agencies as well as the nation’s securities self regulatory organizations
d. Act identifies and prohibits certain types of conduct in the markets and provides SEC
w/ disciplinary powers over regulated entities and persons associated w/ them
e. Empowers SEC to require periodic reporting of information by companies w/ publicly
traded securities
f. Act Regulates:
i. Corporate recording
ii. Proxy statements
iii. Tender off solicitations thru Williams Act
iv. Insider trading
v. Margin trading – borrowing $ to buy stock
vi. Market surveillance of the exchanges
vii. Regulates fraud and manipulation
viii. Regulates stock exchanges / OTC
ix. Broker / dealer registration
x. Proxy’s
xi. Enforcement
4. Corporate Reporting – companies w/ > $10 million in assets whose securities are held by
more than 500 owners must file annual and other periodic reports; reports are available to
public thru SEC database EDGAR
5. Proxy Solicitations – Act governs disclose in materials used to solicit SH votes in annual or
special meetings held for election of directors and approval of other corporate action
a. Proxy information must be filed with SEC in advance of any solicitation to ensure
compliance w/ disclosure rules
b. Solicitations must disclose all important facts concerning the issues on which SH are
asked to vote
6. Prospectuses – disclosure reports before a company issues stock; these must be extremely
accurate
iii. Periodic Disclosure under Securities Exchange Act:
1. SEC imposes periodic reporting requirements on C w/ security registered under § 12; also
known as Structured Disclosure
a. Structured Disclosure also required when C makes a public offering
2. SEA § 13 – requires C to file:
a. Form 10-K: must be filed annually; must include
i. Audited financial statements
ii. Management’s discussion of C’s financial condition and results of
operations, and
iii. Disclosure concerning legal proceedings, developments in C’s business,
executive compensation, conflict of interest transactions, and other issues
b. Form 10-Q: must be filed quarterly; must include
i. Quarterly financial data prepared in accordance w/ general accounting
principles
ii. Management report, and
iii. Disclosures concerning legal proceedings, defaults on senior securities,
and other issues
c. Form 8-K: must be filed w/in 4 business days after the occurrence of certain events:
i. Change in control of C;
ii. Acquisition or disposition of significant amount of assets;
iii. Change of accountants;
iv. Termination of a material definitive agreement;
v. Departure of a director or principal officer;
vi. Amendments to COI or bylaws or code of ethics
vii. Waivers of a provision of C’s code of ethics
3. Proxy Rules – periodic reporting also required in connection w/ C’s annual meeting

49
 4. Note – C’s may make voluntary disclosures of material corporate developments whenever they
want; Also, rules of major stock exchanges often require listed Cs to make timely disclosure of
material developments
kk. Proxy Rules:
i. SEA § 14(a): Proxies
ii. SEA Rules 14a-1: Definitions
iii. SEA Rules 14a-2: Proxy Solicitations
iv. SEA Rules 14a-6: Filing Requirements
v. Introduction:
1. Terms:
a. Proxy Holder – a person authorized to vote shares on a SH behalf
b. Proxy, form of proxy, or proxy form – written instrument in which such an
authorization is embodied (like a power of attorney)
i. Revocable – every proxy is revocable; can revoked by sending in another
vote afterwards or by showing up at the meeting
ii. Valid – proxy is only valid for 11 months, unless otherwise stated; SH
cannot sell their vote for S
iii. NY BCL § 609 – every SH entitled to vote, may authorize another person
to vote for him; person would be your agent acting pursuant to your
instructions
c. Proxy Solicitation – process by which SH are asked to give their proxies; solicitation
is defined broadly
d. Proxy Statement – written statement sent to SH as a means of proxy solicitation; SH
use this to decide how to vote
e. Proxy Materials – proxy statement and form of proxy
2. Overview of Proxy Rules:
a. Background – proxy voting is the dominant mode of SH decision making in publicly
held C b/c SH are geographically dispersed and typical shareholding will normally
represent only a fraction of SH’s total wealth; C usually bears cost of proxy process
b. Coverage – Rule 14a-2 provides that Proxy Rules apply to every solicitation of a
proxy with respect to securities registered pursuant to § 12 of SEA; definitions of
Proxy and Solicitation are very broad
i. If you are contacting > 10 people, have to go thru proxy rules; as such
virtually everything comes under these rules
ii. Any action brought must be in federal court
iii. Penalties – fine and prison time
c. Focus / Purpose of Proxy Rules –
i. Disclosure of Information – material information for SH to vote
ii. Election Contests – apply whenever competition for a board position; ea
participant must file a special disclosure statement; this is very different
from a general election
iii. Anti-Fraud – filing w/ SEC doesn’t mean information is not misleading;
SEC only requires disclosure, info could be wrong
d. Transactional Disclosure – Rule 14a-3; Proxy rules require full disclosure in
connection w/ transactions that SH are being asked to approve, such as mergers,
certificate amendments, or election of directors; specific information that must be
disclosed is listed as well as statement that no solicitation shall contain any statement
that is false or misleading with respect to any material fact or omits a material fact
e. Periodic Disclosure – require certain forms of annual disclosure
f. Proxy Contests – Rule 14a-11 regulates proxy contests, in which insurgents try to oust
incumbent directors
g. Access to body of SH – Rules 14a-7 and 14a-8 provide mechanisms through which
SH can communicate w/ each other
h. Mechanics of Proxy Voting – Rule 14a-4 governs form of proxy
3. Annual Report to SH:

50
 a. C must send an Annual Report to its SH either in advance of or concurrently w/ the
proxy statement
b. This Report must be distinguished from Form 10-K annual report
c. Contents of Annual report governed by Rule 14a-3 and includes:
i. C’s financial statements
ii. Selected financial data
iii. Management’s discussion and analysis of C’s financial condition and
results of operations
vi. Private Actions:
1. SEA Rules 14a-9: False or Misleading Statements
2. JJ Case v. Borak – a SH can bring a private action for violation of Proxy Rules, even though
neither SEA or Proxy Rules provide for such an action; court found an implied right of action
under § 14 of SEA
3. Wyandotte v. US - Individual is subject to Civil NOT Criminal liability for violating Proxy
Rules
4. Gerstle v. Gamble-Skogmo – negligence sufficed to establish liability under Rule 14a-9
5. Cort v. Ash – in order to bring a private action must:
a. P must be one of the class for whose especial benefit the statute was enacted; that is,
does statute create a federal right in favor of P
b. Is there any indication of legislative intent, explicit or implicit, either to create such a
remedy or to deny one
c. Is it consistent with the underlying purposes of the legislative scheme to imply such a
remedy for P
d. Is the cause of action one traditionally relegated to state law, so that it would be
inappropriate to infer a cause of action based solely on federal law
6. Mills v. Electric Auto-Lite –
a. F – C’s minority SH brought a derivative action to set aside a merger between C and
C that was its majority SH by charging that the proxy solicitation for the merger was
materially incorrect in that it failed to mention C’s board of directors was controlled
by majority SH C.
b. H – SH do not need to prove that the material defect in the proxy caused the injury.
Court sets out the test for private action
c. TEST – A private action under § 14(a) of SEA has two elements:
i. Materiality of omision, and
ii. A nexus between the proxy and the transaction (that the proxy was
necessary to complete the proposed transaction)
d. *Note – the court essentially merged the causation issue into the finding of
materiality, so that causation is not a separate element for P to prove; once the two
elements are satisfied, the court just needs to determine what remedy to apply.
7. TSC Industries v. Northway, Inc. –
a. I – How is “Materiality” to be defined?
b. TEST – General Standard of Materiality: An omitted fact is material if there is a
substantial likelihood that a reasonable shareholder would consider it important
in deciding how to vote.
c. BOP – there must be a substantial likelihood that the disclosure of the omitted fact
would have been viewed by the reasonable investor as having significantly altered the
“total mix” of information made available
8. Virginia Bankshares v. Sandberg –
a. F – A SH, who w/held her proxy in a merger vote, sought damages from the bank
holding company that acquired her shares, claiming that proxies were solicited by
means of materially false or misleading statements b/c the board of directors did not
believe their own assertion that the tender price was high. Proxy statement
recommended the merger stating it was “fair” and that it gave minority SH an
opportunity to receive a “high” value for their stock. But b/c of % owned, VA law
didn’t require minority SH approval for the merger.
b. H – SH did state an action, but can’t prove damages.
i. Directors’ statements of reasons, opinions, or beliefs are facts that may be
actionable under § 14(a) as misstatements of material fact

51
 ii. Court refuses to extend Mills (don’t have to prove causation) holding to a
situation where minority votes are not necessary to complete the
transaction; P can’t prove damages.
c. R – Statements of reasons, opinions, or beliefs may be actionable under § 14(a) of
SEA.
vii. Shareholder Proposals:
1. SEA Rules 14a-7: Obligations of Registrants (lists, mailings)
2. SEA Rules 14a-8: Shareholder Proposals (includes list of reasons why mgmt can exclude)
3. No-Action Letters – Rule 14a-8 provides that if management believes SH proposal may be
excluded from C’s proxy statement, it must submit to SEC a statement of reasons why
omission is proper
a. If SEC Agrees – it sends management a No Action Letter, stating if the SH proposal
is omitted, SEC won’t take any action
b. If SEC Disagrees – it sends a letter stating why proposal should be included; these are
also referred to as no-action letters, even though they implicitly threaten legal
proceedings if omitted
c. *Note – C can still omit SH proposal but run legal risks w/ SEC
4. Roosevelt v. EI Du Pont de Nemours –
a. F – A SH brought suit against C under § 14a claiming C improperly excluded her
proposal from the annual proxy materials. C had rec’d a no-action letter from SEC
citing the ordinary business exception as basis for excluding the proposal.
b. I – May C omit SH’s proposal from its annual proxy materials if the proposal relates
to the timetable for implementing a C policy?
c. H – Yes; SH proposal may be excluded under “ordinary business” exception if
the proposal relates to the timetable for implementing corporate policy; SH
sought to move the date up a year, and such a decision is within the “ordinary”
business judgment of C.
i. SH does have an implied right of action under § 14a & Rule 14a-8 when C
refuses to include SH’s proposal in proxy materials
ii. Ordinary Business Judgment – implementation of a policy; the timing for
an agreed-upon action
iii. *Note – the adoption of a corporate policy would probably NOT be w/in
ordinary business judgment
5. Shareholder Proposals / Resolutions – usually divided into 2 categories
a. Social-Policy Resolutions
i. Case by case analysis for employee related shareholder proposals as
significant policy proposals
b. Corporate-Governance Resolutions
c. NY – Dressel case – SH can vote on a precatory proposal and it does not interfere
with board authority.
d. 14a-8(i)(5) – management can exclude proposals that are not significantly related to
company purposes, it must be related to operations that involve 5% of assets,
earnings, or gross sales, or otherwise significantly related to the company’s business.
i. SEC has gone back/forth on this.
ii. 13 reasons for mgmt to exclude proposals
1. to preserve state law scheme of centralized decision making in a
board of directors
2.
e. Should shareholders be able to nominate board members w/o a proxy vote?
i. Dodd-Frank legislation makes it easier to nominate board members w/o
proxy vote.
ii. Shareholders can elect to have more liberal rules
iii. Management can exclude;
1. Proposals that directly conflict with management proposals
2. Duplicative shareholder proposals.
3. Recidivist proposals (that showed up in the past, but did not get
much support)
a. Have to get an increasing amount of votes in order to
submit the same proposal again.

52
 72. Illegal proposals that violate any law, including of SEC.
73. Proposals based on personal grievances.
74. Proposals that are moot/beyond corporation ability
lxxv. If proposal passes all these hurdles, management must include for SH
vote, if failing to do this, SH can seek SEC declaration that rules are being
violated, or bring a private action in court.
f. Annual reports to shareholders are usually very expensive, under current laws proxy
cost may be charged to the C for contested and uncontested meeting/proxy fight.
i. Financial burden to the incumbents should not depend on if someone
contests their leadership

ii. Basic rules of reimbursement – C may not reimburse either party

(management or insurgents) unless the dispute concerns question of
policy, for reasonable and proper expenses. Incumbents may be reinforced
whether they win or lose. Insurgents may only be compensated if they
win, must obtain shareholder approval of reimbursement after disclosure.
(nearly impossible if they lose)

iii. (every dispute involves policy and not personnel, or else nobody could get
reimbursed)

iv. Computer Associates case – proposal to reimburse the candidates for a proxy fight, re:
pension plan.

i. F - Under Del (& NY) law both board and the SH have power to amend
bylaws.

a. Ct. holds that powers are not coextensive. Giving the SH these
powers have to be read with a statutory section saying that C will be
managed under the direction of the board. SH don’t have power
unless statute says so, or bylaws give such permission to SH.

b. Ct. has to determine scope of power of amendment, appeal, and

adoption, and whether the bylaw falls within the allowable type.

c. §109(b) Del. code permits bylaws to contain a provision retaining to

the rights of SH, pension plan argues this pertains to the right to electing
directors.

d. 102(b)(1) Delaware code – any provision limiting the power of

directors must be contained in the COI, and not in the bylaw. (initiative
to amend COI, is taken by directors then voted on by SH)

e. Ct. says CA argument is wrong, as it would allow corporation

to gut shareholder ability to amend bylaws.

ii. I –Is proposed bylaw intruding upon director’s power to manage C’s
business.

ii. H – Ct. concludes that this proposal was proper for shareholder vote, as it
relates.

a. 2nd part of the court’s analysis – that proposal violates federal law as
the issue does not arise from a set of facts, under at least one
hypothetical directors could breach fiduciary duties under this proposal

i. Directors could be required to reimburse insurgents who

brought proxy fight not relating to any policy issue (personal
matters)

53
54
LXXVI. CLOSE CORPORATIONS
ll. Introduction:
i. Three Class of Corporations:
1. Publicly Held – large number of SH and publicly traded
2. Private Corporations – small or large # of SH, but not publicly traded
3. Close Corporations – a subset of private corporations; similar to partnerships, except that in
PN can dissolve, generally provides limited liability and tax benefits.
a. Small # of SH; SH may not have limited liability for many claims
b. Restrictions on Transferability of ownership interests / stock - No ready market for
corporate stock
c. Owner-Management Control - Substantial majority SH participation in the
management, direction and operations of C
i. SH participate in management, no separation of ownership/control
1. BCL §715b – COI can provide that SH rather than managers elect
board.
d. May not have indefinite or perpetual duration, particularly if major shareholder wants
to leave, or runs another business.
e. Every corp. should have shareholder agreement that sets how corp will operate and
how shareholders can get out if the chose.
ii. Legislative Strategies re: Close Corporations –
1. Unified Strategies – don’t make any special laws for CC, just modify traditional C laws to fit
CCs
2. NY and Model Act Strategies – follow unified approach to a point, then add 1 or 2 provisions
that are applicable only to CC
a. BCL § 620(c) – authorizes certain kinds of certificate provisions so long as no shares
of C are listed on a NSE or OTC market
3. Statutory Close Corporations –
a. DE – follows unified up to a point, but adds an integrated set of provision explicitly
applicable only to CC; Under DE law § 342 a C can qualify for statutory close corp
status if its certificate provides:
i. All of C’s issued stock of all classes shall be represented by certificates
and be held of record by not > a specified # of ppl, not to exceed 30;
ii. All of issued stock of all classes shall be subject to 1 or > of the
restrictions on transfer permitted by § 202 of DE;
iii. C shall make no offering of any of its stock of any class, which would
constitute a public offering
iv. *If qualify – can Elect this status by adopting heading in COI
b. Significance – very few newly formed C elect to become statutory CC
4. Corporations that do NOT Elect CC status –
a. One view is that even if a CC doesn’t elect CC status, the courts can still continue to
apply and develop corporate law in a way that is responsive to the needs of CC
b. DE – if you do not elect CC status, then you are NOT subject to CC law, you are
subject to regular corporate law
iii. Donahue v. Rodd Electrotype -
1. F – A minority SH of a CC seeks to rescind C’s purchase of controlling SH’s stock; D claims
that C refused to buy her shares at the same price C offered to another SH.
2. H – Controlling SH breached fiduciary duty to D when he refused to offer her the chance to
sell a ratable number of shares to C at an identical price.
3. R (1) – SH in a CC owe each other a fiduciary duty of the utmost good faith and loyalty,
similar to duty that partners in a PN owe each other.
4. R (2) – SH have an equal opportunity to participate when C is purchasing stock, but SH
have NO right to demand C to buy back stock unless there is a buy-back agreement.
77. Test – must be equal opportunity for each shareholder to participate, subject to being in
good faith, to equal creditors and then shareholders. Controlling group cannot use their
control to obtain special advantages.
mm. Special Voting Arrangements at Shareholder Level:
i. BCL § 609 – Shareholders: Proxies
ii. BLC § 620 – Shareholders: Agreements at to Voting
55
 iii. Vote Pooling Agreement – a contract in which 2 or more SH of a C agree to vote their stock together
as a unit on one or more corporate issues; this is an alternative to the more formal voting trust, except
with VP, each party votes their own shares
iv. Irrevocable Proxies –
1. Even if a proxy is expressly conferred in connection w/ a voting agreement, problem is that
proxy’s are revocable
2. To insure that a proxy will be irrevocable – confer it upon a proxyholder who has an “interest”
in the shares to which the proxy relates; then complies w/ agency laws as well as proxy rules
a. Magic language needed – “power coupled with an interest”
b. Power coupled w/ an interest – the agent has an interest in the subject matter to which
vote or power relates and thus doesn’t exercise vote on behalf of principal, but on
behalf of agent
c. Interest – in stock or C, or when proxy has a charge, lien, or some other property
interest in the shares, or a security interest given to protect proxy holder for $
advanced or obligations incurred
3. Today – most statutes will make such proxies irrevocable
a. NY BCL § 609 and DE § 212(e)
lxxviii. §212(e) – A duly executed proxy shall be irrevocable if it states that it is
irrevocable and if, and only as long as, it is coupled with an interest
sufficient in law to support an irrevocable power, a proxy may be made
irrevocable regardless of whether the interest with which it is coupled is an
interest in the stock itself or an interest in the corporation generally
lxxix. Not seller’s agent, stock can be voted as wanted, owe nothing to other
party, called proxy only because the form is given in traditional matter
lxxx. Power given by a SH, allowing the proxy holder to vote independently.
Seller is still listed as the owner on the company books.
lxxxi. Typical situation is as a means of securing a debt. Company extends
funds, and receives irrevocable proxies sufficient to elect members of the
board of directors. Holder of the proxy does not have the duty to act for
the giver of the power, nor subject to the giver’s control.
lxxxii. Another example – one extends credit to a corporation, and can be given
irrevocable proxy in order to vote to protect the loan. Here the interest is in
the corporation (not in the stock)
lxxxiii. Another example – employee can bargain for a proxy (interest is in the
corporation)

v. Ringling Bros. V. Ringling –

1. F – SH of CC operating a circus sued to enforce terms of a vote-pooling agreement entered
into w/ another SH who had refused to vote according to terms of the agreement.
2. I – Is a vote-pooling agreement among SH automatically unlawful?
3. H – No; SH have broad discretion in voting and in fact don’t even have to vote; this agreement
is lawful, but court didn’t enforce it b/c wouldn’t hold another election. If was an irrevocable
proxy would have been enforceable:
a. Interest in stock – right of first refusal
b. Interest in C – good management, C run by family; BCL § 609(e)
4. R – SH may enter into an agreement to vote their shares jointly; Vote Pooling
agreements are lawful.
84. SCOTUS – arbitrator’s duty was to decide if there was a disagreement between parties, not be
a trustee. The agreement contained no protections against Haley shifting allegiance to North,
parties only bound to each other, no explicit proxy provision. Here one party could not
exercise the voting rights of another, enforcement mechanism was flawed, Haley’s failure to
exercise voting rights in accordance with agreement was a breach of K. (SCOTUS doesn’t
count Haley’s vote, leaving one vacancy) Power of the arbitrator is not independent of the
decision making of the two SH, court finds that the agreement to use an arbitrator is merely a
deadlock breaking device. The agreement is legal, but cannot be enforced.
nn. Voting Trusts & Classified Stock:
i. BCL § 617 – Shareholders: Voting by Class
ii. BCL § 621 – Shareholders: Voting Trust Agreements

56
iii. Voting Trusts – a legal device in which corporate shareholders transfer legal title and voting rights to
a voting trustee who is authorized to vote on their behalf, but still retain the beneficial right to
corporate distributions and stock appreciation
1. In General – voting trust is a device by which SH separate (i) the voting rights in, and the
legal title to, their shares from (ii) beneficial ownership of shares
a. Structure of Voting Trust:
i. Trustees – get voting rights and legal title
ii. Shareholders – retain ultimate right to dividends and stock appreciation
iii. Usually VT is 2 or > SH involved, a type of pooling agreement
iv. Can be 1 SH; created to satisfy creditors or vest control of business in
managers
b. Requirements to create a Voting Trust –
i. 1. Execution of a written trust agreement between participating SH and
voting trustees, and
ii. 2. A transfer to trustee for a specified period, of SH’s stock certificates and
the legal title to their stock
iii. Voting Trustee registers transfer w/ C’s books so that they are Record
owner and thus entitled to voted
iv. Dividends issued to trustee, trustee fwds to beneficial owner
c. Validity – most statues both explicitly validate voting trusts and regulate their
creation and content
i. Max period of time for a voting trust is 10 years (except in Del)
ii. Agreement must be filed w/ C and open to inspection
iii. Must be noted on stock itself that stock is in a voting trust
iv. Beneficial owners have right to inspect the books.
d. Termination –
i. Trust is not terminated just b/c beneficial owners transfer their stock to
someone else; can sell shares while in a trust
ii. Term of trust is renewable
iii. When trust is terminated at end of specified time, beneficial owners
receive stock certificates that reinstate them as complete owners and are
registered on C books
e. Benefits (uses)
i. To protect creditors – allows creditors to elect the board until the debt is
paid, allows corporation to get credit in many situations.

ii. To preserve control in a shareholders agreement (best way, divorced

ownership from control)

iii. To ensure professional management (often used in the publishing industry

where founders did not trust children to run business)

iv. To implement a legally required severance of control (divestiture under an

anti-trust agreement)

2. Overlap of Voting Trusts and Shareholders’ Voting Agreements – frequently these overlap so
courts apply rules of voting trusts to SH voting agreements
iv. Classified Stock & Weighted Voting –
1. BCL § 703 & 704 – Can establish different classes of stock and give each class a different
level of voting rights or # of directors they can elect
a. Can be up to 4 classes, if classified directors, any changes in # directors have to be
proportioned among classes so that all classes are nearly as equal. When increased by
board there is no classification, SH meeting will elect by class at next SH meeting.
2. This is very useful in ensuring family control of C
3. Courts have upheld the creation of a class of stock that has voting rights, but no proprietary
rights
85. Statute allows whatever capital structure wanted.
a. Parties to a corporate entity may create whatever restrictions and limitations they may
want with regard to their corporate stock by expressing such restrictions and
limitations in the articles of incorporation.
57
 4. Very useful in Close C’s where one party contributes capital, other skill and both parties want
to be members of the board
oo. Agreements Controlling Matters within Board’s Discretion:
i. BCL § 620 – Shareholders: Agreements to Voting
1. Shareholder’s Agreements –
a. Restrict transferability of shares
b. Limit or control the power of the Board of Directors
c. Dissolution if deadlock
d. Voting agreement, where SH agree to combine votes to elect directors
2. Purpose – to ensure your agreement is enforceable w/o having to go to court to get specific
performance under the contract, you need an irrevocable proxy
3. Implementation - Any SH voting can be put into an agreement under § 620, and § 609 is the
mechanism to make the § 620 agreement binding
4. § 620(a) – available to anyone, not just CC
5. § 620(b) – only available to CC
a. Clark v. Dodge – still good law, not affected by statute
b. Statute expands holding in Clark to allow SH agreements to limit the authority of the
board of directors minimally
c. Restrictions on Board have to be in COI
6. If SH Agreement designates a certain person as officer, can always remove them for cause
under § 706; action of 10% of SH can remove an officer by going to court
7. Requirements for § 620(b) –
a. Have to be CC
b. Must be authorized / approved by all shareholders
c. Shares can be transferred or issued only to ppl who have knowledge of this SH
agreement
d. SH agreement has to be noted on stock
e. Shares cannot be listed on any stock exchange (Close C - BCL 620(b))
8. How to Strike out Provision in § 620(b) –
a. Ex. if C private and wants to go public
b. Prior to 1998 – need 2/3 vote to do away with provision
c. After 1998 – need ½ vote (simple majority)
d. Board can authorize an amendment to COI under § 805
e. Invalid – agreement will be invalid if injury to other SH or creditors
9. §620 gives matters that would normally be part of the board’s powers to the shareholders.
hhhh. So shareholders assume fiduciary liability
iiii. They assume liability for results of their control. (no longer on directors)
jjjj. 620(a) & (b) (mostly) is used to overrule – provides that management powers of the
board can be restricted, but this provision must be in the certificate.
i. (a) Applies to all

ii. (b) Only applies to close corporations.

ii. BLC § 715(b) – Directors: Officers
1. D are the exclusive executive representatives of C and are charged w/ management and
administration of its assets
2. Have a legal duty to act for C
3. D must be free to exercise their independent business judgment
4. Limits on SH:
a. SH can’t control the power of Board to elect officers of fix salaries
b. SH can unite to elect directors, but can’t unite to limit power of elected directors to
manage business
c. Public Policy – SH can not enter into an agreement to control the directors in the
exercise of their judgment
5. Employment Contracts:
a. If D has an employment contract, court will uphold the economic aspects of contract,
but D has no right to stay in his position as D
b. Employment contract treated separately for your position / duties; BCL § 716(a) and
(b)
iii. McQuade v. Stoneham –
58
 1. F – After being voted off the Board of Directors and removed as an office of CC, a minority
SH sued to enforce an agreement requiring the controlling SH to use their best efforts to keep
him in office.
2. H – Refuses to enforce agreement b/c it limits directors from exercising their judgment; A
directors fiduciary duty of undivided loyalty to C applies in all circumstances, even in CC.
3. R – An agreement among SH of a C to restrict their discretion as directors of C is invalid
and unenforceable as against public policy.
4. *NOTE – this case is no longer law!
iv. Clark v. Dodge – Case is LAW in NY
1. F – Two Cs manufactured medicinal preparations under secret formulas; Clark owned 25% of
stock and Dodge owned 75% of stock. Both entered into an agreement to provide for certain
compensation and to maintain D as director.
2. H – Court upheld agreement finding that McQuade holding is limited to the facts of that case,
and that in this case there was no attempt to sterilize Board
a. Interpreted “net income” as whatever is left so that agreement doesn’t hurt creditors
or 3rd parties;
b. Agreement said C in office as long as faithful, efficient, and competent; so didn’t
require board to keep him in office if he does something bad
3. Ct. holds that these are essentially chartered partnerships.
v. Longpark – Even if all board members agree, if the infringement upon board powers is too great, it
will not be upheld.
vi. Galler v. Galler –
1. F – Widow of one of 2 principal SH of CC sued the other principal SH seeking to enforce an
agreement prescribing how SH would vote for corporate offices and requiring the declaration
of annual dividends and payment of a widow’s pension. When 1 brother died, other brother
refused to uphold agreement. Sues for specific performance and an accounting.
2. I – Whether the SH agreement, limiting the discretion of the board of directors of CC, will be
upheld?
3. H – Yes; in the case of a CC where they have no market to sell their shares, a SH agreement
can protect their interests and be lawful; court upheld agreement b/c no SH not a party to the
agreement was injured (only the 2 SH).
4. R – SH agreement limiting discretion of Board of Directors of CC will be upheld where
no minority SH is prejudiced, corporate creditors or public are not injured, and no
clearly prohibitory statutory language is violated by its enforcement.
5. *Note – should have had a Buy-sell (buyout) agreement that upon one of brothers death, the
other side could buy out shares of the other party. Business motives of C driven by personal
consideration of SH
kkkk. Careful lawyer should always recommend various ancillary agreements
(voting, buy/sell, employment) to serve as shareholder protection.
i. If clients do not want, then lawyer should send a letter acknowledging
their choice. (CYA letter)
vii. Adler v. Svingos –
1. F – Entered into a SH agreement that provided that all C operating, including changes in
corporate structure, would require unanimous consent of all 3; A and S sought to sell business
and SV objected under the agreement; A and S brought action to strike ¶ of agreement as void
under BCL § 620(b) b/c a provision that restricts board in the management of C must be in
COI.
2. H – Court upheld provision and reformed COI to reflect the SH agreement.
llll. Here formalities were ignored, but nobody was injured by it.
91. Possible solution - Put in Berezofhsky clause – ct of appeals case – in the event any provisions
of the agreement shall be deemed illegal or against public policy, the legality and validity of
the remainder shall not be affected. However if any illegality or validity issue can be solved by
amending the certificate it will be done.
pp. Supermajority Voting & Quorum Requirements at Shareholder & Board Level:
i. BLC § 608 – Shareholders: Quorum
ii. BLC § 616 – Shareholders: Greater Requirement for Voting
iii. BLC § 617 – Shareholders: Voting by Class
iv. BLC § 705 – Directors: Newly created Directors & Vacancies
v. BLC § 708 – Directors: Action by Board

59
 vi. BLC § 709 – Directors: Grater Requirement for Voting
vii. Generally:
1. Supermajority Provision – a provision in a C’s COI requiring more than the usual 50%
majority vote to constitute SH approval of a corporate resolution
a. Veto Right comes with a SM provision
2. High Quorum Supermajority Provision – business can’t be conducted at a SH or directors
level w/o all members of the body present; this means that a minority SH or director could veto
an action just by not showing up
a. Advantage – they are valid in more states than a SM voting provision, which
generally require a statute
b. Disadvantage – it discourages parties from getting together in the same room and talk,
they can just boycott the meeting
3. Unanimity Provision – a provision in C’s COI requiring the consent of all SH to approve a
corporate resolution
a. If deadlock - § 1104 is a provision for deadlock where you can go to court to get C
dissolved
b. In real life – one party will just buy the other out
4. Modern statutes provide for these super-majority provisions:
a. BCL § 616 and § 709(a) – expressly permit COI to provide for high votes and high
quorums
i. SM provision may be amended by 2/3 vote unless COI specifically says a
greater vote is required (§616(b))
ii. SM provision must be noted on stock to give notice
viii. Sutton v. Sutton –
1. F – Controlling SH of a CC sued to compel a minority SH/director of C to sign an amendment
to C’s COI striking a provision requiring unanimous SH approval, including for any
amendment of certificate.
2. H – NY law provides supermajority provisions in COI may be amended by 2/3 vote unless
COI specifically provides otherwise; but in this case the certificate is unambiguous and
requires unanimity – it can’t be amended by 2/3 vote.
3. R – A unanimity provision of a C’s COI may not be amended by a less than unanimous
vote of SH of C.
qq. Fiduciary Obligations of Shareholders:
i. Rosenthal v. Rosenthal – fiduciary duties owed by business associates in CC
1. To act with that degree of diligence, care and skill which ordinarily prudent persons would
exercise under similar circumstances in like positions
2. To discharge the duties affecting their relationship in good faith with a view to furthering the
interest of one another as to matters within the scope of the relationship
3. To disclose and not withhold from one another relevant information affecting the status and
affairs of the relationship
4. To not use their position, influence or knowledge respecting the affairs and organization that
are subject to the relationship to gain any special privilege or advantage over the other
person(s) involved in the relationship
ii. Wilkes v. Springside Nursing Home –
1. F – After being removed as an officer and director of CC and having his weekly salary
discontinued, a founding investor in C sued controlling SH for breach of their fiduciary duty to
him as a minority SH.
2. H – Controlling SH failed to demonstrate a legitimate purpose for their actions; they
disregarded long-standing policy that each SH shares equally in profits, salary and
management of C, and that since C never paid dividends, W would have gotten NO return on
his investment.
3. R – In deciding if controlling SH of CC have breached their fiduciary duty to a minority
SH, a court must weigh any legitimate business purpose the controlling SH can
demonstrate for their action against the feasibility of an alternative course of action that
is less harmful to the minority SH.
4. “Legitimate Business Purpose TEST” for Breach of Fiduciary Duty in CC:
a. 1st – Minority SH of CC alleges breach of FD by controlling SH

60
 b. 2nd – Controlling SH have opportunity to demonstrate that a legitimate business
purpose exists for their actions which affect minority SH (burden shifts to SH if
successful)
c. 3rd – If Controlling SH assert a business purpose, Minority SH can rebut this by
showing that there are alternate options that are less harmful to minority SH
d. 4th – Court must weigh any legitimate business purpose that they can demonstrate
Against the alternative options
e. *Note – this is an intermediate test (for fiduciary duty for SH in Close C, less strict
than what partners owe each other, but stricter than BJR) and was criticized;
f. Courts adopted the “Reasonable Expectations of the Parties” Test – look at what
are the reasonable expectations of the parties when they entered the relationship and
how have they changed over time
92. Narrows Donahue v. Rodd – strict good faith standard owed to minority SH, ct is concerned
that strict good faith standard will result in limitations on legitimate actions by a controlling
group in a close C. Majority has certain rights of selfish ownership that needs to be balanced
against the fiduciary rights of the minority.
iii. Smith v. Atlantic Properties –
1. F – 3 of 4 equal SH in CC sued to remove the 4th SH from Board of Directors, after 4th SH used
a supermajority veto power contained in C’s COI to prevent C from declaring any dividends.
He refused for years, even after repeatedly getting hit with a penalty tax by IRS.
2. H – 4th SH breach fiduciary duty to other SH when he recklessly permitted C to be repeatedly
assessed a penalty tax.
3. R – A minority SH in a CC, whose conduct is controlling on a particular corporate issue,
is held to same fiduciary duty as majority SH.
iv. Merola v. Exergen –
1. F – An at-will employee and minority SH of CC sued C and its majority SH, alleging breach of
fiduciary duty for terminating the minority SH’s employment w/o cause.
2. H – Not every discharge of an employee of a CC will gives rise to a breach of fiduciary duty
claim; Here there was no C policy that stock ownership and employment went hand in hand;
Also M got a return on his investment in a form other than salary and sold shares at a fair
price.
a. Court distinguishes this case from Wilkes, where the termination of a minority SH of
CC was terminated to freeze-out SH
b. Wilkes depended on his salary as his principal return on his investment b/c in CC
corporate earnings are generally distributed as salaries
c. Ct. separates SH interests from interests as an employee
3. R – The mere fact that CC, w/o cause, terminates employment of a minority SH who is an
employee in C will not automatically constitute a breach of fiduciary duty to minority
SH. CC has to have ability to maneuver
a. G/R – employees can be terminated at will, w/ or w/o cause
b. Exception – minority SH (Wilkes Balancing Test)
c. *Note – NOT every termination is a breach of Fid Duty (Merola)
rr. Restrictions on Transferability of Shares & Mandatory Sale Provisions:
i. Overview – SH of CC have a legitimate interest in limiting transferability of shares to prevent
outsiders from entering and prevent a shift in control among SH
1. Restrictions on Transferability – reasonable restrictions are valid and enforceable;
a. Must be Reasonable – determined at time restrictions were adopted
b. Flat / absolute prohibitions are not permitted
c. Must have NOTICE of restrictions
d. Must voluntarily agree to restrictions
e. Setting purchase price is generally upheld, in absence of fraud
2. Three basic types of restrictions for CC -
a. First Refusals – prohibit a sale of stock unless shares have been first offered to C, the
other SH, or both, on the terms offered by T
b. First Options – prohibit a transfer of stock unless shares have been first offered to C,
other SH, or both, at a price fixed under the option
c. Consent Restraints – prohibit a transfer of stock w/o permission of C’s board or SH

61
3. Mandatory Sales – give C or the remaining SH an option to purchase a SH’s stock upon the
occurrence of one or more designated contingencies, even if SH doesn’t want to sell
a. Termination – when employee terminated, C has option to re-purchase stock issued to
the employee
b. Buy-Sell or Survivor-Purchase agreement – on death of SH in CC, his estate has an
obligation to sell its shares to C or remaining SH at a price fixed under the agreement,
and C or remaining SH are obligated to buy
4. Problems of Interpretation – courts often give restrictions on transfer a strict interpretation
5. Pricing Provisions – under CC difficult to price shares, so some methods are
a. Book Value – pricing formula based on book value; reflects historical cost of assets,
rather than their present value and ignores good will
b. Capitalized Earnings – fix the price on the basis of a multiple of earnings; more fair
then book value but lots of drafting problems
c. Periodic Revisions – agree on a price when provision is adopted, subject to periodic
revision at agreed-upon intervals
d. Appraisal – appraisal by a third party at the time the option is triggered
6. Notes
oooo. Shareholders have a legitimate interest in controlling the transfer of
stock
i. Essentially partners and have a vested interest in who they work with.
pppp. Stock is personal property of the holder, should have the right to dispose
of the personal property as desired
ii. Law has reached a compromise situation, reasonable restrictions are
permissible and not absolute restriction. Permissible when shareholders
agree to restrictions and have notice when they acquire the stock
iii. Set of purchase price is usually ok, when freely entered into.
qqqq. Share transfer agreements can be used to:
iv. Prevent non-active heirs or non-wanted outsiders etc from taking control
and participating in corporation.
v. Prevent shifts in control from transfer of shares between members.
(between existing shareholders)
vi. Provide a market for the shareholders stock
vii. Permit the corporation to eliminate shareholders in order to give remaining
shareholders larger share of the future growth.
rrrr. This is an important area for lawyers. First a contract is created
between the parties, the bylaws are created to reflect the agreement in the
bylaws. Here precise drafting is needed.
7. Type of restrictions
First option – prohibits the transfer of stock unless first offered to C, SH, or both,
company usually sets the price (F.B.I)
• How the price is set is very important
• Used to prevent outsiders from obtaining ownership, and to
maintain proportionate interest in the shareholders
• Restrictiveness depends on relationship between option price and a
fair price when it is trigged. As long as no unconscionability in setting of
price, it will be upheld *Holland
Consent restriction – requires SH or board of director approval before shares are
transferred. (FBI v. Moore)
• Very strictly viewed by courts.
• Unreasonable withholding is not permissible, but occur all the time
in sales of cooperative apts in NYC. Upheld.
First refusal restriction (most liberal type)
• Selling party (or third party) sets terms
• Shares offered to C or other SH with first option with terms set by
seller
• Courts have ordered specific performance
Option contingent
62
 • Certain event can trigger sale to corporation (firing, death,
retirement)
Corporate call
• Corporation can call stock for purchase. (often for preferred stock)
• Can be used to reduce outstanding shares, also ability to avoid
dividends.
Pricing
• Can be used, but may not be accurate, reflects historical price and
may not reflect value.
o Evangelista is ex. where large difference will not void
agreement
Capitalized earnings
• Pick price based on future stream of earnings, can be very
subjective
Periodic revisions(may be agreed upon to restrictions)
• May lead to inability to agree, or time period may be allowed to
pass causing problems
ii. FBI Farms v. Moore –
1. F –Moore sought a declaratory judgment to establish that FBI restrictions on transfer of stock
(right of 1st refusal and shares can only be transferred to blood members) were unreasonable
and inapplicable to an involuntary transfer (shares were sold at Sheriff’s sale b/c she owed $).
2. H – The restrictions are valid, however restrictions are trumped when it is an involuntary
transfers.
a. Requirements:
i. Restrictions have to be noted on the front or back of stock certificates
ii. If noted on stock, restrictions bind a person with actual notice
iii. Restriction on board approval is valid only if reasonable
iv. If restrictions arise out of fraud or breach of fiduciary duty – not upheld
b. Factors on whether a Reasonable Restriction:
i. Size of corporation
ii. Degree of restraint on alienation
iii. Time restriction was to continue in effect
iv. Method used to determine the transfer price
v. Connection to corporate objectives
vi. Possibility of hostile takeover
vii. Best interests of corporation
3. Rule – A stock transfer restriction is reasonable if it is designed to serve a legitimate purpose
of the party imposing the restraint and the restraint is not an absolute restriction on the
recipient’s right of alienability.
4. Involuntary Transfers – essentially trumps restrictions; restrictions can’t prevent a creditor
from foreclosing on a lien, but a person that purchases the shares at a sheriff’s sale is subject to
the restrictions, if they have notice of the restrictions (personal notice or on the documents
themselves).
iii. Evangelista v. Holland –
1. F – SH agreement allowed C to buyout the estate of a deceased SH for $75k; at time of death,
evidence that stock worth $191k. Argue agreement violates duty of good faith b/c requires SH
to sell share at much less than what worth.
2. H – No violation; agreement was entered into buy all SH when order and time of death of each
SH was unknown; there was a mutuality of risk.
3. R – Questions of good faith and loyalty do not arise when all SH in advance enter into an
agreement for purchase of stock of a w/drawing or deceased SH.
iv. Gallagher v. Lambert –
1. F – After his employment w/ CC was terminated, an employee/minority SH sued to void a
mandatory buy-back provision of a SH agreement giving C a right to repurchase his shares at
book value.
2. H – Buyback provision is enforceable; G freely negotiated and agreed to accept book value for
his shares, he got what he bargained for. Buyback provision was for the benefit of both parties

63
 3. R – A mandatory buy-back provision, permitting C to repurchase an employee/SH stock
in event his employment is terminated, is generally enforceable.
4. *Note – case emphasizes freedom of contract principles, and key factor was that G started as
an employee and later became SH, this met his reasonable expectations of employment were
different than if started as a SH.
5. May stand for proposition that under NY law SH are not bound by fiduciary duties if there is K
setting out the parties’ rights. SH presumably have a statutory remedy to dissolve C under
BCL §1104(a). Maj. ties together price of shares and emp., as to timing and consequences.
v. Jensen v. Christensen & Lee Insurance, Inc.,
97. No wrongful discharge, no cause of action because Wis. wrongful discharge is limited to
discharges that violate public policy
tttt. BUT buyback price was low, benefitting remaining SH. Did not deal fairly with
minority SH. Conflict of interest, device to cut out one of the SH.
ss. Dissolution for Deadlock or Oppression:
i. BCL § 1001 – Non-Judicial Dissolution: Authorization permits voluntary dissolution if authorized
or approved by 2/3 of outstanding shareholders (or maj. If required)
ii. BCL § 1002 – Non-Judicial Dissolution: Under COI
1. (a) COI may contain provision mandating dissolution after specific event, needs all SH
approval unless COI requires lower.
iii. BCL § 1104 – Judicial Dissolution: Petition in case of deadlock
99. Minority shareholders have equitable right to dissolution if majority have committed fraud or
other illegal or wasteful conduct. Otherwise must remain in corp.
100.1104(a) – need 20% of votes of all shareholders
101.1104(b) – only used for non-publically traded corps.
102.Ct is supposed to take into account if liquidation is only feasible means for minority
shareholders to obtain a return on investment.
103.1104(a) leads to hearing, if under §1111 dissolution is ordered, brought by AG – interests of
the public is paramount, if brought by shareholder, their interests are paramount.
iv. BCL § 1104(a) – Judicial Dissolution: Petition under special circumstances
v. BCL § 1111 – Judicial Dissolution: Judgment or Final order –
vi. BCL § 1118 – Judicial Dissolution: Purchase of Shares / Valuation – Ct orderes value of shares to
be determined for purposes of buyout following dissolution order.
civ. Advice – SH agreement should contain clauses defining expectations of parties, then if
disagreement should include buy/sell agreement. Basic idea of this chapter
vii. Dissolution for Deadlock: (Another contract to partnership law)
1. Several statutes provide for involuntary dissolution on a showing of deadlock
2. Deadlock Defined – (different statutes have different definitions)
a. (1) an equally divided board or body of SH, OR
b. (2) a divide brought about by supermajority or veto arrangements
3. Court’s do not like to order a profitable C to dissolve
viii. Stages of Dissolution –
1. 1st Stage: Dissolution Granted only for Deadlock
2. 2nd Stage – Dissolution on Ground of Majority’s Fault
3. 3rd Stage – Dissolution on Ground of Defeat of Minority’s Reasonable Expectations
4. 4th Stage – Dissolution Converted into Mandatory Buy-Out
a. Frequently courts will find grounds for dissolution exist, but will remedy through a
mandatory buy-out rather than dissolution via liquidation
ix. New York Dissolution Statutes:
1. § 1001 – can petition; limited to majority of board of directors or AG
2. § 1002 – can obtain a provision upon occurrence of a specific event
3. § 1004 – judicial dissolution in case of deadlock
a. Can bring action for fraud, oppression, illegality, looting and waste
b. Court will take into account whether liquidation is only feasible mean for SH to get
fair return on their investments
c. Court can make a final judgment or order dissolution
x. Valuation of Minority Shares –
1. Mandatory Buy-Out – Court must value the minority’s interest
2. Dissolution – public sale of C’s business, so market values C’s shares
64
 xi. Wollman v. Littman –
1. F – One of 2 groups of 50% SH of CC sued for dissolution of C, asserting that another lawsuit
between SH groups made it impossible to effectively conduct C business.
2. I – Is dissolution of C appropriate whenever C’s management is deadlocked?
3. H – No; trial court in this case should have considered (1) since both SH perform different
functions, can they function if supervised by a receiver; (2) since SH in separate suit are
charged w/ luring business to their own company, wouldn’t dissolution allow them to achieve
their wrongful goal?
4. R – Dissolution is inappropriate, even if SH are deadlocked, if result would be to permit
one SH group to divert C’s business to itself.
xii. Matter of Kemp & Beatley –
1. F – 2 SH who were formerly employees of CC sued for dissolution after C changed its policy
regarding corporate distributions in a way that ensured SH would not get return on investment.
2. I – Is dissolution of C appropriate where a majority SH engages in “oppressive conduct”
toward a minority SH and majority SH doesn’t want to buy out minority SH at a fair price?
3. H – Yes; in NY dissolution can be ordered where at least 20% of SH complaint of illegal,
fraudulent, or oppressive conduct against them by other SH.
a. Oppression – conduct that substantially defeats the reasonable expectations held by
minority SH in committing their capital to a CC
b. Mere disappoint is NOT enough. SH reasonable expected (job, return, other security)
c. Conduct must substantially defeat expectations that, objectively, were reasonable and
central to SH desire to join C
d. Dissolution will ONLY be ordered if it is the sole means of protecting complaining
SH’s reasonable expectations (look at totality of circumstances, try to find a remedy
short of dissolution that would satisfy minority SH and other parties)
4. R – Conduct by majority SH that substantially defeats the “reasonable expectations”
held by minority SH in committing their capital to CC is appropriate ground for
dissolution of C, provided that majority SH are first given an opportunity to buy out
complaining SH at a fair price.
xiii. Meiselman v. Meiselman – Objective standard for reasonable expectations. Privately held
expectations not made known are not held as reasonable.
xiv. Chesterton v. Chesterton – SH seeks transfer from C corp to S corp, one SH tried to xfer shared to
another C, would end SCorp classification. P sues to stop. Ct holds that the expectations and
understandings of SH were relevant in relation to the breach of fiduciary duty (under MA law)
xv. Mullenberg v. Bikon – claims of oppression are typically remedied by arranging for C or majority
SH to buy out interests of minority SH; minority can also buy-out majority
xvi. Kelley v. Axelson – maintaining an accounting system whose shortcomings have the effect of
substantially preventing the outside, minority SH from ascertaining and verifying C’s income can
constitute unfairness and oppression toward minority SH
xvii. Charland v. Country View Golf Club –
1. F – A minority SH appealed a judicial appraisal of his shares that had discounted their value
due to their lack of marketability and the fact that they were not enough shares to control
corporate decisions.
2. R – In appraising FMV of stock of a minority SH in CC who has filed for dissolution, court
should not apply either a minority discount or lack of marketability discount to determine the
value of the stock.
aaaaa. Relief given in these cases where majority tries to freeze out minority SH. – try to restore a
minority shareholder to the position as closest possible as to where minority shareholder would have been
if there were no wrongdoing. (look at what ct is granting, eval what factors apply in relief granted)
cvi. Donahue – maj SH Caused C to purchase min SH stock at favorable price, while denying Euphemia
the same opportunity. Ct orders rescind sale of stock to C or in alt. Give Euphemia same price.
cvii. Wilkes – expectations of employment – ordered damages for loss of employment as well as the value
of his shares, attempt to reset balance between maj. Right of selfish ownership and min. rights of
reasonable expectations of employment.
cviii. Galler – ct. specifically enforces agreement for both sides to receive the same amount (retrospect
-would have been much better to buy Emma out)
cix. Kemp – reasonable expectations leading to buyout

65
CX. DUTY OF CARE
tt. Introduction –
i. In general a director owes C a duty of care; he must do what a prudent person would do w/ regard to
his business
ii. Duty imposed b/c directors are fiduciaries of C
iii. Burden is on P to prove that Duty of Care was breached, and that breach was proximate cause of
harm
iv. Basics – Duty of Attention and Be informed of what is going on; go to meetings; make sure
bookkeeping methods conform w/ industry standards
v. *Directors are entitled to rely on reports by other directors, officers, and outside parties – but have to
rely in good faith and reliance must be warranted
vi. *NOTE – you can NOT contract out of Duty of Loyalty to C or SH, or for acts or omissions that are
NOT in good faith, or involve intentional misconduct or are a knowing violation of the law
111.Director should consult outside advice if necessary
112.Directors owe a duty to SH, creditors (only as C is dipping towards insolvency), the C
113.Directors should exercise their duty in good faith and skill.
114.Director can fail to discharge the duty by;
a. Failing to monitor C – duty of attention (Francis)
b. Even if the director is disinterested, independent, and acting in good faith, by failing
to make an informed decision. (Van Gorkom)
i. If researched, but decision is rash, then director protected by BJR
ii. To obtain BJR protection, director must show judgment was exercised, but
it only applies in the absence of fraud, illegality, or disabling conflict of
interest.
iii. Even if the duty of care has not been met, can the shareholders hold the
directors liable for ruining the corporation?
1. No, requires proximate cause
115.Directors can rely on repots from other employees, counsel, etc, but it must be in good faith,
and must have reasonable belief that the report is true.
116.Director can rely on a committee of the board if acting in good faith, and believes reliance on a
committee is warranted, but must read the report in order to rely on it
117.Director can rely on competent outside experts, relying on relevant skill and experience
uu. Basic Standard of Care – Duty to Monitor:
i. BCL § 402(b) – Formation: Contents of COI
ii. BCL § 717 – Directors: Duty
iii. BCL § 719 – Directors: Liability
iv. BCL § 720 – Directors: Action against for misconduct
1. Actions for neglect, but must be mis or non-feasance, not just misjudgment
v. Standard – Directors must discharge their duties in good faith and w/ the degree of diligence, care,
and skills that an ordinary prudent person would under similar circumstances in like positions
vi. Generally, as a Director you Should –
1. Have at least a rudimentary understanding of C’s business
2. Stay informed of C’s activities
3. Engage in general monitoring of C affairs and policies
4. Remain familiar with financial status of C
vii. When Director discovers an Illegal Action –
1. D has a duty to object, and if C doesn’t correct the conduct, D should resign
2. Sometimes D’s duty may call for more than objection and resignation – should seek advice of
counsel and even threaten suit
3. Director owes fiduciary duty to C and SH and sometimes to creditors or 3rd parties, depending
on the nature of the business (banks, reinsurance co., etc.)
4. *Director does these things to absolve themselves from liability
5. *Note – a Director is assumed to assent if he is present at a meeting
viii. Liability – under BCL §719 – directors are jointly and severally liable. Director presumed to concur
unless they actually dissent from particular action. If absent assumed to concur, unless sends dissent
by registered mail or cause the dissent to be filed in the minutes of the meeting. Each director is liable
for the failure where the board’s failure is liable for the act (under proximate cause)
ix. Francis v. United Jersey Bank –

66
 1. F – Mom was director of a reinsurance company and her sons who were also directors,
embezzled client funds; mom’s estate (she died) was sued for breaching her duty of care by not
preventing the theft.
2. H – Mom/Estate are liable; failed to act; this H reflects the nature of the reinsurance industry –
dealing with cash and based on trust.
3. Test for Liability – Corporate directors are personally liable for violating their duty of care by
failing to prevent wrongful acts by other corporate officers if:
a. They owed a duty to the victim
b. They were negligent in monitoring the other officers, and (breach)
c. Their negligence was the Proximate Cause of the injury
x. Aronson v. Lewis –
1. Directors have a duty to inform themselves, prior to making a business decision, of all material
information reasonably available to them
2. They must act with the requisite care in the discharge of their duties
3. Under BJR, director liability is predicated upon concepts of gross negligence
vv. Business Judgment Rule –
i. BJR - rule protects Directors from bad decisions, as long as made in good faith; does NOT protect
decisions made in bad faith
1. BJR is based on presumption that D acted on an informed basis, in good faith, and in honest
belief that the action taken was in the best interest of the company
118.BJR protects directors from imposition of liability based on hindsight. Also helps to
encourage D to take risks so that they are not found liable for hindsight bias. Decision
turned out badly v. bad decisions.
ii. Standard of Conduct – how you should conduct a given activity or play a given role
1. Director’s Duties:
a. To monitor
b. To inquire
c. To make prudent or reasonable decisions on matters that the board is obliged or
chooses to act upon
d. Duty to employ a reasonable process to make decisions
2. *Note – duties of director’s are fairly demanding, but SOR are less stringent
iii. Standard of Review – the test a court should apply when it reviews an actor’s conduct to determine
whether to impose liability or grant injunctive relief. Courts tend to look at the process in reaching the
decision, low standard of review in quality of decision.
1. SOR for BJR – decision must be rational, or have a rational basis
a. Unreasonable decision – could be good and bad reasons for it, but can be justified or
explained
b. Irrational decision – no way to explain the particular decision, denies BJR, only way
P can win
2. SOR if Conditions for BJR are NOT met – SOR is based on entire fairness or reasonability of
the decision (higher standard)
iv. 4 Conditions for BJR to Apply:
1. Director must have made a decision
2. Director must have employed a reasonable decision making process
3. Decision must have been made in good faith
4. Director may not have a financial interest in the subject matter of the decision
v. Kamin v. American Express Co. -
1. F – When a C’s directors ordered in-kind dividends which did not utilize available tax
deductions, some SH sued, contending directors carelessly wasted corporate assets. Directors
issued dividends instead of declaring a loss.
2. H – Dismissed; w/in BJR, plus no evidence of fraud or self-dealing
3. R – C directors’ decision on dividends are not actionable as breaches of care, absent
fraud, self-dealing, bad faith or oppression. BCL §20 neglect must stem from nonfeasance
or malfeasance.
vi. Joy v. North

67
 119.If the courts did not abide by the business judgment rule, they might well penalize the choice
of A in each such case and thereby unknowingly injure shareholders generally by creating
incentives for management always to choose b (less risk, less reward)
120.BJR encourages managers to take good risks, and they will be rewarded for this.
vii. Smith v. Van Gorkom –
1. F – When a corporate CEO convinces directors to sell C w/o calculating its value, SH allege
they breached their duty of care. CEO did NOT tell board how he arrived at sale price and did
NOT tell them that he was the one that approached the buyer and initiated the price --- no
negotiations were done.
2. I – Whether Directors breached their duty of care by failing to determine the true value of C?
3. H – Yes; D were grossly negligent b/c they never examined CEO’s role in negotiations (that
basically wasn’t a negotiation), never calculated C’s intrinsic value (w/ good will); didn’t
research or deliberate for > 2 hours; relied on CEO’s presentation w/o reading information.
4. R – C directors who sell C w/o determining its true value have breached their duty of
care.
5. *NOTE - Decision has been criticized for moving away from a bright line rule, allows courts
to examine business decisions (that are always taken under uncertainty and risks)
i. May reduce manager’s willingness to take risks
ii. Creates a process-based method of decision-making.
iii. Courts lack the competence to appreciate complex business decisions.
qqqqq. Gross negligence is the standard that will lead to director liability. SH did
not know that decision was reached without adequate information by the board.
rrrrr. Heightened decision-making is now required for life/death decisions re:
corporation.
viii. Gantler v. Stephens
123.F - Directors killed deal to benefit selves, issued fraudulent proxy statement to shareholders
1. I – Is SH voter approval on fraudulent proxy statement sufficient to ratify board decision.
2. Test – BJR presumption is met if D acted in good faith and acted advisedly.
3. H – BJR presumption overcome and D may be personally liable – Directors act disloyally.
4. Major implications and clarifications for practitioners and corporations in Del re: fiduciary
duties, C restructuring, and the “SH ratification” defense.
a. C directors and officers now owe the same fiduciary duties to SH.
b. Board considering a restructuring, where there might be potential conflicts of interest
for a maj. of its directors should ensure that its actions satisfy an entire fairness
review just to be safe. Additionally, a Board may only issue a statement that it has
carefully deliberated a restructuring, sale, or merger if it has, in fact, done so.
c. “SH ratification” defense does not apply to Board actions that statutorily require SH
approval. A Board may assert the “SH ratification” defense only if it expressly
requested the SH to ratify the action at issue.
ttttt. SH ratification by disinterested SH will cleanse a board decision making process if
board is questionable IF SH RATIFICATION IS NOT LEGALLY REQUIRED (not
necessary) (DELAWARE)
cxxv. Previously disinterested majority of SH ratified action of board directly
therefore, even if board breach duty of care, was ok
126.Board’s deceitful activity isn’t cleansed by SH ratification
cxxvii. IE. Board wants to proceed with action, not required to get SH approval
but do so anyway, it cleans the impure decision-making process. SH must
be fully informed.
cxxviii. Then Board can use Biz Judgment Rule as defense
ww. Duty to Ensure that Corporation has Effective Internal Controls:
i. In Re Caremark – STONE V. RITTER RECLASSIFIES THIS DECISION
1. F – When C charged with health care bribery is forced to pay $250 million and promise better
management in a settlement w/ gov’t agencies, angry SH request court to reject the settlement
and permit them to sue directors for negligently permitting bribery.
2. I – Did Board meet its responsibility in creating a monitoring system so that C operated w/in
the law?
3. H – Agreement is fair / reasonable; D took due care to prevent this from happening and Board
already had a cmt to oversee corporate compliance.

68
 4. R – C directors have a duty to make good faith efforts to institute a corporate monitoring
system they believe will alert them of material events, but are not liable if the system fails to
detect wrongdoing.
5. TEST for their to be a Breach of Duty of Care:
a. D knew or should have known about violations
b. D took no good faith steps to prevent them
c. D’s failure proximately caused the losses
d. *Key – D only have to put systems in place
xx. Liability Shields:
i. BCL § 726 – Directors: Insurance for Indemnification
ii. In assessing duties of directors and officers to act w/ care, account must be taken of 3 elements that
may serve to reduce or eliminate civil liability for breach of those duties:
1. Direct limits of liability
2. Insurance
3. Indemnification
iii. COI – shield from liability provided by COI is in the nature of an affirmative defense
1. Burden is on D to prove that they acted in good faith
2. When claim is based solely on violation of duty of care – protection can be invoked and
applied
yy. Duty to Act in Good Faith:
i. Two types of Violations:
1. Where C, as a result of Board decision, incurs loss that was ill advised or grossly negligent
(Van Grokem)
2. Circumstances in which a loss eventuates not from a decision but from an unconsidered action
(Caremark)
ii. Breach
1. Standard of review – BJR so long as directors act
a. On an informed basis
b. In good faith
c. In the honest belief that the action taken is in the best interest of C
2. Bad Faith
yyyyy. “Subjective bad faith” - conduct of directors motivated by an actual intent to
do harm to the corporation. This type of conduct as “classic, quintessential bad
faith.”
zzzzz. “Intentional dereliction of duty, a conscious disregard for one's
responsibilities.”
cxxxi. Failure to act in good faith may be shown, for instance, where the
fiduciary intentionally acts with a purpose other than that of the best
interests of the corporation, where the fiduciary acts with the intent to
violate applicable positive law, or where the fiduciary intentionally fails to
act in the face of a known duty to act, demonstrating a conscious disregard
for his duties.
132.Cant be indemnified or exculpate
a. Gross negligence
b. If directors comply with statutes and strive to act in the best interests of the C they
won’t have acted in bad faith, even if their decisions lead to loss in SH value.
3. Waste – P must show the exchange was so one sides that no biz person of ordinary judgment
could find it received adequate consideration. Cannot be attributed to any rational biz purpose
iii. Emerald Partner v. Berlin – D bears burden of proving good faith and duty of care where P has
factual basis proving otherwise.
iv. In Re Walt Disney Company – *Supplement p. 57-89
1. F – Disney hired O by giving him a salary was well as stock options; O terminated 14 months
after he was hired w/o cause, resulting in a $130 million severance payment. SH sue Board b/c
of this payout to O.
2. Ct. sates that the duty of directors to act in good faith is separate and distinct from the duty of
directors to act with due care.
3. H - failure to act in good faith is diff from and more culpable than conduct of breach of
fiduciary duty of care (ie gross negligence)
4. R – *Court sets forth what are Best Practices for a Board, p. 67.
69
 v. Stone v. Ritter –
1. F – AmSouth failed to fill out Suspicious Activity Reports; was a Ponzi scheme (u promise
higher rate of return than is normally feasible and pay current investors w/ new investors $
until run out of new investors); AmSouth pays penalty and SH sue claiming they failed to
implement a monitoring system.
2. H – This wasn’t a failure of the board, but a failure of the employees;
3. *Note – Court re-interprets Caremark as a duty of loyalty case rather than a duty of care
case, essentially changing its holding.
cccccc. §107 – duty of care does not apply if there is a breach of duty, but doesn’t
work if there is a lack of good faith duty of loyalty. Caremark decision is reclassified
(to good faith duty of loyalty) Standard in Caremark is sustained or systematic failure
of the board to assure oversight. If this fails, then establishes a lack of good faith.
Draws heavily upon concept of director failure to act in good faith, differs from the
breach of duty of due care.
i. Showing bad faith is essential to establish director oversight liability.

ii. Duty of care v. duty of loyalty

iii. Not independent, good faith is a subsidiary aspect of the duty of loyalty.

iv. In either case, P must show that D weren’t discharging fiduciary

obligations.

4. For a derivative complaint to withstand motion to dismiss, only a sustained or systematic

failure of the board will overcome a summary judgment motion.
zz. Directors and Officers Liability Insurance:
i. Liability and legal expenses of D and O who are subject of claims based on lack of due care, and for
certain other wrongful acts, are often covered by liability insurance
ii. D & O Policy has 2 separate insurance agreements –
1. Corporate reimbursement – insures C against potential liability to O and D under the latters’
right to indemnification from C
a. Does not require insurer to defend (but insurer is required to indemnify for losses,
including defense costs)
b. Insurer’s obligations do no accrue until claim is settled or adjudicated
2. Personal Coverage – insures D and O themselves against losses based on claims against them
for wrongful conduct when they are not indemnified for the loss by C
a. Ex. Law prohibits indemnification (ex. D or O’s loss is from a judgment against him
in a duty-of-care action); C is insolvent; C refuses to make indemnification where it is
discretionary
3. D & O insurance doesn’t render D & O completely risk free -
a. Some claims are excluded from coverage; including some kinds of duty-of-care
claims (especially those owed to the public)
b. Policy limits apply to the total amount of liability and legal expenses
c. Insured v. Insured Exclusion – insurer is not liable in connection w/ claims made
against D or O by C, except made in SH derivative action
d. Only applies to claims made while the policy is in force
4. In some Settlements D & O are required to pay out of pocket -
a. Ex. WorldCom and Enron cases

70
CXXXIV. DUTY OF LOYALTY
aaa. Introduction:
i. Requires directors to act in a manner that doesn’t harm the corp.
ii. Easier to identify in comparison with violations of duty care
iii. Requires the directors to avoid using the position to gain a benefit for himself, which belongs to the
corp.
iv. Decisions should be reached in an impartial environment, disclosure, approval by an impartial board,
and it should be fair to the corp. at the time it was entered into
v. A director is expected to make decisions objectively, to obtain approval from the corp. where there is
a relationship that impairs the directors objectivity
vi. Fairness –
1. Fairness requires not only that terms of a self-interested transaction be fair, but also that
entering into the transaction on the fair terms is in C’s interest
2. Courts have been willing to invalidate a contract entered into by a corp. if it was found to be
unfair to the corp.
vii. Conflicts of Interest – nothing is per se wrong with a conflict of interest or interested transaction, so
long as procedures are followed to provide disclosure of the interest, the board fairly considers the
matter, and it is fair and reasonable to C at time decision is entered into (see BCL § 713)
viii. Remedies for Violation of Duty of Loyalty –
1. Restitutionary in Nature – recission, return of gain, etc.
2. legal sanctions for violation of duty of loyalty are usually less severe than legal sanctions for
violation of duty of care (pay damages)
3. Sometimes punitive damages can be assessed
ix. Lyondell Chemical v. Ryan
1. F – P alleges that D failed to act in good faith in sale of C, thus D violated fiduciary duty.
2. I – whether board breached duty of loyalty by failing to act in good faith
3. H – Decisions of the board have to be reasonable, not perfect
a. Lower court already determined that board was independent, therefore no conflict of
interest.

b. In order to show bad faith, P must show that board knowingly and willingly failed to
undertake their fiduciary responsibilities.

c. Lower court makes mistake in holding that failure was doing nothing after 13D was
filed indicating company was in play. (therefore Revlon (filing with SEC, ) duties did
not kick in, only does when a sale in inevitable)

i. Allows anyone who views to see why the person acquiring is doing so.
Informs the corporation that somebody may be trying to take over the
company. (real importance)

d. Court says that Revlon duties arise when a company’s board actively decides to sell
the company, or gets an unsolicited offer that will clearly arise to a change in control
bbb. Self Interested Transactions:
i. BCL § 713 – Directors: Interested Directors – Directors must obtain approval from C when there is
a conflict of interest, existing when D has direct interest in K between C and 3rd party.
ii. BCL § 714 – Directors: Loans to Directors
iii. Lewis v. SL&E – Merit Based Fairness Test / Conflict of Interest
1. F – SH brought a derivative action against his family’s CC and its directors, claiming the
director’s failure to charger their own CC the fair market rental value constituted corporate
waste; SEL was essentially run for LGT, and directors were the same for both companies.
2. H – There was a conflict of interest, and D failed to meet their burden to show that rental price
was fair and reasonable.
3. GR – BJR dictates the decisions of C’s directors to enter into a transaction; but it presuppose
D have no conflict of interest
4. R for Conflict of Interest - challenge to a transaction entered into by interested D, D have
burden of proving transaction was fair and reasonable.
iv. Talbot v. James – Self Interested Transaction

71
 1.F – SH sued O and D of C for violating his fiduciary duty when D failed to disclose his interest
in a contract entered into by C; basically he hired his own construction company to do the
work and gave himself a fee for doing it, but never disclosed financial information to the
others.
2. H – J violated his fiduciary duty by not disclosing his personal interest, nor the material terms
of the transaction
3. R – O and D of C stand in a fiduciary relationship to individual SH and in every instance
must make a full disclosure of all relevant facts when entering K between C & 3rd party
4. *Key - D have a duty to disclose any personal interest they have in a transaction effected by C.
ccc. Statutory Approaches:
i. DE: Impartial Director Approval – requires a majority of disinterested directors
ii. NY: § 713 BCL – NY’s approval requirements, if comply with the statutes, it provides immunity.
Approval has to be in good faith. Looks at the fairness of the transaction
iii. Cookies Food Products v. Lakes Warehouse –
1. F – Originally H and C entered into an agreement where H was a SH of C and owned a
warehouse where he distributed auto parts; he offered to distribute C’s BBQ sauce for them,
which he got a profit from the distribution. Later agreement amended to give H more sales and
other compensation. SH claimed H breached fiduciary duty b/c he didn’t disclose the benefit
he was to receive.
2. H – Yes there was a breach, but H’s efforts in fact saved the company, so he is only required to
repay his profits;
a. As a majority SH H did owe a fiduciary duty;
b. D’s that engage in self-dealing must:
i. Fully disclose interest to C
ii. D BOP that they acted in good faith, honesty and fairness
1. Fair and Reasonable transaction requires that self-dealing has the
earmarks of an arms-length transaction
2. Fairness isn’t solely defined by fair price, but also a showing of
fairness of bargain to interests of C
3. *Note – after you satisfy statutory hoops, still have to establish that you acted in good faith,
honesty, and fairness
cxxxv. In terms of complying with statute – 3 approaches
4. Disinterested director approval

a. C will often establish independent committees for interested transactions

5. SH approval (i.e. Del. – will put distinction on approval by maj. of disinterested SH)

6. Proof of a transactions fairness

a.Board of directors must show that transaction is fair (if C does not go through
statutory hoops)
ddd. Compensation and Doctrine of Waste; Effect of Shareholder Ratification:
i. BCL § 202(a)(10) – Corporate Powers: Appointments and Compensation
ii. BCL § 202(a)(13) – Corporate Powers: Pensions and Bonuses
iii. BCL § 712(a)(3) – Directors: Committees
iv. BCL § 714 – Directors: Loans to Directors
v. BCL § 720 – Directors: Action against for Misconduct
vi. Compensation –
1. Duty of Directors to set compensation of officers; NOT SH
2. Compensation should bear some reasonable relationship to the services and effort performed
3. Courts give more deference to compensation payouts in public C, then in CC
4. Stock Options – gives directors a stake in the corporations, and puts them on same level as
shareholders.

72
 ffffff. Theory – outstanding performance is warranted. Stock options are supposed
to provide an all or nothing payoff.
gggggg. Reality – even if the investor loses, executives can still win. Options have
strike price reset.
hhhhhh. Until recently federal tax and options policy kept them tax-free.
iiiiii. Excess of options has led to –
i. Refrstricted shares as a replacement – issued to employees, but can only
be sold at some point in the future – advantage is receive dividends and
voting rights even before shares have vested. Still getting something even
if stock price declines

1. BUT typically get lower and will lose shares if leaving company
before they can sell shares.

ii. Gross ups – corp gives perk or bonus, pays exec additional figure = tax on
what that perk is

iii. Pensions for executives

iv. Death benefits, or corporate funded life insurance

vii. Waste –
1. Principle of Waste – waste entails an exchange of corporate assets for consideration so
disproportionately small as to lie beyond the range at which any reasonable person might be
willing to trade
a. Can’t give consideration for past services
b. TEST – no person of ordinary, sound business judgment would say that the
consideration received for the options was a fair exchange for the options granted
c. Waste is very hard to prove
2. Defense – waste will not be found if there is substantial consideration received by C, and if
there is a good faith judgment that in the circumstances the transaction is worthwhile, even if it
was unreasonably risky
3. Application – principle is applicable to actions of Board and SH, but more effective against SH
b/c a Board that commits waste would normally also violate BJR
viii. In Re Tyson Foods –
1. F – Granted options that would receive FMV on day of grant, but the options were backdated.
2. I – Did they exercise BF when they offered options at FMV when they knew the market price
should have been higher, and they controlled the information?
3. H – This was indirect fraud or deception; if SH offer options to be granted at FMV and they
tamper with the pricing, that is an act of bad faith. Board has duty to SH to grant options in
accordance with SH wishes, must prove issued in accordance with SH approved plans.
4. Back Dating – options dated when market price of stock was at a low, to enable execs to make
that much more when they exercise their stock options; this is in essence giving D more $ than
SH agreed to when they agreed to provide D with stock options.
ix. Ryan v. Gifford –
1. F – P alleges D breached duty of care and loyalty by approving / accepting backdated options
that violated the SH approved Stock option plan and Stock incentive plan.
2. H – Demand was excused.
jjjjjj. Cannot issue options below the fair market value of the stock therefore it is a
breach of fiduciary loyalty to the shareholders.
kkkkkk. Bad faith – intentional violation of shareholder approved options plan, plus
intentional misinformation on disclosures.
llllll. Board was not completely honest, and SH were owed candor from the
directors even after the plan was approved
mmmmmm. This was disloyalty and directors cannot rest defense on BJR.
3. Demand - When SH suit is brought, must first make a demand on board of D to give them an
opportunity to address grievance and determine if bringing such action is in best interest of C.
a. Both NY and DE allow for the demand to be excused
b. Demand Excusal Rule in DE (Aronson v. Lewis):

73
 i. 1st Prong – There is doubt that the majority of the board is disinterested or
independent;
ii. If majority is NOT disinterested or is NOT independent go to 2nd Prong –
P can prove a demand would be futile by providing reasons to doubt
whether the challenged transactions were a valid exercise of BJR
c. *In this case – was a decision by subcommittee, not whole board so court went to 2nd
prong of Aaronson; Aaronson was a decision by whole board
4.
eee. Corporate Opportunity Doctrine:
i. Different Types of Corporate Opportunities –
1. A business opportunity that is discovered through the use of corporate property, information,
or position should be a corporate opportunity regardless of X’s corporate position
2. A business opportunity that X discovers on his own is a corporate opportunity solely because it
is closely related to the corporation’s business, depends on X’s corporate position
ii. Tests – for determining whether D or O has wrongfully appropriated a corporate opportunity:
1. Interest or Expectancy Test – corporate opportunity doctrine applies only when D or O has
acquired property in which C has an interest already existing or in which it has an expectancy
growing out of an existing right, or when his interference will in some degree balk C in
effecting purposes of its creation
2. Line of Business Test – whether the opportunity was in C’s line of business
a. Whether opportunity is w/in C’s line of business depends on facts and how it relates
to core business function of C
b. This is the test in NY
c. DE – uses an expansive definition of opportunity (Harris case)
i. Test – if O or D is presented with a business opportunity that C is
financially able to undertake, is in C’s line of business, is advantageous to
C, then C has a reasonable interest and D can’t take the opportunity for
himself
d. *Note – a solvent corporation Always has an expectation to expand
3. Fairness Test – (Durfee) not really a test but ad hoc decision by court as to what is fair to a C
a. Test in Mass
4. Mille Two-Step Test – combines line of business and fairness test
iii. Defense: Ability of C to take the Opportunity –
1. X’s ability to raise as a defense, C’s inability to take advantage of opportunity,
2. Courts have responded differently to this as a defense
iv. Three Important Principles of Fiduciary Duty –
1. Corporate-Opportunity Principle – prohibits a corporate fiduciary from taking a corporate
opportunity
2. Use of Corporate Assets Principle – prohibits a corporate fiduciary from using corporate
property, information, or position for personal gain
3. Competition Principle – prohibits a corporate fiduciary from competing with the corporation
v. Remedies –
1. C may recover the appropriate asset or business property by taking profits after an accounting
2. Court may award punitive damages
vi. Northeast Harbor Golf Club v. Harris –
1. F – A country club sued one of its former Ds claiming that D’s efforts to purchase and develop
land adjacent to the club amounted to a breach of fiduciary duty to refrain from taking a
corporate opportunity for herself; She claimed C didn’t have resources to take advantage of
opportunity.
a. 1st Opportunity – came to her in her capacity w/ club; she was a fiduciary and had a
duty to disclose it
b. 2nd Opportunity – came to her while golfing on golf course
2. H – This was a corporate opportunity and it is the responsibility of C – not a director – to
determine if C has the resources to do something.
3. R – A director must make full disclosure prior to taking advantage of any corporate
opportunity and failure to do so is a per se breach of director’s fiduciary duty.

74
 4. *Note – Court adopts ALI principles § 5.02: Key is full disclosure to C of the opportunity
and C has to reject it; BOP initially on challenger, unless no procedures followed, then it shifts
to C. key is formal rejection of the offer by disinterested D of C then conflicted D can act.
a. Criticism that business moves too fast for this to be practical.
cxliv. In re eBay Inc. Shareholders Litigation (2004)
145.IPO case, Goldman bribed fiduciaries of corporations for whom it was doing business. They
got further business as a result of the granting of stocks at IPO prices.
146.Ebay’s agents were under a duty to account for the profits from the transactions that related to
his/her company. The benefits of the IPO belonged to the corporations.
147.This isn’t really the taking of corporation’s property, but kind of a use, the taking of good will
of eBay’s charity.
fff. Duties of Controlling Shareholders:
i. BCL § 903 – Merger: Authorization by Shareholders
ii. Parent and Subsidiaries –
148.Raise many of same conflict of interest concerns as arise between directors and corporations
a. Can arise when directors of the parent serve on the board of the subs

b. Parent by definition has a controlling shareholder position

c. When a sub is wholly owned by the parent (no minority sharholders) parents can
pretty much do what it wants with the sub (duties only owed to creditors)

d. Duties between a parent and a partially owned sub – then several risks exist

i. Sub can declare dividends beneficial to parent at detriment

ii. Sub can adopt no dividend policy which can harm minority shareholders

iii. Sub can issue stocks at less than fair value, or purchase at more than fair
value from parent.

iv. Other difficulties from parent/sub transaction.

v. Parent may take business opportunities away from the sub

e. Corp statutes don’t really guide where parent must not take action detrimental to
minority shareholders of sub.

f. Most ct. accept the argument that parent should be able to exercise its control position

g. Parent sub dealings are subject to a fairness review only if minority shareholders can
show that the parent benefited itself at the expense of the sub

i. Then assumed that parent dominates the board of the sub, and parent must
show that the transaction was fair to the sub.
ii. Approval by a majority of disinterested shareholders may insulate a parent
sub transaction.
iii. Parent / Subsidiary Dealings:
1. Different jurisdictions have differed on the degree of scrutiny that court will give to p / sub
dealings; most courts, including DE, accept that a Parent should be able to exercise a control
position
2. P / Sub dealings are subject to fairness review, only if minority SH can show that P preferred
itself at sub’s expense
3. Approval by a majority of informed / disinterested SH may insulate a P/sub transaction
4. Parent owes a limited duty to its subsidiary
5. This duty is breached when self-dealing occurs – when P stands on both side of transaction and
there is a disproportionate transfer of assets in favor of parent receives a benefit from the sub,
to the exclusion of the sub and it’s minority SH.
iv. Sinclair Oil v. Levien –
1. F – A minority SH in a wholly owned subsidiary sued parent C for causing Sub to pay out
excessive dividends for breach of contract.

75
 2. I – Is challenged transaction self dealing between Parent and Sub
3. H – No; but here, minority SH and P received a similar benefit, so it is subject to BJR instead
of intrinsic fairness test
4. R – When transaction involves a parent and sub, with parent controlling transaction and fixing
terms, the test of intrinsic fairness, with its resulting shift of the burden of proof, is applied.
a. Intrinsic Fairness Test – Apply if there is Self-Dealing
i. Use test when there is self-dealing – when P, by virtue of its domination of
S, causes S to act in such a way that P receives something from S to the
exclusion and detriment of minority SH of S
ii. Self Dealing party has BOP to show transaction was fair to other party
(likely S or minority SH) COI only exists when sub is hurt.
b. Business Judgment Rule – Apply if there is NO Self-Dealing
i. Use when Sub has lost something, but minority SH have rec’d same gains
as parent
ii. P has to show gross overreaching, waste; difficult to win
v. David J. Greene v. Dunhill International – opportunity for S and P took it; here P got an advantage
over S and under Sinclair, this is self-dealing and burden on P to show the transaction is intrinsically
fair to S
vi. Kahn v. Lynch Communications Systems –
1. F – K sued L for breach of fiduciary duties concerning a cash-out merger.
2. H – Committee had no bargaining power, BOP of proving entire fairness doesn’t shift to Kahn.
3. R – A SH owes a fiduciary duty only if it owns a majority interest in or exercises control
over the business affairs of C.
a. To show SH controls business affairs, absent a majority interest – must establish
domination by a minority SH thru actual control of corporation conduct
i. This case Actel owned < 50% of shares of Lynch stock, but board deferred
to it on decision making; did control business (threat of hostile takeover,
not renewing D contracts)
b. Entire Fairness Test: As a controlling SH, D owes SH the fiduciary duty of entire
fairness, including fair dealing and a fair price
i. Fair Dealing – involves the manner in which a transaction is conducted,
including its timing, structure, negotiations, disclosure and approval
ii. Fair Price – focuses on financial considerations of the proposed merger
iii. *Must view both components as a whole to determine fairness
c. Burden of Proof under Entire Fairness Test:
i. Initial burden of proving fairness rests on party that stands on both sides of
the transaction
ii. If merger is considered and approved by an independent committee of
disinterested directors, BOP shifts to SH to demonstrate that the merger
was unfair
1. To shift burden, majority SH must NOT dictate the terms of the
merger and the independent committee must have real bargaining
power that it can exercise with the majority SH on an arms length
basis
d. Application of Entire Fairness Test –
i. Test for when you have an Interested Merger Transaction
ii. Always applies in P / S mergers b/c of the nature of the transaction
ggg. Sale of Control:
i. Zetlin v. Hanson Holdings, Inc. –
1. F – A minority SH claimed that he and other minority SH were entitled to the premium
received by controlling SH when they sold their controlling interest.
2. R – Absent looting of corporate assets, conversion of a corporate opportunity, fraud, or other
acts of bad faith, a controlling SH is free to sell, and a purchaser free to buy, that controlling
interest at a premium price.
ii. Perlman v. Feldmann –
1. F – A steel company’s minority SH brought a derivative action against C’s former controlling
SH for selling his controlling bloc at a premium to a group of buyer’s who were solely
interested in using C’s supply of steel during a tight market.

76
2. I – May a SH sell his controlling share at a premium in any manner he wishes, absent fraud or
foreseeable looting?
3. H – No; As a dominant SH F owed a duty to minority SH; F siphoned off for his personal gain
corporate advantages deriving from a favorable market situation; This diversion of corporate
opportunities represented a breach of fiduciary duty.
4. R – Where a call on C’s product commands an unusually large premium, a fiduciary may not
appropriate to himself the value of this premium.
5. POINT – the exception applied in this case prevents a controlling SH from selling control in a
manner that deprives C of a business opportunity.
a. Control of Corporate Affairs – may be sold at a premium
b. Control of Corporate Assets – this control belongs to C; and C is entitled to any profit
derived from the use, sale, or diversion of corporate assets
6. *NOTE – Blocks of shares worth more b/c they bring more control
ssssss. In this case an independent committee (plus resigning from the board) may
have helped Feldman’s case here.
tttttt. If Feldman was a minority shareholder – he could probably sell his shares.
uuuuuu. Recovery against Feldman – Feldman had to account to shareholders the
premium he was paid – the opportunity was distributed to the other shareholders.
i. Went to the minority shareholders (otherwise it was have been paid to
Wilport, the purchaser) Feldman was allowed to keep his portion.
vvvvvv. Pearlman could be read – control cannot be sold at a premium to those who
would injure the corporation by failing to maximize profits.

77
 CLIII. INSIDER TRADING
hhh.Common Law
iii. Securities Exchange Act § 10(b) and Rule 10(b)(5)
i. SEA § 10b – Regulation of manipulative / deceptive devices
ii. SEA Rule 10b5 – Employment of manipulative / deceptive devices
iii. SEA Rule 10b5-1 – Insider Trading
iv. SEA Rule 10b5-2 – Duties re: Insider Trading
v. SEA § 14(e) – Proxies
vi. SEA Rule 14(e)(3) – Transactions based on Insider Trading re: Tender Offer
vii. SEA § 20A – Liability for Insider Trading
viii. SEA § 21A – Civil Penalties for Insider Trading
jjj. Liability for Short-Swing Trading Under § 16(b) of SEC Act
i. SEA § 16 – Directors, Officers and Principal Shareholders
kkk. 13B (D) filing – under Williams Act (part of SE Act of 1934) – when any person acquires 5% of the
class of public co stock, w/in 10 days of acquisition must send to issuer, stock exchange, and SEC certain
information; facts about identity and bkground of purchaser, # and shares sold, and if purchaser seeks control of
the company, must disclose any plan or proposal; this is triggered by 5% control of stock

Insider Trading
• 1934 Act is a hodgepodge of regulation, including of insider trading.

• §9,10 – manipulation of stock prohibited, 10a – audit standard

• 10(b) - related to fraud in connection to purchase/sale of existing securities, viewed as catch all, not self-executing

• §12, 13, 14 controls corporate information

• 13 – filing of periodic reports with SEC

• 14 – certain materials filed and sent to stock holders

• §16 – provides for the recording of insider transactions and the recovery of short swing trading profits.

• 17 – applies to fraud in the offer or sale of securities.

• 18 – deals with liability for misrepresentation of documents filed with SEC.

• In ordinary commercial transaction, each party free to keep to self any information that might affect value of the
commodity which is the subject of the negotiation. Exception: one party stands as a trustee or in a fiduciary duty to
another, then can’t stand w/o bias.
• Fraudulent to intentionally tell half-truths, also to take intentional steps to conceal the truth
• Jurisdictional basis –
a. Applies broadly to all securities
b. Interstate commerce (telephone call or letter)
c. Can be brought under state law for actual fraud
d. Special facts doctrine – may have causes special duty to disclose
10b, 10b5
• Prohibits manipulative devices
a. Any device or artifice of fraud
b. Misstatement of material fact
c. Omission of material fact necessary to not make statements misleading
d. Any acts or practices in the course of business that operates as defrauding
• 10b-5(b) Remedy
a. Corporate accounting, to make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances under which they were made,
not misleading

Outsider trading – trading on other companies on non-public information is also prohibited. Misappropriating information is often
outsider trading, often called insider trading in the media.

78
Insider – Person, who possesses insider information, knows or should know that the information is non-public, and receives the
information in his/her business capacity, for a legitimate business reason by virtue of his relationship giving access to the
information. Insider exploits advantage whether the information is good or bad.

• Goodwin v. Agassiz It would be a difficult situation if a director could not buy/sell on an exchange w/o seeking out other
party in order to share information. Personal transaction here was ok.

• Strong v. Repide – shares sold for 1/10 of value 3 months after sale of properties to gov’t, using broker. Defendant was
in full charge of the negotiations, and concealed that he was the purchaser. (agent hired to work through broker, to
purchase from seller) Special duty arises when there are special circumstances.

• Old common law majority rule – no duty to disclose if trading over an impartial exchange (because cannot seek out
purchaser) (MA)
• Strong rule (Special Circumstances) – normally no duty to disclose unless there are special circumstances (intermediate)
while director has no relationship to stockholder, has to disclose all special facts that may have a material effect on the
value of the stock.
• Third rule – Kansas 1932, director’s duty is that of a trustee, and director is under a duty to deal fairly with SH and
communicate all material facts that the Dir. knows or should know. (was minority rule) fiduciary duty to SH

• The Wharf (Holdings) Limited v. United International Holdings, Inc.

• F - U had tech capacity, W bidding on cable contract in HK, promised 10% option. U said only would help if given
right to invest. Option to last for 6 month, only able to exercise if able to raise capital. D never intended to honor the
agreement for 10% This case shows how 10b5 and 10b are applied.

• I – did D’s intent to never honor the 10% amounted to a misrepresentation or other conduct which violated 10b5

• H - To succeed under 10b5 – private P must show that the D used, in connection with the purchase/sale of a security,
on of the four kinds of manipulative or deceptive practices.

o 4 parts of basic fraud. – Intent to deceive, manipulate or defraud, material misrepresentation, and
plaintiff must sustain damage through reliance on the misrepresentation.

• Kardon v. National –
• This was the first case to imply a private right of action under 10b5. Affirmed by SCOTUS.

• In the Matter of Cady, Roberts & Co.

• F - SEC administrative hearing. Stocks & options of Curtis Right were sold with light of knowledge of future
dividend. SEC fined selling executive, held that sale acted as a fraud.

• H – there is an affirmative duty to disclose. CR stock could not have been sold w/o disclosing material information
that he knew and the purchaser did not. (This was a transaction on an exchange)

• If information cannot be disclosed, sale must be withheld from closing until information can be disclosed.

o Gintle – seller – came to be known as a tippee. Rec’d a tip from an insider (tipper)
o This applies to somebody who is in a special relationship to the company and has access to information
available only to a corporate purpose. The inherent unfairness that is involved where one party takes
advantage of this news is to be prevented. “Intimacy demands restraint lest the uninformed be exploited.”

• Extended the duty of disclosure in several ways

o Affirmative duty to disclose material information to purchaser

o Applicable to exchange transactions

o Broadened beyond traditional insiders.

o Applies to all participants in the marketplace

79
 o Owed to purchasers of securities, not to holders of securities.

• Tippee inherits the fiduciary duty of the tipper.

• No longer law – following expansion of 10b and 10b5 then SCOTUS cut back & adopted common law rule –
has to be a fiduciary duty between the insider and the person they are trading with (Chiarella v. US)

• SEC v. Texas Gulf Sulphur Co.

Under SEC 1934 act, SEC can bring an action when it appears that a party is about to violate (Test of Cady admin dec.)
• F - TSG finds large deposit, TSG press release considered misleading. SEC alleges that stock was purchased
(options) on the basis of material information regarding the results of drilling that had not yet been disclosed.
• H – anyone in possession of material non public information must either disclose it
to the investing public, or if not allowed, abstain from trading until that
information becomes public.
• Applies to people who are not traditionally insiders.
o Court holds that the duty to abstain applies – arises in the situations that are
essentially extraordinary in nature and reasonably certain to have an effect of the
share price if that information is disclosed. Only basic facts must be disclosed so that
outsiders can judge based on that.
o When to disclose is a business judgment for management.
o If the corporation is helped by non disclosure, those responsible for that policy, cannot
leak to others or trade on their own (in light of this information)
o When insiders can trade depends on the definition of materiality – def – any fact is
material if a reasonable investor would attach importance to it. Any material fact may
affect the value of the stock. Whether facts are material depends on the balance on
when the event may occur and the magnitude of the event.
• R – Material information must be effectively disclosed in order for the investing
public to have this knowledge, insiders cannot jump the gun.
o Would a reasonable investor find the information important in reaching an
investing decision?
• No longer law – following expansion of 10b and 10b5 then SCOTUS cut back & adopted common law rule –
Has to be a fiduciary duty between insider and the person they are trading with (Chiarella v. US)
• What is the meaning of “in connection with” (the sale of purchase of securities)
o Here requirements were met because the press release was the type of information that reasonable people
would rely on when purchasing stock. (reasonably calculated)
o There is no intent necessary that the violator (here TSG) has to be buying or selling stock. (Only plaintiff
has to be buying/selling securities, defendant does not)
One in possession of material non public information has a duty to disclose information or disclose from trading. (applies
to all material information) Materiality is to be determined on the basis of the facts of each case.
• Ct. says that any fact is material if a reasonable investor would attach importance to it and that such information
may affect the value of the stock (p.543)
• Materiality depends on a balancing of the indicative probability that the event would occur combined with the
magnitude of the event.
• Duty to disclose applies only to situations that are extraordinary in nature and are reasonably certain to affect the
value of the stock price. (totality of the company activity) The information to be disclosed is only applied to basic
information, expert information needs not be disclosed.

NOTE - SEC could see other than injunctive purposes in order to effect the enforcement of the rules. (often injunction)
Calculation of reimbursement (by district court) was the valuation of the price on set date and the date that TSG knew the
full value of the mine. Private judgments paid out of settlement fund held in escrow.
Corporation damage – corporate good will harmed, investor relations harmed.
Criticisms of – insider trading may impede the dissemination of information to the investing public, effects the efficiency
of markets. Skews the dissemination of information. Also harm to the corporation and idea of fair play.

• Blue chip stamps case

• Q re standing to sue, P not entitled to sue for violations of 10b5 because persons who are not actual purchaser or
sellers of the security involved cannot face a private action under 10b5. Use as filter to strain out lawsuits

80
• Ernst & Ernst - Another filter for 10b5 regulation – scienter requirement.
• P are investors in accounts who claim that D aided and abetted – they failed to discover practices that should have
been disclosed to SEC, which would have flushed out the fraud that was occurring.

• Lower Ct (7th cir.) holds that any irregularities that should have been discovered will lead to liability. D is held liable.

• H- Scienter is a necessary element of a 10b5 damage action. Therefore conduct by D that was merely negligent
does not give rise to damages or liability. (2nd cir. Later holds that recklessness will satisfy scienter (reckless is
highly unreasonable, extreme departures from standards of ordinary care, 1995 act eliminates recklessness)

• Santa Fe Industries v. Green.

• F - Merger to cashout SH. Min. objected to terms but did not seek appraisal. 10b5 claim – low valuation was fraud.

• Issue – Can rule 10b5 be used to remedy conduct that essentially amounts to a breach of fiduciary duty under state
corporate law? If so 10b5 provides an entre into federal courts.

o May federal courts interpret fraud so broadly so as to catch conduct by a fiduciary that is objectionable
because it was substantially unfair, even if it did not involve lies or half-truths?

• H – 10b5 does not encompass all breaches of fiduciary duty in connection with a securities transaction. There has to
be deceptive of manipulative conduct. No material misrepresentation of a material fact therefore no deception. No
federal cause of action, P has a state remedy.

• R – 10b5 cannot be used as a basis for the development of a federal corporate law of fiduciary duty, rule not
available to mere breaches of fiduciary duty or substantial unfairness in a transaction. 10b aimed at deception
and manipulation.

• Corporate mismanagement is a matter for state court.

• Goldberg v. Meridor - Shows that scope of Santa Fe decision could be limited

• F – partially owned sub purchased parent co’s assets at inflated price, using sub stock as means of pmt. Press releases
failed to disclose material facts not disclosed re: value of assets.

• 2nd cir. Says this is a violation of 10b5. This transaction involved stock, material facts not disclosed, & was deception.

• Followed by other circuits (escape valve for 10b5) not closed by SCOTUS.

• SEC v. Zandford
• F – Securities broker takes on elderly man and retarded daughter, Essentially steals 400k, later convicted of wire
fraud and ordered to pay 10k restitution. SEC then filed civil complaint for alleged violation of 10b and 10b5

• I – does “in connection with the purchase or sale of any security” apply to misappropriation of funds following a legit
sale of securities.

• H - SCOTUS orders Zandford to repay funds. Statute should be construed flexibly, notes that SEC consistently
adopts broad reading of “in connection with purchase or sale of any security”. Says - “a broker who accepts payment
for securities he never intends to deliver, or sells securities with intent to misappropriate the proceeds violates 10b
and 10b5.”

o But 10b and 10b5 cannot be construed so broadly to encompass every type of fraud. Here fraud was not an
independent event (from security transactions)

 If a broker takes advantage of the fiduciary relationship to induce person to act on a fraudulent
transaction, this does not satisfy “in connection with”

 Does not transform every breach of fiduciary duty into a federal cause of action.

• Or facts like Santa Fe. “this is what you’re getting for shares, too bad”

81
• Basic Inc. v. Levinson (cite for materiality of information)
• Company in merger negotiations, makes statements during eventual agreement to merge, issued 3 public denials of
negotiations. P – SH who sold after denials prior to delisting claim that under 10b5 stocks were affected and were
injured when relying on the market price of the stock.

• I – Do misleading or incomplete statements re: incomplete negotiations become material in violation of 10b5

• H – In order to prevail on 10b5 P must show that statements were misleading as to a material fact.

o Ct. adopts substantial likelihood test for materiality – Same from TSC v. Northway, an omitted fact is
material if there is a substantial likelihood that this disclosure would have been considered significant by a
reasonable investor. Materiality in a merger context depends on the probability that the transaction will be
consummated and the significance to the issuer.

o Same as TSG – must be decided on a case by case basis

o Disclosure is the purpose of the securities law.

 Materiality requirement filters out useless info a reasonable investor would not consider
insignificant

• Cites TSG - materiality depends on any given time upon the balancing of both the indicative probability that
the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.

• Statements are not required, but if saying something must be truthful and not misleading.

o Corporation will need to disclose when markets (or exchange) requires information.

o Disclosure is an operation of the BJR.

• Fraud on the market (Basic Cont’d)

• Principal mechanism thought to cause market price to reflect true valuation of company is market competition.

• 1934 act requires periodic disclosures.

• Efficient capitals markets hypothesis. (Securities markets respond very rapidly to newly released information.)

o Fraud on the market theory piggybacks on ECM hypothesis

o Based on hypothesis that in an open and developed securities market, the price of the companies stock is
determined by the material information available regarding the company and it’s business

 Misleading statements will defraud purchasers of stock even if they do not directly rely on the
statement of the corporation.

o Causal connection between D’s fraud and P’s trans of stock is no less significant than case of direct reliance.
o There is a rebuttable presumption of reliance supported by fraud on the market.

o Mkt price transmits info to the buyers/sellers, market performs a substantial part of the valuation process.
(skt acts as an unpaid agent of the inv by informing on value of the stock in light of all available info)

• Scienter, proximate cause, materiality, & reliance, needed to show for damages (basic torts) for suing under 10b5

o First 3 shade into each other in securities area

o Scienter requires P to show that P acted with intent to deceive or defraud

o P must show that statement was the cause of damages. (rebuttable)

82
 o Causation directly implicates materiality requirement, P must show that reasonable investor would
considered the statement important. If a reasonable investor considers something important it will affect the
price of the stock, which brings back to causation.

• Stock was sold on a depressed market that was created by management (Basic)

o Reliance test fades into materiality standard

o Ct. adopts rebuttable presumption if fail to disclose– absent proof to contrary, plaintiff relied on information.
• Would be too hard to prove this for a class action, so court accepts a presumption of reliance if information is
material (therefore causal connection between D’s misrepresentation and P’s injury)

o Information transmitted to investor in form of the market price.

• Investor is entitled to rely on market absent of any evidence of reliance on misrepresentation of D.

PSLRA—private securities litigation reform act.

What LRA does is establish appointment of lead plaintiff in securities actions. After the filing of a securities fraud class action, the
p has to give notice to potential class members inviting them to serve as lead class members. Supposed to appoint most appropriate
class member with a significant financial stake in the action. Limits to the frequency a particular individual can serve as lead
member.
Congress also requires scienter to weed out class actions. Two components: 1) specific intent to mislead; 2) or the defendant acted
recklessly. Unler LRA, recklessness isn’t sufficient scienter under 10b5 for forward looking statements. What about statements
that are not forward looking? Open. Fraud under the federal rules needs to be pleaded with particularity. Under the 2nd circuit, the p
must state with particularity facts which give a strong inference to the requisite intent. Under this standard, the p could establish
the required strong inference by detailed factual allegations that show a direct evidence of scienter and 2) the D had motive and
opportunity to commit fraud. To prove the 2nd prong p had to allege d benefited in some concrete and personal way from his
purported fraud
What would have been strong inference that person acted with required intent to show scienter? 7th circuit said if the complaint
alleged facts, which if true a reasonable person could infer that the d had requisite intent that was enough.
You have to look at all of the evidence pled to see if there was sufficient motive of the plaintiff that there was intention to commit
fraud.
A person who doesn’t improperly trade may nevertheless aid or abet another who does. For instance an accountant or a lawyer.
There had to be some degree of knowledge by the aider and abettor that his role furthered improper activity. Had to reach some
level of significance in furthering improper activity.
Liability cannot be imposed on a person under 10b5 solely b/c that person aided and abetted a violation of the rule. The ’34 act did
not include giving aid to a person who commits a manipulative or deceptive act by allowing them to rope in deep pockets.
Secondary actors could not be sued on aiding or abetting theory but could be sued as primary violators.
Secondary actors are not always shielded from 10b or 10b5 actions. Court adopted an SEC proposed rule for primary liability of a
2ndary party: when a person acting alone or with others creates a misrepresentation on which investor p’s rely, person can be held
as a primary violator if he acts with the necessary scienter. In 01/08, SCOTUS examined whether a private right of action extended
to a suit against an aider and abettor.
Upon whom were the investors trying to impose liability? No economic substance to transaction, and charter had fake documents
to show separate transactions and charter would book fake advertising revenue, showing that charter’s income was a lot higher
than it really was. Two vendors were scientific Atlanta and Motorola. Charter paid extra for the cable boxes and money flowed
back in form of advertising. Vendors essentially knew what was going on, booked the transactions as a wash on their financial
statements, so scientific Atlanta and Motorola were aiders and abettors. Court said: no private right of action for aiding and
abetting. Actions by scientific Atlanta and Motorola, plaintiffs didn’t rely on them. They relied on charter, and since there was no
reliance on the aiders and abettors by the p’s the 8th circuit found in favor of the D. aiders and abettors had no duty to disclose to
the public and therefore petitioners did not rely on them.
Petitioners say the fraud itself wouldn’t have succeeded if the D’s hadn’t participated in it.

Court’s concern was that it would just go everywhere. Reliance is tied to causation and the actions of Motorola and scientific
Atlanta were remote to the injury. It was charter, not Motorola or SA who mislead auditor. P’s were trying to extend 10b action
beyond the securities marketplace to normal business actions. Court says 10b doesn’t reach all common law fraud. Does this mean
aiders and abettors will completely get off? No, SEC will go after them. Court is concerned that p’s with weak settlements will
extort innocent co’s. if you have a secondary actor who commits a primary violation they could still be covered.

Insider trading
Chiarella v. US
83
Chiarella was someone who was setting type and he deduced the names of the companies merging etc.
Supreme court rejects possession theory (where you have to abstain or disclose). Court said C didn’t have affirmative duty to
disclose b/c he wasn’t an insider. Abstain or disclose rule applies only to those who have fiduciary duty. When does the duty to
disclose arise? When you are a fiduciary and the other party in the transaction is entitled to know because there is a relationship of
trust and confidence between them.

C doesn’t have to disclose or abstain because more possession of non public knowledge is not enough. C doesn’t have a duty to
anybody who has shares in corporation B, nor does he have a duty to corporation B. court rejects parity of information rule.

What is the basis of Tippee liability? Only if the insider has fiduciary duty in giving tippee information. Tippee’s obligation has
been viewed as arising from his role as a participate after the fact in the insider’s breach of a fiduciary duty.
If the tippee knows that it is confidential info then the tippee’s obligation arises out of the tipper’s breach.
There is no fraud when there is no duty to speak. If we were talking about the director of corporation B, he would have to abstain
or disclose.
Plaintiff would have to allege in order to get a conviction that there was a duty owed to the public or to the employer or to the
acquiring corporation or its shareholders. C stands for not every instance of financial unfairness constitutes fraudulent activity.

14a(e)(3) says prohibits trading by anyone who gets information directly or indirectly from either someone from Corp A or
Corp B. the rule also prohibits insiders of the offeror as well as tippers. No reason under 14e3 that tipper need breach
fiduciary duty.

A duty to disclose information arises if there is a relationship of trust and confidence between parties to the transaction. Chiarella
had no such duty. He was not a corporate insider in the acquiring corporation and he did not receive confidential information from
the target company. He also had no fiduciary relationship with the shareholders of the target company: he was not their agent; they
placed no trust or confidence in him; indeed, they had no prior dealings with him. A duty to disclose under Section 10(b) does
not arise from the mere possession of nonpublic market information.

Dirks v. SEC
o F – Dirk got information from Secrist who had been fired and disseminated information which affected the stock price.
Dirks tipped off firms and funds. How does dirks differ from C in source of nonpublic information. in C, C obtained
information on his own efforts.. Dirks is charged with aiding and abetting.
o I – When are individuals other than corporate insiders obligated to either disclose material non public information of
disdain from trading.
o H - Dirks reaffirms Chiarella – There has to be the existence of a relationship or a duty affording access to inside
information that was intended to be available for corporate purpose. Duty under 10b and 10b5 does not arise from mere
possession of non public information. Absent a breach from an insiders there is no derivative action available. The United
States Supreme Court held that Section:10(b) should not be read so broadly as to hold tippees liable when they use
inside information received by insiders who were not breaching their fiduciary duties in their disclosure. The Court
held that the insider must first breach a fiduciary duty and then the tippee’s conduct will be examined to see if they
breached a duty.
• Most important part is footnote 14 (p.591)

• Under certain circumstances corporate information is revealed legitimately to an underwriter, accountant,

lawyer or consultants working for the C, these outsiders may become fiduciaries to the SH, they are
temporary insiders. Lawyers and accounts can be held liable for insider trading under certain circumstances.
(outsiders may become fiduciaries to the insiders.)

o Basis is the special confidentiality and access these people have

o When they breach they are not tippees, they are tippers.

o They are required to disclose or not trade when there is a relationship of trust between shareholders &
directors that has given access to information meant to be confidential, but merely having possession of
information is not enough. Breach of duty depends on the purpose of the disclosure, will the insider benefit
directly or indirectly from the breach, absent personal gain there is no breach (objective criteria)

 Does not mean that tippees are off the hook, but any action is derivative, and there is a
relationship between the tippee and tipper, in this situation the tippee will be held liable.
• This duty to not trade of corporate insiders is held to the shareholders and the corporation itself.
• Classic insider must disclose or abstain from the trading of stock if the information is non public material

84
 • Dirks deals with when information held by people other than officials.
o Chiarella tells, Dirks reaffirms, that there has to be a duty (due to relationship) to withhold corporate
information where there would be an obligation to retain the information as confidential.
o Duty under 10b and 10b5 does not arise from mere possession of non-public market information.
• P.593 – whether there is a breach of duty depends in large part on the breach

o Absent a breach of an insider, there is no derivative action.

o Will the insider benefit either directly or indirectly from the breach

 Pecuniary gain or reputational benefit that may translate into future earnings

 Relationship may suggest quid pro quo

o If the tippee has knowledge or scienter that the information source has knowledge that the information
shouldn’t be used, then tippee is guilty like a classical insider.

• Concern of the court if the Dirks conviction was upheld – it would have a negative effect on the efficiency of the
market, would discourage security analysts and impose liability on anyone in possession of non public information.

o Would have an impact of market analysts and w/o investigatory efforts of them corporate frauds would
not be discovered, and investors will be harmed.

• Basis of tippee liability from this case –

o must know it was breach of fiduciary duty insider used confidential info that shouldn’t have been
disclosed

o Courts will look at the purpose of the insider and will the insider personally benefit.

• Did Seacrist violate his fiduciary duty, he had previously been fired from equity funding and there was no evidence
that his disclosure deceived or defrauded anybody. Ct. says that he did not personally or directly receive any benefit.

• Test for materiality of information – would a reasonable investor chance their mind on an investment in light of
the insider information?

o Can argue here that a reasonable investor might have regarded the information as preposterous – WSJ
and SEC didn’t take the information when offered.

o Seacrist was just fired, his information could be retribution, had a long rap sheet, no credibility.

o So arguably the information was not material.

o Information concerning criminal activities is not regarded as inside, it doesn’t belong to the corporation,
and may belong to the government (investigating the crime)

• SEC v. Yun (note case) – builds on Dirk, showing a benefit does not have to be exclusive.
o “The showing needed to prove an intent to benefit is not extensive. The Supreme Court in Dirks, after
establishing the tipper benefit requirement, proceeded to define ‘benefit in very expansive terms.’

SEC after Dirks and Chiarella – Misappropriation theory - developed alternative basis for insider trading - liability can occur
under 10b5 when a person trades on confidential information even when the source is not direct. (fiduciary relationship)
(misappropriation theory, had mixed results in course)(criticism is that it is not an active type of fraud, difficulty in seeing this
misappropriation as a fraud in connection to a securities transaction, if the victim is unlikely to engage in any securities trading at
all)

Chester case - unilaterally trusting someone with confidential information does not create a fiduciary relationship. SEC creates
10b52 following this case.

Carpenter v. US – WSJ reporter (author of heard on the street) SCOTUS split 4-4 on misappropriation theory (therefore no
precedential value)
85
United States v. O’Hagan - affirmed misappropriation theory
• F - O’Hagan was a partner in a law firm, represented client, and purchased calls on information known, then sold when
information of offer to purchase company. ~$4.3m profits. SEC prosecutes under fraud using 10b-5 and 14e-3(a)

• I – was this really “in connection with the purchase/sale of securities” – court finds that it was closely enough linked to
the stealing of information and securities transaction to bring it under 10b5 (v. santa fe industries, which was not fraud)

• H - basis for liability - he breached the duty owed to the source of information. He deceived those people.

• Misappropriation theory outlaws trading on the basis of non-public information by a corporate outsider, in breach of a
duty owed not to the trading public, but due to the corporation.

o As an outsider, he owes a duty to his firm, and the firm’s client.

o Ct. finds that O’Hagan’s conduct was a fraudulent device in connection of the sale or purchase of securities.

• Upheld 14e, prohibiting fraud actions in connection with a tender offer.

o 14e3 violated when trading with information acquired directly or indirectly from an insider. Court upholds this
as a reasonable rule designed to prevent fraudulent trading.

• O’Hagan suggests that there could be no 10b5 insider trading if there was no breach of trust or confidence. Thus a
person who gains access to material non public information such as by theft would not cease to be guilty of fraud
sanctions. If the person who steals the information discloses, or receives information from the source, there would be no
breach of duty, thus no 10b5 violation.

o O’Hagan leaves unanswered who has duty for breach of confidence, and when does this duty attach.

SEC v. Rocklage
• Wife took confidential information from husband, president of a publically traded company, who then tells brother
leading to trades on information.

• Liability is found on misappropriation. This is not insider trading, Mr. Rocklage expects or receives no benefit.

• Mrs. Rocklage contends that she didn’t violate 10b5 because she told husband that she was going to tell brother. Court
deals with by deciding that telling wasn’t the deception, but was in tricking husband to reveal confidential information.

• Case differes from O’Hagan – doesn’t deal with if he tricked firm in gaining access to information. Here was a scheme in
getting the information, deceived husband initially, when gave to brother it was another deception.

• 10b5-2 – rule promulgated in aftermath of Chester case – applies misappropriation to person obtaining non-public
material information from spouse, partner, or child. Closes family relationship loophole. Person receiving
information has to demonstrate no duty of trust of confidentiality.

• SEC’s position on pre-tip disclosure, that she told husband she would tell brother, marital privilege prevents him from
getting an injunction on wife to stop use of information.

• Unlike in O’Hagan (one deceptive device) here there are sequential acts of deception (to qualify as a scheme)

• Mrs. Deprived Mr. Of exclusive use of the information. Relied on the WSJ (Carpenter) case. Mrs found guilty.

SEC v. Talbot
• Director of fidelity nat’l bank, (part owned company, lending tree)

• Director or lending tree tells that there was an offer from 3rd party, who then mentions with CEO of fidelity. Leading to
discussion among board, (happy with potential sale) board member states it is confidential information (info from
lending tree -> bank was not classified as confidential but known to be)

86
 • Talbot is only one on board who buys calls and stock on lending tree, sells stock after confidentiality agreement. Indicted
for these actions.

• Trial Ct. holds that fidelity, lending tree, Talbot were not linked through fiduciary duty. Reversed that Talbot should have
known this information was material and confidential. Remanded to determine if material information.

• So long as it is a link in a chain, then there is a scheme in connection with the purchase/sale of securities.

December 7, 2010
§16 of the 1934 SEA has been criticized as a trap for the unwary, seeks to limit insider trading. 16b requires 6 month wait to
sell/buy stock from information.
16a – purpose – means to bring to light possible violations of 10b5 as well as purchases and sales in light of 16b (inside directors,
officers, 10% shareholder report requirements) also is a disclosure device that may be used by others in evaluating the security of
others. May be used to detect an involving change in control. Deterrence to certain insider trading because it is so publicized.
Text p.613 – 14 benefits of §16 –
Also penalizes the unfair use of inside information by insiders, and the use of softer types of information that members of the
investing public may not have, but the directors do.
Also want to eliminate the possibility of insiders to manipulate corporate events to benefit themselves.
Under 16b squeeze out maximum profit possible, match lowest purchases against highest sales over six months, disregard losses,
sum = profit.
Potential 16b violation is also a violation of 10b5, but sometimes 10b5 not 16b or vice versa.
16b liability is often referred to as draconian, it is strict liability. Under 16b all loss sales are disregarded.
16a1f – in terms of who comes under 16b, and is an officer, look at those who perform significant policy making functions. Titles
becomes less significant then function person is engaged in.
deputization theory – director may be held to be representative of corporation (hedge fund/ dr corporation relationship) is the
hedge fund subject to 16b liability?
• Succeeded in 2nd cir case – Feder v. Marietta. Stock purchased while bunker was director (deputization) was returnable to
corporation due to transaction within 6 months.

o Must you be an insider at the time of each transaction? SCOTUS 1970’s case – language of subsection does not
apply to person who becomes 10% owner at time of transaction. (need to be 10% at both ends of transaction)

o One need not hold post of director at both ends of the transaction (sale & purchase) for 16b to apply.

Exam
5 questions
1 includes series of short answers
different time allotments for questions.
Open book – can bring stat sup, casebook, outline,
No page limits, but no need to type needlessly.

87