Single
owner, no formality requirement. Only
have to file with the state if doing business under fictitious name. Significant risk for liability, no shield. If the business grows and an employee is
hired, the relationship becomes one of the principal and agent under the
authority of the principal.
·
Has
sole decision making authority
·
An
exclusive claim to business profits
·
Direct
ownership of all business assets
·
Legal
identity of the sole proprietorship and its owner are one, no business entity
·
Unlimited
liability
When principal instructs the agent to act, or expressly authorizes the agent to act in certain circumstances.
Legal fiction – provides authority where it would be
necessary or natural for the agent to act.
Protects 3rd parties
who want to bind the PRINCIPAL when there is a manifestation that creates a
reasonable expectation that the agent has authority to act.
·
Fennell – his lawyer agreed to a settlement, but the principal did not
authorize it. The court said that the attorney was NOT clothed with apparent authority
because there wasn’t a manifestation to the third party that his attorney would
have the authority to settle.
·
African Bio-Botanical – Agent must fully disclose the principal to be
released of liability.
·
Where
3rd party knows identity of the principal involved, agent not
liable.
Watteau - Joe owns and runs a bar called “Joe’s Bar”. One day he sells to Smith, who lets Joe
continue to run the bar, leaves the name alone but requires Joe to only buy
beer mugs from Smith Mugs, Inc. Joe
continues to run the bar, buys mugs from Smith, but also continues to buy mugs
from Jones. One day, Joe stiffs Jones
and Jones finds out that Smith actually owns the bar. Under inherent agency
authority, Jones successfully collects from Smith.
Doherty – Doctrine of ratification imposes liability for agent’s
unauthorized acts. Here there was an
attorney drafting codicils to a will.
To the extent that the codicils were incorrectly drafted, they were
“ratified” by the testator, thus the lawyer was relieved of liability.
Another method of recovery for 3rd
parties that have suffered from an agent’s unauthorized conduct.
Agent
has a high fiduciary obligation to the principal, to act in the best interest
of the principal.
· Tarnowski – all profits made by an agent in the course of an agency belong to the principal, whether they are the fruits of performance or the violation of an agent’s duty.
A
Partnership is an association of 2 or more persons to carry on as co-owners a
business for profit.
·
No
need for a written agreement.
·
Partnership
can be created from one transaction
·
Things
the partnership agreement can NOT change:
1.
The
filing requirements
2.
Unreasonably
restrict access to the books and records
3.
Can’t
eliminate the duty of loyalty
4.
Reduce
the duty of care
5.
Eliminate
obligation of good faith and fair dealing (can
limit though)
6.
Can’t
alter the power to dissociate as a partner
7.
Can’t
vary the court’s discretion to expel a partner
8.
Can’t
vary the wind up requirement
9.
The
P’ship agreement cannot alter joint and several liability to 3rd
parties.
10.
Can’t
vary the law applicable to registered LLPs.
·
§16202
– purpose is to make a profit, need to associate as co-owners, need to share
ability to control business decisions.
Any person receiving a share of the profits is presumed to be a partner unless:
1.
mere
sharing of gross returns
2.
joint
tenancy, common property does not establish a partnership
3.
debt
repayment
4.
rent
payment
5.
independent
contractor for wages
6.
annuities
payment or retirement benefits
7.
payment
of interest on a loan
Courts usually give weight to intent, by looking to
see if a person tried to restrict their rights in managing the
partnership.
Actual control of the day to day business is more
determinative.
·
Martin
– here, even though D shared in the profit and had veto power, court did not
find an existence of a partnership because his actions were only safeguards for
his loan. Where a person shares in
profits, but delineates in agreement that he is NOT a partner AND has no degree
of control over partnership decision, Courts will be reluctant to find a
partnership b/c the control factor is the essence of a partnership.
·
§16202(c)
– if you don’t indicate any particular degrees of control or profits, it will
be presumed to be a partnership.
·
Typical
safeguards for a Lender-Debtor relationship, even though they may impact
control:
1.
provision
on the use of proceeds/profit
2.
right
to inspect books
3.
limited
ability of the borrower to incur add’l debt
4.
provision
stating change in CEO makes entire loan amt due immediately
5.
limits
on distributions of assets, dividends, etc.
§16305
– Partnership is liable for acts of the partners.
§16306
– Partners are jointly and severally liable for ALL obligations of the
partnership.
When
not expressly stated in the partnership agreement, §16401 provides that each
partner is entitled to an equal
share of the profits/losses, regardless of the contribution.
·
Services
are not provided for statutorily, so if a partner will be contributing more
services and less capital, put it in the partnership agreement.
·
No
partner is entitled to remuneration for their services except for winding up
the partnership.
·
§16807(b)
– if there’s a deficiency in the account during windup, requires partners to
contribute to payoff all creditors.
· Richert – joint logging venture. When a partnership ends, the capital contributions of each GP must first be repaid before profits are distributed. Then, profits, losses, dividends may be paid out.
Co-partners
owe to one another the duty of loyalty and the duty of care. §16404
1.
account
to the partnership any partner info, property or opportunity
2.
refrain
from dealing with parties adverse to the partnership
3.
refrain
from competing with the partnership
4.
refraining
from grossly negligent or reckless misconduct, intentional misconduct or
knowing violation of the law
5.
a
partner does not violate this duty merely by furthering his own interest
6.
a
partner may lend $ to and transact other bus w/the partnership
·
Meinhard – partner must disclose opportunities to other partners out of
fiduciary duty.
The
Partnership is an entity and the assets are owned by the entity, rather than by
all the individuals. Each partner has a
partner account
·
§16401(g)
– a partner may use or possess partnership property only on behalf of the
partnership.
§16301
– each partner is an agent of the partnership and can bind the partnership in
the ordinary course of business. Exc – if partner had no authority to act in
the dealing and the other party was aware that the partner had authority.
§16401(j)
– if outside the ordinary course of business, then need the consent of ALL the partners to bind the partnership.
§16401(f)
– unless stated otherwise in the p’ship agmt, each partner has equal rights in
management of the partnership.
§16503
– a partner may transfer only the profit
interest in the partnership, not the management of the partnership, w/o the
consent of the other partners.
·
By
itself, it does not cause the dissociation or a dissolution and winding up of
the P’ship.
·
The
partner retains all the rights and duties of the partner.
§16601(4)(B)
– if there has been a transfer of all or substantially all of the partner’s
interest, the remaining partners may unanimously vote to expel them.
§16303
(d) – a partnership that wishes to limit authority of certain partners may file
a supplemental authority statement, which puts 3rd parties on notice
of the ability of the partner to act and transact on behalf of the p’ship. For real property, file statement with
county recorder’s office.
·
Nabisco – 2 person partnership, conflict on choosing bread vendors, but one
went ahead and ordered anyway, the other refused to pay. Court held that the partnership still bound
to pay for the bread, which the other partner had the authority to order.
§16308
– If 3rd party relied on
representation by a party that they are a partner, then they will be treated as
a partner. To be liable, there must be
an affirmative act of
representation, in a public manner.
§16308(c)
– a person is not liable merely because someone else names them as being a
partner.
·
Standard Oil – father not liable w/o affirmative act. Possible to have implied consent in the rare event that someone
confronts the alleged partner and they fail to deny.
·
When
one party leaves, they “dissociate”, which could but not necessarily cause the
dissolution. The partnership is an
entity, so it still exists if 1 out of 3 partners leaves.
§16601 Events causing dissociation:
1.
partner
gives notice of express will to withdraw from the p’ship
2.
event
agreed upon in the p’ship agrmt occurs
3.
expulsion
pursuant to the p’ship agrmt
4.
unanimous
vote to expel for the following reasons:
·
illegal
to deal w/that partner
·
transfer
of that partner’s interest
·
a
corporate partner’s charter has been revoked, or it has filed a certificate of
dissolution
·
a
partnership, LP, or LLP has been dissolved and is winding up.
5.
judicial
act to expel for the following:
·
partner
engaged in wrongful conduct that adversely affected the p’ship
·
partner
willfully or persistently committed a material breach of the p’ship agrmt or
duty owed to the p’ship or other partners.
·
Partner
engaged in conduct making it unreasonable to carry on business with p’ship.
6.
partner’s
act or failure to act:
·
by
being insolvent, going bankrupt
·
assigning
interest to creditors
·
agreeing
to the appointment of a trustee/receiver to liquidate most or all of the
partner’s property.
·
By
failing to stop the appointment of above
7.
occurrences
in the individual’s life:
·
death
·
appointment
of guardian or conservator (incompetence)
·
judicial
determination of incapacity to serve
8.
partner
that is a trust, distribution of trust property
9.
partner
that is an estate, distribution of that estate
10.
termination
of a partner that is not an individual, partnership, corp, trust or estate.
·
§16602
– a partner has the power to dissociate at any time, rightfully or wrongfully.
·
§16701
– if a partner is dissociated from a p’ship, their share will be bought out by
the p’ship. Liquidation value = value
at date of dissociation, plus interest
·
§16801
– what causes dissolution:
1.
partnership
at will – half the partners agree to dissolve and terminate
2.
partnership
for a term (fixed undertaking): dissociation by bankruptcy or death, wrongful
dissociation by a partner, an automatic dissolution will happen unless the
remaining partners agree to continue the partnership.
3.
Express
will of all partners to dissolve
4.
An
event that makes it illegal for the partnership to continue doing business
5.
Judicial
determination
·
When
you have a dissolution, you automatically have a winding up/liquidation
·
§16802
– on dissolution, the p’ship is not terminated, but continues until the
“winding up” of p’ship affairs is completed.
·
An
association of 2 or more persons or which, at least 1 is a GP and one is an LP.
·
GP
has full personal liability for partnership debts, assumes management
responsibilities and control – GP can be a corporation.
·
LP
contributes cash, other property or services but is not active in running the
business and their liability is limited to their investment.
·
LP
liability is limited to amount of investment
·
Attracts
more funding
·
LP
taxes are attributed to each partner’s profits. Corp. entities are taxed separately.
·
Filing
required (unlike GP) – need to disclose to public that there are some limited
partners.
·
§15632
– When an LP takes active control in the business s(he) becomes a GP. If an LP participates in the control of the
business w/o being named as a GP, that person may be held liable as a GP only
to persons who transact business with the LP w/actual knowledge of that partner’s participation AND with a reasonable belief that the partner is a GP based on the LP’s
conduct at the time of the transaction.
·
LP
does not take part in control by doing any of the following:
1.
being
a contractor, agent, or employee of the LP or transacting business w/a GP
2.
being
an officer, director, or shareholder of corporate GP
3.
consulting
or advising a GP (unless there’s a serious impact)
4.
acting
as a surety for the LP or the GP
5.
voting
or calling a meeting of the partners
6.
approving
or disapproving an amendment
·
Future
claims – no liability if certificate filed promptly
·
Past
claims – not liable unless 3rd party reasonably believed he was a GP
·
§16101(6)(A)
– for lawyers, CPAs and architects.
Must be registered
·
§16306(c)
– a partner in a registered LLP is not liable or accountable for debts,
obligation,s or liabilities of another partner, whether arising in tort,
contract, or otherwise.
·
§16306(e)
– partner is still liable for personal tortious conduct.
·
§16956
(1)(A) – LLP required to maintain an insurance policy of $100k for each
partner, shall not be less than $500K and doesn’t need more than $5M.
·
it’s
a variant of the GP, so maintains the same tax benefits but shields partners
from liability of a general partnership
A corporation is a shielded entity, and can only be
created by the state. The investors of
a corp have limited liability and creditors understand that any liability must
be satisfied out of the assets of the corporation.
·
Must
file Articles of Incorporation, can be formed by 1 or more persons. Existence of a corp. begins upon filing
§200.
·
§202
– Articles must state:
1.
name
of the corporation
2.
purpose
of the corp
3.
address
for service of process
4.
#
of authorized shares
It is difficult to amend the AOI, requires a
shareholder vote for approval.
·
After
filing, an organizational meeting occurs where:
1.
Board of Directors are elected
2.
§212 Bylaws are passed – not public record, this is kept internally
w/the records of corporation. The
bylaws contain duties of officers, corporation seal, # of officers. Management may alter the bylaws w/o
shareholder approval.
·
Common
Stock – owners have residual rights to the profits of the corp, right to vote
and control.
·
Preferred
Stock – owners have priority rights that limited to the investment document
they entered into. (VC’s get this to cash out.) Bylaws specify the rights of preferred stock owners. Anything left over is reserved to the common
stockholders.
·
Other
than stock, corps can take loans (corp IOUs), or make money from licenses of
their patents.
·
Officers
– execute the policy of the board, run the day to day operations
·
Board
of Directors – directs and manages the affairs of the corporation, elects the
officers
·
Shareholders
– elect the board, own stock, not involved in management
1.
Promoters
·
Function
– participate in the formation, arrange legal compliance, secure capital, enter
into contracts pre-incorp
·
Fiduciary
Duty – promoters owe this duty to the corp they are formng, should not make
secret profits on selling property to corp.
They are in charge of creating the corp, and signing for a corp which
does not yet exist (ie, commercial lease).
2.
Liability
·
Promoter
signing for non-existent corp is personally liable when no corp is formed (even
if promoter says only want to be liable as agent of corp).
·
If
corp is formed, promoter is still liable b/c law rejects idea that promoter was
agent of principal (corp) since the principal did not exist at time of k.
·
NOVATION
– is the only way principal can avoid being liable, agreement w/3rd
party that they will look only to the corporation to repay obligation. If no agreement, promoter still personally
liable.
·
3rd
party v. new corp – when corp knows the benefit they’re receiving, or promoter
still in control of corp. then 3rd parties can enforce against corp
after it’s formed, even if the corp doesn’t adopt the k.
·
A
new corp. can enforce k against 3rd party if 3rd party’s
rights have not been substantially altered, contract is not necessarily void.
·
Southern Gulf – 3rd party k w/promoter to build ship for the corp, 3rd
p wants to break the k, so argues that corp was formed in different place than
they were told. Court said 3rd
p still got what they bargained for, k valid.
·
If
the Corp failed to comply w/statutory formalities for incorporation (papers not
filed), there may not be a valid corp.
Whether owners can be held liable for corp debts depends on whether a
corp exists, de facto, or by estoppel.
1.
de
facto (not followed in CA or majority j/x)
·
existence
of a statute under which you have incorporated AND
·
an
effort in good faith to incorp under existing law (difficult to prove) AND
·
conduct,
acting like a corp (using corp powers, issuing stock etc)
2.
Estoppel
(doctrine exists in CA)
·
Different
than normal estoppel, which protects P (D is estopped), here P is the one
estopped from denying existence of corporation b/c acted like a corp
existed. Court holds the attacking
party is “estopped” to treat the entity as anything other than a corp.
·
P
must have dealt w/entity as if it were a corp, in effect admitting its
existence as such
·
P
must have relied on credit of corp, rather than that of shareholders or
officers
·
In
most j/x, courts will allow estoppel doctrine for investors (who didn’t have
any management control) to avoid personal liability when defective incorp
occurs.
·
Under
CL, acts beyond the corporation AOI were held to be “ultra vires”, and were
unenforceable, but there were numerous exceptions.
·
§207
– A corp shall have ALL the powers of a natural person in carrying out its business
activities
·
§207(e)
– can make charitable contributions, s/h can restrict this in AOI (cannot be a
“pet charity” of the board)
·
§207(h)
– gives corp power to enter into a p’ship
·
§207(f)
– power to pay pension, carryout profit sharing, bonus plans
·
§207(g)
– allows corp to secure debt w/assets of its franchises, property, income
Powers can be limited in AOI, must be explicitly
stated what the corporation cannot do.
Even
if corp has been properly formed, the owners can still be personally liable to
creditors.
·
GR: courts will pierce
whenever necessary to prevent fraud (tort) or to achieve equity (k)
·
GR for nonK-tort: if corp is
run for profit, there are sufficient assets and formalities are followed,
unless it is totally egregious, the court will not pierce.
Factors:
1.
fraudulent
representation by corporation directors
2.
undercapitalization
3.
failure
to observe corporate formalities
4.
absence
of corporate records
5.
payment
by the corporation of individual obligations, OR
6.
use
of the corporation to promote fraud, injustice or illegalities
·
Occurs
most commonly with close corporation and parent/subsidiary corporation.
·
Party
asking to pierce must prove that honoring the separate corporate existence
would cause fraud, inequity or promote injustice. Act of the corp must have misled 3rd party to their
detriment.
·
Walkovszky (tort) – one owner, numerous
small taxi corporations, each holding the minimum insurance, with few
assets. Court held that
undercapitalization alone was not sufficient to disregard corporate shield as
the structure was not illegal.
·
Baatz
(tort) – dram shop, family run bar.
Court found no indication that corp was set up as fraud to avoid
liability.
·
Sea-Land Services (reverse pierce) – d owned 4 corps, p was owed $ by one of them that
had no assets, so went after assets of sister corps (not owner). If you can show that all of the corps are
essentially engaged in a single enterprise and just artificially
compartmentalized, you can attach to the assets of the entire enterprise.
·
Kinney Shoe – P wants to sue D personally for rent owed by one of D’s corps. Court found undercapitalization and no
formalities were followed, so allowed piercing. Court looked at “totality of the circumstances”:
1.
unity
of interest and ownership (owner indistinct from corp)
2.
equitable
reason for piercing
·
Equitable
subordination (used if piercing fails) – applies to bankruptcy settings and is
NOT piercing the corporate veil. Court
subordinates a shareholder’s loan, raising priority on debts held by other
creditors.
·
known
as Deep Rock Doctrine, occurs in
bankruptcy. If SmallCo sells all shares
to BigCo for $5K, and BigCo turns around and lends SmallCo $50M. BigCo’s “loan” is not really a payment
obligation, so if SmallCo goes bankrupt, the court will allow other creditors
to attach first, ensuring some payment, as opposed to virtually nothing if
BigCo’s “loan” were repaid first.
Reasons for subordination:
1.
loan
was part of a capital structure which consisted of too high a proportion of
debt
2.
s/h
corp $ really meant as contribution to capital, not “loan”
3.
claim
creditors had no prior warning of evidence for subordination
4. s/h engaged in transaction which unfairly hindered collection of creditor claims
GR – the right to manage the
corp is vested in the BOD, not in the S/H, unless otherwise provided in the
AOI, by law or valid agreement
·
President
or VP may bind the Corporation even if they have no actual authority b/c they
have “apparent authority” to 3rd parties.
Board of Directors (elects
officers)
|
Officers
|
Shareholders (elects BOD)
1.
Rights
and powers – under §300, “all corp powers shall be exercised under the ultimate
direction of the board.”
2.
Number
of directors allowed - §212 requires no less than 3, can be a range.
3.
Filling
of vacancies – under §305, BOD approves new member, unless vacancy was by
removal, in which case, the S/H get to fill that slot.
4.
Formalities
required for action by the board – need to act by resolution or vote at
properly called meeting, at which there is a quorum.
a.
Quorum
§307(a)(7)
·
Min.
# of ppl needed to transact business
·
Members
need not be physically present as long as they can hear each other (phone/video
conference)
·
A
majority of the authorized # of
directors constitutes a quorum
1)
if
5 directors and 2 vacancies, still need majority of authorized directors, so 4
out of 7.
2)
Articles
or bylaws may state that a quorum is other than majority, but
3)
Quorum
can never be less than 1/3 of the authorized # of directors, so 3 out of 7.
b.
Meetings
– can only be called by the chairman, president, vp, secretary, or 2 directors.
c.
Notice
·
Regular meetings of the board may
be held w/o notice if time and place are fixed by by-laws
·
Special meetings require 48 hours
notice by phone/personal service or 4 days by mail (starting when placed in
mailbox, regardless of when received).
·
Notice
doesn’t have to specify the purpose of the meeting
·
AOI
& bylaws may not dispense notice, but
·
Waiver
of notice - if a quorum cannot be
attained, action may be taken w/out meeting if
1)
all
members give a unanimous written consent to that action and their consent is
filed in the minutes.
2)
Approve
minutes of meeting
3)
Sign
waiver of notice before the meeting.
Can be after, but more difficult if they disapprove of action taken.
·
Protesting
Notice – if all BOD are present, it still might not be sufficient for notice,
b/c if they protest lack of notice, they aren’t counted as receiving notice.
d.
Majority
vote of the quorum is needed for action to take effect
·
An
act or decision done or made by the majority of the directors present at a
meeting at which a quorum is present is an act of the board,
·
Does
not need to be unanimous unless directors waived notice of meeting.
·
Even
if a director leaves the meeting where there was a quorum, the board may
continue to transact business.
1)
action
only needs the approval of the majority of quorum for that meeting
2)
this
prevents people from just leaving so that an action cannot be passed.
5.
Executive
Committees §311
·
BOD
may designate a committee (smaller group) to act for BOD in certain
circumstances
·
Committee
must be adopted by a majority of the authorized # of directors
·
Each
committee consisting of 2 or more members of the BOD
·
EC
has the same authority of BOD, except they may not act on important matters
such as:
1)
dividend
payments
2)
amendment/repeal
of bylaws
3)
filling
vacancies on BOD
4)
areas
where S/H approval is required
5)
appointment
of other committees of the BOD
6)
fixing
compensation of BOD
1.
Elect
the Board
2.
Fundamental
Corporate Changes that require S/H approval
·
Organic
changes (mergers, dissolutions, reducing capital, etc)
·
Voluntary
dissolution
·
Election
and Removal of the Board
·
Sale
of significant portion of assets
·
#
of shares to be authorized (this amends the AOI, which requires S/H approval)
·
Amendment
of the Articles
3.
Removal
of Directors
·
§303(a)
– any or all of the directors may be removed w/o cause if the removal is
approved by the outstanding shares
(very liberal)
·
§304
– can remove w/cause if 10% of outstanding shares bring suit
·
§305
– S/H may fill vacancies if they removed the director(s)
·
§152
– can vote by majority of outstanding
shares (those entitled to vote) OR
·
§153
– can vote by majority of shares represented
and at a meeting where quorum is present
·
difference
between §152 and §153, getting the maj of outstanding shares is much more
difficult
4.
Amending
the AOI – amendments may be adopted if approved by the board and approved by
the outstanding shares
5.
Amending
the bylaws to add more directors
·
§212
bylaws; contents
1)
bylaws
must state # of directors OR
2)
state
that the # of directors shall not be less than a stated minimum, nor more than
a stated maximum w/an exact number.
(Max can’t be greater than twice the stated minimum, minus one.)
·
§211
bylaws; adoption, amendment or repeal
1)
bylaws
may be adopted, amended or repealed either by approval of the outstanding
shares or OR by approval of the Board
2)
need
§152 approval, exception is §212
6.
Formalities
for a S/H action
·
Meetings:
§600(d) – holders of at least 10% of shares may call S/H meeting (to change
bylaws)
·
Notice
(written)
a)
written
notice must be given 10 days in advance of a meeting when S/H going to be taken
b)
S/H
may waive notice if they give written consent
·
Quorum
– majority of those entitled to vote
7.
Dissolution
– §1900: if more than 50% of S/H approve of dissolution, court will order
dissolution, even w/o Board approval.
·
BOD
– may sell assets acting alone if it is in the ordinary course of business,
otherwise, needs the approval of the BOD plus S/H.
1.
Director
must act with such care, including reasonable inquiry as an ordinarily prudent person in a like
position would use under similar circumstances. §309(a)
·
“in
a like position” : obligation of care changes w/respect to complexity &
size of Corp.
·
ordinarily
prudent person : doesn’t require special skill or expertise, could be non
business person using common sense.
·
Similar
circumstances : duty of care varies for specific person depending on their
experience, training & expertise.
·
Reasonable
inquiry : keep current, explore suspicious circumstances, no duty to
micro-manage.
2.
Director
entitled to rely on opinions of officers, employees so long as director acts in
good faith (no doubts) §309(b)
3.
If
person is filling in as director, he is not liable if he follows §309(b)
4.
Liability
of a director may be limited or eliminated in articles under §204(a)(10)
·
Only
for negligence, not for reckless or intentional misconduct
5.
Indemnification §317
·
Against
3rd parties, corp can indemnify director for expenses involved and
judgment, provided officer acted in good faith and in a manner s(he) believed
was in the best interest of the corp.
·
In
S/H derivative suits, can only indemnify for expense of litigation
·
Insurance,
corp can buy for non-deliberate negligence action of director.
6.
Business Judgment Rule
·
Directors
are shielded from personal liability even if they made a poor decision (not
negligent)
·
Requirements:
a)
focused
decision, made in good faith
b)
informed
decision
c)
director
disinterested (no conflict in interest)
d)
no
fraud (legality)
e)
rational
basis for decision
·
To
invoke BJR, you cannot have a violation of the law
·
Smith
v. Van Gorkom – Gross Negligence of Directors in LBO
a)
holding:
directors are personally liable and cannot use the BJR as a defense since they
did not properly obtain info to make informed decision. Did not meet duty of care.
b)
Rationale:
1)
No
independent study made to determine intrinsic value of company (didn’t get
outside professional opinion)
2)
Directors
didn’t read the agreement
3)
CEO’s
presentation was inadequate for directors to actually make an informed
decision.
·
In
situations where there is a conflict of interest, the director has the duty to
place the best interests of the corporation above their own personal gain.
·
Modern
Law – transactions are voidable.
Director may make transaction w/corp so long as he does not breach
fiduciary duty. If it’s fairly priced
and transacted for, then it’s ok for the director to make a profit selling it
to the corporation.
·
§310
governs contracts where a direct has a material financial interest
(1)
If
a transaction occurs between a Corp. and one or more of its directors; [OR]
(2)
If
a transaction occurs between Corp A & Corp B, where Corp A director has a
material financial interest in Corp B, then for the transaction to not be void
or voidable, the director must:
(a)
Fully
disclose all material facts & financial interest AND get shareholder
approval (quorum – w/o counting the votes of the interested
director-shareholder); [OR]
(i)
No
possibility for litigation after the fact if full disclosure is made.
(b)
Fully
disclose all material facts & financial interests, get BOD approval (again,
not counting votes of interested director-shareholder), AND must show that the
transaction was just & reasonable to the Corp at the time entered into [OR]
(i)
Possibility
for litigation after the fact because of just & reasonable requirement
(what’s just & reasonable can only be determined after the fact.)
(ii)
One
does not need to show just & reasonableness to get s/h approval because of
the assumption of structural bias when dealing with fellow directors.
(c)
If
no approval was granted (director doesn’t try to get BOD approval or s/h) prior
to completing the transaction, the director can still be protected if he can
show that the transaction was just & reasonable at the time it was entered
into.
(3)
§ 310(b) transaction between Corp A
& Corp B where Corp A director is also a director in Corp B. To not be voidable, the director must make complete
disclosure. He needs a good faith
vote w/ either s/h or BOD. If he gets
approval, there is no need to show just & reasonableness. DIRECTOR’S VOTE CANNOT COUNT.
(4)
Burden
of Proof
(a)
Where
the director does not get advanced approval for an interested transaction, the
director has the burden of proving that the transaction was just &
reasonable.
(b)
Fairness
alone will meet the BOP: Bayer –
Director hired wife to sing. The court
held that even though directors didn’t ratify the contract, it was fair. Corp. received good value for services so
director met the BOP.
(c)
Where
director has received advanced approval for an interested transaction, the P has the burden of proving that the
transaction was not just & reasonable.
(5)
Full
& Complete Disclosure Required:
Requires the director to information the BOD or s/h about any matters
affecting the value of the property, the amount of his profit, and all other
relevant info that might affect the Corp’s decision to enter into the contract.
(6)
Authorization
for Transaction
(a)
BOD: Interested directors may be counted at a
director’s meeting to determine if there is a quorum, although the director’s
vote may not be counted for a transaction in which he is interested. § 310(c)
(b)
Shareholders: Same as above—interested
director-shareholder’s stock maybe counted toward quorum, but not for voting.
b)
Determination
of Corporate Opportunity: Courts find
it is a Corp opportunity if it’s fair
& just to offer to the Corp first.
(1)
Expectation of the Corp: Corp had an expectancy (i.e. Corp leases building & when
lease comes up for renewal, it has an expectancy. If the director leases it himself, he’s stolen a Corp
Opportunity.
(2)
Corp has interest: Corp has interest in some sort such as Contractual interest and
the director gets the license himself.
(3)
Necessity: Where the Corp can show a provable need for the opportunity.
(i.e. Where the Corp needs to expand & property next door becomes
available).
(4)
Same Line of Business Test: Where the opportunity is a natural extension of the
business through the same technology, marketing or other expertise possessed
currently by the Corp.
(5)
Opportunity
closely related to Corp’s business: Present or Future
(6)
Opportunity
involves business that’s a competitor of the Corp: Or one that the Corp might buy or sell to.
c)
Circumstances
by which Director Became Aware of Opportunity:
Courts may examine to determine if it’s a Corp. Opportunity.
(1)
If
he is approached as a director of the Corp = Corp opportunity.
(2)
If
director gets opportunity collaterally to his duties as director – probably
Corp opportunity (even if director is playing golf when he gets the
opportunity, it may still belong to the Corp.)
(3)
While
on vacation: look at actual facts,
could still be a Corp opp as too easy excuse
(4)
3rd
party wouldn’t have dealt w/ Corp:
Court has held that the director must still give the Corp opportunity,
again, because this is too easy to use as an excuse.
d)
Director
of Multiple Corporations: If Corp is
director of multiple Corps & gets the opportunity that would be of use to
both companies:
(1)
Most
courts let the director choose in good faith, which Corp to give the
opportunity to. Director doesn’t have
to disclose opportunity to both Corps.
(2)
Courts
look to reasonable expectations of s/h that director may not turn over
every business opportunity if they know that the director is involved in a
similar Corp.
e)
Financial
Inability of Corp: Can a director exploit an opportunity, w/ out
first offering it to the cop first, when the Corp is in financial constraints? No.
(1)
Director
has affirmative duty to find reasonable finances for the Corp.
(2)
Director
must make a full disclosure of the
opportunity to the Corp & have the Corp reject the opportunity before he
exploits it himself.
(3)
Exception: Where the Director can show that he has
tried every available means to obtain needed funds for the Corp, he may take
opportunity for himself.
Where
the majority Shareholders have the power to effectuate a Corp. transaction, the
majority Shareholders must act in good faith and not to the detriment of the
minority Shareholders
1.
Duty
to operate Corp in the Corp’s best interest (Improperly Operating Corp): Dominant S/H cannot cause the Corp to take
action for the benefit of the Dominant S/H if the action taken is not in the
best interest of the Corp.
a)
Hypo: Standard Oil had many subsidiaries and owned
70% of sub C. Outsiders owned 30%. Standard caused C to sell all of the oil it
drilled to a wholly owned sub of Standard (B).
30% of C (minority Shareholder) filed suit saying Standard caused C to
sell oil below market price.
b)
The
court held that Shareholder’s win because the only reason C sold at a below
market price was b/c it was controlled by the Parent and these Majority
Shareholder did not act in the best interests of the company.
2.
Dissolution to “freeze out”
minority: Dissolution of corporation for the sole
purpose of “freezing out” the minority S/H, so that the dominant S/H can buy
the assets and continue the business formerly carried on by the Corp,
constitutes a breach of fiduciary duty. It is an organic change in the Corp
structure which promotes the Majority’s self interest.
a)
INLAND
STEEL: Court found 70% majority’s
dissolution of Corp in order to buy out minority 30% was unlawful due to the majority’s
primary purpose of keeping profits for itself. (Majority did not want to pay
minority a fair price for their stock.)
b)
Court
found that even though there was a proper dissolution, the maj breached
fiduciary obligation to the minority because after the sale, the barges were
still in business continuing work. Min
Shareholders got liquid value rather than going concern value so the
court awarded going concern value.
c)
Court
held OK to liquidate assets if doing it for profit, but here the barge company
was still continuing business, showing the goal of the transaction was just to
squeeze out he minority.
3.
Full Disclosure Required
Upon Corp Liquidation: The maj S/H should fully
disclose the material facts to the min S/H, where upon the min may have an
equal opp to share in the profits.
a)
ZAHN v. TRANSAMERICA: Maj S/H holding all B (common) stock, through it’s BOD “called
in” A (preferred) stock per redemption agreement, but w/o disclosing material
facts (true value of assets or that they planned liquidation afterwards). Although neither calling stock or
liquidation is wrong, under circ of nondisclosure, it becomes a breach of
fiduciary duty b/c no business purpose
for doing it ( the purpose was to carve up the value of the Corp in an unfair
manner to benefit the majority at the expense of the min)
b)
General Rule: Maj S/H can’t use control of the BOD to gain at the expense of
the Minority.
4.
Dominant Shareholder Action
Outside of Corp which Excludes the Minority Shareholder: Although actions by the Majority may not directly affect the
minority, courts may find a breach of fiduciary duty where the majority
indirectly benefits at the detriment of the minority.
a)
JONES v. AHMANSON: Where the court found the majority breached by denying the 15%
minority the ability to create a market for its stock. Majority used their control of operating
company to create an opportunity (publicly held holding company) solely for
themselves & intentionally left out the Minority.
(1)
Majority
cannot cause a holding company to be formed at the detriment to the minority.
(2)
Most
Jx don’t follow this case because the court held that all that matters is
inherent fairness so even if the action was not detrimental to the Corp, it is
improper if not fair to the minority.
5.
Unfair
allocation in Merger: if the allocation in the merger is unfair, it’s a breach
of fiduciary duty.
·
Example: B owns small Corp. B is also a majority in larger Corp. C is a minority in the larger Corp. B causes his small Corp & large Corp to merge and B ends up
owning half of the larger Corp. This is
an oppression of the minority Shareholder by the Majority causing Corp to enter
into the transaction.
Act regulated a wide variety of transactions
involving the securities market. (offerings & sales of securities to the
public or information related to securities.)
Regulates solicitation of proxies in publicly held
corps & rules for contents of proxy solicitation, mandates public disclosure
of publicly held Corp of massive info annually, quarterly, monthly, and if
something important occurs. Also
requires:
1.
Full Disclosure: requires disclosure to S/H
of sufficient information so S/H can make a rational judgment as to whether or
not they want to give you their proxy.
a)
Proxy
– power granted by a Shareholder to another person to exercise his voting
rights.
b)
Proxy
holder = Shareholder’s agent.
c)
Proxy statement: Proxy solicitation must include a proxy statement that gives
Shareholders specific information such as pension plans, director salaries, and
what the director has been doing for the past 5 years.
(1)
Must
also disclose whether there will be a material
conflict of interest in the proxy statement.
(2)
Management’s
proxy statement must be accompanied by or include certain financial
statements. (These statements are set
out in the annual report of the company which also serves a s a public
relations document.)
(3)
These
management proxy solicitations are not neutral. They’re designed to give management a proxy for position they
endorse. (However, you can give mgmt
your proxy and vote for all or w/ hold your vote for director “x”, but can’t
vote for someone else).
(4)
You
can give your proxy to any Shareholders or anyone as long as they go to the
meeting.
2.
Anti
Fraud: Act states it is unlawful to
make material untrue statements or omissions in connection w/ a proxy
solicitation. No solicitation of
proxies shall be made containing false or misleading statement w/ respect to
material facts or omissions.
a)
SEC Rule 14a-9 provides: No solicitation subject to this regulation shall be made by means
of any proxy statement…containing any statement which, at the time and
in the light of the circumstances under which it was made, is false or
misleading with respect to any material fact, or which omits to state any
material fact necessary in order to make the statements therein not false or
misleading.
(1)
Private Right of Action: There’s nothing in § 14, but Borach held there’s an implied private right of
action for damages for a § 14 violation.
(Court held that a private cause of action helps to ensure disclosure of
info).
(2)
Materiality: A statement or omitted fact is material if there is a substantial
likelihood that a reasonable Shareholder would consider it important in
deciding how to vote.
b)
Causation
= Necessary Link Requirement:
(1)
In
MILLS, 54% majority needed
66.6% to merge and 46% minority claimed there was misrepresentation in proxy
solicitation. Court held that every P does not need to show that misrepresentation
caused them to vote as the did (would have voted otherwise if it had been
correct) all that must be shown is:
(a)
The
Omission was material.
(b)
The
proxy solicitation was a necessary link
to produce the action (i.e. must show that couldn’t have gotten merger through
w/o solicitation).
(c)
Here
proxy solicitation was necessary so causation was satisfied.
(2)
In
VIRGINIA BANK SHARES, the
solicitation was not necessary because 85% maj didn’t need the vote of the 15%
min even though they solicited there proxies.
Therefore, existence of misleading material fact in proxy solicitation
doesn’t satisfy causation.
Proposals Shareholders want
to be disbursed to other S/H, included in the management’s proxy statement.
1.
Purpose: The main reason why shareholders place proposals in the Corp’s
proxy is the cost is too prohibitive for individuals to mail out the material
themselves.
2.
Grounds for Omitting
Proposal:
a)
Proposal that’s part of
ordinary business operations – It’s the role of the BOD to make decisions
regarding ordinary bus operations so mgnt can exclude a S/H proposal that
conflicts.
b)
Counter
proposals
c)
Usual
Business matters
d)
Contrary
to Law
e)
Can’t
be economically related.
1. Shareholder must send out
material to other Shareholders to ask for their proxy. This solicitation is also covered by § 14,
so it is subject to anti fraud provisions.
In this case, the Corp must:
a)
Give
them a Shareholder list [OR]
b)
Mail
out & address solicitation material for Shareholders as long as the
Shareholder pays.
2. Reasons Shareholder wants to
gain control
a)
(S)he
may feel the present management sucks and could be more profitable.
b)
Wants
to dismantle the Corp and give more dividends to Shareholders.
3. Other ways to Gain Control
for Shareholder
a)
Tender
Offer: Shareholders can make a tender
offer to buy shares but this is limited by the amount of $ needed to buy all
the required shares.
1. Management Proxy Solicitations: When Management solicits proxies, the corp pays.
2. Solicitations by Shareholder or a Group Trying to Take Control: Must pay themselves.
a)
Exception: If they are successful in taking over, then
they may be reimbursed for the costs incurred over the proxy fight.
(1)
They
have a fiduciary duty to S/H so this justifies taking $ to reimburse themselves
if they:
(a)
Justify
– claim that by virtue of being the new management, they are conferring a
benefit on the Corp and therefore deserve reimbursement.
(b)
Get
Shareholders’ approval for reimbursement.
3. Shareholder says costs of
Management’s Proxy Solicitation is Unreasonable:
a)
Courts
haven't given a solid answer on whether all acts of management should be
reimbursed (i.e. take Shareholders’ to Bermuda to solicit proxy.)
b)
GR: “Reasonable” expenses are acceptable,
but the Court doesn’t state what is reasonable.
A. Shareholders’
Voting Powers
1.
Straight Voting: where Shareholder gets one vote for each share held.
a)
Person
w/ majority of the stock may control who gets elected (51% or more of stock)
b)
Must
distribute shares equally over number of candidates.
c)
If
5 candidates w/3 seats available & A owns 100 shares, then A gets to vote
for 3 and each candidate A votes for gets the same 3 of votes (A can cast 100
votes for 3 candidates. 3 candidates w/
highest 3 of votes are elected).
2.
Cumulative Voting (Mandatory
in CA): each S/H may cast a # of votes equal to the
# of directors to be elected multiplied by # of shares held. S/H may distribute votes unequally over # of
candidates.
a)
Example: If 5 directors are to be elected, a
Shareholder w/ 10 voting shares has 50 votes; and he may vote all 50 shares for
one candidate (or split his voting among several candidates).
b)
Purpose: Assures minority S/H of representation on
the BOD. Device for increasing S/H
power in the publicly held Corp.
c)
CA § 708: Every Shareholder can vote cumulatively at any election of
directors so long as:
(1)
Candidates
names have been placed in nomination prior to the voting, AND
(2)
Shareholder
has given notice at the prior meeting of intent to cumulate vote. If any Shareholder has given notice, all
Shareholders may vote cumulatively.
(3)
Exception §301.5: Shareholder’s may vote to eliminate cumulative voting in listed
companies (publicly held Corp – usually large publicly held corps. On AMEX,
NASDAQ, NYSE, or 800 Shareholders or more).
d)
Staggering
the BOD: in many Jx, rather than elect all directors each year, some Corps want
to stagger their elections (i.e. 9 person BOD; elect 3 members each year)
(1)
Effect of Staggering on
Cumulative Voting: minority could be shut out
(especially if 1 board member each year for 3 person board.)
(2)
§ 301: Can’t stagger boards (CA all directors must be elected each
year).
(3)
Exception – CA § 301.5: You can stagger the board in publicly held Corps if you vote
to. If stagger in 2 classes must have
at least 6 directors and elect ½ of them at the annual S/H meeting; 3 classes must have at least 9 directors and
elect 1/3 at annual meeting.
e)
§ 303(a)(1) – Cumulative
voting & removing directors w/o cause: S/H
can remove directors w/o cause if they want to remove the entire board. But S/H may not remove one single
director. If the people who object to
his removal could have elected him by cumulative votes. (if votes against his removal would be sufficient
to elect him in cumulative voting)
f)
Min S/H may try to increase
# of BOD to
keep place on the board if cumulative voting is allowed b/c the more
individuals that are being voted on the smaller % of shares is needed to elect
(fewer the board members, the more shares min needs to elect 1 director w/ cum.
voting).
(1)
§
212(a) number of directors can’t be reduced if reduction is imposed by a
minority sufficient to elect at least one director in cumulative voting.
B.
Devices
By Which Shareholder’s May Control Voting Rights (Control Devices)
1.
Shareholder Voting
Agreements (“Pooling”): Where Shareholders agree
between themselves in advance of voting that they’ll vote in a certain
way. (attempts to sterilize the board).
a)
General
Rule: Law says S/H has every right in
the world to combine with 1 or more other S/H for the purpose of gaining
control as long as not done fraudulently or to oppression of minority.
b)
RINGLING BROS: P and H entered into
agreement that they would act jointly in exercising their voting rights and if
they could not agree then the decision would be made by L, an arbitrator. They disagreed, L told how to vote, and H
violated the agreement.
(1)
Held: Court did not enforce the agreement because
agmt did not provide that on violation either party could vote the shares of
the other, or that the arbitrator could vote them.
(2)
Solution
= Proxy: If they really wanted the
agreement to be upheld an not irrevocable then they should have given L proxy
to vote their shares.
(a)
Irrevocable
Proxy: Even if they give proxy to L
because of agency law, it will be revocable so the solution would be to give
irrevocable proxy. If the proxy has been given for
the benefit of the agent (person getting the proxy) rather then for the person
giving the proxy, then it will be irrevocable.
(b)
If
RINGLING BROS had been a close Corp, and L was designated under
Shareholder agreement [705(e)(5)] as holder of irrevocable then it would be
irrevocable.
c)
§706 – voting agreement &
statutory close Corp: only applies to
statutory close corporations – under706(a) voting agreements in close
corporations will automatically be upheld.
2.
Proxies: Power of attorney given by Shareholder to someone else to
exercise the voting rights attached to shares.
Must be signed and filed w/ the Corp.
a)
Revocability
of Proxy: A proxy is revocable at any
time, unless made irrevocable.
b)
Irrevocable
Proxy: If the proxy has been given for
the benefit of the agent (person getting the proxy) rather than for the person
giving he proxy, then it will be irrevocable.
(1)
§ 705 (3): If you label the proxy as irrevocable, it will be when it is held
by someone in the 6 categories in the code.
(2)
§ 705 (3)(e)(6): If proxy was given to secure the performance of some obligation
it will be irrevocable until the service is performed.
(3)
§ 705 (f): If transferee of shares takes w/o notice of irrevocability, the
proxy may be revoked unless statement of irrevocability is on the face of the
stock certificate.
(4)
Example: B tells C he wants to buy the stock of C’s
co. but does not have sufficient money, and wants to spread the payments out
over 5 years. C agrees, but wants to
retain title to the stock until final payment.
B agrees, but wants proxy so he can vote on the stock. C agrees then wishes to revoke the
proxy. C cannot because the proxy is
irrevocable.
(5)
Example: B (agent) is VP of ABC co. for the
manufacturing division. C (principal)
is the owner & CEO of widget Corp & needs new VP of manufacturing &
goes to B and asks “I need you to be my VP.”
B agrees but wants a proxy on voting the stock because he does not want
to be ousted for people not liking his management. C agrees for 5 years.
After the first 2 years, C does not like B’s management style so tries to
terminate proxy. C is unable because
the proxy is irrevocable.
(6)
RINGLING BROS – If ladies had given
proxy, it would be revocable because it was for the benefit of the ladies, not
for the benefit of Mr. L.
3.
Voting Trusts: Device employed by Shareholders to assure control of voting
whereby each Shareholder transfers legal title of his shares to a trustee and
trustee votes all the shares in accordance w/ instructions in the document
establishing the trust. Dividends must
be distributed to beneficial owners (trustee has voting rights for life of the
trust)
a)
Transferability: The certificates are transferable, but the trustee (not
transferee) always has the right to vote.
b)
Example:
HH controlled TWA & TWA needed $ to buy new planes. Bank would not lend b/c feared that HH would use funds
improperly. Bank agreed to lend if the
voting rights of the stock in TWA were put into a voting trust managed by the
bank until the loans were paid off.
c)
Example: B owns 60% in Corp A. B wants to acquire C Corp that’s very
anxious to join w/ A. A has no cash so
to merge C to A & old C’s Shareholder stock in the new larger A. B is worried that if he carries it out, old
A stock will be redistributed & his % will decrease and he will lose
control. B says he will only do it if
Shareholder of 40% put their votes in a voting trust w/ B as the trustee.
4.
Non Voting Stock: Can be owner of the stock
& yet not have the rights to vote because of the type of stock.
5.
Classify Vote: Turn Stock into 3 classes & put in AOI that class A gets 2
directors, B gets 2, etc.
C.
S/H
Agreements: Shareholder’s can try using
agreements to cause the BOD to take certain action. This depicts a deviation
from the corporate norm since traditionally, the BOD has independent judgment.
1.
General
Rule: Can’t tie the hands of the BOD by
deciding in advance who will be officer or director, but S/H can decide who
they want to elect as directors.
(Rationale: Directors are
charged w/ fiduciary duties to the Corp, therefore the S/H agreement which
restricts their actions is void.)
2.
MCQUADE – Minority S/H
Agreement: M was controlling
Shareholder of the Giants and wanted to sell shares but still vote & sold
to D’s but made agreement so D would vote their stock so M would be
director & be employed as treasurer of the co. D then had M fired & not
voted as director.
a)
Held: Shareholders can get together & agree to
vote their shares any way the want but they cannot agree among themselves as to
how they will act as directors in managing the affairs of the Corp because
directors are supposed to use independent judgment.
b)
Rationale: Protects the minority Shareholders that
didn’t agree because every Shareholder has the right to expect these norms
& one of the norms is that the directors will be independent.
3.
CLARK – Agreement Between 100% of
Shareholders: C (25% owner) & D
(75%) enter into a Shareholder agreement agreeing to elect people as directors
& then agree how they would act once they were directors. C performed, then D refused.
a)
Held: court enforced the agreement because there
was no minority Shareholders. Here 100%
of the Shareholders agreed to tie the hands of the BOD.
b)
When
100% of the Shareholders agree, then the court will enforce.
4.
GALLER –Shareholders voting agreement: E-B
(475.5%), I-S(47.5), and R (5.4% employee) are owners of Corp. E-B & I-S sign S/H agmt that each group
gets to vote for 2 of the 4 BOD; they would get paid a fixed dividend and that
upon death of either brother, Corp would give the widow a pension. B died &
Corp refused to pay agreed pension. R
had sold his shares back to I-S.
a)
Held: Agreement enforced because even though there
was a minority Shareholder, he was no longer there & he never complained
about the agreement when he was part of the company.
5.
Summary: As long as there’s no dissenting minority & not in violation
of law, and it’s reasonable, the courts will uphold the agreement. CA came up w/ statutory close corps to solve
this problem.
D.
Statutory
Close Corporations: Device where S/H
may participate in the mngmt of the business; limits BOD decision making power
due to prior agrmt, but must fit w/in statutory definitions of a close Corp.
1.
Definition of a Close
Corp. CCC § 158:
a)
AOI
must state a max of Shareholders and that number cannot exceed 35 Shareholders
[AND]
b)
Must
state “This is a close Corp” in stock certificates. (Also need “Inc., Corp.” in the name)
2.
Shareholder Agreements § 706:
a)
They are 100% enforceable by becoming a
close Corp, you can enter into Shareholder agreements to alter statutory norms
of the Corp. (can provide anything about internal governance.) Agreement can provide for any thing[300(b)]
and these agreements will be enforced in a close Corp because they are provided
for in §300.
b)
To
enter into a binding Shareholder agreement:
(1)
Agreement
must be written [AND]
(2)
Must
be unanimous (signed by 100% of Shareholders).
3.
Losing
Close Corp Status:
a)
Shareholders
can just agree they no longer want to be a close Corp. All that is needed is a 2/3 vote. (Ordinary corps can agree to be a close
Corp, but this is difficult because 100% shareholder approval is needed. These Shareholders expected a general Corp.)
b)
§ 418(d): S/H agrmt & close Corp status are terminated (left w/
nothing) if # of S/H in Corp becomes greater than max # stated in AOI unless it
is written into the S/H agreement that the Corp loses close Corp status, the
agrmt will be enforced as much as possible under CL.
c)
Issue
of New Stock: If 100% of Shareholders
in close Corp sign agreement, then Corp decides to sell additional stock (w/ o
surpassing max in AOI), if the new Shareholder refuses to sign agreement, then
Shareholder agreement is terminated.
4.
Transfer of Shares - § 418:
a)
Transferee
is bound by Shareholder agreement [(§ 300(b)]
b)
Transferee
must have either actual or constructive knowledge.
5.
Piercing the Corporate Veil: court examines if the Corp
has complied w/ formalities. This
argument cannot be used to Pierce a Corp Veil of a “close Corp” if a close Corp
puts something in the AOI that says they don’t have to follow formalities. § 300(e)
6.
Dissolution: Any Shareholder in a close
Corp can petition for dissolution and they automatically have standing.
7.
Other
Control Devices (Only in Close Corps):
Minority Shareholder in Close Corp seek to achieve a certain degree of
control by Shareholder agreement.
a)
Super Majority: C wants to be 25% owner in a Corp (minority Shareholder) so wants
to the Corp to put in AOI that BOD can bind only if 80% agree. This gives
minority Shareholders an effective veto, even though they won’t be able to push
their policies through. (Danger: if there’s a serious falling out between the
majority & minority, it will totally paralyze the Corp.)
b)
Restrictions on
Transferability of Stock: since S/H in a close Corp
have more power than in a public Corp, the S/H may want to prevent the transfer
of shares unless approved.
(1)
General Rule: Share transfer restrictions will be upheld as long as reasonable.
(a)
Unreasonable
= put into the stock “this stock cannot be sold unless approved by Joe”
(b)
Reasonable
= determined at the time the agreement is made. Courts have held as reasonable:
(i)
Right
of first refusal – Shares offered to Corp, other S/H or both on same terms.
(ii)
First
Option – Prohibit transfers unless shares has been offered to Corp at price
fixed by some formula.
E.
Shareholder Derivative Suits: Shareholder unhappy because BOD not vindicating certain rights.
1.
Reasons
Shareholder may bring Derivative Action:
a)
BOD
not following through where Shareholders thought they should make a collection
against someone who owes Corp Money because he is a friend of BOD.
b)
BOD
itself is acting improperly. (i.e. stealing from Corp.)
2.
Shareholder suit: In a derivative suit, S/H is suing a behalf of Corp not on behalf
of themselves.
3.
Uniqueness:
a)
Lawyer
seeks out Client not other way around:
S/H doesn’t gain much in derivative suit so usually instigated by L to
make money. (Lawyer gets paid on
contingency)
b)
Client
is not active in litigation. Once
litigation as begun, the Shareholders don’t participate so they have no control
(no input to Lawyers) because they only own small shares.
c)
Shareholders
don’t have real large stake in the litigation.
4.
FRCP 23.1 Lawyers cannot settle w/o approval of court:
a)
3
elements necessary to bring derivative action
(1)
Contemporaneous
Ownership: must own the shares already at the time the complained of action
occurred. Can’t buy litigation by
noticing something that was done wrong, then running out and buying a single
share. (Except if shares were obtained
by operation of law (i.e. inheritance) and person who had it earlier was owner
at the time of the transaction.
(2)
Security
for D: must put up cash/bond so if P lose, the costs put out by D will be paid for (except in Federal courts
where this isn’t required. However, if
there is diversity, then federal law may look at state law and require it.)
(3)
Demand: Demand on the BOD must be made 1st.
(a)
If
claim of Shareholder is that the board must collect $ from a 3rd
party, then Shareholder must have made a demand on the BOD before bringing the
claim
(i)
Since
BOD is in charge of control & management, in this situation, derivative
suit will be halted.
(b)
If
claim is that BOD did something wrong, then may be able to avoid demand because
it would be futile to ask BOD to sue themselves.
A. Definition: someone related to the Corp (directors, officers) is in a position to have inside info about how the Corp is doing, and what the Corp’s stock is or will be worth. This person (“insider”) then buys stock (w/ an advantage over the seller) or sells (w/ an advantage over the buyer). For this reason, duties and restrictions have been placed on the insider, both at CL and by the fed securities law.
1.
STRONG – Special Facts Doctrine: Director
cannot seek out a stockholder for the purpose of buying his shares w/o making
disclosure of material facts he has that the stockholder doesn’t know.
a)
General
Rule: No fiduciary duty to Shareholders
unless there are special facts.
b)
Here,
there were special facts because the director, using inside info, sought
out the minority Shareholders in the Corp to purposefully purchase their
stock before the value increased.
2.
GOODWIN v. AGAZZIZ – Indirect Transactions:
Special Facts Doctrine not applied b/c the director purchased the S/H’s
stock on the exchange, w/ no communication between them. (There was no “seeking out”; the P decided voluntarily to sell & sold
anonymously over the exchange.)
a)
General
Rule: Insiders do not have any
fiduciary duty to their fellow Shareholders but they do have a fiduciary duty
to the Corp itself.
3.
Material Information: Information does not have to be certain. If it would have an impact on a reasonable
investor, then such information is Material and must be disclosed.
4.
DIAMOND –Duty to Corporation
a)
Due
negative inside info (IBM’s raised the price for fixing PC’s will make Corp go
downhill), the CEO sold Corp stock on the market before public discl. and the
sale devalued the stock.
b)
The
court held that it could not find a duty between the directors & the S/H
(the buyer of the stock) but found wrong committed. Therefore, the court held that a duty existed between the
director and the corp. Loss of reputation due to the
director's acts was a breach of that duty.
c)
This
is a minority opinion, rarely
followed.
d)
Solution
= Legislation (see below) where the buyer could have presumably sued the
insiders under rule 10b-5.
1.
SEC Rule 10b-5 (Anti Fraud Provision) – It
shall be unlawful for any person, directly or indirectly, by the use of any
means or instrumentality of Interstate Commerce, or of the mails or of any
facility of any national securities exchange
(1)
To
employ any device, scheme or artifice to defraud,
(2)
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 light of the
circumstances under which they were made, not misleading, or
(3)
To
engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person, in connection with the purchase
or sale of any security.
b)
Application: 10b-5 applies to cases regarding schemes to defraud,
misrepresentation and non-disclosure in securities transactions. The breach of a fiduciary duty when
purchasing or selling stocks is a concern addressed by the statute. The P must be a buyer or seller,
and the D must have knowingly
(possibly recklessly) made 1) a material misrepresentation or 2) non-disclosure
which affected a securities transaction.
(1)
Purchase
or sale may be of any Security: Applies
to all sales/purchases of any security, including debt securities (not limited
to large or public corps)
(2)
Any
Person: 10b-5 applies to any person, not just insiders.
(3)
Use
of Any Means of Interstate Commerce:
This has been read very broadly.
Using Telephone lines where the lines are somehow connected interstate
is sufficient.
(4)
In
Connection w/ Purchase of Sale:
(a)
The
P must have actually purchased or sold
securities due to the deception to have standing.
(b)
BLUE CHIP STAMP: Company had a prospectus that P claimed made negative
implications because the Corp really didn’t want to sell it’s stock. P claimed he relied on this
& did not buy & now seeks relief under 10b-5. SC said 10b-5 does not apply unless an actual sale/purchase is
made.
(c)
D doesn’t have to purchase or
sell; it’s enough if his acts affect the market. See press release in TEXAS GULF.
(5)
Material Requirement (Objective Standard): What constitutes a material misstatement or
omission for the purposes of 10b-5?
(a)
Test: Would a reasonable investor consider it
important in making his decision to buy or sell stock?
(b)
Materiality
requires a balancing of the anticipated magnitude of the event (whether or not
there is a deal yet) against the probability that the event will occur.
(6)
Remedies:
(a)
Private
Right of Actions: The courts have
implied a private right of action although not explicitly stated in
statute. P may sue for injunction,
damages, or recession.
(b)
SEC
Enforcement Actions
(c)
Criminal
Action:
2.
Requirements
added by the Courts for 10b-5 Violation:
a)
State of Mind – Scienter: D must have made the false statement
w/ an intent to defraud, manipulate, or deceive. Negligence is insufficient, though some courts have held that
reckless disregard is enough.
b)
Causation: Misrepresentation must have caused the damage (withheld
information must always be the cause)
(1)
Hypothetical Illustration: Director of ABC calls D & tells him to buy shares of ABC
because the Corp found a cure for cancer.
D buys shares from X. Info turned
out to be false, but the stock price increased anyway because ABC found
oil. Is D liable to X? Does it matter that info D got wasn’t true?
(2)
2 Theories of Causation: X must show that D’s info was the cause of the transaction AND
the loss.
(a)
Transactional
Causation: Here, the info did cause the
transaction whether it was true or not D bought because of the directors’ false
info.
(b)
Loss
Causation: The cause of the loss to X
had to do w/ something totally different (oil found ) then D’s info.
(3)
Private Cause of Action: Must show both Transactional & Loss Causation.
(4)
10b-5 Violation: Just needs to show that the info was a breach of fiduciary
obligation.
c)
Reliance: P must have relied on the
misrepresentation when deciding whether to purchase or sell. If P would have bought anyway,
then no reliance (Primarily in private Causes of Action)
(1)
Face to Face Misrepresentation: P must have relied on affirmative statement. If there was an omission, then reliance is
assumed if the omission is material.
(2)
Affirmative
Misstatement in Anonymous Market Transaction:
(a)
Fraud on the Market: In a well-defined market (i.e. stock exchange) reliance on any
public misrepresentation may be presumed based on the fraud on the market
theory which creates a rebuttable presumption that P relied on D’s material
misrepresentations. (No affirmative
reliance required because the market as a whole already relied on the
misrepresentation by setting the price that was paid.)
(b)
BASIC v. LEVINSON: Where P’s reliance on D’s misleading statement (denial of merger
negotiations) was presumed for the purposes of a 10b-5 action, and D had the burden of rebutting this presumption
(could be rebutted by showing that P independently purchased
stock outside any market place info).
d)
Breach of Duty Required: To violate 10b-5 insider must breach a duty owed to the Corp.
e)
Insiders – Duty of
Disclosure or Abstain: Corporate insiders who know
material facts owe a duty of disclosure to the persons from whom they buy or to
whom they sell. They must disclose the
inside info or abstain from trading.
(1)
SEC v. TEXAS GULF (Mineral Case)
(a)
D made a significant
discovery of ore, but issued a press release downplaying their find. The SEC brought action under 10b-5 against
employees of D that bought stock prior to
the full disclosure to the public concerning the discovery, and also sued D for the misleading press release.
(b)
Held: Violation of 10b-5 for insiders (employees)
of a Corp, having inside info, which has not been disclosed to the public, to
purchase the Corp’s securities w/o public disclosure of the material info.
(c)
Held: The court found that the misleading press
release was a violation of 10b-5 because the effect of the release caused the
market price to be affected so it was “in connection with the purchase or sale
of securities.”
(d)
The
SEC requires full and complete disclosure when making a statement to the
public.
(e)
Timing
Required: Market must have time to
absorb any disclosure made before an insider can begin trading the stock. The more complex the disclosure, the longer
the waiting period. Must wait until the
news could have reasonably been expected to appear over media of widest
circulation.
f)
Outsiders – No duty to
Abstain: A person who busy or sells a security, w/o
disclosing material information about the security, and who has no
relationship/fiduciary duty to the Corp or to the person w/ whom he deals
(other side of the transaction) does not violate 10b-5.
(1)
CHIARELLA v. U.S. (Printer not Insider)
(a)
D, a printer, acquired
takeover info while printing takeover bids.
Before the offer became public knowledge, D purchased stock in the
target company w/o informing its Shareholder’s of his knowledge of the proposed
takeover.
(b)
Held: D could not be convicted on a
failure to disclose his knowledge to the Shareholders or the target Corp.
because he had no duty to disclose.
(i)
Mere
possession of important market info does not impose any duty to disclose it
before trading.
(ii)
Duty
arises from the relationship between the parties and not merely from one’s
ability to acquire info due to his position in the market.
(c)
General Rule: There must be a breach of fiduciary duty (existence of a relationship
affording access to insider information intended to be available only for Corp.
purpose) to the person on the other side of the transaction in order to violate
10b-5. In this case, D owed no duty to the target co. or the
acquiring Corp.
g)
Misappropriation Theory: (Adopted in CHESTMAN
& by Dissent in CHIARELLA,
but SC is split on it.) In situations
where someone expends their own energy & puts together public info, they
should be able to trade even if they somehow acquire non-public info. But if he has stolen the information, he
cannot trade even if he’s an outsider & has no fiduciary duty to the other
side of the transaction. Breach of
fiduciary duty to the person it was stolen from is implied.
h)
Tips
(Giving & Receiving Stock Tips)
(1)
General Rule: A person receiving the tip assumes a fiduciary obligation to the
Shareholders of a Corp not to trade on material, non-public info only when:
(a)
The
insider has breached his fiduciary duty tot the Corp by disclosing confidential
info to the receiver for some personal benefit; AND
(b)
The
receiver of the tip knows or should know that there has been a breach (the tip
receiver must be a “knowing confederate”)
(c)
Personal Benefit Test – DIRKS: VP of the
Corp (tip giver) gave info to D (tip receiver) regarding
the Corp producing fraudulent insurance policies. D, a financial analyst, gave
this info to his clients, whereby this clients sold their shares to the Corp.
(i)
Where
an insider breaches a duty by giving a tip depends in large part on whether he
is exploiting the info for his own benefit.
(ii)
Here,
absent personal benefit, there was no breach to the Shareholders by the
insider.
(iii)
Since
there was no breach by the insider, there is no derivative breach by D.
(iv)
The
court also wanted to protect financial analysts, because they provide a
valuable service to the public.
(2)
Hypo: Tip giver must have breached fiduciary obligation for the tip
receiver to be liable so if the tip giver goes to B (banker) and asks for a
loan telling B they just had a mineral find, and B calls his broker to buy
stock in the Tip Giver’s company, B is not liable because the Tip giver didn’t
breach fiduciary duty by asking for a loan.
(a)
But,
FN 14 in DIRKS says that if
corp info is told to an underwriter, accountant, outsiders, etc., they may have
a fiduciary duty to the S/H b/c they got non-public info only for corp
purposes. This duty only imposed if the
Corp expects the outsider to keep disclosed non-public info secret and the
relationship at least implies such a duty.
3.
Tender Offers – Rule
14e-3(a): Rule promulgated by SEC that only applies to
tender offers. Upheld in CHESTMAN—if
you have non-public material info you received from the party making the tender
offer, party on the other side, or anyone who’s an agent of either side, then
if you have this info about the tender offer, it is illegal to act.
4.
SEA § 16 (Short Swing
Profits):
C’s attempt to limit insider trading, wanted to make it unattractive for
insiders to trade & make profit.
a)
§ 16(b): Officers, Directors, and More than 10% owners must pay to the Corp
any profits they make within a 3 month period, from buying and selling
stock.
(1)
Only
applies to “certain Corporations”: 16(b) only applies to publicly held
corporations that:
(a)
Register
on a national securities exchange; OR
(b)
Has
both a minimum of $5 million in assets AND at least 500 Shareholders.
(2)
Intent not required: director can buy and be innocent then 4 months later, need to
sell for heart transplant & he would still be subject to 16(b).
(3)
Only Applies to “Certain
Insiders”:
16(b) applies only to officers, directors, and holders of more than 10% of a
class of equity securities of the Corp.
(a)
Officers
& Directors:
(i)
One
cannot avoid a 16(b) violation buy resigning.
(As long as he was an officer at the time of the purchase of stock)
(ii)
Deputization: If X Corp asks one of it’s officers to be on the BOD of Y Corp,
then X Corp makes a profit on Y stock, w/ in 6 mos, X may be liable under
16(b).
(b)
More than 10% Beneficial
Owners: must be such owners at both ends of the
transaction for the purposes of 16(b).
(i)
Reliance: Owner had 14%, then sold
4% and turned in the profits, then sold the other 9.99% and kept the
profit. USSC held this allowable
because D must have more than 10% at
the time of purchase AND at the time of sale to be subject to 16(b).
(ii)
MACKESSON: Court held that D must have > 10% at the time of the
purchase that you want to match w/ the sale. Here, D wasn’t more than 10% at the time of the
purchase so he could keep the profits.
(4)
Only
applies to Equitable Securities.
b)
Enforcement of § 16(a): Requires all officers, directors, more than 10% owners to file on
public record when they purchase & sale securities.
c)
Determining “Profit” under
16(b): Profit is computed by matching the lowest
purchase price and the highest sale w/in the 6 month period, followed by the next
lowest price and the next highest sale, and so on. Only gains are counted and they are not offset by losses.
Date |
Transaction |
# of Shares |
Stock Price |
Jan 1 |
Buy |
800 |
$30 |
Feb 1 |
Buy |
200 |
$10 |
Mar 1 |
Sell |
300 |
$50 |
Jun 1 |
Sell |
700 |
$1 |
Solution:
300($50) – [200($10) +100(30) {from Jan1}] = $10,000 short swing
profit |
d)
Determining
what constitutes a “sale” for 16(b)
violation:
(1)
KERN: O Corp wanted to acquire KERN,
but K management did not agree. O went
to Shareholder’s & made tender offer & acquired 30% of stock (only
stock at issue is the stock acquired after O became a 10% owner). In the meantime, K approached T for a merger
so K’s S/Hs would be come a small percentage of T & O and K could not take
over. Under the merger agreement K’s
S/H would get preferred stock of T. O
negotiates an option w/ T for T to buy back stock O has in K, but says T can’t
exercise option for at least 6 mos and 1 day after their tender offer (to K
Shareholders) expires. P’s here are claiming that at the time of the
merger between T& K, O got preferred stock of T and this was a “sale”.
(2)
General Rule
(a)
In
most situations, stock swap will be deemed a sale.
(b)
Here,
the Court focused on policy & purpose of 16(b) as prohibiting insider
trading & holds there’s no possibility of speculative abuse due to O’s
>10% ownership because K wanted nothing to do w/ O so O couldn’t have any
inside info. Therefore, no sale.
(c)
16(b)
usually applies to cash transactions, but may apply to mergers; if there’s a
chance for speculative abuse, then it will be considered a sale and subject to
16(b)
A. Voluntary Dissolution - § 1900:
state law provides that if a certain percentage of the Shareholders
agree then the court must order dissolution.
1.
Definition: Any Corp may elect voluntarily to wind-up
and dissolve by the vote of Shareholders holding shares representing 50% or
more of the voting power.”
2.
Don’t
need to go to court as long as 50% or more agree to dissolve.
3.
If
minority wants dissolution, then must go to court for petition.
A.
Involuntary Dissolution - §
1800: On petition of a Shareholder and on certain
conditions, the court may order the Corp to dissolve.
1. Must have Standing - §
1800(a)
a)
One-half
or more of the directors in office.
b)
The
Shareholders representing not less than 33 1/3% of:
(1)
Outstanding
Shares [OR]
(2)
Outstanding
Common Shares [OR]
(3)
Equity
of the Corp.
(4)
See Exception Below.
2. Grounds for Dissolution
a)
Corp
has abandoned business for more than 1 year.
b)
Even
numbers of directors are equally divided and cannot agree resulting in
disadvantage to business or property and the Shareholders are so divided that
they cannot elect a BOD consisting of an uneven number of directors. This is the notion that there must be
economic adversity even if also have an equally divided board & divided
Shareholders.
c)
The
Shareholders are so deadlocked that business can no longer run at an advantage
or Shareholders have failed at 2 consecutive annual meetings to elect
successors to BOD whose terms have expired.
(Also need economic adversity here or Shareholders cannot elect.)
d)
Those
in control are guilty of fraud, mismanagement, abuse of authority, or waste of
Corp property. (Here, 1/3 isn’t needed
for standing)
e)
In
close corps, liquidation is reasonably necessary to protect interest of
Shareholders.
3. Economically Viable Corp: Having an economically viable Corp won’t stop
dissolution but has a big impact.
a)
RADDUM: Falling out between 50% owners of Corp. Court wouldn’t allow dissolution because during the period of
turmoil, the Corp was making lots of $$$.
b)
Economic
Adversity: not enough for dissolution usually must also show some other
grounds (i.e. deadlock)
B.
Avoiding Dissolution - §
2000: Subject to contrary provision, the S/Hs with
at least 50% of the votes can dissolution of the Corp by purchasing for cash,
the shares owned by those who want dissolution.
1. Example: A owns 50%, B owns 40%, C owns 10%
a)
A
may cause voluntary dissolution because 50% is sufficient.
b)
B
cannot cause voluntary dissolution due to only having 40%. Assuming B can show economic adversity for
involuntary solution, A &C can block B by coercing B to sell his shares
under § 2000.
2. Buy Out Price: If they can’t agree on a
price that those against dissolution will pay to get the shares, then § 2000
allows the court o appoint 3 independent appraisers to determine a fair value
of stock. B is then obligated to accept
that price.
I. §1700
(enacted 1994)
B. Melds Corp code & Partnership Code.
II.
Characteristics
1. Limited Liability for all
owners
2. Owners = “Members” (not
Shareholders)
3. Personal Assets: Not
available to creditors
4. Taxation: There’s assurance of no double taxation;
taxed same as a Partnership & profits & losses are passed to owners
directly.
a)
Distinguish
Corporation: In Corp, the profit is
taxed to the Corp as an entity, then after tax funds may go to Shareholders as
dividends and are taxed again.
b)
Distinguish
Subchapter S Corp: Taxed like a
Partnership, but they’re very restricted & limited. (Must have less than 35 Shareholders and
could only have one class of stock, etc.)
5. Doesn’t matter how many
members in LLC, and doesn’t matter whether member is foreign or domestic.
6. At least 2 people required.
7. Flexibility of
Management: Similar to a Partnership,
can arrange in any way.
III.
Formation
1. Filing: Short Document called “Articles of
Organization” must be filed w/ secretary of state
2. Operating Agreement: must be signed by 100% of
members & this is very flexible.
Internal Governance can be arranged in anyway.
IV.
Duration: Not perpetual—duration must be fixed.
A.
Transferability – One can assign his
membership, but assignee gets no managerial control unless 100% members agree
or it is allowed in AOO. So only
transfer economic interests w/ rights to management.
B.
Dissolution
1. Voluntary: Majority of members can have
voluntary dissolution unless otherwise stated in AOO.
2. Judicial Decree: Any member can ask court for
dissolution and in some cases, courts can order it.
3. Coerced buy-out: similar to § 2000, court can force party wanting dissolution to accept cash rather than dissolution.