AGENCY: (Express - one that occurs when a principal and an agent expressly agree to enter into an agency agreement

with each other) OR (Implied - one that occurs when a principle and an agent do not
expressly create an agency; instead, the agency is implied from the conduct of the parties)

1. Ways an Agent May Bind Principal: in a contract action, whether the principal is bound the agent’s actions?
Actual Authority Apparent Authority Ratification Liability of an Undisclosed Principal Estoppel

A. Express – involves C. Apparent to Whom? D. Ratification – authority that is granted by the E. Liability of Undisclosed Principals – law will hold F. Estoppel – is an equitable doctrine that
examining the principal’s  it is about what a 3rd principal after an agreement has been made; involves them liable for unauthorized transactions when… prevents the principal from denying that an
explicit instructions party reasonably believes situations where agent enters into agreements on 1) a 3rd party has made a “detrimental change in agency relationship exists; arises when principal
the principal has behalf of the principal without any authority to do so position,” has done something improper
B. Implied – 1) involves authorized the agent to do 2) the principal had notice of the agent’s conduct,
examining explicit  look at the WHAT IS A VALID RATIFICATION? 3) the conduct might induce 3rd parties to change their WHEN IS ESTOPPEL INVOLVED?
instructions of principal, manifestations between  1) whether the principal, through words or conduct, positions, AND  Intentional, negligent or otherwise
AND principal and 3rd party manifests assent to affirm the agreement 4) the principal did not take reasonable steps to notify culpable acts or omissions by
2) what else might [R 3rd §2.03]  2) whether, given the facts and circumstances of the 3rd party of the facts [R 3rd §2.06] principal that create an appearance
reasonably be included to the situation, the law will give effect to that assent? of authority in the purported agent,
get job done (this is based in CREATION OF APPARENT SPECIAL RULES FOR K W/ UNDISCLOSED PRINCIPALS  A 3rd party who reasonably and in
part on what agent believes AUTHORITY Affirmation can be express or implied 1. 3rd party is sometimes entitled to: good faith relies on that appearance
the principal wishes him to 1) An objective Insist on rendering performance to the agent, or of authority, AND
do based on agent’s manifestation from LIMITATIONS ON RATIFICATION Escape the contract entirely  The 3rd party changes her position in
reasonable understanding of one party (“apparent  Principal MUST KNOW or have reason to 2. Rendering performance to the agent: The 3rd party reliance upon that appearance of
the authority granted) principal”) know, at the time of the alleged may insist upon rendering performance to the agent if authority
2) Which somehow ratification, the MATERIAL FACTS relating the K requires the 3rd party to perform personal services
Gorton v. Doty (Id., 1937) reaches a 3rd party, to transaction. [R 3rd § 4.05] or if rendering performance to the undisclosed principal HOW IS IT DIFFERENT FROM APPARENT
Rule: where one undertakes and,  Principal may not partially ratify, must be would significantly increase or change the 3rd party’s AUTHORITY?
to transact some business or 3) Which causes the 3rd ALL or NOTHING. [R 3rd § 4.07] burden.  Estoppel requires the 3rd party change their
manage some affair for party to reasonably  If 3rd party manifests INTENT TO 3. Escaping Contract Entirely: In a narrow range of position in reliance on the purported authority
another by authority and on believe that another WITHDRAW from transaction PRIOR to circumstances a 3rd party may escape entirely a K made (i.e. detrimental reliance)
account of the latter, the
relationship of principal and
party (“apparent ratification, principal MAY NOT RATIFY. [R with an undisclosed principal if…  No manifestation requirement
agent arises. agent”) is indeed 3rd § 4.05] If the K between the 3rd party and agent provides that
authorized to act for  Ratification may be DENIED to protect it is inoperative if the agent is representing someone, or HOW IS IT USED?
the 1st party (i.e., for rights of INNOCENT 3rd PARTIES. The agent fraudulently represents that the agent is  to prevent one party from denying the
the apparent not acting for the principal, the 3rd party would not have purported agent’s authority when the 3rd party
principal) NOTES entered into the K knowing the principal was a party, wants to enforce K
[R 3rd § 3.03] Once a K is ratified, retroactive authority is created. [R and the agent or undisclosed principal knows or should  Exception: NOT used to create a binding
3rd § 4.02] know that the 3rd party would not have made the K with K that may be enforced on both parties
 Exception: when principal had no capacity to the principal.
enter into the agreement at the time that it 4. Active misrepresentation of the principal’s role is
was made. {If an agent enters an agreement on insufficient. The 3rd party must also show:
behalf of a minor but the minor does not ratify That had the 3rd party known of the principal’s role,
until she is an adult the agreement is effective there have been no K, and
with respect to that former minor upon The agent or principal had reason to know of the 3rd
ratification, not the date of the original party’s aversion
agreement} 5. Mere failure to disclose existence is always
insufficient
Boticello v. Stefanovicz (1979)
Rule: Marital status cannot in and of itself prove an Mill Street Church of Christ v. Hogan (Ky., 1990)
agency relationship. Ratification of an agency Rule: A person possesses implied authority as an agent to
relationship by the principal requires full knowledge of hire another worker where such implied authority is
the material circumstances, regardless of the principles necessary to implement the agent’s express authority
receiving the proceeds of the agent’s work

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Business Organizations – Attack Outline – Faiq
 2. Liabilities & Respective Duties Owed
Principal’s Liability Agent’s Liability Duty of Principal  Agent Duty of Agent  Principal

ANALYSIS QUESTIONS LIABILITY FOR K GENERAL DUTY GENERAL DUTY

 Did the Principal give Actual Authority to Usually Agent’s do not incur liability as a party to the  Duty to indemnify [R 3rd  Duty of care, competence and diligence [R 3rd § 8.08]
the Agent (either express or implied)? contracts that the Agent enters on behalf of a § 8.14]  Duty of loyalty [R 3rd § 8.01]
 Did the Principal make some disclosed principal. There are two situations where an  Duty of good faith and fair  Duty not to acquire material benefits arising out of the
manifestations to the 3rd party creating Agent will be liable: dealing [R 3rd § 8.15] agency [R 3rd § 8.02]
Apparent Authority? 1) An undisclosed principal, OR  Duty to not act as or on behalf of an adverse party [R 3rd §
 Was the Principal undisclosed, creating 2) An unidentified principal (AKA partially ANALYSIS QUESTIONS: DUTY OF 8.03]
liability of an undisclosed principal? disclosed principal) PRINCIPAL  Duty not to compete [R 3rd § 8.04]
o If yes, SEE ABOVE “Liability of In both of the above scenarios the agent will be bound  If Agent incurred any o This duty does not extend beyond the end of
an Undisclosed Principal” and the principal may ALSO be bound . costs, expenses, damages, the agency relationship; once the agency
 Did the Principal ratify the K?  This means the 3rd party may sue either the does the agent have a relationship terminates the ex-agent can
o Do any exceptions apply (not Principal or the Agent claim for indemnification directly compete
knowing all the facts, partial  IF the Agent is sued and they were acting within the against Principal?  Duty to not use principal’s property [R 3rd § 8.05(1)]
ratification, was it unfair to the scope of their authority, they can seek indemnification o This includes the duty to not co-mingle
3rd party)? from the Principal property of the principal with any other
 Is Estoppel an issue? property including the agent’s [R 3rd § 8.12]
o Did the Principal do something ANALYSIS QUESTIONS  Duty not to use confidential information [R 3rd
wrong or fail to do something  DEFAULT RULE: If Principal is disclosed § 8.05(2)]
that created an impression and the Agent, with authority to do so, o This duty LIKELY extends beyond the scope of
with the 3rd party? enters into an agreement with a 3rd party, the agency relationship and covers confidential
o Did the 3rd party rely and alter then generally, the Principal will be bound information learned during the course of the
but the Agent will NOT relationship
their position to their own
 DISCLOSED WITHOUT AUTHORITY: Agent  Duty of good conduct [R 3rd § 8.01]
detriment?
enters into an agreement with a 3rd party  Duty to provide information [R 3rd 8.11]
the Principal may or may not be bound o The agent must provide information to the
and Agent could be liable to 3rd party via…
principal ONLY to the extent that the agent
o Breach of Agent’s warranty of
does not violate the superior duty owed by
authority, OR the agent to another person
o Owe damages to Principal for
damages caused by Agent as ANALYSIS QUESTIONS: DUTY OF AGENT
indemnification  Violation of duty to Principal?
 UNDISCLOSED/ UNIDENTIFIED PRINCIPAL  Violation of duty to 3rd party?
WITH AUTHORITY: Agent enters into an  Willfully/ Negligently damaging a 3rd party?
agreement with a 3rd party the Principal  What damages is Agent responsible for?
and the Agent are both bound
 UNDISCLOSED/ UNIDENTIFIED PRINCIPAL Reading v. Regem (1948)
WITHOUT AUTHORITY: Agent enters into Rule: (1) An agent who takes advantage of the agency to make a profit
an agreement with a 3rd party the Agent dishonestly is accountable to the principal for the wrongfully obtained
will be bound BUT Principal will NOT, proceeds. (2) An agent has a duty to act solely for the master and any
unless… profit earned while violating this duty belongs to the master.
o Ratification or other
Town & Country House & Home Service, Inc. v. Newberry (N.Y., 1958)
circumstances triggering Rule: Former employees may not use confidential customer list
liability for undisclosed belonging to their former employer to solicit new customers
principal

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Business Organizations – Attack Outline – Faiq
 PARTNERSHIPS: If not expressly written out, the UPA’s default rules fill in [UPA § 103(a)] – NJ, CA, DE have adopted Revised UPA 1997 but NY, PA, and MA have not and still follow UPA 1994.
 Voluntary agreement (express or implied) – This can be satisfied simply through a handshake; a written contract is not needed.
 An association of two or more persons
 To carry on as co-owners of a business
 Anticipation of profit
 Profit sharing
Characteristics Does a Attributes Arising Once a Partnership is Limitations on Joint Venture, Partnership by
Partnership Established Partnerships Estoppel and Agency Theory
Exist?

 Partnership cannot be another THRESHOLD QUESTION Liabilities (each partner is jointly & severally liable) [UPA Agreement may NOT JOINT VENTURES
entity [UPA § 201] Is it the intent of the §306(a)] [UPA §103(b)] - Business endeavor undertaken by two or
 Owners in a partnership parties to carry on, as Control (each partner can participate in control and management  Unreasonably restrict a more parties
generally make some co-owners, a definite of the partnership, UPA 1997 entitles each partner to one vote partner’s access to - Limited scope and limited time
contribution (doesn’t have to business? regardless of what they contributed… alternative voting standards books and record - Just calling a joint venture does not make it
be $) in exchange for their  Lack of intent to be can be agreed upon by partners)  Eliminate general duty a partnership
share in the partnership [UPA in a partnership is NOT Returns (Profits are shared equally, so if the partnership dissolves of loyalty (although ** Usually a fact pattern with a joint venture means
§ 18(a)] dispositive the money is divided as such… most states hold the profits are specific exceptions may partnership rules should be applied **
 Partners generally share the equally distributed regardless of the contribution of that partner) be approved)
profits of the business [UPA § EMPLOYEE-EMPLOYER Tax Treatment (tax responsibility for profits/ losses is passed o Delaware allows PARTNERSHIP BY ESTOPPEL
18(a)] RELATIONSHIP OR A through to the partners to include on their personal tax returns) elimination of  Actual Reliance – party claiming estoppel
 Partners generally share the PARTNERSHIP? Fiduciary Duties (partners owe fiduciary duties to one another) liability for breach needs to actually rely on the manifestation.
risk of financial loss [UPA §  Court will of fiduciary duties,  Reliance Must be Reasonable – The 3rd party
18(a)] examine… FIDUCIARY DUTIES [UPA § 404] including the duty may not assert that partnership by estoppel
 Partners jointly share the  INTENT of A. Duty of Loyalty of loyalty, if it is due to an unreasonable assumption
management, but equal votes parties  Account to the partnership for profits, property, specified in the  Some Manifestation by the Alleged Partner –
or control is not needed  LANGUAGE of benefits from the conduct (or winding up) of the agreement. The alleged partner must act or fail to act in
 Other individuals can be hired agreement partnership or the use of partnership property o However, actions some way that conveys the message that such
who are not partners  CONDUCT of  Refrain from acting on behalf of a party with an of partners are individual or entity is a partner. Even if the
parties toward adverse interest to partnership still subject to manifestation is not made directly to the 3rd
ADDITIONAL BUT UNNECESSARY 3rd parties  Refrain from competing in the same line of business good faith and fair party, it must be traceable back to some
CHARACTERISTICS  Treatment of as partnership dealing. action or inaction of the alleged partner.
 Joint ownership itself doesn’t RETURNS of  Perform all duties in good faith and fair dealing  Unreasonably reduce
mean a partnership exists business  Avoid acting on partnership opportunities that fall within the the duty of care ESTOPPEL IS DIFFERENT FROM AGENCY THEORY
 Neither sharing gross returns  Who bears the scope of the business of the partnership… IF acting on such  Eliminate the obligation  In AGENCY theory: a “non-partner” is treated as
nor giving capital RISK of the opportunity, partner MUST of good faith and fair though they had the authority of the actual partner to
independently is enough to financial losses 1. Disclose the business opportunity to other partners, dealing bind the partnership. This concept turns on apparent
create a partnership AND  Vary the power of a authority.
 Sharing profits in a business is Fenwick v. 2. Decide whether or not to act on behalf of the partner to dissociate The reasonable understanding must be
prima facie evidence that a Unemployment partnership and take the opportunity traced back to something the partnership
Compensation  Vary the right of a court
partnership exists [UPA § [See Meinhard v. Salmon, “Not honesty alone, but the to expel a partner under did to create the understanding.
Commission (N.J., 1945)
202(c)] punctilio of an honor the most sensitive is the specific circumstances  NO requirement of detrimental
Rule: (1) A partnership
EXECPT where profits are standard of behavior”] reliance
is an association of two  Vary the requirement to
received as: or more persons to carry B. Duty of Care (do not engage in)  Concerns ability to bind
wind up the partnership
o Debt service on as co-owners a  Gross negligence  In ESTOPPEL theory: the question turns on
in certain circumstances
o Wages business for profit. (2)  Reckless conduct whether the reasonable understanding of the 3rd
 Restrict the rights of 3rd
o Rent The sharing of profits  Intentional misconduct or party can be traced back to something that non-
does not alone create a parties under the UPA
o Annuity  A knowing violation of law partner did to create the understanding
partnership, despite the  All duties must be discharged in good faith and fair dealing  Concerns non-partner being held liable
parties’ intentions
as a partner
 Detrimental reliance is NEEDED

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Business Organizations – Attack Outline – Faiq
 PARTNERSHIPS: continued
Expulsion Nature of Partnership Interests Rights of Partnerships in Partnership Dissolution & Dissociation
[UPA § 26] Management

A PARTNER MAY BE EXPELLED IF: A. ECONOMIC RIGHTS [UPA § 401(a)] I. Any partner can bind partnership in STEPS TO THE END OF A PARTNERSHIP [UPA § 801]
 Partnership agreement details it  Include the right to receive $ ordinary course of business [UPA § 1. Dissolution [UPA §§ 29, 31, 32]
 There is a unanimous vote of the distributed from the partnership to the 9(1)] 2. Winding Up – Selling of assets, paying creditors, and making distribution
other partners: holder of the economic right [UPA § a. Sometimes apparent to partners [UPA §§ 30, 40]
o if it is unlawful to carry on 18(a)] authority supplements and if - Partners may not embark on new business
the partnership with that  Transferrable [UPA § 502] there is no actual authority
- Partners may vote to continue partnership rather than terminate (must
partner,  Do not entitle holder to any right in but the 3rd party reasonably
be unanimous)
o if there has been a transfer any of the specific property of the believed partner had actual
3. Termination
of all (or substantially all) partnership [UPA § 203] authority, the partnership is
of the partner’s  Transferee does not have right to vote bound to the 3rd party WHAT IS DISSOCIATION
transferable interest [UPA or become partner simply by holding  Other partners can bring  Whenever a partner leaves a firm, voluntarily or involuntarily.
§ 601(4)(ii)]; or economic rights [UPA § 503(a)] claim against the partner
 It does not necessarily trigger dissolution.
o if the partner to be B. MANAGEMENT RIGHTS [UPA § 401(f)] who acted out of apparent
 It can be wrongful.
expelled is another entity  Include the right to vote and authority to bind the
 If a partnership is for a term of years but the partner dissociates prior
ending its existence participate in management of the partnership if the apparent
to the completion of the term, the partner may be liable to the
 There is judicial determination if partnership [UPA §§ 9, 18(e)] authority was in violation of
partnership for damages
certain circumstances are  Non-transferrable, unless all other the partnership agreement
 If a partner dissociates in violation of the agreement.
satisfied involving the wrongful partners consent [UPA § 18(g)] II. Majority approval is needed for day-to-
 If partnership is not for a term or for an undertaking, it is an at-will
conduct of the partner to be day operations [UPA § 18(h)]
partnership. In at-will partnerships, partners may dissociate at any point
expelled HOW TO OBTAIN ECONOMIC INTEREST IF YOU ARE III. Unanimous approval is needed for
A TRANSFEREE?
UNLESS the agreement provides otherwise.
matters outside the ordinary course of
LIMITATIONS ON EXPULSION  By voluntary transfer by the transferor business such as selling all partnership
DISSOCIATED PARTNERS RIGHTS
 EVEN PERMISSIBLE PROVISIONS partner assets Dissociated partners are entitled to receive funds that represent their share of
must be exercised in good faith and fair  By an involuntary transfer by the transferor
the partnership MINUS the damages… if any.
dealing partner, which may happen due to a
National Biscuit Company v. Stroud (N.C., 1959)  Going concern value: value of partnership as an operating entity without the
judgment being enforced against that
Rule: (1) The acts of a partner, if performed on dissociated partner
partner behalf of the partnership and within the scope of  Liquidation value: value one could get for selling all assets of the business
 By death of transferor partner its business, are binding upon all co-partners (2)  IF At-Will: then dissociated partner is entitled to the value of their share
Each partner is an agent of the partnership for
shortly after dissociating
purpose of its business & has ability to bind
Putnam v. Shoaf (Tn., 1981) partnership. Therefore, each partner’s acts
Rule: A conveyance of partnership property by one considered to be the usual course of business GENERAL RULE OF DISSOCIATING PARTNER’S FUNDS
another held in the name of the partnership is made binds the partnership, unless the acting partner  Value of their partnership interest (the greater of the going concern
in the name of the partnership and not as a has no authority to act for partnership and value OR the liquidation value); MINUS
conveyance of the individual interests of the partners person w/ whom he’s dealing w/ knows of the  Partner’s share of liabilities; MINUS
lack of authority  Any damages for wrongful dissociation; PLUS
 Interest paid from date of dissociation to date of payment;
 Usually, payable within 120 days if at-will, or at end of term, or end of
undertaking

Pav-Saver Corp. v. Vasso Corp. (Ill., 1986).

Rule: When a wrongful dissolution occurs, partners who have not wrongfully
caused the dissolution shall have the right to continue the business in the same
name & to receive damages for breach of the agreement

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Business Organizations – Attack Outline – Faiq
 CORPORATIONS:
Corporations are owned by shareholders, and the shareholders are entitled to residual value of the corporation after it has paid off its creditors. Shareholders do not participate in the management of the corporation.
They only elect the Board of Directors. The Board of Directors then appoints officers for the corporation.
FORMATION Characteristics Shareholders Board of Directors De Facto Corporations vs.
Corporations by Estoppel

Corporations are created under  Being treated as a separate person under SHAREHOLDERS VOTE ON: DIRECTORS OF A CORP.: DE FACTO CORPORATIONS
state law. Articles of Incorporation law  Election of directors  Are elected by the If a corporation is not properly formed,
must be filed with the Secretary of I. Decisions: requirement that BOD meet  Amendments to articles of shareholders sometimes shareholders of an organization are
State in the state selected for its and maintain minutes in order to make incorporation  Serve for a set term given protection under this equitable doctrine.
formation. decisions. Corporate formalities  Amendments to by-laws  Typically make the major
demonstrate the corporation’s separate  Fundamental transactions (like decisions relating to the Requirements:
Corporations is subject to personal identity from individual actors. mergers & acquisitions) operation of the corporation 1) A good faith, substantial effort must have
jxd.: 1) where their principal place II. Rights & Lawsuits: can be sued in  Miscellaneous matters (like  Select the officers (who then been made to comply with the state’s
of business is, and 2) where their principal place of business or state of approval of independent handle the day-to-day affairs) incorporation statute;
state of incorporation is incorporation auditors) 2) The business must have had a legal right
III. Taxation: Corp. must file its own taxes ** Shareholder votes can only be cast to incorporate; and
ARTICLES OF INCORPORATION on the money it earns. Then at the annual meetings ** 3) The parties must have had a good faith
INCLUDE: shareholders are also taxed for their belief that, and acted as though, they
 Name of the corp. receipt of dividends. This is a double Shareholders are entitled to residual had, in fact, formed a corporation
 Purpose of the corp. (which taxation structure. interest in the assets of a corporation.  If the requirements are met, then principals
may be as broad as “any  Providing limited liability for its owners  Upon liquidation shareholders are have limited liability from the debts of the
lawful purpose”) I. Shareholders: are not personally liable entitled to the value of the remaining corporation although this is unlikely given the
 Number of shares beyond the amount they invest assets after the corporation’s modern filing procedures.
authorized for each class of II. Requirements: 1) follow rules/ obligations have been satisfied  Because most states provide notice when
stock of corp. formalities, 2) provide notice to world articles of incorporation are filed properly or not,
 Name and address of the that it is a corp., 3) treat corp. as incorporators almost always have (constructive)
agent for service of process separate from its owners, and 4) be a notice that the corporation has been formed.
real business
OPTIONAL PROVISIONS INCLUDE: III. Exceptions: 1) when $ is taken out CORPORATIONS BY ESTOPPEL
 Selection of initial directors fraudulently  but not unlimited If a 3rd party treats an organization as though it
 Limitations on directors’ and liability, OR 2) when shareholder loses were a corporation, that 3rd party may be
officers’ liability protection of corporate shield  estopped from denying the organization’s
 Restrictions on transfer of become personally liable (AKA piercing corporate structure if the denial would result in
shares the corporate veil) unjust harm to the principals.
 Dividend requirements  Creating a division between ownership and
and/or preemptive rights for control Requirements:
shareholders  Allowing flexible capital structure 1) Parties need to have consistently
 Allowing owners to freely transfer treated the organization as though it
ownership were a corporation; and
2) If one party were allowed to deny the
existence of the corporation, that party
would be unfairly benefitted
 Typically only arises in contract cases NOT in
tort cases because it requires that the party have
had prior dealings with the organization and tort
victims usually have no prior contact with the
organization.

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Business Organizations – Attack Outline – Faiq
 CORPORATIONS: Finding liability
Piercing Corporate Veil Preventing Piercing Corporate Veil of Reverse Piercing Enterprise Liability
Piercing of Subsidiary
Corporate Veil

Piercing the corporate veil allows a creditor of a corporation to sue the RULES THAT Sometimes there are efforts to pierce Occurs when a claim against an Is sometimes referred to as “horizontal
shareholders personally for the debt that creditor is owed by the corporation. CORPORATIONS the veil of a subsidiary to get to the individual shareholder is found to piercing” but it is NOT piercing.
SHOULD RESPECT TO assets of a parent corporation be enforceable directly against the
THRESHOLD QUESTION: PREVENT PIERCING  Courts usually require a less rigorous corporation in which the Creditor claims there are several
Whether the separate existence of the corporation has been respected?  Keep the showing of fraud-like conduct or individual is a shareholder. related corporations and all or some
 If no, PIERCE CORPORATE VEIL corporation’s injustice  Does not enable a creditor to are really part of the same corporation.
 If yes, NO PERSONAL LIABILITY business  Courts will look to overlapping BoD collect on a claim that otherwise  Involves creditors effort to enforce a
separate – members between the parent and would necessarily be unpaid by claim that creditor holds against one
EFFECT OF PIERCING THE VEIL: separate bank subsidiary as an indication that the two the party reaching the piercing. corporation against other, related
The shareholders of the corporation and the corporation become jointly and accounts, are not separate  Changes the status of the claim corporations.
severally liable for the debt. separate  Subsidiaries must be separate and holder enabling the individual  Commonly seen where the
property, independent from its parent or it risks shareholder’s creditor to be commonly owned corporations are
TEST: separate records piercing treated as the creditor of the “sister corporations.”
C. First, there must be unity of interest and ownership that the separate  Keep corporate corporation.
personalities of the corporation and shareholders no longer exists; AND funds and FACTORS TEST: UNITED STATES V. RULE:
D. Second, circumstances must be such that adherence to the fiction of transactions JON-T CHEMICALS, INC. FEATURES OF REVERSE There is enterprise liability when the
separate corporate existence would sanction a fraud OR promote separate from  Parent and subsidiary have PIERCING: sister corporation transgresses the
injustice that of common directors or officers  Makes the individual corporation to corporation boundary.
shareholders’  Parent and subsidiary share shareholder’s personal
UNITY OF INTEREST ELEMENT  Hold meetings business departments creditor a creditor directly ANALYSIS QUESTIONS:
E. Failure to follow corporate formalities – not taking minutes, not of BoD and  Parent and subsidiary consolidate against the corporation,  Are two or more nominally
conducting meetings, not electing officers, not maintaining books and Shareholders at financial statements and tax which puts the creditor separate sister corporations
records least once a year returns higher in line to be paid really operating as a single
F. Failure to maintain separate accounts (AKA comingling) – keeping  Keep meeting  Parent finances subsidiary  If creditor can reverse enterprise?
personal funds and corporation’s funds together minutes  Parent caused incorporation of pierce, it can collect from  Are the corporations operated
G. Failure to “adequately capitalize” corporation – not placing sufficient  Elect BoD the subsidiary corporation on equal footing as separate entities?
funds into the corporation to enable it to operate as a viable business  Issue stock  Subsidiary is grossly with the corporation’s  Are the respective
 Adequately undercapitalized creditors corporations’ assets
SANCTIONING FRAUD/ PROMOTING INJUSTICE ELEMENT capitalize  Parent pays salaries and other  If creditor cannot reverse intermingled for use toward a
H. Unfair business practices – actions that thwart legal rights of others corporation pierce, it may only get $ that common business?
expenses of the subsidiary
I. Intentional misrepresentations  Make sure  Subsidiary gets business ONLY the corporation decides to
J. Conduct that may incur civil or criminal penalty corporation pay the shareholder Enterprise liability is similar to an
from parent
K. Creation of corporate structure solely to avoid liability 
caries minimum  Parent uses subsidiary’s property Test is same as regular agency theory of liability applied to
L. Unjust enrichment – removing assets in bad faith or leaving business amount of piercing – some states don’t corporations.
as its own
undercapitalized required  Daily operations of the two are allow reverse piercing
M. Fraud insurance  There have been cases HOW TO AVOID ENTERPRISE
kept the same
 Subsidiary does not observe the where reverse piercing was LIABILITY:
** Piercing corporate basic corporate formalities – like allowed using a shareholder  Separate books and records
PIERCING THE VEIL OF LLCS veil ONLY occurs in  Avoid sharing resources
no separate books and records that no obligation to the
- Same test as regular piercing the veil for corporations closely held creditor just as long as there  If resources are shared, make
- BUT LLC’s have fewer formalities to follow so it is more difficult to corporations** is unity of interest sure accounting practices are
show the existence of unity of interest based on failure to follow separate
formalities
** Enterprise Liability is usually used to
Walkovzsky v. Carlton (NY 1966) try and reach the pockets of
Rule: An individual can be held liable for the acts of a corporation through the transportation companies, like Taxi
Doctrine of Respondeat Superior if it can be shown that the individual used his businesses. **
control of the corporation for personal gain. However, where a corporation is a
fragment of a larger corporate combine which actually conducts the business, a
court will not “pierce the corporate veil” to hold individual shareholders liable.

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Business Organizations – Attack Outline – Faiq
 FIDUCIARY DUTIES (& Other Checks on Corporate Action): Two major categories, duty of care and duty of loyalty.
Powers of the Duty of Care & the Business Judgment Rule Procedural & Substantive Requirements for the BJR Affirmative Defenses to
Corporation Duty of Care Violation

ULTRA VIRES & “WASTE” DUTY OF CARE REQUIRES, BOD SHALL ACT: PROCEDURAL REQUIREMENTS EVEN IF VIOLATION, MAYBE NO
Ultra Vires: actions taken outside 1) In good faith, and  BJR Protection if BoD make an informed decision LIABILITY IF:
of the corporate purpose are void 2) In a manner the director reasonably believes to be in  NO BJR Protection if BoD makes an uninformed decision OR when BoD fails BoD can show that the transaction was
or voidable the best interests of the corporation. [MBCA § to act 1) beneficial to the
 Currently referenced as the 830(a)]  Standard of Proof: Plaintiff must show that 1) the BoD was corporation;
“Waste” of corporate assets grossly negligent in failing to inform itself of material 2) fair; OR
 Corporation’s purpose is to ROLE OF BJR information reasonably available to it, AND 2) the decision 3) there were no damages
maximize wealth for shareholders  When sued based on violation of duty of care, director is itself was grossly negligent
entitled to protection of BJR FAIRNESS:
ANALYSIS OF THE CHARITABLE  BJR provides protection from lawsuits that might seek to HOW TO AVOID LIABILITY FOR VIOLATING DUTY OF CARE ON - Generally, courts look to
ACT: challenge business judgment of directors PROCEDURAL GROUNDS: substantive or intrinsic
Threshold Question – Whether  BJR gives wide latitude to directors to successfully run the  Keep informed about and properly oversee the corporation’s activities fairness
there is some direct or indirect business, protecting directors from second-guessing of and policies; - Except, in the case of a
benefit to the shareholders or shareholders  Be adequately informed about the corporation’s business, its interests merger then court will look to
corporation? and the relevant issues before making decisions; entire fairness
 Whether the gift was  Possess a minimum level of skill and expertise with regard to the role of
anonymous? (if anonymous BJR APPLIES UNLESS PLAINTIFF CAN SHOW: director for the specific business; and
then reduced value to firm if  Fraud;  Be aware of the financial status of the corporation.
the goal is marketing or  Illegality or “Wrongful” Conduct;
public relations)  Conflict of Interest (Duty of Loyalty Analysis Proceeds); SUBSTANTIVE REQUIREMENTS
 Whether the amount  Bad Faith (Duty of Loyalty Analysis Proceeds in DE); Bad faith  If BoD is acting within procedural requirements, in order to avoid the BJR,
donated was significant can include: Plaintiff must show that there has been a substantive violation
when compared to the o Subjective bad faith  conduct motivated by an  If NO BJR Protection (because of lack of procedural or substantive
corporation’s earnings? actual intent to do harm requirements) Plaintiff must show a violation of underlying duty of care
 Whether the gift was made o Intentional dereliction of duty, a conscious  Threshold Question: Even though this situation does not
to a “pet” charity? (More disregard for one’s responsibilities [In re Walt warrant the protection of BJR, did the Defendant violate the
suspect if it is a pet charity Disney (Del. 2006)] applicable duty of care?
that is not helping o Acts with a purpose other than that of advancing  IF NO, then no violation.
corporation) the best interests of the corporation [Stone v.
Ritter (Del. 2006)] WHEN DOES BJR NOT APPLY? IF…
A.P. Smith Mfg. Co. v. Barlow  Egregious/ Irrational Decision (Decision with no business 1) Conflict of Interest
(N.J. 1953) justification); OR
Rule: P, corporation, had a history
of donating minor sums of money
 Waste (A transaction that lacks any business rationale to 2) Bad Faith
to various charities and support it or one that is so one sided that no business person
institutions. P voted to give $1,500 of ordinary, sound judgment could conclude “that the  If conflict of interest exists, NO BJR, unless conflict is cleaned. So not
to Princeton. P instituted a corporation has received adequate consideration” [Glazer necessarily a violation of duty of care. If cleansed, no violation of duty of care.
declaratory judgment action after v. Zapata (Del. Ch. 1993)]);  Standard of Proof: Plaintiff must show breach of fiduciary duty by
D stockholders questioned the  Uninformed Decisions (Including a lack of investigation); or showing a violation of duty of loyalty.
proposed gift. We find that the  No Decision (for example, no action was taken by BoD but a
donation was a lawful exercise of NOTES ON BJR:
the corporation’s implied and Plaintiff alleges some action should have been taken)
Directors are allowed to be wrong or to make mistakes and still have the
incidental powers under common-
law principles and that it came protection of the BJR, as long as they: 1) act in good faith, 2) consider their
within the express authority of the decision, and 3) have a business reason for their decision.
pertinent state legislation.

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Business Organizations – Attack Outline – Faiq
 FIDUCIARY DUTIES (& Other Checks on Corporate Action):
The BJR & The BJR & Failure to Act Duty of Loyalty Corporate Opportunity Doctrine & Its Requirement of
Protection by or to Monitor the Firm Defenses Offering the
Consulting an Corporate Opportunity
Expert to the Corporation

If the Board hired or FAILURE TO ACT W/ VALID BJR WHAT IS THE DUTY OF LOYALTY? WHAT IS THE CORPORATE OPPORTUNITY DOCTRINE? IF YOU WANT TO TAKE THE
consulted an expert If the BoD decide NOT to act but  Requires fiduciaries (like officers and directors) put the (a subset of Duty of Loyalty) CORPORATE OPPORTUNITY AS A
regarding certain matters, they made an affirmative informed interests of the corporation ahead of their own interests  Fiduciary may not take, for personal gain, an FIDUCIARY:
the Board’s decisions and decision not to act, then BJR is valid opportunity like a business venture or a new opportunity  MUST disclose opportunity
action with regard to those WHEN IS THE DUTY OF LOYALTY IMPLICATED? or discovery, in which the firm has a property right, and to the BoD
matters will later be FAILURE TO ACT ACCUSATIONS:  When there is a conflict of interest that creates a personal use it for his or her own advantage without first offering it  MUST disclose interest in
protected under the BJR as CORPORATE WRONGDOING benefit for the fiduciary to the corporation. opportunity to the BoD
“informed” decisions Examples when a BoD is accused of  BoD has right of first refusal
(provided of course, that failing to act is when they fail to CONFLICT OF INTEREST IS… WHO DOES IT APPLY TO?  IF BoD does not properly
the decision does not - Detect When fiduciary knows that when he is asked to take action  A corporation’s officers and BoD (NOT S/H who do reject, then there still may be
with regard to the potential transaction he or a person breach of the duty of loyalty
violate another - Prevent not have another position in the firm); and
requirement of the BJR). related to him  Certain other individuals who have a fiduciary or UNLESS the opportunity is
 There is a duty of care
- Stop 1) Is a party to the transaction, or fiduciary-like relationship with the corporation (like cleansed by the S/H or by
actions. 2) Has a beneficial financial interest in the transaction showing the transaction was
required in hiring an expert lawyers and consultants)
(the scope of the expert’s fair
CAREMARK CLAIMS ANALYSIS OF DUTY OF LOYALTY
competence) HOW TO IDENTIFY A CORPORATE OPPORTUNITY (3
(When BJR does not apply in the  Is there a conflict of interest? (direct or indirect) TESTS):
 Reliance upon the expert
failure to act situations, a different  If NO, there is no duty of loyalty issue. 1) Early Test: where corporation had an interest, an
must also be reasonable
standard, the Caremark standard,  If YES, must determine whether transaction can be expectancy, or a necessity. (narrow test)
applies) “cleansed”
DIRECTOR’S FAILURE TO i. Interest: preexisting contractual right
ACT 1) Absent suspicion of  If transaction is cleansed it is protected and may ii. Expectancy: not necessarily a legal right but
Remember that the BJR wrongdoing, NO DUTY on BoD proceed. (If transaction is cleansed via a vote of given contractual dealings of the corporation,
protects decisions NOT the to install and operate a disinterested directors, the decision to cleanse will be where there is a reasonable expectancy that
people making them. If no monitoring system subject to scrutiny but likely still protected by BJR) the opportunity would be offered (like renewal
judgment is made, there is 2) BoD must make good faith  If transaction is NOT cleansed, transaction is of contracts)
no protection of BJR. attempt to ensure that an “voidable” by the corporation and the director may be iii. Necessity: something a corporation needs to
 No action does NOT adequate reporting system is liable for damages for breach of the duty of loyalty stay in business (like raw materials)
mean automatic liability for in place so BoD can get 2) Line of Business Test: where the corporation has
directors information necessary to TYPES OF CONFLICTS OF INTEREST: fundamental knowledge, practical experience
make an informed decision
 Plaintiff must still show a
a. Once BoD is informed,
- Self-Dealing and the ability to pursue, which, logically and
violation of duty of care - Taking a Corporate Opportunity naturally are adaptable to its business taking into
their decisions are account the corporation’s financial position, needs
typically protected by - Stealing
and aspirations. (forward-looking test)
BJR - Executive Compensation 3) Fairness Test: whether the fiduciary taking the
- Evaluation by BoD of Whether and How Much Info opportunity would violate equitable standards of
to Give to S/H what is fair and equitable by corporate standards
- Entrenchment
COMMON DEFENSES:
HOW TO CLEANSE: - Incapacity: corporation would not have been
 Approval by vote of majority of fully informed, able to take advantage of the opportunity
disinterested directors. anyway
 Ratification by informed S/H. - Source: the opportunity arose for the fiduciary
 When it is shown to have been an intrinsically fair not because of their corporate position but
transaction. because of their personal skills and attributes

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Business Organizations – Attack Outline – Faiq
 FIDUCIARY DUTIES (& Other Checks on Corporate Action):
Corporate Opportunity Analysis Dominant Shareholders Summary of Fiduciary Duties

CORPORATE OPPORTUNITY ANALYSIS: GENERALLY… WHEN IS A FIDUCIARY’S DUTY IMPLICATED?

 First, whether the opportunity is a  S/H acting as S/H do not have an obligation to one another;  Did BoD Act or did the situation involve a failure to act?
“corporate opportunity.”  UNLESS, the S/H owns so much of the stock that they are seen to  Was a dominant S/H involved in the transaction, and, if so, did the transaction involve a conflict of
 If NO  NO breach. have control. THEN, S/H has an obligation to the minority S/H in interest, or did the dominant S/H receive something that the other S/H did not?
 If YES, then whether the opportunity specific duty of loyalty transactions;  If no dominant S/H, did a fiduciary have a conflict of interest in the transaction?
was disclosed to the appropriate  If there is a dominant shareholder must ask whether the  Was the transaction cleansed?
corporate authority, such as the BoD. transaction involves a situation in which the dominant  Would the transaction be protected by the BJR?
 If NOT properly disclosed  Breach of shareholder has a conflict or in which the dominant shareholder  Even if NO BJR protection, did the transaction violate the duty of care?
duty of loyalty. is receiving a benefit at the expense of the minority S/H OR that  Even if the transaction violated a duty, was the transaction fair to the corporation?
 If YES properly disclosed, whether the the minority S/H do not receive such benefit;
opportunity was properly rejected by  If YES, then a fully informed majority of the minority S/H will DUTY OF CARE IMPLICATION:
the BoD. need to be shown that the transaction was either fair to the  If there was an informed vote of the BoD and none of the BJR exceptions apply, then the BJR
 If YES properly rejected  NO breach. corporation through intrinsic fairness OR entire fairness (in the typically applies and the transaction is protected.
Decision to reject is protected by BJR. case of a merger). Burden of proof is on the dominant  If the BJR does NOT apply, then there still should be an actual duty of care analysis.
 If NOT properly rejected  Breach of shareholder;  If there was a violation of the duty of care, the parties may still be protected if there was an
duty of loyalty UNLESS the breach is  If fully informed majority of the minority S/H approve the informed S/H vote or if the parties can show the transaction was fair to the corporation (in a duty of
cleansed. transaction it still may be challenged by the disapproving care claim fairness is an affirmative defense NOT a bar to the claim).
minority S/H BUT the burden is on the disapproving minority to
show that the transaction was not fair to the corporation. DUTY OF LOYALTY FOR FIDUCIARIES IMPLICATION:
 If there was a transaction involving a conflict of interest, but not a dominant S/H, the conflict may
TRANSACTIONS THAT COULD FALL WITHIN DOMINANT S/H have been cleansed by the fully informed approval of a majority of the disinterest directors. Such
ANALYSIS: approval would eliminate the duty of loyalty claim.
 Large dividends – The dominant S/H causes distribution of  THEN, the disinterested majority’s approval of the transaction would be subject to the BJR and
dividends to ALL S/H, so everyone is benefitting equally. In order further, if necessary, to the duty of care analysis.
to challenge, the standard would be BJR.  If all the directors are interested or if the transaction was not cleansed, then the transaction may
 Failure to enforce a provision in a contract – If the dominant S/H STILL be cleansed by a vote of the fully informed S/H.
has an interest in the other party to the contract, the action is  If the transaction was approved by a majority of the disinterested S/H, then no further inquiry.
subject to dominant S/H analysis; If the dominant S/H has NO  If the transaction was approved by a majority of the S/H but in order to get approval, the interested
interest in the other party to the contract there is no conflict, the S/H also voted, then there is a question to whether or not the transaction was cleansed. (In CA, the
standard would be BJR. transaction would not be cleansed. In DE, it is unclear.)
 Selling company to outside 3rd party, the standard would be BJR.  If the transaction is not cleansed by the S/H or the directors, then the Defendant has the burden of
 Selling company to an entity in which the dominant S/H has an proving fairness.
interest, then dominant S/H analysis AND a showing of entire
fairness. DUTY OF LOYALTY FOR DOMINANT SHAREHOLDERS:
 In situations where there is a claim for duty of loyalty involving a dominant S/H it cannot be
ENTIRE FAIRNESS VS. INTRINSIC FAIRNESS cleansed.
- Entire Fairness: involves the substance of the transaction as  If there was a S/H vote to ratify the transaction, then, although the transaction was still not
well as the process and procedure by which it was cleansed, the burden of proof MAY shift to the Plaintiff to show that the transaction was unfair.
accomplished. Both substance and procedure must be fair.  If a majority of the disinterested S/H approved the transaction, the burden of proof shifts to the
- Intrinsic Fairness: involves the substance of the transaction Plaintiff.
(like price and terms of the transaction).  If a majority of the disinterested S/H did not vote to approve the transaction (or if there was no
vote) then the burden is on the Defendant to show fairness.
 If the transaction involved a merger (or another significant transaction that requires a vote by S/H),
then the Defendant needs to show entire fairness. If the transaction did not involve a significant
transaction, then the Defendant need only show intrinsic fairness.

9
Business Organizations – Attack Outline – Faiq
 SHAREHOLDERS & THE RIGHTS & RESTRICTIONS ASSOCIATED WITH OWNERSHIP
Shareholder Ownership Rights How do Shareholders Vote Proxy Rules, Fights & Costs Associated

Shareholders vote on major transactions, Shareholder voting can take place at ANY meeting of the PROXY RULES
elect BoD and may also vote on various shareholders. A shareholder can usually vote all their shares on Proxy Rules are addressed in Regulation 14A of the SEC Act of 1934, the “1934 Act.”
resolutions that are typically not binding on a particular matter. Shareholders vote pro rata which means
the BoD. Shareholders get to decide who the shareholders vote in proportion to their holdings in the Solicitation Includes:
operates the corporation, but they may NOT company.  Any request for a proxy;
operate the corporation themselves.  Any request to execute, not execute, or to revoke a proxy; and
 The effect of this limitation on Generally, a simple majority vote is required in order to take an  Furnishing a form of proxy or other communication, reasonably calculated to result in the procurement,
management is a creation of limited liability action, and the shareholders are entitled to one vote for each withholding, or revocation of a proxy. (Courts have found that even communications, which may constitute a
for shareholders. share they hold. However, Articles of Incorporation or the step in a chain of communications designed to accomplish such a result may also constitute solicitation.)
Bylaws may provide for different voting structures or different
WHERE DO SHAREHOLDER RIGHTS COME numbers of affirmative votes needed to approve certain **Person being solicited must first receive or have received a “proxy statement.” These rules, which prohibit
FROM? matters. materially misleading statements, are intended, among other things, to provide for adequate disclosure to
When a corporation is formed, the Articles shareholders before their proxies are solicited.**
of Incorporation set forth how many shares Shareholders who hold stock on a certain date, known as the
are authorized and whether there is more record date, are entitled to vote in a shareholder election Exceptions to Solicitation Include:
than one class of stock. Common stock immediately following that date. The BoD establish the record  Public statements or speeches or advertisements stating how a S/H intends to vote and the reason why;
typically has the right to vote AND the right date (usually a few weeks ahead of the scheduled vote). The  Solicitations by someone (other than, among many exceptions, an affiliate of the corporation or a part in
to receive dividends. Common stock is record date determines which shareholders are entitled to vote interest) who does not intend to act on another’s behalf;
usually where most corporation’s economic at a particular meeting or on a particular proposal, even if they  Any solicitation made to 10 or fewer persons provided it is not made by the corporation; and
and voting rights reside. sell their shares after the record date but prior to the vote.  Advice to any person with whom the person furnishing the advice (the “advisor”) has a business relationship
(provided that such advisor does not have certain other interests or undisclosed connections to the
SHAREHOLDER ECONOMIC RIGHTS CUMULATIVE VOTING corporation that would amount to a conflict of interest).
Regardless of how many shares (or classes) Cumulative voting is an alternative to traditional voting that
of stock a corporation has authorized, gives minority S/H a greater opportunity to select a director to PROXY FIGHTS
economic rights are determined based on BoD. In a traditional vote, the majority S/H would be able to A proxy fight is a battle to obtain control of a corporation through the vote of the shareholders.
how many shares are issued and outstanding appoint ALL BoD. In a cumulative vote, S/H are entitled to
(i.e. shares that are actually owned by S/H at
- When group that wants control AKA insurgent group tries to become elected to BoD and oust existing
spread out their votes for several directors or to “accumulate”
any given time). management AKA incumbent group by soliciting proxies from a large enough number of S/H to elect the
all their votes to select one or two directors, to maximize the
insurgent representatives to the BoD.
minority S/H’s impact and to increase the minority’s odds at
SHAREHOLDER VOTING RIGHTS electing a director. - Rules governing when an insurgent wants to contact S/H under Rule 14a-7:
 Election of Directors  Some states like CA require cumulative voting, except in o Management may mail the insurgent group’s material to S/H directly and charge the insurgent
 Fundamental Changes to the publicly held corporations. for the cost; OR
Corporation (such as a merger, sale of o Management can give the insurgent group a copy of the S/H list and let the insurgent group
all of assets, corporate dissolution, and PROXIES distribute its own materials.
amending the Articles of What is a proxy?
Incorporation); and  If a S/H cannot make it to a meeting but they still want to RECOVERING COSTS ASSOCIATED WITH OBTAINING PROXIES IN A BATTEL FOR CONTROL
 S/H Resolutions (2 types) vote they can assign their voting rights to a proxy. The proxy When the incumbent directors expend money to defend their positions from insurgents’ efforts to oust them, as
o i) resolutions proposed by agreement must be express (in writing or electronic). long as the expenses are not excessive and not illegal, incumbent group can usually reimburse themselves.
corporation’s management  The proxy may receive specific instructions on how to vote or
such as a resolution to may have great latitude in casting the vote. RULES FOR REIMBURSEMENT:
ratify a plan or action by  Proxies can be revocable or irrevocable.  Corporation may NOT reimburse either party UNLESS the dispute involves a question of corporate policy.
BoD, OR  If it is specifically provided in the written (or electronic) The dispute cannot just involve an argument that one group is better than the other. Because most people
o ii) resolutions proposed by proxy agreement that it is irrevocable, it can validly be are aware of this rule, the proxy battles are usually proposed to be “policy” disputes;
S/H requesting the BoD irrevocable.  Corporation may ONLY reimburse reasonable and proper expenses (Note: this is a broad standard that
take some action  Proxies are important in meeting quorum requirements for a includes disclosure statements, telephone solicitations, and in-person visits to corporate S/H)
vote. Generally, the quorum requirement is 50% of the votes +  Corporation may reimburse incumbent NO MATTER if they win or lose;
1 vote. (For example is a corporation has 100 shares issued and  Corporation may ONLY reimburse insurgents if they win and (if they do not want that reimbursement to be
outstanding there must be 51 shares represented at a meeting subject to attack) ONLY if the corporation’s S/H ratify the reimbursement after full disclosure.
for quorum to be met).

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Business Organizations – Attack Outline – Faiq
 SHAREHOLDERS & THE RIGHTS & RESTRICTIONS ASSOCIATED WITH OWNERSHIP
Shareholder Proposals The Dodd-Frank Act, Director Shareholder Inspection Rights Example on Shareholder
Nominations & “Say On Pay” Voting Schemes

Rule 14a-8 allows qualifying shareholders to submit certain proposals to fellow The Dodd-Frank Act of 2010 allowed the BURDEN SHIFTING FRAMEWORK ON SHOWING PROPER PROBLEM:
shareholders for a vote by having the proposal placed on the company’s proxy SEC to adopt rules to provide PURPOSE At the annual shareholder’s
statement. shareholders with increased input about  If the shareholder wants to obtain the list of the meeting of Foster’s Supply
shareholder names, the burden of proof is on the (Supply), a publicly-held company,
 The company bears the expenses of the proposal if the proposal is on the proxy the directors elected to a BoD.
Tom, Dick, and Harry run for the
statement.  Rules were adopted to address corporation for it to show that the shareholder
does not in fact have a “proper purpose.” board of directors. There are 1000
 The proposal must be regarding an area which is a proper subject for action by the concern that shareholders of a publicly
of 1500 shares outstanding present
shareholders. Most are worded as recommendations rather than mandates and are traded company did not have the right to  If the shareholder wants to obtain corporate
(in person or by proxy) at the
non-binding in nature. nominate directors and typically could records, the burden of proof is usually on the
meeting. Tom receives 600 votes,
only vote on a “slate” proposed by BoD. shareholder to show that he or she or it does in fact with a further 200 votes marked
THRESHOLD ISSUE: Whether a shareholder proposal qualifies to be included in the  SEC’s Rule 14a-11 of the 1934 Act have a “proper purpose.” “withhold authority” (SEC proxy
proxy statement. MUST MEET PROCEDURAL & SUBSTANTIVE REQUIREMENTS BELOW. applied to companies and would have regulations do not permit “no”
allowed certain shareholders (those who INSTANCES DEMONSTRATING PROPER PURPOSE votes in the election of directors
PROCEDURAL REQUIREMENTS: had owned at least 3% of the outstanding  An effort to gain control of the corporation (unless it unless the corporation’s articles or
 S/H submitting proposal must hold either $2,000 in market value of the corporation for an uninterrupted 3-year is for a hostile or detrimental purpose to the bylaw provide for them). Dick
company’s stock OR 1% of the company’s voting stock, AND the S/H must have period) to nominate a director for corporation or its S/H, rather than to current receives 475 votes with 300
held it continuously for 12 months preceding the proposal; inclusion on the “slate” using the management); marked “withhold authority.” Harry
 S/H may not submit more than one proposal per S/H meeting; corporation’s proxy materials.  An effort to gain a S/H list for someone else trying to receives 375 votes while proxies
gain control of the corporation; representing 400 shares are
 A proposal may not exceed 500 words;  Rule 14a-11 was vacated by
 An effort to investigate alleged corporate marked “withhold authority.”
 Most proposals must be submitted to the company at least 120 days before the Roundtable & Chamber of Commerce of
company’s proxy statement is to be released; and USA v. SEC, 647 F.3d 1144 (D.C. Cir. 2011) mismanagement or malfeasance; - Under a majority scheme,
 Either the S/H or the S/H’s “qualified representative” must attend the meeting because the SEC “acted arbitrarily and  An effort to gather information to assess the values of Tom is elected but Harry
one’s shares; and and Dick are not.
at which the proposal is to be considered; capriciously here because it neglected its
statutory responsibility to determine the  An effort to communicate with other S/H in - Under a plurality voting
SUBSTANTIVE REQUIREMENTS: likely economic consequences of Rule connection with a proxy fight or S/H proposal. scheme, all are elected
 Topic of the proposal must be proper subject for action by S/H under state law 14a-11 and to connect those because the number of
where the company is organized; consequences to efficiency, competition, INSTANCES DEMONSTRATING IMPROPER PURPOSE votes (even though not a
 Proposal may not, if implemented, cause the company to violate the law; and capital formation.”  Finding potential customers for a personal business majority in Dick’s and
venture; Harry’s cases) cast in
 Proposal may not address a personal grievance or special interest that is not favor exceeds the number
applicable to other S/H;  Persuading the corporation to adopt one’s social or
cast against, given the
 If the proposal relates to the company’s operations, those operations must The Dodd-Frank Act of 2010 also allowed political concerns, irrespective of any economic
presence of a quorum at
involve at least 5% of the company’s assets, net earnings or gross sales, OR the SEC to adopt Rule 14a-21(a), which benefit to the S/H of the corporation;
the meeting.
 Instituting a strike suit (a suit without substantive
operations must otherwise be “significantly related to the company’s business.” requires publicly held companies to
basis, designed to obtain money or property from the
- Under a Pfizer scheme, all
(Proposals will be included notwithstanding their failure to reach the economic provide shareholders with an advisory are elected but Harry
threshold IF a significant relationship to the company’s business is “say-on-pay” vote (at least once every 3 corporation because the costs of litigation far exceed
must tender a letter of
demonstrated on the face of the resolution or in the supporting materials); years) on the compensation of senior the costs of settlement) against the corporation;
resignation which the
 Proposal must not violate the Proxy Rules (such as the prohibition on material executives.  Seeking proprietary information such as trade secrets board may then accept or
misleading statements);  Section 14A(a)(1) of the 1934 Act and or other intellectual property; and reject because the
 Proposal cannot be beyond the company’s power to implement (such as a vote Rule 14a-21(a) require companies to  Seeking information to aid a competitor of the number of withheld
requiring the world to adopt a universal currency); provide a separate shareholder advisory corporation. authority votes exceeds
 Proposal may not address management functions such as the company’s vote in proxy statements to approve the the number of yes votes.
ordinary business operations; compensation of their named executive State Ex Rel. Pillsbury v. Honeywell (Minn. 1971)
Rule: Denial of access to S/H was due to distinguishing a
 Proposal may not relate to specific amounts of cash or stock dividends; and officers.
proper purpose that involves any economic benefit to the S/H
 Proposal may not directly conflict with one of the company’s own proposals  Most companies conduct such votes of the company from an improper purpose that was to
that is being submitted at the same meeting. annually even though the requirement is persuade the company to adopt the S/H’s socio-political
 ADDITIONALLY, if the proposal was submitted in the last 5 years and did not 3 years. concerns.
get the required % of votes, it may be excluded. (However, if more than 10% of  These votes are advisory and NOT
the S/H voted in favor of the previously submitted proposal it will not be binding on the company.
excluded on these grounds. If fewer than 10% of the S/H voted in favor of the
previously submitted proposal, the rules become more complex).

11
Business Organizations – Attack Outline – Faiq
12
Business Organizations – Attack Outline – Faiq
 ISSUES OF CONTROL
Devices for Control (usually applicable in closely-held or Limits on Control Arrangements Abuse of Control
private companies)

 Voting Trusts GENERAL RULE FREEZEOUTS

 Vote Pooling Agreements (a specific type of a S/H agreement) - Shareholders may agree on how they will act as A Freeze out occurs when the majority shareholder or block of
 S/H Agreements shareholders. shareholders earns a return at the expense of the other shareholders,
 Irrevocable Proxies - Shareholders MAY NOT agree on how directors often channeling corporate funds to the controlling shareholder block
will vote as directors or what actions they may and depriving other shareholders of the opportunity to share in funds
LIMITS ON S/H CONTROL: Shareholders may agree to exercise control to determine who take as directors. paid out by the company.
will be directors but not to determine how those directors will vote BECAUSE shareholders are
allowed to act in self-interest but directors have to act in the best interest of ALL shareholders. EXCEPTIONS TYPICAL FEATURES OF A FREEZEOUT:
When otherwise unenforceable agreements (or  The corporation does not pay dividends (or pays minimal
VOTING TRUST provisions in agreements) are enforceable: dividends) so that non (or little) of the corporation’s profits are
 Is a device whereby two or more S/H place their shares in a trust  Shareholder Unanimity Exception: Typically, S/H distributed to S/H; and
 The trust has a trustee who is responsible for voting the shares may agree how they will vote on certain matters as  The only (or vast majority of) corporate funds that are “paid out”
 The trust is usually governed by a trust agreement, which determines how long the trust directors (such as dividends or the election of are paid in the form of salary to those S/H; and
will last and how the shares will be voted officers) if ALL of the S/H have entered into that  The “frozen-out” S/H is prevented from holding a paying position;
 PROS: there is little question about enforcement because the trustee holds and votes the agreement. then,
shares; helps avoid deadlocks among S/H  There are also cases in some states that hold that,  As a result, the minority S/H or S/H’s do not receive any of these
 CONS: loss of control that accompanies relinquishing possession of shares; also there is a even if all of the S/H are not parties to the corporate funds distributed as “salary,” and therefore, are unable
limit of how long trusts can exist (usually is a 10 year limit in most states) agreement, the agreement is still enforceable IF to “profit” in any way from their investment in the corporation.
(a) the shares of the corporation are closely held;
VOTE POOLING AGREEMENT (b) none of the S/H who were not parties to the FROZEN-OUT SHAREHOLDER MUST SHOW:
 Is a device that is similar to a trust agreement object, AND (c) the terms of the  Breach of a duty;
 There is no trustee and S/H don’t relinquish control of their shares agreement are reasonable.  That the majority is diverting the funds from the corporation to
 The agreement is between two or more S/H that states that the parties’ shares will be themselves to the exclusion of the frozen-out S/H;
voted in a certain way SUMMARY  The diversion of funds deprives the frozen-out S/H of their
 Shareholders can agree about how they will vote rightful return on investment.
EXAMPLES OF VOTE POOLING AGREEMENTS as shareholders.
 May cover all S/H votes or only certain votes such as the election of directors;  Shareholders CANNOT agree about how they will
 May be for an unlimited period of time or for a defined period of time; vote as directors (with fiduciary duties) UNLESS:
 May cover a portion of a S/H’s shares or all of their shares; and o The agreement is signed by ALL the
 May delegate control to an individual who has a relatively small ownership %. S/H, OR
o When the minority S/H who have not
SHAREHOLDER AGREEMENTS agreed do not or cannot object,
 Basically, the same as a vote pooling agreement but can cover subject-matter beyond provided that the agreement is
and unrelated to the control of the corporation, such as: transferability restrictions, reasonable.
rights to repurchase stock.
 Sometimes S/H agreements try to address matters in the realm of management of the
corporation and such agreements will be deemed unenforceable.

IRREVOCABLE PROXIES
 When a proxy is given to one entity or individual who has an interest in the corporation
to enable that individual to have control
 Proxy usually involves one or more S/H handing their votes to a 3 rd party to increase that
party’s control
 To make the proxy irrevocable it must be coupled with an interest (examples are: a job
with the company, a loan made to the corporation or some other interest in the firm).
 Parties MUST intend to make the proxy irrevocable. Just because a proxy is coupled with
an interest does not automatically make it irrevocable.
 The proxy is irrevocable for as long as the interest lasts.

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Business Organizations – Attack Outline – Faiq
 ISSUES OF CONTROL
Fiduciary Duties in Freeze Outs Employee or Shareholder? Minority Shareholder Protection Transfer of Control

IN MASSACHUSETTS: Many freeze out cases involve a shareholder’s OPTIONS FOR A MINORITY SHAREHOLDER FACING A When control is purchased, the amount which the
 Apply a partnership-like analysis to closely held claim that he should be allowed to be an FREEZE OUT: purchaser pays in excess of the “market value” of
corporations. employee and receive a salary since that was  A S/H’s agreement, protecting the minority’s right the stock is known as a “control premium.”
 Often the courts find some fiduciary duties among the only way funds were distributed by the to be on the BoD and/or (if all other S/H agree) to
shareholders are reminiscent of certain duties between corporation. be an officer; RULE:
partners.  These cases turn on whether the individual  An employment agreement, assuring the minority Absent looting of corporate assets, conversion of a
 The courts in this jurisdiction have taken the position that is a of a certain position in the corporation and a salary; corporate opportunity, fraud, or other acts of bad
shareholders in closely held corporations owe each other a) A shareholder whose right to  A buyout agreement (or a S/H’s agreement faith, a controlling shareholder is free to sell, and a
a duty of good faith. employment is a byproduct of his containing buyout provisions), entitling the purchaser is free to buy, that controlling interest at
 In a freeze-out: position as a shareholder, OR minority to force the company to buy his or her a premium.
o The majority or the controlling group must b) An employee who happened to shares under certain circumstances (like a freeze  One cannot generally buy a seat on the BoD
have a legitimate business purpose for its obtain shares as a result of out);  So S/H can sell control but not offices in a
action; employment.  Statutory dissolution (sometimes, even minority’s corporation
o Even if there is a legitimate business purpose, have this right in a closely held corporation to force  If a purchaser acquires a majority interest in the
the minority S/H still can show that the same AT-WILL EMPLOYEES: do not have the dissolution) which would result in payment for the corporation, some courts allow the selling S/H to
legitimate objective could have been fiduciary duties protecting their rights to minority’s interest in the dissolution process or in a facilitate the resignation of the existing BoD to be
achieved through an alternative course of employment. settlement with the majority; and/or replaced with the purchaser’s nominees
action less harmful to the minority’s interest.  Mandatory dividends (provisions requiring that
o Court must then balance the legitimate HOW TO AVOID THESE certain dividends be paid might be included in the
EMPLOYEE/SHAREHOLDER ISSUES? Articles of Incorporation).
business purpose against the minority’s
proposed alternative. [See Wilkes v. - Have an express employment
Springside Nursing Home (Mass. agreement to determine the rights of
1976)] the employee/shareholder, rather
than relying on the more abstract
applications of fiduciary duties.

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Business Organizations – Attack Outline – Faiq
 ISSUES OF CONTROL
Shareholder Actions Derivative Lawsuit Summary

DIRECT ACTIONS (ADDRESSES HARMS DIRECTLY TO SHAREHOLDERS, THAT IS WHERE RECOVERY WOULD GO) IF DEMAND IS NOT MADE (DE STANDARDS):
Shareholder makes a claim in their own name against the corporation, or a director or officer, for a wrong that was done directly to that shareholder. Direct 1) Whether demand is made: NO.
actions are usually brought as a class action where the shareholder sues as a representative of a class of similarly situated shareholders who have suffered  Proceed to the Marx analysis (reasonable doubt)
from the same harm. 2) Whether BoD is interested
Examples of Direct Suits:  YES: Plaintiff continues suit
 Suit to compel payment of dividends;  NO: BoD appoints SLC
 Suit to enjoin an activity that is ultra-vires; 3) Whether SLC continues suit
 Suit claiming fraud;  YES: Suit continues but the SLC controls the litigation, not the
 Suit brought to protect certain S/H rights (like preemptive rights or right to vote on certain matters); Plaintiff
 Suit in which a S/H has been denied rights (like redemption rights or right to inspect books and records); and  NO: SLC terminates the suit
 Suit involving a S/H-Employee who is fired and forced to sell stock and is suing to recover their job OR stock. 4) Whether the SLC was independent
 YES: SLC is independent then MSJ is properly granted for SLC
DERIVATIVE ACTIONS (ADDRESSES HARMS TO THE CORPORATION, THAT IS WHERE RECOVERY WOULD GO)  NO: Plaintiff continues suit
When the complained of wrong has damaged the corporation and, as a result of the harm to the corporation, the shareholder is negatively impacted. 5) The Court inputs their business judgment
Examples of Derivative Suits:  If the court is PASSIVE, then the suit is dismissed if the SLC
 Claim that a director has violated their duty of care to the corporation by making a bad deal with a 3 rd party; was found to be independent
 Claim that an officer has misappropriated a corporate opportunity (or committed some other duty of loyalty violation), and the corporation failed to  If the court is NOT PASSIVE, then the suit’s dismissal by the
take action against them; SLC is subject to the court’s business judgment
 Claim that a 3rd party who has a contract with the corporation breached the contract and the BoD failed to take action against the 3 rd party;
 Claim that the senior management’s salaries are excessive; and IF DEMAND IS MADE:
 Suit seeking to prevent management practices which are calculated to prevent challenges to current management. 1) Demand is made.
2) Is refusal of the demand wrongful?
KEY DIFFERENCES PROCEDURALLY BETWEEN DIRECT AND DERIVATIVE SUITS:  NO: Dismiss suit.
 Only S/H can bring derivative suits (not creditors);  YES: Suit continues.
 Because derivative suits arise out of a wrong to the corporation, the remedy goes to the corporation NOT the S/H suing;
OVERVIEW: HOW A SHAREHOLDER SUCCEEDS IN BRINGING
 Because a direct suit arises out of a wrong to the S/H, the S/H may collect money damages;
DERIVATIVE SUIT
 In a derivative suit, the corporation is required to pay for the S/H’s attorney fees PROVIDED that the S/H is successful;
 Corporation does something (allegedly) wrong and S/H wants to
 There are many more procedural hurdles to meet in a derivative suit than in a direct suit.
sue BoD for breach of fiduciary duty to the corporation. S/H bring
suit.
BASIC REQUIREMENTS IN ORDER TO BRING A DERIVATIVE SUIT:
 First, S/H must post a bond to cover costs in event the S/H loses.
 Contemporaneous Ownership: A S/H must have been a S/H at the time of the injury claimed and at the time the suit is brought.
 Second, 1) S/H must make a demand on BoD OR 2) show that
 5% Rule: In some states a S/H holding less than 5% of the outstanding stock is liable for the costs associated with bringing an unsuccessful derivative
demand is excused (because it is futile to make a demand on the
suit.
BoD) by showing:
 Bond Purchase: In some states a S/H must purchase a bond when bringing suit to cover the potential costs of an unsuccessful suit.
i) for example that a majority of the BoD has an interest
in the transaction in question, OR
THE DEMAND REQUIREMENT IN DERIVATIVE SUITS:
ii) that a reasonable doubt exists about the exercise of
- S/H must approach BoD and demand the BoD pursue litigation before the S/H is allowed to bring suit on behalf of the corporation sound business judgment with respect to the
- If demand is made and the BoD determine they won’t bring suit then BJR protects the BoD decision transaction in question.
- Because of the BJR protection, usually Plaintiffs will seek to avoid making demand by seeking demand excusal  Third, if there is a SLC, the SLC has to 1) agree to let S/H bring suit
OR 2) if the SLC votes to dismiss the suit, then the burden of
WHEN IS DEMAND FUTILE (DE STANDARD): proof is on the S/H to show that the decision of the SLC was
 A majority of the BoD has a material financial or familial interest in the transaction; invalid because:
 A majority of the BoD is incapable of acting independently for some other reason such as domination or control (usually by an individual who is i) The process was flawed and SLC was not
“interested”); OR disinterested, OR
 The underlying transaction is not the product of a valid excuse of business judgment. (Note that since the BJR is inapplicable where the BoD did not ii) The SLC’s decision violated BJR.
exercise any business judgment, AKA the oversight cases, some argue demand is automatically excused in oversight cases BUT THAT IS NOT THE  Fourth, if the S/H doesn’t prevail in showing any of step 3, then
CASE). the S/H can hope the court institutes its own independent
business judgment.

15
Business Organizations – Attack Outline – Faiq
 SECURITIES LAW
What is a Security? Registration Private Placements (exempt from Rule 10b-5
registering)

Section 2(1) of the 1933 Act lists two broad categories of In order for a security to be sold to the public, it must either be If an issuer wants to raise money without registering, Rule 10b-5 creates liability for
instruments, which qualify as a security. There are some registered with the SEC or have an exemption from registration. then that issuer must qualify for an exemption. anyone who makes a misleading
instruments that automatically qualify as a security. Generally, publicly traded companies MUST register at least representation or omission that is
some portions of their company’s securities if they have at least FACTORS THAT DETERMINE WHETHER IT IS EXEMPT: connected to the purchase or sale
SOME SPECIFIC INSTRUMENTS INCLUDE: one class of stock that is publicly traded.  Size of the offering. How much money is being of a security.
 Stock; raised? There are exemption for certain offerings  Liability arises when someone
 Notes; SECTION 11 OF THE 1934 ACT REGULATES REGISTRATION under $1 Million and $5 Million. buys or self a security.
 Bonds; STATEMENTS AND CREATES RESPONSIBILITIES FOR THE  Number of units offered. How many shares are  Creates a private right of action
 Debentures; FOLLOWING GROUPS OF PEOPLE: available and what percentage of the company’s as well as SEC enforcement.
 Options; and  Anyone who signs the registration statement; total ownership does that constitute?  Is also used to restrict insider
 Voting Trust Certificates.  Officers of the issuer;  Manner of the offering. How do people hear trading actions.
 Experts who assisted in the preparation of the about the transaction? Rules restrict advertising
THE CATCH-ALL GENERAL CATEGORIES OF SECURITIES ARE: registration statement; AND to, and solicitation of, the general public. Section 10(b) of the 1934 Act:
 Evidence of Indebtedness; and  Underwriters promoting the offering.  Number of offerees. How many people are offered It shall be unlawful…
 Investment Contracts. the deal? The focus of this factor is NOT how many (b) to use or employ, in connection
If you are an issuer you are strictly liable for anything people actually invest, but how many are offered with the purchase or sale of any
WHETHER A SCHEME, CONTRACT OR INVESTMENT QUALIFIES misleading (including omissions or misstatements) in the the opportunity to invest. (Note, often, different security on a national securities
AS A SECURITY: COMMON FEATURES OF SECURITIES TO registration statement. offerees are treated differently. Some exemptions exchange or any security not so
CONSIDER doe not “count” certain sophisticated investors, registered, . . . any manipulative or
 The right to receive dividends contingent upon an Others, outside of the issuer has a defense of due diligence known as “accredited investors” as part of the deceptive device or contrivance in
apportionment of profits; (basically a negligence standard) for any misleading information number of offerees. An individual accredited contravention of such rules and
 Negotiability; with regard to the registration statement. investor typically has a net worth, not including regulations as the Commission may
prescribe as necessary or appropriate
 The ability to be pledged or hypothecated; the investor’s house, over $1 Million or income
in the public interest or for the
 Voting rights that accompany an instrument and THE DUE DILIGENCE DEFENSE REQUIRES: over $200,000 for the prior few years. There are
protection of investors.
correspond to the number of “shares” owned; and/or  Reading of the registration statement; AND different standards for corporations seeking
 The ability to appreciate in value.  Investigating the registration statement to make sure that accredited investor status. It is also important to
To enforce Section 10(b), the SEC
the statements and assertions contained in the statement show that an offeree has access to information
created and adopted Rule 10b-5,
WHETHER SOMETHING IS AN INVESTMENT CONTRACT (HOWEY are true. (Note, if something turned out to be false, in from, and about, the issuer.)
which states:
TEST): order to avoid liability, the defendant in question would
It shall be unlawful for any person,
 A contract, transaction or scheme through which a person need to show that he or she did not know that it was Most private placements are conducted under directly or indirectly, by the use of any
invests money (or any other consideration); false and should not have known that it was false.) Regulation D or Section 4(2) of the 1933 Act. While means or instrumentality of interstate
 The investment is made into a common enterprise (either private placements are exempt from Section 11 of the commerce, or of the mails or of any
with “horizontal commonality” in which the investment is MAKINGS OF A REGISTRATION STATEMENT (STANDARD OF 1933 Act, they are still subject to Section 10b-5 of the facility of any national securities
made with others or, in some circuits but not all, with CARE IS THE CARE THAT A REASONABLE PERSON WOULD 1934 Act, as well as other provisions of the Act. exchange,
“vertical commonality” in which the investment is made EXERCISE IF HIS MONEY WERE AT STAKE):  In addition to satisfying federal standards, issuers a) To employ any device, scheme,
with a promoter who is working to make money for the  Expertised Portion: accountants, auditors, etc. have gone seeking an exemption must also satisfy state laws for or artifice to defraud,
investor); through the statement and confirmed the information securities called “blue sky laws.” b) To make any untrue statement
 With the expectation of profits (or some other financial under a reasonable investigation standard and that they  If the securities take place entirely in one state, they of a material fact or to omit to
benefit); AND believe reasonably the information is true. don’t have to comply with federal regulations, as they state a material fact necessary
 With profits to come “solely” from the” efforts of others”.  Non-Expertised Portion: non-experts must show only are exempt as intrastate, and instead have to comply
in order to make the statements
that they had no reason to believe that the statements in made, in the light of the
(This “efforts of others” clause is intended to include the only with the “blue sky laws.”
the expertised portion were misleading. circumstances under which they
requirement that the investor not participate in the
 Experts have NO liability with regard to the non- were made, not misleading, or
operation of the investment opportunity. To expect profit CROWDFUNDING EXEMPTION:
expertised portion. c) To engage in any act, practice,
(or financial benefit) based on the efforts of others means - A provision in the Act of 2012 that allows or course of business which
the investor is depending on the work, skill, expertise  Non-experts must have gone through the statement
entrepreneurs and small businesses to raise up operated or would operate as a
and/or efforts of other people rather than himself for the and confirmed the information under a reasonable
to $1 Million from a large number of investors, fraud or deceit upon any
profitable result. However, most courts interpret the word investigation standard and that they believe reasonably
even if those investors are not accredited. person, in connection with the
“solely” to mean “primarily”.) the information is true.
- THESE issuers are still subject to Rule 10b-5. purchase or sale of any security.

16
Business Organizations – Attack Outline – Faiq
 SECURITIES LAW
Claims Made Under Rule 10b-5 Analysis of 10b-5 Requirements Damages in a 10b-5 Claim &
Claims not Covered by Rule
10b-5

BASIC STANDING REQUIREMENTS OF 10B- UNTRUE STATEMENT OR OMISSION DAMAGES

5: WHETHER RULE 10B-5 EVEN  Defendant had to make a false or misleading statement or omit information, which made a statement false or misleading. a) “Out of Pocket” Damages: which
APPLIES?  In situations in which liability is based on the omission of a material fact rather than a misrepresentation, then there can only be would involve a determination of the
 Section 10(b) has an interstate liability if there was a duty to disclose that fact. difference between the price actually
commerce jurisdictional requirement. paid or received and the price that should
 Even if the facts meet the jurisdictional SCIENTER (INTENT OR KNOWLEDGE OF WRONGDOING) have been paid without the 10b-5
requirements, the plaintiff must show  Defendant must have acted with the intent to deceive, manipulate, or defraud violation.
that the activity involves a “security.”  Negligence alone does NOT suffice, although some courts will allow deliberate recklessness. b) Restitution/ Disgorgement: which
 Even if jurisdiction is satisfied, and so is  This element is different from fraud because intent deals with the representation and not to the transaction itself. would involve the defendant turning over
the security requirement, the activity the profit derived from the fraud
must involve a purchase or sale of MATERIALITY perpetrated on the plaintiff.
securities.  Defendant’s misrepresentation or omission must have been material, meaning a reasonable investor would likely consider the c) Rescission: which would involve the
misstatement or omission to be important in determining whether to buy or sell. return of the price paid or the securities
WHAT ABOUT SHOWING FRAUD?  What about the materiality of a contingent event? sold by the plaintiff, or the difference
 The fraud need only touch and concern - Basic Test: evaluate the probability that an event will happen and the importance of the event, if it does happen. There are four between the original sales price and the
the transaction. possible results of the test… subsequent sale price by the defendant.

BEYOND STANDING, STATUTORY

- ONE: contingent event could have both a high probability of occurring and a high magnitude of importance it does occur. IF SO, d) Benefit of the Bargain Damages: which
then MATERIAL. would only arise in a limited number of
REQUIREMENTS OF 10B-5: THE circumstances in which there is a
DEFENDANT… - TWO: contingent event could have a low probability of occurring and a low magnitude if it does occur. IF SO, NOT MATERIAL. difference between the value received
a) Employed a device, scheme, or - THREE: Even an event that has a high probability of occurring but a low magnitude if it does occur, it is STILL NOT MATERIAL, and the value promised, which may be
artifice to defraud, AND since it is unlikely that something of little significance would impact the stock price. established with reasonable certainty.
b) Either, - FOUR: Low possibility of occurring but high magnitude of occurring, is what MOST MATERIALITY CASES ARE ABOUT. (Examples e) Punitive Damages: (not available in a
i) Made an untrue statement include unlikely mergers.) private 10b-5 action)
of a material fact, OR
ii) Omitted or failed to state a RELIANCE CLAIMS NOT COVERED BY 10B-5
material fact necessary in
order to make the
 If a Plaintiff brings a private action, there must also be a showing that he or she actually AND justifiably relied on the defendant’s - Rule 10b-5 is NOT about
misrepresentation. (Can be referred to as “transaction causation” which means the misrepresentation caused the Plaintiff to engage in correcting every wrong; it is
statements made, in light the transaction) ONLY about full disclosure. Once
of the circumstances under  Reliance on Omissions full and fair disclosure is made,
which they were made, not
misleading; OR
- Generally, no duty to disclose UNLESS officer of the company had duty to speak but did not. the fairness of the transaction is
c) Engaged in “any act, practice or - Given the duty to disclose, a person is entitled to rely on silence as a “statement” that there is no material information that the not an issue under federal law.
course of business which would company is required to disclosed, which has not been disclosed. Thus, reliance is presumed and is a rebuttable presumption. - Rule 10b-5 claims MUST touch
operate or would operate as a  Fraud on the Market and concern the purchase or
fraud or deceit upon any - Creates a rebuttable presumption that, even if the Plaintiff did not hear the misstatement, there was still reliance. This theory sale of securities.
person,” all in connection with creates a presumption that the investor relied on the integrity of the market price. - The question under 10b-5 is NOT
that purchase or sale of a - Invoked when: there is a public affirmative misrepresentation and the market is an efficient market (i.e. the stock market). whether a wrong had been
security. committed.
- CANNOT be used in private transactions.
- To Rebut: Defendants can Show
- The question under 10b-5 is
ELEMENTS NECESSARY TO MEET STATUTORY whether a wrong has been
REQUIREMENTS:  Misrepresentation did NOT affect the market price;
committed which meets all
 Untrue statement or omission;  Defendants issued corrective statements, which were also priced into the market;
elements of 10b-5.
 Scienter (AKA intent);  Plaintiffs would have bought or sold ANYWAY, even with full disclosure (for example if a Plaintiff had to sell his stock
 Materiality; because he had other financial difficulties); OR
 Reliance; AND  Defendant did NOT rely on the integrity of the market.
 Causation (Proximate cause OR “loss
causation”). CAUSATION: THAT THE MISREPRESENTATION CAUSED THE LOSS.

17
Business Organizations – Attack Outline – Faiq
 INSIDER TRADING
State Law on Insider Trading Rule 10b-5 & Insider Trading Tipper/ Tippee Liability (Under the
Traditional Analysis)

3 DIFFERENT STATE STANDARDS ON DEVELOPMENT OF INSIDER TRADING LAW FEDERALLY TIPPER LIABILITY: TIPPER IS LIABLE IF THEY…
INSIDER TRADING: Insider trading involves a very specific trade under 10b-5 in which someone deceives by omission.  Disclose material, nonpublic information to others; AND
1) Majority Rule: Except in  The omission is that the person is in possession of material, nonpublic information, which, if known, would  That disclosure is made in breach of a fiduciary duty of loyalty
instances involving fraud, impact the price of the security. (or in the case of a tippee turned tipper, with the knowledge
officers and directors of a  In the past, there was a blanket duty to “disclose or abstain” from trading while in possession of material that the information was obtained as the result of a breach of
corporation may trade in the nonpublic information. [See In re Cady, 40 S.E.C. 907 (1961); SEC v. Texas Gulph Sulfur, 401 a duty of loyalty). Either way, the question is: did the tipper
corporation’s stock without F.2d 833 (2d Cir. 1968)] obtain a personal benefit by engaging in the “tipping?” The
disclosing material  Eventually, SCOTUS limited restrictions on the use of nonpublic information to certain situations such as those existence of a breach is measured by whether the tipper
information. (Note, while it is in which the use of nonpublic information could be traced to a breach of some fiduciary duty. personally benefitted, directly or indirectly, from the
called the majority rule it is  It is important to note that insiders (and constructive insiders) have a duty to disclose or abstain. However, disclosure. It can include: monetary benefit, quid pro quo, an
only the law in several states). they are not prevented from possessing material, nonpublic information. They just may not trade on such enhanced reputation, or even a “gift.”; AND
2) Special Circumstances Rule: information.  Someone traded on that information. (Note, that a tipper is
Makes certain exceptions to liable if anyone along the chain of information dissemination
the majority rule, taking the FACTUAL DETERMINATIONS TO AN INSIDER TRADING ISSUE trades on the information, not just the tipper’s direct tippee.)
position that a corporation’s  Whether the information in possession of the person involved in the trade is “material”, nonpublic
officers and directors have a information; NO LIABILITY if: 1) there is no personal benefit, or 2) no one traded
duty to disclose information  How did the person involved come to have the information; on the information.
before they trade with  What did the person do with the information; AND
shareholders of the  Was there a breach of a duty involved in the use OR the dissemination of the information? TIPPEE LIABILITY: TIPPEE IS LIABLE IF THEY…
corporation when these  Receives material, nonpublic information which was
circumstances are present: ** NO REQUIREMENTS OF RELIANCE OR CAUSATION. JUST A REQUIREMENT OF SCIENTER (INTENT) and disclosed in breach of a fiduciary duty by an insider (for the
 Information is highly MATERIALITY.** personal benefit of the insider) at the company whose stock
material; is being (or will be) treaded; AND
 Officer or director There are two types of insider trading: 1) Traditional Insider Trading and 2) Misappropriation.  The tippee knew or should have known that the tipper was
conceals his/her breaching a duty by providing the information (rememv\ber
identity or engages in TRADITIONAL INSIDER TRADING ANALYSIS: that the breach of duty is measured by whether the tipper
some other fraud or  Did the defendant have possession of the nonpublic information? received a benefit); AND
deceit; OR  If NOT, then there is no insider trading. However, if YES the defendant did have possession of nonpublic  The tippee trades on that information; OR
 Officer or director is information, was that information “material?”  Provides the information to others, and receives a personal
trading with an  If NOT, then there is no claim. However, if YES then the next step is to determine if the person was a(n) benefit, and someone trades on the passed along
especially vulnerable  Insider, meaning they were an officer, director or majority shareholder (a typical measure of a information.
person with no majority shareholder is a person who holds 10% or more of the stock); OR
understanding of  Constructive Insider, meaning someone like an accountant, underwriter, lawyer, or consultant who NO LIABILITY if: 1) tipper breached a duty, or 2) no one traded on
financial matters (for has a special relationship of trust and confidence with the company; whose position provides the information (either themselves OR another tippee).
example, an elderly access to confidential information and the company has a reasonable expectation that the person
person). will keep the information confidential, AND the person does IN FACT have an obligation to keep TIPPERS CAN PROTECT TIPPEES:
3) Minority Rule: Sometimes that information confidential by virtue of their position. Tippers may protect tippees from liability by not telling them what
known as the Kansas Rule, it  If the defendant is neither an insider nor a constructive insider, then they are not liable under the the source of the information is. However, this would only shield the
takes the position that traditional analysis even if they traded on the information. However, that person may be liable under the tippees. The tipper themselves would still be liable if the remaining
corporation’s officers and misappropriation OR tipper/tippee analysis. elements are met.
directors do have a duty to  If the above analysis does reveal that the person was an insider or constructive insider, then they are
disclose material information subject to liability for the trades under 10b-5.
whenever buying from a
shareholder, at least in face- POSSESSION OF INFORMATION DOES NOT ALWAYS = TRADING ON INFORMATION
to-face interactions.  Limit in Civil Cases: “while in possession” raises a strong inference that the person traded on such
information, but it is rebuttable inference which the insider can disprove.
 Limit in Criminal Cases: is even stronger in favor of the insider because courts require that the government
PROVE the defendant used the information to trade.

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 INSIDER TRADING
Misappropriation Misappropriation and Tipper/Tippee Liability Rule 14e-3 & Insider Trading Relating to
Tender Offers

O’HAGAN & MISAPPROPRIATION: TIPPER LIABILITY UNDER MISAPPROPRIATION: A TIPPER IS RULE 14E-3
Prior to O’Hagan: in order to find liability, one needed to show that the defendant LIABLE IF… Rule 14e-3 creates liability if a person trades while in
breached a duty (or in the case of tippee liability, that the information arose out of a breach  The tipper is in possession of material, nonpublic information; possession of material, nonpublic information relating to a
of duty) to the company in whose stock the defendant had traded. AND tender offer that was acquired from the person or entity
 asked about breach of fiduciary duty to the company  That material, nonpublic information was acquired either: making the offer (the “offeror”) once the offeror has taken
O’Hagan Onwards: the misappropriation theory broadens liability to include those who o By the tipper through a fiduciary relationship or a similar “substantial” steps toward making the offer.
breach a duty to the source of the information. relationship of trust and confidence (RETAC) with the
 asks about fiduciary duties to the source of the information and about whether the source of the information, in which there are fiduciary (or 14E-3 LIABILITY IS CREATED IF:
defendant breached (or knew about a breach of) a duty arising out of a relationship of fiduciary-like) duties, OR  A person (the “recipient”) is in possession of information
trust and confidence (“RETAC”) to the source of the information o By the tipper as a result of somone else violating a relating to a tender offer being made by someone other
fiduciary duty arising out of a fiduciary relationship or than the recipient; AND
RULE OF MISAPPROPRIATION: RETAC with the source of the information, AND the tipper  The information is material; AND
A person commits fraud in a securities transaction when he or she “misappropriates” knew or had reason to know of that violation of duty;  The recipient of the information knows or has reason to
material, nonpublic information in a breach of a duty (typically a duty of trust and AND know that the information is nonpublic information
confidence) owed to the source of the information, AND does not disclose his intentions to  The tipper discloses the material, nonpublic information to which came directly or indirectly from the offeror, the
trade to the source of the information, AND trades on that information. others (i.e. Does he or she “tip” anyone?) and, as a result, target company (i.e., the issuer of the securities sought
 NOTE: the fiduciary duty here is not the one to the company but rather to the source of receives a personal benefit (Under misappropriation, the by the offeror), or an officer, director, agent, employee
the information. existence of a breach is still measured by whether the tipper or constructive insider of the offeror or the target
personally benefitted, directly or indirectly, from the company; AND
ASSESSMENT OF INSIDER TRADING UNDER MISAPPROPRIATION THEORY: disclosure); AND  The recipient of that information purchases or sells (or
 Did the defendant have possession of nonpublic information?  The tipper did not disclose his or her intention to disclose the causes to be purchased or sold) securities of the target
 If NOT, then no 10b-5 insider trading claim. If YES, then was that information information to the source of the information; AND company or the offeror at any time prior to the public
“material”?  Someone who receives the information provided by the tipper announcement of the tender offer, without first
 If the defendant was in possession of material nonpublic information, the next step is trades on that information. (Note that a tipper is liable if anyone disclosing the information (along with its source) to the
to determine how the defendant acquired the information. Did that person acquire alone the chain of information dissemination trades on the person with whom the recipient is trading; if, and only
the information under a RETAC? (Several relationships that are RETAC are: employee/ information, not just the tipper’s direct tippee.) if…
employer, attorney/ client, doctor/ patient, principal/ agent, family members, etc.)  The offeror has commenced or has taken substantial
 Assuming there was a duty to the source of the information and/or a fiduciary TIPPEE LIABILITY UNDER MISAPPROPRIATION: TIPPEE IS steps toward commencement of a bid for the target
relationship or RETAC, was the information within the scope of that duty? (Be aware LIABLE IF… company (e.g., passage of a resolution about the tender
that many people unintentionally skip this question.)  Receives material, nonpublic information from someone else; offer by the offeror’s BoD, formulation of a tender offer
 If NO, then no liability under 10b-5 misappropriation analysis. AND plan, arrangement of financing to pay for all or a portion
 If YES, then the final step is to determine if the defendant traded using the material,  That information is provided (directly or indirectly) by someone of the tender offer, preparing the tender offer
nonpublic information without disclosing their intention to trade to the source of the (who could be any tipper in a chain of tippers), violating a documents/ materials).
information. fiduciary (or fiduciary-like) duty arising out of a fiduciary
 If YES, then they are subject to liability for their personal trades under Rule 10b-5. relationship or RETAC with the source of the information; AND ** NO BREACH OF DUTY REQUIRED FOR LIABILITY**
 The tippee knows or should have known that someone
WHEN DOES RETAC EXIST? (meaning any tipper in the chain) was breaching a duty to the
 Whenever a person agrees to maintain information in confidence; source of the information by providing the information; AND
 Whenever the person communicating the material, nonpublic information and the  The tippee trades on that information; OR
person to whom it is communicated have a history, pattern or practice of sharing  Provides the information to others (i.e., tips and becomes a
confidences, such that the recipient should know or reasonably should know the tipper), receives a personal benefit for the tip, and someone
person communicating the information expects confidentiality to be maintained; OR trades on that information (i.e., becomes a tipper).
 Whenever a person receives or obtained material, nonpublic information from his or
her spouse, parent, child or sibling (however, person receiving the information may
rebut and show there is no RETAC because there is NO history, pattern or practice of
sharing confidences).

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 INSIDER TRADING
Short Swing Profits, Section 16(b)

Section 16(b) applies to any insider at a “registered” company, who buys or sells equity securities in that company within a 6 month period. It does not matter whether the insider purchases first and then sells or sells first and then
subsequently buys. Any profit that an insider makes in such a transaction must be paid to the company.

RULES OF SECTION 16(B):

 Applies to all insiders. An insider is considered to be an officer, director, or a shareholder holding more than 10% of the corporation’s equity securities. Section 16(b) applies to someone who was an officer or a director of the
corporation either at the time of the purchase or the sale. However, it only applies to shareholders who beneficially (directly or indirectly) hold more than 10% of the corporation’s equity securities both at the time of the
purchase and the sale;
 Applies only to companies that are required to register under the 1934 Act. Companies with more than $10 Million in assets and more than 500 shareholders of record are required to register with the SEC and are subject to
certain reporting and other requirements. Section 16(b) DOES NOT apply to closely held companies;
 Only covers transactions in a company’s stock or convertible debt;
 Enables a company to recover any profit made by an insider within a 6 month period. (In evaluating the profit, the insider does not get to identify specific shares that were bought and sold. Any transaction in a company’s
securities may be matched with any other transactions in those securities that occurred within a 6 month window to determine the maximum profit (with the exception of transactions made by shareholders (who were not also
officers or directors) when they were not holders of 10% or more of the company’s equity securities). That maximum profit is what is recoverable from the insider); AND
 Allows a shareholder of the company to sue derivatively on behalf of the company to recover the profit if the company does not bring or diligently prosecute a 16(b) claim.

SECTION 16(B) DOES NOT APPLY IN SITUATIONS IN WHICH:

 The purchase or sale of equity securities is involuntary (for example required by a preexisting contractual agreement); AND
 The specific facts of the situation do not create the possibility of “speculative abuse of inside information” (for example where a 10% shareholder, because they were at odds with the company, were extremely unlikely to,
and did not, have access to any confidential information or input regarding the timing of the transaction.)

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 Table of Contents
Agency: (PAGE ONE) Agency: (PAGE TWO)
- Actual Authority - Principal’s Liability
- Apparent Authority - Agent’s Liability
- Ratification - Duty of Principal  Agent
- Liability of an Undisclosed Principal - Duty of Agent  Principal
- Estoppel

1 2
Partnerships: (PAGE THREE) Partnerships: (PAGE FOUR)
- Characteristics - Expulsion
- Does a Partnership Exist? - Nature of Partnership Interests [UPA § 26]
- Attributes Arising Once a Partnership is Established - Rights of Partnerships in Management
- Limitations on Partnerships - Partnership Dissolution & Dissociation
- Joint Venture, Partnership by Estoppel and Agency Theory

3 4
Corporations: (PAGE FIVE) Corporations – Finding Liability: (PAGE SIX)
- Formation - Piercing Corporate Veil
- Characteristics - Preventing Piercing of Corporate Veil
- Shareholders - Piercing Corporate Veil of Subsidiary
- Board of Directors - Reverse Piercing
- De Facto Corporations vs. Corporations by Estoppel - Enterprise Liability

5 6
Fiduciary Duties (& Other Checks on Corporate Action): Fiduciary Duties (& Other Checks on Corporate Action): Fiduciary Duties (& Other Checks on Corporate Action):
(PAGE SEVEN) (PAGE EIGHT) (PAGE NINE)
- Powers of the Corporation - The BJR & Protection by Consulting an Expert - Corporate Opportunity Analysis
- Duty of Care & the Business Judgment Rule - The BJR & Failure to Act or to Monitor the Firm - Dominant Shareholders
- Procedural & Substantive Requirements for the Duty of Loyalty - Summary of Fiduciary Duties
BJR - Corporate Opportunity Doctrine & Its Defenses
- Affirmative Defenses to Duty of Care Violation - Requirement of Offering the Corporate

7 Opportunity to the Corporation

9
8
Shareholders & the Rights & Restrictions Associated Shareholders & the Rights & Restrictions Associated
Issues of Control: (PAGE TWELVE) 12
with Ownership: (PAGE TEN) 10 with Ownership: (PAGE ELEVEN) 11 - Devices for Control (usually applicable in
- Shareholder Ownership Rights - Shareholder Proposals closely-held or private companies)
- How do Shareholders Vote - The Dodd-Frank Act, Director Nominations & - Limits on Control Arrangements
- Proxy Rules, Fights & Costs Associated “Say On Pay” Shareholder Inspection Rights - Abuse of Control

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Business Organizations – Attack Outline – Faiq
 - Example on Shareholder Voting Schemes

Table of Contents
Issues of Control: (PAGE THIRTEEN)13 Issues of Control: (PAGE FOURTEEN) 14
- Fiduciary Duties in Freeze Outs - Shareholder Actions
- Employee or Shareholder? - Derivative Lawsuit Summary
- Minority Shareholder Protection
- Transfer of Control

Securities Law: (PAGE FIFTEEN)15 Securities Law: (PAGE SIXTEEN)16

- What is a Security? - Claims Made Under Rule 10b-5
- Registration - Analysis of 10b-5 Requirements
- Private Placements (exempt from registering) - Damages in a 10b-5 Claim & Claims not Covered by Rule 10b-5
- Rule 10b-5

Insider Trading: (PAGE SEVENTEEN) 17 Insider Trading: (PAGE EIGHTEEN)18 Insider Trading: (PAGE NINETEEN)19
- State Law on Insider Trading - Misappropriation - Short Swing Profits, Section 16(b)
- Rule 10b-5 & Insider Trading - Misappropriation and Tipper/Tippee Liability
- Tipper/ Tippee Liability (Under the Traditional - Rule 14e-3 & Insider Trading Relating to Tender
Analysis) Offers

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