Notes on Reading

Notes on reading:

What is a Corporation?
Promoter Liability
“Where a party has contracted with what he acknowledges to be a corporation, he is estopped from denying the existence or the legal validity of such corporation.” Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. p.201 – where Δ tries to renege on contract b/c claims π didn’t have legal status as a corporation, but court says no way b/c Δ acknowledged π as a corporation at time of contract.
Corporation Entity and Limited Liability
Piercing the Corporation Veil
Courts may PCV when anyone uses control of the corp. to further his own rather than the corporation’s business. In Walkovszky, though, π didn’t show that stockholder was conducting the business in his individual capacity. Walkovszky v. Carlton p.206 (taxicab case where π seeks to PCV after being injured by one of Δ’s corporation’s cabs, which doesn’t hold enough insurance. Δ owner of ~10 corporations, each of which holds 2 cabs.)
Two-Prong Test: Courts can PCV when
“there is a unity of interest and ownership between the corporation and an individual and
unity where there was undercapitalization, commingling, lack of corporate formalities (no article of incorporation), shuttling of funds back and forth
where adherence to the fiction of a separate corporate existence would sanction a fraud or promote injustice” Sea-Land Services, Inc. v. Pepper Source, p.211 (where court finds unity of interest and ownership between corporation and individual – Δ sole shareholder of Pepper Source, didn’t maintain records, and funds and assets commingled “with abandon.”)
Totality-of-the-circumstances test – each case decided on its own facts.
Kinney Shoe Corporation v. Polan p.217 where lower court is reversed by higher court. Lower court found that, even though two-prong test satisfied, π had assumed the risk of Δ’s undercapitalization. Δ had invested nothing in Δ corporation, and lower court saw this as risky for π, and π should have known better. Higher court says this should not provide protection to Δ!
Summary judgment for PCV is proper if the evidence presented could lead to but one result. In the case where the jury could find otherwise, then summary judgment must be denied.
In re Silicone Gel Breast Implants Products Liability Litigation p.221 where π class action seeks to PCV against Δ parent corporation. Δ sought summary judgment, and court denies, saying that the different jurisdictions might find differently.
What do courts consider when deciding if something satisfies the tests?
whether parent and subsidiary have common directors, officers, or common business depts.
whether parent and subsidiary file consolidated financial statements and tax returns
whether the parent finances the subsidiary
whether the subsidiary operates with grossly inadequate capital
ALL jurisdictions require a show of substantial domination.
Purpose of the Corporation
Altruism!
State legislation adopted in the public interest can be constitutionally applied to preexisting corporations under the reserved power.
A.P. Smith Mfg. Co. v. Barlow p.270, where corporation makes donations to Princeton University’s annual fund, and shareholders had challenged this decision b/c its certificate of incorporation didn’t specify authorizing donations and b/c N.J. statutes that would have authorized the contributions were enacted long after A.P. Smith’s incorporation (and thus the statutes didn’t apply retroactively).
Court wants to promote charitable giving.
Court as interested in philanthropy and social policy as by statutory law.
Provide profits for its stockholders!
A corporation’s primary purpose is to provide profits for its stockholders.
Dodge v. Ford Motor Co. p. 276, where Δ Ford stops giving π (and other shareholders) dividends in order to reinvest the money in the business. Court says he shouldn’t have done this and should pay the shareholders their dividends.
Ford Motor Co. had a “clearly prosperous outlook.”
Ford isn’t entitled arbitrarily to decide to refuse to pay a dividend which had been est’d over several years.
Ford was probably motivated to refuse the dividend b/c Dodge opened up its own automobile company, and Ford didn’t want the dividends essentially to go straight to funding his competitors.
Business Judgment Rule
Don’t mess with what the directors are doing!
Unless they’re doing something BAD.
A shareholder’s derivative suit can only be based on conduct by the directors which borders on
Fraud
Illegality
Or conflict of interest.
Shlensky v. Wrigley p. 281, where π shareholder sued Δ Wrigley for not installing lights at Wrigley Field in order to hold night games and increase revenues. π says refusal to install was a personal decision and not in the best interest of the shareholders.
π can’t force a business judgment on the directors.
There is no showing of fraud, illegality, or conflict of interest.
Wrigley has valid (non-personal) reasons not to install the lights.
Fiduciary Duties
Duty of Care
Duty of care requires “that amount of care which ordinarily careful and prudent men would exercise in similar circumstances.” (slide 15, class 5)
BJR allows directors a wide berth in conducting affairs of corp. so that they don’t have to worry constantly whether or not what they’re doing could be a cause for action.
Kamin v. American Express Co. p.316 where court says it will not interfere with Δ’s decision whether or not to declare a dividend or make a distribution.
Δ shareholder sued π corporation for distributing shares that were worth far less than what π paid for and that might have benefited shareholders otherwise (taxes, etc.) if another action were taken.
Court says it’s not enough just to say that another course of action would have been better.
BJR requires a showing of fraud, illegality, or conflict of interest.
BUT, directors need to act on an informed basis, availing themselves of all material information reasonably available.
Smith v. Van Gorkom, p.320, where Δ company/board of directors approves a proposed merger based on a 20 minute presentation and w/o any other outside information.
Court says NO WAY and shareholders are correct in suing.
BJR doesn’t shield the directors when they failed to conduct further investigation.
Super crazy lucrative compensation agreement and termination payout doesn’t necessarily constitute breach of fiduciary duty.
A board’s decision on executive compensation is entitled to great deference.
It is the essence of business judgment for a board of directors to determine if a particular individual warrants large amounts of money.
Outer limits are confined to unconscionable cases where directors irrationally squander or give away corporate assets.
BJR does NOT take into account “substantive due care,” as Brehm tries to allege in Brehm v. Eisner, p.339 where π shareholders sue Δ corporation and board of directors for giving Ovitz, erstwhile president, HUGE crazy compensation package and severance agreement.
Possible that there are other factors going into the huge compensation package.
Maybe Disney is trying to avoid expensive litigation that might ensue should they fire Ovitz for-cause and give him nothing.
Basically, there’s a BIG burden on stockholders who believe they should pursue a derivative suit instead of
Selling their stock
Or seeking to reform or oust directors from office.
Director’s liability to third parties (NOT shareholders) CAN exist, however. Court has looked at nature of the business to see how directors’ actions have affected directly the firm’s clients.
Director is liable to its clients if:
a duty existed
the directors breached that duty
and the breach was a proximate cause of the client’s losses
Francis v. United Jersey Bank p.349, where Δ director ignored her duties as a director, allowing her sons to withdraw over $12 million from client trust accounts.
Court says that she is individually liable.
“As a general rule, a director should acquire at least a rudimentary understanding of the business of the corporation. Accordingly, a director should become familiar with the fundamentals of the business in which the corporation is engaged.” (p.351)
Court looked at nature of the business – reinsurance business relies on entrustment of a capital within the company and on transmission of funds to the appropriate parties. Resembles a bank more than a small business.
Duty to monitor: Part of a board’s duty is to make sure a “corporate information and reporting system” exists and is adequate in order to monitor possibly shady dealings. Slide 4, class 8.
This is an affirmative duty and should be attempted in good faith.
In re Caremark International Inc. Derivative Litigation, p. 355, where Δ company acted illegally and π shareholders bring shareholder derivative action, charging Δ with failure to adequately monitor as part of its duty of care.
NOT everything under the sun of its corporate activity.
Awareness of major activities and related issues that could pose a threat to the company.
BJR still protects the choice of what structure to use in informational gathering.
NO duty to monitor personal affairs.
Beam v. Martha Stewart Living Omnimedia, Inc., supp. p.16
Derivative action against MSO for not monitoring MS’s personal affairs.
ImClone/Martha Stewart’s divestment of its stock scandal – “After barely two months of such adverse publicity, MSO’s stock price had declined by slightly more than 65%.” (p.19)
Court says that the directors have no duty to monitor her personal affairs. Graham v. Allis-Chalmers Manufacturing Co. “refers to wrongdoing by the corporation.”
No reason to expect wrongdoing (as opposed to Francis, for example, where husband had said previously that the son would take the shirt off his back if given a chance).
Duty of Loyalty – duty of constant and unqualified fidelity.
Directors and Managers
BJR usually shields directors and managers in all policies of business management.
But that’s only after a determination that duties of care and loyalty haven’t been violated.
In the case where the transactions are entered into for personal reasons, then the transactions are scrutinized.
Bayer v. Beran, p.368 where the Δ board of directors hire the president’s wife to perform on their radio advertisement. Shareholders allege that Δ board was commencing an illegal radio advertising program and was engaging in self-interest by hiring wife of president.
No showing that the radio program was inefficient.
No showing that it was disproportionate in price.
No showing that it was conducted for the personal gain of the president’s wife.
Directors are engaged in a transaction with an entity in which the directors have an interest.
Directors are considered independent unless:
Employed by firm within past 3 years.
An immediate relative was employed by firm as executive officer within last 3 years.
Has a business relationship with the firm.
Is a partner, controlling shareholder, or executive officer of a company that does business with the firm.
Every firm must have at least three independent directors; an audit committee comprised solely of independent directors (all of whom must be financially literate, and one of whom must be an expert in accounting and finance)
Burden of proof shifts to the directors, who have to show that the transaction was fair and reasonable to the corporation.
Lewis v. S.L. & E., Inc., p.373, where Δ company charges the other company in which Δ company had an interest super ridiculously low rent without any showing that it was the fair rental value of the property.
Burden of proof (slide 16, class 8)
No conflict of interest: π has burden of proof, will lose under BJR.
Unratified conflict of interest: Δ directors have burden of proof to show transaction was fair and reasonable.
Conflict of interest but transaction ratified (by disinterested shareholders, majority of disinterested directors): π has burden of proof and has to overcome pretty strong BJR.
Corporate Opportunities
Corporate opportunity doctrine implicated in cases where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.
Two prong test
Definitional – is it a corporate opportunity?
Existing contract rights?
Business essential to the firm?
Logical place for expansion?
Will competition arise? Will it be harmful?
Financial and technical ability to exploit?
Substance – did it violate fiduciary duty?
Totality of circumstances, burden on Δ.
How did employee learn of opportunity?
What is relationship between employee and company?
What disclosure was made to firm?
Were corporate funds used?
Broz v. Cellular Information Systems, Inc. p. 377 where π corporate officer charges Δ corporation with breaching fiduciary duty and usurping a corporate opportunity that should have been Δ defendant’s.
In the totality of circumstances, the court takes into account:
Conflict of interest.
How director became aware of opportunity.
In Broz, he becomes aware of it in his individual and not corporate capacity.
Business nexus – is the opportunity within the line of business?
In Broz, it’s more in the line of business of the director’s (100% owned) company than CIS.
Financial capacity to exploit the opportunity.
CIS was in trouble. Probably couldn’t afford to take the opportunity.
Whether or not the company was given an opportunity to express interest/whether the company actually did express interest in the opportunity.
CIS expressed no interest when Broz mentioned it to them.
“If the director or officer believes, based on one of the factors articulated above, that the corporation is not entitled to the opportunity, then he may take it for himself.” P.381
Dominant Shareholders
Who are controlling shareholders?
Securities law: presumption at 10%
ALI §1.10b: presumption at 25%
Bright line rules don’t work here, so real question is whether board lacks independence.
Delaware: >50% or exercises control over decisionmaking.
Intrinsic Fairness test versus BJR – When does the dominant shareholder find itself facing the intrinsic fairness test.
Self-dealing: Intrinsic fairness test applies only when the business transaction:
Is by one who has a fiduciary duty.
And the transaction is accompanied by self-dealing.
self-dealing = parent receives benefit “to the exclusion and the expense of the subsidiary”
Sinclair Oil Corp. v. Levien, p.385, where Δ corporation controlled π shareholder’s subsidiary.
Court finds no need for intrinsic fairness test b/c there was no self-dealing in paying out the dividends.
Court finds there IS self-dealing in contracting with the subsidiary and subsequently breaching the contract.
Δ Sinclair Oil can’t show that its actions under the contract were intrinsically fair to the π shareholders (who hold shares in the subsidiary).
Fiduciary duty – majority shareholders owe a duty to minority shareholders that is similar to the duty owed by a director.
Voting: controlling stockholder violates his duty if he votes for his own personal benefit at the expense of the stockholders.
Zahn v. Transamerica Corp. p.389, where Δ controlling stockholder makes decisions and votes for the benefit of the Δ corporaiton rather than the shareholders of the subsidiary as a whole.
Where fiduciary duties conflict, directors should protect the interests of the investors bearing the greatest risk. (slide 17, class 9)
Ratification
Essentially: “[T]he entire atmosphere is freshened and a new set of rules invoked where formal approval has been given by a majority of independent, fully informed shareholders.” Gottlieb
If yes ratification, then
A director conflict: π shows waste.
A controlling shareholder’s conflict: π shows unfairness.
If no ratification, then
Directors can still show that it was a fair deal.
“Disinterested shareholders” – ratification by a majority of independent, fully informed shareholders shifts the burden to π objecting shareholder to demonstrate that the terms of the transaction are so unequal as to amount to a gift or a waste of corporate assets.
Fliegler v. Lawrence, p.395, where Δ company got approval of majority of shareholders to go ahead with option.
But still need to meet burden of “intrinsic fairness” to company because that majority of shareholders was NOT a majority of disinterested shareholders. The majority included the interested shareholders’ votes. Only about 1/3 of the votes was by disinterested shareholders.
Nevertheless, court finds there’s intrinsic fairness because the corporation rec’d properties of substantial value, a potentially self-financing and profit-generating enterprise, and the interest given to the USAC shareholders was at a fair price.
Duty of loyalty claim – A fully informed shareholder ratification does not extinguish a duty of loyalty claim, but it serves to make the business judgment rule the applicable review standard with the burden of proof resting on the plaintiff stockholder.
In re Wheelabrator Technologies, Inc. Shareholders Litigation, p.398, where court draws distinction between duty of care and duty of loyalty claims.
π argues that Δ breached duty of disclosure with the proxy statement issued in connection w/their merger.
π says it was misleading.
π thinks “carefully considered financial, business, and tax aspects” is a lie. They only met for 3 hours!
Court says no dice – no support for argument that 3 hours is insufficient consideration of the proposal.
Fiduciary duty claims
duty of care
shareholder vote was fully informed  extinguishes claim that board failed to exercise due care
duty of loyalty – two types of ratification decisions that involve duty of loyalty
“interested” transactions between corporation and its directors
This type is a-okay and NOT voidable if it’s
Approved in good faith
By a majority of disinterested shareholders
burden of proof: BJR

cases involving a transaction between controlling shareholder and the corporation
parent-subsidiary merger
that is conditioned upon receiving “majority of the minority” approval
burden of proof: entire fairness of the transaction as proved by Δ
NOT parent-subsidiary merger
That is conditioned upon receiving “majority of minority” approval
Burden of proof: fairness (or Unfairness) of the transaction as proved by π

Shareholder Derivative Actions
Shareholder derivative actions
Indemnification
It’s constitutional for a state to have a statute holding an unsuccessful π liable for the reaosnable expenses of a corporation in defending a derivative action brought by π.
Cohen v. Beneficial Industrial Loan Corp., p.232, where court upholds statute that makes liable plaintiffs having less than a 5% or $50,000 interest in a corporation.
State is merely providing liability and security for payment if the litigation is adjudged to be unsustainable.
By making it a financial interest threshold, state is probably deterring a number of harassment suits that might arise by shareholders of, say, 1 share.
Personal/direct cause of action (NOT derivative action) – no security $ is required.
Definition of derivative suit: a suit brought in the right of a corporation (in the name of a corporation!) to procure a judgment in its favor.
Eisenberg v.