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82 Cards in this Set
- Front
- Back
- 3rd side (hint)
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What are the critical attributes of corporations?
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1. Legal personality
2. Limited liability 3. Liquidity 4. Separation of ownership and control 5. Formal capital structure 6. Financial statements 7. Tax treatment |
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What are the steps for forming a corporation?
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A. After choosing state (whose corporate law will govern), corp. must…
1. Draft Articles of Incorporation (governing document #1/“constitution”) a. Under MBCA… i. Must include → name, # of shares, address, incorporators [MBCA § 2.02(a)] ii. May include → initial directors, management, limits on rights, liability on a shareholder [MBCA § 2.02(b)] b. Under DGCL (known as “Certificate of Incorporation”/“Corporate Charter”)… i. Also must include nature/purpose of corp. (though, “Legal Business” is sufficient) ii. Also MAY include provision limiting director liability 2. Draft By-Laws (governing document #2/“legislation”) (may include “Provision for managing the business and regulating affairs of the corporation” [MBCA § 2.06(b)]) 3. File Articles w/ Secretary of State [MBCA § 2.03] 4. Organizational Meeting [MBCA § 2.05] 5. Final steps… a. Finalize directors [MBCA § 2.05] b. Appoint officer [MBCA § 2.06] c. Adopt By-Laws [MBCA § 2.06] |
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What are the doctrines related to defective formation of corporations?
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a. De facto incorporation – treat improperly-incorporated entity as corp. if organizers…
i. … tried to incorporate in good faith (easier now to incorporate, SO difficult to prove)… ii. … had legal right to do so… iii. … AND, acted as if a corp. b. Incorporation by estoppel – treat firm as corp. if person dealing w/ firm… i. … thought firm was a corp.… ii. … AND, a windfall (unjust enrichment) if allowed to argue that firm was NOT a corp. c. De facto incorporation benefits/protects the personal liability of the shareholders of the “corp.”… whereas, incorporation by estoppel is NOT for benefit/protection of “corp.” 2. Promoter – one who acts as agent of “corp.” prior to incorporation (though, again, easier now to incorporate) a. Does corp. become party to contract (made by promoter, usually promising stake in corp. in exchange for $$)? → YES, if adopted b. Is promoter liable if corp. breaches contract? → YES, unless corp. AND investor release promoter (promoter should/would include release provision in contract) c. Is promoter liable if corp. is NOT formed? → YES [MBCA § 2.04] |
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What is the liability of a shareholder with respect to actions of a corporation?
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A. Shareholder losses limited to the $$ amount invested in the corp. → corp., as “legal person”, incurs the debt/commits the tort
- Must pierce the corp veil to have individual liability Avoiding Personal liability: • Easy, respect the corporate formalities and take out the minimum insurance |
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What do you need to prove to have enterprise liability?
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• Enterprise liability – it is the unity of interest between the corp and its sister corporations
o What would plaintiff have to show in order to recover under the enterprise theory? • That Carlton did not respect the separate identities of the corporations • Assignment of drivers • Use of bank accounts • Ordering of supplies, etc. - • Enterprise liability: o Allows sister companies to be held liable • The larger corp entity held financially responsible Avoiding Enterprise Liability: • A little more difficult: need to separate books and bank accounts for each corporation, plus careful accounting for supplies, for borrowing of drivers, etc… |
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Walkovszky v. Carlton,
- No shareholder liability |
a. D is agent of Seon Cab Corp. (principal)… AND, driver of taxi cab is also agent of Seon Cab Corp.… thus, D (as agent) is NOT liable for torts of driver (as agent)
i. If driver were agent of D, then D (principal) would be liable… ii. … BUT, under corporate form, D is NOT a principal… b. … rather, D is a shareholder → thus, D is NOT liable… i. Granted, MAY be equitable to allow P to sue D… ii. … BUT, “[T]he law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability”… iii. … thus, D escaped personal liability merely by respecting corp. formalities (doesn’t matter that Seon Cab Corp.’s funds were insufficient to cover P’s injuries) c. … BUT, Seon Cab Corp. is still liable to P… AND, some/all of the other 9 corps. MAY be liable to P as well, as per enterprise liability i. When there is unity of interests b/w sister corps., then “the larger corporate entity” (Seon Cab Corp. + the other 9 corps.) is financially responsible… ii. … thus, depends on whether D respected the separate identities of the 10 corps. (i.e. assignment of drivers, use of bank accounts, ordering of supplis) 2. Thus, one MAY incorporate own business for express purpose of avoiding personal liability… AND, one MAY split a single business enterprise into multiple corps. so as to limit the liability exposure of each part of the business |
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What test must you meet to Pierce the Corporate Veil?
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2- prong Van Dorn Test:
a. Prong #1→ unity of interest (shareholder and corp. essentially one in the same), consider factors… i. Lack of corporate formalities (i.e. records) ii. Commingling of funds/assets iii. Severe under-capitalization iv. Treating corporate assets as one’s own b. Prong #2 → refusing to allow PCV would sanction fraud OR promote injustice |
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Sea-Land Services v. Pepper Source
- PCV found |
Sea-Land makes to collect delivery payment from Pepper Source, BUT Pepper Source has NO $$... thus, Sea-Land attempts to collect from Marchese (Pepper Source’s shareholder) as per PCV
a. Prong #1 satisfied → Marchese held NO meetings, passed NO Articles/ By-Laws, personally borrowed $$ from Pepper Source b. Prong #2 satisfied → Sea-Land providing services to Pepper Source and NOT getting paid IS injustice i. In Walkovszky, Prong #2 likely would’ve been satisfied (arguable fraud of splitting up corps. so as to pay minimum insurance)… ii. … BUT, Prong #1 likely would NOT have been satisfied (b/c corporate formalities respected 3. PCV allows D-shareholder to be liable for corp.… whereas, “reverse piercing” allows for claim against other corps. of which D is also a shareholder a. In Sea-Land, Marchese was also a shareholder in 5 other corps. (besides Pepper Source), of which there was also lack of corporate formalities, commingling of funds, etc. b. Under enterprise liability, several corps. operate as one entity (NO shareholder liability)… whereas, under “reverse piercing”, several corps. are being used by shareholder to promote fraud/injustice (YES shareholder liability) i. Thus, easy to avoid shareholder liability (merely respect corporate formalities)… ii. … BUT, more difficult to avoid enterprise liability (respect corporate formalities for each sister corp.) o Reverse piercing is going to the individual shareholder from the corporation, finding them liable, then going from that shareholder to the assets of another corporation and holding that corporation liable • Going from Corp to another Corp through the shareholder |
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Does corp owe fiduciary duties to creditors such as bondholders?
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NO fiduciary duties to creditors (holders of debt securities) → thus, debt relationship governed by…
1. Interpretation of express contractual terms 2. Implied duty of good faith and fair dealing (GFFD) |
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What are the typical provisions of bond indentures?
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1. Default provisions
a. If default occurs, then bondholders may accelerate bonds → face value becomes immediately due and payable, typically after notice/cure period (i.e. 60-90 days) b. Forces corp. to comply w/ other provisions 2. Restrictive covenants a. Limit corp.’s ability to pay dividends (distribution of after-tax corporate earnings to shareholders) b. Limit use of proceeds (spending) c. Specify financial ratios (i.e. debt-to-equity ratio → require corp. earn certain amount of $$) i. Bondholders (as opposed to holders of equity) ordinarily do NOT expect substantial gain to compensate for risk of loss… ii. … simply want to ensure that $$ is repaid 3. Negative pledge covenants a. Restrict corp.’s ability to issue debt senior to bond in question (NO priority for other lender(s)) b. Assets assumed by such bondholder(s) may NOT be used as collateral (for secured debt) 4. Liquidation clause → if corp. is liquidated (i.e. goes out of business), then debt must be paid off at face amount 5. Successor obligor clause → if sale of “all or substantially all of the assets”, then new corp. can “assume” debt |
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Sharon Steel v. Chase Manhattan
- Role of debtholders and competing clauses |
UV sells half of its divisions and sells the other have to Sharon. UV had really low coupon rate bonds outstanding so Sharon wanted that to transfer over to them via the Successor Obligor Clause. Bank says that it was liquidation so the face amount is due (they want to get the money so they could get new bonds at higher coupon rates). Court says SOC does not apply because SOC is triggered at the time of the planned liquidation and half of the corp was sold to someone else! (GTag thinks this is wrong, they looked at book value rather than market value).
A. Sharon Steel – when the corp initially plans the liquidation is when the SOC gets triggered; company must sell all or substantially all to a single purchaser. i. But when the corp sold the 1st half of divisions, it had money (assets) that was also being sold to Sharon (J. Winters did not see it that way) ii. Problem: J. Winters used book value rather than market value! |
Review of Sharon Steel v. Chase Manhattan
• Why didn’t UV just sell remaining assets? o Tax considerations o Avoid redeeming 123 million in bonds (interest rates are higher now than when the bonds were issued) (got a good deal in the debt) • What were the competing covenants? o Successor Obligor clause: if sale of ‘all or substantially all of the assets,’ surviving corp can assume debt o Liquidation clause: If issuer is liquidated, the debt must be paid off at the face amount • What was Judge Winter’s decision? o Liquidation clause applies, not successor obligor clause o May be wrong calculation because Judge looked at the physical businesses that were present at the time of purchase, looked at value primarily of Mueller Brass and compared it with the value of UV industries at the time liquidation was announced – thus Mueller Brass was not close to value of UV, but UV really had cash in addition to that • Only looking at current ongoing business • Prof says he should have looked at Mueller Brass Company and the cash from selling the other businesses |
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Met Life v. RJR
- No duty of GFFD if not contracted for |
RJR had a strong capital structure, but LBO gave them more debt & less equity, making them more of a credit risk. ML did not have a restrictive covenant in the debt indenture, but tried to argue that it should be covered by implied duty of good faith and fair dealing to not dilute debt; court says the risks are clear from the beginning and if they want it, they should have bargained for it. Only imply if we know it is what both the parties wanted.
1. Met Life v. RJR – the court will only imply a duty of good faith and fair dealing if both of the parties intended for it but wasn’t in the K. A. Indentures can specify a debt/equity ratio so corporations cannot abuse their powers to screw over creditors. However, these need to be bargained for and explicit in the indenture. B. This case also introduced Federal Securities Fraud Statute, Rule 10b-5: covers untrue statements in connection with the purchase or sale of any security. → this provision does not apply in RJR because an LBO is not considered purchasing but reassigning debt! |
1. No duty 99% of the time.
2. Possibility arises when firm’s assets fall to such a large degree that the debt claims exceed the firm’s assets; insolvency, the verge of bankruptcy; → some courts held that the board owed fiduciary duty to debtholders. |
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Are there fiduciary duties owed to debtholders?
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No, 99% of the time there is no duty unless contracted for and specififed or falls within the typical provisions of the indenture
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Who are the groups that Board owes fiduciary duties to? What are the theories?
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1. Stakeholder theory = fiduciary duties are owed to the stakeholders of the company
A. Stakeholders = shareholders, clients/customers, employees, community around it. 2. Shareholder primacy = fiduciary duties are owed only to shareholders. (this applies!) |
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A.P. Smith v. Barlow,
- Stakeholder primacy |
Directors made a corporate donation to Princeton University; shareholders challenge this; there was a statute enacted after company made the donation allowing it; Court said the statute’s modification can apply retroactively because the corp is granted its status at the will of the state; corps can do it as long as it doesn’t advance the directors’ individual pet projects (conflict of int)
B. AP Smith – court was sympathetic to this theory; individuals used to donate, but the wealth is all in corporations now, so they should act like other citizens. → but a big problem comes up because it is OPM (OTHER PEOPLE’S MONEY!) and they’re not free to spend it! i. This case does not resolve which of these views apply in the law – donations to liberal arts institutions leads to free flow of properly trained personnel (maybe shareholder primacy) C. This theory is not the law, but people still argue it for normative purposes: “this should be the law!” |
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Dodge v. Ford
- Shareholder Primacy - Fails to get BJR for lack of belief in best interest of the corp |
“it is not within the lawful powers of the board to shape and conduct the affairs of a corp for the merely incidental benefit of shareholder and for the primary purpose of helping others” → the law definitively is shareholder primacy.
i. Ford only lost because he explicitly said he wasn’t doing it for the shareholders. ii. Although shareholder primacy is the law, boards are given a great amount of deference (rational basis review) for determining what is in the best interest of the shareholders; many times, benefiting other stakeholders is a legitimate means to ultimately benefit shareholders. iii. “The directors’ room rather than the courtroom is the appropriate forum for thrashing out purely business questions” – the BUSINESS JUDGMENT RULE (BJR) iv. *random but might need to know this: Semi-eleemosynary = of, relating to, or supported by charity. v. *random: Determining Value of a Firm: (I) Look at the stock: balance sheet → assets, liabilities, shareholder equity (II) Look at the flow: income statement → sales, revenues, gross, net income, profit (III) Determining if an offer is fair (a) Step 1 – Dodge offered to sell 10% share to Ford for $35M → $350M total (b) Step 2 – is $350 fair? (1) Balance sheet (book value; accountant view) said $112M; it’s 3 times that! (2) Income statement said it makes $60M/yr, price to earnings multiple is about 6! c. Thus, shareholder primacy is the law… BUT, scholars still argue for stakeholder theory for normative reasons (what law should be) i. Corps. MAY still do for the public good… ii. … just MUST state that it will ultimately benefit shareholders |
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What are the duties owed by corporations to their shareholders?
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Two fiduciary duties (and perhaps more)
• Duty of care o No illegal activities • Duty of loyalty o No conflict of interest • Duty to act in good faith (?) o Be honest • Duty to disclose (?) |
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What is the duty of care for the corporation?
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1. Corporate duty of care is NOT a tort duty of care → procedural, NOT substantive review of actions
o In Tort law, we look at the action, in Bus Ass, we look at the method of arriving at the action! a. Tort duty of care requires adherence to reasonable standard of care while performing any acts that could foreseeably harm others (negligence) → breach involves testing actions against RPP standard b. Corporate duty of care requires less of a director → director MAY act negligently, so long as… 1. When discharging duties, shal act in good faith and in a manner the director reasonably believes to be in the best interests of the corp 2. When becoming informed, the BOD shall do this with the care a person in a like position would reasonably believe appropriate (BJR) 3. Directors must disclose material information 4. Director may be found liable if Articles does not preclude liability |
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What must a director demonstrate so that his actions may be negligent, and he will not be liable?
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b. Corporate duty of care requires less of a director → director MAY act negligently, so long as…
i. “Each member of [BoD], when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation” [MBCA § 8.30(a)] ii. “[BoD], when becoming informed or devoting attention, shall discharge their duties with the care a person in a like position would reasonably believe appropriate” [MBCA § 8.30(b)] iii. “Directors shall disclose material information” [MBCA § 8.30(c)] |
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How may a director be found liable?
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If Articles of incorp does not preclude liability and director
1. Did NOT act in good faith –OR– 2. Did NOT believe was acting in the best interest of corp. (as per rational basis) –OR– 3. Was NOT informed –OR– 4. Lacks independence –OR– 5. Failed to devote ongoing attention to oversight/when particular facts arise |
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How is the shareholder hindered in asserting that a corporation breached its duty of care?
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a. Corporate duty of care regulates diligence in performing tasks… BUT, is severally limited by business judgment rule (BJR)
i. The directors’ room, NOT the courtroom, is “the appropriate forum for thrashing out purely business questions” → court will NOT judge directors’ business decisions ii. Rationales… 1. Shareholders can elect new directors 2. Competition will lead to failure of poorly managed corps. 3. Do NOT want to discourage risk taking |
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When does the BJR not protect corporate fiduciaries?
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1. Actions are not in honest belief that the action is in the best interests of the corp
2. Actions are not based on an informed investigation 3. Actions involve conflict of interest (breach of duty of loyalty) |
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Kamin v. American Express
- Afforded BJR |
Amex bought 2M shares of another corp. for $15/Sh, but price dropped to $2/Sh. Amex decided to dividend the shares rather than selling it at a loss, which would off-set taxes, saving $8M. Shareholders sue. Court applies the BJR and dismisses shareholder’s claim because directors did not act in bad faith.
i. Unlike in Dodge v. Ford, AmEx claims that they were acting in best interests of corp.… ii. … it just so happens that, in the process, AmEx made a stupid decision 1. Shareholders could’ve argued for conflict of interest (possibility #3), as AmEx directors received bonuses by NOT reporting loss… 2. … BUT, ONLY 4 of 20 AmEx directors would’ve received such bonuses (NOT every action that has impact on earnings creates conflict of interest)… 3. … though, better (for shareholders, at least) to tie directors’ bonuses to stock price, NOT income statement |
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Smith v. Van Gorkom
- Fails prong 2, rare - action not based informed investigation |
Trans Union wanted a MBO(management buy out, managers borrow against corp to acquire outstanding shares from shareholders, unifying ownership and control)
Van gorkum does not want MBO and meets with pritzker to negotiate LBO at 55/share, 17 premium over market price - BOD approves LBO after 2/hr meeting with majority of shareholders approving LBO b. Issue #1 → whether BoD’s decision to approve LBO was informed i. BoD knew that Pritzker was willing to pay $17 premium over market price… ii. … BUT, BoD did NOT know how this price was set… iii. … AND, price was set based on feasibility (of LBO), NOT based on value (of corp.) 1. BoD has duty of inquiry → can’t rely blindly (“gross negligence” to make decision to sell corp. after 2-hr. meeting) 2. Defense available for BoD based on good faith reliance on directors’ reports [DGCL § 141(e)]… BUT, NO such report was made re: basis of Pritzker’s price (Van Gorkom himself was NOT informed) c. Issue #2 → since BoD’s decision was NOT informed, did BoD cure its uninformed decision (via “market test”) i. Via “market test”, corp. offered for sale publicly (to see if anyone would purchase for more than Pritzker’s $55/share)… ii. … thus, if no one submits higher bid, then $55/share is deemed reasonable… iii. … BUT, absence of competing bids is misleading b/c terms of agreement creating this “market test” (which, again, BoD approved sight unseen) did NOT make for fair market 1. Corp. could NOT solicit bids… 2. … nor could corp. provide info to bidders d. Issue #3 → since BoD’s decision was (still) NOT informed, did shareholders’ approval cure BoD’s uninformed decision i. BoD is liable for uninformed decision regardless of whether shareholders approve… ii. … AND, regardless, shareholders were also NOT informed → like BoD, knew Pritzker’s price, but NOT its basis Creates a PROCESS REQUIREMENT = hire lawyers/bankers to look at the transaction and have a meeting longer than two hours to avoid this!!! (I) Dissent – this decision is wrong because these were all highly seasoned officers and it would be impossible for them to have not been informed! (potential counter-arg) |
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What are the ways that a director (like Van Gorkum) be protected from personal liability?
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i. BJR → act in best interest of corp., in good faith, AND be informed
ii. Indemnification → any expenses incurred will be reimbursed by corp. 1. Under MBCA ([MBCA §§ 8.51-8.56]) and DGCL ([DGCL § 145(a)-(b)])… 2. … BUT, in DE, NOT reimbursed if director adjudged liable (thus, settlement preferred) iii. Directors and officers insurance → corp. buys insurance protecting from personal liability (if corp. goes bankrupt/can’t reimburse) 1. Under MBCA ([MBCA § 8.57]) and DGCL ([DGCL § 145(g)])… 2. … AND, in DE, indemnification restriction does NOT apply to insurance iv. Legislative reaction to Van Gorkom → Articles of Incorporation MAY include provision limiting liability for personal monetary damages for breach of duty of care 1. Under MBCA ([MBCA § 2.02(b)(4)]) and DGCL ([DGCL § 102(b)(7)]) 2. Directors want such provisions, while shareholders do NOT… BUT, public corps. generally adopt such provisions (NO disincentives for becoming director) |
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If a director fails to act, are they afforded BJR? If not, what affirmative duties are required?
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5. BJR protection applies ONLY to director actions → higher standard for director inaction (failure to act)
a. Director has 3 affirmative duties… i. Obligation of basic knowledge and supervision ii. Read/understand financial statements iii. Object to misconduct and, if necessary, resign |
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Francis v. United Jersey Bank
- Inactive as director |
Lillian Pritchard was drunk and listless most of the time, sons embezzled money from the company
i. Applies when the corp holds funds of others in trust; they are: (I) To have basic knowledge and supervision of the workings of the business (II) Read and understand basic financial statements (III) Object to misconduct and, if necessary, resign. ii. In Francis, the director should have inquired further, objected to the embezzlement, and resigned if the objection did not work → would have absolved her. |
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In re Caremark
- Inaction of directors, duty to adopt compliance program |
Does away with 'one free bite' rule from Allis-Chalmers case - directors are not longer entitled to rely on the honesty of their subordinates until something occurs to put them on notice
In re caremark - Directors obligation includes a duty to assure that - a corporate information and reporting system exists...failure to do so may render a director liable for losses cased by non-compliance with legal standards (I) Rationale – Van Gorkom requires board to make informed decisions; timely info is important for board to adequately supervise; fed sentencing guidelines create incentive for compliance programs (reduces penalties and it’s crazy to not have it). d. In Caremark, health care provider settles w/ fed. govt. AND w/ shareholders (after illegally making payments to physicians for referrals)… i. Benefits to corp. → new provisions (regulation discussions at BoD meetings, creation of subcommittee w/ compliance officers) ii. Costs to corp. → costs to defend shareholders’ lawsuit AND shareholders’ attorney’s fees (AND fines) |
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What constitutes adequate law compliance programs?
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i. Policy manual
ii. Training of employees iii. Compliance audits iv. Sanctions for violation v. Provisions for self-reporting of violations to regulators |
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What does the corporate duty of loyalty require under general terms?
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Duty of loyalty requires that the best interests of the corporation and its stockholders takes precedence over any interest possessed by a director and not shared by the stockholders generally
- No direct financial interest in a party adverse to a transaction - Must act in good faith Related party transactions - 3 views - No related party transactions - BJR treatment - Let 3rd party decide When the director is self dealing in some way, the directors do not get the BJR rule |
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What does the delaware statutory scheme state with respect to conflict of loyalty of a director?
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a. Under DGCL, NO contract/transaction b/w a corp. and 1(+) of its directors shall be void/voidable if [DGCL § 144(a)(1)-(3)]…
i. Informed, disinterested directors approve –OR– ii. Informed, disinterested shareholders ratify –OR– iii. Transaction is substantively fair to corp. (intrinsic fairness) |
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What does the Model Act state with respect to conflict of interest for the director?
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o Model Act statutory scheme:
• MBCA §8.60 • Conflicting interest if: o Director is a party to the transaction o Director had knowledge and a material financial interest in the transaction; or o A transaction which the director knew a related party had an interest in • Is there a conflict of interest? (Burden on plaintiff) • → No – then not a duty of loyalty issue • → Yes – then you have a duty to cleanse yourself of the transaction o §8.62: Qualified director’s cleanse o §8.63: Independent shareholders ratify o §8.61: Transaction is adjudged to be fair |
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What is the Corporate Opportunity Doctrine?
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a type of conflict of interest (CoI) transaction; when the fiduciary personally takes an opportunity rightfully belonging to the corp. (Also seen in Meinhard v. Salmon and General Auto v. Singer)
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How do you determine a corporate opportunity?
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Guth Factors:
i. Corp. is financially able to take the opportunity (capacity NOT dispositive, BUT lessens burden) ii. Opportunity is in corp.’s line of business 1. “[A]ctivity as to which it has fundamental knowledge, practical experience and ability to pursue” 2. “[C]onsonant with its reasonable needs and aspirations for expansion” iii. Corp. has interest or expectancy in the opportunity 1. Interest – something to which corp. has a (contractual) right 2. Expectancy – something which, in the ordinary course of things, would come to corp. (i.e. renewal rights to lease) iv. Embracing the opportunity would create a conflict b/w director’s AND corp.’s self-interest (did NOT exist beforehand) |
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Broz v. PriCellular
- Is there Corp Opportunity/ Conflict of Interest? |
a. Broz was sole shareholder/president of RFBC, AND also director of CIS → CIS, in financial difficulty, in the process of being acquired by PriCellular (contingent on successful tender offer)… meawhile, Broz, in RFBC capacity, offered MI-2 (cell phone license) for purchase
i. Broz purchases MI-2 for RFBC w/o formal approval from CIS BoD (ONLY an informal “OK”)… ii. … then, PriCellular officially acquires CIS… iii. … now, PriCellular/CIS claims that Broz usurped corporate opportunity (by buying MI-2 for RFBC w/o disclosure) Applying factors to Broz Broz did NOT usurp a corporate opportunity… i. CIS NOT financially able to buy MI-2 (Broz paid $7.2M, whereas CIS had just recovered from bankruptcy) ii. MI-2 MAY have been in CIS’s line of business… BUT, CIS had been selling licenses at the time (NOT buying) iii. CIS had NO interest/expectancy in buying MI-2 (party selling MI-2 approached Broz, NOT CIS) iv. Broz buying MI-2 did NOT create conflict of interest b/w Broz (as director of CIS) and CIS… in fact, Broz had also owned MI-4 (if anything, conflict already existed) c. … however, if Broz had purchased MI-2 after PriCellular had officially acquired CIS, then Broz more likley to have usurped corporate opportunity → re-apply factors… i. PriCellular likely financially able to buy MI-2 (bid $6M+ to acquire CIS) ii. MI-2 likely in PriCellular’s line of business (PriCellular acquired CIS to be in business of buying licenses, made prior bid for MI-2) iii. NO interest/right in MI-2… BUT, may have had expectancy iv. NO conflict of interest created (again, conflict already existed) |
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If a corp opportunity exists for competing corps, what are the options for a director that sits on both corps?
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i. Disclose opportunity (hope one corp. will cleanse/approve)
ii. Abstain from opportunity iii. Resign from one of the corps. |
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What are the ways a corp can cleanse a conflict of interest transaction?
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1. Transaction cleansed by actions of qualified board (MBCA §8.62)
2. Transaction cleansed by independent shareholder ratification (MBCA §8.63) 3. Transaction judged fair (MBCA §8.61) |
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What are the requirements and what is the effect of Board approval of Corporate opportunity?
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a. Approval NOT required… BUT, does create safe harbor
i. Would be inefficient to require formal presentation of every potential corporate opportunity ii. Seeking approval of individual directors one-by-one does NOT count b. Requirements for formal BoD action… i. Either regular OR special BoD meeting [MBCA § 8.20] ii. If NO meeting, then unanimous written consent required [MBCA § 8.21] iii. NO notice for regular meeting, 2-day notice for special meeting [MBCA § 8.22] iv. Director MAY waive notice, but ONLY if in writing [MBCA § 8.23(a)] v. Director’s attendance at meeting waives any required notice, unless director objects [MBCA § 8.23(b)] vi. Majority vote, minimum quorum requirement 1/3rd [MBCA § 8.24] |
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What are the requirements and what is the effect of Shareholder approval of corporate opportunity?
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Shareholder approval must be done by majority of DISINTERESTED shareholders
Effect: Depends on type of claim - Duty of care: Shareholder ratification extinguishes claim - Duty of loyalty claim against director - (Broz) burden on P to show waste (ie. usurping corp opportunity) - Duty of loyalty claim against controlling shareholders (Sinclair) - burden on P to show unfairness (disadvantaging minority shareholders) Regardless of type of claim, ratification must be fully informed: - Recall Smith v. Van Gorkum - Majority of disinterested shareholders ratified but because shareholders were not fully informed, duty of care was breached |
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Sinclair Oil v. Levien
- What is COI transaction when dealing with majority shareholders |
Majority Shareholders 50%+ owe same fiduciary duties as directors - but when shareholders are only shareholders, no fiduciary duties to each other
- Thus only COI only exists where controlling shareholders benefit from exclusion of minority shareholders Sinclair Oil v. Levien – SO owns 90% stake in SinVen; the rest of the 10% claims a breach of duty of loyalty because SO paid out large dividends to itself and the 10% and prevented SinVen from expanding; there was also a K between SinV and another corp wholly owned by SO. Court said transaction between controlling parent corp and the subsidiary corp is a conflict of interest if it benefits parents to the exclusion of the minority corp. i. Sinven’s minority shareholders argue that 3 transactions were NOT substantively fair to Sinven [DGCL § 144(a)(3)]… 1. Sinven has NO independent, disinterested directors (b/c elected by Sinclair) [DGCL § 144(a)(1)]… 2. … AND, Sinven’s independent, disinterested shareholders comprise ONLY 3% [DGCL § 144(a)(2)] ii. Transaction #1 → Sinven pays large dividend to shareholders 1. NOT a duty of loyalty issue… 2. … b/c both controlling shareholders (Sinclair) AND minority shareholders (3%) received proportionate share iii. Transaction #2 → Sinclair acquires land that Sinven could’ve acquired (preventing Sinven from expanding) 1. NOT a duty of loyalty issue… 2. … b/c corporate opportunity came to Sinclair independently (NOT usurped) iv. Transaction #3 → breach of contract b/w Sinclair and Sinven (Sinclair receives products from Sinven, but NOT meeting minimum requirements, AND 30 days late) 1. Court looks to intrinsic fairness of breach and finds that Sinclair breached duty of loyalty (receiving products w/o complying w/ contract disadvantaged minority shareholders)… 2. … BUT, court should’ve looked to intrinsic fairness of contract itself (whether contract terms disadvantaged minority shareholders) |
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In re Wheelabrator
- Cleansing COI transaction where majority of disinterested shareholders ratify |
a. Waste Mgmt. buys shares of WTI, going from owning 22% of WTI to owning 55% of WTI (becomes controlling shareholder)… BUT, a majority of disinterested shareholders ratified this transaction [DGCL § 144(a)(2)]
i. The votes of the 22% of WTI shareholders (that were also shareholders of Waste Mgmt.) were NOT considered, since these shareholders were NOT disinterested… ii. … BUT, amongst the 78% of WTI shareholders who were disinterested (NOT also shareholders of Waste Mgmt.), a majority voted in favor of Waste Mgmt. becoming controlling shareholder i. Transaction violates duty of care → Extinguishes the claim ii. Director violates duty of loyalty through transaction → burden shifts to plaintiff to show waste (There is a BJR standard here) iii. Shareholder violated duty of loyalty through transaction → burden shifts to plaintiff to show unfairness. |
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What are the roles of the shareholder and what are the differences in these roles?
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Shareholder Sues:
2 different kind of lawsuits: a. Direct suit alleges direct loss to shareholder → bases… i. Force payment of promised dividend ii. Enjoin ultra vires activities iii. Claims of securities fraud iv. Protect participatory rights for shareholders b. Derivative suit alleges loss to shareholder caused by loss to corp. i. 2 suits in 1 → compel corp. to sue other party (director(s)) AND suit against that other party ii. Bases for derivative suit… 1. Breach of duty of care 2. Breach of duty of loyalty 3. Enjoin “management-retrenching” practices |
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What are the examples of the corporate opportunity doctrine with respect to the 3 different Business Associations?
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• Partnership law – Meinhard v. Salmon
o Getting lease for other building was not disclosed to other partner • Set up trust for profits as remedy • Agency – General Automotive v. Singer o Manager trying to keep business operating and personally profited from some jobs by shipping them out to another company and did not disclose • Disgorge full profit as remedy • Corp – Director must disclose the existence of the corp opportunity o Corp has right of first refusal on project • But can choose to give it to fiduciary o Remedy • Gains based (constructive trust) • Injunective relief and Punitive damages also |
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What are the factors for distinguishing between direct and derivative claims?
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o Who suffered the most immediate and direct injury?
o Who did the defendant owe a duty to (ALI test) o Who would benefit from a favorable verdict (De test) o Is the remedy injunctive? If YES, can be a direct suit |
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What are the remedies in a derivative lawsuit?
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• The shareholder is suing ‘in right’ of the corporation, so…
• Remedy from principal suit goes to corporation • Corporation is required to pay shareholder attorney’s fees if suit is successful or settles • Benefits the lawyer that brings successful lawsuit, not so much the shareholder |
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What are the advantages/disadvantages of derivative suits and the arguments for and against?
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• Advantages of derivative suits:
• Possibly more attractive damages • Undoubtedly more attractive fee allocation • Disadvantages of derivative suits: • Damages and other remedies usually go to the corporation, not directly to shareholders • Economically, bringing a suit against director, and company is probably indemnifying director so corp is just paying itself • Trade offs for defendant in defending a derivative law suit o If a person is ‘adjudged liable’ it removes the right to be indemnified in most cases • If you’re a director, you settle • If you get beyond the hurdle of pleading and get to a hearing, the outcome will be a settlement (corp will indemnify the directors, who will in turn pay the corporation while attorneys just get fees) |
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What are the procedural hurdles to bringing a derivative lawsuit?
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a. Hurdle #1 → bonding requirement
b. Hurdle #2 → demand requirement c. Hurdle #3 → special litigation committee (SLC) |
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What is involved in the the bonding requirement?
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NOT required in DE
i. In some states (but NOT DE), a derivative claimant w/ “low stakes” must post security for corp.’s legal expenses ii. Why? → to deter frivolous lawsuits |
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What is involved with the Demand Requirement?
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i. Most states require shareholders in derivative lawsuit to approach BoD and demand that they pursue legal action…
1. By filing derivative lawsuit, shareholder is taking control of the corp. away from director (in opposition to separation b/w ownership and control)… 2. … thus, shareholder must send letter to BoD, requesting that BoD bring suit on alleged cause of action… 3. … AND, letter must be sufficiently specific as to apprise BoD of nature of alleged cause of action and to evaluate its merits Demand excused in DE if: Plaintiff creates reasonable doubt that… 1. Directors are disinterested/independent –OR– 2. Challenged transaction was product of valid exercise of business judgment |
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What is involved with a special litigation committee (SLC)?
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i. After shareholder brings derivative lawsuit (and fulfills bonding/ demand requirements), corp. MAY not rush into settlement, BUT instead bring in new (“untainted”) directors…
ii. … then, form SLC out of “untainted” directors, who decide to drop lawsuit (since derivative lawsuit is brought on corp.’s behalf) → NO settlement, so NO attorney’s fees |
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Grimes v. Donald
- Demand requirement at issue - as per DE code |
Grimes is Shareholder, Donald is CEO
- Donald negotiated really good contract with corporation, BOD gives almost all management power to Donald (agrees to pay Donald big $$ if wrongfully terminated_ Grimes brings direct and derivative claim Grimes’ direct claim → abdication of BoD’s powers 1. Shareholders have right to elect managers… AND, BoD has subsequently given (almost) all management power to Donald (by agreeing to pay Donald big $$ if wrongfully terminated)… 2. … BUT, nonetheless, BoD has NOT abdicated its powers → still has power to terminate Donald (though, would have to pay big $$ as consequence) Grimes’ derivative claim → excessive compensation 1. BoD’s decision to compensate Donald beyond potential wrongful termination as a potential breach of duty of care (though, compensations issues likely entitled to BJR protection)… 2. … thus, Grimes must first meet demand requirement (NO bonding requirement b/c in DE) Grimes takes shotgun approach, makes demand to BOD and plead demand futility - Refusal of demand is subject to BJR - By making demand Grimes waves the right to plead demand futility: Now, Grimes can no longer argue actions involve COI (breach of duty of loyalty - #3); and is limited to possibility 1,2 (from Aronson case that specified corp fiduciary duties; 1. Actions were not in honest belief in best interest of corp; 2. not based an informed investigation) Thus, in DE (as per Grimes), better for P to plead that demand is futile → NO pre-suit demand and NO “shotgun approach” i. If plea for demand futility is rejected by court, then proceed w/ demand (ONLY consequence is slight delay)… ii. … BUT, if accepted, then P has preserved right to litigate (all 3 possibilities under BJR still available, better chance to force settlement, have attorney’s fees paid by corp.) EG. 1. Demand Made 2. Board says No 3. Challenge the Boards decision (this step is affected by losing the conflict of interest) o When you challenge this decision o Its made on 2 basis: • Either argue that it wasn’t an exercise of good business judgment • (this argument hard to prove because BJR) • Or that it was a conflict of interest because they lack independence • (this argument is hurt, because you lost your ability to claim they are not independent) Thus in DE, you always plead Demand futility – never make a demand |
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What is the demand requirement under MBCA
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d. Different demand requirement under MBCA [MBCA §§ 7.42, 7.44]…
i. P is required to send pre-suit demand to BoD (unlike in DE, where essentially NO benefit to doing so)… ii. … BUT, P’s right to litigate is NOT affected if demand is rejected (unlike in DE, where right to plead lack of independence would’ve been waived) Under Model Rules - you do not lose a pleading right after making demand |
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Zapata v. Maldonado
- SLC at issue |
Shareholders here did NOT make demand
Pled demand futility → after 5 yrs. of litigation, BoD appoints SLC, comprised of “untainted” directors (hired after litigation began), which recommends dismissal of derivative lawsuit i. Can BoD can appoint SLC? Court holds YES, SLC MAY “seize” a derivative lawsuit… ii. … BUT, court will NOT automatically defer to SLC’s decisions b. Standard of review for SLC recommendations → Zapata 2-step… i. Step #1 → inquiry into independence and good faith of SLC AND bases supporting SLC’s recommendations (essentially applying BJR) ii. Step #2 → application of court’s (own) business judgment (“special consideration to matters of law and public policy in addition to the corporation’s best interests”) 1. Some states (i.e. NY) ONLY apply Step #1… 2. … BUT, DE applies alternative Step #2 as well → court placing itself in seat of director to decide whether to continue or dismiss derivative lawsuit (though, director would most always choose to dismiss, save $$) c. Zapata 2-step is a far more intrusive judicial review (b/c NOT deferring to BoD’s business judgment)… i. … BUT, it needs to be intrusive b/c P was able to successfully plead demand futility, thereby disabling BoD from acting (due to conflict of interest)… ii. … AND, disabled BoD appointed SLC (MAY be acting through SLC) |
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Which shareholders get to vote, when do they vote, and how do they vote?
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a. Who votes? → shareholder of record
i. Must be a shareholder on the record date (no more than 70 days before) [MBCA § 7.07] ii. 1 share = 1 vote (unless Articles of Incorporation provides otherwise) [MBCA § 7.21] b. When?… i. At shareholder meeting… 1. Annual meetings [MBCA § 7.01] → set in By-Laws 2. Special meetings [MBCA § 7.02] → by BoD request OR written request of at least 10% of shares ii. … OR, w/ unanimous written consent [MBCA § 7.04] c. How?… i. Most matters require majority vote (of shares present at a meeting w/ quorum) [MBCA § 7.25(c)] ii. Shareholders vote in person OR (typically) by proxy [MBCA § 7.22] 1. In proxy voting, shareholder appoints proxy agent (via proxy card) to vote his/her shares at meeting 2. Shareholder can specify how to vote shares OR give proxy agent discretion |
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What do shareholders vote on?
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d. What to vote on?…
i. Election of directors [MBCA §§ 8.03-8.08] ii. Amendments to Articles of Incorporation/By-Laws [MBCA §§ 10.03, 10.20] iii. Fundamental transactions (i.e. mergers [MBCA § 11.04]) iv. Odds and ends (i.e. “precatory” measures/suggestions to BoD) |
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What are the two methods of electing directors?
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i. Cumulative voting [MBCA § 7.28]
1. Allows minority shareholders to assure BoD representation 2. Must be provided for in Articles of Incorporation ii. Classified/staggered board [MBCA § 8.06] 1. Directors separated into 2-3 groups → different group up for election each term (limits # of directors that can be changed by one shareholder vote) 2. Under MBCA, must be provided for in Articles of Incorporation… BUT, under DGCL, may be provided for in By-Laws instead [DGCL § 141(d)] |
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Who are the directors that the shareholders can vote for?
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i. Incumbents (BoD) nominate slate of directors, corp. pays for mailing out of official proxy materials…
ii. … whereas, if insurgents (shareholders) want to nominate a competing slate of directors, then must pay for mailing of separate (“unofficial”) proxy materials 1. Recent law in DE [DGCL § 112] permits corp. to allow shareholders to nominate directors AND have nominations included in official proxy materials (NOT separate)… 2. … so long as provided for in By-Laws |
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What are the options to Corporations when it comes to proxy contests?
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i. Corp. has option to mail out “unofficial” proxy materials, charge insurgents for costs [1934 Securities Act, Rule 14a-7]…
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What are the options to Insurgents when it comes to proxy contests?
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under state law, insurgents can request names/addresses of shareholders (for proper purpose), mail out “unofficial” proxy materials themselves
1. Insurgents would rather request names/addresses so as to cut costs (seek inexpensive mailing)… 2. … whereas, corp. would rather NOT provide insurgents w/ such info |
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What is the Froessel Rule?
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Regards reimbursement following a proxy contest
i. If proxy contest is over a bona fide policy dispute (NOT a personal dispute, though impractical to differentiate)… ii. … then incumbents (BoD nominating slate) will be reimbursed by corp. for their costs, regardless of whether they win or lose… iii. … BUT, insurgents (shareholders nominating competing slate) will ONLY be reimbursed for their costs if they win 1. If insurgents bring proxy contest, incumbents need to be able to defend (prove that they chose proper slate for election)… 2. … BUT, incumbents are spending corp.’s $$ (OPM) regardless, so MAY make ultra vires expenditures (i.e. limos, private jets)… 3. … thus, proxy contests are relatively rare |
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How are the articles of incorporation or the by-laws amended?
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a. Modifying Articles of Incorporation…
i. Under MBCA, must be adopted by directors AND approved by majority vote of shareholders present [MBCA § 10.03]… ii. … BUT, under DGCL, majority vote comes from outstanding stock [DGCL § 242(b)(1)] b. Modifying By-Laws… i. Under MBCA, shareholders may amend/repeal w/o directors’ input… AND, directors may amend/repeal, unless re: election of directors OR prohibited by By-Laws [MBCA § 10.20]… ii. … BUT, under DGCL, ONLY shareholders may adopt/amend/ repeal (though, Articles of Incorporation MAY also give such power to directors) [DGCL § 109(a)] |
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What are the options for shareholders regarding shareholder proposals and what are the proposals affects if passed?
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a. Qualifying shareholders are allowed to put proposal before their fellow shareholders AND have proxies solicited in favor of their proposal in the corp.’s official proxy statement (thus, paid for by corp.)…
i. … BUT, such proposals are “precatory” (non-binding) → thus, even if proposal passes, directors MAY refuse to act as such… ii. … in which case, directors’ refusal would be governed by BJR |
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What are the requirements for a shareholder to qualify to make a proposal?
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i. Timing → must submit at least 120 days before date on which official proxy materials mailed for prior yr.’s annual shareholder meeting
ii. Share holding → must have owned 1% OR $2K market value (whichever is less) for at least 1 yr. from date submitted iii. Submission → ONLY 1 proposal/yr. per corp. (failure to show up at shareholder meeting to present proposal in person renders proponent ineligible for 2 yrs.) iv. Length → 500 words or less |
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Lovenheim v. Iroquois Brands,
- Shareholder proposal |
Qualifying shareholder/proponent writes proposal re: force-feeding of geese for pate manufacturing → NOT to be excluded
i. Proponent’s 200 shares is (likely) greater than $2K → shares (likely) $10+ each ii. Proposal IS proper subject matter for shareholder → merely recommending formation of committee (NOT telling directors how to manage operations) iii. Proposal is NOT economically significant (pate sales ONLY 0.5% of corp.’s revenues)… but, IS “otherwise significantly related” (ethical/social significance) • How did he meet the not a proper subject action for shareholders requirement? o He argued that he was just recommending that he board look into an issue • Why didn’t Lovenheim offer a propsal prohibiting the company from selling pate? o Because it would be infringement of board’s jurisdiction, violation of proper subject for action • Why did Lovenheim offer this proposal? o He was animal rights lover • How do you feel about the SEC spending resources to monitor shareholder proposals? o G feels not a good idea |
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What are the reasons a shareholder proposal may be excluded from a proxy?
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i. NOT a proper subject of action for shareholders (under state law)
ii. Violates law iii. Violates proxy rules iv. Involves personal grievance/special interest v. NOT relevant to corp.’s operations (i.e. NOT economically significant) vi. Corp. lacks power to implement vii. Deals w/ corp.’s ordinary business operations viii. Relates to election of directors 1. If BoD wishes to exclude proposal, must file notice of intent to exclude w/ SEC… 2. … then, SEC informs whether exclusion would be wrongful |
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When is a shareholder sale not a public offering?
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a. A shareholder sale is NOT a public offering if either…
i. Shares are already registered (secondary trading) –OR– ii. Private placement → factors to consider… 1. # of investors to whom offer made 2. Size of offering 3. Manner of offering (NO general advertising/solicitation) |
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What are the requirements if a shareholder sale is a public offering?
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i. Pre-registration period (“quiet” period) – NO offer to buy/sell any security unless one files a registration statement w/ SEC
ii. “Waiting” period – offers to sell allowed, BUT can’t close until after the effective date (at least 20 days, as determined by SEC) iii. Post-registration period – sales can be closed, BUT must be accompanied by a prospectus |
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What may one NOT do regardless of whether a shareholder sale is or is not a public offering?
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c. Regardless of whether shareholder sale is public offering → in connection w/ purchase/sale of security, one may NOT [1934 Securities Act, Rule 10b-5]…
i. “… employ any device, scheme, or artifice to defraud” ii. “… make any untrue statement of a material fact or… omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading” (OK to say “No comment”) iii. “… engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person” |
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When is a shareholder sale 'insider trading'?
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a. Insider trading – buying/selling shares using inside information
i. Inside information is NOT public available… ii. … BUT, buying/selling shares using non-public info re: corp. is NOT always insider trading → depends on… 1. How info gathered → within role as fiduciary worse than overheard in public 2. How info used → buying/selling in advance of a tender offer worse than buying/selling on open market b. Distinguish b/w… i. “Generic” Rule 10b-5 violations –AND– “insider trading” Rule 10b-5 violations ii. Govt. enforcement actions (SEC/Dept. of Justice) against violators (leading to fines/imprisonment) –AND– private rights of action by contemporaneous traders (leading to damages) |
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What are the 4 types of insider trading?
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i. Statutory insider trading
ii. Classic insider trading iii. Tipper/tippee liability iv. Fiduciary trades using misappropriated info |
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What is a 'statutory insider' and what are the rules imposed on them in terms of selling shares?
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a. “Statutory insider” – director/officer that owns 10+% of corp.’s shares
i. “Statutory insider” must report ownership stake/changes to SEC [§ 16(a)] ii. If “statutory insider” profits from a purchase-and-sale OR sale-and-purchase within 6 mos., then profits are recoverable by corp. [§ 16(b)] b. Courts interpret so as to maximize corp.’s gains/recovery… i. … thus, if D (a “statutory insider”) buys 100 shares of corp. at $10/share, then buys 100 shares of corp. at $5/share, then sells 50 shares of corp. at $7/share (all within 6 mos.)… ii. … corp. would recover $2/share as D’s profit 1. Granted, D’s $10/share purchase is “matchable” w/ D’s $7/share sale (in which case, D lost $3/share)… 2. … BUT, D’s $5/share purchase is also “matchable” w/ D’s $7/share sale (in which case, D made $2/share profit) • Both over – and under-inclusive • Could just own less than 10%, or just sell after 6 months |
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Reliance Electric v. Emerson Electric
- Statutory insider and matching |
Emerson buys 13.2% of Dodge stock on 6/16 (Dodge then acquired by Reliance)… then, on 8/28, Emerson sells some shares, so as to reduce ownership of Reliance to 9.96%… then, on 9/11, Emerson sells remaining shares
i. As of 6/16, Emerson was a “statutory insider”… thus, 8/28-sale was “matchable” to 6/16-purchase → Reliance entitled to this profit ii. As of 8/28, Emerson was no longer a “statutory insider”… thus, 9/11-sale was NOT “matchable” to 6/16-purchase → Reliance NOT entitled to this profit 1. Granted, Emerson’s 6/16-9/11 transactions MAY have been a single plan (w/ Emerson selling just enough shares on 8/28 to escape liability)… 2. … BUT, statutory insider trading is a bright-line prohibition (NO interpretation of language necessary) → Emerson did NOT own 10+% at the time of 9/11-sale, SO Emerson did NOT violate statute |
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What is classic insider trading?
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Classic insider trading → fiduciary trades in shares of his/her own corp. based on inside information gained as a fiduciary
o What is insider trading? • Buying or selling shares using inside information – information abut the firm which is not publicly available • But buying and selling using nonpublic firm information is not always insider trading |
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SEC v. TX Gulf Sulphur
- Classic insider trading |
TGS strikes oil in eastern Canada, keeps secret, buys land from farmers (for cheap), gets rich
TGS’s “insiders” begin acquiring shares AND call options TGS later made a statement in a press release - in which misleading information was given about the striking of oil i. TGS had NO affirmative obligation to Canadian farmers to disclose real value of land… ii. … AND, NO statutory insider trading (ONLY purchase, NO sale) Was the information that TGS struck oil material? - Yes, Standard of materiality is 'whether there is a substantial likelihood that a reasonable shareholder would consider the fact important' Was the 4/12 press release 'in connection' with the purchase/sale of TGS shares? -Yes, if it 'would cause reasonable investors to rely on it and cause such investors to purchase or sell shares' Did TGS have a duty to disclose the material fact of finding oil? - No, but if an insider has material nonpublic information, they must either DISCLOSE before trading, or ABSTAIN from trading Disclosure is not merely the reading of a news release but the first step in the process, thus TGS director selling after news release was still insider trading - fiduciary must wait reasonable time until people know about it |
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When does an insider not breach his fiduciary duty by trading?
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ii. Breach of fiduciary duty → “insiders” entering into transaction at expense of shareholders… BUT, insider trading may NOT always breach a fiduciary duty
1. In Chiarella, “insider” used info to acquire shares of another corp. on the verge of being taken over… 2. … BUT, b/c “insider” owed NO fiduciary duty to another corp., NOT classic insider trading… 3. … thus, dicta in TX Gulf Sulphur re: “level playing field” is NOT followed i. Chiarella – there is no violation of §10(b)(5) fraud statute if the tippee is buying or selling for a company to which he owes no fiduciary duty |
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What is tipper/ tippee liability?
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Prohibition on insider trading extends to those using inside information known to have been provided by a tipper, AND for tipper’s personal benefit
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Dirks v. SEC
- Tipper/Tippee Liability |
Secrist (tipper) provides inside information re: EFA’s fraudulent bookkeeping to Dirks (tippee), Dirks then trades off his shares in EFA
i. In order for Dirks to have inherited Secrist’s Cady/Roberts duty (to either disclose OR abstain)… 1. Dirks must have known (OR had reason to know) that Secrist breached fiduciary duty (to EFA and its shareholders) –AND– 2. Secrist must flunk “personal benefit test” ii. If both criteria NOT met, then Dirks is NOT liable b. Secrist revealed inside information to Dirks in retaliation for being fired by EFA (pleasure/revenge)… BUT, this does NOT constitute a personal benefit i. Personal benefit → monetary gain, reputational gain, quid pro quo ii. NOT personal benefit → desire to provide a public good c. Dirks establishes new category of violators of insider trading prohibition → “constructive insiders” i. One (tippee) who obtains material non-public info (inside information) from the issuer (tipper)… ii. … w/ an expectation on the part of the corp. that the outsider will keep the disclosed info confidential… iii. … AND, the relationship at least implies such a duty |
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O’Hagan
- Overturns Chiarella, extends fiduciary duty to target corp not just own corp |
a. In O’Hagan, Grand Met (corp.) buys Pillsbury (corp.), Grand Met is represented by Dorsey & Whitney (law firm), which is where O’Hagan (lawyer) works → O’Hagan buying shares of Pillsbury IS insider trading
i. In Chiarella, “insider” (employed by one corp.) was held to have NOT committed insider trading b/c “insider” did NOT owe fiduciary duty to the other (target) corp.… ii. … BUT, O’Hagan overrules Chiarella → even though O’Hagan (“insider”) did NOT owe fiduciary duty to Pillsbury (target corp.), O’Hagan nonetheless breached a fiduciary duty owed to Grand Met (by gathering inside information re: takeover of Pillsbury) In addition to violating 10b-5,O’Hagan’s actions also illegal b/c… i. … once substantial steps toward a tender offer have been taken, NO one in possession of inside information (except the bidder) may trade in the target corp.’s securities [1934 Securities Act, Rule 14e-3]… ii. … AND, violation of tender offer prohibition is NOT premised on breach of fiduciary duty → thus, O’Hagan’s violation of Rule 14e-3 is irregardless of his“misappropriation” |
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What is rule 10b-5?
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D. §10(b)(5) of ’34 Act
i. Unlawful if, directly or indirectly, by use of any means or instrumentality of interstate commerce (mail or any facility of any national security exchange), (I) To employ any device, scheme or artifice to defraud, (II) To make any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of circumstances under which they were made, not misleading (III) To engage in any act, practice, or course of business which operates as a fraud or deceit upon any person (IV) (In connection with the purchase or sale of any security) |
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What is rule 14e-3?
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Rule 14e-3
• Under TGS or O’Hagan, if a person walking on the street picked up a piece of paper about a tender offer that was pending on Disney, it would not be illegal because it was not based on fiduciary information • 14e-3 also makes it illegal to use any information about a pending tender offer to trade a stock |
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What are the questions to ask when selling securities?
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• Are you selling a security?
o What is a security (broad federal definition – almost always yes) • Two ways to sell: • Public offering – then must comply with §5 of ’33 act (Pre-registration quiet period, no offer to buy/sell security unless file with sec, waiting period, post-registration period) and §10 of ’34 act (disclosure) • If no: avoid §5 but §10 still applies • Is your sale insider trading? o Statutory insider §16 • If §16 applies the yes it is statutory insider trading (all gains within six months are forfeited to firm) o Classic insider trading • If they are fiduciary of the company and trades on his/her firm and using inside information o Tippers and tippees (Dirks v. SEC) o Misappropriation insider trading (14e-3) |
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What is required to terminate a corp?
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A. BoD submits and shareholders vote on proposal to dissolve [MBCA § 14.02(b)] (provisions for governing possible deadlock [MBCA § 14.30])…
B. … then, submit Articles of Dissolution to state, commence winding up |
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