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Agency

A

Agency (Definition)

Fiduciary relationship which results from manifestation of consent by one person (principal) to another (agent) that agent shall act on principal's behalf, subject to principal's control.




Need (1) control and (2) authorization


-Under control of principal, and agent authorized to act on principal's behalf

Manifestation/Conduct

Agency relationship can arise conduct, even if it was not intended




Manifestation can be explicit or implicit; look to works, conduct, context

Forming an Agency Relationship

Principal must have contractual capacity




Person disqualified from serving as agent when:


(1) representing both parties


(2) self-dealing


(3) not licensed, where license required

Two Types of Agents

General Agent: An agent who is authorized to conduct a series of transactions




Special Agent: An agent who is authorized to conduct only a single transaction, or only a series of transactions not involving continuity of service

Three Types of Principals

Disclosed Principal: 3rd party has notice that agent acts for a principal AND who principal is.




Partially Disclosed Principal: 3rd party has notice agent acts for a principal BUT doesn't know who principal is




Undisclosed Principal: 3rd party has NO NOTICE that agents acts for principal

Agent's Liability depending on Principal

Disclosed Principal: Agent generally not bound




Partially Disclosed Principal: Agent generally bound




Undisclosed Principal: Agent generally bound even though principal bound as well

Actual Authority

Where at the time of action, agent reasonably believes, in accordance with principal's manifestations to the agent, that the principal wishes the agent to so act.


-Focus on agent's reasonable understanding of his authority


-Actual authority can be express or implied (authority necessary or incidental to achieve principal's objective)



Apparent Authority

Where 3rd party reasonably believes the actor has authority to act on behalf of principal and that belief is traceable to the principal's manifestations.


-Focus on principal's manifestations to third parties; often concerns agent's title

Agency By Estoppel

Binds principal to K even if agent had no actual/apparent authority.


(1) Justifiable relief of 3rd party;


(2) Detrimental reliance of 3rd party; AND


(3) Fault (of principal or agent)


-Person intentionally or carelessly causes such belief; or had notice of such belief and that it might induce 3rd parties to change positions, person does not take reasonably steps to notify 3rd parties of absence of agency relationship



Inherent Authority

Power solely from agency relationship and exists for the protection of the person harmed by or dealing with a servant or other agent.




Courts invoke this as a last resort when fairness dictates holding a principal liable even though the purported agent lacked authority.




Menard: Inherent authority invoked to bind company to president's actions (president lacked actual and apparent authority).

Ratification

The principal will be bound to the 3rd person if:


(1) the agent purported to act on the principal's behalf; AND


(2) the principal, with knowledge of the material facts, either:


(a) affirms the agent's conduct by manifesting an intention to treat the agent's conduct as authorized; or (b) engaged in conduct that is justifiable only if he has such an intention


-Ratification can be express or implied

Agency for Partnerships

Partners are agents of the partnership that have actual (from statute) AND apparent authority for ordinary course transactions.


-Acts by partner outside the ordinary course of business will generally not bind the partnership (look at partnership agreement to determine ordinary course of business).


-Third party's belief that partner had authority not reasonable if: (1) partner lacked authority; and (2) third party had knowledge of lack of authority (and therefore partnership will not be liable)

Agency for LLCs

(1) Member Managed: Essentially the same as partnership; all members are agents




(2) Manager Managed: Members generally not agents (except when authority delegated); managers are agents that can bind LLC in ordinary course transactions (except if no authority and third party has knowledge manager has no authority).

Agency for Corporations

-Shareholders do not have authority


-Individual directors do not have authority


-The BOD has authority (though some issues subject to SH vote)


-Officers (e.g. President; CEO) agency authority specified in by-laws, board resolutions

Principal's Liability for Acts of Agent

Rule: When agent has authority, principal will be bound under the contract




Torts (Vicarious liability): Principal liable for tort committed by agent if: (a) agent is an employee of principal; and (b) agent committed tort while acting within the scope of employment


-Direct Liability: Principal liable for torts committed by agent if principal negligent in selecting or supervising the agent.

Independent Contractors (vs. Employees)

Principal generally not responsible for the torts of independent contractors. Exceptions:


-Inherently dangerous activities


-Non-delegable duties


-Negligent selection of contractor

Agent as Fiduciary

Duty of Care: Must act with reasonable care; obey principal in all reasonable directions; indemnify principal against loss caused by agent's wrongful behavior




Duty of Loyalty: Must act for benefit of principal; must not use position for personal benefit; must not compete with principal; must not use principal's property for personal benefit

Termination of Agency Relationship

Principal or agent can terminate at any time, even if doing some violates K between parties




-Other methods: passage of specified time; happening of specified event; change of circumstances; agent's breach of fiduciary duty; death; incapacity of principal

Partnerships

P

Partnership Definition

Definition: An association of two or more persons to carry on a business as co-owners for profit.


-Association: K not required; can be created voluntarily or involuntarily through conduct


-Need more than 1 person; must be for a business (not a non-profit); and defining feature that all partners must have an ownership interest.


-For profit: Profit hoped for, but not required

Factors to Determine if Partnership Exists (Through Conduct)

(1) Sharing of profits (prima facie evidence, but does not dictate necessarily); (2) sharing of losses; (3) ownership of partnership assets; (4) joint management and control; (5) joint liability to creditors; (6) intention of parties; (7) compensation; (8) contribution of capital; (9) loans to the organization




NY: When there is no written agreement, court determines existence of partnership from conduct, intention, and relation between parties.





Governing Law

Common Law: GP governed by partnership law where partnership agreement made




RUPA: GP governed by partnership law where its CEO is located

Management of Partnership

Default: Partners have equal rights in management; one person, one vote (per capita). Can be modified by partnership agreement


-Note: Even if you give authority to other partners for certain things, this does not preclude another partner's management rights and control; always have right to weigh in on management/control of GP

Voting

Ordinary course matters (partnership agreement) = majority vote




If act contradicts agreement between partners = unanimous vote


-E.g. partnership agreement silent on issue of profit sharing, so default rule is 50-50. To change this, need unanimous consent of all parties.




Pick Your Partner Principal: Admission of new partner needs consent of all partners (default; can be modified by agreement)

Fiduciary Duties of Partnership

All partners owe duty of care and loyalty to GP.




Duty of Care: Refrain from engaging in grossly negligent or reckless conduct; intentional misconduct; knowing violation of law




Duty of Loyalty: Must tell GP about any benefit, hold as trustee any profits made on the side b/c of business (w/out their consent)

Fiduciary Duties (continued)

-Cant use partnership assets for own benefit


-Cant take secret profits


-Cant carry on business for private advantage


-Cant compete without being held accountable for profits


-Cant usurp partnership opportunities


-Cant avail for himself knowledge that belong to partnership

Power to Bind Partnership (Agency Review)

If partner acts in ordinary course of business, GP bound


-Exception: If partner has no authority to act AND third party has knowledge of no authority, GP not bound


-Note: If 1 partner tells 3rd person other partner lacks authority, that's still not enough; need to legally strip partner of authority


-Non-ordinary course: Partner acting outside ordinary course, GP not bound, unless GP authorized it.

Unanimous Consent Decisions (NY)

Unanimous consent required to (unless authorized by other partners or biz has been abandoned):


-assign partnership property in trust for creditors


-dispose of goodwill of the business


-do any act that would make it impossible to carry on the ordinary course of business for GP;


-change purpose/scope of business the entity engages in

Other ways Partner binds the Partnership

GP bound by partner's wrongful acts


-When partner acting within the scope of GP business defrauds 3rd party, GP liable


-If fraudulent act outside scope of business, GP generally not liable

Liability

All partners are personally liable (jointly and severally) for the debts of the entity.




Contracts: GP liable on contracts made by a partner in scope of partnership business




Torts: GP liable for torts committed by partner or by an employee in ordinary course of partnership business

Judgment Creditors—Exhaustion Rule

Creditor generally must seek to get money from GP before going after partner


-Applies to both K and tort debts

Categories of Partnership Property

Partnership Capital: Property/money contributed by each partner for the purpose of carrying on the business of the partnership




Partnership Property: Property owned by the partnership, consisting of both capital contributed and property subsequently acquired




Note: Each partner has equal right to possess partnership property for partnership purposes, but has no right to possess it for any other purpose w/o consent of co-partners.

Transferability

Partner can transfer economic interest but not management rights.


-Note: Partner's conveyance of interest in GP does not of itself dissolve the partnership

Profits, Losses, Contribution

Profits: Partners shall equally in profits


Losses: Losses follow profits (specified share in profits = share in losses)


Contribution: Each parter is repaid her contribution, whether by way of capital or advances to the partnership property


-E.g. if one partner compelled to pay whole or more than her share of GP debt, she may require other partners to contribute their pro rata shares via contribution action

Indemnification, Allocation, Distribution

Indemnification: GP must indemnify partner for actions taken in ordinary course of business OR preservation of business property




Allocation: Amount of partnership profits a partner has to include on individual tax return




Distribution: Amount of partnership profits that are actually paid out to a partner

Dissolution

Definition: Designates time when partners cease to carry on business together




-Partnership not terminated upon dissolution. Dissolution, then winding up, then termination (time when winding up of GP is complete).




-GPs are very fragile under UPA (NY); partnership can dissolve at any time even if before set end date or without violation of partnership agreement

Causes of Dissolution (NY)

(1) Without violation of agreement: (a) termination of definite term or particular undertaking; (b) express will by any partner; (c) express will of all partners; (d) expulsion of any partner


(2) With violating agreement, by express will of any partner;


(3) Any event which makes it unlawful for business to carry on


(4) Death of any partner


(5) Bankruptcy of any partner or the GP


(6) Court decree

Post-Dissolution Authority

Generally, dissolution terminates authority of partner to act as agent for GP, except for purpose of winding up business

Impact of Dissolution

If rightfully caused, partner may have his partnership property applied to discharge liabilities, and surplus to pay amount owed to respective partners.


-Continuation Agreement is possible: essentially says if 1 partner leaves, you pay them amount representing their interest and the partnership continues




If wrongfully caused, partnership is dissolved, but remaining partners have great flexibility to continue partnership

Liquidation

In absence of continuation agreement, partnership must begin winding up.




Partnership business continues while operations are in process of being terminated




GP assets = partnership property + partner capital contributions

Priority of Distributions

(1) Liabilities owed to creditors other than partners


(2) Liabilities owed to partners other than for capital and profits (e.g. loans)


(3) Liabilities owed to partners in respect of capital (pay back their contributions)


(4) Liabilities owed to partners in respect of profits

Dissociation (RUPA only—Not NY)

Definition: Denotes a change in relationship caused by partner's ceasing to be associated in the carrying on of the business (not every dissociation triggers a dissolution)




Unless a partner's dissociation triggers a dissolution, the partnership is required to cause the dissociated partner to be bought out of his/her partnership interests

Causes of Dissociation

(1) Notice of partner's express will to withdraw


(2) Event agreed to in GP agreement


(3) Expulsion


(4) Death/serious disability


(5) Bankruptcy

Where Dissociation Triggers Dissolution

(1) In a GP at will, any partner has express will to leave;


(2) Happening of an event agreed to in Partnership Agreement


(3) Event that makes it unlawful to continue business


(4) Death of partner


(5) Judicial determination

Wrongful Dissociation

Wrongful when:


(1) it is in breach of an express provision of the GP agreement;


(2) If GP of definite term/purpose, before expiration of those if: (i) partner withdraws by express will; (ii) partner expelled by judicial determination; (iii) partner becomes bankrupt; (iv) if partner is an entity, it is willfully discharged or terminated




Partner who wrongfully dissociates is liable to GP and to other partners for damages caused by dissociation.

Limited Partnerships

LP

Definition

Entity with a general partner who operates the business, and one or more limited partners who contribute investment capital, but do not participate in management

Governing Law

Governed by limited partnership statute in state of organization

General Partner

Control, Agency, Fiduciary Duties: Same as GP




Liability: NO liability shield




Note: Can set up a corporation/LLC as general partner to give full liability shield (subject, of course, to veil piercing)

Limited Partner

Liability: Full liability shield; can only lose contribution




Control: Rights and powers limited; ordinarily does not take part in day-to-day contributions.


-Control Rule: If LP exercises too much control, will lose liability shield.

Rights of General and Limited Partners

Distributions: Share in distributions allocated on basis of value of contributions made (pro rata)


Transferability: Assign economic interest in distributions, not ownership rights

Veil Piercing

VP

Background

"Piercing the corporate veil" is an exception to the general rule that directors/shareholders are not personally liable for the debts and obligations of the corporation


-Note: Generally permitted only to prevent fraud/illegality. It is NOT a separate cause of action but merely an equitable remedy.




Common Fact Patterns: (1) Parent/subsidiary; (2) Controlling shareholder

Application

Applies to Corporations AND LLCs

Test

Requires P to show that:


(1) Owners exercised complete domination of the corporation in respect to the transaction attacked; AND


(2) That such domination was used to commit a fraud or wrong against the P which resulted in P's injury.




Note: Same test for LLCs

Factors

(1) Failure to adhere to corporate formalities (note that more may be required of larger, more sophisticated entities, but perfection is not required). E.g. no meetings; no minutes of meetings; failure to properly appoint directors; sloppiness in signing docs; failure to keep bank accounts


(2) Inadequate capitalization (measured at time of formation). I.e, a corp. which was sufficiently capitalized at formation but which has since suffered losses is not necessarily undercapitalized.


(3) Commingling of Assets


(4) Use of corporate funds for personal use

Reverse Veil Piercing

Goal to hold corp./LLC liable for the individual/other entity obligations.




-E.g. 3rd party creditor seeks to recover debts owed by corporation's owner from corporations itself


-E.g. 3rd party creditor seeks to recover debts owed by a parent corporation from subsidiary

Reverse Veil Piercing (Continued)

Petitioner bears a heavy burden of showing that the corporation was dominated as to the transaction attacked and that such domination was the instrument of fraud or otherwise resulted in wrongful or inequitable consequences.




Factors:


(1) When was entity established vs. liability


(2) Use of entity to pay personal expenses


(3) Co-mingling

Enterprise Theory

Whether and when 2 or more corporations may be held liable for each other's debts.




When two or more corporations are not operated as separate entities, but instead integrate their resources to achieve a common business purpose, each corp. may be held liable for the debts incurred in pursuit of that business purpose.

Enterprise Theory (Factors)

(1) Common employees


(2) Common record-keeping


(3) Centralized accounting


(4) Payment of wages of one corp. by another corp.


(5) Undocumented transfers between corps.


(6) Unclear allocation of profits/losses


(7) Same officers, shareholders

Corporations: Incorporation And Formation

C

Pre-Incorporated Transactions:


Promoter Liability

General Rule: Promoter is liable for pre-inc. transactions, and remains liable after corp. formed.


-Exception: IF party who contracted knew corp. not incorporated AND agreed to look solely to the corp. for performance.




-Signature: If promoter signs his own name, he is personally liable under K law.

Pre-Incorporated Transactions:


Corporate Liability

General Rule: Corp. not liable for pre-incorporation transactions.


Exceptions: A corp. will be held liable for pre-inc. transactions IF:


(1) Adoption: Manifesting an assent to be bound by it; corp. MUST exist at time of adoption and have knowledge of all material facts


(2) Ratification: Same as adoption; e.g. accept benefits of services


-Note: Both promoter AND corp. liable under these 2 exceptions


(3) Novation: Where other party agreed to substitute corp. for promoter (only time promoter escapes liability)

Formation

-One or more persons, called "incorporators", may form a corporation (natural person who are 18 or older).


-Incorporator usually elects the directors of the corp.


-Incorporator signs the certificate of incorporation. Mandatory contents of COI:



Mandatory Contents of COI

(1) Name of corporation; (2) Purpose(s) for which it is formed; (3) County within state in which office of corp. is to be located; (4) # of shares of stock to be issued, the par value of shares or a statement that shares are w/o par value, OR if shares are to be divided in classes, the # of shares and their par value; (5) If shares divided in class, the designation of each class and a statement of relative rights of each class; (6) Designation of Sec. of St. as agent for service of process; (7) Duration of corp. if other than perpetual

Optional Contents of COI

NY: The COI may eliminate or limit the personal liability of directors/SHs for damages for any breach EXCEPT:


-CANNOT eliminate or limit liability for acts/omissions in bad faith, involving intentional misconduct or intentional illegality




May address other matters like power/rights of directors and SHs in COI, or can do it in the bylaws.

Defective Incorporation

Rule: If there's a defective incorporation, there will be personal liability against the owners who actively participated in the management of the business, unless De Facto Corporation or Corporation By Estoppel apply

De Facto Corporation

Insufficient compliance to constitute de jure corp., but steps are taken sufficient to treat the enterprise as a corporation with respect to 3rd parties.


Requirement:


-(1) Colorable attempt to incorporate; AND


-(2) Some use or exercise of corporate privileges




-Courts invoke de facto corporation doctrine under limited circumstances

Corporation By Estoppel

A party who has dealt with an enterprise on the basis that it is a corp. may be estopped from denying corp. status.




One who contracts/deals with entity as a corp. admits that entity is a corp. and is estopped to deny its incorporation in an action arising out of the contract/course of dealing

Managing the Corporation: Ultra Vires Doctrine

Before: Corp. endowed with life only insofar as provided in charter; corps. required to confine activities to those specified in charter (corp. purposes had to be stated with specificity). Transactions outside the charter's scope characterized as ultra vires and unenforceable.


Now: Doctrine eroded; move from specific purpose clauses to all purpose clauses; courts liberal in finding implied powers.


-Not a defense to corporate tort/criminal liability


-can't invoke to reverse completed transactions

Doing Business in Other States

Domestic Corporation: Corp. doing business in state of incorporation.




Foreign Corporation: Corp. doing business in a state that is not its state of incorporation.


-States generally require a foreign corp. to "qualify to do business" in the state by filing a form and paying a fee

Ethical Issues

-Generally can represent multiple founder but must get informed consent


-Can invest in a client on fair and reasonable terms


-Generally can provide legal advice regarding laws of states (e.g. Delaware) in which you are not licensed, but check rules of specific state before meeting with a client in that state.

Corporate Governance

C

Matters Shareholders Can Vote On

(1) Election and Removal of directors


(2) Amendments to corporation's charter


(3) Shareholder Initiated amendments to a corps. bylaws


(4) Dissolution of the corp.


(5) Merger of the corp.


(6) A sale of all (or substantially all) of the corps. assets


-No vote for anything else! e.g. whether to fire CEO; enter new line of business; go public; etc.

Note: Removal of Directors

NY: SHs can vote to remove directors for cause no matter what; they can also vote to remove without cause IF provided in the charter or bylaws. Majority of outstanding shares in favor of removal.




DE: Any director may be removed with or without cause, regardless of charter/bylaws. Majority of outstanding shares in favor of removal.


-Note: DE Staggered Board Rule: If board is staggered, board may only be removed for cause unless charter says otherwise.



Shareholder Meetings

Annual Meetings: Required by statute


Special Meetings: Called to vote on particular matters


Notice Requirements: Notice gives place, date, and hour of meeting. Notice of any meeting may be written or electronic (email notice ok if consent to by recipient). For special meetings, must additionally state specific purpose(s) for which meeting is to be called.


-Notice of any meeting must be given no fewer than 10 days nor more than 60 days. If there is defective notice, meeting is invalid.

Quorum Requirements/Proxies

Requirement: Quorum based on shares, not headcount. Quorum = majority of outstanding shares




Adjusting quorum: Can increase or decrease (minimum = 1/3 outstanding shares) through charter or bylaws




Proxies: Agent appointed by SH who is given express actual authority to vote the SHs shares.

Written Consent

Rule: SHs may express approval through written consent rather than having a meeting vote.


-NY/MBCA: If no meeting, need unanimous written consent.


-DE: If no meeting, it's the same amount of votes that would be required if regular meeting vote.




No notice is required for written consent

Voting Requirements

MBCA: More votes for than against


NY/DE: Matters SHs can vote on require a majority of a quorum for approval (except election of directors)




Election fo Directors Default Rule: Election requires plurality vote.

Class Voting

-Arises when a corp. has more than one class/series of stock outstanding


-Issue whether matter needs to be approved by:


-Common stock and preferred stock counted together consecutively; just common stock; each of common and preferred stock voting separately; some combination of the foregoing.


-Turns on what statute/charter/bylaws say about class voting, and particular matter(s) up for vote.

Director Authority

Default Rule: Ultimate managerial authority resides in BOD




Number & Qualifications: A single director is ok; no statutory qualifications; if silent, default rule is 1 director (MBCA/NY/DE)





Director Responsibility

Major areas of Responsibility:


(1) Selection, evaluate, and (when appropriate) replace CEO/executive team


(2) Review and approve financial objectives, strategies, and plans


(3) Provide advice/counsel to management


(4) Select and recommend slate of directors for SH approval


(5) Review adequacy of internal controls

Inside v. Outside Directors

Inside: Also holds management position




Outside: No employment relationship

BOD Action

MUST have: (1) validly convened meeting (notice/no notice); (2) quorum; (3) voting


-Notice: DE has NO statutory requirement; NY requires no notice for regular meetings, but notice for special meetings and BOD sets reqs


-Quorum: Default = majority; can lower to no less than 1/3 (NY/DE)


-Voting Requirements: Default BOD actions require a majority vote of a quorum. For written consent if meeting not held, unanimous written consent required. Meetings may be in person or via telephone. In NY, charter/bylaws can require a supermajority vote for BOD action.

Election of Directors

Straight Voting (default): Each SH casts own vote


Cumulative Voting: Can opt-in in COI.




Directors elected at annual SH meeting (typically serve 1-year term for non-staggered boards); specific SH classes allowed to elect their own directors




Interim Director: BOD can appoint interim D to hold office until next annual meeting

Term of Office

Default Rule: Generally year unless staggered board.




Staggered Board: Charter/bylaws may provide for staggered board (directors can be divided into 2, 3, 4 classes). Terms of directors in first class shall expire at next annual SH meeting, the second class at the second succeeding annual meeting, etc.

Removal of Directors

See flash card above under shareholders (for SH removal of directors)




Directors: BOD does not have the right to remove directors; but can grant in charter or bylaws (MBCA/NY/DE)




Note—Class Directors: If a specific class of SHs are entitled to elect a director, he can only be removed by them.



Filling Vacancies

NY: Vacancies due to new position or removal, if done for cause, are filled by directors. Unless charter says otherwise, removals without cause can only be replaced by SH vote.




DE/MBCA: ANY vacancy can be filled by remaining directors or SHs.

Committees (General)

(1) Executive Committee


(2) Compensation Committee


(3) Audit Committee


-Sarbanes-Oxley requires outside auditors to report to AC. Also, AC is directly responsible for hiring, overseeing, compensating outside auditors; AC members must be independent; important to have financial experts; provide for whistleblower access


(4) Special Litigation Committee


(5) Nominating Committee

Committees (DE/MBCA)

Board can delegate power to committees of 1 or more directors.




Committees cannot amend bylaws or approve things that SHs are not allowed to vote on

Committees (NY)

If allowed in charter/bylaws, BOD can delegate power to committees of 1 or more directors, except that no such committee has authority on the following: (1) avoid SH approval; (2) fill vacancies on BOD or any committee; (3) fix compensation for directors; (4) amend or repeal by laws; or (5) amend or repeal non-repealable actions of board.

Officers


Authority: Oversee day-to-day management of corp.; statute say little of scope of their authority so leave it to BOD to specify duties.


Elections: Elected by BOD; appointed by senior officers; SH vote


Removal: Can be removed with or without cause, by directors or SHs


Fiduciary Duties: Owe same duties to corp. as directors


Note (Agency): Authority of President/CEO: President has apparent authority to bind corps. to Ks in usual and regular course of business, but not Ks of extraordinary nature.

By-Laws

Content: Typically address notice/quorum reqs., # and qualification of directors, voting standards, proxy voting, appointment of officers, and stock certificates




Hierarchy of supremacy: Statute > Charter > Bylaws

Amending By-Laws

ONLY SHs have power to unilaterally amend/repeal bylaws; the BOD does not have that power (although power can be given to BOD through charter); SH power cannot be limited.




Forum Selection (Note): DE courts have begun to uphold bylaws unilaterally passed by BOD that mandate the forum in which litigation relating to internal affairs of company must proceed.

Charter Amendment

Default Rule: Amending the charter may be authorized by vote of the board, followed by a vote of majority of all outstanding shares entitled to vote thereon at a meeting of the shareholders.

Corporate Finance

CF

(1) Debt Financing

Debt: Synonymous with a loan




Does not provide ownership rights in the company

(2) Equity Financing

Equity: Provides ownership rights





Common Stock vs. Preferred Stock

Common Stock: Stock that is entitled to (1) full voting rights; AND (2) receive net assets of the corp. upon dissolution (residual claim)


-Issuance: Requires BOD approval


-Issuing Additional Stock: Requires charter amendment




Preferred Stock: Stock that has preference over common stock in either (1) dividends (dividend preference) or (2) distribution of assets upon dissolution (liquidation preference)

Types of Dividends

Cumulative & Non Cumulative; Participating and Non Participating


Cumulative (default): A Dividend that is not paid in one year is carried over and must be paid before common stockholders.


Non-cumulative: Dividend not paid in one year vanishes


Participating: Preferred SHs get dividend preference and if corp. gives dividends to commons SHs, preferred SHs get some of that too


Non-Participating (default): Opposite of participating

Conversion

When preferred is converted into common at the option of the holder.


-Note: IPO usually automatically converts preferred to common stock.

Anti-Dilution

Means of preventing SHs ownership stake from decreasing

Redemption

Enables preferred SHs to require corp. to buy stock back or allows the corp. the right to buy back preferred stock at a specified price

(3) Internally Generated Funds

Includes proceeds from sale of goods and services the corp. provides

Capital Structure

Refer to the mix of debt and equity financing a company uses to finance its business.




Repayment Obligations: Debt is a contractual obligation that MUST be repaid, even if corp. is failing; equity payments (dividends) do not have to be repaid.

Debt vs. Equity Financing

(1) Ownership dilution


-Equity financing leads to ownership dilution; reduction in ownership stake since company had to sell more equity


(2) Repayment Obligations


-Have to repay loans for debt financing first; technically don't have to pay dividends to stockholders

Corporate Fiduciary Duties

CFD

Business Judgment Rule (BJR)

A presumption that in making a business decision, directors acted on an informed basis, in good faith, and in honest belief that the action taken was in the best interests of the company.

Rebutting the BJR

To rebut the BJR presumption, P must provide evidence that the majority of directors, in reaching their decision, breach their fiduciary duty:


(1) fraudulent, illegal, motivated by personal interest;


(2) lacking rational business purpose;


(3) acted in bad faith;


(4) wasteful


-If presumption rebutted, burden shifts to BOD to establish entire fairness (fair dealing/fair price)

Rebuttal Fails

If rebuttal fails, the board's decision is upheld if it had any rational basis.




Waste Standard: Used to determine whether there was any rational purpose. P must prove decision was "so one sided that no business person of ordinary sound judgment could conclude that corp. has received adequate consideration." Rare exception; used when decision unconscionable.

Standards

BJR: Highly deferential standard for directors (similar to rational basis scrutiny); very likely BOD wins if presumption not rebutted




Entire Fairness: Need to prove fair price and fair dealing; much higher standard (similar to strict scrutiny); BOD much more likely to lose when presumption is rebutted and BOD must prove transaction entirely fair.

Duty of Care

Focuses on the decision-making process instead of the substance of the decision itself; requires the BOD to be adequately informed of all material information reasonably available when making a decision.


Standard: Standard for determining whether BOD adequately informed when making a decision is gross negligence.

Duty of Care (Continued)

Decision-making process must comply with duty of care:


(1) Haste for no clear reason; act too quickly (can't do this)


(2) Distribute information and read it before meeting


(3) Consult appropriate experts/uninformed.

Exculpation Provisions (Duty of Care)

Allows a corp. to opt out of having its directors (not officers) personally liable for money damages for breach of duty of care. Opt out through charter/bylaws.


-Both NY & DE have these statutory provisions


-Note: Only applies to duty of care where directors liable for money damages as a result of gross negligence; not available for loyalty breaches (acts of bad faith) which are non-exculpatable.



Duty of Loyalty

Requires the director act in the best interests of the corporation.




Duty of Loyalty implicated with: (1) conflicting interest transactions; (2) failure to provide adequate oversight; (3) failure to act in good faith; (4) usurpation of corporate opportunity; (5) duty of disclosure

(1) Conflicting Interest Transactions

Any transaction between a director and the corporation




(See flowchart). Existence of conflicting interest transaction = interested directors = BJR rebutted


(1) Was the transaction approved by a majority of informed, independent, disinterested directors/SHs? If YES, P must prove waste. If NO:


(2) Director must prove transaction was fair (Entire Fairness—Fair Price and Fair Dealing). IF can't prove, P wins; if can, D wins.

Entire Fairness Test

Must prove both:


(1) Fair Price: economic and financial considerations; assets, market value, earnings, future prospects, etc.


(2) Fair Dealing: when transaction timed; how it was initiated, structured, negotiated, disclosed to directors, and how approvals were obtained.

(2) Duty to Monitor/Provide Oversight


Caremark Claims

Duty to Monitor: BOD must ensure that information and reporting systems exist and are reasonably designed to provide senior management with timely, accurate information sufficient for the board to make informed judgments concerning both the corporation's compliance with laws and business performance.

Duty to Monitor/Caremark Claims (Continued)

Caremark Standard: P must prove:


Lack of good faith as evidenced by a sustained or systematic failure to exercise reasonable oversight (high standard).


-(a) utterly failed to implement any reporting or information system/controls; OR


-(b) having implemented such a system, consciously failed to monitor/oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention

Proving Failure to Monitor/Caremark Claims

Standard is "possibly the most difficult to prove."




Need to prove scienter (knowing/bad faith requirement) to bring a Caremark claim.

(3) Duty of Good Faith

Bad Faith Test: Intentional dereliction of duty; a conscious disregard for one's responsibilities; deliberate indifference & inaction in the face of duty to act; intentional illegality.


E.g.:


(1) D intentionally acts with purpose other than furthering best interests of corp.


(2) D intentionally violates applicable law


(3) D intentionally fails to act in the face of a known duty, demonstrating a conscious disregard for his responsibilities

(4) Usurpation of Corporate Opportunity

When director takes for himself business opportunity that should have gone to the corporation first for consideration


-Consider ALL factors; no one factor is dispositive




NY: Test unclear as to what constitutes corporate opportunity;


-NY courts refer to a tangible expectancy in the opportunity

Usurpation of Corporate Opportunity


(DE Factors)

In determining if usurpation, consider whether:


(1) Corp. is financially OR legally able to exploit the opportunity


(2) The opportunity is necessary/essential to the corporation's line of business (activities which it has fundamental knowledge, practical experience, consistent with corp's needs and aspirations)


(3) Corp. has an interest/reasonable expectancy in the opportunity


(4) by taking opportunity for themselves, director/officer will have conflict of interest

(5) Duty of Disclosure

Directors must provide SHs with accurate and complete information material to a transaction or other corp. event being presented to them for action.


-When there is no request for a SH action, a SH Plaintiff can demonstrate breach of fiduciary duty by showing that the directors deliberately misinformed SHs about the business of the corp., either directly or by public statement.

Fiduciary Duty Litigation/


Derivative Suits

FD

Pre-Suit Demand Requirement/


DE Court of Chancery Rule 23.1

Prior to bringing a derivative claim, a SH MUST:


(1) Make a pre-suit demand on the corps. BOD to pursue the claim; OR


(2) Plead particularized facts as to why making a demand would be futile (conclusory statements insufficient; must plead with particularity)

Consequences of Making Pre-Suit Demand

If SH makes a demand and is denied by BOD, BJR attaches, and then SH can only rebut presumption by providing bad faith.




Therefore, Ps usually sue without making pre-suit demand, and instead allege futility to avoid BJR presumption that attaches when BOD denies the demand.

Demand Futility—Board Action (Aronson Test)

P must provide particularized facts that raise a reasonable doubt that:


(1) the majority of directors were disinterested and independent; OR


(2) the challenged transaction was otherwise the product of a valid exercise of business judgment


-I.e., board not adequately informed in making decision, or board did not act honestly and in good faith


-Note: Easier to prove (1) than (2)

Demand Futility—No Board Action (Rales Test)

P must allege whether the particularized facts create a reasonable doubt that, at time complaint was filed, directors could have exercised its independent and disinterested judgment in responding to the demand.




Note: Caremark claim/duty to monitor would be board inaction, so use this test.

Interested and Independent Definitions

Interested: Directors having potential personal benefit/directors who face substantial likelihood of personal liability b/c of transaction are deemed interested.




Independent: Decision based on the merits rather than extraneous considerations.


-Focus on whether relationship creates bias; friendships and relationships alone are ok, if they don't interfere w/ independent business judgment.

Demand/Futility Requirement (NY)

P must either make a demand on the board or allege particular facts that demand would be futile.


Demand Futile (Marx v. Akers): Proven if complaint alleges that:


(1) majority of directors are interested in transaction; or


(2) directors fail to inform themselves to degree reasonably necessary about transaction; or


(3) directors fail to exercise their business judgment in approving the transaction

Special Litigation Committee

Committee composed of directors that are disinterested and independent that investigates SHs allegations and determine whether filing suit is in corporation's best interests.

Zapata (DE Rule)

After an objective and thorough SLC investigation of the potential derivative action, the SLC may cause the corp. to file a motion to dismiss. Basis of motion should be that it's in the best interest of the corp. not to pursue the claim; motion should include thorough written record of investigation, its findings, and recommendations.

Zapata 2-Step (DE Rule)

(1) Court should inquire into the independence and good faith of the committee AND the bases supporting its decision; THEN


-burden on corp. to show SLC independent/acted in good faith


-focus on impartiality and objectivity


(2) Court should determine, applying its own independent business judgment, whether the motion should be granted.

Auerbach (Non-DE Rule)

Court only examines members of SLC for disinterested and independent




Court will not examine the substance of the SLC's decision, but will review the process to assess the adequacy and appropriateness of the decision.

Standing for SHs

General Rule: P MUST be SH at time action begun & remain SH during pendency of action.




Note: A SH who was not a SH at the time of the alleged wrongdoing may commence a derivative action ONLY IF: (a) P acquired her shares through operation of law; or (b) substantial injustice will occur unless the action is permitted.




Creditors: ordinarily have no right to bring derivative action

Standing for SHs (Continued)

Mergers: A merger may cause SH to lose standing.


Exceptions: (1) merger was done solely so SH would lose standing; (2) merger is "in reality" a reorganization that does not affect SHs ownership stake in the business




Directors: Sometimes statutes give officers/director right to bring derivative action (NYBCL); absent such authority, they lack standing to sue derivatively

Direct v. Derivative

Direct Suit: P asserts that he was directly harmed by the directors' breach of fiduciary duty AND therefore is suing in his individual capacity (not on behalf of corp.) to redress his harm.




-Note: pleading particularized facts does not apply here.

Direct v. Derivative Test

Test: Turns solely based on:


(1) who suffered the harm (the corp., SHs, individuals); AND


(2) who would receive the benefit of any recovery?


-In a derivative suit, the corp. is the injured party and that's where recovery would go. Direct suit recovery would go to individual P.

Personal Defenses

SH barred from bringing derivative action if:


(1) participated in alleged wrongdoing


(2) Consented to the wrong or explicitly ratified;


(3) Guilty of laches; OR


(4) (Under a few decisions) acquiesced in wrongdoing by failing to object

Tainted Share Rule

If SH barred due to a personal defense, so is a transferee from suing derivatively.

Controlling SH Fiduciary Duties

SH

General Rule

Controlling SHs owe fiduciary duties to corp's and SHs to ensure benefits are shared proportionally with all SHs; minority SHs do not.




-Test is control, not majority. That is, you can still be a controlling SH if you own less than 50%

Test for When SH Owes Fiduciary Duties


(Controlling)

(1) When it is a majority SH, owning more than 50% of the shares; OR


(2) When it exercises control over the business affairs of the corp.

Controlling v. Minority

To be a controlling SH, P must establish the "actual exercise" of control over the corp's conduct.


-Note: Pervasive control is NOT required; P can allege actual control with regard to a particular transaction.

Controlling SH Conflicting Interest Transaction


(Lynch—Entire Fairness Test)

(1) Was transaction approved by majority of informed, independent, disinterested directors or SHs?


-If YES, P must prove transaction unfair. If NO:




(2) Controlling SH has burden to prove transaction was entirely fair.

Controlling SH Self Dealing


(Americas Mining—Entire Fairness)

Controlling SH must prove entire fairness; satisfied if:


(1) Prove transaction was approved by well-functioning committee of independent directors; OR


(2) Prove transaction approved by an informed vote of a majority of the minority SHs.

Controlling SH Merger Buyouts (Kahn)

The BJR, rather than entire fairness standard of review applies to controlling SH merger buyouts if merger discussions are conditioned up front on both the negotiation and approval of: (1) an empowered independent committee of board members; and (2) an un-coerced, fully informed, majority of the minority SH vote (these are 2 cleansing devices).




Therefore: If buyout deal not conditioned on these 2 cleansing devices, entire fairness will apply (Americas Mining). If, and only if, deal conditioned on cleaning devices, BJR applies (Kahn).

Minority SH Protections

SH

Default Rights of Minority SH

(1) NO right to be employed by corp. or participate in management


(2) CANNOT compel the corp. to pay dividends or buy-back shares


(3) INSUFFICIENT voting power to elect even a single director

Negotiated Protections

NP

Cumulative Voting

Can multiply # of votes a SH has by the # of directors being elected; minority SH can then aggregate those shares and vote for a single director.




Corps can opt into cumulative voting; can enable minority SHs to have more representation when straight voting would not.

Voting (Pooling) Agreements

A K between 2 or more SHs as to how to vote; corp. can permit minority SHs to select one or more directors

Frequency/Attendance at Board Meetings

Minority SHs can set the frequency of board meetings and require that their director is on every board committee

Preemptive Rights (provided in charter)

Give an existing SH the opportunity to purchase a proportionate part of to-be issued shares before they are offered to others. Allows SHs to avoid dilution




Note: It's common for corp. to provide for these rights in contract (instead of opting in by charter provision). These contract rights are called "right of first refusal"

Veto Rights

SHs right to prevent corp. from taking specific action; can be explicit or implicit

Employment Rights

Minority SHs do not have right to employment; can secure employment by contract.

Buyout Obligations

Under default rules, neither corp. nor SHs have obligations to buy out an exiting SH.




Can provide for buyout upon happening of certain event; usually death = buyout

Dividend Policy

Payment of dividends is left to discretion of board; minority SHs CANNOT force payment of dividends, even in the face of huge profits; can provide for specific dividend policy

Documenting Minority SH Protections

Protections usually documented by (1) charter provision; (2) bylaws provision; OR (3) SH agreement provision




-SH agreement usually preferable; not a public doc. and easier and less costly to amend.

Shareholder (Pooling) Agreements

NY: 2 or more SHs may agree, in writing, that their shares will be voted: (1) as provided in the agreement; (2) as they may agree in the future; or (3) as determined by a procedure agreed upon by them.

Shareholder (Pooling) Agreements Continued

NY: Allows for delegation of management authority to SHs in closely held corps if:


(1) included provision in COI; and


(2) all incorporators or holders of all outstanding shares, w/ or w/o voting power, consent in writing; and


(3) subsequent SHs have notice or consent in writing; and


(4) NO shares listed on exchange (NYSE) or Over the Counter Market (e.g. NASDAQ)

Shareholder Trust Agreements

SHs, in a written agreement, may transfer their shares to a voting trustee for the purpose of conferring voting power to the trustee.


-Courts more hesitant allowing these, as opposed to pooling agreements.


-10 year limit


-Unless voting trust is explicit, trustee will not be permitted to vote as to extraordinary matters (sale of substantially all assets; dissolution merger; etc.)

SH Pooling Agreement v. SH Trust Agreement

Pooling Agreement:


Ownership—SH retains legal interest in shares


Dividends—SH receives dividends directly


Duration—Until SH have voted on issue that is subject of agreement


Revocation—Unanimous consent of all SHs

Pooling v. Trust (Continued)

Voting Trust:


Ownership—SH assigns legal interest to trustee in exchange for trust certificate.


Dividends—Trustee remits dividends to SH


Duration—Up to 10 years before renewal required


Revocation—Unanimous consent of all SHs.

Immutable Statutory Protections for Minority


SHs

IP

Immutable Statutory Protections

These are mandatory protections for minority SHs:


(1) Inspection/Informational Rights


(2) Judicial Dissolution for Oppression (limited to closely-held corps.)


(3) Judicial Dissolution for Deadlock


(4) Non-Judicial Dissolution Authorized by SHs



Inspection/Informational Rights

Rule: SHs have right to inspect corps' books & records


DE: SH can investigate anything reasonably related to interests as SH, including possible corp. wrongdoing. Must state purpose for which info sought (proper purpose—some evidence of a credible basis for request for which court can infer possible mismanagement).


-Note: Even if P demonstrates proper purpose, P is not entitled to inspect all docs. that P believes relevant; the scope of inspection is limited to those docs that are necessary, essential, and sufficient to P's purpose.

Inspection/Informational Rights


(Continued)

NY: SH can investigate anything reasonably related to interests as SH (same rule); has right to inspect upon written demand




NY Common Law Inspection Rights (broader than statute): Can extend to all relevant corporation books and records. Available if the SH presents in good faith and shows a "proper purpose" for seeking corp. records.

Judicial Dissolution for Oppression


(NY—Close Corps; No DE counterpart)

SHs holding 20% or more of outstanding shares can cause dissolution IF:


(1) the directors or those in control acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent towards complaining SH; and/or


(2) those in control acted, are acting, or will act in a manner that allows property or assets of corp. to be looted, wasted, or diverted for non-corp. use.

Oppressive Actions

Conduct that substantially defeats the reasonable expectations held by minority SHs when investing, such as the defeat of a reasonable expectation of a job, a share of corporate earnings, or a place in corporate management.


-Consider what the majority knew or should've known about the minority's expectations (mere subjective hopes of minority do not satisfy the test).

Court's Role

In determining whether to dissolve the corp., court should consider whether: (1) liquidation is only feasible means that P will get a fair return on investment; AND (2) liquidation is reasonably necessary for protection of rights/interests of substantial # of SHs.




Note: Dissolution for Oppression is a drastic remedy that should be used with extreme caution and only when justice requires it.

Avoiding Dissolution for Oppression

SHs or corp. can purchase stock of SHs petitioning for dissolution, and can therefore avoid dissolution by electing to purchase the minority's shares within 90 days after the dissolution filing.




-If petitioning SHs elect to buy-out, the purchase price is the "fair value" of the shares on the day before filing of the petition for dissolution.

Judicial Dissolution for Deadlock


(NOT limited to closely held corps.)

Rule: When corp. is evenly divided on an issue and can't make a decision, SHs holding at least 50% of outstanding shares can petition for judicial dissolution for deadlock. Grounds for dissolution:


(1) directors so divided respecting the management of the corps' affairs that the votes required for board action cannot be obtained;


(2) SHs so divided that votes required for election of directors cannot be obtained;


(3) internal dissension and 2 or more factions of SHs so divided that dissolution would be beneficial to the SHs.

Non-Judicial Dissolution Authorized by SHs

NY: Corp. dissolution may be authorized at a meeting of SHs If:


(1) COI expressly provides for it or corps. incorporated after 2/2/98—a majority of votes of all outstanding shares entitled to vote


(2) For other corps. (incorporated before 2/2/98; and/or no COI provision)—two-thirds of all votes of all outstanding shares entitled to vote.

Judicial Dissolution by AG

NY: AG may bring action to dissolve corp. IF:


(1) Corp. formed through fraud, misrepresentation, or concealment of material fact;


(2) corp. exceeded authority conferred by law or violated any provision of law that caused it to forfeit its charter or conducted its business in a persistent fraudulent or illegal manner or abused its power, contrary to the public policy of the state.

Close Corporations

CC

Distinguishing Features

-Usually smaller vs. public corporation (though size alone not dispositive)


-Shares not freely traded


-Ownership and control not separated—owners usually managers

SH (Heightened) Fiduciary Duties

In close corps., SHs owe fiduciary duties to each other. Reason is that minority SHs are vulnerable to oppressive devices.


Freeze-Out Tactics: Entire Fairness standard.


-E.g. Controlling SH creates another corp and arranges merger transaction whereby minority SHs are cashed out; deprive minority of corp. offices and employment; deals on unfavorable terms


Note: Most court's establish heightened fiduciary duties for close corps.; DE does not.

Buy-Sell Agreements

Standard in close corps. These agreements:


(1) restrict owner's right to transfer shares; and


(2) specify how shares are to be transferred following SH's death, disability, etc.

Types of Restraints

Blanket Prohibition on Transfers: Prohibits transfers except as provided by agreement


Right of First Refusal: Corp/SHs has first refusal right. If not accepted, then selling SHs can sell shares to third party.


Obligations to Sell and Buy: Require buying/selling upon happening of triggering event. Triggering event commonly include: SHs death, disability, or termination of employment with corp.

NY Restraints on Transfer

Rule: Restraints on transfer must be reasonable AND SH must have knowledge;


-absolute prohibitions on transfer not allowed!


-Limitations on who it can be transferred to is ok.

Limited Liability Companies (LLCs)

LLC

LLCs (Generally)

Combine elements of corporate and partnership law:


-Limited liability for members (corp.)


-Entity able to hold property, sue, be sued (corp.,)


-Filing requirements vs. de facto (corp.)


-BUT, significant freedom to customize internal governance through contract (partnership)

Two Types

(1) Member-Managed (default): Similar to partnership/decentralized management; members have authority to manage the LLC.


(2) Manager-Managed: Similar to corporate/centralized management; management authority vested in a board of managers elected by the LLC members.

Formation

Filing articles of organization with secretary of state.




Operating Agreement: addresses governance; capitalizations; admission/withdrawal of members

Governance

Statutes mixed on whether voting is per capita or pro rata.




NYLLC Law: Your voting follows your contributions (pro rata)

Transferability

General Rule: Can transfer economic, but not governance, rights (similar to partnership). This can, of course, be modified by operating agreement.


-Transfer does not dissolve the LLC


-Transferring member retains no power after transferring economic interests

Liability

All members have a full liability shield.

Allocation of Profits/Losses

Profits/losses allocated among members based on the operating agreement; if agreement silent, default rule is allocate based on value of each members contributions to the LLC (pro rata)


-Note: Different from default partnership rule, where profits/losses split 50/50.

Allocation of Distributions

Distributions allocated based on operating agreement; if not, default rule is distribute based on value of each members contributions to LLC.


-Also different than default partnership

Fiduciary Duties (case law)

-LLCMembers owe fiduciary duty to make full disclosure of all material facts.


-Organizer duty (counterpart to incorporator): No definitive rule if organizer role alone creates fiduciary duty.


-Pappas v. Tzolis: Case where 1 member offers to buyout others for fairly low price when business was assigned months later for much more; limited holding saying no fiduciary duty owed since departing members signed buyout K saying they performed due diligence and had legal counsel.

DE Fiduciary Duties

Must have good faith and fair dealing. Duties of care and loyalty can be modified or eliminated under an LLC agreement.




Manager-Managed: Unsettled whether generic members in manager-managed LLC owe fiduciary duties, since they are not agents in this form (in member-managed, they would owe duties).

NY Fiduciary Duties

May be able to waive fiduciary duties by contract, if parties are sophisticated, represented by counsel, and documents/context show they are relinquishing certain rights (Pappas v. Tzolis).




-NY, as opposed to DE, is very limited in terms of waiving these duties, as Pappas is the only example of waiving these duties, and it was on very limited facts

Agency

See flashcard above for agency rules pertaining to both LLC forms.

LLC Dissolution—Voluntary Dissolution

DE: LLC is dissolved and must wind up: (i) at the time specified in LLC agreement; (ii) upon the happening of an event specified in LLC agreement; or (iii) a 2/3 vote (based on ownership interest)




NY: Unless otherwise provided in operating agreement: death, retirement, resignation, expulsion, bankruptcy, or dissolution does not cause LLC to be dissolved.


-Note: 1 member exit generally does not dissolve the LLC

LLC Dissolution—Judicial Dissolution

NY: Judicial dissolution allowed where it is not reasonably practicable to carry on business in conformity with parties' agreement




Note: Different from corp. oppression standard; not the standard here.



Judicial Dissolution—Reasonably Practical Test

Focus is on the operating agreement; P must establish:


(1) Management of the entity is unable or unwilling to reasonably permit or promote the stated purpose of the entity to be realized or achieved; or


(2) Continuing the entity is financially unfeasible.


-E.g. voting deadlock: might be grounds for dissolution when defined purpose of entity has become impracticable to fulfill.

Other Remedies

Veil Piercing: Permitted for LLCs (same test as corp.)




Derivative Actions: Can bring derivative actions

Corporate Social Responsibility

CSR

Primary Goal

Corp. primary goal is shareholder wealth maximization

Director Decisions (NY)

In taking any action, a director is entitled to consider, w/out limitation (can, not must): (1) the long-term and short-term interests of corp. and SHs; and (2) effects corp's actions have in short and long term on the following:


(i) prospects for potential growth, development, production/profit of corp; (ii) corp's current employees; (iii) corp's retired employees and beneficiaries; (iv) corp's customers and creditors; and (v) ability of corp. to provide ongoing goods, services, employment pops. and benefits and otherwise contribute to the community in which it does business.

Insolvency and Creditors (DE)

Rule: When corp. becomes insolvent, corp. owes fiduciary duties to creditors.

Mergers and Acquisitions

M&A

Friendly Acquisitions

Four Structures:


(1) Asset Purchase


(2) Stock Purchase


(3) Merger


(4) Share Exchange

Asset Purchase

Bidder acquires target's business by buying its assets; target sells its assets and assigns its Ks;


Bidder: Owns B's assets and specified T's assets; subject to B's liabilities and any liabilities assumed from T.


Target: Owns deal consideration (cash/securities) and retained assets (if any); remains subject to T's liabilities (important to consider for choice of deal structure).

Asset Purchase (Continued)

Rule: When corp. sells all/substantially all assets not in ordinary course of business:


-target directors & SHs must approve the deal (DE = majority of outstanding shares to approve; MBCA = more votes for than against to approve)




Asset Purchase Agreement: document that specifies everything

Stock Purchase

Bidder acquires target's business by buying out of target's outstanding stock.


Bidder: Owns B's assets including T stock; subject to B's liabilities


Target: Owns T's assets; subject to T's liabilities; owns deal consideration

Stock Purchase (Continued)

Approval: The board of both bidder and target must approve the deal; Target SHs do not get a formal vote (b/c/ they get to make individual decision on whether to sell their target stock to bidder).




After Effect: If ALL outstanding target stock purchased, target is a wholly owned subsidiary of bidder.

Merger (Steps)

Need:


(1) approval of plan by board of both B and T;


(2) approval by T's SHs


(3) Filing of articles of merger with secretary of state

Merger (Types)

(1) Direct Merger


(2) Forward Triangular Merger


(3) Reverse Triangular Merger

(1) Direct Merger

Direct Merger: Target merges with and directly into the bidder.




After Effect: (1) T's assets and liabilities transferred to B; (2) T's outstanding shares converted into deal consideration; and (3) T ceases to exist

(2) Forward Triangular Merger

T merges with and into a newly created wholly owned subsidiary of B (Merger Sub)


After Effect: Same as above


NY General Rule: B SHs do not get a vote in a reverse triangular merger, since B is not a party (transaction between Sub and T).

(3) Reverse Triangular Merger

Newly created and wholly owned subsidiary of B (merger sub) merges with and into T




After Effect: (1) T's outstanding shares are converted into deal consideration; (2) merger sub's outstanding shares (all of which owned by B) converted into target common stock; and (3) merger sub ceases to exist.

Share Exchanges

Authorized in MBCA/NYBCL (not in DGCL)




Bidder acquires all outstanding stock of Target, pay Target's SHs directly; Target becomes wholly owned subsidiary.




Need: (1) approval of plan by board of both B and T; (2) approval by T SHs; and (3) filing articles of share exchange with sec. of st.

Structuring Considerations

Considerations driving choice of deal structure:


(1) Target Liabilities


(2) Target Contracts


(3) Tax


(4) Voting Concerns


(5) Appraisal Rights

(1) Target Liabilities

(i) If T merges directly into B --> B gets all liabilities of T


(ii) If B purchases T's stock (whether through stock purchase or share exchange) --> B does not get liabilities but owns T who still has those liabilities (same with forward/reverse triangular merger)


(iii) If asset purchase --> B can avoid T liabilities (best way to avoid liabilities in Asset Purchase Agreement—can specifically list liabilities B is and is not assuming)

(2) Target's Contracts

In absence of provision to the contrary, K's are assignable. Look at Ks to see if there are anti-assignment clauses; or see if they are not assignable.


(i) Identify key contracts


(ii) See who parties are


(iii) See if K has anti-assignment/delegation clause


(iv) Then see if it's a K that is not assignable as a matter of law

(3) Tax

The sale of a Target will be taxable on T's SHs, unless deal qualifies as "tax-free reorganization"

(4) Voting Concerns

Voting by T SHs: T SHs get vote on deal regardless of structure except stock purchases




Voting by B SHs: (MBCA): Whether B SHs get vote on proposed acquisition of target turns on how much stock B will be issuing in deal; requires B SH to vote on deal if B will be issuing shares equal to or more than 20% of its outstanding power pre-deal. (DE) Same 20% rule, but only applies to direct mergers

(5) Appraisal Rights

Afforded SH who vote against corp. action the option to have their shares bought back by corp. for value determined by court.


Target SH Appraisal Rights:


-MBCA: Triggered by merger, share exchange, and sale of all/substantially all assets


-DE: ONLY triggered by merger


-NY: Don't need to know triggering events

Hostile Acquisitions

Happens when Target BOD against deal. Two types:


(1) Tender Offer


(2) Proxy Fight

(1) Tender Offer

B bypasses T's BOD by purchasing stock directly from T's SHs.


Attributes: active and widespread solicitation; solicitation for substantial % of stock; offer higher than prevailing market price; firm, non-negotiable terms; offer contingent on sale of certain # of shares; pressure on offeree.


Squeeze Out Merger: B causes T to be merged with subsidiary of bidder so it can push out T's remaining SHs

(2) Proxy Fight

B seeks to elect majority of board members to T's BOD;


done by becoming controlling SH and then voting on desired board member

Defensive Measures

Make it more difficult to accomplish a hostile takeover. Two Kinds:


(1) SH Rights Plan/"Poison Pills"


(2) Staggered Boards

(1) SH Rights Plan/Poison Pills

Adopted by BODs to make target takeover prohibitively expensive; give BOD authority to adopt and execute discriminatory SH rights plan upon occurrence of certain "triggering" events.




-Typically designed to deter share accumulations by imposing substantial dilution upon SH who acquires shares in excess of specified ownership threshold

Analyzing a Poison Pill

(1) BOD must reasonably identify a threat to company that supports adoption of pill;


(2) Pill's operation must be proportional in relation to threat


(3) Pill (in combination w/ other defensive measures) cannot be preclusive of SH exercise of franchise, and in particular, must not have effect of preventing a successful proxy contest; and


(4) Pill cannot be coercive in context of SH exercise of franchise.

(2) Staggered Boards

Not ever BOD member is up every year for re-elections; split into groups to be voted on in different years. Good defensive measure for proxy fights

Unocal Test

Applies when BOD implements defensive measure in response to hostile takeover (ensure defensive measure motivated by good faith and not to benefit BOD directly).


Test: Directors must show that: (1) They had reasonable grounds (good faith and reasonable investigation) for believing the takeover device presents danger to corporate police/effectiveness (i.e. the board must articulate a legally cognizable threat [proxy fight; tender offer]); AND (2) BOD must show response was proportional (i.e. reasonable) in relation to the threat posed.

Unocal (Continued)

Rule: Devices implemented by BOD cannot be coercive or preclusive.




Coercive: Aimed at forcing down upon SHs a management-sponsored alternative to a hostile tender offer




Preclusive: Deprives SH right to receive all tender offers or precludes bidder from seeking control by fundamentally restricting proxy contests or otherwise.

Revlon Duties

Prior to time sale becomes inevitable, director's duty focuses on protecting SHs from inadequate bid/consideration (protect the SHs); At the point where firm's sale is inevitable, duty is to maximize value for SHs.



3 Scenarios When Revlon Duties Attach

(1) Company initiates active bidding process where it puts company up for sale;


(2) Company, in response to hostile bid, abandons long-term strategy and seeks friendly bidder that will break up the company


-Rule: If a board's reaction to a hostile offer is found to constitute only a defensive response, and not abandonment of corp's existence, Unocal applies (of course, both can be trigger in a fact pattern).


(3) Focus on change of control transactions.

Maximizing Value to SH (Revlon)

Board has flexibility/discretion to maximize SH value;


Enhanced Scrutiny: Burden on BOD to prove adequately informed and acted reasonably;


(1) Court determined decision-making process used by directors was adequate and decision was well-supported; and


(2) decision was reasonable under the circumstances then existing.


E.g.: Auction; market check (2 good methods to maximize SH profit)


Proxy Voting

PV

Generally

Proxy voting is a public company phenomenon. Process by which public company reaches out to SHs on a yearly basis on matters to which they are entitled to vote.




Proxy: SH assigns an agent to go to the SH meeting and vote on SHs behalf.

Proxy Statement and Card

Corp. must provide SH with detailed disclosure statement whenever it solicits proxies; designed to ensure voters can be adequately informed and avoid deception.


-Whether a SH gets the right to vote on a certain thing is a product of state law. The process, however, is governed by federal securities law.

Proxy Access

Allows SHs to include their own director-nominees in corps' proxy materials.


-Thus, the frequency of contested elections would presumably increase because no longer would a SH have to incur the significant expense of independently soliciting proxies but could instead piggyback on the company's proxy materials.


Note: Only applies if company has/intends to engage in proxy solicitation.

Say-on-Pay

Allows SHs an advisory vote on compensation for highest officers, frequency of the say-on-pay votes, AND golden parachutes.

Shareholder Proposals

Shareholder Proposal: A document recommendation that a SH formally submits to a company advocating the company take a specific course of action.




SEC rules require public companies to include in their proxy materials shareholder proposals that meet certain qualifications (see next few flash cards).

Exchange Act Rule 14a-8 (SH Proposals)

Grounds on which corp. can deny SH proxy materials:


(1) If you or representative fail to appear and address proposal without good cause;


(2) If proposal would violate any law


(3) If it is contrary to any proxy rules;


(4) If it relates to redressing a personal claim or grievance against corp. or other person, or if it is designed to benefit you and not other SHs;

Exchange Act Rule 14a-8 (Continued)

(5) If it relates to operations which account for less than 5% of corp's total assets at the end of its most recent fiscal year, and is otherwise not significantly related to corp's business;


(6) If the corp. lacks power/authority to implement the proposal;


(7) If it deals with a matter relating to ordinary business operations (see Apache case)

Exchange Act Rule 14a-8 (Continued)

(8) If it would disqualify a nominee who is standing for director election; remove a director from office before term of expiration; questions the competence, business judgment, or character of a nominee or director; seeks to include a specific individual in the proxy material for board election; or could otherwise effect the outcome of an upcoming election of directors;


(9) It conflicts with one of the corporation's own proposals to be submitted at the same meeting

Exchange Act Rule 14a-8 (Continued)

(10) If the corp. has already substantially implemented the proposal;


(11) If it substantially duplicates another proposal previously submitted by another proponent that will be included in the proxy materials for the same meeting;


(12) If it deals with substantially the same subject matter as another proposal that has previously been included in proxy materials within preceding 5 years.


(13) If it relates to specific amounts of cash/stock dividends

No-Action Letter

If corp. intends to excude a SH proposal, it typically files a no-action letter request with the SEC explaining why the corp. believes the proposal is excludable.


-After the SEC grants or denies the request, the company will generally include or exclude the proposal in conformance with the SEC's decision.