Business Associations - LoPucki - 2018 FA

1. Straight Voting: Each share may cast one vote each for a number of candidates equal to the number of seats to be filled (five). 2. Cumulative Voting: Each share may cast one vote multiplied by the number of seats to be filled (five). The holder may cumulate the votes for one or more candidates. 3. Class Voting: The entity issues two classes of shares, each entitled to elect some number of managers. (Each class votes separately, by straight voting). LLC Decision-Making Business Ass'ns Page 2 Business Judgment Rule Fed. Deposit Ins. Corp. v. Dee, 222 F. Supp. 3d 972 (D. N.M. 2016). Limited Liability An entity’s investors are not liable in their capacities as investors for the entity’s obligations. AGENCY The people who act for an artificial entity can have these statuses: 1. Agents 2. Employees 3. Boards of directors 4. Partners 5. Members 6. Managers

business in a satisfactory way is NOT control. Business Ass'ns Page 5 business in a satisfactory way is NOT control . 2. A Franchisor is not the franchisee's employer unless it exercised enough control over the manner of franchisee's performance [See eTeam v. Hilton Worldwide, p.75] i. In this case, franchisor is only liable for the torts arising from the heavily controlled aspects of work (not liable for uncontrolled aspect torts) 3. The use of a franchisor's signage or logo is NOT a manifestation to the customer that the franchisor exercises any control . Franchisor as Trademark Owner ○ Trademark owners have an express duty to "exercise adequate quality control over licensee[s]" to prevent degradation of the trademark as a symbol of a controlled source (this creates an odd contradiction for the franchisor-franchisee relationship) Landlord-Tenant Liability Eads v. Borman and Willamette Spine Center, LLC (Ore. 2012) Principal's Liability (Agent to Third Party) Step 1: Ask "What Type of Authority?" 1. Actual Authority 2. Apparent Authority Notice that, unlike Inherent Authority, Apparent Authority requires a manifestation on the part of the principal to 3rd party. Does not matter what the apparent agent was told or knew at the time. 3. Inherent Authority Notice that no principal manifestation is required here. Just a reasonable belief based on what is normally the case (e.g. CEOs generally have the power to contract) ▪ (When used, usually functions in lieu of Apparent Authority and acts much the same)

Principal's Fiduciary Duties A principal has a duty to deal with the agent fairly and in good faith. • The duty includes refraining from conduct likely to injure the agent’s business reputation or reasonable self-respect, § 8.15. Wall Systems v. Pompa ○ Pompa is a disgruntled employee who makes $149,000 a year. ○ For six years, he moonlighted for his employer’s competitor. ○ For a not-yet-specified period of time, he took kickback’s from his employer’s customers ○ What remedies are the court considering? Disgorgement of “any profit or benefit he received as a result of his disloyal activities.” Business Ass'ns Page 8 ○ Disgorgement of “any profit or benefit he received as a result of his disloyal activities.” ○ $89,782 from moonlighting ○ Compensation forfeiture “during the period of disloyalty.” ○ $894,000 from his job ○ Pompa could owe Wall Systems a million dollars. ○ Is this reasonable? Lopucki Says, "No." Clark Resources v. Verizon Business Network ○ Apparent Authority Holding: Authority to contact is not authority to contract ▪ (just because principal assigns DeRogatis to meet with third party doesn’t mean she is authorized to enter into an agreement on behalf of Verizon) ○ Inherent Authority Holding: Vice-Presidents DO NOT presumptively have the authority to contract on behalf of Principal. BINDING ENTITIES Managerial Capacities A person may have authority to act for an entity because the person has a particular capacity (role). Partners (Partnerships) Members (LLCs)

3. Authority to Delegate Authority to Officers: Example of Delegation in Bylaws: One Interpretation of Language: ▪ So, the CEO would potentially have the authority to go out sell land owned by the corporation if s/he felt that it was a desire of the Board Another Interpretation (Prevailing Theory): ▪ Under this interpretation, the CEO could only take actions that were within the ordinary course of business. ▪ CEOs are usually held to have apparent authority to bind the corp regarding matters in the ordinary course of business . Legal Opinions Lots can go wrong in contracting: 1. The entity you contract with may not exist. 2. The person you dealt with may not be authorized. 3. The deal may contrary to the entity’s fundamental documents. 4. The deal may be contrary to statutes, regulations, or court orders. A legal opinion may help in 4 ways: 1. The attorney will investigate; may discover and fix any problems. 2. The opinion makes parties and financiers more comfortable.

Regulation of Entity Names • For a registered entity , the applicable entity law determines the name requirements. • An unregistered entity can use any name, subject to the requirements of non-entity law (trademark, obscenity, etc.) Registered Entity Names Some Specific Rules: Business Ass'ns Page 14 Some Specific Rules: 1. The “entity type designator” is an insufficient distinction. ▪ Smith Corp. will not be accepted if there is a Smith, LLC. 2. Differences in punctuation or typography are not sufficient. ▪ A.B.C. Insurance, Inc. preempts use of “ABC Insurance, Inc.” ▪ All States Widget Co. preempts Allstates Widget Co. 3. Differences as little as one letter may be adequate ▪ Brown Corp. will not preclude Browne Corp. 4. Corporate name is not an intellectual property right. How to Find Information About a Registered Entity: Can find the following information on the Sec. of State website: a) Entity name and type; b) File number; c) Date of incorporation/formation; d) Registered agent name; e) Address; f) Phone number; and g) Residency Corporation Name Requirements Partnership, LLC, and LP Name Requirements

○ Started a competition among states to sell charters ○ The way states attract entities to buy charters in their jurisdiction: ▪ Provide for lax regulatory laws ○ Result: ▪ Few state entity laws impose any meaningful requirements. Alternatives to The IAD 1) Lex Loci: The law of the place where the contract was made or the tort occurred. (Losing argument in Mancinelli .) 2) Interest analysis: “The law of the state with the greatest interest in the issue governs.” Tyco Business Ass'ns Page 17 2) Interest analysis: “The law of the state with the greatest interest in the issue governs.” Tyco v. Kozlowski (S.D.N.Y., 2010). 3) Pseudo-foreign corporation doctrine: Each state governs business located primarily in it; internal affairs doctrine applies to the rest. 4) Real seat doctrine: A corporation must be chartered at its real physical location. 5) Federal incorporation: Federal government grants all charters. 6) Senator Elizabeth Warren’s bill: Billion-dollar entities must also have a federal charter that imposes additional requirements California Entity Law: Pseudo-Foreign Corporation Doctrine Cal. Corporations Code §2115 Doctrine: If a corporation does most of its business in a single state, that state has the authority to regulate its internal affairs Jurisdictions: California, Japan, India Rationale: 1. The state where the corporation does business has the strongest interest in regulating its conduct (cumulative voting). 2. The state must be able to protect its citizens. Case law:

▪ One contractor may be employed by more than one corporation (more than one corp can "maintain" the same physical Delaware office) 4. File the Certificate or Articles of Incorporation ▪ Do not need to include very much info: Business Ass'ns Page 20 5. Buy a Corporate Kit

▪ A physical manifestation of the corporation ▪ Leather-bound binder with metal hinges. Includes: i) Corporate seal ii) Application for Employer Identification Number (“EIN”) iii) Sample documents – Certificate to minutes iv) Difficult-to-reproduce preprinted cardboard separators v) Membership certificates, transfer forms on back vi) Membership register (“Stock register”) 6. Organizational Meeting 1. Incorporator conducts the organizational meeting, DGCL §108(a) 2. Incorporator adopts bylaws. DGCL §107 3. Incorporator elects directors. DGCL §107 4. Directors appoint officers. DGCL §142(b) , Facebook bylaws 4.1 5. Directors adopt corporate seal. DGCL §122(3) 6. Directors adopt a resolution authorizing a bank account (on a form provided by the bank) 7. The board issues share certificates. DGCL §151(a) 8. Formation process is complete. Forming a Limited Liability Partnership (LLP) • An LLP is a partnership with limited liability (Kirkland & Ellis, LLP) • To form a partnership requires only one step: a partnership agreement (oral or written) between two or more persons. • For a partnership to be an LLP requires three steps: 1. Elect internally to become an LLP, RUPA §901(b) 2. File a “Statement of Qualification,” RUPA §901(c) 3. Adopt a name that includes “LLP,” “RLLP” or like, RUPA §902 . 4. Designate an office in the state and appoint a resident agent to receive service of process, RUPA §908 . 5. File annual reports, RUPA §913 Business Ass'ns Page 21 Forming a Partnership (Sometimes Unintended) ○ Those who lend to partnerships (even secured creditors who can veto financial decisions) are not necessarily partners.

Ziegler v. Dahl & MacArthur v. Stein Test for Partnership 1. Parties intend to do the following 2. Contribute something to the business venture 3. Reserve the right to control management of the business ▪ The right to demand payment of a loan is sufficient for "control" 4. Parties are motivated by profit 5. There is an agreement or reserved right to share profits ▪ Sharing of gross returns is not enough to establish profit-sharing Professional Responsibility for Corporate Lawyers Attorney-Client Relationship Disclosure of Confidential Information In General: Reporting Up: Business Ass'ns Page 22

Duty to Inform Client Conflicts of Interest re Representation Who is the Client? ○ Cannot represent an unformed entity ○ If asked to help form a corporation, you may represent one or more of the parties (and perhaps a partnership, if parties' actions/intentions meet the test) Pre-Incorporation (Promoter's) Contracts Business Ass'ns Page 23 Pre-Incorporation (Promoter's) Contracts Promoter’s Initial Tasks: 1. Contract with the friends to invest 2. Contract with the franchisor (advice about location) 3. Contract for the location 4. Form the corporation (maybe contract with a lawyer) • Promoter doesn’t want to be bound to any unless she gets all four. How the promoter “should” do it: • Option contracts (e.g., an assignable option to lease) or • Add “[promoter] is not liable and doesn’t warrant authority” or • Form the corporation and contract in its name Common Problem A promoter contracts in the corporate name before the corporation exists. ○ How can you bind an unformed entity? General Rule: The promoter is liable (MBCA §2.04). No provision in Delaware General Corporation Law. ○ But the promoter may not be liable if any of the following apply:

1. Parties agree the promoter is not liable 2. Contract is in name of the proposed entity; third party knows the entity doesn’t exist. Example: “A corporation to be formed.” 3. The corporation later adopts the agreement (little support) 4. Promoter thought corporation existed (MBCA §2.04). 5. MBCA §2.04 comment. Third party knew corporation didn’t exist and “urged” contracting in its name. 6. De facto corporation (discussed below) Promoter Liability Under MBCA § 2.04 ○ Notice, this estoppel requires "urging " How Does Promoter Create Liability for Unformed Corp? Inferences Drawn from Signature Form 1. Inferences: i. The corporation will be liable. ii. The agent will not be liable. iii. The agent warrants his authority to obligate the corporation. Bu siness Ass'ns Page 24 2. Inferences: i. Corporation IS NOT liable, but parties intend that it will be liable once formed ii. Parties intend that agent IS NOT liable (signature is in a representative capacity), OR iii. The parties intent that the agent IS liable (under MBCA § 2.04)

3. Inferences: i. The parties intend that Camcraft be liable on the contract, AND ii. The parties intend that Bowman be liable as a guarantor. Corporate Liability 1. No one can bind a corporation prior to incorporation 2. If a contract was made on behalf of a corporation, the corporation can adopt (ratify) after incorporation. 3. Ratification can be (1) by formal decision or (2) by “acquiescence or acceptance of benefits.” 4. The corporation can also be liable on an unjust enrichment theory: 5. Release of a promoter after incorporation requires agreement of parties to a contract to substitute a new contract for the old one (novation). De Facto Corporations Doctrine: A corporation may exist even absent incorporation Elements: a. There is a law under which such a corporation could incorporate; b. There is a good faith attempt to incorporate under the law; and c. There is an actual exercise of corporate powers. Corporation by Estoppel Elements: a. Third party thinks a corporation exists and deals with the supposed corporation. b. The action arises out of the contract or course of dealing. Effect: The third party is estopped to deny the corporate existence. That creates a corporation for-the-case. The promoter is not liable. Rationale: The third party gets what it bargained for and expected. Business Ass'ns Page 25 Rationale: The third party gets what it bargained for and expected. The MBCA partially rejects corporation by estoppel: The promoter can’t claim the protection of corporation by estoppel.

The Stock Subscription Problem If no corporation exists, how can it contract with subscribers to sell shares? ○ Generally, because there is no corporation, there are no shares, so only promises are exchanged (see diagram below): ○ Thus, under normal contract law, there is no consideration for the offeror's promise, meaning that no contract exists. Court's Solutions: a. The court considers other subscribers' promises to buys stock as consideration (the prospect of buying into something that others are also buying into is valuable); OR b. Court sees promoter (in his position of power over unformed corporation) as contracting with subscriber. Promoter is contracting to cause the corp to issue stock. Promoter is binding corp. Delaware's Solution: MERGERS, ACQUISITIONS, & REINCORPORATIONS Mergers: Two corps become one. Typically, the shareholders both own it. Acquisitions: One corp acquires the stock of the other. Typically shareholders own stock of the parent. Some shareholders may be cashed out, voluntarily or involuntarily. Terms ○ Target: the entity to be acquired or dominated in a merger ○ Constituent: an entity that will merge in the transactions Surviving Entity: A constituent that will continue to exist after merger Business Ass'ns Page 26 ○ Surviving Entity: A constituent that will continue to exist after merger ○ Resulting Entity: Newly formed entity (will just call these surviving entities for our purposes) ○ Consideration: What shareholders get in return for their shares Shareholders' Rights re Mergers & Acquisitions: 1. Right to vote against the merger 2. If shares are traded, right to sell shares on the open market

3. If shares are not traded, right to sell shares to the surviving corporation for an appraised price ***Availability of voting and appraisal rights differ among the seven transactions.*** The Seven Transactions: Mergers 1. Statutory Merger (DGCL § 262) Definition: 2 entities combine into one (single management). Advantages: Only really used when you know you have the votes on both sides to merge Procedure: 1. Both bds adopt a plan of merger by majority vote 2. Both shareholder groups approve by absolute majority (majority of outstanding stock entitled to vote) 3. Resulting entity files a certificate of merger 4. Dissenting shareholders may (usually) have appraisal rights i. Shareholders' contracts may make shares redeemable on merger (only works when Business Ass'ns Page 27 i. Shareholders' contracts may make shares redeemable on merger (only works when you get in on the "ground floor") 5. Creditors do not vote , but become creditors of the resulting entity i. More creditors now compete for more assets ii. Could make it easier or harder to recover debts iii. Creditors should make repayment due upon merger Consideration for Shares: ○ If this was a stock for stock merger, all shareholders receive resulting corp shares.

○ If this was a cash-out merger, the red shareholders received cash for red shares. ▪ Formerly blue shareholders now own purple corp Effect on Creditors: ○ Each retains its claim, but against more assets, with more creditors competing. ○ Collection may be more or less difficult. ○ Creditors’ contracts should make the debts due on merger. Effect on Shareholders: ○ Each now owns a smaller percentage of a larger entity. ○ A Shareholder's Contract may make shares redeemable on merger. 2. Whale-Minnow Merger (DGCL § 251) Definition: A statutory merger that complies with DGCL § 251(f) Advantages: The surviving corporation's (SC) shareholders DO NOT VOTE Procedure: 1. EXACTLY the same as Statutory Merger, but Surviving Corp (Whale) Shareholders do not vote 2. Only "minnow" shareholders vote 3. Resulting entity is always "whale" Three additional restrictions (Protect Against SC Share Dilution): 1. SC's certificate of incorporation doesn’t change 2. SC's outstanding shares don’t change 3. SC does not issue more than 20% of the number of shares outstanding before merger Rationale for No Voting: Shareholders don’t need to vote if their shares aren't changing Limitations: Requires agreement between leadership of each entity. Does not allow for as much freedom for surviving entity as statutory merger. 3. Short Form Merger Definition: A merger between Parent and Subsidiary, where parent owns at least 90% of subsidiary Advantages: Called "short-form" because the subsidiary shareholder's votes do not matter. Procedure: 1. Parent sets price (cash or stock) for Sub's shares (to buy out Sub's shareholders) and merges Sub into Parent i. Can do this just by filing a certificate ii. Forces the minority shareholders to sell 2. Sub's shareholders choose btwn price offered and appraisal rights Note: ○ Even though the parent can essentially merge without approval of sub shareholders, it must still "state the terms and conditions of the merger" in the certificate filed (only if it doesn’t Business Ass'ns Page 28 still "state the terms and conditions of the merger" in the certificate filed (only if it doesn’t own 100% of sub's outstanding stock) Limitations: only works if an entity already owns 90% of sub

Acquisitions 4. Asset Sale [DGCL §271(a)] Definition: A transaction in which one entity sells all (or substantially all) of its assets to another entity. Advantages: this accomplishes a merger (buyer-entity shareholders do not vote, seller pays off creditors, and no appraisal rights) Procedure: 1. Red contracts to sell all of its assets to Blue in return for Blue shares 2. Red (seller) shareholders vote on approval of sale 3. Blue (buyer) shareholders DO NOT VOTE 4. After deal closes, Red owns only Blue shares & Blue owns all assets i. NO APPRAISAL RIGHTS 5. Red is now a shareholder of Blue i. Red pays its creditors ii. Distributes its Blue shares to Red's shareholders iii. And dissolves Limitations: ○ Transfer of titles to assets, licenses, and transfer taxes may be more difficult in an asset sale. ○ Only works if Red is willing to pay off its creditors first and has the votes to sell its assets. 5. Tender Offer Business Ass'ns Page 29 Definition: An entity, instead of agreeing to terms, makes a general offer to shareholders (or a

class of shareholders) to buy a controlling percentage of the target entity's shares. Advantages: No voting required & no one has appraisal rights Procedure: 1. If Blue doesn’t want to agree to Red's terms, Blue buys what shares of Red they can on the open market 2. Then Blue makes an offer to Red's shareholders: "I will purchase 51% of Red’s shares for $38 a share” if at least 51% agree to sell 30 days from now." 3. If the offer is accepted, Blue owns 51% of Red and controls Red Limitations: Can prove to be quite expensive for the buyer 6. Triangular Merger [DGCL §251(a)] Advantages: Works when one corp wants to acquire another, but doesn’t want to expose itself to the other corp's creditors ○ Perhaps this is better than an Asset Sale since it removes the requirement that Red pay off its creditors beforehand. Procedure: 1. Blue incorporates a subsidiary (Acquisition) and gives it Blue shares 2. Red agrees to merge into Acquisition (this is a forward triangular merger ) 3. Red shareholders and Acquisition shareholders (Blue Corporation Board) vote 4. Acquisition gets the Red assets; Red shareholders get Acquisition's Blue shares. 5. Red creditors are now Acquisition's creditors Forward vs. Reverse Triangle (All depends on the Surviving Entity): a. Forward = Red merges into Sub b. Reverse = Sub merges into Red (red is now a sub of blue) 7. Share Exchange [NOT PERMITTED IN DELAWARE] Business Ass'ns Page 30 Definition: like a tender offer in that Blue doesn’t have to deal with Red's management. But Blue

exchanges it's shares for Red shares, ending up with 100% of Red's shares. Procedure: 1. Each share of red is exchanged for the same number of newly issued blue shares 2. If quantity of new shares issued equates to more than 20% of outstanding shares, the buyer corp shareholders must vote. De Facto Merger Doctrine 1. Some courts treat acquisitions as mergers: give both buyer and seller's shareholders voting and appraisal rights (because court has said that this is an end run around a merger) 2. Only applies in certain states 3. Doesn’t apply in Delaware Arrowhead v. Seven Arts Entertainment ○ Fraudulent transfers (statute of limitations had probably run) ○ So Arrowhead sued on de facto merger doctrine De Facto Merger Doctrine: as a protection against creditor evasion The hallmarks of a de facto merger are: a. a predecessor corporation owned by the same individuals or entities as a successor corporation; b. dissolution of the predecessor corporation or cessation of the predecessor’s ordinary business; c. an assumption of the predecessor’s liabilities to the extent necessary to continue the predecessor’s business, d. and continuity of the predecessor’s management, personnel, physical location, assets, and general business operations. If a court finds a de facto merger, it will allow a creditor of one entity to go after transactions with other entities with which it had "merged" Appraisal Rights • Available for most kinds of mergers ○ not available for stock that is listed on a national securities exchange or that which is held of record by more than 2,000 shareholders (Market Exception) • Appraisal price is what the share is worth BEFORE merger ○ Doesn’t take into account any increase in value after merger (or added artificially by the merger agreement) • Problem with the "market out" The idea is that the market will reflect a more accurate value than an judge's determination Business Ass'ns Page 31

○ The idea is that the market will reflect a more accurate value than an judge's determination ○ But, the market (trade value) after a merger has been announced reflects the anticipated value of the stock AFTER the merger. So shareholders could just sell on the market, but they get ripped off. ○ Empirical research states that i. Mergers do not create wealth/value ii. The market out exception does not protect shareholders (Lopucki thinks this exception should be abolished) Who Has Appraisal Rights When, and How? (see chart above for permutations) Reincorporation • An entity can change its State of incorporation Three ways to do it: i) Merge into shell entity in that state ii) Sell all assets to a shell entity of that state for stock iii) Convert to an entity of that state (refiling) Business Ass'ns Page 32

iii) Convert to an entity of that state (refiling) Can only do these if the law of the destination state permits Fisher v. Tails, Inc. Virginia Code § 13.1–730(A) provides: A shareholder is entitled to appraisal rights, and to obtain payment of the fair value of that shareholder’s shares, in the event of any of the following corporate actions: a. Consummation of a merger to which the corporation is a party if shareholder approval is required for the merger; b. Consummation of a share exchange to which the corporation is a party as the corporation whose shares will be acquired, except that appraisal rights shall not be available to any shareholder of the corporation with respect to any class or series of shares of the corporation that is not exchanged; c. Consummation of a disposition of assets if the shareholder is entitled to vote on the disposition; VA corp minority shareholders do not have appraisal rights in the case of reincorporation. LIABILITY, LTD. LIABILITY, & VEIL PIERCING Limited Liability • Investors in an entity—even those who control the entity—are not liable for the entity’s obligations. • Limited liability is an entity characteristic. • Most entity types have it. • Limited liability is an exception to vicarious (but not direct ) liability. ○ Directors can be sued for the torts they, personally, commit. • It prevents the liability system from reaching the deep pocket. Veil Piercing • The liability system exists to hold wrongdoers and deep pockets liable. • Limited liability is an exception from the liability system. • Veil piercing is an exception from limited liability. • Definition: A legal theory under which courts may in certain circumstances disregard the entity to hold the investors liable. ○ Piercing applies to all entity types that have limited liability The Tests for Veil Piercing: 1) The two pronged test: i. The entity lacks separate existence ii. Recognizing the entity would cause fraud or injustice 2) The weighing of factors The Two Pronged Veil Piercing Test Folger v. Cottle Version

Veil piercing is proper when: 1. There is such a unity of interest and ownership between the corporation and the individual or organization controlling it that their separate personalities no longer exist; AND ▪ This element is only met when the corporation and the owner do not act as if they were separate (requires same formalities, meetings, minutes, bank accounts, signing, Business Ass'ns Page 33 were separate (requires same formalities, meetings, minutes, bank accounts, signing, etc.) 2. Failure to [pierce the corporate veil] would sanction a fraud or promote injustice. Weighing the Factors Courts consider these factor in determining whether to pierce: 1. Failure to observe formalities (not for LLCs) ▪ But Country v. Westside (Ind. App. 2014) required a “causal link between Country’s recordkeeping and any injustice resulting.” ▪ Veil piercing “standards” are the same for all entity types. RUPA, ULLCA, and ULPA eliminate “formalities” as a ground: ▪ RUPA, ULLCA, and ULPA impose no meeting or minute requirements. □ Even if the operating agreement requires meetings and minutes they are “irrelevant to a piercing claim.” ULLCA §304(b) Comment. 2. Absence of corporate records (corporate kit) ▪ See above (does not matter for LLCs) 3. Undercapitalization ▪ Capitalization: The amount contributed by investors as equity. ▪ Inadequate capitalization is: i) An important factor considered in veil piercing. ii) “Alone not enough.” (one exception, an old California case)

4. Commingling of assets ▪ Definition: combining funds or property into a common fund or stock Two kinds of commingling: i. Mixing assets, event while keeping records necessary to separate them back out. □ Example: “loans” between shareholder and corporation. ii. Mixing assets without the records necessary to separate them. Business Ass'ns Page 34 ii. Mixing assets without the records necessary to separate them. □ Example: Not keeping records showing the purposes of payments. □ A court has no alternative to piercing. How to Get Around Comingling Problem: "Cash Management Systems" ▪ Courts do not regard cash management systems as commingling ▪ But do regard loans between entities and human owners as commingling. i. Each entity operates a business, earns revenues, pays bills, has a bank account. ii. All cash is swept to Parent’s account (recorded as loan owed to sub) iii. All bills are paid from Parent’s account (recorded as loan made to sub) iv. Cash shifts are recorded as loans and loan repayments among the entities v. Sub A earns $5 cash, and Sub A’s deposit is swept into Kodak’s bank account vi. Recorded as a loan to Kodak 5. Identity of managers, investors, and business premises ▪ The fact that two entities share offices and employees may weigh in favor of piercing (but not heavily) ▪ Courts have said that it is not enough to show that two entities have the same directors/officers ▪ They have also said that sharing a board is not indicative of "a parent's domination" 6. Fraudulent representations by shareholders or directors 7. Use of the entity to promote fraud, injustice, or illegal activities 8. Entity’s payment of individual obligations. 9. Non-payment of dividends (investor-employee capacities)

10. Domination and control (separate existence) ▪ One-person corporations (single investor corps) establish separation between themselves and the investor using formalities (pretending using minutes, bank accounts, meetings, etc.) OTR Associates v. IBC Services, Inc. Business Ass'ns Page 35 Facts: • OTR leases sandwich shop premises to IBC, a judgment-proof shell. • IBC subleases to Samyrna. Samyrna pays rent directly to OTR. • Samyrna falls $150,000 behind in rent. • IBC has no assets, so OTR sues Blimpie. Holding: • Court pierces IBC’s veil and holds Blimpie liable on the lease. Rationale: • Court applied the two-prong test 1. “IBC had no separate existence” because it had “no business premises,” “no income,” “no employees” was not seeking a profit. ▪ However, IBC “had its own officers and directors,” “filed annual reports” “kept minutes,” “held meetings,” “had a bank account.” (“formalities”) 2. IBC was used to perpetrate a fraud because it misled OTR. Geigo Properties, LLP v. RJ Gators • Holds the opposite of OTR, saying that it is not fraud when lessees do not explain that they are a shell-corporation without assets (designed to protect parent from default on rent) Suggestion: • It is probably a good idea for a parent to disclose to the lessor that the lessee is their shell corp. • At this point, the lessor 1) may not approve lease, 2) may require parent to personally guarantee the lease, or 3) may simply take the risk and rent to shell

Does the Lessor assume the risk of dealing with a corp. that is inadequately capitalized? OTHER THEORIES FOR ENTITY DISREGARD 1. Veil Piercing • See Above Section. 2. Equitable Ownership • If adopted in jurisdiction, Veil-Piercing renders the share owners liable • It does not render non-shareholders liable • Under doctrine, non-shareholders can control by: Hiring nominee shareholders Business Ass'ns Page 36 ○ Hiring nominee shareholders ○ Personal family ties 3. Reverse Veil Piercing • Holding the entity liable for the investor's debts (instead of holding investor's liable for the entity's debts) ○ Couldn't you just take their shares? ▪ Not with an LLC or LLP (since ownership comes with managerial rights) ○ Used when investors owe personal debts to creditors. Creditors attempt to recover from entity if investor is insolvent. • Normal Two-Pronged test applies • Like normal Veil Piercing, the court treats the two entities as one. 4. Enterprise Liability (not the law, only theory) • An "enterprise" is a business ○ Business is the employment relationship, not the entity • Enterprise liability is liability based on the business, not the entities. ○ Sees the employment relationships among entities as forming one "business" from which recovery can be taken. • All entities that are part of the same business are liable for the business's obligations

Can only do this IF: 1. The entities are part of the same enterprise, and 2. The piercing requirements other than ownership are met • Enterprise liability allows us to pierce the veil to reach any entity in the business without having to show ownership, BUT does not reach the investors. 5. Agency • An entity can be the agent of its investors • Consequence: The principal is liable for the agent’s acts. ○ What’s new in this assignment: Shareholder-corporation and parent-subsidiary relationships may be principal-agent relationships. • Consequence: The parent is liable for a subsidiary’s acts. ○ This not veil piercing. But it has the same result (parent liable). Bowoto v. ChevronTexaco [p.184] Business Ass'ns Page 37 Bowoto v. ChevronTexaco [p.184] ○ Why wasn't CTOP liable ▪ Limited Liability's purpose is to allow a parent to reap benefits without being liable for the sub's actions 6. Ratification • See "Ratification" above. 7. Aiding and Abetting • Elements a. Tortfeasor (sub) is committing wrongful acts b. Abettor (parent) is knowingly helping • Effect: Abettor is liable for the tort 8. Partnership • If parent and sub are carrying on as partners: a. Each contributes something b. Share control c. Share profits d. And intend to do a-c • They are then liable for each other's actions

9. Partnership by Estoppel • If Parent and Subsidiary are carrying on as co-owners and business for profit, they are partners. 1. Each “contributes something.” 2. They share control. 3. They share profits. 4. They intend to do 1-3. • Partners are liable for each other's actions. Note: use of the word "partner" on a website or a sign to refer to a relationship between entities is not a representation of a partnership (XYZ Two Way Radio v. Uber) 10. Substantive Consolidation • Definition: combining assets and liabilities of two or more entities into a single bankruptcy estate. • Bypasses barriers put up by a cash management system when the records are poorly kept ○ Only occurs when the entities cannot prove separate existence • Level of Use: estates are substantively consolidated in about 50% of all large company bankruptcies Business Ass'ns Page 38 CAPITAL STRUCTURE Vocabulary Capital Structure: Definition: The combination of debt and equity by which the corporation is financed. Debt: rights to the repayment of money at specified times. Current liabilities : debts on which payment is due within a year. Long-term liabilities : debts on which payment is due more than one year in the future. Contingent Debt: usually a guarantee made by a parent to pay the debt of its subsidiary (if less than 50% that debt will be payed, it doesn’t appear on the balance sheet). Secured Debt: if agreed upon in writing that the creditor retains a security interest (lien) in the debt, the creditor may force a sale of the entity's assets upon default on the loan. First to obtain a security interest is the first paid. Debt Security (Bond): an investment right to the payment of a debt (usually $1,000 one to thirty yrs later) that an entity issues as one of a class or series (subclass) of identical rights.

Convertible Bond: can change the bond into common stock or another security. Equity: also referred to as stock , shares , or interests —is the right to specified shares of any distributions the entities make to investors other than debt holders. • The actual value of all shares roughly equals the amount of assets Balance Sheet: one of several types of documents typically prepared to show the financial condition of a business. Capital (Legal Capital): an amount set by the board of directors. Must be at least the total par value (defined, if at all, in the certificate of incorp.) of outstanding shares (often an imaginary number and not at all relevant) • Avoided in Delaware and abolished by MBCA • Think of "capital" as a cushion for creditors • To shrink capital, an entity can change the par value or stated capital ○ It can also buy back (redeem) its outstanding par value stock and cancel it to shrink capital even further. Other Ways to Avoid the Legal Capital Requirement: 1. Chose a very small amount for the par value of shares or a small amount for stated value. 2. Create capital surplus by revaluing assets. Klang v. Smith’s Food & Drug Centers. 3. For par value shares, buy them back and then reduce capital to the new, lower par value outstanding. DCGL §244(a)(4)(ii) 4. For no par shares, transfer stated capital value to surplus (DCGL §244(a)(4)(iii)) 5. Assign a high value to property contributed in return for stock, assuring that shares will not be assessable. DCGL § 152 6. Classes holding par stock can vote to reduce par. DGCL §242(b)(2) Surplus: the excess of the total equity (actual dollar amount of outstanding shares) of the corporation Business Ass'ns Page 39 Surplus: the excess of the total equity (actual dollar amount of outstanding shares) of the corporation over the amount determined to be capital. (Note: if a corp can define its capital, it can also define its surplus) • By changing par value and stated capital to lower amount, the entity can "create" surplus. Net Assets: The amount by which total assets exceed total liabilities Book Value: the value for which the entity paid to obtain an asset (does not take into account the potential for future earnings and tends to be lower than the actual value )

Revaluation: a determination by an entity’s management that the entity’s assets have an actual value that is different from their book value. • The entity can tell the bankers what values would enable the entity to do what the entity wants, and if those values are within a wide range of plausible values, the bankers can furnish them. • Once the bankers furnish a value, the directors are entitled to rely on it. DGCL § 141(e). Absolute Priority Rule • “Absolute priority” means that one obligation is entitled to payment in full before another is entitled to any payment at all. • 1. Creditors are entitled to absolute priority over shareholders. • 2. Secured creditors (lienors) are entitled to absolute priority over unsecured creditors in the collateral. • 3. Creditors or shareholders with contractual priority over others are entitled to absolute priority over the others ○ Example: If the first lien is for $300,000, the first lienor is entitled to $300,000 before the second lien gets anything at all. ○ Example: If the preferred have a $320,000 priority in liquidation, the preferred are entitled to $320,000 before common shareholders get anything at all. • Absent contract or statutory priority, creditors share pro-rata. DIVIDENDS & DISTRIBUTIONS Capital Accounts Definition: An account in the equity portion of the balance sheet. For a Corporation: Capital, surplus, preference, retained earnings For a Partnership: Each investor will have an individual account Distribution Sharing Concepts 1. Per share: The entity issues shares. Each share receives the same distribution. Business Ass'ns Page 40 1. Per share: The entity issues shares. Each share receives the same distribution. 2. Per capita: Each person receives the same distribution. 3. Per contribution: Each person receives the percentage of each distribution equity to the person’s percentage of all contributions. Default Rules for Distribution Sharing Before Dissolution At Dissolution Corporations Per Share Per Share

Partnerships & LLCs Per Capita Return Original Contributions LPs Per Contribution Return Original Contributions • RUPA § 806(b), ULLCA § 707(a). RUPA § 406(a)(2) and ULLCA § 405(a)(2) prohibit distributions prior to dissolution that would leave Partnerships, LLCs, and LLPs with insufficient assets to return the original contributions at dissolution. No Required Remuneration for Services Rendered : 1. Services may constitute contributions to an entity 2. HOWEVER, the default rule is that partners, members, and general partners are “not entitled to remuneration for services performed ” for the entity. RUPA § 401(j), ULLCA § 407(h), ULPA § 406(e). Losses: 1. The default rule for a partnership with no limited liability is that partners share losses proportionately to their share of the distributions. Partnership Accounts Robertson v. Jacobs Cattle Co. Facts: ○ Four of seven partners dissociate from the partnership. ○ The partnership agreement required buyout based on a hypothetical sale. ○ The hypothetical sale returned $5,212,015. ○ $4,052,201 of that money was profit. ○ How should that profit be distributed? ○ The partnership agreement specified two kinds of distributions: ▪ 5.3% to each dissociating partner’s capital account or ▪ 12.5% to each partner’s income account ○ Which kind of distribution is the $4,052,201? ○ Each partner has a capital account and an income account. Holding: ○ The court holds the $4 million profit on the sale is income not capital. Leveraged Buyouts All of the following steps occur simultaneously: Equity holders are currently taking the risk for any MegaCorp losses (or gains). If they want out of the risk, they should use a "leveraged buyout." Business Ass'ns Page 41 Step 1: MegaCorp takes out a sizeable secured loan (in this case, for $440 million)

Step 2: MegaCorp pays a $440 million dividend to Equity holders Step 3: Third-party buyer, "Hedge Fund" buys Equity holders' shares for low price ($10 million) Outcomes: 1. Hedge Fund bears only a $10 mil. risk but chance at huge gains; 2. Secured lender makes a very safe loan (w/ high interest); 3. Equity holders gets cashed out; 4. Unsecured creditors take on high risk with no additional reward; 5. MegaCorp is at risk for bankruptcy b/c of debt. Restrictions on Payment of Dividends DGCL UFTA (Fraudulent Transfer Restrictions) Business Ass'ns Page 42 ○ So, a delaware corp may impair capital so far as their net profits of the previous year allow, BUT as long as the impairment does not cause their liabilities to exceed their assets.

○ Just means that an entity cannot pay a dividend if it was (or about to be) engaged in a "business" and its assets are "unreasonably small in relation to the business" MBCA CAPITAL INVESTMENT & WITHDRAWAL Investments Subscriptions and Contributions a. In corporations , investors subscribe to purchase shares in the future. b. In partnerships, LLCs, and limited partnerships investors “promise contributions.” The effect is the same. ▪ Under the DGCL, subscriptions must be made in writing ▪ Under the MBCA, RUPA, ULLCA, and ULPA, no writing is required for a subscription , but general statute of frauds laws may apply ▪ Under the DGCL and the MBCA, the default rule is that subscriptions made prior to incorporation are irrevocable for a period of six months. DGCL § 165, MBCA § 6.20(a). Business Ass'ns Page 43 incorporation are irrevocable for a period of six months. DGCL § 165, MBCA § 6.20(a). RUPA, ULLCA, and ULPA place no time limit on agreements to contribute. ▪ Corporations

must pass a bd resolution to issue new shares ▪ Partnerships, LPs, and LLCs do not issue interests (shares), but instead admit new partners who make contributions, in order to gain more capital. Choosing New Partners Non-Corporations ▪ RUPA, ULLCA, and ULPA are highly attentive to compatibility considerations. For example, the default rules require the unanimous consent of the existing partners and members to admit new partners or members. RUPA § 402(b), ULLCA § 401(c), ULPA §§ 301(b) and 401(b). ▪ The underlying idea is that partnership or membership is an intimate relationship that the law should not impose on investors. ▪ Comments in all three statutes endorse pick your partner principle. Corporations ▪ By contrast, the default rule for corporations deems any person who buys a share to be a shareholder. Assessability Corporations ▪ Shares or interests are assessable if the entity has the right to additional investment from the holder. ▪ Once the investor in a corporation pays the agreed consideration for the issuance of shares, the investor’s shares are fully paid and nonassessable . DGCL § 152, MBCA § 6.20(c). □ That phrase means that the investor has no further liability to the corporation or its creditors. Non-Corporations ▪ The rule is the same for partnerships, LLCs, and limited partnerships that have limited liability. □ Partners/members are liable for promised contributions, nothing more. □ Partners in partnerships and general partners in limited partnerships that have not elected limited liability are liable for contributions in whatever amounts are necessary to discharge their partnerships’ obligations. Steps of an Initial Public Offering (IPO) 1. Letter of Intent ○ A company that wants to go public begins by signing a letter of intent that provides for an investment bank to underwrite the IPO. ▪ When they serve as underwriters of IPOs, investment banks typically provide the company with a firm commitment to buy the entire offering at a fixed price. A letter of intent is a statement of intention to enter into a legally binding agreement on stated terms at a later time.

○ Fixes the underwriter's fee as the difference between the price at which the underwriter will buy the shares (the issue ) and the price at which it will resell them. ○ This difference is known as the spread , and is usually 7% of the issue. An investment bank is a business that advises large companies and manages large transactions on their behalf. JPMorgan and Goldman Sachs are examples. An underwriter is an investment bank that buys large quantities of newly issued stock and resells Business Ass'ns Page 44 An underwriter is an investment bank that buys large quantities of newly issued stock and resells them to investors. A firm commitment is a legally binding agreement ○ If company chooses not to go through with IPO, company must reimburse the underwriter's expenses. 2. Preliminary Registration ○ The second step is for the parties to prepare a registration statement for the IPO and file it with the Securities and Exchange Commission, (SEC). ▪ The registration statement includes a preliminary prospectus . This prospectus is referred to as a red herring prospectus . Registration statement: describes the offering and all material aspects of the company’s financial condition. Prospectus: the disclosure statement that the company and its underwriter will provide to prospective purchasers of the shares. Red Herring Prospectus: does not yet contain the number of shares to be offered or the price at which they will be offered. 3. Road Show ○ Underwriter makes representations to prospective buyers to test the market. ○ Underwriter may also recruit other investment banks to underwrite other portions of the IPO. ○ Underwriter cannot actually sell anything yet. 4. Stock Exchange ○ Exchanges compete to provide the market in which the shares will trade ○ Contract with an exchange is made. 5. Offering Price ○ Company and underwriter negotiate the number of shares the underwriter will purchase and the price. ○ Company and underwriter sign a legally binding underwriting agreement. 6. Final Registration ○ Company and underwriter insert price and number of shares into the registration statement and prospectus, and file w/ §

7. Distribution and Stabilization ○ SEC declares registration effective. ○ Underwriter purchases shares and distributes them to investors ○ Trading on exchange begins ○ Underwriter can make a stabilizing bid for shares in order to prevent the market price from falling below the IPO price. Note: ○ Companies do not have to work with an underwriter, but can also just contract with an exchange and begin selling shares. Dissolution Procedure (Default Rules) Business Ass'ns Page 45 Step 1: Dissolution (3 Types) 1) Voluntary Dissolution How to Dissolve Corporations: □ Board approval and shareholder vote or else provision in fundamental document (no vote required) • Once certificate of dissolution is filed with the state, dissolution is official How to Dissolve Partnerships: □ any partner may dissolve the partnership at any time ( partnership at will ), by giving the partnership notice of the partner’s “express will to withdraw as a partner.” • No state filing required □ Partnership agreement may waive at will nature. • Such a partnership dissolves automatically “at the expiration of the term or the completion of the undertaking.” • Before that, the partnership may dissolve by: i) Affirmative vote of all partners; or ii) Affirmative vote of at least half of remaining partners if vote happens within 90 days after partner withdraws from partnership □ Default rule: partnership automatically dissolves if it does not have at least 2 partners for a period of 90 consecutive days. How to Dissolve LLCs: □ Default rule: affirmative vote of all members □ Dissolves automatically if it does not have at least 1 member for 90 consecutive days □ Operating agreement may specify circumstances in which LLC dissolves automatically

How to Dissolve LPs: □ Default rule: affirmative vote of all general partners and of limited partners owning a majority of the distribution rights □ In any period within 90 days after the dissociation of a general partner, the vote needed to dissolve is only that of “partners owning a majority of the rights to receive distributions.” □ Partnership agreement may specify circumstances in which LP dissolves automatically □ Dissolves automatically if it does not have at least 1 general partner for 90 consecutive days 1) Administrative Dissolution (easiest way to dissolve) ▪ Every state requires registered entities to file an annual report, pay an annual fee, and maintain a resident agent to receive service of process in the state. ▪ If entities do not comply, the state may force dissolution Reinstatement After Admin. Dissolution ▪ Administratively dissolved entities may reinstate themselves by curing their lapses and paying penalties to the state (within 2-3 years) Business Ass'ns Page 46 Pannell v. Shannon (p.252) □ When owner reinstates a dissolved entity, the reinstatement relates back to the dissolution. (even though she breached her lease b/c the entity was dissolved, the reinstatement cures the problem) 2) Judicial Dissolution ▪ Courts may enter order to dissolve entity ▪ Majority Rule: only a court of the state that issued the entity's charter can enter a dissolution order Who Has Standing to Seek Such an Order? i. Atty. General - for abuse, misuse, or nonuse of corp powers, privileges, or franchises (Delaware); or for fraud or illegal activity (MBCA) ii. Investor - In the case of deadlocks or impending irreparable harm iii. Creditor - ONLY under the MBCA Step 2: Winding up ○

The entity continues to exist only to wind up. The entity is in control during this time (all officers remain in office). ○ The entity may operate the business for a “reasonable time.” RUPA §802(b)(2)(B). ○ ULC entities must sell all assets (liquidation requirement), distribute money. RUPA §806(f); ULLCA §707(d). ○ But corporations may distribute “in kind” in forms other than money (no liquidation requirement). Fire Sale: ○ A sale of assets (often by auction) for substantially lower price (usually with businesses & real estate) ▪ Worth less than actual value because there is no way for outsiders to assess risks ○ Owners of dissolved entity may bid if they can raise enough cash (could bring in an outside party to finance their bid); OR ○ Owners may bid on a limited amount of credit (defined by the amount of the final sale price they would be entitled to) ▪ Example: if partner entitled to a 1/2 share wants to buy back a farm, and they bid $500,000, only $250,000 of the bid can be on credit. Step 3: Settlement ○ The entity pays creditors; then equity holders. Step 4: Statement of termination ○ Entities may file statements: ULLCA §702(b)(2)(F), RUPA §802(b)(2)(F), ULPA §802(b)(2)(F). Disassociation (Withdrawal) • Definition: termination of a partner’s or member’s association with a partnership, LLC, or limited partnership. Immediately upon dissociation, the partner or member ceases to have governance or information rights, but continues to own the transferrable interest. Corporations Business Ass'ns Page 47 Corporations ○ Do not have disassociation Transferrable Interests ○ An "interest" is the equivalent of a corporation's "share" ○ It comes with certain rights i. Distribution Rights: Freely Transferrable i) Right to receive distributions can be given to another ii. Control Rights: Not Transferrable i) Right to vote/manage the entity cannot be given, but stay with the

partner/member ii) Terminate with disassociation Disassociation Causes 1) Mandatory Rule: member/partner may disassociate by giving notice of their express will to withdraw (cannot be in violation of partnership or operating agreement) i. Disassociation is automatic if partner/member is a natural person and dies (or is declared incompetent) or if partner/member is an artificial entity and is dissolved ii. Members and partners dissociated if expelled as partners or members under a variety of procedures (file bankruptcy, make an assignment for the benefit of creditors, or suffer the appointment of a receiver) Disassociation Effects Partnership/LLP: ▪ Withdrawal dissolves partnership & triggers winding up □ If partner dies or goes bankrupt, other partner(s) must buy out interest to prevent dissolution □ Withdrawing partner is still responsible for partnership debt incurred after withdrawal • Remaining partners could sell to themselves □ Disassociating partner may or may not participate in wind up LLC: ▪ Withdrawal (even death) terminates member's managerial rights, but doesn’t trigger dissolution ▪ Member cannot withdraw investment unless allowed by controlling members • Operating agreement can override this statute LP: ▪ Withdrawal of general or limited partner doesn’t trigger dissolution (unless he was the only general partner and not replaced w/in 90 days) Business Ass'ns Page 48

▪ General partner still liable for debt incurred before withdrawal, not after □ Disassociated partner retains a transferrable interest in distributions & information rights but managerial rights are terminated. ▪ Limited partners not liable for any debts Buyout Arrangements Notes on Buyout Clauses in Relevant Statutes: Partnerships: ▪ If partner gives notice of express will to withdraw, he can demand payment for his interest. □ If partnership chooses to wind up, it can ignore this demand ▪ But RUPA §801(1) also allows partners to rescind a dissolution and resume “carrying on business as if the dissolution had never occurred.” □ If this happens, RUPA §701(a) requires the partnership to buy the withdrawing partner out □ The price will be the amount that would have been distributed to the dissociating partner if the partnership had wound up. RUPA § 701(b). ▪ If partnership is for specified time or purpose, partner's withdrawal before such time/purpose is wrongful & partner liable for damages □ Partner may still demand buyout, but payment is not mandatory until partnership's time/purpose is complete Corporations: ▪ MBCA gives corps the option to buy out shareholders who sue for dissolution b/c of deadlock or illegal/oppressive/fraudulent actions of those in control Buyout Agreements (absence of statutory mandate) Methods for Setting Buyout Price (via investor agreement before incorp) i. Book value: Buyout price for existing shares set at book value. • Pros: book value reevaluated each year → readily available • Cons: usually lower than fair market price (or higher for failing business) ii. Auction sale: Auction (public or exclusive to investors). Winning bidder(s) buy other investors out. • Works poorly when investors have liquidity/wealth to participate iii. Capitalized earnings (“earnings multiple”): Buyout price set at multiple of entity's profits in recent years (3-10 times earnings). • Cons: based on past earnings, but ignores important future potential iv. Right of first refusal: Investor finds a buyer, then corp has right to buy first at that

price. • Cons: Arms-length buyers won’t want to bid if they know there is little chance to buy v. Appraisal: Professional appraiser sets price • Pros: fair to both sides • Cons: Expensive, somewhat arbitrary, may require arbitration vi. Annual agreements: Time and resource consuming; parties are unlikely to do it. vii. “Texas offer”: Any investor may fix a company value at which the party agrees to buy or sell. The others must buy or sell at that value. Business Ass'ns Page 49 or sell. The others must buy or sell at that value. • Pro/Con: Differences in wealth or liquidity confer bidding advantages. Cash-Out Merger ○ Usually, investors cannot buy other investor's shares without consent ○ A cash-out merger is a kind of exception to this rule: ▪ Ajax corp. owns 55% interest in Mega corp. ▪ Ajax and Mega agree to a merger ▪ Agreement provides that Mega will issue cash in exchange for all Mega shares & holders of Ajax shares will receive all shares issued by the surviving corp. ▪ Ajax has effectively cashed out other Mega investors SCOPE OF INVESTOR DECISION-MAKING Two Types of Entity Decision-Making Structures 1. One-tier: Investors make all decisions (partnerships & LLCs) 2. Two-tier: Investors & managers share decision-making power ○ The investors usually elect the managers. BUT; ○ The fundamental documents may specify the managers (limited partnerships), or ○ Managers may choose their successors. Two-Tier Decision-Making Structures Decision-making is shared several ways: 1. Investors make certain decisions; managers make others. Forced two-tier system. (manager managed LLCs, limited partnerships) 2. Only managers can initiate certain decisions. Shareholders must vote to approve. (Certificate amendment in corporations) 3. Investors and managers can each make the decision. The most recent controls. (Bylaws in corporations) Default Statutory Decision-Making By Entity Type

Business Ass'ns Page 50 Corporations: Which Rules Are Simply Defaults? ○ A corporation's founding documents may override the requirement for a board of directors ○ But, whoever makes decisions must have fiduciary duties RUPA, ULLCA, ULPA: Which Rules Are Simply Defaults? ▪ Requirement of a unanimous decision to give up LLP or LLLP limited liability status cannot be overridden Bylaws

Where Do Bylaws Come From? ○ Bylaws are agreed upon by insiders before investors invest (gives directors the power to amend bylaws). What Can Be in the Bylaws? And how are they different from Certificates of Incorporation? Business Ass'ns Page 51 ○ DGCL §141(a) expressly yields to the certificate, but not the bylaws ○ Bylaws may only define the process and procedures by which management decisions are made (not the content of the decisions themselves). ○ Bylaws must also allow directors to discharge their fiduciary duties Why Do Bylaws Exist? If everything in the bylaws can also be in the certificate, why use bylaws? ○ Because the procedure for amending bylaws is different Who Can Amend Bylaws? ○ Shareholders have an irrevocable right to make bylaws:

○ The certificate (normally) or the MBCA gives directors this right as well: Business Ass'ns Page 52 What Public Companies Normally Do ○ All shareholders vote in one election, only on the following: i. The election and removal of directors ii. Proposals by the board, including certificate amendments, mergers, all asset sales, conversions and dissolutions iii. Bylaw amendments iv. Shareholder resolutions (nearly all non-binding) ○ The board of directors has authority to make all other decisions. ○ Regarding bylaws, the customary rules differ from the default rules: i. No default bylaws exist, but the customary company has bylaws. ii. The DGCL default rule is that the shareholders make bylaws, but the customary and MBCA rule allows both to make bylaws. Proxy Access Definition: Having one’s proposal included on the entity’s proxy card (name for the corporate ballot) at the entity’s expense • Any shareholder may solicit proxies to force proxy access, but, if the company is public, the cost to do so is substantial.

3-3-20 Bylaw: A type of proxy access statute . Stipulates that shareholders who have held 3% of the company's shares for 3 years can nominate enough candidates to fill 20% of the available board seats. • Ex. If A and B each separately hold 3% for 3 years, they can each nominate enough candidates to fill 20% of the board. MBCA and DGCL Defaults for Proxy Access ○ Corporations are not required (under MBCA or DGCL) to provide proxy access, but instead merely authorize them to do so. ○ Once a proxy access bylaw is passed, directors cannot repeal it, but may amend it to provide for "reasonable, practical, and orderly process." ○ Under the default rules, shareholders have the power to remove directors without cause [MBCA § 8.08(a); DGCL § 141(k)] ▪ Unless the board is a staggered board (only for cause). Requires the shareholder to win 2 proxy wars to take control of the board. ○ Removal of directors requires a shareholder vote & to win a shareholder vote requires that someone bear the expense of a proxy solicitation ▪ Proxy solicitation : A proxy fight. Shareholders must nominate their own candidates and solicit votes by sending their own proxy statements and cards to the shareholders. VERY EXPENSIVE. Federal Requirements on Proxy Access Business Ass'ns Page 53 Federal Requirements on Proxy Access Federal law mandates proxy access except as excluded under 1934 Securities Exchange Act Rules 14a.-8(i), Moll page 1499. Subject Matter Requirements: 8(i) excludes shareholder proposals which meet any of the following: 1) Improper under state law • (most mandatory resolutions about management of business are against state law) 4) Regarding personal grievances 5) Relating to operations less than 5% of the business 7) Relating to ordinary business operations 8) Director Elections (See Statute Below) 9) In conflict with the company’s proposal 13) Setting a specific amount of dividend

Eligibility Requirements: To be eligible to submit a shareholder proposal, the shareholder must: 1) have continuously held at least $2,000 in market value, or 1%, of the company’s securities (stocks/bonds) entitled to be voted on the proposal 2) For at least 1 year before submission; AND 3) Must continue to hold those securities through the date of the meeting at which the vote is held. INVESTOR VOTING Certificating Shares: Issuing certificates for shares in private companies Registered Shares: Recording issued shares (issued to who, when, how many) on a stock ledger . Only the record owner of the shares is entitled to vote. Annual Shareholder Meeting: held at a date and time fixed by or in accord with the bylaws. The meeting can take place anywhere, or even “by means of remote communication. Special Shareholder Meeting: In public companies, these can be called by either the board or the holders of 10% of the voting power (default rule). Articles may set higher percentage, but no more than 25%. Notices must specify purpose of meeting. Notice of Meetings: Corporations must notify all shareholders eligible to vote of any meeting no less Business Ass'ns Page 54 Notice of Meetings: Corporations must notify all shareholders eligible to vote of any meeting no less than 10 days and no more than 60 days in advance. Notice for an annual meeting must include place, time, and date. Notice of a special meeting must also include the purpose of the meeting. • If proper notice is not given, any action taken at the meeting is void. Record Dates: dates upon which shareholders must be registered in the stock ledger to be eligible to vote. Allows time to compile shareholder list & provide notice of meetings to those on the list. Record date cannot be set later than 10 days and no earlier than 60 (DGCL) or 70 (MBCA) days before the meeting. Beneficial Owner: Person for whom shares are held by securities intermediaries (the person who owns the securities account with a brokerage). May instruct their securities intermediaries how to vote their shares.

Indirect Securities Holding System • Registered entities own the shares for which they are registered directly . • But shares can be held indirectly by a securities intermediary (like a stockbroker) in a securities account . • When you open up a securities account through a broker, you do not own the shares represented within the account. You only own a securities entitlement (a contract right against the intermediary for the value of the shares) ○ If an intermediary contracts with a customer for this right, they must own the number of shares directly or own a securities right to that number of shares. • Purpose: this system alleviates the work it would take to record every share transfer in the corporate stock ledger. • All security interest transfers are tracked on the intermediaries' private records Public Company Voting Procedure Steps 1. The board sets a date and calls the meeting. DGCL §211(a), (b) 2. The board sets a “record date.” That date must be ten to sixty days before the meeting. DGCL §213(a). 3. An officer prepares a list of record-date stockholders. DGCL §219(a). They can omit email addresses. 4. Any stockholder may examine the list for “a purpose germane to the meeting.” DGCL § 219(a) 5. The corporation files its proxy statement with the SEC. Form 14 6. The corporation sends meeting notice, proxy statement, and ballot to shareholders. DGCL § 222(a), (b) 7. At their own expense, others may solicit proxies. (but no email) 8. At the meeting, shareholders vote by written ballot or proxy. 9. A corporation-appointed “inspector” counts the votes and certifies the outcome. DGCL § 231(a) and (b) Voting Types Revisited 1. Straight (DCGL default) 2. Class 3. Cumulative (California has "mandatory" cumulative voting) Business Ass'ns Page 55

Cumulative Voting Formula: The Problem of Notifying Beneficial Owners of a Meeting ○ Beneficial owners of stock may not be the registered owner of that stock. ○ A firm known as "DTC" owns most shares directly. ○ Beneficial owners of stock may instruct DTC how to vote, but are not allowed to receive proxy cards. ▪ Therefore, the brokers contract out Broadridge, who receives the proxies as power of atty for DTC and sends the beneficial owners voting instruction forms (VIF). ▪ Beneficial owners send their VIFs back to Broadridge who vote the shares according to the VIFs Compiling a Shareholder List 1. First step is to get the cede breakdown (a list of clients (brokers) with securities accounts with DTC & number of the corp's shares in each account). 2. Second step is to get a NOBO List (a list of all beneficial owners (who have not objected to the listing of their identity) from each of the clients (brokers) listed on the cede breakdown). 3. If beneficial owners object, they may still vote. The number of objectors is reported and an appropriate number of VIFs are issued to the broker to distribute. Achieving a Quorum ○ A class of shares may take action at a meeting only if a quorum is present in person or by proxy. ○ A quorum is a majority of the shares entitled to vote. ○ The MBCA allows provisions of the articles of incorporation to fix a higher or lower quorum requirement. ○ The DGCL allows the certificate of incorporation or bylaws to fix a higher or lower quorum requirement, except that the requirement cannot be less than one-third of the shares. Three Standards for Winning a Shareholder Vote 1. Plurality: The candidate received more votes than the competing candidate. ▪ Default rule for election of directors. DGCL §216(3). 2. Absolute majority: Received the vote of a majority of the outstanding stock entitled to vote.

▪ Default rule for shareholder approval of fundamental transactions. DGCL §242(b) (1), §275(b), etc. 3. Simple majority: Received more than half of all votes actually cast. Business Ass'ns Page 56 3. Simple majority: Received more than half of all votes actually cast. ▪ Default rule for all other investor votes. DGCL §216(2). Consent Procedures • Shareholders may take action without a meeting if there is unanimous consent (default rule) • Consent forms must be written and signed by the shareholders, setting for the action to be taken. • The articles of incorporation may provide that the consent need only be by “the minimum number of votes that would be required to authorize or take the action at a meeting at which all shares entitled to vote on the action were present and voted.” That required number of votes is referred to as an absolute majorit y . • Under the DGCL, the default rule is that an absolute majority can take action by consent. • To appoint directors via consent rather than a vote, the DGCL says that all directors must first be removed then all seats refilled by consent, BUT ONLY IF CONSENT IS NON-UNANIMOUS . If consent is unanimous, directors can be appointed via consent one-by-one ○ However, the Delaware Supreme Court says that shareholders may not "use a non unanimous written consent to remove lawfully serving incumbent directors, and then elect successor directors, between annual meetings." ○ How to Get Around This (using only consent): 1) Remove the undesirable Director 2) Remove all other Directors 3) Elect the all other Directors (minus undesirable Director) plus desired replacement Allocation of Voting Rights • Fundamental documents can allocate voting rights in any manner the drafters want. ○ Voting rights can even be assigned to a single shareholder (in a separate class) • Under the DGCL, anything goes • Under the MBCA, the only restriction is: ○ partnership agreements cannot eliminate the necessity for the consent of partners with limited liability to a change that would give them unlimited liability • The default rule for Corporations is per share voting • The default rule for partnerships, ULLCA LLCs, and LPs is per capita (1 vote per person) voting

○ ULLCA doesn’t require any formal decision-making procedure. Thus, managerial decisions can be made without formal meeting of all members (as long as by a majority of members) and members in minority have no rights or duties with respect to the decision (meaning no Business Ass'ns Page 57 and members in minority have no rights or duties with respect to the decision (meaning no information rights either, even under the below statute) Conflicts of Interest and Voting • Majority shareholders have fiduciary duties to the minority shareholders and must vote accordingly. ○ It is not objectionable that majority shareholders' motives be for personal profit, or determined by whim or caprice, so long as they violate no duty owed other shareholders. • MBCA § 7.21(b) and DGCL § 160(c) prohibit a corporation from voting shares that are directly or indirectly owned by the corporation. ○ Otherwise, directors could opt to vote their corp's shares to reelect themselves. ○ The prohibition extends to shares of the corporation held by a majority-owned subsidiary of the corporation, because those shares are owned “indirectly” by the corporation. Voting Alliance Devices Corporate law provides three devices—voting trusts, voting agreements, and irrevocable proxies—by which shareholders can pre-commit to voting alliances. 1. Voting Trusts When 2 or more shareholders transfer shares to a 3rd person who, by written contract , agrees to hold them in trust and vote them in accord with the terms of the trust. ○ Trust may be limited in time or permanent ○ The agreed terms may specify how the trustee will vote the shares or give the trustee discretion to vote them ○ Trustee must register as the registered owner and disclose agreement to the corp ○ DGCL mandates that the trust agreement must be open to inspection by any shareholder of the corp. ○ The MBCA does not!

2. Voting/Pooling Agreements A normal contract between a number of shareholders to vote a certain way ○ If a shareholder breaches the agreement by voting contrary to its terms, the vote will probably be effective as cast, unless the corporation has agreed not to honor such a vote. 3. Irrevocable Proxies A proxy is a written authorization to cast votes on a shareholder's behalf. This is an agency relationship. ○ The proxy document may specify how the agent is to vote the shares or give the agent discretion and the document is not open for inspection. A proxy may specify the length of time for which it will be effective. If it does not, an MBCA Business Ass'ns Page 58 ○ A proxy may specify the length of time for which it will be effective. If it does not, an MBCA proxy expires in eleven months, § 7.22(c), and a DGCL proxy expires in three years, § 212(b). ○ Even if not expired, a proxy is revocable unless it is coupled with an interest and specifically states that it is irrevocable. ○ MBCA § 7.22(d) identifies specific circumstances in which a proxy is coupled with an interest: ▪ They include the interest of a person who lent money against or agreed to purchase the shares, and has been given a proxy in order to protect that interest. ○ DGCL § 212(e) provides more broadly that a proxy is coupled with an interest when the agent has “an interest in the corporation.” ○ Under either statute, a proxy granted to another shareholder in connection with a voting agreement would be coupled with an interest. Other Notes on Voting • A share's voting rights can be separated from the economic rights associated with it ○ Shares held in a mutual fund: the beneficiaries of the fund are entitled to the distributions

or increase in value of the shares, but are not entitled to vote the shares. • Shares can have more than one vote under certain circumstances: ○ If Card votes (by VIF) their 10,000 shares, and Stix votes (by VIF) their 9000 shares, what vote does SuperStar Report to Etrade? ▪ SuperStar must reduce the number of voting shares to 10,000, but may do so however they want without notification to the beneficial owners. INVESTOR INFORMATION ACCESS Big Picture Business Ass'ns Page 59 Big Picture • Unhappy investors have the right to vote, sue, or sell their shares. • To do any of those things, they need information. • Entity laws provide mandatory rights to information. • RUPA, ULLCA, and ULPA: ○ Without demand : information material to the proper exercise of the partner/member’s rights ○ On demand : any other information unless the demand is unreasonable or otherwise improper. ○ Those information rights can be restricted “reasonably.” • DGCL and MBCA: ○ Without demand : a few fiduciary disclosures (page 319) ○ On demand : recorded information, for a proper purpose • The rights can’t be restricted, but can be avoided by strategy. Duty to Disclose Without Request Public Companies ○ The information on the thousands of companies whose securities are registered with the Securities and Exchange Commission is available on the EDGAR website. ○ Types of Mandatory Federal Public Filings:

1) Proxy Statements: • voting information, results and procedures 2) Annual Report: • financial info, risks, directors/officers, certificate and bylaws, pending litigation 3) Prospectus: • Required to transfer securities to a new owner. • Details the security issuer's financial info and the info of the transfer Private Companies ○ All entities must file annual reports with, and pay fees to the filing office of the chartering state ▪ Do not need to disclose shareholders or beneficial owners. ▪ Usually one page in length. ○ RUPA, ULLCA, and ULPA: ○ Without demand: information material to the proper exercise of the partner/member’s rights • If info is not disclosed, court may void the action of the entity ○ Corporations 1. Ratification. If directors seek shareholder approval for a transaction that does not require it, the directors must disclose all facts material to the stockholders’ decision. Failure to disclose eliminates any effect that a favorable stockholder vote otherwise might have. 2. Shareholder Decisions . Directors required to submit a transaction for stockholder approval or who know shareholders must make an investment decision such as tendering shares or electing appraisal, must exercise reasonable care to disclose all material facts known or available to the directors. 3. False Statements. Directors violate their fiduciary duties if they make false statements to shareholders or others about the corporation’s affairs. 4. Purchase or Sale of Shares. Under the “special facts doctrine,” a director possessed of special knowledge who purchases or sells shares in a private transaction has a duty to Business Ass'ns Page 60 special knowledge who purchases or sells shares in a private transaction has a duty to disclose that knowledge. The doctrine does not apply to purchases or sales in impersonal secondary markets. Duty to Disclose Upon Request

Stockholder List ○ Who is on the "complete list?" 1. Registered shareholders (on the stock ledger) 2. Shareholders on the CEDE breakdown 3. Shareholders on the NOBO list Books and Records DGCL Business Ass'ns Page 61

What is a "Proper Purpose?" □ Does not include purposes like collecting info to bring a derivative action or to start a proxy fight (solicit proxies) MBCA Records Open To Inspection: 1. Corporate kit: Certificate, bylaws, minutes, resolutions, stock ledger. 2. Accounting records, including financial advisors’ “reports and correspondence.” Saito McKesson HBOC, Inc. (Del. 2002) 3. Documents useful in investigation of wrongdoing (Seinfeld). 4. Documents prepared by outsiders. (Saito)

Business Ass'ns Page 62 4. Documents prepared by outsiders. (Saito) 5. Maybe even privileged or protected work product records. Wal-Mart Store v. Indiana Electrical Workers (Del. 2015). Corporate Duties vs. Non-Corporation Duties How to Make a "Black Corporation" One with no information rights 1. Sub-contractors of government do not have to disclose information; OR 2. Use a sub. If secrets are in Sub, investors cannot access, since they only have a right to info the corp can exercise control to obtain (corp cannot force sub to give info). ○ Could also made a "Black LLC" since members of the Black LLC have no right to vote in the Sub (therefore, do not have information rights to Sub info). INVESTOR FIDUCIARY DUTIES Big Picture • Investors make decisions through voting or consent. • General rule: Each investor is free to vote in its self-interest ○ even if contrary to the entity’s interests and co-investors’ interests. • Controlling investors are an exception: ○ In all U.S. jurisdictions, controlling investors must vote in the entity’s interests. ▪ Zuckerberg must vote in Facebook’s interests, not his own. ○ In some jurisdictions and some entity types, controlling investors have duties to their co investors. • In some jurisdictions and some entity types, all investors have fiduciary duties to all other investors. The Basic Rules Controlling Investor Rule: • The controlling investor owes a fiduciary duty to the entity to act in the entity’s interests. In all states, across all entity types.

• The duty : to act in what the investor believes is the best interests of the entity. (The courts don’t decide that. Surrogate issues.) • If the investor transacts with the entity, the investor is “self-dealing.” • If the investor is self-dealing, entire fairness is the review standard. Business Ass'ns Page 63 Partnership Fiduciary Duties: ○ Partner fiduciary duties may be limited: Entire Fairness Standard: fair (reasonable, not highest) price and fair process. • If the transaction is entirely fair, the transaction is valid and the controlling investor is not liable. (But the courts rarely decide fairness.) • Entire fairness is burdensome, so investors seek exceptions from it. The Duty to Co-Investors Rule: • Partners, members, and shareholders have duties of “utmost good faith and loyalty” to co investors • In every state, partners owe fiduciary duties to other partners. • In most states, LLC members owe fiduciary duties to other members. • The “majority rule” is that corporate shareholders owe fiduciary duties to other shareholders. (Actually adopted in 5 to 18 states) ○ Shareholders do not owe fiduciary duties in Delaware or Texas. • Unequal treatment, frustration of reasonable expectations, and freeze-outs are breaches. ○ The remedies include damages. Freeze-Out (not an issue in Delaware): • The majority investors employ themselves and declare no dividends. The majority gets all benefits; the minority get none. • Delaware on freeze-outs:

Oppression (no remedy in Delaware): Business Ass'ns Page 64 Oppression (no remedy in Delaware): • If the controller acts “in a manner that is illegal, oppressive, or fraudulent,” or control is deadlocked, the court can dissolve the entity. MBCA corporation, §14.30 (a)(2)(ii), ULLCA LLC, § 701(a)(4). ○ Adopted in about 37 states, but not Delaware. • Unequal treatment, frustration of reasonable expectations, and freezeouts are breaches. ○ The sole remedy is dissolution. Delaware Alternatives to "Entire Fairness" 1. Kahn v. M&F Worldwide (Perelman Standard): 2. In re Pure Resources: Coercive Shareholder Votes A vote or decision to sell that does not reflect the shareholders’ opinion of the transaction. • Example: ○ Target trades for $25 as share. Bidder tenders for a controlling interest at $30 ($5 “control premium”). Bidder states that if Bidder gets control, it will merge with Target and pay Target shareholders $25 a share—the value of non-controlling shares. ○ Shareholders think control share are worth $35, but they tender at $30 now, so they won’t be cashed out at $25 a share later.

THE MANAGER DECISION-MAKING PROCESS • Entity decisions can be made by investors or manager(s) • Managers can be a single person or a group Boards of Directors • There are no mandatory rules about having a board of directors: ○ Any type of entity can have a board of directors No entity type must have a board of directors Business Ass'ns Page 65 ○ No entity type must have a board of directors ○ EXCEPTION: Delaware corps must name a "natural person" who holds the title of "director" in their annual report. ▪ But, can be a director in name only. • Many board members are not employees of the corp ○ Officers tend to be the real managers 6 Board Meeting Procedure Rules 1. Power to call a special meeting. ▪ In CEO by default. 2. Notice of a special meeting. ▪ Failure to give invalidates action. 3. Meetings. ▪ Everyone must be able to hear everyone else. Each director has one vote and must cast it in person. 4. Quorum. ▪ More than half of the “whole board” must attend the meeting for the board to take action. ▪ Example: If the whole board is 10, a quorum is 6, so 4 is the smallest number who can take action. 5. Minutes. ▪ The MBCA, but not the DGCL, requires minutes of meetings. 6. Board action without meeting. ▪ Must be unanimous. Board Committees • Boards may appoint committees. • Every committee consists of one or more board members. • The committee has the power the board delegated to the committee. ○ A few duties are non-delegable to committees (e.g., bylaws, mergers). • Committees can make recommendations or take action . • Public companies have an average and median of four committees.

○ Executive. Broad power to substitute for the board. ○ Audit. Communicates with the auditors. Required by Sarbanes-Oxley. All members must be independent. ○ Compensation. Fixes pay of directors and highly paid employees. ○ Nominating. Nominates candidates for directorships. ○ Finance. Arranges borrowing and investment from outside. Responsibility to Make Informed Decisions ○ Delaware directors are personally liable if they are grossly negligent in informing themselves before making a decision. ○ However, uninformed Directors (i.e. who haven't read the proposal) may rely on any statements made by other directors. In re Walt Disney Derivative Litigation. ○ Can also rely on other information presented to them Business Ass'ns Page 66 Who Actually Controls a Public Company? Default Rules of Manager Decision-Making • Corporate boards and general partners decide matter in and out of the ordinary course. • LLC managers decide only matters in the ordinary course. • RUPA does not provide for or prohibit the appointment of managers. General Partnership (LP) Decision-Making

• Below is the typical structure • Sponsor Corp makes all the decisions but only 3% of the money at stake (Empty Voting) Director Information Rights • Personal emails sent between directors are not considered "official corporate business" and cannot be examined by other directors. Chammas v. NavLink, Inc. FIDUCIARY DUTIES AND THE BUSINESS JUDGMENT RULE Business Ass'ns Page 67 Business Judgment Rule The Business Judgment Rule applies when all of the following conditions are met: 1. The managers made a discretionary business decision . 2. Loyalty: there was an intention to act in the entity's best interests . 3. Good Faith: Conduct that is not disloyal and less culpable than gross negligence (managers can be negligent and still be okay!) 4. Due Care in Process: the managers informed themselves to the degree they reasonably believed necessary . 5. Rationality: the decision is not waste —"beyond the range at which any reasonable person would be willing to trade." (DGCL corporations can make "reasonable charitable donations). • The presumption is that loyalty, good faith, and due care conditions are satisfied (rebuttable presumption). • If all conditions are satisfied: 1. Managers are not liable (to shareholders) for their decision (may be liable to 3rd parties for things like defective products) 2. Court will not invalidate their decision Reliance Rule (Due Care)

• Example: Director fails to prepare for meeting, but CEO says proposal will increase profits, so Director votes in favor (but proposal actually tanks company) ○ Director is completely protected from liability (even if proposal was obviously nuts) • This DOES NOT PROTECT Against "Self-Dealing" Situations ○ Directors can rely on stated facts, but not legal conclusions. Oversight Rule • Directors have no liability for failure to discover problems Charitable Donations and Waste • 16% of annual profits was deemed "reasonable" [Kahn v. Sullivan] Business Ass'ns Page 68 • 16% of annual profits was deemed "reasonable" [Kahn v. Sullivan]

Waiver of Fiduciary Duties (Exculpation) • Because of this, the following is a valid provision: Non-Corporations: ▪ "Good Faith" Breaches can be waived. Reliance in Partnerships, LLCs, and LPs • The RUPA, the ULLCA, and the ULPA impose a duty of care on managers, but contain no provisions entitling managers to rely on anyone or anything. • Under the law of probably any state, partnerships, LLCs, and limited partnerships can include provisions in their fundamental documents protecting managers who rely on particular persons or documents. ○ Because such reliance rights exist in corporations, it is highly unlikely that creating them in other entity types would be considered manifestly unreasonable. FIDUCIARY DUTIES: LOYALTY AND GOOD FAITH Overview Business Ass'ns Page 69 Overview • The duty of loyalty is to act in what the manager believes to be the best interests of the entity.

• A conflict of interest is a manager’s personal interest that is contrary to the entity’s interest. • A manager breaches the duty of loyalty by acting in the manager’s personal interest. • A conflicted transaction is one in which one or more directors has a conflict of interest. • Conflicts matter in two legal contexts: 1. Is the transaction valid and binding on the corporation? 2. Is the director liable for breach of fiduciary duty? • Entity law’s solution to a conflict of interest is to substitute a disinterested decision maker (one with no conflict). The Conflict-Loyalty Distinction 1. Conflict: Having an interest contrary to the interests of the corporation. ○ In Benihana , Abdo did have a conflict of interest. He was on both sides of the transaction. ○ That conflict was excused by disinterested director approval after full disclosure. 2. Breach of the duty of loyalty: Taking an action , or failing to take an action, contrary to the interests of the corporation. ○ Abdo did not breach his fiduciary duty of loyalty. He did not use confidential information against Benihana. ○ If he had breached his duty of loyalty, disinterested directors couldn’t excuse it. ○ Abdo’s purchase of the preferred stock benefitted Benihana. "Disinterested" vs. "Independent" Directors • Disinterested : Not having a material financial interest in the transaction, except through the entity. • Independent : Not being controlled by, or beholden to, a person who has an interest in the transaction. ○ Friends are not beholden to their friends by virtue of their friendship. Needs to be something more. Types of Conflicts: DGCL Business Ass'ns Page 70

Types of Conflicts: MBCA "related persons" include: 1. Spouse 2. Child, stepchild, grandchild, parent, step parent, grandparent, sibling, step sibling, half sibling, aunt, uncle, niece or nephew (or spouse of any such person) of the individual or the individual’s spouse; 3. Housemate Exceptions: ○ Means that disinterested director actions are valid if interested directors do not vote. BUT the interested director may still be personally liable. ○ Example: a lawyer for one corp is on the board of another corp. Types of Conflicts: RUPA, ULLCA, and ULPA

Business Ass'ns Page 71 • Really only covers "self-dealing." Everything else is not a breach. Delaware Common Law: Conflict Excusal Under Delaware common law conflicts are excused if disclosed and: 1. A “majority of disinterested directors” approves the transaction. 2. A majority of disinterested shareholders approves the transaction, or 3. The transaction is entirely fair to the corporation. "Majority" is ambiguous, and may mean: 1. a majority of whole board must be disinterested and vote in favor, 2. a majority of the approving directors must be disinterested, or 3. a majority of the voting directors must be disinterested DGCL § 144's Approval Standard is Lower than the Common Law's 1. §144 allows less than a majority of the quorum to approve. 2. §144 allows interested shareholders to vote. 3. Excuses several conflicts • If the approval satisfies DCGL §144, but not the common law, entire fairness is the standard of review. DGCL § 144: Overview • DGCL § 144: Transactions are valid if there is (1) no director conflict, (2) a director conflict that is disclosed followed by common-law-disinterested director or disinterested shareholder approval, OR (3) a finding of entire fairness. ○ "fair to corp." test is the same as "entire fairness" test. DGCL § 144: Conflict Excusal The Statute Excuses 4 Kinds of Conflicts: 1. The director or officer transacts with the corporation

Business Ass'ns Page 72 1. The director or officer transacts with the corporation 2. The director or officer has a financial interest in the transaction 3. The director or officer has a financial interest in a party that transacts with the corporation 4. The director or officer is a director or officer of a party that transacts with the corporation (interlocking directorates) • (The common law also includes "Has a material financial interest in the transaction) The Statute Excuses Three Aspects/Results of Conflict: 1. The existence of the conflict 2. The conflicted director or officer’s presence at, and participation in, the meeting 3. The counting of the conflicted officer’s or director’s votes Any One of the Three Conditions is Sufficient for Excusal: 1. Disinterested and independent (good faith) director approval 2. Disinterested and independent (good faith) stockholder approval 3. The contract is fair to the corporation (entire fairness). a. Requires procedural fairness (approval procedure was fair); AND b. Substantive fairness : i. Was the price within the range an unrelated party might have been willing to pay or accept? ii. Did the transaction provide benefit to the corporation? Need for the property, detriment, gain siphoned off, etc. THE MASTER DELAWARE CONFLICT CHART INVESTOR LITIGATION PROCEDURES The Big Picture • Start: Directors and officers are liable for breaches of fiduciary duties. The corporation is entitled to sue. ○ The directors and officers are usually in control. They don’t want to sue themselves. ○ But if the corporation can’t sue, the shareholders can. • The difficulties. ○ Assignments 18 and 19, business judgment rule, exculpation, “disinterested” approval of conflicts ○ Assignment 24. Shareholders and directors struggle for control in a procedural maze. ○

Assignment 25. Indemnification, D & O insurance. The corporation, not the directors, pay the settleme • End: Directors and officers almost never pay anything for breach of fiduciary duty. Shareholder Action Types Business Ass'ns Page 73 Shareholder Action Types 1. Shareholder derivative action: Suit by shareholder against the corporation to compel the corporation to sue a third party. 2. Shareholder direct action: a. Individual action: Suit by a shareholder against the corporation for a wrong done to the shareholder b. Class action: Suit by a shareholder(s) against the corporation for a wrong done to a shareholder class. Class Actions Direct Actions Derivative Actions Derivative or Direct ? • If the plaintiff chooses incorrectly, the court dismisses the case and the plaintiff starts over. • If the action is direct, the plaintiff recovers; if the action is derivative, the entity recovers. Analysis to Determine: 1. Who suffered the alleged harm? The corporation or the individual suing stockholders? 2. Who would receive the benefit of the recovery or other remedy? a. If the shareholders would receive the benefit, the action is direct . b. If the entity would receive the benefit, the action is derivative. 3. [As to the first prong] Has the plaintiff demonstrated that he or she can prevail without showing an injury to the corporation? a. If yes, direct. b. If no, derivative. c. If both are injured, derivative.

Examples a. An action against the directors for breach of fiduciary duty. (Excessive compensation to a retiring executive.) i. Answer: Derivative. The directors paid with corporate money. b. An action seeking inspection of corporate records for litigation. i. Answer: Direct. Shareholder is injured, corporation may not be. c. An action challenging the price for which the board sold the company’s assets. i. Answer: Derivative because sale injured the corporation. d. An action challenging the price at which shares were issued. Business Ass'ns Page 74 d. An action challenging the price at which shares were issued. i. Derivative (money the corporation could have had) ii. Direct (share dilution injures shareholders, not the corporation) e. A claim that a new bylaw interferes with shareholder voting i. Direct. Shareholders may be injured even if the corporation isn’t. f. An action to recover $68,000 the bookkeeper embezzled. i. Derivative. Investors are hurt only because the entity was hurt. g. An action alleging that share prices are depressed because the majority shareholder is paying himself a high salary and benefits i. Derivative (same as a., above, but with a majority shareholder) Derivative or Direct ?: Closely-Held Corporations • For example: If B embezzles from the closely-held corp. A (shareholder) may sue derivatively, but the court may let A recover directly instead. Who Qualifies as a Plaintiff? (Derivative) Significance: If the plaintiff loses, the decision precludes derivative actions by other plaintiffs on the same matter. • Surowitz v. Hilton Hotels Corp. (U.S. 1966). A person with limited grasp of English and almost no under-standing of the complaint held adequate (helped by nephew) • In re Fuqua Industries, Inc. (Del Ch. 1999). Ill shareholder, “confused” about her lawsuit held adequate (helped by husband) ○ “Lawyers take a dominant role in prosecuting litigation.”

Who Qualifies as a Plaintiff? (Class Action) Significance: If the plaintiff loses, the decision precludes actions by other plaintiffs who do not opt out of the class. Creditor Standing to Sue (Derivative) NACEPF v. Gheewalla 930 A.2d 92, 101 (Del. 2007): Business Ass'ns Page 75 Creditor Standing: Class Actions Creditors, like any other group, have standing to file class actions. Shareholder Standing: Timing Requirements • Class action: Plaintiff must own shares at the time of the wrong. ○ The “typicality requirement” • Derivative action: Plaintiff must own shares at the time of the wrong and hold through the

litigation. ○ The “contemporaneous ownership doctrine” F.R.C.P. 23.1 • California derivative action: Plaintiff must be a shareholder before disclosure of the wrong and hold through the litigation. Forum Selection Bylaws • Court says they are valid, BUT • Only apply to actions arising out of the shareholder capacity (derivative, class, and direct) • Do not apply to tort claims (personal injury) or employment actions • Do not apply to claims under federal law (securities fraud) Business Ass'ns Page 76 • Do not apply to claims under federal law (securities fraud) Attorney Fee Awards Holders of a small number of shares can’t afford to pay attorneys. Solution is for courts to award attorneys’ fees from the recovery. • Derivative action: Plaintiff is entitled attorney's fees award if a. The action is “successful” and b. The action confers “a substantial benefit” on the corporation Amalgamated v. Wal-Mart Stores, (2d Cir. 1995) (text 455) • Class action: Plaintiff is entitled to an attorneys fee award under the “common fund” doctrine. Alyeska Pipeline v. Wilderness Soc'y, 421 U.S. 240 (1975) ○ Class actions that generate no funds, generate no fees. ○ Example: Directors’ denial of voting rights. • In Class and Derivative actions: Fee award is part of the settlement. Courts must approve the settlements, including the awards. • Contingent fee arrangements are enforceable if reasonable (court does not look at the hourly rate in finding of reasonableness). (28.9% is considered reasonable). • Fee-Shifting Bylaws (bylaws which require a shareholder who loses a suit against the entity to pay the entity's attorney's fees) are invalid: Shareholder Litigation: Suing Yourself • Shareholder litigation is technically suing the managers of a corp. • But, the managers are almost always indemnified by the corp. itself • When corp pays the judgment, the shareholder wins money, but the corp. loses money ○ Share values decrease for everyone, and shareholder loses money from a different pocket. Settlement Approval (Derivative)

Delaware settlement approval requires that the Court exercise its business judgment: Settlement Approval (Class Actions) Business Ass'ns Page 77 Derivative and Class Action settlement standards are similar: 1. Derivative: Chancellor’s business judgment, considering “law and public policy in addition to the corporation’s best interests.” Zapata. 2. Class action: “Fair, reasonable, and adequate” The Settlement Imperative • Nearly all public companies indemnify directors and officers against attorney's fees and settlements . The company pays for everything. • Companies are not permitted to indemnify against judgments . • The effect is to force all four parties to settle. • Managers: If the managers settle, the corporation pays. If the managers lose, the managers pay. Managers should always settle. • Plaintiffs’ attorneys: If the attorneys settle, the entity and insurers pay the attorneys’ fees. If the attorneys win, only the managers are liable for the attorneys’ fees. • Entity: The entity settles because (1) it is paying the defendants’ attorney's fees, and (2) managers can use corporate money to pay.

• Insurors: Insurors settle because (1) they can’t unreasonably withhold consent, (2) they can’t go to trial without manager cooperation, (3) they have already paid most of the policy limits for defense fees. CONTROL OF INVESTOR LITIGATION Three Competitions for Control 1. Shareholders can control a derivative action if the managers are too conflicted to control it. 2. Shareholders with larger investments can take class actions from shareholders with smaller investments. 3. Earlier-finished cases preclude later cases from continuing. Control of Derivative Actions • Whether to sue and how are business decisions. • Managers have the right to make the decision(s) unless they are conflicted. • Conflicted means interested or dependent. • A manager is interested if: ○ the manager gets a material benefit from the decision that other shareholders do not, or ○ the manager stands on both sides of the transaction. • A manager is not independent if the manager is “controlled by another.” (beholden) ○ A manager is beholden if the other controls a benefit of such subjective importance to the manager that the manager may not be able to consider the merits of the transaction. Business Ass'ns Page 78 • The law bars conflicted managers from controlling litigation ○ If the managers cannot control, the shareholders can control by bringing derivative actions. • The same rules that determine which conflicts impair transaction validity are the same conflicts that keep managers from controlling litigation ○ Thus, a majority of disinterested directors can make the decision instead, or ○ A "majority of disinterested committee members" can decide. • A board that can't control litigation can appoint a committee to control litigation Derivative Action Procedures Each entity law specifies one of two procedures: 1. Universal demand (MBCA): The plaintiff must demand that the entity sue, and can sue (if at all) only after the entity responds. 2. Demand futility: The plaintiff can make a demand or sue immediately if demand would be futile.

DGCL Demand Futility (Aronson v. Lewis) ○ Court found no futility when the plaintiff alleged that the board members were chosen by Fink and those directors voted to award Fink (who was retiring) a $150k/yr contract (alleged a "structural bias") Business Ass'ns Page 79 ○ MUST ALLEGE a specific reason why you think the board is beholden ▪ Fink- Myers contract paid Prudential’s debt to Fink (adequate!) ▪ Meyers directors are also Prudential's directors/officers (adequate!) MBCA Universal Demand ○ Plaintiff must serve a demand on the entity before filing a derivative action ○ The entity has 90 days to respond ○ The plaintiff can sue ONLY if the board is so conflicted the "corporation will not adequately pursue the matter."

ULLCA and ULPA Derivative Actions These statutes create demand futility systems . . . They are very similar to Delaware . . . Special Litigation Committees (Derivative) Even a board so conflicted that it cannot control a derivative action can appoint a special litigation committee (SLC) to control it. • To make the decision whether to sue, the committee must be independent and disinterested ○ Or at least one member of the committee must be ("majority of disinterested members") Delaware applies a 2 part test to determine, when a SLC dismisses a claim, whether the SLC is independent & disinterested: Business Ass'ns Page 80