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Business Associations II
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    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.
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)
§ 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
§ 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 cost Waltuch personally 2.1 MM
§ Also cost Waltuch $1.2 MM in defending the government suit.
§ Waltuch is seeking indemnification for legal expenses.
§ Question if company must indemnify for expenses: §145 of Delaware act requires acting in good faith and can by agreement expand indemnification. §145(a) – (f).
§ Court holds corporation can agree by contract to expand indemnification beyond the statute BUT CANNOT be inconsistent with statute. The agreement doesn’t require good faith but the court says you cant do that…the power to indemnify is conditioned on good faith, and thus cannot draft an agreement such as to remove the good faith requirement of the statute.
§ Waltuch argues for reimbursement….company doesn’t want to pay.
§ Court NOTES under section (g) and (g) only, you can acquire insurance whether or not you have the power to indemnify, ie without requiring good faith, but not for other sections. It is specific to section (g).
§ Company says he didn’t act in good faith…at least to one claim. So Waltuch wins one claim and not the other.
§ The agreement reads successful on the merits or otherwise under §145(c). This doesn’t require good faith…just that he be successful. Court finds he was successful otherwise which = vindication as he was NOT Adjudged guilty on the personal suit.
o    Citadel Holding Corp v. Roven:
§ Contract has an advancement provision. He wants advancements.
§ Company says indemnification not required for SEC 16(b) suits.
§ Court says this isn’t about the 16(b) indemnification, only the advancement provision.
§ Company says this is a federal action also excluded. Same thing…this is for the advancement.
§ Roven has to agree to repay in writing if adjudged guilty…but the advancement provision is not limited like the indemnification portion. 
§ The advanced expenses do have to be reasonable though…no blank check.
§ Officers are agents. Directors are NOT.
§ §8.01 Restatement of Agency 3rd : Fiduciary Duty of Loyalty to principal.
§ §8.02 Rest. Agency 3rd: Material Benefit arising out of Position: Agent not acquire material benefit from 3rd party through use of agent position.
§ §8.03 Rest. Of Agency 3rd: Acting as or on behalf of an adverse party: Duty not to deal with principal on behalf of an adverse party. Cant play both sides.
§ §8.04 Rest. Of Agency 3rd: Competition: throughout the duration of the agency relationship, duty to refrain from competing with the principal or assisting principals competitors. Agent may take action to prepare for competition after relationship.
§ §8.05 Rest. Of Agency 3rd: Use of principals Property; Us eof confidential information: Agent has a duty, NOT to use property of principal for the agents own purposes or those of third parties, and NOT to use or communicate confidential information of the principal for agents or third parties purposes.
§ §8.06: Principals consent: Principal can consent with full disclosure of competition/etc. If dealing with more then one principal must NOT favor one over the other.
§ §8.07 Rest. Of Agency 3rd:
§ §8.08 Rest Agency 3rd:
§ §8.09 Rest. Of Agency 3rd: Duty to act within scope of agency.
§ §8.10 Rest. Of Agency 3rd: Duty of Good Conduct
§ §8.11: Duty to
§ RMBCA: §8.42: Standards of Conduct for officers. Slightly different then restatement of agency 3rd. 
§ The Business Lawyer Handout
§ Short Swing Profits:
o    Part I
o    Reliance Electric v. Emerson Electric (1972):
§ In contemplation of a merger takeover bid, Emerson acquired 13.2% of Dodge.
§ Doge merged with Reliance instead.
§ Seeing no possibility of merger, Emerson sold its 13.2% shares, in two sales, the first to reduce them below 10% and then the remaining 9.8% a month later…but both within 6 months.
§ Reliance seeks repayment of profits on those sales.
§ Question
o    Foremost-McKesson, Inc. v. Provident Securities:
§ The 10% rule only applies if the purchaser owns 10% BEFORE the purchase in question…not as a result of that particular purchase.
§ Notes on 16(b): GET THESE FROM TARA à Pages 516-17
§ Proxy Wars:
o    Shareholders recorded on company books. Company directors will send out proxies for voting rights.
o    Levin v. Metro-Goldwyn-Meyer, Inc.
§ Two groups vying for control of MGM. Group in control

hey can solicited votes as the bylaws require 80% vote to replace directors.
·         2 Problems: 80% is a lot, and AT&T doesn’t have a right to the list.
·         AT&T approaches Sadlers and says you get the list and we’ll pay the costs.
·         AT&T wants both the CEDE list and the NOBO list. Cede is brokers holders of stock on their street name for their clients. Clients object to being disclosed.
·         NOBO are listed persons who don’t mind disclosure.
·         But AT&T cant get list as not holding stock for 6 months…thus Sadlers can get it.
·         NCR complains NOBO would have to be compiled.
·         NCR says AT&T is not Sadlers agent….Sadlers are AT&T’s agent.
·         Court says doesn’t matter. The shareholders are Bona Fide…once that’s satisfied, its up to the corporation to justify its refusal, by showing either improper purpose or bad faith.
·         The prayed for relief by NCR makes insubstantial basis for the distinction in the lists and orders compilation as well as disclosure to the shareholder as §1315 requires liberal construction.
·         Lastly, stockholder list disclosure to shareholders is a long recognized exception to the internal affaris doctrine and it takes a lot more then this claim to threaten that traditional state perview of regulation.
§ Independence of Directors: Handouts on Sarbanes-Oxley and Corporate Governance Guidelines.
§ RMBCA §8.25: Committees
o    Page 804 official comment à Nominating and compensation committees composed primarily of independent directors are now widely used.
§ RMBCA §8.20-8.24: Meetings, notice, quorum, and Voting.
§ RMBCA §8.30-8.31: Standards of conduct for directors.
§ Checks and Balance between board and CEO. Its not a check if the directors are cronies of the CEO and rely on him to keep their board seat.
o    Thus using an independent nominating committee not accountable to the CEO helps eliminate this conflict.
§ Roadmap:
o    Federal:
§ SH Proposals: 571, 14a-8 (2049SS)
§ Election of Directors, 14a-7 (2046 SS)
o    State:
§ 576 Minn. & C.L. (Lists etc.)
§ 583 Lists (NOBO).
§ Oh the mysterious stock split. Company decides to split the shares, if it is 2 for 1 and they had 1000 shares to begin with there is now 2000. If they were $1 per share the share they are now .50 cents.
o    If the articles only authorize you to issue 1000 you can only issue 1000, so in order to do a split you would have to amend the articles so that they can do the split.
§ Why would a company split shares rather than just issue more shares? They may not be able to find people to buy them, economically they want more shares out there, but they need buyers. They perceive that in a split if they are selling for less than they will become more marketable.
o    Under a split SEC regulations do not apply as they normally would in new shares, no underwriter fees, just a lot less cumbersome.
o    A downside of a stock split is cheapening the way they look – if you are selling at .50 cent share – what kind of company is that.
§ State of Wisconsin Investment Board v. Peerless (2000)                               pg. 591
o    G/R: If a board takes an action designed to interfere or impede exercise of the shareholder franchise, the action is not protected under the business judgment rule without compelling justification for the board’s actions.
o    Blasius Standard:
§ P must establish that the board acted for the primary purpose of thwarting the exercise of a shareholder vote
§ The board has the burden to demonstrate a compelling justification for its actions.
§ This test potentially presents the defendants with the quite onerous burden of demonstrating a compelling justification for their actions.
o    Blasius does not apply in all cases where a board of directors has interfered with a shareholder vote
o    However in this case there is an absence of a finding that the primary purpose of the boards action was to interfere or impede exercise of the shareholder franchise the Business Judgment Rule applies.
o    Business Judgment Rule: standard for imposing liability on corporate directors for failing to exercise ‘due care.’  This rule shields directors and officers from personal liability for unprofitable or harmful corporate transactions if they were made in good faith, with due care, and within the director’s or officer’s authority.
o    In this case the authorization of more options would give Galvadon more money- self interest.
o    Problem 4: Talks about those things they did do. SEC RULES etc. They settle after concessions and SWIB wanted Peerless to pay fees. Even that is a little dicey as all other stockholders now get less if paid by company. Also the idea of impropriety as it was in effort to settle.
o    Problem 5: Yes. Big investors have pull and power and resources. Also they owe a duty to their investors so they must make efforts to ensure the money is being used wisely.
§ Corporate Governance Guidelines by Gelb:
o    Talking about institutional ownership in private funds.
o    Independent directors.
o    Independent compensation committees or independent directors determine compensation.
o    Executive sessions with outside directors.
§ Void & Voidable Acts (bottom of page 596):
o    Black Letter Law in Delaware
§ Voidable Acts: performed in the interest of the company, but beyond the authority of management. If shareholders ratify the voidable act, the ratification cures the defect and relates back to moot all claims provided that the ratification was fairly accomplished.
§ Void Acts: includes those that are ultra vires, fraudulent, gifts or waste, and are legal nullities incapable of cure.
If it is unanimous approval then it may be OK. However there still may be a problem with