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Advanced Corporate Law
University of Wyoming School of Law
Gelb, Harvey

§ Advanced Business Org
 
§ January 14, 2008
 
§ Lynch v. Patterson (little treatise on fiduciary duty by Robert Rose, Sr.)
o    Law is relatively unchanged since 1985
o    CASE IS BIG EXCEPTION
o    This exception only applies to closed corporations
o    Derivative suit: shareholder champions the corporation to rectify the situation
o    Lynch is the minority stockholder
o    Statutes are subject to equitable inquiries
o    Under LLC/Partnership law equitable principles will always arise
o    Money that was recovered went directly back to Patterson
o    Court made the exception here (this makes it a big case all across the country). The black letter law is that usually the money goes directly to the company.
§ DUTY OF LOYALTY TO THE CORPORATION:
o    Standard G/R: A challenged interested director to prove that he acted in good faith and that the contested transaction were fair to the corporation.
o    Burden of proof by interested director: clear and convincing evidence that the transaction was open, fair and honest
o    TEST: Whether or not under all the circumstances the transaction carries the earmarks of an arm’s length bargain. If it does not, equity will set it aside. Pepper v Litton
o    Gelb does not think that Justice Rose made his case on why he let Lynch get away with his behavior.
o    It was OK for him to compete but not take the job (on conflict of interest)
 
§ RATIFICATION:
§ Fiegler v. Lawrence (1976) pg. 405
o    Because of shareholder ratification it shifts the burden of proof to the objecting shareholder to demonstrate that the terms are so unequal as to amount to a gift or waste of corporate assets.
o    Only 1/3 of the disinterested shareholders voted. It was the vote of the people who wanted it that put it over. The result is that it is not a fair vote.  Does not sanitize.
o    Thus they can’t win under case law so they go to statute.
o    Only applies to contracts or transactions (looking at deal between company and directors/officers
o    Del Stat. § 144(a)(1) page 406 – Sanitizing votes: Director or officer must tell the board of directors two things:
§ the material facts (not all facts) as to relationship or interest and
§ the material facts as to the k or transaction 
o    § 144(a)(2) must tell the shareholders
o    K is fair if approved/ratified by the board of directors, committee, or shareholders
o    D’s argue that there is nothing in statute requiring disinterested or independent ratifying by shareholders. Only disinterested directors in directors vote.
o    Holding: Court does not take this broad interpretation they say the statute merely removes an interested director cloud when its terms are met.
§ Question 4 – First try a disinterested director vote then try a shareholder
 
§ DOMINANT SHAREHOLDERS:
§ Sinclair Oil v. Levien (1971)          pg. 395
o    G/R: When there is a conflict of interest by self dealing the test is intrinsic fairness test.
o    Facts: Derivative action based on Sinclair causing Sinven to pay out excessive dividends in excess of  earnings = $38 million.
o    Issue: Are dividend payments in essence self dealing?
o    Holding: No, a proportionate share of the money was received by the minority shareholders. The appropriate test that should have been applied was BJR.
o    Issue 2: Company did not have to bind self to a K but when did…Was breach of k evidence of self dealing?
o    Holding: Yes, Sinclair received the benefits of the k, so it must comply with contractual duties.
o    Sinclair owed Sinven a fiduciary duty based on the following factors:
§ Sinclair nominates all Sinven’s board of directors
§ Directors are not independent
§ Result is that Sinclair dominated Sinven
o    Since a fiduciary duty was owed lower court said the intrinsic fairness test applies:
o    Intrinsic Fairness: P must prove, subject to careful judicial scrutiny, that its transactions with D were objectively fair.
o    This test involves a high degree of fairness and shifts the burden of proof to Defendant Corporation.
§ See page 48 of Jost
§ Page 29 of mine
o    When to Apply: When situation involves a parent and a subsidiary, with the parent controlling the transaction and fixing the terms AND is accompanied by self dealing.
o    Self Dealing: Where the parent has received a benefit to the exclusion and at the expense of the subsidiary and thus the minority stockholders.
o    However, lower court was overturned b/c there was no evidence of self dealing in regards to the dividend payments. However there was evidence of self dealing in re to k claim.
o    Since there was evidence of self dealing in re to k claim that Sinclair would have to show under IFT that its choosing not to enforce the k was Intrinsically Fair/Objectively Fair to the minority shareholders of Sinven. (They did not)
 
 
§ Zahn v. Transamerica (1947) pg. 399
o    Issue: Fraud and deceit- book value of tobacco they said was 6 million but the market value was actually 20 million.
o    The board, dominated by Transamerica, did not disclose value or intentions properly to the shareholders.
o    Transamerica board in reality controls Zahn board. They know the value of the tobacco. They also know they can call the class A stocks and buy them at $60 a share. 
o    They call in most of the class A shares. 
o    The value of the tobacco and the liquidation intentions of the board are unknown to those Class A shareholders.
o    Had those Class A shareholders known the value, and the plan, they may have converted to Class B(their right) to share in the liquidated company value including the tobacco appreciation value.
o    The board was aware that Class A get paid 2 to 1 as compared to Class B which is the shares Transamerica owned most of.
o    Court found that Transamerica had a fiduciary duty as board members. When voting as a shareholder you can hold yourself out for your own good. BUT…when you vote as a board you have to honor your fiduciary duty.
o    Disclosure should matter. They didn’t disclose the plan to liquidate OR the value of the tobacco.
o    Thus that is a breach of their fiduciary duty and fraud and deceit.
 
§ Benihana TOK, Inc. v. Benihana, Inc. Supplement.
o    BOT is parent company. BOT Owner owns 50.9% of Benihana Inc. in Delaware. 
o    Owner marries and changes will. Wants to leave wife in control of Benihana Inc. Kids freak out. 
o    There are two things happening here: Power struggle and Renovation plans.
o    One is the possible plan to issue additional shares such as to trigger a provision to allow voting change. (Power struggle)
o    Two is the company needs financing for renovations of chain facilities. (Renovation)
o    The question is…the issuing of shares in the financing scheme, and the voting rights associated, will dilute the “owners” voting rights, similar to the first plan. Thus renovation plan will have same affect as power struggle plan.
o    Joseph is independent finance advisor. Abdo is VP on board for Benihana AND a director for BFC(Finance company).
o    These two work out terms.  Conflict of interest claim by BOT owner.
o    Owner asked for board to abandon transaction and seek alternate financing. 
o    This transaction would reduce his voting rights from 50.9% to 42.5% and eventually 36%.
o    In short, this will ALSO remove his authority to appoint his new wife as control of the company.
o    §144(a)(1) Delaware: Freshening the atmosphere by disclosed or known material facts and vote by uninterested director vote. Safe harbor.
o    Owner claims not disclosed to board that Abdo negotiated for BFC. He played both sides of the transaction.
o    And Abdo had the inside numbers from Benihana during the negotiation.
o    Court said: Abdo made the presentation to the board. Thus they knew. 
o    Also they got the terms that were important to Benihana and no record he used inside info against them.
o    Entrenchment: The SOLE purpose here was not entrenchment. (Power struggle) It was for financing as well if not primarily.
§ Assign for Friday: Rest. Of Agency 3d 8.01-8.12, RMBCA 8.42, CB 511-517
§ Application of RMBCA 8.60-8.63 to conflict of interests:
o    A, B, C, D, E Directors
o     “A” wants to sell land to Company for $1MM. How can he insulate the transaction fro attack by shareholders.
§ Consider 8.61: Cant challenge unless it’s a conflicting interest action à 8.60 definitions of conflicting interest.
·         Definition says if director is a party it IS conflicting interest.
·         But best friend is not…seems a little nuts….but watch out for material relationship under 1.43
§ Thus here there is a conflict so need to look at the two sanitizing sections or the fairness sections under 8.61(b):
·         (1) Qualified, meaning disinterested, directors, sanitize by majority vote after disclosure and deliberated outside presence of conflicted director…then ok under rules of 8.62
o    Note: Definition of required disclosure in 8.60 and qualified director under 1.43
·         (2) Shareholders do this same thing under 8.63
·         (3) Fairness standard under definition in 8.60(6)
o    Stone v. Ritter Case: 2006 Supplement
§ Bank employees were not properly submitting SAR and such to federal agency.
§ Fed’s fined them millions of dollars.
§ The question is whether the directors acted in good faith in discharging their duties.
§ Here if you are not doing your job, you are violating you duty of loyalty to act in good faith.
§ KPMG did find the directors acted in good faith in implementing and overseeing their duties.
§ Caremark case: ………………..
§ The directors were found not liable as they did in fact have oversight program, education, and policies in place.
 
§ Indemnification and Insurance: Summary on Page 520:
o    Protecting directors against suits/liability against them as a result of serving as a director for the company.
o    Waltuch v. Conticommodity Services, Inc.
§ Silver expert trader Waltuch worked for Conti trading silver.
§ Company and Waltuch were sued by private suits and Federal govt.
§ All private suits eventually settled and Conti paid settlement. This

curities Exchange Act provision authorizes federal cause of action for rescission or damages to corporate stockholder with respect to consummated merger which was authorized pursuant to use of proxy statement alleged to contain false and misleading statements in violation of the Act. Securities Exchange Act of 1934, §§ 14(a)
§ The purpose of Securities Exchange Act provision making it unlawful to solicit proxy or consent authorization in violation of commission rule is to prevent management or others from obtaining authorization for corporate action by means of deceptive or inadequate disclosure of proxy solicitation, stemming from congressional belief that fair corporate suffrage is important right that should attach to every equity security bought on a public exchange. Securities Exchange Act of 1934, § 14(a)
§ It is for federal courts to adjust their remedies so as to grant necessary relief where federally secured rights are invaded, and when federal statute provides for general right to sue for such invasion, federal courts may use any available remedy to make good wrong done.
§ Today’s court would never have made this decision.
o    If an investor does not feel they are meaningful protected they will stop investing, so it is critical to have the utmost integrity in the market.
§ Corp. Governance: 
o    State Law:
§ Director Powers under 8.01
§ Shareholders §§7.28 (election directors), 10.03 (amendments to articles), 10.20 (bylaw amendments), 11.04 (mergers), 14.02 (dissolution).
o    Federal Law:
§ Shareholders ability to make proposals:
§ Case: Lovenheim v. Iroquois Brands, Ltd.                           Page 559
·         Basically he wants a study done on force feeding in France of geese by a committee.
·         Wants this request and the underlying information included in the proxy disclosure.
·         He plans to introduce this shareholder proposal at the annual meeting under SEC Rule 14a-8.
·         Iroquois refuses to do it also citing 14a-8([i})(5) saying it must be related to more then 5% of operations or earnings…and not otherwise significantly related to the issuers business.
·         Iroquois points to this section and shows that this issue only represents 1% and they lost money on it last year.
·         Guy then claims its “otherwise related” as its an ethical issue that could affect sales.
·         HOLDING: Court says it’s a close call…looks to history…finds many instances of this type of info being included…and decides this guy should be allowed to include this information
·         NOTE: Federal law allows the shareholder the right to propose to the board…but cannot command the board to do something…its only advisory. The distinction is the separation of power to the board of directors under state law. Essentially, even though this guy wins, his proposal is still only advisory.
§ Case: NYCERS v. Dole Food Company:                                              Page 563
·         NYCERS owns stock in Dole. They are asking for the same thing as in the last case. For directors to form a committee to evaluate the healthcare reform proposals being made by the company.
·         Essentially its making the company less profitable because the cost of healthcare is too much.
·         General counsel for Dole wants a shelter, a no action letter, to exclude the proposal.
·         Claims it IS related to “ordinary business operations”, “insignificant relation”, and “beyond power to effectuate”.
·         Corp has burden of showing the exception applies.
·         HOLDS: This is a broad social issue and one that’s continuing in society, this is not within the ordinary business. Exception fails.
·         HOLDS: This proposal DOES relate to more then 5% thus its not insignificant. Exception fails.
·         HOLDS: Not beyond power to effectuate. They are only asking for a study and a report which is within their power. They aren’t asking the directors to lobby or effectuate a change of law…only study. Exception Fails.
·         Include the request in the proxy solicitation.