1. Pareto Efficiency- No change can be made making at least one person better off without making at least one person worse off
Doesn't go to net value
Doesn't address externalities
2. Kaldor-Hicks Efficiency - If at least one person would gain, after all losers are compensated
Doesn't involve actual compensation
3. Both Ignore distributive effects and legitimacy of original asset distribution
B. Developing the firm
1. Adam Smith believed agency costs of monitoring managers and assuring incentive alignment would be to high
2. Coase theorized extra-organizational transaction costs would be higher than inter-organizational agency costs.
C. Agency costs
Monitoring
Bonding- trust creation costs
Residual - Incentive Alignment costs
II Agency
Restatement 2nd of Agency (RSA)
1. Fiduciary relation resulting from:
a. Manifestation of consent by principal that agent shall act on his behalf and subject to his control
b. Consent by Agent
2.Termination by either party
Master/Servant vs. IC
1. extent of control over details
a. work hours
2. is agent involved in a distinct occupation
3. IS the work typically done by an employee or an IC
4. skill required
5. who provides tools and workplace
6. length of time of employment
7. payment by time or by job
8. is the work part of the employer's regular business
9. what do the parties believe
10. is the employer in business
Actual Authority
Apparent authority - reasonable 3d party may infer authority from acts or statements of P
Inherent Authority A would ordinarily have such authority and T doesn't know otherwise §161
A. Liability in Tort - Respondeat Superior
1. Generally liable if and only if there is a Master/Servant relationship and agent is acting within the scope of his employment.
2. RS2 §228 Within scope of employment if:
a. type of work employed to perform
b. occurs within time/space parameters of employment
c. intent at least in part to serve employer, AND
d. in case of use of force, force not unexpectable by master
3. §230 forbidden act may be w/in scope of employment
4. §231 criminal or tortious acts may be w/in scope
5. §232 failure to act may be w/in scope
Humble v. Martin
Woman leaves car at station, car rolls away and injures π
Humble owns station and Schneider, IC runs it
Agreement with Schneider found to create agency relationship
perform other duties as required by company
Humble pays majority of utility expenses
Humble set hours of operation
Terminable at will of Humble
Hoover v. Sun Oil
Sun owns all equipment and station and leases to Barone
No Agency relationship found
Barone independently determined hours of operation and hiring conditions
Barone had risk of profitability
No control over day to day operations
B. Liability in Contract
Nogales Service Center Ariz. 1980 p. 20
ARCO's rep promises a fuel discount if certain conditions, ARCO reneges
Trial court refused to give instruction on inherent authority
Appeals upheld for procedural reasons, but inherent seems to have been present
Jenson v. CargillMinn. 1981 p. 16
Cargill financed Warren grain mill
Agency found due to extent of Cargill's control over operations
Cargill an active participant in managing the business, and made the key economic decisions
Illustrates risk of overly active creditors becoming Ps under law
C. Nature of Fiduciary Relationship
Duty of Obedience
Duty of Care
Good faith
Manner to best advance Ps interests
Not to work for self benefit
Duty of Loyalty
Good Faith As a reasonable person would
Become informed in
Exercising agency
Duty of Loyalty
RS2 §387 duty to act solely for Ps benefit in all matters connected w/ agency
§338 Duty to give P any Profit made in connections with transactions conducted on behalf of P
§389 Duty not to deal as adverse party without P's knowledge - voidable
§390 When acting as adverse party w/ principals consent, duty to deal fairly and disclose all facts which A knows or should know would reasonably affect P's judgment
Tarnowski v. Resop Minn. 1952 p. 34
A takes secret commission on coin op franchise purchase by P
Deal found to not actually contain what it was purported to contain
P remedy from agent includes
secret commission
costs of recovery from seller
Recovers MORE than he lost
Restatement 2 of Trusts
§203 - trustee accountable for any profit arising from administration of trust even if it doesn't arise from breach of trust
§205 - liability in case of Breach - liable for
Any depreciation of estate
Any profits made by Trustee
Any profits which might otherwise have been made by Trust
§206 liability for Breach of loyalty - §205 applicable when trustee sells property to himself
In Re Gleeson Ill. 1954 p. 36
Tenant becomes trustee when landowner dies
Increases rent and extends lease for next season
Claims too difficult to secure a new tenant
Trustee was honest with beneficiaries
Court holds he was barred from dealing with himself as trustee and must return all profits
Regardless of good faith or disclosure
III. Joint Ownership: Partnership
Partnership property: tenancy in partnership
Meinhard v. Salmon NY 1928 p. 43
Duty of Loyalty
JV covering lease of building in NY
One partner approached re: leasing a larger piece of land and does deal
Other partner feels left out
Punctilio of on honor the most sensitive
Salmon should have shared at least notice of the opportunity w/ his partner
Meinhard gets 49% of the new venture
Vohland v. Sweet Ind. 1982 p. 47
Sweet employed in exchange for 20% of profits
Doesn't participate in mgt or financing, or file as a partner
§7(4) UPA receipt of share of profits is PF evidence of partnership
Throughout course inventory increases through investment of earnings, which otherwise would have belonged by 20% to Sweet.
Sweet found to be a partner entitled to “wind up”
NB: If Vohland had reinvested solely out of his 80% he probably could have avoided this
Munn v. Scelera Conn. 1980 p. 51
Brothers agree to build house, go bankrupt
Before going kaput, π's agree to have house finished by brother A
Brother A defaults and π's seek recovery against brother B
UPA § 34-39 dissolution does not discharge one partner from responsibilities, but when a party assumes partnership obligation, departing party absolved w.r.t T if T, knowing of the agreement, consents to a material change in nature or time of payment obligations.
Court finds brother B non-liable b/e π's materially altered the contract w.r.t. payment terms.
In Re Comark Cal. 1985 p. 55
Partnership goes bankrupt, but individual partners do not
Partnership creditor wins judgment against on partner's property
Court hold creditor cannot enforce because such property must be accessible to partnership creditors as a whole, to be distributed by the bankruptcy trustee.
Jingle Rule (p. 57 and slides)
Parity Rule
UPA § 40
78 Bankruptcy (Ch 7) RUPA §807
Partnership Creditors always have first claim on Partnership Assets
Personal Creditors have first claim on Personal Assets
Partnership (only as a whole Comark) and Personal creditors on parity
Applies only if Partnership is not in Ch7 bankruptcy, and UPA is in force
National Biscuit v. Stroud N.C. 1959 p. 58
Stroud and Freeman partners in a grocery
Stroud tells Nabisco he won't be responsible for any more orders
Freeman places orders
General partners under UPA §18 have equal rights in mgt and conduct of partnership business.
Stroud held liable b/e he couldn't restrict power and authority of his general partner to conduct “ordinary matters connected with partnership business”
Dissolution and Disassociation
UPA
RUPA
§29 Dissolution upon any change of partnership relations i.e. exit of a P, Dissolution forces Winding up
§601 Disassociation, pursuant to agreement Pship can continue if a P departs
§37 Winding up, orderly liquidation and settlement of Pship affairs
§801 Dissolution onset of liquidation and winding up
§30 Termination, follows winding up
§38 dissolution caused in any way, except in violation of Pship Agreement, unless otherwise agreed, each P may call for P property to be used to pay off liabilities, and remainder to be distributed in cash (sale of assets)
Issues
Ability of Ps to opt out of statutory wind-up when a partner leaves (Adams v. Jarvis)
Mode of liquidation in statutory wind-up (Dreifurst v. Dreifurst)
Limitations on power to force statutory dissolution and wind up (Page v. Page)
Adams v. Jarvis Wis. 1964 p. 63
Dr. Adams withdraws from 3 doc partnership
Pshp agreement holds withdrawal does not result in termination
Trial court finds withdrawal works as dissolution
Appeal finds parties are free to structure a Pship such that withdrawal does not force such a dissolution which would force winding up
Dreifurst v. Dreifurst Wis. 1979 p. 66
3 brothers own 3 mills in partnership, one wants dissolution and wind up and sale of assets
Trial court just splits the mills
UPA §38 allows payment in cash ergo sale of assets
In Kind Distribution only if agreed to by partnership or in Mich.
No creditors
Sale sense less b/e nobody else interested in assets
In Kind is fair
NB If In kind is really more economically suitable, remaining P's can buy withdrawing P's rights to a liquidation, and they're probably free to bid on assets.
Page v. Page Cal. 1961 p. 70
Partnership agreement to run laundry
When partnership appears to be about to make good money, big P calls for dissolution
Little P argues big P wants opportunity for himself
Restrictions on dissolution only through a term of partnership
Term can be implied only when supported by evidence
i.e. to make a certain amount of money or
Recoup investment
If π had proven bad faith (fiduciary breach), dissolution would be wrongful and could sue for damages
Limited Partnership
Limited liability for limited partners who don't manage the business
Must always be one general partner
If ltd partners exercise mgt powers they may lose their ltd liability
Originally liked b/e you can get partnership (1 tier) taxation with corp. ltd liability
Now mostly LLCs
Delaney v. Fidelity Lease Ltd Tex. 1975 p. 74
3 ltd partners formed a corp. to act as general partner
Corp only function was to operate the partnership
No requirement that creditor show reliance on partnership
If they controlled partnership through the corporation than they are liable as general partners
LLC - can have partnership taxation unless publicly traded equity
Actual Authority
Apparent authority - reasonable 3d party may infer authority from acts or statements of P
Inherent Authority A would ordinarily have such authority and T doesn't know otherwise §161
IV. Introduction to the Corporate Form
5 Basic Characteristics of a Corporation
Legal Personality with indefinite life
Ltd liability for investors
Free transferability of share interests
Centralized management appointed by equity investors
Ownership and Profit sharing by capital investment (only sort of, only by IPO price)
Why Does Delaware Dominate?
Race to the bottom/race to the top?
Management paradise or most efficient body of law and best procedure?
Corporation statutes are primarily enabling
Can't always contract around them
Judicially created fiduciary duties
Federal securities Law
Mandated terms:
Voting stock
Board of Directors
Shareholder voting for certain transactions
Charter also defines:
Corporations name, original capital structure
Different voting shares/rights
Can Board issue blank check preferred?
May establish size of board and other governance terms
Annual elections or classified
Bylaws
Must conform to incorporation statute and charter
Operating rules
Responsibilities of executives and directors
Sometimes SH have inalienable right to alter bylaws, sometimes Directors only
Shareholder Agreements
Agreements between SH
Case for limited Liability Easterbrook and Fischel p. 93
Decreases need for monitoring corporation
Less need to monitor other SH (in case of joint and several liability)
Makes diversification and passivity a more rational strategy
The above promote free transfer, which incentives mgt to act efficiently
Makes creditors real monitors of mgt tort exposure (HH notes 38)
Centralized management
Board can act contrary to SH Majority
BOD has primary management power
Automatic Self Cleansing v. Cunningham Eng. 1906 p.98 HH p. 42
Articles provide ¾ majority required for special resolution compelling board
Î wanted Board to sell some assets at specific terms but only has 55% majority
Judge doesn't force sale
Protects Board's responsibility to the minority
Del § 271 requires Board motion and SH vote on sale of assets, Board can still decide against sale even if SH are pro, why?
Board still has duty of care and loyalty to the minority (liability)
Del §141 Certificate of incorporation may modify Board power
RBCA §8.01 permits modification of Board powers by SH agreement (which must also be in articles) under §7.32 but only if the corp. isn't exchange traded
Jennings v. Pittsburgh Mercantile Pa. 1964 p. 103 HH 46
Executive solicits RE agent to explore a sale and leaseback deal of all Co. owned land
Jennings was on constructive notice to verify authority
Menard v. Dage MTI Ind. 2000 p. 106 HH 46
President operated Co. For years w/o board input
President signs and sale is held valid
Ruled to have inherent authority
Pres even told Menard he had to go back and get approval
Puzzling
V. Debt, Equity, and Economic Value
Basic Concepts of valuation HH 47
Economic risk calculi HH50
Efficient Capital Market Hypothesis- stock prices reflect all public info. Bearing on value of stock p. 123 HH 58
Debt v. Equity
Interest is pretax, dividends are not
VI. Protection of Creditors
Ltd liability means creditors can only recover from corp. ergo greater risk.
Protection Strategies
Mandatory Disclosure - Financial statements
Rules regulating corporate capital
Safeguard duties imposed on directors, creditors, or SH
Regulating Corporate Capital
Requiring equity contributions
Restricting Distributions
Dividend tests
Fraudulent Conveyance Doctrine
Fiduciary duties to creditors
Equitable subordination
Piercing the corporate veil
Dividend Tests
Minimum level of capital (abandoned in US)
Prohibitions on Issuing dividends when net assets fall below a certain stated amount
Stated amount chosen by company
Can't pay dividends when value falls below
Capital surplus test
Can only pay dividends out of surplus
Some RE only, some also Paid in surplus
Del §170a nimble dividend test
Capital surplus or if no surplus can pay out of
Current or preceding year net profits
Equity insolvency test
Can't pay dividends if inability to meet debt obligations would result
Tests can be avoided
SH can reduce stated capital
Can revalue assets upward
Distribution Constraints
NY Bus Corp Law §510 may only pay out of surplus and cannot render company insolvent
§516a4 can only reduce stated capital w/ SH approval
DGCL §170 nimble test
Capital surplus or if no surplus can pay out of
Current or preceding year net profits
Cal §500 Modified Retained Earnings
RE or
Assets, as long as assets remain 1.25x liabilities and CA>CL
RMBCA §6.4
Can't pay dividends if it would make you unable to pay debts as they come due or
If liabilities plus preferential SH claims exceed assets
But can use a fair value asset test (not bound to Balance sheet value)
Standards Based Duties
Director Liability
Credit Lyonnaise Del.1991 HH72
Del: when a firm is insolvent or “in the vicinity of insolvency” duty to consider not only SH, but creditors as well
Firms must maximize value of a firm as a whole
Why didn't the Bond Holders have to covenant for this?
Creditor Liability: Fraudulent Transfers
Fraudulent conveyance Doctrine-effective obligation to T parties dealing with an insolvent or near insolvent debtor must give fair value in any transaction or can be targeted by debtor's creditors.
UFTA §4a1 & UFCA §7 p. 140
Present or future Creditors may void transactions with intent to hinder, delay or defraud any creditor of a debtor
Void transfers made w/o reasonably equivalent value if debtor left w/ unreasonably little assets in relation to its business or debtor intended, or reasonably should have known that he was incurring debts beyond his ability to pay when due, or if the debtor becomes insolvent
Kupetz v. Wolf future creditors who knew or could easily have found out about transfers cannot attack them
Capital surplus or if no surplus can pay out of
Current or preceding year net profits
Leveraged Buyouts crease senior preferred debt, displacing equity and old debt
Equitable subordination applies where controlling party is also a creditor
Costello v. Fazio 9th cir. 1958 p. 142 HH 78
Partnership with Fazio as principal contributor
Partners withdraw most of their investments and incorporate
Corporation goes bankrupt 2 years later, complete turnover of creditors
New capital found to be inadequate
When a partnership is incorporated and the partners become officers directors and shareholders, and they convert the bulk of their capital contributions into loans leaving the corporation undercapitalized their claims as creditors will be subordinated to general creditors
No mismanagement, fraud or deception
Transaction must be justifiable “within the bounds of reason and fairness”
Costello Issues
Can they escape liability to continuous creditors? Only if creditors agree - Munn v. Scelera TR 4
What if its a new corporation with no predecessor? No problem as long as no one is misled no law against undercapitalization
What about creditor turnover as in Fazio?
Perhaps they were relying on Pships established Rep.
See UFTA §4
Piercing the Corporate Veil
Lowendahl test
SH who completely dominates corporate policy
Usually failing to treat corporation formality seriously
uses control to commit a wrong which causes injury
Krivo Industrial Test
Pierce the veil whenever its recognition would extend the principle of incorporation beyond its legitimate purposes and would produce an iniquity
Generally
Disregard of corporate formalities
Thin capitalization
Few SH
Active SH involvement in mgt
Sealand v. Pepper Source 7th Cir. 1991 p. 148 HH83
Marchese owns Pepper Source and several other Co.s
Ignores almost all corporate formalities
Mixes their finances with each other and his own
2 part test
Unity of Interest and ownership focus on 4 factors
Ignoring formalities
Commingling funds and assets
Undercapitalization
One corp. treating another's assets as its own
Not piercing would sanction fraud or promote injustice
Must be a wrong beyond a creditors inability to collect
Intent to avoid responsibility
Unjust enrichment
In this case tax fraud, and intent to manipulate assets to avoid repayment
Sealand notes
Are funds pushed around to mislead creditors as to what's available to pay debts?
Kinney v. Polan 4th cir. 1991 p. 152 HH 86
Industrial (shell owned by Polan) leases from Kinney
Polan leases from Industrial
Industrial defaults
Industrial veil pierced
no formalities
zero capitalization
clear intent to use Industrial purely as a shield
but see Laya when creditors can be expected to check up (i.e. banks) maybe they can't pierce
Courts won't pierce vis-Ã -vis
Public Corporations
Passive SH
Unlikely against minority SH
Almost never if all formalities are respected and nothing funny about its accounts
Walkovsy v. Carlton NY 1966 p. 157 HH 90
Cab company tort case
Carlton owns 10 Cos. 2 cabs each
Funds regularly drained (dividended out)
Î wants more than the 10K liability insurance min. but Co. that hit him had no real assets
Free to pierce horizontally, as all companies were owned and operated as one
run as a single enterprise with common financing, support, and intermingling
Can't pierce v-a-v Carlton b/e there's no allegation that he was operating the business in his individual capacity
low capitalization never enough
legislature set the 10K minimum why F with it
must allege intermingling of assets or lack of formal barrier between Carlton and corp.
might be able to recover from Carlton with
NY §510 dividend test
fraudulent conveyance of some monies
Dissent Keating wants reasonable capitalization test
are torts so expectable that money should be set aside for them
what about the statutory minimum
Clark's idea tort victims should get primacy over creditors (but they don't)
Liability after dissolution p. 162 HH97
Del §278, 282 SH liable for pro rate share of distributed assets for claims arising w/in 3 yrs of dissolution
RMBCA §14.07(c)(3)-doesn't state 3 year limit
Successor Corporation liability p. 162
Liability follows the product line
Hannsman and Kraakman Pro unlimited SH liability in torts p. 162 HH 98
VII. Normal Governance: The Voting System
Role and Limits of SH voting p. 171 HH 101
Right to elect Board
Collective action problems ergo SEC 1934 proxy rules
Mandated Disclosure
1992 made institutional block voting easier
Primary Right
Every Corp must have voting stock
Annual elections (can be classified Max of 3 in Del)
Law dictates minimum circumstances
Notice dates and requirements as well as quorum
Board Removal
At common law by SH for cause
D's cannot remove colleagues but can petition a court to do so
DGCL §141k makes it harder to get rid of a classified board p. 175
Board delays SH meeting and enacts comprehensive plan creating 3 spin-offs
Major spin-off now has classified board w/ 80% vote required to declassify or remove D's w/o cause
Board cannot take an action otherwise permissible w/ purpose of disenfranchising SH
Circumstantial evidence which goes to purpose
Timing
Entrenchment
Stated Purpose
Benefits
Effects
“Interference w/ the SH franchise is especially serious”
b/e sale and voting are SH only protections
SH Meetings and Alternatives
SH may vote to ammend and repeal bylaws
Remove Ds
Adopt SH resolutions to ratify Board actions or request actions
If no meeting held w/in 13 mos. Of last meeting, Del §211 courts will entertain a SH petition and require a prompt meeting
Special Meetings
RMBCA §7.02 Corp. must hold a special meeting if called for by Board or aperson authorized in charter, or 10% SH demand it in writing
Del doesn't have 10% provision
SH Consent Solicitations - Paper meetings
Del §228 if they could do it at a real meeting w/ 100& attendance, they can do it by paper
RMBCA requires unanimous SH consent
Rosenfeld v. Fairchild NY 1955 p. 183 HH 104
Who pays for the proxy war?
Incumbents spent 106K corp money and 28K personal
Insurgents won and spent 127K which they reimbursed after winning w/ SH approval
Also reimbursed losers for 28K
Dissenting SH wants money returned
Incumbents reimbursed win/lose if acting in good faith in a contest over policy
SH ratified insurgent reimbursement is upheld
Generally insurgents must win to get reimbursed
HH 105 explores financial incentives involved
Class Voting
Typical class voting requires a majority in every class of voting stock entitled to such a class vote
DGCL §242(b)(2) holders of a class of stock entitled to vote upon any ammendment which would
increase or decrese the aggregate shares of of the class
increase or decrease par value of the shares
alter or change the powers, preferences, or special rights of the shares so as to affect them adversely
RMBCA if a proposed charter ammendment would have an adverse affect (doesn't require it to be an ammendment to their class)
Del could still insert a senior class
SH Information Rights p. 187
DGCL §220 any stockholder on written demand and sworn oath of legitimate purpose can inspect stock ledger, list of SH and other
Legitimate purpose - reasonably related to SH interests as a SH
General Time Corp v. Talley Del. 1968 p. 189
Desire to solicit proxies is a legitimate purpose
Entitled to a SH list to make a proxy
Thiele denied when he wanted to sell it as a mailing list.
Separating Control from Cash Flow Rights
A Corp can't vote shares in itself which it owns directly or indirectly p. 190
DGCL §160(c) cannot vote or count for quorum shares of a corp
Belonging to it
Belonging to another corp if majority of shares entitled to vote in the election of directors is held directly or indirectly by the corporation
Speiser v. Baker Del 1987 p. 191 HH 110
See HH110 for picture of ownership
Baker and Speiser own a piece of Chem, but control it through Med.
Med is owned by Chem, but owns a big piece of Chem.
Speiser (bad) wants to force a Med SH meeting, and can under Del §211
Stock held by a corporate subsidiary can in some circumstances belong to the parent and be prohibited from voting even if the Parent doesn't hold a majority of shares entitled to elect directors.
Reasoning, §160 says you cant vote them if you control the elections, doesn't say you always CAN vote them if you don't control the elections.
Easterbrook and Fischel Voting in Corporate law p. 197 cant separate vote from own
Schreiber v. Carney Del 1982 p. 199 HH 111
TI wants to merge with TA
JCC owns 35% of TI, and threatens to veto merger because it has warrants which would expire in case of merger, and doesn't have enough cash to exercise them
IC of TI, negotiating at arms length decides to lend JCC the money
Loan had no cash effect on TI because it was immediately paid back to exercise the warrants
Loan approved by Board and Majority of uninvolved SH
Vote buying illegal per se if its purpose is to defraud or disenfranchise other SH
Not void per se b/e object not to defraud, and it was in other SH best interest
Voidable, but ratified by the independent SH vote
Controlling Minority Structures p. 203 HH 112
Dual Class equity structures - most popular
High vote and low vote stock
Pyramiding controller owns 51% of A which owns 51% of B ….
US and UK tax at each transfer, so this is pricey
Cross Ownership
Investment Co. act of 1940 requires disclosure of B and C
Easterbrook and Fischel voting and collective action p. 207
Proxy Rules basic framework
Securities Act of 1933 - Disclosure procedures when selling securities on public markets
SA 1934 - establishes disclosure reqmnts for corps when they go public
Reg 14A (14A1-12) - regulate proxy solicitation process and interSH communication
Schedule 14A - disclosure reqmnts in “full dress” registration statement
Section
Old p. 211
New (post 1992)
14a1
Almost anything held to be a proxy solicitation
Expensive and difficult
Excluded:
Solicitations not actually seeking proxy authority
People owning < $5million
Self funded solicitations by mgt. or Board
Simple announcements and explanations, even if in advertisement form
14a2
Exempts Solicitations to fewer than 10 SH
Exempts solicitations by individuals who don't actually solicit proxies
Unless you own >$5million, but then you can still advertise freely
14a3
Disclosure requirements
Doesn't apply to speeches or advertisements provided no proxy form is attatched, and data has been filed w/ SEC
14a 4,5
SH can choose or cross out nominees
Mgt can bundle Directors and initiatives
Must unbundled
Short Slate rule (ie if I propose only a portion of the Board I can indicate which of mgts I like)
14a6-12
Requires advanced deposit of proxy solicitations w/ SEC
Proxy statements must be prefiled
Other Comm. Can be filed at time of issue
14a7
Must provide SH list, or mail the proxy
Unclear p. 216
Tapers Hypothetical p. 216 HH114???????????????????????????????????????????????
14a8 Shareholder proposals to be included w/ proxy materials p. 218 HH 115
Must hold $2K or 1% of stock for a year
Must File w/ Mgt 120 dys prior to release
May not be > 500 wds
May not violate subject matter restrictions
Cannot relate to ordinary business
Cannot relate to <5% of business
Cannot relate to election of Directors
Cannot conflict with Co. proposal
Cannot be illegal
Co. has burden to justify exclusion
CASE STUDY p. 220 HH 116
CASE STUDY: Binding Pill Redemption p. 224 HH 116
SH vote to force Board to redeem pill and not adopt new one
Board ignores it
Oklahoma court overturns
Oklahoma Legislature subsequently reserved power to amend bylaws to Ds
Delawazre probably would not allow such a motion
Corporate Social Responsibility Proposals p. 225
Social policy issues cant be tossed out as ordinary business p. 226
14a9 Antifraud p. 227 roughly same ot prove as fraud
materiality
culpability
reliance and causation
remedies
Virginia Bankshares US 1990 p. 229 HH 118
Whether a statement couched in conclusory or qualitative concerns purporting to explain Ds reasons for recommending corporate action can be misleading under 14a (YES)
when knowingly false
Whether damages can be shown by a group of voters too small to be required for the action(NO)
material if a reasonable SH would consider it important
Still have a fiduciary Claim
Dissent: 15% could have tried to convince others
Fiduciary duty of Candor
State law fraud remedy
knowingly false
material
relied on
causing injury
Del Majority SH and D's have duties to include all germane facts
proxies or tender offers
when asking SH to take action
Whenever Ds communicate publicy or directly with SH about corp affairs, fiduciary duty
VIII. Normal Governance: Duty of Care
Fiduciary Duties are:
Obedience
Loyalty (self dealing)
Care
Duty of Care ALI §4.01(a) p. 240 HH 119
Ds and Os have duty to perform functions
In good faith
In a manner he/she reasonably believes to be in co.s best interests
With care that an ordinarily prudent person would reasonably be expected to exercise in a like position & similar circumstances
Business Judgment Rule ALI §4.01(c)
D or O who makes a BJ in good faith fulfills duty if
Non interested party
Is informed to the extent he believes appropriate under circumstances
Rationally believes it to be in Corp's best interests
Gagliardi v. Trifoods Intl Del 1996 p. 241 HH 120
When a Director is independent and disinterested there can be no liability for Corp loss unless facts are such that no person could possibly authorize such a transaction if they were trying to exercise their duty in good faith
Del §145 Indemnification
§145(a) can indemnify in any action brought as a result of person's connection to corp so long as they act in good faith, even if they lose
§145(b) can indemnify in actions brought by the corporation itself
not if they are found liable to corp, unless court gives OK
§145(c) mandatory indemnification for D or O successful in defending an A or B action
§145(g) Corp can purchase insurance against any liability even if they can't indemnify for it
good faith generally required p. 243
Waltuch v. Conticommodity Services 2nd Cir. 1996 p. 243 HH 121
Waltuch executive and trader for Conti
Silver crashes and CFTC brings action for fraud and market manipulation
Waltuch dismissed from private suit but Conti has to pay $35 Mil, Waltuch incurs $1.2M in legal fees
Waltuch fined by CFTC $100K and penalized with another $1Mil in legal fees
Can't §145a indemnify in absence of good faith
§145(c) requires indemnification if successful “on merits or otherwise”
since he was dismissed he was successful
even though only really dismissed b/e Conti was prime target
D & O insurance p. 248 HH 122
Del §145f
RMBCA §8.57
Kamin v. American Express NY 1976 p. 248 HH 122
Amex loses $26 Mil on a stock purchase
Instead of selling and using the devaluation to offset capital gains, Amex distributes the shares in a special dividend to avoid accounting losses
BJ protection
No claim of fraud or self dealing or bad faith
Business Judgment Rule a la ABA Valid BJ if
Financially disinterested D or O
Duly informed
Good faith effort to advance corp. interests
Since it is an issue of law not fact, Ds and Os are insulated from juries
Economically appropriate b/e you don't want to discourage risk taking
Smith v. Van Gorkom Del 1985 p. 253 HH 123
On CEO's recommendation, Board approves Merger in a 2 hour meeting w/o any other information
D's held grossly negligent by not becoming even reasonably informed
Legislative Response: DGCL §102(b)(7) validated charter amendments that provide that a D has no liability for losses when violating duty of loyalty if disinterested
Breach of Duty of Care rebuts BJ rule entire fairness review
Mcmillan v. Intercargo Del 2000 p. 256 HH 124
Intercargo sells itself at $12/share alter apparently turning down $14/ share
Charter immunizes D's under Del §102(b)(7) for duty of care breaches
Eliminates Revlon and Disclosure claims as they relate to care
Î 's only remedy then becomes Duty of Loyalty
Î never really alleges any bad faith or self dealing Dismissed
Cede v. Technicolor Del 1995 p. 261 HH 125
Board authorizes sale based on little info
Breach of duty of care does not require proof of injury to rebut BJ rule
Breach of loyalty or care rebuts BJ rule and required Ds to prove entire fairness
If Î established PF case of negligence, D's must prove due care or entire fairness
Emerald Parnters v. Berlin Del 2001 p. 264 HH 125
1 interested controlling SH rest Independent Ds
Independent D's had burden of showing entire fairness b/e of the 1 interested one (he was in the room with them when they voted).
Francis v. United Jersey Bank NJ 1981 p. 266 HH 126
Charles Sr. commingles company funds with personal loans
Son goes nuts and bilks the company
Mrs. Pritchard was on the Board but never exercised any oversight
Board has responsibility to monitor, she breached duty of care
Her sons “spawned their fraud in the backwater of her neglect”.
Hoye v. Meek 10th Cir. 1986 p. 270 HH 126
Son makes a bad investment and Trust co. goes to pot under semi-watch of semi retired father and chairman of the Board
If he's on the board he's got the duty to monitor, breached Care
Graham v. Alice Chalmers Del 1963 p. 271 HH 127
Electrical equipment company
1937 fined by FTC for price fixing
Late 1950's fined again
SH sues claiming Board should have been on notice to monitor b/e of previous claims.
D's entitled to rely on honesty of subordinates until something occurs to put them on suspicion
Liability will only attach through neglect if
Reckless confidence
Neglect of duty
Ignored willfully or through inattention obvious signs of danger
In re Caremark Del 1996 p. 276 HH 128
Caremark gets fined under laws preventing physician referral kickbacks
Company has a compliance system in place including ethics guide books.
b/e of compliance system, little chance of winning
Failure to monitor only a sustained or systemic failure of Board to exercise oversight.
D have duty to see that a reasonable control system is in place designed to offer a reasonable assurance of compliance.
Miller v. ATT 3rd Cir. 1974 p. 282 HH 128
ATT makes a $1.5 Mil loan to DNC and doesn't bother collecting
SH bring action claiming it is a violation of lthe law as an illegal contribution
Court holds private right of action exists vis-Ã -vis SH because they were the protected class
BJ rule doesn't apply to illegal acts
IX. Conflict Transactions Duty of Loyalty
2 types of transactions are closely controlled
When a D or controlling SH has a financial stake in the transaction
Substantial decisions
Loyalty generally to the SH - SH primacy
Penn §1715(a) D's may consider HH 130
Effects on all groups including SH, employees, suppliers, customers, and creditors and communities
Short term and long term interests of the corporation
Resources, intent, and past conduct of any would-be acquirer
All other pertinent factors
Dodge v. Ford Mich. 1919 p. 286
Shareholder primacy
Henry Ford can't give Corp money to charity.
Can't donate unless it benefits the corp.
AP Smith v. Barlow NJ 1953 p. 288 HH 132
Corp. makes modest donation to Princeton
1930 NJ statute allows Corps to be charitable if D's believe it will contribute to protection of corp interest
1950 statute allows donations of up to 1% of capital unless SH wuthorize
Î syas statutes not elegible b/e Corp already incorporated
BUT NJ legislature has reserved power to amend charters
Donation OK
No suggestion that it was indiscriminate
No suggestion that it was for a D's pet charity
Hayes Oyster Co. Wash 1964 p. 294 HH 132
Hayed D, 23% SH and CEO Corp. has CF problems and Hayes convinces the to sell 2 oyster beds
Hayes convinces an employee to buy them and finances him in exchange for 50% ownership.
Interested transaction not voidable if D or O can show that they were fair
However, nondisclosure is per se unfair
Intent to defraud or injury not necessary (punctilio)
Coastal has option to affirm or ratify
Chooses to affirm, and Hayes' 50% now belongs to Coastal
Duty of Disclosure p. 297
All information
Not necessarily price
Sinclair Oil v. Levien Del 1971 p. 299 HH 133
Sinclair 97% ownership of Venezuelan subsidiary
Milks the subsidiary, declaring dividends and minimizing capital investment.
Sinclair owed Sinven a Fiduciary duty
Intrinsic fairness applies only with self-dealing
Since minority SH got their fair share of dividends no self dealing no total fairness test
Parent not found to be responsible for sharing business opportunities
Sinclair says fairness review in parent subsidiary only necessary when parent receives something to the exclusion of the minority SH.
P. 302 this test disused, now all controlling actions get the fairness treatment.
Cookies Food Products Iowa 1988 p. 303 HH 134
Duane “Speed” Herrig makes the company with his distribution agreement, then becomes majority SH
Gives himself distributing deals, salary, and royalties on a sauce recipe he invents.
Agreements all benefited cookies, and court “unconvinced that they weren't fair” unclear where the court places this burden
Board was aware, and court finds compensation reasonable
DGCL §144(a) approval of an interested transaction by an informed board authorizes the transaction but does not preclude a fairness review
Kahn v. Lynch Del IC approval shifts fairness burden to Î
Cooke v. Oolie Del 2000 p. 311 HH 134
Minority SH claim a particular acquisition target was chosen to protect debt investments in TNN
Interested D who is not a majority SH and discloses his interest, and a majority of Independent D ratify transaction BJ rule
Lewis v. Vogelstein Del. 1997 p. 315 HH 135
SH ratification ineffectual if
Majority has a conflict of interest
Transaction constitutes Corporate waste.
In Re Wheelabrator Del 1995 p. 316 HH 135
In absence of a controlling SH, SH ratification of an interested transaction results in BJ rule with Î 's Burden.
For disinterested approval consequences, see HH 135.
(BOP)
RMBCA §8.61 7 DGCL §144
ALI
Neither Board nor SH approve
Entire fairness(d) but siliconix, no obligation to pay fair price in non-coercive tender offer
Entire Fairness(d)
Disinterested D's authorize
BJR(P)
Reasonable belief in fairness (p)
Disinterested D's ratify
BJR(P)
Entire Fairness(d)
SH ratify
Waste(P)
Waste(P)
Lezis v. Vogelstein Del 1997 p. 322 HH 138
O and D stock option grants get BJ Rule
Other compensation tidbits from same neighborhood
Sarbanes Oxley no loans to D's or Os
Compensation Siclosure reqmnts p. 325
Corporate Opportunity Doctrine
Broz v. Cellular info. Systems Del 1996 p. 332
Broz owns RFB and is CEO of CIS
Mackinac offers to sell a license to RFB, does not approach CIS
Broz confirms w/ some CIS D's that they're not interested, then buys
Pricellular buys CIS and sues Broz claiming he took a corporate opportunity
No dudty to Pricellular
Not a CIS opportunity (CIS broke)
No requirement of formal Board presentation, though it is a safe harbor
O or D may not take an opportunity if
Corp is financially able to exploit it
Op is w/in Corps LOB
Corp has an interest or expectancy in the opportunity, &
Taking the Op will place him in a position inimical to his duties
May take an Op
Presented to him in his individual capacity
Op is not essential to the Corp
Corp has no expectancy or interest
He hasn't wrongfully employed Corps resources in pursuing Op
Presentation to CEO Not a safe harbor - Telxon p. 336
Donahue v. Rodd Electrotype Mass. 1975 p. 338 HH 139
Closely held corp, buys out a retiring D at $800/share
Minority SH Donahue wants to sell at same price but isn't allowed to.
Limited to closely held Corps. Ie
Small # of SH
No ready market for corporate stock
Substantial Maj. SH participation in Mgt.
SH in a closely held corp. owe same duties as partners
In a selected purchase, if seller was a member of the control group, the repurchase must be open to all SH on a pro rate basis p. 342 equal opportunity
Smith v. Atlantic Properties Mass 1981 p. 344 HH 139
4 person equally owned corp, requiring 80% SH approval for any action
Wolfson keeps vetoing dividends partly for tax reasons partly spite
IRS assesses big ole' fine for unreasonable accumulation
Trial court holds Wolfson breached his Fiduciary duty and makes him indemnify fines.
“the 80% provision” reverses the roles of minority and majority, making the minority an ad hoc controlling interest
X. Shareholder Lawsuits
Derivative Suit - assertion of a corporate claim against a D, O or Third Party
Brought on behalf of the Company
Theoretically 2 suits
1st against Board for not bringing suit
2nd it Corp. claim itself
Direct Actions (often class actions)
Common Fund Doctrine: Attorney's fees can be paid out of a settlement which creates a common fund for the benefit of people in addition to the plaintiff
Fletcher v. A.J. Industries Cal 1968 p. 352 HH 142
SH bring derivative suit against company and D's alleging damages resulting from 1 D's domination of the board and another's overpayment.
Î 's lawyers negotiate a settlement reducing D's influence and removing other one, referred money claims to arbitration
Settlement says Î fees only in case of monetary award in arbitration
Î 's attorneys apply for fees anyway.
Court applies Substantial benefit rule - when the corporation receives substantial benefits from the litigation and no fund exists, Î 's can be paid
Dissent p. 354 points out substantial benefit is no threshold, and that without a fund, fee payments could force inefficient asset liquidation.
Agency costs in SH litigation p. 355
Strike suits (hold ups)
Settlement too appealing for both sides, lawyers get paid and D's avoid anything too bad, usually just their insurance that pays.
Fed Rule 23.1 - Standing in Derivative Actions (also in Del)
Î must be SH for duration of the action
Î must be SH at time of alleged wrong
Î must be able to fairly and adequately represent the interests of SH
No obvious conflicts of interest
Complaint must specify what actions the have taken to get the board to sue (demand requirement) or why they haven't done so.
Aronson Demand Futility Test
Must be reasonable doubt either
Ds are disinterested and independent and
Challenged transaction was otherwise valid BJ
Demand requirements, Î 's must either have demand denied, or prove futility
Levine v. Smith Del 1991 p. 364 HH 143
GM buys out Ross Perot for money and an agreement not to wage a proxy contest or criticize mgt
Must establish doubt about independence of a MAJORITY of the board
In order to establish Demand futility Î must
Establish that the directors (majority?) are interested and dominated incapable of passing on a demand, or
Create a reasonable doubt that the challenged transaction is sound enough to be protected by the BJ rule
Making demand is a concession of Board independence Spiegel p. 367
G. comparative approaches to above under RMBCA and ALI HH 144
RMBCA - no assumption when demand is made
Rales v. Blasband Del 1993 p. 368 HH 144
Rales Bros take over Easco and issue $100Mil in notes to “finance investments”
Instead invest in Drexel junk (happen to be Milken friends)
After deal but before suit, Rales merge Easco indo another of their companies, Danaher
Where the board that would be considering demand is not the board that made the challenged decision, complaint must raise doubt regarding ability of a majority of D's who must decide demand to properly exercise BJ if demand were made when suit is filed p. 373
Court finds 3 D's out b/e they were involved, and 2 D's out b/e they had strong financial ties to Rales Bros. 5/8 reasonable doubt as to majority to exercise independent BJ Demand excused
Special Litigation Committees
NY if SLC is independent BJ rule
Del Zapato, court will determine appropriateness of SLC
Zapato Corp. v. Maldanado Del 1981 p. 375 HH 145
Î files suit, and demand is excused
4 years into litigation Zapata appoints 2 Indep D's to serve as an SLC
shockingly enough they recommend dismissal
passing demand does not create a SH right to continue suit
interest taint of Board Majority does not bar SLC's legitimacy per se
Zapata 2 step to analyze an SLC's decision to cancel litigation p. 379
Corp. burden to show independence, good faith and reasonable investigation
Court will determine base don its own BJ
Where appropriate court should give consideration to matters of law and pub policy p. 380
Joy v. North 2nd Cir. 1982 p.381
BC analysis of an SLC's decision to dismiss
Are expected damages >/< expected costs?
Delaware Decision Tree:
Carlton v. TLC Beatrice Del 1997 p. 386 HH 147
Lewis does an LBO of Beatrice and gets a $19.5 Mil compensation
Big bank Sh brings derivative action
SLC negotiates a settlement where Lewis estate repays $14.9 Mil
Passes Zapata 2 step
SLC proceeded in good faith & informed
“cannot conclude that the settlement is badly off the mark
treats 2nd step as a test of “egregious or irrational”
XI. Transactions in Control
Zetlin v. Hanson Holdings NY 1979 p. 395 HH 148
Hanson and Sylvestri sell their 44.4% controlling interest for a 100% premium
Minority Sh brings suit claiming a right to a pro rata opportunity to recognize premium
NY court holds that a controlling SH is free to reap a control premium absent
Looting of corporate assets
Conversion of a corporate opportunity
Fraud or other acts of bad faith
Perlman v. Feldman 2nd Cir. 1955 p. 396 HH 149
Steel company with unique opportunity to direct output
Controlling SH sells to customer who wants to ensure his supply at a substantial premium
Finds it to be a sale of a corporate opportunity and rules that the premium belongs to the company
BOP on defendants to establish fair dealing p. 399
When a sale results in the sacrifice of this element of corporate goodwill and consequent unusual profit to the fiduciary who has cause the sacrifice, he should account for his gains.
On remand forced to share premium pro rate with other SH
In re Digex Del 2000 p. 406 HH 154
Worldcom buys Intermedia which owns 52% of Digex
Seeks a waiver of Del §203 to allow Worldcom to pursue a freeze-out merger before the 3 year moratorium.
Board grants waiver
Ruling: Board can only grant waiver for benefit of the corp. as a whole
Harris v. Carter Del 1990 p. 408
Buyer loots
Carter should have done more investigation before selling his control SH
Presence of several “warning signs”
Seller of a control block, if reason to reasonably foresee a danger, owes a duty to reasonably investigate potential purchaser p. 412.
1967 Williams act regulates tender offers
must disclose if you accumulate 5% or more voting shares
disclose identity, financing and future plans
prohibits misrepresentation
mandatory terms
20 day acceptance window
must pay all who tender
Brascan v. Edper SDNY 1979 p. 415 HH 154
Offer to solicit a large but not controlling block found to not be a tender offer
No widespread solicitation
Didn't provide for tenders or security
Not at a fixed price
Not contingent on acquiring a certain # of shares
Wellman p. 419
Tender offer found
Fixed price open for an hour
P. 417 8 factors that make a tender offer
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XII. M&A
p. 428
Mergers require majority SH vote
Minority dissenters can receive judicial appraised value
Mergers can be stock for stock
SH vote required if a co. issues 20% of its outstand ing stock in a single transaction
DGCL § 270 sale of substantially all assets requires vote p. 430
DGCL §251 Statutory merger HH 157
Acquirer votes if
Its charter is modified
Its SH shares change
Increases outstanding chares > 20%
Target always votes
DGCL §271 Stock/Asset acquisition
T SH get voting and appraisal rights
Increased Transaction costs b/e titles must be changed
Often made through wholly owned subsidiary to avoid
Katz v. Bregman Del 1981 p. 432 HH 158
PI sells its Canadian operations 51% of assets 45% of rev, and 52% of operating income
But most or all of net profit
Held to be a sale of substantially all assets
Thorp v. Cerbco Del 1996 p. 434 HH 159
Cerbco's wnership of insituform is 68% of assets.
Substantiall all assets SH vote and controlling SH can block
Need for SH approval not measured on size alone, but also on its qualitative effect on the corporation
Thorp and Katz represented prime profit centers.
Getting the whole pie
Most J's allow a short form compulsory cash out merger by a party controlling 90%
Del doesn't but you can do a 2 step
Step 1 A gets most shares
Step 2 A executes a cash-out merger of T into itself or a subsidiary
Triangular mergers involve a subsidiary which purchases (liability shield)
Reverse triangular the subsidiary folds into the target (no transaction costs relating to title)
Merger considerations p. 439 HH 160
DGCL §262 appraisal process p. 453 HH 160
§262 h no element of value arising from the accomplishment or expectation of the merger.
But wee Weinberger v. UOP which trashes this sort of.
Market Out rule DGCL §262(b) appraisal in a statutory merger (if you dissent)
§262(b)(1)No appraisal rights if your shares are market-traded, or company has 2K plus SH, or SH vote not required for merger.
§262(b)(2) Yes appraisal rights if your consideration is not shares in the survivor, or shares in an exchange traded/2k SH company.
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Valuation
Del SH entitled to Pro Rate claim on Corp. as a going concern
Del Block Method looks at
Mkt value of shares
Earnings value last 3 years
Asset Value
Weinberger v. UOP approved DCF method
In Re vision Hardware Del 1995 p. 456 HH 162
Vision nearly bankrupt TCF, major creditor, exhanges debt for assets, and cashes out minority at $125,000
Court holds TCF didn't have to convert to equity, and company was worthless
SH entitled to no element of value arising from the transaction
Hariton v. Arco Electronics Del 1963 p. 460 HH 163
Loral buys Arco in arms length asset acquisition
Loral gets Arco assets and Arco gets Loral stock, which it distributes
Arco SH wants appraisal b/e of De facto merger
Del doesn't recognize de facto mergers
No right to appraisal b/e leg didn;'t explicitly provide one
RMBCA gives appraisal rights in all restructurings
Loyalty in controlled Mergers Singer v. Magnavox Del 1977 HH 164
Challenging a freeze-out merger on breach of fiduciary duty of fairness
Can bring class actions in addition to appraisal
A freeze-out w/o a colorable business purpose breaches fairness duty per se
Getting rid of minority not a legit purpose
Minority SH remedy recissory dmgs
Weinberger v. UOP Del 1983 p. 465 HH 164
Signal owns majority of UOP
2 common directors make a proposal to buy UOP
determine it's a good value up to $24
Interested directors negotiate deal and propose it
Independent directors approve at $21
Î challenges as breach of fiduciary duty
Obvious breach by not sharing all info
Widens acceptable valuation methods to include DCF
Allows some concept of merger added value into valuation process
Arm's length process strong evidence fairness
Remedies p. 475
Where Fiduciary duty as in
Parent subsidiary
Interested directors
2-step
Appraisal is not only remedy, can bring action for entire fairness
But not in an arms length one step
Fair price gets at the value created by the merger
Rabkin v. Hunt p. 473
Self dealing Entire fairness claim
Cede v. Technicolor HH 165
2 step merger process, Perlman had begun reorganization
Controller owes fiduciary duty to minority in a 2 step
Original price not presumptively fair b/e Perlman had begun implementing plan
Kahn v. Lynch Del 1994 p. 476 HH 166
Alcatel, 43.3% owner wants to buy rest
IC caves to a 15.50 price on threat of a hostile bid
“any semblance of arms length bargaining ended when IC surrendered to ultimatum”
even at 43.4% Alcatel exercised control entire fairness burden
with a controlling or dominant SH on both sides, it must prove entire fairness
In Re Western p. 482
Existence of standstill agreement not controlling
Merger gets BJ rule
In Re Siliconix Del 2001 p. 483 HH 166
Majority SH no duty to offer fair price in a tender offer unless
Actual coercion or disclosure violations
In Re Pure Resources p. 483 HH 167
Entire fairness not applicable to tender offers
Controlling SH tenders cannot be coercive
Not coercive when
Subject to nonwaivable majority of minority requirement and
Controlling SH promises prompt and equivalent cash out and
CSH has made no threats
Controlling SH owed duty to allow D's free reign & time to react
D's have a duty to hire their own advisors
Provide minority w/ recommendation
14ad-9 SH entitled to a fair summary of substantive advice of I-Bankers upon whose advice the Board relies
Then options become options to buy Co's stock for ½ price
Flip-over gives a right to buy acquirer's assets
Unocal v. Mesa Del 1985 p. 500
Discriminatory self tender offer, tender offer to everyone but Mesa
Mesa threatening coercive tender offer
In acquiring shares a corp can deal selectively if primary purpose is not entrenchment.
When defending against a take-over Enhanced BJ review
Board must demonstrate action was
Reasonably (proportionally) related to
A Reasonably perceived risk
If if meets these criteria BJ rule
UNOCAL THREATS HH 170
Structural coercion -front loaded 2 tier
Opportunity loss - hostile takeover threatens to rob SH of right to reap greater value under a mgt alternative
Substantive coercion - SH just don't know how much they're worth
Moran v. Household Del 1985 p. 508 HH 168
Flip-over pill
Approved meets Unocal
Smith v. Van Gorkom Del 1985 p. 513 HH 169
Gross negligence by board in not evaluating offer properly
No attempt to value enterprise
A premium alone is not sufficient bases for determining fairness
Need an independent appraisal/ commissioned valuation
Revlon v. Macandrews Del 1986 p. 520 HH 169
Board shoots itself a bit in the foot in order to placate some bondholders who wanted to sue
Concern for non-stockholder interests not relevant in a bidding war
Lockups and other methods only to be used to increase bidding
REVLON DUTIES HH 169
Level playing field among bidders
Market check
When board considering a single offer without reliable grounds to judge its adequacy, fairness demands a canvas of the marketplace to determine if higher bids may be elicited.
Limited exception
REVLON TRIGGERS
When a corp. initiates an active bidding process to sell itself or a business re-org involving a clear break up
Where, in response to a bid, it abandons its long term strategy and seeks an alternative transaction involving break up
Change in control (30% or so threshold for control) QVC
Paramount v. Time Del 1989 p. 524 HH 170
Time and Warner agree to a stock for stock merger
Paramount tries to acquire Time, to avoid SH vote time issues bonds and buys warner
Claim unreasonable under Unocal and Revlon duties active
Unocal: threat of SH making a mistake found to be enough to justify response
This guts Unocal
Revlon no change of control foundb/e control was with market and will stay with market.
Paramount v. QVC Del 1994 p. 530 HH 171
Paramount agrees to be acquired by Viacom
QVC tried to buy
Revlon duties triggered by initial decision towards change in corporate control
Viacom lockups not justified
Cant claim protecting corp vision when you're selling control
Revlon Mode more likely when HH 172
Consideration is cash instead of assets (Revlon)
Acquirer is larger in comparison to Target (Revlon)
Acquirer has a controlling SH (QVC)
Deal Protections and lockups p. 544
CTS v. Dynamics Corp. US 1987 p. 549 HH 174
Dynamics makes hostile offer for CTS
Challenges Indiana anti-takeover statute
Statute upheld
Non discriminatory
Not in conflict w/ Williams act
DGCL § 203 Bars business combination between A and T for 3 years after A gets 15% unless
§203(a)(1) advance board approval
§203(a)(2) A gets over 85% in first step
§203(a)(3) Board approval and 2/3 disinterested SH approval
Proxies:
In order to circumvent the pill, a proposed avquiror must gain board control to have it redeemed.
Schnell v. Chris-Craft Del 1971 p. 559 HH 177
Dissidents negotiating to avoid costly proxy fight
Mgt strings them along, then moves up the meeting to leave them too little time to organize.
Get an injunction delaying meeting
Blasius v. Atlas Del 1988 p. 560 HH 177
Blasius plans to launch proxy war to gain control of Board
Atlas creates 2 new board positions and fills them
Court holds D not entitled to BJ rule when Fucking w/ SH franchise
Unitrin v. American General Del 1995 p. 564 HH 178
AmGen makes hostile takeover bid
Board institutes morning after pill and repurchases 20% of shares
Gives D's a 28% stake and gives them a veto over a freeze-out
Makes a proxy test pretty tough (but they had enough before anyway?)p. 566
QVC test is under a range of reasonableness
If measures are proportionate (non draconian) BJ rule
Draconian -coercive/preclusive
Î 's must show motive was:
entrenchment
bad faith
uninformed
preclusive is mathematically impossible or realistically unattainable
erodes Unocal
Hilton v. ITT Nev. 1997 p. 571 HH 178
ITT does the 3 way split and distribution and gives the prime spin-off a classified board
Classified Board found to be preclusive
Structural Defenses HH 180
Poison pills HH 182
Mentor Graphics Del 1998 p. 573
Hand pills in which board limits power of future boards are illegal
Mandatory pill redemption by laws - generally not gonna work p. 575 HH 182
XIV. Trading in the Corporations Securities
Goodwin v. Agassiz Mass 1933 p. 578 HH 186
Î 's had knowledge of a geologists report suggesting mineral deposits
Buy shares from Î
Since theory was speculative, not required to disclose it to SH
Not found illegal
Freeman v. Decio 7th Cir. 1978 p. 583 HH 186
Decio resigns as CEO
2 months later Skyline announces unexpected 17% earnings drop
Freeman alleges past earnings had been overstated, and Decio inter alia sold stock with that knowledge
§16(a) Statutory insiders (Ds, Os, and 10% SHs) must file reports of any trades w/in 2 days
Officer status = access to nonpublic information in course of employment
§16(b) insiders must disgorge any profits made on purchases and sales w/in any 6 month period
exemption for unorthodox transactions ie cash out merger (involuntary sale)
Calculating the 6 month swing under Gratz. V. Claughton as incriminatingly as possible
SEC §10 p. 590 unlawful to use or employ in purchase or sale of any security, any manipulative or deceptive device or contrivance in contravention of such rules as the Comission may proscribe as necessary or appropriate in the public interest.
P. 590 §10b-5 it shall be unlawful
To employ any device, cheme or artifice to defraud
To make any untrue statement or material fact or omit a material fact necessary in order to make statements made, in the light of the circumstances, not misleading, or
To engage in any act, practice or course of business which operates or would operate as fraud or deceit on any person, in connection with the sale or purchase of any security
Private right of action found in Kardon v. National Gypsum p. 591
SEC v. Texas Gulf Sulphur 2nd Cir. 1968 p. 592 HH 190
TG employees buy on information about a mineral deposit
Insiders not trading on an equal footing
Violation of 10b-5
3 theories of 10b-5 liability
Equal Access - all traders must disclose or refrain from trading on non-public corporate info. (Tex Gulf Sulfur)
Fiduciary Duty - must show a specific pre-existing legal relationship of trust and confidence between insider and counterparty (Chiarella, Dirks)
Misappropriation - a person who has misappropriated nonpublic info has an absolute duty to disclose or refrain from trading (Burger dissent in Chiarella)
Santa Fe Industries v. Green US 1977 p. 598 HH 191
Santa fe buys 95% of green and the executes a short form
Morgan Stanley appraises assets at $640/share and stock at $125/share
SF discloses stock valuation and offer $150
Î 's bring 10b5 complaint
Supreme court holds no fraud was here and doesn't want to fold fiduciary claims into 10b-5 claims, Î 's msut sue in state court on the fiduciary issue.
Goldberg v. Mentor 2nd cir. 1977 p. 603
Brings it back to reality
10b-5 claim exists where there is misrepresentation or non-disclosure
Chiarella v. US US 1980 p. 608 HH 192
Chiarella works in a print shop deciphers deals, and trades on them
Consent decree w/ SEC agreeing to return profits to SH
Supreme court overturns conviction b/e 10(b) doesn't say that silence is a manipulative or deceptive device
Cady obligation to disclose applies to statutory insiders
Its only fraud to not disclose info if you're under duty to do so
Must have a relationship of trust and confidence RETAC
Maybe he breached a duty to the corp. who gave him the info dicta
Dirks v. SEC US 1983 p. 612 HH 193
Former officer of Equity tells an investment advisor the Equity has overstated its assets
Dirks clients sell their shares
Must have abreach by the tipper to have a breach by the tippee
If tipper doesn't gain no breach
Going forward p. 616
SEC finds benefit by tippee from personal relationships
If trader “overhears” something he's not an intended beneficiary
US v. Chestman 2nd Cir. 1991 p. 619 HH 194
Telephone game of telling people about the Waldbaum sale everyone told not to repeat it, Loeb(married into the Waldbaums as his broker knows) tells his a stockbroker
Broker, Chestman sys he can't make any recommendations to Loeb
Chestman buys for himself and his clients including Loeb
Loeb rolls over and repays 25K in profits and pays 25K fine
Finds 14e3 is w/in SEC's reasonable scope
Dismisses §10b-5 b/e it requires
Breach of duty by tipper
Known by tippee
Finds no fiduciary duty in Loeb, govt failed to show
Loeb was in family inner circle
Sec adopts 10b5-2 extending the liability to persons who
Agree to maintain a confidence
Are in a relationship where confidences are routinely exchanged
When he gets it from a spouse or family member unless he can show no duty of trust or confidence
Rule 14e-3
It is a violation of the '34 securities act to purchase or sell securities on the basis of information that the possessor knows or has reason to know is non-public and originates with the tender offerror or target or their officers
D, also violation for possessor to communicate such information under circumstances in which tippee is likely to trade on it
US v. Carpenter 1987 US HH195
WSJ reporter shares and trades on some info she learns
Splits on 10b-5 under misappropriation but upholds mail and wire fraud convictions
US v. O'Hagan US 1997 p. 624 HH 196
Grant Met hires DW to represent it in acquisition of Pillsbury
Ohagan a Pner not involved in the deal buys stock
DW withdraws from representation, and GM Makes the offer
SEC brings criminal charges against ohagan, 8th cir. Reverses conviction
Supreme Court upholds conviction and the misappropriation theory
Elements of a 10b-5 action
False or misleading statement or omission: Chiarella, Dirks, O'Hagan
Materiality: what would a reasonable shareholder would consider. Basic - probability x magnitude test.
Scienter: specific intent to deceive, manipulate, or defraud (Ernst & Ernst), though may be inferred from reckless or grossly negligent behavior.
Standing: must be a purchase or sale of securities (Blue Chip Stamp).
Reliance/Causation: presumption of reliance on the integrity of market price (Basic).
Injury/Damages: disgorgement rule (Liggett).
Basic v. Levinson US 1988 p. 629 HH 197
Basis in merger negotiations w/CE for 2 years
Rumors circulate and Basic flatly denies them
SH sell after first public denial sue claiming a 10b-5 misleading statement
Court finds it material
An omitted fact is material if there is a substantial likeliehood that a reasonable SH would consider it important in deciding how to vote -TSC Northway
Must be a substantial likeliehood that the disclosure of the omitted fact would have been viewed by the investor as significantly altering the “total mix” of info made available
10b5-1 Trading pursuant to a preexisting plan HH 14 OK if can demonstrate
ordered sale, or written plan to do it before getting the info and
contract, instruction or plan specified the number and price or an algorithm for determining such or didn't permit the person to influence it and
trade conducted pursuant to plan
Elkind v. Liggett & Meyers 2nd Cir. 1980 p. 640 HH 199
Lm tells analysts about negative earnings for next day
Analysts sell clients stock stock drops 5546
SH bring class action against LM
Finds damages to be disgorgement
Out-of-pocket measure: Price paid minus “true value” when bought. Here, P can recover ($48 - $40) * 10,000 shares = $80,000.
Causation-in-fact measure: Price decline caused by D's wrongful trading. Here, P can recover ($50 - $48) * 10,000 shares = $20,000.
Disgorgement measure: Post-purchase decline due to disclosure, capped at gain by tippee. Here, same as out-of-pocket measure by assumption ($80,000), capped at gain by tippee ($50,000) = $50,000.
ITSA 1984 and ITSFEA 1988 amendments to 1934 act HH 200
§20A creates private right of action for any trades opposite an insider trader with dmgs limited to profit gained or losses avoided (disgorgement)
§21(a)(2) civil penalties up to 3 times gain
§21(a)(1)(B) controlling person may be liable if controlling person knew or recklessly disregarded the likelihood of insider trading and failed to take preventative steps
§21A(e) “bounty hunter” allows SEC to provide 10% of recovery to those who inform on insider traders.
Hierarchy of remedies
§21(d) SEC can seek disgorgement
§21A(a) if SEC fails to act, or if any profits are left over after SEC acts, contemporaneous traders can seek disgorgement as well
§21A(a)(2) SEC can seek civil penalties up t 3x gains in addition to disgorgement
Arguments against insider trading rules p. 646 HH 201
Compensation - Insider trading increases incentives to create valuable information
Doesn't the fiduciary duty do that?
Comunication - it provides a valuable and credible mechanism for communicating information to the marketplace
Not unfair - people will pay less for securities because of the danger so they'll get the same rate of return
