1. Valuation of the Corporation

1. Accounting

1. Balance Sheet - analogous to a “snapshot”

1. Assets=Liabilities + Equity

2. Assets

1. cash, inventory, fixed assets (buildings, equipment), intangibles (patents, goodwill), accounts receivable

2. current assets-assets that are likely to be converted to cash within one year

1. cash, inventory, securities

3. generally, assets on balance sheet reflect historical costs, not market value, liquidation value, or replacement value.

3. Liabilities

1. current liabilities - due within the year

2. long-term liabilities - due in greater than one year

1. to the extent that assets depreciate, they represent future expenses, and so are depreciated over their useful life rather than expensed in the year purchased

1. whether company uses straight line or accelerated affects apparent growth - more accelerated means more growth and lower current taxes

2. intangibles are “amortized” over their useful life (similar to depreciation)

4. Equity - two sources:

1. direct investment by shareholders

1. “legal capital account” or “capital account” or “capital surplus” is where direct investment by shareholders is tracked

2. profits/income/earnings

1. “earned surplus” or “retained earnings” are where earnings are tracked

3. Shareholder’s equity = net assets = book value of corporation.

2. GAAP - Generally Accepted Accounting Principles

1. Individual journal entries are made

2. Journal entries are summarized into General Ledger

3. General Ledger is “closed out” into balance sheet

4. “matching principle” or “accrual accounting” - match expenses for this year with income from this year (except for depreciated assets - see above)

3. Income Statement - analogous to a “motion picture”

1. Operating Income or Earnings Before Interest & Taxes (EBIT) equals:

1. Net Sales; minus

2. Operating Expenses

2. Net Income (profit, earnings) equals

1. EBIT; minus

2. Interest Expenses; minus

3. Income Taxes

3. Income statement is an entry in the balance sheet in the retained earnings account (see above)

4. Comparison Ratios:

1. Profit Margin - equals Net Income over Net Sales (is it increasing or decreasing)

2. Operating Margin - equals Operating Expenses over Net Income (is it costing more or less to make money from year to year)

3. Current Ratio - “Quick Test” equals current assets over current liabilities (ability to cover current debts as they become due)

1. Working Capital - equals current assets MINUS current liabilities (how much extra cash is available for new things)

4. Debt Ratio - equals total debt over total assets (how much does the company have to show for its debts)

5. Debt to Equity Ratio - equals total debt over total equity (how much is the company leveraged)

6. Price to Earnings Ratio - equals market price over net income (earnings) per share

7. Inventory Turnover Ratio - equals net sales over Inventory (how many times per year care you able to turn over you entire inventory - more is better - is the company holding too much inventory)

8. Total Assets Turnover Ratio - equals net sales over total assets (is the company holding too many assets?)

9. Return on Assets (ROA) - equals net income (earnings) over total assets (how efficiently is the company using its assets)

10. Return on Equity (ROE) - equals net income from current year over shareholder’s equity of prior year (is the company investing its assets wisely or could it do better in other investments)

2. Methods of Valuation

1. Book Value - Net Asset Value - Shareholder’s Equity

1. Merely add up the Equity from the balance sheet.

2. only reflects historical data and ignores appreciation or depreciation

2. Adjusted Book Value

1. Add up Equity from balance sheet and correct for depreciation, or appreciation (current valuation)

3. Liquidation Value

1. add up what the Net Assets would sell for if they were sold in pieces today

2. only reflects the break-up value of the individual assets, ignoring the going concern value of the company

4. Capitalized Earnings

1. discount the anticipated future earnings to the present day

2. Divide 100 by the discount rate to get an capitalization rate -

1. higher discount rate means that the company is more risky (less likely to show a profit)

2. discount rate also includes the time value of money

3. Multiply the capitalization rate times the expected earnings

4. ex: If Company A anticipates to make a profit of $50K per year, but it is fairly risky, then the earnings multiple might be 100/15% = 6.6. So it would be fair to pay 6.6 times $50K or $330K for Company A for the chance to make a 15% return per year on your investment.

5. Capitalized Cash Flow

1. discount cash flow to present value

6. Capitalized Dividends

1. discount future dividends to present value

7. Stock Market Price

1. what is the “market” willing to pay for this company?

2. What are Earnings Per Share (EPS)?

3. What is the Price to Earnings (P-E) ratio?

2. Choice of Organizational Form

1. Key Considerations

1. Liability of Owners

2. Management and Control of Owners

3. Transferability of Ownership

4. Continuity of Life

5. Entity Status

6. Taxation

7. Formation and Organization

2. Tax Considerations

1. Corporation is treated as a separate entity for tax purposes

1. when there are losses or gains, corporation retains the reporting requirements on its own tax return.

2. Partnership (P), Limited Partnership (LP), Limited Liability Partnership (LLP), Limited Liability Company (LLC) - all make an election as to whether they wish to be taxed as a “corporation” or as a “partnership” for the next 5 year period.

1. default for failure to elect is partnership

2. a partnership passes on losses and gains to the individual partners for recognition on their individual tax returns.

3. partnerships may therefore act as tax shelters to offset personal income if the partnership is expecting losses

3. S-Corporation (S-Corp.) - treated like a partnership as far as passing on losses to shareholders.

1. must be less than 30 shareholders who are individuals, trusts, or estates (not other corporations)

2. must only have one economic class of stock, but can have many voting classes.

4. “Double-Taxing” - if a corporation makes money, it is taxed on its income. If the corporation then declares a dividend, the dividends are taxable to the individual shareholders as income.

1. Corporations try to hide dividends as excessive salaries because salaries are deductible to the corporation as a current expense.

2. Corporations try to avoid distributions by selling debt instead of selling equity because the interest on the debt is deductible as a current expense.

1. Conflicts of Interest

3. Lawyer representing the constituent promotors of a corporation may have a conflict of interest that prevents him from representing all of them

5. Each individual may have pre-existing conflict

3. however, their interests are generally aligned so you may represent them as a lawyer for the “situation.”

6. Must advise clients that:

1. nothing they say is confidential with respect to the others present

2. may not be able to represent ANY of them as individuals if a conflict arises in the future

3. will become “lawyer for the corporation” after the formation.

1. Danforth “entity rule” applies retroactively if:

1. the persons only contact with the firm was for forming a corporation; and

2. a corporation was thereby formed.

4. Lawyer should not sit on the board of a corporation for which he is the attorney.

1. Board of directors determines the lawyer’s fee

2. Possible future conflict if the shareholders sue the board of directors

3. might be liable to a greater extent than the other directors for legal violations

4. other directors may ask for free or personal legal advice or representation

5. If lawyer accepts stock as payment of fees, a conflict would arise if shareholders decided to sue the corporation.

2. Incorporation Process

1. Internal Affairs Doctrine - the state of incorporation determines the laws that will apply to the internal affairs of the corporation, not the state(s) of place of business.

1. For small corporations:

1. tax considerations might weigh in favor of local incorporation (foreign corporations are taxed at a higher state tax rate).

2. personal jurisdiction might weigh in favor of local incorporation (can’ t be sued easily elsewhere).

2. For large corporations

1. directors liability considerations might weigh in favor of incorporation in Delaware

2. more limited shareholders rights might weigh in favor of incorporation in Delaware

2. Formalities

1. File the Articles of Incorporation with the state authority

1. RMBCA §2.02 -

1. Articles must set forth names, addresses, number of shares.

2. Articles optionally may also set forth:

1. purpose of corporation - RMBCA §3.01 - any lawful purpose

1. ultra-vires RMBCA §3.04 - court can provide damages if the corporation or directors enter into obligations outside of corporate purpose

2. powers of corporation - RMBCA §3.02 - non-exclusive (illustrative) list of 14 general powers - same powers as a natural person.

2. Corporate existence begins when the articles of incorporation are filed - RMBCA §2.03

3. Rendering of Legal Opinions on Corporate Status

1. “Duly Incorporated”

1. must file articles of incorporation; AND

2. be in compliance with the corporation law of the state as to the form and contents of the filed documents.

3. Many states provide “duly incorporated” certifications, but a prudent lawyer does not take the state clerk’s evaluation as conclusive.

2. “Duly Organized” RMBCA §2.05

1. Need to have bylaws adopted

2. Need to verify that there are shareholders

3. Need to verify that there is a board of directors

4. Need minutes of the corporate meetings

5. Need a corporate seal

3. “Validly Existing”

1. Make sure that company still has a charter

1. Make sure that company has not been dissolved

2. Make sure that attorney general has not revoked charter

4. “In Good Standing”

1. corporation has paid all of its taxes

2. corporation has paid all of its franchise fees

5. “Qualified to Do Business” in a foreign state

1. Proper documents and fees filed

4. Consequences of Failing to File Articles of Incorporation

1. Constituents are personally liable for the debts of the corporation unless:

1. “corporation by estoppel” - creditor thought he was dealing with a corporation, so he can’t claim now that the promotor is personally liable

2. “de facto incorporation” - a good faith effort to file the articles plus proper following of corporate procedures

1. having board meetings

2. keeping minutes

3. treating corporation as a separate entity with its own accounts, etc.

4. ex: in Cranson, IBM could not sue the promotor of the corporation for personal liability because he had a good faith effort to incorporate, and had observed corporate formalities. Furthermore, IBM contracted with what it believed to be a corporation and is therefore estopped from claiming now that it was not a corporation.

2. RMBCA §2.04 - promotors are liable for knowing failure to comply with filing of documents, but are not liable if they are unaware of an agent’s (lawyer’s) failure to file the documents

1. ex: if you are responsible for filing the articles, but forget to do so, and then enter into a contract on behalf of the corporation, then you are personally liable for knowing failure to file.

2. trend is toward stricter liability for non-filing - promotor can always bring an action against the person who failed to file (lawyer) for indemnification.

5. Pre-Incorporation Contracts

1. Two types of contracts:

1. “Novation” type

1. promotor is expressly personally liable in the contract until the corporation is “duly incorporated” at which time the corporation’s liability is substituted for the promotor’s

2. Other type

1. if there is no express term on promotor liability, then it is a question of fact whether the intent of the parties was for the corporation to substitute its liability in place of that of the individual.

2. corporation may not unilaterally “adopt” the contract without the consent of the creditor because it changes the creditor’s security.

3. Financial Structure of the Corporation

1. Debt Securities

1. Notes - a short term unsecured debt

2. Debenture - long term unsecured debt

1. “sinking fund” debenture - company saves up earnings in a sinking fund to buy back debentures at a periodic rate so that all do not come due at the same time. - decreases the company’s risk and therefore decreases the interest rate they pay on the debenture

3. Bond - long-term secured debt with a consequent interest rate that is lower than a note or debenture

4. debt instruments may be “redeemable” by the company before their full term allowing the company to refinance.

5. Convertible Debt - a debt that becomes convertible to an equity

6. Right of return - debt holder is entitled to return the debt instrument for face value on maturity

1. there may also be a market value for the debt security which changes according to increases/decreases in interest rates

7. Indenture Contract

1. a public offering of debt that sets for the terms of the offering

2. managed by a trustee

3. may provide for restrictive covenants to prevent the corporation from issuing more debt in order to protect the security of the existing debt holders (helps prevent hostile takeover by raider which is highly leveraged with junk bonds)

8. Tax Consequences

1. Interest on debt is deductible as a current expense - avoids double taxation (see above)

2. Company must pay debt, even if it is doing poorly, whereas in regard to equities, the company could decide not to pay dividends.

9. Procedure for issuing debt - board of directors authorizes an officer to negotiate a debt issuance

2. Equity Securities

1. Preferred Stock

1. Right to return - preferred stock is entitled to be paid dividends before common stock (but not entitled to anything unless the board declares a dividend)

1. ex: $8 preferred shares - pay an annual dividend of $8 to the holder as long as the board declares a dividend at all.

2. May be cumulative or non-cumulative

1. cumulative - if the dividend is not paid in one year, it cumulates for the next year and pays double (or triple if three years, etc.)

2. non-cumulative - does not cumulate from year to year if the board does not declare a dividend, then you are out of luck

3. “liquidation preference” - If the corporation is liquidated, preferred shareholders are paid from the proceeds before common shareholders

4. May have different voting or control rights than common stock

1. ex: a preferred shareholder may have the right to vote out the board of directors if they fail to declare a dividend for X years running.

2. Common Stock

1. Right to residual - a proportionate interest in whatever is left after creditors and preferred shareholders are paid.

2. voting rights - generally one share is one vote unless articles provide otherwise (see below).

3. Procedure for Issuing More Stock -

1. since the Article of Incorporation are required to state the number of shares authorized (see RMBCA §2.02), the only way to authorize more shares is to amend the articles under RMBCA §10.03.

1. majority of directors propose the amendment to the stockholders

2. majority of stockholders approve the proposed amendment

2. DGCL §152 - consideration to be paid for stock

1. in the absence of fraud, the directors have the power to determine, conclusively, the value of consideration paid for stock (the stock price)

2. future consideration is NOT valid for stock in Delaware.

3. RMBCA §6.21 - consideration to be paid for stock

1. director’s valuation of shares is conclusive

2. shares MAY be issued for may types of consideration, including future consideration

4. DGCL §153 - Shares can not be issued for less than their par value - but par value is almost meaningless because it is set artificially low.

5. DGCL §162 - shareholder must pay for the full value of shares, but is not liable beyond that amount

6. RMBCA §6.22 - shareholders are only liable to the extent of the consideration paid for their shares

4. Procedure for Issuing More Preferred Stock

1. still need to amend the articles to increase the number of shares;

2. however, articles may provide that the board of directors determines the precise terms of the preferred shares - “blank check preferred shares”

5. Legal Capital Account

1. the par value of the shares times the number of shares issued

2. board of directors can reduce the par value such that the lion’s share of the consideration paid for the shares goes to the “additional paid-in capital surplus” account.

3. Payment of Dividends

1. In Delaware

1. DGCL §170 can distribute dividends out of “surplus” or net profits of the current or preceding year

1. DGCL §154 “surplus” is the net assets in excess of “capital” and “capital” is the price of the shares issue over par value.

2. DGCL §172 - a director who acts in good faith in reliance on prepared data is exculpated for voting for a dividend that later turns out to be illegal.

3. DGCL §174 - director who willfully directs the payment of an unlawful dividend is personally liable for the full amount

2. In California

1. CGCL §500 - can distribute dividends out of retained earnings or surplus and

1. the sum of the assets remaining must be 125% of the liabilities; AND

2. the current assets must be at least equal to the current liabilities.

1. this allows the corporation to meet their liabilities as they mature

3. A board of directors is protected by the business judgment rule in its decision whether to declare a dividend, but a dividend may be compelled if the failure to declare a dividend by the board is an abuse of their discretion in bad faith.

1. ex: Dodge Bros. v. Ford Motor Co. - corporation had excessive surplus, and the failure to declare a dividend was to prevent the Dodge Bros. from having the money to build a competing business.

2. counter-ex: Kamin v. American Express - board may properly decide to declare a stock dividend rather than a cash dividend to make their income look better, even though it had adverse tax consequences.

4. Limited Liability of Shareholders

1. “piercing the corporate veil” - passing on the obligations of the corporation to the shareholders themselves

1. corporate veil will be pierced for equitable reasons if the owners are conducting business to further their personal pecuniary interests rather than that of the corporation

1. ex: in Walkovsky v. Carlton, the claim did not allege that the owners were doing business in their personal capacity, and so the claim was defective, even though the owner set up many small corporations with limited assets as a shield to liability.

2. Instrumentality Rule:

1. domination and control over the corporation which is so complete that the corporation has no separate mind or existence of its own

1. counter-ex: claimants may not pierce the corporate veil to get at the parent of a wholly-owned subsidiary that has a valid separate existence respected by the parent. - American Trading.

2. use of this domination and control to commit fraud or wrong or any other dishonest or unjust act

1. counter-ex: in Brunswick v. Waxman, the court declined to allow a sophisticated corporation to recover from a failed no-asset corporation under the instrumentality rule because there was no fraud - Brunswick knew they were contracting with a no-asset corporation.

3. injury proximately caused by the unjust act.

3. Corporate veil may also be pierced if the corporation is grossly undercapitalized and an obvious front or shield for personal business to avoid liability

1. ex: in Kinney Shoes, the court allowed the corporate veil to be pierced to avoid the an inequitable result.

5. Agency Power in a Corporation

1. Actual Authority - authority granted by the corporation for a person to bind the corporation

1. express authority - expressed by the corporation in words

1. ex: board of directors passes a resolution authorizing the president to contract for the construction of a new building

2. also can arise if the board (or someone else with sufficient authority) later “ratifies” a previously unauthorized contract.

2. implied authority - implied by the nature of the office and the surrounding circumstances

1. implied authority to perform all things necessary or incidental to the assignment

2. ex: a Vice President purchases $1,000 of equipment without specific authorization from the board, but as a normal part of carrying out his duties.

2. Apparent Authority - person is “clothed” in indicia of authority sufficient to induce the reasonable reliance of a third party

1. ex: President of a company, representing himself as such, contracts with a vendor for the purchase of equipment in the normal course of business, and the vendor relies on such representation.

2. ex: President contracts with valuable employee for a life pension, and the employee relies on that pension as a reason to remain at the company. - Lee v. Jenkins Bros.

3. ex: in First Interstate Bank of Texas v. First National Bank of Jefferson, the court held that there was sufficient evidence to present a jury question as to apparent authority for a bank vice-president to negotiate a financial deal.

4. not valid for “extraordinary” transactions that are out of the normal course of business

3. Inherent Agency power - miscellaneous - mostly used for tort liability under respondeat superior.

4. How to render an opinion that a contract will be binding on a corporation:

1. get a confirmation that the person has actual authority to bind the corporation.

1. ex: get corporate secretary to certify that the board of directors meeting minutes grant such authority

2. determine the scope of the express authority granted in the meeting minutes

1. is it express or implied

2. are any of the terms “extraordinary” in the contract

3. verify that the corporation was duly incorporated and is in good standing

4. verify the signature as authentic

6. Authority of the Board of Directors

1. Formalities

1. Quorum - RMBCA §8.24 - by default it is a majority of the directors, but it may be reduced by the articles or bylaws to no less than 1/3 of the directors.

2. Notice - RMBCA §8.22

1. by default, notice is not required for regular meetings

2. by default, 2 days notice is required for special meetings

3. RMBCA §8.23 - director may waive notice, thereby curing any defect in the notice given, by merely showing up.

3. Directors may not vote by proxy - it must be in person (or conference call RMBCA §8.20)

4. RMBCA §8.21 - if all directors are unanimous, the board may proceed informally without conducting a formal meeting.

1. RMBCA §3.03 - also may act informally in an emergency unless there is a pre-emptive statute.

5. RMBCA §8.25 / DGCL §141 - committees of the board

1. must comprise two or more persons

2. must be elected and created by majority of the entire board

3. can exercise many of the lesser functions of the board, except as specified.

2. RMBCA §10.20 - Board may unilaterally amend the bylaws unless that power is specifically reserved to the shareholders by the Articles.

7. Mergers and Acquisitions

1. Statutory Merger RMBCA §11.01/DGCL §251(a)

1. all assets and liabilities of target company become those of the parent.

2. all of target’s shareholders get consideration - Parent’s shares

3. Both parent and target shareholders get to vote under RMBCA §11.03/DGCL §251(b) unless:

1. “small scale merger” - the merger would not increase (dilute) the parent’s outstanding shares by 20%, in which case it may merge without the approval of the parent’s shareholders - RMBCA §11.03(g)/DGCL §251(f); OR

2. “short form merger” - the parent already owned 90% of the stock of the target in which case neither the parent’s nor the target’s shareholders have voting rights. RMBCA §11.04/DGCL §253

4. Both parent and subsidiary shareholders may seek appraisal rights. RMBCA §13.02/DGCL §262 unless

1. in Delaware, no appraisal rights for a public corporation if the merger consideration is stock DGCL §262(b)(1)

2. Triangular Merger

1. parent sets up a subsidiary which then executes a statutory merger - into the target (reverse) or target into subsidiary (forward).

2. target’s shareholders get to vote under RMBCA §11.03

3. target’s shareholders get appraisal rights under RMBCA §13.02

4. however PARENT’S shareholders do NOT get voting or dissenter’s rights because the parent’s board of directors, not the shareholders, have control of the stock of the subsidiary.

5. parent can then, if it desires, merge with its subsidiary under a short form merger.

3. Exchange of Shares

1. RMBCA §11.02 - shares of the target are purchased using shares of the parent.

2. shareholders of the TARGET, but NOT shareholders of the parent, have voting rights under RMBCA §11.03.

3. shareholders of the target also have dissenter’s rights.

4. after the exchange, target becomes a subsidiary of parent, and the parent can merge with it under a short form merger.

4. Tender Offer

1. Parent offers to buy Target’s shares directly from Target’s shareholders.

2. If parent is successful, parent gains control of a majority of target’s stock and controls the board

1. No appraisal rights by either company’s shareholders

1. Target’s shareholders vote with their pocketbook

2. Parent’s shareholders have no right to control the transaction because it is not a merger

3. If parent gets sufficient shares of Target, it may execute a merger.

1. then voting rights would be determined by the form of the merger.

5. Exchange of Stock for Assets

1. Parent uses its stock to buy target’s assets

2. The shareholders of the TARGET, but NOT the parent, have voting rights - RMBCA §12.02/DGCL §271 (sale of all or substantially all of the assets)

3. Shareholders of the TARGET, but NOT the parent, have dissenter’s rights - RMBCA §13.02(a)(3), EXCEPT:

1. in Delaware, there are no dissenter’s rights for Exchange of Stock for Assets - DGCL §262

4. Target then becomes a subsidiary of the parent, and may thereafter be merged by short form.

6. De Facto Merger Doctrine

1. A shareholder who does not have voting or appraisal rights because the parent structured the merger in a different way may try to sue for voting or appraisal rights under the doctrine of de facto merger

1. counter-ex: in Delaware, an exchange of stock for assets (not dissenter’s rights for target) followed by a short form merger is not a de-facto merger because of the doctrine of “independent significance”. There is a stock for assets statute that is independent from the statutory merger statute. Hariton

2. Counter-ex: same is true for triangular mergers - Terry v. Penn. Central

* There are no appraisal rights for a public corporation under DGCL §262(b)(1) if the merger consideration is stock.

1. Shareholder’s Rights

7. RMBCA §13.02 - dissenter’s rights arise if an amendment of the Articles of Incorporation adversely affects the dissenter’s rights in their shares

2. ex: shareholders can dissent if the articles are amended to eliminate or change the preferred nature of their preferred shares.

8. Sale of “all or substantially all” of the assets

1. Under the RMBCA:

3. Definition under the RMBCA §12.01 official comment:

1. “what it literally says...synonymous with ‘nearly all’”

2. includes retention of a “minimal residue”

3. sale of several distinct manufacturing lines while retaining one is normally NOT a sale of substantially all assets

4. sale of plant with retention of operating assets toward the view of continuing the operation at another location is NOT a sale of substantially all the assets

4. RMBCA §12.01 - in the regular course of business

1. approval by shareholders is NOT required unless the Articles so provide.

5. RMBCA §12.02 - NOT in regular course of business

1. board of directors must recommend the proposed transaction; and

2. shareholders entitled to vote must approve the transaction.

2. Under the DGCL:

1. Definition under DGCL §271(a) as interpreted by Gimbel v. Signal:

1. must be “out of the normal routine” and

2. QUANTITATIVELY vital to the operation of the corporation; and

3. QUALITATIVELY substantially affects the existence and purpose of the corporation (“strikes at the heart of the corporate existence”)

2. counter-ex: sale by large conglomerate of one of its major divisions is not a sale of substantially all of the assets since the normal routine of the company is to buy and sell divisions. - Gimbel

3. ex: a sale of 51% of the total assets and 45% of the net sales that causes the corporation to depart radically from its historically successful line of business is a sale of substantially all assets. - Katz v. Bregman.

9. Formalities of Voting

1. Authorization to call special meeting:

1. RMBCA §7.02(a)(2) - the holders of at least 10 percent of the stock may call a special meeting by submitting a written demand; or

2. the board of directors or “persons authorized to do so by the articles.”

3. In Del. DGCL §211(d) provides that only persons authorized in the Articles may call a special meeting. So even a large stockholder couldn’t call one unless the articles so provided.

2. RMBCA §7.04 - action may be taken without a meeting only by written consent of ALL the shareholders (not modifiable).

3. DGCL §228 - action without a meeting in Del. may be taken with the consent of only a majority of shareholders

4. Notice -

1. RMBCA §7.05 - notice must be given to the shareholders entitled to vote

2. RMBCA §7.06 - shareholders may waive notice merely by attending

5. Quorum

1. RMBCA §7.25(a) - unless the articles provides otherwise, a majority of shareholders entitled to vote constitutes a quorum.

1. RMBCA §7.27 - articles may provide for a greater quorum for shareholders (but not less)

2. RMBCA §7.25(c) - unless the articles provides otherwise, a majority of the quorum is sufficient for action (can have a supermajority provision in the Articles).

10. Election of Directors

1. RMBCA §8.03(a) - number of directors may be fixed in either the Articles or the bylaws.

1. RMBCA §8.03(b) although the board may amend the bylaws unilaterally, the board may not increase its size by more than 30% without shareholder approval.

2. RMBCA §8.05 terms of the directors expire year to year unless staggered.

3. RMBCA §8.08(a) shareholders may remove directors without cause unless the Articles provide that they only may be removed for cause.

1. DGCL §223 - Shareholders have the inherent right to fill vacant directorships which they have removed for cause. - Campbell v. Loew’s. (may have to amend the bylaws to grant themselves this power first like in Auer v. Dressel).

2. RMBCA §8.10 - shareholders or directors may fill a vacancy unless the articles provide otherwise.

11. Amendments to the Articles of Incorporation and Bylaws

1. Articles of Incorporation

1. RMBCA §10.02 - directors may unilaterally amend the Articles to change minor formalities of name, duration, addresses, etc.

2. RMBCA §10.03 - for substantive amendments to the Articles:

1. board of directors must recommend the amendment; and

2. shareholders entitled to vote must approve of the amendment.

2. Bylaws

1. RMBCA §10.20(a) - board of directors may amend bylaws unless:

1. such power is reserved exclusively to the shareholders in the Articles

2. shareholders specifically direct that the directors may not re-amend a provision that shareholders just amended.

2. RMBCA §10.20(b) - shareholders may amend the bylaws even if the directors can

3. DGCL §109 - shareholders can amend the bylaws, and directors can not unless provided for in the Articles.

3. Amendments to the bylaws by the directors may not be done for the primary purpose of defeating the shareholder’s existing rights to vote. - Blasius (board has a fiduciary duty not to interfere with shareholders allocation of control).

2. Control Devices Relating to Shareholder Voting

1. Class Voting

1. RMBCA §6.01(c) - the Articles may authorize different voting classes of stock, with each class having different voting rights (i.e. electing certain directors, etc.) - also see DGCL §141(d)

2. it is not against public policy to separate voting rights from beneficial stock ownership, but it must be in the Articles - DGCL §151(a)

3. ex: in Lehrman the court held that although a separate class of “tie-breaking” voting stock that had no economic rights diluted the voting power of the other classes of stock, it was not a voting trust and was allowable because the other classes retained control over their own stock.

2. Pooling Agreements

1. RMBCA §7.31 - two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement.

1. any kind of corporation (whether public or closely held) may have shareholder pooling agreements

2. there is no specific time limit

3. they are specifically enforceable under RMBCA §7.31(b)

4. may not affect the powers of the board of directors, or it falls under RMBCA §7.32

2. CGCL §706 - two or more shareholders of a close corporation may agree to pool their votes

1. a “close” corporation is defined in CGCL §158(a) as one having 35 shareholders or less, having a statement in the Articles “This is a close corporation.”

2. no time limit

3. it is specifically enforceable.

3. DGCL §218(e) - two or more shareholders may agree to pool their votes

1. can be any type of corporation

2. no time limit

3. unknown whether it is specifically enforceable.

3. Irrevocable Proxy - useful when coupled with a pooling agreement to make the pooling agreement self-executing (don’t have to go to court).

1. RMBCA §7.22(d) -

1. form is revocable unless it conspicuously states that it is irrevocable; and

2. it is coupled with an interest

1. a “party” to a voting agreement (i.e. one of the shareholders) has a sufficient interest. RMBCA §7.22(d)(5)

2. CGCL §705(e) - proxy which states it is irrevocable must be held by an enumerated list of persons, which includes “a person designated by or under [a pooling] agreement”

1. can be anyone designated in the agreement, even third parties.

3. DGCL §212(e) - irrevocable proxy must be coupled with an interest, but the interest only need be in the corporation generally (more broad than RMBCA or CA)

4. Voting Trusts

1. trustee becomes shareholder of record

2. trustee votes on the beneficial interest of the shareholders

3. uncommon and expensive, but not prohibited

4. see RMBCA §7.30 and DGCL §218(a)

5. Cumulative Voting - shareholder votes as many shares as he has times the number of directors being elected, and cast the product among the director candidates.

1. RMBCA §7.28 - all that is required is a simple statement in the Articles that “shareholders are entitled to cumulate their votes for directors.”

1. conversely, a director may not be removed if there are enough cumulative votes in his support as would be necessary to elect him.

2. CGCL §708 - default is mandatory cumulative voting if one shareholder desires (not required to be put in the articles).

3. DGCL §214 - cumulative voting must be provided for in the articles

6. Preemptive Rights - existing shareholders have “fair and reasonable opportunity” to exercise a right of first refusal on newly issued shares in proportion to the shares they already own.

1. RMBCA §6.30(a) - no pre-emptive rights unless the Articles so provide.

2. RMBCA §6.30(b)(3) - there is no preemptive rights with respect to shares issued as compensation to directors, those issued within 6 months of incorporation, or those sold for other than money.

1. unless prevented, the directors could vote to compensate themselves with stock, and thus increase their proportional share of control

2. does not work for different voting classes of stock RMBCA 6.30(b)(4)-(5).

3. does not work well if the shareholders are short on cash to buy the stock when offered.

7. Voting Agreements that Affect Board of Director Functions

1. RMBCA §7.32 - if a shareholder agreement affects the functions of the board of directors (see RMBCA §8.01), it must be approved by ALL shareholders.

1. ex: eliminates the board of directors or limits their discretion, establishes who shall be directors or officers, transfers the authority to one or more shareholders to manage the affairs of the corporation.

1. counter-ex: in Triggs, the court did not invalidate a shareholder’s agreement that guaranteed their employment and salaries because it was unknown to the other directors/shareholders and thus could not have affected their judgment/functions.

2. must be either in the articles or a written agreement

3. all shareholder certificates must note the agreement conspicuously

4. although there is no limit on the size of the corporation that can use these agreements, the agreement ceases when the corporation becomes public.

5. 10 year time limit

2. DGCL §350

1. only close corporations can have these agreements

2. “close corporation” as defined in DGCL §342 has:

1. no more than 30 shareholders

2. no public offering of stock

2. only a majority of the stockholders approval is required

3. no time limit

3. DGCL §351 - shareholders in a close corporation may eliminate the board of directors altogether if so provided in the Articles.

1. stockholders then become fiduciaries in place of board

8. Staggered Board

1. RMBCA §8.06 - if there are nine or more directors, they may be staggered into two or three groups, with one group being elected each year.

1. must be in the Articles

2. alters the balance of power for cumulative voting because it reduces the number of directors up for election at any one time.

3. provides some protection for management from a sweeping takeover being accomplished in one year.

2. DGCL §141(k) - directors on a staggered board may be removed only for cause

9. Supermajority Provisions

1. RMBCA §7.25/7.27 - the Articles may provide for a supermajority provision for both the shareholders quorum requirement, and the votes necessary to take action.

1. an amendment to change the supermajority provision requires as many votes as it specifies in order to change it.

2. RMBCA §8.24 - the Articles OR bylaws may provide for a supermajority provision for directors quorum requirement, and the votes necessary to take action.

3. places more power in the hands of the minority shareholders.

10. Buy-Sell Agreements - RMBCA §6.27 allow other shareholders to continue the corporation by buying out another shareholder upon the happening of a triggering event (deadlock, death, etc.)

1. Possible methods of valuation:

1. book value - inaccurate, may disadvantage the minority because it does not take into account the going concern value

2. capitalized earnings - difficult to draft what “earnings” are

3. right of first refusal - does not apply to “gifts” or inheritance

4. Appraisal - costly

5. mutual agreement - low motivation to perform revaluation

6. arbitration - costly

2. Probably the best method is the greatest of the various methods, rather than any weighted average of them.

3. If the corporation is given the right to buy out a shareholder, it should establish a sinking fund for that purpose.

1. if corporation does the buyout, it may alter the balance of power between the remaining shareholders

3. Shareholder Oppression

1. Shareholders in a close corporation owe each other the same fiduciary duty as in a partnership (i.e. “utmost good faith and loyalty.”) Wilkes

1. majority shareholders may not “freeze out” the minority by refusing to declare dividends and forcing the minority off the board.

2. majority prima facie breaches their duty if they frustrate the “reasonable expectations” of the minority (i.e. the reasons that the minority shareholder invested in the corporation in the first place)

1. ex: minority invests in corporation for a reasonable return on his investment as well as some say in the operations.

3. majority shareholders can rebut the presumption if they show that they were acting out of a “legitimate business purpose.”

4. minority shareholders can still win if they can prove a “less harmful alternative.”

5. A minority shareholder can not unreasonably withhold or exercise his vote in a manner which harms the majority or the corporation - Smith v. Atlantic Properties

1. ex: rich shareholder can not refuse to vote for a dividend to avoid personal income tax when such a vote subjects the corporation to tax penalties.

2. Involuntary Dissolution

1. RMBCA §14.30 - a corporation may be involuntarily dissolved by the court if:

1. the directors and shareholders are hopelessly deadlocked to the damage of the corporation; OR

2. the directors are acting in a manner that is illegal, oppressive, or fraudulent.

1. ex: if there is a freeze out of the minority, and there is no alternate remedy, involuntary dissolution may be ordered. Matter of Kemp & Beatley.

3. this gives the directors or other shareholders the option to buy out the minority at a fair value price rather than let the corporation die. See RMBCA §14.34(a)

4. alternately, under RMBCA §14.32 the court may appoint a receiver to manage the corporation (but you still have to satisfy §14.30 requirements).

4. Shareholder’s Role in the Public Corporation (Securities Act of 1934)

1. SEC Rule 14a-8 - shareholders may submit proposals to the corporation for inclusion in their proxy statement, unless

1. 14a-8(c)(1) - it is not a proper subject for action by the shareholders

1. determined by state law shareholder’s rights:

1. sale of substantially all assets

2. election of directors

3. amendment of the bylaws

4. mergers

5. amendments to the articles

6. dissolution

7. “recommendations”

2. 14a-8(c)(3) - it includes false or misleading statement under SEC Rule 14a-9

1. this can be avoided if the proxy uses words like “in my opinion...” to preface bad things.

3. 14a-8(c)(4) - it relates to a personal claim, grievance, or interest not shared by the shareholders at large

4. 14a-8(c)(5) - it relates to an operation which:

1. accounts for less than 5% of total assets; AND

2. accounts for less than 5% of the net earnings and gross sales; AND

3. is not otherwise “significantly related” to the registrant’s business.

1. ex: this is not a purely economic rule. The proposal will be allowed even if it deals with less than 5% of the operations, if it raises a substantial policy concern (such as animal abuse - Lovenheim).

4. this section deals with whether the subject of the proposal is even related to the business

5. 14a-8(c)(7) - it relates to ordinary business operations.

1. this does not include matters which involve a “substantial policy matter” such as equal opportunity - Wal-Mart.

2. Rule 14a-8 applies to any solicitation which is “reasonably calculated” to influence the shareholder’s votes

1. ex: a newspaper advertisement condemning the action of the corporation falls under the proxy rules, and is an invalid proxy solicitation attempt, if it deals with issues which are the subject of an upcoming shareholder’s vote. - Long Island Lighting

3. Rule 14a-8(b)(1) the proposal and all supporting statements must not exceed 500 words.

4. Rule 14a-8(a)(1) - must own at least 1% or $1,000 of stock.

5. Fiduciary Duties of Directors

1. RMBCA §8.30(a) - A director must discharge his duties:

1. in good faith

2. with the care an ordinarily prudent person would exercise under similar circumstances; and

3. in a manner he reasonably believes is in the best interest of the corporation.

4. Directors are required to keep themselves informed about the general operations and affairs of the corporation - Francis

1. directors in a close corporation may be required to investigate more closely than those in a large publicly-held corporation.

2. special training subjects the director to a higher standard of care (i.e. corporate lawyer is expected to recognize problems more easily).

5. Directors owe a fiduciary duty to the corporation and the stockholders, and even creditors if the corporation is insolvent or if it acts like a bank - Francis.

6. Directors are entitled to assume that their employees are acting in a legal and reasonable manner until some “triggering event” puts them on notice, at which time they may have a duty to inquire further - Graham v. Ellis.

1. legal compliance programs are becoming an industry-wide standard and are likely to become the legal standard of care required of a prudent director.

7. RMBCA §8.30(b) - directors are entitled to rely on reports generated by employees or legal/accounting professionals who the director reasonably believes is competent (not blind reliance).

2. Business Judgment Rule

1. A presumption that a decision by the board is valid arises if:

1. it is made with informed judgment (standard is gross negligence)

1. director must inform themselves of “all material information reasonably available to them” Van Gorkam

2. in good faith; and

3. with the honest belief (rational basis) that it is in the best interest of the corporation.

2. If the plaintiff rebuts the presumption (by eliminating on of the three elements), then the burden shifts to the directors to show that their decision was “fair.”

3. Exculpatory Provisions

1. RMBCA §2.02(b)(4) -

1. the articles may include a provision limiting the liability of the directors, except for:

1. financial benefit from self-dealing

2. intentional infliction of harm on the corporation

3. distribution of an illegal dividend

4. intentional criminal acts

2. must be in the articles (“opt-in”) approach

3. only precludes monetary damages, not equitable relief.

4. only protects the directors

2. DGCL §102(b)(7) - same as the RMBCA, except it has different exclusions including violation of duty of loyalty.

4. Duty of Loyalty - Conflicted Decisions

1. Definition of conflict RMBCA §8.60 - a transaction in which the director knows that he has an interest that would reasonably be expected to exert an influence on the director’s judgment.

1. ex: in Shlensky, the court stated that dual-directors may not grant favorable transactions to their other corporations - transactions between two corporations having some common directors are subject to close scrutiny.

2. Under the RMBCA §8.61, an interested transaction is not voidable due to the conflicted interest if:

1. it was approved by a majority of “qualified” directors under RMBCA §8.62;

1. “qualified” director is one who does not have a conflict, or a professional or employment relationship with a conflicted director

2. if so, decision is protected by the business judgment rule

1. counter-ex: in Remillard Brick Co, the court held that even if a decision was ratified by the directors, it was not necessarily valid if there was not full disclosure.

2. it was approved by a majority of “qualified” shareholders under RMBCA §8.63; or

1. “qualified” shares are ones that are not owned by a director who has a conflicting interest

2. if so, decision is protected by the business judgment rule

3. it was otherwise a “fair” transaction to the corporation (burden of proof on defendant directors)

1. “fairness” is a broad range that an arm’s length transaction would bring - Official comment to 8.61

2. fairness is narrower than reasonableness, which is narrower than the business judgment rule

3. Under DGCL §144 - an transaction is not voidable solely because one of the directors present is interested if:

1. it is approved by a majority of disinterested directors after disclosure; OR

1. if so, burden of proof is on the challenger to prove that the transaction was not fair

2. it is approved by a majority of disinterested shareholders after disclosure; OR

1. if so, burden of proof is on the challenger to prove that the transaction was not fair

3. the transaction is “fair” (burden of proof on defendant directors)

4. Footnote 3 of the Marciano case: Delaware has an additional distinction when the transaction involves a conflict with a non-controlling shareholder:

1. if it was approved by disinterested shareholders or disinterested directors, then the business judgment rule applies to protect the decision

2. otherwise, the burden of proof remains on the defendant to prove the fairness of the transaction

5. Once the cloud of conflict is removed by any of the above methods, then a separate vote of all directors (or shareholders), even those who are interested, is required to approve the transaction.

6. In Delaware, there is a two-tiered analysis: first apply 144(a), and then apply a fairness test even if the requirements of 144(a) were not satisfied.

6. Corporate Opportunity

1. Definition of a Corporate Opportunity

1. Under Farber a corporate opportunity exists if:

1. the transaction fit into the present activities of the corporation; and

2. the corporation had the ability to act on the transaction.

3. ex: directors of a golf course corporation buy adjoining land in their individual capacities, and then both the golf course and the adjoining land are sold at a profit because they can be sold together - a corporate opportunity has been taken

4. counter-ex: in Burg v. Horn a corporate opportunity did not exist because the other directors of the plaintiff’s real estate corporation had a separate pre-existing real estate investment corporation of their own, and there was no agreement that prospective purchases would be first offered to the plaintiff’s corporation.

2. ALI §5.02 definition of a corporation opportunity (adopted in Northeast Harbor Golf)

1. any opportunity closely related to the business in which a corporation is engaged or expects to be engaged; OR

2. a director becomes aware of the opportunity by virtue of his position by a person who expects them to offer it to the corporation; OR

3. a director uses corporate property or resources to obtain the opportunity.

3. Traditional Corporate Opportunity Doctrine tests:

1. Interest or Expectancy test - had the corporation undertaken to negotiate in the field?

2. Line of Business test - applied broadly to extend beyond current operations

3. Fairness test - using fairness factors:

1. was it presented to the corporation

2. was the conflict disclosed to the corporation

3. were the corporation’s assets or resources used

4. was there good faith

4. Combination of the above tests.

4. because a corporate opportunity is determined as of the time it was presented, the corporation usually waits until it is successful to bring an action (thus avoiding risks associated with developing the opportunity).

5. Analysis Tree for Corporate Opportunity:

1. Is the opportunity a corporate opportunity as defined above?

2. If so, was it presented to the board?

1. if not presented to the board, the defendant loses.

3. If the board was presented with the opportunity and rejected it, then perform the following conflicted decision analysis:

1. If the rejection was approved by a disinterested majority of directors, then the business judgment rule applies with the burden of proof on the plaintiffs;

2. If the rejection was approved by a disinterested majority of shareholders, then it is not actionable unless it is a waste of corporate assets with the burden of proof on the plaintiffs;

3. Otherwise, the standard of review is “fairness” of the transaction with the burden of proof on the defendants.

7. Responsibilities of Controlling Shareholders

1. Sale of Control

1. fiduciary duty not to sell the controlling shares to someone you have reason to know will “loot” the corporation.

1. there is not duty to inquire into the buyer’s motives

2. fiduciary duty not to take a corporate opportunity by selling of the controlling shares

1. ex: buyer comes to controlling shareholder in his capacity as controlling interest for the purpose of buying the entire company, but the controlling shareholder convinces him only to buy his controlling interest at a premium because then he will still have control, but pay less for it, and controlling shareholder gets the profit that otherwise would have been spread among all shareholders.

2. ex: in Perlman v. Feldman, the controlling shareholder sold his controlling interest to a customer which then used its directoral power to allocate more steel to itself, thereby denying the corporation of the opportunity to expand its customer base or upgrade its equipment.

3. ex: in Jones v. H.F. Ahmanson, the majority shareholders destroyed the market for the minority shareholder’s shares by setting up a holding company for their controlling shares, and then holding a public offering of shares in the holding company.

3. fiduciary duty not to buy up the minority shares in connection with their resale as a sale of control.

1. ex: shareholder buys up many individual shares and then resells them in a block at a premium to a buyer who wants to buy a controlling interest

4. fiduciary duty not to sell a director’s position (power to elect)

1. ex: a majority shareholder sells fewer shares than would ordinarily be necessary to gain a power to elect a director, and then promises not to interfere with buyer’s election of a director.

8. Cash out Mergers

1. Standard of Review

1. Fairness

1. Procedural Fairness (fair dealing); and

2. Substantive Fairness (fair price)

2. Weindberger v. UOP, Inc.,

1. fair dealing was not followed because UOP’s resources were used to determine the intrinsic value of UOP, and then these figures were used only for the benefit of Signal Co, and not disclosed to UOP’s shareholders. - breach of fiduciary duty to UOP’s stockholders by the dual-directors.

2. Fair price was not achieved, even though the shareholders voted to approve the tender offer, because the shareholders were materially uninformed in view of the undisclosed information.

9. Derivative Actions

1. Definition- an action by the shareholders which is on behalf of the corporation, to recover damages to the corporation.

1. recovery goes to corporation, except where that would be unfair (ex: Perlman, in which case it goes to shareholders)

2. Purpose

1. prevents multiple suits by individual shareholders

2. protects corporation’s creditors because damages go to the corporation

3. proportional recovery among shareholders by virtue of share ownership

3. Protection mechanisms against abuse of derivative actions (“strike actions”)

1. must be a shareholder at the time of the wrong

1. can’t buy a lawsuit

2. possible exception is the continuing wrong theory

3. must be a fair and adequate representative of all shareholders’ interests

4. RMBCA §7.42 - must make a written demand prior to filing the lawsuit

1. “demand futility” - may do away with demand requirement if it would be futile given:

1. the composition of the board (interested directors?); or

2. if there was an obvious breach that did not fall under the business judgment rule

5. RMBCA §7.44 - the derivative action may be dismissed if a majority of disinterested directors or committee has determined in good faith and after reasonable inquiry that the maintenance of the derivative action is not in the best interest of the company (it is, after all, on behalf of the company).

1. Zapata test - court exercises its own business judgment as to whether the case should be dismissed.

6. Security for Expenses - challenger must put up a large bond.

4. Director’s Indemnification

1. RMBCA §8.51 - can indemnify a director if:

1. he acted in good faith; and

2. he reasonably believed his actions were in the best interest of the corporation;

3. even in a settlement - RMBCA §8.51(e) UNLESS

4. he is adjudged liable to the corporation or in connection with self-dealing

2. RMBCA §8.52 - the corporation MUST indemnify a director who was wholly successful on the merits in an action in which he was a party because he was a director.

10. Tender Offers

1. The Unocal/Unitrin test - “enhanced” business judgment rule for defenses initiated by the board of directors (two-parts)

1. directors must show that they had “reasonable grounds” (low standard - rational relationship) for believing that a “threat” existed.

1. “threat” is defined as:

1. opportunity loss - hostile offer deprives the corporation of a better alternative; OR

1. a better offer by existing management if they had more time; or

2. better offer by another bidder

2. structural coercion - disparate treatment of shareholders who refuse to tender shares promptly; OR

1. ex: $50 tender offer, and $40 cash-out merger for the remaining shareholders who do not tender shares

3. substantive coercion -

1. likelihood that shareholders will accept an underpriced offer

2. inadequate consideration (i.e. junk bonds) being exchanged for stock

3. illegality of merger due to anti-trust considerations

4. too many conditions precedent to effect the merger

1. “green mailer” buys up stock threatening to take over, hoping that the corporation will buy back its shares at a premium.

2. board of directors proves the existence of a threat by showing:

1. good faith; and

2. reasonable investigation of the issue

2. directors must also show that the defensive measure employed is “proportional” to the threat posed.

1. “draconian” measures are not proportional because they actually prevent the tender offer from occurring.

1. ex: poison pill or “shark repellent” provision is not draconian because it the raider may still be able to gain control of the corporation by getting sufficient shares to elect a director, without getting sufficient shares to trigger the poison pill - Unitrin.

2. if the measure is not “draconian”, then it is valid if it falls within a “range of reasonableness.”

2. The Revlon test - directors have a fiduciary duty to obtain the “maximum value reasonably available” for shareholders in the short term, in each of these three triggering events:

1. target company is going to change control (sale of control)

1. ex: in Paramount, the company was owned by the public, and QVC, which is controlled by a single shareholder, would become the majority shareholder if successful, thus it was a sale of control - triggering the Revlon standard

2. board of directors has approved a “break-up” and “sell-off” of the company; or

3. board of directors initiates an active bidding process for the company (auction)

1. “white knight” - target seeks another bidder who will rescue the company by providing more favorable terms.

3. Statutory Protection against Hostile Takeover

1. “Moratorium statute” once raider reaches a certain percentage of control of the target company, it can not merge (second step) for a number of years (3 to 5) unless the target’s old board approves.

2. Williams Act - added to the SEC act of 1934

1. requires disclosure by the tender offer raider if he expects to acquire more than 5% of the equity stock of a reporting company (one that is listed on an exchange or has $10 million in assets and ≥ 500 shareholders).

2. requires tender offer to be held open for 20 days to allow shareholders to think.

3. shareholders can only sell their stock on a pro-rata basis (not first come first served)

11. Insider Trading

1. Classic Theory - An insider breaches a fiduciary duty owed to company A by trading (or tipping others to trade) in A’s stock based on material non-public information, and the insider intended to receive a personal benefit.

2. Misappropriation Theory - the insider:

1. misappropriated material non-public information

2. obtained by breaching a duty arising out of a relationship of trust and confidence

3. information is then used in a securities transaction

4. regardless of whether a fiduciary duty is owed to the shareholders of the traded stock.

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