business enterprises: legal structures, governance, and ... · pdf filebusiness enterprises:...

BUSINESS ENTERPRISES:LEGAL STRUCTURES,GOVERNANCE, AND

POLICYCases, Materials, and Problems

LexisNexis Law School PublishingAdvisory Board

William Araiza

Professor of Law

Brooklyn Law School

Ruth Colker

Distinguished University Professor & Heck-Faust Memorial Chair in Constitutional Law

Ohio State University Moritz College of Law

Olympia Duhart

Associate Professor of Law

Nova Southeastern University Shepard Broad Law School

Samuel Estreicher

Dwight D. Opperman Professor of Law

Director, Center for Labor and Employment Law

NYU School of Law

David Gamage

Assistant Professor of Law

UC Berkeley School of Law

Joan Heminway

College of Law Distinguished Professor of Law

University of Tennessee College of Law

Edward Imwinkelried

Edward L. Barrett, Jr. Professor of Law

UC Davis School of Law

Paul Marcus

Haynes Professor of Law

William and Mary Law School

Melissa Weresh

Director of Legal Writing and Professor of Law

Drake University Law School

BUSINESS ENTERPRISES:LEGAL STRUCTURES,GOVERNANCE, ANDPOLICYCases, Materials, andProblemsSecond Edition

Douglas M. BransonW. Edward Sell Chair in Business Law

University of Pittsburgh

Joan MacLeod HeminwayCollege of Law

Distinguished Professor of Law

The University of Tennessee

Mark J. LoewensteinNicholas A. Rosenbaum Professor of Law

University of Colorado

Marc I. SteinbergRadford Professor of Law & Senior Associate Dean for Research

Southern Methodist University

Manning Gilbert Warren IIIHarold Edward Harter Chair of Commercial Law

University of Louisville

Casebook ISBN: 978-0-7698-4905-8

Looseleaf ISBN: 978-0-7698-4906-5

eBook ISBN: 978-0-3271-7592-6

Library of Congress Cataloging-in-Publication Data

Business enterprises: legal structures, governance, and policy: cases, materials, and problems/Douglas M. Branson . . .

[et al.].

p. cm.

Includes index.

ISBN 978-0-8205-6467-8 (case bound)

1. Business enterprises—Law and legislation—United States. 2. Business enterprises—Law and legislation—United

States—Cases. 3. Securities—United States. 4. Limited partnership—United States. 5. Private companies—United

States. I. Branson, Douglas M.

KF1366.B87 2008

346.73’065—dc22

2008045293

This publication is designed to provide authoritative information in regard to the subject matter covered. It is soldwith the understanding that the publisher is not engaged in rendering legal, accounting, or other professionalservices. If legal advice or other expert assistance is required, the services of a competent professional shouldbe sought.

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DEDICATIONS

Douglas M. Branson

I dedicate this book to my co-authors, who remained of good cheer throughout, and to my

wife, Elizabeth Hurtt.

Joan MacLeod Heminway

I dedicate this book to Merrit, Helen, and Lou, who afforded me the time and knowledge I

needed to accomplish this.

Mark J. Loewenstein

I dedicate this book to Louis Rosen, who took me under his wing when I first entered the

practice of law and whose teachings I carry with me to this day.

Marc I. Steinberg

I dedicate this book to my wonderful family — my wife Laurie, my daughter Alexandra

(Alex), and my sons Avram (Avi) and Phillip (Bear) — with all of my love.

Manning Gilbert Warren III

I dedicate this book to my former law partners at Ritchie, Rediker & Warren, Thomas A.

Ritchie and J. Michael Rediker, for their creativity, their pragmatism and their

professionalism in the practice of corporate law.

iii

ACKNOWLEDGMENTSI would like to acknowledge the support and understanding of my spouse, Elizabeth

Hurtt. — Douglas Branson

I wish to acknowledge the more-than-capable research assistance of Rachel Kuipers

Bates, Richard McDermott, and Todd Skelton in helping to construct and edit my

chapters and others in the first and second editions. Thanks also are due to The University

of Tennessee College of Law (which supported this project with research funding), to my

coauthors (who have taught me so very much), and to my amazing administrative

assistant, Sean Cary von Gunter (who manages to make me and my work look good

regardless of the circumstances). And, finally, my family, especially Merrit, Scott, and

Kate, deserves credit for putting up with my unavailability and moodiness when I work

on intense projects like this. Without the assistance and support of all of these folks, I

would not have been able to complete my work on this book. — Joan MacLeod

Heminway

I thank my colleague, Professor Emeritus J. Dennis Hynes, who graciously allowed me to

draw on our co-authored casebook for the materials in Chapters 2 and 3 of this book; my

research assistants on this project, Jessica Lynn Broderick and Jennifer Kim, for their

excellent work; the University of Colorado Law School for its financial support; and to

my wonderful coauthors, who made this project a delightful one. — Mark J. Loewenstein

I thank the SMU Dedman School of Law for supporting this project. My gratitude is

expressed to Dean John B. Attanasio, my former research assistant Mr. Aaron Rigby, and

my administrative assistant Ms. Jan Spann. The strong support I receive from this superb

law school is truly appreciated by me. I also wish to thank my coauthors for their

friendship, support, diligence, and courtesy. — Marc I. Steinberg

I would like to acknowledge the outstanding work of my administrative assistant, Janet

Gribbins Sullivan, in all aspects of this effort, including her critical review of the final

drafts. I also would like to express special appreciation to my research assistant, Stacy

Anne Hoehle, for her tireless editing, research, and dedication throughout the project.

Last, I would like thank my wife, Judith, and the three of my children still at home during

this work, my sons Marnix, Sebrand, and Marc, for their constant inspiration. —

Manning Gilbert Warren III

v

PREFACE

In this book, five law professors from across the country have assembled cases,

problems, and other materials for use in an introductory Business Associations, Business

Organizations, Corporations, or similar law school course. Each author brings to the book

his or her individual experience in the teaching and practice of the subject matter and his

or her own voice.

This teaching and learning resource is designed to provide comprehensive coverage of

state and federal law and policy governing the legal structures through which business is

conducted in the United States, principally including unincorporated and incorporated

business entities (as opposed to sole proprietorships). The authors generally anchor this

law and policy in relevant theory and practice. In carrying out its objectives, the book

covers foundational issues relating to agency and entity formation, corporate finance,

internal governance, and legal liability to third parties. Moreover, the text covers

fundamental state and federal rules governing corporate transactions and litigation and, in

its final chapter, touchstone issues relating to the role of legal counsel in representing

business enterprises. Importantly, the book focuses on privately held entities and also

provides comprehensive coverage of the basics of public company theory, policy, law,

and practice.

Each chapter begins with a title and a narrative that covers an introductory point or

otherwise sets the stage for the materials that follow. Consideration is given to both legal

analysis and practice issues. A number of chapters include significant descriptions of

applicable theory and policy as framing devices for the chapter contents.

The materials in each chapter have been selected to afford adequate coverage of

business law basics (including, for example, fundamental corporate finance and takeover

nomenclature and other information necessary to an understanding of transactional

business law). Law review articles, glossaries, charts, and textual citations to statutes and

other materials supplement the standard fare of case law. Moreover, in key areas of study,

the text allows for a comparison of laws and practices in other countries with those of the

United States. These parts of the book are especially important, since more and more

students must handle international contracts, transactions, or cases in the early years of

their practice. To reinforce key principles and analysis, the book includes notes and

problems that permit the integration of concepts and foster applied skills.

In short, this text allows for coverage of law, underlying theory and policy, and

practice skills. In one volume, the book contains material sufficient to educate an

emerging lawyer to function in general business law practice in a transactional or

advocacy-oriented setting. In creating this resource, the five authors, all of whom have

extensive academic and practical credentials, seek to create a comprehensive,

introductory resource for students regardless whether they will subsequently practice in

small, medium or large-sized firms here in the United States or abroad. In our

increasingly electronic and global world, these students need wide-ranging, inclusive,

applied knowledge of the legal aspects of business enterprises — structures, governance,

and policy — and this book is designed to foster that knowledge.

vii

TABLE OF CONTENTS

Chapter 1 INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Chapter 2 THE LAW OF AGENCY . . . . . . . . . . . . . . . . . . . . . . . . . . 9

A. DEFINING THE AGENCY RELATIONSHIP . . . . . . . . . . . . . . . . . . . . . 9

Thayer v. Pacific Electric Railway . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

A. Gay Jenson Farms Co. v. Cargill, Inc. . . . . . . . . . . . . . . . . . . . . . . 12


Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

B. CONTRACTUAL POWERS OF AN AGENT . . . . . . . . . . . . . . . . . . . . 19

1. An Agent’s Express Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

King v. Bankerd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

2. An Agent’s Apparent Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Smith v. Hansen, Hansen & Johnson, Inc. . . . . . . . . . . . . . . . . . . . . 25

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

C. DUTIES OF PRINCIPALS AND AGENTS . . . . . . . . . . . . . . . . . . . . . . 32

1. Duties of the Principal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

2. Duties of the Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

a. Duty of Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Carrier v. McLlarky . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

b. Duty of Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

c. Duty of Loyalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

Gelfand v. Horizon Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36


D. VICARIOUS LIABILITY FOR NEGLIGENT ACT . . . . . . . . . . . . . . . . 42

1. Introductory Note on Terminology . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

2. The Control Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Kane Furniture Corp. v. Miranda . . . . . . . . . . . . . . . . . . . . . . . . . 43

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

3. The Scope of Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Clover v. Snowbird Ski Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

ix

E. VICARIOUS LIABILITY FOR INTENTIONAL MISCONDUCT . . . . . . 54

Ira S. Bushey & Sons v. United States . . . . . . . . . . . . . . . . . . . . . . . . 54


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

Chapter 3 THE LAW OF UNINCORPORATED BUSINESS

ENTITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

B. GENERAL PARTNERSHIPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

1. The Definition of a Partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Byker v. Mannes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

2. When a Partner Is Not a Partner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

Note On Non-Equity Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

3. Partnership Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

4. Keeping Track of Things — A Brief Look at Partnership Accounting . . 72

5. The Authority of Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

a. Actual Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

Summers v. Dooley . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

b. Apparent Authority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

RNR Investments Limited Partnership v. Peoples First Community

Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

6. Liability for a Partner’s Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Rouse v. Pollard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81


7. Rights and Duties Among Partners . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

a. Duty of Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Duffy v. Piazza Construction, Inc. . . . . . . . . . . . . . . . . . . . . . . . . 83


Moren v. Jax Restaurant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

Note and Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

b. Duty of Loyalty (Partnership Opportunity) . . . . . . . . . . . . . . . . . . . . 89

Meinhard v. Salmon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89


c. Duty of Loyalty (Conflict of Interest) . . . . . . . . . . . . . . . . . . . . . . . 94

J & J Celcom v. AT&T Wireless Services, Inc. . . . . . . . . . . . . . . . 97

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

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x

d. Contracting Around Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . 104

8. The LLP Shield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

Ederer v. Gursky . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

9. Dissociation and Dissolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

a. The Dissolution Concept under UPA and RUPA . . . . . . . . . . . . . . . 111

b. Liquidation Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112

C. LIMITED PARTNERSHIPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

1. Organizational Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

2. The Agreement of Limited Partnership . . . . . . . . . . . . . . . . . . . . . . . 114

Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

3. The Limited Partner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

a. Participation in the Business of the Limited Partnership . . . . . . . . . . 115

Gateway Potato Sales v. G.B. Investment Co. . . . . . . . . . . . . . . . 115

b. The Limited Partner as Agent of the Corporate General Partner . . . . 119

Zeiger v. Wilf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

c. Limited Partner’s Right to Maintain a Derivative Action . . . . . . . . . 125

4. The General Partner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

Appletree Square I Limited Partnership v. Investmark, Inc. . . . . . . . 126

Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

Brickell Partners v. Wise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

D. LIMITED LIABILITY COMPANIES . . . . . . . . . . . . . . . . . . . . . . . . . 134

1. Formation; Operating Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . 135

Elf Atochem North America, Inc. v. Jaffari . . . . . . . . . . . . . . . . . . 135

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

2. The LLC as an Entity Apart from Its Members . . . . . . . . . . . . . . . . . 141

Abrahim & Sons Enterprises v. Equilon Enterprises, LLC . . . . . . . . 141


Premier Van Schaack Realty, Inc. v. Sieg . . . . . . . . . . . . . . . . . . . 145


3. Authority of Members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

Taghipour v. Jerez . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150


4. Fiduciary Duty of Members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

McConnell v. Hunt Sports Enterprises . . . . . . . . . . . . . . . . . . . . . 155


Katris v. Carroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162

Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

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xi

5. Fiduciary Duty of Managers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167

6. Expulsion of a Member . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

7. Derivative Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

8. Oppression of Members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

9. Series LLCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

10. The L3C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

11. Some Miscellaneous Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

Chapter 4 THE PROCESS OF INCORPORATION . . . . . . . . . . . . . 175

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175

B. MECHANICS OF INCORPORATION . . . . . . . . . . . . . . . . . . . . . . . . 176

C. TAILORED ARTICLES OF INCORPORATION (PRIVATE

ORDERING) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

D. CHOICE OF THE STATE OF INCORPORATION . . . . . . . . . . . . . . . 184

Note On Delaware’s Popularity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

E. ETHICAL CONSIDERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186

Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186

F. TAXONOMY OF CORPORATIONS . . . . . . . . . . . . . . . . . . . . . . . . . 187

G. DEFECTIVE INCORPORATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

Thompson & Green Machinery Co. v. Music City Lumber Co. . . . . . . 190


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

H. CORPORATE DEATH (INVOLUNTARY DISSOLUTION) . . . . . . . . 194

Equipto Division Aurora Equip. Co. v. Yarmouth . . . . . . . . . . . . . . . 194

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

I. PROMOTER’S LIABILITY ON PREINCORPORATION

CONTRACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201

Note On Promoter’s Liability to the Corporation . . . . . . . . . . . . . . . . 201

J. LIABILITY ON PREINCORPORATION CONTRACTS — THE

CORPORATION’S VIEWPOINT . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202

K. ULTRA VIRES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202

2. Reasons for the Decline of the Doctrine . . . . . . . . . . . . . . . . . . . . . . 203

3. Ultra Vires Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205

Total Access, Inc. v. Caddo Electric Cooperative . . . . . . . . . . . . . . 205


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209

L. THE ORGANIZATIONAL MEETING . . . . . . . . . . . . . . . . . . . . . . . . 209

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Chapter 5 THE REGULATION OF SECURITIES OFFERINGS . . . 213

A. WHAT IS A SECURITY? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213

Wartzman v. Hightower Productions, Ltd. . . . . . . . . . . . . . . . . . . . . 213

1. “Stock” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215

2. “Notes” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216

3. “Investment Contracts” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216

Securities And Exchange Commission v. W.J. Howey Co. . . . . . . . . 216

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219

B. THE EXEMPTION-REGISTRATION QUERY . . . . . . . . . . . . . . . . . . 220

C. EXEMPTIONS FROM REGISTRATION . . . . . . . . . . . . . . . . . . . . . . 223

1. The Statutory Private Offering Exemption — Section 4(2) . . . . . . . . . 223

Securities and Exchange Commission v. Ralston Purina Co. . . . . . . 223

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226

2. Rule 506 of Regulation D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227

3. The Limited Offering Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . 229

a. The Section 4(5) Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229

b. The Section 4(6) Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229

c. The Section 3(b) Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229

4. Intrastate Offerings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231

D. OVERVIEW OF THE REGISTRATION PROCESS . . . . . . . . . . . . . . . 231

E. “GOING PUBLIC” — PROS AND CONS . . . . . . . . . . . . . . . . . . . . . . 232

F. A BRIEF LOOK AT THE PROCESS OF A PUBLIC OFFERING . . . . . 233

G. STATE “BLUE SKY” LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234

H. THE REGISTERED OFFERING — FRAMEWORK OF SECTION 11 . 235

Escott v. BarChris Construction Corporation . . . . . . . . . . . . . . . . . . 236

I. THE SARBANES-OXLEY ACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236

1. CEO and CFO Certifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

2. Audit Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239

3. Forfeiture of Bonuses and Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . 239

4. Officer and Director Bars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239

5. Prohibition of Loans to Directors and Officers . . . . . . . . . . . . . . . . . . 240

6. Management Assessment of Internal Controls . . . . . . . . . . . . . . . . . . 240

7. Real-Time Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241

8. Accounting Oversight Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241

J. THE DODD-FRANK ACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241

Chapter 6 BASIC CORPORATE FINANCE, ACCOUNTING, AND

DISTRIBUTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243

A. INTRODUCTION AND GLOSSARY . . . . . . . . . . . . . . . . . . . . . . . . . 243

B. BASIC CORPORATE FINANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

1. Corporate Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

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a. Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

i. Common Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248

ii. Preferred Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249

2. Debt Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250

C. THE BASICS OF FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . 251

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251

2. Double-Entry Bookkeeping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252

3. Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252

4. Income Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253


D. DIVIDENDS AND OTHER DISTRIBUTIONS TO SHAREHOLDERS . 255

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255

2. Basic Types of Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255

3. The Board of Directors’ Discretion . . . . . . . . . . . . . . . . . . . . . . . . . . 256

Gottfried v. Gottfried . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256

Dodge v. Ford Motor Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260

Miller v. Magline, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260


4. Limitations on Corporate Distributions Under Corporate Statutes . . . . 266

a. Policies Supporting Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . 266

b. Balance Sheet or Capital Impairment Restrictions . . . . . . . . . . . . . . 266

c. Earned Surplus Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267

d. Solvency Restriction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267

5. Director Liability for Improper Distributions . . . . . . . . . . . . . . . . . . . 268

Klang v. Smith’s Food & Drug Centers, Inc. . . . . . . . . . . . . . . . . . 268

6. Shareholder Liability for Improper Distributions . . . . . . . . . . . . . . . . 273

7. Contractual Restrictions on Corporate Distributions . . . . . . . . . . . . . . 274

Chapter 7 LIMITATIONS ON LIMITED LIABILITY . . . . . . . . . . 275

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275

Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276

B. GENERAL CHARACTERISTICS OF PIERCING THE CORPORATE

VEIL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277

C. FACTORS TO PIERCE THE CORPORATE VEIL . . . . . . . . . . . . . . . 278

1. Lack of Corporate Formalities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

2. Commingling of Corporate Affairs . . . . . . . . . . . . . . . . . . . . . . . . . . 280

3. Undercapitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281

4. Tort v. Creditor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282

5. Misrepresentation/Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283

D. CONTEXT MATTERS WHEN PIERCING THE CORPORATE VEIL . 284

1. Individual Shareholder Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . 284

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a. Individual Shareholder Piercing: Tort . . . . . . . . . . . . . . . . . . . . . . 285

Minton v. Cavaney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285

National Labor Relations Board v. West Dixie Enterprises, Inc. . . 286

Baatz v. Arrow Bar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288

b. Individual Shareholder Piercing: Contract . . . . . . . . . . . . . . . . . . . 291

Brunswick Corp. v. Waxman . . . . . . . . . . . . . . . . . . . . . . . . . . . 291

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293

2. Alter Ego/Corporate Family Piercing . . . . . . . . . . . . . . . . . . . . . . . . 295

a. Corporate Family: Tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

Walkovszky v. Carlton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

Gardemal v. Westin Hotel Co. . . . . . . . . . . . . . . . . . . . . . . . . . 299

b. Corporate Family: Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302

OTR Associates v. IBC Services, Inc. . . . . . . . . . . . . . . . . . . . . . 302

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304

E. REVERSE VEIL PIERCING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305

F. EQUITABLE SUBORDINATION: THE DEEP ROCK DOCTRINE . . . 307

G. PIERCING THE VEIL OF THE LIMITED LIABILITY COMPANY . . . 309

H. SHAREHOLDER LIABILITY UNDER FEDERAL LAW:

ENVIRONMENTAL VEIL PIERCING . . . . . . . . . . . . . . . . . . . . . . . . 310

United States v. Bestfoods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311

Chapter 8 MANAGEMENT AND CONTROL OF THE

CORPORATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313

A. SOCIAL RESPONSIBILITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313

A.P. Smith Mfg. Co. v. Barlow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314


B. CORPORATE PURPOSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 317

Dodge v. Ford Motor Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318


C. CORPORATE GOVERNANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323

1. Voting for the Election of Directors . . . . . . . . . . . . . . . . . . . . . . . . . 324

a. Straight Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324

b. Cumulative Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 325

c. Weighted Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 326

d. Pooling agreements and other voting arrangements . . . . . . . . . . . . . 327

Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling . . 328

Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 334

Mountain Manor Realty, Inc. v. Buccheri . . . . . . . . . . . . . . . . . . 334

Notes and Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 338

2. Procedural requirements for shareholder and director meetings . . . . . . 338

a. Shareholder meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 338

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b. Director meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 340

c. Informal action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341

3. A Larger Role for Shareholders (of Publicly Held Corporations)? . . . . 342

4. A Comparative Law Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . 342

D. THE BOARD OF DIRECTORS AND ITS COMMITTEES . . . . . . . . . . 343

1. The Function of the Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343

2. Board Structures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344

a. Independent Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344

b. Staggered Boards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345

3. Removal of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347

Superwire.com, Inc. v. Hampton . . . . . . . . . . . . . . . . . . . . . . . . . 348


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350

4. Equitable Restraints on Board Action . . . . . . . . . . . . . . . . . . . . . . . . 350

Schnell v. Chris-Craft Industries, Inc. . . . . . . . . . . . . . . . . . . . . . . 351

Blasius Industries, Inc. v. Atlas Corp. . . . . . . . . . . . . . . . . . . . . . . 352

Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 357

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 357

5. Board Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 358

6. The Role of Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359

Grimes v. Alteon, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359


E. THE ROLE OF SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . . . 363

International Brotherhood of Teamsters General Fund v. Fleming

Companies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369

F. DUTY TO CREDITORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369

G. SHAREHOLDER VOTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370

1. Proxy Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370

2. State Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 371

Lacos Land Company v. Arden Group, Inc. . . . . . . . . . . . . . . . . . . 371


Schreiber v. Carney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380

3. Federal Regulation: Proxy Solicitations . . . . . . . . . . . . . . . . . . . . . . . 381

Mills v. Electric Auto-Lite Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . 382


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388

4. Federal Regulation: Shareholder Proposals . . . . . . . . . . . . . . . . . . . . 388

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a. The “Not Significantly Related” Exception . . . . . . . . . . . . . . . . . . . 390

Lovenheim v. Iroquois Brands, Ltd. . . . . . . . . . . . . . . . . . . . . . . 390

Note on “Ordinary Business” Exception and Socially Significant Issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393

b. The “Election of Directors” Exception . . . . . . . . . . . . . . . . . . . . . . 394

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395

H. SHAREHOLDER INSPECTION RIGHTS . . . . . . . . . . . . . . . . . . . . . . 396

State ex rel. Pillsbury v. Honeywell, Inc. . . . . . . . . . . . . . . . . . . . . . 396

Seinfeld v. Verizon Communications, Inc. . . . . . . . . . . . . . . . . . . . . . 398


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403

Chapter 9 PROBLEMS IN CLOSELY HELD CORPORATIONS . . 405

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405

B. FIDUCIARY DUTIES AMONG SHAREHOLDERS . . . . . . . . . . . . . . 407

Donahue v. Rodd Electrotype Co. of New England, Inc. . . . . . . . . . . . 407

Wilkes v. Springside Nursing Home, Inc. . . . . . . . . . . . . . . . . . . . . . 416


Smith v. Atlantic Properties, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 421

Merola v. Exergen Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 424

Riblet Products Corporation v. Nagy . . . . . . . . . . . . . . . . . . . . . . . . 427


Sletteland v. Roberts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 431

Rosenthal v. Rosenthal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434

Hagshenas v. Gaylord . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 435

C. OPPRESSION, DEADLOCK, AND DISSOLUTION . . . . . . . . . . . . . . 439

Meiselman v. Meiselman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 440

In the Matter of Kemp & Beatley, Inc. . . . . . . . . . . . . . . . . . . . . . . . 441

Gimpel v. Bolstein . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445

D. SHAREHOLDER AGREEMENTS AND OTHER CONTROL

DEVICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450

2. Preemptive Rights, Supermajority Voting, and Classified Stock . . . . . . 451

a. Preemptive Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 451

b. Supermajority Voting and Quorum Provisions . . . . . . . . . . . . . . . . 452

c. Classification of Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454

Lehrman v. Cohen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455

3. Shareholder Voting Agreements and Irrevocable Proxies . . . . . . . . . . 460

a. Pooling Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 460

b. Voting Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 460

c. Irrevocable Proxies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461

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4. Shareholder Agreements Restricting Board Discretion . . . . . . . . . . . . 461

McQuade v. Stoneham . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 463

Clark v. Dodge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466

Galler v. Galler . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 468


5. Restrictions on Transfers of Shares . . . . . . . . . . . . . . . . . . . . . . . . . . 475

a. Introductory Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475

b. First Options and Refusals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 476

In re Estate of Mather . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477

Lash v. Lash Furniture Company of Barre . . . . . . . . . . . . . . . . . 479

c. Mandatory Buy-Outs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480

d. Consent Restraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480

e. Marketability Restraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 481

f. Judicial Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 481

g. Pricing Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 481

(i) Book Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482

(ii) Capitalized Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482

(iii) Periodic Revisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 482

(iv) Appraisals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483

6. Fiduciary Duties in Implementing Restrictions on Transfer . . . . . . . . . 483

Gallagher v. Lambert . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483

Pedro v. Pedro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486

Jensen v. Christensen & Lee Insurance, Inc. . . . . . . . . . . . . . . . . . 491

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 493

Chapter 10 FIDUCIARY DUTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495

B. THE DUTY OF CARE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497

Brane v. Roth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 499

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502

C. VIOLATION OF DUTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503

Francis v. United Jersey Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 503


North American Catholic Educational Programming Foundation

[NACEPF], Inc. v. Gheewalla . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 511


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 516

D. CAREMARK DUTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 517

Stone ex rel. Amsouth Bancorporation v. Ritter . . . . . . . . . . . . . . . . . 517

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523

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Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523

E. PROXIMATE CAUSATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 524

Barnes v. Andrews . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 524


F. THE BUSINESS JUDGMENT RULE . . . . . . . . . . . . . . . . . . . . . . . . . 525

Smith v. Van Gorkom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525


Lyman Johnson, The Modest Business Judgment Rule . . . . . . . . . . . . 538

American Law Institute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 539

Douglas M. Branson, The Rule That Isn’t a Rule — The Business Judgment

Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540

Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544

G. THE DUTY OF LOYALTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 545

State ex rel. Hayes Oyster Co. v. Keypoint Oyster Co. . . . . . . . . . . . . 545


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550

H. INTERESTED DIRECTOR TRANSACTIONS . . . . . . . . . . . . . . . . . . 550

Del. Gen. Corp. Law § 144 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 550


Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556

I. USURPATION OF A CORPORATE OPPORTUNITY . . . . . . . . . . . . . 557

Today Homes, Inc. v. Williams . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557

Brandt v. Somerville . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560


Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 565

J. COMPETITION WITH THE CORPORATION . . . . . . . . . . . . . . . . . . 567

ALI, Corporate Governance Project . . . . . . . . . . . . . . . . . . . . . . . . . 567

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 567

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569

K. DIRECTORS’ AND OFFICERS’ COMPENSATION . . . . . . . . . . . . . . 569

Ryan v. Gifford . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569

In re Tyson Foods, Inc., Consolidated Shareholder Litigation . . . . . . 572


Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 577

In re The Walt Disney Company Derivative Litigation . . . . . . . . . . . . 578

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589

L. AIDING AND ABETTING BREACHES OF FIDUCIARY DUTY . . . . 593

Koken v. Steinberg . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 593


M. THREE ADDITIONAL (INCHOATE) FIDUCIARY DUTIES . . . . . . . 597

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1. The Duty of Candor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 597

Turner v. Bernstein . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 597


2. The Duty of Good Faith . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 602

Randy J. Holland, Delaware Directors’ Fiduciary Duties: The Focus on

Loyalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 602

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 605

3. The Duty to Act Lawfully . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 605

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 605

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 606

Sinclair Oil Co. v. Levien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 607

Chapter 11 DERIVATIVE LITIGATION . . . . . . . . . . . . . . . . . . . . . 613

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 613

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 614

B. THE SPECIAL LITIGATION COMMITTEE AND THE SCOPE OF

JUDICIAL REVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615

Zapata Corp. v. Maldonado . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615


Desigoudar v. Meyercord . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 620

Thompson v. Scientific Atlanta, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . 625


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 630

C. WHEN IS DEMAND EXCUSED AS FUTILE? . . . . . . . . . . . . . . . . . . 631

Aronson v. Lewis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 631


Rales v. Blasband . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 638

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 642

Notes on Strike Suit Era Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . 643

Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 647

D. UNIVERSAL DEMAND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 648

In re Guidant Shareholders Derivative Litigation . . . . . . . . . . . . . . . 648

Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 651

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 652

E. AVOIDING DERIVATIVE CHARACTERIZATION — DIRECT VERSUS

DERIVATIVE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 652

Tooley v. Donaldson, Lufkin & Jenreette, Inc. . . . . . . . . . . . . . . . . . . 652


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 657

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Chapter 12 SECURITIES LITIGATION . . . . . . . . . . . . . . . . . . . . . . 659

A. SECTION 11 OF THE SECURITIES ACT . . . . . . . . . . . . . . . . . . . . . 659

Escott v. BarChris Construction Corporation . . . . . . . . . . . . . . . . . . 659

B. SECTION 10(b) OF THE SECURITIES EXCHANGE ACT . . . . . . . . . 672

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 676

1. The “Deception” or “Manipulation” Requirement . . . . . . . . . . . . . . . 677

Santa Fe Industries, Inc. v. Green . . . . . . . . . . . . . . . . . . . . . . . . 677

2. Materiality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 681

3. The Reliance Requirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 683

Basic, Inc. v. Levinson . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 683

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 689

4. Forward-Looking Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691

Asher v. Baxter International, Inc. . . . . . . . . . . . . . . . . . . . . . . . . 691

5. Primary Liability Exposure for “Secondary” Actors . . . . . . . . . . . . . . 696

C. CLASS ACTION “REFORM” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 697

Private Securities Litigation Reform Act Joint Explanatory Statement of the

Committee of Conference (1995) . . . . . . . . . . . . . . . . . . . . . . . . . . 697

Presidential Veto Message on the Private Securities Litigation Reform

Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 706

D. STATE SECURITIES REMEDIES . . . . . . . . . . . . . . . . . . . . . . . . . . . 708

Chapter 13 INSIDER TRADING . . . . . . . . . . . . . . . . . . . . . . . . . . . . 715

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 715

1. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 715

2. The Meaning of “Material” and “Nonpublic” Information . . . . . . . . . . 717

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720

Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 723

B. THE “DUTY” THEORY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 724

Chiarella v. United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 724

C. “TIPPER-TIPPEE” LIABILITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 731

Dirks v. Securities and Exchange Commission . . . . . . . . . . . . . . . . . 731

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 737

Securities and Exchange Commission v. Switzer . . . . . . . . . . . . . . . . 738

D. THE “MISAPPROPRIATION” THEORY . . . . . . . . . . . . . . . . . . . . . . 744

United States v. O’Hagan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 744

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 753

E. “POSSESSION” vs. “USE” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 754

F. RULE 14e-3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 756

G. DAMAGES AND PENALITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 756

1. Damages — Section 10(b) Actions . . . . . . . . . . . . . . . . . . . . . . . . . . 756

2. Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 758

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3. Contemporaneous and Option Traders . . . . . . . . . . . . . . . . . . . . . . . 759

H. SECTION 16 — “SHORT-SWING” TRADING . . . . . . . . . . . . . . . . . . 760

I. BLACKOUT PERIODS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 761

J. REGULATION FD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 762

Chapter 14 EXCULPATION, INDEMNIFICATION, AND

INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 763

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 763

B. EXCULPATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 765


C. INDEMNIFICATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 768


D. INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 774

Sphinx International, Inc. v. National Union Fire Insurance Company of

Pittsburgh . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 775


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 780

E. COMPARATIVE PERSPECTIVE . . . . . . . . . . . . . . . . . . . . . . . . . . . 780

F. FURTHER DEVELOPMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 781

Chapter 15 BASIC CORPORATE CHANGES . . . . . . . . . . . . . . . . . . 783

A. OVERVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 783

B. CHARTER AND BYLAW AMENDMENTS . . . . . . . . . . . . . . . . . . . . 785

1. Charter Amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 787

Farahpour v. DCX, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 788

2. Bylaw Amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 792


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 794

C. STATUTORY BUSINESS COMBINATIONS . . . . . . . . . . . . . . . . . . . 794

1. Statutory Mergers and Consolidations . . . . . . . . . . . . . . . . . . . . . . . . 800


2. Statutory Share Exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 805


3. Dispositions of All or Substantially All of a Corporation’s Assets . . . . 806

Katz v. Bregman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 809


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 812

4. Appraisal Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 812

Mary Siegel, Back to the Future: Appraisal Rights in the Twenty-First

Century . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 813


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5. De Facto Mergers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 823

Hariton v. Arco Electronics, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . 824


Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830

D. DOMESTICATIONS AND CONVERSIONS . . . . . . . . . . . . . . . . . . . 830

E. DISSOLUTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 831


Chapter 16 CHANGE OF CONTROL OF THE CORPORATION . . . 837

A. OVERVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 837

1. Shareholder Primacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 837

2. Director Primacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 838

3. Managerialism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 838

4. Resulting Theoretical Confusion . . . . . . . . . . . . . . . . . . . . . . . . . . . 839

5. Market for Corporate Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 839

6. A Birds-Eye View of Change-of-Control Transactions . . . . . . . . . . . . 840

B. TYPES AND REGULATION OF CHANGE OF CONTROL

TRANSACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 842

1. Charter Amendments and Business Combinations . . . . . . . . . . . . . . . 842

2. Proxy Contests (a.k.a. Proxy Fights) and Other Changes in Control of the

Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 842

3. Tender Offers and Other Share Purchases . . . . . . . . . . . . . . . . . . . . . 843

4. Going Private Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 846

a. State Law Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 846

Weinberger v. UOP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 847


b. Federal Law Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 863


C. DEFENDING THE CORPORATE BASTION . . . . . . . . . . . . . . . . . . . 866

1. Corporate Takeover Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 866

2. Applicable Judicial Review Standards . . . . . . . . . . . . . . . . . . . . . . . . 871

a. Use and Decline of a Traditional BJR Analysis . . . . . . . . . . . . . . . . 872

b. Enhanced Scrutiny under Unocal . . . . . . . . . . . . . . . . . . . . . . . . . 873

Unocal Corp. v. Mesa Petroleum Co. . . . . . . . . . . . . . . . . . . . . 873


c. The Need for a Compelling Justification Under Blasius . . . . . . . . . . 886

d. Price Maximization under Revlon and its Progeny . . . . . . . . . . . . . . 887

i. The Emergence of a Revlon Duty . . . . . . . . . . . . . . . . . . . . . . . . 887

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. . . . . . . . 887

ii. Defining the Applicability and Scope of the Revlon Duty . . . . . . . 896

Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900

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3. State Anti-Takeover Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 902

D. REFORM PROPOSALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 903

Margaret M. Blair, Reforming Corporate Governance: What History Can

Teach Us . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 903

E. COMPARATIVE INTERNATIONAL PERSPECTIVES . . . . . . . . . . . . 909

Robert B. Thompson, Takeover Regulation after the ‘Convergence’ of

Corporate Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 909

Marco Ventoruzzo, Europe’s Thirteenth Directive and U.S. Takeover

Regulation: Regulatory Means and Political and Economic Ends . . . . 911

Chapter 17 THE ROLE OF COUNSEL . . . . . . . . . . . . . . . . . . . . . . . 915

A. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 915

B. ENRON AND OTHER CORPORATE DEBACLES: RAMIFICATIONS ON

ATTORNEY CONDUCT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 915

C. ATTORNEY LIABILITY BASED ON CLIENT FRAUD . . . . . . . . . . . 918

Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 918

1. SEC Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 919

In the Matter of Carter and Johnson . . . . . . . . . . . . . . . . . . . . . . . 919

SEC Adopts Attorney Conduct Rule Under Sarbanes-Oxley Act . . . 925

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 927

2. Duty to Disclose Client Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 927

3. Attorney Malpractice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 928

D. PREDECESSOR-SUCCESSOR COMMUNICATIONS . . . . . . . . . . . . 929

In re OPM Leasing Services, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . 929

Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 934

E. LEGAL OPINIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 934

Rice & Steinberg, Legal Opinions in Securities Transactions . . . . . . . 934

TABLE OF CASES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TC-1

INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1

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