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Course: Business Associations Nofar Fall 2000
School: University of Detroit
Year: 2001
Professor: Huchinson
Course Outline provided by
  1. AGENCY § 219- Is there sufficient evidence to persuade a reasonable person that there was an agency?

  2. Look for:

    1. Fiduciary relationship KNOW FIDUCIARY DUTIES 1998 EXAM

      1. No filing is required

      2. Not liable for debts like a partner

    2. Consent by one person to another to act

      1. What was agreed upon? Not unilaterally created. Can be unilaterally terminated.

      2. Breach of duty terminates relationship

    3. *Control*

      1. Lending Relationship can create and agency

      2. Must follow P’s instructions

        1. General agent

        2. Special agent—single transaction or a series or trans

      3. Continuous subjection. Control may change at any time

      4. Independent K’r

        1. Not controlled

        2. Contracts

        3. Independent

          1. Franchisor

          2. OR’s control or influence over the results alone are insufficient to est. P-A relationship

          3. Setting standards vs. control over daily operations

          4. The more you standardize franchise the more you control. EE’s can be turned into agents.

      5. Economic Reason: P is in the best position to prevent this occurrence

        1. P selects A

        2. P can buy insurance

  3. P has greater access to information

    1. M Ø subj. to liab for S acting OUTSIDE scope UNLESS: ULTRA VIRES

    1. M intended conduct or conseq.

    2. M was neg. or reckless;

    3. Conduct violated nondelegable duty of M; OR

    4. S purported to act on behalf of princ. and reliance upon apparent auth. OR was aided in tort by existence of agency rel.

    • NOTE: act may be w/in scope even if consciously crim. or tortuous. R2d Ag. § 231. BUT Ø liab. for acts of indep. contr.

    • Types - R2d Ag. § 4

  1. Disclosed - Reveals fact and ID of Princ.

  2. Partially Disclosed - Reveals fact but Ø ID of Princ.

  3. Undisclosed - Ø reveal anything. Ag. purports to act alone

  1. Authority - Types

  1. Actual Authority - § 26 - written or spoken words or conduct of princ. which reas. interpreted, causes A to bel. princ. desires him to act on princ.’s behalf

  2. Apparent Authority - § 27 - created as to 3rd party by action of princ. which, reas. int., causes 3rd to bel. that princ. consents to have act done on his behalf by A. REQUIRES Princ.’s manifestation to 3rd party. § 8.

  1. Ratification - § 82 - IF Princ. treats act as valid that was orig. outside power of A, it will be given effect as if orig. auth.

  2. Termination - § 124A - Term. of auth Ø thereby term. app. auth. § 125 - App. Auth. terminates when 3rd Party has notice of the term. OR manif. from Pr. that he Ø longer consents

  3. Liability

  1. Generally - § 140 - Liab to Princ. from 3rd upon trans conducted by A MAY be based on (a) actual auth; (b) app. auth.; OR (c) A had power from rel. Ø dependent on act. or app. auth.

  2. Disclosed -

  1. Pr. is liab. to 3rd and can sue 3rd § 292

  2. A has Ø liab to 3rd and CANNOT sue 3rd. § 320

  3. 3rd can sue Princ. but Ø agent

  1. Partially Disclosed -

  1. Pr. is liab to 3rd and can sue 3rd § 292

  2. A is ALSO liab. to 3rd and can sue 3rd, (& Pr. if liab. to 3rd)

  3. 3rd can sue or be sued by A or princ.

  1. Undisclosed -

  1. Pr. can sue 3rd as 3rd party ben.

  2. A is party and can sue AND be sued § 322

  3. 3rd can sue A OR Pr. if A was in act. auth (Ø app. auth. b/c Ø manif. by Pr. b/c Ø known to exist)

  • NOTE: If Pr.’s non-existence is part of K, then 3rd CANNOT sue P. BUT CAN sue P if existence is fraudulently concealed

  • NOTE: If A misrep. his auth, he becomes liab. to 3rd who relied, even if normally Ø liab. ALSO Disc. or part. disclosed P is liable for K made by A in violation of instr. to A not known to 3rd § 160.

  1. Sole Proprietor - Can have liab. under (1) agency rel.; (2) M-S rel. w/ employees; OR (2) indep. contractor rel.



  1. PARTNERSHIP - UPA § 6(1) - Ñ is an assoc.(assoc. implies consent) of TWO or more persons to carry on as co-owners of a business (must share profits & losses) for profit.

  1. Writing - Ø writing is req. BUT should do so to avoid disputes over agr. and force consideration of tough issues like dissolution, control and profit sharing

  2. Determining Existence - UPA § 7

  3. joint tenancy, etc., alone does Ø establish Ñ regardless of profit share.

  4. sharing of gross returns from prop. Ø establ. Ñ reg. of ownership.

  5. receipt of profit share from bus. is PRIMA FACIE evid. of Ñ UNLESS

  1. as debt by installment

  2. as wages or rent to LL

  3. as annuity to widow of deceased P

  4. as int. on loan, though amt. may vary w/ profitability of Ñ

  5. as consid. for sale of goodwill by installment

  1. Martin v. Peyton - (loan Ø Ñ) JOINT VENTURE; Look at totality of circ.; control, debt v. eq.; defined period or amt.; collateral; covenants. Option may indicate Ñ. Absence of an explicit partnership agreement does not preclude the creation of a partnership.

                1. HYPOTHICATE: to pledge without transferring title

                2. MORTGAGE; pledge of property as a security

                3. COLLATERAL; property that is pledged

  2. Sharing Profits and Losses -

  1. Profits and Losses - UPA § 18 - Ñ may set own agr. for profits and losses, (a) DEFAULT- if Ø agr. then all P’s share equally in profits. Losses absent agr. are shared just like profits.

2. Liability -

  1. UPA § 13 - Ñ is bound by the wrongful act of P acting in ord. course of business.

  2. UPA § 14 - Ñ is bound by one P’s breach of trust where P is acting in scope of app. auth. INCLUDES misappr. of funds.

  3. UPA § 15 - Ps are liable JOINT AND SEVERAL for everything chargeable to Ñ under §§ 13 & 14 and JOINTLY for all other debts and obl. of Ñ (ie- must name ALL Ps if joint, can just hit deep pockets if joint and several. NEITHER - have to go for Ñ first) (TN - all J&S)

  • NOTE: Ø as flexible as § 18. NOT SUBJECT TO AGREEMENT

  • 1994 UPA §§ 306-07 - MUST go after Ñ before indiv. P

  1. Losses - § 15 (a) says all partners are joint and several liab. for everything chargeable to the partnership. (b) reg. of agr., § 18 allows for agr. MAYBE § 18 applies to internal losses and profits, § 15 applies to dealings w/3rd parties

  2. Contribution - P MUST, absent agr., contribute towards losses, capital or otherwise, sustained by Ñ in prop. to profit share. UPA § 18(a). IF any P is insolvent, remaining Ps shall pick up insolvent’s share in ratio to their share of profits

  3. Indemnification - Ñ MUST, absent agr., indemnify P if pursued legally in ord. & proper course of bus. UPA § 18(b) SO even if J&S, P has action against other Ps for indemnity. § 40 - must dissolve Ñ before one P can enforce against another

  1. Management -

  1. Governance - UPA § 18(h) - Absent agr., majority vote rules. BUT Ø act against agr. may be rightfully done w/out consent of ALL Ps.

  • NOTE: Ø based on % own, but # of Ps. Could agr. otherwise.

  • Agency - UPA § 9 - Every P is agent of Ñ for purposes of its bus. AND acts of every P for apparently carrying on the bus. of the Ñ binds the Ñ, UNLESS there is Ø auth. AND the 3rd has knowledge of Ø auth.

    • Apparently Carrying on Bus. - look to what these type of Ñs do, and to lesser extent what this Ñ does

    • UPA § 4(3) - Law of agency will apply under UPA.

    1. Wrongful Acts - See UPA §§ 13 &14 above. § 15 J&S Liab.

    2. New Partners - UPA § 17 - New P is liable for ALL obl. arising before admission BUT shall be satisfied out of Ñ prop. ONLY.

    3. Nabisco v. Stroud - (P told Nabisco he would Ø longer be resp. for any deliveries, other P then ordered.) Ct. held that other P had act. auth. b/c every P is agent. Ñ is principal. NOTE: even if Ø act. auth. P had app. auth. b/c Nab. had Ø knowledge of restr. on auth. The acts of the partners are binding upon all copartners. Partners are JOINTLY & SEVERALLY liable for the acts & obligations of the parties.

    4. Holzman v. De Escamilla; if a limited partner exercises control over the partnership business, he becomes a general partner.

          1. Duties of Partners to Each Other

    5. UPA § 21(1) - Every P must acc. to Ñ for any benefit, and hold as T/ee any profits derived w/out consent, from any trans. connected w/formation, conduct, or liq. of Ñ, OR from use of Ñ prop.

    6. Meinhard v. Salmon - Per Cardozo - Ps have fid. rel. and owe each other “the duty of the finest loyalty” “Punctilios of honor.” At very least a duty to say what was going on and give M chance to compete. Owe each other the highest duty of loyalty while the enterprise is ongoing. §404 General Std of partner’s conduct.

    • NOTE: §21(1) only applies to profits, SO if S’s deal crashed Ø can hold M liab.

    • Partnership Property -

      1. UPA § 25 -

      2. each P is co-owner as tenant in partnership

      3. Incidents of Tenancy:

      1. each can use prop. for Ñ purposes

      2. rt. in specific prop. is Ø assignable, except by ALL Ps

      3. P’s rt.s Ø subj. to attachment, except on claim against Ñ

      4. On death P’s int. vests w/surviving Ps

      * 1994 UPA - clearly puts ownership in hands of entity

      1. UPA § 24 - Property rts of P are (1) rt. in spec. Ñ prop.; (2) int. in Ñ; (3) rt. to participate in management.

      2. UPA § 22 - ANY P has rt. to formal accounting as to affairs, IF:

      1. wrongfully excluded from Ñ business or poss. of prop. by co-P

      2. If rt. exists under agreement

      3. under § 21 (P acc. as fiduciary)

      4. When circ. render it just and reas.

      1. UPA § 28 - Although creditors Ø get Ñ prop., CAN stand in shoes of P for any prop. or $ coming out of Ñ. (2) suggests that Ct. can foreclose on Ñ without dissolution

      2. UPA § 27 - If P assigns P int., Ø make assignee full P, ONLY allow to receive profits & proceeds of dissolution. Does NOT dissolve Ñ

      3. UPA § 26 - int in Ñ, profits, and surplus is same as personal prop.

      4. UPA § 40(b) & (i) - Indiv. cred. have priority as to indiv. prop.; Ñ cred. have priority as to Ñ prop.

      5. Bankruptcy Exception (to Jingle Rule) - Ñ cred. have priority as to Ñ prop.; Ñ cred. are equal to indiv. cred. as to indiv. prop. (Rationale: if make loan to Ñ you are relying on Ps; if loan to P, Ø relying on Ñ)

      6. Putnam v. Shoaf; a co-partner owns no specific interest in an y specific property or asset of the partnership, and may only convey an undivided interest in the value or deficit of the partnership.

      1. Partnership Dissolution -

      1. UPA § 29 - Dissolution Defined - Diss. is the change in relation of the Ps caused ANY P ceasing to be assoc. in the carrying on, as distinguished from the winding up, of the business

      2. UPA § 30 - On diss. Ñ is Ø term., but continues until winding up of Ñ affairs is completed

      • NOTE: Diss. is something that happens b/c act says it happens. NOT related to cessation or operations.

      • UPA § 31 - Dissolution is caused:


        1. WITHOUT violation of agreement b/w Ps

        1. by term of definite period or particular task specified in the agreement

        2. By express will of ANY P if Ø time or task

        3. by express will of ALL Ps, who have Ø assigned int., either before or after expiration of per. or task

        4. By the expulsion of ANY P

        1. WITH violation of agreement b/w Ps, where the circ. Ø permit the a diss. under any other provision, by the express will of ANY P at any time

        2. By any event which makes it unlawful for bus. of Ñ to carry on

        3. by death of any Ñ

        4. by bankruptcy of any P or Ñ

        5. by decree of ct.

        6. UPA § 42 - Legal rep. of deceased P has right to P’s int. in Ñ at time of diss. (ie-death); AND option of (A) receiving interest, OR (B) profits attrib. to his rt.s in prop. of Ñ up until date of judgment.

        7. UPA § 38(1) - if Ø violation of agr. P has rt. to have Ñ assets applied against liab. and surplus paid in cash

        (2) - when diss. is caused by contravention of agr

        1. Each P who Ø wrongfully cause diss. shall have (II) the rt., as against P causing diss. wrongfully, to damages for breach.

        2. Ps Ø causing diss. MAY cont. bus., PROVIDED they secure payment to ousted P for amt. due up to diss. and indemn. that P for future liab.

        1. Bohatch v. Butler; no duty not to expel a partner when she reported unethical conduct, BREACH OF TRUST. No fiduciary duty to remain partners. Partners have the right to withdrawal their consent and expulse a partner. Partner AT WILL. If not at will then must show causes. Whistle-blowers have special protection statutes.

        2. Putnam v. Shoaf; if a partner leaves the partnership & then the partnership wins a lawsuit, the expulsed partner gets nothing. The lawsuit is the property of the partnership.

        3. Owen v. Cohen; a court may order the dissolution of a Partnership where there are disagreements of such a nature and extent that all confidences and cooperation between the parties has been destroyed or where one of the parties by his misbehavior materially hinders a proper conduct of the partnership business.

        4. Collins v. Lewis - a partner who has not fully performed the obligations of the partnership may not obtain an order dissolving the partnership (L gets lease on café in bldg.; C contr. capital. L gets salary, C gets repayment from ALL profits, then split later. Start up costs C 2x anticipated. Fixed term Ñ (ie-life of lease). When Ø profitable C sues for diss.)

        1. Court - Rt. to dissolve rests in equity. C Ø perform all of duties and L had so Ø diss

        2. UPA - Since fixed time, need BOTH to consent § 31(1)(c). IF diss., L would have action for lost profits b/c of C’s breach § 38(2). THUS C would get back his share of cap. less lost profits he caused (see Rickert).

        1. Value of Partnership -

        1. Equity - Assets - liabilities; Problem - Ø consider incr. in fmv and goodwill

        2. Capitalization of earnings - inc. stream X factor;

        3. Comparable business - sale value as a whole

        1. UPA § 33 - Except as nec. to wind up affairs, Diss. term all auth of ANY P to act for Ñ, UNLESS b/c of bankr. or death of P

        2. UPA § 34 - If diss. caused by the act, death or bankr. each P is liab. to co-P for his share of any liab. created by P acting for Ñ as if Ñ Ø diss. UNLESS: (1) diss. being by act of a P, the P acting for Ñ had knowledge of diss. (2) diss. by death or bankr., P acting for Ñ had knowledge of death or bankr.

        3. UPA § 35 - (1) can still bind Ñ after diss. (a) if in winding up OR (2) by apparent auth. Can dispense app. auth. by notice to those w/whom previously dealt AND by publ. in newspaper for those w/whom Ø deal

        4. UPA § 36 - (1) Diss. ALONE Ø discharge existing liab. of P (2) MAY disch. if by agr. w/cred. OR by course of dealing if cred. knows of diss.

        5. UPA § 41 - New Ñ assumes liab of old Ñ, BUT old Ñ and old Ps Ø let off hook unless agr. b/w all parties

        1. Partnership by Estoppel

        1. UPA § 18(g) - Ø person can become a member of Ñ w/out consent of ALL P’s

        2. UPA § 16(1) - When pers. represents self as P in Ñ, he is liab. to anyone who, on the basis of such rep., gives cred. to actual or app. Ñ, (a) when Ñ liab. results he is liab. as if actual member of Ñ;

        3. When a pers. rep. self as P, and other person (in Ñ) consents, he is an agent for that pers. as for anyone relying on that rep. IF all Ps consent then he is agent for Ñ.

        4. Young v. Jones; A person who represents himself or permits another to represent him, as a partner is liable to persons who *relied* on such representations.

        5. Martin v. Peyton - loaned securities to Ñ. Got % of Ñ until paid off, as well as demanded who ran Ñ and veto power, etc. Statement in loan said “Ø a Ñ”) Ct. said statement Ø dispositive, actions were. ) liab. as if P b/c crossed fine line of what is proper to sec. loan and what is mgmt. and co-ownership for profit.

        6. Smith v. Kelly - (Ñ held S out to be P in K to 3rd, on tax returns, in suit against 3rd, BUT Ø agreement. S contr. nothing took Ø part in mgmt., Ø obligated for losses. S sued for acc. claiming was P) Ct. said not P. Ñ by estoppel may arise as to 3rd, but as for Ñ it is an agreement that req. intend and mutuality. WOULD be liab. to 3rd if rep. as P and Ñ consented. Could Ø be sued for slip & fall though, b/c Ø reliance.

        • 1994 UPA - Ø require extension of credit ut works w/ANY transaction. STILL requires reliance.

        • Limited Partnerships

          1. Certificate - MUST file certificate w/ state. ULP § 201.

          2. ULP § 303(a) - Liability - LP only liab. to extent of investment UNLESS LP rep.s to be GP, then to extent someone relies on that rep.; (b)(1) LP Ø exercise control by virtue of being officer, dir., or Sh. of Corp. GP (1)-(6) other things LP can do including consult and vote on things agr. says will be approved by LP’s

          3. LP is liab for his TORTS

          4. ULP § 503 - Absent agreement, profits shared based on contr. (as compared to per pers. in Ñ)

          5. Dissolution - difficult. ONLY by unanimous consent, loss of all GPs or by Court

          6. IRS 1987 - If LP is publicly traded then taxed as .

          7. Participation - NEW RULE is that LP can only be liab. if part. is subst. the same as that of GP, OR if people that trans. w/LÑ do so w/ actual knowledge of LP’s control.



                        1. Detailed agreement between the parties

                        2. Choose partner wisely—investigate potential partners

                        3. Internal control

                        4. Buy insurance



          1. Corporate Formation

          1. Mechanics of Formation

          1. WHY DELAWARE? Well defined, predicable, body of law, and slightly pro-management bias.

          2. Articles of Incorporation -

          1. Unless delayed existence is specified,  existence begins when articles are filed. MBCA § 2.03(a). Sec. of State (SOS) filing articles is CONCLUSIVE proof that incorporators satisfied all conditions. § 2.03(b).

          2. § 2.02 - (a) Articles must set forth:

          1. Name

          2. Number of auth. shares

          3. street address of initial registered office and agent name

          4. name and address of each incorporator (inc/or)

          5. Name - Must contain “corp.” “Inc.,” etc. § 4.01(a). Must be distinguishable by SOS from other  or nonprofit. §4.01(b). Can reserve name for 120 days § 4.02. Foreign  can reg. name § 4.03

          • NOTE: Ø deceptively similar std., BUT can be sued for copyright infringement.

          • D/B/A - If use name other than registered name, MUST comply w/assumed name stat. which entails only a filing of d/b/a

          1. Purpose, Duration, & Powers - Ø longer need in charter. Unless otherwise stated PURPOSE is “any lawful business.” § 3.01(a). DURATION is perpetual § 3.02. POWERS can do anything an indiv. can, including those specified § 3.02

          2. Incorporators - One or more pers. who deliver art. to SOS

          3. By-Laws - Inc/or OR initial bd. SHALL adopt by-laws; MAY contain any prov. Ø inconsistent w/art. or law. § 2.06

          1. Ultra Vires - Beyond the scope of authority

          1. Generally - when the  did not have the power to act, Ø liab. for act.

          2. § 3.04(a) except as provided in (b) an act of  may Ø be challenged on grounds that Ø have power to act. (b) MAY be challenged:

          3. in proceeding by Sh. against  to enjoin act;

          4. in proceeding by , directly, derivitively, etc., against incumbent or former dir., officer, etc.; OR

          5. In proceeding by the Atty. Gen.

          1. in Sh. proc. under (b)(1), ct. may enjoin act IF equitable AND persons affected act are parties to proc. (Ø eq. unless 3rd knew)

          • NOTE: MAY have argument if gift to widow and Ø part of preplanned benefit. Ø a pension under (12). MAY fit under (15) (catch all) BUT req. furtherance of corp.


          1. Corporate Financial Matters

          1. Financing a Corporation - Equity Securities, Par Value, Eligible Consideration

          1. Equity Securities

          1. PREFERRED STK: more like a bond. Rec’ stated dividends. Better off when mkt dwn.

          2. COMMON STK: gets what is left. Rt to vote & elect directors. Better off when mkt is up.

          3. BONDS: are paid off first

          4. MBCA § 2.02(2) - MUST specify number of auth. shares in the articles (any shares in excess are void. Dir. can be sued.)

          • NOTE: too many shares bad for minority b/c will be diluted by later issuance. BUT Maj. can just amend art. Min. should get K

          • MBCA § 6.01(a) - art. can auth. more than one class of stock but must set # of each AND distinguish them. (b) MUST auth (1) one or more classes that have unlimited voting rights AND (2) one or more that are entitled to net proceeds on diss. CAN be same.

            • OTHERWISE stock is flexible. Ø even mention preferred. ANY feature is allowed if put in art. OR give BOD power. MUST ALWAYS account for 100% of voting and liquidation rights.

            • § 6.02(a) - IF art. so provide, BOD may determine the preferences, lim., & rights of any class of shares before they are issued. (ie-can create diff. types of stock)

              1. Par Value - completely arbitrary value for stock set in articles.

              1. MBCA § 2.02(b)(2)(iv) - Ø have to set par but “MAY.”

              2. 1969 MBCA § 18 - Shares having par value may be issued for such consid. as set by bd. NOT LESS THAN par value.

              3. 1969 MBCA § 19 - judgment by the BOD is conclusive as to the price of stock EXCEPT where there is fraud in the trans.

              4. 1969 MBCA § 25 - Holder or subscriber of shares shall be under Ø obl. to corp. or cred. EXCEPT for the full consideration for which the shares were issued (ie - par value if sold for less. See § 18)

              • BONUS STOCK - issued for no consideration

              • WATERED STOCK - issued in return for prop. of lesser value than par value of stock


              • DISCOUNT STOCK - where cash is paid but less than par val.

              • Accounting

                1. Stated Capital - # of shares X capital

                2. Capital surplus - sales price - stated cap.

                3. Earned surplus - add. cap. from growth

                4. CAN make distr. out of ES or CS, but Ø SC

                5. Some states base taxes on SC, but cred. usually Ø rely

                3. Eligible Consideration -

                1. 1969 MBCA § 19 - Prohibited forms of consideration: (1) notes payable; (2) future services to be rendered. CAN have tangibles, intangibles, and past services. (if violate could cancel stock or create watered stock)

                2. MBCA § 6.21(b) - any consideration of tangible or intangible prop., cash, PROMISSORY NOTES, services performed, K FOR SERVICES TO BE PERFORMED, or other securities. (e) shares for future services or prom. note MAY be placed in escrow, but Ø have to. (NOTE: if for future serv. or prom. note, MUST report to other sh. § 16.21(b)

                3. Subscriptions - offer to buy stock from  after it is formed. Used to line up investors. When formed call in Ks. Split as to whether K is accepted when  formed or if must form then accept. GENERALLY K law applies. EXCEPT preincorp. subscr. K is irrevocable for 6mos unless otherwise stated. Idea is to give  time to form.

                1. Debt Financing; Capital Structure

                1. Definitions -

                1. Debenture - unsecured corp. obligation

                2. Bond - secured by lien on corp. prop.

                3. Registered bond - reg. in name of cred., coupons freely transferable

                4. Equity Securities - pref. & comm. stock

                5. Debt Securities - bonds and debentures

                6. Thin Corp. - High debt to equity ratio

                7. Leveraged - refers to debt/eq. ratio. More Leveraged requires higher rate of return to cover cost of interest on debt.

                1. Liquidation - Order of Rights:

                1. Debt/bonds

                2. Unsubordinated debentures

                3. Convertible subordinated debentures

                4. Preferred Stock

                5. Common Stock

                1. Debt - Primary features -

                1. fixed repayments

                2. Lack of mgmt.

                3. payments on interest tax deductible by 

                4. Inv. pays taxes on int. as ord. gain, but return of cap. tax free

                1. Factors in Determining Whether Debt or Equity

                1. presence or absence of fixed maturity date

                2. source of payments

                3. rt. to enforce payment of int. & princ.

                4. part. in mgmt.

                5. intent of parties

                6. thin or adequate cap.

                7. failure to repay on due date or to seek postponement

                8. parties Ø respect own documents



                1. Promoter Liability & Limited Liability

                • Issuance of art. is conclusive proof that all cond. are met. § 2.03

                • ALL pers. purporting to act as or on behalf of  KNOWING there was Ø  are J&S liab. for liab. created while acting § 2.04

                PRE-INCORP K’s

                1. Southern-gulf Marine v. Camcraft; RULE; Where a party has contracted with a corp, the party is estopped from denying the legal validity of such a corp. when the obligations are sought to be enforced. Allowing someone to escape a K would not accord with justice and fair dealings. Corp had not been formed yet. Entered into a K to build a ship. The ship appreciated in value. & D wanted out of K.

                • LIABLITY: If promoter knows corp. hasn’t been formed yet he is liable. Howver Corp. can adopt K’s made prior to formation


                1. Walkovszky v. Carlton; Cab hit a person. (10 cabs in individual corps) HUCHTINSONS FAVORITE CASE. RULE; Whenever anyone uses control of the corp. to further his own rather than the corp.’s business, he will be liable for the corp.’s acts. Upon the principle of Respondeat Superior (Rules of Agency), the liability extends to negligent acts as well as commercial dealings. When a corp. is part of a larger corp., which actually conducts the business, the corp. will not pierce the corp. veil but will impose ENTERPRISE LIAB. Reverse piercing. Piercing theories: (1) alter ego; (2) unity of interest (3) fraud (siphoning $).

                2. PARENT/SUB; generally not liable for sub unless; (1) failure to follow corp. formalities (both have the same board and don’t have separate meetings) (2) P & S are operating pieces of the same business & S is undercapitalized; (3) public is misled about which entity is operating which business; (4) assets are intermingled bwn P & S; (S is forced to sell products to P.

                3. Tort v. K; courts are more likely to pierce the veil under TORT case (involuntary) than in a CONTRACT case (where the creditor is voluntary).

                4. Respondeat Superior; rule that the principle is responsible for the tortuous acts committed by its agents in the scope of their agency authority.

                5. Corporate Veil; Refers to the shielding from personal liability of the corp.’s officers, directors or shs for unlawful conduct engaged in by the corp. Whether creditors have been misled is not of primary importance. Rather, a ct will look at the degree to which the corp. shell has been perfected and the corp.’s use as a mere business conduit of its shs.

                1. De Jure Corp. - the stat. has been followed and, even if there was a mistake, the art. were filed. THUS  for all purposes. SUBSTANTIAL COMPLIANCE

                2. De Facto Corp. - Exists where there was (1) a valid law under which the bus. could operate; (2) bona fide effort to comply w/legal req.; (3) actual exercise of  powers. THEN Q of  can only be challenged by State. CORPORATION IN FACT

                3. Corporation by Estoppel - One is estopped from denying the corp. existence where the pers. seeking to hold the officer pers. liab. has contracted or otherwise dealt with the assoc. in such a manner as to recog. and in effect admit its existence as a corp. body. (i.e.-3rd recogn. , cannot then say Ø  and sue indiv.)

                1. Piercing the Corporate Veil

                1. PURPOSE; Piercing Corp. veil is invoked by Ct. to prevent fraud or achieve eq. Most important factors are (1) ignoring corporate formalities, (2) under capitalization, (3) commingling of funds

                ALTER EGO

                1. Sea-Land Services v. Pepper Source; alter ego was claimed. Creditors had option to (1) look at credit reports; (2) dealt intentionally; (3) cts have less sympathy for creditors. VAN DORN TESTS (Not an exclusive test. Not accepted in every jurisdiction) RULE: The corp. veil will be pierced where there is a unity of interest and ownership (alter ego--no separation of ownership) bwtn the corp. and an individual AND where adherence to the fiction of a separate corp. existence would sanction a fraud or promote injustice. Promoter took loans and salaries in such a way as to insure that the corp. has insufficient funds to pay the debts. Intentional wrong is required.

                2. MBCA § 6.22 - Purchaser of share from a  is Ø liab. to  or cred. beyond price authorized for shares

                3. Factors for Piercing the Corp. Veil

                1. inequity, illegality

                2. fraud (negl is insufficient, need SCIENTER aka knowledge) , misrep., disregard of formalities NO CORP BOOKS

                3. Mere facade, alter ego theory-one corp. treating the assets of another as its own. (u of int.)

                4. siphoning $$ (fraud)

                5. commingling of $ (unity of interest)

                6. under-capitalization (unity of interest)

                7. one or small # of Shs (shouldn’t be relevant but sometimes is)

                8. failure to maintain adequate corporate records (unity of interest)


                1. Kinney Shoe v. Polan; RULE; The corp. veil will be pierced (equitable remedy) where there is unity of interest & ownership between the corp. and the individual shareholder and an inequitable result would occur if the acts were treated as of the corp. alone. Grossly inadequate capitalization (this alone is not enough to prove fraud!) combined with disregard of corp. formalities. POTENTIAL 3RD PRONG: should have conducted a credit investigation; would have disclosed gross under-capitalization. (NOT WELL EXCEPTED). Totality of the Circumstances is used to determine whether to pierce the corp. veil, and each case must be decided on its own facts.


                              1. Do Parent & Sub have c’mon directors & officers?

                              2. Common business depts.?

                              3. Do they file a consolidated return?

                              4. Does P pay the salaries of the Sub?

                              5. Is all of the Subs bus from the Parent?

                              6. Are daily operations of the two entities separate?

                              7. Does Sub observe basic corp. formalities?

                UNDUE CONTROL W/O FRAUD

                1. Perpetual Real Estate v. Michaelson; General partner was a Corp. RULE: Where a sole shareholder exercises undue domination and control over the corp., the corp. veil will be pierced if the sole shs also used the corp. form to obscure fraud or conceal a crime. Cts usually apply more stringent standards when piercing the corp. veil in a K case than a tort case. Unless the corp. misrepresents its financial condition to the creditor, the creditor should bound by its decision to deal with the corp. It should not be able to complain later that the corp. was unsound. The agreement included no personal guarantees by D. Burden of proof is on the P. Should have sought a complete personal guarantee.

                • JOINT VENTURE; Undertaken based on an express or implied agreement between the members, common purpose and interest, and equal power and control.

                ATTACH GENERAL LIAB TO LIMITED PARTNERS -DIRECT SUIT—(1) suit based on voting rts; (2) oppression of minority shs; (3) pmt of dividends; (4 inspection of corp books).

                1. Frigidaire Sales v. Union; RULE: Limited partners do not incur general liability (unless there is a piercing) for the limited partnership obligation simply because they are officers, directors, or shareholder or a corporate general partner. Limited partner can incur general liability where there is a showing of fraud or deception. DIRECT—loss to shareholder. DERIVATIVE—loss to any shareholders.

                • LIMITED PARTNERSHIP; A voluntary agreement entered into by two or more parties whereby one or more general partners are responsible for the enterprise’s liabilities and mgt. and the other partners are only liable to the extent of their investment.

                • DIRECT SUIT;

                • General order of debt -

                • Partnership Ñ - (1) sec. cred.; (2) unsec. cred.; (3) debts to P; (4) P

                • Corporation  - (1) fees; (2) taxes; (3) sec. cred.; (4) unsec. cred.; (5) Sh

                • KEY DIF. - debts owed a P are automatically subordinated, unlike  that is Ø auto. but stays w/ other cred.


                1. Fiduciary Obligations

                1. Duty of Care FOR DIRECTORS

                1. MBCA § 8.24(d) - Dir. present at meeting when corp. action is taken is deemed to have assented to the action UNLESS: (1) objects at beginning to holding of mtg. or conducting its bus. (2) his dissent or abstention is entered into minutes OR (3) he delivers written notice of abstention or dissent to presiding officer before adjournment or to  immediately after adjournment. CANNOT dissent if vote in favor.


                1. MBCA § 8.30 - Dir. shall act in good faith and with care of ord. prudent person in manner reas. believes in best int. of . NOTE: much less protective of dir. than BJR (closer to Litwin) Comment says Ø adopt BJR b/c ct.s are still working it out.


                1. Derivative Litigation -

                1. Purpose; - action brought on behalf of  to assert  rights. Suit at EQUITY. Not at law. To make shareholder whole. No direct PRIVITY btwn the shareholder and the 3rd party.

                2. PRO’s;

                • Provides proper monitoring of fiduciary duties by shs.

                • May prevent against future breaches

                • Act as an incentive for mgt to act in socially responsible conduct

                • May be the only effective remedy in certain circumstances

                • DEMAND REQUIREMNTS prevent baseless claims, CON—when a BOD refuses a demand, the only issues to be examined are the good faith and reasonableness of its investigation.

                • Bond requirement protect the corp.

                • WE WANT SUSPICION & A HIGH DEGREE OF SCRUITINY when committee seeks to terminate derivative suit.

                1. CON’s:

                • Impinges on the managerial freedom of the directors; challenges majority view

                • Benefits do not necessarily flow to any shs

                • Benefits entrepreneurial attnys, freedom from client monitoring

                • Poorly aligns the interest of attorney & client

                • Dual misalignment of interest coupled with insufficient judicial scrutiny may result in meritorious claims, which fail to vindicate shs interest in the proper monitoring of fiduc.

                • Enlarge agency costs associated with the proper operation of the corp.

                • Tarnishing the social meaning of a shs deriv action.

                • Abusive settlements are inevitable

                • Special committees may shield the BOD form judicial scrutiny

                • Corp managers & P’ attorneys have less than pure motives

                1. SAFEGUARDS;

                • demand by shs

                • special lit committees

                • ct review of the settlement; however each corp transaction is susceptible to difference of opinions.

                1. COURTS

                • Are ill equipped to evaluate BJ’s

                • No avail objective std to measure the correctness of every corp decision.

                • Q as to whether the cts s/ review both the procedural (largely deferential) & substanive (largely an examination based on the merits) of the committee

                1. Corp. is the P. If shs collects the corp. gets the profits. Not seeking to pierce the corp. veil because then the shs would be liable.

                2. 1st Place a demand on the BOD

                3. 2nd shs must 1st demand on the BOD’s: if demand would be futile, shs may ask for DEMAND EXCUSAL; P asserts board is incapable or rendering an independent decision. 3 basis for claiming demand excusal: (1) self-interest of majority of BOD; (2) board incapable of acting independantly; (3) underlying transaction is not valid BJ (duty of care). IF DEMAND IS MADE, and refused then shs may then argue Wrongful Rejection/Refusal. P concedes board is sufficently independent to render a proper decision, but P contends that the merits of the decision are wrong (not that the BOD is tainted) (must prove gross negl).

                4. 3rd Plead with particularity WRONGFUL REFUSAL/REJECTION

                5. 4th FRCP - requires B to have been Sh. at time of wrongdoing AND for Sh. to make DEMAND on  for it to take up action or explain why Ø, fully and adeq. rep rt.s of Shs

                6. MBCA §7.40 -

                7. 5th MBCA § 7.41 - Sh. may NOT commence deriv. suit UNLESS: (1) sh. at time of wrongdoing (2) fully and adeq. rep. interests of Corp.

                8. 6th MBCA § 7.42 - Ø deriv. proc. unless DEMAND made and 90 days given (NO DEMAND EXCUSED)

                9. MBCA § 7.43 - If  commences inquiry into allegations, Ct. MAY stay suit until investigation completed

                10. MBCA § 7.44 - Deriv. suit SHALL be dismissed by Ct. on motion of  IF (1) reas. investigation, AND (2) determined in good faith that suit Ø in best int. of 


                1. Cohen v. Beneficial; RULE: Statute requiring an unsuccessful P liable for the reasonable expenses of a corp. in defending a derivative action and entitling the corp. to require a security for such pmt is constitutional. Nothing forbids a state in using the amount of financial interest in the corporation of the litigant as a measure of his accountability. An individual who purchased just one share of stock could wreak havoc upon a corp.

                • SHS DERIVATIVE ACTION; Action asserted by a shs in order to enforce a cause of action on behalf of the corp. Suit at equity to make shs whole. No direct privity btwn shs and #rd party. Money goes to the corp. unless ct uses its discretion and orders that the judgement in the derivative action be paid to the shs who may have been indirectly harmed by the wrongdoing, if it is determined that recovery by the corp. would constitute a windfall to controlling shs or would not adequately compensate the injured shs’s.

                • STRIKE SUIT: shareholder sues to harass the corp. Like a strike. Shareholder only owns 5 shares of stock.

                • MERGER: combination of two or more companies

                • HOLDING CO: buys & sells other companies for profits. Non-operational. Usually receive income in the form of dividends.

                • PARENT: has subsidiaries, usually entirely or partially controlled by the parent.


                1. Eisenburg v. Flying Tiger; RULE: A cause of action that is personal rather than derivative cannot be dismissed because the P failed to post security for the corp. costs. P claims that there was a dilution of his voting rts as a result of the formation & replacement by new organizations/entities to which to which his share was transferred. DIRECT action—this is personal rather than derivative. Nuisance suit has a settlement value. EXAMPLES of DIRECT ACTION:

                • PROXY STMT; stmt containing specified infor by the SEC in order to provide shs with adequate infor upon which to make informed decisions regarding solicitations of proxies.

                • CLASS ACTION; a suit commenced by a representative on behalf of any ascertainable group that is too large to appear in court, who shares a commonality of interest and who will benefit from a successful result.

                • Direct Suit; Shs must allege more than injury resulting from wrong to the corp. Shs must state a claim for “an injury which is separte and distinct from that suffered by other shs…or a wrong involving a K’ual right of a shs…which exists independently of any right of the corp.

                • DIRECT SUIT

                • Compel pmt of dividends

                • Rt to inspect corp. bks

                • Action to protect preemptive rights—that is rt. of an existing shareholder to participate in sale of add’l shares of corp. stk.

                • Action to enforce rt. to vote

                • Action to compel corp. dissolution

                • Enjoin an Ultra Vires act before consummation


                1. Grimes v. Donald; RULE: If a shs demands that the BOD take action and that demand is rejected, the BOD rejecting the demand is entitled to the presumption that the rejection was made in good faith unless the stk’r can allege sufficient facts to overcome the presumption

                • BUSINESS JUDGEMENT RULE; –Relieves corp. directors and officer from liability for decisions honestly and rationally made in the corp.’s best interest. There is a presumption that the BOD’s effectiveness in the fiduciary duties: Duty of Care & duty of Loyalty. If there is a fiduciary breach (2nd step) then examine FAIRNESS and don’t use BJR.

                • STRUCTUARAL BIAS; if some BOD are tainted all maybe tainted. Fraternity mentality

                • DIRECT ACTION; sth’r must allege more than na injury from a wrong of a corp. P must state a claim for an injury, which is separate and distinct from that suffered by other shs.

                • DUT OF BOD; (1) manage corp. business; (2) create policy; (3) appt officers; (4) delegate discretion.


                1. Marx v. Akers; RULE: Demands on the BOD are futile if a complaint alleges with particularity that (1) a majority of the directors are interested in the transaction; (2) the directors failed to inform themselves to a degree reasonably necessary about the transaction; or (3) the directors failed to exercise their business judgment in approving the transaction. HOLDING A cause of action will not stand alone on the basis of excessive salary raises unless wrong doing, oppression, or abuse of a fiduciary position.

                • Delaware approach; P carries the burden of showing a reasonable doubt standard about whether the BOD were (1) disinterested and independent (duty of loyalty); OR (2) was entitled to the protections of the BJR (acted rationally after a reasonable investigation & w/o self-dealings) (duty of care). Must plead with great specificity / particularity. P usually charges that the BOD breached their duty of care & loyalty. Not sufficient to show breach of Duty of Care; usually a breach of duty of loyalty must be alleged with specificity.

                • NY approach: More Flexible; Demand is excused b/c of futility when a complaint alleges w/ particularity that: (1) a majority of BOD are interested in the transaction ( D of L) OR; (2) BOD failed to inform themselves to a degree reasonably necessary about the transaction (D of C); (3) the directors failed to exercise their BJ in approving the transaction (challenge that the transaction was so egregious on its face that it couldn’t have been the product of sound BJ.) Only have to charge that breached the duty of care to get demand excused. The directors failed to inform themselves to a degree reasonably necessary about the transaction. OR, the BOD failed to exercise their business judgment in approving the transaction (BJR).

                • Universal Demand; MI; Bright-line rule requiring a demand in all cases, w/o exception, and allows start of a derivative proceeding w/in 90 days of the demand unless demand is rejected earlier. EXCEPTION is that all P’s may file suit b/4 the expiration of the 90 days, even if their demand has not been rejected, if the corp would suffer irreparable injury as a result.

                • BJR; influencing a corp. about your own salary is technically a self-dealing transaction. Cts will not likely strike down decisions about executive compensation if the decision was made on an informed , rational basis and in good faith. EXCEPTION; Excessive or unreasonable compensation levels ---they must be reasonably related to the value of the services performed by the BOD.



                1. Auerbach v. Bennett; Questions whether there were funds distributed as kickback & bribes by the board. So an audit was conducted. Demand Excuse case. Rule: A court may inquire as to the adequacy and appropriateness of a special committee’s investigative procedures and methodologies, but may not consider factors under the domain of BJR. Derivative claims belong to the corp itself and the decision to prosecute and control such cases lies in the judgment of the corp.’s BOD. STANDARD OF REVIEW: Deferential std of review (means that subjective good faith is adequate) whereby judicial review is constrained to an investigation of the gd faith, independence and adequacy of the committee’s investigation. Burden of proof as to good faith rested with the corp.

                1. RULE: BJR limits judicial scrutiny of the recommendations of special litigation committee to Good Faith, Thoroughness & independence.

                2. PUPOSES OF DEMAND; (1) relieve cts from deciding matters of internal corp governance by providing corp. directors w/opportunity to correct alleged abuses; (2) provide corp. boards w/ reasonable protection from harassment by litigation on matters clearly w/in in the discretion, and (3) discourage “strike suits” commenced by shs for personal gain rather than for the benefit of the corp.

                3. SPECIAL LITIG. COMMITTEES; - if comm. is formed to look into suit. Duty is on  to prove indep. Disinterested, and good faith and reas. Then applies its own BJ in evaluating the evidence presented and the committee’s recommendation.

                4. NY RULE ON SP/LIT/CMTE;

                5. DELAWARE RULE ON SP/LIT CMTE;





                1. Zapate v. Maldonado Demand Excuse case (Officers given option to buy shares. Officers voted to move up date of option b/c of upcoming tender offer, which would up fmv of option and force more taxes. Schland case: rt. to independently initiate litigation. McKee case, no independent rt. to control litigation. BOD use BJR defensively. Rule: When assessing whether a special litigation committee’s motion to dismiss a derivative action, the courts must: two step procedure to cure bias in demand excused cases. Ct recognized the BOD’s power to control litigation even where a majority of the BOD is tainted with self-interest. – CT should have focused on determining whether the decision of the special lit committee was “manifestly unreasonable” or “unsupported by the evidence”. Critized for showing too much DEFERENTIAL S of R.

                ZAPATA 2 PART TEST:

                1. Determine whether the committee acted (a) independently & in good faith; (b) the factual bases supporting its conclusion (limited discovery allowed; reasonableness & through investigation). If this step is satisfied, ct denies its motion. (D of C)

                2. AND (discretionary step) apply the courts own independent BJ. Problem with this step is that the ct is not in the best position to make BJ. Problem is that cts are incompetent to apply their own BJ. (BJ)

                • McKee Rule; (emphasizes demand);(1) BOD will not be able to dismiss a derivative suit when it would be a breach of their fiduciary duty; (2) BOD decision to dismiss derivative suit will be respected unless it was wrongful; (3) shs may sue, w/o prior demand when demand would be futile.

                SUBSTANTIAL SUSPICION S of R; STRUCURAL BIAS—infectious disease that spreads across the BOD

                Alford v. Shaw: Makes the second step of Zapata mandatory because of Structural Bias. Precludes those accused of wrongdoing from decisions of conferring power to bind the corp. to the committee (special litigation) STANDARD OF REVIEW; NC ct used SUBSTANTIAL SUSPICION, and held that a derivative action may not be dismissed unless there is a judicial judgment that the action will not benefit the corp and this suspicion is maintained regardless of whether demand should be required or excused.

                RT TO MAKE DONATIONS

                1. A.P Smith v. Barlow; RULE; state legislation adopted in the public interest can be constitutionally applied to preexisting corp.’s under the reserved power. Shareholders challenged the rt. of corp. to make donations. Isn’t giving away shareholders’ money? Does contribution maximize interest of co? Ct said it advances public interest, social policy



                1. Dodge v. Ford; RULE: A corps primary purpose is to provide profits for its stk’r.

                BAD JUDGMENT –BJR

                1. Shlensky v. Wrigley; RULE; a shs deriv suit can only be based on conduct by the directors that does not border on fraud, illegality, or conflict of interest. Bad judgement is permitted by BJR. No night baseball games.


                1. Duty of Care and Corporate Control Transactions

                1. DUTY OF CARE The basic std is that the dir or offic must behave as a reasonably prudent person (objective std) would behave in similar circumstances. (a) Supervise and monitoring mechanisms (internal acctg; audit committee—these mechanisms will put him on NOTICE) ; (b) Process information (reliance on experts) ; (c) Good Faith.

                • BREACH OF THE DUTY BY; Egregious cases of reckless behavior or with gross negligence. EXAMPLES: (fail to attend board meetings, fail to read corp. reports, fail to obtain advice of a lawyer or acct when signs of mismgt; BOD would be liable for losses suffered by the corp. b/c c/have been reasonably prevented (P must show proximate cause. BOD will only be liable for proximate damages). BOD may rely on experts. So if embezzlement is not discovered by acct or lawyer, BOD/ Officers is not on NOTICE & not liable.

                • BJR; a substantively unwise decision by a director or officer will not by itself constitute a lack of due care. Must meet 3 requirements; (1) No-self dealings (interest in a transaction); (2) Informed decisions (make use of a reasonable amount of information); (3) Rational decisions; (rationally believe that it was in the corp.’s best interest)

                • COMPARE W/ BJR; duty of care imposes procedural requirements on BOD. If these procedural requirements are in place BJR permits BOD to make substantive decisions.


                1. Smith v. Van GorkomRULE; the BJR shields dir or off of a corp. from liab only if in reaching a business decision, the directors or off acted on an informed basis, availing themselves of all material infor reasonably avail. The BOD may only rely on credible information provided by competent individuals, after taking reasonable measures to substantiate it. (1)Made no attempt to learn the intrinsic value of the company; (2) had no written documentation of the company; (3) spent 2 hours on the deal; (4) there was no real emergency or pressure. BJR; The rule itself “is a presumption that in making a business decision, the directors of a corp acted on an informed basis, in good faith and in the honest belief that the action was in the best interest of the corp. Aronson v. Lewis. The standard shs must prove is Gross Negligence as to whether shs were fully informed such that ther vote can be said to ratify directors action. Turns on fairness and completeness of the proxy info.

                • LOCK UP OPTION; right to purchase stk (futures option)

                • GREEN MAIL; pay off to get rid of a shs that is trying to take over a company.

                • LEVERAGED B/O; purchase of a Co by a small amount of equity and a large amt of debt

                • Uninformed BOD means uninformed shs; b/c shs have to vote based on given infor..


                1. Kamin v. Amer Exp; RULE: whether a dividend is to be declared or distributed is exclusively a matter for the BOD and the cts will not interfere as long as the decision is made in good faith. Board decision was based on an investigation. BOARD MADE AN INVESTIGATION. BJR only applies if : (1) no fraud; (2) no illegality; (3) no conflict of int. (4) no gross neg. Court will only infer if conduct was: (1) fraudulent; (2) oppressive; (3) arbitrary; (4) breach of trust; (5) illegal or unconscientously executed; (6) done in bad faith.

                • STRUCURAL BIAS if some of the BOD are bias, all may be—look at compensation arrangement—put bonus ahead of shareholders.);

                • BUSNIESS CORP LAW §720; Permits an action against directors for failure to perform duties in managing corp. assets.

                • BJR; only if no fraud, illegality. Conflicts of interest or gross negl.


                1. Joy v. North; EXAM RULE: In evaluating a recommendation by a special litigation committee for dismissal of a derivative action, a ct must use its own independent BJ as to the corp.’s best interest. There was NO INVESTIGATION by spec. lit committee.

                • BJR doesn’t apply in cases which the decision (1) lacks bus purpose; (2) is tainted by a conflict of interest, (3) is so egregious as to amt. to a NO-Win decision, or results from (4) an obvious and prolonged failure to exercise oversight or supervision.

                • Reasons to uphold BJR: (1) shareholders voluntarily undertake risk of bad judgment; (2) after the fact litigation is likely an imperfect device to evaluate corp. business decision; (3) b/c profits correspond to risk –reward.

                • FIDUCIARY DUTY; a legal obligation to act for the benefit of another, including subordinating one’s personal interest to that of another person.


                1. Francis v. United Jersey Bank: RULE: liab of a corp.’s directors to its clients requires that: Duty, breach, causation & damages. Reinsurance case. Son borrowed against shareholder loans that caused the corp. to go bankrupt. Mother did nothing; she ignored her duty—NONFEASANCE. Directors are ordinariliy not required to owe a duty of care to 3rd parties unless the corp is insolvent. Because the reinsurance business relies on the entrustment of capital within the company, D’s owed a duty of care to creditors –third. SUBSTITUTION THEORY.

                • PROXIMATE CAUSE; The natural consequences of events without which injury would not have been sustained.


                1. MBCA § 11.01(a) - one or more may merge if (1) BOD of each adopts; AND Shs., if required, adopt. (b) Plan must set forth names, terms & cond., manner of converting shares from to cask or prop.

                2. MBCA § 11.03 –

                1. After adopting plan BOD for BOTH s shall submit to sh.

                2. For plan to be approved (1) BOD must recommend unless they determine there is conflict of interest; (2) sh. entitled to vote must approve

                3. must be approved by each voting group by maj. of votes cast

                4. Sh. vote Ø required IF: (1) art. of surviving  Ø differ; (2) each Sh. of surviving have same number of shares and rt.s (3) # of voting shares Ø increase by more than 20% (4) number of participating shares Ø increase by more than 20%

                1. MBCA § 11.04 - P owning at least 90% may merge W/OUT Sh. approval, BUT may not include changes to art. of P

                2. MBCA § 11.06 - When merger takes effect (when art. of merger are filed w/SOS § 11.05) everything moves to surv. and all other entities cease to exist.

                3. MBCA § 13.02 - Sh. is entitled to DISSENT and obtain a payment of fair value for shares in event of following corp. actions:

                4. consummation of plan of merger

                5. share exchange

                6. sale or exchange of all or subs. all of  prop.

                7. amendment of articles that materially and adversely affect rt.:

                1. alters or abolishes pref. rt. of shares

                2. alters redemption rt.s

                3. alters preemptive rt.s

                4. changes vote or cumulative vote

                5. reduces number of shares of sh.

                1. Statutory Limits on Director Liability; Indemnification of Director or Officer -

                1. MBCA § 2.02(b)(4) - Art. of inc. MAY set forth prov. eliminating or limiting liab. of dir. for any action or failure to act EXCEPT: (A) the amt. of fin. benefit received by dir. to which he is not entitled; (B) intentional infliction of harm to  or sh.; (C) violation of § 8.33 (unlawful distr.); OR (D) intentional violation of criminal law

                2. MBCA § 8.51 -

                1.  MAY indemnify. party made to proceeding b/c was or is dir. against liab. IF

                1. acted in good faith

                2. reas. believed action was in best int of 

                3. in crom. proc., had Ø reas. cause to bel. action was crim.

                1.  may NOT indemn. dir. if (1) in proc. by or in rt. of  dir. was found liab. to ; (2) if adjudicated to have received improper personal benefit

                2. Limited to REASONABLE expenses.

                1. MBCA § 8.52 - Unless limited by art.  SHALL indemnify. dir. who is successful, on merits or otherwise, in defense of any proceeding resulting from position as dir.

                2. MBCA § 8.53 - MAY provide advance expenses if (1) written good faith affirmation of believe that met std of conduct (2) written undertaking to pay back if Ø meet std. (3) determination is made that facts then known would Ø prohibit indemn.

                3. MBCA § 8.54 - Dir. may apply to ct. for indemn. which may allow IF: dir. otherwise should have been given under mandatory, OR dir. is fairly and reas. entitled under the circ.


                1. Duty of LoyaltyBOD owe a duty of utmost good faith and loyalty to his corp and its shs. (1) Put interest of corp. ahead of ones own interest (2) not engage in self dealing transactions or conflicts of interest. Cannot bargain for yourself. Have a fiduciary duty to corp.

                1. SELF-DEALING TRANSACTIONS; 3 conditions; (1) the BOD and the corp. are on opposite sides of the transaction; (2) BOD influenced the corp.; (3) BOD’s interests are in conflict with the corp.

                • Self-dealing transaction must be FAIR; cannot be fair to constitute WASTE or FRAUD; was there SHS RATIFICATION or BOD approval (this requires full disclosure about the conflicts of interest/ facts about the transaction – either b4 or after the transaction; by a majority of disinterested directors. Approval or ratification will not stand if there is structural bias or the deal is unfair)

                • INDIRECT CONFLICTS; owns equity in the other party to the transactions.

                • REMEDIES; Rescission of the transaction; restitutionary damages (pay back damages

                1. Common Law - traditionally ALL self-dealing trans. were void. NOW intrinsic fairness test is applied - strict scrutiny

                2. MBCA § 8.60(1) - Conflict of interest arises where (1) Dir. or related person is a party; (2) fin. sign. to dir. is so great that it would reas. be expected to exert an influence on the Director’s judgment; OR (3) trans. is brought before BOD and (1) or (2) apply.

                3. T.C.A. § 48-48-302 - Trans. w/conflict will be upheld anyway IF:

                1. material facts and dir.’s interest are disclosed

                2. transaction was fair to 

                1. Delaware - Maj. of sh., interested and not interested, can approve trans., BUT has to be maj. of disinterested dir.s.

                HIRING FAMILY – DUTY OF LOYALTY- fAIRNESS TEST—are they QUALIFIED? What would a reasonable trier of facts conclude? How long did it take to make the decision?

                1. Bayer v. Beran; RULE: Policy’s of mgt. are left solely to discretion of the BOD and may not be questioned absent a showing of fraud, improper motive or self-interest. DEALINGS WITH REALATIVES will be scrutinized. Nothing improper in this case.

                President hired his wife to do commercials for his company. This is direct self-dealing because the husband and the wife had joint bank accounts so he benefited from hiring his wife—duty of loyalty issue. BJR yields when there is self-interest. FAIRNESS TEST: (1) Ask if transaction was FAIR? (2)Were the BOD using GOOD FAITH?; (3) PROCESS? Case turns on whether the hiring was FAIR-“BJR”. BOD is given broad discretion-because “risk reward”. PARENT SUB –DUTY OF LOYALTY


                1. Lewis v. S.LE.; RULE: where the directors of a corp. are engaged in a transaction with an entity in which the directors have an interest, the burden of proof rests on the interested directors to show that the transaction was fair and reasonable to the corp. Derivative suit claiming waste of assets. Grossly undercharging subsidiary. Consider VanDorn—failure of corp formalities—enterprise liability.

                • BUS CORP LAW §713(b): A K between a corp. and an entity in which directors are involved may be set aside unless the K is Fair and Reasonable to the corp. at the time of the Board approval. When BJR doesn’t apply then look to a high degree of FAIRNESS.




                1. In Re Caremark; STD OF REVIEW; fairness and reasonableness good faith & rationality, test to determine potential liab for BOD. (Footnote; an ill-conceived decision cannot alone be a basis for an action. Redistribution of income from shs to attorneys. BJR applies to negl & ill-advised decisions of BOD’s. ELEMENTS must show to prevail in a breach of duty of care: RULE; members of BOD do not have to ensure that there are no violations of the law. BOD may consider a cost benefit analysis. BOD decision doesn’t have to be substantially right.


                1. Energy Resource v.Porter; RULE: if an off or dir of a corp. invokes refusal to deal as a defense to a charge that he seized a corp. oppor, he must first disclose the refusal to the corp. along with a stmt of reasons for the refusal. DUTY: disclose the refusal to deal (2) along with the reasons for the refusal. Failure to disclose Corp Opportunity; compare with General Auto-(agency principles agents duty to P)-Used corp. to exploit opportunity. Compare with Bancroft Whitney--need confirmation by BOD—not secret. In Singer there were secret profits; ct said must forfeit ALL of the profits in the sideline business “FULL & COMPLETE DISGOREMENT”. Even Unrelated business opportunities must be disclosed. Employment K may disclose what is a bus opportunity. DEFENSES: (1) refusal to deal (2) Financial Capacity Defense; however, it encourages officers to use less than their best efforts & cts frown on it.

                1. ALI Principles of Corporate Governance: §5.05 Taking corporate Opportunities by Directors or Senior Executives. Can’t take a corp. oppor unless: (1) it is first offered to the corp. and makes disclosure concerning the conflict of interest and the corp. oppor. (2) the corp. oppor is rejected by the corp. AND either (A) the rejection to the corp. is fair; (B) the oppor is rejected in advance following disclosure; (C) the rejection is authorized in advance or ratified following disclosure.

                2. CORP. OPPORUNITY: In connection with the performance of functions as director or circumstances, which would reasonably believe, that person is offering opportunity to corp. REQUIRES: full & complete disclosure to non-interested BOD’s & they decline to pursue the opportunity OR (2) corp is clearly unable to exploit it

                3. BURDEN OF PROOF: A party who challenges the taking of corp. opportunity has the burden of proof

                INTRINSIC FAIRNESS TEST— DOMINANT SHDR. Must say it was an interested trans & which duty was breached. THIS IS ONE OF THE REASONS WHY THE BJR IS INAPPLICABLE.

                • 1st assess alleged conduct

                • 2nd conflict of interest or self-dealing?

                • 3rd removes BJR and employs intrinsic fairness

                • Sinclair Oil v. LevienRULE: The intrinsic Fairness test is not applied to business transactions where a fiduciary duty exists but only if it is NOT accompanied by self-dealings. INTRINSIC FAIRNESS TEST: This test will be applied when (1) there is a breach of fiduciary duty, (2) accompanied by self-dealing. A defense to a claim that a director engaged in an interested transaction by showing the transaction’s fairness to the corp. 2 elements: (1) High degree of fairness; (2) burden shifting to corp/dominant shareholder, must prove subject to strict scrutiny that the transaction was objectively fair.

                • NOT A PIERCING CASE because there is no individual operator to hold liable for recovery. Piercing is likely when there is 10 or less shareholders.

                • FUDUCIARY DUTY; a legal obligation to act for the benefit of another.

                • SELF-DEALING; Transaction in which a fiduciary uses property of another, held because of the confidential relationship, for personal gain.

                1. Corporate Opportunity -

                RATIFICATION – 2 elements (1) full disclosure to BOD or shs for vote (2) need a majority votr – this is good faith. Burden shifts

                1. Fliegler v. Lawrence; RULE: Ratification of an interested transaction by a majority of independent, fully informed BOD shifts the Burden of Proof to the objecting shareholder to demonstrate that the term of the transaction are so unequal as to amount to a gift or waste of the corporate assets. Gottlieb v. Hayden Chem.; (ratification shifts burden of proof) noted that when approval is granted by a majority of independent, fully informed shareholders the entire atmosphere is freshened and a new set of rules invoked.


                • DELAWARE CODE §144(a)(2); That a transaction bwtn a corp. and one or more of its directors and officers is not void or violable solely b/c of the director’s participation, if certain requirements are met. Need only an affirmative vote—not a disinterested vote.

                • Cant have ratification if shareholders are uninformed

                • D’s prevail on intrinsic fairness test (in a shareholder derivative suit involving interested directors or officers transactions is that the burden of proof is on the directors/officer to prove the transaction was “Intrinsically Fair”) in this case the directors proved the fairness of the transaction. Corp rec’d substantial value, and the interest given was at a fair price.— Compare w/ Sinclair.

                • PREPARING TO COMPLETE.; BOD has violated his duty of loyalty even if he only prepares to compete. BOD should return his salary he earned during the period of preparation.

                • COMPETITION AFTER END OF EMPLOYMENT; This is generally not a violation of a duty of loyalty. Watch for theft of trade secrets & non-completion agreements.

                • FACTORS TO CONSIDER:

                • Was opportunity offered to insider as an individual or as a corp. mgr?

                • Did insider learn of the opportunity while acting as the corp.’s agent?

                • Did insider use corp. resources to take advantage of the opportunity?

                • Is corp. closely held or privately held?

                • Did the corp. have the ability to take advantage of the opportunity?

                • REMEDIES; ct will impose a constructive trust & order full disgorement of profits.


                1. Public Offerings of Securities; Exemptions From Registration With SEC

                1. Fed. v. State - Fed. sec. laws DO NOT preempt state laws, but specifically allow for them. Called “blue sky laws.” BUT if publicly traded, fed. trumps. Dif. - fed. will allow anything if disclosed, states will reject for unfairness.

                2. 1933 Act - Primarily issuance and registration

                        1. PURPOSE—disclosure and prevent fraud

                          1. State action for fraud is harder to prove. Venue is also harder.

                          2. RULE: If (1) dealing with a security (2) any offer or sale (3) must be registered (4) unless there is some exception

                          3. Violations - If Ø register then basically become a guarantor

                        2. WHAT IS A SECURTITY? § 2 - Any stock, bond, debenture, or note (if to someone other than bank) OR INVESTMENT K (catchall) which is one (i) parts with value-“invests”; (ii) expecting return or profit; (iii) (KEY) arising primarily from the efforts of others


                1. Koch v. Hankins; RULE: whether an investment K exists the court must determine whether the investors had an expectation of profits that would be produced primarily through the efforts of others. In Williamson v. Tucker; the ct stated that a general partnership c/be a security if the could establish: (1) an agreement leaving so little power in the hands of the partner that the structure resembles a limited partnership; (2) the partner is inexperienced or unknowledgeable in the particular business to render him incapable of intelligently exercising his power; OR (3) the partner is dependant on some unique ability of the promoter (this one applies in this case). These factors are not exclusive (oral representations).

                • Registration - very costly disclosure forms and filings. Should offer at least $10mm to make it worthwhile

                • HOWEY TEST; to determine if investment K is a security: (1) invests $ in; (2) a common enterprise and is led to (3) expectation of profits solely from the efforts of the promoter or a 3rd party. CONTROL ELEMENT: whether the efforts made by those other than investor are the undeniable significant ones, those essential managerial efforts which effect the failure or success of the enterprise.

                Exemptions to 1933 ActREGISTRATION STATMENT

                1. Section 4(2) - Non-Public Offerings (private) - Exempt if Ø a public offering, BUT public offering is fairly broad. Public includes everyone w/out first hand knowledge of financial situation. BURDEN of proving non-public is on the ). Look to inv. sophistication AND availability of info, Ø size of offer. Look at EVERY offeree, if one is unsoph. ALL are public. All must be sophisticated investors & have effective access to info.


                1. Doran v. Petroleum MGT Corp.; REGISTRATION PROCESS. Oil wells were sealed. Rule: Even when an offering is relatively small and is made informally to just a few sophisticated investors, it will not be deemed a “private offering” exempt from the registration requ. Of the 1933 Act absent of proof that each offeree had been furnished or had access to, such information about the issuer that a registration stmt w/have disclosed. FOUR FACTORS in determining whether a security is a private offering: (1) the # of offerees; (2) the # of units offered; (3) the size of the offering; (4) the manner of the offering.

                • PRIVATE OFFERING; An offering of securities in a corp. for sale to a limited number of investors and which is not subject to the requirements of the SEC 1933. Private offering applies to the Initial sale and not the Resale.

                • Sec Act §11 is the principle express cause of action directed at the fraud committed in connection with the sale of securities through the registration stmt. The material misrep or omission must occur in the reg stmt. §11 cannot be used in connection with an exempt offering. Neither Reliance nor causation generally is an element of the P’s prima facie case. D has the burden of proving that its misconduct did not cause P damages (some other factor caused harm §11(e)). This section contains NO privity requirement.

                • Sec Act §12(a)(1): imposes civil liability on the seller of securities. Liability occurs from improperly failing to register the securities, failure to deliver a statutory prospectus, violating the gun-jumping rules. The main REMEDY is rescission. This § is broader than §11 because it imposes liability where the D made ORAL material misrep.


                1. Escott v. Barchris Const.; RULE; Due Diligence is a defense is under §11 when a D believes after a reasonable investigation that the alleged material misrep are correct and there are no material misreps. To successfully assert a due diligence defense under §11, newly elected directors and outside counsel cannot rely on corp. officer’s accuracy of stmts. Should review doc’s and talk to ee’s.

                • SEC §11; Makes it unlawful to make untrue stmts. in registration stmts.

                • SEC §11(c); Defines reasonable investigation as that required of a prudent man in the mgt. Of his business.

                • DEBENTURE is not a bond, not secured, may be publicly traded.

                • May sue every person who signs the stmt, (2) directors, (3) every one who gave authority to the stmt.

                • Order of pay-off in bankruptcy: (1) Bond; (2) unsubordinated Debenture; (3) convertible subordinated debenture; (4) Preferred Stock; (5) c’mon stk.

                • §145 Delaware General Corp Law. (a) suits by 3rd parties allow indemnification in certain circ’s for expense…judgments, fines and amts paid in settlements. . (b) indemnification for suits only for expenses and, if the person seeking indem has been found liab to the corp., only w/judicial approval.

                • Accredited Investors –equals conclusive proof of sophistication

                Regulation D for private placementONLY FOR INITIAL SALE

                1. R504 - Can sell $1mm of sec. in any 12 mos. period (look back 12 mos. from date of offer not sale) with Ø limitations on resale, manner, or disclosure

                2. R505 - Can sell up to $5mm. Limited to 35 investors (Ø count spouses or accredited investors - officers of org. or wealthy people); CANNOT use general advertising or solicitation; resale is restricted, MUST disclose to non accredited

                3. R506 - Unlimited dollar amount; any non-accredited must be sophisticated; otherwise like R505.

                • Section 3(a)(11), R147 - exempts interest. offerings. MUST be:

                • A distinct issue (Ø part of issue). More than 6 mos. from other Reg. D offering, OR 5 integration factors:

                  1. same financing plan

                  2. same class of stock

                  3. time span b/w sales

                  4. type of consideration received

                  5. same general purpose

                  1. offered and sold ONLY to residents of 1 St. (intend to reside) considered sold only in that state so long as Ø resale out of state w/in 9mos.

                  2. by corp. from that state (incorporated there);

                  3. doing bus. primarily in that st. (i) primary place of bus.; (ii) most assets in st. (80%); (iii) most proceeds earned from st. (80%)

                  Preemptive Rights - Rt. to purchase from new stock issue to prevent dilution

                  1. MBCA § 6.30 - (a) Ø preemptive rights UNLESS art. so provide. (b)(2) IF there are, they can be waived and waiver in writing is not rev., regardless of consideration. (b)(3) Ø preemptive rt.s w/respect to (i) shares issued as comp.; (ii) to satisfy conversion or option rt.s created as comp.; OR (iii) shares auth in art. and issued w/in 6mos. of effective date of incorp.; (iv) shares issued otherwise than for money

                  • NOTE: Ø eliminate dir. fid. duty. If dir. offers selves stock at lower than fmv price, may violate that duty even w/out preemptive

                  Legal Restrictions on Redemption -

                                1. Governing Rules - Depends on juris.

                                2. Earned Surplus - Can pay out whatever is in earned surplus, as long as Ø make insolvent

                                3. Nimble Dividends Rule - can pay out of this years ES, even if negative ES from previous years.

                  Impairment of Capital - Can pay out of ANY surplus acc. but Ø paid in cap.

                  1. MBCA § 6.40(c) - Ø distr. may be made if after giving it effect:

                  2.  would Ø be able to pay its debts as they come due in ord. course of business; OR

                  3. The ’s total assets would be less than its total liab. PLUS the amt. that would be needed if  were to be dissolved at time of distr. to satisfy the preferential rt.s of Sh.s whose pref. rt.s are superior to those rec. div. (assets>liab + pref. stock rt.s)





                  1. Insider Trading and Rule 10b-5

                  1. Rule 10b-5 It shall be unlawful for anyone :

                  1. to employ any device, scheme or artifice to defraud

                  2. To make untrue statement of material fact or to so omit nec. fact

                  3. To engage in any act or practice which operates or would operate as fraud.

                  • Need (1) false rep. or omission; (2) relating to mat. fact; (3) that ) has scienter of; (4) by one owing duty (5) B action in reliance.


                  • Applies to privately or publicly held companies.

                  • PENALTY; violation of 10b-5 is a crime. SEC can also get an injunction against the misconduct.

                  REQUIREMENTS FOR A PRIVATE CAUSE OF ACTION 10b & 10b-5

                  1. Instrumentality of interstate commerce;

                  2. Manipulative or deceptive;

                  3. In connection w/ the purchase or sale;

                  4. Duty to disclose;

                  5. Scienter/knowledge; Ernst & Ernst v. Hochfelder; intent to deceive, manipulate or defraud.

                  6. Confidentiality;

                  • Insider & Tippee (only) are covered by 10b-5

                  • Standing – P must be a purchaser or seller of the stock during the time of non-disclosure. Blue Chip Stamps v. Manor Drug; B must have bought or sold sec. in near proximity to ) having info. ALTHOUGH ) Ø actually have to trade. Causation and reliance are often assumed though

                  • Traded on material, non-public info; D must have misstated or omitted a material fact. Material: there is a substantial likelihood that a reasonable shs w/ consider it important in deciding whether to buy, hold, or sell the stk.

                  • Reliance & causation; P must show that he relied on the misstatement or omission & that it was the proximate cause of his loss. If there is an affirmative misrepresentation (not just silent insider trading) P will be given a presumption that he relied on the infor.

                  • Jurisdiction; the fraud or manipulation must have been done “by the use of interstate commerce or of the mails, or of any facility of any national securities exchange.



                  AFFIRMATIVE MISSTATEMENT -- DISCLOSURE OF MERGER 10b &10b-5 action

                  1. Basic v. Levinson; Corp denied that is was it was planning a merger. P’s sold stk and claimed that they lost potential profits. RULE: (1) whether a company statement is MATERIAL requires a case-by-case analysis of FACTS & CIRCUMSTANCES the probability that the transaction will be consummated and the significance of the transaction to the issuer of securities. (2) An investor’s RELIANCE (As an element of common law fraud & a private 10b action) on material public misrepresentations may be presumed under a fraud on the mkt. Theory (10b-5). Require a P to prove actual reliance would place an unrealistic evidentiary burden on them. Market price of a company is a reflection of all information in the market. Therefore, a P who buys and sells stock at the price set by the market can be PRESUMED to have relied on any material misrep affecting that price.

                  • RULE 10bB-5; Unlawful to defend or make untrue stmts. In connection with purchase or sale of securities.

                  GENERAL RULE:

                  • If its an affirmative misstatement, P must prove reliance. If P argues FRAUD ON THE MARKET THEORY; there is a rebuttable presumption of reliance in the context of affirmative misrepresentations as to material facts. This same rational applies to cases in which there is an OMISSION to state material facts. The party failing to make disclosure must be under a duty to disclose because of a fiduciary or other relationship of trust or confidence.

                  • TSC INDUSTRIES; Standard of Materiality (1) an omitted fact is material if there is a substantial likelihood that the reasonable shs would consider it important in deciding how to vote as far as purchasing or selling a security. (2) to fulfill materiality requirement, there must be a substantial likelihood that the disclosure of the omitted fact would’ve been viewed by the reasonable investor as having a significantly altered the “total mix” of info made available

                  MATERIALLY FALSE STMT

                  1. Pommer v. Medtest; RULE: A stmt is MATERIAL when there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investors as having significantly altered the “total mix” of information available. P claimed he was induced to purchase stk. in Medtest as a result of materially false stmts. made to him by Medtest agents. The fact that a patent was eventually obtained does not make the falsehood any less substantial. Even savvy investors may recover damages when a lie understates the gravity of a known risk.

                  • Rule 10b-5; Unlawful to defend or make untrue stmts in connection with purchase or sale of securities.


                  1. Santa Fe Indust v. Green; RULE: Before a claim of fraud or breach can be maintained under 10b or 10b-5, there must be a showing of manipulation or deception. Merger with 90% owned company for purpose for eliminating minority shs. CASH-OUT or SHORT-FORM MERGER—freeze-out; minority shs do not have a rt to refuse. It’s a forced sale. State-Remedy is a ct ordered appraisal—no private right of action is granted under §10b or §10b-5. Ernst & Ernst; held that the SEC could not enact rules which conflicted with plain expression of congressional intent. Hence, rule §10b-5 could not be more restrictive in nature than could actions under §10b.

                  • Rule 10b: Makes it unlawful for any person to use or manipulation or deception (these are int’l torts vs. negligence) in the buying or selling of securities.

                  FALSE STMTS; DUTY OF LOYALTY; OPTION K –intentional inflation of mkt price to encourage shs

                  1. Deutschman v. Beneficial; RULE; A purchaser of options to buy stk in a corp. may state a 10b claim against that corp. and its officers for affirmative misrepresentation affecting the market price of the option whether or not there is any fiduciary relationship between the purchaser and the corp. or its officers. 10minute case

                  • Chiarella Case MISSAPPRPRIATION THEORY RULE; a corp. insider must abstain from trading in the shs of his corp, unless first disclosed (10b-5) all material inside info known to him. REASONS (1) fiduciary duty insiders owe to shs; (2) level playing field argument. Required a SPECIFIC RELATIONSHIP: agent/ fiduciary/ officers of securities


                  INSIDE INFORMATION


                  1. Goodwin v. AgassizRULE: A director of a corp. may not personally seek out stockholders for the purpose of buying his shares without disclosing material facts within his peculiar knowledge as a director and not within reach of the stockholder. But the fiduciary obligation of the directors is not so onerous as to preclude all dealings in the corp.’s stk where there is no evidence of fraud. 10minutes in class


                  1. Texas Gulf SulfurRULE; (1) it is unlawful to trade on material inside infor until such infor has been equally disclosed to the public and has time to become equally available to investors. (2) A company press release is considered to have been issued in connection with the purchase or sale of a security for purposes of imposing liability under the federal securities law, and liability will flow if a reasonable investor, in exercise of due care, would have been misled by it.

                  • INSIDER; anyone who obtains information by virtue of his employment and trades on it; even a low-level employee (secretary).

                  • CONSTRUCTIVE INSIDERS; Independent K’r (acct’s or attnys) same as insiders.

                  • Keeping a discovery secret is ok—just don’t act upon it.

                  • Disclose or Abstain rule

                  • MATERIALITY TEST: is whether a reasonable man would attach importance . . . in determining his choice of action in the transaction in question. Whether facts are material under 10b-5 will depend at any given time will depend upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the circumstances

                  • In a private cause of action P must prove (1) materiality of the concealed or misstated fact; (2) reliance; (3) scienter; (4) causation


                  1. Dirks v. SEC; RULE; a tippee will be held liable for openly disclosing nonpublic information received from an insider, if the tippee knows of should have known that the insider will benefit in some fashion from disclosing the information to the tippee. Focus on insiders conduct. Did he benefit? Were there any fiduciary duties breached? A c’mon violation doesn’t breach 10b-5. Need manipulation & deception. Consistent with Basic—need scienter.

                  • TIPPEE; if he knows (if he doesn’t know he is not liable) that the source of his tip has violated a fiduciary obligation to the issuer.

                  • Acquired by chance; overhear insider infor in a restaurant witout any fiduciary violation by the speaker = may trade on it

                  • Acquired by diligence; analysis non-public infor –ex interviewing former ee’s & they are not receiving and $. May trade on it

                  • Intent to make a gift; if an insider intends to give an outsider information as a gift; the outsider will be a tippee and both the insider and the outsider will be liable.

                  • Disclosure between family members; if the tipper learns infor from a close relative, this is not enough to give the tipper a fiduciary responsibility.

                  • Confidential infor from other than the issuer; Where the outsider rec’s infor but not from the issuer, the outsider will be liable for mail or wire fraud. (ex a news reporter trades on infor he hears from other than the issuer)

                  • Suit by acquiring corp; If the outsider learns the infor in breach of his fiduciary obligation to the would-be acquirer of the target, the acquirer will be able to recover damages from the outsider.

                  • RULE 14e-3; prohibits trading on non-public infor about a tender offer even if the infor comes from the acquirer and the infor is not obtained in violation of any fiduciary duty.

                  • In re Cady &-- Chiarella v. U.S; elements for establishing a rule 10b-5 violation (1) the existence of a relationship affording access to inside infor intended to be available only for a corp. purpose, and (2) the unfairness of allowing a corp. insider to take advantage of that information by trading without disclosure.


                  1. SEC v. Texas Gulf; RULE; it is unlawful to trade on material inside infor until such infor has been disclosed to the public and has had time to become equally available to all investors.


                  • §10b operates to limit those who can recover under that § to actual purchasers or sellers of a company’s securities.


                  1. US v. Hagan; RULE (1) when a person misappropriates confidential infor in violation of a fiduciary duty, and trades on that infor for his own personal benefit, he is in violation of 10b & 10b-5. Insider trading can be broken down into 3 groups: (A) CLASSICAL OR TRADITIONAL THEORY: deals with INSIDERS—stands in a fiduciary relationship with shs ; (B) MISAPPROPRIATION THEORY deals with OUTSIDERS who have no fiduciary relationship with the shs he trades. Acquires infor wrongfully (that’s why we use the term misappropriates—fraud at the source (C) AFFIRMATIVE MISSTATMENT;

                  • 14e-3; prohibits trading on undisclosed info in a tender offer even where a person has no fiduciary duty to disclose.

                  • MISAPPROPRAITOR; is one who takes infor from anyone, especially from someone who is not the issuer in violation of express or implied obligation of confidentiality. (in this case an attny took infor from his client and sold stk on the info.



                  §16b SHORT SWING PROFITS

                  • Public companies; §16b applies to companies who are registered on a stk exchange under §12 or have assets greater than 5M an a class of stk held of record by more than 500 or more people.

                  • Who may sue; any shs, but recovery goes to corp.

                  • Officer; VP Treasurer

                  • Beneficial owner; owns more than 10% of any class of the companies stk. Attribution: stk listed in minor children’s name or in the spouse’s names will be regarded as being that of the fathers if he is an officer or beneficial owner. So if wife sells stk it is attributed to the husband.

                  • Merger exception; Kern case; if a corp merges into another company (and thus disappears) the insiders will not necessarily be deemed to have made a sale. As ong as he can show that (1) the transaction was involuntary); (2) and that he didn’t have access to inside infor.

                  SHORT SWING PROFITS 16b

                  1. Reliance Electric v. Emerson Electric; RULE When a holder of more than 10% of the stock in a corp. sells enough shares to reduce its holdings to less than 10% and then sells the balance of its shares to another buyer within 6 months of its original purchase, it is not liable to the corp. for the profits it made on the second sale. Presumption that you traded on inside info. If you own 10% or more you are a statutory insider & must sign quarterly stmts.

                  • RULE 16b provides that corps may recover profits realized by an owner of more than 10% of the shares when that owner buys and sells stk w/in a 6month period. (Convertible debentures count as stk). Statutory assumption. Applies to equity securities an stock exchange.

                  BENEFICIAL OWNER §16b

                  1. Foremost v. Mckesson v. Provident; RULE; in a purchase/sale a beneficial owner must account for profits if he was a beneficial owner before the purchase.

                  SALE BASED ON A MERGER

                  1. Kern County v. Occiential Petroluem; RULE; neither the accrual of the right to exchange recently acquired shs for shares in the survivor of a merger, Nor the granting of an OPTION to buy the shares received in such an exchange, constitute a “sale” within the meaning of Rule 16b, absent any abuse, or potential for abuse, of inside infor.

                  • Notes on §16b: to escape 16b liability wait 6months to avoid disgorgement.

                  • Any sale or purchase starts the 6months. OR when you become a 10% holder

                  • You have earned a profit even if you buy, b/c you bought @ a discount

                  • To qualify as a 10% owner only need to own 10% of any one class of the company’s stk, and not 10% of the total stk. For a convertible bond holder, ct will look to see what percentage of the stock the bondholder would own is she converted the bond for stk.

                  • ISSUERS: corp. must be on a nat’l exchange; assets of at least 5m and 500 or more shs

                  • OFFICERS; must occupy the position either at the time of purchase or at the time of sale.

                  • Deputization; if a firm’s ee serves as a director of another firm. §16b may apply to the first firm’s trades in the stk of the second firm. Deputize the officer

                  • Stock classes & convertible debentures; applies to equity securities.

                  • Shareholder may enforce corp. action Derivatively;
















                  1. Waltuch v. Conticommodity Services; RULE: A corp. director or officer who has been successful on the merits /vindicated from claims asserted against him is entitled to indemnification from the corp. against reasonably incurred legal expenses. Indemnification rights provided by contract can’t exceed the scope of a corp.’s indemnification powers as set out by statute. Although indemnification rights can be broader than those set out in the statute, they can’t be inconsistent with the scope of the statute.

                  • INDEMNIFICATION: Reimbursement for losses sustained or security against anticipated loss or damage. Indemnification rights provided by K cannot exceed the scope (inconsistency) of a corp.’s indemnification powers as set out by statute.

                  • Del Code §145(a) permits indemnification only if the officer acted in good faith. (dealing w/ 3rd party actions.

                  • 145(b) Indemnification of derivate suits

                  • 145© Expenses must be reimbursed if the D was successful

                  • 145(d)

                  • 145(e) expenses incurred by an officer in defending any civil or criminal, administrative or investigative action, suit or proceeding may be paid by the corp. IN ADVANCE of the final disposition of such action.

                  • 145(f) says cant bypass the good faith requirement of (a)

                  • 145(g) permits a corp. to circumvent the good faith clause of (a) by purchasing liability insurance policy .


                  1. Citadel Holding Corp v. Roven; RULE: A corp. may advance reasonable costs in defending a suit to a director even when the suit is brought by the corp. §145(e). Reasonableness was not an issue in this case because agreement didn’t mention reasonableness. Not a 16b case because there was no sales or purchases w/in 6month period & 10% is irrelevant because D was a director.

                  • Proxy Fight; result when insurgent groups tries to oust incumbent managers by soliciting proxy cards and electing its own representatives to the board.

                  • Cumulative Voting; can add up all votes on behalf of all directors; I.e. can use 50 votes for 1 director. Like a tender offer, proxy fights are subject to regulations derived form 1934 act and state corp. statutes.




                  1. Levin v. MGM; RULE: Incumbent directors may use corp. funds and resources in a proxy solicitation contest if the sums are not excessive and the shs are fully informed. The proxy stmt will fully disclose this information to the shs.


                  1. Rosenfeld v. Fairchild Engine; RULE: in a contest over policy, corporate directors have the right to make reasonable and proper expenditures from the corp. treasury for the purpose of persuading stkr’s of the correctness of their position and soliciting their support for policies that the directors believe, in good faith, are in the best interest of the corp. (1)Corp. may reimburse unless it’s a dispute over personality. It must be over policy. (2) may only reimburse reasonable and proper expense. (3) may reimburse INCUMBANTS whether they prevail or not. (4) may reimburse INSURGENTS if the shs ratify pmts. These rules are NOT SYMMETRICAL, they are in favor of incumbents. The rule against reimbursement either party can have ONEROUS consequences for incumbents.

                  • Proxy: a person (agent) authorized to act for another

                  • Ratification; (1) full disclosure (2) approval by disinterested majority vote BOD. Use intrinsic fairness test if interested BOD’s.

                  • An advantage of a Proxy contest is that it is cheaper than a Tender Offer. Another advantage is that insurgent groups may be reimbursed for their expenses

                  • §14a; prohibits people from soliciting proxies in violation of SEC rules

                  • §14a-3, 14a-4, 14a-5, & 14a-11; require people who solicit proxies to furnish each shs with a proxy stmt & enclose annual report, conflicts of interest and major issues.

                  • §14a-6 the parties soliciting the proxies must file copies of this material with the SEC

                  • §14a-7 give mgt. A choice: it can either mail the insurgent group’s material to the shs directly and charge the group for the csts, or it can give the group a copy of the shs list and let it distribute its own material.


                  1. Virginia Bankshare v. Sanberg; RULE: A conclusory stmt of belief or opinion is actionable under §14(a) if the stmts are made knowing that material facts do not support this belief or opinion.

                  • §14(a) Authorizes the adoption of rules governing the solicitation of proxies and make it illegal to violate these rules.

                  • §14a-9; Prohibits the solicitation of proxies by means of false or misleading stmts

                  • MATERIALITY; Importance; the degree of relevance or necessity to the particular matter.

                  • FREEZE-OUT; minority shs have not choice but to sell out. Only remedy is to ask court to get an independent appraisal and approve a higher price.


                  1. Stahl v. Gibralter; RULE: A shs has a standing to initiate a direct action against the corp whether he voted in reliance on a false or misleading stmt, either before or after a proxy vote is conducted. No reliance is required. 10 minute case.

                  SHS VOTING & CONTROL

                  1. Stroh v. Blackhawk Holding; RULE: A corp. may prescribe whatever restrictions it deems necessary in regard to the issuance of stk, provided that it not limit or negate the voting power of any share. 10 minute case.


                  1. SHAREHOLDER VOTING & CONTROL

                  1. The Traditional Roles of Shareholders and Directors

                  1. MBCA § 7.32 - (a) Sh.s can agree, even if contrary to other provisions, to (1) restrict discretion of BOD; (b)(1) such an agr. shall be in the art. OR signed by ALL sh. NOTE: an agr. puts Sh. in pos. as FIDUCIARY to the extent they take powers away from BOD.


                  1. T.C.A. § 48-17-302 - Allows agr. b/w two or more Sh. (Ø nec. all) to bind those who assent ONLY, even if limits discr. of BOD.


                  1. McQuade v. Stoneham - ON 1997 EXAM RULE: a shs agreement prohibiting BOD from changing officers, salaries, or policies, or retaining individuals in office, is illegal and void absent express contractual consent or shs approval. A K is illegal and void to the extent it precludes BOD, at risk of incurring legal liab., from changing officers, salaries, or retention policies, except by consent of contracting parties. Could have K to stay on BOD, but stat. said BOD will elect officers, this interferes w/indep. judgment. 10-minute case.


                  1. .Ringling Bro’s v. Ringling; RULE; A group of shs may lawfully contract to vote in any manner they determine.

                  • PROXY EXPENSE Rule 14a-7 shs bears the expense of communicating withhis fellow shs’r (printing & postage). 14a-8 corp. bears the exp when it sends out its own material

                  • FIDUCIARY STOCKHOLDER; a shs that owes a legal obligation to deal fairly with, and not to exploit or oppress, minority shs.

                  • VOTING TRUST: an agreement establishing a trust, whereby shs transfer their title to shares to a ttee who is authorized to exercise their voting pwrs. Voting trust must be of limited duration—10years

                  • VOTING AGREEMENT; they are valid.


                  1. Clark v. Dodge; RULE; Where the directors are also the sole shs of a corp. a K between them to vote for specified persons to serve as directors is legal, and not against public policy. Contra of McQuade; where there was a dif. result, but Ø other stockholders at stake, ONLY a slight infringement of statute.


                  1. Galler v. Galler – IMPT CASE. RULE; shs in a closely held corp. are free to K regarding the mgt. of the corp. absent the presence of an objecting minority, and threat of public injury. Different jurisdiction than McQuade (conflicts with McQuade)and different type of entity.

                  2. Ramos v. Estrada; RULE; Voting agreements binding individual shs to vote in concurrence with the majority constitute valid K’s. In closely held corp.’s the shs usually serve as BOD and do not have the alternative of selling their shs on the open market. Thus, shs agreements regarding the transfer of shs, voting rights, and election of directors are necessary for investors in close corp.’s to safeguard their investments.

                  • CAL CORP CODE §706; An agreement btwn two or more stk’rs in a close corp may prescribe voting agreements.

                  • FIDUCIARY DUTIES; shs in a closely held corp owe each shs a fiduciary duty like a partnership. See Meinhard case & Sinclair case or dominant shs.


                  1. WILKS v. SPRINGSIDE; RULE; in a closely held corp., the majority shs have a duty to deal with th eminority in accordance with good faith std. Should incorporate into a operating agreement a DISSOLUTION CLAUSE or a BUY-OUT CLAUSE.

                  • CLOSELY HELD CORP.; A corp whose shares or at least voting shares are held by a closely knit group of shs or a single person.

                  • MINORITY SHS; a shs in a corp controlling such a small portion of those shares that are outstanding that its votes have no influence in the mgt of the corp.

                  • FREEZE-OUT; frozen out from dividends and salary raises. For it to be legal---Don’t give anyone any dividends. Cant discriminate against only one person.

                  • EXCESSIVE SALARIES; is actually a dividend or self-dealings. Look at intrinsic fairness and breach of fiduciary duty or conflict of interest.

                  1. MBCA § 7.02 - Special meetings will be called by (1) BOD (2) 10% of the Sh. entitled to vote on issue proposed for mtg. NOTE: prov. has Ø “unless otherwise agreed.” BUT most St.s add that in)

                  2. MBCA § 8.08(a) - Sh. may remove dir. with or W/OUT cause unless art. provide that only can be removed for cause. (b) if dri. is elected by voting group only that group can remove

                  3. MBCA § 8.10(a) vacancy on BOD can be filled by Sh. or BOD (b) IF dir. was elected by voting group, ONLY that group can replace.

                  1. Shareholder Voting -

                  1. MBCA § 7.07 - bylaws will fix record date. Anyone entitled to vote on that date will be entitled to vote at meeting.

                  2. MBCA § 7.22 - Sh may vote by proxy. Is rev. unless consp. says irrev.

                  3. MBCA § 7.24 - (a) If signature on proxy corresponds to owner then  can accept in good faith. (b) can also accept in good faith if (1) officer or agent of  sh.; (2) conservator, etc.; (3) receiver or T/ee in bankr.

                  4. MBCA § 7.25 - (a) QUORUM must be present to take any Sh. action. Unless otherwise stated in art. a quorum for a voting group is a maj. of the shares of that group. (b) once a share is present for any purpose at a meeting it is present for quorum for remainder of mtg. (c) IF quorum present, then an action (OTHER than to elect dir.) passes w/in a voting group when Y>N, (those voting, Ø those present)

                  5. MBCA § 7.28 - (a) Unless otherwise provided, dir. are elected by plurality of votes cast (maj. of those present) when quorum present. (b) Ø rt. to cumulative UNLESS art. so provide (d) when auth., fact of cumulative voting must be consp. on proxy or notice (NOTE: only an issue when voting on director)

                  6. MBCA § 7.26 - If art. provide for voting by single voting group then § 7.25 applies. IF art. or act provide for voting by 2 or more groups then each group is counted separately under § 7.25.

                  7. MBCA § 7.04 - Action can be taken w/out mtg. if ALL sh.s approve. § 8.21 allows dir. to do same. DEL. will allow large  to act w/out meeting on maj. vote.

                  8. MBCA § 10.04 - If amendment to art. or bylaws will affect a part. class of stock or voting group, that group must approve separately

                  1. Cumulative Voting -

                  1. Straight Voting - each Sh. allowed to vote a # of shares equal to the # of shares he has for each dir. slot to be filled

                  2. Cumulative Voting - Sh. allotted # of votes equal to his # of shares X number of dir. being elected. Can divide among dir. OR put all votes on one.

                  1. POLICY - allows minority. to get someone on BOD. BUT is cumbersome, devisive, and req. min. coalition to be helpful

                  2. FORMULA - to vote in 1 dir. w/cumulative: (s/(D+1))+1=number of shares needed. S is # of total shares voting; D is # of dir. slots; +1 is go up to next whole #.

                  1. MBCA § 8.08(c) - If cumulative voting is auth, dir. may NOT be removed if the number of votes suff. to elect him under cumulative votes against removal (keeps maj. from just removing dir. put in by min. through cumulative)

                  2. MBCA § 13.02(a)(4)(iv) - allows dissenter rights if there is an amendment to art. limiting cumulative voting

                  3. MBCA § 8.06 - allows for staggered terms IF there are at least 9 dir. THEN can only stagger by dividing term by 2 or three and having ½ to 1/3 each election, or as close as possible (Keeps the efficacy of cum.)

                  1. Voting Trusts and Pooling Agreements

                  1. MBCA § 7.31 -Voting Trust v. Voting Pool

                  1. Trust -

                  1. t/ee charged w/ voting

                  2. More formality - (i) set up; (ii) create agr.; (iii) trans. shares to name of T/ee; (iv) orig. owner is just ben. owner; (v) rt. to vote is separated from other stock rt.s

                  3. more certainty of result

                  4. MBCA § 7.30 - (a) T/ee must compile list of ben. owners and submit to  or T is invalidated; (b) can ONLY last for 10 years beyond effective date; (c) extension agr. must be signed by ALL who shall remain if want to last longer than 10 years

                  1. Pool - § 7.31b - Ø req. writing, Ø time limit

                  1. Share Transfer Restrictions or why have multiple classes of stk

                  1. Reasons - small  may need to:

                  1. control who they do bus. with

                  2. comply w/securities exemptions

                  3. comply w/subchapter S

                  4. estate liquidity - provide for ability to sell back

                  5. estate valuation - put buy back price in agr. to avoid fights

                  1. MBCA § 6.27(c) - restrictions on trans. of share is authorized:

                  2. to maintain ’s status when dependent on number or ID of Sh.

                  3. preserve exemption under sec. law

                  4. for ANY OTHER REASONABLE purpose

                  1. restriction on transfer of shares MAY:

                  1. obligate sh. to first offer to corp.

                  2. obligate corp. or other person to buy

                  3. require ANYONE to approve sale if Ø manifestly unreas.

                  4. prohibit trans. to specific pers. if Ø manifestly unreas.

                  1. Authority of Officers -

                  1. MBCA § 8.41 - Off. has auth and shall perform duties set forth in by-laws or, to the extent consistent w/bylaws, duties prescribed by BOD. (INCLUDES: Express auth, Implied auth., Apparent Auth.)

                  1. Dissension, Deadlock and Oppression

                  1. MBCA § 14.01 - Incorporators and initial BOD can dissolve by giving assurances to SOS

                  2. MBCA § 14.02 - Diss. may be effected by BOD proposal and maj. sh. approval

                  3. MBCA § 14.20 - SOS can diss. corp. failing in 6o days to provide taxes, annual report, have properly registered agent, or when art. duration expires

                  4. MBCA § 14.30(2) - Court MAY dissolve a corp. if established that:

                  1. dir.s are deadlocked in mgmt., sh. cannot break deadlock, AND irreparable injury to corp. is being threatened OR bus. affairs can no longer be conducted to benefit of Sh.

                  2. Dir. have or will act illegally, oppressively, or fraudulently

                  3. Sh.s are deadlocked in voting power and have failed, for a period that includes at least 2 annual meeting dates, to elect successors to dir.s whose terms have expired

                  4.  assets are being misplaced or wasted

                  1. MBCA § 14.34 - If pet. is filed for diss.  and non-pet. sh. are given option to buy.























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