November Notes Business Organizations
November 1, 1999
More on piercing the corporate veil
Undercapitalization -
don’t have enough funds to pay a liability; so a claimant can ask the court to disregard the corporate form in order to get to more funds; what do you have to prove?
- equity, injustice if the corporate veil is not pierced; a court will usually say this is not sufficient injustice
- undercapitalization - what is adequate capitalization? Very hard to know what is adequate capitalization; not any realistic way of estimating potential damages that might come from operating a business; with a contract situation it is much easier to get some idea of the magnitude of liability; courts do not often indicate what would be adequate; most often the courts will not rely only on undercapitalization
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November 3, 1999
F. Equitable Subordination
1. Deep Rock- put s/h behind creditors in collecting when no assets- use when not able to pierce- bankruptcy court can take particular claim and subordinate others (ct. of equity)- use to try to get claim paid off- can take place in many factual situation if can convince court that equitable
HYPO:
A mechanic shop is on the side of a road. Across the road a huge warehouse is being built. When it is completed, there are a giant number of trucks moving things in and out of the warehouse. The corporation manufactures lots of household goods. The warehouse corporation sends its trucks to the mechanic for repair. Things go good for awhile, but then the warehouse is going bankrupt and cannot pay the mechanic.
- Can the mechanic collect his money from someone in the bankrupt warehouse (piece the corporate veil?)
Could piece the corporate veil if one corporation is owned by a larger corporation. And the larger corporation gave the smaller one a big loan, and that is how they were able to operate. When the smaller corporation went bankrupt, the big one is also responsible.
NEW subject:
I.. Director’s duties
A.. fiduciary duty of care - deals primarily with negligence
1.. Francis v. United Jersey Bank - a reinsurance corporation where the sons cause bankruptcy. Mother is the director but does not keep an eye on what is happening in her corporation. Court said she is liable in negligence for the losses caused by her sons because she is the director.
Some of the things she failed to do was understand the business, attend meetings, keep informed about the activities of the business, get financial statements.
2.. CA § 309 - standard: ordinary prudent person in like position in the circumstances; does not make a distinction between what type of person; focuses on notion of common sense; practical wisdom; standard is not one of asset preservation; “in like position” - takes into account level of expertise, also take into account knowledge and experience; also take into account difference in circumstances (big corporation vs. small)
3.. HYPO: director of 3M; director has plead guilty to price fixing on a product that is fire fighting foam; a group of shareholders has instituted a shareholder’s derivative action claiming that the directors have been negligent and not met their duty of care; w/ sales of $15 Billion and profits of $720 Million- worldwide operation and wide variety of products; spending was $1.4 billion; 10 major divisions; directors are liable if they should have known or should have made inquiry notice
4.. Allis- Chalmers - no duty to ferret out the wrongdoing. This was good law for a long time until limited by Caremark - directors need to ensure there is a reasonable reporting system in place to collect and gather information; those systems should bring notice to BOD that something is wrong; if you have these kinds of systems and BOD still does not get notice, then the BOD is not liable
5.. directors are supposed to make their decisions including with reasonable inquiry §109; ability to rely on opinion qualified as long as act in good faith after reasonable inquiry when have reason to suspect
6.. duty of care is very low for commercial/industrial corporation; almost unheard of personal liability for directors; need some kind of self dealing for personal liability
7.. Business Judgment Rule - first kind of defense that BOD has; they made their best judgment, and it can’t always be perfect; ALI definition: Director in capacity as director protected from personal liability if make poor choice; this defense is not always available - must go through the elements: 1). A deliberate, focused kind of decision, 2). No benefit if question regarding loyalty; 4) must believe it was made in best interest of corporation; 3).. must be a disinterested decision; 4).. reasonably informed, some rational basis for making the decision (from ALI)
EXCEPTIONS: when the corporation is to be sold - courts have held corporation to a higher standard. FED-EX double parking hypo: what to do about parking tickets? The company must permit the drivers to double park in order to do business, but also the director’s don’t want to condone illegal activity. Cannot break the law by altering the articles to exclude that area of fiduciary obligation. Cannot exclude certain areas or personal liability by altering the articles.
8.. Smith v. Van Gorkom
- publicly traded securities that
produced huge tax write-offs. If a
director is grossly negligent in making decisions, he will loose benefit of the
business judgment rule. Gross negligence: Approved sale without learning real
value of company, did not have any written documentation of the proposed deal,
no true bargaining took place, and only spent 2 hours on the decision although
there was no emergency. HELD: this
process was so sloppy, that the decision was not an informed one and therefore
they do not have the protection of the BJR; liable for breach of the duty of
due care. Will be negligent unless you
make an informed decision.
9.. CA - passed some statutory provisions to avoid director’s liability
10.. statute to avoid some personal liability which will protect directors - § 204(a)(10) - limits director liability; §204(a)(11) - can have corporation sign an indemnification agreement (corporation can indemnify the directors); §317 spells out the kind of indemnification that can be obtained
B.. fiduciary duty of loyalty - most frequent factual situation is where there is a
conflict of interest
1.. HYPO: director of a corporation sells a piece of real estate to the corporation. Should this be voidable? Historically, the sale is voidable. But not anymore, as long as the price is fair. Don’t want the shareholders to miss out on good opportunities. Okay for the director to sell as long as he is not making money off of the corporation. He can only sell at a “fair” price. Agency law states director cannot keep profits from a sale.
2.. HYPO: director of Biologists. Individually have another business and wants to sell equipment from other business to Biologists. Director hires expert to inspect equipment to make sure it is worth the fair price. Director also does not participate in board discussion about purchasing the equipment. Director knows there is a defect in the equipment (the BOD did not know, and the expert did not find the defect). Should the transaction be voidable? There is an affirmative obligation of director, to NOT deal with own corporation at arm’s length. Have to give all relevant material facts in regard to the transaction. This should be voidable.
3.. CA § 310(a) Three types of voidable transactions: X sells to corporation in which he is a director; X sells to a corporation in which he is an owner; X is a director in two corporations but has no financial interest in either corporation. Ways to protect transaction from being voided: disclose all material facts; shareholders ratify decision (majority under § 153, do not count interested party’s shares); shareholders act in good faith; transaction must be just and reasonable towards corporation
4.. 310(b) - when on board of directors of two corporations (common directorship) then full disclosure to shareholders of the board and need to ratify. NO requirement that need determine just and reasonable. If director has no financial interest, then the standard is lower.
5.. The interested parties may be counted for quorum purposes even though their vote may NOT be counted (in a director’s meeting)
C.. Corporate Opportunity Doctrine - if director is presented with an opportunity, is he required to share the opportunity with his corporation?
1.. most cases deal with cases where person is in competition with their own corporation after they have exploited the opportunity. Does not include any business opportunity - must have an expectancy in transaction, transaction is in direct competition with corp.
2.. HYPO: elements of corporate opportunity doctrine; director of a steel housewares company presented with opportunity to purchase another company. Can the director buy it, or must he first present the opportunity to the corporation. 1). Opportunity was made in director’s corporate capacity and meant to be for corporation; 2). No direct competition with own corporation; 3). If corporation is likely to expand into area of opportunity - same line of business - a corporate opportunity
3.. Broz - although a corporate director may be shielded from liability by offering to the corporation an opportunity which has come to the director independently and individually, the failure of the director to present the opportunity does not necessarily result in the improper usurpation of a corporate opportunity.
XI.. Proxies
A.. solicitation regulation - federal law - governed by SEC Act of 1934; attempts to bring integrity into the market; applies to publicly held corporations ($5 mil. In assets, 500 Shareholders); before regulation there were wild abuses in solicitation of proxies
B.. disclosure -
1.. every publicly held corporation required to file annual report (public relations, upbeat description of corporation)
2.. proxy statement required to give certain information - usually the document with lots of small type that no one looks at
3.. HYPO: proxy statement to company; did not mention bribes in other country and different country to get business. How does 14a-9 affect lies, omissions, bribes? Only affects those that are MATERIAL fact (material - kind of information that would be likely influential or desirable by the shareholder in making the decision to vote one way or the other; if it might be valuable to shareholder it IS material)
C.. elements in order to obtain relief in a private right of action for those who have been injured by proxy
1.. material - must have been a material misstatement or omission in the proxy (material if it is likely to affect how the shareholder would vote)
2.. reliance - there must have been some reliance by shareholders on the omission or misstatement in the proxy; P does not have to show that the falsehood or omission directly "caused" the damage to shareholders; he only has to show that the proxy solicitation itself (not the error or omission) was an essential part of the transaction
a.. Virginia Bankshares - If P is a member of a minority class whose votes were not necessary for the proposed transaction to go through, P may not recover no matter how material or how intentional the deception in the proxy statement was.
3.. fault - P must show D at fault in some way. If D is an insider, P only needs to show negligence
D.. Exclusion of proposals (14a-8) - A company may exclude a proposal if the proposal directly conflicts with one of the company’s own proposals
1.. will need to get a shareholder’s list - person requesting it must pay for the list
a.. other alternative, is the corporation will send out the material for the person (because they don’t trust him with the shareholder list; requesting person must pay for it)
C.. Anti Fraud provisions
D.. Access by shareholders to proxy machinery
XII.. Insider Trading
A.. Diamond - sell stock based on inside information; don’t want insiders to get advantage because of their inside knowledge; 10b-5 - antifraud provisions in regard to sales to public; it is used to protect shareholders; applies to any corporation with dealings in securities; must have jurisdiction means (such as interstate commerce, telephone, mail), Any purchase or sale of securities involves 10b-5;
-/- most litigation has been under subsection b of 10b-5 (not make false, misleading statements)
B.. Texas Gulf Sulfur - in addition to insiders purchasing stock, the corporation itself, put out a couple of press releases that played down the fact of the find; in order to bring a 10b-5 in respect to the PLAINTIFF, you must have bought or sold securities. If the DEFENDANT puts out false press releases, you can sue the defendant with the defendant having purchased or sold securities (because the D took misleading steps)
C.. 10b-5 - 1. disclose or abstain, 2. standing, 3. scienter (state of mind of party making false statement or omission), 4. reliance (causation), 5. breach of duty;
D.. STATE OF MIND - scienter - if statements were made, and later they were found out to be false; if the information came through negligence, should it be a 10b-5 violation? NO, simple negligence does not support a 10b-5 action. There must be a state of mind where you INTEND to mislead or lie, or at least reckless disregard. Mere negligence is NOT enough; 10b-5 does not immunize statements made in relation to an IPO
E.. Private securities Reform Act of 1995 - Protected if: 1) identify forward looking statement (estimate, guess), OR 2) no actual knowledge that statement false
-/- EXCEPTIONS: no protection if statement is made in an IPO
F.. Reliance - if an affirmative statement made into the market, there is the fraud on the market theory. Presumption that there is fraud, can only overcome this if the defendants can show that plaintiffs would have purchased the securities anyway CHECK EMANUALS; D’s misstatement will be presumed to have affected the market price
G.. causation - If the case involves affirmative misrepresentation (not just silent insider trading), P will be given the benefit of a presumption that P relied on the misrepresentation and that it caused P’s injury. 1) transaction causation - have to show that the transaction caused injury (misrepresentation caused insider to enter into the transaction); 2) loss causation - that the misrepresentation actually caused some loss (MUST HAVE BOTH OF THESE) same factors that caused person to enter into transaction, also caused the loss
H.. Duty - Chiarella - he was accused of trading on inside, private information; the information was gained through his printing business and not through the corporation; he had NO DUTY and therefore no fiduciary obligation, so not 10b-5 violation; he was an OUTSIDER; there must be a duty to disclose information in order for there to be a violation
I.. Hagan case - breach of duty to firm; misappropriation theory - breach of fiduciary duty not to the other party in transaction, but to employer
J.. Dirks case - situation involving massive fraud by insurance company; tippee is in the shoes of the tippor (former employee) have to have a breach of duty in order to have a 10b-5 action; employer did not breach the duty because he was exposing fraud; in giving the information to the tippee was not breaching the duty to the shareholders; the tippor must be getting personal financial benefit by passing on tip; in this case there was no reputational or financial benefit; D was not a knowing tippee
XIII.. § 16 (b) Securities Exchange Act of 1934 - no insider trading; makes unattractive to try trading
A.. applies to officers, directors and shareholders that are more than 10% owners; they must pay to the corporation any profits they make within a 3 month period, from buying and selling stock; this is an attempt to stop insider trading
B.. intent is not required - applies to any profits made within the period; courts want to produce a detrimental result for the officer or director
C.. must have been an officer or director either at time of purchase or time of sale is sufficient in order to bring you in the scope of 16(b)
D.. in order to have a violation if you are a more than 10% shareholder you must be more than 10% at time of purchase and time of sale - this led to fraud - people would sell off a few shares so that they were less than 10% and then could keep the profit of the rest of the shares; this seems bad, but is still allowed
E.. main concern is that it is completely arbitrary in 6 month period and has no necessary connection with inside information; will be subject to 16b even if you bought for completely different reasons -
F.. RULE: if you made a profit within 6 months and you are a officer or director of a corporation, you state of mind is totally irrelevant; cannot retain profit on traded securities of own corporation
G.. Kern County - KC merged with Tenneco in order to stop Occidental from taking over the company. KC shareholders got Tenneco shares from a result of the merger. Whether the merger was a sale for purposes of 16b? Court said it was an unorthodox transaction. HELD: court wanted to see if there was a possibility of speculative abuse. Occidental did not have inside information. If the corporation merges into another company (and thus disappears), the insiders will not necessarily be deemed to have made a "sale."
-/- D may escape short swing liability (under 16b) if he shows: 1) transaction was involuntary, 2) D almost certainly did not have access to inside information
IX.. Limited Liability Corporation
1.. NOT available to professionals in CA
2.. has some elements for a corporation and elements of a partnership
3.. Steps to form:
a.. file articles of organization (must include in name LLC or something like that) (are a public record); just a bare bones document and address for service of process
b.. two or more individuals must get together as members and enter into an operating agreement (not a public record)
4.. terms to know
a.. member - an owner in the enterprise
b.. manager - elected by the members (owners) of the LLC
c.. articles of incorporation - barebones document, must identify
management
d.. economic interest - individual’s right to receive profit and losses
e.. membership interest - broader than economic interest; includes
economic interest plus the owners right to vote, participate in management
f.. operating agreement - all parties must agree to, not a public record
5.. management - LLC can be managed by manager OR the members them selves (this is a striking, new move); see 17151
a.. practically this means that the organization can be run like a partnership (owners participate in management) OR you can elect a board of directors
b.. so you can end up with internal governance looking either like a corporation or partnership
6.. Power to bind: §17157 - all members are able to bind the LLC if in the usual course of business no managers are selected; if there IS a manager selected, then members are not agents, and ONLY managers can bind (similar to corporation in that if have member that have no authority to bind the LLC, then have to notify the 3rd party that have no authority to avoid liability
7.. Personal liability of members - if you invest a member, you are not going to be personally liable for the acts of others in the corporation
8.. Personal liability of officers or managers - NO personal liability
a.. failure to hold meetings by managers or members - if you fail to hold
meetings, cannot use for piercing the corporate veil purposes (17101b)
9.. fiduciary obligations - §17153 - similar to those of a partner; cannot eliminate duty of loyalty but can define certain areas where participation in certain activities that would normally look like breach of duty of loyalty; ability to modify look at partnership codes: 16103b3
10.. voting - can have non voting members
11.. enormous flexibility - remember this, can do lots of stuff with a LLC
a.. 17005 - can arrange things as you want EXCEPT:
i.. requiring at least a majority of interest to alter articles of organization
ii.. assured certain rights for dissolution and merger
b.. items that can be altered, but not effective unless in articles:
i.. manner in which you can amend articles or operating agreement; if you want to change it, you have to spell it out by a change in articles or operating agreement itself
ii.. rights of voting
iii.. removal of election of managers
iv.. and a number of other things….. CHECK
12.. the most important driving force of LLC is because of the tax treatment for federal income tax purposes
a.. been on books in CA for 4 or 5 years; not done until IRS said they would treat these kinds of entities as if they were partnerships and provide pass through taxation like in a partnership as opposed to double taxation in corporation
b.. choice to have IRS treat these as pass through taxation OR treated as a corporation for taxes purposes (depending on how LLC is organized)
i.. this is the only form in CA where all investors can have limited liability AND you can have pass through taxation for income tax purposes
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