Corporations Cases

A. Gay Jenson Farms Co. v. Cargill, Inc., Supreme Court of Minnesota, 309 N.W.2d 285 (1981)

Warren Grain & Seed Co. wanted to expand its business, so it sought financing from Cargill, Inc. Cargill wanted to obtain a source of market grain for its business, so it gave Warren an open line of credit with a maximum first at $175,000, then at $300,000, and so on up to $1,250,000. It became evident that Warren had financial problems, so Cargill conditioned credit on its permission for certain activities; sent a manager to help make business decisions at Warren; required periodic checks on the Warren business; and stated that Warren needed paternal guidance. When Warren ceased operations and defaulted on grain sale contracts, 86 farmers sued Warren and Cargill, claiming an agent/principal relationship. Held Cargill is liable for the grain contracts because Warren was an agent for Cargill as to purchase, storage, and sale of seed grain. Restatement (Second) of Agency § 14 O (1958) states that a security holder who "takes over [de facto] management of the debtor's business either in person or through an agent, and directs what contracts may or may not be made …, becomes a principal, liable as a principal for the obligations incurred thereafter in the normal course of business by the debtor who has now become his general agent." The financing situation here was not an ordinary instance of bank financing, but a special business enterprise in which Cargill primarily wanted grain rather than income from financing. Cargill was an active participant in Warren's operations and essentially became "owner of the operation without the accompanying legal indicia."

Fennel v. TLB Kent Co., United States Court of Appeals, Second Circuit, 865 F.2d 498 (1989)

Fennell's attorney, negotiating with the defense counsel in a discrimination case alleging wrongful discharge because of race and age, agreed on a settlement of $10,000 and notified the court. Fennell expressed dissatisfaction with the amount, dismissed his attorneys, and asked that the court place the case back on the court's calendar. Were Fennell's attorneys acting with apparent authority as Fennell's agent? Held No. Restatement (Second) of Agency § 8 (1958) says that agency is "the power to affect the legal relations of another person by transactions with third persons, professedly as agent for the other, arising from and in accordance with the other's manifestations to such third persons." Regardless of whether Fennell indicated to his attorneys that there was a limit to their negotiating authority, there was no apparent agency without Fennell manifesting to defendant counsel that Fennell's attorneys were authorized to settle the case, and this Fennell didn't do.

United States v. International Brotherhood of Teamsters, United States Court of Appeals, Second Circuit, 986 F.2d 15 (1993)

The government filed suit against Local 493, International Brotherhood of Teamsters (the "IBT") under the Racketeer Influenced and Corrupt Organizations statute ("RICO"). IBT agreed on a settlement and started to execute it, including a reduction of severance pay, but then their attorney indicated in court in May 1991 that his clients would be willing to resign their posts rather than fulfill the remaining obligations of the settlement. After the government accepted the new terms, many of the defendants refused to enforce it, claiming the attorney had no authority to seek new settlement terms. Did the attorney have actual authority? Held Yes. Actual authority of an agent-principal "may be inferred from words or conduct which the principal has reason to know indicates to the agent that he is to do the act." Here the attorney stated in open court that he had authority and asked for the new settlement terms, after which several officers did resign. This all indicates the attorney operated under the clients' guidance. Even if there were no actual authority, was there apparent authority? Held Yes. After the attorney's offer to settle, negotiations continued for sixteen months before the clients attempted to deny the attorney's authority, so they cannot say that the settlement caught them by surprise.

Koval and Koval v. Simon Telelect, Inc., Supreme Court of Indiana, 693 N.E.2d 1299 (1998)

Does the agency of an attorney come with the inherent authority to settle a claim in the context of an ADR proceeding? Held Yes. Although the attorney-client relationship is that of general agency, and in itself does not imply the that the attorney has the power to settle or compromise the client's claim, like a special agency it does come with some implied powers: namely, to bind the client to procedural actions performed in court. For the purposes of determining rights of agency, an ADR proceeding is considered a court proceeding, and an attorney implicitly has the power through the ADR proceedings to bind the client to the outcome.

Connecticut Junior Republic v. Doherty, Appeals Court of Massachusetts, 478 N.E.2d 735 (1985)

Richards Haskell Emerson created a will naming seven charities as beneficiaries. Nine years later, he employed Paul S. Doherty to create a codicil changing the seven beneficiaries to 11 beneficiaries, only one of them remaining the same. After Emerson's banker, Sager McDonald, notified him of changes in the Internal Revenue Code, Doherty created a second codicil to meet the code changes, but inadvertently reverted the beneficiaries to the original seven. McDonald and three others went to Emerson's house and read the new codicil to him, while Emerson followed along. Emerson signed and notarized with witnesses the second codicil. Is the attorney liable for the mistake of substituting names in the codicil? Held No, Emerson ratified the changes. One is assumed to know the contents of a legal document one is signing, and even though the changes were the result of a mistake, the names of beneficiaries is an important section of which the one signing would be aware.

African Bio-Botanica, Inc. v. Sally Leiner, t/a Ecco Bella, Superior Court of New Jersey, Appellate Division, 624 A.2d 1003 (1993)

Sally Leiner was sole stockholder, director, and president of Ecco Bella Incorporated, a New Jersey corporation. Sally ordered merchandise from African Bio-Botanica, Inc., shipping the items to "Ecco Bella" at her address. The $1530 price of the last shipment was not paid. Is Sally liable for the purchases of the corporation? Held Yes, because agents are liable in transactions involving an undisclosed or partially disclosed principal. Sally was acting as an agent of Ecco Bella, and had a duty to put African Bio-Botanica on notice that the principal was a corporation. As Sally did not give notice that the principal was a corporation, the principal-agent relationship was therefore that of a partially disclosed or undisclosed principal.

Tarnowski v. Resop, Supreme Court of Minnesota, 51 N.W.2d 801 (1952)

Plaintiff desired to invest by purchasing a string of coin-operated music machines, and engaged defendant to investigate. The defendant got a secret $2000 commission from the seller to report back that there were over 75 locations, each with machines less than six months old, and that the overall gross income was over $3,000 per month. In reality, the agent had only investigated five of the locations, some machines were up to seven years old, and the gross income was substantially less than $3,000. Upon discovering this, the plaintiff successfully sued the seller to rescind the contract and for a refund of the $11,000 downpayment out of the price of $30,620. Does recovering from the seller bar the plaintiff from suing defendant agent for the secret commission? Held No. It is established that any profit made by an agent belongs to the seller. Does recovering from the seller bar the plaintiff from suing defendant agent for business losses and attorney fees? Held No. The contract-related suit regarding the seller does not preclude recovering tort-related losses from the agent; the attorney fees and expenses were directly traceable to the harm caused by the defendant's wrongful act. Moreover, many of the damages sought from the agent were not available in the suit against the seller.

Martin v. Peyton, Court of Appeals of New York, 158 N.E. 77 (1927)

John Hall and others were partners in Knauth, Nachod & Kuhne and, through business practices including speculative investments, had approached bankruptcy. John knew Mr. and Mrs. Perkins, Mr. and Mrs. Peyton, and Mr. and Mrs. Freeman, and he convinced them to loan the company $2,500,000 worth of liquid securities. They signed three documents: "the agreement," "the indenture," and "the option." The agreement stipulated that Mr. Peyton and Mr. Freeman would represent the lenders as "trustees;" that the firm would be ran by John Hall and that he would have a life insurance policy of $1,000,000; that the trustees could inspect the books and veto any highly speculative business practice; that the members of K.N. & K. would assign to the trusties their interest in the firm. The indenture was essentially a mortgage. The option allowed any of the trustees to enter the firm by buying 50% or less of the interest at a stated price; and each member of the firm is to place his resignation in the hands of John Hall to be accepted if the trustees so desire. Do these agreements form a partnership? Held No, these agreement requirements (the last of which is a bit unusual) by themselves represent only a normal desire to protect the interest of the parties giving the loan. Even taking together these agreements do not cover so wide a field as to create a partnership.

Holmes v. Lerner, Court of Appeals of California, 88 Cal Rptr. 2d 130 (1999)

Sandra Lerner, one of the founders of Cisco, met and became friends with Patricia Holmes when Lerner sought Holmes to train Lerner's horses. While in England, Holmes thought of mixing nail polish to make new colors; later back home, Holmes and Lerner decided to form Urban Decay, marketing alternative nail polish colors. Lerner claimed that the company would be "our baby, and we're going to work on it together." Lerner secured capital, and Holmes attended board meetings and worked in the warehouse. Holmes was called a "director," but when she attempted to pin down exactly how much of the company she owned she was repeatedly rebuffed by Lerner. Finally she sued. Was a partnership formed even if it was not agreed that profits would be divided? Held Yes. An agreement to share profits is only evidence of a partnership, and is not dispositive—it is not one of the elements required to find a partnership. Urban Decay had no profits yet, so there were none to distribute. Here there was sufficient evidence that the plaintiff and defendent intended to form a partnership, even if there was no agreement to divide profits. [Some courts have held that an agreement for profit sharing is a prequisite to the formation of a corporation. See Schlumberger Technology Corporation v. Swanson, 959 S.W.2d 171 (Tex. 1997).

Meinhard v. Salmon, Court of Appeals of New York, 164 N.E. 545 (1928)

Defendant Walter Salmon and plaintiff Meinhard created a joint venture in leasing from Gerry the Hotel Bristol for 20 years. Meinhard came up with half the money and Salmon managed the property, giving Meinhard 40% net profits for the first five years and splitting net profits 50/50 after that; over the years, this deal made Salmon and Meinhard rich. At the end of the lease, after Gerry received the reversion, Gerry searched for someone to tear the buildings down at the site and create a new complex. He could find no one, so he approached Salmon and Salmon accepted without telling Meinhard. Did Salmon have an obligation to tell Meinhard? Held Cardozo: Yes. Coadventurers have a higher level of responsibility to each other than do competitors, especially if one is responsible for managing the property, as Salmon is here. As the opportunity was on the same site, Salmon had an opportunity to alert his partner to the option. What sort of equitable interest should be alloted to Meinhard? Held A trust should be created for Salmon's option, with 50% given to Meinhard to reflect his interest in the current partnership, with one extra share allotted to Salmon to reflect his management capacity in the current arrangement. Dissent Andrews: This relationship looks less like a partnership and more like a joint venture for a single project, ending at a certain time. The new project accepted by Salmon was totally separate, stemming from Gerry's reversion, not a renewal of the original lease. No one contends there was any fraud. Salmon has no responsibility to tell another in a joint venture of a new, separate venture set to begin after the first is completed.

Kansallis Finance Ltd v. Fern, Supreme Judicial Court of Massachusetts, 659 N.E.2d 731 (1995)

Jones, as a partner in Fern, Anderson, Donahue, Jones & Sabatt, P.A., created a fraudulent opinion letter of the partnership's letterhead, causing plaintiff Kansallis to lose money. Kansallis but was unable to obtain the $880,000 in damages from Jones and other conspirators, so it sued the law partnership. The jury found for the defendant firm, finding (1) that Jones did not have apparent authority to issue the opinion latter, and (2) that this issuing of the opinion letter was outside the scope of the partnership. In determining the latter, the jury instructions required that the jury find that Jones' action was "motivated at least in part by a purpose to serve the partnership." Was this instruction correct? Held Yes. According to the Uniform Partnership Act, there are two different ways in which a partnership can be found liable for the acts of a principal: (1) if the principal is acting with apparent authority of the partnership (requiring no motivation to serve the partnership, allowing actual fraud), or if (2) if the principal is acting within the scope of the partnership. Because liability from acting within the scope of a partnership can increase liability beyond apparent authority, the UPA uses the Restatement (Second) of Agency (1957) definition to restrict the scope of partnership to only those cases in which the agent is motivated, at least in part, by a purpose to serve the master. Here the jury found that there was no apparent authority (which would have allowed liability through fraud). Alternatively, the jury found that the act was not within the scope of employment, which require finding a motivation to serve the partnership (i.e. fraud doesn't count under this theory of liability).

Rapoport v. 55 Perry Co., Supreme Court of New York, Appellate Division, 50 A.D.2d 54 (1975)

The Rapoport and Parnes family created a partnership called 55 Perry Co. Paragraph 12 of the partnership agreement said that no partner could assign or transfer realty or transfer shares in the firm or form an agreement for anyone else to have an interest in the firm without the agreement in writing of a majority of the partners, except for the case of adult family members. Two of the Rapoports assigned a 10% interest of their share to their adult children and filed an amended partnership certificate indicating that the children were partners. May the Rapoports add children as partners without the consent of a majority of shareholders? Held No. The partnership agreement follows the UPA (1914) in distinguishing between assigning an interest and adding a partner. The default under the UPA is to allow any assigning of interest but to allow adding partners only with the agreement of all other parties. Here the agreement restricts assigning interests to anyone but adult family members unless there is majority agreement among partners; adding a partner still requires agreement of all other partners. Dissent The partnership agreement is ambiguous; the factual issue should be tried.

Girard Bank v. Haley, Supreme Court of Pennsylvania, 332 A.2d 443 (1975)

Anna Reid and three others entered an agreement to manage real estate. As Anna Reid neared death, she sent a letter to the other partners saying that, as she needed "clarify the status of my various assets at this particular time, …" "I hereby notify you that I am terminating the partnership." Meetings between the partners failed to reach an agreement on the specifics of liquidation, so a suit was brought to wind up the affairs of the partnership. Anna died during the suit. Did Anna's letter dissolve the partnership, or did the partnership only dissolve upon her death? Held The letter dissolved the partnership. A partnership under UPA (1914) may be dissolved any time "by the express will of any partner." The partnership agreement provisions concerning the death of a partner therefore do not apply. As the partnership agreement does not address dissolution by a partner, the UPA will determine the manner of winding up. Did Anna's dissolution of the partnership violate the partnership agreement? Held No. The agreement contains no specific term and, as a general real estate business, it does not classified as a "particular undertaking" that would prohibit dissolution under the UPA.

Dreifuerst v. Dreifuerst, Court of Appeals of Wisconsin, 280 N.W.2d 335 (1979)

Several brothers formed a partnership to operated two mills, one in St. Cloud, Wisconsin and the other in Elkhart Lake, Wisconsin. There were no articles of partnership. Plaintiff brothers wanted to dissolve the partnership, so the defendant brother asked that the assets be sold at a state sale and the proceeds be distributed appropriately. Instead, the court ruled that the assets should be distributed in kind, with the plaintiff brothers getting the Elkhard Lake mill and the defendant brother getting the St. Cloud mill. May a court, absent a partnership agreement for such, order distribution in kind rather than allow a partner to force a sale? Held No. If there were no articles of partnership calling for in-kind distribution, the UPA applies, which allows any partner to request liquidation. This not only helps assure creditors are satisfied, it may also provide greater proceeds if the assets are worth more together than they are worth separately. Although Rinke v. Rinke, 330 Mich. 615, 48 N.W.2d 201 (1951) allowed distribution in kind without an agreement for such, this was only under the circumstances that "(1) there were no creditors to be paid from the proceeds, (2) ordering a sale would be senseless since no one other than the partners would be interested in the assets of the business, and (3) an in-kind distribution was fair to all partners." Here there is no evidence that there are no creditors. Furthermore, this court decides that even if there were none, an in-kind distribution cannot be applied in the absence of such in a partnership agreement unless all partners agree.

Drashner v. Sorenson, Supreme Court of South Dakota, 63 N.W.2d 255 (1954)

Plaintiff Drashner and defendants Sorenson and Deis created a real estate partnership, with a profit-sharing agreement in which each got 1/3 of one half of commissions, with the other half of commissions going towards operating expenses. The plaintiff spent a lot of time in a local bar during business hours and kept asking for more than his share of the funds, and when he didn't get as much money as he would have liked he dissolved the partnership. Did the plaintiff dissolve the partnership wrongfully? Held Yes. This was not an at-will partnership. The agreement said that the partnership would continue at least until the $7,500 advance of defendants had been repaid from the gross earnings; the plaintiff wrongly dissolved the partnership before this occurred. The UPA (1914) allows, in the event of wrongful dissolution, that the other partners may continue the partnership if they pay the dissolving partner they value of his/her interest in the property, minus any damages from the wrongful dissolution and minus any good will. Should the plaintiff be awarded any portion of good will of the partnership? Held No. Even though most of the value of the partnership is in the good will of the name and location, the UPA (1914) says not to award good will to a wrongly dissolving partner, and the trial court correctly applied the statute. Should the current real estate listings of the partnership be exluded as good will? Held No. Although listings may arise from good will, after they are secured they become an aspect of the partnership's going concern. They cannot be valued on an exchange basis because they are not transferable and are revocable at will. The trial court judge was correct in placing a conservative value on these listings as the plaintiff had secured many of the listings and was likely to take them with him when he left the partnership.

Gateway Potato Sales v. G.B. Investment Co., Court of Appeals of Arizona, 822 P.2d 490 (1991)

Sunworth Corporation as a general partner and G.B. Investment as a limited partner formed Sunworth Packing to engage in potato farming in Arizona. Robert Ellsworth, the president of Sunworth Corporation, called Robert Pribula, the owner of Gateway Potato Sales, wanting Gateway to supply Sunworth Packing with seed potatoes. Pribula was worried because Ellsworth had been bankrupt before, but Ellsworth assured Pribula that G.B. Investment was providing financing, and that Ellsworth reported to G.B. Investment's vice-president, Darl Anderson, who was often at the office. Ellsworth could not make any significant business decisions, improvements, or purchases without the approval of Anderson or another G.B. employee, Thomas McHolm; and Anderson and McHolm oversaw many daily operations of Sunworth Packing. In Arizona, can a limited partner be liable beyond its investment even if it had no contact with the creditor? Held Yes, if the control of the limited partner is "substantially the same" as that of the general partner. A.R.S. § 29-319(a) says that if a limited partner's control of the business is not substantially the same as that of the general partner, it is only liable to creditors who had actual knowledge of the limited partner's participation or control. This implies that "substantially the same" control does not require creditor contact or knowledge for liability. Although the Revised Uniform Limited Partnership Act, amended in 1985, requires a creditor to have reasonably believed that a limited partner participates in the control of the business and that the limited partner does participate, the Arizona legislature apparently intentionally retained the "substantially the same" test.

McArthur v. Times Printing Co., Supreme Court of Minnesota, 51 N.W. 216 (1892)

Nimrocks and others were promoters of a corporation to publish a newspaper, and contracted with plaintiff to be advertising solicitor for one year after the company was formed. The corporation after formation never formally adopted the contract, although all the stockholders, directors, and officers of the corporation knew of the contract and didn't object, but instead retained plaintiff as an employee. Is a corporation liable for promoters' contracts to which the corporation implicitly accepts? Held Yes. A corporation is not bound to a contract made by promoters before the company's organization, but the corporation can adopt a contract as if it were making the contract originally: by acceptance by the board of directors. The contract must be one the corporation would have made and one for which the agents of the corporation would have express or implied authority to make. Here the plaintiff's employment contract was inferred from acts and/or acquiescence on the part of the corporation. Does the statute of frauds make the contract void because its performance was to be completed more than a year from the date the promoters created it? Held No. Such a theory assumes ratification under a theory of agency. Ratification is not appropriate, because it creates the contract at a time in which the corporation did not exist. In reality, the time of the start of the contract was when the corporation adopted the contract, after the formation of the corporation, which allowed less than a year for fulfillment of performance.

Toms v. Cooperative Management Corporation, Court of Appeals of Louisiana, 741 So. 2d 164 (1999)

Mr. and Mrs. Evans, along with their children, J. Bruce Evans, Barbara Evans Rogers, Janis Evans Leach and Janet Evans Toms, formed Cooperative Management Coorporation (CMC). Article VII(2) of the by-laws stated that before an increase or reduction of stated capital, 85% of shareholders must approve the action. CMC directors, constituting over 85% of shareholders, authorized CMC to redeem and cancel Janet Evans Toms' 150 shares of CMC for $22,500, or $190 per share. Years later, Mrs. Toms found out that an appraisal of CMC meant that her stock should have been worth more, so she sued CMC for a recision of the sale. To stop the suit, CMC directors voted to issue 150 shares of no par stock and sell them to Mrs. Toms for $190 per share, except that this time less than 85% of shareholders approved the action. The shareholders sued CMC for a mandamus to prevent the issuance of stock to Mrs. Toms. Can CMC get around Article VII(2) of the by-laws by allocating all of the payment for the stock to capital surplus and $0 to stated capital? Held No. La. R.S. 12:61(A) requires that "the board of directors shall state an amount to be allocated to stated capital" with the rest to capital surplus. "Zero is not an amount. Zero is no amount." Does the transaction have no effect on stated capital because the shares are treasury stock, the same shares Mrs. Toms sold back to the company, that were issued and not outstanding, and now transferred back to Mrs. Toms? Held No, the transaction does have an effect on stated capital. The record shows that Mrs. Toms' original stock was redeemed and then cancelled, and the stated capital reduced. Issueing more shares must therefore increase the stated capital.

Hanewald v. Bryan's, Inc., Supreme Court of North Dakota, 429 N.W.2d 414 (1988)

Keith and Joan Bryan incorporated Bryans, Inc., a retail clothing company, which issued them each 50 shares of stock with a par value of $1,000 apiece. Neither Bryan paid anything for these shares. Bryan's got a $55,000 loan from Union State Bank and a $10,000 loan from Keith and Joan Bryan. Bryan's bought a dry goods store from Hanewald for $60,000 and leased a building from him, paying the $55,000 loaned from the bank with a promissory note for the other $5,000. The business went under and Bryan's, Inc. was dissolved. Bryan's paid the bank debt and the debt to Keith and Jon, but not the debt to Hanewald. Hanewald sued Keith and Joan for the $5,000. Are Keith and Joan liable to the corporation for par value stock for which they have not paid? Held Yes. "[T]he limited personal liability of shareholders does not come free." Shareholders are not liable for more than they contribute, but stock distribution is a contractual arrangement between the shareholder and the company, for which a shareholder is liable if the price is not paid. Is a shareholder who hasn't paid for shares personally liable to a corporate creditor? Held Yes. There is a generally recognized rule, derived from common law, that "a shareholder is liable to corporate creditors to the extent his stock has not been paid for." 18A Am. Jur. 2d Corporations § 863, at p. 739 (1985). As the value owed is less than the difference between the stock par value and the amount paid, the shareholders here are liable to the creditor. Was the $10,000 loan from Keith and Joan sufficient consideration for the stock? Held No, that was a loan, not a capital contribution, and was repaid by the corporation before it was dissolved.

Obre v. Alban Tractor Co., Court of Appeals of Maryland, 179 A2d 861 (1962)

Henry Obre, and F. Stevens Nelson created the Annel Corporation for building roads. Obre transferred equipment and cash totaling over $65,000. Nelson contributed equipment and cash totaling $10,000. Each received $10,000 worth of common stock, and Obre also received $20,000 worth of non-voting preferred stock. Obre also received an unsecured note from the corporation for balance of his contribution, over $35,000, payable in five years. The business never did well, Obre stopped receiving a salary, and finally the corporation executed a deed of trust for its creditors. Alban Tractor Co. and other creditors sued to subordinate Obre's debt, pointing out that the note was given on the same day the corporation was formed; that it was a five-year note; and that the corporation was underfunded. Was Obre's contribution a risk capital contribution rather than a loan, and therefore should be subordinated to the debts of other creditors? Held No. The debt was issued in order to keep the common stock issued to Obre the same as that given to Nelson; and the debt was issued for five years, rather than in installments, for tax reasons. All the parties forming the corporate structure believed the capital to be adequate. If a third party had made Obre's contributions, the third party would be considered a valid creditor. As a previous court stated, "So long as the corporate plan is adopted and pursued in good faith and in accordance with the … laws of the state, those dealing with the corporation have only themselves to blame if they suffer from neglect to seek information obtainable from public records and other available sources." Here the creditors could have seen the current financial situation by analyzing stock issuance certificates filed with the State Tax Commission or by requesting financial reports.

Fett Roofing and Sheet Metal Co. v. Moore, United States District Court, E.D. Virginia, 438 F. Supp. 726 (1977)

Defendant Donald M. Fett converted his proprietorship into the corporation Fett Roofing and Sheet Metal Co. and transferred almost $5,000 worth of assets to the corporation. Fett, as president and sole stockholder of the corporation, borrowed money from the bank and advanced money as loans to the corporation as the need arose, together totaling almost $80,000, receiving in return promissory notes from the corporation. When the corporation became insolvent, Fett deeds of trust to secure the notes with company property, backdating the deeds of trust to the time the loans were made. A few months later, the corporation filed for bankruptcy. Were Fett's contributions to the corporation valid loans, or should they be considered capital contributions, subordinating them to the corporate liabilities to other creditors? Held The contributions were, in contemplation of law, capital contributions and the deeds of trust can be set aside, as there was therefore no debt to be secured. "[N]o one fact will result in the determination that putative loans are actually contributions to capital," but considerations include whether there were multiple stockholders or a single controlling stockholder; whether the corporation was adequately funded; whether the "loans" were made at the formation of the corporation or afterwards; whether corporate formalities were followed and the corporation formally authorized the contributions as loans; whether interest was paid; and whether the company actively attempted to repay the loans. Here the corporation, with debt to secured creditors at over $400,000, had a debt-to-equity ratio of over 80 to 1. Fett completely controlled the corporation to the point that he was the corporation's alter ego. Fett did not go through the formalities of having the corporation authorize the loans, and there is no evidence that interest was ever paid on the loans. Fett contributed more money whenever the corporation needed more, yet the corporation did not attempt to repay the money on equal footing with other creditors, instead paying back other creditors first. These factors, despite the fact that the contributions were made throughout the life of the corporation and not solely at its formation, are adequate to allow the contributions to be considered capitalizations of the corporation that may be subordinated to the liabilities to other creditors rather than loans.

Katzowitz v. Sidler, Court of Appeals of New York, 249 N.E.2d 359 (1969)

Plaintiff Isador Katzowitz, along with Jacob Sidler and Max Lasker, were equal owners in several corporations and had worked together over 25 years. They formed Sulburn Holding Corp. and were directors and equal owners. Sidler's and Lasker's relationship with Katzowitz deteriorated, and finally they mutually agreed that Katzowitz would withdraw from active participation in the corporation but would remain on the board of directors, and that there would only be three stockholders. Sulburn owed each stockholder $2,500 for fees and commissions. Sidler and Lasker voted that this money be distributed in the form of new stock, but Katzowitz refused the preemption option because he didn't want to invest additional funds in the corporation. Sulburn therefore issued 25 shares each to Sidler and Lasker for $100 apiece, even though the book value of the stock was $1800, and paid a check for $2,500 to Katzowitz for his share in the fees and commissions. The next year the directors dissolved the corporation. Because of the now disparity in ownership, Sidler and Lasker each received $18,885.52 but Katzowitz only received $3,147.59. Katzowitz sued for a proporitional interest in the corporation, minus the $5,000 Sidler and Lasker together effectively paid for their additional shares. Does Katzowitz have a right to a proportional share of the corporation, even though he didn't exercise his pre-emptive right to retain proportional ownership or attempt to prevent the sale of additional stock? Held Yes. (Preemptive rights were created for two purposes: (1) to protect against dilution of equity, and (2) to protect against proportional dilution of voting control.) "The corollary of a stockholder's right to maintain his proportionate equity in a corporation by purchasing additional shares is the right not to purchase additional shares without being confronted with dilution of his existing equity if no valid business justification exists for the dilution." If the additional shares are offered at a price below fair value, the consequences of not exercising preemptive rights causes the party's proportional equity to rapidly decrease "to the vanishing point." A party therefore has, besides the preemptive right to maintain proportional equity, the right to require that additional stock be offered at fair value. Here there was no evidence of any legitimate business reason for the disparity between the stock price and its fair value; instead, it was "calculated to force the dissident stockholder into investing additional sums." Is Katzowitz prevented from complaining at the time of dissolution because he had a chance to purchase the additional stock when it was offered? Held No, Katzowitz at the time might not have been aware of the extent to which the stock issuance would affect his proportional share, because no notice was given of the effect of the issued shares on outstanding shares was given. "Katzowitz' delay in commencing the action did not prejudice the defendant." By allowing Katzowitz an equal proportion of shares, "all the stockholders will be treated equitably."

Denkins v. Zinkan Enterprises, Court of Appeals of Ohio, 1997 WL 775660 (1997)

Plaintiff James Denkins purchased 147 shares of defendant Zinkan Enterprise's common stock for $200,000, signing a share transfer restriction, option, and pre-emptive rights agreement. The agreement allowed Denkins to exercise a "put" option to sell his shares back to the defendant for either $1500 per share or 2.5 times the book value of the stock, whichever was greater. The agreement defined "book value" for stock purchase options as the equity shown on a yearly financial statement divided by outstanding common shares, after taking into account all accrued taxes. Denkins attempted to exercise his put option, but defendant did not repurchase the stock, so Denkins sued. Denkins produced a corporate balance sheet showing Zinkan equity of $685,745, and asked for $343,340.55, which was the given equity divided by the number of shares, multiplied by 2.5. Was the trial court in error to only allow Denkins $220,500, or $1500 per share? Held No. Denkins did not produce any evidence that the agreement calculated stock put options in the same way as stock purchase options. Even if put options were calculated identically to stock purchase options, Denkins produced no evidence of accrued taxes, so the balance sheet provided was irrelevant in determining the book value according the agreement's definition.

Roach & The Legal Center, Inc. v. Bynum, Supreme Court of Alabama, 403 So. 2d 187 (1981)

John Roach, Jr., his wife, and Hjalma Johnson formed The Legal Center, Inc. Roach's wife and Johnson surrendered their holdings and resigned as directors. As Roach was then sole shareholder and director, he modified the bylaws to vest management authority in the president, to require a quorum of 70%, and to require 70% of shareholders to modify the bylaws. He then brought in James Forstman and Frank K. Bynum; each were then a director, and each owned one third of the shares of the corporation. Disagreements arose, and one or more of the three would block each other's proposals by preventing a 70% majority. Bynum and Forstman sued for dissolution because of deadlock. Does Roach's ability to act under his authority as president prevent the corporation from being deadlocked? Held No, the directors manage the corporation. Both the Alabama Business Corporation Act and Legal's articles of corporation place management and control in the directors, not the president, so the aspect of the bylaws that places this authority in the president is in contradiction and therefore void. Is the corporation deadlocked? Held No, a majority of shareholders may convene a meeting and create new bylaws. The common law allows simply a majority of shareholders to modify bylaws. The Alabama Business Corporation Act allows the articles of incorporation to set majority and quorum requirements. Other jurisdictions have interpreted similar statutes to mean that the bylaws may not change majority and quorum requirements for modifying bylaws. The bylaws that attempt to modify Legal's majority and quorum requirements are therefore void; as Legal's articles of incorporation allow modification of the bylaws by shareholders, a majority of shareholders, as allowed by the common law, may convene a meeting and modify the bylaws. Concur Although the bylaw requirements of a 70% quorum and majority are void under Alabama law, this doesn't preclude such a requirement by agreement of all stockholders.

Datapoint Corp. v. Plaza Securities Co., Supreme Court of Delaware, 496 A.2d 1031 (1985)

Asher Edelman owned over 10% of Datapoint's stock, and informed Datapoint's chairman that Edelman wanted to acquire control of Datapoint. The board of directors turned down the offer. When Edelman indicated he would ask for consent from shareholders, the board created a new bylaw that added a 60-day waiting period for all actions by shareholder consent, and effectively suspended such actions if there was a legal proceeding over the validity of such actions. Delaware statute 8 Del. C. § 228 allows shareholders to take actions in lieu of a meeting by consent in writing, "[u]nless otherwise provided in the certificate of incorporation …." When Edelman gave notice of intent to solicit shareholders' consent, the board set in action the waiting period and then filed suit to invalidate any consents obtained by Edelman. Does the new bylaw conflict with § 288? Held Yes, the Datapoint bylaw conflicts with the letter and intent of § 288. The issue is not whether § 288 allows a delay or whether a board of directors can change solicitation procedures through bylaws. The issue is that § 288 grants shareholders power and gives no indication that this power of action "may be lawfully deferred or thwarted on grounds not relating to the legal sufficiency of the consents obtained." Here the bylaw imposes and arbitrary and unreasonable delay upon shareholder action in lieu of a meeting and is designed not to defer shareholder action so that its sufficiency can be objectively reviewed, but instead to give the incumbent board time to try to defeat the shareholders' action.

Paulek v. Isgar, Colorado Court of Appeals, 551 P.2d 213 (1976)

The articles of incorporation of H.H. Ditch Co. authorized stock series A, B, C, and D, the latter of which could be exchanged for water rights, and indicated that the board of directors had the power to amend the bylaws. The bylaws only provided for stock series A, B, and C, but allowed the bylaws to be amended by a two-thirds vote of stockholders. The shareholders of H.H. voted to consolodate Short Line Ditch Co., with the latter paying a proportion of H.H.'s debts, and to issue series D stock in exchange for water rights and other property of Short Line. As the bylaws do not authorize series D stock but the articles of incorporation do, the trial court ruled that the articles controlled. Must there first be a shareholder meeting to modify the bylaws to allow series D stock? Held No. Although the bylaws allow their own modification through shareholder approval, the articles of incorporation only provide for bylaw modification by the board of directors. "Where bylaws conflict with the articles of incorporation, the articles of incorporation control and the bylaws in conflict are void."

Jones v. Wallace, Supreme Court of Oregon, 628 P.2d 388 (1981)

Wallace was the sole shareholder of Capital Credit & Collection Service, Inc. and one of its directors when the directors adopted bylaws which required a quorum of stockholders at the stockholders meeting. The Oregon Business Corporation Act required only a quorum of a majority of voting shares unless modified by the articles of incorporation. Plaintiffs Jones and Gaarde each purchased 49.5 shares, leaving Wallace with 100 shares or 50.25% of the company. There was a directors' meeting in which a majority of directors removed Wallace as president and put Jones in as president and Gaarde in as secretary. The following month there was a shareholder meeting without Gaarde in which Wallace used his majority of shares to remove Jones and Gaarde as directors and put in defendants Roberts and Smith. Jones and Gaarde sued Roberts and Smith, saying that the bylaws' requirement of all voting shares present made the shareholders' meeting decision ineffective. Did the bylaws override the statutory quorum requirement and require all shares present for quorum, invalidating the shareholders' replacement of Jones and Gaarde? Held No, the statute only allows the articles of incorporation to overrule the majority quorum requirement, not the bylaws. Do the bylaws constitute a contract enforceable against new shareholders who purchase shares in the company, thereby requiring all voting shares for a quorum? Held No. In some cases the bylaws of a closely held corporation may be considered to give rise to contractual obligations of shareholders and members, such as when bylaws were faultily adopted. However, existing bylaws may not be considered a contract with new shareholder buying into the corporation giving rise to obligations in conflict with statutory requirements and the articles of incorporation.

Robertson v. Levy, District of Columbia Court of Appeals, 197 A2d443 (1964)

Martin Robertson and Eugene Levy entered an agreement in which Levy was to form the corporation Penn Ave. Record Shack, Inc. which would then buy Robertson's business. Levy submitted articles of incorporation to the Superintendent of Corporations, and then, acting as president, entered into a lease with Robertson. The articles of incorporation were rejected, but Levy, still acting as president of the corporation, executed a bill of sale for Robertson's business in return for a note of installment payments. The certificate of incorporation was finally issued, and Levy made one installment payment. After Penn Ave. Record Shack, Inc. stopped doing business, Robertson sued Levy for the balance of the note plus additional expenses. Can Levy, the corporation's president, be held personally liable for an obligation entered into by the corporation before the certificate of corporation was issued? Held Yes. Modern corporation statutes such as Model Act (1969) §§ 56 and 146 [the predecessors to Model Act §§ 2.03 and 2.04, respectively] have effectively done away with de facto corporations and corporations by estoppel favoring a single-event proof of corporation formation by the issuance of the certificate of corporation. Persons assuming to act as a corporation without authority to do so will be held personally liable. Does Robertson's receipt of one of the installments after the certificate of corporation was issued and the corporation formed estop him from denying the existence of the corporation? Held No. Someone who incurs statutory liability on an obligation under these codes is not relieved of a liability if subsequent partial payment is accepted at a later time when the corporation has come into existence.

Timberline Equipment Co. v. Davenport, Supreme Court of Oregon, 514 P.2d 1109 (1973)

Dr. Bennett was an incorporator, director, and shareholder of Aero-Fabb Corp., a company formed to sell airplanes, recondition airplanes, and give flying lessons. Dr. Bennett signed articles of incorporation that were not in accord with statutes, so no certificate of incorporation was issued until new articles were filed almost five months later. In the meantime, the "corporation" Aero-Fabb Corp. entered into equipment rental leases with the plaintiff, Timberline Equipment Co. Some of the leases were signed by "Kenneth L. Davenport, dba Aero-Fabb Co." and other variations, and the plaintiff's salesperson checked the deed to the title of the land and found it was registered in individuals' names. The plaintiff sued Dr. Bennett and two others for the remaining lease payments. Did a de facto corporation exist that shielded defendants from liability? Held No. Because Oregon adopted the Oregon Business Corporation Act, which has a section virtually identical to Model Act (1969) § 56, the principle of de facto corporation no longer exists in Oregon, opting instead for the bright-line certificate-issuance rule of the Model Act. Are plaintiffs estopped from asserting the non-existence of a corporation because they believed they were doing business with a corporation? Held No. There is conflicting evidence whether the plaintiffs believed they were contracting with a corporate entity, but the trial court found that, based upon the evidence such as the signed "dba" on the leases and the land deed in the individuals' names, the plaintiffs knew that they were not dealing with a corporation. Can the plaintiff recover against Dr. Bennett individually? Held Yes. The Oregon Business Corporation Act and Model Act (1969) § 146 assign liability to "[a]ll persons who assume to act as a corporation without the authority of a[n issued] certificate of incorporation …." This statute "should be interpreted to include those persons who have an investment in the organization and who actively participate in the policy and operational decisions of the organization," not just the one who personally incurred the obligation. Dr. Bennett frequently visited the business site and met with employees to discuss the operation of the business, and maintained some control over management, and thereby "acted in the business venture."

Gashwiler v. Willis, Supreme Court of California, 33 Cal. 11 (1867)

All the stockholders of Rawhide Ranch Gold and Silver Mining Company held a stockholders' meeting and unanimously adopted a resolution authorizing S.S. Turner, T.N. Willis and James J. Hodges, Trustees of the corporation, to sell the company's mill, mine, and related property to D. W. Barney. Turner, Willis, and Hodges then executed a deed as Trustees selling the mill and mine to Barney. At trial, the stockholders' action was introduced as evidence, but the defendants objected to the deed being introduced into evidence. Is the document an act or deed of the corporation? Held Sawyer: No. The property was owned by the corporation, not the shareholders. The Act authorizing the formation of corporations for mining purposes does not authorize shareholders to sell and convey corporate property—even though the Trustees were shareholders and voted on the resolution, they were acting as shareholders, not as Trustees. Similarly, even though the Trustees signed the deed, the Trustees had not authorized the sale when "duly assembled as a Board," as required by the Act. (It may still be the case that the Board of Trustees may need the consent of the shareholders before authorizing the conveyance of this corporate property.)

State ex rel. Pillsbury v. Honeywell, Inc., Supreme Court of Minnesota, 191 N.W.2d 406 (1971)

The plaintiff, who believed that America's involvement in the Vietnam war was wrong, found out that Honeywell, a Delaware corporation doing business in Minnesota, was producing munitions used in the war. The plaintiff told his fiscal agent to purchase 100 shares of Honeywell, and when the agent registered the shares in the name of a Pillsbury family nominee the plaintiff purchased one share of Honeywell pesonally. Plaintiff also searched and discovered that he had a contingent beneficial interest in 242 shares of Honeywell stock through his grandmother's trust. Plaintiff submitted two formal demands to Honeywell to produce its original shareholder ledger, current shareholder ledger, and all corporate records dealing with weapons and munitions manufacture. When Honeywell refused, plaintiff sued for a writ of mandamus. Must a Deleware corporation produce corporate records to a shareholder? Held Yes, but information other than shareholder lists requires that the shareholder have a proper purpose. Is soliciting stockholders to change corporate management to those who have different social and political ideals a proper purpose? Held No. A "proper purpose" for a shareholder with tenuous holdings to inspect corporate records must be concerned with economic return. The power to inspect records is like a weapon that, due to the complicated nature of bookkeeping, can "render impossible not only any attempt to keep their records efficiently, but the proper carrying on of their businesses." Here plaintiff has only one share of stock, and only purchased the stock "to persuade the company to adopt his social and political concerns, irrespective of any economic benefit to himself or Honeywell." He only discovered his contingent interest in his grandmother's trust after he looked, for the same reason. Changing a company's management, in the absence of interest in the corporation's or the shareholder's, is not the proper procedure to further petitioner's political and social beliefs. [This decision was disapproved one year later in Credit Bureau Reports, Inc. v. Credit Bureau of St. Paul, Inc., 290 A.2d 691 (Del. 1972).]

Manson v. Curtis, Court of Appeals of New York, 119 N.E. 559 (1918)

The defendant and the plaintiff made an agreement to select passive directors who would essentially allow plaintiff to run the company. Is such an agreement valid? Held No. The law does not allow stockholders to create a "sterilized" board of directors. Directors are not employees; they are the exclusive executive representatives of the corporation, acting as trustees, and derive their original and undelegated powers directly from the state. Stockholders cannot confer or revoke these powers, so the agreement is illegal and void.

Joseph Greenspon's Sons Iron & Steel Co. v. Pecos Valley Gas Co., Superior Court of Delaware, 156 A. 350 (1931)

The president of defendant Pecos Valley Gas signed a contract for 45 miles of 65/8 inch gas pipe for 61 cents a foot. The defendant then claimed that it was not obligated to the plaintiff because the president did not have authority to purchase pipe without approval of the Board of Directors. Is the power of a corporation's president as complete and effective as that of the Board of Directors? Held No. A president is an agent of the corporation, and only has such powers as the board delegates. A board usually expressly or impliedly makes the president the chief executive officer, and as such the president has the implied authority to "perform all acts of an ordinary nature which by usage or necessity are incidents to his office," and the president may "enter into a contract and bind his corporation in matters arising from and concerning the usual course of the corporation's business." Did the president have implied authority to order pipe because it was within the "ordinary and usual duty" of the president? Held This depends on the specific facts such as the type of goods and the nature of the company; this is therefore an issue for the jury. Did the president have authority over the "ordinary and usual duty" power implied in the office of the president? Held This too is a question for the jury. Powers above those implied in the office of the president must be granted, either (1) through statutory law, (2) by the corporate charter, (3) in the by-laws, (4) by a resolution of the Board of Directors, or (5) by a "course of conduct" of the president and the corporation showing a habit of acting in similar matters and that the company recognized, approved, or ratified those actions.

Anderson v. Campbell, Supreme Court of Minnesota, 223 N.W. 624 (1929)

There were three corporations doing monumental and construction work and operating quarries: Pioneer Granite Company with three stockholders, Great Northern Granite Company, with five stockholders, and the Campbell North Star Granite Company with three stockholders. Defendant North Star Granite Corporation was formed to consolodate the first three corporations. A deed was prepared to convey real estate from the Pioneer Granite Company to the new corporation, containing blanks in which the president and secretary would insert their names and signatures. The president was not available so the vice president, Anderson, signed instead, neglecting to place "vice" in front of the title "president" under the signature. Is the deed void because the vice president purported to be president? Held No. The vice president was acting with the same authority as the president. The president had the authority to execute the deed, if the president was not available, the vice president had the authority to act in place of the president. The designation of Anderson as president instead of vice president was just a "harmless clerical inadvertence" of which the plaintiff can't take advantage.

In re Drive In Development Corp., United States Court of Appeals, Seventh Circuit, 371 F.2d 215 (1966)

National Boulevard Bank of Chicago was a creditor to Drive In Development Corporation. Drive In's holding company Tastee Freez, through another subsidiary Allied Business, assigned conditional sales contracts to National Boulevard. Drive In and other Tastee Freez subsidiaries jointly and severally guaranteed the obligations, and Drive In vice president Maranz signed the guaranty as "Chairman", and secretary Dick attested the guaranty's execution as well as a separate board of directors resolution authorizing the guarantee. It turns out that the board apparently had not really authorized the guaranty. Is Drive In obligated to guarantee the contracts, even though the vice president was not authorized by the board to execute the guaranty? Held Yes. A corporate secretary is authorized to keep corporate records and to certify resolutions. As Dick as secretary attested the resolution authorizing Chairman Maranz to execute the guaranty, Drive In is estopped from denying that Maranz had such authority.

Jacobus v. Jamestown Mantel Co., Court of Appeals of New York, 105 N.E. 210 (1914)

Searing was president of the Delaware and Eastern Railroad Company, which owed attorney Welch a substantial amount of money. Welch needed some cash so Searing told Welch to borrow a note from someone and he would have it discounted. Turner, treasurer of Jamestown Mantel Co., signed a note to Welch, who gave it to Searing, who went and got it discounted at one of his holding companies. Searing secretly used the proceeds and reported back to Welch that there were no funds to discount the note, only telling Welch later before the note became due. The Mantel Company thereafter refused to pay the note. Did the treasurer have authority to sign a promissory note? Held No. A treasurer has no authority to make promissory notes in the name of the corporation, and there were no by-laws or director resolution giving the treasurer such authority. Is the mantel company estopped from denying the treasurer's authority because the treasurer had signed such promissory notes in the past and the mantel company had paid those notes? Held No. There is no evidence that the treasurer had signed similar notes in the past, but more importantly, the plaintiff trust company apparently did not know of previous acts when it accepted the note. Estoppel requires that the plaintiff be influenced by or rely on another's actions, which cannot happen if the plaintiff, as here, did not know of previous signings by the treasurer, whether or not there were such previous signings.

Auer v. Dressel, Court of Appeals of New York, 118 N.E.2d 590 (1954)

The directors of R. Hoe & Co. removed Joseph L. Auer as president. Class A stockholders had the power to elect nine of 11 directors. The bylaws required the president to call a special meeting when asked by a majority of stockholders entitled to vote at such a meeting, so over 55% of class A stockholders asked the new president to call a meeting. The new president refused to call the meeting claiming that none of the stated purposes for the meeting were proper for class A stockholders. Is it proper for the class A stockholders to call a meeting to vote on a resolution indorsing Auer to be reinstated as president? Held Yes. The shareholders can express themselves, even if they cannot by the resolution actually effect the change. Do the class A shareholders have the power to amend the bylaws to authorize replacement of a director only by the class of stockholders represented by the removed director? Held Yes. These particular stockholders have the power to elect and remove nine of the 11 directors with cause, so it is appropriate that they would amend the bylaws to allow themselves to name replacements. Even though the certificate of incorporation allows directors to remove a director on charges, that doesn't take away the "traditional, inherent power [of the stockholders] to remove their own directors." That class has the power to name nine of the 11 directors, so they should be able to exclude common stockholders from naming their replacements.

Campbell v. Loews, Inc., Court of Chancery of Delaware, 134 A.2d 852 (1957)

Two factions were fighting for control of Loew's, Inc.: one headed by Joseph Tomlinson, and one headed by President Joseph Vogel. Vogel called a stockholders' meeting to inrease the number of the board, to fill those new positions, and to remove Stanley Meyer and Joseph Tomlinson as directors and fill their vacancies. The notice for the meeting came accompanied by a letter claiming that the two directors were trying to gain control of the company, and that they attempted to harrass the president to the detriment of the company. The corporate bylaws provided that stockholders could fill director vacancies. The corporation would not supply shareholder records so that the two directors could contact them to refute the charges. Is filling new director positions by the stockholders at other than an annual meeting a valid meeting purpose? Held Yes. Although Delaware has held that "vacancy" does not include "newly created directorships," another case held that stockholders already have the inherent right to fill newly created directorships. Do Delaware corporate shareholders have the power to remove directors even for cause? Held Yes. Delaware statutes are silent about shareholder removal of directors, and the Loew's bylaws mention shareholder removal of officers and employees but not director. However, directors can do much harm to the corporation, so it must be implied that Delaware allows shareholders to remove directors for cause. Would the removal by shareholder majority of directors elected using cumulative voting violate the right of minority shareholders and thus be contrary to Delaware law concerning cumulative voting? Held No. Although the cumulative voting election issue presents a valid concern, it is offset by the possibility that a director could be clearly damaging to the corporation—he or she should not be "be free to continue such damage merely because he was elected under a cumulative voting provision." Were the directors to be removed for cause given adequate notice of charges? Held Yes, the letter accompanying the meeting notice gave an adequate description of the charges. "Matters for stockholder consideration need not be conducted with the same formality as judicial proceedings." Does the charge of "a planned scheme of harassment" constitute a "cause" allowing removal as a matter of law? Held Yes. Although trying to take over control of the corporation is not a good reason—that is by itself a "perfectly legitimate objective which is a part of the very fabric of corporate existence…"—there is a line at which a calculated plan of harassment can exceed the call of duty to ask questions and instead become a detriment to the corporation. Have the directors to be removed been given a reasonable opportunity to be heard by the stockholders regarding the charges? Held No. The accused directors must be "afforded an opportunity to present their case to the stockholders," but here "the corporation admittedly refused to supply them with a stockholders' list." Not allowing the accused directors access to stockholders "would make a mockery of the requirement that a director sought to be removed for cause is entitled to an opportunity to be heard before the stockholders vote."

Hall v. Hall, Missouri Court of Appeals, 506 S.W.2d 42 (1974)

Hall Contractors, Inc. was owned equally by Edward and Harry Hall, and both were its only directors. Edward died and his stock in the company passed to his widow, the appellant. Harry appointed his wife, Florence, to take Edward's place as a director, and then they appointed themselves president and vice president. Appellant called the annual meeting as specified in the bylaws, but Harry didn't show up. Because a majority is needed to conduct business of the corporation, appellant dismissed the meeting and called another one each week after that, but Harry never showed up. Harry and Florence authorized the saled of the authorized but unissued 3000 shares, but appellant didn't exercise her preemptive right because she claims they were invalid, approved by unlawful directors. Should one owning 50% or more interest in the corporation be compelled to attend meetings so that a quorum can be reached and business can take place? Held No. Other than paying full consideration for purchased shares, a shareholder has no other obligations to the company; attending meetings is mandatory. There is therefore no legal duty for which an injunction could be issued. (Appellant might try to use quo warranto to declare a director illegal and oust him/her from office, thereby creating a vacancy that might require an election of officers. The appellant might also move to dissolve the corporation.)

Donahue v. Rodd Electrotype Co. of New England, Inc., Supreme Judicial Court of Massachusetts, 328 N.E.2d 505 (1975)

Defendant Harry Rodd in 1935 started working at the Royal Electrotype Company of New England, Inc., a wholly-owned subsidiary of the Royal Electrotype Company. The late husband of Euphemia Donahue, Joseph Donahue, began working there in 1936. Harry worked his way up to corporate vice president, while Joseph never participated in the busines management. Harry Rodd and Joseph Donahue purchased shares in Royal of New England, and then that subsidiary repurchased all the shared owned by the parent company, leaving Harry, the president, with an 80% interest and Joseph only a minority interest. The company was renamed to Rodd Electrotype Company of New England, Inc., and Harry brought in his two sons, Charles and Frederick, as corporate vice president, and president and general manager, respectively. Harry later gifted many of his shares to his two sons and his daughter. In 1970, when Harry was 77 years old, the corporation purchased most of Harry's remaining shares and Harry gave the rest to his children. After the Donahues learned of this, they did not ratify the repurchase and instead requested that the corporation offer them the same terms for repurchasing their shares. Must a closely-held corporation, when a group of controlling shareholders authorizes a stock repurchase, offer the same terms to minority shareholders? Held Yes. This court defines a closely-held corporation as one having (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation. A closely-held corporation is similar to a partnership, so "stockholders in the closely held corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another[:]" one of the "utmost good faith and loyalty." Otherwise, the majority owners could "freeze out" the minority by draining off corporate earnings by high salaries, deprive minority shareholders of offices and employment, assets at an inadequate price to majority shareholders. Minority shareholders would then be without income, could not dissolve the corporation, and could not even get out of the closely-held corporation because there is no market for the shares. Allowing minority shareholders the opportunity to sell shares back to the corporation provides (1) a market for shares, and access to corporate assets for personal use. Here Rodd Electrotype was a closely-held corporation, controlled by the Rodds, and the repurchase was authorized by the majority group, the Rodd family. The repurchase gave the Rodd children control and is on its face a breach of the majority shareholders' fiduciary duty to the minority shareholders. Harry Rodd must give back the $36,000 he received for his shares, with interest; or the corporation must allow the plaintiff an equal opportunity to sell all her shares back to the company, as Harry sold back all of his shares he didn't intend his children to have.

In re Kemp & Beatley, Inc., Court of Appeals of New York, 473 N.E.2d 1173 (1984)

Petitioner Dissin owned 200 shares out of 1,500 shares of Kemp & Beatley, and had worked there for 42 years. Petitioner Gardstein owned 105 shares of Kemp & Beatley and had been employed there for 35 years. The company had traditionally given "extra compensation bonuses" as dividends. Dissin and Gardstein lost their employement, and around the same time they company started distributing the extra compensation via ways other than dividends. New York Business Corporation Law § 1104-a allows shareholders of 20% of shares to bring about dissolution in a non-publicly-traded corporation if the complaining shareholders have been mistreated or controlling shareholders, directors, or officers misappropriated corporate assetts. Specifically, the statute prohibits "illegal," "fraudulent," and "oppressive" conduct. Can petitioners dissolve the corporation because of oppressive conduct? Held Yes. Oppressive conduct, as distinct from illegal conduct, refers conduct that substantially defeats the "reasonable expectations" held by minority shareholders in committing their capital to the particular closely-held corporation. "[O]ppression should be deemed to arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioner's decision to join the venture." Here the company had a long-standing policy of granting extra compensation based upon stock ownership, and petitioners reasonably expected that it would continue. Abandoning the practice around the time of petitioners' severed employment could indicate the majority shareholders were trying to "freeze out" the minority. The corporation should be given a chance to buy petitioners' as an alternative to dissolution, though.

Nixon v. Blackwell, Supreme Court of Delaware, 626 A2d 1366 (1992)

E.C. Barton in 1928 formed E.C. Barton & Co. with two classes of common stock: Class A voting stock and Class B non-voting stock. Mr. Barton created a plan in which valuable employees held Class A stock and passive investors owned Class B stock—the latter of which constituted about 75% of the corporation's equity at the time of trial. The corporation created an Employee Stock Ownership Plan (ESOP), which provided employees with the right to Class B stock or cash when terminated or retired. The corporation also purchased key man life insurance policies, insuring the lives of key executives and directors, and a resolution was passed allowing the corporation to call Class A stock and substitute Class B stock, and there was a recommendation to repurchase the exchanged Class B stock with insurance proceeds. Plaintiffs charged board members and the corporation with "breaching their fiduciary duties by pursuing a discriminatory liquidity policy that favors employee stockholders over non-employee stockholders through the ESOP and key man life insurance policies." Is it "inherently unfair" for the directors of this closely-held corporation to establish the ESOP and to purchase key man life insurance to provide liquidity for themselves while providing no comparable method by which the minority, non-employee Class B stockholders may liquidate their stock at fair value? Held No. Just because stockholders are treated unequally do not mean they are being treated unfairly. Mr. Barton created a plan for the corporation's "continuity through employee management and ownership," and to "prevent the stock from passing out of the control of the employees of the Corporation into the hands of family or descendants of the employees." It is fair to treat the minority, non-employee Class B stockholders differently because they are not employees of the corporation, are not entitled to share in an ESOP, are not qualified for key man insurance, and are not protected by specific provisions in the certificate of incorporation, by-laws, or a stockholders' agreement. Does Subchapter XIV of the Delaware General Corporation Law regarding a "close corporation" provide a judicially-created rule to protect the minority stockholders of this corporation? Held No. This corporation, although it is a closely-held corporation, does not meet the Subchapter XIV definition of a "close corporation" and is therefore not governed by that part of the statute.

Lehrman v. Cohen, Supreme Court of Delaware, 222 A.2d 800 (1966)

Defendant N. M. Cohen and Samuel Lehrman, deceased father of plaintiff Jacob Lehrman, created Giant Food Inc. in Delaware in 1935. Ownership and control was divided between the Cohen family through Class AC stock which could elect two directors, and the Lehrman family through Class AL stock which could also elect two directors. After disputes arose over the years, stock ownership was changed so that issued Class AC and Class AL stock remained equal, and a new Class AD stock was created and issued with voting rights to elect a tie-breaking fifth director, but no rights for distributions or remunerations over the $10 par value. A single share of Class AD was issued to counsel Joseph B. Danzansky, who used it to elect himself as the fifth director. Years later, the company voted Danzansky as president, with AC and AD directors voting for and AL directors voting against. Lehrman sued, claiming that the Class AD stock is really a voting trust, which is void because the Delaware Voting Trust Statute § 218 requires voting trusts to have a 10-year limit. Is the Class AD stock really a voting trust? Held No. The criteria under Delaware precedence for finding a voting trust is that (1) the voting rights of the stock are separated from the other attributes of ownership; (2) the voting rights granted are intended to be irrevocable for a definite period of time; and (3) the principal purpose of the grant of voting rights is to acquire voting control of the corporation. Here the first prong of the test is not met: Class AD stock does not separate voting from other attributes of ownership, such as dividends—that stock simply has no other attributes. The stock does dilute the voting power of the AC and AL classes, but that is true of any new stock issuance—that cannot be said to have separated ownership attributes from those other classes of stock. Is the issuance of Class AD illegal because it has voting rights only without any substantial proprietary interest in the corporation, violating the public policy expressed in § 218? Held No. The Voting Trust Statute disfavored separation of the vote from the stock, not separation of the vote from stock ownership. Nothing expressed or implied in § 218 requires that all stock have both voting powers and proprietary interests. This stock is analogous to non-voting stock, which has proprietary interests but no voting powers. Does the AD stock arrangement provide a means to circumvent the Voting Trust Statute, making it a "dead letter?" Held No, the Voting Trust Statute was meant to avoid secret, uncontrolled groups of stockholders acquiring control, which is not the case here. (Even if it were, the hole would be one for the General Assembly to patch, not the judiciary.)

Ramos v. Estrada, Court of Appeals of California, 10 Cal Rptr. 2d 833 (1992)

Leopoldo Ramos, his wife, and others formed Broadcast Corporation to get an FCC license to broadcast Spanish television programming in Ventura County. Tila Estrada and her husband purchased a 10% interest in the company, and Tila Estrada became president. Broadcast Corp. merged with Ventura 41 Television Associates to form Costa del Oro Television, Inc. The merging companies allowed stock in Television Inc. to be issued directly to the respective owners, and Broadcast Corp. created the "June Broadcast Agreement." Under the June Broadcast Agreement, members of Broadcast Corp. would vote for directors as the majority decided, and that failure adhere to the agreement constituted an irrevocable selling of that shareholder's shares according to the agreement's buy/sell provision. Tila Estrada joined the Ventura 41 block, voting to remove Ramos as president and to install herself as secretary, and sent a letter revoking participation in the June Broadcast Agreement. The Broadcast block met and nominated directors that did not include either of the Estradas. Is the June Broadcast Agreement a valid shareholder agreement which the Estradas breached, so that their shares must be sold? Held Yes. The June Broadcast Agreement was not a proxy agreement that could expire or be revoked. The agreement was a shareholders' voting agreement authorized by § 706(a) for close corporations. Even though this corporation does not explicitly call itself a "close corporation" in its articles of incorporation, § 706(d) states that "This section shall not invalidate any voting or other agreement among shareholders … which agreement … is not otherwise illegal." Here the stockholders entered into this agreement to vote on consensus so that they could ensure that "the Company does not pass into the control of persons whose interests might be incompatible with the interests of the Company and of the Stockholders …." Such an agreement is "valid, enforceable and supported by consideration." "The Estradas breached the agreement by their written repudiation of it," constituting an election by the Estradas to sell their shares in Television, Inc.

Galler v. Galler, Supreme Court of Illinois, 203 N.E.2d 577 (1964)

Brothers Benjamin and Isadore Galler founded the partnership Galler Drug Company, which was later incorporated. They each owned 110 shares, and then each sold six shares to employee Rosenberg. Isadore and his wife Rose later bought Rosenberg's 12 shares. The brothers entered into an agreement for the protection of their family in case either brother were to die. The agreement specified that certain parties would be elected for a certain length of time, that certain dividends would be issued, and that upon the death of either brother the corporation would pay double the brother's salary to the widow paid out over five years. When Benajamin died his wife Emma demanded execution of the agreement, but Isadore and Rose refused. Is the agreement void because it has no termination date? Held No; this is a shareholders' agreement, not a voting trust, only the latter of which has time limits. Is the salary continuation provision void because, by dealing with corporate property, it violates the Business Corporation Act by violating the rights of other stockholders? Held No—there are no other stockholders. Shareholder agreements of close corporations are allowed "slight deviations" from corporate "norms" "in order to give legal efficacy to common business practice …." A shareholders' agreement in a closely held corporation may control corporate property as long as there is no detriment to minority stock interests, creditors or other public injury.

Baatz v. Arrow Bar, Supreme Court of South Dakota, 452 N.W.2d 138 (1990)

Edmond and LaVella Neuroth formed Arrow Bar, Inc., in 1980 and contributed $50,000 in capital. The corporation purchased the Arrow Bar business with $5,000 down, with Edmond and LaVella executing a personal promissory note for the $145,000 balance. The corporation later got a bank loan for $145,000, which Edmond and LaVella also personally guaranteed. Edmond is president and Jacquette Neuroth is the manager. In 1982 Roland McBride, after drinking at the Arrow Bar, got in an automobile without insurance and, crossing the center line, struck and seriously injured Kenny and Peggy Baatz, who were riding a motorcycle. SDCL § 35-4-78 creates a liability as a matter of law for injury or death resulting from intoxication from a particular sale, making the business and the particular serving employee liable. Plaintiff Baatz sued Arrow Bar, Inc. along with the Neuroths, claiming that the bar served McBride drinks after he was already intoxicated. The Neuroths claim that the corporation shields them from liability. Is Jacquette Neuroth as bar manager liable for the actions of the serving employee under the doctrine of respondeat superior? Held Sabers: No. Jacquette Neuroth is not the employer—the corporation Arrow Bar, Inc. is the employer. Does personally guaranteeing corporate liabilities make the Neuroths personally liable? Held No. In South Dakota the corporate veil may be pierced when recognition of the corporation as a separate legal entity would "produce injustices and inequitable consequences," evidenced by such factors as (1) fraudulent representation by corporation directors; (2) undercapitalization; (3) failure to observe corporate formalities; (4) absence of corporate records; (5) payment by the corporation of individual obligations; or (6) use of the corporation to promote fraud, injustice, or illegalities. Here personal guarantees is the opposite of factor 5, supporting rather than detracting from recognition of a separate legal entity. Should the corporate veil be pierced because the corporation was undercapitalized with only $5,000 in borrowed capital? Held No, there is no evidence that $5,000 was inadequate for the corporation to conduct business, considering the personal guarantees by Neuroths. "[S]imply asserting that the corporation is undercapitalized does not make it so." Should the corporate veil be pierced because the bar was not indicated as a corporation in its advertisements? Held No. The corporate name, "Arrow Bar, Inc.," indicated that it was a corporation, but even if there was no indication, that in itself would not be sufficient reason to pierce the corporate veil, as "there is no relationship between the claimed defect and the resulting harm." Dissent Henderson: This is fraud—this family formed a corporation just to get around previous court holdings of drinking establishment liabilities. Poor Peggy, a young mother, lost a leg; and Kenny, a young father, lost a foot in the accident. Roland was a drunkard, and Arrow Bar had a reputation for serving intoxicated persons. The Arrow Bar would not sell to Arrow Bar, Inc. without the personal guarantees of the owners, so "the individuals are the real party in interest …." The corporation was underfunded. The jury should be allowed to determine (1) whether the defendants are negligent, and (2) whether the Neuroth family "falsely establish[ed] a corporation to shield themselves from individual liability"—in other words, whether there are facts present to allow the corporate veil to be pierced.

Walkovsky v. Carlton, Court of Appeals of New York, 223 N.E.2d 6 (1966)

Plaintiff Walkovsky was run down and injured by a taxicab owned by Seon Cab Corporation. Defendant Carlton is a stockholder in 10 corporations, including Seon, each of which has two cabs registered in its name and each cab carries only the minimum automobile liability insurance of $10,000. The plaintiff requests that stockholder Carlton should be held personally liable for his injury because the multiple corporate structure is an attempt "to defraud members of the general public" who might be injured by the cabs. Is organizing, managing, and controlling a fragmented corporate entity in itself sufficient to pierce the corporate veil? Held Fuld: No. New York allows piercing the corporate veil "to prevent fraud or to achieve equity," guided, as Judge Cardozo put it, by "general rules of agency." (If the corporations were being run by a larger shell corporation, New York case law may allow the larger corporate entity to be financially responsible.) In any case, for an individual stockholder to be held responsible for the actions of the corporation it must be shown that the stockholder is "conducting the business in his individual capacity." Here there are no such allegations, and therefore plaintiff fails to state a cause of action. If merely owning a corporation with few cabs were sufficient to pierce the corporate veil, then many small cab companies would not survive scrutiny. And if $10,000 is not enough insurance, then the legislature should change the minimum allowed. Dissent Keating: If a corporation vested with a public interest is undercapitalized to meet its liabilities, then the shareholders should be held liable. Here the separate corporations were underfunded and money was siphoned out of them to prevent payments from liabilities. Surely the legislature intended that if a company were making profits it should purchase more insurance. The individual shareholders here should face liability as a matter of public policy, as automobiles are dangerous and hospital care is expensive.

Sea-Land Services, Inc. v. Pepper Source, United States Court of Appeals, Seventh Circuit, 941 F.2d 519 (1991)

Plaintiff Sea-Land Services, Inc., an ocean carrier, shipped peppers for defendants The Pepper Source, the latter of which didn't pay and later was dissolved, having no assets, anyway. Defendant Gerald J. Marchese owns defendants Pepper Source, Caribe Crown, Inc., Jamar Corp., Salescaster Distributors, Inc., and Marchese Fegan Associates. Marchese also is one of two owners of Tie-Net International, Inc. Marchese didn't create articles of incorporation or keep minutes for the corporations, he runs them out of a single office and a single bank account, he freely shifts money among them, and he takes out interest-free loans for himself. Sea-Land asks for summary judgment that the court pierce The Pepper Source's corporate veil to hold Marchese liable, and then reverese-pierce the other corporations which are alleged alter-egos of Marchese. Illinois allows a corporation to be disregarded when (A) there is "such unity of interest and ownership" that the individual and corporation are not really distinct, and (B) recognizing a corporate distinction would "sanction a fraud or promote injustice." Are the corporations merely alter egos of Marchese? Held Yes. Following Van Born Co. v. Future Chemical & Oil Corp., 753 F.2d 565 (7th Cir. 1985), Illinois uses four factors to determine the absence of a distinct corporate identity: "(1) the failure to maintain adequate corporate records or to comply with corporate formalities, (2) the commingling of funds or assets, (3) undercapitalization, and (4) one corporation treating the assets of another corporation as its own." Here Marchese didn't maintain records, commingled funds, and treated the corporate bank account as his own—he didn't even use a separate, personal bank account. Is it evident for summary judgment that recognizing a corporate distinction "sanction a fraud or promote injustice?" Held No. It would be almost impossible to prove fraud for the purpose of summary judgment. "Promoting injustice" in Illinois means that some "wrong" beyond a creditor's inability to collect would result—e.g. the common sense rules of "adverse possession would be undermined; former partners would be permitted to skirt the legal rules concerning monetary obligations; a party would be unjustly enriched; a parent corporation that caused a sub's liabilities and its inability to pay for them would escape those liabilities; or an intentional scheme to squirrel assets into a liability-free corporation while heaping liabilities upon an asset-free corporation would be successful." Without this requirement, every piercing-the-corporate-veil suit would automatically pass the second prong of the test. Here the plaintiff has not shown any injustice beyond the lack of ability to collect on a contract, so summary judgment is denied.

United States v. Bestfoods, United States Supreme Court, 524 U.S. 51 (1998)

Congress passed the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) to establish a "Hazardous Substance Superfund" for financing industrial pollution cleanups, and to sue persons who, at the time of pollution, "owned or operated" the facility in question. In 1957 Ott Chemical Co. (Ott I) began polluting. CPC International Inc. created a wholly owned subsidiary, Ott Chemical Co. (Ott II), to buy the assets of Ott I. Several officers of CPC were also officers in Ott II. In 1972 CPC sold Ott II to Story Chemical Company, which later went bankrupt. Michigan Department of Natural Resources (MDNR) found extensive environmental damage and negotiated with Aerojet-General Corp. to buy and clean up the property. Aerojet created a wholly owned California subsidiary, Cordova Chemical Company (Cordova/California), to run the site. By 1981 the Environmental Protection Agency was trying to get things cleaned up once and for all, and in 1989 sued CPC, Aerojet, Cordova/California, Cordova/Michigan, and Arnold Ott, an officer of Ott II, now defunct. Is a parent company responsible under CERCLA for the actions of its subsidiary corporation? Held Souter: No. It is a general principle that a parent corporation is not liable for the acts of its subsidiaries unless the corporate veil is pierced, and nothing in CERCLA changes this "bedrock principle." Does control of Ott II by CPC and of Cordova/California by Aerojet-General meet the "owned or operated" requirement of CERCLA for liability? Held No. A parent corporation's ownership and control of a subsidiary which operates a facility does not transitively mean that the parent corporation therefore operates the facility. Does individuals' positions as officers both in CPC and Ott II serve to confer facility operation to CPC? Held Not necessarily. Parent companies regularly place officers on the boards of subsidiaries, and it is assumed that these individuals change hats when representing the parent and the subsidiary. However, there can be "actions directed to the facility by an agent of the parent [which] are eccentric under accepted norms of parental oversight of a subsidiary's facility" and thereby confer ownership. The Court of Appeals, with its mistaken view of CERCLA, did not collect enough information of the "degree and detail" of such a possibility, so its judgment is vacated and the case remanded for further proceedings.

Francis v. United Jersey Bank, Supreme Court of New Jersey, 432 A.2d 814 (1981)

Pritchard & Baird Intermediaries Corp. was a reinsurance broker, working with a ceding insurance company to help it spread its risk by getting a reinsurer to share large exposures. Pritchard & Baird had five directors: Charles Pritchard, Sr., his wife Lillian Pritchard, their son Charles Pritchard, Jr., George Baird and his wife Marjorie; these were joined by another Pritchard son, William Pritchard. Eventually Charles, Jr. became president and William became executive vice president. They comingled company funds with those of ceding companies and reinsurers, and took out large "loans" from these funds without paying interest. These "loans" eventually exceeded $12,000,000. Mrs. Pritchard knew virtually nothing about the business and visited the corporate office only once. Does Mrs. Pritchard, a director of the corporation, have a duty to prevent the misappropriation of funds by officers of the corporation? Held Yes. N.J.S.A. 14A:6-14 says that directors must "discharge their duties in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions." This parallels the Model Business Corporation Act § 43. "A director is not an ornament, but an essential component of corporate governance," and hence "should acquire at least a rudimentary understanding of the business of the corporation," and is "under a continuing obligation to keep informed about the activities of the corporation." Did Mrs. Pritchard breach her duty of care to the company clients? Held Yes. If she would have read the annual financial statements she would have known that her sons were withdrawing funds under the guise of "shareholder loans," and that these "loans" were escalating—that "her sons were converting trust funds." Held Is Mrs. Pritchard's breach of duty a proximate cause of the loss? Held Yes. Although "[c]ases involving nonfeasance present a much more difficult causation question than those in which the director has committed an affirmative act of negligence leading to the loss[,] … [h]er duties extended beyond mere objection and resignation to reasonable attempts to prevent the misappropriation of the trust funds." While it might be difficult for a director to stop general mismanagement, an illegal "loan" could likely have been deterred by an objection or "consultation with an attorney and the threat of suit." Her sons knew that she was not reviewing their conduct, and thus "[h]er neglect of duty contributed to the climate of corruption," making her conduct "a substantial factor contributing to the loss" and her negligence "a proximate cause of the misappropriations."

In re Caremark International Inc. Derivative Litigation, Delaware Court of Chancery, 1996, 698 A.2d 959

Caremark (which was later spun off from Baxter International, Inc.) provided patient care and managed care services, with revenues derived from third party payments, insurers, and Medicare and Medicaid reimbursement programs. The Anti-Referral Payments Law ("ARPL") prohibited remuneration for referral of Medicare or Medicaid patients. Caremark had several questionable practices that included entering into service agreement with recommending physicians. After an investigation was started by the HHS Office of the Inspector General ("OIG"), Caremark pay management fees to such physicians and continued to update and distribute its "Guide to Contractual Relationships" governing contracts with physicians and hospitals. Inside and outside counsel advised Caremark's directors that their contracts were in accord with the law, although Caremark did note on its annual report that the outcome of continuing investigations was unknown. As a result of the investigations by the United States Department of Health and Human Services and the Department of Justice, Caremark was indicted with multiple felonies and a settlement was eventually reached. The company sued its board of directors claiming that they breached their duty of care to Caremark. Did the directors breach a duty of care in failing to discover that company employees were violating non-kickback laws? Held No; such claims are "extremely weak" in this case. "[A]bsent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company's behalf." To show breach of duty to adequately control employees, one must show either "(1) that the directors knew or (2) should have known that violations of law were occurring and, in either event, (3) that the directors took no steps in a good faith effort to prevent or remedy that situation, and (4) that such failure proximately resulted in the losses complained of…." Here the directors did not know the statutes were being violated, and were in fact informed by experts that the company's practices were lawful. The burden for meeting the alternative test, that of failure to investigate and monitor employee activity, is even higher to meet, requiring a showing of "lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight…." Rather than displaying a sustained lack of oversight, the directors here seemed to have made a good faith effort to be informed of relevant facts. "If the directors did not know the specifics of the activities that lead to the indictments, they cannot be faulted."

Joy v. North, United States Court of Appeals, Second Circuit, 692 F.2d 880 (1982)

"[L]iability is rarely imposed upon corporate directors or officers simply for bad judgment and this reluctance to impose liability for unsuccessful business decisions has been doctrinally labelled the business judgment rule." This is because shareholders voluntarily undertake the risk of bad business judgment; after-the-fact litigation is not the best way to evaluate business judgements, as hindsight often makes the correct decision seem more clear that it was at the time; and it would not be in the best interest of shareholders for the law to "create incentives for overly cautious corporate decisions," because large risk sometimes leands to the greatest profit.

Smith v. Van Gorkom, Supreme Court of Delaware, 488 A.2d 858 (1985)

Trans Union Corporation was a publicly-traded, diversified holding company which made money by leasing railcars. The company had trouble generating sufficient income to offset increasingly large investment tax credits (ITCs), so it eventually considered merging with a company with higher income. Van Gorkom, CEO and Chairman of the Board, met with CFO Donald Romans and other senior management and did quick calculations on whether $50 or $60 a share would be sufficient for a leveraged buyout. Van Gorkom then went to talk to Jay A. Pritzker and privately offered him a deal for $55 per share, to merge Trans Union into New T Company, a wholly-owned subsidiary of Pritzker's Marmon Group, Inc. After Pritzker later came back with a positive response, Van Gorkom met with senior management, who were against the deal, and then met with the board of directors and showed them the agreement, saying that Pritzker's deal had a time limit—and not revealing that Van Gorkom had first proposed $55 per share. The board members on September 20, 1980 accepted the agreement, as the market price of the stock had never hit $40 per share. They sent out a press release announcing a "definitive" merger agreement, but according to the merger agreement could not solicit other bids during the "market test" period before the merger was finalized. The shareholders approved the merger. Did the board of directors breach their duty to the stockholders and thus were grossly negligent? Held Horsey: Yes. The business judgment rule "is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Here burden has been met to show this presumption incorrect, that the dirctors made "an unintelligent or unadvised judgment." A director has a duty under 8 Del. C. § 251(b) "to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders." The directors here did not review the merger agreement in depth and immediately approved it, without ensuring that the price offered was what the company was worth. If they would have inquired they would have found out that no study of company worth had been done and that Van Gorkom had actually first suggested the $55 price in negotiations. Were the post-September 20 actions of the board informed and "sufficient to legally rectify and cure the Board's derelictions of September 20[?]" Held No. The board did not solicit other offers, and published a press release which, using the term "definitive agreements to merge," did not publicly encourage other offers. Did stockholder approval have "the legal effect of curing any failure of the Board to reach an informed business judgment in its approval of the merger[?]" Held No, the stockholders "were not fully informed of all facts material to their vote" on the merger. The directors, having acted as one, are liable to the extent that the fair value of Trans Union exceeds the merger price of $55 per share. Dissent McNeilly: "The majority opinion reads like an advocate's closing address to a hostile jury." Rather than being taken in by a "fast shuffle" by Van Gorkom and Pritzker, the directors knew what they were doing—the inside directors had decades of combined experience, and the outside directors included a professor of economics, a statiticians, a deans of a business school, a lawyer, a CPA, and a presidents of another company. These directors did not make an uninformed business judgment.

Shlensky v. Wrigley, Appellate Court of Illinois, 237 N.E.2d 776 (1968)

Philip K. Wrigley was president and owner of approximately 80% of the shares of the Chicago National League Ball Club (Inc.), which operated the Chicago Cubs. The Cubs sustained operating losses from direct baseball operations from 1961-1965. the other directors wouldn't install lights at Wrigley Field so that the Cubs could play at night when at home, even though the other 19 major league teams schedule night games. Wrigley said that baseball is a day sport and that playing at night would adversely affect the surrounding neighborhood. Plaintiff filed a derivative stockholders' suit against Wrigley and the company, claiming that night games would help the company's financial condition, and that the sales from attendance at night games would pay for the cost of the lights. Have the directors been negligent in failing to exercise reasonable care and prudence in the management of the corporate affairs by making decisions, not out of a good faith concern for the company, but for personal views? Held No. Nothing in the complaint even borders on no fraud, illegality or conflict of interest in the directors' decision. The effect on the surrounding neighborhood is something to be considered when making company decisions, as that affects who attends games as well as the value of the property. There is no allegation that this decision damaged the company, or that playing night games would on balance help the company—the plaintiff didn't even take into consideration how much it would cost to maintain the lights. It even appears that that "factors other than attendance affect the net earnings or losses." For negligence the court must find a derilection of duty, and directors are allowed to make individual judgements—"mere failure to 'follow the crowd' is not such a dereliction."

Arnold v. Society for Savings Bancorp, Inc., Supreme Court of Delaware, 650 A.2d 1270 (1994)

BBC Connecticut Holding Corporation ("BBC"), a wholly-owned Connecticut subsidiary of Bank of Boston Corporation ("BoB"), a Massachusetts corporation, was merging into Society for Savings ("Society"), a wholly-owned Connecticut subsidiary of Society for Savings Bancorp, Incorporated ("Bancorp"), a Delaware corporation. Plaintiff alleged that the merger proxy statement had omissions and misrepresentations. Article XIII of Bancorp's certificate of incorporation parallels Delaware's General Corporation Law § 102(b)(7), which allows elimination or limitation of the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except if there is breach of duty of loyalty or intentional or knowing misconduct. Plaintiff argued that legislative history indicates that § 102(b)(7) should not apply to disclosure violations. Does § 102(b)(7) allow elimination of liability for incorrect disclosure? Held Veasey, Chief Justice: Yes. Section 102(b)(7) provides protection "for breach of fiduciary duty," which includes disclosure requirements. As the statute is clear and unambiguous on its face, there is no need to examine legislative history. (In any event, legislative history is not in conflict with this interpretation.) Does the conduct fall under one of the § 102(b)(7) exceptions because it violated the duty of loyalty or was was knowing or intentional? Held No, the facts of the case are not sufficient to show violation of duty of loyalty, and the "intentional violation argument is unsupported by the record." Did the defendants waive their § 102(b)(7) contractual protection? Held No, any such waiver must be clear and unambiguous. Vague references, such as the defendants suggesting the court "determine the value of non-disclosure," are not sufficient to qualifiy as a waiver.

WLR Foods, Inc. v. Tyson Foods, Inc., United States Court of Appeals, Fourth Circuit, 65 F.3d 1172 (1995)

Tyson Foods, Inc. tried to acquire WLR Foods, Inc., a chicken and turkey producer. The WLR board didn't like this idea and adopted defensive measures against the takeover. Tyson presented the offer to the WLR stockholders, but then withdrew the offer claiming that the WLR board's defensive measures devalued the company. Tyson represented to the court that WLR's defensive measures were illegal. Virginia Code Ann.… 13.1-690 states that a director must discharge his/her duties with "good faith business judgment of the best interests of the corporation …." Should the court allow Tyson access to the substantive content of the materials used by the WLR Board in responding to Tyson's takeover attempt? Held No, § 690 only makes an issue the good faith business judgment of the directors, not the rationality that ultimately guided the decision. Tyson should only be allowed access to "the procedures followed by the WLR directors during their investigation of Tyson's offer that indicated whether or not they were considering the offer in good faith," not "the actual substantive information that was used by the directors in making their decision regarding the offer." Unlike the parallel Model Act § 8.30, which uses the standard of an "ordinarily prudent person," the Virginia legislature intentionally left out any reference to a "reasonable person," thereby "protect[ing] the utterly inept, but well-meaning, good faith director."

Lewis v. S.L. & E., Inc., United States Court of Appeals, Second Circuit, 629 F.2d 764 (1980)

Leon Lewis, Sr. formed Lewis General Tires, Inc. ("LGT") in Rochester, New York in 1933, and 10 years later formed S.L. & E., Inc. ("SLE") which functioned as a shell corporation for the benefit of LGT, owning and leasing it a section of property, SLE's only asset. In 1962 Leon, Sr. transferred his SLE stock to his six children, Richard, Alan, Leon, Jr., Donald, Margaret, and Carol, with an agreement that those not a shareholder of LGT would in 1972 sell all SLE shares to LGT. When LGT's lease on the property expired in 1966 the SLE board did not renew the lease but allowed LGT to continue paying $14,400 per year. All SLE directors, including Richard, Alan and Leon, Jr., were also directors of LGT. In 1972 Donald sued his brothers, refusing to sell his shares to LGE until the value of the shares were revalued, claiming that his brothers had wasted the corporate asset of SLE by not charging LGT a sufficiently high rental price. The defendants, Richard, Alan and Leon, Jr., showed evidence that the neighborhood prices had declined over the period from 1966 to 1972, and that in 1973 and 1974 other property in the area had brought lower per-square-foot rental prices. Does the plaintiff have a burden of proof in proving that a contract was fair and reasonable when the directors of the corporation have an interest on both side of a contract? Held No. BCL § 713 says that if a corporation contracts with an entity in which the directors have an interest, the contract may be set aside unless the director(s) promoting the contract "shall establish affirmatively that the contract or transaction was fair and reasonable as to the corporation at the time it was approved by the board…." Here the defendants were directors of both corporations involved in the rental agreement, so they have the burden to show that the conflict of interest agreement did not adversely affect the plaintiff, who was only a stockholder in one of the corporations. Did the defendants meet their burden of proof in showing that rental prices to LGT were adequate between 1966 and 1972? Held No. Although the defendants showed evidence that the property value had went down and that rental prices were low in 1973 and 1974, they did not provide adequate proof of the rental worth during 1966 and 1972. (Although defendants showed some proof that LGT could not afford a higher rental price, this evidence was not persuasive and moreover SLE might have been able to find other tenants who could have paid more.) The defendants are therefore liable to the plaintiff for the amount by which any higher rental price would have increased the value of the plaintiff's shares in SLE.

Marciano v. Nakash, Supreme Court of Delaware, 535 A.2d 400 (1987)

Georges, Maurice, Armand and Paul Marciano formed Guess? Inc. in California to design and sell jeans. Ari, Joe, and Ralph Nakash owned the jean manufacturer Jordache Enterprises, Inc. in New York. They went together and formed Gasoline, a subsidiary of Guess, equally splitting stock ownership and board composition. The Marcianos stopped participating in loan guarantees from Israel Discount Bank in New York, so the Nakashes withdrew their guarantees as well, causing the bank to terminate its loan of $1.6 million. So that Gasoline could pay its bills and acquire inventory, the Nakashes then advanced $2.3 million of their personal funds, eventually allowing one of their entities, U.F. Factors, to take over the loan. Because of deadlock, Gasoline was placed in custodial status, and if allowed the debt to the Nakashes and their entities would exhaust Gasoline's assets, leaving nothing for shareholders. Is a contract made by an interested director per se voidable regardless of a showing of fairness and good faith? Held No. Although the common law holds that self-interested dealing without shareholder ratification is constructively fraudulent; and although Section 144 of the Delaware General Corporation Law provides several bases for immunizing self-interested transactions—none of which, including shareholder approval, were applicable here; Delaware cases have formed a two-part test for determining voidability: "application of section 144 coupled with an intrinsic fairness test." Section 144 is not exclusive. "When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain." (Here the Nakashes couldn't appeal to section 144 anyway, because of shareholder deadlock.) Was the Nakash loan to Gasoline intrinsicly fair? Held Yes. The loan provided by the Nakashes was at a rate comparable to that of other lenders, and the Nakashes showed that they made the loan with "the bona fide intention of assisting Gasoline's efforts to remain in business."

In re Wheelabrator Technologies, Inc. Shareholders Litigation, Court of Chancery of Delaware, 663 A.2d 1194 (1995)

Held In Delaware only two types of voidable acts by management have been held automatically curable by shareholder approval: (1) actions by directors that exceed the board's authority but does not constitute ultra vires, fraud, or waste; and (2) when directors did not exercise care in informing themselves before executing a transaction. For duty of loyalty transactions, if a majority of disinterested stockholders approve a transaction by an interested director, 8 Del. C. § 144(a)(2) requires that the business rule be applied, limiting judicial review to issues of gift or waste, with the burden of proof on the party attacking the transaction. In another duty of loyalty situation, a transaction between a corporation and its controlling shareholder, a parent-subsidiary merger that requires and receives "majority of the minority" stockholder approval will shift the burden of showing entire fairness from the directors to the plaintiff. [This holding does not agree with Model Act § 8.61(b), which allows shareholder approval to cure interested transactions if it complies with the "care, best interests and good faith criteria" of the Act.]

Broz v. Cellular Information Systems, Inc., Supreme Court of Delaware, 673 AM 148 (1996)

Robert F. Broz is the president and sole stockholder of RFB Cellular, Inc., and also an outside director of Cellular Information Systems, Inc., both competing Delaware corporations. In April of 1994, Mackinac Cellular Corp. wanted to sell its Michigan-2 Rural Service Area Cellular License, and contacted RFBC. As CIS had just emerged from Chapter 11 proceedings, had sold many of its licenses, and was not financially able to buy more licenses, Mackinac did not contact CIS. Broz on June 13 talked to a couple of CIS directors, who verified that CIS could not afford and did not want the license. On June 28 PriCellular, Inc. agreed to acquire CIS, but funding problems later made it seem as if the deal would fall through. In September 1994 PriCellular entered and option agreement to buy the Michigan-2 license, but on November 14 Broz paid the requisite amount to bypass the option and bought the Michigan license. On November 23 PriCellular completed its financing and closed its tender offer for CIS. Did Broz breach his fiduciary duty to CIS by taking advantage of a corporate opportunity roperly belonging to CIS? Held Veasey, Chief Justice: No. The corporate opportunity doctrine is "judicially crafted" and "seeks to reduce the possibility of conflict between a director's duties to the corporation and interests unrelated to that role." As formulated by Guth v. Loft, Inc., "a corporate officer or director may not take a business opportunity for his own if: (1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation's line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation." The corollary to this is that "a director or officer may take a corporate opportunity if: (1) the opportunity is presented to the director or officer in his individual and not his corporate capacity; (2) the opportunity is not essential to the corporation; (3) the corporation holds no interest or expectancy in the opportunity; and (4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity." All these factors must be balanced—none are dispositive. Here CIS was not financially able to purchase the license, and management had indicated that it was not currently interested in acquiring new licenses; consequently Broz' interest in the license was not inimicable to his obligations at CIS. (Formally presenting the matter to the board would have provided a "safe harbor" for Broz, but this is not required. Broz' mentioning the matter to two directors should not be considered a formal presentation to the board, but it does lend credence that Broz' actions were in good faith.) Does a director when presented with an opportunity have a duty to consider the interests of an acquiring company? Held No. PriCellular had not yet acquired CIS, and "plans to do so would still have been wholly speculative." The financial cabilities of PriCellular were moreover less than certain. "The right of a director or officer to engage in business affairs outside of his or her fiduciary capacity would be illusory if these individuals were required to consider every potential, future occurrence in determining whether a particular business strategy would implicate fiduciary duty concerns. In order for a director to engage meaningfully in business unrelated to his or her corporate role, the director must be allowed to make decisions based on the situation as it exists at the time a given opportunity is presented."

Northeast Harbor Golf Club, Inc. v. Harris, Supreme Judicial Court of Maine, 661 A.2d 1146 (1995)

Nancy Harris had been president of Northeast Harbor Golf Club, a Main corporation, since 1971. She occasionally brought up the idea of developing property surrounding the golf course, but the directors would have nothing of it. In 1979 a real estate broker told Nancy, in case the club was interested in buying, about the Gilpin property, "which comprised three noncontiguous parcels located among the fairways of the golf course" and included a right of way on which the golf course clubhouse and parking lot were located. Nancy bought the propety herself and later told the board, indicating that she had no development plans. In 1984 Nancy learned of the availability of the Smallidge property, surrounded on three sides by the golf course. She mentioned to a few board members her intention to purchase, and then later informed the board that she had bought the Smallidge property. In 1988 Nancy and her children separated the property into lots and started plans for a subdivision named Bushwood on the Gilpin property. The board asked Nancy to resign in 1990 and in 1991, after a change in the makeup of the board, the Club sued Nancy for breaching her fiduciary duties. What standard should be used to determine whether Nancy breached her duty of loyalty as a corporate officer by taking advantage personally of a corporate opportunity? Held Here in Maine we have decided to use an ALI restatement. Justice Cardozo noted in Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545, 546 (1928) that "A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate." Delaware in Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939) uses a "line of business" test, but this is vague: the Club might be interested in developing property even though it wasn't in that line of business, and even if the Club couldn't afford all the property it might have been able to purchase enough property to prevent a housing development. Massachusetts in Durfee v. Durfee & Canning, Inc., 323 Mass. 187, 80 N.E.2d 522 (1948) uses a "fairness test," but this "provides little or no practical guidance." Minnesota in Miller v. Miller, 301 Minn. 207, 222 N.W.2d 71 (1974) creates a two-step analysis which "merely piles the uncertainty and vagueness of the fairness test on top of the weaknesses in the line of business test." "At bottom, the corporate opportunity doctrine recognizes that a corporate fiduciary should not serve both corporate and personal interests at the same time." We instead therefore adopt the ALI Principles of Corporate Governance § 5.05 (May 13, 1992), which creates an absolute requirement that a director or senior executive first present to the corporation and the corporation reject any corporate opportunity, defined as an opportunity closely related to the business or discovered in connection with the person's duties in a situation reasonably believed to be of interest to the corporation or intended to be offered to the corporation. The case is remanded so that the trial court may make further factual findings to determine if such a full disclosure took place under § 5.05.

Sinclair Oil Corp. v. Levien, Supreme Court of Delaware, 280 A.2d 717 (1971)

Perlman v. Feldmann, United States Court of Appeals, Second Circuit, 219 F.2d 173 (1955)

Russell Feldmann was chairman and president of Newport Steel Corporation, as well as its majority stockholder through his family. As the market for steel tightened during the Korean War, a syndicate organized as Wilport Company, a Delaware corporation, which consisted of end-users of steel who were interested in securing a source of steel, approached Feldmann and bought control of Newport Steel for $20 per share—even thugh the stock was trading under $12 and had a book value of $17.03. The shareholders sued Feldmann for breach of fiduciary duty to the corporation and to shareholders. Does a director and majority stockholder have a fiduciary duty to the corporation and to stockholders not to sell stock to the detriminet of the company? Held Clark: Yes. Controlling stock has an inherent power that is the asset of a corporation, held in trust by the majority stockholder. If a shareholder who is a director acts in a way that can have personal ramifications at odds with the benefit of the business, "it is presumed … that self-interest will overcome his fidelity to his principal, to his own benefit and to his principal's hurt," and "fiduciaries always have the burden of proof in establishing the fairness of their dealings with trust property …." It is possible that Newport could have used the steel shortage to secure interest-free advances from prospective purshasers—the "Feldmann Plan"—or build up patronage in the geographical area, rather than selling control to buyers who would profit from access to the steel. Because of this presumed lost opportunity which was not rebutted by the defendant, Feldmann is liable to stockholders for the difference in the stock that was sold and the value of the stock minus any power gained from its majority status. (The defendant would not be liable if the sale was to an outsider or interested customer, as such a sale would not have been at odds with the interest of the company.) Dissent Swan: I agree with the majority that Feldmann had a fiduciary duty, but the majority isn't clear on to whom the duty was due, and whether the duty arose from Feldmann as a directory or Feldmann as a stockholder. A majority stockholder doesn't breach a duty when selling control of the company unless he/she knows that the buyer will be a detriment to the company, and here Feldmann did not know that Wilport would injure Newport, even though he knew that Wilport wanted to put in directors to allow its members to purchase more steel than they otherwise would. If the majority asserts that Feldmann breached his duty as director, that would only be the case if Feldmann received a premium for the stock that was a payment his vote in the next directors' elections. There is no evidence that the price of the stock included such a payment; its higher price is appropriate for its inherent control. Finally, if the majority is correct in that the duty breached consisted in selling the controlling power inherent in the stock as an asset of the company, then why didn't the majority say that Feldmann breached a duty to the company rather than to the stockholders?

Weinberger v. UOP, Inc., Supreme Court of Delaware, 457A.2d701 (1983)

Signal was a diversified, technically based company operating through various subsidiaries. Signal in 1974 sold one of its wholly-owned subsidiaries and decided to invest its resulting cash surplus in UOP, Inc., formerly Universal Oil Products Company. After friendly negotiations, Signal bought 50.5% of outstanding UOP shares at $21 per share. The portion of this stock purchased from shareholders was oversubscribed. Signal put in only two out of 13 directors. In 1978 Signal couldn't find another suitable investment candidate for its extra cash, so it board charman, William W. Walkup and its president, Forrest N. Shumway conducted a feasibility study showing that it would be worth it to Signal to purchase the rest of UOP for up to $24 per share. Signal notified the rest of UOP that it wanted to perform a cash-out merger at $20 to $21 per share, and the UOP president, Crawford, thought that sounded reasonable. Crawford paid Lehman Brothers $150,000 for a quick fairness opinion, which came back stating that $21 per share was fair. Shareholders were notified, a little over half of them voted, and combined with Signal's controlling shares a total of 76.2% of shares approved of the merger. Minority shareholders of UOP sued. Did Signal directors owe a fiduciary duty to both the parent and the subsidiary corporation? Held Moore: Yes. "[I]ndividuals who act in a dual capacity as directors of two corporations, one of whom is parent and the other subsidiary, owe the same duty of good management to both corporations, and in the absence of an independent negotiating structure, or the directors' total abstention from any participation in the matter, this duty is to be exercised in light of what is best for both companies." The defendant has the burden to establish fairness, which consists of fair dealing and fair price. Did the directors of Signal breach the duty to UOP of fair dealing? Held Yes. Signal did a feasibility study for the merger that resulted in a price of up to $24, but Signal proposed to UOP a price of $21 without revealing the outcome of Signal study. The entire merger discussions were initiated by Signal and were on Signal's timetable, for Signal's benefit. Did the Signal directors breach their duty of fair price in the merger? Held The fair stock price for the merger cannot be determined from the facts. "Fair price obviously requires consideration of all relevant factors involving the value of a company …." The Chancellor accepted the defendant's submitted price valuation that used the so-called "Delaware block" or weighted average method, and rejected the plaintiff's discounted cash flow method of valuing UOPs stock as not corresponding with "either logic or the existing law." "While we do not suggest a monetary result one way or the other, we do think the plaintiffs evidence should be part of the factual mix and weighed as such. Until the $ 21 price is measured on remand by the valuation standards mandated by Delaware law, there can be no finding at the present stage of these proceedings that the price is fair."

Kahn v. Tremont Corp., Supreme Court of Delaware, 1997, 694 A.2d 422

Harold C. Simmons owned 90% of Valhi, Inc., a Delaware corporation conducting a variety of business through subsidiaries. Valhi owned a majority of NL Industries, Inc., a New Jersey corporation selling titanium oxide, and controlled Tremont Corporation, a Delaware corporation selling titanium sponge, ingot and mill products. In 1990 NL believed its stock to be undervalued, so it made several stock repurchases, raising its stock price from $10 to $16. NL finally had a "Dutch auction" which purchased more shares, mostly from Valhi, after which NL stock fell from $16 to around $13.50. Valhi wanted to drop its ownership in NL from its new 62% (down from 68%) to below 50% so that it could get a tax savings from the proceeds of the Dutch auction, as well as uncouple NL's financial statements from its own. Valhi approached Tremont to buy NL shares, and the Tremont board set up a Special Committee consisting of supposedly independent persons Richard Boushka, Thomas Stafford, and Avy Stein. Although Stein was closely connected to Simmons, he became chairman of the committee. Tremont finally purchased NL stock at $11.75 per share. Kahn, a Tremont shareholder, sued the company claiming that Simmons as a majority shareholder in NL and a controller of Tremont unfairly manipulated Dutch auction and the stock purchase deal to his benefit. Does Simmons as a majority stockholder have a burden of proof to show the deal was not unfair? Held Yes. A transaction involving self-dealing by a controlling shareholder must meet the legal standard of entire fairness, with the burden of persuasion resting on the defendant. This burden may be shifted from the defendant to the plaintiffs if there is a well-functioning committee of independent directors. Here, however, the Special Committee's dominant member, Stein, "had a long and personally beneficial relationship" with Simmons' controlled companies, and all three had previous affiliations with Simmons. "Boushka and Stafford abdicated their responsibility as committee members by permitting Stein, the member whose independence was most suspect, to perform the Special Committee's essential functions." The Special Committee followed Tremont's advice on hiring professional advisors, who might have influended those in the committee. "The failure of the individual directors to fully participate in an active process, severely limited the exchange of ideas and prevented the Special Committee as a whole from acquiring critical knowledge of essential aspects of the purchase." The presence of the Special Committee was therefore not sufficient to shift to the plaintiff the burden of showing absence of entire fairness.

Farris v. Glen Alden Corp., Supreme Court of Pennsylvania, 143 AM 25 (1958)

Glen Alden was a Pennsylvania coal-mining company. List, a Delaware holding company owning interest in movie theaters, textile companies, and real estate, purchased 38.5% of Glen Alden's outstanding stock through a wholly owned subsidiary and put three List directors on Glen Alden's board. Less than a year later the two corporations entered into a "reorganization agreement" in which Glen Alden would purchase most of the the assets of List in return for stock, Glen Alden would assume List's liabilities, Glen Alden would change its name to List Alden, the directors of both corporations would become the directors of List Alden, and List would be dissolved with List Alden carrying on the operations of both corporations. Section 908, subd. A of the Pennsylvania Business Corporation Law required, if there is a corporate merger, that any objecting shareholder be allowed to exchange his/her stock for fair value. Plaintiff sued, as he was not given this option. Should this contract for asset purchase be classified as a merger for the purposes of Section 908? Held Cohen: Yes. As new forms of transactions have created hybrid forms of mergers, "it is no longer helpful to consider an individual transaction in the abstract," and instead "we must refer not only to all the provisions of the agreement, but also to the consequences of the transaction and to the purposes of the provisions of the corporation law said to be applicable." A corporation which "combines with another so as to lose its essential nature and alter the original fundamental relationships of the shareholders among themselves and to the corporation" is a de facto merger to which Section 908 applies. Here after the "asset purchase" the company would be doing different business, have twice as many assets but seven times the debt, and the plaintiff's stock would have a much lower book value. Even though Section 908 has specific language exempting asset purchase agreements, "we will not blind our eyes to the realities of the transaction." Because the shareholders weren't notified according to Section 908, the agreement is invalid and the directors are enjoined from carrying out the agreement.

Hariton v. Arco Electronics, Inc., Supreme Court of Delaware, 188 A.2d 123 (1963)

Defendant Arco and Loral Electronics Corporation, a New York corporation, both deal in electronic equipment. They entered into a "Reorganization Agreement and Plan" in which Arco agrees to sell its assets to Loral for Loral stock, to voluntarily dissolve, and to distribute the Loral stock to its shareholders. At an Arco meeting the stockholders approved the plan, but one stockholder not at the meeting sued, claiming the agreement was a de facto merger and was therefore illegal. Is a sale of assets that has the same effect as a merger illegal? Held Southerland: No. Deleware has a merger statute, and it also has § 271 allowing the sale of assets in exchange for stock. A corporation can decide to effect a merger with either method, as they are of "equal dignity" in effecting the same result through different means that may have different tangential consequences, such as the elimination of accrued dividends.

Knapp v. North American Rockwell Corp., United States Court of Appeals, Third Circuit, 506 F.2d 361 (1974)

Cheff v. Mathes, Supreme Court of Delaware, 199 A.2d 548 (1964)

Holland Furnace Company, a Delaware corporation, sold home heating equipment, and after its reorganization after World War II its sales started to increase again, seemingly due to its force of retail salespeople. Holland's stock started going up, but it was not until Mr. Arnold H. Maremont, President of Maremont Automotive Products, Inc. and Chairman of the boards of Motor Products Corporation and Allied Paper Corporation, met with Mr. Cheff, CEO of Holland, that Holland's directors became aware of the reason for the stock rise: Mr. Maremont had been buying Holland stock and wanted Holland to merge with Motor Products. Mr. Cheff explained that Holland's sales practices were incompatible with that of Motor Products, so Mr. Maremont apparently was no longer interested. However, Mr. Maremont continued to buy stock, and Holland's directors came to believe that Mr. Maremont had purchased and liquidated other companies for a quick profit and that he intended to do the same at Holland; in any case, Mr. Maremont expressed to Mr. Cheff that he intended to do away with the Holland sales force because "he felt furnaces could be sold as he sold mufflers." To prevent a takeover by Mr. Maremont, the Holland directors borrowed money and purchased all of Mr Maremont's Holland stock for above the market price. Some shareholders sued the directors alleging that the stock repurchase was not to better the company but to ensure the directors remained in office. Do the directors have the burden of proof to show presence of good faith? Held Yes. Although normally the business judgment rule presumes directors acted in good faith, the purchasing of shares in the face of a threat of control is a special case creating a conflict of interest and, in Delaware, placing the burden of proof on the directors. (This is not the same extent of burden as any director, such as Mr. Cheff, who has a pecuniary interest in the corporation through large stock holdings.) Did the directors have reasonable grounds to believe that a danger to corporate policy and effectiveness existed by the presence of the Maremont stock ownership? Held Yes. Whether or not Mr. Maremont intended to liquidate the company, the directors were given evidence, such as Dunn and Bradstreet reports, that Mr. Maremont had a history of company acquisition and liquidation. Mr. Maremont indicated to Mr. Cheff that he intended to eliminate the Holland retail sales force, and he also demanded a place on the board. Corporate officers had made an investigation of Mr. Maremont disclosing a poor reputation, and directors are allowed to rely on reports of corporate officers. The directors therefore had reasonable grounds to believe that a takeover by Mr. Maremont would not be in the best interest of the corporation.

Unocal Corp. v. Mesa Petroleum Co., Supreme Court of Delaware, 493 A.2d 946 (1985)

Plaintiffs Mesa Petroleum Co., Mesa Asset Co., Mesa Partners II, and Mesa Eastern, Inc. tried to take over Unocal Corporation with a two-tier "front loaded" cash tender offer at $54 per share, with a "back-end" mop-up of exchanging shares for junk bonds worth less than $54 per share. Goldman Sachs & Co. and Dillon, Read & Co. made presentations to Unocal illustrating that the Unocal stock was worth more than $54 per share and that Unocal could defeat the offer by purchasing its own stock for $70-$75 per share. The Unocal directors agreed to purchase its own stock for $72 per share but to exclude Mesa from the stock repurchase. Does the Unocal board of directors have the power to take defensive measures against a takeover? Held Yes, the directors have a "fundamental duty and obligation to protect the corporate enterprise," and may deal in the corporations own stock. Were the directors acting in good faith? Held Yes. Normally the business judgment rule would cover give a presumption to director actions, but if corporate funds are used to purchase company stock to remove a threat takeover, there is a conflict of interest and directors must show that they had "reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person's stock ownership." The directors must show that they have not "acted solely or primarily out of a desire to perpetuate themselves in office." Here the directors had reason to believe that Mesa was offering a "grossly inadequate two-tier coercive tender offer coupled with the threat of greenmail" and that action against this was needed. Was the directors' action reasonable in relation to the threat posed? Held Yes. The board may take into account "inadequacy of the price offered, nature and timing of the offer, questions of illegality, the impact on 'constituencies' other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally), the risk of nonconsummation, and the quality of securities being offered in the exchange." In order to meet the "grossly inadequate offer," the directors acted upon options presented by experts to defeat the takeover and to provide adequate exchange to its shareholders. Should Unocal be allowed to treat its shareholders differently by excluding Mesa from the exchange with Unocal stockholders? Held Yes. Recently boards have been allowed to create a variety of takeover defense measures. Although the exchange offer is a form of selective treatment, it was appropriate in the face of the takeover threat—otherwise, Unocal would have been funding the Mesa takeover by buying shares from Mesa at a higher price.

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Supreme Court of Delaware, 506A.2d 173 (1986)

After Revlon, Inc. turned down its friendly takeover offer, Pantry Pride, Inc. attempted to take over Revlon by buying shares at $45 per share. Revlon directors, feeling that the price was inadequate and fearing that Pantry Pride would acquire Revlon through junk bonds and then liquidate the company, adopted a Note Purchase Rights Plan which allowed shareholders to purchase rights with 12% interest which would kick in in a takeover attempt but that Revlon could redeem for 10 cents apiece. Pantry Pride raised its price to $47.50, so Revlon attempted to purchase 10 million shares in exchange for notes of $47.50 principal at 11.75%. Pantry Pride made a new offer for $42 a share for 90% of the shares, offering to pay more if Revlon removed the impending Rights. Revlon then negotiated with Forstmann Little & Co. for a leveraged buyout, allowing them access to privileged financial data, after which the value of the Notes dropped substantially. Forstmann agreed to support the par value of the Notes, so the Revlon board agreed to a lock-up of Revlon's Vision Care and National Health Laboratories for a lower price, agreed to a no-shop provision, and then agreed to a Forstmann buying because "(1) it was for a higher price than the Pantry Pride bid, (2) it protected the noteholders, and (3) Forstmann's financing was firmly in place." Should Pantry Pride be granted a preliminary injunction against the sale? Held Moore: Yes. A preliminary injunction should be granted when there is "both a reasonable probability of success on the merits and some irreparable harm which will occur absent the injunction." Here it is likely that the Revlon board will be shown to have have violated the duty of loyalty, and Pantry Pride will lose its opportunity to bid for Revlon. Normally the business judgment rule will allow a presumption that the directors operated in informed good faith for the good of the company, but as Unocal pointed out, when a board implements anti-takeover measures the directors have a burden to show they had reasonable grounds for believing there was a danger to the corporation by showing good faith and investigation, as well as a burden to show that the responsive action is reasonable in relation to the threat posed. Was the Rights Plan a reasonable response to a reasonably perceived threat? Held Yes. The directors reasonably believed that the takeover was grossly inadequate and would result in liquidation of the company, and such a "poison pill" was reasonable to ward off the takeover threat. Was the company's own exchange offer for 10 million shares a reasonable response to a reasonably perceived threat? Held Yes. A corporation can deal in its own stock, but in light of a takeover the directors' actions, according to Unocal, must be in the best interest of the corporation and its stockholders, not out of self-interest. As Pantry Pride continued raising its price and was not thwarted by the Rights Plan, the directors reasonably thought that the company's purchasing its own stock would prevent what was reasonably considered a takeover at an inadequate price. Was the lock-up of assets with Forstmann and a deal to uphold the Notes a reasonable response to a reasonably perceived threat? Held No. After previous efforts failed "it became apparent to all that the break-up of the company was inevitable. … The duty of the board had thus changed from the preservation of Revlon as a corporate entity to the maximization of the company's value at a sale for the stockholders' benefit." Instead, the directors favored the Forstmann offer, which would used financing virtually indistinguishable from that of Pantry Pride, in an attempt to serve the Notes holders rather than the shareholders. The holders of the Notes, after all, purchased them with the understanding that they could be waived to permit the sale of the company at a fair price. "The principal object [of the directors in favoring the Forstmann offer], contrary to the board's duty of care, appears to have been protection of the noteholders over the shareholders' interests." Similarly the no-shop provision, while not illegal per se, is not permissible under Unocal standards when the duty of the board is to get the highest price for the company. "[U]nder all the circumstances the directors allowed considerations other than the maximization of shareholder profit to affect their judgment …" so "the board's action is not entitled to the deference accorded it by the business judgment rule."

Paramount Communications, Inc. v. Time, Inc., Supreme Court of Delaware, 571 A.2d 1140 (1989)

Time Incorporated was proud of its journalistic integrity—its "Time Culture" in which management did not interfere with editorial content. When Time wanted to get into the global entertainment market, it researched and chose Warner Communication, Inc. and negotiated a stock-for-stock merger deal, ensuring that Time directors would remain in control of the combined company. Time also put in place certain defensive measures including an automatic share exhange agreements which would prevent hostile third-party takeovers. At the last minute, Paramount Communications, Inc. initiated an all-cash all-stock offer of $175 per share. Feeling that the price was inadequate and fearful that stockholders would not understand the long-range benefits of the Warner merger over a Paramount takeover, Time directors recast the Warner deal to a cash and securities acquisition, so that a shareholder vote would not be needed. Paramount raised its offer to $200 per share, which Time rejected. Time shareholders sued claiming a breach of Unocal duties, and also claimed along with Paramount a breach of Revlon duties. Did Time, by entering into a proposed merger with Warner, put itself up for sale and thereby trigger Revlon duties to seek the highest price which would result in the biggest gain for shareholders? Held Horsey: No. Unlike in Revlon, the breakup of Time was not inevitable. Revlon duties are only triggered (1) "when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company" or (2) "when, in response to a bidder's offer, a target abandons its long-term strategy and seeks an alternative transaction involving the breakup of the company." Here Time simply initiated a merger agreement as part of its strategic long-term plan. Did Time breach its Unocal duties by the absence of a reasonable threat or by an unreasonable reaction? Held No. Unocal "held that before the business judgment rule is applied to a board's adoption of a defensive measure, the burden will lie with the board to prove (a) reasonable grounds for believing that a danger to corporate policy and effectiveness existed; and (b) that the defensive measure adopted was reasonable in relation to the threat posed." The Unocal anlaysis is not meant to be "a simple mathematical exercise." Even though Paramount's offer was an all-cash, all-shares offer with a reasonable value, Time's directors nevertheless perceived the offer as an objective threat to the corporation because the timing and substance of the offer might confuse shareholders about the benefits of the Paramount offer as compared to the Warner merger. Moreover, Time's investigation of companies before the Warner merger discussions served as adequate investigation of the Paramount takeover offer. Time's precluding its shareholders from accepting the Paramount offer was a reasonable response to the threat. Directors have a duty to set the corporate strategy. "That duty may not be delegated to the stockholders. Directors are not obliged to abandon a deliberately conceived corporate plan for a short-term shareholder profit unless there is clearly no basis to sustain the corporate strategy."

Paramount Communications, Inc. v. QVC Network, Inc., Supreme Court of Delaware, 637 A.2d 34 (1993)

Edgar v. Mite Corp., United States Supreme Court, 457 U.S. 624 (1982)

(853-)

CTS Corp. v. Dynamics Corp. of America, United States Supreme Court, 481 U.S. 69 (1987)

Grimes v. Donald, Delaware Supreme Court, 1996, 673 A.2d 1207

Aronson v. Lewis, Supreme Court of Delaware, 473 A.2d 805 (1984)

Meyers Parking System, Inc., a Delaware corporation, was spun off from Prudential Building Maintenance Corp. Leo Fink, who owns 47% of the outstanding stock, had an employment agreement with Prudiential that he would become a consultant for 10 years after his retirement. A year after retirement, Meyers and Fink entered another agreement for $150,000 per year for five years with automatic renewal, with eventual salary of $100,000 for life, which "was not to be affected by any inability to perform services on Meyers' behalf." Fink at this point was 75 years old. Meyers also made interest-free loans to Fink. Harry Lewis, a Meyers stockholder, filed a derivative suit against all the directors claiming a waste of corporate assets by the contract and loans. Lewis made no demand on the directors, claiming such a demand would be futile. When is demand on directors excused when filing a derivative suit? Held Moore: A reasonable doubt must created that: "(1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." This entire review must be based upon the facts alleged, "although in rare cases a transaction may be so egregious on its face" that it the business judgment rule obviously does not apply. Does the fact that Fink owns 47% of stock raise a reasonable doubt as to the director's disinterest and independence? Held No. Stock ownership alone, less than a majority, is not sufficient proof of control. Even if Fink did have a majority of stock, in the demand context that doesn't remove the presumption that the directors acted in the best interest of the corporation. The plaintiff alleges no facts that would indicate the directors are being controlled by Fink. Are all the directors automatically interested because Lewis is suing all the directors alleging a contract with no consideration and a wasteful loan, thereby possibly making all the directors jointly and severally liable? Held No. In Delaware approving a transaction doesn't excuse one from making a demand to the directors. Lewis hasn't even shown any facts that would uphold a claim of waste, so it may be that he hasn't even stated a claim under Delaware law. Is demand excused because the directors would have to sue themselves, putting the suit "in hostile hands" and preventing its effectiveness? Held No. The directors would only have to sue themselves if a lack of independence and an absence of proper business judgment were shown. Again the plaintiff has not provided any facts to show this is the case.

Auerbach v. Bennett, Court of Appeals of New York, 393 N.E.2d 994 (1979)

There had been rumors that some international companies had made bribes to officials in other countries, so General Telephone & Electronics Corporation's audit committee retained special counsel who, along with Arthur Andersen & Co., found that the company had made more than $11 million worth of bribes and kickbacks outside the United States between 1971 and 1975. Shareholder Auerbach filed a derivative shareholder action on behalf of the corporation against the directors, Arthur Anderson, and the corporation for breach of duty regarding the bribes. The board of directors created a special litigation committee made up of three disinterested directors who had joined the company after the bribes occurred. The special litigation committee found that the claim was without merit, no duty having been breached by the directors or Arthur Anderson; that the litigation would unnecessarily take up company time and resources and cause bad publicity; and asked the court to dismiss the complaint or grant summary judgment on the merits. Should the court defer to the special litigation committee and dismiss the case on its merits? Held Jones: Yes. The court's examining the merits of the special litigation committee's dismissal request would contradict the business judgment rule, as it is presumed that the corporation's directors best know how to run the company. The court may, however, verify the makeup of the special litigation committee and the procedures used by the committee. Here the members of the committee were in fact disinterested, having joined the company after the events occurred. The committee secured special counsel and thoroughly reviewed the work of the outside auditors and counsel used to discover the bribes. People were interviewed, and questionnaires were sent out. "[W]e do not find either insufficiency or infirmity as to the procedures and methodologies chosen and pursued by the special litigation committee." The specific data that "has been uncovered and the relative weight accorded in evaluating and balancing the several factors and considerations are beyond the scope of judicial concern."

Zapata Corp. v. Maldonado, Supreme Court of Delaware, 430 A.2d 779 (1981)

Diamond v. Oreamuno, Court of Appeals of New York, 24 N.Y.2d 494, 248 N.E.2d 910 (1969)

Management Assistance, Inc. leased computers with an agreement to repair and maintain them, which it outsourced to IBM, who made the computers. IBM started charging more for its services, which decreased MAI's net earnings by 75%. Defendants Oreamuno, chairman of the board of directors, and Gonzalez, president, sold their stock at $28 before the company released its earnings report and the stock subsequently dropped to $11. A stockholder initiated a derivative action for the savings realized by the defendants. Are officers and directors liable to the corporation for gains realized by them from transactions in the company's stock as a result of their use of material inside information, even if no harm is realized by the corporation? Held Fuld: Yes. A claim of insider information is not only to restore damages but to prevent the action from occurring. The actions might have hurt the image of the company, too. According to Restatement, 2d, Agency § 388, comment c, an agent using confidential information of the principal must account to the principal for any gains realized, even if the principal is not harmed. The corporation in other words has a superior claim to any gains realized by insider information gained by one's position of fiduciary duty. May the state impose damages for SEC violations? Held Yes. Corporations are ultimately controlled by state law, and the Securities Exchange Act of 1934 says that "[t]he rights and remedies provided by this title shall be in addition to any and all other rights and remedies that may exist at law or in equity." As the direct harm of this transaction was to the buyer of the stock, to whom the SEC provides a remedy, does the possibility of double liability preclude a claim by the corporation? Held No. It is unlikely that the stock buyer will come forward with a claim, as most stock transactions are anonymous. "But, even if it were not, the mere possibility of such a suit is not a defense nor does it render the complaint insufficient. It is not unusual for an action to be brought to recover a fund which may be subject to a superior claim by a third party." Besides, the defendant can always inteplead all possible claimants.

Freeman v. Decio, United States Court of Appeals, Seventh Circuit, 584 F.2d 186 (1978)

Skyline Corporation, which produces mobile homes, had increased sales over five years at a 40% compound rate and stock had reached $72 per share. On news that earnings declined, stock fell almost 30% to $13.50. Marcia Freeman, a stockholder of the Skyline, filed a derivative suit against Arthur J. Decio, the largest shareholder of Skyline, along with two other directors, claiming that they knew that financial results had understated costs and overstated earnings, and on this basis the defendants had sold and gifted over $14 million of stock knowing it would decline. The court dismissed the case for failing to state a cause of action, finding it unlikely that New Jersey would follow Diamond v. Oreamuno. Is it likely that New Jersey would follow New York's Diamond and allow corporate recovery for gains made by insider trading even if there was no corporate harm? Held No. In duty of loyalty cases, it is customary to consider whether, by using a corporate asset to one's own advantage, one with a fiduciary duty denied the corporation of some opportunity. Here the SEC prevented the corporation from profiting from the insider information, so the corporation didn't lose an opportunity to make money. Furthermore, any loss of goodwill to the company is slight—analogous to illegal use of corporate property, for instance—and certainly pales in comparison to the actual loss incurred by the buyer of the stock. Lastly, Diamond was decided in part because of a lack of other adequate means for preventing insider trading, but "that over the decade since Diamond was decided, the 10b-5 class action has made substantial advances toward becoming the kind of effective remedy for insider trading that the court of appeals hoped that it might become."

Securities and Exchange Commission v. Texas Gulph Sulphur Co., United States Court of Appeals, Second Circuit, 401 F.2d 833 (1968)

In October 1963, one of the defendants working for Texas Gulf Sulphur Company (TGS) explored an ananomaly in eastern Canada and, after having drilled hole K-55-1, found high concentrations of copper and zinc. Several defendants between November 1963 and March 1964 increased stock from 1135 shares to 8235 shares and bought 12,000 calls, but didn't tell other directors and officers about the find. After rumor circulated about a new mineral find, some defendants on April 12 issued a press release saying the rumors were "without factual basis" and that the work "has not been sufficient to reach definite conclusions." TGS finally announced the find on April 16, and several defendants issued instructions to brokers to buy stock at the opening of the exchange on that day. Did defendants violate SEC Rule 10b-5 against insider trading based upon their knowledge of the drilled hole K-55-1? Held Yes. Anyone, not just an insider, in possession of material inside information—information that would "have a substantial effect on the market price of the security if disclosed"—must either disclose the information to the investing public or abstain from trading or recommending the security while the information remains undisclosed. Congress intended that "all investors should have equal access to the rewards of participation in securities transactions." Whether something is material depends on balancing the probability that an event will occur and the magnitude of the event. Here a trade publication on April 16 referred to the K-55-1 as "one of the most impressive drill holes completed in modern times," and it was certainly impressive enough to make defendants to buy stock based upon its discovery. Does Rule 10b-5 prohibit defendants from insider trading early on the same day the information is released? Held Yes. Defendants bought stock when the market opened on April 16 before the released information had time to disseminate. "At the minimum [the defendants] should have waited until the news could reasonably have been expected to appear over the media of widest circulation…." May insiders accept stock options without disclosing material information to the issuer? Held No. Several defendants could assume that their superiors, directors in the corporation, would report the find to the other directors, so they need not rescind the issuance. The director defendants must rescind the options. Does Rule 10b-5 apply to the issuance of press releases when it states, ""in connection with the purchase or sale of any security?" Held Yes. Congress intended for Rule 10b-5 to apply to any device that would cause reasonable investors to rely on it and purchase or sell corporate securities. Did the issuance of the April 12 release violate Rule 10b-5 by painting a misleading and deceptive picture of the drilling progress? Held This issue must be remanded to the trial court, as it judged defendants on the facts known to them. Instead an inquiry should be made into "the meaning of the statement to the reasonable investor and its relationship to truth…."

Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., United States Court of Appeals, Second Circuit, 495 F.2d 228 (1974)

Merrill Lynch, Pierce, Fenner & Smith Inc. was managing underwriter of $75,000,000 of a new issue of 43/4% convertible subordinated debentures for Douglas Aircraft Company, Inc. Douglas informed Merrill Lynch confidentially that its earnings were going down. Defendant Merrill Lynch and certain defendant employees informed some of its institutional investor customers (the "selling defendants"), who sold or shorted Douglas stock before the public Douglas announcement, with Merrill Lynch making money off the transactions. After Douglas announced lower earnings, the price of Douglas stock "took a sudden and substantial drop." Did defendants violate SEC Section 10(b) and Rule 10b-5 by divulging to its customers material insider information and not disclosing to the investing public this inside information? Held Yes. As this court held in Texas Gulph Sulphur Co., anyone possessing material inside information must disclose it to the investing public or restrain from trading or recommending the security. Here Merrill Lynch and the selling defendants had access to inside information and traded on the basis of that information, without revealing it to the investing public. Are defendants liable in private action for damages to plaintiffs who bought Douglas stock in the open market during the same period without knowledge of the material inside information held by the defendants? Held Yes. "Causation as an element of a rule 10b-5 cause of action can be established notwithstanding lack of privity." For Rule 10b-5 claims, "the proper test to determine whether causation in fact has been established in a non-disclosure case is 'whether the plaintiff would have been influenced to act differently than he did act if the defendant had disclosed to him the undisclosed fact.'" If the other investor "might have considered [the undisclosed information] important in the making of this decision," liability is created because the defendants did not discluse material inside information. "They breached that duty. Causation in fact therefore has been established."

Fridrich v. Bradford, United States Court of Appeals, Sixth Circuit, 542 F.2d 307 (1976)

J. C. Bradford, Jr. purchased 1,225 shares of common stock of Old Line Life Insurance Company through J. C. Bradford and Co., which J.C. owns with his father, based upon inside information from his father, and made $13,000 when he sold them. After Bradford was punished by the SEC, plaintiff stockholders on the open market sued Bradford for $361,186.75. Is an inside trader liable to traders on the open market who did not trade on the same day or with the defendant, and if there is no evidence that the inside trading affected the price of the stock? Held No. Although Shapiro, using the "abstain or disclose" rule from Texas Gulph Sulphur Co., found that inside traders have a duty to others who trade stock, we believe that argument flawed because one with inside information does not have an absolute duty to reveal—that person may alternately abstain from trading—and those on the impersonal market assume some lack of information in every trade. Here there was no contact with the defendant to alter plaintiffs' expectations. Similarly "defendants did not perpetrate any scheme to induce defendants to sell their stock. Plaintiffs and defendants here had no relationship whatever during the period in question." Just because the proscriptions of § 10(b) and Rule 10b-5 encompass open market transactions doesn't mean that "the civil remedy must invariably be coextensive in its reach with the reach of the SEC…." "[E]xtension of the private remedy to impersonal market cases where plaintiffs have neither dealt with defendants nor been influenced in their trading decisions by any act of the defendants would present a situation wholly lacking in the natural limitations on damages present in cases dealing with face-to-face transactions." To hold otherwise would make Bradford liable for the entire amount even if he had only purchased five shares of Old Line and made a profit of only $53.00. How about if the court allows liability on the impersonal market, but only to the extent of the defendant's inside trading profits? Held No, Congress and the SEC should make such rules—"the courts are ill-fitted to the task…."

Basic, Inc. v. Levinson, United States Supreme Court, 485 U.S. 224 (1988)

Basic Incorporated, which made chemical refractories for the steel industry, was in merger talks with Combustion Engineering, Inc. Basic made three public statements denying that merger negotiations were going on, and then finally accepted the merger offer. Four Basic shareholders who had sold stock at low prices after the statements sued Basic alleging violation of SEC § 10(b) and Rule 10b-5 by issuing false and misleading statements. Should summary judgment be granted to defendants for lack of materiality of information because the negotiations had not reached "agreement-in-principle?" Held Blackmun: No. A fear of overloading investors with tentative information is no reason, as it treats investors like "nitwits." The need for secrecy before this time is irrelevant to materiality. Such a bright-line rule would be easy for corporate managers to follow, but would always be over- or under-inclusive, as materiality is "an inherently fact-specific finding." Should the public statements be considered material simply because they denied the existence of merger talks that were in fact ongoing? Held No. Information falsity does not make it significant—Rule 10b-5 requires that a disclosure must also be misleading to be a material fact. Should there be a presumption that plaintiff relied on the information through a fraud-on-the-market theory, thereby defeating summary judgment? Held Yes. "[P]resumptions are … useful devices for allocating the burdens of proof between parties." We assume that an open market at all times takes into consideration all available information, even misrepresentation of information. Plaintiffs who performed transactions in an open market can therefore be presumed to have relied on the misrepresentation of information. The defendant then has the burden of proving at trial that the misrepresentation did not affect the price or that the plaintiff would have still traded knowing the information to be false.

Superintendent of Insurance of New York v. Bankers Life & Casualty Co., United States Supreme Court, 404 U.S. 6 (1971)

Begole bought from Bankers Life & Casualty Co. for $5 million all the stock of Manhattan Casualty Co., now represented by New York's Superintendent of Insurance. Begole arranged to get a check for $5 million from Irving Trust Co. and then after purchasing Manhattan Casualty sold Manhattan Casualty's United States Treasury bonds for almost $5 million, and with this money paid Irving Trust. Sweeney, the new president of Manhattan Casualty who was put in by Begole, got another $5 million check from Irving Trust and used it to get a $5 million certificate of deposit from Belgian-American Bank & Trust Co., endorsed it to New England Note Corp., controlled by Bourne who endorsed it to Belgian-American Banking Corp. as collateral for a loan to New England which was then used to pay the Irving Trust for the $5 million check. Does this act of fraud on Manhattan Casualty raise a cause of action under Section 10(b) of the Securities and Exchange Act? Held Yes. "Section 10(b) outlaws the use 'in connection with the purchase or sale' of any security of 'any manipulative or deceptive device or contrivance.' The Act protects corporations as well as individuals who are sellers of a security. Manhattan was injured as an investor through a deceptive device which deprived it of any compensation for the sale of its valuable block of securities. … We agree that Congress by § 10(b) did not seek to regulate transactions which constitute no more than internal corporate mismanagement. But we read § 10(b) to mean that Congress meant to bar deceptive devices and contrivances in the purchase or sale of securities whether conducted in the organized markets or face to face. … The crux of the present case is that Manhattan suffered an injury as a result of deceptive practices touching its sale of securities as an investor."

Brown v. Ivie, United States Court of Appeals, Fifth Circuit, 661 F.2d 62 (1981)

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