I intro to Law of Enterprise Organization

§145(a) can indemnify in any action brought as a result of person’s connection to corp so long as they act in good faith, even if they lose

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§145(b) can indemnify in actions brought by the corporation itself

not if they are found liable to corp, unless court gives OK

§145(c) mandatory indemnification for D or O successful in defending an A or B action

§145(f) Vague provision saying others aren’t exclusive

§145(g) Corp can purchase insurance against any liability even if they can’t indemnify for it

good faith generally required p. 243

Waltuch v. Conticommodity Services 2^nd Cir. 1996 p. 243 HH 121

Waltuch executive and trader for Conti
Silver crashes and CFTC brings action for fraud and market manipulation
Waltuch dismissed from private suit but Conti has to pay $35 Mil, Waltuch incurs $1.2M in legal fees
Waltuch fined by CFTC $100K and penalized with another $1Mil in legal fees
Can’t §145a indemnify in absence of good faith
§145(c) requires indemnification if successful “on merits or otherwise”
1. since he was dismissed he was successful
2. even though only really dismissed b/e Conti was prime target

D & O insurance p. 248 HH 122

Del §145f
RMBCA §8.57

Kamin v. American Express NY 1976 p. 248 HH 122

Amex loses $26 Mil on a stock purchase
Instead of selling and using the devaluation to offset capital gains, Amex distributes the shares in a special dividend to avoid accounting losses
BJ protection
1. No claim of fraud or self dealing or bad faith

Business Judgment Rule a la ABA Valid BJ if

Financially disinterested D or O
Duly informed
Good faith effort to advance corp. interests
Since it is an issue of law not fact, Ds and Os are insulated from juries
Economically appropriate b/e you don’t want to discourage risk taking

Smith v. Van Gorkom Del 1985 p. 253 HH 123

On CEO’s recommendation, Board approves Merger in a 2 hour meeting w/o any other information
D’s held grossly negligent by not becoming even reasonably informed
Legislative Response: DGCL §102(b)(7) validated charter amendments that provide that a D has no liability for losses when violating duty of loyalty if disinterested
Breach of Duty of Care  rebuts BJ rule entire fairness review

Mcmillan v. Intercargo Del 2000 p. 256 HH 124

Intercargo sells itself at $12/share alter apparently turning down $14/ share
Charter immunizes D’s under Del §102(b)(7) for duty of care breaches
1. Eliminates Revlon and Disclosure claims as they relate to care
Π’s only remedy then becomes Duty of Loyalty
Π never really alleges any bad faith or self dealing  Dismissed

Cede v. Technicolor Del 1995 p. 261 HH 125

Board authorizes sale based on little info
Breach of duty of care does not require proof of injury to rebut BJ rule
Breach of loyalty or care rebuts BJ rule and required Ds to prove entire fairness
If Π established PF case of negligence, D’s must prove due care or entire fairness

Emerald Parnters v. Berlin Del 2001 p. 264 HH 125

1 interested controlling SH rest Independent Ds
Independent D’s had burden of showing entire fairness b/e of the 1 interested one (he was in the room with them when they voted).

Francis v. United Jersey Bank NJ 1981 p. 266 HH 126

Charles Sr. commingles company funds with personal loans
Son goes nuts and bilks the company
Mrs. Pritchard was on the Board but never exercised any oversight
Board has responsibility to monitor, she breached duty of care
Her sons “spawned their fraud in the backwater of her neglect”.

Hoye v. Meek 10^th Cir. 1986 p. 270 HH 126

Son makes a bad investment and Trust co. goes to pot under semi-watch of semi retired father and chairman of the Board
If he’s on the board he’s got the duty to monitor, breached Care

Graham v. Alice Chalmers Del 1963 p. 271 HH 127

Electrical equipment company
1937 fined by FTC for price fixing
Late 1950’s fined again
SH sues claiming Board should have been on notice to monitor b/e of previous claims.
D’s entitled to rely on honesty of subordinates until something occurs to put them on suspicion
Liability will only attach through neglect if
1. Reckless confidence
2. Neglect of duty
3. Ignored willfully or through inattention obvious signs of danger

In re Caremark Del 1996 p. 276 HH 128

Caremark gets fined under laws preventing physician referral kickbacks
Company has a compliance system in place including ethics guide books.
b/e of compliance system, little chance of winning
Failure to monitor only a sustained or systemic failure of Board to exercise oversight.
D have duty to see that a reasonable control system is in place designed to offer a reasonable assurance of compliance.

Miller v. ATT 3^rd Cir. 1974 p. 282 HH 128

ATT makes a $1.5 Mil loan to DNC and doesn’t bother collecting
SH bring action claiming it is a violation of lthe law as an illegal contribution
Court holds private right of action exists vis-à-vis SH because they were the protected class
BJ rule doesn’t apply to illegal acts

IX. Conflict Transactions Duty of Loyalty
2 types of transactions are closely controlled

When a D or controlling SH has a financial stake in the transaction
Substantial decisions

Loyalty generally to the SH – SH primacy

Penn §1715(a) D’s may consider HH 130

Effects on all groups including SH, employees, suppliers, customers, and creditors and communities
Short term and long term interests of the corporation
Resources, intent, and past conduct of any would-be acquirer
All other pertinent factors

Dodge v. Ford Mich. 1919 p. 286
1. Shareholder primacy
2. Henry Ford can’t give Corp money to charity.
3. Can’t donate unless it benefits the corp.
AP Smith v. Barlow NJ 1953 p. 288 HH 132
1. Corp. makes modest donation to Princeton
2. 1930 NJ statute allows Corps to be charitable if D’s believe it will contribute to protection of corp interest
3. 1950 statute allows donations of up to 1% of capital unless SH wuthorize
4. Π syas statutes not elegible b/e Corp already incorporated
5. BUT NJ legislature has reserved power to amend charters
6. Donation OK
  1. No suggestion that it was indiscriminate
  2. No suggestion that it was for a D’s pet charity
Hayes Oyster Co. Wash 1964 p. 294 HH 132
1. Hayed D, 23% SH and CEO Corp. has CF problems and Hayes convinces the to sell 2 oyster beds
2. Hayes convinces an employee to buy them and finances him in exchange for 50% ownership.
3. Interested transaction not voidable if D or O can show that they were fair
4. However, nondisclosure is per se unfair
  1. Intent to defraud or injury not necessary (punctilio)
5. Coastal has option to affirm or ratify
6. Chooses to affirm, and Hayes’ 50% now belongs to Coastal
Duty of Disclosure p. 297
1. All information
2. Not necessarily price
Sinclair Oil v. Levien Del 1971 p. 299 HH 133
1. Sinclair 97% ownership of Venezuelan subsidiary
2. Milks the subsidiary, declaring dividends and minimizing capital investment.
3. Sinclair owed Sinven a Fiduciary duty
4. Intrinsic fairness applies only with self-dealing
5. Since minority SH got their fair share of dividends  no self dealing  no total fairness test
6. Parent not found to be responsible for sharing business opportunities
7. Sinclair says fairness review in parent subsidiary only necessary when parent receives something to the exclusion of the minority SH.
8. P. 302 this test disused, now all controlling actions get the fairness treatment.
Cookies Food Products Iowa 1988 p. 303 HH 134
1. Duane “Speed” Herrig makes the company with his distribution agreement, then becomes majority SH
2. Gives himself distributing deals, salary, and royalties on a sauce recipe he invents.
3. Agreements all benefited cookies, and court “unconvinced that they weren’t fair” unclear where the court places this burden
4. Board was aware, and court finds compensation reasonable
DGCL §144(a) approval of an interested transaction by an informed board authorizes the transaction but does not preclude a fairness review
Kahn v. Lynch Del IC approval shifts fairness burden to Π
Cooke v. Oolie Del 2000 p. 311 HH 134
1. Minority SH claim a particular acquisition target was chosen to protect debt investments in TNN
2. Interested D who is not a majority SH and discloses his interest, and a majority of Independent D ratify transaction  BJ rule
Lewis v. Vogelstein Del. 1997 p. 315 HH 135
1. SH ratification ineffectual if
  1. Majority has a conflict of interest
  2. Transaction constitutes Corporate waste.
In Re Wheelabrator Del 1995 p. 316 HH 135
1. In absence of a controlling SH, SH ratification of an interested transaction results in BJ rule with Π’s Burden.

For disinterested approval consequences, see HH 135.

(BOP)	RMBCA §8.61 7 DGCL §144	ALI
Neither Board nor SH approve	Entire fairness(d) but siliconix, no obligation to pay fair price in non-coercive tender offer	Entire Fairness(d)
Disinterested D’s authorize	BJR(P)	Reasonable belief in fairness (p)
Disinterested D’s ratify	BJR(P)	Entire Fairness(d)
SH ratify	Waste(P)	Waste(P)

Lezis v. Vogelstein Del 1997 p. 322 HH 138
1. O and D stock option grants get BJ Rule
Other compensation tidbits from same neighborhood
1. Sarbanes Oxley no loans to D’s or Os
2. Compensation Siclosure reqmnts p. 325
Corporate Opportunity Doctrine
Broz v. Cellular info. Systems Del 1996 p. 332
1. Broz owns RFB and is CEO of CIS
2. Mackinac offers to sell a license to RFB, does not approach CIS
3. Broz confirms w/ some CIS D’s that they’re not interested, then buys
4. Pricellular buys CIS and sues Broz claiming he took a corporate opportunity
5. No dudty to Pricellular
6. Not a CIS opportunity (CIS broke)
7. No requirement of formal Board presentation, though it is a safe harbor
8. O or D may not take an opportunity if
  1. Corp is financially able to exploit it
  2. Op is w/in Corps LOB
  3. Corp has an interest or expectancy in the opportunity, &
  4. Taking the Op will place him in a position inimical to his duties
9. May take an Op
  1. Presented to him in his individual capacity
  2. Op is not essential to the Corp
  3. Corp has no expectancy or interest
  4. He hasn’t wrongfully employed Corps resources in pursuing Op
10. Presentation to CEO Not a safe harbor – Telxon p. 336
Donahue v. Rodd Electrotype Mass. 1975 p. 338 HH 139
1. Closely held corp, buys out a retiring D at $800/share
2. Minority SH Donahue wants to sell at same price but isn’t allowed to.
3. Limited to closely held Corps. Ie
  1. Small # of SH
  2. No ready market for corporate stock
  3. Substantial Maj. SH participation in Mgt.
4. SH in a closely held corp. owe same duties as partners
5. In a selected purchase, if seller was a member of the control group, the repurchase must be open to all SH on a pro rate basis p. 342 equal opportunity
Smith v. Atlantic Properties Mass 1981 p. 344 HH 139
1. 4 person equally owned corp, requiring 80% SH approval for any action
2. Wolfson keeps vetoing dividends partly for tax reasons partly spite
3. IRS assesses big ole’ fine for unreasonable accumulation
4. Trial court holds Wolfson breached his Fiduciary duty and makes him indemnify fines.
5. “the 80% provision” reverses the roles of minority and majority, making the minority an ad hoc controlling interest

X. Shareholder Lawsuits
Derivative Suit – assertion of a corporate claim against a D, O or Third Party

Brought on behalf of the Company
Theoretically 2 suits
- 1^st against Board for not bringing suit
- 2^nd it Corp. claim itself

Direct Actions (often class actions)
Common Fund Doctrine: Attorney’s fees can be paid out of a settlement which creates a common fund for the benefit of people in addition to the plaintiff

Fletcher v. A.J. Industries Cal 1968 p. 352 HH 142
1. SH bring derivative suit against company and D’s alleging damages resulting from 1 D’s domination of the board and another’s overpayment.
2. Π’s lawyers negotiate a settlement reducing D’s influence and removing other one, referred money claims to arbitration
3. Settlement says Π fees only in case of monetary award in arbitration
4. Π’s attorneys apply for fees anyway.
5. Court applies Substantial benefit rule – when the corporation receives substantial benefits from the litigation and no fund exists, Π’s can be paid
6. Dissent p. 354 points out substantial benefit is no threshold, and that without a fund, fee payments could force inefficient asset liquidation.
Agency costs in SH litigation p. 355
1. Strike suits (hold ups)
2. Settlement too appealing for both sides, lawyers get paid and D’s avoid anything too bad, usually just their insurance that pays.
Fed Rule 23.1 – Standing in Derivative Actions (also in Del)
1. Π must be SH for duration of the action
2. Π must be SH at time of alleged wrong
3. Π must be able to fairly and adequately represent the interests of SH
4. No obvious conflicts of interest
5. Complaint must specify what actions the have taken to get the board to sue (demand requirement) or why they haven’t done so.
Aronson Demand Futility Test
1. Must be reasonable doubt either
  1. Ds are disinterested and independent and
  2. Challenged transaction was otherwise valid BJ
2. Demand requirements, Π’s must either have demand denied, or prove futility
Levine v. Smith Del 1991 p. 364 HH 143
1. GM buys out Ross Perot for money and an agreement not to wage a proxy contest or criticize mgt
2. Must establish doubt about independence of a MAJORITY of the board
3. In order to establish Demand futility Π must
  1. Establish that the directors (majority?) are interested and dominated  incapable of passing on a demand, or
  2. Create a reasonable doubt that the challenged transaction is sound enough to be protected by the BJ rule
Making demand is a concession of Board independence Spiegel p. 367
G. comparative approaches to above under RMBCA and ALI HH 144
1. RMBCA – no assumption when demand is made
Rales v. Blasband Del 1993 p. 368 HH 144
1. Rales Bros take over Easco and issue $100Mil in notes to “finance investments”
2. Instead invest in Drexel junk (happen to be Milken friends)
3. After deal but before suit, Rales merge Easco indo another of their companies, Danaher
4. Where the board that would be considering demand is not the board that made the challenged decision, complaint must raise doubt regarding ability of a majority of D’s who must decide demand to properly exercise BJ if demand were made when suit is filed p. 373
5. Court finds 3 D’s out b/e they were involved, and 2 D’s out b/e they had strong financial ties to Rales Bros. 5/8  reasonable doubt as to majority to exercise independent BJ  Demand excused
Special Litigation Committees
1. NY if SLC is independent  BJ rule
2. Del Zapato, court will determine appropriateness of SLC
Zapato Corp. v. Maldanado Del 1981 p. 375 HH 145
1. Π files suit, and demand is excused
2. 4 years into litigation Zapata appoints 2 Indep D’s to serve as an SLC
3. shockingly enough they recommend dismissal
4. passing demand does not create a SH right to continue suit
5. interest taint of Board Majority does not bar SLC’s legitimacy per se
6. Zapata 2 step to analyze an SLC’s decision to cancel litigation p. 379
  1. Corp. burden to show independence, good faith and reasonable investigation
  2. Court will determine base don its own BJ
7. Where appropriate court should give consideration to matters of law and pub policy p. 380
Joy v. North 2^nd Cir. 1982 p.381
1. BC analysis of an SLC’s decision to dismiss
2. Are expected damages >/< expected costs?
Delaware Decision Tree:
Carlton v. TLC Beatrice Del 1997 p. 386 HH 147
1. Lewis does an LBO of Beatrice and gets a $19.5 Mil compensation
2. Big bank Sh brings derivative action
3. SLC negotiates a settlement where Lewis estate repays $14.9 Mil
4. Passes Zapata 2 step
  1. SLC proceeded in good faith & informed
  2. “cannot conclude that the settlement is badly off the mark
5. treats 2^nd step as a test of “egregious or irrational”

XI. Transactions in Control

Zetlin v. Hanson Holdings NY 1979 p. 395 HH 148
1. Hanson and Sylvestri sell their 44.4% controlling interest for a 100% premium
2. Minority Sh brings suit claiming a right to a pro rata opportunity to recognize premium
3. NY court holds that a controlling SH is free to reap a control premium absent
  1. Looting of corporate assets
  2. Conversion of a corporate opportunity
  3. Fraud or other acts of bad faith
Perlman v. Feldman 2^nd Cir. 1955 p. 396 HH 149
1. Steel company with unique opportunity to direct output
2. Controlling SH sells to customer who wants to ensure his supply at a substantial premium
3. Finds it to be a sale of a corporate opportunity and rules that the premium belongs to the company
4. BOP on defendants to establish fair dealing p. 399
5. When a sale results in the sacrifice of this element of corporate goodwill and consequent unusual profit to the fiduciary who has cause the sacrifice, he should account for his gains.
6. On remand forced to share premium pro rate with other SH
In re Digex Del 2000 p. 406 HH 154
1. Worldcom buys Intermedia which owns 52% of Digex
2. Seeks a waiver of Del §203 to allow Worldcom to pursue a freeze-out merger before the 3 year moratorium.
3. Board grants waiver
4. Ruling: Board can only grant waiver for benefit of the corp. as a whole
Harris v. Carter Del 1990 p. 408
1. Buyer loots
2. Carter should have done more investigation before selling his control SH
3. Presence of several “warning signs”
4. Seller of a control block, if reason to reasonably foresee a danger, owes a duty to reasonably investigate potential purchaser p. 412.
1967 Williams act regulates tender offers
1. must disclose if you accumulate 5% or more voting shares
2. disclose identity, financing and future plans
3. prohibits misrepresentation
4. mandatory terms
  1. 20 day acceptance window
  2. must pay all who tender
Brascan v. Edper SDNY 1979 p. 415 HH 154
1. Offer to solicit a large but not controlling block found to not be a tender offer
  1. No widespread solicitation
  2. Didn’t provide for tenders or security
  3. Not at a fixed price
  4. Not contingent on acquiring a certain # of shares
Wellman p. 419
1. Tender offer found
  1. Fixed price open for an hour
P. 417 8 factors that make a tender offer
D
D
D
D
D
D
D

XII. M&A
p. 428

Mergers require majority SH vote

Minority dissenters can receive judicial appraised value

Mergers can be stock for stock

SH vote required if a co. issues 20% of its outstand ing stock in a single transaction

DGCL § 270 sale of substantially all assets requires vote p. 430

DGCL §251 Statutory merger HH 157
1. Acquirer votes if
  1. Its charter is modified
  2. Its SH shares change
  3. Increases outstanding chares > 20%
2. Target always votes
DGCL §271 Stock/Asset acquisition
1. T SH get voting and appraisal rights
2. Increased Transaction costs b/e titles must be changed
3. Often made through wholly owned subsidiary to avoid
Katz v. Bregman Del 1981 p. 432 HH 158
1. PI sells its Canadian operations 51% of assets 45% of rev, and 52% of operating income
2. But most or all of net profit
3. Held to be a sale of substantially all assets
Thorp v. Cerbco Del 1996 p. 434 HH 159
1. Cerbco’s wnership of insituform is 68% of assets.
2. Substantiall all assets  SH vote and controlling SH can block
3. Need for SH approval not measured on size alone, but also on its qualitative effect on the corporation
4. Thorp and Katz represented prime profit centers.
Getting the whole pie
1. Most J’s allow a short form compulsory cash out merger by a party controlling 90%
2. Del doesn’t but you can do a 2 step
  1. Step 1 A gets most shares
  2. Step 2 A executes a cash-out merger of T into itself or a subsidiary
3. Triangular mergers involve a subsidiary which purchases (liability shield)
4. Reverse triangular the subsidiary folds into the target (no transaction costs relating to title)
Merger considerations p. 439 HH 160
DGCL §262 appraisal process p. 453 HH 160
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