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Corporations

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Corporations

Course Info

Professor: Unknown Semester: Fall 2016 Jurisdiction: Delaware (DGCL), with references to UPA/RUPA, MBCA, and ALI Principles

Topics Covered

  • Agency: formation, termination, actual/apparent/inherent authority, ratification, respondeat superior, fiduciary duties of agents
  • Partnership: formation, governance, dissolution under UPA/RUPA, fiduciary duties (Meinhard v. Salmon)
  • Alternative business forms: LP, LLP, LLLP, LLC; comparative advantages; waiver of fiduciary duties in LLCs
  • Corporate formation: certificate of incorporation, bylaws, charter amendments; DGCL §§ 101–109
  • Centralized management: board of directors, committees, officers; director-centric model; separation of ownership and control
  • Shareholder voting: elections (plurality vs. majority), cumulative voting, staggered boards, proxies, written consent; class voting §§ 212–216, 242
  • Shareholder information rights: DGCL § 220
  • Techniques separating control from cash flow: dual-class stock, pyramidal structures, vote buying
  • Duty of care: business judgment rule; gross negligence standard; Caremark/Stone v. Ritter monitoring duty; DGCL § 102(b)(7) waiver
  • Duty of loyalty: self-dealing, interested director transactions, DGCL § 144; disclosure, approval, and intrinsic fairness
  • Good faith: Disney case; relationship to duty of loyalty; bad faith between negligence and intentional misconduct
  • Controlling shareholders: Sinclair Oil pro-rata rule; Weinberger entire fairness roadmap; MFW safe harbor (Kahn v. M&F Worldwide)
  • Corporate opportunity doctrine: DGCL § 122(17) waiver; safe harbor of presenting to board
  • Executive compensation: § 144(a)(1) conflict treatment; independent compensation committees; Dodd-Frank say-on-pay; § 162(m) deductibility cap
  • Shareholder lawsuits: direct vs. derivative (Tooley test); attorneys’ fees; substantial benefit doctrine
  • Demand requirement: Aronson-Levine demand futility test; Rales variant; universal demand (MBCA)
  • Special litigation committees: Zapata two-step; Oracle independence standard; Joy v. North business judgment approach
  • Exclusive forum and fee-shifting bylaws: DGCL §§ 102(f), 115
  • Mergers and acquisitions: statutory merger (§ 251), stock acquisition, asset acquisition (§ 271); triangular merger; two-step merger; § 251(h); § 253 short-form merger; appraisal remedy § 262; de facto merger doctrine
  • Controlling shareholder cash-out mergers: Kahn v. Lynch entire fairness; MFW BJR safe harbor
  • Williams Act: tender offers; Schedule TO and 14D-9; Schedule 13D; 20-day open period
  • Hostile takeovers: Unocal enhanced scrutiny; Unitrin preclusion analysis; poison pill (Moran); Revlon mode; Paramount I and II
  • State antitakeover statutes: DGCL § 203; proxy contests; Blasius disenfranchisement doctrine
  • Antitrust implications: Hospital Corporation of America v. FTC

Detailed Outline

I. Agency Law

Formation and Types

  • Rest. 3d § 1.01: manifestation of mutual assent + principal control over agent
  • Disclosed, unidentified (partially disclosed), undisclosed principals — Rest. 3d § 1.04(2)
  • General agents (continuity of transactions) vs. special agents (single transaction) — Rest. 2d § 3

Authority and Liability

  • Actual authority (§ 2.01): principal’s manifestation to agent; agent’s reasonable belief
  • Apparent authority (§ 2.03): traceable to principal’s manifestation to third party; third-party reasonable belief
  • Inherent/implied authority (Rest. 2d § 8A): usual acts of general agents, even if forbidden; requires no notice from principal
  • Ratification (§ 4.01): ex post affirmance; converts to actual authority
  • Respondeat superior (§ 2.04): employer-employee; scope of employment; right to control manner and means

Agent Fiduciary Duties

  • Obedience (§ 8.09): act within actual authority; follow lawful instructions
  • Care (§ 8.08): standard of similarly situated agents
  • Loyalty: no material benefits from position (§ 8.02); no adverse party transactions without principal consent (§ 8.03)
  • Remedy for breach: disgorgement of all benefits (Tarnowski v. Resop); per se prohibition on trustee self-dealing (In re Gleeson)

Key Agency Cases

  • Jenson Farms v. Cargill: de facto principal-agent from control, even without formal contract
  • White v. Thomas: blank check creates apparent authority for purchases, but not sales of land
  • Gallant Ins. v. Isaac: inherent authority protects third parties in common practice transactions
  • Humble Oil v. Martin vs. Hoover v. Sun Oil: control vs. profit-sharing distinguishes employee from independent contractor

II. Partnership Law

Formation

  • UPA § 6(1): association of 2+ persons to carry on as co-owners; share profits (§ 7(4) prima facie evidence)
  • Sharing gross revenues does not establish partnership (§ 7(3))
  • Vohland v. Sweet: profit-sharing + mutual control = partnership, regardless of label

Authority and Liability

  • UPA § 9(1): act of partner in usual course of business binds partnership
  • § 9(2): extraordinary decisions require unanimity
  • § 9(3): no authority to assign property for creditors, dispose of goodwill, make it impossible to carry on business, etc.
  • All partners jointly and severally liable for wrongful acts (§ 15)

Governance and Rights

  • § 18: equal rights in management; majority rules on ordinary matters; unanimity for extraordinary
  • National Biscuit v. Stroud: in two-person partnership, one partner can bind partnership in ordinary course even if other objects

Dissolution

  • UPA default: withdrawal → dissolution (§ 29) → winding up (§ 37) → liquidation (§ 38)
  • At-will partnership: power (and right) to withdraw; good faith constraint on opportunistic dissolution (Page v. Page)
  • Adams v. Jarvis: partnership agreement can override default dissolution rules
  • Liquidation value vs. going concern value: withdrawing partner penalized for destroying going-concern premium
  • RUPA § 801(2): majority rule replaces unanimity for continuation

Fiduciary Duties

  • Meinhard v. Salmon: active partner owes passive partner “duty of finest loyalty” — must disclose opportunities
  • Agency law duties apply: obedience, care, loyalty

Alternative Forms

  • LP: general partners (J&S liability + management); limited partners (limited liability, no management); popular for VC/PE
  • LLP: add limited liability to general partnership; minimum capital or insurance requirements
  • LLC: limited liability + single taxation + contractual freedom; Delaware § 18-1101(b) maximum effect to contract; Papas v. Tzolis: sophisticated parties can contract out of fiduciary duties if clear and precise

III. The Corporate Form

Characteristics and History

  • Four essentials: legal personality/indefinite life; limited liability (personal asset shielding + entity asset shielding); free transferability of shares; centralized management
  • Internal affairs doctrine: charter state law governs wherever corporation operates
  • Delaware dominates: race to the top vs. race to the bottom debate

Formation under DGCL

  • § 101(a): incorporators sign certificate, file with Secretary of State
  • § 102(a) mandatory: name, address, nature of business, capital stock structure, incorporator name/address
  • § 102(b)(7) optional waiver of director monetary liability for duty of care (not loyalty, bad faith, § 174 violations, improper personal benefit)
  • § 109: board can amend bylaws; shareholders retain concurrent power

Board Structure

  • § 141(a): business managed by board; director-centric model
  • Majority quorum default (not less than 1/3); majority of quorum to pass resolution — § 141(b)
  • Committees (§ 141(c)(2)): can exercise all board powers except fundamental transactions, bylaw amendments
  • Staggered boards (§ 141(d)): 1/3 elected annually; two years to achieve majority replacement

Shareholder Voting

  • One share-one vote (§ 212(a)); cumulative voting allowed (§ 214)
  • Plurality default in elections; majority voting trend (§ 216)
  • Director removal by majority shareholders without cause (§ 141(k)); exceptions for staggered boards + cumulative voting
  • Written consent in lieu of meeting: § 228(a)
  • Federal proxy rules: § 14a-8 shareholder proposals; § 14a-9 antifraud; § 14a-3 proxy statement filing
  • Virginia Bankshares: false proxy statement must be causally related to shareholder injury

Class Voting

  • § 242: board resolution + majority shareholder vote required for charter amendment
  • Class voting triggered if amendment adversely affects rights of a class

IV. Duty of Care

Standard and Business Judgment Rule

  • Default standard: gross negligence (Gagliardi); ALI § 4.01: good faith + best interest of corporation + ordinarily prudent person
  • BJR protects disinterested, informed, good-faith directors from liability for business losses
  • § 102(b)(7) eliminates even gross negligence monetary liability (except loyalty, bad faith, § 174, improper benefit)
  • Kamin v. American Express: court will not overrule business decisions absent fraud or dishonest dealing

Monitoring Duty (Caremark/Stone Line)

  • Francis v. United Jersey Bank: directors must attend meetings, review financials, inquire on red flags, then correct, object, resign, or sue
  • Graham v. Allis-Chalmers: directors can rely on management honesty, but must respond to red flags in reports
  • In re Caremark: board must establish adequate monitoring and information system for legal risks
  • In re Citigroup: no Caremark duty as to business risks; only legal/compliance risks
  • Stone v. Ritter: two failures: (1) utterly fail to implement monitoring system, or (2) consciously fail to use existing system

Smith v. Van Gorkom — Benchmark Case

  • CEO sold company unilaterally; board approved without adequate information
  • Breach of duty of care: directors must be adequately informed before major transactions
  • BJR inapplicable when directors are uninformed

V. Duty of Loyalty

Self-Dealing Transactions

  • Hayes Oyster: disclosure required even when transaction is substantively fair; disgorgement remedy
  • DGCL § 144 safe harbors:
    • (a)(1): full disclosure + disinterested director approval in good faith
    • (a)(2): full disclosure + shareholder approval in good faith
    • (a)(3): intrinsic fairness (entire fairness)
  • With safe harbor → BJR review; without safe harbor → entire fairness (burden on defendant)
  • Cookies Food Products: Iowa CL imposes entire fairness despite statutory safe harbor; director must show good faith + fairness
  • Cooke v. Oolie: Delaware trend toward BJR deference when disinterested directors approve transaction

Good Faith

  • Disney case: good faith is part of duty of loyalty; bad faith = actual intent to harm; something more than gross negligence required
  • Between gross negligence (care) and intentional harm (loyalty) lies conscious disregard = bad faith → loyalty violation

Controlling Shareholders

  • Sinclair Oil: pro-rata distribution to all → BJR; exclusion of minority → entire fairness
  • Weinberger v. UOP: entire fairness = fair dealing (procedural) + fair price (substantive); burden on defendant
    • Weinberger Roadmap to BJR: (1) full disclosure; (2) independent negotiating committee with real bargaining power; (3) majority-of-minority approval
    • Fair price: any professional valuation technique; DCF analysis is de facto standard
  • Kahn v. Lynch: domination of independent committee by controlling shareholder → entire fairness
  • Kahn v. M&F Worldwide (MFW): business judgment review if, from the outset, merger conditioned on both (i) independent committee with real power and (ii) majority-of-minority approval

Corporate Opportunity Doctrine

  • Agent/partner standard: strong loyalty requires disclosure; principal must approve
  • Corporate context: present opportunity to board (DGCL § 122(17) safe harbor); absent safe harbor → entire fairness
  • DreamWorks example: charter can waive opportunity doctrine for competing businesses

Executive Compensation

  • § 144(a)(1): self-dealing → full disclosure + independent compensation committee → BJR
  • § 162(m): compensation over $1m not deductible unless pay-for-performance
  • Dodd-Frank: say-on-pay (advisory); say-on-frequency; enhanced disclosure
  • Corporate waste standard: no reasonable person would make the exchange; not curable by ratification
  • Goldman Sachs: weak judicial review when 102(b)(7) waiver exists and directors not truly conflicted

VI. Shareholder Lawsuits

Direct vs. Derivative (Tooley v. DLJ)

  1. To whom does the claim belong (corporation or shareholder)?
  2. To whom will recovery go?
  • Derivative: corp suffered loss; recovery to corp (e.g., breach of fiduciary duty by directors)
  • Direct: shareholder’s own rights harmed (e.g., discriminatory voting, disclosure rights, dividends)

Attorneys’ Fees

  • Common fund: percentage of recovery (Delaware)
  • Substantial benefit doctrine (Fletcher v. A.J. Industries): non-pecuniary benefits (governance reforms, board changes) can support fee award

Standing Requirements (FRCP 23.1; DGCL § 327)

  1. Contemporaneous ownership at time of alleged wrong
  2. Continuous ownership during litigation
  3. Fair and adequate representation
  4. Demand requirement (most critical)

Demand Requirement

  • Delaware rule: making a demand concedes board independence (Siegel v. Buntrock)
  • Aronson-Levine demand futility test (at time of complaint):
    • Prong 1: particularized facts creating reasonable doubt that directors are disinterested and independent
    • Prong 2: (alternative) that challenged transaction was not product of valid business judgment
  • Rales variant: when current board did not make the challenged decision, only Prong 1 independence inquiry applies
  • MBCA/ALI: universal demand always required (deters strike suits)

Special Litigation Committees

  • Zapata Corp. v. Maldonado — two-step test:
    1. SLC must prove its independence, good faith, and adequate investigation (burden on corporation)
    2. Court applies independent business judgment whether suit should proceed (discretionary)
  • In re Oracle: very high independence standard for SLC — Stanford ties among SLC members and defendant directors failed
  • Joy v. North (2d Cir.): narrows step 2 to business cost-benefit analysis; makes it mandatory rather than discretionary
  • Auerbach v. Bennett (N.Y.): if SLC proves independence and good faith, entitled to business judgment deference

VII. Fundamental Transactions: Mergers and Acquisitions

Three Principal Forms

FormBoard ApprovalSH VoteLiability TransferAppraisal
Statutory merger (§ 251)Both boardsBoth SH (majority outstanding)Automatic (§ 259)Yes
Stock acquisition (§§ 201, 122)None neededSH vote with feetNone (target survives as sub)No
Asset acquisition (§ 271)Buyer board; target board + SH if “substantially all”Target SH if substantially allCherry-pickingNo

Statutory Merger (§ 251)

  • § 251(f) small-scale exception: bypass acquiring corp SH vote if charter unchanged, stock identical, <20% new shares issued
  • Triangular merger: reverse triangular preferred — target survives, preserves licenses/contracts, shields buyer from target liabilities, bypasses buyer SH vote
  • Two-step: § 251(h) (2014): listed corp; get >50% in tender offer → bypass SH vote; or § 253 short-form if >90%
  • De facto merger doctrine: Hariton v. Arco — independent legal significance doctrine; legislature controls, not courts

Asset Acquisition — “Substantially All”

  • Katz v. Bregman: quantitative + qualitative test (citing Gimbel); radical departure from existing business
  • Hollinger (dictum): quantitative means essentially all assets, well above 50%

Appraisal Remedy (§ 262)

  • Who gets it: § 251 mergers; § 251(h) two-step; § 253 short-form
  • Market-out exception (§ 262(b)(1)): no appraisal if stock is listed on national exchange AND consideration is stock, except when involuntarily terminated for other than stock/cash-for-fractional
  • Valuation: fair value as going concern, excluding merger effect; any professional technique (DCF preferred, Weinberger)
  • Exclusivity: sole remedy for § 253 short-form minority cash-out

Controlled Mergers and Freeze-Outs

  • Kahn v. Lynch: even 43.3% controller exercising dominance → entire fairness; threat of hostile offer at lower price = coercion
  • MFW safe harbor: entire fairness → BJR if conditioned from outset on both independent committee (with real power, own advisors, can say no) and majority-of-minority vote (informed, not coerced)
  • In re CNX Gas: same MFW logic applies to first-step tender offers

VIII. Hostile Takeovers

Background

  • Williams Act: any 5% accumulation requires § 13(d) filing; tender offer open 20 business days, unconditional, open to all SH; Schedule TO by acquirer; Schedule 14D-9 by target
  • Two-tier offer structure: front-end cash premium + back-end junk bonds → structurally coercive (now largely disappeared)

Unocal Enhanced Scrutiny

  • Unocal Corp. v. Mesa Petroleum: director self-interest is “omnipresent specter” in defensive measures
  • Two-part test (Unocal-Unitrin):
    1. Identify genuine threat to corporate policy and effectiveness (inadequate price, illegality, timing, impact on constituencies; coercive structure)
    2. Response must be: (a) not preclusive, and (b) not coercive, and (c) within range of reasonableness → BJR deference
  • If preclusive → court enjoins; if outside reasonableness range → entire fairness

Poison Pill (Shareholder Rights Plan)

  • Moran v. Household: board may adopt pill in absence of immediate threat; relies on § 151(a), § 151(g) blank-check preferred, § 157 rights
  • Still subject to Unocal-Unitrin; redeemable by board; can be forced through (at large cost); target board’s pill can be defeated through proxy contest to replace board

Revlon Mode

  • Revlon, Inc. v. MacAndrews & Forbes: once board decides to sell/break up company, defensive posture ends; board becomes “auctioneer” obligated to maximize shareholder value
  • Revlon triggers (Paramount v. Time; Paramount v. QVC):
    • Board initiates sale/break-up (clear break-up of the company)
    • Sale results in “change of control” — control shifts from dispersed public shareholders to a controlling block
  • Paramount v. Time: no Revlon trigger where Time-Warner was a merger of equals and shareholders retained meaningful equity interest in combined company; Unocal analysis applied
  • Paramount v. QVC: Revlon triggered — control shifting to Redstone’s block; QVC’s competing bid entitled to good-faith consideration
  • Lyondell: Revlon duty only arises when board “embarks on” a change-of-control transaction; passive “wait and see” is not a breach unless board knowingly and completely failed to act

Protecting the Deal

  • No-shop clauses; termination fees; fiduciary outs (must be present for board to comply with Revlon)
  • Lock-up options: permissible if they promote bidding; impermissible if they end the auction (Revlon)
  • Stock options given to favored bidder: draconian if they allow bidder to extract value from rival bid

State Antitakeover Statutes

  • DGCL § 203: any person acquiring 15%+ becomes “interested stockholder”; business combinations with interested stockholder blocked for 3 years unless board pre-approved acquisition or post-acquisition 85% approval by remaining SH
  • Blasius Industries v. Atlas Corp.: disenfranchisement of shareholders requires compelling justification even if not primary purpose to entrench

Hospital Corporation of America v. FTC

  • Antitrust dimension to acquisitions: FTC challenged HCA hospital acquisitions reducing competition
  • Product market definition; geographic market analysis; effects on price and quality of medical services

IX. Piercing the Corporate Veil

  • Limited liability is the default; piercing is the exception
  • Veil-piercing doctrine: courts disregard entity separation when corporation is mere alter ego of shareholder; typically requires:
    1. Unity of interest and ownership (commingling of funds, failure to observe corporate formalities, undercapitalization)
    2. Adherence to fiction of separateness would sanction fraud or promote injustice
  • Reverse triangular merger: target subsidiary’s liabilities do not automatically pass to parent buyer; veil-piercing required to reach parent

Key Doctrines

Key Cases

Exam Approach

Step 1: Identify the Type of Transaction and Applicable Standard

SituationStandard
Routine business decision, disinterested directorsBusiness judgment rule (gross negligence + good faith)
Director self-dealing (§ 144)§ 144 safe harbor → BJR; no safe harbor → entire fairness
Controlling SH pro-rata actionBusiness judgment rule (Sinclair Oil)
Controlling SH self-dealing to exclusion of minorityEntire fairness (Weinberger)
Controlling SH cash-out merger, MFW conditions metBusiness judgment rule (MFW)
Hostile takeover defenseUnocal enhanced scrutiny (threat + proportionality)
Sale/break-up of company or change of controlRevlon mode (maximize shareholder value)

Agency Authority Checklist

  1. Actual authority: principal’s manifestation to agent + agent’s reasonable belief
  2. Apparent authority: principal’s manifestation to third party + third party’s reasonable belief
  3. Inherent authority (Rest. 2d § 8A): usual acts of general agent, even if forbidden; no notice to third party
  4. Ratification: principal’s ex post affirmance

Duty of Care Analysis

  • Is director independent and disinterested? → BJR presumption
  • Was director adequately informed? → Van Gorkom red flag
  • Was decision made in good faith? → Not conscious disregard
  • 102(b)(7) waiver in charter? → No monetary liability for care violations (not loyalty, bad faith, § 174, improper benefit)
  • Caremark monitoring: is there a compliance system? Stone v. Ritter: utterly fail to implement OR consciously fail to use

Duty of Loyalty — Self-Dealing

  • DGCL § 144 safe harbor: full disclosure + (a) disinterested director approval, or (b) shareholder approval, or (c) intrinsic fairness
  • Without safe harbor: entire fairness (fair dealing + fair price); burden on defendant
  • With safe harbor: BJR review (deference)
  • Corporate waste: no reasonable person would make the exchange; ratification cannot cure

Controlling Shareholder Transactions

  • Pro-rata treatment → BJR (Sinclair Oil)
  • Self-dealing to exclusion of minority → entire fairness (Weinberger); burden on defendant
  • MFW safe harbor: BJR if conditioned from outset on (i) independent negotiating committee with real bargaining power + own advisors + power to say no definitively, AND (ii) majority-of-minority vote (informed, uncoerced)

Derivative Suit Checklist

  1. Contemporaneous ownership at time of wrong (§ 327)
  2. Continuous ownership during litigation
  3. Fair and adequate representation
  4. Demand requirement:
    • Aronson-Levine test: reasonable doubt that (1) directors are disinterested/independent, OR (2) transaction product of valid BJR
    • Rales variant (no board overlap): only prong (1) independence inquiry
    • Universal demand (MBCA/ALI): always make demand
  5. Special litigation committee: Zapata step 1 (SLC independence, good faith, adequate investigation) + step 2 (court’s discretionary business judgment)

Mergers and Acquisitions

  • Statutory merger (§ 251): board resolution + majority SH vote (both boards); § 251(f) small-scale exception (<20%)
  • Stock acquisition: no board approval needed; SH vote with feet
  • Asset acquisition (§ 271): board + majority SH vote if “substantially all” assets (quantitative + qualitative test)
  • Triangular merger: reverse triangular preserves target’s attributes; liability shielding; bypasses buyer SH vote
  • Two-step merger: § 251(h) tender offer + short-form merger (§ 253 if >90%); or § 251(h) if listed, >50%
  • Appraisal remedy (§ 262): fair value as going concern; market-out exception if listed stock; DCF preferred method

Takeover Defenses

  • Unocal two-step: (1) identify genuine threat; (2) response not preclusive, not coercive, within range of reasonableness → BJR
  • If preclusive: court enjoins; if outside range of reasonableness: entire fairness
  • Revlon triggers: (i) sale/break-up initiated by board, or (ii) change of control to controlling block
  • Revlon duty: maximize shareholder value; be a fair auctioneer; no deal protections that end the auction
  • Poison pill: valid under Moran; subject to Unocal proportionality; can be redeemed by board
  • § 203: 3-year moratorium on business combinations with 15%+ interested stockholder

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