Presentation is loading. Please wait.

Presentation is loading. Please wait.

PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 14 REVIEW Business Organizations 2010-2011 Lectures.

Similar presentations


Presentation on theme: "PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 14 REVIEW Business Organizations 2010-2011 Lectures."— Presentation transcript:

1 PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 14 REVIEW Business Organizations Lectures

2 What are we talking about? Two Umbrella Types of Entities:  Limited personal liability for owners  Limited partnership  Limited Liability Company  Corporation  No protection from personal liability:  General partnership  Sole proprietorship Review lecture Corps Prof. McCann

3 Some Basic Terms Partnership  Two or more persons (and by “person” we also mean other entities)  Share power  Share profits  Share losses  Partnership reports its profits and losses to the partners who each take their percentage on their own tax return (pass through)  Partnership itself is not taxed  Each partner personally liable  Dissolves on death of partner or other  No formal registration required with State Review lecture Corps Prof. McCann

4 Corporation One or more owners No personal liability (assuming formalities met) Registered with Secretary of State Managed by its Board of Directors who are elected by the owners Board names officers who run day-to-day operations Separate existence from its owners (perpetual life)  Pays taxes  Distributes profits via dividends to owners Review lecture Corps Prof. McCann

5 ENTITY V AGGREGATE, ETC PARTNERSHIP

6 Aggregation vs Entity Theories Commonlaw (Aggregation)  Partners held undivided but separate interests in property  Partnership was not an entity distinct from its partners  Withdrawing partner entitled to piece of each asset as is her estate  Unanimous consent to admit new partner  Partnership meant one exact constellation of partners. Any change resulted in dissolution. Review lecture Corps Prof. McCann

7 Aggregation or Entity Theories Review lecture Corps Prof. McCann Under Uniform Partnership Act, 1997  Partnership is an entity distinct from the partners  Withdrawing partner has no interest in partnership assets but only right to receive pro rata share of the value of assets  Entity may continue on despite withdrawal or death of partner

8 Under Entity Theory Review lecture Corps Prof. McCann CAL. CORP. CODE § : California Code - Section The only transferable interest of a partner in the partnership is the partner's share of the profits and losses of the partnership and the partner's right to receive distributions. The interest is personal property.

9 Under UPA, Modern P/S a Hybrid Still an aggregation of partners in sense that:  Each partner individually (jointly and severally) liable for debts  Pass through entity, invisible to taxing authorities – each partner pays on her own income from the partnership Review lecture Corps Prof. McCann

10 Formation Review lecture Corps Prof. McCann CAL. CORP. CODE § : (a)Except as otherwise provided in subdivision (b), the association of two or more persons to carry on as coowners a business for profit forms a partnership, whether or not the persons intend to form a partnership. (Emphasis added.) * * *

11 Establishing a Partnership Review lecture Corps Prof. McCann Majority: Intent is key, as evidenced by conduct and circumstances. Minority: Requires finding all of the following:  1. A community of interest in the venture  2. An agreement to share profits  3. An agreement to share losses  4. A mutual right of control or management

12 RECAP OF PARTNER LIABILITY Restatement of Agency  A Principal is liable for torts of employee if they are committed within the course and scope of employment  “Course and scope” requires that there be some intent in the mind of the agent to serve the purposes of the principal Uniform Partnership Act  Partnership is liable if partner is carrying on in the usual way the business of the partnership and has actual or apparent authority  NO REQUIREMENT that the partner is motivated to benefit the partnership Review lecture Corps Prof. McCann

13 “The Usual Way” Review lecture Corps Prof. McCann American Rule: partner must be acting consistently with the way that particular partnership operates. English Rule: partner must be acting as do others in that type of business, whether or not usual for that particular partnership. UPA follows English Rule interpretation

14 Review lecture Corps Prof. McCann California Corporations Code Section [Excerpt]  The fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth [below]  A partner's duty of loyalty to the partnership and the other partners includes all of the following: ***(3) To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.  A partner shall discharge the duties to the partnership and the other partners under this chapter or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing.  A partner does not violate a duty or obligation under this chapter or under the partnership agreement merely because the partner' s conduct furthers the partner's own interest

15 The End Game of a Partnership Review lecture Corps Prof. McCann Dissolution (or Dissociation)  An event triggers the end of the partnership Winding Up  The affairs of the partnership are concluded  Assets liquidated or earmarked for distribution  Taxes paid  Creditors paid  Partners are paid Termination  All affairs are wound up

16 Dissociating Partner Review lecture Corps Prof. McCann Within Rights Under Agreement  Share as per agreement or per UPA  Price if all assets sold as of date of dissociation at greater of liquidation value or going concern value, with interest In Violation of Agreement or Wrongful  Same less  Value of Goodwill (discretionary)  Offsets for damage caused by wrongful dissociation  Any other amounts owed by departing partner

17 LIMITED PARTNERSHIPS Review lecture Corps Prof. McCann Form allows limited liability to limited partners provided they do not manage 1976 ULPA provided “safe harbor” if acts of limited confined to such things as:  Consulting with general partner re partnership affairs  Requesting or attending meeting of partners  Voting on matter relating to business affairs if subject of vote is one allowing approval or disapproval of limiteds  Serving as agent or employee of LP

18 LIMITED LIABILITY COMPANIES LLC

19 Review lecture Corps Prof. McCann California Corporations Code Section The fiduciary duties a manager owes to the limited liability company and to its members are those of a partner to a partnership and to the partners of the partnership.

20 California Corporations Code Section Review lecture Corps Prof. McCann (z) "Membership interest" means a member's rights in the limited liability company, collectively, including the member's economic interest, any right to vote or participate in management, and any right to information concerning the business and affairs of the limited liability company provided by this title.

21 California Corporations Code Section Review lecture Corps Prof. McCann (n) "Economic interest" means a person's right to share in the income, gains, losses, deductions, credit, or similar items of, and to receive distributions from, the limited liability company, but does not include any other rights of a member, including, without limitation, the right to vote or to participate in management, or, except as provided in Section 17106, any right to information concerning the business and affairs of the limited liability company.

22 LLC Re-Cap Creature of Contract Variation between states as to what the operating agreement can do with respect to:  Eliminating fiduciary duties, namely  Duty of Care  Duty of Loyalty California, for example,  Cannot entirely eliminate duty of loyalty in operating agreement  But can specify certain acts which will not constitute breach if not “manifestly unreasonable.” Review lecture Corps Prof. McCann

23 Duty of Loyalty Duty to account for property or profit or benefit derived by the member from LLC property. Duty not to appropriate an LLC opportunity Duty to avoid conflicts of interest Duty to refrain from competing Acts in violation require consent of the members. Review lecture Corps Prof. McCann

24 Duty of Care Duty to refrain from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. Agreement cannot unreasonably reduce this duty of care. Review lecture Corps Prof. McCann

25 THE REST OF THE STORY CORPORATIONS

26 Promoters and Pre-incorporation Liability Review lecture Corps Prof. McCann Liability that of promoters until corporation adopts pre-incorporation agreements and other party agrees to novation, replacing promoter with corporation Contract language indicating promoter not to be personally liable may exonerate promoter

27 Overview of Corporate Structure Shareholders PresidentSecretaryTreasurer Directors Review lecture Corps Prof. McCann

28 Incorporation Process Review Review lecture Corps Prof. McCann

29 Incorporation Process Review Review lecture Corps Prof. McCann Articles filed By laws prepared First meeting held of shareholders  Elect Directors  Make subchapter S election Directors meeting  Adopt pre-existing agreements  Appoint officers  Authorize issuance of stock  Authorize banking relationships

30 The Debt-Equity Relationship Review lecture Corps Prof. McCann Control (Equity) Liquidity (Debt)

31 Why Capitalize with Debt? Review lecture Corps Prof. McCann You can keep (i.e., leverage) the cash you have. You retain ownership (control) of the business Interest payments are tax-deductible Generally easier to sell debt because you don’t have to convince someone that the company will grow, only have to convince them that they’ll get paid back (and they get paid first).  Lender is first in line to get paid if must liquidate assets  Have a good return on investment (ROI)

32 Advantages of Selling Equity Review lecture Corps Prof. McCann Motivate buyer to pull for the success of the company Doesn’t use precious cash No obligation to re-pay Can “print” more when needed

33 Disadvantages of Selling Equity Review lecture Corps Prof. McCann Usually requires giving up at least some control Allows “camel’s nose under the tent” Dividends are not deductible from corporate tax

34 Status of Shares Review lecture Corps Prof. McCann Validly Issued  Board has authorized and Dept of Corporations has issued authorization Fully Paid  All consideration has been received Non-assessable  The holder of the shares has no obligation to honor any assessments against the shares

35 Common Stock Review lecture Corps Prof. McCann Required to be issued Usually carries voting power May or may not have “par” value First in line in terms of control, last in line in terms of getting paid on liquidation

36 Preferred Stock Review lecture Corps Prof. McCann Preference given as to  Dividends  Liquidation of the company’s assets  May also allow certain rights if the dividends are not paid (such as electing a number of directors)

37 Capital Contribution Issues Review lecture Corps Prof. McCann Watered Stock  Shareholder liable to creditors to extent stock has not been paid for  Measured by difference between share’s value and what was (was not) paid  Comes up where:  Did not pay par for the stock or  Value of the consideration given was overstated

38 THE PLAYERS, REVISITED Review lecture Corps Prof. McCann SHAREHOLDERS  Elect directors  Usually must ratify certain acts of directors  Resolution to dissolve  Resolution to merge with another entity  Resolution to sell principal assets  Resolution to change corporate purpose  Resolution to amend by-laws or charter

39 VOTING Review lecture Corps Prof. McCann Statutory (or Regular) Voting  One vote per share, each directorship voted on independently  i.e., Jim has 500 shares, there are 3 directorships up for election. Jim can vote his 500 shares for each of the 3, but cannot accumulate his “1500” votes and put all on one directorship. Cumulative Voting  One vote per share multiplied by the number of directorships up for election. Total number of votes can be allocated as shareholder wishes  i.e., Jim can cast all 1500 votes for one director.

40 “Closely Held” vs Statutory Close Corporation Review lecture Corps Prof. McCann Any corporation can be held by a small number of shareholders. One shareholder is not uncommon. A “closely held” corporation is a term with no particular legal significance other than to mean:  Few shareholders  Most of whom participate in management  No general market for the stock (because of limitations on control and liquidity) and  Some limitations on transfer of the stock Courts now widely allow shareholders to control management via controlling director’s powers.

41 Statutory Close Corporation Review lecture Corps Prof. McCann Specifically so-identified in Articles Limited as to number of shareholders possible, usually 30 or 35. Stock certificates must bear “legend” detailing that there are restrictions on transfer Prohibited from making a public offering If adhere to rules, statutes allow exemption from claims regarding improper limits on directors’ powers Delaware allows shareholders to manage directly without a board of directors.

42 Pricing the Shares Review lecture Corps Prof. McCann Three usual approaches:  Book Value  What do the accounts show the shares are worth if you divide the number of outstanding shares into the number you get when you subtract the liabilities from the assets?  Liquidation Value  What would you get if you closed the doors, sold all the assets, paid all the debts, and divided the money up?  Cash Flow or Earnings  What would an investor be willing to pay today to own a company that generates the profits your company generates?

43 Recording the Corporate History Review lecture Corps Prof. McCann All States Require Minutes be Maintained Calif Corps Code 314  The original or a copy in writing or in any other form capable of being converted into clearly legible tangible form of the bylaws or of the minutes of any incorporators', shareholders', directors', committee or other meeting or of any resolution adopted by the board or a committee thereof, or shareholders, certified to be a true copy by a person purporting to be the secretary or an assistant secretary of the corporation, is prima facie evidence of the adoption of such bylaws or resolution or of the due holding of such meeting and of the matters stated therein.

44 By Laws Review lecture Corps Prof. McCann Must conform to the Articles Must conform to the law  e.g., by-law prohibiting any transfer of interest would be unenforceable

45 California Corps Code 204 Review lecture Corps Prof. McCann The articles of incorporation may set forth: (a) Any or all of the following provisions, which shall not be effective unless expressly provided in the articles: * * * (5) A provision requiring, for any or all corporate actions … the vote of a larger proportion or of all of the shares of any class or series, or the vote or quorum for taking action of a larger proportion or of all of the directors, than is otherwise required by this division.

46 Calif. Corporations Code Section 603(d) Review lecture Corps Prof. McCann (d) Notwithstanding subdivision (a), directors may not be elected by written consent except by unanimous written consent of all shares entitled to vote for the election of directors; provided that the shareholders may elect a director to fill a vacancy, other than a vacancy created by removal, by the written consent of a majority of the outstanding shares entitled to vote.

47 Postscript on Consents Review lecture Corps Prof. McCann Model Act now allows electronic or other consents without unanimity and without notice to all shareholders if:  Articles of Incorporation provide for passage by majority vote, and  The action is approved by consents signed, even electronically, by a majority of eligible voters By default, Directors are to be elected by “plurality” (rather than cumulative vote or majority vote)  True both under Model Act and Delaware law  BUT, bylaws may provide for majority or other constraint

48 Pillsbury v Honeywell Review lecture Corps Prof. McCann Shareholders Rights  Right to review corporate records is not unlimited  Must be for “a proper purpose germane to his interest as a stockholder” Del. Code, Title 8, § 220.  “Proper purpose” means a concern relating to “investment return”  BUT investment return can include shareholder motivated by desire to take control of the corporation

49 Who Has the Power to Act for Shareholder? Review lecture Corps Prof. McCann Shareholder “of record” Proxy Assignee (Pledgee) if assignment or pledge so allows

50 The Powers and Duties of the Board Review lecture Corps Prof. McCann It is a Board, not a gathering of Generals  No director has any power acting alone  Their only power derives from decisions they make acting as a Board and which are recorded in the minutes of the corporation  Power of directors is “original and undelegated.” Their powers are not granted by others but originate with their election to the Board.  Directors’ power comes from the state, if anywhere.  The relation of directors to shareholders is that of trustee to beneficiaries.

51 The Powers and Duties of the Board Review lecture Corps Prof. McCann May Delegate Some of Its Duties  Where large board, usual to allow for subcommittees to operate with relative autonomy  “Executive Committee” is common device, organized to handle decisions or required resolutions (such as approval of significant contract) when full board cannot be readily convened. In Public Corporations, Usually See “Inside” and “Outside” Directors  Inside: are also officers of corporation  Outside: are recruited from other corporations, public service, etc.

52 The Powers and Duties of the Board Review lecture Corps Prof. McCann Key Functions:  Provide advice and counsel  Instill discipline in the decision-making of the corporation  Oversee crises  Monitor the conduct of Management

53 REMOVAL OF DIRECTORS Review lecture Corps Prof. McCann Tension between treatment of shareholders who are also directors  They want security against removal And treatment of directors who are not shareholders  Shareholders do not want to have any impediment to voting such directors out. RULE: Under Model Act statutes, cannot deny shareholders right to remove with or without cause.  May require supermajority to remove shareholder-director without cause, however.

54 Tools for Dealing with Deadlock or Misconduct Review lecture Corps Prof. McCann Judicial Dissolution Buyout of dissenting shareholder Appointment of custodial director or manager Arbitration provision in bylaws or other contract

55 VOTING TRUSTS Review lecture Corps Prof. McCann Under Model Act, requires Writing Setting out provisions 10 yr limit (can be extended by some or all) Delivery to corporation’s principal office

56 POOLING AGREEMENTS Review lecture Corps Prof. McCann Widely used to “pool” smaller stock holdings into a unit having power to influence Board or corporate actions Generally provide for process to “pre-vote” an issue put to the shareholders, then cast all shares in pool for winner of the internal vote. Agreements are contracts and enforced as such  Equitable relief now available via statute  Previously courts could only remedy breach by damages

57 Shareholder Agreements Review lecture Corps Prof. McCann Liberally construed in closely held corporations BUT, under Model Act,  Must be included in writing filed with the corporation  Must be unanimously approved by all shareholders at time of creation  Must be included in articles or bylaws or in a separate writing  BUT  Cannot eliminate fiduciary duties of officers and directors,  Are not binding on creditors or third parties  Are not binding on shareholders without knowledge

58 GALLER V GALLER Review lecture Corps Prof. McCann Held: Shareholder agreement not violative of public policy unless  Violates an express statement of policy or  Is “manifestly injurious” to public welfare and  Where corrupt or dangerous tendency clearly appears on face of agreement or is part of a corrupt scheme and disguised to conceal true nature of the transaction

59 Sea-Land Rule Review lecture Corps Prof. McCann Corporate entity will be disregarded and veil of limited liability pierced if:  There is a unity of interest and ownership such that the separateness of the personalities of the entity and the individual (or other entity) no longer exists;  Circumstances must be such that adherence to the fiction of separateness would SANCTION A FRAUD PROMOTE INJUSTICE

60 Sea-Land Rule – “Promote Injustice?” Review lecture Corps Prof. McCann Means more than that a creditor will go unpaid. There must be a wrong beyond creditor’s inability to correct, e.g.,  Unjust enrichment to person or entity who looted corporation  Scheme to move assets to one entity and liabilities to another  Must be sufficient to “merit the evocation” of the court’s equitable powers.

61 Piercing Based on Agency Analysis Review lecture Corps Prof. McCann Where person uses a corporation as a shield to pursue the person’s interests and activities, effectively same conduct as if used any other agent:  Therefore, liability imposed on principal via respondeat superior  No matter if agent’s wrongdoing arises in contract or tort

62 Declaring Dividends Review lecture Corps Prof. McCann Highlights the tension between creditors and shareholders  CREDITORS do not want money taken out of the corporation until they have been paid  SHAREHOLDERS like dividends because  (a) represents a return on investment that is no longer subject to market forces;  (b) declaring a dividend signals optimism about the future and often drives the share price higher.

63 Basic Policy Objective: Protect the Creditor Review lecture Corps Prof. McCann Limit so that dividends can only be paid from “surplus” after sufficient capital held in reserve to pay debts.

64 Solely Within Authority of Directors Review lecture Corps Prof. McCann Holders of common shares have no vested right to a dividend  Some preferred shares carry right to a dividend and enforcement power (such as right to name directors) if required dividend is not paid to preferred shareholders Courts will not interfere with directors’ decision to declare or withhold dividend absent showing of fraud, bad faith or abuse of discretion by directors BUT once a dividend is declared, shareholders may enforce in court

65 TYPES OF SURPLUS Review lecture Corps Prof. McCann  Capital surplus  Excess portion of price received by corporation for its stock after subtracting the par value  Plus any amount directors deem necessary (sometimes required by creditors)  Earned surplus  Earning of the company from operations after subtracting liabilities and net of capital accounts  Reduction surplus  The amount directors vote to take out of Stated Capital (e.g., by reducing par or because augmented from capital surplus and now unwinding  Revaluation surplus  The amount of previously unrealized appreciation directors choose to recognize (and which moves into earned surplus)

66 Stock Dividends Review lecture Corps Prof. McCann Issue additional shares in lieu of cash. Reasons:  Don’t want to spend the cash but want to appease shareholders  Want to increase voting rights of pro-board shareholders in case of takeover bid  Need to issue more shares to make an offering work and must issue stock dividends to keep voting rights intact  Drives down stock price somewhat (because more shares over which ratios operate, such as “earnings per share”)

67 Directors’ Duty of Care Review lecture Corps Prof. McCann Francis v United Jersey Bank:  Director is fiduciary of the corporation and its shareholders  And in the context of the business of the corporation, may be a fiduciary to its creditors  Where there is constructive or actual trust Director must “discharge duties in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions”

68 Francis v United Jersey Bank Review lecture Corps Prof. McCann Where director breaches duty, personally liable if negligence was a proximate cause of a loss to the creditor or shareholder or corporation Plaintiff has burden of showing loss would have been avoided if defendant had performed her duties Analysis includes determination of “reasonable steps” director should have taken BUT causation will be inferred where reasonable to conclude particular result from a failure to act and that result has occurred.

69 Caremark Review lecture Corps Prof. McCann Director liability can be grounded on several theories:  Liability following poor decision by board because decision was negligent and ill advised  Liability based on failure to act where due diligence would prevent the loss BUT, “absent cause for suspicion there is no duty…to install and operate a system of corporate espionage to ferret out wrongdoing that they have no reason to suspect exists.”

70 Caremark cont’d Review lecture Corps Prof. McCann There must be a system in place adequate to assure the board that appropriate information will come to its attention in a timely manner Failure to insist upon and maintain such a system may render a director liable

71 Caremark cont’d Review lecture Corps Prof. McCann Plaintiffs must show: Director knew or Should have known were violations of law Took no steps to prevent or remedy Failure proximately caused the loss

72 The Rule Review lecture Corps Prof. McCann Absent fraud, illegality or conflict of interest, a director who acts in good faith is not personally liable for mere errors of judgment short of CLEAR AND GROSS NEGLIGENCE Shlensky v Wrigley 237 N.E. 2d 776 (Ill. 1968) Unless director(s) had an interest in the subject of the decision or Unless decision constitutes illegal conduct (e.g., decision to pay a bribe)

73 ALI Version Review lecture Corps Prof. McCann No liability for a business judgment reached in good faith provided: 1. Director or officer was disinterested 2. Director or officer was informed as to the subject of the decision to a degree the director or officer reasonably believes appropriate; and 3. Rationally believes decision is in the best interests of the corporation

74 SMITH V VAN GORKOM Review lecture Corps Prof. McCann "Informed" within meaning of "due care" means board reviewed all material information reasonably available Liability under Business Judgment Rule arises only where there is a showing of gross negligence, meaning something more careless than ordinary negligence.  E.g., failure to even read a report which was itself deficient

75 Delaware Gen Corp Law Sec. 141 Review lecture Corps Prof. McCann (e) A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.

76 Shareholder Ratification Review lecture Corps Prof. McCann Shareholders may ratify acts of even interested directors PROVIDED shareholders are “fully informed”  Burden is on directors to establish shareholders were fully informed

77 Model Act Review lecture Corps Prof. McCann SECTION GENERAL STANDARDS FOR DIRECTORS (a) A director shall discharge his (sic) duties as a director, including his (sic) duties as a member of a committee: (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner he (sic) reasonably believes to be in the best interests of the corporation. (b) In discharging his (sic) duties a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by: (1) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented; (2) legal counsel, public accountants, or other persons as to matters the director reasonably believes are within the person's professional or expert competence; or (3) a committee of the board of directors of which he (sic) is not a member if the director reasonably believes the committee merits confidence. (c) A director is not acting in good faith if he (sic) has knowledge concerning the matter in question that makes reliance otherwise permitted by subsection (b) unwarranted. (d) A director is not liable for any action taken as a director, or any failure to take any action, if he (sic) performed the duties of his (sic) office in compliance with this section.

78 Calif. Corp Code Sec. 309 Review lecture Corps Prof. McCann (a) A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. (b) In performing the duties of a director, a director shall be entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by [officers, consultants, etc]. (c) A person who performs the duties of a director in accordance with subdivisions (a) and (b) shall have no liability based upon any alleged failure to discharge the person's obligations as a director. In addition, the liability of a director for monetary damages may be eliminated or limited in a corporation's articles to the extent provided in paragraph (10) of subdivision (a) of Section 204.

79 The Duty of Loyalty and the BJR Review lecture Corps Prof. McCann The Business Judgment Rule only shields directors where there is no conflict of interest. Where a potential conflict of interest exists, burden is on directors to demonstrate decision is fair and reasonable to the corporation.

80 What is “Fair and Reasonable”? Review lecture Corps Prof. McCann An objective test. There must be procedural fairness There must be substantive fairness The transaction must be reasonable in the overall context of the objectives of the corporation  As measured against transactions with unrelated parties  As measured against strategic goals – i.e., not only must the terms be fair, but the transaction itself has to be one the corporation would have pursued even were the other party not affiliated  As measured at the time of the decision

81 Safe Harbor for the Interested Director/Officer Review lecture Corps Prof. McCann Delaware provides: No transaction void or voidable just because interested director or officer participated if: a. All material facts regarding the conflict of interest were disclosed to the board or shareholders who nonetheless approved the transaction in good faith; or b. The transaction was intrinsically fair to the corporation at the time it was approved. NOTE: Regardless of board or shareholder approval, many states require fairness test be satisfied

82 Split As to Application of Safe Harbor Rules Review lecture Corps Prof. McCann Majority: Burden is on shareholders to prove board action unfair so long as BJR criteria met Shifting burden to shareholders to show unfair provided one of the safe harbor tests is met (i.e., board need not also show intrinsic fairness) Burden of proof on board to demonstrate intrinsic fairness (Minority)

83 Interplay with BJR Review lecture Corps Prof. McCann Benihana: If fully informed disinterested directors approve the transaction, the burden shifts to the shareholders to show decision does not satisfy the Business Judgment Rule (i.e., that the process followed in reaching the decision was flawed, regardless of the merits of the decision) Effect is to insulate the decision from judicial review for fairness

84 Alternative Attacks on the Transaction Review lecture Corps Prof. McCann Waste Fraud Exceeding Authority Breach of Loyalty action against the interested director

85 The Emerging Duty of Good Faith Review lecture Corps Prof. McCann Walt Disney:  The decision of the compensation committee will be sheltered by the BJR if they acted with due care (i.e., were not grossly negligent) and if they were not acting in BAD FAITH.  BAD FAITH can be  Subjective: motivated by an actual intent to do harm, or  Unintentional but grossly negligent  QUESTION: If the board is grossly negligent for duty of care purposes, are they then automatically acting in bad faith?  ANSWER: No, gross negligence alone does not constitute bad faith. (Otherwise, exculpation statutes meaningless.)

86 What is Bad Faith for Purposes of Liability? Review lecture Corps Prof. McCann Intentional dereliction of duty or a conscious disregard for one’s responsibilities Deliberate inattention and inaction in the face of a duty to act.

87 A Taste of Waste Review lecture Corps Prof. McCann Board is guilty of corporate waste only if Transaction is so one-sided that no business person of ordinary sound judgment would have concluded that the corporation has received adequate consideration

88 Compensation as Waste Review lecture Corps Prof. McCann If compensation decision concerns non-insider (i.e., not a director), directors alone decide if adequate consideration is received by corporation If for insider, directors have burden of showing fair to corporation and in good faith – BJR does not apply (because self-interest exception)…UNLESS  Full disclosure and subsequent ratification by disinterested directors or by the shareholders  In which case, BJR again protects the directors

89 The Evolving Good Faith Standard Review lecture Corps Prof. McCann Not an independent basis for director liability A subset of the Duty of Loyalty Caremark remains the standard insofar as duty to monitor

90 The Duty of Good Faith and Compensation Review lecture Corps Prof. McCann “Spring Loaded” Options: options granted to employees at a time directors reasonably believe value is going to rise in near future as a result of non- public information “Bullet Dodging” Options: options timed to be issued right after stock is going to drop as the result of information not yet made public

91 Option Grants and the BJR Review lecture Corps Prof. McCann Tyson I: The BJR does not protect directors who grant spring- loaded or bullet-dodging options if plaintiff pleads and proves: Options were issued per shareholder approved employee compensation plan and When they approved the options the directors possessed material non-public information that would impact share price and Issued the options with the intent to circumvent restrictions in the shareholder-approved plan

92 The Corporate Opportunity Doctrine Review lecture Corps Prof. McCann Corporate fiduciary may not take an opportunity for herself if:  1. The Corporation is financially able to exploit the opportunity  2. The opportunity is within the Corporation’s line of business  3. The Corporation has an interest or expectancy in the opportunity, and  4. By taking the opportunity the fiduciary will be placed in a position inimicable to her duties to the Corporation

93 The Corporate Opportunity Doctrine Review lecture Corps Prof. McCann Corporate fiduciary may take an opportunity for herself if:  1. The opportunity is presented to the fiduciary as an individual and not in her corporate capacity  2. The opportunity is not essential to the Corporation  3. The Corporation has no interest or expectancy in the opportunity, and  4. The fiduciary has not wrongfully used Corporate resources in pursuing or exploiting the opportunity

94 The Line of Business Test Review lecture Corps Prof. McCann Guth v Loft:  Fiduciary cannot take opportunity for herself if  A. The corporation is financially able to exploit it  B. It is “in the line of the corporation’s business”  C. It is of “practical advantage” to the corporation  D. The corporation has an interest in the opportunity and  E. If the fiduciary were to take the opportunity she would be brought into “conflict” with the interests of the corporation

95 The A.L.I. Test Review lecture Corps Prof. McCann Fiduciary may not take advantage of a corporate opportunity unless: A. The fiduciary first offers it to the corporation and discloses the conflict of interest. B. The corporation rejects the opportunity and C. Either the rejection is fair to the corporation or D. The decision to reject satisfies the BJR or E. The rejection is authorized in advance following disclosure by disinterested shareholders and does not constitute waste.

96 ALI Test Continued: Review lecture Corps Prof. McCann What is a corporate opportunity? A business opportunity presented initially by someone who believes it is being presented to the corporation. An opportunity developed using corporate information or property Any opportunity which a senior executive knows is closely related to the corporation’s current or projected business activities

97 Duties of Controlling Shareholders Review lecture Corps Prof. McCann A dominant shareholder owes a fiduciary duty to the corporation to conform its actions to the “intrinsic fairness” doctrine. Such a shareholder bears burden of proving transaction was objectively fair. BUT only comes into play when self-dealing is involved, where parent is on both sides of transaction with subsidiary and receives benefit from the transaction that minority shareholders of subsidiary do not.

98 Intrinsic Fairness vs BJR Review lecture Corps Prof. McCann Absent showing transaction benefited dominant s/h and not minority, standard is BJR Example: declaring dividend which equally applies to minority s/h not unfair regardless of disparity in number of shares held  If transaction satisfies BJR re methodology, will be upheld unless  Improper motive and  Amounted to waste

99 Duty of Majority in Sale of Controlling Interest Review lecture Corps Prof. McCann Feldmann  Where majority shareholder received premium for controlling interest in steel operation during period of market shortage, held liable to minority shareholders, individually, for premium received.  Burden on defendant majority s/h to demonstrate acted in best interest of corporation (and minority)  Extra value derived from market conditions equivalent to business opportunity belonging to the corporation generally  Dissent: Majority always carries power of control of directors and there is no fiduciary duty not to sell your stock Modern trend

100 ALI Standard Review lecture Corps Prof. McCann So long as sale of control does not generate premium to the seller because buyer intends to exploit its power over minority shareholders, sale is not breach of any fiduciary duty.

101 Dual Directors Review lecture Corps Prof. McCann Director serving on boards of both selling and buying corporations owes identical duty of loyalty to each corporation and must act with utmost good faith and candor

102 Fairness Review lecture Corps Prof. McCann Analysis involves both  Fairness of the process (fair dealing)  Includes duty of candor  Includes transparency as to access to corporate information  Fairness of the price  Considering all relevant factors- including future value likely

103 Statutory “Short Form” Mergers Review lecture Corps Prof. McCann Expedited process whereby corporation can retire minority interests for cash. Issue: Must transaction pass “fairness” test beyond fair price? Held: No, to so require would frustrate purpose of statutes. Exclusive remedy of minority is appraisal.  BUT duty of full disclosure of all facts relevant to price remains

104 Burden of Proof Review lecture Corps Prof. McCann Initially, proponents of transaction have burden to establish “entire fairness” Where an independent committee is empanelled to evaluate and negotiate the transaction, burden shifts to opponents  PROVIDED committee exercises true bargaining power independent of majority shareholder(s)

105 How Can Control of a Corporation Change? Review lecture Corps Prof. McCann Voluntarily 1. It can sell all of its assets.  Alternatively, it can swap its assets for stock in another company. 2. It can sell all of its stock.  Alternatively, it can swap its stock for the stock of another company, leaving the other company holding all of its stock. 3. It can formally merge with another company.

106 Why Prefer One Approach to Another? Review lecture Corps Prof. McCann Purchase of Assets  Simpler  Leaves corporate liabilities as the problem of the shareholders of the corporation  Tax benefits of asset purchases simpler Purchase of Stock  Broader range of rights usually acquired (e.g., brand, employees)  Inherit business contracts,  BUT also all liabilities

107 De Facto Merger Review lecture Corps Prof. McCann Despite the characterization given to the transaction by the parties, a transaction which has, in practical effect, the characteristics of a merger.  The combination of two corporations  The virtual extinction of one of them in its previous form with respect to  Asset value or type  Stock value  Nature of its business  Management  Control  And the stock of the acquiring corporation going to the shareholders of the disappearing corporation

108 Other Responses Review lecture Corps Prof. McCann California  Denominates a general classification termed “reorganizations”  A. Merger  B. Exchange (one corp gets 50% or more of stock of another in exchange for its own shares)  C. Sale of Assets Reorganization (assets for cash or stock)  Majority of Shareholders of both corporations must approve A and C.  Majority of acquiring corp shareholders must approve B reorganization.  Where Shareholder approval required, shareholders generally have appraisal rights if they dissent.

109 Anatomy of a Takeover Review lecture Corps Prof. McCann Predator buys small percentage of stock of Prey Predator makes tender offer to shareholders of record, often “two tiered,”  One price will be paid until Predator has acquired majority interest (“first tier”).  Predator will take control of board of directors.  Second, often lower, price will be paid to those who don’t sell in the first tier. “Mopping Up.”

110 Directors and Tender Offers Review lecture Corps Prof. McCann The “Enhanced Business Judgment Rule”  Directors must determine if takeover proposal is in the best interests of the corporation and its shareholders.  If they act to repel the takeover, their decision are shielded by the BJR if  Directors first establish that they had reasonable grounds for believing that the takeover posed a danger to corporate policy and effectiveness.  Burden is satisfied by showing “good faith” and “reasonable investigation”

111 Enhanced BJR Review lecture Corps Prof. McCann The “Enhanced Business Judgment Rule”  Directors must determine if takeover proposal is in the best interests of the corporation and its shareholders.  If they act to repel the takeover, their decision are shielded by the BJR if  Directors first establish that they had reasonable grounds for believing that the takeover posed a danger to corporate policy and effectiveness.  Burden is satisfied by showing “good faith” and “reasonable investigation”

112 Unocal Review lecture Corps Prof. McCann Is offer in the best interests of the corporation? If contend it is not, the board must show:  Offer is threat to corporate policy or effectiveness  Via evidence of investigation  The defensive response is “proportional” to the threat.

113 Paramount v Time Review lecture Corps Prof. McCann Even an “all cash” sale can be a threat where sale will defeat corporate strategic alliance of potentially greater benefit So long as response does not preclude future offer for the combined alliance.

114 Revlon Review lecture Corps Prof. McCann Once board takes steps to sell the corporation (or where sale inevitable) duty of board is to maximize the price. Defensive measures are “moot”. Triggered at least two ways:  When corporation initiates active bidding process to sell itself or  When a corporation seeks to reorganize in such a way that it involves a clear break-up of the company

115 Stalking Horse Review lecture Corps Prof. McCann The initial bidder with whom the debtor negotiates a purchase agreement is called the "stalking horse" bidder. The term is an old hunting term referring to either a real horse or an image of a horse (typically some type of screen) behind which a hunter would hide to conceal himself from, and get closer to, his prey.

116 DGCL Section Mergers Review lecture Corps Prof. McCann Board of each corporation must first adopt resolution approving merger agreement. Agreement shall set forth terms of the merger, mode of bringing into effect, manner of converting shares. The agreement shall then be submitted to the shareholders of each corporation for vote on no less than 20 days notice. Merger is not effective until requisite number of shares approve it.

117 Omnicare Refinements to Unocal Review lecture Corps Prof. McCann Where defensive measures are invoked to protect a merger agreement, Unocal proportionality test is applied as follows: 1.Court must first determine if the measures are preclusive or coercive. If either, measures are illegal. 2. If measures pass that threshold test, then the Board must establish their measures were within a “range of reasonable responses.”

118 LYONDELL Review lecture Corps Prof. McCann Revlon duties do not arise simply because a company is “in play.” The duty to obtain best price arises only when the company itself embarks on a transaction that will result in a change of control.  Either on its own initiative or  In response to an unsolicited offer

119 Shareholder Derivative Litigation Review lecture Corps Prof. McCann An action by shareholders to remedy an alleged wrong to the corporation.  A wrong by the directors or controlling shareholders or  A wrong by a third party, such as a supplier  The action is “founded on a right of action existing in the corporation itself, and in which the corporation itself is the appropriate plaintiff.” Daily Income Fund, Inc. v. Fox 464 US 523, 528 (1984)

120 Shareholder Derivative Litigation Review lecture Corps Prof. McCann Two actions in one: A. A suit to compel the corporation to sue and B. A suit by the corporation (asserted by the shareholder –plaintiffs) against those liable to it

121 Shareholder Derivative Litigation Review lecture Corps Prof. McCann In addition to demand requirement, shareholders filing derivative action must first post a bond to pay the defendants’ costs if the plaintiffs lose or abandon the litigation (in certain states); establish they are “adequate representatives” of the shareholder s in general and counsel is able to prosecute the action

122 Direct vs. Derivative Review lecture Corps Prof. McCann ClaimDirectDerivative Δs conpired to deplete corporate assets√ Δs diverted corporate assets√ Δs paid dividends to only certain shareholders in class√√ Δs conduct caused share value to decline√ Δs diluted minority shares for benefit of majority s/h√ Δs refused to allow inspection of corporate records√ Δs prevented shareholder from voting√ Δs proposed action is ultra vires√ Δs wrongfully failing to dissolve the corporation√ Δs are acting fraudulently√

123 Demand Futility Review lecture Corps Prof. McCann Demand requirement waived if “futile” Test is whether there is a reasonable doubt that  The directors are disinterested and independent (as to the action proposed by the plaintiff) and  The transaction being challenged was the product of the valid exercise of business judgment

124 The Corporate Response Review lecture Corps Prof. McCann BJR shields directors as to  1. Their response to the demand  2. Decision to dismiss the derivative suit  3. If suit is directed against them, the directors have the BJR shield as a defense.  PROVIDED:  1. Directors are disinterested as to any decision in question  2. The directors have not been grossly negligent with respect to their duty to inform themselves regarding the decisions(s)

125 Approaches to Demand Futility Review lecture Corps Prof. McCann Model Act: Absent a showing of irreparable harm if demand is required, a demand must always be made before a derivative action can be pursued. “Universal Demand.” New York: Demand required unless plaintiff shows:  1. Majority of board are not disinterested as to the transaction  2. Board did not inform themselves as to the transaction; or  3. Transaction is so egregious could not have resulted from sound business judgment.

126 The Rise of the ILC Review lecture Corps Prof. McCann Corp Gets Named in Shareholder Derivative Action (SDA) Board Votes to Create Independent Litigation Committee (ILC) Board Expands Itself to Add Members and appoints only new board members to be the ILC Corporation seeks Stay of SDA proceedings in court to “investigate” the merits of the SDA ILC “investigates” and reports back to the board that the SDA is not in “best interests of the corporation” Corp files motion to dismiss the SDA and/or for summary judgment along with report.

127 The “Structural Problem” of the ILC Review lecture Corps Prof. McCann The “Independent Litigation Committee”  Who appointed them?  What will the appointees be doing once the ILC disbands?  Whose Country Club do they belong to? Plaintiffs or defendants?  How do they feel about rabble-rousing shareholders?  “There but for the grace of God go I.”

128 Zapata Review lecture Corps Prof. McCann In balancing corporation’s right to avoid being hi- jacked by fringe shareholders with shareholders right to protect themselves from directors’ failure to act, In deciding corporation’s motion to dismiss derivative suit, court test the motion as follows: 1. First, was board (committee) independent and acting in good faith? 1. If no, motion shall be denied. 2. If passes that test, court may still test the decision applying the court’s own “business judgment” if court suspects corporation’s interests so require

129 The Limited Review lecture Corps Prof. McCann Aronson test re demand futility is operative  Complaint must allege with particularity facts raising reasonable doubt that  Directors had financial interest or  Directors were motivated by desire to remain in power (entrenchment) or  Directors were dominated or controlled by person interested in the transaction Test as to director’s independence is subjective:  Did that particular director lack independence under the circumstances?

130 Other Approaches Review lecture Corps Prof. McCann Other jurisdictions apply slightly different tests to board motions to dismiss derivative suits:  North Carolina: burden is on board to establish transactions giving rise to the derivative suit were “just and reasonable” to the corporation  New Jersey: In rejecting demand or moving to dismiss a derivative claim, board must show  Members independent  Were acting in good faith with due care  Decision is reasonable  Model Act: Court will grant motion of board to dismiss only after court conducts “reasonable inquiry” and concludes derivative action is not in the corporation’s best interests

131 Protecting Directors and Officers Review lecture Corps Prof. McCann Three principal approaches:  1. Buy “D&O” insurance  2. Provide “contractual indemnification” through agreements with directors and officers  3. Exculpate directors through available statutes and/or by- laws

132 Permissive Indemnification Review lecture Corps Prof. McCann Delaware: Corporation may indemnify where director sued “by reason of the fact” he or she was a director. Heffernan says policy of exculpation requires expansive interpretation of “by reason of the fact.” Model Act: Indemnification authorized if director acting in good faith and in best interests of corporation, even if her conduct didn’t satisfy duty of care.  Articles/By-laws may expand or limit this duty to indemnify

133 Waltuch Review lecture Corps Prof. McCann Corporation may agree to broader indemnification rights for its directors and officers than are provided by statute, but Those rights cannot be inconsistent with the statutory scheme

134 Insurance Issues Review lecture Corps Prof. McCann A corporation can often use D&O (“Directors and Officers”) coverage to indemnify risks that the corporation itself could not indemnify. Insurance Coverage can be broader than statutory limits of indemnification allowed the corporation itself. BUT Public policy forbids indemnifying against criminal conduct, willful conduct or fraudulent conduct

135 D&O Policies Review lecture Corps Prof. McCann Typically provide: 1. “Company Reimbursement” – compensates company for monies it expends for mandatory indemnification expenses. (Side B) 2. “Directors and Officers Liability” – covers losses incurred by the directors and officers and not reimbursed by the company for statutory or other reasons. (Side A) 3. “Entity Coverage” – insures for the company’s direct liability to the plaintiff. (Side C)

136 What is a Security? Review lecture Corps Prof. McCann "Security" means any note; stock; treasury stock; membership in an incorporated or unincorporated association; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral trust certificate; preorganization certificate or subscription; transferable share; investment contract; viatical settlement contract or a fractionalized or pooled interest therein; life settlement contract or a fractionalized or pooled interest therein; voting trust certificate; certificate of deposit for a security; interest in a limited liability company and any class or series of those interests (including any fractional or other interest in that interest…; certificate of interest or participation in an oil, gas or mining title or lease or in payments out of production under that title or lease; put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof); or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency; any beneficial interest or other security issued in connection with a funded employees' pension, profit sharing, stock bonus, or similar benefit plan; or, in general, any interest or instrument commonly known as a "security"; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. All of the foregoing are securities whether or not evidenced by a written document. "Security" does not include: (1) any beneficial interest in any voluntary inter vivos trust which is not created for the purpose of carrying on any business or solely for the purpose of voting, or (2) any beneficial interest in any testamentary trust, or (3) any insurance or endowment policy or annuity contract under which an insurance company admitted in this state promises to pay a sum of money (whether or not based upon the investment performance of a segregated fund) either in a lump sum or periodically for life or some other specified period, or (4) any franchise subject to registration under the Franchise Investment Law (Division 5 (commencing with Section 31000)), or exempted from registration by Section or Calif. Corporations Code Sec

137 Sarbanes-Oxley Review lecture Corps Prof. McCann Section 302 of the Act mandates a set of internal procedures designed to ensure accurate financial disclosure. The signing officers must certify that they are “responsible for establishing and maintaining internal controls” and “have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officersinternal controlscompanyconsolidated subsidiaries Under Section 404 of the Act, management is required to produce an “internal control report” as part of each annual Exchange Act report. See 15 U.S.C. § The report must affirm “the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting.” 15 U.S.C. § 7262(a). The report must also “contain an assessment, as of the end of the most recent fiscal year of the Company, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.15 U.S.C.§ U.S.C.§ 7262(a)Company Section 802(a) of the SOX, 18 U.S.C. § 1519 states:18 U.S.C.§ 1519 “ Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.

138 SEC Rule 14(a) Review lecture Corps Prof. McCann Rule 14a-9 -- False or Misleading Statements No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.

139 Virginia Bankshares v Sandberg Review lecture Corps Prof. McCann 1. Because of the weight given director opinions by shareholders, statements of opinion (“we recommend it because it is a fair price”) which are misleading will support 14a action. 2. But, before liability will lie, the proxy solicitation must be an “essential link” to the corporate action giving rise to the damage to the plaintiff. 3. Where proxy solicitation is superfluous, no liability will lie.

140 Shareholder’s Rights to Solicit Proxies Review lecture Corps Prof. McCann SEC v Transamerica  Proxy Rule x-14A-7 requires management to present a shareholder proposal if  Shareholder gives reasonable notice to management  Proposal is “proper subject” for action by shareholders

141 Fradkin v Ernst Review lecture Corps Prof. McCann FRADKIN V ERNST ISSUE: Must a plaintiff prove scienter to prevail on a 14(a) misleading proxy solicitation claim? HOLDING AND REASONING: No. Where issuer is the defendant, general principles of tort law apply. Negligence will suffice. No need to prove evil intent or recklessness. DISTINGUISHED first party from third party defendants, finding scienter required as to third parties (such as accountants assisting in preparation of proxy statement) because statutory intent is to prevent corporate officers from profiting from their own deception. No direct benefit to the accountant.

142 Shareholder Proxies 14(a)-8 Review lecture Corps Prof. McCann If I have complied with the procedural requirements, on what other bases may a company rely to exclude my proposal? Improper under state law: If the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company's organization; Violation of law: If the proposal would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject; Violation of proxy rules: If the proposal or supporting statement is contrary to any of the Commission's proxy rules, including Rule 14a-9, which prohibits materially false or misleading statements in proxy soliciting materials;Rule 14a-9 Personal grievance; special interest: If the proposal relates to the redress of a personal claim or grievance against the company or any other person, or if it is designed to result in a benefit to you, or to further a personal interest, which is not shared by the other shareholders at large; Relevance: If the proposal relates to operations which account for less than 5 percent of the company's total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earning sand gross sales for its most recent fiscal year, and is not otherwise significantly related to the company's business; Absence of power/authority: If the company would lack the power or authority to implement the proposal;

143 14(a)-8 (Contid) Review lecture Corps Prof. McCann Management functions: If the proposal deals with a matter relating to the company's ordinary business operations; Relates to election: If the proposal relates to a nomination or an election for membership on the company's board of directors or analogous governing body or a procedure for such nomination or election; Conflicts with company's proposal: If the proposal directly conflicts with one of the company's own proposals to be submitted to shareholders at the same meeting. Substantially implemented: If the company has already substantially implemented the proposal; Duplication: If the proposal substantially duplicates another proposal previously submitted to the company by another proponent that will be included in the company's proxy materials for the same meeting;

144 The Elements Review lecture Corps Prof. McCann Material misrepresentation or nondisclosure Scienter A connection between the misrepresentation and the purchase or sale of a security Reliance Economic Loss Loss Causation (a “causal relationship” between the misrep and the loss

145 And more Review lecture Corps Prof. McCann Resubmissions: If the proposal deals with substantially the same subject matter as another proposal or proposals that has or have been previously included in the company's proxy materials within the preceding 5 calendar years, a company may exclude it from its proxy materials for any meeting held within 3 calendar years of the last time it was included if the proposal received:  Less than 3% of the vote if proposed once within the preceding 5 calendar years;  Less than 6% of the vote on its last submission to shareholders if proposed twice previously within the preceding 5 calendar years; or  Less than 10% of the vote on its last submission to shareholders if proposed three times or more previously within the preceding 5 calendar years; and Specific amount of dividends: If the proposal relates to specific amounts of cash or stock dividends.

146 And more Review lecture Corps Prof. McCann Resubmissions: If the proposal deals with substantially the same subject matter as another proposal or proposals that has or have been previously included in the company's proxy materials within the preceding 5 calendar years, a company may exclude it from its proxy materials for any meeting held within 3 calendar years of the last time it was included if the proposal received:  Less than 3% of the vote if proposed once within the preceding 5 calendar years;  Less than 6% of the vote on its last submission to shareholders if proposed twice previously within the preceding 5 calendar years; or  Less than 10% of the vote on its last submission to shareholders if proposed three times or more previously within the preceding 5 calendar years; and Specific amount of dividends: If the proposal relates to specific amounts of cash or stock dividends.

147 10b-5 Review lecture Corps Prof. McCann "Rule 10b-5: Employment of Manipulative and Deceptive Practices": It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."

148 The Essence of 10b-5 Review lecture Corps Prof. McCann Persons (insiders or not) Having material information not known to the investing public (or others with whom the person is dealing) Must disclose it prior to transacting or Must abstain from transaction until it is disclosed

149 Material Review lecture Corps Prof. McCann Information to which a reasonable investor would attach importance in determining her choice of action regarding a transaction A balancing:  How likely is it that the fact will actually come to fruition (i.e., a merger; and  How significant will be the impact of the event in the totality of the company’s operations?

150 The Elements Review lecture Corps Prof. McCann Material misrepresentation or nondisclosure Scienter A connection between the misrepresentation and the purchase or sale of a security Reliance Economic Loss Loss Causation (a “causal relationship” between the misrep and the loss

151 Sub-Issues in 10b-5 Cases Review lecture Corps Prof. McCann Fault  Simple negligence is insufficient to suport an action for civil damages. There must be an intent to deceive, defraud or manipulate. Ernst and Ernst v Hochfelder  Recklessness will suffice to establish requisite scienter.

152 Sub-Issues in 10b-5 Cases Review lecture Corps Prof. McCann Who Is Subject to 10b-5 Constraint?  Absent a relationship between a purchaser of stock and the seller, there is no duty to disclose information acquired by the purchaser under 10(b).  However, that relationship can be found to exist where purchaser works for, say, printer employed by seller. (Misappropriation)  Duty likewise where purchaser is insider or fiduciary of seller  But, SEC can find violation if anyone was owed a duty by the purchaser, even if a particular plaintiff cannot succeed. Materia (SEC prosecution against printer’s employee).

153 Sub-Issues in 10b-5 Cases Review lecture Corps Prof. McCann Tippees/ Aiders and Abettors  Where insider who made disclosure did so without violating fiduciary duty, a tippee who passes the disclosure on is not liable under 10(b)-5  Dirks v SEC: Source of information was insider who disclosed it in the process of trying to investigate wrongdoing.  Test: Did the insider personally gain?

154 The Elements Review lecture Corps Prof. McCann Material misrepresentation or nondisclosure Scienter A connection between the misrepresentation and the purchase or sale of a security Reliance Economic Loss Loss Causation (a “causal relationship” between the misrep and the loss

155 Loss Causation and Damages Review lecture Corps Prof. McCann Fact price is inflated (“fraud on market” test) is not sufficient to prove the misrepresentation caused the loss.  At the moment of purchase the stock is worth what was paid, so no loss.  The inflated price may, but may not, lead to the later loss when the stock is sold for a lower price.  Dura Pharmaceuticals, Inc. v. Broudo (reversing 9 th circuit test that plaintiff sufficiently alleged causation between the loss and the misrepresentation for 10(b)-5 purposes by alleging the price paid was inflated)

156 Calculation of Damages Review lecture Corps Prof. McCann Disgorgement Measure:  Plaintiff may recover post-purchase decline in value up to reasonable time after purchase, limited by the total gain enjoyed by the tippee as a result of trading on the inside information.  Where multiple plaintiffs, recover pro rata from the tippee. Subsequently, Sec. 20A provided for treble damages and other disincentives in SEC prosecutions.

157 Other Statutes Review lecture Corps Prof. McCann Sarbanes-Oxley Act of 2002  Creates criminal violation for executing or attempting to execute a fraud in connection with any security;  Or to obtain by fraud any money or property in connection with purchase or sale of security

158 Sec. 16 of the Exchange Act Review lecture Corps Prof. McCann a. Directors, officers, and principal stockholders required to file Every person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security …or who is a director or an officer of the issuer of such security, shall file the statements …[with]… the amount of all equity securities of such issuer of which the filing person is the beneficial owner; and…shall indicate …at the date of filing, any such changes in such ownership, and such purchases and sales of the security[.]

159 Sec. 16 of the Exchange Act Review lecture Corps Prof. McCann b. For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale…within any period of less than six months, unless such security …was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer

160 Smolowe v Delendo Review lecture Corps Prof. McCann Must each sale unfairly use inside information before it is subject to Sec. 16?  No. All transactions in the 6 month period covered. Disgorgement is of difference between highest sale and lowest purchase, times number of shares bought or sold.  Purpose to sweep in all conceivable profits.

161 Smolowe v Delendo The Real World Review lecture Corps Prof. McCann DateBuy/SellSharesPriceNet Profit (Loss) 1/1Buy100$115 ½Sell100$93($2,200) 1/3Buy100$90 ¼Buy100$95 1/5Sell100$97$700 1/6Buy100$105 1/7Sell100$108$300 1/8Sell100$115$1,000 Total$800

162 Smolowe v Delendo Under 16b Review lecture Corps Prof. McCann DateBuy/SellSharesPriceNet Profit (Loss) 1/1Buy100$115 ½Sell100$93 1/3Buy100$90Match with $115 sale = $2500 profit ¼Buy100$95Match with $108 sale = $1300 profit 1/5Sell100$97 1/6Buy100$105No other buys matched with sells generate gains. 1/7Sell100$108 1/8Sell100$115 Total$3,800 profit

163 The Universe of Defendants Review lecture Corps Prof. McCann 16b Means What It Says:  Only directors, officers or beneficial owners of 10% of the stock are potential defendants.  Ownership measured immediately prior to the transaction (i.e., was the shareholder a 10% owner when he entered into the transaction in question?)  So, “step transaction” to reduce ownership to less than 10% will shield sale of remaining interest.


Download ppt "PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 14 REVIEW Business Organizations 2010-2011 Lectures."

Similar presentations


Ads by Google