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Course: Business Org Jano
School: University of Detroit
Year: 2001
Professor: Huchinson
Course Outline provided by

Nature of the Corporation


Corporate Formation

Southern-Gulf Marine (Δ) v. Camcraft (P)

Facts: P sought to get out of a k w/ Δ, b/c Δ hadn’t been incorporated when the k was signed. P contracted to purchase a ship from Δ. When the ship appreciated in value, Δ wanted out of k.

Rule: Where a party has contracted w/ what he acknowledges to be a corp., he is estopped from denying the existence or the legal validity of such a corp. J/P

Q: Suppose the corp. was never formed and P sued Δ as an individual to enforce the k. On what theories might it rely? §2.04

Promoter: A person who identifies a business opportunity and puts together a deal, forming a corporation as the vehicle for investment by other people.



Corporate Entity & Limited Liability: Enterprise Liability

Walkovsky (P) v. Carlton (Δ) – HUTCHISON’S FAVORITE CASE

Facts: P run down by a taxicab owned by Seon Cab Corp (Δ), sued Carlton (Δ), a stockholder of 10 corps, including Seon, each of which had only 2 cabs registered in its names. Δ had taken out no more than the minimum insurance.

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 act upon the principle of respondent superior (rules of agency), and the liability extends to negligent acts as well as commercial dealings. Cts will pierce to prevent fraud or to achieve equity. However, ct will not pierce simply b/c assets of corp., together w/ inadequate insurance, are insufficient to assure recovery.

Dissent: Undercapitalization and minimum insurance liabilities is an abuse of the corporate entity and minimizing personal liability.

2 Theories: Enterprise Liability v. Piercing Corp. Veil

Enterprise Liability: reverse piercing; suing affiliated companies; ex. the law allows you to go after all 10 companies, jut not the owner personally.

Piercing Corp. Veil: apply general rules of agency using respondent superior

  1. alter ego

  2. unity of interest

  3. fraud (whether the funds were being shuttled out of the corp. w/out regard to formality & to suit their own conveniences)

Respondent Superior: rule that the principal is responsible for tortuous acts committed by its agents in the scope of their agency or authority.

Undercapitalization: $ is purposely being funneled out of corp.

Corporation: it’s a legal entity (fictional) having authority to act as a single person (citizen) distinct from the SHs who make it up (used to encourage economic growth); principal = individual, agent = corporation

Exam: In context of piercing corporate veil (ct. should be more sympathetic to tort creditors)

Tort Creditor: results from an accident (involuntary)

K Creditor: knew & entered into willingly & can reduce risk by engaging in thorough investigation (privity)


Alter Ego

Sea-Land Services (P) v. Pepper Source (Δ)

Facts: When P couldn’t collect a shipping bill b/c Δ had been dissolved, P sought to pierce corp. veil to hold Δ’s sole SH personally liable. The corporation was his “alter ego.”

Rule: The corporate veil will be pierced where there’s a unity of interest and ownership btw the corp. and an individual and where adherence to the fiction of a separate corp. existence would sanction a fraud or promote injustice.


VAN DORN TEST: Test for Piercing Corporate Veil

  1. there must be such unity of interest and ownership that the separate personalities of the corp and the individual (or other corp) no longer exist; and

4 Factors (to determine if corp is controlled by another):

      1. failure to maintain adequate corp records or to comply w/ corp formalities,

      2. the commingling of funds or assets,

      3. undercapitalization

      4. one corp treating the assets of another corp as its own

  1. circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice.

2 Factors (to establish 2nd element of Van Dorn):

      1. fraud (intentional wrongdoing)

        1. no proof of “intent to defraud” is required

        2. negligence is not sufficient to show fraud – need scienter

        3. ex. misrepresentation, siphoning $

      2. promotion of injustice

        1. requires something less than affirmative showing of fraud

        2. requires a wrong beyond the creditor’s inability to collect

        3. some element of unfairness, something akin to fraud or deception or the existence of a compelling public interest

        4. must show the kind of injustice to merit the ct of equity

Alter Ego: reflects unity of interest, no separate ownership; a corp. used by an individual in conducting personal business, such that a ct may impose personal liability by piercing corp. veil when fraud has been perpetrated on someone dealing w/ the corp.

Scienter: knowledge, intentional misstatement of material fact, material misstatement made recklessly.


Potential 3rd Prong

Kinney Shoe (P) v. Polan (Δ) Hutchison doesn’t like outcome of this case.

Facts: After Industrial Realty Co. (Δ), of which Δ-Polan was the sole SH, failed to pay rent due on a sublease from P, P filed suit seeking to pierce corp veil to recover the $ owed. P had not done thorough investigation of Δ company and did not have a complete personal guarantee.

Rule: The corp veil will be pierced where there’s a unity of interest and ownership btw. the corp and the individual SH and an inequitable result would occur if the acts were treated as those of the corp. alone.

Exam: Always use Van Dorn Test (whether tort or k case) and include 3rd prong of Laya.


3rd Prong of VAN DORN test for Piercing Corporate Veil (Laya Test)

  1. When, under the totality of the circumstances, it would be reasonable for the party entering into a k w/ the corp., to conduct an investigation of the credit of the corp. prior to entering into the k, such party will be charged w/ the knowledge that a reasonable credit check would disclose. If such investigation would disclose the corp. is grossly undercapitalized , the party will be deemed to have assumed the risk of the gross undercapitalzation and will not be permitted to pierce the corp veil.

    1. 3rd prong is permissive (not mandatory)

    2. not well accepted in most jurisdictions


General Partner was a Corporation

Perpetual Real Estate (P) v. Michaelson Properties (Δ)

Facts: P argued that Δ should be held personally liable for a debt his corp. incurred during the course of 2 joint venture real estate partnerships. P didn’t get personal guarantees from Δ.

Rule: Where a sole SH exercises undue domination and control over the corp., the corp veil will be pierced if the sole SH also used the corporate form to obscure fraud or conceal crime. Unless a corp. misrepresents its financial condition to the creditor, the creditor should be bound by its decision to deal w/ the corp.

Purpose of incorporation is to limit liability in a joint venture.

Cheatle Test (P bears burden of convincing ct to disregard corp entity):

  1. establish that corp was alter ego of the individuals sought to be charged personally, and

  1. establish that Δ exercised undue domination and control over corp.

  2. consider factors as to whether Δ observed corp. formalities, kept corp, records, paid dividends, were there other officers and directors.

  1. establish that corp was a device/sham used to disguise wrongs, obscure fraud, or conceal crime.

Joint Venture: venture undertaken based on an express or implied agreement btw the members, common purpose and interest, and an equal power of control.



In re Silicone Gel breast Implants Products Liability Litigation (Bristol- Δ, MEC- P)

Facts: MEC became a wholly owned subsidiary of Bristol, and Bristol is sole SH of MEC, a breast implant supplier. Bristol allowed its name to appear on breast implant ads, packages, and product inserts to improve sales by giving product additional credibility.

Rule: Δ held itself out (consider agency, partnership, etc.) and cannot now avoid liability in defending against potential breast implant claims. Delaware cts do not necessarily require showing of fraud if a sub is found to be the mere instrumentality or alter ego of its sole sh. Also, most jurisdictions that require a showing of fraud, injustice, or inequity in a k case do not in a tort case.

K cases: the creditor has willingly transacted business w/ the sub, although it could’ve insisted on assurances that would make the parent also responsible.

Tort cases: the injured party had no choice; the limitations on corporate liability were, from its standpoint, fortuitous and non-consensual.


Exam: distinguish btw. individual who choses to deal w/ corp. v. one who didn’t (it’s possible to have a tort individual who “choses” to deal w/ a corp.)

- know the difference btw. voluntary v. involuntary creditor


Substantial Domination Factors:

  • parent & sub have common directors & officers

  • parent & sub have common business departments

  • parent & sub file consolidated financial statements (SEC) & tax returns

  • parent finances the sub

  • parent caused the incorp of the sub

  • sub operates w/ grossly inadequate capital

  • parent pays the salaries & other expenses of the sub

  • sub receives no business except that given to it by the parent

  • parent uses the sub’s property as its own

  • the daily operations of the 2 corps are not kept separate

  • sub doesn’t observe the basic corporate formalities, such as keeping separate books and records and holding sh and board mtgs.


Direct Suit

Fridgidaire (P) v. Union Properties (Δ)

Facts: P attempted to hold the limited partners of Commercial Investors generally liable after Commercial breached its k w/ Δ.

Rule: Limited partners do not incur general liability for the limited partnership’s obligations simply b/c they’re officers, directors, or shs of the corporate general partner. If the limited partners are agents acting wrongfully, then their principal is liable as a corp, which thereby shields them from personal liability.

Q: How do you set up a “no personal liability” situation?

A: Limited partnership btw. A & B, and then A sets up a separate corporation which is then general partner to the limited partnership. (Limited partnerships require a general partner.)

In corporation cases, we prefer form over substance.


Law on piercing corp. veil also applies to LLCs.


Shareholder Derivative Actions

Fill in Notes


Strike Suit: Intro to Procedural Hurdles

Cohen (P) v. Beneficial Industrial Loan Corp. (Δ)

Facts: P, a shareholder, brought a derivative action challenging the constitutionality of a state statute requiring an unsuccessful P to indemnify the corp. for its reasonable expenses in defending the action. P was required to post bond for the action.

Rule: Statute holding an unsuccessful P liable for the reasonable expenses of a corp. in defending a derivative action is constitutional.

A SH who brings suit on a cause of action derived from the corp. assumes a position of a fiduciary character. Such statutes are often nec. to prevent nuisance litigation which are sometimes brought due to their strong likelihood that it’ll settle.

Strike Suit: SH only sues to harass the corp.

Suit in Equity: suit by SH against corp. to compel corp. to take action against a general manager of fraud


Direct Suit

Eisenberg (P) v. Flying Tiger Line (Δ)

Facts: P filed class action suit against Δ to overturn a reorganization and merger that he alleged was intended to dilute his voting rights.

Rule: A cause of action that is determined to be personal, rather than derivative, cannot be dismissed b/c the P fails to post security for the corp.’s costs.

Test: Suits are derivative only if brought in the right of the corp. to procure a J “in its favor.”



Business Judgment Rule

Fill in Notes


Requirement of Demand on the Directors

Grimes (P) v. Donald (Δ) EXAM

Facts: P sought a declaration of the invalidity of certain agreements made btw. Δ –CEO & the BofDs, alleging excessive compensation & abdication (abandoning duties) of directorial duty by the BofDs.

Rule: If a SH demands that the BofDs take action and the demand is rejected, the board rejecting the demand is entitled to the presumption that the rejection was made in good faith unless the SH can allege sufficient facts to overcome the presumption.

Directors may not delegate duties which lie “at the heart of the management of the corp.”

Duties of BofDs:

    1. manage corp. business

    2. create policy

    3. appoint officers

    4. delegate discretion (may delegate discretion, but not waive it)

Direct Action Reqs:

SH must allege more than an injury resulting from a wrong to the corp. SH must state a claim for “an injury which is separate and distinct from that suffered by other SHs… or a wrong involving a contractual right of a SH… which exists independently of any right of the corp.”

        • When demand is made by a SH, the SH can’t claim “demand was excused” but can claim that the board’s “refusal was wrong.” (Spiegel v. Buntrock)

        • Demand is not excused simply b/c P chose to sue all directors. Likewise, a p can’t necessarily disqualify all directors simply by attacking a transaction in which all participated.

        • Derivative Ps are not entitled to discovery.

        • In demand-excused cases the BofDs may sometimes reassert its authority over a derivative claim in certain instances through the device of the Special Litigation Cmtee. (Zapata)


SH must 1st make demand on BofDs

          1. if demand would be futile, SH may ask for Demand Excusal

- P asserts board is incapable of rendering an independent decision

3 Basis for claiming Demand Excusal:

  1. self-interest of majority of BofDs

  2. board incapable of acting independently

  3. underlying transaction is not valid business J

          1. if demand is made, and refused, SH may then argue Wrongful Rejection/Refusal

- P concedes board is sufficiently independent to render a proper decision, but P contends that merits of decision are wrong (not that board was tainted)

- extremely difficult for P to trump presumption of Bus J Rule


Structural Bias: individuals on board who are wealthy, tight-knit social/economic friends; argument is that such members of BofDs are incapable of ascertaining whether fellow directors should be sued



Marx (P) v. Aker (Δ)

Facts: P brought derivative action against the corp. alleging that the BofDs violated their fiduciary duty by voting for unreasonably high compensation for company executives.

Rule: Demands on BofDs are futile if a complaint alleges w/ particularity that: 1) a majority of the directors are interested in the transation, 2) the directors failed to inform themselves to a degree reasonably nec. about the transaction, or 30 the directors failed to exercise their business J in approving the transaction.

* Self-dealing is a breach of the duty of loyalty.


Purposes of Demand Req:

  1. relieve cts from deciding matters of internal corporate governance by providing corporate directors w/ opportunities to correct alleged abuses

  2. provide corporate boards w/ reasonable protection from harassment by litigation on matters clearly w/in the discretion of directors, and

  3. discourage “strike suits” commenced by SHs for personal gain rather than for the benefit of the corp.


SH derivative actions infringe upon the managerial discretion of corporate boards.

Insert 7.40-7.46


Delaware Approach (Reasonable Doubt Standard)

  1. once director interest has been established, the bus J rule becomes inapplicable and the demand excused w/out further inquiry

  2. whether a board has validly exercised its bus J must be evaluated by determining whether the directors exercised procedural (informed decision) and substantive (terms of the transaction) due care.


Universal Demand (Michigan)

Bright-Line Rule requiring a demand in all cases, w/out exception, and allows start of a derivative proceeding w/in 90 days of the demand unless demand is rejected earlier. Exception is that Ps may file suit b/4 the expiration of 90 days, even if their demand has not been rejected, if the corp. would suffer irreparable injury as a result.


New York’s Approach to Demand Futility (broader than Delaware)

Demand is excused b/c of futility when a complaint alleges w/ particularity that:

  1. a majority of the directors are interested in the transaction, or

    1. may be either self-interest in the transaction, or

    2. a loss of independence b/c a director w/ no direct interest in a transaction is “controlled” by a self-interested director

  2. directors failed to inform themselves to a degree reasonably nec about the transaction, or

  3. the directors failed to exercise their business J in approving the transaction (challenged transaction was so egregious on its face that it couldn’t have been the product of sound bus j of the directors)


Special Cmtees

Auerbach (P) v. Bennett (Δ)

Facts: P challenged the decision by a board-appointed special litigation cmtee to terminate a SH’s derivative action.

Rule: A ct may properly inquire as to the adequacy and appropriateness of a special litigation cmtee’s investigative procedures, but may not consider factors under the domain of bus J.

Bus J Doctrine: grounded in the prudent recognition that cts are ill equipped to evaluate what are and must be essentially bus Js.

Application to Special Cmtees: Bus J rule only shields decisions taken by special litigation cmtees where decision can be shown to be disinterested and independent. Disinterestedness and independence of board is looked at from a financial standpoint.

The ct may inquire as to adequacy & appropriateness of the investigation cmtee procedures and may require the cmtee to show they have pursued the method of investigation in good faith. However, the ct may not exercise its own bus J if it’s satisfied w/ disinterestedness and independence of decision of cmtee.


Elements to Assert Bus J: D must prove following elements to assert Bus J

  1. good faith w/ respect to character

  2. reasonableness of investigation

  3. disinterest w/ respect to

  4. independence cmtee members


Bus J Rule only applies if there's been no showing of:

1. fraud

2. illegality

3. conflict of interest

4. gross negligence (duty of care)


Investigation cmtee is made up of BofD members, which makes you wonder whether cmtee is ever really disinterested.

Hutch: cts should engage in a more substantive review using their own bus J where there’s an allegation of breach of fiduciary duty.


Dismissing Special Cmtee

Zapata (Δ) v. Maldonado (P)

Facts: P sought to prevent the dismissal of his derivative action following the recommendation for dismissal by a corp-appointed investigation cmtee. Demand excused case.

Rule: When assessing a special litigation cmtee’s motion to dismiss a derivative action, a ct. must: 1) determine whether the cmtee acted independently, in good faith, and made a reasonable investigation; & 2) apply the ct’s own independent bus J.

Bus J Rule: presumption; judicial creation which isn’t relevant until a decision is rendered improper; doesn’t create authority

Sohland Case: when demand is futile SHs have right to initiate a suit, but not to control the litigation

Demand Excused: can infer that board is incapable of rendering an independent decision; just b/c all board members are being sued, doesn’t mean demand will be excused – must have a factual basis for such a claim


Zapata 2-Part Test

In Demand Excused cases in Delaware (burden on corp):

  1. Cts should inquire into:

    1. independence & good faith of cmtee, and

    2. the factual bases supporting its conclusion (limited discovery allowed)

      1. reasonableness, and

      2. thorough investigation

If ct is satisfied that reqs of 1st step have been met, it denies motion.

If ct determines there’s a genuine issue of material fact (Rule 56), ct may go to step 2.

  1. (Discretionary) Cts should apply its own Bus J as to whether motion should be granted.

Hutch: believes cts are incompetent to apply their own bus J.


McKee Rule (emphasizes demand req.)

  1. board members will not be able to dismiss a derivative suit when it would be a breach of their fiduciary duty

  2. board decision to dimiss derivative suit will be respected unless it was wrongful (in demand required cases)

  3. SH may sue, w/out prior demand, when demand would be futile


Dual Misalignment of Interest (involves agency)

  1. directors aiming to maximize personal interests (Dirctors v. SHs)

  2. atty who’s out to maximize his own $, not SH’s (Attorneys v. SHs)



Iowa – tainted directors can’t participate in the appointment of special litigation cmtee members (Miller)

Michigan – if all directors are named, corp can ask ct to appoint members to special cmtee.

Alfred v. Shaw

Rule: NC believes 2nd step of Zapata test should be mandatory due to the strong chance of structural bias.



A.P. Smith (P) v. Barlow (Δ)

Facts: Δ –SHs challenged authority of P-corp to make donation to Princeton University.

Rule: State legislation adopted in the public interest can be constitutionally applied to preexisting corps under the reserved power. Where justified by the advancement of the public interest, public policy supporting statutes override existing SH's rights

Zabriskie Doctrine (NJ): Although the reserved power permits alterations in the public interest of the K btw. the state and the corp, it has no effect on the contractual rights btw the corp and its SHs and btw SHs inter se. Later NJ cases have allowed for an exception (above).

Intra vires: actions w/n the powers of corp



Dodge v. Ford Motor Co

Facts: P-SHs filed suit against D after D decided not to pay any more special dividends and to instead reinvest the $ in the business.

Rule: A corp's primary purpose is to provide profits for its SHs. Cts of equity will not interefere in the management of the directors unless it's clear that they're guilty of fraud or misappropriation of funds, or refuse to declare a dividend when corp has a surplus of net profits it can distribute to SHs, and when a refusal to do so would amt to such abuse of discretion as would constitute fraud, or breach of good faith to SHs.

This case is a rare exception to the judicial deference usu given by cts to the bus J of BofDs.

A bus corp is organized and carried on primarily for the profit of the SHs.

Note: If it's a closely held co, cts are more likely to interfere in order to protect minority SHs.

Rule of Corporate Choice of Law: the law of the state of incorporation controls on issues relaing to a corp's "internal affaris," which includes responsibilities of directors to SHs.



Shlensky v. Wrigley

Hutch: wrongly decided

Facts: D-majority SH of Chicago Cubs, refused to install lights at Wrigley Field in order to hold night games, and P-minority SH, filed a derivative suit to compel installation.

Rule: A SH's derivative suit can only be based on conduct by the directors which borders on fraud, illegality, or conflict of interest.

Hutch: should've argued structural bias, gross negligence as a breach of duty of care, breach of duty of loyalty, tainted board and conflict of interest.



Duty of Care & Corporate Control

BJR - Special Litigation Cmtee - investigation

Kamin (P) v. American Express

Facts: P brought a SH's derivative suit claiming D had engaged in waste of corp assets by declaring a certain dividend (payout) in kind.

Rule: Whether or not a dividend is to be declared or a distribution made is exclusively a matter of bus J for he BofDs, and the cts will not interfere as long as the decision is made in good faith. Allegations of imprudence, mistaken or errors of J are not sufficient for interference.

Cts will only interfere if conduct was:

  1. fraudulent (collusive, nonfeasance, and destructive to rights of SHs)

  2. oppressive

  3. arbitrary

  4. breach of trust

  5. illegal or unconscientiously executed, or

  6. done in bad faith and for a dishonest purpose (self-interest)


Payout Order

  1. cumulative SHs

  2. preferred SHs

  3. common SHs


BJR - Special Litigation Cmtee - no investigation

Joy (P) v. North

Facts: P-SHs filed derivative action alleging that Ds (directors, senior officers/outsiders, and CEO) violated their duty of care in making a series of loans to a real estate development co. Ct. rejected recommendation of special litigation cmtee.

Rule: In evaluating a recommendation by a special litigation cmtee for dismissal of a derivative action, a ct must use its own independent bus J as to the corp's best interests.

(Zapata & Alfred v. Shaw applied)

* BJR extends only as far as the reasons which justify its existence. It doesn't apply in cases in which the corp decisions lacks a bus purpose, is tainted by a conflict of interest, is so egregious as to amt to a no-win decisions, or results from an obvious and prolonged failure to exercise oversight and supervision.

* MI adopts deferential standard of review - Bus J examined by looking at good faith, independence, and thoroughness/reasonableness.

* Bus J rule does not apply if there's a conflict of interest.

* Failure to investigate may give rise to breach of fiduciary duty.

* Directors who willingly allow others to make major decisions affecting the future of the corp w/out supervision or oversight may not defend on their lack of knowledge, for that in itself is a breach of fiduciary duty.


Reasons to Uphold BJR

  1. SHs voluntarily undertake the risk of bad bus J

  2. after the fact litigation is an imperfect device to evaluate corp bus decisions since they often involve quick decisions inevitable based on less than perfect info.

  3. b/c potential profit often corresponds to the potential risk, it's in the interest of SHs that the law not create incentives for overly cautious corporate decisions; SHs can reduce risk by diversifying their holdings


Demand-required: In demand required cases, cts apply the BJR to the directors' decision to refuse demand to bring an action, and their decision will be conclusive unless bad faith is proven.

Demand-excused: In demand excused cases, the cts will mot apply the BJR when a special litigation cmtee recommends dismissal of a suit (as in this case).


Liability to Creditors

Francis v. United Jersey Bank

Hutch has problem w/ stretch of making her owe a duty

Facts: D ignored her duties as a director, allowing her sons to w/draw over $12 million from client trust accounts. B/c of nature of bus (reinsurance), D owed a duty of care to 3rd party clients.

Rule: Liability of a corp's directors to its clients require duty, breach, proximate cause, and damages. Directors of financial institutions are held to a higher standard of care. Generally, directors must be familiar w/ fundamental of the bus. Lack of knowledge is not a defense to duty of care. Ct applies substitution theory arguing that D was a trustee owing a duty to her SHs.

Ordinarily, directors don't owe a duty of care corp is insolvent. Duty arises after insolvency.

Reinsurance: process by which an insurance co that has agreed to insure a risk assigns all/part of that risk to another co, along w/ share of premium; spreads the risk.



Smith (P) v. Van Gorkom EXAM

Facts: D-BofDs voted to approve a merger agreement based solely on the representations of D-Van Gorkom, one of its directors. Ct held that BofDs didn't reach an informed bus J.

Rule: The BJR shield directors/officers of a corp from liability only if, in reaching a bus decision, the directors/officers acted on an informed basis, availing themselves of all material info reasonably available. Subsequent SH ratification does not relieve the director from this duty, unless their approval is also based on an informed decision.

EXAM RULE: The rule itself "is a presumption that in making a bus decision, the directors of a corp acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. (Aronson v. Lewis)

Burden: party attacking board's decision must rebut presumption that its bus J was an informed 1

Test for whether bus J is an informed one: Whether the directors have informed themselves prior to making a bus decision, of all material info reasonably available to them.

W/out presumptions of BJR, D must prove entire fairness.

Delaware Law: per se rule of awarding damages for breach of fiduciary duty of disclosure.

Factors to consider in determining entire fairness of transaction: timing, initiation, negotiation, and structure of transaction, the disclosure to and approval but directors, and SHs.

* Standard: Gross Negligence

Test for whether SHs were fully informed such that their vote can be said to ratify director action: turns on fairness and completeness of the proxy materials given to SHs.

BJR provides no protection for directors who made an unintelligent or unadvised J.

* Inference of conflict of interest means a potential breach of duty of loyalty (Singer). Demand will likely be excused in the event of conflict of interest.

* Duty of care analysis is based on an appropriate process.

Failure of BofDs to reach an informed bus J in approving the merger constitutes a voidable act.


Q: Can a fully informed SH's decision to approve a proposal override directors' breach of fiduciary duty?

A: Yes, and claims will be prevented. For exam, argue that in merger situations, directors can't leave to SHs alone the decision to approve/disapprove an agreement.



In re Caremark Int'l Derivative Litigation

Facts: Derivative suit for breach of duty of care of directors in connection w/ employee violations of fed. & state laws resulting in indictments against Caremark. Caremark required to pay $250 million. Ct found directors were blamelessly unaware of the conduct leading to the corp liability.

Rule: The BJR is process oriented and informed by a deep respect for all good faith board decisions. Under BJR, directors are protected from liability if their "decision was the product of a process that was either deliberately considered in good faith or was otherwise rational," even if a judge/jury were to conclude that the decision itself was "stupid, egregious, or irrational." BofDs do not have to ensure that there are NO violations of the law (board may consider cost/benefit analysis) and board's ultimate decision doesn't have to be substantively right.

* Absent grounds to suspect deception, neither corporate boards nor senior officers can be charged w/ wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company's b1/2. (Rule based on narrow construction of Graham case).

Board must satisfy supervisory and monitoring role, and director's obligation incl duty to attempt in good faith to assure that a corp info and reporting system exists, and failure to so may render director liable.


Hutch: agency cost - BofDs acts as principal to SHs, who are agents; BofDs as a fiduciary duty to monitor conduct of employees on b1/2 of SHs; derivative action would be brought to align interests of directors and SHs


Standard of review: fairness & reasonableness, good faith & rationality

  1. BJR applies to negligence, ill advised, and ill conceived substantive decisions (these cannot alone be the basis for an action)

  2. process , good faith, & rationality is the test used for director's unconsidered action


Duty of Care: involves rational process, staying informed, and monitoring corp activities


Elements for Breach of Duty of Care:

  1. director's knew, or

  2. should've known that violations of law were occurring, and

  3. directors took no steps in a good faith effort to prevent or remedy situation, and

  4. such failure proximately resulted in the losses complained of.


Test of liability (high standard)

lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight (heart of good faith is to keep well informed).


Duty of Loyalty


Bayer v. Beran

Facts: D-directors were charged w/ negligence and self-interest in commencing a radio advertising program featuring the president's wife as singer. Ct. found no breach of fiduciary duty on part of directors and no evid of personal gain.

Rule: Policies of bus management are left solely to the directors and may not be Qed absent a showing of fraud, improper motive, or self-interest. BJR yields when there's self-interest.

BJR did not apply in this case b/c there was an allegation of conflict of interest (structural bias).


FAIRNESS TEST: Transactions that may produce conflict btw self-interest and fiduciary obligations are subject to rigorous scrutiny and voided if there's a showing of oppression, unfairness, undue advantage, or improvidence. Burden shifts to directors to demonstrate good faith and inherent fairness to corp.


  1. Was transaction fair?

  2. Were BofDs using good faith?

  3. Was the process proper?


General rule: Directors not acting collectively as a board cannot bind corp. However, liability may not be imposed on directors b/c they failed to pass a resolution at a board mtg.


*If there's an interested director, apply good faith & fairness test.

*If there's no conflict of interest, apply BJR.


Parent-Subsidiary: Duty of Loyalty

Lewis (P) v. SLE

Facts: P-SH claimed that its directors had committed waste by grossly undercharging a tenant/subsidiary.

Rule: Where the directors of a corp are engaged in a transaction w/ 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.

When directors have a personal interest in the transaction, the merits of the transaction are open for review, and directors now have burden to prove transactions were fair & reasonable (BJR wouldn't apply).

Today: apply special rules of scrutiny and common law rule (transaction is voidable unless there's a showing of fairness and reasonableness)

Consider Van Dorn (piercing corp veil).


General Rule: If a disinterested majority of directors had ratified a K and if the complaining party could not prove it unfair, the cots generally hold the K valid. Bayer takes the rule further: b/c the K is fair, it's valid even though disinterested directors haven't formally ratified it.


Corporate Opportunity

Energy Resources (P) v. Porter

Facts: D seized a corp opportunity of his employer-P by snatching it for his personal gain.

Rule: If an officer/director of a corp invokes refusal to deal as a defense to a charge that he seized a corp opportunity, he must first disclose the refusal to the corp along w/ a statement of reasons for the refusal.

If it's determined that an officer/director seized a corp opportunity for his personal gain, he must relinquish the opportunity to the corp, and reimburse it for any damages incurred or profits gained.

? Singer, General Automotive, Bancroft Whitney cases.

Corporate Opportunity: an opportunity that a fiduciary to a corp has to take advantage of info acquired by virtue of his position for his benefit

Financial Capacity Defense: person who used the opportunity argues that corp lacked the $ to exploit the opp. Cts reject argument unless the executive explicitly offered the opp. to the corp.


Dominant SHs - Intrinsic Fairness Test

Sinclair Oil v. Levien (P)

Facts: D contended that although it controlled its subsidiary Sinven & owed it a fiduciary duty, its business transactions w/ Sinven should be governed by the BJR, & not the intrinsic fairness test.

Rule: The intrinsic fairness test should not be applied to business transactions where a fiduciary duty exists but is unaccompanied by self-dealing, ie. where the parent co receives a benefit to the detriment or exclusion of the subsidiary (minority SHs).

To invoke Intrinsic Fairness, P must show:

  1. existence of a fiduciary duty, and

  2. self-dealing by D (will rarely pass muster)


Intrinsic Fairness Test - 2 Elements

  1. standard is high degree of fairness, and

  2. burden shifting - a shift in the burden of proof to D (dominant SH) to show that transaction was objectively fair (subject to strict judicial scrutiny)


Self-dealing: transaction in which a fiduciary uses property of another, held by virtue of the confidential rltnshp (or in the case of parent, by virtue of its domination), for personal gain (to detriment of minority SHs)



Fliegler (P) v. Lawrence

Facts: P-SH brought suit against officers and directors claiming they wrongfully seized a corp opportunity belonging to the corp and profited thereby.

Rule: Ratification of an interested transaction by a majority of independent, fully informed SHs shift the burden of proof to P-the objecting SH to demonstrate that the terms of the transaction are so unequal as to amt to a gift or a waste of corp assets.

General Rule: In SH derivative suits involving interested director/officer transactions, the burden of proof is on D-director/officer to prove the transaction was intrinsically fair. (Gottlieb v. Hayden) When approval is granted by a majority of independent & disinterested, fully informed SHs, a new set of rules apply and burden shifts to P.


Disclosure and Fairness

Koch v. Hankins

Facts: P-investors in general partnerships believed they were purchasing part of a 2,700 acre jojoba plantation, not that they were purchasing separate 80 acre farms each. Ct had to determine whether investments constituted securities w/in meaning of the SEA.

Rule: In determining whether an investment constitutes an “investment k” the court must determine whether the investors had an expectation of profits that would be produced primarily through the efforts of others.

To determine whether devices are investment ks, cts must examine the economic realities of transactions.

Howey 3-part Definition of Investment K: a k, transaction, or scheme whereby a person

  1. invests his $ in

  2. a common enterprise and is led to

  3. expect profits solely (broadly interpreted) form the efforts of the promoter or a 3rd party

Control Element (3rd part): whether the efforts made by those other than investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.

Williamson v. Tucker: a general partnership or joint venture interest could be deemed a security if the investor could establish (factors aren’t exclusive):

  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 bus to render him incapable of intelligently exercising his powers, or

  3. the partner is dependent on some unique ability of the promoter.

*critical factor is whether investor retains control over his investment or relied on efforts of others

Cts look to: partnership agreement, docs structuring investment, promo material, oral representations by promoters, practicality of investors exercising powers granted by prtnrshp agreement.

Purpose of asking whether investors were general partners is: 1) to determine personal liability (under §15 of UPA), 2) security or not, generally non-active general or operating general partners can still be held liable, but we ask Q b/c the degree of investor participation may be important in determining whether this was a security.

Generally, limited partnership interests will be a security b/c they often rely on others.


Registration Process

Failure to comply w/ §5 of Act could be a cause of action for recission.

§5 imposes 3 basic rules:

  1. a security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed w/ SEC

  2. securities may not be sold until the registration statement has become effective, and

  3. the prospectus (a disclosure document) must be delivered to the purchaser b/4 a sale


Private Offering

Doran v. Petroleum Management Corp.

Facts: A limited partnership in an oil drilling venture was offered, in and informal manner, to a handful of sophisticated investors, incl. P, and the venture subsequently faired poorly.

Rule: Even where an offering of securities 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 reqs of the 1933 Act absent proof that each offeree had been furnished, or had access to, such info about the issuer that a registration statement would have disclosed.

Summary: Private offering exemption is conditioned on either actual disclosure of the info registration would provide, or the offerees effective access to such info. If investors do not possess such info, they cannot bring their sophisticated knowledge of bus affairs to bear in deciding whether to invest. Thus, the rlthnshp btw the investors and the company, and the access to the kind of info that registration would disclose, are highly relevant factors.


- D has burden of proving affirmative defense: that the offering of securities was not a public offering, but a private one

Factors to determine whether a security is a private offering (not defined by Act), and therefore qualifies for §4(2) exemption:

  1. the # of offerees and their rltnshp to each other and the issuer (most important factor),

  2. the # of units offered,

  3. the size of the offering, and

  4. the manner of the offering

§4(2) Exemption Q turns on knowledge of the offerees (1st of the 4 factors)

- sophistication of investor alone doesn’t bring the offering w/in the private placement exemption; sophistication is not a substitute for access to info that registration would disclose; there must be sufficient basis of accurate info upon which the sophisticated investor may exercise his skills

- private offering exemption applies only to the initial sale, and not to a resale of same security

- accredited investors are presumed to be sophisticated, ex. banks, brokers, other financial institutions, and wealthy buyers


See pg. 405-409

EXAM: §11, §10(b), Rule 10b-5, §16(b)

3 ways to commit a 10b-5 violation




Result of violation could be:

  1. civil penalty (SEC)

  2. criminal action

  3. private action


Due Diligence Process – Investigate

Escott v. BarChris Construction Corp.

Facts: P & other purchasers of debentures sued D for material false statements & material omissions on the registration statement of debentures. Involved construction of bowling alleys.

Rule: Due diligence is a defense under §11 of the 1933 Act when the D believes after a reasonable investigation, and there are reasonable grounds to believe, that alleged misstatements are correct and that there are no material omissions.


  1. Did registration statement contain false statements of fact, or did it omit to state facts and become misleading?

  2. If so, were the facts which were falsely stated or omitted “material” w/in meaning of Act?

    1. Material means info which an average prudent investor ought reasonably to be informed b/4 purchasing the security registered

    2. Test: important info would be facts bearing upon the nature or condition of the issuing corp

  3. If so, have Ds established their affirmative defenses?

    1. D would assert due diligence defense after a reasonable investigation

      1. §11(c) defines reasonable investigation as that required of a prudent man in the management of his property/business

    2. §11 defenses are not available to issuer, so once P makes prima facie case, issuer is strictly liable

      1. P need not show reliance, causation, or anything about D’s state of mind as elements of prima facie case

    3. D has burden of proving that its misconduct didn’t cause P’s damages


In bankruptcy, order of pay-offs are:

  1. bond

  2. unsubordinated debenture

  3. convertible subordinated debenture

  4. preferred stock

  5. common stock



Rule 10b-5

Basic v. Levinson (P)

Facts: P alleged that D’s repeated denials regarding its participation in merger discussions and negotiations were material misrepresentations as to which D SHs should be entitled to a presumption of reliance for purposes of class certification.

Rule: 1) Whether a co statement is material, in the context of merger discussions, requires a case-by-case analysis of the probability that the transaction will be consummated and the significance of the transaction to the issuer of the securities. 2) An investor’s reliance on material, public misrepresentations may be presumed under a fraud-on-the-marked theory for purposes of a Rule 10b-5 action.

General Rule:

  1. If it’s an affirmative misstatement, P must prove reliance.

  2. If P argues fraud-on-the-market theory, a rebuttable presumption (that there was reliance on material misrepresentations) is created and P need not prove reliance. (same rationale is used w/ omitted facts)

  3. If there was a breach of the duty to disclose material info (omitted facts), P need not prove reliance.


TSC Industries (6th circuit) Standard of Materiality (on EXAM, state both rules)

  1. an omitted fact is material if there’s a substantial likelihood that a reasonable SH would consider it important in deciding how to vote as far as purchasing or selling a security

  2. *to fulfill materiality req, there must be a substantial likelihood that the disclosure of the omitted fact would’ve been viewed by the reasonable investor as having significantly altered the ‘total mix’ of info made available


Materiality depends on the significance a reasonable investor would place on the w/held or misrepresented info.

Publicly available info is reflected in stock market price, therefore there may be some reliance.


Private causes of action exist for a violation of §10(b) and Rule 10b-5.

Reqs for a violation:

  1. instrumentality of interstate commerce

  2. manipulative or deceptive

  3. in connection w/ the purchase or sale

  4. duty to disclose

  5. scienter/knowledge

  6. confidentiality

(damages are not explicitly required although ct likely to dismiss case w/out them)


Materially False Statement

Pommer v. Medtest Corp.

Facts: P claimed he was induced to purchase stock in D-corp as a result of materially false statements made to him by D’s agents.

Rule: A statement is material when there’s a substantial likelihood that the disclosure of the omitted fact would’ve been viewed by the reasonable investor as having significantly altered the ‘total mix’ of info made available.

Even savvy investors may recover damages when a bald lie understates the gravity of a known risk.


Need to distinguish 3rd party action v. derivative action.

**Insert pg. 445 Note


Manipulation & Deception

Santa Fe Industries v. Green (P)

Facts: D merged w/ Kirby Lumber for the sole purpose of eliminating minority SHs.

Rule: B/4 a claim of fraud or breach of fiduciary duty may be maintained under 10(b) or Rule 10b-5, there must 1st be a showing of manipulation or deception.

* There’s no private right of action for §10(b) violations.













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