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Business Associations Illig
University of Oregon

Additional Law Flashcards




Reasons why corporations are preferred
Limited Investor liability
Hierarchical management
Jenson v. Cargill
Farmers suing Cargill to get money but it was Warren's grain elevator they were using

-If Cargill is the principal, it's actually Cargill's contract. The agent is simply the right arm, and this is ultimately controlled by the head (Cargill)

Agency- Is there (1) consent by both parties (2) the agent acts on the principals behalf, or (3) they are subject to principals control

Affirmative control: Although Cargill claimed to only finance Warren's company, Cargill's control became affirmative when the began telling him what to do.

Rule: Follow the money--The checks are signed by Cargill, so Warren is simply an agent of Cargill, and Cargill as the principal is on the hook for the money owed the farmers
Mill Street Church of Christ
Brother of painter falls off of ladder after only a few minutes of work

Q: Did he have authority to hire?

Implied Authority: We ask whether the person in the agent's shoes, under the circumstances would believe he had the authority to hire his brother

He had "implied authority" to hire because he had hired his brother before
Watteau v. Fenlich
Classic British Brewmaster

Bartender was purchasing cigars from Watteau which he wasn't supposed to do--Still he had "inherent" authority because his name was still over the bar even after he sold it, and nothing had seemingly changed in terms of how it ran

Although he did not have actual authority, he did have inherent making the business owners accountable for his transactions

-->IF there's a principal, it doesn't matter if you know that he exists or he doesn't exist, the principal will always pay the debts of the agent. It doesn't matter if the principal is disclosed or undisclosed.
A matter for partnerships 3 types:
1) Express/Actual authority--directly given by principal to the agent--a manifestation to the agent to act on the principal's behalf

2) Implied- The agent's powers are practically necessary to carry out the duties actually delegated; whether the reasonable person in the agent's position would believe he has the authority to act.

3) Apparent--depends on manifestations from the principal to the 3rd party
1) manifestation by the principal that the agent has the authority
2) reasonableness of the third party to believe that this person has authority

4) Inherent Authority--this is authority that comes with the job
--->it generally applies if it is in the ordinary course of business, or is some type of transaction the two parties have done before
Hodderson v. koos Bros
Lady ripping off furniture store

She is demanding a refund because nameless salesman took her cash money and never delivered the couch

• Holding: Essentially there’s no way to hold the store liable on an agency theory, because they didn’t hold this person out (they don’t even know who it is). The court feels bad, and that there is negligence here. The department stores job is make sure thieves don’t wander in and take people’s money. The court did not find agency here, but they did think there was tort negligence and vicarious liability. The plaintiff can bring the claim and show that the defendant failed to monitor the store and should be held liable.
Botticello v. Stefanovicz
Guy trying to exercise option to purchase a farm

• Facts: In this case, the two defendants (married couple) Mary and Walter owned the property jointly. The plaintiff in this case came to the defendant Walter and asked him if he wanted to sell, Walter told him the price was $100,000. The plaintiff returned and made a counter offer for $75,000 but Mary said she would not accept. She said she could sell for $85,000, and the plaintiff returned again and he and Walter executed a deal for that much. The deal was reviewed by both parties’ lawyers but at no time did Walter mention that he was acting for his wife as her agent. The plaintiff had an option to purchase and he attempted to execute it. However, the defendants resisted.
• Issues: Did Mary (the wife) ratify Walter to be her agent based on his conduct?

• Holding: Ratification requires affirmation by the other party of the action and this is demonstrated by intent. Receipt of benefits (taking money from the buyer) is important but it has to be combined with other actions to demonstrate that this was ratified by Mary, this would include Mary knowing the entire situation about the benefits (like the option to buy the house) and an intent to ratify.

• Notes: She knew there was a lease. This is ratification of the lease itself. She knows the lease is month to month, and she willingly accepts the rent checks. What she didn’t know was the important term: the option to buy the property.
• Ratification Elements:
• (1) Acceptance of the Result of the Act
• (2) Intent to Ratify
o The wife had no intent to ratify
• (3) Full Knowledge of All The Material Circumstances
o The wife had no knowledge of all material circumstances

• Silent Ratification:
• You can technically ratify by silence. If you go to a broker, and ask him to buy something safe. Instead, the broker buys something crazy but when you get the statement, you saw that he made you thousands of dollars. If you don’t say anything, and the next week the market crashes, you have ratified this transaction. Normally, silence is not ratification because you need to do something to ratify. But in certain cases, like a choice not to do something, you can demonstrate ratification.
Never Create one

It is the default form of a business association

Every partner is an agent of the partnership, and every act by an agent is binding upon the entire partnership

- Every partner and either partner has power over management if it's in the ordinary course of business
- If it's extraordinary, the partner has to have unanimous approval from all of the partners to execute this measure

There is no continuation of a partnership if one of the partners leaves; it can be renegotiated but at that point a new partnership is formed

Each partner has an equal share of the partnership, regardless of their original or prolonged capital investment
Martin v. Peyton
Was there a partnership?

Peyton gives this guy Hall a butt load of liberty bonds and then liquid securities, and Hall keeps investing the poorly, so Martin (the creditor) comes after Peyton for the cashish

• Holding: The agreement did not establish a partnership. Although Peyton had some control over the business, the control bargained for was merely to ensure that his investment was secure. The business owner was still able to control the day-to-day affairs of the business. Two or three provisions contained in such a contract do not require a partnership conclusion, yet sometimes there also reaches a point where stipulations immaterial separately cover so wide a field that we should hold a partnership exists. Here, that point has not been reached.

Despite Peyton's influence on the business, he was just doing this to ensure he got his cash back; a partnership is two or more people conducting business for profit and therefore, there was not a partnership in this case
NABISCO v. Stroud
Do the Grocer's owe NABISCO

Stroud and Freeman throw a GP together to run a grocery store, and at one point Stroud tells NABISCO he's not buying their bread anymore, but then Freeman orders some

• Two Categories of Partnership Binding:
(1) Ordinary Course of Business
o In the ordinary course of business, each partner has the full, actual authority to make decisions that are completely binding on the partnership.
o Test: See what type of business the partnership is in, or what type of business the partnership has conducted in the past.
• Ex. Blockbuster selling movies
• Ex. Coldstone buying ice cream from suppliers
(2) Extraordinary Course of Business
o Outside of the ordinary course of business, you must have every partner agree on the deal in order to bind the partnership to conduct.
• Ex. Engaging in BK proceedings

Rule--in a 50/50 GP any decision within the ordinary course of business made by any partner alone is binding on the entire partnership
8182 Maryland Associates v. Sheehan
80's law firm with a huge lease--creditor goes after former partner with serious cash

• Holding: Each succeeding partnership became jointly and severally liable for rent payments only during the period the partnerships were in privity of estate with the real property company. Privity of estate, demonstrated by occupation of the leased premises and payment of the rent, ends when those members of the partnership leave. Thus, the defendants are not personally liable for rent arising after they left the partnership.

o Winding Up Partnerships: Partnerships end when they dissolve, and someone says something. This is metaphysical though, because the business hasn’t actually ended. Imagine a law firm: even after the partnership has technically ended, you still have cases to take care of, bills to pay. Winding up the business means you have the intent of shutting down, and your winding it down by writing letters to employees and clients, notifying them that the partnership is over. You have to sell the computers, pay the last payroll, etc.

o Transferring Partnership Interests: You can’t sell an interest in a partnership. You can’t force your partner into an involuntary relationship with a new partner. You can’t transfer your right to show up to partnership meetings and vote.
Meinhard v. Salmon
• Fiduciary Duty in Partnerships: A partner in a partnership is held with the highest fiduciary duty to his partner.
• Facts: Salmon (runs the business) and Meinhard (has the money) enter into a partnership whereby they would split the partnership profits by 50% each. Meinhard was behind the scenes as an investor, while Salmon ran the show publicly. At the end of their longtime lease, the property developer that owned the land approached Salmon personally and gave Salmon’s personal company a 20 year lease with renewals up to 80 years. Meinhard was not told about these negotiations and only found out when the lease was signed. Meinhard demanded that he be allowed to participate but was refused.
• Issues: Did Salmon have a duty to disclose to Meinhard that he had been offered a new lease on the building and several others from the owner?
• Cardozo’s Famous Reasoning: Partnerships have a duty to each other like that of Trust Officers. The Trust Officer cannot think of herself, she has to be completely selfless with the money: she can’t invest, borrow, or give herself a raise. A partner, like a trustee, is held to the highest fiduciary duty to his partner. The trouble about Salmon’s conduct is that he excluded from his “co-adventurer” any chance to enjoy the opportunity for benefit that had come to him alone. The very fact that Salmon was in control of the company charges him more with the duty of disclosure in this instance. There is no fraud here, but the rule of undivided loyalty in a partnership (between partners) is relentless and supreme. You can’t think of yourself: each partner must think of the partnership as a whole. Salmon had to manage the partnership for each of their interests, not just his own interest.

• Illig / Important: Why should we hold partners to a higher standard than the normal rules of the market (buyer beware)?
• Loyalty: We want people to be partners. Cardozo is trying to impose trust. If you’re partners, you’re going to have to trust each other. This is what this case is about. Cardozo is trying to create a realm: there is the market place realm, and the partnership realm. He’s trying to create a safe place for partnerships in the business world.

• Illig / Important: What’s with Cardozo’s vague language? Why not give us a clear rule we can operate with?
• It’s better to have a vague rule here about the “duty of finest loyalty.” You can’t set rules like these solid, because people will always try and figure out ways around these “set-in-stone” rules.
o Ex./ If you are told there’s a cliff coming up (a rule), you will speed and drive recklessly all the way up to that spot. However, if you are told there is a smoky cliff somewhere in the distance, but you’re not sure where it is, you’re going to drive very carefully and cooperate.

• Illig / Important: Should partners be allowed to opt out of these fiduciary duties?
• No. Most people say that you cannot get out of fiduciary duties. If you allow people to contract out of fiduciary duties, it would be like the Wild Wild West.
Richert v. Handly
π and ∆ entered into a partnership to log a stand of timber, and they were to share equally in the profits and losses

Labor is not a valued contribution unless it is stipulated in the contract--Since π put up the cash in the beginning, ∆ has to pay off that amount prior to receiving his share of the cash--basically from the beginning Handly was in the hole 13k
Kavocik v. Reed
The two entered into an agreement to remodel a Sears, and Kovacik would front the money and Reed would be the contractor--Reed then didn't want to pay for the losses the venture incurred; He was wrong

Rule--In the absence of an agreement, joint venturers equally share in the profits and losses-->a general partnership is formed
Formed through receiving a certificate of incorporation from the state

To dissolve a corporation, papers for dissolution have to filed with the state

There are managers and owners
Owners are investors
Managerial decisions are left to a board of directors which is a power delegated to them by the owners

Extraordinary transactions are determined through a shareholder vote

As a shareholder you are only liable for what you invested (limited liability)

Profits are double taxed
Limited Partnership
• There are general partners –all the rights of regular partners--who are in charge of managerial decisions, and they are jointly and severally liable for the debts—limited partners are simply shareholders and are only liable for what they contribute
• You have to get a certificate to be a limited partnership
• Also have to file a paper to dissolve a limited partnership
Limited Liability Partnerships
• A partnership that has filed a statement of qualification under §1001 (UPA) and does not have a similar statement in effect in any other jurisdiction
• LLP’s are typically authorized and governed by provisions found in a state’s general partnership statute
• A general partner’s personal assets are protected in an LLP
• They are formed through filing with the state
• Many states have a minimum capital requirement or insurance requirement to create an LLP
Subchapter S Corporation
• This was created by the IRS
• An S corporation does not have any different rules about incorporation or management, because that is up to state law, but it can regulate taxes
• If the operation is kind of small and runs similarly to a partnership, it can be taxed like a partnership→no double taxation
• Rules
o Less than 100 shareholders
o Can’t have a shareholder that is another entity—cant have a shareholder that is a corporation (can’t be a subsidiary)
o No foreigners
o Can’t have more than one class of stock
• You should never form an S subchapter corporation→less emphasis on this point than with partnership
• You can’t get investments from different people—you are limiting your access to money
• Maybe in the 50’s and 60’s this was a good thing, but today there are better options with no restrictions
Limited Liability Company (LLC)
• Formed through a file with the state, and dissolved with the state as well
• The members are liable for what they contribute to the partnership
• Flow through taxation and limited liability
• Management is determined by the formers of the LLC
• Generally do a member managed LLC
• The state cannot determine the tax status of a new entity
• Originally Wyoming is the one who adopts the statute
• Then Florida
• In the late 80’s the IRS comes in and says, “OK, we will make these flow through taxation” (taxed like a partnership)
• The wrinkle is that it is taxed for what it is not what you say it is
• Check the box—you choose what you are
• Read the form—the default is single taxation, and you check the box for double taxation
• You are either a manager or a member in an LLC
• If you are a member managed LLC, the members manage—instead of a partnership do a member managed LLC and you get the same organization as a partnership, but limited liability
• If you are a manager managed LLC you can appoint a President and the organization is slightly more hierarchical
• There is no case law on LLC—limited liability for LLC is the same as in corporate law, and partnership taxation can be determined from previous law—learn the law for partnerships and corporations and apply it
• Downside→Lack of case law—love to give your clients certainty, but corporate law is very extensive
• The problem with tons of flexibility you lose the network externalities—you’re not working with an off the rack suit, so you have to look at all of the random parts and pieces that make a business different from the other—you don’t know all the rules
Common Stock
• The most junior claim against the corporations assets, prior to liquidation there is no right to receive dividends, and upon liquidation, they claim only what is not distributed to everyone else
• Wield the most voting power
Preferred Stock
• Next to most junior claims to the corporations assets
• Typically entitled to receive dividends at a specified rate before any dividends are paid to common stockholders→like common stockholders, they only receive dividends once the board of directors determines dividends should be paid
• Holders of cumulative preferred stock are entitled to receive dividends earned but not paid in prior periods plus the current period before common stockholders
• Upon liquidation, preferred stockholders are entitled to a specific amount
• As a tradeoff for greater security, preferred stockholders have less voting rights, and no right to share in the corporations earnings beyond the specified dividend and liquidation preference
• A preference on liquidation
Balance Sheet
• It identifies and quantifies the corporations assets AND
• Shows how the claims against those assets are divided among creditors, holders of preferred stock, and holders of common stock
Dodge v. Ford Motor Co.
Dodge brothers brought the case on behalf of the minority shareholders who want a bigger dividend

o The judge says that he is not holding up his end of the bargain to the shareholders

•Holding: A corporation is a business, not a charity. You can be a nice guy incidentally on the side, but you can’t run the whole business corporation for the benefit of society. A business corporation is organized and carried out primarily for stockholders.
(1) A corporation must be run primarily for the profit of stockholders, and only incidentally for humanity
(2) Running a corporation incidentally for humanity is fine, just don’t take it too far like you did here.

Illig’s Notes:
• (1) How is a court going to decide whether or not Ford is doing good business? Ford is an expert, and the judge is not an expert. What group of experts know what the best angle for Ford’s business is than the group of experts Ford employs?
• (2) If Ford wanted to win, he should have said that this was in the best interest in the long run for the company (instead, he admitted to raising the pay of his employees to make them happier, and claimed to owe a duty to society and consumers to give them cheaper cars). He needs to focus on the equity-holders. If he had tailored his interrogation to say that his decisions were in the best interest of the company for the long run, he likely would have won his case.
• (3) Corporate law can be tricky. We want people who screw up to be punished! At the same time, we want to give management the discretion to take chances and make some mistakes because in the end, they know what’s best. You always need to balance this accountability with the discretion you must give them to be effective directors.
• (4) At the end of the day, Ford knows that Dodge will take the dividends and make his own car company. Although disguised in this “social agenda,” Ford is likely fighting tooth and nail for the future of his company. It’s ironic, because Dodge claims that there’s a duty to the “corporation,” but they themselves are going to take the money they earn and try and run Ford out of business. At the end of the day, maybe Ford’s decision was for the primary benefit of the corporation (maybe he should have made this more explicit).

• As long as you are mostly working for the shareholders you can do plenty of work for the others as well
• Shareholder wealth maximization
AP Smith v. Barlow
This case runs contrary to the Ford v. Dodge, and says that it is OK for corporations to donate to private bodies

What has really happened is that times have changed, and by 1953 people are just expectant that businesses will do great things for the country on top of just running a business

Illig: Note that this case is very similar to Ford v. Dodge, in that the directors are giving away money against a shareholder’s wish. Why is there a different decision?
• (1) Henry Ford actually claimed that he was running a charity (eleemosynary) for the public.
• (2) Excellent Witnesses (e.g. Chairman of Standard Oil, President of Princeton, President of the Corporation) all testified that it was a sound investment for philanthropic reasons, favorable public light, benefitting democracy (there was lots of non-communist rhetoric during the red scare); also, so public sees this public gesture, and buys the product of the Corporation.
o Note: All of these reasons make it a benefit for the shareholders in the long run.
• Important To Think About--> What would a court say if Nike were to give money to charity…but did so anonymously. There would no longer be any argument that it benefited shareholders. This is interesting to think about.
Coopers and Lybrand v. Fox
Fox had met with a representative of Coopers, and requested their services in regards to the formation of a corporation

While the corporation was later formed and Coopers performed their work, Fox said they didn't owe anything because there wasn't an actual corporation

Coopers then went after Fox individually under the theory of promoter liability

• “As a general rule, promoters are personally liable for the contracts they make, though made on behalf of a corporation to be formed.”

• Novation Exception: The well recognized exception to this rule is if the contracting party agrees to contract solely with the corporation, and not hold the promoter liable for future payment. In contract law and business law, novation is the act of either replacing an obligation to perform with a new obligation, or replacing a party to an agreement with a new party
Smith v. Dixon
A family of farmers make up the company E.F. Smith & Sons, and this action was brought to enforce the sale of a tract of land to Dixon

The first court denied specific performance and awarded damages to Dixon

It is undeniable that Father Smith was authorized to sell the land, but it is claimed he was only authorized to do so for a greater amount thus rendering the contract with Dixon unenforceable

The court says, "a partnership is bound by the acts of a partner when he acts within the scope or apparent scope of his authority."-->Father Smith had been the negotiating partner before, and he signed the present contract, binding the partnership

Every partner is an agent of the partnership, and every act by an agent is binding upon the entire partnership
370 Leasing Corp
370 leases computers out to companies, and it attempted to purchase some from Ampex

Joyce of 370 met with Kays, a salesman of Ampex, and Mueller, a manager at Ampex--He was told he could only purchase computers if he passed the credit requirements

At the same time Joyce entered into a contract to lease the computers with EDS

Kays, at the instruction of Mueller, gave Joyce a contract, which he promptly returned, but it was never executed by Ampex--Kays did send a confirmation letter for delivery dates to Joyce at some point

Holding-There was an acceptance of the contract, and Kays had the authority for this--An agent has apparent authority sufficient to bind the principal when the principal acts in such a manner as would lead a reasonably prudent person to suppose that the agent had the authority he purports to exercise--all of the documents and memoranda sent around at Ampex suggest that Kays had authority to accept
-Agency is a fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other to so act

-The one for whom action is to be taken is the principal, the one who is to act is the agent

2 Aspects to Agency Law
1) Authority
2) fiduciary duty
Cranson v. IBM Corp
Cranson invested in a new business that was being incorporated, and in the early part of its existence handled its transactions; after not paying IBM, and discovering that the letters of incorporation had yet to be filed, IBM came after Cranson and tried to hold him personally liable for the debt

o Issue—is an officer of a defectively incorporated association subjected to personal liability under these circumstances?
• 2 doctrines have been established
• De facto—1) the existence of law authorizing incorporation; (2) an effort in good faith to incorporate under the existing law; and (3) actual user or exercise of corporate powers.
• Estoppel—generally employed where the person seeking to hold the officer personally liable has contracted or otherwise dealt with the association in such a manner as to recognize and in effect admit its existence as a corporate body

• Although the corporation was never in fact formed while it dealt with IBM, the two had a relationship as if it were an actual corporation
• “Since I.B.M. is estopped to deny the corporate existence of the Bureau, we hold that Cranson was not liable for the balance due on account of the typewriters.”

• Illig: The lawyer is at fault for not filing the corporation papers. However, the court made an equitable decision not to hold Cranson personally liable. This doctrine works on the idea that it would be inequitable to permit the corporate existence of an association to be denied by person who have represented it to be a corporation, or held it out as a corporation or by any person who have recognized it as a corporation by dealing with it as such. Everyone thinks that the corporation signed the form so this is not a case of promoter liability. IBM thought that they were selling to the corporation and they built into the price they charged the risk of selling to a corporation.
Trustees of Dartmouth College v. Woodward
Dartmouth College was established as a private university and Woodward along with the legislature tried to make it an institution controlled by the state government

• In a 6-1 decision the Court held that the College’s corporate charter qualified as a contract between private parties, with which the legislature could not interfere. The fact that the government had commissioned the charter did not transform the school into a civil institution. Chief Justice Marshall’s opinion emphasized that the term contract referred to transactions involving individual property rights, not to the political relations between the government and its citizens
• 3 reasons it matters
o it tells us that this is a contract
• you create a corporation in Oregon, and later Oregon comes along to change the law, but they can’t change the contract you formed, therefore your corporation maintains its position—you can’t change a contract unilaterally unless it says in the contract that you can change it unilaterally

• SCOTUS Corporation Definition: Corporations are an artificial being, invisible, intangible, and exists because they are helpful. Among the best attribute is its immortality as a single individual (never dies).

• the human beings that created this contract died—the only thing that remains is the institution—immortality and central management is really what matters
In the Matter of Drive in Development
Drive In was a subsidiary of Taste Freez Industries, and Maranz, the chairman of Drive in, along with Dick, the secretary, executed a guarantee of payment to induce a loan from National Bank

Despite there assurances, nothing was ever agreed to at the board meeting like they contested

The guaranty is enforceable--even though it is a somewhat extraordinary measure, it is an ordinary function of the director to enter into contracts, and it would be unfeasible for the bank to investigate the minutes every time there is a contract--> he had apparent authority, as it would be reasonable for a third party to assume that the chairman had authority to enter this type of agreement
In the matter of Radom & Neidorff Inc.
Radom and Neidorff ran a lithographing firm—Neidorff died and passed his 50% share to his wife, who was also Radom’s sister; They did not get along and Radom filed for dissolution of the corporation because he was not getting paid

The court disallowed its dissolution because it was still a successful corporation-->"There is no absolute right to dissolution under such circumstances. Even when majority stockholders file a petition because of internal corporate conflicts, the order is granted only when the competing interests ‘are so discordant as to prevent efficient management’ and the ‘object of its corporate existence cannot be attained.’ The prime inquiry is, always, as to necessity for dissolution, that is, whether judicially imposed death ‘will be beneficial to the stockholders or members and not injurious to the public."

• Two Kinds of Corporate Dissolution:
• (1) The owners/shareholders agree on a vote to dissolve
• (2) Petition the court to put this thing to death, and dissolve the corporation.
o Test: The test is to see if the dissolution will “be beneficial to the stockholders or members and not injurious to the public.” In this case, there is not a need for dissolution because the company is still well run and growing. Also, Anna will allow a third director to be named to end the deadlock.
o This case failed here

• Illig’s Notes: The point of this case is that corporation’s don’t die easy. It is very hard to put your cooperation to death. Corporations are almost synonymous with immortality. For one, we make them hard to kill so that when a creditor lends money to the corporation, the corporate entity will still be there. This assurance allows banks to work with corporations for more credit/less risk.
Ringling Brothers v. Edith Conway
The Ringling Brothers Wives' failed proxy voting system

• They make an agreement to vote together w/ certain provisions
o Right of first refusal
o They agree to act jointly
o They have to go to arbitration if they don’t agree

The arbitration guy was an adviser--this provision in the pool holder agreement was legal
• The court says you can make any pool holder agreement and it is not objectionable that his voters be for profit or capriciously
o Voters can do what they want with their vote and their reasoning doesn’t matter
Hilton Hotels v. ITT Corporation
Hilton Hotels was attempting to purchase ITT and replace all of its board of directors with people of its own--Classic 80's corporate raider

In response, the ITT board of directors attempted to split up the divisions of ITT into new subsidiaries and also appoint the present directors for longer terms
Stroh et AL v. Blackhawk Holding Corporation
• The promoters who started this company created two classes of stock
o You can create different classes of different stock with different benefits and so on and so forth
o In this case the B shares had no rights except for the right to vote
• They did this so they could have outsized control of the company
o Stroh comes forward and says you have to say that these stocks are invalid because they aren’t attached to anything
• The judge says look at the statute—you can do what you want when you issue the stocks
• The Class A shareholders knew what was going on, that they didn’t have any voting power
• Facebook did this exact same thing
o There simply has to be at least some of the stock as common stock
McQuade v. Stoneham
New York Baseball Giants Executive Switch

• The shareholder agreement stipulates that they will use their best endeavors—they’re not agreeing to keep so and so as president, but they are agreeing to vote their shares for a particular candidate
o As directors they agree to appoint each other as officers
o Also they agree to never remove any of the other people from their position, or lower the salaries→you have to look at all of the possible ways that Stoneham could screw them over

• Shareholder Agreement Rule: Shareholders are allowed to create an agreement that promises to vote in certain people as Directors (majority shareholders have the power to do this anyway). However, shareholders are not allowed to create an agreement that limits a Director’s voting power. Shareholders are forbidden to make a contract that usurps the decision-making normally left to the directors, such as the voting of corporate officers. Directors must have this voting power in order for choosing the best interests of the corporation, as they owe a fiduciary duty to “try hard” for the shareholders not privy to the original shareholder contract.

• Against Public Policy: If Directors always know that they are going to be re-elected as Officers (treasurer, president, etc.), there is no incentive to do what’s best for the corporation at any given time, as there will never be any repercussions to being terrible as a corporate officer. Additionally, minority shareholders won’t be able to sell their shares because buyers aren’t going to be willing to pay for a company where they won’t have control. Lastly, this effectively sterilizes the other Directors’ ability to vote for the best possible corporate officers. Directors have been entrusted with the shareholders money, and they have a fiduciary duty to exercise their independent judgment of who will be the best fit in a corporate position.

• Illig: Directors owe a fiduciary duty to “try hard” and protect the shareholders not in privy to the original shareholder agreement, the shareholders who buy into the corporation later, the shareholders with a small stake in the company, etc. In this case, they were also limiting the other directors’ ability to vote for the best possible corporate officers.
Clark v. Dodge Et. Al
• Plaintiff entered into an agreement with ∆ where π agreed to disclose the formula of the medicine to ∆’s son in return for the promise the π would remain as a director and would be entitled 25% of the net income
• Defendant then did not vote Clark back onto the board, and didn’t pay him what was agreed to
• Was the agreement invalid in a similar fashion to the one in McQuade because it was an over-reaching agreement between shareholders to control powers of the directors?
o The agreement was not invalid because unlike McQuade, where the rights of others were interfered with, in this case, Clark and Dodge were the only shareholders—they weren’t interfering with any of the other shareholders rights
• Don’t care about fiduciary duties to creditors—they are at the front of the line—we care about the fiduciary duties to the people at the end of the line

• Holding: Where the directors are also the sole stockholders in the corporation there is nothing wrong with having an agreement to perpetually vote for certain people as officers.
• Illig: Where the public is not affected, the parties in interest can limit their respective rights and powers, even where there is a conflicting statutory standard.
Walkovsky v. Carlton
Taxicabs are kept within smaller corporations with only 2 cabs per corporation, and they only have the minimum liability insurance as required by the state

-Guy gets run over by a cab, and he wants to go after the entire conglomerate--Should the corporate veil be pierced?

-Instead of going after the owner, π is attempting to prove fraud and injustice because of the structure of the company

o The real argument should be that Carlton was using the cab company personally—that there isn’t a separation between his own assets and those of the corporation; he was intermingling his own business with that of the corporation; therefore the corporation would be falsely set up, the veil could be pierced
• Trying to go vertical after the ownership rather than horizontal after all of the cab companies→even though the cab companies are essentially run as one entity, they still are not set up illegally; they have the proper liability insurance and permits

• Illig: To avoid liability from piercing the corporate veil, the cab owner should have made different corporations that each separately own the garage, the cab, the driver company, etc. Thus, the owner would pay “fees” to different corporations (moving the profit around). While the “cab company” becomes less profitable, he owns the other corporations where the money is going. Because the most important thing is form, any future owner who does this should:
• Keep a careful system of the books separate from the books of his other corporations
• Keep a system of money transfers of these different types of corporations
• Have a directors meeting and file forms separately for each corporation
• Not reach in the “piggy bank” of the corporation and put the money into his other corporations.
The Contractarian View
A business association is viewed simply as a nexus of contracts

The law plays two basic roles:
1) provides a mechanism for enforcing the parties arrangements
2) provides a way of determining the parties' contract terms. The law minimizes costs over determining the details of ambiguous and incomplete contracts by providing standard terms that the parties can opt into or that apply unless the parties opt out.
The regulatory view
-the law should dictate some of the terms of business associations
-government regulation is believed to be necessary to protect public corporation shareholders from terms whcih they have not actually consented, and to rescue them from a position of weakness in the corporation
Corporate Finance
• Income Statements
• This shows how much money the company earned during a period. These are important because it provides information on how the company is performing on a birds-eye macro level, and provides information about a company’s ability to repay a debt.

• Balance Sheets
• A balance sheet does two things:
(1) Identifies a corporation’s assets
(2) Shows how the claims against those assets are divided among creditors (liabilities column) and stockholders (equity column).
• Balance sheets don’t have an the work ethic, the intellectual property, nor the company’s reputation included in the balance sheet (unless these things were purchased for money).
Lee v. Jenkins Bros
• Facts: Lee was hired as a business manager; he used to work for Crane Company. Jenkins Bros. had just purchased Crane Company. It needed a manager so it approached Lee about filing the position. Lee met with Yardley (President), a Vice-President, and the Vice-President’s wife. Lee was interested, but asked if his retirement pension with Crane Company would be honored. Yardley said that if Jenkins Bros. did not then he would personally. Lee went on to give 25 years of service to the Jenkins Bros. Company. He was discharged at the age of 55, and when he wanted his pension, the company claimed Yardley (President) did not have authority to make this promise. The argument was that Yardley (President) made a promise outside the regular course of business, and because this was extraordinary in the course of business, he needed Board of Director Vote approval.

• President General Rule: The President only has the authority to bind his company by acts arising in the usual and regular course of business, but not for contracts of an extraordinary nature. It is generally settled that the President, as part of the regular course of business, has the authority to hire and discharge employees and fix their compensation. However, lifetime employment contracts are generally regarded has extraordinary.

• Pension Plans: However, pension plans are not the same as lifetime employment contracts, because:
o (1) Pension Plans don’t unduly restrict the power of the shareholders and future boards of directors on questions of managerial policy
o (2) They don’t subject the corporation to an inordinately substantial amount of liability.
• Thus, the power to contract for the pension plan was in the ordinary course of the President’s authority.
• Holding: Jenkin Bros. is liable for Lee’s pension plan.
Sea Land Services v. Pepper Source
• Facts: A shipping company (Sea-Land) ships peppers for a pepper company (Pepper Source), but the pepper company never pays, and subsequently goes bankrupt. The pepper company owner dissolves the corporation. Sea-Land still wants its money so it sues the owner of the Pepper Co., and the five other businesses that he owns, on the theory that all the other corporations are alter-egos of each other and the owner controls the corporations for his own personal use.

• General Rule: A corporation is an entity, separate and distinct from its officers and stockholders, and individual stockholders are usually not responsible for the debts of the corporation. This fiction of law will be disregarded, however, in such a way that its retention would produce injustice or inequitable consequences, so Court’s allow plaintiffs to “pierce the corporate veil.”

Illig’s “Piercing The Corporate Veil Test:” A court will likely pierce the corporate veil if the following are met:
• (1) There must be such a unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist. This can be shown by:
o (A) Undercapitalization
• There cannot be too little capital for the reasonable expectations to run a business of that type. This is calculated at the start of the business, and can be demonstrated in one way by having enough capital to pay for externalities/debts for future debts or problems.
• There is a spectrum in courts as to whether “insurance” is enough, but $1 in capital and $1 Million in insurance is definitely enough to demonstrate capitalization.

o And Either:

• (B) Failure to Follow Corporate Formalities
• No Minute Book
• No Corporate Meetings or Very Infrequently
o Or:

• (C) Commingling of Funds or Assets
• Using corporate money for own personal expenses (reaching in the “piggy bank”), such as alimony, pets, etc.
• Borrowing money, or writing checks to personal accounts are okay as long as you have a ledger that keeps track of this money (QuickBooks, etc.).
• A separate corporation treating the assets of the corporation at issue as its own.

• (2) Circumstances must be such that adherence to the “separate corporate structure” would promote injustice

o Injustice Test:
• Some wrong, deception, fraud beyond a creditor’s ability to collect.
• Courts distinguish between a creditor making a “bad bet” to take on a shady client, and an “actual injustice”

• Holding: The plaintiff lost on the Injustice Test under the second prong, but Illig thinks that most courts aren’t as bad of sticklers as this court. Illig believes that as long as you plead an injustice, show evidence of that injustice, and make some noise about what the injustice was, you will be able to satisfy the second prong.
Kinney Shoe Corp v. Polan
• Facts: Polan had two corporations, A and B. Under A, he negotiated a sublease from Kinney. A had no assets, no meetings, nothing. Right after this sublease, A then transferred part of the sublease to Polan’s other corporation, B. Kinney wanted to sue A for rent owed, but A had no assets whatsoever, so Kinney wanted to pierce the corporate veil to get to Polan, who should be personally liable.
• Test: The test is the same as above (Sea-Land v. Pepper), except with an interesting twist. The corporate statute in this state said that there was a “permissive” third prong that was part of the “Piercing the Corporate Veil” test.
-Assumption of Risk Prong: WHen it would be reasonable for that particular type of a party, such as a bank or other lending institution, to conduct an investigation of the credit of the corporation prior to entering into the contract, such party will be charged with the knowledge that a reasonable credit investigation would disclose

• Holding: Because Polan and his corporations A and B had such a unity of interest that the separate personalities of the corporation and the individual no longer existed and that there would be an injustice if these were acts were treated as those of corporation A alone, Kinney is allowed to pierce the corporate veil.

• Illig: Illig actually thinks that the second prong of the “Piercing Test” is not met, because there was no real injustice here other than engaging into a “bad business deal” with A. As we said above, engaging into a bad business deal is not usually going to satisfy the type of “injustice” required because no one will ever try and “pierce the corporate veil” after a good business deal. Wouldn’t this requirement just become too easy to ever fail if all it required was “losing money” on a bad business deal?
Silicone Breast Implants
• Facts: MEC was an independent, privately held corporation that created plastic breast implants. Bristol purchased MEC’s stock for $28 million and became the sole shareholder. Injured plaintiffs want to “pierce the corporate veil” under an “alter ego” theory: that one corporation (MEC) is so controlled by its stockholder (Bristol) as to be the alter ego or mere instrumentality of its stockholder (Bristol).
• Issue: Different jurisdictions have different “piercing the corporate veil tests.” Here, the court asks whether, under the totality of the circumstances, there was substantial dominion by Bristol of MEC that shows that MEC was nothing but an alter ego of Bristol. Another way of looking at this totality of the circumstances “alter ego” test is just to use Illig’s “Piercing Test” above from Sea-Land.

• Alter-Ego Claim: The totality of the circumstances must be evaluated in determining whether a subsidiary may be found to be the alter ego or mere instrumentality of the parent corporation. All jurisdictions require a showing of substantial dominion. Factors to be considered are:
o The parent and the subsidiary have common directors or officers
• They shared directors
o The parent and the subsidiary have common business departments
• They shared legal, auditing, communication departments
o Commingling of Assets
• Bristol financed MEC, providing loans on request. By itself, this is fine, but Bristol received and kept the interest on these loans

Direct Liability Claim-->o By allowing its name to be placed on breast implant packages and product inserts, Bristol held itself out as supporting the product, apparently to increase confidence in the product and to increase sales. Bristol also issued press releases saying the breast implants were safe. Having engaged in this type of marketing, it cannot deny its potential responsibility under the theory of negligent undertaking:

(1) Corporation’s failure to exercise reasonable care increases the harm
(2) Corporation has undertaken to perform a duty owed by the other to the third person
(3) The harm is suffered because of a reliance of the other or the third person upon the undertaking.
Costello v. Fazio
• Facts: Three partners contribute capital towards their partnership in different amounts. When they decide to make a corporation, they all want to have the same amount of stock, so they all give $2,000 each, and call whatever else they put in the original partnership a loan to get back. After the company goes bankrupt, a trustee is appointed to pay back the creditors.

• Holding: The trustee says that the “loans” provided by the partners are not “real loans,” just fake-loans done soley to get a tax advantage. Therefore, they are “equitably subordinated” to the back of the line, so they can’t get their “loans” paid out before the other real lenders.

• Illig: This is an equitable subordination case, which means you basically have to move to the back of the line. This is probably not the kind of case I would put on an exam because it is too complicated.
Donahue v. Rodd Electrotype Co.
• Closely Held Corporation: This is a corporation in which the stock is held in a few hands and rarely dealt by buying or selling. In close corporations, there is a large degree of stockholder (owner) participation in the management, direction, and operations of the corporation. In Massachusetts, after this case, because of the small nature of closely held corporations, the strict duty of loyalty is extended to all stockholders in closely held corporations. [Springside Nursing Home Is Delaware’s Response].
• Facts: The Rodd family owned 200 shares, and Donahue owned 50 shares (Rodd family gets to make all the decisions as majority shareholders). The eldest Rodd family member wanted to get out of the close corporation, so he redeemed (sold back) his shares to the corporation. Where before Donahue owned 20% of the close corporation, she now owned 40% (still minority) of the corporation after the redemption. Although this would seem like a good thing, Donahue sued. Donahue alleged that this violated the Rodd Family’s fiduciary duty to her as a shareholder. She complained that because the majority shareholders allowed their family member to sell back their shares, she should be allowed to sell back her shares also in this close corporation.
• Issue: Should close corporations also have the same “high fiduciary duties” as partnership law, even though this is technically a corporation?
• Holding: The court looked to “partnership law” because close corporations resemble partnerships so much. The court borrows fiduciary duty law from partnership law (remember, in partnerships there is a highest fiduciary duty of undivided loyalty) and used it to apply to “close corporations.”
• Illig: The problem here is that she will always be at the mercy of the majority because she has no control as a minority shareholder. This company never needed to pay dividends to the shareholders, like Donahue, because the majority can pay themselves a salary, and not pay Donahue a salary. Furthermore, she has no exit strategy, as no one will want to buy shares in a small corporation that receives dividends at the whim of a majority. These shares have basically no exit value, because of how small the corporation is, and how little control these minority shares have. Thus, this is a problem of:
• (1) No control/voice
• (2) No exit strategy.

• Could Donahue Have Protected Herself: She could have negotiated for a shareholder’s agreement that said she wouldn’t buy shares unless all allowed redemptions would be offered to everyone at the same rate.
Wilkes v. Springside Nursing Home
• Background: This was decided one year after Donahue because the new judges on the bench hated the new rule from Donahue.
• Facts: Four guys formed a nursing home close corporation. All four shareholders had been electing each other as directors, and then as officers. As a corporation, this was a good idea because they could pay themselves as salaries (not taxed in corporations), instead of dividends (taxed in corporations). Three of the shareholders start to hate the other one so in the next director meeting, they use their director powers to fire that shareholder from his “Officer Position.” Even though he was still a shareholder, they no longer had to pay him a salary, and they could still vote to not pay out dividends.

•New Test After Wilkes (Delaware):
• (1) Majority (shareholders) must find a legitimate business purpose for its action.
o Ex. Drunk of the job
o Ex. Doesn’t know computer programming
• (2) If the majority finds a legitimate business purpose for its action, the minority plaintiff must demonstrate that the same legitimate objective (fired for being drunk, fired for not knowing computer programming) could have been achieved through an alternative course of action less harmful to the minority’s interest.
o Ex. Send to Betty Ford Clinic for one month
o Ex. Could have cheaply trained him to learn computer programming
• Thus: Courts must weigh the legitimate business purpose (if any), against the practicability of a less harmful alternative.

• No Duty Of Loyalty in Close Corporations: While there is a test in Delaware, there is no fiduciary duty of loyalty for shareholders. Delaware though, says no fiduciary duties in corporations, even in close corporations. If you want them, ask for them, and pay for them.

• Close Corporation Recap: When you have a close corporation, management is really in the hands of the shareholders. When you have no exit and no voice, you have a situation where the shareholders have been entrusted with the money and investment of other shareholders. When this happens, we are going to give “fiduciary duties” onto those shareholders. Absent close corporations, there are never fiduciary duties for shareholders in corporations.
Litwin v. Allen
• Facts: A shareholder brought this lawsuit against the Directors of a Corporation. The Directors of the Corporation agreed to loan money to another business (Allegheny), and in return, all the Corporation received were debentures (IOU’s tied to the market). What’s more, the Corporation gave Allegheny the option to buy back the IOU’s after 6 months time. The great crash of the stock market occurred shortly thereafter, and of course, Allegheny did not buy back the now worthless debentures. This is a derivative lawsuit to get the money back
• Rule: The Business Judgment Rule presumes that the directors of a corporation, when making a business decision, have made an informed decision, and acted in the honest belief and good faith that the action was taken in the best interests of the company.
• Issues: This case asks what duty does a director owe when it makes a decision?
• Holding: A director has an obligation that is similar to a trustee. There are not liable for errors of judgment or for mistakes while acting with reasonable skill and prudence. This case will not come out this way today. The business judgment rule is a presumption that courts cannot understand a business decision, but someone has to. So, when it is so bad then the court will step up. This sets up a balancing between allowing directors taking risks and not going nuts. We presume they acted in good faith (duty of care) and acted in the honest belief they acted in the best interest of the company (duty of loyalty), they asked the right question and ran the numbers. The plaintiff can rebut this presumption but this is a high standard, you can also show fraud. If you rebut the presumption then the duty shifts to the directors show the entire fairness of the transaction, “we didn’t ask the right question but we made a shitload of money.” This court is talking about negligence as a standard, but the standard is gross negligence. It is hard to rebut this presumption now, but if you can then you probably win on the entire fairness of the transaction.
• Reasoning: Here, there is no evidence of fraud, no evidence of bad faith, and no evidence of theft. However, the Corporation didn’t make any terms of the loan that would make any money on this business deal. First, there was no interest rate on the loan. Second if the debentures lost money (like they did) the Corporation would be stuck with the worthless debentures. If the debentures made more money then the original loan, Allegheny would of course buy them back from the Corporation.

• Notes: This may actually not be a bad deal for the bank. The judge doesn’t understand that because these debentures are actually IOU’s, the original borrowers (who created the debenture/IOU’s) are paying interest to begin with on these original debentures, which the Corporation has now exchanged for. Also, there are some things that can’t be valued by money. There might be a business relationship between the Corporation and Allegheny, or Allegheny might be a terrific customer, who is very influential with 8 of the biggest companies that could give the Corporation business! There may always be other ancillary benefits to the deal.
Smith v. Van Gorkam
• Facts: This is the famous hostile takeover case. Van Gorkom was the CFO and Board Chairman. He wants to sell the company to Jay Pritzker. A rough estimate of the company’s value was proposed at either $50 or $60 per share. Van Gorkom stated he would accept $55 for his shares, and proposed this number to Jay Pritzker. Jay Pritzker wrote up a contract, and the weekend before the agreement was to be signed, Van Gorkom called for an emergency board meeting to get the directors to sign off on the deal.

o The rushed board meeting lasted only 2 hours, it was not clear who was there, there was nothing in writing given to the directors, no sale agreement was passed around to the directors to look at, there was no power point presentation, there was no summary of the significant terms, no “practicing” lawyer advice, although a retired attorney said that “if you don’t agree to this agreement, you might be sued.” All in all, Van Gorkom basically told them what was going on really quickly, and the board stamped off on it.
• Court: This process is grossly negligent.

• Rule: Before you can get to the merits of the case, you must rebut the presumption of the business judgment rule. The business judgment rule holds that the directors of a corporation, when making a business decision, are presumed to have made a decision on an:
• (1) Informed Basis
• (2) Honest Belief
• (3) Good Faith (that the action was taken in the best interest of the company)
• Court: Here, the Judge believes that the presumption is rebutted, because the Directors did not act with a good process (see list above), and therefore did not make an informed business decision. The fiduciary duty of care means that directors don’t have a good outcome (sometimes they make wrong business decisions) but they must go through the process; here they failed to go through the process, thus violating the fiduciary duty of care.
• Holding: For this reason, the board of directors breached the duty of care that it owed to the corporation's shareholders. As such, the protection of the business judgment rule was unavailable.

o Corporate America and Lawyers hated this decision (especially those in Delaware)
• The shitty law has the potential of causing corporations from leaving Delaware and reincorporating elsewhere
• The state legislature creates 102(b)(7)
Delaware GCL §102(b)(7)
• The certificate of incorporation (corporate charter) may also contain a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director for:
(1) Duty of Loyalty
(2) Bad Faith
(3) Intentional Misconduct
(4) Knowing Violations of the Law
(5) Paying Dividends When No Surplus In Storage
In Re Caremark
Duty to Investigate the company

• Facts: Caremark Corporation was bribing doctors in order to get referrals for Caremark products. They got busted, and lost $250 million in fines for violating federal law. The shareholders brought suit against the directors / officers for the $250 million. While the directors and officers didn’t actually approve the sketchy behavior themselves, lower officers under their control did. However, directors and officers had published a guide internally to help demonstrate good behavior, but it was not clear in the guide what was inappropriate action.
• Issues: Did the directors violate their duty of care by not having a system in place to monitor lower levels of the company?
• Holding: It is part of the duty of care to have a sense of what is going on in the corporation (how the company is operating at all levels). The Board of Directors must have a system of internal control (but the level of detail we don’t have a great sense of). The Board of Directors must put a reporting system in place to ensure that the proper information about wrongdoing at lower levels of the company will come to the attention of the Board of Directors.

• Illig: A reporting system has to be designed in good faith to make sure that the correct information is presented to the Board. The directors did not have any meetings to deal with this situation. However, they did take steps to centralize management and create new internal audit policies. If the board failed to follow the proper process then there is liability, however, there is a presumption of good faith in all business decisions. Today, there are three separate ideas that require Corporations to have more oversight:
• (1) Van Gorkom
• (2) Caremark
• (3) Federal guidelines provide greater incentives to act in good faith. The federal sentencing guidelines set up what are the mandatory minimums for certain crimes. A corporation can receive lower sentences for internal controls and ethics policies.
Sarbanes-Oxley §404
• When WorldCom and Enron messed up, President Bush took the position that while 99% of corporations were doing well, there would always be bad apples in the corporate world. Bush argued that the corporate system worked well, they caught the bad apples, and they were sent to jail. All in all, Bush claimed he had it under control. During his speech, stocks absolutely plummeted. This led to the enacting of the Sarbanes-Oxley, which was a horribly drafted statute, with no cohesiveness.

• Note: One of the main things this did was create a FEDERAL duty of care. The only competition that Delaware’s lax corporate laws had was the federal government. §404 tells us that senior managers (top officers) of large, publicly traded companies are responsible for putting into place a system of internal control. When Corporation’s send out annual reports, they must show that they have assessed the internal controls and given them a grade. If this assessment of the internal control is put in the annual report, it creates fraud liability (in theory, the corporation would be fine if it were to say that there was a system of internal control, although it is not very good). However, it is important to note that the companies took §404 as saying that a corporation must have state of the art internal controls. Companies ended up spending hundreds of millions of dollars to install these internal controls.
• Today: Corporations have expensive systems of internal control, and they watch over them very closely.
Cede & Co v. Technicolor
• Facts: Technicolor got bought out in which Technicolor’s shareholders got $23 per share. Plaintiffs claimed that $23 was too little and sued. The reason this case is important is because it demonstrates the procedural posture that occurs when the shareholder plaintiffs’ rebut the business judgment rule presumption.
• Intrinsic Fairness Rule: Normally, if a shareholder plaintiff fails to meet the evidentiary burden, the business judgment rule protects corporate officers and directors and the decisions they make. However, if evidence is brought and the rule is rebutted (evidence of a breach of fiduciary duty), the burden shifts to the defendant directors to prove the intrinsic fairness of the transaction. Under this standard, the Directors must show that the action was intrinsically fair to the minority shareholders. To do this, directors must show that (yes, I was disloyal or not careful) but there was both a:
• (1) Fair Price; and
o Look at economic and financial considerations, assets, market value, earnings, future prospects, etc.
• (2) Fair Dealing
o Look how the transaction was timed, initiated, structured, negotiated.
o Look how the transaction was disclosed to the directors, approved by the directors.
o Standard: That the price offered was the highest value reasonably available under the circumstances.

• Holding: The court applied a balancing test taking into account all relevant factors, meticulously weighing each aspect of fair dealing and fair price. The transaction was entirely fair to the Technicolor shareholders.
Lewis General Tires, Inc. v. Lewis
• Family owned and operated a tire shop. The tire shop was LGT Corp., and the property that it occupied was incorporated as SLE Corp. Rent was paid to SLE at $14,400 annually, and from this income, property taxes were paid
• The father had transferred SLE stock to his children
o Some owned and operated LGT, but all owned a portion of SLE
• the children made a shareholders agreement that promised to sell their stock of SLE at a certain date if by that time they were not shareholders in LGT—That day came, and one of the chilren’ without LGT stock felt the SLE stock was undervalued and brought a shareholders derivative action
o The court held that disgruntled child failed to establish the rental value of the Property during the period at issue, and ∆ were entitled to judgment –District court incorrectly placed the burden of proof upon plaintiff→Because the directors of SLE were also officers/directors of LGT the burden should have been on the ∆ directors to demonstrate the dealings b/w the two corporations were fair and reasonable

• Holding: The defendants (tire company) failed to prove that the rental paid by the tire company to the land company was fair and reasonable.
• Illig: This is a duty of loyalty problem, not a duty of care problem. There is overlapping management, with the same directors in both corporations. Because some of the directors are on both sides of the transaction, this implicates loyalty to the corporation’s interests.

• Notes: If these were two corporations where the Dad gave everyone equal shares in both companies, we would not care where the profits came from and what the rent paid was (it could be a nominal $1.00 for all we care). Here, however, where there are two different ownership interests, there appears to be an undeniable conflict of interest: If the rent was high, the land company gets paid more money; If the rent was low, the tire company keeps more money. They are in perpetual conflict, and there is a conflict of interest.
Sinclair Oil Corp v. Levien
• Facts: Sinclair is a huge oil company, and they own the subsidiary SinVenezuela, who does their exclusive oil digging in Venezuela. Sinclair nominates all members of SinVenezuela’s Board of Directors, and it was found at trial that SinVenezuela’s Board of Directors were also the officers, directors, and employees within the Sinclair family. Thus, it is clear that Sinclair owed its subsidiary SinVenezuela a fiduciary duty. A minority shareholder for SinVenezuela sued complaining that:
• (1) Sinclair made SinVenezula pay out too many dividends (by not recirculating the money in the company, it basically cashed itself out).
• (2) Sinclair gave opportunities to its other subsidiaries (SinAustralia, SinJapan, SinChina, etc.) at the expense of SinVenezuela.
• (3) Breach of Contract
• Reasoning: Normally, we start with the business judgment rule. Businesses should have discretion to make choices, and we presume that these choices were in the best judgment of the corporation. Intrinsic Fairness: However, courts can skip using the Business Judgment Rule and jump straight to using the Intrinsic Fairness standard (see Cede & Co. test above: fair price and fair dealing/process) when both:
• (1) A fiduciary duty was owed
• (2) There was self-dealing

• When Do We Use The Intrinsic Fairness Standard (instead of using Business Judgment Rule):
• (1) First, there must be a fiduciary duty. A fiduciary duty is established, for example, when a parent and subsidiary are engaged in dealings, and the parent is on both sides of the transaction.
• (2) A fiduciary duty alone will not evoke the intrinsic fairness standard. The fiduciary duty must be accompanied by self dealing:

o Self Dealing: Self-dealing is a situation when a parent is on both sides of a transaction with its subsidiary. It occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority shareholders of the subsidiary. Note: The standard we use is if the dealings disproportionately favor the parent over the subsidiary.

• Illig: Just remember that whatever test you choose, likely chooses the outcome.
• If the court applies the business judgment rule, management will always win.
• If the court applies the intrinsic fairness standard, management will always lose.
Zahn v. Transamerica Corp.
• Facts: A minority shareholder of AF Tobacco brought a derivative lawsuit against majority shareholder (Transamerica) who had purchased most of the shares of AF Tobacco (Transamerica bought the Tobacco company to strike it rich at the right time). The minority shareholder claimed that Transamerica ran the company for its own profit, as it caused management to redeem (force plaintiffs to sell shares back to AF Tobacco) plaintiffs’ shares for an amount much lower than what plaintiff would have received once the company was liquidated (which it was). The corporate charter specified that the shares could be redeemable at the option of the company for this low amount that the plaintiff complained about. Transamerica was sneaky and had done the math and thought if they liquidated the company, paid all the money as dividends, that this class of shareholders would get $240 instead of the $80 they received (by redeeming the shares).
• Reasoning: While perfectly legal, Transamerica acted in self-dealing. Transamerica redeemed the shares on the first day and liquidated the company the second day (instead of the other way around), and the shareholders got less money. As majority shareholder, Transamerica was in control of the minority, and they disproportionately benefitted themselves. This is self-dealing, because it disproportionately favors the parent (here, majority shareholder) over the subsidiary (here, minority shareholders). Thus, we apply the intrinsic fairness test.
• Holding: You might think that Transamerica was merely a majority shareholder, and not a director, and thus shouldn’t be held to the same standard as directors. However, the court said that Transamerica was entitled as a shareholder to cast votes to represent their interests, but their capacity as a director (as directors are acting as an extension of the majority shareholders) is limited because they owe a fiduciary duty to every shareholder.

• Illig: The rule of corporation law is well settled that the majority as the right to control, but when it does so, it occupies a fiduciary duty (of loyalty) toward the minority, as much so as the corporation itself or its officers and directors. There is a radical difference when a stockholder is voting strictly as a stockholder and when voting as a director. When voting as a stockholder, he may have the legal right to vote with a view of his own benefits and to represent himself only. When he votes as a director, he represents all the stockholders in the capacity of a trustee for them, and cannot use his office as a director for his personal benefit at the expense of stockholders.
Broz c. Cellular Information Systems
• Facts: The government owns the airwaves, and they sell airwaves location by location (towers) to cell phone companies. Broz owns his own little company (A), and he is also on the board of directors for a bigger company (B). (B) is selling off all of their existing cell phone towers because they are reorganizing their debts in bankruptcy, while Broz’s smaller, personal company (A) is in money-making mode. There doesn’t appear to be a conflict of interest. Broz is approached by a separate company looking to sell a tower. Broz asks (B) if he can negotiate with this company, because it is well known that (B) is not in the business of buying towers at that point. (B) thinks its fine, so (A) starts negotiating with the new company. However, a completely different company, (C), is a famous and humongous cell phone carrier, and they decide to buy every share of (B). After they do it, they realize how valuable Broz’s new cell phone tower he bought is worth, and they want to get their hands on it. As majority shareholders of (B), they bring suit alleging that Broz owed a fiduciary duty of loyalty to (B), which he breached. (C)’s argument is that when Broz caused his company (A) to buy the new tower, this was a corporate opportunity that was taken away from (B), and Broz should have given the opportunity to (B) as he was a director of that corporation also.
• Corporate Opportunity Rule (Part of Duty of Loyalty): A corporate fiduciary agrees to place the interests of the corporation before his or her own in appropriate circumstances. If there is presented to a corporate officer or director a business opportunity which:
1) The corporation is financially able to undertake--This will always be met because a corporation can always borrow money
2) From its nature, is in the line of the corporation's business and is of practical advantage to it
3) Is one in which the corporation has an interest or reasonable expectancy--This element is dispositive of the outcome. This is the most important element, and it usually always comes down to whether the company objectively expected it would be given the opportunity
4) By embracing the opportunity, the self interest of the officer or director will be brought into conflict with that of the corporation and the law will not permit him to seize the opportunity for himself

• Holding: The corporate opportunity doctrine seeks to reduce the possibility of conflict between a director’s duties to the corporation, and his own interests unrelated to that role. Here, Broz adhered to his obligations. (B) had no interest in buying cell towers, or trying to acquire an opportunity to buy cell towers. Thus, Broz did not breach his fiduciary duty (loyalty) to (B).
Cookies Food Products v. Lakes Distributing
• Shareholders derivative suit by minority shareholders of a closely held Iowa corporation that makes barbeque sauce
o They allege that ∆ by acquiring control of Cookies and executing self-dealing contracts, breached his fiduciary duty to the company
• Cookies was created in 1975, and Herrig (∆) owned a distribution company at the time. After a year where the sales of the sauce were atrocious, Cookies entered into an exclusive distributorship with Herrig

• Self Dealing Test-->No contract or other transaction b/w a corporation and one or more of its directors or any other corporation, firm, association or entity in which one or more of its directors are directors or officers or are financially interested, shall be either void or voidable because of such relationship or interest if any of the following occur:
o The fact of such relationship or interest is disclosed or known to the board of directors or committee which authorizes, approves, or ratifies the contract of transaction without counting the votes of such interested director
o The fact of such relationship or interest is disclosed or known to the shareholders entitled to vote and they authorize such contract or transaction by vote or written consent
o The contract or transaction is fair and reasonable to the corporation

o Additionally, we require directors who engage in self-dealing to establish the additional element that they have acted in:
(1) Good Faith
(2) Honesty
(3) Fairness
• Illig: First, we have them get permission first, and last, we ask that they acted in good faith, honesty, and fairness.
Walt Disney Cases
• Facts: Ovitz was hired as President of Disney, where he was friend of Eisner. Ovitz was a successful talent-broker but had no experience running a firm like Disney. He was given incredible downside protection. Downside protection is the bargaining chip to incentivize a guy like Ovitz to leave his very successful career as a talent-broker: because he’s giving up his current opportunity to make money (by taking a risk at a new job), Disney wants to “protect him in the case it doesn’t work out” in order to get him to jump ship from his current job. However, Disney’s expert, nor the Board of Directors, ever made the perfect calculation of how much Ovitz stood to gain by being fired in a “no-fault” capacity versus an “at-fault” capacity. Because of this insane discrepancy, Ovitz stood to make a lucrative $140 million dollars after being fired under the “no-fault” provision after a mere 14 pathetic months on the job.
• Issues: There were a few claims made: (1) The Old board made a bad decision in approving the Ovitz pay. (2) The New Board was even worse by approving the no-fault clause and this was waste. The argument is that there is no justification for this amount of money when he fails. The Board never did the math, and should have figured out the formulas. Additionally, they fired him without cause. If he was such a bad fit, he shouldn’t have been fired. Because of this, the Directors (being personally liable for our money) should be held personally liable in Court.

• Duty of Care For Directorial Decision-Making: A Board is responsible for considering only the material facts that are reasonably available, not those that are immaterial or out of the Board’s reasonable reach. This is measured by gross negligence. The standard for judging the informational component of the directors’ decision-making does not mean that the Board must be informed of every fact.
o Court Says: The Old Board is entitled to the presumption that it exercised proper judgment, including proper reliance on the expert. Crystal was an expert on whom the Board was entitled to rely in good faith, and what he believes in hindsight done does not provide a rebuttal to the business judgment rule.

• Waste Test: An exchange that is so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration. A board’s decision on executive compensation is also entitled to great deference.
o Court Says: The size and structure of executive compensation are inherently matters of judgment, and we give deference to the business judgment rule.

judgment rule.
• Holding: While shareholders have a right to be angry here, there is a very large burden on stockholders who believe they should pursue the remedy of a derivative suit instead of selling their stock (or seek to oust these directors from office). Dismissed.
Stone v. Ritter
• Facts: The directors of the corporation had poor oversight, and certain people stopped filling out an important form. Because of this oversight, the corporation was fined by the government. The shareholders were rightfully upset, and sued the corporation’s directors. They claimed that the directors were so egregiously bad, they needed to pay money back to the corporation themselves.
• Reasoning: The Delaware Supreme Court found that the standard for determining whether directors can be personally liable (for failure to exercise oversight of employees who fail to comply with their duties) was a "lack of good faith as evidenced by a sustained or systematic failure of a director to exercise reasonable oversight." That's the same standard that was given in Caremark. The Court found that there are two conditions necessary for liability under the standard set by Caremark:
• (1) The directors utterly failed to implement any reporting or information system or controls; or
• (2) Having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.
• Note: In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.

• Holding: The Court found that there is no duty of good faith that forms a basis, independent of the duties of care and loyalty, for director liability. Additionally, just because there was a bad outcome in this case, that was not evidence of bad faith on the part of the directors. In other words, directors are not responsible for ensuring the legality of every act by the corporation's personnel, even if the illegal conduct would have been discovered if there hadn't been a failure of the corporate compliance program.

• Illig: The most important part about this case is that the Delaware court finally said that there is no such thing as a duty of good faith. There are only two fiduciary duties: (1) The Duty of Care and (2) The Duty of Loyalty. Good faith, from here on out, is merely just a subsection of the duty of loyalty.
Gall v. Exxon Corp.
• Facts: Some guy at Exxon, who manages a subsidiary in Italy, is “bribing” Italian officials. The Plaintiff (shareholder) is pissed off because this is against the interest of the company because shareholder money was being used for some random purpose like bribing. I gave you money to invest, and you were supposed to build the company, but you handed it over to Italians, so you should pay it back. Exxon’s Board of Directors established a Special Committee on Litigation composed of Exxon Directors and referred to the Committee for the determination of Exxon’s action the matters raised in this and other pending actions. The committee investigated and recommended that it would be contrary to the interests of Exxon and its shareholders for Exxon or anyone on its behalf to bring legal action against any Exxon director or officer. The Committee resolved to oppose and seek dismissal of all shareholder derivative actions relating to the above-mentioned bribes.
• Procedure: Exxon Corp., (Defendant), has moved for summary judgment dismissing Gall’s, (Plaintiff), complaint alleging that the litigation committee exercised sound business judgment in deciding it would be contrary to the interests of Defendant to pursue a legal remedy. Defendant brought lawsuit anyway.
• Special Litigation Committees: When a shareholder brings a derivative lawsuit, a Special Litigation Committee are brought in as allegedly disinterested people to make a special report. They have nothing to do with the alleged misconduct. They have great reputations. They create a report, interview 100 people, 3 volumes, hardbound at Kinkos (looks thorough and official) and usually conclude that its not in the best interest that the Corporation sue management (obviously).

• Holding: Plaintiff must be given the opportunity to test the bona fides and independence of the Committee through discovery and if necessary at a plenary hearing. See the Delaware evolution of these SLC, demand lawsuits, demand futility in Zapata and Aaronson
• Note: In derivative lawsuits, the company gets the money back, it never gets into the hands of the plaintiff, but the plaintiff owns stock in a company that it is now richer, so the stock is now more valuable.
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