Business Associations II
Table of Contents
1) COMPLETION OF BA I
(1) CLOSE CORPORATIONS: AGREEMENTS RESTRICTING SHARHEOLDER ACTION———————————- 2
(2) CLOSE CORPORATIONS: AGREEMENTS RESTRICTING DIRECTOR ACTION—————————————– 8
(3) CLOSE CORPORATIONS: RESOLUTION OF INTRACORPORATE DISPUTES—————————————— 9
(4) CLOSE CORPORATIONS: TRANSFER RESTRICTIONS———————————————————————— 10
2) FIDUCIARY DUTIES OF DIRECTORS AND CONTROLLING SHAREHOLDERS
a) NATURE OF A DERIVATIVE CAUSE OF ACTION————————————————————————————- 11
b) DUTY OF CARE
i) LIABILITY DERIVING FROM INATTENTION—————————————————————————– 12
ii) LIABILITY DERIVING FROM UNPROFITABLE BUSINESS DECISIONS—————————————– 13
iii) INATTENTION REVISITED—————————————————————————————————- 16
c) DUTY OF LOYALTY
i) INTERESTED PARTY TRANSACTIONS———————————————————————————– 16
(1) CASE LAW———————————————————————————————————- 16
(2) STATUTORY TREATMENT———————————————————————————— 17
(3) CASE LAW: “FAIRNESS” ————————————————————————————– 19
(4) SHAREHOLDER RATIFICATION OF TRANSACTIONS OTHERWISE VOIDABLE————- 26
ii) CORPORATE OPPORTUNITIES——————————————————————————————— 24
iii) COMPETITION BY FIDUCIARIES——————————————————————————————- 25
iv) OBLIGATIONS OF CONTROLLING SHAREHOLDERS TO MINORITY SHAREHOLDERS [?]———— 26
d) TRANSACTIONS IN SHARES
i) INTRODUCTION——————————————————————————————————————- 36
ii) COMMON LAW——————————————————————————————————————— 38
iii) FEDERAL LAW: INTRODUCTION TO SECURITIES ACTS———————————————————– 40
iv) FEDERAL LAW: DEFINTION OF THE TERM “SECURITY”———————————————————— 42
v) FEDERAL LAW: SECTION 10(b) AND RULE 10b-5, ENOFORCEMENT AND CRIMINAL ACTIONS—— 44
vi) FEDERAL LAW: SECTION 10(b) AND RULE 10b-5, PRIVATE CAUSES OF ACTION: “TRADING”——– 53
(1) ELEMENTS OF THE CAUSE OF ACTION; INTRODUCTION—————————————— 54
(2) ELEMENTS OF THE CAUSE OF ACTION: THE CULPABILITY REQUIRMENT—————— 54
(3) ELEMENTS OF THE CAUSE OF ACITON: PLAINTIFFS DUTY OF CARE/DILLIGENCE—— 56
(4) ELEMENTS OF THE CAUSE OF ACTION: RELIANCE/TRANSACTION CAUSATION——— 57
(5) ELEMENTS OF THE CAUSE OF ACTION: BASIC INC. V. LEVINSON (1988)——————– 61
(6) ELEMENTS OF THE CAUSE OF ACTION: LOSS CAUSATION————————————– 62
(7) ELEMENTS OF THE CAUSE OF ACTION: STATUTE OF LIMITATIONS————————– 63
(8) SECONDARY LIABILITY: AIDING AND ABETTING—————————————————— 64
(9) INSIDER TRADING SANCTIONS ACT OF 1988 (ITSA)——————————————— 64
vii) FEDERAL LAW: SECTION 10(b) AND RULE 10b-5, PRIVATE CAUSE OF ACTION: “NON-TRADING”– 67
viii) FEDERAL LAW: ANTI-FRAUD PROVISIONS OF THE SECURITIES ACT OF 1933—————————- 73
ix) SALE OF “CONTROL SHARES”———————————————————————————————– 74
1) CLOSE CORPORATIONS: AGREEMENTS RESTRICTING SHAREHOLDER ACTION
a) Types of Agreements
i) Complicated and composed of:
(1) Voting agreements
(a) Ringling (see handout)
(i) seven directors and were elected by cumulative voting
1. any two branches could come together and be able to elect five directors (a majority)
(ii) contract was entered into 1941 and took effect in 1942.
1. Under contract, each party agreed to act together
2. If they could not agree, their lawyer would arbitrate a solution
(iii) In 1946, the voting agreement became a subject of its validity.
1. Under agreement, Loos, a personal lawyer, was appointed to arbitrate the allocation of the shares.
2. See handout distribution
3. If actual voting had been recognized, the North’s and the Haley’s would have had a five vote margin
(iv) Action brought by Ringling’s to get a court ruling on how the shares should be counted.
1. Ringling: Loos determination
2. Haley: Any way I want to.
3. why was a 4-3 not enough?
a. Maybe the corporation had a supermajority requirement of five votes
b. Maybe Haley felt that if you have a 5-2 margin instead of a 4-3 margin, it would be a lot easier to control the meeting. An absent member could force a tie with a 4-3, but not a 5-2.
c. Haley wanted resolved in 1946
(v) What did Edith Ringling want the court to do?
1. That the court enter an order that eh Haley votes be counted the way Loos said.
(vi) Haley wanted the vote to be counted as if there was no agreement.
1. His argument is that shareholders only have two lawful ways to irrevocably sever voting rights from the ownership of the stock.
a. One lawful way is to follow the statutory procedure of creating a voting trust. Delaware §218(a)
b. The other way is to form a proxy covered with an interest.
(vii) Delaware §218(a)
1. They should have entered into a arrangement where they gave their shares to Loos as a voting trust. Loos would then give the shares to the corporation who would cancel the shares in their name and issue a new certificate in Loos name. Then a copy of the voting trust agreement would have to be on file in the office and there would be nothing secret about arrangement.
a. They did not do this nor did they have paragraph that said the abiding party could vote the non-abiding parties shares.
(viii)Delaware Supreme Court
1. Voting or pooling agreements are okay by law
2. Not the same as voting trusts and this contract was not.
a. if Ringling-Haley would have had a voting trust it would have been invalid because it would have been required to be the §218 way.
b. this is different.
3. The court points out the that Contracts I was fulfilled with consideration by the two parties.
4. Both courts determined that this is a VALID AGREEMENT
5. What kind of RELIEF is the court going to grant to the Ringlings’?
a. trial ct:
i. a new meeting should be held that the Haley shares should be voted by Ms. Ringling
ii. implied: Ms. Ringling has the right to vote the non-abiding parties votes.
b. Sup ct
ii. No power for Ringling to vote shares
iii. No words in agreement that said non-abiding could vote abiding shares
iv. Loose court did a “Prater like job” = terrible
v. Should have thought about what happens if arbitration is not abided for.
6. Valid Contract but NO RELIEF
a. the Haleys’ shares are simply not counted
i. Who gets elected directors?
ii. Court created corporate deadlock
(ix) Who actually won this case a practical matter?
(x) Loose (arbitrator under valid contract)
1. could give the same direction he gave in the 1946; OR
2. direct that all the Ringling and Haley shares be voted for five Ringlings
a. What are the Haley’s choices?
i. NOT vote
ii. Vote the way they please
iii. If they do this, we now know there votes would not be counted
b. What happens if the Haley’s votes are not counted?
i. 685 shares are going to be voted.
ii. Only two can vote
iii. 1947 meeting, the North’s control
(xi) When can this occur (the winning party loses)
1. In a three party context, the non-abiding party has more shares then the abiding party.
2. In any context, it is WHEN THE NON-PARTIES HAVE MORE SHARES THAN THE ABIDING PARTIES
a. the abiding parties can get outvoted by the abiding parties
(xii) Note on Voting Agreements and Irrevocable Proxies (page 361)
1. Ringling the majority rule in the validity of shareholder agreements
2. What kind of relief is going to be granted?
a. some court have granted specific performance (books overstates that this a trend, probably not enough cases to declare trend)
b. crazy results as in Ringling
i. watch out for saying too much to your client if you have this enforcement question up in the air.
(2) Voting trusts
(a) Statutory Voting Trust (§218(a))
(i) Hypo: Corporation has 5 shareholders. None over 50%. A and B decide they will act together in the future. One way to do this would be to create a voting agreement. Another way would be to create a statutory voting trust. To do this:
1. sign a written agreement
2. each A and B would transfer certificates to the person designated to be the voting trustee
a. holds them and gives a receipt
3. voting trustee would transfer certificate to corporation and corporation would cancel and issue a new certificate to voting trustee
4. file a copy of that agreement in the registered office of that corporation.
a. The main point is that there is nothing secret about this kind of voting agreement.
(ii) Hypo: In 1952, Ringling agreement expired, Ringling and Haley are pals and mad at North. This time they want a voting agreement that is not only valid but also enforceable. They want an agreement that the binding person will be able to vote the shares when the non-abiding party will not. Loos read Ringling [maybe he was not such an idiot!] and he now knows that he needs to add an express proxy saying that Loos can vote the shares. We have a voting agreement, as in Ringling, including a proxy. This solves the problem of Ringling.
1. What might be the problem with
stock itself or an interest in the corporation generally.
b. nothing in there that changes hypo #1 above
c. supports hypo #2
d. if you have a third party that will be holding the proxy, because that person would be the agent of the abiding person, he would have the abiding person’s interest in the corporation.
(a) Where a court is reluctant to grant specific enforcement of vote-pooling agreements, shareholders can agree to give each other or a neutral third-party an irrevocable proxy to vote their shares.
3) Ringling case: voting agreements are generally valid. Although they are valid, if they do not contain, specific proxy language, there are enormous potential problems. If the shares not in the voting agreement exceed the numbers of shares by the abiding party, the abiding party can simply be outvoted.
4) Proxies: whether or not a proxy can be created that is in fact irrevocable. By hypothetical, we covered agency case law. They can be made irrevocable only if you can prove that the proxy was coupled with an interest OR given as a security. The hard question arises when an irrevocable proxy is sought to be created in a voting agreement. The parties in the agreement will have an interest GENERALLY, is this enough interest? Case law is split.
5) 212(e): clearly and unambiguously answers that in Delaware an interest in the corporation generally is enough.
6) Voting agreement that contains an irrevocable proxy. Is that package so much like a voting trust that it is a voting trust? We know under the case law, that it is treated like a voting trust and treated like that in that purpose. 218 (c) and (d) falls a little short.
7) The Oceanic case does not remove this threat of the ambiguity under the case law.
8) Given the danger that a voting agreement with an irrevocable proxy runs, why not just have a statutory voting agreement following §218 to be sure? What is the advantage? If the original arrangement is upheld it is secret and after it is upheld, it will not be secret anymore. That is why following the statutory voting trust §218 is smart since the only advantage, secret, will be exposed anyway in a court ruling declaring the irrevocable proxy valid.
9) CLOSE CORPORTATIONS: AGREEMENTS RESTRICTING DIRECTOR ACTION
10) Allocation of Power
a) Shareholders have few powers.
(1) in normal circumstances, it is the directors that do the every day affairs of the corporation.
b) In limited corporations, lots of humans are both shareholders AND directors, this is when the problems start to arise.
i) An agreement of voting on future matters is often the solution, this creates a conflict with §141(a).
c) An agreement among shareholders of a corporation to restrict their discretion as directors of the corporation is invalid and unenforceable as against public policy.
i) McQuade v. Stoneham (1934)  (1) After being voted off the board of directors and removed as an officer of a closely held corporation, a minority shareholder sued to enforce an agreement requiring the controlling shareholders to use their best efforts to keep him in office.
(2) D’s found cases that hold that directors cannot do this.
(a) Court followed and concluded an illegal and void contract.
(i) Who is being protected by this rule?
1. the minority shareholders who are entitled to have a board of directors exercising judgments in the best interest of the corporation as matters arise.
ii) Note: Clark v. Dodge [375cb] (1) contract between three shareholders who owned all the shares, action by minority shareholder.
(2) this contract was upheld.
(a) Why did it not follow McQuade?
(i) The McQuade applies when the contract STERILIZES the board (i.e. enormously interferes with the board of director power)
d) A shareholder agreement limiting the discretion of the board of directors of a close corporation will be upheld where no minority shareholder is prejudices, neither the corporate creditors nor the public are injured, and no clearly prohibitory statutory language is violated by its enforcement.
i) Galler v. Galler (1964)