Business Organizations Outline

BUSINESS ORGANIZATIONS OUTLINE
AGENCY
CONTRACT LIABILITY
I.
OVERARCHING ISSUE: The first issue is whether [principal] is liable to [third party] for
[agents contract].
II.
OVERARCHING RULE: In assessing contract liability, [third party] must prove an

agency relationship existed between [principal] and [agent] and [agent] had authority
to do what he did. An agency relationship exists where: (1) the principal manifests
desire for the agent to act on his behalf; (2) the agent accepts; and (3) it is understood
between the parties that the principal will control the relationship.
III.
APPLICATION: [Look to the amount of control the principal had over the agent.]
a. Cargill Farmers sell grain to Warren. Warren defaults on payment. Farmers sue
Cargill alleging that Warren was acting as Cargills agent.
i. The court finds an agency relationship. Cargill loaned money to
Warren and even though not even lender is a principal, Cargill was
because they had a ton of control over Warren. This control was
evidenced by:
1. Cargills constant recommendations
2. Cargills right of first refusal on grain
3. Cargills right to audit Warren
4. Cargill financed all of Warrens operations and had a right to
discontinue financing
ii. Courts look to:
1. Ps right to control agent
2. Alleged agents duty to act for primary benefit of the P
3. Alleged agents power to alter legal relations of P
iii. Lender is liable if its control affects borrowers management decisions beyond
those necessary merely to protect lenders investment
b. Buyer-Supplier: one who contracts to acquire property from X and convey it to
Buyer
i. Supplier is Buyers agent only if it agreed that he is to act primarily for the
benefit of the other and not for himself; factors:
1. Supplier receives fixed price for property regardless of what supplier
paid to X
2. Supplier acts in his own name and receives title to property that he
transfers
3. Supplier has independent business in buying/selling similar property
IV.
ISSUE TWO: Because there was an agency relationship between [principal] and
[agent], the next issue is whether [agent] had authority [to do what it did], such that
[principal] is liable. Therefore, we must determine whether there is: (1) actual express
authority; (2) actual implied authority; (3) apparent authority; (4) inherent agency
power; or (5) ratification.
** APPLY MORE THAN ONE UNLESS IT IS VERY CLEAR **
a. SUB-ISSUE/RULE ONE: The issue is whether there is ACTUAL EXPRESS
AUTHORITY. This exists when the principal expressly tells the agent to do
something. [Look for communication between P and A] Here
i. CONCLUSION: Therefore, there is (not) actual express authority.
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b. SUB-ISSUE/RULE TWO: The next issue is whether there is ACTUAL IMPLIED

AUTHORITY. This exists where either: (1) the agent acts in a way that is necessary,
usual and/or proper to carry out their express responsibilities/actions incidental to
Ps objectives; or (2) the principal acts in a way that causes the agent to reasonably
believe he had authority to act. Here
i. Note: For there to be actual implied authority, it still must be clear that the
principal wanted the agent to do something.
ii. EX for (1): Eli (principal) tells Tim (agent) to re-sod the Arizona
Diamondbacks field. Tim has actual express authority to re-sod the field. Tim
has actual implied authority to buy a plane ticket to travel to Arizona.
iii. For (2), look at:
1. The principals past and present conduct
2. The existence of prior similar practices
3. The nature of the task delegated
a. Mill Street Church Church (P) hires Bill (A) to paint the church.
Bill needs help so he hires his brother Sam (TP), which he had
done on prior occasions. Sam gets hurt and sues the Church.
i. Looking at what Bill (A) reasonably believed - Bill had
actual implied authority because based on the Churchs
past conduct (allowing him to hire Sam for past jobs), Bill
reasonably believed he could hire Sam again.
iv. CONCLUSION: Therefore, there is (not) actual implied authority.
c. SUB-ISSUE/RULE THREE: [P is disclosed] The next issue is whether there is
APPARENT AUTHORITY. This exists where: (1) a principal acts in such a way that
causes a third party to reasonably believe the agent had authority to do what the
agent did; and (2) the third party relied on that holding out. [Look at:]
Scenario: 1) persons appear to be agents and are not (2) agents act beyond the scope
actual authority
i. The agents title:
1. 370 Corp. v. Ampex Joyce (TP) was an officer at 370 Corporation.
Kays (A) was a salesman at Ampex. Mueller (P) was Kays boss. Kays
signed a sales agreement with Joyce on Muellers behalf.
a. Looking at what Joyce (TP) reasonably believed - Kays (A) had
apparent authority to enter into an agreement with Joyce (TP)
because it was reasonable for Joyce to assume someone with the
title salesman could enter into a sales agreement with a third
party.
b. If the sales order was for a HUGE amount, the outcome might be
different because Joyce was smart and would know Kays does not
have that much authority to bind Ampex in that situation.
c. AA trumps bylaws if conduct is within ordinary course of business
ii. The principals written or oral statements to manifest assent to 3rd
party:
1. Mill Street Church see above
a. Looking at what Sam (TP) reasonably believed Bill had apparent
authority because Sam reasonably believed that Bill could hire
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him based on the Churchs past conduct (allowing him to hire

Sam for past jobs).
iii. CONCLUSION: Therefore, there is (not) apparent authority.
iv. Note: Apparent authority is different than apparent employee/employer
(estoppel) because here, there IS an actual agency relationship and this just
expands the agents authority. Whereas for apparent employee/employer,
there is no actual agency relationship but the court finds one based on the
principals holding out, does not give any rights against third party.
d. SUB-ISSUE/RULE FOUR:[Look for undisclosed P] The next issue is whether there is
inherent agency power. Under Watteau v. Fenwick, INHERENT AGENCY POWER
(rare) exists when undisclosed principal clothes an agent with power and the
agent acts in a manner that is usual for the business, even if prohibited by the
principal. However, Restatement 3d adds a notice requirement: liability only
attaches if the principal is aware of the agents conduct and that a third party might
rely on the agents conduct, but failed to take reasonable steps to notify the third
party of the fact. Here
i. Public Policy: It would be unfair to let an undisclosed principal escape
liability when they are benefiting from the business
1. Watteau Manager (agent) of Ds (principal) bar only had authority to
buy ales, but he bought cigars without D knowing. There was inherent
agency power because: (1) D entrusted the agent with management of
the business; and (2) buying cigar was a usual transaction for the
business.
a. NOTE: If Restatement 3d was the law, D would not be liable
because D did not know his agent was buying cigars.
b. Limits P liability to actions by agent reasonable under the
circumstances even if expressly forbidden by P
ii. CONCLUSION: Therefore, there is (not) inherent agency power.
e. SUB-ISSUE/RULE FIVE: The next issue is whether [principal] ratified [agents]
conduct. RATIFICATION occurs where the principal subsequently agrees with the
actions of its agent, even if the agent did not have authority at the time to act. In
order to prove ratification, a party must show: (1) intent by the principal to ratify the
agreement; and (2) the principals knowledge of all the material circumstances
surrounding the deal. Here
i. Botticello Mary and Walter owned farm as tenants in common and leased to
Botticello. Walter gave Botticello and option to buy, without Marys consent.
Years later, Botticello tried to exercise the option and Mary objected, saying
she never consented to the deal. Botticello argued that Mary ratified the
agreement by accepting his rent payments and allowing him to make
improvements to the property.
1. Mary did not ratify the option. Mary didnt have the requisite
knowledge because she didnt know there was an option to
buy.
a. NOTE: Walter was not acting as Marys authorized agent
because marriage is not enough to create an agency relationship.
ii. CONCLUSION: Therefore, [principal] did (not) ratify [agents] conduct.
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V.
OVERARCHING CONCLUSION: Therefore, [principal] is (not) liable to [third party] for

[agents contract].
TORT LIABILITY
I.
OVERARCHING ISSUE: The first issue is whether [principal] is liable to [third party] for
[agents tort].
II.
OVERARCHING RULE: A principal may be liable when: (1) there is an

employer/employee relationship; (2) there is an apparent employer/employee
relationship; (3) an independent contractor is engaged in an inherently dangerous
activity; (4) the principal negligently hired an independent contractor; or (5) the act is
done at the principals direction.
a. SUB
ISSUE/RULE
ONE: The
next issue
is whether there
is an
EMPLOYER/EMPLOYEE RELATIONSHIP between [principal] and [agent], or
whether [agent] is an independent contractor. There is no bright line test to
determine whether an employer/employee relationship exists. Rather, the court will
make a fact-intensive inquiry focusing on the amount of control the principal
exercises over the day-to-day operations of the job. The more control, the more
likely an employer/employee relationship exists. Here, considering the totality of the
circumstances there was (not) an employer/employee relationship because . . .
[analyze amount of control]
1. Note: An employer/employee relationship is a subset of principal/agent.
You can be an agent without being an employee. For example, if you
hire a lawyer, the lawyer is your agent, but not your employee.
ii. CONCLUSION IF NOT EMPLOYEE: Thus, there is no employee/employer
relationship and the [principal] will not be liable unless: (2) there is an
apparent employer/employee relationship; (3) an independent contractor is
engaged in an inherently dangerous activity; (4) the principal negligently
hired an independent contractor; or (5) the act is done at the principals
direction.
iii. CONCLUSION IF EMPLOYEE (Respondeat Superior): Thus, [agent] is an
employee. Therefore, [principal] is liable so long as the employees act was
within the scope of [agents] employment. In making this determination,
courts primarily focus on the intent of the employee. For example, courts look
to whether: (1) the employees actions intended to benefit the employer; (2)
the employees actions were the sort of thing the employee was hired to do;
and (3) the employees actions were within the authorized timeframe and
space limitations of the employer. Here . . .
1. Ira Bushey v. US Drunken sailor turned a wheel and flooded a drydocked and ship. Owner of the dock (TP) sued Coast Guard (P) for
sailors (A) negligence.
a. Even though the court found the sailors conduct was
outside the scope of their duties, the court made the
policy argument saying it is fair to hold a Principal liable
if an agents conduct is foreseeable to the principal.
i. Note: Sailors go on leave all the time and get drunk so P
knew this type of behavior could happen.
1. If the sailor was ashore and set a car of fire, the CG

would not have been liable because the sailors
conduct was not foreseeable.
2. If the sailor came back to ship, recognized his
lovers wife and shot him, the Coast Guard would
not have been liable because the sailors conduct
related to his personal life.
2. Manning v. Grimsley Orioles (P) were liable when Grimsley (A) threw a
pitch at heckling fans (TP).
a. Court said a Principal will be liable for an employees tort
where the tort was in response to a third partys
interference with the employees ability to do his job.
i. Here, Grimsley was trying to silence the hecklers so he
could pitch more effectively (i.e. benefit the employer).
3. Miller Case Porter (A) at Filenes Basement (P) slapped a customer
(TP) who annoyed him while he was mopping floors.
a. Distinguished from Grimsley because in Miller, the court
said the agents tort was not an effort by an employee to
stop a third party from interfering with his job duties. In
Grimsley it was.
iv. CONCLUSION FOR SCOPE OF EMPLOYMENT: Therefore [agents] tort was (not)
within the scope of his employment such that [principal] will (not) be liable to
[third party].
1. RECOMMENDATION: Get insurance to protect against agents torts
(car crashes)!
b. SUB ISSUE/RULE TWO: The next issue is whether there is an APPARENT
EMPLOYER/EMPLOYEE RELATIONSHIP.
A court will impose an apparent
employer/employee relationship when: (1) the employer holds someone out as their
employee; and (2) a third party relies on that holding out. Here
i. Note: Apparent authority is different than apparent employee/employer
because there, there IS an actual agency relationship in the former and this
just
expands
the
agents
authority.
Whereas
for
apparent
employee/employer, there is no actual agency relationship but the court finds
one based on the principals holding out.
ii. CONCLUSION: Therefore, there is (not) an apparent employee/employer
relationship.
c. SUB ISSUE/RULE THREE: Because no actual or apparent employee/employer
relationship existed, [name] is an independent contractor. Non-delegable duty to
ensure the work is not done in a negligent manner. Therefore, [principal] will be
liable if what [name] was hired to do was an INHERENTLY DANGEROUS ACTIVITY.
Here
i. Majestic Realty v. Toti Parking Authority (P) hired Toti Construction (A) to
demolish a bunch of buildings. Wrecking ball accidentally struck and knocked
over part of Majestics (TP) building.
1. Court said Principal was liable for the acts of an independent contract
where the independent contractor was engaged in an inherently
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dangerous activity even where the Principal has NO control over the
ICs operations.
a. Public Policy: We want people to be careful when they hire
contractors to do dangerous stuff.
d. SUB ISSUE FOUR: Although [name] was not hired to conduct an inherently
dangerous activity, [principal] may still be liable if they NEGLIGENTLY HIRED
[name] as an independent contractor. Should have known IC does not have skill to
do work then liable for that ICs negligence. Here
i. EX Exxon Mobile wants to transport oil. They hire an alcoholic captain to
transport the oil and the ship crashes. Exxon (P) will be liable for negligently
hiring the captain (IC) even if Exxon doesnt own the ship.
e. SUB ISSUE/RULE FIVE: The issue is whether [the act] was DONE AT THE
PRINCIPALS DIRECTION. When an act is done at a principals direction, the
principal will be liable regardless of whether the agent is an employee or
independent contractor. Here
III.
OVERARCHING CONCLUSION: Therefore, [principal] is (not) liable to [third party] for

[agents tort].
FRANCHISES
I.
OVERARCHING ISSUE: Here, the facts indicate a franchisor/franchisee relationship

exists between [franchisor] and [franchisee]. Although this is a grey area of the law and
may not constitute agency, a franchisor will typically be liable for the acts of a
franchisee when: (1) an actual employer/employee relationship exists; or (2) where an
apparent employer/employee relationship exists.
II.
RULE for ACTUAL EMPLOYER/EMPLOYEE: An actual employer/employee relationship

exists when the franchisor: (1) maintains the right to control the day-to-day operations
of the franchisee; or (2) the franchisor maintains the right to control the particular
aspect of the day-to-day operations that led to the injury. Here
a. Murphy v. Holliday Inns Betsy-Lynn (A) owned a Holiday Inn (P) franchise. Plaintiff
(TP) slipped and fell at Betsy-Lynns hotel. Betsy-Lynn was broke so Plaintiff tried to
sue Holiday Inn, arguing the franchise agreement established a franchisor/franchisee
relationship.
i. The court said the franchise agreement did not create an
employer/employee relationship because Holiday Inn had no right to
control Betsy-Lynns day-to-day operations.
b. Humble Oil v. Martin Humble (P) owned gas station and leased it to Schneider (A)
and sold him gasoline and other products. Car was left at station for repairs and
Schneider didnt secure it. Car rolled down hill and hit Martin and his kids (TP).
Plaintiff sued Humble Oil (P).
i. The court said Humble (P) was liable because the language in the
contract made is such that Humble exercised financial control over
Schneider.
1. Humble paid of all the utility bills, which was the most important
operational expense.
2. The title to all the products remained in Humbles name until a
customer actually purchased them.
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3. Humble controlled the hours of operation

4. Schneiders right to occupy the premises was terminable at the will of
Humble.
c. Hoover v. Sun Oil Sun Oil (P) owned gas station and leased it to Barone (A).
Barones employee caused fire. Plaintiff (TP) sued Sun Oil (P).
i. The court said even in the absence of actual control, where the
Principal reserves the right to control the details of the day-to-day
operations, the principal will be liable.
1. Here, the court found there was no right to control because Barone: (1)
determined how much to pay his employees; (2) set the working
conditions at the gas station; and (3) determined the gas stations
operating hours.
a. Note: Professor disagrees because the lease gave Sun Oil the
right to terminate Barones (A) lease with just 30 days notice
giving them substantial control. For example, if Barone was not
staying open long enough, Sun Oil could just terminate the lease.
d. CONCLUSION: Therefore, an actual employee/employer relationship does (not)
exist.
i. RECOMMENDATION: The franchisor should get insurance to protect against
torts by franchisees. For McDonalds and similar business chains, it is very
important for them to have control in order to maintain uniformity between
restaurants. So, since the business will likely be held liable, they should just
get insurance.
III.
RULE for APPARENT EMPLOYER/EMPLOYEE: However, there might still be an

apparent employee/employer relationship if: (1) the franchisor held the franchisee out
as an agent; and (2) the third-party relied on that holding out. Here
a. Miller v. McDonalds Plaintiff (TP) bit into a stone while eating her Big Mac at a
McDonalds (P) owned and operated by 3K Restaurants (A). (TP) realized 3K didnt
have any money so she tried to sue McDonalds.
i. The court remanded for more fact finding. Two theories of liability:
1. Actual Employer/Employee
a. Right to Control Test Where the practical effect of the
franchisor/franchisee relationship goes beyond setting standards
and gives the franchisor the right to control, an actual agency
relationship exists and the franchisor is probably liable. APPLY
FACTS!
2. Apparent Employer/Employee
a. A jury could find: (1) 3K was held out to the TP as an agent; and
(2) the TP relied on the principals holding out.
b. CONCLUSION: Therefore, [Principal] will [not] be liable because [it] did [not]
exercise sufficient control to create an agency relationship.
i. Recommendation: The franchisor should get insurance to protect against
torts by franchisees. For McDonalds and similar business chains, it is very
important for them to have control in order to maintain uniformity between
restaurants. So, since the business will likely be held liable, they should just
get insurance.
FIDUCIARY OBLIGATIONS OF AGENTS

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Scenario: Comes up when P is suing agent (not plaintiff suing Principal because o agent)
** IF DEALING WITH A PARTNERSHIP OR CORPORATION SKIP TO BELOW **
I.
OVERARCHING ISSUE: Because there is an agency relationship, [agent] owes a

fiduciary duty of loyalty to [principal]. Thus, the issue is whether [agent] breached its
fiduciary obligation to [principal].
II.
OVERARCHING RULE: Unless otherwise agreed, an agent has a duty to act solely for
the benefit of the principal in all matters connected to his agency. He cannot use his
position of confidence or trust to further his private interests. Further, he must disclose
to the principal any matter affecting the principals interest.
III.
APPLICATION: Here, [agent] did (not) breach his fiduciary duty to [principal] because
an agent cant:
a. Divert business from the principal for the agents own use without disclosing; (Corp.
opportunity)
i. EX: An agent cant say principals company cant do it, but my company can
do it.
b. Sell assets to the principal without key disclosing (Rash);
i. EX: President of Ps company sells land that he owns to principals company
without disclosing.
c. Leave and take the principals employees or confidential information (business) with
you (Town and Country)
i. EX: Improperly soliciting former clients
d. RECOMMENDATIONS:
i. If you want to do a deal that you have an interest in with your principal,
disclose it to your principal.
ii. When entering into a non-compete agreement, remember that they are
generally not enforceable (in IL). In order to be enforceable courts look for:
(1) Duration; (2) Geography; (3) Scope; (4) Context; (5) Subject Matter.
e. Rash v. JV International, Ltd. Rash managed JVICs Oklahoma plants. While
managing JVIC, he then started a scaffolding business and didnt tell JVIC. His
scaffolding company bid on jobs for the plant and won and JVIC paid them almost $1
million.
i. The court said the duty of an agent is to disclose to the principal any
matter affecting the principals interests.
1. Here, Rash breached his fiduciary duty to JVIC because JVIC had a right
to know about Rashs relationship with the scaffolding company. A way
for Rash to avoid this is for Rash to have disclosed this information in a
letter to JVIC.
a. Note: it doesnt matter whether Rashs company was the best
company or offered the lowest price, Rash had a duty to let JVIC
know.
b. Note: People can form other businesses, but they cannot do
business with the company they currently work for unless they
tell the company.
f.
Town and County v. Newberry Plaintiffs owned a cleaning service. Defendants

worked for them. Defendants quit, started own business, and called old clients to
get them to switch.
i. The court said Plaintiff is entitled to damages. Agents have a duty to
protect their principals trade secrets even after their employment
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ends. Here, the Plaintiffs had formulated the client list through much
effort so it was a secret and Defendants couldnt use it for their own
benefit.
1. Note: Defendants didnt have to stop their cleaning services because
Plaintiffs cleaning methods were not too secretive to merit protection
2. Note: Lawyers cannot persuade clients to hire them until after they
have left the firm.
IV.
CONCLUSION: Therefore [agent] did [not] breach its fiduciary duty to [principal].
FORMS OF BUSINESS
I.
PARTNERSHIPS
a. Taxation: Good. Taxation occurs at the individual partner level (conduit taxation).
b. Limited Liability: Bad. Each partner is personally liable for partnership debt
regardless how much they put in
II.
CORPORATIONS
a. Taxation: Bad. Corporations are taxed twice: (1) at the shareholder level; and (2) at
the corporate level
i. Recommendation: form an S corporation to avoid double taxations
(only shareholders pay taxes and one class of stock and less than 75
SH).
b. Limited Liability: Good. Shareholders are not liable for business debts and can only
lose what they put in (unless PCV)
III.
LIMITED LIABILITY COMPANIES

a. Taxation: Good. Conduit taxation taxation occurs at the shareholder level.
b. Limited Liability: Good. Shareholders are not liable for business debts and can only
lose what they put in
PARTNERSHIPS
DOES A PARTNERSHIP EXIST?
I.
OVERARCHING ISSUE: The first issue is whether a partnership exists between ___ and
___.
II.
RULE FOR PARTNER vs. EMPLOYEE: A partnership is an association of two or more

people established to carry on as co-owners of a business for a profit. No formality is
required and there are many factors the court will consider to determine whether a
partnership exists including: [PICK FROM BELOW] (internal rules can be changed by
agreement)
a. Intent of the parties
i. Relevant but not controlling.
People may think of themselves as a
partnership, but that doesnt mean they are one.
b. Language of the agreement
c. Right to share profits partners share equally in profits and losses regardless of
investment amount, unless agreed to otherwise
i. Prima facie evidence of partnership unless it is for wages
d. Obligation to share loses
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e. Indemnification of partners partnership must indemnify for payments made and

personal liability in ordinary and proper course of business
f. Conduct of the parties towards third parties estoppel
i. i.e. did the people hold themselves out as partners?
g. Ownership and control of the partnership property
i. Default Rule - Each partner has one vote regardless of how much money they
invest in the partnership. But, the partnership agreement can alter this.
h. Right of dissociation even if violates partnership agreement; may be liable for
damages or bought out
i. Fenwick v. UCC
1. Fenwick owned a beauty shop and his receptionist wanted a raise;
offered to make her partner. They entered into an agreement where
the receptionist received salary plus 20% of the profits if the business
did well. The UCC is arguing partnership because they want to collect
the unemployment taxes.
a. The court found no partnership by analyzing:
i. Control: the receptionists role didnt change because
Fenwick retained exclusive control over the business;
ii. Intent of the Parties: the intent of the agreement was to
give the receptionist more money, not make her partner.
iii. Right to Share Profits: The receptionist had a right to
share profits only if the business did well.
iv. Obligation to Share Losses: The receptionist had no
obligation for losses.
2. Note: This is an unusual case. It is generally a creditor arguing that
there was a partnership so they can go after the deep pockets of one of
the partners.
i.
III.
CONCLUSION: Therefore, ____ and ____ are [not] partners. [IF NOT PARTNERS GO
TO ESTOPPEL]
RULE FOR PARTNER vs. LENDER: A partnership is an association of two or more

people established to carry on as co-owners of a business for a profit. No formality is
required and there are many factors the court will consider to determine whether a
partnership exists including [PICK FROM BELOW]:
a. Look to factors above that establish a partnership; if present, likely not a
lender
b. Lenders have an unconditional right to repayment (this is the BIG ISSUE)
i. Payment can relate to profits, but it does not establish a partnership if the
payment is unconditional. Equity kicker may allow bank to participate in
profits.
ii. Covenant controls does not mean partnership
c. Lenders are not responsible for losses/debts of the borrower.
d. Lenders are entitled to a certain level of control, but not too much control (Martin v.
Peyton)
i. Lenders can veto transactions, but cant initiate transactions
ii. Lenders can inspect the firms books
1. Cargill Martin is different from Cargill because in Cargill, the lenders
had total control over operations.
e. Consequences: If lender is partner then loan is subordinate to claims of creditors
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f.
IV.
CONCLUSION: Therefore, ____ and ____ are [not] partners. [IF NOT PARTNERS GO
TO ESTOPPEL]
RULE FOR PARTNERSHIP BY ESTOPPEL: Here, even though no actual partnership

existed between ____ and ____, a court still might find partnership by estoppel if: (1)
[defendant] represented ____ and D were partners; and (2) plaintiff relied on this
representation. P can establish partner ship between A and B and B will be liable for A.
If one person purports to be acting with another then partnership by estoppel. Here
[common sense argument].
a. Young v. Jones Plaintiffs hired PW-Bahamas to do their audit. PW-Bahamas did a
bad job and P wants to sue the deep pockets of PW-US. Since there is no actual
partnership, P claims that PW-US represented that PW-Bahamas was its partner.
i. The court found no partnership by estoppel because P did not rely on
defendants representation. There was a brochure that made it seem
like there was a representation of a partnership but plaintiff didnt
rely on it.
FIDUCIARY OBLIGATIONS OF PARTNERS

I.
OVERARCHING ISSUE/RULE: (Similar to agency) Because there is a partnership, the

issue is whether [partner] breached [his/her] fiduciary duty to the partnership. As Chief
Judge Cardozo stated in Meinhard, joint-venturers and co-partners owe the duty of
finest loyalty to one another. Further, UPA 404 says that partners owe a duty of care
and loyalty to one another.
***IF GRABBING AND LEAVING OR EXPULSION SKIP TO NEXT RULE***
a. APPLICATION/CONCLUSION: Here [partner] did (not) breach [his/her] duty of
(loyalty and/or care) when he [ ] because
i. Duty of Loyalty - A partner cant:
1. Take a partnership opportunity for himself (cant profit yourself from a
deal without your other partners profiting); (corporate opportunity
2. Participate in self-dealing and profit without disclosure to the
partnership; or
3. Compete with the partnership. Duty of loyalty trumps self-interest
ii.
Duty of Care A partner cant:

1. Act recklessly or grossly negligent;
2. Intentionally harm the partnership;
3. Knowingly violate the law.
iii. Meinhard v. Salmon - Salmon leased a building from Gerry. Salmon managed
and operated it. Meinhard gave him money to renovate it. They agreed to
share profits and losses (as joint venturers). As the lease was expiring, Gerry
and Salmon entered into a bigger deal without telling Meinhard. Meinhard
sued for being cut out of deal.
1. The court said Salmon had a duty to disclose the business
opportunity to Meinhard.
a. Dissent the venture had a defined end date so Salmon had no
obligation to involve Meinhard in future deals. But Professor
disagreed because this was essentially an extension of the same
deal. It would have been different if this was a separate property
a block away.
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II.
SUB-RULE IF GRABBING AND LEAVING PARTNERSHIP:

partnership, there are certain things a partner can and cannot do.
When
leaving
a. APPLICATION/CONCLUSION: Here, [partner] did (not) breach their fiduciary duty

when they [insert what they did before leaving] prior to leaving the partnership.
i. SOLICITING CLIENTS:
1. CAN:
a. Tell partnership who you are going to solicit so that they have an
opportunity to try and keep those clients.
i. How much notice you have to give old partnership
depends on circumstances; (ARGUE WHAT IS A FAIR
TIMEFRAME)
2. CANNOT:
a. Solicit your old partnerships clients in secret while still at the
partnership
i. If you do, this is a breach of fiduciary duty b/c you would
be stealing assets from your old partnership (i.e. cant
undercut old partnership)
ii. RECOMMENDATION: Even though you can solicit while
still with the partnership if you disclose that you are
leaving and plan to solicit. But the safest thing to do is
wait until after youve already left because then no
disclosure is needed. Not necessary to leave partnership.
b. Cannot bad mouth old partnership
i. Recommendation: play up your new business
c. Give one-sided notice to the client that you are leaving
i. Cannot say: I have left and I want you to come with me.
ii. Can say: Of course I want you to come with me, but it is
your choice.
d. Give short notice period to old partnership that you are leaving
i. If, you tell them today that you are leaving tomorrow, and
you start soliciting business today, it does not give
partnership a fair chance to figure out how to retain
business
1. Note: you are more likely to be sued if you are
taking big business
e. Use confidential information to assist in your effort of moving
clients from your old partnership to your new venture (Town and
Country).
f.
Use the company computers or other facilities in your efforts to

switch clients.
ii. SOLICITING PARTNERS:

1. CAN:
a. Solicit other partners to leave with you (even if made in secret)
iii. SOLICITING ASSOCIATES:
1. Soliciting associates is unclear b/c they are viewed as more vulnerable
12
iv. MISC.
1. CAN
a. Prepare without telling old firm (i.e. enter into new lease; hire
secretary; get stationary; obtain malpractice insurance)
2. CANNOT
a. Meehan affirmatively lied when partners asked if he was
leaving
b. Dowd Steal old firms line of credit;
III.
SUB RULE FOR EXPULSION: Generally, partners can agree to anything they want
related to expulsion. However, the UPA imposes certain limitations on the general rule;
for example, partners cannot: (1) agree to anything that affects third parties; (2) vary
the courts right to expel a partner; or (3) vary a partners right to disassociate. [RULPA
retained this provision and adds that partners can be expelled by the unanimous vote of
remaining partners regardless of the reason.]
a. APPLICATION/CONCLUSION: Here, [partners] did (not) breach their duty when
they expelled [partner] by [action] because...
i. Note: Some states, including Illinois, require expulsion be made in good faith
and fair dealing.
IV.
1. Lawlis Lawlis was a drunken lawyer and got fired. He claimed that his
firm violated his duty of good faith because they fired him to increase
the partner/lawyer ratio.
a. The court said Lawlis loses because Indiana doesnt have
a duty of good faith requirement so the partners could
agree to whatever they want (and here they agreed
partners could be fired for any reason with a 2/3 vote).
Therefore, if they fired him because he was gay, it
wouldnt matter because the partnership agreement said
they could fire him for any reason.
Raising Additional Capital
a. There is no obligation on partners to contribute more money to the partnership
b. Often times, additional funds will be needed
i. All investors would be better off if each provided a pro rata share of the
amount needed
ii. However, each investor may act out of self-interest and decline to invest more
money (if this happens, everyone will lose b/c business will not raise the
money needed to continue and business will fail)
c. Solutions:
i. Pro rata Dilution: a common provision permits the managing partner to issue a
call for additional funds and provides that if any partner does not provide the
funds called for, her share is reduced according to a formula
ii. Penalty Dilution
PARTNERSHIP MANAGEMENT
I.
ISSUE IF WITHIN PARTNERSHIP: The issue is whether [partner] had authority to [do
what he did].
II.
RULE: Generally, partners have an equal share in management and bind the
partnership when acting within the ordinary course of business. However, a partners
13
authority can be limited by either: (1) the partnership agreement; or (2) a vote of a
majority of partners to strip the partners power. [When a partner acts outside of the
ordinary course of business, 100% vote of the partners is needed to authorize the
partners actions.]
a. APPLICATION/CONCLUSION: Here
i. Step 1: Did partner act within the ordinary course of business?
1. If so, partner had authority unless partners agreed to something
else.
ii. Step 2: What did the partners agree to? (Summers and Day)
iii. Step 3: Did the partners vote to change anything?
iv. Step 4: If so what percentage was required?
1. 100% vote needed to amend the partnership agreement.
2. UPA section 401(j) A majority is not measured on percentage of
ownership, but literally measured per person. (50% of partners plus
1 partner is a majority).
b. Summers v. Dooley Summers and Dooley had an equal share in a trash
collection partnership. Summers decided they needed a third employee, but
Dooley disagreed. Summers hired one anyway and tried to get the partnership to
foot the bill. Partnership agreement said 100% vote needed to hire someone.
i. The court said hiring an employee unilaterally violated the terms
of the partnership agreement and Summers couldnt change the
agreement because neither partner was a majority.
1. Note: A partnership may add new partners, but absent the
partnership agreement saying differently, such additions require a
unanimous vote of existing partners.
a. Policy: The partnership is a personal relationship and one
partner cannot require the others to accept a new co-owner.
c. Day v. Sidley Austin Day was head of new Washington Office but not on
executive committee. Sidley merged and promised no partner would be worse
off as a result of the merger. After the merger, Day sued because he was forced
to share his leadership of Washington office with new partner (he claims he was
worse off).
i. The court said the partnership agreement gave the executive
committee sole discretion to determine heads of offices. Sidley
could have fired Day before the merger so the merger didnt
change anything.
III.
ISSUE IF INVOLVING THIRD PARTY: The issue is whether [partnership] is liable to

[third party] for [partners] act/omission.
IV.
RULE: Generally, each partner is an agent of the partnership and a partners act is
binding on the partnership if done in the ordinary course of business. A partnership
cannot absolve itself of liability to third parties simply by agreement among the
partners, unless: (1) [partner] didnt have authority, and (2) [third party] knew [partner]
lacked authority.
a. Policy The reason partners cannot agree to something that affects third parties
is because third parties have no way of knowing of the agreement.
i. Example of affecting third parties: saying partners are not liable for
unpaid debts of the partnership
ii. No authority stems from partnership agreement or from UPA
where majority needed to bind.
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b. APPLICATION: Here
i. Step One: Analyze whether the partner acted within the ordinary course of
business.
1. Note: If the partner acted outside the ordinary course, the
partnership is never liable.
ii. Step Two: If he did, did the partners strip him of his authority and did the
TP know?
c. NABISCO case - Stroud and Freeman started a partnership. Stroud told NABISCO
he would not be personally liable for any bread sold to the store. Freeman
ordered more bread, NABISCO delivered and sued Stroud for payment.
i. The court said that Freeman buying bread was within the ordinary
course of business. There were no restrictions on his actual
authority. Stroud could not limit Freemans authority because the
partnership agreement was silent and because there were only
two partners, there could not be a majority.
1. SHOULD HAVE In the agreement, Stroud has the sole authority
to buy X Y Z If NABISCO knew this, they lose.
d. HYPO If there was a third partner involved and third partner owned 5%; Stroud
owned 5%; Freeman owned 90%, then Stroud and third partner could vote to strip
Freeman of his authority. The partnership would not be liable if NABISCO knew
Freeman lacked authority.
e. HYPO Same facts as Summers but employee sues the partnership for his
salary.
i. Partnership is liable because Summers had apparent authority to
hire the employee. If the employee knew the partner had no
authority, the partnership would not be liable (same situation as
NABISCO).
f.
CONCLUSION: Therefore, the partnership is (not) liable to [third party]
DISSOCIATION OF A PARTNER
I.
OVERARCHING ISSUE: Here, [partner] dissociated himself from the partnership

therefore the issue is whether his/her dissociation was wrongful such that he is liable for
damages.
II.
RULE/APPLICATION: A partner has the right to dissociate from a partnership at any

time, rightfully or wrongfully. In an at-will partnership, the dissociated partner will not
be liable for damages, while in a term partnership, it is more likely he/she will be liable
for damages. Here
a. NOTE: After the dissociation, the partner is not liable for new partnership debts, but
liable for old debts.
b. NOTE: After the dissociation, the partnership can continue (other partners might
want to continue).
i. *Look to Buyout section if necessary*
15
c. RECOMMENDATION: Dissociating partner should seek judicial dissolution instead of

dissociating. This is a way to shield partner from liability in case his dissociation
would be wrongful.
III.
CONCLUSION: Therefore, [partners] dissociation was (rightful/wrongful), and [partner]

will (not) be liable for damages.
JUDICIAL DISSOLUTION OF A PARTNERSHIP

I.
OVERARCHING ISSUE: Here, the issue is whether the court will grant []s request to
dissolve the partnership.
IV.
RULE: Judicial dissolution is a high bar and you cant ask the courts to get you out of
something you agreed to do. (Collins). Under section 801(5), a court will order
dissolution of a partnership and a partnership must be wound up when the court
determines that: [PICK ONE]
a. the economic purpose of the partnership is likely to be unreasonably frustrated;
b. another partner has engaged in conduct relating to the partnership business which
makes it not reasonably practicable to carry on the business in partnership with
that partner; or
c. It is not otherwise reasonably practicable to carry on the partnership business in
conformity with the partnership agreement.
V.
APPLICATION/CONCLUSION: Here, the court will (not) order dissolution because

a. Order of Liabilities: creditors, debts to partners, capital to partners, profits to
partners
b. Owen v. Cohen Owen and Cohen entered into a partnership to own a bowling alley.
Owen sought dissolution of the partnership claiming Cohen belittled him in front of
customers.
i. The court dissolved the partnership because, this was more than
petty discord; Owen behaved so badly that cooperation and
confidence between the parties had been destroyed.
c. Collins v. Lewis Collins and Lewis entered into a partnership to build and operate a
cafeteria. Collins was supposed to put up the money and Lewis was supposed to be
the manager. Initially estimates were $300,000 but once the cost rose to $600,000,
had enough and sued for dissolution and repayment of the debt.
i. The court said Collins had no right to dissolve the partnership and no
right to judicial dissolution.
d. RECOMMENDATION: Get a cap. Collins had a crappy lawyer and the agreement
had no cap. Collins had to put up as much money as was necessary to build the
cafeteria so Collins was stuck with it.
BUYOUT AGREEMENTS IN A PARTNERSHIP

Two reasons for buyout agreements:
- To restrict who can become a fellow owner
- To give partners the ability to exit
16
I.
OVERARCHING ISSUE: The issue is whether [partnership] has an obligation to buyout

[partners] interest.
II.
RULE: A buyout is an agreement that allows a partner (or his estate) to end his
relationship with the partnership and receive an asset in return for his interest. A
partnerships obligation to buyout an investor is triggered when: (1) a partner dies; (2) a
partner is disabled; or (3) at the will of any partner.
III.
APPLICATION:
a. Restrict who can be a fellow owner and give yourself and opportunity to exit. Cannot
bring in new partner without consent of 100% of partners under UPA.
b. In agreement, think about triggering event and price. What is the method of
payment? Collateral if going to be paid overtime.
c. Here, the agreement states that [partnership] must
IV.
CONCLUSION: Therefore, the partnership does (not) have an obligation to buyout

[partners] interest and can do so by paying either the book value or set value in cash
or installments.
a. Note: Is there any protection against debts of the partnership? Look to agreement.
LIMITED LIABILITY PARTNERSHIP

I.
OVERARCHING ISSUE: The issue is whether [limited partner] is liable to [third party].
II.
RULE: Typically, general partners are subject to personal liability, and limited partners
are only liable for the amount of money they put into the partnership. However, limited
partners can become liable if they act as general partners by exercising sufficient
control over the business.
a. **In Illinois: [If a contract suit and RULPA applies say: In addition to control,
RULPA requires a plaintiff prove he: (1) transacted business with the limited partner,
and (2) reasonably believed the limited partner was a general partner.]
i. Note: RULPA helps limited partners a lot. There is no tort exposure and even
if the limited partner has control, they still will not be liable unless there was
reliance by a third party.
ii. Note: A general partner can be a corporation.
iii. Only contract creditors can sue pg under RULPA
III.
APPLICATION: Here...
a. Holzman v. De Escamilla Russell and Andrews were limited partners in a farm. De
Escamilla was the general partner. Farm went bankrupt and creditors wanted to hold
Russell and Andrews personally liable.
i. The court held that Russells and Andrews were acting general
partners because they:
1. Decided what was planted on the farm;
2. Had full access to the partnerships bank account;
3. Escamilla could not withdraw checks without the two limited partners;
4. Russell and Andrews asked that Escamilla resign.
17
ii. Note: if RULPA was in effect, Russell and Andrews would not have been liable
because the creditors did not have a reasonable belief that Russell and
Andrews were general partners (they did not know about the four things
above).
b. HYPO What if the farm truck ran someone over and you represent that person.
Could you collect from the limited partners under RULPA? NO! RULPA says you
have to transact business with the limited partners.
i. RULPA is limited to contract situations, not torts.
IV.
CONCLUSION: Therefore, [limited partner] is (not) liable to [third party].
LIMITED LIABILITY COMPANIES

I.
Attributes of a Limited Liability Companies (LLC)

a. Owners are called members, not shareholders or partners
b. No Board of Directors LLCs have Board of Managers or can choose to run the
business themselves and have no managers.
i. Managers may be members or non-members
1. Note: Managers/Members can act either formally or informally.
Regardless, to pass a measure or to approve something, only a
majority vote is needed.
a. Different from corporation corporations need unanimity
when acting informally.
II.
Default Rules In absence of an agreement or contract, look to the DE Rules

because they are sensible.
a. Delaware Rules Similar to corporate law in that you get one vote per share.
Profits distributed according to shares owned.
b. Illinois Rules Professor doesnt like these.
i. In Illinois, you have one vote per member. Even if one puts in 90% of the
money and the other puts in 10%, they have equal voting rights. Likewise,
all members receive equal payment on distribution (like a dividend).
ii. You need 100% vote for new members. If there are 10 members and
someone new wants to invest, they cant unless all 10 members agree.
III.
RECOMMENDATIONS WHEN DECIDING WHETHER TO FORM AN LLC:

a. Advantages
i. Its a hybrid. It has the best feature of a partnership (no double tax) and
the best feature of a corporation (limited liability).
b. Disadvantages
i. It costs more to create an LLC than a corporation
ii. It is more unpredictable because there is a lack of case law.
1. Note: No matter what, if you are negligent and hurt someone, you
are liable. It doesnt matter if you were acting as president of the
18
company. There are a lot of benefits of the LLC, but protecting you
from torts is not one of them.
c. If you do form an LLC, have an agreement, especially in Illinois to counteract the
bad rules.
Piercing the LLC Veil

I.
ISSUE: The issue is whether [Plaintiff] can pierce the LLCs veil to hold [Defendant
Member(s)] personally liable.
II.
RULE: As the court stated in Kaycee, piercing an LLCs veil is possible. Just like
piercing the corporate veil, a plaintiff must show: (1) total dominion; and (2) that a
failure to pierce would permit a fraud or promote injustice. Proving total dominion is
more difficult in this scenario because LLCs are not required to have the same level
of formality as corporations. However, like piercing the corporate veil, this is a fact
intensive inquiry to determine whether piercing is equitable.
III.
APPLICATION: Here
a. There is (not) total dominion because:
i. The members did (not) ignore formalities [Judicial reluctance to use
this factor]
1. Not relevant that LLC does not observe formalities
2. Did the company fail to maintain adequate records?
ii. The members did (not) commingle the LLCs funds
1. Was there a distinction between LLC and personal bank accounts?
a. Did the members pay for personal expenses out of the
business account?
iii. The members did (not) undercapitalize the LLC at the time the LLC was
formed
1. An LLC should be formed with enough capital to cover all
foreseeable issues.
2. Members should have enough skin in the game to have an
incentive to run the business with care.
a. Note: A lack of capital at the time of the lawsuit, alone, is not
sufficient to pierce. Obviously, if there was enough capital
there would be no lawsuit because the creditors would get
paid.
b. Note: Amount of money for adequate capitalization depends
on the business.
b. Failure to pierce would (not) permit a fraud or promote injustice because:
i. The members did (not) undercapitalize the LLC
1. An LLC should be formed with enough capital to cover all
foreseeable claims.
2. Members should have enough skin in the game to have an
sufficient to pierce. Obviously, if there was enough capital
19
there would be no lawsuit because the creditors would get

paid.
b. Note: Amount of money for adequate capitalization depends
on the business.
ii. The members did (not) mislead creditors
1. Before investing in an LLC, it is wise for creditors to look into the
businesss financial records. If members mislead creditors (i.e. by
filing false statements), creditors can likely PCV.
iii. The members did (not) engage in asset stripping
1. Where the LLC pays members and, as a result, the LLC doesnt have
any money to pay creditors. Its like the LLC is hiding money from
the creditors who have a legal right to it.
iv. Not enough that there are common directors and officers in a
parent/subsidiary relationship
1. This shouldnt be relevant (Silicone Breast Implants mentioned this
as a factor, but Professor said they were wrong to do so).
IV.
CONCLUSION: Therefore, [Plaintiff] can (not) pierce the LLCs veil to hold
[Defendant Member(s)] personally liable.
CORPORATIONS
INTRODUCTION
I.
Types of Corporations
a. Publicly Owned A corporation whose shares are traded on a public market (i.e.
NYSE)
b. Privately Owned A corporation where no market exists for its shares and relatively
few shareholders
II.
Structure
a. Separate Legal Entity
i. A corporations assets and liabilities are its own
ii. Creditor of a corporation has no claim against a shareholders for a
corporations debt (unless PCV)
iii. Creditor of a shareholder has no claim against a corporation for a
shareholders debt
b. Shareholders
i. These are the owners of corporations. Their main job is to elect the Directors.
ii. Shareholders also amend the articles of incorporation when needed.
iii. Stock:
1. Common Stock There is always common stock
2. Preferred Stock Stock slip can say many things, but usually: (1) no
dividend can be paid on common stock until it is paid on preferred
stock; and (2) the preferred stock gets par value back in liquidation
before common stock.
iv. Shareholders can act formally meetings or informally through written consent
c. Directors
i. They manage the corporation. Their main job is appointing the Officers and
setting their salaries.
20
ii. They do not run the day-to-day operations, but set corporate policies and do
major transactions.
iii. Make enterprise decisions
iv. Directors can act formally at meetings or informally through written consent.
Typically 100% consent is needed because directors have a right to know what
other directors are doing.
v. Vote in meeting: Majority of Dirs constitutes quorum and majority of quorum
is needed for decision.
vi. Directors have authority to set up committees.
1. The executive committee is typically given all the powers of the board
itself because it is inconvenient to have the entire board get together
all the time.
d. Officers
i. Employees who are hired by the Directors to run the day-to-day operations of
the corporation.
ii. Officers are actual agents of the corporation and MIGHT have actual and
apparent authority.
1. EX: Officers have actual authority to borrow money. But how much
they can borrow is a different question.
III.
How to Form a Corporation

a. Filing
i. You need to obtain a form from the secretary of state, called articles of
incorporation and send it in.
ii. Fill in the name of the company, number of authorized shares, initial board of
directors
b. Bylaws
i. After filing the corporation sets bylaws which set forth internal procedures.
ii. Bylaws contain things like: (1) how corporation will call meetings; (2)
requirements for a quorum; (3) percentages required for shareholder/director
actions; and (4) how to amend the bylaws.
IV.
Recommendations: What Should People Discuss When Setting Up a

Corporation?
a. Where will you incorporate your business?
i. You should incorporate in Delaware because:
1. The law is more predictable because there is a special court for
business litigation
2. Plaintiffs like Delaware because courts rarely dismiss lawsuits and
directors of DE corporations are automatically subject to its jurisdiction.
3. Defendants like Delaware because Delaware has no juries.
ii. Note: No matter where you incorporate, you can do business in any state.
b. How will you capitalize your business?
i. You should have enough skin in the game to prevent a PCV claim.
c. How to allocate control
i. Typically one share one vote, but this can be altered
d. Different classes of stock? Preferred, common, voting/non-voting etc.
e. Form a close corporation?
i. If so, how will you run it? (Will you have a board of directors or will
shareholders run the business?)
ii. How will you ensure you will be a director
1. Pooling Agreement
2. Shareholder Agreement
iii. How will you ensure you will be an officer
1. Can agree if no minority
21
2. In Illinois, can agree if no objecting minority

3. Employment agreement guaranteeing position and salary
iv. Whether unanimous consent of directors will be needed for action
1. Minority shareholder should require unanimous consent (maintains veto
power)
2. If not, will other director need notice?
v. What happens if someone wants to leave?
1. Right of first refusal
2. All shareholders should get a buyout provision to avoid litigation
vi. Freeze-out protection (for minority shareholders)
1. Minority veto power
2. Russian Roulette agreement
3. Employment agreement
4. Buyout Agreement
a. What will the trigger be?
b. How will you determine the price Appraisal rights
f. What happens to shares in event of death or incapacity?
i. Buyout Agreement
1. What will the trigger be?
2. How will you determine the price Appraisal rights
g. You should probably form an S corporation Professor loves these because of
taxation and limited liability
CORPORATIONS BY ESTOPPEL (promoters)

Scenario 1 in Contract: Bob thinks he created a corporation, but in reality, he didnt
because he messed up the paperwork. Bob enters into a contract with Steve and Bob defaults
on the contract. Steve finds out there is no real corporation and tries to hold Bob personally
liable (because Bob has deep pockets). STEVE CANT!
Scenario 2 in Contract: Same facts but Steve defaults. Bob sues Steve and Steve tries to
defend by saying the contract was void because there was no corporation. STEVE CANT!
Scenario in Tort: Bob thinks he created a corporation, but in reality, he didnt because he
messed up the paperwork. Bobs delivery driver runs Steve over. Steve wants to hold Bob
personally liable. STEVE CAN!
I.
ISSUE: The issue is whether [plaintiff/defendant] is estopped from denying the

existence of a corporation.
II.
RULE: Where a party has contracted with a corporation, and is sued upon contract,
neither party is permitted to deny the existence or the legal validity of such corporation.
In tort, however, the plaintiff can deny the existence of a corporation and hold the
defendant personally liable.
a. Corporation by estoppel doctrine one who contracts with what he acknowledges to
be and treats as a corporation, incurring obligations in its favor, is estopped from
denying its corporate existence
III.
APPLICATION: Here
a. Southern Gulf Marine P held himself out as a corporation even though he had not
yet filed his corporation papers. Ps corporation entered into a contract with D
22
who then defaulted on the contract. When sued for breach, D argued that the
contract was void because no such corporation existed.
i. The court upheld the contract and estopped D from denying the
existence of the contract.
b. RECOMMENDATION: D should have put the wealthy owner on the contract. Just
because a corporation is formed by a credit-worthy person, it does not mean the
corporation is credit-worthy because the corporation, itself, might not have any
money. Must keep the wealthy individual on the hook.
c. Promoters: Person that identifies a business opportunity and puts together a deal,
forming a corporation as a vehicle for investment by other people.
i. Fiduciary duties to TP for pre-incorporation commitments
1. If promoter knows corp has not been formed, he is personally liable if it
has not
2. If promoter believes corp has been formed but is not, corp does not
exist and he may be relieved of personal liability
ii. Courts may treat as corp if promoter:
1. Acted in good faith in trying to incorporate
2. Legal right to incorporate and
3. Acted like a corporation
d. De facto corporation doctrine:
i. Courts may treat a not properly incorporated as a properly incorporated Corp,
if the promoter:
ii. In good faith tried to incorporate;
iii. Legal right to incorporate; and
iv. Acted like a corporation
v. Advice to seller: require time to incorporate and limit terms in order to get
out if the deal becomes unattractive; make sure corp is adequately capitalized
vi. Advice to buyer: specify in new agreement when corp is formed;
specify what occurs if corp never forms at all
IV.
CONCLUSION: Therefore [plaintiff/defendant] is (not) estopped from denying the

existence of a corporation.
PIERCING THE CORPORATE VEIL

IN PUBLIC CORPRORATIONS This applies to directors, officers, or major shareholders
(those who control the board). This is a form of partial piercing to get at the inner-core of
ownership and control.
a. Note: Stockholders of a public company will never be personally liable.
IN PRIVATE CORPORATIONS This may apply to shareholders, directors or officers
TRADITIONAL SCENARIO: Creditor of a subsidiary goes upstream to pierce a parent.
REVERSE PIERCING SCENARIO: Parent owns S1 and S2. Creditor of S1 pierces upstream to
the parent and then reverse pierces downstream to S2.
ENTERPRISE SCENARIO: Parent has multiple subsidiaries. Plaintiff sues one of the
subsidiaries, but they have no assets, so P wants to pierce to get at the parents assets. If
Plaintiff is unable to pierce, he can try an alternative theory: the enterprise theory. This wont
23
allow him to get at the parents assets but it will allow him to get at the assets of ALL the
subsidiaries because this theory treats all the subsidiaries as one company.
I.
OVERARCHING ISSUE: The issue is whether [Plaintiff] can pierce the corporate veil to
hold [Defendant] personally liable.
II.
RULE: In order to pierce the corporate veil, a plaintiff must show: (1) total dominion;
and (2) that a failure to pierce would permit a fraud or promote injustice. Courts
sometimes use the enterprise theory to disregard multiple incorporations of the same
business under common ownership. This is a fact intensive inquiry and there is a strong
presumption against piercing the corporate veil.
III.
APPLICATION: Here . . .
a. There is (not) total dominion (alter-ego) because: [parent-subsidiary piercing]
i. The defendant did (not) ignore corporate formalities
1. Did the corporation fail to maintain adequate records?
2. Did the shareholders sign corp, agreements with their own names/not
use corp. titles?
3. Did the corporation hold meetings in shareholder/directors offices?
4. Did the corporation fail to hold annual shareholder meetings?
5. Application: 1) if disregard corp form = should not benefit from limited
liability, (2) disregard corp. form = may indicate that creditors were
misled (3) no formalities = SH disregard corp. obligations
ii. The defendant did (not) commingle corporate funds
1. Was there a distinction between corporate and personal bank accounts?
a. Did the corporation (parent) pay the salaries and expenses of the
subsidiary?
b. Did the corporation (parent) use the subsidiarys property as its
own?
c. Did the shareholders (sometimes this is a parent company) pay
for personal expenses out of the corporate account?
2. Application: commingling accounts = disregard creditor interests
iii. The defendant did (not) undercapitalize the corporation at the time
the corporation was formed
1. Amount of money for adequate capitalization depends on the business.
A riskier business needs more money, but no bright-line test.
2. A corporation should be formed with enough capital to cover all
foreseeable issues.
3. Shareholders should have enough skin in the game to have an
iv. All of the following are proper and dont indicate total dominion
1. The parent and the subsidiary have common directors and officers
a. This is very common in a parent/subsidiary relationship and is
almost automatic.
2. The parent and the subsidiary have common business departments
a. EX: having one legal department for both the parent and the
subsidiary. Its more cost effective to have one department and
share them.
24
3. The parent and the subsidiary file consolidated financial statements and
tax returns
a. This is frequently required by law
4. The parent finances the subsidiary
a. Common practice
5. The parent caused incorporation of the subsidiary
a. Common practice. This is what happens when you form a
subsidiary
6. The subsidiary receives no business except that given to it by the
parent
a. Where a subsidiarys business is closely related to the parent, the
parent often sends business to the subsidiary.
b. Failure to pierce would (not) permit a fraud or promote injustice because:
[Look for abuse of creditor expectations or excessive business risk]
i. The defendant did (not) undercapitalize the corporation
1. A corporation should be formed with enough capital to cover all
foreseeable claims.
2. Shareholders should have enough skin in the game to have an
sufficient to pierce. Obviously, if there was enough capital there
would be no lawsuit because the creditors would get paid.
b. Note: Amount of money for adequate capitalization depends on
the business.
3. Shell Corporation formed just to take on liability
4. Recommendation for corp: at least have minimum required
insurance insurance
ii. The defendant did (not) mislead creditors
1. RECOMMENDATION for corp: Dont incur more debt when insolvent.
2. RECOMMENDATION for creditor: Before investing in a corporation, it
is wise for creditors to look into the businesss financial records. If
shareholders mislead creditors (i.e. by filing false statements), creditors
can likely PCV.
iii. The defendant did (not) engage in asset stripping
1. Where the corporation pays stockholders or the board of directors and,
as a result, the corporation doesnt have any money to pay creditors.
Its like the corp. is hiding money from the creditors who have a legal
right to it.
2. Continuing to take on debt in time of insolvency
3. RECOMMENDATION: Dont make distributions of assets while
insolvent.
iv. Not enough that there are common directors and officers in a
parent/subsidiary relationship
1. This shouldnt be relevant (Silicone Breast Implants mentioned this as a
factor, but Professor said they were wrong to do so).
c. 3rd Prong for Piercing Corp Veil: First 2 are mandatory, but there may be an optional
3rd:
i. Total dominance by shareholders -> unity of interest and ownership such that
separate personalities of corp and shareholder no longer exist
25
d. Piercing the corporate veil is HARDER in contract claims and EASIER in tort
claims
i. Contract Claims Contract creditors have a hard time PCV since they
entered into the agreement and could have found out about the total
dominion or fraud/injustice (Frigidaire).
1. RECOMMENDATION: The creditors should have looked into the
situation and at the very least, got a shareholder guarantee before they
gave the corporation money.
2. This is especially the case if the plaintiff is sophisticated (not a
babe in the woods).
ii. Tort Claims Corporate veil is more likely to be pierced because individuals
were harmed or injured. Ex: corporation owes a tort judgment and retail
customers.
iii. Enterprise Theory: Walkovszky v. Carlton D was the sole shareholder of 10
different cab companies that he set up as different corporations. One of the
cabs hit P. Since the cabs only carried minimum insurance, P wanted to hold
D personally liable.
1. DISSENT D set up the 10 corporations this way to avoid
liability and that the cabs were intentionally undercapitalized.
So, it is equitable to allow P to go after D.
a. Professor agrees with the dissent
2. RECOMMENDATION: PCV under the enterprise theory
a. Enterprise theory is more likely when the mangers who run the
asset corporation also run the risk corporation
iv. Sea-Land Services v. Pepper Pepper Source defaulted on a shipping contract
with Sea-Land. Pepper Source had no assets so Sea-Land sued Pepper
Sources owner, Marchase, and all other corporations Marchase owned (this
was reverse piercing).
1. Sea-Land proved total dominion because
a. The corporations never held a single corporate meeting
b. Marchase borrowed corporate money interest-free to pay
personal expenses
c. Marchase never passed bylaws, articles of incorporation or other
agreements
d. The physical facilities for all of Marcheses corporations were the
same.
2. Court remanded for more facts on fraud or injustice element
a. Judge Bauer stated that injustice means something less than
fraud, but more than simply not being able to pay your debt.
3. RECOMMENDATION: Reverse pierce to become a creditor of the
owners other corporation. This will put you in a senior position to
receive the money owed to you. Otherwise, you are basically just
garnishing the owners wages and he doesnt get paid until all the other
creditors get paid.
26
v. Estoppel Theory: refers to situations where there has been an abuse of

corporate privilege, because of which the equitable owner of a corporation will
be held liable for the actions of the corporation
1. In re Silicone Gel Breast Implants Case - Bristol Corporation (parent)
bought MEC (subsidiary). P bought a breast implant made by MEC. MEC
had minimal assets so P sued Bristol Corp.
2. P proved total dominion because
a. MEC went a long periods without board meetings
b. Bristol made financial decisions for MEC and approved
MECs budget
c. Bristol set up MECs employment policies
d. Bristol paid MEC employee salaries
e. Bristol used MECs property as its own
f. MEC was undercapitalized
3. Court didnt analyze the second element, but it was
WRONG to do so.
vi. Frigidaire Sales v. Union Properties Frigidaire entered into a contract with
Commercial LLP and Commercial breached.
1. Commercials general partner = Union Properties Corporation
2. Commercials limited partners = B and M
3. Union Properties Corporation Sole Shareholders = B and M
a. The court said that Frigidaire is not allowed to pierce
Unions veil and hold B and M liable. This is an example
of hesitance to PCV in a contracts case. Frigidaire would
have known Commercial was set up this way had they
used due diligence.
i. Note: You are deemed to know what you could have found
out if you used due diligence.
ii. When SHs of a corporation, who are also the corporations
officers and directors, conscientiously keep the affairs of
the corporation separate from their personal affairs, and
no fraud or manifest injustice is perpetrated upon third
persons who deal with the corporation, the corporations
separate entity should be respected
IV.
CONCLUSION: Therefore, [Plaintiff] can (not) pierce the corporate veil to hold
[Defendant] personally liable.
27
DERIVATIVE OR CLASS ACTION?

I.
OVERARCHING ISSUE: Because this is a suit by shareholders against directors of a

corporation, the first issue is whether the suit is a derivative action or a class action.
II.
RULE/APPLICATION: A class action is a private right of action where shareholders sue

the directors of the corporation for their own personal benefit (the directors harmed
shareholders personally), whereas a derivative action is where shareholders sue the
directors on behalf of the corporation for its benefit (the directors harmed the
corporation). Here . . .
i. Note: If some but not all shareholders are hurt, this would be a class action,
not a derivative suit.
ii. Note: In rare cases a derivative suit can result in plaintiff getting their own
damages. This happens when the bad guy owns most of the stock so money
to the corporation is really like money to him and he should not recover.
(Pearlman v. Feldmann)
iii. Two ways of solving a derivative action: (1) non-monetary judgment; and (2)
indemnification.
1. Collusive Settlement When the lawyer is the real winner, the plaintiffs
recovery is just window dressing and the lawyer gets his big fee paid for
by the corporation.
a. Lawyers do not want to risk losing so they are incentivized to
settle
b. Directors do not care because corp. indemnifies them for fees
and there is no monetary judgment
III.
OVERARCHING CONCLUSION IF CLASS ACTION: Therefore, because this is a class

action, the procedural issues involved in a derivative suit are inapplicable, and we can
proceed to the merits of the case.
IV.
OVERARCHING CONCLUSION IF DERIVATIVE SUIT: Therefore, because this is a

derivative suit, the next issue is whether [Plaintiff] has met the procedural
requirements.
DERIVATIVE SUIT PROCEDURAL REQUIREMENTS

I.
OVERARCHING ISSUE/RULE: In order to properly bring a derivative suit, [Plaintiffs]

must: (1) make a demand or show such a demand would be futile (if the state permits);
and (2) post security if required by state law.
II.
APPLICATION FOR DEMAND: Here [Plaintiff] did (not) make a demand. [In DERec.
no demand]
Demand required
Demand Excused
Board decides fate of claim, subject to

review under BJR
Claim goes forward; board cannot
dismiss
a. Option if Demand Made Because the board rejected the demand, in Delaware,
Plaintiff cannot argue the futility exception because it is waived. Therefore, if
Plaintiff decides to continue with the derivative suit, they must allege specific facts
to show the board is not entitled to the business judgment rule and the suit will likely
be dismissed.
28
i. DE 102(b)(7) In Delaware, the exculpation provision provides that directors

are not personally liable for negligence (duty of care) so the plaintiff would
have to allege the directors breach of the duty of loyalty to show futility
(Stone v. Ritter).
1. Cannot sue for being careless
2. If all P is alleging that BOD is negligent and not capable of making
independent then CANNOT overcome exculpation provision
3. Must allege breach of loyalty
b. Option if No Demand Made Because demand was never made, Plaintiff must
argue demand is excused because of futility. In a state that recognizes the futility
exception (DE), a demand is futile if there is a reasonable doubt that (1) the
majority of the board is incapable of making an independent decision on whether to
bring the claim or (2) doubt that the challenged transaction was protected by BJR by
showing conflict of interest, bad faith, grossly uninformed decision making, or
significant failure of oversight. Look to:
i. Interested Transaction. Does the board have a financial or familial interest?
1. Would a majority of the board be financially harmed by the action?
2. BOD not independent because someone has control over them?
a. EX: A lawsuit is saying CEO is doing terrible things. A majority of
directors are under the CEOs thumb. So if you can show that a
majority of the board will do whatever the CEO says, demand
would be futile.
ii. Waste. Is the underlying transaction the product of a valid exercise of
business judgment?
iii. Futility is not satisfied just because the plaintiff sues all directors. There must
be a substantial likelihood that they would all be liable (Grimes v. Donald).
c. CONCLUSION: Therefore, [plaintiff] did (not) prove demand would have been futile
and this procedural requirement is (not) met.
i. ISSUE/RULE IF FUTILITY MET (INDEPENDENT COMMITTEE): Even though
the plaintiff has proven futility, this exception can be abused (forcing a
corporation to spend a lot of time and money to fight the suit).
Thus, a
corporation can form an independent litigation committee to make a decision
on whether to recommend to the court that the derivative suit be terminated.
1. Option if no committee formed Here, the corporation never
formed an independent committee.
Therefore, the next issue is
whether [plaintiff] was required to post security.
2. Option if the Committee does not recommend dismissal Here
the committee recommended the case proceed. Therefore, the next
issue is whether [plaintiff] was required to post security.
3. Option if the Committee recommends dismissal Here, the
committee recommended dismissal. Therefore, the court will look to
whether the committee was in fact independent. The committee has a
very high burden of establishing its independence. [Moreover, because
we are in Delaware, the second step established in Zapata requires
the court apply its own business judgment to determine whether the
decision of the committee was made in good faith pg. 247.]
i. Note: New York does not have the second step and
Professor thinks the second step is ridiculous because the
29
court requiring a committee be independent but then does

not trust the committees recommendation is silly.
Committees know more about business than judges do.
b. APPLICATION: Here, the court will likely find the committee was
(not) independent because
i. If independent: recommendation entitled to full judicial
deference under the BJR
c. CONCLUSION: Therefore, the court will likely (not) dismiss the
derivative action based on the committees recommendation.
ii. RECOMMENDATION TO CORPORATION:
1. Form a truly independent committee because if the independent
committee recommends dismissal, the court will likely dismiss the case
against you.
III.
ISSUE/RULE FOR SECURITY: Many state statutes require certain shareholders provide
security for the corporations expenses in a derivative action.
i. Application/Conclusion if State Statute: Here, the [state] statute requires
[certain shareholder] post ______ security to cover the corporations expenses.
Therefore [plaintiff] did (not) meet this requirement because he did (not) post
the requisite security.
1. Note: The policy reasons for requiring security is twofold: (1) to prevent
frivolous lawsuits; and (2) shareholders bringing a derivative suit are
taking on a fiduciary duty to act in the best interest of the corporation
and must be held accountable if they cause the corporation to incur
costs.
ii. Application/Conclusion if No State Statute: Here, the facts do not
indicate that there is any such statute, such that we assume that no security
is required.
iii. RECOMMENDATION: Recommend that a plaintiff see if security is required
and see if the plaintiff wants to pay for this requirement.
IV.
OVERARCHING CONCLUSION: Therefore [Plaintiffs] did (not) clear the procedural

requirements of a derivative suit [and the case can proceed to the merits].
MERITS #1 - ROLE AND PURPOSE OF CORPORATIONS

I.
OVERARCHING ISSUE: The issue is whether [what the corporation did] was proper.
II.
RULE: The purpose of corporations is to make money for shareholders. Therefore, a

court will likely overrule actions that are made for non-business purposes (i.e. personal
or moral reasons).
III.
APPLICATION: Here
a. Did the corporation make a charitable donation? (AP Smith)
i. Cant be a pet charity
ii. Cant be anonymous
b. What was the corporations stated purpose? (Dodge, Shlensky, and Salami Hypo)
i. RECOMMENDATION its very important how the corporation frames the
decision to do what it did. As a lawyer, it is important to tell your client to be
careful with the corporations words.
ii. Note: corp. has the power to make donations; good for PR/community
relations
30
c. AP Smith v. Barlow Corporation donated $1,500 to Princeton.

Shareholder
challenged the donation.
i. The court allowed the donation because: (1) charitable donations
increase good will; and (2) Princeton has a great business program
and by donating, the corporation is really recruiting.
1. Note: anonymous donations are not allowed because you are not
building good will.
2. Donations to pet charities are also not allowed.
a. EX: your Companys earnings are about $1 million and you make
a $100,000 donation to your best friends charity.
This is
probably a pet charity because its the guys friend and that is a
lot of money to give away for a company making $1 million.
d. Dodge v. Ford Ford lowered the price of cars and withheld profits in order to use
the money to build a new plant. Both of these actions resulted in lower dividends.
i. The court allowed Ford to withhold money for the new plant because
there was a legitimate business purpose (i.e. to increase efficiency).
ii. The court did not allow the lowered car price because Ford did not
state a business reason (i.e. that it would increase sales), but rather
said that every man should own a car.
e. Shlensky v. Wrigley Shareholder of the Cubs sues Wrigley for refusing to put in
lights. He says the Cubs are losing profits because night games are more profitable.
i. The court allowed Wrigleys actions because he said that night
games would lower the neighborhood property values and therefore
potentially decrease attendance and revenue. This was a legitimate
business concern.
f.
Salami HYPO Bill only wants to use high quality, expensive ingredients in his
salami. Shareholder sues saying he should use the cheaper ingredients to increase
profit margin. How should an attorney advice Bill?
i. Say if we dont make a high quality product, customers will leave and we will
lose money.
ii. Dont say this is my familys business and I just cant sleep if we dont make
a high quality product.
MERITS #2 -
DUTY OF CARE
OF OFFICERS AND DIRECTORS
Duty of care cases occur when there is no adverse interest. The directors are not feathering
their own nest.
If feathering nest is a concern analyze duty of loyalty also!
I.
OVERARCHING ISSUE:
The issue is whether [director/officer] breached his/her
fiduciary duty of care when [they did what they did].
II.
RULE: Generally, directors and officers receive the benefit of the business judgment
rule, which creates a presumption that the directors acted with procedural due care
and loyalty. However, a plaintiff has burden to overcome this presumption if they prove
a breach of due care by showing: (1) waste; (2) irrational behavior; or (3) uninformed
decisions. Pg. 356.
31
a. Policy Directors and Officers decisions are discretionary and because judges are
not business experts, they will not second-guess their decisions if they used the
proper procedural steps.
i. Note: It is very hard for plaintiffs to overcome the presumption of procedural
due care because it doesnt matter if the directors or officers made a bad
decision or mistake.
What matters is whether they took reasonable
procedural steps to reach that decision.
1. It strikes a balance between businessmen running their business and
dishonest directors.
2. BOD not liable for ordinary negligence, must be gross negligence
b. Overcoming presumption:
i. Plaintiff must show fraud, conscious disregard of duties, condoning of illegal
activity, or conflict of interest
III.
APPLICATION: Here, Plaintiff did (not) overcome the presumption of care created by
the BJR because the board did [say the procedural things that they did or failed to do
with care when making their decision].
a. Did the board:
i. Make an informed decision?
1. Acquiring a rudimentary understanding about the business
2. Keeping informed about the corporations activities
a. This doesnt inspection of day to day activities, but just a general
monitoring of corporate policies and affairs.
i. EX: Directors dont have to audit corporate books, but
they should maintain familiarity with the financial
statements
b. Inquire about managements competencies and loyalty
3. Shop around
4. Hire an investment banking firm to make sure the offer is for a good
price
ii. Act in good faith?
1. DE 141(e) If directors or officers rely on good faith on corporate
records or informal reports, they will be protected under the business
judgment rule.
iii. Have an honest belief?
1. DE 141(e) If directors or officers have an honest belief based on
corporate records or informal reports, they will be protected under the
business judgment rule.
iv. Waste removed from the realm of reason
1. Board approves transaction in which corp. gets no benefit
v. Was there board inattentive to corporate illegality?
1. Failure to be attentive to corporate illegality may beach duty of good
faith (subset of duty of loyalty)
2. When there are indications corporate activities may be illegal, the case
for having a monitoring system is strong.
b. Kamin v. AmEx AmEx bought stock of a company for $30 million. The stock was
now worth $4 million. AmEx distributed stock to shareholders. Shareholders sued
because they disagreed with AmExs decision.
32
i. The court gave AmEx the benefit of the business judgment rule
because alleging that some other course of action would have been
more advantageous is not enough to overcome the presumption.
c. Smith v. Van Gorkom Van Gorkom wanted to sell his company. He met with one
buyer and they agreed on a deal. Van Gorkom then called a special board meeting
to approve the sale and provided the board with a short 20-minute presentation but
no documentation. The directors approved the deal and shareholders sued saying
that Van Gorkom breached his duty of care.
i. The court held the directors personally liable and did not give them
the benefit of the business judgment rule because the boards
decision making process (procedure) was flawed because they were
not adequately informed.
1. RECOMMENDATION: the board should have hired an investment
banker to review the offer and shop for other buyers.
a. Note: The company didnt need to get the best price possible for
the sale, but needed to take the proper steps to make a welladvised decision.
ii. Legislative Response to Van Gorkom (DE Section 102(b)(7))
1. Now, in DE, directors (not officers) wont be personally liable
for a breach of the duty of care to the corporation (i.e. in
derivative actions not class actions).
a. The directors can still be personally liable to:
i. third parties (i.e. shareholders in class actions) because
there is no exculpation in these situations
ii. breaches of duty of loyalty
iii. acts or ommissions not in good faith or that involve
intentional misconduct or knowing illegality
iv. approval of illegal distributions
v. obtaining a personal benefit (insider trading
b. This change works to induce other directors to work for DE
corporations because they wont face losing all of their assets in
a derivative action.
2. Note: exculpation statute does not affect equitable relief or officers who
can still be liable for their gross negligence
d. In re Walt Disney Disney shareholders brought a derivative suit because Disney
paid Ovitz a ton of money to be their president and then fired him a year later giving
him a $130 million severance package.
i. No breach of duty of care
1. Distinguished from Van Gorkom Unlike the directors in Van
Gorkom, here, the Disney Board had done enough homework and
reviewed enough expert analysis to be protected by the BJR.
ii. No breach of duty of loyalty (good faith)
iii. RECOMMENDATION TO THE DISNEY BOARD
1. The board should have had meetings, written material presenting the
implications of the agreement and should have documented this
information in the minutes.
a. Note: This was a compensation decision and is the inner
sanctum of what the board was designed to do. The court is not
going to second guess the boards decision.
iv. RECOMMENDATION TO THE DISNEY SHAREHOLDERS
1. Sell your shares if you dont like the decision.
33
e. Francis v. United Jersey Bank Father and sons ran a business. Father died and
mother elected to the board. While the mother was bedridden, sons stole money.
The corporations bankruptcy trustee sued the mother for breach of care.
i. The court did not give the mother the benefit of the business
judgment rule because the mother: (1) knew nothing about the
business; (2) didnt attend meetings; and (3) didnt attempt to learn
anything about the business.
1. Note: the mother need not inspect the corporations day to day
activities, but just needed generally monitor the corporations policies
and affairs.
a. The mother should have resigned because she owed the
corporation a duty of care from day one so on the job
training would not have made a difference.
ii. Note: If the company had adopted the DE legislative language, the mother
would not have been liable because you cannot hold directors liable for
breach of duty of care to the corporation (but to third parties you can).
IV.
CONCLUSION: Therefore, the directors did (not) breach their duty of care and the BJR
does (not) apply.
a. IF BREACH ISSUE/APPLICATION:
i. Option One: Here, even though it appears BJR doesnt apply, if the corporation
had put in its charter the language from DE Section 102(b)(7), it is likely the
board of directors wont be personally liable for a breach of the duty of care to
the corporation.
ii. Option Two: Here, even though it appears BJR doesnt apply, under In re
Wheelabrator, the board of directors would be shielded from liability if the
directors actions were subsequently RATIFIED by a majority of shareholders.
Here there was (not) ratification
b. IF BREACH CONCLUSION: Despite [directors] breach, the corporation may still
indemnify or exculpate [officer/director] unless [officer/director] also breached their
duty of loyalty.
DUTY OF LOYALTY
RECOMMENDATION: If you are doing any transaction that might be second guessed, get it
looked at by an independent third party. Such parties may include: (1) an independent
banking firm; (2) a committee of independent directors; or (3) compensation experts. This will
make it very hard for Plaintiff to be successful.
MERITS #3 - DUTY OF LOYALTY TO THE CORPORATION (interested

transaction)
34
I.
ISSUE: The issue is whether [director/officer] breached his duty of loyalty to

[corporation] when he entered into a contract with [third party] to [what the contract
was for].
a. Examples: Officer/Director/Major SH on both sides of the deal. beneficial financial
interested, transaction that would reasonably be expected to influence judgment
II.
RULE FOR COMMON LAW: In a jurisdiction that adheres to unadulterated common

law such interested transactions are per-se void regardless of their fairness and the
[director/officer] does not get the benefit of the business judgment rule. However, the
directors can argue that the court should follow Bayer v. Beran and uphold the contract
so long as they can prove the fairness of the deal.
a. Bayer v. Beran (NY Court) Director hired his wife to star in his corporations
commercials.
i. The court said D breached his duty of loyalty to the corporation
because his relationship with his wife potentially influenced his
judgment. However, the court approved the contract because D
proved fairness.
III.
RULE FOR DELAWARE 144: [safe harbor] In Delaware, or any jurisdiction with a
statute similar to Delaware 144, such interested transactions may be upheld so long
as (1) the insiders relationship with the person is disclosed (fully informed); (2) a
majority of disinterested directors or shares held by stockholders approved the
transaction; and (3) that approval was made in good faith (see below).
a. APPLICATION/CONCLUSION: Here [did they meet the 3 requirements?]
i. IF REQUIREMENTS MET: Therefore, because the three requirements are
met, the directors receive the BJR and the interested transaction will likely
be upheld. Here [enough procedure to satisfy BJR?]
1. Challenger has burden to prove invalidity of transaction
2. Disinterested BOD have no pecuniary interest and not related to
someone with pecuniary interest; directors who have neither a direct
nor indirect interest in the transaction and are not dominated by the
interested director (independent)
a. QUORUM: Majority of disinterested directors constitute quorum in
self-dealing
b. BJR protects disinterested directors who approve self-dealing
transaction in good faith
c. Outside counsel director may be interested bc of conflicting
interest fees
3. Majority disinterested SH Ratification (In DE, must be non-controlling
shareholder that self-dealed)
a. Judicial review limited to waste
ii. IF REQUIREMENTS NOT MET: Therefore, because the three requirements
are not met, the directors must prove that the transaction was fair and
reasonable. Here [Fair and reasonable?]
1. ENITRE FAIRENESS:
a. Substantive Fairness
i. Objective self-dealing transaction must replicate arms
length transaction by falling into range of reasonableness
35
ii. Value to Corp. must be of value as judged by needs and

scope of business
iii. More personal interest = more scrutiny
b. Procedural Fairness
i. Full Disclosure there cannot be fraud
ii. Board/Committee Composition disinterested directors.
Burden shifts to plaintiff to prove unfairness if self-dealing
approved by disinterested directors
iii. No improper pressure
IV.
CONCLUSION: Therefore, [director/officer] did (not) breach his/her duty of loyalty, and
the interested transaction will (not) be upheld.
MERITS #4 - DUTY OF LOYALTY TO THE CORPORATION (corporate

opportunity)
I.
ISSUE: [Look for director/officer getting opportunity due to his position in corp.] The
issue is whether [director/officer] breached his duty of loyalty to the corporation when
he took a corporate opportunity away from [corporation].
a. Note: This occurs when the director/officer is in the same business the company is
in OR the opportunity came to the person based on their position in the company.
II.
RULE: A director/officer breaches his duty of loyalty to the corporation when they take
an opportunity that rightly belongs to the corporation and uses it for their own benefit.
III.
APPLICATION: Here
a. In re eBay eBay hired Goldman Sachs to handle its IPO. Because this was a very
lucrative deal, Goldman secretly allocated some of the initial shares to eBay officers
as a gift.
i. The court said the officers breached their duty of loyalty because
they took eBays corporate opportunity. If the shares had not been
given to the officers, eBay would have sold them on the market and
made a ton of money.
ii. RECOMMENDATION: Have the board of directors approve the allocation of
stock to the officers. This would be viewed as officer compensation which the
directors have the right to set and it would have all been disclosed.
b. Corp MUST get first choice. If rejected by disinterested BOD of SH, then officer can
take the opportunity
i. To determine whether an opportunity properly belongs to the corporation, ask:
1. Does the corp have a need for it?
2. Has the corporation actively considered taking the opportunity?
3. Did the director discover the opportunity while acting as a director, and
were any corp funds involved in the discovery?
4. Expansion: Line of business test compare new biz w/ corp. existing
operations
a. Competitive or synergistic overlap is evidence of corp.
opportunity
5. 2 variables:
a. The higher you are in the corp., higher scrutiny is applied by the
Ct
b. If you learned about it at the job, more likely a corp opportunity
36
6. If you have an opportunity, take it to the board and they may decline
the opportunity and you may be allowed to take the opportunity
ii. Possible self-dealing because of conflict between manager and corps interest
1. BOD informed, considered refusal creates safe harbor
IV.
CONCLUSION: Therefore, [director/officer] did (not) take a corporate opportunity away

from [corporation].
MERITS #5 - DUTY OF LOYALTY TO THE CORPORATION (dominant

shareholders)
I.
ISSUE: The issue is whether [parent] breached its duty of loyalty to [subsidiary].
II.
RULE: Generally, shareholders do not owe a duty of loyalty to other shareholders.

Controlling SH controls BOD and any self-dealing that controlling SH has burden to
prove entire fairness. However, a dominant shareholder (parent) owes a duty of loyalty
to the minority shareholders of the corporation it dominates (subsidiary). Normally, an
alleged breach of this duty is analyzed under the BJR. However, when the dominant
shareholders are engaged in self-dealing, the dominant shareholders (parent) have the
burden to prove the entire fairness of the transaction.
a. NOTE: 144 does not apply
b. Sub-Issue: Here, [parent] was a dominant shareholder because it owned sufficient
voting shares to determine the outcome of a shareholder vote over [subsidiary].
Therefore we must determine whether [parent] was engaged in self-dealing.
i. Note: If control is an issue argue what counts as control see Transfer of
Control Judge Lumbard v. Judge Friendly.
1. In re Wheelabrator Waste (parent) owns 22% of WTI (subsidiary).
Waste and WTI negotiate a merger where Waste acquires an
additional 33%. So Waste now owns 55% total. WTI shareholders sued
for breach of loyalty, claiming that WTI directors did not disclose
relevant information prior to approving the merger.
a. The court held that even though the parent was on both
sides of the transactions, the parent was not in control of
the subsidiary because it only owned 22%. Therefore, the
business judgment rule, rather than the entire fairness
rule applied.
c. Sub-Rule: Self-dealing occurs when the parent is on both sides of the transaction
and receives a benefit to the detriment of the subsidiarys minority shareholders.
d. Application: Here (talk about how the parent has an interest on both sides and
detriment to the subsidiary) [Look for parent preferring itself at minoritys expense].
i. If wholly owned subsidiary then not subject to fairness because no minority
shareholders.
ii. Sinclair Oil Sinclair is parent and owns 97% of Sinven. Two issues:
1. Dividend Payout Sinclair needed cash and forced Sinven to payout
huge dividends. This dividend payout made it so that Sinven could not
develop.
37
a. Court held there was no self-dealing because even though

Sinclair was benefiting, the minority shareholders of
Sinven were benefiting too because they received these
large dividend payments (no detriment to minority
shareholders).
b. Difficult burden to show dividends preferred parent.
2. Breach of k Sinclair created Sinclair Intl which contracted with Sinven.
Sinclair Intl breached k by failing to pay Sinven on time.
a. Court held that this was self-dealing because Sinclair was
on both sides of the transaction and received the benefit
of Sinvens product while Sinvens minority shareholders
received nothing (Sinclair did not meet burden to prove
that failing to pay was entirely fair).
3. Takeaways:
a. Key is whether the minority SH could show a clear
parental preference detrimental to the subsidiary
b. The burden is on the minority SH to show the dealings were NOT
those that might be expected in an arms length relationship,
rather than on the parent to show that they were
c. In absence of preferential of preferential treatment, SH must
show action was not protected by BJR
iii. Zahn v. Transamerica AF (subsidiary) had two classes of stock: A and B.
Transamerica (Parent) owned almost all of the class B stock and controlled
AFs board of directors. The Class A stock slip said that holders could convert
their class A stock into class B stock at anytime, but it also gave AF the right
to call all class A shares at anytime for a certain price. When Transamerica
found out about a secret tobacco supply that was worth a ton of money, they
told AFs board to call all the shares. Transamerica then sold all the tobacco,
which increased which made the value of the company skyrocket. So the
Class A stockholders sued for breach of loyalty, because if Transamerica had
disclosed the tobacco supply, the Class A holders would have converted to
class B so that they could stay in the company.
1. The court remanded to see if the subsidiarys board was acting
as the parents puppet. If they were, the parent was essentially
on both sides of the transaction. So the parent would be liable
because they benefited at the expense of the subsidiary.
a. Note: The charter allowed the subsidiarys board to call stock so
it wasnt their actions that caused the problem. It was the
withholding of information.
III.
CONCLUSION IF SELF-DEALING: Therefore, [parent] engaged in self-dealing and the

court will apply the entire fairness standard to the transaction. Under the entire
fairness test, the burden is on the parent to show entire fairness: (1) fair procedure; and
(2) fair price.
a. However, if the deal is approved by sanitized voting, the burden shifts to the
plaintiff to prove: (1) unfair procedure; and (2) unfair price. Here, [parent] did (not)
show entire fairness because (fair procedure? Fair price?) ....
Therefore, the
transaction will (not) be upheld.
i. If parent discloses the conflict and terms and is approved by a majority of
disinterested SH the challenger must show waste (no rational business
justification).
38
IV.
CONCLUSION IF NO SELF-DEALING/NO PREFERENCE TO PARENT: Therefore,

[parent] did not engage in self-dealing and the court will give the parent the benefit of
the BJR. In this instance, the BJR creates a presumption the parent acted with
procedural due care unless the subsidiary can show disloyalty or irrationality (show
waste) or approval was grossly uninformed. Here, [subsidiary] did (not) show [parents]
disloyalty or irrationality because... Therefore, the transaction will (not) be upheld.
MERITS #6 - DUTY OF LOYALTY TO THE CORPORATION (good faith)

I.
ISSUE: Here, [plaintiffs] have alleged a breach of the duty of good faith by
[officers/directors/dominant shareholder].
II.
RULE: [Relates to 144 above] The duty of good faith is a subset of the duty of loyalty.
Although the Court in In re Walt Disney said that there is no concrete definition of all
acts that could constitute bad faith, the court did identify two categories of bad faith:
(1) subjective bad faith (acting with an intent to do harm), and (2) intentional
dereliction of duty (a conscious disregard for ones responsibilities). Importantly, the
Court noted that gross negligence alone cannot constitute bad faith because it concerns
the duty of care, not loyalty.
III.
APPLICATION: Here, [defendant] did (not) show

a. Examples of Subjective Bad Faith:
i. Intentionally violating the law
ii. Purposely acting in a way that doesnt advance the interests of the
corporation
b. Examples of Intentional Dereliction of Duty:
i. Caremark Claim: Directors knew they had a duty to create a system of
oversight and monitor that system, but failed to do so. These directors would
not be exculpated.
1. Note: This will arise when employees are doing something bad and
plaintiffs claim the board should have known about it.
c. Stone v. Ritter: A banks employees were violating money laundering statutes, so
the bank had to pay $40 million in fines. Plaintiffs brought a Caremark Claim
derivative suit to make the directors pay the fine instead of the corporation.
i. Court held that the directors did not act in bad faith and thus were
not personally liable. They hired KPMG to create a reporting system,
and they monitored the system because they had a reporting
officer make presentations to the directors.
IV.
CONCLUSION IF NO BREACH: Therefore, [defendant] did not act with bad faith, and
thus did not breach their duty of loyalty. Defendant can thus be exculpated and
indemnified even if they acted with gross negligence.
V.
CONCLUSION IF BREACH: Therefore, [defendant] acted with bad faith and thus
breached their duty of loyalty. Because of this breach, [defendant] does not receive the
benefit of the business judgment rule, [defendant] can be held personally liable, and
the corporation will not indemnify or exculpate them.
39
SECURITIES
REGISTRATION ISSUES
I.
ISSUE ONE: The first issue is whether [the investment] is a security.

a. RULE: Section 2 of the 33 Act provides two broad categories of securities. The first
lists specific instruments including stocks, notes, and bonds. The second is a broad
list of catch-all phrases including evidence of indebtedness and investment
contracts. To determine whether an atypical instrument falls into one of these broad
categories, courts will look to the amount of control an individual has over their
investment. If an individual is able to exercise meaningful control over their
investment, it is unlikely to be considered a security interest.
b. APPLICATION: Here, [the investor] [talk about how much control they had].
i. Characteristics of stock (security)
1. Right to receive dividends contingent on profits
2. Ability to be pledged as security (collateral)
3. Negotiability of sale price
4. Conferring of voting rights
5. Capacity to appreciate in value
ii. Investment Contract - Where a person:
1. Invests money or other form
2. in a common enterprise and
a. can be managed pool of investors (horizontal) or single investor
(vertical)
3. is led to expect profits (from earnings not additional capital)
4. solely from the benefit of others
a. someone other than investor contributed predominant
managerial effort
iii. Robinson v. Glynn: Robinson invested in Geophone, and later sued Glynn
saying Glynn made misrepresentations and Robinson wouldnt have invested
if he knew the truth about Geophones capabilities.
1. Court said there was no jurisdiction under the Act because the
membership investment wasnt a security. Robinson had a lot
of control (he served as treasurer, could appoint two directors,
etc.).
a. Note: Court said it doesnt matter that Robinson didnt consider
his membership interest to be a security when he invested.
Cant call a cactus a rose and make it a rose.
iv. Note: When LLC members are passive, and have only tangential involvement
in management, courts have found a security. When LLC investors have
significant management oversight, courts have refused to find a security.
1. Same with a partnership interest, however, a limited partners interest
in an LLP is probably a security because they dont have any real
control, but ARGUE FACTS!
c. CONCLUSION: Therefore, [the investment] is (not) a security.
i. Note: If not a security stop.
40
I.
ISSUE TWO: Because we are dealing with a security, the next issue is whether
[defendant] was required to register the security with the SEC.
a. RULE: Section 5 of the 33 Act makes it illegal to sell a security in interstate
commerce without a registration statement. However, there are a number of
exceptions to this rule, and it is beneficial for companies to satisfy these exemptions
in order to avoid the high costs associated with SEC registration.
b. APPLICATION FOR EXEMPTION: Here, [company] appears to fall into _____
exemption because [Prof says we dont have to know details of how to satisfy each
exception].
i. Major Exemptions:
1. Municipal Bonds or commercial paper
2. Transactions by a person other than an underwriter, issuer or
dealer
a. i.e. people selling their own stock on the secondary market
(broker transactions)
b. underwriter = purchaser from issuer with a view to resell to
public
3. 3(a)(11) Intrastate Sales are exempt must all be residents of
same state
4. 4(2) Exemption: private offerings (MAIN) Doran pg. 408
1. 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
requirements of the 1933 Act absent proof that each offeree
had been furnished, or had access to, such information about
the issuer that a registration statement would have disclosed
2. 4 factors relevant to deciding whether an offering qualifies for
an exemption:
a. Number of offerees and their relationship to each other
and the issuer;
b. The number of units offered;
c. The size of the offering;
d. The manner of the offering
3. Key inquiry: whether the persons affected need the protection
of the Act
4. Doran test: If ALL offerees are
e. Sophisticated AND
f. Offerees were furnished with or had opportunity to learn
all the information that a registration statement would
have disclosed,
g. THEN the Ralston Purina inquiry is probably satisfied,
because none of the offerees needed the protection of
the act
5. Reg. D Safe Harbors to get to Private Placement
Exemption & Avoid/Reduce Required Disclosure:
h. 504: If an issuer raises no more than $1m through the
securities, the issuer may sell to an unlimited # of
buyers without having to register. No general solicitation
41
i.
Skipped. 505: if an issuer raises no more than $5m

through the securities, the issuer may sell to no more
than 35 non-accredited investors without having to
register. Restricted security
j. 506: Permits up to 35 investors and accredited investors
are not counted in that number or non-accredited . if an
issuer raises over $5m through the securities, the issuer
may sell to up to 35 buyers who must pass various tests
of financial sophistication without having to register. No
general solicitation
k. NOTE: accredited investors banks, brokers, and other
financial institutions and wealthy buyers
l. Reg D generally exempts only the initial sale; most
buyers can resell the securities ONLY IF they find another
exemption
m. Issuers must give some info about the company to the
buyers, depending upon the amount of money at stake
5. The Jobs Act of 2012
a. Section 4(a)(6) permits up to $1 million/year can be sold via
Internet or social media (does not have to be to accredited
investors).
b. Section 3(b)(2) permits up to $5 million/year pursuant to an
offering statement.
c. 506(c) unlimited # of investors if all are accredited. Allows
general solicitation
d. Note: Professor says this is a horrible law because the courts will
be clawed with retirees who are suckered in to making
investments.
c. APPLICATION IF NO EXEMPTION: Here, [company] does not appear to fall into an
exemption and thus, registration is required.
The NEXT ISSUE is whether
[defendant] properly registered the security.
i. SUB RULE: Under 5 of Sec. Act, Proper registration requires a registration
statement, including a prospectus, to be filed with the SEC. Under 11(a), If
the registration statement contains material misstatements or omissions, the
company (issuer) is absolutely liable. Further, all officers, directors,
accountants involved in preparation of the certified financial statements, all
underwriters, and anyone who signed the registration statement could be
personally liable if they are unable to assert the due diligence defense.
ii. MATERIAL APPLICATION: Here, plaintiff alleges that ____ was a material
misstatement or omission. A misstatement/omission is material if it is
something that an average prudent investor ought to know before investing.
Here ___ was (not) material because
*** If not material misstatement, STOP ***
iii. DUE DILIGENCE APPLICATION: [Not available to issuer]. Because defendants
misstatement was material, the company (issuer) is absolutely liable and the
next issue is whether [people who worked on the registration] can establish
the due diligence defense. To do so, a defendant must prove under 11(b): (1)
they conducted a reasonable investigation, (2) after the investigation, they
had reasonable ground to believe the statement was accurate, and (3) after
the investigation, they actually believed the statement was accurate. Here,
42
the [defendant(s)] can (not) establish the due diligence defense because
[what did they do? ARGUE]
1. Reasonable Investigation = 11(c), An investigation a prudent man
would have done in managing his own funds.
Expert
Nonexpert
2. Just asking if something is true is not enough you cant rely on what
people tell you you must verify!
a. Exception: the standard of reasonableness is different for the
expertised portions.
Expertised Portion
Non-expertised portion
Must investigate and believe No liability
information is true (ignorance
is no excuse
No reasonable ground to Must investigate and believe
believe information is false information is true (ignorance
(ignorance is excuse
is no excuse)
i. EX: If the material omission occurs on the accounting
statement, it might be more reasonable for the director to
rely on the accountant, because the director is not an
accounting expert.
3. RECOMMENDATION: If you are the lawyer in charge of drafting the
statement, it is going to be very hard to wiggle out of liability. Courts
think more is required of the lawyer by way of reasonable investigation.
a. Note: Dont let your partner serve on a board of directors. Your
partnership could be on the hook.
4. Escott v. BarChris: BarChris constructed bowling alleys. It went bust.
Before it did, it issued debentures and in statements for debentures it
misstated financial condition of company. People who bought the
debentures sued. All defendants asserted the due diligence defense.
a. Reasonable investigation varies according to position and
relationship to issuer. The court held that none of the
defendants could establish the due diligence defense
because a reasonable investigation was not conducted.
Didnt matter that some defendants had no education, no
lower standard for them.
d. CONCLUSION: Therefore, the security was (not) properly registered with the SEC. If
the arrangement was an unregistered, non-exempt offering, the purchaser can seek
a recission under 12(a)(1).
Material Misstatement under Rule 10b-5 (press release)

Scenario: Tim is a CEO at a company and his company publishes nationwide press release
saying we are not merging with X. This statement was untrue but Steve traded on this
information in reliance on this information. Is Tim liable under 10b-5?
I.
OVERARCHING ISSUE: Here, [plaintiffs] have brought a claim under Rule 10b-5, which
creates a private right of action for a buyer or seller alleging fraud in connection with
43
the sale or purchase of securities. In order for a plaintiff to prove a 10b-5 violation, the
plaintiff must show: (1) plaintiff was a buyer or seller of a security; (2) defendant made
a material misstatement or omission in connection with the sale; (3) plaintiff relied on
the misstatement or omission, and (4) the misstatement or omission was made with
intent to deceive (scienter).
i. Policy: Rule 10b-5 seeks to prohibit deception by encouraging full disclosure.
So, a transaction that is adequately disclosed cannot be attacked under rule
10b-5, even if the transaction is unfair.
ii. RECOMMENDATION: There are legitimate reasons for companies to withhold
secrets. To avoid making a material misstatement or omission, say no
comment.
1. Corporate officials who make false statements expose the corp.
II.
ISSUE ONE: Therefore, the first issue is whether [plaintiff] was the buyer or seller of a
security.
a. RULE: Section 2 of the 33 Act provides two broad categories of securities. The first
lists specific instruments including stocks, notes, and bonds. The second is a broad
list of catch-all phrases including evidence of indebtedness and investment
contracts. To determine whether an atypical instrument falls into one of these broad
categories, courts will look to the amount of control an individual has over their
investment. If an individual is able to exercise meaningful control over their
investment, it is unlikely to be considered a security interest.
b. APPLICATION: Here, [investor] [talk about how much control they had AND whether
they bought or sold a security.]
i. Characteristics of stock (security)
1. Right to receive dividends contingent on profits
2. Ability to be pledged as security (collateral)
3. Negotiability of sale price
4. Conferring of voting rights
5. Capacity to appreciate in value
ii. Robinson v. Glynn: Robinson invested in Geophone, and later sued Glynn
saying that Glynn made misrepresentations and that Robinson wouldnt have
invested if he knew the truth about Geophones capabilities.
1. Court said there was no jurisdiction under the Act because the
membership investment wasnt a security. Robinson had a lot of control
(he served as treasurer, could appoint two directors, etc.).
a. Note: Court said it doesnt matter that Robinson didnt consider
his membership interest to be a security when he invested.
Cant call a cactus a rose and make it a rose.
iii. Note: Generally, a membership interest in an LLC is not a security because
you are not dependent on the efforts of others. However, if there is a contract
that says the member had no power whatsoever, it may be a security.
1. Same with a partnership interest, however, a limited partners interest
in an LLP is probably a security because they dont have any real
control, but ARGUE FACTS!
iv. Note: applies to sale of business of structured as a stock purchase.
c. CONCLUSION: Therefore, [plaintiff] did (not) (buy/sell) a security when they
(bought/sold) [the investment at issue].
*** IF NOT A SECURITY, STOP ***
44
III.
ISSUE TWO: The next issue is whether [defendant] made material misstatements or
omissions in connection with the sale.
i. Note: In connection with the sale or purchase of security means the
defendant doesnt have to be the one buying or selling so long as their
behavior affects buying or selling
b. RULE: A misstatement or omission or silent in the face of fiduciary duty to disclose is
material if it is something that an average prudent investor ought to know before
investing. [In the context of a merger, an omitted fact is material if there is a
substantial likelihood that a reasonable shareholder would consider it important in
deciding how to vote. No one factor is enough, courts must look to the probability of
the merger happening and the magnitude of the transaction.]
i. Higher Probability = more likely to be material; Larger Magnitude = more
likely to be material
ii. Note: Under 10b-5 there is no private right of action based on aiding and
abetting. This protects lawyers unless they are SO DEEPLY involved that they
can be considered co-tortfeasors engaging in fraudulent behavior not merely
substantial assistance. Recklessly.
c. APPLICATION: Common sense application would you consider it important??
i. Materiality: if disclosure would affect the price of the companys stock it is
material
ii. Safe harbor: if forward looking information as meaningful cautionary
statement
iii. Duty to Speak: Duff Phelps case D liable to shareholder-employee for
remaining silent when the firm purchased shares from employee who quit on
the eve of lucrative merger
iv. Duty to Update: if plans change that affect prior statement then update
d. CONCLUSION: Therefore, the [misstatement/omission] was (not) material.
IV.
ISSUE THREE: Because there was a material [misstatement/omission], the next issue is
whether plaintiff relied on the [misstatement/omission].
a. RULE: Typically, individual shareholders have the burden of proving actual
reliance in order to succeed on a 10b-5 claim. [In class action cases, however,
Basic v. Levinson established the fraud on the market theory, which creates a
rebuttable presumption of reliance by any individual stockholder. The theory is that
stock prices are a function of ALL material information in the marketplace, and
therefore any material misstatement or omission affects stock prices.]
i. Policy for Fraud on the Market: If a showing of actual reliance was
required, then stockholders could never bring a class action. When you have
thousands of stockholders, some relied and some didnt.
1. Rebutting: (1) challenged information did not affect stock price OR (2)
the particular plaintiff would have traded regardless.
ii. In cases involving a duty to speak, courts dispense reliance if the
undisclosed information was material.
iii. In cases involving transactions on impersonal trading markets, courts
infer reliance from the dissemination of misinformation in the trading market.
(fraud on the market)
45
b. APPLICATION/CONCLUSION: Here, Plaintiff did (not) satisfy the reliance element of

their 10b-5 claim because
V.
ISSUE FOUR: The next issue is whether material misstatement or omissions were made
with intent to deceive or gross recklessness.
a. RULE/APPLICATION: Use common sense argument ARGUE FACTS.
i. Show D was aware of the true state of affairs and appreciated the propensity
of his misstatement or omission to mislead.
ii. Recklessness is sufficient misrepresentations were so obvious that D must
have been aware
1. Provide facts to suggest actual knowledge
b. CONCLUSION: Therefore, plaintiff did (not) satisfy 10b-5s scienter requirement.
VI.
OVERARCHING CONCLUSION: Therefore, P did (not) establish 10b-5 liability.
Insider Trading under Rule 10b-5

Traditional Scenario: If insider knows material, non-public info then must abstain or wait
until disclosure. Tim is a CEO of a company. He knows that the company is about to tank so he
sells all his shares.
Misappropriation Scenario: Tim is a CEO of a company. Tim meets Eli on the golf course
and tells Eli Yo man, we are merging with X. That night, Eli buys a bunch of stock in Tims
company. Is Tim liable as a tipper? Is Eli liable as a tippee?
Who is harmed by insider trading? No one. We have the rules in place as to avoid people
losing confidence in the marketplace. If you do, then they will not buy securities because they
view the marketplace as rigged.
I.
ISSUE: Here, [plaintiff] is alleging [defendant] misused insider information.
II.
RULE: Courts have interpreted 10b-5 to create two theories of liability. Under the
traditional theory, an insider is liable if he purchases or sells securities based on
material nonpublic information. Additionally, under the misappropriation theory, an
insider and/or an outsider can be liable if he breaches a fiduciary duty by using nonpublic information to buy or sell securities for his own benefit.
a. RECOMMENDATIONS FOR INSIDERS:
i. If you have non-public information: (1) abstain from trading; or (2) disclose the
information. After disclosure, you must wait until the information until it is
adequately disseminated. But with the Internet, this is not a very long wait.
ii. Under 10b5-1, if you are insider and want to legitimately trade your stock,
make a trading plan (i.e. I will sell X shares on the first of each month for the
next 10 months.)
III.
TRADITIONAL APPLICATION: Here, the traditional theory does (not) apply because
[defendant] [owed/did not owe] a fiduciary duty to the corporation. Further, he is
(not) liable under the traditional theory because [(1) material?; (2) non-public
information?; and (3) he himself traded?]
a. Note: General employees (janitors, secretaries, etc.) owe a fiduciary duty to the
corporation because they are agents.
46
b. Note: Material = information a reasonably prudent investor would like to

consider before investing.
c. Must breach fiduciary of duty to be liable as an insider.
d. Texas Gulf Sulphur- TGS discovers oil and starts buying up land. Before
disclosing the oil discovery to the public, insiders bought stock in TGS
themselves.
i. The court said that the insiders were liable because they used
material non-public information to buy securities.
1. RECOMMENDATION: The insiders would have been okay if they: (1)
disclosed the information; and (2) provided a reasonable waiting period
prior to trading.
e. TRADITIONAL CONCLUSION: Thus, the defendant will be liable for insider trading
under 10b-5 if they directly traded on insider information. Therefore, defendant
is (not) liable because
IV.
MISAPPROPRIATION of CI APPLICATION (golf course): Even though [tipper] is

(not) liable under the traditional theory, he may still be liable under the
misappropriation theory because there is a tipper/tippee relationship. Liability arises
when a person trades on confidential information in breach of duty owed to the source
of the information, even if the source is a stranger to the traded securities. Further,
the tippee might be liable because he traded on the tippers information under the
misappropriation theory (OHagan).
a. TIPPER RULE/APPLICATION: In assessing the liability of a tipper, the issue is
whether the tipper breached a fiduciary duty to the corporation by receiving a
personal benefit from their tip. Further, to satisfy the scienter requirement of 10b5, the tipper must know the information is material and non-public and that the
tippee is likely to trade on the information. Here [so we need: (1) material nonpublic information; (2) personal benefit (breach of fiduciary duty); (3) knowledge
tippee will trade; and (4) tippee traded.]
i. Note: Personal Benefit (very broadly defined) = reputation enhancement,
bragging, boasting and gifting; spouse trades then insider is benefitted.
1. Dirks exposed fraud but no expectation of personal benefit no
liability
ii. Scienter requirement: tipper must know info is material and non-public and
reasonable likelihood that tippee will trade
1. I know requirement
iii. TIPPER CONCLUSION: Therefore, the tipper is (not) liable [because tippee
traded].
1. Note: The tippee must trade for the tipper to be liable.
b. TIPPEE RULE/APPLICATION: When a tippee trades on insider information, they
can be liable in two situations: (1) where the tippee owed a fiduciary duty to the
tipper; or (2) where the tippee knew or had reason to know that the tipper was
breaching the tippers fiduciary duty to the original source of the information.
i. APPLICATION TIPPEES Fiduciary DUTY: Here, [tippee] (owed/did not owe) a
fiduciary duty to [tipper] under 10b5-2 because [pick one of four]: pg 492
10b5-2
1. (1) Whenever someone agrees to maintain information in confidence;
2. (2) whenever the tipper and tippee have a pattern of sharing
confidences such that the recipient of the information knows, or
47
reasonably should know, that the speaker expects the recipient to

maintain the informations confidentiality;
3. (3) when two people are a spouse, parent, child, or sibling.
4. (4) none of the duties listed 10b5-2 applies.
ii. Note: Difference between an outsider who misappropriates information from
a source unrelated to the company in whose securities the outsider trade and
a tippee who receives information from a fiduciary inside a company in
whose securities the tippee trades.
1. The outsiders duty is to the outside source; the tippees
duty is derived from the duty of the insider who tips
improperly.
iii. Misappropriation Application: [Look for agreement of confidentiality
of outside source]
1. Employee could be liable for misappropriating the information in breach
of his employers expectation of confidentiality. Trading would be
breach of duty to his employer aka the outside source.
2. OHagan case OHagan is a partner at the law firm handling Pillsburys
merger (target company). OHagan bought Pillsbury stock on material
non-public information and made a huge profit.
a. The court said that OHagan was liable because he
breached his duty to both his law firm and their client
(the tippers the source of the information).
Unauthorized use of client confidences was deceptive and
in connection with securities trading.
iv. TEMPORARY INSIDER: retained temp. by the company in whose securities
they trade such as accountants, lawyers, and investment bankers have the
same 10b-5 duties as corp. insiders.
1. whenever the tipper and tippee have a pattern of sharing confidences
such that the recipient of the information knows, or reasonably should
know, that the speaker expects the recipient to maintain the
informations confidentiality
v. [CONCLUSION: Because tippee has a fiduciary duty, they violated rule 10b-5
when they traded on the tippers information.]
vi. APPLICATION TIPPEES KNOWLEDGE: Even though [tippee] does not owe a
fiduciary duty to [tipper], the tippee may be liable under the second situation.
Here, [tippee] did (not) know, or had reason to know that [tipper] was
breaching his fiduciary duty to the original source of the information
because
1. CONCLUSION: Therefore, the tippee is (not) liable.
Insider Trading under 14e-3 (only for tender offers)

Note: Tim is a janitor at a corporation. While cleaning, Tim sees a bunch of papers on the
companys upcoming tender offer. While drinking at a bar, he tells Eli what he saw. Tim and
Eli both trade. Are Tim and Eli liable under 14e-3? Yes because ANYONE can be liable under
14e-3 regardless of fiduciary duty.
I.
ISSUE: Here, [plaintiff] is alleging [defendant] misused insider information relating to a

tender offer so the issue is whether [defendant] is liable under 14e-3.
48
II.
RULE: Anyone can be liable under 14e-3 for purchasing or selling securities based
upon nonpublic information in connection with a tender offer. In order to establish
14e-3 liability, a plaintiff must show: (1) there was a tender offer; (2) defendant
obtained material non-public information relating to the tender offer; and (3)
defendant knew or had reason to know that the information was obtained from an
insider.
a. May not be valid because Does not require breach of fiduciary duty (SC said
in Dirks that there must be breach but SEC disagrees)
b. EXCEPTION: A raider can trade based on their own intentions.
i. EX: A raider who makes a tender offer obviously has knowledge of non-public
information relating to a tender offer. They can still trade on this information
and not be liable.
III.
APPLICATION: Here [analyze all three elements]

a. Tender Offer Its a way to buy a company. The prospective buyer makes a
formal offer to shareholders for them to sell their shares at a specified price.
Directors cannot prohibit prospective buyers from doing this.
b. Note:
The court in OHagan said that it is unclear whether 14e-3 is
constitutional because breach of a fiduciary duty is not a required
element. So you can be a guy at a bar who overhears a conversation about a
tender offer and if you trade on this information, you are liable.
IV.
CONCLUSION: Therefore, [defendant] is (not) liable under 14e-3, assuming that 14e3 is constitutional.
Short-Swing Profits under 16(b)

I.
ISSUE: The issue is whether [defendant] is liable for short swing profits under section
16(b) of the 34 Act.
II.
RULE: Section 16(b) prohibits: (1) directors; (2) officers; or (3) shareholders with
more than 10% of any class of stock, from profiting off of the purchase or sale of
company securities within a six month period of purchasing or selling the securities.
a. Note: Only applies to Public Companies trading in the equity securities of a
corporation that has a class of equity stock registered under 12 of the Exchange
Act
i. Ex: common stock is registered and preferred stock is not, still subject to
16
b. Equity: options, convertible securities, and other equity derivatives
III.
DIRECTOR/OFFICERS: In determining 16(b) liability, the court will look to whether the
defendant is a director or officer at the time of the first transaction. Here,
[defendant] was (not) an [director/officer] at the time of the first transaction.
Therefore, if the second transaction occurred within six months of the first
transaction, and [defendant] profited, he is liable under 16(b).
a. Note: If defendant was not a [director/officer] at the first transaction, but was a
[director/officer] at the second transaction, this does not count; so ignore
trades that were made before the person became a director or officer.
IV.
SHAREHOLDERS: In determining 16(b) liability, the court will look to whether the
defendant owned more than 10% of the SAME class of stock immediately before
the first transaction.
49
a. EX: If you own 11% of class B stock, but this only totals 5% of ALL company stock
(including A stock), section 16(b) applies.
b. Timing: The shareholder must own more than 10% before the first transaction.
In other words, the purchase that causes someone to become more than a 10%
shareholder does not count. Owns 10% of the shares of a corporation at the time
of purchase AND at the time of sale.
i. APPLIES: You own 20%. You sell 5% (first transaction). One month later,
you buy another 5%.
1. Here, there is a matching transaction
ii. DOESNT APPLY: You own 20%. You sell 15% (first transaction). One
month later, you buy another 15%.
iii. does not matter if the s shares dipped below 10% at any time during the
6 months. Just look to whether at the second before the purchase the
was a 10% SH
c. Match any transactions that produce a profit: any purchases and sales in which
the sales price is higher than purchase price in 6 month period.
d. Deputization: firms employees serve as director of other firm, 16b may apply to
the first firms trades in the stock of the second
i. Ex: X corp asks one of its officers to serve on the BOD of Y Corp; if X profits
on Y stock within a 6 month period, X may be liable under 16(b) on the
theory that it deputized the officer
e. Policy: Section 16(b) is a prophylactic rule put in place to minimize the risk that
insider information is being used
f.
V.
Note: Does not apply to unconventional transactions (i.e. forced sale of shares
in a hostile takeover).
CONCLUSION: Therefore, [defendant] is (not) liable for short swing profits under
section 16(b) of the 34 Act.
Indemnification and Insurance

I.
INDEMNIFICATION UNDER DELAWARE LAW

a. The corporation may (not must) indemnify an officer/director for:
i. Derivative Suits: settlements, attorneys fees, but never judgments.
1. It wouldnt make sense for the corp. to win a judgment and have to pay
for that judgment.
ii. Class action: settlements, attorneys fees, and judgments if the corporation
gets consent from the court.
b. Del. Gen. Corp Law:
i. 145(a) indemnification in 3rd Party Actions: Del. Allows indemnification by the
Corp for BOD, officers, agents, employees, etc., for legal fees in defending
against suits by 3rd parties (unless the person acted illegally or in bad faith)
ii. 145(b) Indemnification in Derivative Suits: The comp CAN indemnify D&O for
costs of legal fees but not for the settlement costs
iii. The code gives the power to indemnify, but the Comp HAS to say it wants to
do that
*The company MUST state in bylaws that D&O are indemnified to the fullest
extent allowable by law
50
iv. Del. Allows indemnification by the Corp for BOD, officers, agents, employees,
etc. for legal expenses in defending a derivative lawsuit, but NOT for the cost
of settlement
c. Rec: HAVE an indemnification by law
II.
RECOMMENDATIONS FOR A DIRECTOR OR OFFICER CLIENT

a. Get three levels of protection:
i. Level One: make indemnification obligatory see above
ii. Level Two: Get D&O insurance Very important in derivative actions. There
are two parts:
1. First part protects the corporation because it reimburses the
corporation for what they had to pay to indemnify the director/officer in
a class action suit.
2. Second part protects the director/officer for situations where the
corporation cant pay such as: (1) in derivative suits; (2) where the
corporation is insolvent; (3) if the court declines to give consent for
indemnification; or (4) where indemnity agreement is unenforceable
because the director/officer violated securities laws.
a. Note: This does not cover intentional wrongdoing. So if the
director/officer stole money, this will not help them.
iii. Level Three: Get an exculpation provision
1. Note: Exculpation provisions only protect directors. If this provision is in
the company charter and the company sues you for breach of duty of
care, you will not be personally liable.
PROXY RULE VIOLATIONS (public corporations

only)
MISTATEMENTS OR OMISSIONS
Scenario: SH sues after management undertakes a merger or other control transaction
accomplished with an allegedly false or misleading proxy statement. (NOTE: these elements
are different than 10b-5 securities fraud
I.
ISSUE: Here, [Plaintiff] alleges there was a material misstatement or omission in the
proxy statement.
a. Note: Anyone can issue a proxy including the corporation and other shareholders.
II.
RULE: 14a-9: A misstatement or omission is material when a reasonably prudent

investor would consider it important when deciding how to vote their share s. Under
Mills, as long as the statement or omission is material, then it is undoubted that
shareholders might have been misled, and therefore there is a causal relationship (so
plaintiff need not separately prove causation).
a. Exception to Causation: However, plaintiffs claim will fail if management owns
enough shares to approve the transaction without any votes from the proxy at issue
(indicating there was no causation). If controlling SH had enough votes to make
proxy solicitation pro forma then there is no causation, may still be violation of state
law. 574?
51
III.
APPLICATION: Here
a. Silence is actionable: applies to any statement in proxy solicitation that is false
or misleading or which omits to state any material fact necessary in order to make
the statements not false or misleading.
b. Statement of reasons, opinions, motives for approving merger can be
actionable
i. Only if board: 1) misstates its true beliefs AND 2) misleads about the subject
matter of the statement
c. Materiality: not material if redundant or otherwise available to SH
d. Causation: No recovery if transaction did not depend on the shareholder vote
e. State Law: In DE, duty of disclosure prohibits false and misleading statements in
any management communication with public shareholders.
i. Individual SH reliance required
IV.
CONCLUSION: Therefore, [defendant] is (not) liable for a misstatement or omission in

the proxy statement.
SHAREHOLDER PROPOSALS
Two types of proposals:
Social/Environmental Affirmative action programs and environmental proposals
Corporate Governance Removal of a poison pill, require a certain number of
independent directors
I.
ISSUE: The issue is whether the corporation can refuse to include [plaintiff
shareholders] proposal in its proxy materials.
II.
RULE: As a general rule, a public corporation must include shareholder proposals in its
proxy statements.
However, a corporation can refuse to include: (1) irrelevant
proposals; (2) proposals that are not in accordance with state law; (3) proposals relating
to the corporations management functions; and (4) proposals the corporation lacks
power or authority to implement.
a. RELEVANCE SUB-RULE: Under Rule 14a-8(i)(5), a proposal is irrelevant when it
relates to operations which account for less than 5% of the companys total assets,
net earnings, and gross sales. However, shareholders can get around this by
showing the proposal is otherwise ethically or socially significant.
i. APPLICATION/CONCLUSION: Here, the proposal is (not) irrelevant because
Pg 328 of rules
1. Lovenheim Shareholder proposal sought to prevent pt from being
served. Pt production was less than 1% of the companys business,
but court remanded to determine whether it was a socially important
issue.
a. Note: Significant social proposals are usually must be included.
b. STATE LAW SUB-RULE: Under Rule 14a-8(i)(1), a shareholder violates state law
when it attempts to bind the company.
i. APPLICATION/CONCLUSION: Here, the proposal does (not) violate state law
because
1. Note: Look to whether the proposal says must or recommends.
52
a. EX: Cant make a proposal that says the board of directors must
pay dividends and cant make a proposal that says company
must open an office in Des Moines.
c. MANAGEMENT FUNCTIONS SUB-RULE: Under Rule 14a-8(i)(7), a proposal relates
to a corporations management functions when it concerns ordinary business
operations
i. APPLICATION/CONCLUSION: Here, the proposal does (not) relate to the
corporations management functions because.
1. i.e. employment policies: hiring and firing. Exception: EE policies that
raise significant social policy issues
2. Related to nomination or election to office
d. ABSENCE OF POWER/AUTHORITY: Here, under Rule 14a-8(i)(6), the corporation
lacks power or authority to implement the shareholder proposal because... [Some
bullshit]
III.
CONCLUSION: Therefore, the corporation must (not) include the shareholder proposal in
its proxy materials.
PROXY FIGHTS
I.
ISSUE: Here, [plaintiff] is challenging [incumbent managements -OR- successful

insurgents] use of funds during the proxy fight.
II.
RULE FOR MANAGEMENT: Management is permitted to use corporate funds in a proxy

fight so long as the dispute is about differences in business policy and the expenses
are reasonable. If this is true, management will be reimbursed regardless of whether
management wins or loses.
a. APPLICATION: Here . . . [BOTH PRONGS ARE EASY TO SATISFY]
i. Note: Look to what management said.
1. RECOMMENDATION: You have to be very careful what you say in a
proxy fight. But, once you prove a genuine policy dispute, you can
spend almost any amount of money.
a. EX: The insurgents are probably good business people, but I
really need this salary.
ii. Note: In Rosenfeld, the court found that managements use of entertainment,
chartered air planes, public relations counsel, proxy solicitors and limos were
reasonable expenses.
iii. Public Policy: If directors were not allowed to spend a lot of money on proxy
fights, they would just have to surrender. It is best for the company to let
management defend itself when there are legitimate policy disputes.
III.
RULE FOR INSURGENTS: Successful insurgents can be reimbursed for reasonable and
bona fide expenditures during a proxy fight so long as they had a legitimate business
purpose and the shareholders approved the reimbursement.
a. APPLICATION: Here . . .
i. Legitimate purpose = making money or accomplishing goals
ii. Illegitimate purpose = personal vendetta
53
IV.
CONCLUSION: Therefore, the use of funds was valid.
SHAREHOLDER INSPECTION RIGHTS

I.
ISSUE: The issue is whether the corporation must provide [plaintiff shareholder] with
[the corporations shareholder list -OR- other documents they have requested].
II.
RULE/APPLICATION IF FEDERAL LAW: The federal law, 14a-7 provides that a

corporation must either give a shareholder its shareholder list or it can send out a
shareholders proxy materials for them. Either option is at the expense of the
shareholder.
a. RECOMMENDATION: Neither route is useful because sending materials under
either option will break the bank. Find a way to get under state law. Do not want to
send to everybody.
III.
RULE/APPLICATION IF STATE STATUTE: Generally, state statutes control when a

shareholder is entitled to a corporations shareholder list or other documents. Here, the
statute says
a. DE/NY statutes If the shareholder has a proper purpose they are entitled to the
shareholder list, the seed list, and the NOBO list (if the corporation already has a
NOBO list).
i. Identify specific, already-existing documents and show how they are essential
to stated purpose
ii. Proper Purpose = reasonably related to their interest as a shareholder (i.e.
making money)
1. Note: there is a presumption that this is why you want the list.
b. Note: The controlling law is the state in which the plaintiff resides.
c. State ex rel Pillsbury v. Honeywell During Vietnam, Honeywell made napalm and
materials for shrapnel bombs. Pillsbury requested the shareholders list and company
records. He publicly stated that he only cared about the morality of Honeywells
work.
i. Court held that morality was not a proper purpose the DE statute
required the purpose relate to increasing the companys profits.
1. SHOULD HAVE ALLEGED ECONOMIC RISK: If we were Pillsburys lawyer,
we should have told him to say: Making bombs hurts the companys
image, and this hurts the companys ability to sell other products and
make profits.
IV.
RULE/APPLICATION IF NO STATE STATUTE: Because there is no state statutory language

to the contrary, a shareholder is likely entitled to the shareholder list so long as their
purpose is to communicate with other shareholders about corporate affairs; the
corporation can properly withhold the list by showing the shareholder has an improper
purpose. [However, if the shareholder requests other documents, the shareholder will
bear the burden to prove a proper purpose.] Here
a. Policy: Other documents contain confidential information that could potentially
harm the corporation if it gets into the wrong hands.
i. SH burden to show credible evidence of mismanagement for books and
records
54
b. Want seed list and NOBO List

i. Non objecting beneficial owners contact info from record owner brokers
c. Crane Co. v. Anaconda Crane wanted to buy Anaconda and made a tender offer.
After 11% of shareholders accepted the tender offer, Crane (as Anacondas largest
shareholder) requested a shareholder list. Anaconda argued improper purpose (to
obtain control of the business).
i. Court held that Crane had a proper purpose: the tender offer was a
big deal it was important to Anacondas stockholders. Furthermore,
Crane met the procedural requirements of the NY statute because
they gave written notice and an affidavit saying they had a proper
purpose.
1. Note: Would have come out different if Crane was a competitor of
Anaconda and wanted Anacondas business papers in addition to the
list. This request would be against Anacondas interest and Crane could
probably only get the list.
CLOSELY HELD CORPORATIONS

SHAREHOLDER VOTING CONTROL
Scenario 1: You are advising someone who is considering buying shares in a closely held
corporation regarding their potential shareholder agreement.
Scenario 2: Shareholders agreeing to vote for certain directors and/or directors agreeing to
vote a certain way.
Notes on Quorums
Directors: A majority of directors must be present to vote
Shareholders: a Majority of shares must be represented to vote
EX: Corporation has 20,000 shares and 700 shareholders. 10,001 shares must be
present for quorum.
Note: These are default rules. The bylaws can amend.
I.
ISSUE: The issue is whether [what the shareholders agreed to] is valid.
a. RULE: Generally, shareholders can agree to whatever they want, including how they
will vote their shares in order to elect directors. Shareholders can even choose to
have no directors whatsoever. However, shareholders cannot agree to anything that
would bind the hands of the directors unless 100% of the shareholders agree.
i. EX: So if there are only two shareholders and they agree, they can bind
directors.
ii. Note: Once a shareholder is elected as director, they are free to vote in any
way they want- regardless of the shareholder agreement. (They take off their
shareholder hat and put on their director hat).
1. Validity of management agreement is unclear unless 100% SH approval
a. If no 100% then must vote as directors to approve.
b. [Additionally, in Illinois, Galler v. Galler modified this rule so that 100% SH approval
is no longer needed to bind directors. Rather, majority shareholders can agree to
whatever they want so long as: (1) no minority shareholder objects, and (2) the
55
agreement doesnt endanger other stockholders, creditors, or the public, or violate

the law.]
i. EX: Cant agree to do something inconsistent with the Illinois Closed
Corporation Act that would violate the law.
ii. In DE: Majority SH can agree to management agreement but become liable
for duties imposed; cannot adversely affect non-party interest
c. APPLICATION: Here
i. Possible recommendations to a shareholder client:
1. Minority veto power:
a. Step One Have a shareholder (pooling) agreement to make you
a director
b. Step Two Have the bylaws of the corporation say that 100%
vote of the directors is needed to act or amend the bylaws.(veto
power at the director level)
c. Step Three If shareholders can amend bylaws, say the bylaws
cannot be amended without 100% shareholder approval (veto
power at shareholder level).
2. Buyout agreement Allows a shareholder to end his relationship with
the corporation and receive cash in return for his shares upon certain
triggering events.
a. Note: You never want an estate to be a shareholder because
they have much different goals.
3. Employment contract You should get an employment agreement that
ensures your salary and provides that if you are terminated without
cause, you will get severance pay and the corporation is required to
buy your shares (mandatory repurchase agreement).
4. Russian Roulette Provision This works best when there are only two
shareholders.
a. EX: One shareholder tells you that he wants to buy your shares
for X price. You can either: (1) accept the offer; or (2) turn the
tables and purchase the other shareholders shares at the stated
price. This will ensure that you offer a fair price because if you
dont, you can be bought out for cheap.
ii. Ringling Bros. Edith and Aubrey each owned 315 shares of Ringling. North
owned 370. Aubrey and Edith agreed to always vote the same way for
directors so that they could out-vote John (pooling agreement). Court upheld
this agreement.
iii. McQuade v. Stoneham Stoneham was the majority shareholder of the Giants
and McQuade was one of the minority shareholders. Stoneham, McQuade, and
McGraw had a shareholder agreement to vote for each other as directors, and
then once they were directors to hire each other as officers. Stoneham got
mad and fired McQuade. McQuade sued to enforce the agreement.
1. Court held the agreement invalid. Agreement to elect each
other as directors was perfectly fine, but absent 100%
shareholder approval (or silent minorities in Illinois), an
agreement cant dictate who directors hire as officers.
a. Policy: Directors owe a fiduciary duty to ALL shareholders, so
tying their hands to benefit certain shareholders is inconsistent
with that duty.
i. Counterargument: Case law does not agree with this,
but professor says to get people to invest in closely held
corporations, they will want assurances as to how the
56
business will be run. So we should let them bind directors,

and then if the directors behave badly we can still sue for
breach of care and loyalty.
2. SHOULD HAVE: McQuades lawyer should have told him not to invest
until he gets an employment contract guaranteeing his salary as an
officer. Since he isnt a director yet, he wouldnt be breaching any duty.
iv. Clark v. Dodge Clark owned 25% and Dodge owned 75% of a drug company.
Clark had the secret formula for a drug, and to get him to share it Dodge
promised him a seat on the board and a position as general manager, which
paid him 25% of all profits. After Clark handed over the formula, Dodge fired
him, and Clark sued to enforce the agreement.
1. Court held the agreement was valid. Because they made up
100% of the shareholders, they could agree to whatever they
want. They werent hurting any other minority shareholders.
v. Ramos v. Estrada Broadcast Group (including Estrada and Ramos) owned
51% of Television. Broadcast Group had agreement to vote together so that
they could maintain control of the company. The agreement said that if
anyone breached, they have to sell their shares to the non-breaching
members at a low price. Estrada breached and was forced to sell his shares.
1. Court upheld the agreement forced sale provisions are ok.
Estrada argued unconscionability, but the court said she was an
astute businesswoman and knew what she was doing.
d. CONCLUSION:
Therefore,
(void/enforceable).
[whatever
the
shareholders
agreed
to]
is
SHAREHOLDER ABUSE OF CONTROL

Look for: Minority SH in closely held corp.
Scenario 1: Where someone invests in a close corporation in anticipation of working there
(employee or officer). But then the shareholder gets fired. So his money is locked into a
corporation with no market to sell. Can he sell the shares to other shareholders? Can the
other shareholders freeze him out?
Scenario 2: Where a close corporation buys stocks from one of its shareholders and they do
not disclose material facts to that shareholder prior to the purchase.
I.
ISSUE: The issue is whether [the majority shareholders] breached a fiduciary duty to
[minority shareholder] when they [freeze out -OR- Failed to disclose].
a. FREEZE OUT RULE: As the court held in Wilkes (Mass.), the majority shareholders
typically have the burden to prove they were acting for a legitimate business
purpose, and not simply trying to freeze out the minority. However, the law is not
entirely clear in this area because other courts, such as the Ingle court (NY), have
declined to hold majority shareholders liable in similar situations.
i. APPLICATION/CONCLUSION: Here, the majority shareholders conduct was [a
freeze out -OR- made with a legitimate business purpose] because
1. Possible recommendations to a MINORITY shareholder:
a. Minority veto power:
57
i. Step One Have a shareholder (pooling) agreement to

make you a director
ii. Step Two Have the bylaws of the corporation say that
100% vote of the directors is needed to act or amend the
bylaws (veto power at the director level)
iii. Step Three If shareholders can amend bylaws, say the
bylaws cannot be amended without 100% shareholder
approval (veto power at shareholder level).
b. Buyout agreement Allows a shareholder to end his relationship
with the corporation and receive cash in return for his shares
upon certain triggering events.
c. Employment contract You should get an employment
agreement that ensures your salary and provides that if you are
terminated without cause, you will get severance pay and the
corporation is required to buy your shares (mandatory
repurchase agreement).
2. Possible recommendations to a MAJORITY shareholder:
a. State a legitimate business reason in letters, corporate minutes,
emails, or other conversations.
b. Go to the minority and say we are really sorry about this, but we
do not have the money for four peoples salaries and you are the
least important.
c. Dont offer a low ball price; make it fair its not worth the cost of
litigation.
d. All in all, it is important what you say in email, minutes notes,
etc. IF all of this was done properly, then the result will likely be
in your favor.
i. Note: Make sure there was no smoking gun so no one
confesses as to what the real reason for the freeze out
was.
3. Wilkes v. Springside Wilkes and three others formed a corporation.
They each collected salaries and the corporation didnt pay dividends.
The other three fired Wilkes which severed his salary so he had no
money coming in on his investment. The other three offered to buy his
shares at a really low price.
4. Ingle v. Glamore Motor Sales Ingle was an employee of Glamore and
Glamore sold him 40 shares. The agreement said that if Ingle ceased to
be a Glamore employee, he must sell his shares to Glamore. Ingle got
fired. Glamore bought his shares for a fair price. Ingle sued Glamore
for breach of fiduciary duty.
a. Breach in Wilkes; No breach in Ingle because:
i. Ingle was being offered a fair price; Wilkes was
getting lowballed.
ii. Ingle had a buyout provision in the agreement;
Wilkes did not.
iii. Ingles agreement said he could be fired for any
reason; Wilkes didnt have an agreement
iv. Ingle was simply an employee before he bought
shares; Wilkes was one of the original owners
getting thrown overboard.
58
b. FAILURE TO DISCLOSE RULE: Generally, shareholders do not owe a fiduciary duty

toward one another. However, in Jordan v. Duff & Phelps, the Seventh Circuit stated
that shareholders should not take opportunistic advantage of one another. In other
words, the court imposed a duty of good faith where a shareholder agreement is
silent as to the particular issue.
i. Jordan v. Duff and Phelps Jordan was an at will employee for Duff. He bought
stock and the purchase agreement said if his employment agreement was
terminated for any reason, Duff would buy his stock at book value. Jordan
decided to move to Houston (meaning he would have to sell his stock) and
Duff failed to disclose merger negotiations that made his stock more valuable.
1. The court said Duff breached its duty by failing to disclose this
information.
II.
OVERARCHING CONCLUSION: Therefore, the majority shareholders did (not) breach

their fiduciary duty to the minority shareholder. [If breach: Thus, the next issue is
whether the minority shareholder has a remedy.]
a. APPLICATION IF SHAREHOLDER AGREEMENT: Here, the shareholder agreement
provides
i. Minority veto power:
1. Step One Have a shareholder (pooling) agreement to make you a
director
2. Step Two Have the bylaws of the corporation say that 100% vote of
the directors is needed to act or amend the bylaws.(veto power at the
director level)
3. Step Three If shareholders can amend bylaws, say the bylaws cannot
be amended without 100% shareholder approval (veto power at
shareholder level).
ii. Buyout agreement Allows a shareholder to end his relationship with the
corporation and receive cash in return for his shares upon certain triggering
events.
iii. Employment contract You should get an employment agreement that
ensures your salary and provides that if you are terminated without cause,
you will get severance pay and the corporation is required to buy your shares
(mandatory repurchase agreement).
b. APPLICATION IF NO SHAREHOLDER AGREEMENT OR IF AGREEMENT SILENT: Here,
there is no shareholder agreement addressing remedies. This was a mistake
because [pick one]:
i. RULE FOR ILLINOIS: Generally, state statutes are unsatisfactory in resolving
this issue. In Illinois, Section 12.56 of the Illinois Business Corporation Act
requires one of the following triggers for judicial intervention: (1) the directors
must be deadlocked and irreparable injury is threatened; (2) illegal,
oppressive, fraudulent conduct or; (3) the corporations assets are being
misapplied or wasted. If any of these events trigger the statute, the court
may, but is not required, to order a remedy.
1. NOTE: Remedies include: (1) buying back the shares at a fair price; (2)
removing any officer and director; or (3) appointing any officer or
director.
ii. RULE OUTSIDE ILLINOIS: state statutes are unsatisfactory in resolving this
issue for three reasons. First, state statutes often have an extreme trigger
59
(typically irreparable harm). Second, judges often have complete discretion

in deciding an applicable course of action. Finally, unclear remedy. In some
statutes, the remedies are like an atomic bomb where all the court can do is
blow up the corporation.
1. Alaska Plastics case Muir was a minority shareholder who alleged the
majority was not giving her notice of meetings and taking excessive
directors fees. Muir wanted the court to order the company to buy her
out.
a. The court refused to buy Muir out because if they did,
Muir would be treated better than other shareholders.
For the court to buy her out, Muir needed to prove that
the company: (1) did something illegal, oppressive, or
fraudulent; or (2) that the company paid a constructive
dividend.
i. Constructive Dividend = Company only wants to give
dividends to directors and not shareholders so they
disguise the dividends as directors fees.
b. RECOMMENDATION:
i. Alaska Plastics should have offered Muir a fair price for her
stock. The lowball offer supports her argument that the
company was just trying to squeeze her out and lacked a
legitimate business purpose.
ii. Alaska Plastics should have given Muir notice of the
shareholder meetings.
2. Stuparich v. Harbor Furniture Malcolm was a majority shareholder of
the voting shares.
Malcolms two sisters were the minority
shareholders of the voting shares. The company had two businesses
and the sisters wanted to set them up as subsidiaries. Malcolm
refused. Sisters sought involuntary dissolution under California law.
a. The court found for Malcolm. The California test for
involuntary dissolution of a closed corporation requires:
(1) less than 35 shareholders; and (2) plaintiff has to
show that dissolution is reasonably necessary.
i. Note: The California test is easier to meet than the typical
test.
ii. Note: What should have been in the agreement for a
different outcome? A buyout provision or some sort of veto
power.
TRANSFER OF CONTROL
Scenario: There are two shareholders in a close corporation. One owns 80% the other owns
20%. The only reason the minority has invested is because he loves the way the majority
shareholder runs the business. The majority shareholder decides to sell all of his shares to
someone who will not run the corporation as well. The minority shareholder would not have
invested if he knew this. What can the minority shareholder do? Can he get out?
60
I.
ISSUE: Here, the minority shareholders is alleging [controlling bloc] improperly [sold
shares at a premium or sold board of directors or violated shareholders agreement].
Because a controlling bloc is allowed to sell their shares at a premium [and/or sell the
board of directors] (unless the shareholders agreement states otherwise), the issue is
whether [controlling blocs] shares are the controlling shares of the corporation.
II.
RULE: There are differing viewpoints on what is considered control of a corporation. In

Essex Universal Corp. v. Yates, Chief Judge Lumbard explained that the controlling
shares of a corporation dont have to constitute 51% of the shares of the corporation.
Rather, he found that ownership of 28.3% of the shares was tantamount to control.
On the other hand, Judge Friendly argued that a buyer must obtain more than half of the
corporations stock in order to establish control.
a. Exception: Cant sell at a premium to a looter. Looter = someone the majority
shareholder knows or believes will exercise his control to the detriment to the
remaining shareholders (e.g. runs the company as his private piggy bank); basically
sucks assets out of the company for his own person benefit.
i. Look for past record
ii. Note: If the majority sells to a looter, the majority will be liable to the
minority for the premium they received.
1. Solution: Allow the minority to sell their shares with the majoritys.
iii. Sale of Office: Sale cannot be conditioned on control SH improperly selling
corporate offices
1. Challenger must show:
a. The buyer did not acquire control to elect own BOD (Essex), OR
b. The sales prices exceeds the premium the control block alone
commands, suggesting the price included sale of office (Perlman)
III.
APPLICATION:
a. If Large Corporation: Here, the court should side with Judge Lumbard because having
more than 51% of a large corporation is illogical. (Professor agrees with Lumbard).
On balance, since the burden is on the challenging party to establish percentage of
shares isnt control, _____ will likely succeed.
b. If Small Corporation: Here, while Judge Lumbards opinion makes more sense in a
large corporation, in a small corporation, such as the one at issue here, a court is
more likely to side with Judge Friendly. On balance, since the burden is on the
challenging party to establish percentage of shares isnt control, _____ will likely
succeed.
c. Note: Selling the officers of the corporation is a more difficult issue than the
directors. However, in light of Judge Lumbards opinion, this is really a minor point.
Judge Friendly is the only fly in the ointment.
d. Possible recommendations to a MINORITY shareholder
i. Right of First Refusal (Frandsen): If the controlling bloc is given an offer to sell
its shares, it must give the minority the right to buy the shares at the offer
price.
1. However, if the client does not want to buy the shares and become a
majority shareholder, recommend the client get a second layer of
protection: having the shareholder agreement state: If the minority
declines, the majority bloc must offer to buy the minoritys shares at
the same price at which it sold its own shares.
61
a. EX: Eli owns 92% and Bob owns 8%. If Eli wants to sell his
shares at a premium price to Steve and Bob declines his right of
first refusal, Bob can force Eli to buy his shares and then sell
100% of the company to Steve.
2. Note: Also, make sure the client is aware that a merger does not
qualify as a sale of shares for the purposes of the right of first refusal.
ii. Appraisal Rights determine price that buyer must offer to buy minoritys
shares at.
IV.
CONCLUSION: Therefore, [controlling bloc] did (not) have control of the corporation
and could (not) [do what they did].
62
MERGERS AND ACQUISITIONS

SELLER (TARGET)
APPROVAL
NEEED FROM:
MERGER
ASSET
TRANSFER
STOCK
TRANSFER
BUYER APPROVAL
NEEED FROM:
BUYER TAKES ON
SELLERS:
APPRAISAL
RIGHTS
BOARD
SHAREHOLDERS
BOAR
D
SHAREHOLDERS
Liability
All Assets
SELLER
BUYER
Y (except short
form)
PLAINTIFF CLAIMING DE FACTO MERGER (not an asset or stock

purchase)
Scenario: Where a target corporation immediately liquidates following the sale of its assets or
stock and:
Targets unpaid creditors want a de facto merger because a merger allows the creditors to get
at the buyers (subsidiarys) assets whereas in an asset or stock purchase they can only get at
the targets assets (and the target no longer has any assets).
Targets shareholders want a de facto merger because they want appraisal rights which they
dont get under asset/stock purchases. Also some state statutes give them more rights.
I.
ISSUE: Here, Plaintiff [targets unpaid creditor or targets shareholder] claims the asset
purchase or stock purchase is actually a de facto merger. [Look for immediate
liquidation]
II.
RULE: Illinois and a minority of states recognize de facto mergers when a target
corporation immediately liquidates following the sale of its assets or stock. However, in
Delaware the Hariton case rejected the de facto merger doctrine and instead applied
the equal dignity doctrine. It reasoned that there are two distinct paths a corporation
can follow (asset/stock purchase OR merger) and the court will not second guess a
corporations decision.
III.
APPLICATION: Here, because we are in [state], Plaintiff [unpaid creditor or minority

shareholder of target]s argument will [succeed/fail] because
a. Note: If the target has liquidated right away in a jurisdiction that has the de facto
doctrine and the majority of what the target received was stock, it will likely be a de
facto merger.
i. In IL in will be unpaid creditors
IV.
CONCLUSION: Therefore, the asset purchase or stock purchase is (not) a de facto

merger
PLAINTIFF CLAIMING ASSET OR STOCK PURCHASE (not a merger)

Scenario: Companies is calling their transaction a merger, but the shareholders want it to be
called an asset or stock purchase because that way they can redeem their shares.
63
I.
ISSUE: Here, Plaintiff [targets shareholders] claims the merger was actually an asset
purchase or stock purchase.
II.
RULE: If a corporations articles of incorporation provide that shareholders are entitled

to redemption, the corporation will often try to structure the transaction as a merger so
that the corporation does not have to redeem the shares. In Delaware, a plaintiff
attempting to argue against the merger will fail because the Rauch case held the equal
dignity doctrine favors form over substance. If the corporation chooses to structure the
deal as a merger, the court will not second guess this.
a. Note: Cant call a cactus a rose and make it a rose.
III.
APPLICATION: Here
a. Recommendations for the Target Corporation:
i. Hire an Investment Banking House The Corporation should hire an
investment banking house to tell them how much to pay for the stock. If they
do, Section 144(e) protects them from liability.
b. Rauch v. RCA RCA merged into GE. RCA had common and preferred shareholders.
Certificate of incorporation said that RCA could redeem the preferred stock for
$100.00/share. If GE had bought the assets for cash and then RCA liquidated, this
could involve the redemption of the preferred stock. Instead, they merged and paid
preferred shareholders $40.00/share and common stockholders got $66.50/share.
i. The court denied plaintiffs claim and said that the merger was valid
under the equal dignity doctrine.
IV.
CONCLUSION: Therefore, the merger is (not) an asset purchase or stock purchase.
LLC MERGER
I.
ISSUE: Here, we are dealing with a merger of an LLC.

whether plaintiff can void the merger.
Therefore, the first issue is
II.
RULE: In a contested merger, the company will generally get the benefit of the
business judgment rule. However, where the members breach their duty of loyalty, as
seen in Castiel, the managers will not get the benefit of the business judgment rule and
the court will likely block the merger.
III.
APPLICATION: Here . . . argue whether the members breached their duty of loyalty.
a. VGS Inc. v. Castiel Castiel and Sahagen formed an LLC where Castiel owned 75%
and Sahagen owned 25% of the membership interest. They hired a three person
board of managers. Castiel could hire/fire two of the three and Sahagen could
hire/fire one. Castiel appointed himself and Quinn and Sahagen appointed himself.
Sahagen had secret meetings with Quinn and got him to turn on Castiel. Sahagen
and Quinn secretly voted for a merger which diluted Castiels shares and turned him
into a minority member.
i. Even though only two managers were needed to approve the merger,
the court blocked it anyway because the secret meetings violated the
duty of loyalty. If Castiel knew about their plans, he would have
exercised his right to fire Quinn and appoint someone loyal to him.
1. It doesnt matter if Castiel was incompetent because the business
judgment rule protects him.
SQUEEZE OUT MERGER (always a parent and a subsidiary)

64
Scenario: Majority shareholders attempting to get rid of minority shareholders.

shareholders dont like it.
Minority
I.
ISSUE: Here we are dealing with a squeeze out merger, therefore the issue is whether
plaintiff is entitled to damages.
II.
RULE: In a squeeze out merger, the business judgment rule does not apply because the
same people are on both sides of the deal. Generally, as the court in Weinberger
explained, the burden is on the majority shareholders to pass the entire fairness test by
showing: (1) fair procedure; and (2) fair price. However, if the merger is approved by
sanitized voting, the burden shifts to the plaintiff minority shareholder to prove: (1)
unfair procedure; and (2) unfair price.
[The Coggins court reaffirmed that in
Massachusetts, courts apply the business purpose test and uphold mergers so long as
there is a valid corporate objective. (But there needs to be some other purpose than
just getting rid of people).]
a. EXCEPTION: Short-Form Mergers Under Delaware law, if the parent owns 90%
of the subsidiary, all you need is the approval of the parent companys board of
directors. The court in Glassman further clarified that the subsidiary doesnt have to
jump through the hoops of entire fairness.
i. Recommendation to Parent
1. If the parent owns close to 90%, tell them to buy enough shares to get
to 90%. You only need to disclose why you are buying up shares.
III.
APPLICATION: Here
a. Things that indicate Fair Procedure
i. Sanitized voting = parent company voting the same as the majority of
minority shareholders approve the deal.
ii. Subsidiary forming an independent committee of the board to negotiate the
transaction
iii. Subsidiary getting an independent investment banking house and lawyer to
say the price is fair
b. Things that indicate Fair Price
i. Hire a totally independent investment banking firm
ii. Have the independent committee do the hiring of the investment banking firm
IV.
CONCLUSION: Therefore, plaintiffs claim will (not) succeed. [Because we are in

Delaware, plaintiff is only entitled to appraisal rights, not damages, unless he can
show fraud, waste, or self-dealing.]
TAKEOVERS
Scenario: Company wants to acquire another company so they talk to the target board.
Target board says no deal. So the raider makes a tender offer to the target shareholders. The
target shareholders want to take the deal, but the target board of directors does not want to
take the deal. Did the board act proper in fending off the sale?
Note: The raider OR target shareholders can bring the suit
**Note: Green-mailers were people who would buy up a bunch of shares, and then offer to sell
them back to the company at a higher price. There was a dispute over whether the
65
corporation could use their funds to buy back the shares. Corps had to show good faith and
reasonableness. This is no longer an issue because Congress taxes green-mail profits, so no
one green-mails anymore. **
I.
ISSUE: Here, we are dealing with a hostile takeover because the [target] board rejected
the [raiders] initial offer to buy [target] and the [raider] made a tender offer to
[targets] shareholders. In assessing whether the target board acted properly, the first
issue is whether the [target] board is entitled to the business judgment rule or the
enhanced business judgment rule.
II.
RULE: The enhanced business judgment rule is triggered where: (1) there is a sale of
control; (2) the breakup of a company is inevitable; or (3) defensive measures are in
place.
III.
APPLICATION: Here, the enhanced business judgment rule does (not) apply because
[pick one of four]
a. SALE OF CONTROL (QVC) There was a sale of control in the target corporation.
Here, there was a sale because [someone] acquired ___ percentage of target. [Look
to whether P becomes minority in surviving corp] [Argue what counts as control
see Transfer of Control Judge Lumbard v. Judge Friendly].
i. ENHANCED BJR RULE: When dealing with the sale of control of a target
corporation, the court in QVC stated that the Enhanced BJR requires the
targets board satisfy its Revlon duties: (1) that it acted reasonably; and (2)
the goal of the transaction was to maximize the present value for
shareholders (no need to get competing bid, only best price).
1. APPLICATION: Here, the target did (not) act reasonably and did (not)
maximize the present value because
a. Reasonably: [adequacy of decision making process] if the board
acted as protector of the target shareholders (to fend off the
raider) then it did not act reasonably. The board needs to stop
playing defense and start playing offense to get the most money
now. Be informed of all material information.
i. Ex: auction, canvas the market, no single blueprint
ii. Reasonable decision, not perfect; balance
b. Maximizing Value: maximizing present value means that the
target board sought the best price for target shareholders right
now. Long-term goals are irrelevant. Once control shifts, the
current stockholders have no leverage in future to demand
another control premium and that is why max value is significant.
i. Cannot contract out of fiduciary duty: (QVC) Board
cannot use defensive measures (No-shop) in a merger
agreement to effectively remove their duties to
shareholders, therefore agreement is invalid and Corp can
get other offers (fiduciary out).
ii. Even if make higher bid, other measures still in place to
void deal. Where measures prevent board from
maximizing value then it is invalid.
iii. Possible cap stock option to reach reasonable levels
2. CONCLUSION: Therefore, the enhanced business judgment rule is (not)
satisfied and the target board did (not) breach their fiduciary duty to
the target corporation.
66
b. BREAKUP/SALE INEVITABLE (Revlon) the breakup/sale of the target corporation was

inevitable. The breakup became inevitable when: pg. 777
i. The target company shops around after a raider makes an offer
ii. the target company makes a counteroffer to a raiders offer
iii. Heavy leverage buyout the raider borrowed so much money to acquire the
target that they will have to sell off parts of the target corporation to pay back
the money.
iv. Where there is a bidding war
v. In response to raiders offer, target abandons long-term strategy and seeks
alternative transaction involving break up
vi. ENHANCED BJR RULE: When dealing with the sale of control of a target
corporation, the court in Revlon stated that the Enhanced BJR triggers two
duties for the target board: (1) to act reasonably; and (2) to maximize the
present value for shareholders (no need to get competing bid, only best
price).
1. APPLICATION: Here, the target did (not) act reasonably and did (not)
maximize the present value because
a. Reasonably: If the board acted as protector of the target
shareholders (to fend off the raider) then it did not act
reasonably. The board needs to stop playing defense and start
playing offense to get the most money now.
b. Maximizing Value: maximizing present value means that the
target board sought the best price for target shareholders right
now. Long-term goals are irrelevant.
c. DEFENSIVE MEASURES (Unocal and Time-Warner) defensive measures were in
place to prevent a hostile takeover. Here [three below]
i. Poison Pill When target management gives its shareholders an option to
acquire stock. This right is not given to the raider. The price starts very high,
but when someone acquires a threshold amount of the targets shares (usually
15% to 20%), the stock price drops drastically, causing dilution of the raiders
ownership interest in the target.
1. EX: Tim, Eli and Steve each own 100 shares in a corporation. They are
also the board of directors. Bob, the raider, asks to buy the company.
The board rejects the offers and puts a poison pill in place. Bob buys all
of Steves shares (so now he owns 33%) and the poison pill is triggered.
Tim and Eli now have the right to buy 100 additional shares each for
the price of 50 shares. This right does not extend to Bob. So now Bob
only owns 16.50% of the corporation.
ii. Restructuring the Deal Instead of A merging into B, B makes a tender offer to
A so that As shareholders do not get a vote.
1. EX: Time and Warner wanted to merger. The initial plan was for Warner
to buy all of Times shares, but Paramount made an unexpected tender
offer to buy Times shares at a much higher price than Warner.
67
Because Times board did not want to take the Paramount deal, they
restructured the Warner deal so that Time would buy Warners shares
instead of the other way around. This way, Times shareholders could
not vote on the merger.
iii. State Anti-Takeover Statute States put these in place to prevent companies
from leaving.
1. Delaware Statute Requires a three year wait between the raiders
tender offer and when the raider can actually consummate the merger.
a. Note: If the raider can eliminate the three year wait period if
they are able to acquire 85% of the target through the tender
offer.
iv. ENHANCED BJR RULE: In this instance, under Unocal, the Enhanced BJR
requires the targets board to show it: (1) reasonably believed there was a
threat to the company or shareholders; and (2) its response was proportional.
1. APPLICATION: Here it was (not) reasonable for the target board to be
threatened by [threat].
Further, the boards response was (not)
proportional because
a. THREATS
i. Inadequate offer price
1. RECOMMENDATION: Have an investment banking
firm verify that the offer price is inadequate.
2. Note: A target can claim a price is inadequate if it
believes the long term prospects look good. This is
different than Revlon where there is a duty to
maximize present value.
ii. Coercive offer (Unocal) if you dont accept this tender
offer now, I am going to make another tender offer for $1.
(T. Boone Pickens)
iii. 11th hour offer tender offer; shareholders can be tricked
if they dont have time to analyze last minute offer.
1. EX: There is a deal on the table to merger with
shareholders getting $10/share. At the last minute,
a raider comes in and offers $11/share. The target
is worried that shareholders might make a rash
decision and accept the raiders offer even though
the $10 offer is better for them.
a. Counterargument Professor thinks this
assumes shareholders are stupid and risks
judges telling them what is best for them.
b. PROPORTIONAL RESPONSE
i. There must be a reasonable time limit on the poison pill.
1. i.e. there is a poison pill in place. There have been
a few offers but the bidding process has run out of
steam. So there is no justification for keeping the
poison pill.
68
d. NONE OF THE ABOVE APPLY none of those three scenarios are present and
therefore, we apply the BJR.
i. BJR RULE: In this instance, the BJR creates a presumption the target board
acted with procedural due care in rejecting the raiders offer. The raider can
only overcome this presumption by showing: (1) disloyalty; or (2) irrationality.
1. APPLICATION: Here, the target rejected the raiders offer because
a. Recommendations to Target Board:
i. Consult an investment bank who said the raiders offer
was inadequately priced.
ii. State that you are focusing on the long term interests of
shareholders (this is good)
1. Note: Even if a raider makes an offer for a premium
price, the target does not have to take it if they can
prove the offer is not in the long-term interest of its
shareholders.
a. EX: Time is a respected for its journalistic
integrity.
Directors were worried that
merging with Paramount, a fictional movie
company, would harm Times image and
ultimately be bad for the company. So even
though Paramount offered a premium price,
Time was allowed to reject it.
ii. CONCLUSION: Therefore, applying the BJR, the court will likely [uphold/void]
the target boards actions.
CORPORATE DEBT
** Corporations issue bonds (debentures), but in reality, corporations are just borrowing
money **
ALL OR SUBSTANTIALLY ALL ASSETS

SCENARIO: Company A issued a $1000 bond to creditor. When Company A sells its assets,
including the bond obligation to Company B, Company B will argue that the sale was all or
substantially all. Otherwise, the creditor can call the bond for accelerated payments.
I.
OVERARCHING ISSUE: Here, [Company A] originally issued a debenture to creditor.

[Company B] bought [Company As] assets and undertook the obligation of the original
debenture. Therefore, the issue is whether the creditor can call the debenture from
[Company B] to accelerate payment.
a. RULE: Where a company purchases all or substantially all of the assets of another
company, the debentures do not become due and payable. Whether a purchase
involved all or substantially all of a companys assets is determined at the time the
selling company made the plan to liquidate its assets. (Sharon Steel)
69
b. APPLICATION: Here, at the time [company As] liquidation was planned, the assets
purchased by [Company B] made up ____ percent of [company A].
i. Note: Under Delaware law, if the purchased asset was the most valuable part
or most profitable part of company A, this may be enough to satisfy the all or
substantially all requirements (value over volume).
c. CONCLUSION: Thus, [company Bs] purchase of [company As] assets did (not)
involve all or substantially all of [company As] assets and therefore the creditor can
(not) call the debenture from [Company B] to accelerate payment.
LEVERAGED BUYOUT
SCENARIO: Company A issued a $1000 bond to creditor. Company B borrowed a ton of
money to buy Company A in an LBO. Company A merges into Company B. Now, Company As
creditor is in a junior position and wants to call the bond.
II.
OVERARCHING ISSUE: Here, [Company A] originally issued a debenture to creditor.

[Company A] then incurred additional debt when it was purchased in a leveraged buyout by
[Company B]. Therefore, the issue is whether the creditor can call the bond from
[Company B] to accelerate payment.
a. RULE: Generally, creditors are limited to the four corners of the indenture.
Therefore, unless the indenture says otherwise, incurrence of additional debt
through a leverage buyout does not permit a creditor to call the bond. (Metlife)
b. APPLICATION: Here, the text of the indenture states
i. Recommendation for Creditors
1. Try to get the debenture to provide that if a change of control occurs,
each debenture holder may require that the issuer redeem its
debenture for 101% of the principal amount plus accrued interest.
a. Metlife didnt insist on this because they were greedy.
They wanted the high interest and didnt want RJR to pull
out of the deal.
ii. Note: Courts are more likely to imply protection of a shareholder than for a
creditor because a creditor has a contract that it can use to protect itself.
1. Policy The court is only going to imply something if they can assume
the parties would have included in their written agreement had their
attention been called to it.
c. CONCLUSION: Therefore, the creditor can (not) call the bond from [Company B] to
accelerate payment.
EXCHANGE OFFERS
SCENARIO: Company A issued a $1,000 bond to investor. Company A is in financial trouble
so it makes an exchange offer seeking to switch the $1,000 bond with an $800 bond and the
offer contains an exit consent (meaning the investor loses their covenants if they chose to
keep the $1,000 bond). What should the investor do?
III.
OVERARCHING ISSUE: Here, [public company A] has made an exchange offer to its bond
holders, which contains an exit clause. Because the court in Katz v. Oak Industries upheld
70
the legality of exit clauses, the only remaining issue is whether the bond holder (the
investor) should accept the exchange.
a. APPLICATION: Argue pros/cons of accepting the exchange offer (prisoners dilemma)
i. EX: Company A issued a $1,000 bond to investor. Company A is in financial
trouble so it makes an exchange offer seeking to switch the $1,000 bond with
an $800 bond and the offer contains an exit consent (meaning the investor
loses their covenants if they chose to keep the $1,000 bond). What should
the investor do?
ii. Possible outcomes for the investor:
1. BEST OUTCOME: Reject the exchange offer and lose your original
covenants in the indenture, but enough other investors accept the offer
such that company As financial position improves and it can now pay
the investor the full $1,000.
2. MIDDLE OUTCOME: Take the $800 exchange offer (haircut) with the
original covenants (protections) agreed to.
**RECOMMEND THE
HAIRCUT LEAST RISK**
3. WORST OUTCOME: Reject the exchange offer and lose your original
covenants in the indenture, but enough other investors also think like
you and dont take the exchange. Company goes under and you get
nothing.
b. CONCLUSION: Therefore, investor should (not) accept the exchange offer.
REDEMPTION AND CALL PROTECTION

SCENARIO: Company A issued a $1,000 bond to investor at 5% interest for a 30-year term.
The indenture states that it cannot be paid back with money borrowed at anything less than
5%. Interest rates drop drastically, so Company A goes and borrows $1,000 from someone
else at 1% and wants to pay off the original debenture right away. The investor wants to
prevent this because if the bond is paid off, they will have to reinvest in someone at the
current interest rates.
IV.
OVERARCHING ISSUE: Here, [Company A] originally issued a debenture to creditor. The

indenture contained a provision that the debenture may not be redeemed with money
borrowed at an interest rate less than the interest rate of the debenture. Therefore, the
issue is whether the redemption violated this provision.
a. RULE: As the court held in Morgan Stanley v. ADM, if money borrowed at a lower
interest rate is not comingled with other corporate funds, then the company can use
those other corporate funds to redeem the bonds.
b. APPLICATION: Here
i. RECOMMENDATION for Company:
1. Dont indirectly use bad money (money borrowed at a lower rate) to
facility the redemption. Tell investor that company used good money
to pay off the investor.
a. EX: Company A has $1 million of good money and $1 million of
bad money. It needs $1 million for operating expenses. The
71
company uses the good money to redeem $1 million of old bonds

and uses the bad cash to pay for the operating expenses. Here,
the company indirectly uses the bad money to facilitate the
redemption because they would not be able to redeem the bond
without the bad money.
2. Instead, issue shares of stock to get good money. Dont comingle it.
Then use the good money to pay back the debenture. Now you can get
a new debenture at the lower rate.
c. CONCLUSION: Therefore, [company As] redemption did (not) violate the indenture.
72

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BUSINESS ORGANIZATIONS OUTLINE

OVERARCHING RULE: In assessing contract liability, [third party] must prove an