SEU Corporate Law Analysis

Understanding Corporate Law
Chapter 1
Introduction and Formation
Introduction
Corporations
• Definition from the book
“A corporation is an artificial being, invisible, intangible, and existing
only in contemplation of law. Being a mere creature of law, it
possesses only those properties which the charter of its creation
confers upon it, either expressly, or as incidental to its very
existence.”
• Separate legal entity
• Owners are called shareholders
• Board of directors (elected by the shareholders) oversees
the management of the company
➢ Select officers run the company
Introduction
Sources of Corporate Law
• There are law statutes that provide rules for how
companies are incorporated.
• The statues dictate how
➢ To incorporate
➢ Deal with financing
➢ Legal capital rules
➢ Establish the basic structure for the Board of
Directors
➢ Shareholder power and rights
Introduction
Company Forms
• Sole proprietorship
➢ An individual is the sole owner.
➢ No formal requirements for the ownership and
management of the company.
➢ Owner is the principal and can employ people to
work for him/her.
➢ Owner is personally liable for the obligations of the
business.
Introduction
Company Forms
• Partnerships
➢ Two or more owners of a company
➢ Formation requires no formal action or written
agreements.
➢ Advisable to have an agreement among partners
or shareholders to protect the interests of the
parties.
➢ Partnership law is more protective of all owners
than corporate law.
Introduction
Company Forms
• Corporation
➢ To form a corporation, the founders of the
corporation must comply with a list of
requirements.
❖ These requirements are often instituted by the
government.
➢ Attorneys are often needed to navigate the
paperwork.
Introduction
Difference Between Partnerships and Corporations
• Partnership: Owners are personally liable
• Corporation
➢ Shareholders are insulated from the liabilities of
the corporation. Shareholders are protected from
anyone going after the company.
➢ Conversely, the corporation is protected against
attacks on its shareholders cr.
➢ The protection offered by the formation of a
corporation is one of the biggest advantages of
forming a corporation.
Introduction
Company Forms
• Limited Liability Partnerships
➢ Business organization which provides partnershipstyle tax treatment and limited liability for some of
the owners as limited partners.
➢ Limited partnership must have at least one general
partner with unlimited liability.
• Limited Liability Company
➢ Permits unlimited participation by all the owners.
➢ Has unlimited flexibility.
Introduction
Taxation
• The biggest difference in the forms of companies is
the rate at which the different types of companies are
taxed.
• Corporations pay taxes as legal entities.
Double Taxation
• Corporations pay tax on the profits they receive and
when that profit is distributed to shareholders in the
form of dividends.
Introduction
Incorporation and Organization
• When forming a corporation, one person must act as
an incorporator.
• The articles of incorporation are filed with a
government entity.
• Name of the corporation must different from any other
corporation.
• Corporations must also use a denomination after the
corporation name such as Inc., Ltd., or Corp.
Introduction
Incorporation and Organization
• Incorporator must:
➢ Adopt a set of bylaws
➢ Hold the initial shareholders’ and directors’
meetings
➢ Arrange for election of directors and officers
➢ Open bank accounts for the corporation
➢ Issue shares
➢ Conduct other important acts
Introduction
Choice of Law
• Every country has their own set of laws for
incorporating companies.
• Companies must follow these laws when forming and
incorporating the company.
Introduction
Ultra Vires
• According to Pinto and Branson:
Ultra vires results when a corporation has acted beyond its
purpose (the object of the incorporation) or powers (the
means by which the corporation carries out the object). For
example, a corporation established for the purpose of
washing windows would have the power to enter contracts
to wash windows.
• Less significant now than in the past.
• Companies can be incorporated with broad purposes
and powers.
Introduction
Corporation Social Responsibility and Philanthropy
• Issues of corporate social responsibility involve issues
of corporate philanthropy and corporate governance.
• The issue involves determining whether a corporation
should be managed solely to benefit its shareholders
or should both societal concerns and stakeholders
other than shareholders such as employees,
consumers, and creditors play a role.
Introduction
Social Benefit Organizations
• Companies can seek profits and pursue social good.
• Hybrid companies that are not non-profit organizations
strive to balance seeking profits and pursuing social
good.
• Benefit corporations are corporations that must be
formed for the “greater public benefit”.
• The main thrust of benefit corporation statutes is to
require these entities to pursue purposes beyond profitmaking.
Chapter 2
Promoters’ Liability and Defective
Incorporation
Introduction
• Issues of legal personality
➢ Questions the extent to which entities are separate
from the company
➢ These entities include:
❖ Lenders
❖ Contractors
❖ Landlords
❖ Tort claimants
❖ Courts
Introduction
• Corporate personality
➢ People who act on behalf of the to be formed or in
formation.
➢ “People” referring usually to the promoter.
➢ Often, unless the promoter follows a strict set of
rules, the promoter is liable for any goods and
services supplied to the new company.
Introduction
• Liability of a newly-formed corporation
➢ According to the text,
“Once the corporation comes into existence, the
initial board of directors should review and take
action with respect to each contract made by the
promoter on the corporation’s behalf. Otherwise,
through mere inaction, the corporation may find itself
bound by contracts it later deems unsuitable or not
in accord with its business plan.”
Introduction
• Promoter
➢ Someone who takes responsibility for the existence
of the business.
➢ Promoters:
❖ Bring important parties together
❖ Raise capital
❖ Make arrangements for the business
Introduction
• Promoter’s fiduciary duties
➢ Must be loyal to other promoters, the corporation
being formed, and investors in the corporation.
➢ May not profit self deal or secretly profit from his/her
duties.
➢ Must act in the best interests of the company.
Defective Incorporation
• Defective incorporation
➢ Occurs when there has been an incomplete filing to
incorporate the company.
❖ Can result from a clerk not filing paperwork or
the government agency sending back the
paperwork.
❖ Can also arise at the end of a company when
annual reports have not been filed or fees paid.
De Facto Corporation
• De Facto corporation
➢ According to the text, “the de facto corporation defense
has three elements.
❖ There must be a law pursuant to which the
contemplated enterprise could have incorporated.
❖ The defendants must prove a good faith or
“colorable” attempt to incorporate under that law.
❖ The defendants must demonstrate actual use or
exercise of the corporate powers the participants
believe themselves to have, which in the usual case
will involve doing business under a corporate
name.”
De Facto Corporation
• Corporation by estoppel
➢ The text states “if an ersatz corporation is unable to
establish the three elements of the de facto corporation
doctrine, the defense could still inquire if the particular
creditor dealt with the participants as if they were acting
on behalf of or as a corporation.
➢ Persons who have dealt with a business as though it
were a corporation may not later protest when
attempting to hold shareholders individually liable on
grounds that the corporation had been defectively
formed.”
Corporate Death
• Corporate Death
➢ Defunct corporations may be reinstated by filing annual
reports and paying fees owed.
➢ Neither shareholders or their attorney can reinstate a
company after the two year period has elapsed.
➢ Shareholders are not held liable for the defunct
corporation.
Chapter 3
Piercing the Corporate Veil
Piercing the Corporate Veil
Limited Liability
• A corporation is its own person and is liable for its
debts.
• Encourages capital formation.
• Low level of risk allows for managers to take risks
they otherwise would not take.
➢ If a company fails, owners do not need to
bankrupt the business, they turn it over to their
creditors.
Grounds for Piercing the Corporate Veil
• Introduction
➢ According to the text:
“Piercing the corporate veil is an equitable theory in
which the facts of each case are important.”
➢ The factors include:
❖ “the failure to maintain adequate corporate
records or to comply with corporate formalities
❖ the commingling of funds or assets
❖ undercapitalization
❖ one corporation treating the assets of another
corporation as its own.”
Grounds for Piercing the Corporate Veil
• Intermixture of affairs
➢ “Refers to the blurring of the distinction between the
concerns of the corporation and those of the owners.
➢ When affairs are intermixed, it becomes difficult for a
third party to determine where the affairs of the owner
leave off and those of the incorporated business
begin.
➢ This ground for piercing the corporate veil usually
occurs in connection with, and is closely related to,
the next ground, lack of observation of form”
Grounds for Piercing the Corporate Veil
• Lack of corporate formalities
➢ Courts are more successful when piercing the veil of
corporations if the corporations in question have not
followed corporate formalities.
➢ “Failure to observe formalities may indicate an
impermissible intermixture of affairs or may indicate
the use of a corporation as a “mere instrumentality.”
Grounds for Piercing the Corporate Veil
• Inadequate capitalization
Professor Ballantine defined inadequate capitalization as a ground
for piercing the corporate veil: “If the capital be trifling or illusory
compared with the business to be done or the risks of loss, this is a
ground for denying the separate entity privilege.” Earlier in the same
passage, Ballantine stated that “[i]t is coming to be recognized as the
policy of the law that shareholders should in good faith put at risk of
the business unencumbered capital reasonably adequate for its
prospective liabilities.”34 The test requires incorporators and directors
to peer into the future, at least for the intermediate term, funding the
corporation in a manner adequate for the business plan (risk and size
of the undertaking.”
Grounds for Piercing the Corporate Veil
Three corporate settings which a plaintiff may invoke the
doctrine
(1) Personal shareholder liability
➢ Plaintiff wins the judgment, but find the assets of
the company are inadequate to pay liability.
➢ Plaintiff tries to pierce the veil.
➢ Shareholders and directors are held personally
liable for the company.
➢ Personal assets of individuals are held
accountable.
Grounds for Piercing the Corporate Veil
Three corporate settings which a plaintiff may invoke the
doctrine
(2) Parent-subsidiary settings
➢ “plaintiff could face piercing the veil twice, first
reaching from subsidiary to parent corporation and,
second, reaching from parent corporation to
grandparent corporation or individual shareholders.”
➢ Companies use several strategies to prevent this
type piercing of the veil.
❖ Segmentation strategy: business is allocated among many
corporations so liabilities do not affect all of the
companies.
❖ Isolate risky parts of the corporation from the subsidiaries.
Grounds for Piercing the Corporate Veil
Three corporate settings which a plaintiff may invoke the
doctrine
(3) Brother-sister (sibling) corporate settings
❖ Sibling corporations are those corporations with
the same parent.
❖ “In sibling corporation cases, rather than
piercing the veil vertically (↑) to reach the pocket
of the common shareholder, the plaintiff may
attempt to pierce the veil horizontally (→),
dropping the veil that exists between sibling
corporations.”
Grounds for Piercing the Corporate Veil
• Enterprise liability
➢ Sometimes referred to as horizontal piercing.
➢ When a group of corporations (brother-sister
subsidiaries, parent, grandparent and even
great-grandparent) are under common control,
and contribute to a collective endeavor, they
may be held all to be one single enterprise.
Grounds for Piercing the Corporate Veil
• Reverse piercing
➢ “In a reverse pierce, a contract or tort claimant, or a judgment
creditor, finds her judgment unsatisfied (because the defendant
has insufficient assets), or predicts that such could be the
case.
➢ She then attempts to pierce downward to reach the assets of a
corporation in which the defendant is a shareholder.
➢ Commentators sort some reverse piercing cases into “inside
claims,” in which a controlling shareholder seeks to have
himself regarded as one and the same as the corporation so
that he can avail himself of corporation privileges or of
corporate claims against third parties.”
Grounds for Piercing the Corporate Veil
• Reverse piercing
➢ “Most reverse piercing claims are “outside claims.” A
creditor of the human shareholder seeks to reach the
corporation’s assets.114
➢ Courts must be wary of reverse piercing because, if
successful, a reverse pierce represents a reach through
the backdoor, resulting in the exhaustion of corporate
assets, leaving legitimate creditors empty handed,
standing at the front door, so to speak.
➢ In the usual case, the corporation’s assets should remain
available for claims by persons who extended credit to
the corporation in the normal course.”
Grounds for Piercing the Corporate Veil
• Summary
➢ “A creditor or tort claimant plaintiff may plead facts attempting to
reach the pockets:
❖ individual shareholders
❖ parent corporations as shareholder
❖ both parent and grandparent corporation
❖ parent corporations and individual shareholders in the
parent.
➢ This section has discussed all of the foregoing instances as
examples of “vertical piercing.” A claimant may also attempt
“horizontal piercing,” claiming that a group of brother-sister
corporations are a single enterprise, all of the assets of which
should be available to satisfy her claim.”
Grounds for Piercing the Corporate Veil
• Summary
➢ “another variant in structural setting is the “reverse pierce.”
➢ The claimant pierces vertically to reach the pocket of the
individual or corporate owner of the corporation.
➢ Finding insufficient assets to satisfy her claims, the claimant
may try to reach down to the assets of another corporation
which is the sibling of the corporation first sued.
➢ Plaintiff may also seek to pierce the veil forward, through time,
as in the products liability cases.
➢ A plaintiff may attempt to reach back or forward through time to
a succession of incorporated entities, such as when a series of
corporations are used to shield assets from creditors or when a
new corporation is formed to evade a contract signed by a
predecessor entity.121”
Chapter 4
Financing the Corporation
Financing the Corporation
• Capital
➢ Companies need capital to function.
➢ Companies can raise capital in two ways:
❖ Borrowing: which incurs debt
❖ Investment of funds by owners: creates equity
• Equity
➢ Represented by shareholders
➢ Shareholders may receive dividends when a profit is
made by the corporation.
❖ Shareholders may not have their invested funds
returned unless corporation is disbanded or the
directors of the company offer to buy the shares.
Financing the Corporation
Securities
• Two types of securities:
➢ Debt
➢ Shares
• Generally, each security carries with it attributes relating to:
➢ the risk of loss on the investment
➢ the power to control the business
➢ the ability to share in success of the enterprise.
• Investment in the different securities depends upon the purchaser’s
willingness to trade the risks associated with each security (the
amount of control may impact risk) with its return.
• In order to induce investors to turn their capital over to a business,
investors need an expectation of some return. “
Financing the Corporation
Securities
• “The return should compensate for inflation (the fact that money loses
value over time, i.e., a dollar today is more valuable than a future
dollar).
• Because all the securities described involve long term investment,
there is additional risk resulting from the duration of the investment.
• The interest rate that creditors are paid on their loans and the
dividends paid and expected to be paid to equity reflect this
compensation.
• Since all business investments involve inflation3 and lost
opportunities, risk is the primary factor to be weighed against potential
return in deciding among business investment opportunities.”
Financing the Corporation
Debt
• Debt is denominated by bonds or debentures
➢ Bonds:
❖ Secured by specific assets.
❖ By defaulting, bond holders may claim payment
from specific assets of the corporation.
➢ Debentures
❖ Involves unsecured debt.
❖ Debenture holders have claim on assets from
unsecured creditors.
Financing the Corporation
Common shares
• Common shareholders:
➢ “Residual claimants in the corporation because they
have a claim to receive the income and assets of the
corporation after all other claims have been satisfied.8”
➢ Are interested in the success of the corporation.
• “Common shares have lower priority and greater risks of
loss than other securities but have the potential for
greater return than other investments.”
• Low risk gives shareholders the significant control through
voting rights.
Financing the Corporation
Preferred shares
• Equity authorized by government statutes.
• Authorized in the articles of confederation.
• “Preferred shareholders are paid fixed dividends after the
creditors are paid their interest but before the common
shareholders are paid dividends.
➢ Since preferred shares are considered equity, their holders have no
right to be paid like creditors. Rather, preferred shareholders are
paid when the board of directors authorizes payment (that is,
declares dividends).11
➢ Preferred shares are an unusual security which has the
disadvantages of both debt (little direct control or potential for
increased return) and common shares[74/75] (lower priority and
greater risk) without any of their respective advantages.”
Financing the Corporation
Legal capital rules
• Preemptive rights
➢ “A shareholder’s ownership interest depends on the
number of shares issued and not the number of
shares authorized for sale.
➢ Preemptive rights require that each shareholder be
offered the right to purchase a proportionate number
of shares in order to maintain the percentage of
ownership and voting control.25”
➢ Preemptive rights are provided for in the articles of
confederation.
Financing the Corporation
Legal capital rules
• Par value
➢ Minimum price at which a share must be sold.
❖ The board of directors sets the price for the shares
of the corporation.
❖ However, government agencies may require the
share price be set at a certain value.
❖ Almost all shares are sold at the par value.
❖ Par value assures creditors that the corporation
has a cushion to pay them.
Financing the Corporation
Legal capital rules
• Dividends and repurchasing of share
➢ “Dividends are payments to shareholders which represent a
current return on investment.32
➢ Dividends are paid at the discretion of the directors.
➢ As an alternative to paying dividends, the board of directors may
decide to have the corporation buy back or repurchase shares.
➢ Like dividends, this repurchase is another means by which
shareholders may receive funds from the corporation.
➢ The basic principle is not to permit payment of dividends or stock
repurchases in cases where the payment will adversely impact
investors or creditors.”
Financing the Corporation
Valuation
• Liquidation value
➢ “Liquidation value is the amount for which the assets could be sold
minus the liabilities owed.
❖ The assets of this business include pails, soap, sponges,
uniforms and a building which houses the business.”
• Book Value
➢ Value placed on the business by accountants who have analyzed
the corporation’s financial statements.
❖ One of these financial statements used in the analysis is the
balance sheet.
➢ “Valuing a business based on its balance sheet and book value
has several limitations, including the need to use cost based
accounting methods, the depreciation of certain fixed assets and
the exclusion of certain intangible assets from the balance sheet.”
Financing the Corporation
Valuation
• Valuing a business on the balance sheet alone, has the following limitations:
➢ Cost-based accounting
❖ This approach is conservative.
❖ This approach helps to prevent the corporation from over-valuing assets
instead of valuing the assets at market value.
➢ Depreciation
❖ Writing off the cost of assets over the lifetime of the asset.
❖ Certain fixed assets may not reflect the market value.
➢ Intangible assets
❖ “Certain valuable assets such as trade names, patents or trademarks are
not purchased but are developed over time. These assets may be very
valuable.
❖ Another reason the book value of the corporation reflected in the equity
figure does not usually represent the real value of the business is because
the market value of intangible assets might be missing from the balance
sheet under accounting rules.”
Financing the Corporation
Valuation
• Earnings Approach
➢ “According to the earnings approach, a business may be valued by
finding the present value (or the amount one will pay currently) for a
future expected return.
➢ Thus, one must determine the future expected return, its duration and
the economic and business conditions under which the future return
may be expected to determine the present value.”
➢ Capitalization of earnings
❖ “Businesses and investments are valued based on future returns.
❖ This method involves calculating the present value of the future
returns by predicting how much one expects to earn from the
business in the future.
❖ Risk, inflation and lost opportunity of the investment are factors
that help to determine the appropriate rate of return.”
Financing the Corporation
Valuation
• Earnings Approach
➢ Cash flow as earnings
❖ “The earnings approach to valuation more truly reflects the
purpose of investing, which is to earn a return on an
investment. In the financial world, sophisticated methods and
models can be used to determine both the rate and earnings
for valuation purposes.
❖ To calculate future earnings, one could look at the
corporation’s financial statements to find past earnings of the
business and then try to predict its future earnings.”
➢ The rate
❖ Calculating the rate for a given business or investment can be
very complex.51
❖ One method that is often used compares our business to how
other similar businesses are valued.
Chapter 6
Merger and Acquisitions
Merger and Acquisitions
• Corporations can expand by acquiring other corporations.
• Corporations expand for several reasons:
➢ Increase the overall value of the corporation.
➢ Satisfy management’s desire to expand the corporation.
➢ A control group within the corporation seeks to increase
its position with the acquisition of another corporation.
• A corporation can acquire another corporation by:
➢ Mergers
➢ Sale of assets
➢ Tender offer
Merger and Acquisitions
Mergers
• Mergers are when two companies or corporations are
combined.
• Statutory mergers
➢ Occurs when Corporation A acquires Corporation B
and Corporation B is merged into Corporation A.
➢ Consolidations occur when Corporation A and
Corporation B merge into a new corporation,
Corporation C. Corporation A and Corporation B
cease to exist as individual corporations.
Merger and Acquisitions
Different types of mergers
• Triangle mergers
➢ “The acquiring party (“A Inc.”) forms a wholly owned
subsidiary (AS) and B Inc. merges into AS. B Inc.
shareholders receive consideration in exchange for
their B shares. Shares of AS owned by A Inc. are
unaffected.
➢ The triangular merger is used when A Inc. wishes to
keep the business acquired from B Inc. in a separate
corporation.
❖ One common reason to do this occurs when B Inc. is in he
triangular merger is used when A Inc. wishes to keep the
business acquired from B Inc. in a separate corporation.”
Merger and Acquisitions
Different types of mergers
• Reverse triangle mergers
➢ Corporation A acquires Corporation B. Corporation A is merged
into Corporation B with Corporation B as the surviving corporation.
➢ This type of merger occurs when the acquired corporation does
not want to disappear because the acquired company has
something special to offer.
• Short form merger
➢ “Statutes permit a parent corporation with a large controlling
interest (usually owning 90% or more of the shares of the
subsidiary) to merge the subsidiary out of existence without the
formal requirements of a board or shareholder vote by the
shareholders of the subsidiary.”
Merger and Acquisitions
Sale of assets
• When two corporations merge, the distribution of assets
can take on different forms.
➢ Corporation A acquires all of the assets of Corporation
B and Corporation B will be paid for these assets.
❖ Corporation B will remain in existence (holding
company) with shareholders.
❖ Corporation B will be completely liquidated.
• Shareholders must approve of the sale of the assets of the
company that is being merged.
Merger and Acquisitions
Tender offer
• A tender offer is often referred to as a takeover bid.
➢ Corporation A makes a direct offer to Company B’s
shareholders.
➢ If Corporation A can buy over 51% of Corporation B’s
shares, Corporation A will take control of Corporation
B.
➢ Corporation B will then become a subsidiary of
Corporation A.
➢ “This acquisition technique is the only one where the
corporate statutes do not require the approval of B’s
board and allows for an acquisition that they oppose.”
Merger and Acquisitions
Tender offer
➢ “The tender offer usually takes place when Corporation
B is a publicly traded corporation. If Corporation B
were a private corporation, the offer to buy Corporation
B’s shares would probably involve a privately
negotiated sale.
➢ The tender offer requires the board approval.
➢ This acquisition technique is the only one where the
corporate statutes do not require the approval of B’s
board and allows for an acquisition that they oppose.”
Merger and Acquisitions
Other legal issues
• Acquisitions can incur other legal issues. For example:
➢ Taxation
➢ Labor law
➢ Antitrust
➢ Environmental law
➢ Pension law
➢ Contract law
• Fiduciary duties:
➢ “The directors must act in good faith and in an
informed manner in making the decision whether to
sell the corporation.”
Merger and Acquisitions
Appraisal remedy
• Historically, all mergers had to be approved unanimously
by the shareholders.
• Appraisal remedy gives shareholders the right to seek
judicial intervention if they do not approve of the changes
in the merger.
• “Appraisal was an exit strategy designed to protect
shareholders by providing liquidity and an independent
review of fair value.
• “It was also meant as a check or a monitoring device, to
regulate those in control and to offer the shareholders a
fair deal.25”
Merger and Acquisitions
De facto mergers
• “An acquisition tries to preclude shareholder voting or
appraisal rights.”
• Occurs when shareholders of the acquiring corporation
argue that the acquisition was structured as an asset sale.
• If it is an asset sale, the shareholders of the selling
corporation do not have the right to valuation of shares.
• The shareholders of the selling company will argue that it
was not an asset sale, but a merger or de facto merger.
➢ The shareholders will then take it to the courts to
decide.
Chapter 12
Hostile Tender Offers
Hostile Tender Offers
Introduction
• There are many ways a corporation can gain corporate
control. These include:
➢ Buying controlling shares in the corporation.
➢ Mergers
➢ Hostile takeover
• If the method to gain control is hostile (without the approval
of the board of directors), the takeover can be done in two
ways:
➢ Proxy fight
➢ Tender offer
Hostile Tender Offers
Rise and fall of tender offers
• Tender offers
➢ Means of gaining control when the management is
against a sale.
➢ Shareholders are offered cash for their shares above
the market value.
➢ Buyer purchases these shares from the shareholders to
gain control.
• Tender offers were popular in the 1970’s, but began to
decline in the 1980’s and 1990’s.
Hostile Tender Offers
Policy changes
• Proponents for tender offers
➢ Thought that takeovers represented a market solution
to the problems of corporate mismanagement.
➢ “This “market for control” theory is built upon the
efficient market hypothesis, which assumes that by
using all publicly available information the stock
markets were informationally efficient in pricing shares
at levels that best represent the value of their
respective corporations.19”
➢ Mismanagement of the corporation would cause share
prices to fall.
Hostile Tender Offers
Policy changes
• Opponents of tender offers
➢ “Opponents of hostile tender offers argue that they are
harmful to shareholders because the future value of the
target would be higher than the bidder’s offer and thus,
shareholder gains are usurped by the bidder.”
➢ Shareholders feel they must sell to avoid being part of a
minority and subject to sell at unfavorable terms in a
later sale.
➢ Can force managers to focus only on short-term profits
and not long-term gains.
Hostile Tender Offers
Tactics
• Bidders
➢ Use a tender offer to all shareholders to gain control.
➢ Want to own 100% of the shares to use the assets of
the corporation.
• Bidder Tactics
➢ Front-loaded two-tier tender offer
❖ “If for example, a target’s shares are selling for $20
in the market and the bidder is willing to pay $25 per
share for all the shares, the bidder control could
offer a cash premium in the tender offer of $30 for
only 51% of the shares, to gain control.”
Hostile Tender Offers
Tactics
• Bidder Tactics
❖ “At the same time, it will announce that after the
tender offer is successful, it will use its control to
merge the target and buy out the minority
shareholders at a lower price, such as $20 in cash
or securities.”
❖ Tactic is considered coercive because if the
shareholders did not sell at first, they would be
subject to lower prices for their shares if the tender
offer went through.
Hostile Tender Offers
Tactics
• Target Tactics
➢ Poison pill
❖ “The plans have a variety of provisions, but in
general at some initial triggering event (usually the
announcement or threat of a tender) the target
issues to its shareholders “Rights”.”
❖ These rights can allow shareholders to purchase
securities at a substantial discounts.
❖ “The issuance of these securities pursuant to these
Rights have the effect of making the hostile tender
offer more expensive for the bidder by either
adversely affecting the target or the bidder itself.”
Hostile Tender Offers
State laws
• Target Tactics
➢ Actions taken by the management and directors to fight
off a takeover can be subject to breach of fiduciary duty
under state law.
➢ Directors can be charged with conflict of interest
because in their defense of a hostile takeover, they are
only interested in defending their position.
➢ Opponents of hostile takeovers view the defense
against hostile takeovers as necessary per the
business judgment rule.
Hostile Tender Offers
Federal securities law
• “Generally, corporate law is an issue of state law,139 but
there are clear areas in which federal interests in interstate
commerce and, more particularly, the functioning of the
public markets for securities have resulted in legislative
and regulatory developments at the federal level that do
regulate corporate behavior.140”
Hostile Tender Offers
Federal securities law – The Williams Act
• History
➢ 1960’s – tender offers were announced on Fridays after
the stock market had closed.
❖ Tender offer period was left open for a short time
thereafter.
• Disclosure rules
➢ Requires anyone who acquires 5% of a class equity
securities of a public corporation must file a disclosure
statement.
➢ Disclosure is used to prevent “secret” accumulations of
control.
Hostile Tender Offers
Federal securities law
• Other rules
➢ “Once a tender offer is commenced,149 it must remain
open for the receipt of share tenders for at least twenty
business days, which may be extended by the bidder
and will be automatically extended in the event the
bidder changes its terms.150”
• Section 14(e)
➢ Anti-fraud provision – “prohibits material misstatements
and omissions and manipulation and fraudulent
practices “in connection with any tender offer.”154”
Hostile Tender Offers
State takeover statutes
• Introduction
➢ States enacted statutes in the 1980’s to restrict hostile
takeover offers.
➢ Business combination statute – Requires board
approval of share purchases over a certain percentage.
• Policy issues
➢ Raise the questions of federal government’s role in
corporate business.
➢ Statutes are pro-management
Hostile Tender Offers
State takeover statutes
• Constitutionality
➢ Statutes raise issues of constitutional dimension
❖ “Whether Congress in enacting the Williams Act
exercised its exclusive power to regulate tender
offers and thus preempted these statues under the
Constitution’s’ supremacy clause.172”
❖ “Whether these statutes violate the Constitutions’
commerce clause by unreasonably burdening
interstate commerce.173”
SEU 301 Companies Law
Week 2: (CHAPTER 1)
1.
In forming a corporation:
a) The incorporator Is responsible for filing the articles of incorporation
b) The process is complicated and expensive
c) Upon acceptance of articles of incorporation, corporate existence begins
d) All of the above
Answer: D
Source: Paragraph 1.08
2.
Ultra vires results when:
a) The corporation has been properly formed
b) The corporation has been incorporated defectively
c) The corporation has acted beyond its purpose or powers
d) The corporation has acted within its purpose or powers
Answer: C
Source: Paragraph 1.10
3. The law of the state of incorporation should govern most intra-govern relationships, such as
a) Between officers and corporation
b) Between directors and corporation
c) Between shareholders and corporation
d) All of the above
Answer: D
Source: Paragraph 1.09
4. Businesses that need to raise large amounts of capital by attracting public investors will choose:
a) Partnership
b) Corporate form
c) Limited Liability Company (LLC)
d) Limited Partnership
Answer: B
Source: Paragraphs 1.04 thru 1.06
5. What are sources of corporate law?
a) Independent legal organizations, like the American Law Institute
b) State Statutes
1
c) Judicially created common law
d) All of the above
Answer: D
Source: Paragraph 1.02
6. Which of the following is true?
a) Corporations pay tax on the profits they receive and when profits are distributed to
shareholders in the form of dividends; it is again taxed in the hands of the individual
shareholders
b) Answers A and D
c) The formation of a partnership requires a formal written agreement
d) A corporation is viewed as a separate entity distinct from its owners
Answer: B
Source: Paragraphs 1.04 and 1.07.
Week 3: (CHAPTER 2)
1. Defective incorporation occurs when:
a) Improper or incomplete filing necessary to create the Corporation or LLC
b) When there has been a piercing of the corporate veil
c) In midlife by Secretary of State Corporation is administratively dissolved for failure to pay
annual taxes or file annual reports
d) A and C
Answer: D
Source: Paragraph 2.01
2. A Promoter will want to provide for what in a contract with a third party before a corporation is
formed?
a) Guarantee that corporation will be formed
b) Confirmation of Promoter as party to contract
c) Substitution of a new party to a contract (novation)
d) Fee for signing contract as Promoter
Answer: C
Source: Paragraph 2.02
3. Promoter’s owe a duty of care and loyalty to:
a) The corporation they form
b) Co-promoters
2
c) Others with financial interests in corporation
d) All of the above
Answer: D
Source: 2.02
4. The newly formed corporation will not be subject to the liabilities of contracts entered into by
the promoter in which of the following :
a) Directors affirmatively rejects the contract
b) Directors review the contracts and accept no benefits
c) A and B
d) Directors accept the contract
Answer: A
Source: Paragraph 2.02
5.
Defective incorporation means:
a) Loss of limited liability
b) Limited liability that never existed
c) Both A and B
d) None of the above
Answer: C
Source: Paragraph 2.03
Week 4: (Chapter 3)
1. Which of the following are concepts of Piercing the Corporate Veil?
a) Due to abuse of the corporate form, shareholders should be held liable
b) Must first establish an independent basis for holding the corporation liable
c) Piercing the Corporate Veil doctrine is not frequently invoked
d) A and B
Answer: D
Source: Paragraph 3.01
2. What are grounds for piercing the corporate veil?
a) When there is an intermixture of affairs between the concerns of corporation and owners
b) When all corporate formalities have been followed
c) When there is inadequate capitalization
d) A and C
3
Answer: D
Source: Paragraph 3.03
3.
Undercapitalization in a Piercing the Corporate Veil case is determined in most U.S. jurisdictions
as including:
a) Equity
b) Loans
c) Liability Insurance
d) All of the above
Answer: D
Source: Paragraph 3.03
4. Structural settings for Piercing the Corporate Veil include:
a) Parent –subsidiary Corporation relationships
b) Brother-Sister (Sibling) Corporation settings
c) Personal Shareholder liability
d) All of the above
Answer: D
Source: Paragraph 3.08
5. What are the characteristics of Enterprise Liability?
a) Common control
b) Contribute to a collective endeavor
c) Multiple corporate veils are disregarded
d) A and B only
e) A and B and C
Answer: E
Source: Paragraph 3.08
Week 5 – (Chapter 4)
1.
Attributes that all Securities share include:
a) Risk of loss on investment
b) The power to control the business
c) The ability to share in the success of the business
d) A and C only
e) A and B and C
4
Answer = E
Source: Paragraph 4.02
2. What is the primary factor to weigh when evaluating different securities?
a) Inflation
b) Lost opportunities
c) Risk
d) All of the above
Answer= C
Source: Paragraph 4.02
3. The priority of payment of dividends and liquidation rights for preferred shareholders is as
follows:
a) Before creditors and common shareholders
b) After creditors but before common shareholders
c) After creditors and common shareholders
d) Before creditors but after common shareholders
Answer = B
Source: Paragraph 4.02
4. Which of the following valuation methods focuses on net present value and cash flows?
a) Liquidation value
b) Book Value
c) Earnings Value
d) None of the above
Answer = C
Source: Paragraph 4.05
5. Which relationship between the corporation is considered contractual?
a) Common shareholder
b) Creditor
c) Preferred shareholder
d) None of the above
Answer = B
Source: Paragraph 4.02
Week 6 (Chapter 6)
5
1. In a statutory merger, who must approve the merger:
a) Board of Directors and shareholders of buyer
b) Board of Directors of buyer and seller
c) Board of Directors and Shareholders of both buyer and seller
d) Board of Directors of buyer and seller and Shareholders of seller
Answer: C
Source: Paragraph 6.02
2. In a sale of all or substantially all assets, who must generally approve the transaction:
a) Board of Directors and Shareholders of buyer
b) Board of Directors of buyer and seller
c) Board of Directors and Shareholders of both buyer and seller
d) Board of Directors of buyer and seller and Shareholders of Seller
Answer: D
Source: Paragraph 6.03
3. In a Tender Offer for the shares of target, who must approve the transaction or accept the offer:
a) Board of Directors and Shareholders of buyer
b) Board of Directors of buyer and seller
c) Board of Directors of buyer and Shareholders of seller
d) Board of Directors of buyer and seller and Shareholders of Seller
Answer: C:
Source: Paragraph 6.04
4.
In a Consolidation, where A Inc. and B Inc. merge into new C Inc., which Companies are in
existences after the merger:
a) C Inc. only
b) A Inc., B Inc. and C Inc.
c) A Inc. and C Inc.
d) B Inc. and C Inc.
Answer: A
Source: Paragraph 6.02
6
5. Which merger transaction is used if it is critical that the corporate entity of the seller
corporation remain intact?
a) Statutory Merger
b) Triangular Merger
c) Reverse Triangular Merger
d) Short form Merger
Answer: C
Source: Paragraph 6.02
Week 7 (Chapter 12)
1. Which method of acquiring control of a corporation does not require the approval of the board
of Directors of the target corporation?
a) Acquire substantially all of the assets of the Corporation
b) Merger of the target corporation into buying corporation or buying Company’s subsidiary
c) Acquire stock from Shareholders
d) All of the above
Answer: C
Source: Paragraph 12.1
2. Bidders in a hostile tender officer can do which of the following:
a) Not accept all shares tendered
b) May set conditions to receive enough shares
c) Use cash as consideration
d) All of the above
Answer: D
Source: Paragraph 12.04
3. What defensive tactics can Directors of Target Corporation do without a Shareholder vote?
a) Sell off or grant an option to sell significant assets to a third party (“Crown Jewel”)
b) Split the corporation into different component corporations
c) Seek another bidder to serve as a “White Knight”
d) Establish increased compensation plans if a change of control occurs
e) All of the Above
f) None of the Above
Answer: E
7
Source: Paragraph 12.04
4.
In general, the steps in a Poison Pill defensive tactic may include:
a) Define an initial triggering event as an announcement or threat of a tender offer
b) At initial triggering event, target issues redeemable “Rights” to Shareholders
c) At second triggering event (purchase of X percentage of shares of Target), shares become
effective and nonredeemable
d) All of the above
Answer: D:
Source: Paragraph 12.4
5.
In most cases, the Courts use which standard of review to evaluate the actions of Directors of
Target in a Hostile Tender Offer?
a) Duty of Care
b) Modified Business Judgment Rule or proportionality Test, under Unocal v. Mesa. Petroleum
c) Duty of Loyalty with Fairness Test and no Business Judgment Rule
d) A and C
Answer: B
8
Multiple choices questions:
1. Promoter’s owe a duty of care and loyalty to:
a. The corporation they form
b. Others with financial interests in corporation
c. All of the above
2. Defective incorporation occurs when:
a. Improper or incomplete filing necessary to create the Corporation or LLC
b. When there has been a piercing of the corporate veil
c. In midlife by Secretary of State Corporation is administratively dissolved for failure to pay annual taxes or file
annual reports
d. A and C
3. “in which of the following shareholders and directors are held personally liable for the company and their assets are
held accountable.”
a. Parent –subsidiary Corporation relationships
b. Brother-Sister (Sibling) Corporation settings
c. Personal Shareholder liability’
Old Quiz for Law 401
Multiple choices questions:
1. Example of lack of good faith include
a. In international act in not advancing the corporation’s best interest
b. An intent to violate positive law
c. Intentionally failing to act when in the face of duty to act
d. All of these answer choices are correct
2. Which of these are disadvantages for shareholders in a corporation with a control group?
a. Neither of the answers presented here is correct
b. Many monitoring devices are not available when there are separation of ownership and control
c. Both answers presented here are correct
d. Truly independent directors are less likely to serve on the board of directors
3. Which of these are steps in freezeout merger?
a. The controlling shareholders of the old corporation of vote to merge
b. The controlling shareholders creates a subsidiary
c. The merger agreement calls for minority shareholders to receive cash or securities
d. All of these answer choices are correct
4. The purpose of the business judgment rule is
a. To allow judicial inquiry into the substance of a directors business decisions
b. To prohibit judicial review of the process of a business decision
c. To limit judicial inquiry into the substance of a directors business decisions
d. To set a standard of conduct
5. Which methods of acquiring control of a corporation does not require the approval of the board of directors of the
target corporation
a. Merger of the target into the buyer or buying its subsidiary
b. Acquire substantially all the assets of the corporations
c. Acquire stock from shareholders
d. All of the answers choices are correct
6. In most cases courts use which standard of review to evaluate the actions of directors of a target corporations in a
hostile tender offers
a. Duty of loyalty with fairness test and no business judgment rule
b. Modified business judgment rule or proportionality test
c. Duty of care
d. All of these answer choices are correct
7. In corporate law waste is referred to as a transaction such as an example of options for executive compensation
a. Involving nominal or almost no payment or services
b. Which is a gift
c. Unnecessary
d. All of these answer choices are correct
8. which of the following is requirement is privates right of action is disclosure action under rule 10b-5 ?
a. purchaser seller standing rule
b. reliance transaction causation
c. loss causation
d. all of these answer choices are correct
9. which of these statements supports thee propositions that insider trading should be prohibited?
a. Insider trading profit align the interests of corporate officials and shareholders
b. Profits made through insider trading rewards insiders entrepreneurial efforts
c. Investors would perceive a disadvantages if insider trading where permitted
d. All of the answer choices are correct
10. Shareholder may vote on a transaction
a. To approve amendments to the articles of incorporations
b. To potentially minimize judicial scrutiny
c. To ratify a transaction already completed
d. All of these answer choices are correct
11. If a shareholder can establish a cause of action for both a direct and derivative lawsuit which may be filed in court?
a. Both simultaneously
b. A direct lawsuit
c. A derivative lawsuit
d. Either one or the other or both simultaneously
12. In a direct lawsuit shareholder can be bring an action
a. When there is a contractual duty
b. In the case of a denial of right related to shareholding
c. When there is a special duty
d. All of these answer choices are correct
•
Question 1
“On January 10th, Tom, acting as a promotor for a corporation not yet formed, leases a building from Mick
and signs the lease under the name ABC Inc. . On January 20th ABC Inc. is incorporated. Who is liable for
the contract?”
Answers:
“Tom, because he signed the contract ”
ABC Inc. will be liable for the contract providing the board of directors approved it (novation)
ABC Inc. will be liable for the contract
“Mick, because at the time the contract was signed the corporation was not yet formed ”
•
Question 2
A corporation and a limited liability company share the same feature of
Answers:
The ability to raise capital by selling its shares to the public in the stock market
Limited liability of shareholders
Double taxation
Incorporation procedures
•
Question 3
Which of the followings business organization is considered a legal entity separated from its owners
Answers:
Sole proprietorship
General partnership
Limited partnership
Corporation
•
Question 4
Ultra vires act occurs when
Answers:
The corporation acts beyond its scope and power
The corporation acts within its scope and power
The corporation has been incorporated defectively
The corporation has been incorporated properly
•
Question 5
Which of the following is defense to defective incorporation?
Answers:
De jure corporation
Corporation by estoppels
Ultra vires act
None of the above
•
Question 6
To whom a Promotor owes the duty of loyalty and care?
Answers:
Co-promotors
The corporation to be formed
The shareholders of the corporation to be formed
All of the above
Question 2
“ABC Inc. is a corporation organized under the laws of the United States. The certificate of incorporation of
ABC Inc. indicates that the corporation purpose is to manufacture and sell refrigeration components ,
however ABC Inc. manufactures and markets children clothes. What is the legal term for this situation?”
Answers:
Defective incorporation
Defective purpose
Ultra vires act
De facto corporation
Question 3
Defective incorporation occurs in all the following events except
Answers:
When there has been improper or incomplete filing during incorporating the company
When annual reports have not been filled
When there has piercing of corporate veil
When fees have not been paid
Question 1
1. “In a corporation, who is viewed as residual claimant: ”
Common shareholders
Preferred shareholders
Creditors
Board of directors
Question 2
1. Plaintiff may pierce the corporation through:
Parent-subsidiary settings
Brother-sisters corporate settings
A and B
None of the above
Question 3
1. Raising capital may include:
Borrowing
Investment of funds by owners
A and B
None of the above
Question 4
1. Which of the following are NOT a shareholders right:
Rights to information
Right to compensation
Rights to vote
Right to receive dividends
Question 5
1. The [n] _______ are delegated with the power to run the day-to-day business in the corporation.
The shareholders
The directors
The officers
All of the above
•
•
•
Question 6
1. Preemptive rights refer to:
Preferred shares
Right to purchase a proportionate number of shares in order to maintain the percentage of ownership
Shareholders right to vote and control
None of the above
Question 1
According to the legal model:
Answers:
Directors and officers monitor shareholders
Directors and officers manage while shareholders monitor their performance
All of the above
None of the above
Question 2
The Board of Directors can act within its fiduciary power to run the corporation:
Answers:
For the interest of the shareholders that elect them
Only if the majority of shareholders approve
“Best interests of the corporation, including all of the shareholders”
For the benefit of the officers of the corporation
Question 3
“In a corporation, who is viewed as residual claimant: ”
Answers:
Common shareholders
Preferred shareholders
Creditors
Board of directors
•
•
•
Question 4
Debt is denominated by:
Answers:
Bonds
Common shares
Preferred shares
Stocks
Question 5
“””Minimum price at which a share must be sold”” is a definition of:”
Answers:
Liquidation value
Par value
Book value
Dividends
Question 6
“According to US state law, the number of the board of directors should be: ”
Answers:
Set in the bylaw or article of incorporation
At least 3 directors
At least 1 director
A and B
1- Business that need to raise large amount of capital by attracting public investor will chose :
Corporate form
2- Which of this concept related to piercing the corporate veil
Must first establish independent basis for holding the corporate liable
3- Structural setting for piercing the corporate veil include:
a- Parent subsidiary corporation relationship
b- Personal shareholder liability
c- Brother-sister corporation setting
d- All of above
4- in forming corporation:
a- the incorporator is responsible for filling the article for incorporation
b- upon acceptance of article of incorporation, corporate existing begin.
c- The process is complicated and expensive
d- All of above
5- The board of director can act within its fiduciary power to run the corporation:
In the best interest of the corporation including all of shareholders.
6- In consolidation where A Inc. and B Inc. merge to form a new C Inc. which companies are in existence after the
merger
C Inc. only
7- Which is the primary factor to weigh when evaluating different securities:
Risk
8- The priority of payment of dividends and liquidation right to preferred shareholder is ass follow:
After creditors but before common shareholders
9- A promoter will want to provide for what in a contract with a third party before a corporation is formed:
Substitution of a new party to a contract (novation)
10- Which of these are viewed as residual claimant of a corporation:
Common shareholders
11- Defective incorporation means:
Loss of limited liability or limited liability that never existed
12- In a statutory merger who must approve the merger:
The board of director and the shareholders of both the buyer and seller
1- Which of the following are true regarding corporate officers?
a- The power of officers to bind a corporation is usually based on agency principle
b- An officers` s power originates from the board of directors
c- An example of express authority provided to an officer can be evidenced by corporate bylaws, valid
employment contract, or board resolution.
d- all of the above
2- In a publicly traded corporation, in which situation can a proxy fight occur:
a- Challenge to current directors by replacing with new directors( change management)
b- Changing directors with new directors to facilitate an acquisition.
c- Seeking a shareholder vote on a policy decision or corporate governance rules.
d- All of the above
3- Under a Berle-Means thesis, much of corporate governance has focused on balancing the cost and
benefits of:
a- The separation of ownership and control the prevent managers from unfairly dealing or
mismanaging the business when shareholders are dispersed.
4- undercapitalization in a piercing the corporate Veil case is determined in most U.S jurisdictions as
including:
a- Equity
b- Loans
c- Liability insurance
d- All of the above
5- Which relationship between the corporation is considered contractual?
b-creditor
6- Which of the following valuation methods focuses on net present value and cash flows?
a- Liquidation value
b- Book value
c- Earnings value
7- Ultra vires results when:
c-the corporation has been incorporated defectively
13-
8- Which of the following are true regarding corporate officers?
e- The power of officers to bind a corporation is usually based on agency principle
f- An officers` s power originates from the board of directors
g- An example of express authority provided to an officer can be evidenced by corporate bylaws, valid
employment contract, or board resolution.
h- all of the above
9- Who is viewed as residual claimants of a
b- common shareholders
10- In a publicly traded corporation, in which situation can a proxy fight occur:
e- Challenge to current directors by replacing with new directors( change management)
f- Changing directors with new directors to facilitate an acquisition.
g- Seeking a shareholder vote on a policy decision or corporate governance rules.
h- All of the above
11- Under a Berle-Means thesis, much of corporate governance has focused on balancing the cost and
benefits of:
b- The separation of ownership and control the prevent managers from unfairly dealing or
mismanaging the business when shareholders are dispersed.
12- the Board of Directors can act within its fiduciary power to run the corporation:
c-Best interest of the corporation, including all of the shareholders
13- undercapitalization in a piercing the corporate Veil case is determined in most U.S jurisdictions as
including:
e- Equity
f- Loans
g- Liability insurance
h- All of the above
Question 1
1.
Which of the following is NOT a factor to piercing the corporate veil
Corporate bankruptcy
Commingling assents and funds
Undercapitalization
Failure to maintain adequate corporate records
Board of directors in a corporation can take action by:
Approving resolution at meetings
Unanimous written consent without a meeting
Approve resolution at meetings or unanimous written consent without a meeting
None of the above
Question 11
1.
Debt is denominated by:
Bonds
Common shares
Preferred shares
Stocks
14- Structural setting for Piercing the corporate Veil include:
a- Parent-subsidiary corporation relationship.
b- Brother-sister (sibling) corporation setting
c- Personal shareholder liability
d- All of the above
15- What is the primary factor to weight when evaluating different securities?
c-Risk
16- The priority of payment of dividends and liquidation rights for preferred shareholders is as follow:
c- After creditors but before common shareholders
17- Which relationship between the corporation is considered contractual?
b-creditor
18- Which of the following valuation methods focuses on net present value and cash flows?
d- Liquidation value
e- Book value
f- Earnings value
19- Ultra vires results when:
c-the corporation has been incorporated defectively
20- In forming a corporation:
a- The incorporator is responsible for filing the article of incorporation
b- The process is complicated and expensive
c- Upon acceptance of articles of incorporation, corporate existence begins
d- All of the above
21- Businesses that need to raise large amount of capital by attracting public investors will choose:
Corporate form
22- A promoter will want to provide for what in a contract with a third party before a corporation is
formed?
Substitution of a new party to a contract (novation)
23- Defective incorporation means:
Loss of limited liability or limited liability that never existed
24- Which of these is a concept related to piercing the corporate Veil?
Must first establish independent basis for holding the corporation liable.
25- In a statutory merger, who must approve the merger?
The board of directors and the shareholders of both the buyer and the seller
26- In a consolidation, where A Inc. and B Inc. merge to form a new C Inc. which companies are in
existence after the merger?
C Inc. only
3rd assign …
Multiple-choice questions (3X1=3)
Q1- In Mergers, the Board of Directors and shareholders must approve the merger by:
1- 51% of the votes.
2- 64% of the votes.
3-75% of the votes.
4- It depends on the corporate policy.
Q2 – When a corporation purchases another corporation assets that can not considered as merger because:
1-The liabilities of the corporation do not transfer to the corporation which purchased the assets.
2- It is not require approval from the board of directors and shareholders.
3- The corporation which purchased the assets of another corporation con not control their decisions unlike
mergers.
4- Actually it can consider as merger.
Q3- Aggressor (acquiring corporation) offers target shareholders a price above current market value of their
stock is:
1-Exchange Offer.
2- Cash tender offer.
3- Beachhead Acquisition.
4- Tender Offer.
SEU 301 Companies Law
Week 2: (CHAPTER 1)
1. In forming a corporation:
a) The incorporator Is responsible for filing the articles of incorporation
b) The process is complicated and expensive
c) Upon acceptance of articles of incorporation, corporate existence begins
d) All of the above
Source: Paragraph 1.08
2. Ultra vires results when:
a) The corporation has been properly formed
b) The corporation has been incorporated defectively
c) The corporation has acted beyond its purpose or powers
d) The corporation has acted within its purpose or powers
Source: Paragraph 1.10
3. The law of the state of incorporation should govern most intra-govern relationships, such as
a) Between officers and corporation
b) Between directors and corporation
c) Between shareholders and corporation
d) All of the above
Source: Paragraph 1.09
4. Businesses that need to raise large amounts of capital by attracting public investors will choose:
a) Partnership
b) Corporate form
c) Limited Liability Company (LLC)
d) Limited Partnership
Source: Paragraphs 1.04 thru 1.06
5. What are sources of corporate law?
a) Independent legal organizations, like the American Law Institute
b) State Statutes
c) Judicially created common law
d) All of the above
Source: Paragraph 1.02
6. Which of the following is true?
a) Corporations pay tax on the profits they receive and when profits are distributed to shareholders in the form
of dividends; it is again taxed in the hands of the individual shareholders
b) Answers A and D
c) The formation of a partnership requires a formal written agreement
d) A corporation is viewed as a separate entity distinct from its owners
Source: Paragraphs 1.04 and 1.07.
Week 3: (CHAPTER 2)
1. Defective incorporation occurs when:
a) Improper or incomplete filing necessary to create the Corporation or LLC
b) When there has been a piercing of the corporate veil
c) In midlife by Secretary of State Corporation is administratively dissolved for failure to pay annual taxes or file
annual reports
d) A and C
Source: Paragraph 2.01
2. A Promoter will want to provide for what in a contract with a third party before a corporation is formed?
a) Guarantee that corporation will be formed
b) Confirmation of Promoter as party to contract
c) Substitution of a new party to a contract (novation)
d) Fee for signing contract as Promoter
Source: Paragraph 2.02
3. Promoter’s owe a duty of care and loyalty to:
a) The corporation they form
b) Co-promoters
c) Others with financial interests in corporation
d) All of the above
Source: Paragraph 2.02
4. The newly formed corporation will not be subject to the liabilities of contracts entered into by the promoter in
which of the following :
a) Directors affirmatively rejects the contract
b) Directors review the contracts and accept no benefits
c) A and B
d) Directors accept the contract
Source: Paragraph 2.02
5. Defective incorporation means:
a) Loss of limited liability
b) Limited liability that never existed
c) Both A and B
d) None of the above
Source: Paragraph 2.03
Week 4: (Chapter 3)
1. Which of the following are concepts of Piercing the Corporate Veil?
a) Due to abuse of the corporate form, shareholders should be held liable
b) Must first establish an independent basis for holding the corporation liable
c) Piercing the Corporate Veil doctrine is not frequently invoked
d) A and B
Source: Paragraph 3.01
2. What are grounds for piercing the corporate veil?
a) When there is an intermixture of affairs between the concerns of corporation and owners
b) When all corporate formalities have been followed
c) When there is inadequate capitalization
d) A and C
Source: Paragraph 3.03
3. Undercapitalization in a Piercing the Corporate Veil case is determined in most U.S. jurisdictions as including:
a) Equity
b) Loans
c) Liability Insurance
d) All of the above
Source: Paragraph 3.03
4. Structural settings for Piercing the Corporate Veil include:
a) Parent –subsidiary Corporation relationships
b) Brother-Sister (Sibling) Corporation settings
c) Personal Shareholder liability
d) All of the above
Source: Paragraph 3.08
5. What are the characteristics of Enterprise Liability?
a) Common control
b) Contribute to a collective endeavor
c) Multiple corporate veils are disregarded
d) A and B only
e) A and B and C
Source: Paragraph 3.08
Week 5 – (Chapter 4)
1. Attributes that all Securities share include:
a) Risk of loss on investment
b) The power to control the business
c) The ability to share in the success of the business
d) A and C only
e) A and B and C
Source: Paragraph 4.02
2. What is the primary factor to weigh when evaluating different securities?
a) Inflation
b) Lost opportunities
c) Risk
d) All of the above
Source: Paragraph 4.02
3. The priority of payment of dividends and liquidation rights for preferred shareholders is as follows:
a) Before creditors and common shareholders
b) After creditors but before common shareholders
c) After creditors and common shareholders
d) Before creditors but after common shareholders
Source: Paragraph 4.02
4. Which of the following valuation methods focuses on net present value and cash flows?
a) Liquidation value
b) Book Value
c) Earnings Value
d) None of the above
Source: Paragraph 4.05
5. Which relationship between the corporation is considered contractual?
a) Common shareholder
b) Creditor
c) Preferred shareholder
d) None of the above
Source: Paragraph 4.02
Week 6 (Chapter 5):
1. Which of the following are true regarding corporate officers?
a) The power of officers to bind a corporation is usually based on agency principles
b) An officer’s power originates from the board of directors
c) An example of express authority provided to an officer can be evidenced by corporate bylaws, valid
employment contract, or board resolution
d) All of the above
Source: Paragraph 5.07
2. Who is viewed as residual claimants of a corporation?
a) Preferred shareholders
b) Common shareholders
c) Creditors
d) All of the above
Source: Paragraph 5.05
3. In a publicly traded corporation, in which situation(s) can a proxy fight occur:
a) Challenge to current directors by replacing with new directors (change management)
b) Changing directors with new directors to facilitate an acquisition
c) Seeking a shareholder vote on a policy decision or corporate governance rules
d) All of the above
Source: Paragraph 5.05
4. Under a Berle-Means thesis, much of corporate governance has focused on balancing the costs and benefits of:
a) The separation of ownership and control to prevent managers from unfairly dealing or mismanaging the
business when shareholders are widely dispersed
b) corporate governance so officers can run the corporation without unnecessary interference
c) the role of Directors so they can make proper decisions for controlling shareholders
d) B and C
Source: Paragraph 5.02
5. The Board of Directors can act within its fiduciary power to run the corporation:
a) For the interest of the shareholders that elect them
b) Only if the majority of shareholders approve
c) Best interests of the corporation, including all of the shareholders
d) For the benefit of the officers of the corporation
Source: Paragraph 5.06
True and False Questions:
1. Liquidation value is the amount for which the assets could be sold minus the liabilities owed. Ture
2. Courts are more successful when piercing the veil of corporations if the corporations in question have not
followed corporate formalities. Ture
3. Residual claimant refers to preferred shareholders. False
.4
Q1-The name of corporation do not change after consideration. .5
False .6
Q2- The government _Ministry of Commerce in Saudi Arabia_ must approve tender offers. .7
True .8
Q3- In mergers, the corporation which continuous to exist is the absorbed corporation. .9
10. False
questions:
Q1: Define corporations? And list the people who play a really important part in a corporation?
To define corporation clearly there were a number of terms that comes together to describe the existence
of corporation. Such as, artificial, intangible, invisible in inspection of law. Existence a meager creature of
law, it holds just those properties that been charters of its establishment based on it, whichever
expressly, or incidental with its actual existence. moreover, there are different people who play a really
important part in a corporation and they are shareholder who consider as the owners of the
corporation. And the board of directors been selected by shareholders. Finally, board of directors chose
the officers. And the whole people are working upon the law and state regulations to run the corporation
smoothly and efficiently.
Q2: What are the characteristics of having a Sole proprietorship?
Sole proprietorship is one of an important type of a company forms. Which been described as, the
existence of property which owned by an individual person who is the owner. Without any formal
requirements requested from that promoter for both of ownership or management of that company.
The characteristics of having a Sole proprietorship starting with the simplest and flexible structure by the
promoter who have to be an individual person. That person is the sole owner and total control with the
fully power of decision making. Also, there is no formal requirements needed of how to own or manage or
control the business. Therefore, the owner is the responsible for every liability, setting the company’s
obligations and selecting the employees. And for taxes it’s got the lowest charging taxes if we compared it
with the corporation. Because it’s been taxed over the sole proprietor’s marginal tax rate. Finally, it’s easy
to end and closed the business.
From another hand, there were a number of negative characteristics. Such as the huge risk that might
face the owner e.g. bankruptcy. The death or long period illness, which case end the business. Finally, the
difficulties that raised from limitation of individual owner such as expand the business or rising an extra
capital.
Q3: What is the legal process in which the corporation can be incorporated?
To answer this question there four general legal processes which have to applied in each corporation
type. Firstly, the financial deal. Which been considering the budget and the financial resources.
Secondly, the legal roles of capital. And it was considered as the law or resolution that
necessity applied within a corporation. Aim to restricted for purposes of both of dividends or other
distributions. Thirdly, establishing and forming the fundamental characteristics and structures for
the board directors. Fourthly, emphasis that the right, power, and control belong to the
shareholder.
There a set of legal process that must been applied in corporation. First of all, At forming the
corporation there is only an individual person who is acting as an incorporator. Who prove a set of
bylaws. And chose the initial shareholders’ and directors’ meetings. To Assemble for election of
directors and officers. Also, Open bank accounts for the corporation. Then Issue shares. Finally,
Demeanor other important acts.
Secondly, corporation articles should be filed by the government entity. Thirdly, corporation name
must be “unique” differ name than others corporation. finally, Business entity identifier, using a
denomination ( Inc., Ltd., Pc, Co or Corp) after the corporation name. some countries considered that,
the name of the corporation have to be in an English alphabet or Arabic numerals.
Q4: What are the differences between Partnerships and Corporations?
Advantages & disadvantages
Partnership
Corporation
association of two or more
persons
co-owners in a business
for profit
Owner liable for
partnership debts
separate legal entity
The entity
owes its existence to the
state
which Protects owners
from:
liabilities
any attacked on its
shareholders that going
after the company.
No formal action or
written agreement
required
Files articles of
incorporation with state
The form of the entity
Interests are not freely
transferable
Shareholders can freely
transfer shares.
Transferability
ends partnership
limits continuity of
business
no effect
Interests are not freely transferable
perpetual existence
Continuity of existence
Right as co-owners to
Centralized management
participate in management
Shareholders no
Agent in normal course of management limited
business
capacity
Management
pays only one layer of tax
double taxation
Taxation
Less expensive to operate
Higher costs to operate
Cost
Partnership law is more
protective
corporation is protected
against attacks on its
shareholders.
Protection
-The protection offered
by the formation of a
corporation is one of the
biggest advantages of
forming a corporation
Assign… from coordinator – Madinah Branch
1st. assign…
Q1: Define corporations? And list the people who paly a really important part in a corporation?
Answer:
A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law. Being a mere
creature of law, it possesses only those properties which the charter of its creation confers upon it, either
expressly, or as incidental to its very existence.
•
•
Owners are called shareholders
Board of directors (elected by the shareholders) oversees the management of the company
➢ Select officers run the company
Q2: What are the characteristics of having a Sole proprietorship?
Answer:
➢ An individual is the sole owner.
➢ No formal requirements for the ownership and management of the company.
➢ Owner is the principal and can employ people to work for him/her.
➢ Owner is personally liable for the obligations of the business
Q3: What are the differences between Partnerships and Corporations?
Answer:
•
•
Partnership: Owners are personally liable
Corporation
➢ Shareholders are insulated from the liabilities of the corporation. Shareholders are
protected from anyone going after the company.
➢ Conversely, the corporation is protected against attacks on its shareholders cr.
➢ The protection offered by the formation of a corporation is one of the biggest
advantages of forming a corporation.
Q4: What is the legal process in which the corporation can be incorporated?
Answer:
•
•
•
•
•
When forming a corporation, one person must act as an incorporator.
The articles of incorporation are filed with a government entity.
Name of the corporation must different from any other corporation.
Corporations must also use a denomination after the corporation name such as Inc., Ltd., or
Corp.
Incorporator must:
• Adopt a set of bylaws
• Hold the initial shareholders’ and directors’ meetings
• Arrange for election of directors and officers
• Open bank accounts for the corporation
• Issue shares
• Conduct other important acts
—————————————————————————————-2nd assign …
Q1: Define promoters, and what are the promoters’ responsibilities and duties in regarding to the
corporation?
Answer:
➢ Promotor is someone who takes responsibility for the existence of the business.
➢ Promoters:
❖ Bring important parties together
❖ Raise capital
❖ Make arrangements for the business
➢ Promoter’s fiduciary duties
❖ Must be loyal to other promoters, the corporation being formed, and investors in the
corporation.
❖ May not profit self-deal or secretly profit from his/her duties.
❖ Must act in the best interests of the company.
Q2: When defective incorporation occurs? And “De Facto Corporation” consider as one of the remedies for
defective incorporation and it has three elements that must be satisfy, what are they?
Answer:
➢ According to the text, “the de facto corporation defense has three elements.
❖ There must be a law pursuant to which the contemplated enterprise could have
incorporated.
❖ The defendants must prove a good faith or “colorable” attempt to incorporate under
that law.
❖ The defendants must demonstrate actual use or exercise of the corporate powers the
participants believe themselves to have, which in the usual case will involve doing
business under a corporate name.”
Q3: On what grounds will the court be able to pierce the corporate veil? And discuss two of them in more
details.
Answer:
•
Intermixture of affairs
“Refers to the blurring of the distinction between the concerns of the corporation
and those of the owners.
When affairs are intermixed, it becomes difficult for a third party to determine
where the affairs of the owner leave off and those of the incorporated business
begin.
This ground for piercing the corporate veil usually occurs in connection with, and is
closely related to, the next ground, lack of observation of form”
•
•
Lack of corporate formalities
Courts are more successful when piercing the veil of corporations if the corporations
in question have not followed corporate formalities.
“Failure to observe formalities may indicate an impermissible intermixture of affairs
or may indicate the use of a corporation as a “mere instrumentality.”
Inadequate capitalization
Q4: Define and discuss the legal rules for each of the following terms:
✓ Par value
✓ Dividends and repurchasing of share
Answer:
1. Par Value:
Minimum price at which a share must be sold.
✓ The board of directors sets the price for the shares of the corporation.
✓ However, government agencies may require the share price be set at a certain value.
✓ Almost all shares are sold at the par value.
✓ Par value assures creditors that the corporation has a cushion to pay them.
2. Dividends and repurchasing of share
“Dividends are payments to shareholders which represent a current return on investment. 32
Dividends are paid at the discretion of the directors.
As an alternative to paying dividends, the board of directors may decide to have the
corporation buy back or repurchase shares.
Like dividends, this repurchase is another means by which shareholders may receive funds from
the corporation.
The basic principle is not to permit payment of dividends or stock repurchases in cases where
the payment will adversely impact investors or creditors.”
1- Name two of the reasons for court ordered involuntary dissolution of corporation?
❖ Defunct corporations may be reinstated b filing annual reports and paying fees owed.
❖ Neither shareholders nor their attorney can reinstate a company after the two year period has elapsed.
2-What is the definition of consolidation?
Consolidations occur when corporation A and corporation B merge into a new corporation, corporation C.
Corporation A and Corporation B cease to exist as individual corporations.
———————————————————————————————————————————- End.—–
Chapter 8
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Introduction
• The book defines fiduciary relationship as:
“created when one is give the power that carries a duty to
use that power to benefit another.1”
• Fiduciary relationships include:
➢ Trustee relationships
➢ Beneficiaries of trusts
➢ Partners or agents to principals
• Enforcement of fiduciary duty is used to reduce
mismanagement of the company or unfair self-dealing.
• Fiduciaries are accountable to shareholders and directors
of the company.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
• “The characterization of someone as a fiduciary generally
means that the individual has to obey certain duties and
look out for the interests of whoever is owed the duty.”
• Fiduciaries are bound by a duty of care and duty of
loyalty.”
➢ Duty of care:
❖ Directors perform their duties with care and
diligence.
❖ Can be liable for both malfeasance and
nonfeasance.
❖ Protected under business judgment rule (limits
court questioning business decisions).
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
➢ Duty of care:
❖ Directors perform their duties with care and
diligence.
❖ Can be liable for both malfeasance and
nonfeasance.
❖ Protected under business judgment rule (limits
court questioning business decisions).
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
➢ Duty of loyalty:
❖ Act in the best interests of the company and in
good faith.
❖ A lack of duty loyalty involves intent to harm the
company and dereliction of duty.
▪ Can occur when the person responsible for the
fiduciary duty puts his/her own interests over
the interests of the company.
❖ Courts will get involved in cases where the person
in charge of fiduciary duty puts their personal
interests over loyalty of duty.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
The textbook states the difference between duty of loyalty
and duty of care is as follows:
“Thus, in duty of loyalty cases involving a conflict of
interest, there is more judicial involvement and scrutiny
than in duty of care or good faith cases.11 The difference is
justified because in a duty of care case, the courts want to
protect business decisions that are intended to enhance
corporate gain, while in a duty of loyalty involving a
conflict of interest case the directors may be motivated by
personal gain.12”
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Policy issues
• “The fiduciary duty of those who manage or control is to
the corporation and shareholders and the shareholders
have the right to enforce it through litigation.”
• Publicly traded companies have outside directors to
monitor the inside directors.
• Company representatives disagree on the involvement of
litigation to enforce fiduciary responsibility:
➢ Shareholders want judicial scrutiny.
➢ Managers who have fiduciary duties do not want judicial
scrutiny.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Policy issues
• Law and economics approach
➢ View the relationship between shareholders and
managers as a contract.
➢ The duties of the fiduciary manager are included in the
terms of the contract.
➢ Detractors of this approach include shareholders who
would not be able to negotiate the contract.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Duty of care
• Liability under duty of care requires:
➢ Finding duty
➢ Breach
➢ Proximate cause and loss
• “Issues of breach of duty of care can arise in two kinds
of situations; when
➢ There is a failure to act or monitor where a loss
could have been prevented (i.e., nonfeasance)
➢ There is a decision made in a negligent manner
(i.e., malfeasance).”
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Malfeasance and the business judgment rule
• Malfeasance occurs when directors are accused of making
ill-advised decisions or negligence of duties.
• The ill-advised decisions are subject to judicial review and
can be protected under the business judgment rule.
• Even if malfeasance is found, finding causation may be
required.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Malfeasance and the business judgment rule
• Business judgment rule
➢ “limits judicial inquiry into business decisions and
protects directors who are not negligent in the decision
making process.”
➢ Courts defer to the director’s decision and do not infer
that they have more knowledge over business
decisions than the director’s.
➢ Under this rule, courts will review the process of the
process, not the decision.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Causation
• Breach of duty does not necessarily end the inquiry.
• The actual cause of the breach of duty must be found.
• Plaintiffs have the burden of proof and must prove
themselves free of negligence.
• Plaintiffs must also show the amount of damages.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Good faith
• “Lack of good faith would include
➢ Conduct motivated by subjective bad intent
➢ By an actual intent to harm the corporation
➢ An intentional dereliction of duty and a conscious
disregard for one’s responsibilities would also constitute
a lack of good faith because it shows more culpability..”
Chapter 9
The Duty of Loyalty and Conflicts of Interest
Duty of Loyalty and Conflicts of Interest
Introduction
• “Traditionally, the duty of loyalty was raised when the
fiduciary (or those associated with him or her) had a
conflict of interest with the corporation, suggesting that
personal interests may be advanced over corporate
interests.
• Conflicts of interest may involve a use of position for
personal gain, taking something that belongs to the
corporation,4 or some form of self-dealing with the
corporation where the fiduciary is on both sides of the
transaction and in a position to receive a benefit
unavailable to other shareholders.”
Duty of Loyalty and Conflicts of Interest
Policy
• Duty of loyalty
➢ Tries to prevent directors from going against the best
interests of the corporation or self-dealing to benefit
themselves.
➢ Different from duty of care because duty of loyalty
focuses on self-dealing rather than poor decision
making.
➢ Fiduciary rules are stricter on duty of loyalty than on
duty of care.
Duty of Loyalty and Conflicts of Interest
Interested director transactions
• Common law
➢ “Common law cases generally followed the view that
the process of approval and the terms of the transaction
itself must be fair, with the burden of proof on the
fiduciary.
➢ This rule protects shareholders from exploitation and
permits flexibility in corporate dealings.”
Duty of Loyalty and Conflicts of Interest
Interested director transactions
• Statutory responses
➢ “Many states have enacted statutory provisions that
deal with interested director transactions (“interested
director statutes”).
➢ Many states do not codify the duty of loyalty, but
provide mechanisms that may create presumptions or
deal with the burden of proof or act as safe harbors that
limit any judicial review.”
Duty of Loyalty and Conflicts of Interest
Executive compensation
• Executive compensation can be in various forms, including:
➢ Salaries
➢ Bonuses
➢ Pensions
➢ Fringe benefits
➢ Restricted stock
➢ Severance packages
➢ Golden parachutes
➢ Stock options
Duty of Loyalty and Conflicts of Interest
Corporate opportunity and abuse of position
• Abuse of position happens when the fiduciary taking
advantage of his/her position.
• Fiduciary’s should not benefit personally from their
position.
Duty of Loyalty and Conflicts of Interest
Corporate opportunity and abuse of position
• Financial inability
➢ Corporation’s lack the ability to take advantage of corporate
opportunities.
• Multiple boards
➢ Directors serve on boards for multiple corporations.
• Use of information and competition
➢ “A corporate fiduciary cannot use corporate information, a
corporate position150 or assets unfairly for personal profit151 and
may not be able to compete with the corporation.152”
• Undisclosed profits
➢ Improper use of information for personal profits which are not
disclosed to the corporation.
Duty of Loyalty and Conflicts of Interest
Shareholder voting and ratification
•
•
•
“When shareholders vote on a transaction, an issue arises
as to the effects of that vote.
A shareholder vote is not optional, but a statutory
requirement, such as voting amendments to the articles of
corporation or to effectuate a merger or fundamental
transaction.”
Shareholders sometimes vote on ratification of a
transaction.
Duty of Loyalty and Conflicts of Interest
Shareholder voting and ratification
•
There are two types of shareholder voting:
➢ Required voting
❖ Voting that is not to validate a transaction. The
voting is more authorize the transaction. The
transaction requires the shareholder vote.
➢ Optional shareholder voting and ratification
❖ Voting when the shareholder vote is not required,
but is optional.
❖ By having the shareholders vote on a transaction, it
may limit the extent of judicial scrutiny.
Chapter 10
Controlling Shareholders
Controlling Shareholders
Introduction
• De jure control
➢ Shareholder or group owns a majority of voting shares
of a corporation.
• De facto control
➢ Working control because no shareholders or group of
shareholders has majority control.
• Control group
➢ Group of shareholders acting together or another
corporation owning control.
Controlling Shareholders
Introduction
• Advantages/disadvantages for shareholders in the control
group
➢ Control group is less diversified
❖ Lack of diversification leads to the corporation fortunes having
a larger impact on the control group.
➢ Control group can monitor potential mismanagement.
❖ Corporation, because of this monitoring by the control group,
could be run more effectively.
➢ “A significant disadvantage occurs when there is an
unfair conflict of interest transaction (i.e., self-dealing)
between the control group and the corporation where
the shareholders are excluded.”
Controlling Shareholders
Use of control
• The Zahn case
➢ “Controlling shareholders cannot use their control to
self-deal unfairly with the assets of the corporation.”
• Parent-subsidiary dealings
➢ “A corporation that is a controlling shareholder
(“parent”) of another corporation (“subsidiary”) often
contracts with the controlled corporation.”
• Sale of corporation
➢ Judicial scrutiny may be higher if controlling
shareholders are involved in a sale of a corporation.
Controlling Shareholders
Sale of control
• “When the control group sells its shares, they are sharing
their personal property, which does not automatically
implicate any breach of fiduciary duty.
• Controlling shareholders who sell their controlling shares
often receive a premium from a purchaser, that is, they
receive more for their shares than the current market price,
and that may raise issues of fiduciary duty.”
Controlling Shareholders
Sale of control
• “The premium for control may represent the advantages of
control, which include the ability to establish business
policy and decide how the business will run,138 as well as
the ability to receive the perquisites of control, including
reasonable salary and benefits from legitimate fair selfdealing transactions.”
• “The premium may also enable the control group to unfairly
use corporate assets for its own advantages.”
• “Sale of control raises the issue of whether a rule of equal
treatment of shareholders should be a goal of corporate
law.141”
Controlling Shareholders
Sale of control
• Pro rate sharing rule
➢ Purchaser may buy as many shares as they want to
achieve control without buying 100% of the shares.
❖ Purchaser must make the same offer to the
shareholders.
• Mandatory bid rule
➢ Purchaser must offer to buy 100% of the shares at the
same price.
➢ Controlling shareholders would not get a premium price
on their shares as opposed to the minority
shareholders.
Controlling Shareholders
Sale of control
• Looting
➢ Purchasers bought “controlling interest at a premium to
loot the company of its primary liquid assets.”
• The Perlman case
➢ “Perlman v. Feldman150 dealt with the sale of control
issue and explored the idea of a pro rata sharing rule
and equal opportunity for all shareholders to share in
the premium paid to the controlling shareholders.”
➢ “The court recognized that this was no ordinary case of
duty of loyalty because their was no fraud, misuse of
confidential information, contracting with the corporation
or looting.”
Controlling Shareholders
Sale of control
• The California approach
➢ Controlling shareholders in a savings and loan decided
to profit from the increased market value of their
shares.
➢ To profit from the increase in market value, the
controlling shareholders transferred their shares to a
private holding company that became a part of the
parent company.
➢ When the private holding company offered public
shares, the sale of these shares would make the
controlling shareholders a profit.
Controlling Shareholders
Sale of control
• The California approach
➢ Minority shareholders brought a lawsuit against the
controlling shareholders for breach of fiduciary duties.
➢ Court ruled in favor of the minority shareholders.
➢ The controlling shareholders had not established that
their actions were in “good faith”.
Controlling Shareholders
Sale of office
• “When the sale of control takes place, the directors usually
resign and select the designated nominees of the
purchaser of control to replace them as directors.
• While the purchaser could arrange for a shareholder vote,
they prefer to act quickly and without the expense.”
• Resignations of directors can raise the issue of whether or
not an illegal sale of office has happened.
• Purchasers should have actual or de facto control before
electing new directors.
Chapter 13
Disclosure and Insider Trading
Disclosure and Insider Trading
Introduction
• Insider trading
➢ “involves the use of nonpublic information by any
person “having a relationship [director, officer, attorney]
giving access, directly or indirectly, to information
intended to be available only for a corporate purpose
and not for the personal benefit of anyone.9”
➢ Use of the information to trade or give other people tips
that a trade is going to occur.
Disclosure and Insider Trading
Disclosure concepts and elements of a cause of action under
rule 10b-5
• Disclosure concepts
➢ Implication of private rights of action
➢ Standing to sue
➢ Materiality
➢ State of mind (5 culpable states)
❖ Strict liability
❖ Negligence
❖ Recklessness
❖ Knowing conduct
❖ Intentional conduct
Disclosure and Insider Trading
Disclosure concepts and elements of a cause of action under
rule 10b-5
➢ Pleading state of mind
➢ Reliance (Transaction causation)
➢ The fraud on the market theory reliance substitute
➢ Loss causation
➢ The “In connection with” requirement
➢ Privity
➢ Secondary liability for disclosure violations
➢ Statues of limitation
Disclosure and Insider Trading
The prohibition of insider trading: Is it good or bad?
• Arguments for insider trading
➢ “Profits made by insiders through their trading
constitute rewards for their entrepreneurial efforts.
➢ Inside trading profits constitute the very type of
performance-based compensation that aligns corporate
official’s interests with those of shareholder owners.
➢ Insider trading helps move stock prices quickly in the
correct direction and magnitudes, reflective of events
occurring within the particular company, thereby
contributing to stock market efficiency, which is
beneficial to investor.”
Disclosure and Insider Trading
The prohibition of insider trading: Is it good or bad?
• Arguments for insider trading
➢ “Insider trading harms no one because if the inside
information needed to be secret, those who sell when
insiders are buying or those who buy when insiders are
selling would have bought or sold anyway (“No One is
Harmed”).”
Disclosure and Insider Trading
The prohibition of insider trading: Is it good or bad?
• Arguments against insider trading
➢ “Entrepreneurs: Senior managers and directors of publicly held
corporation are for the most part not entrepreneurs.”
➢ “The ideal performance-based compensations: Insiders who possess
negative news may sell before other investors receive the news and
react.”
➢ “Enhancement of accurate securities pricing: information is held back
to benefit the insider.”
➢ “No one is harmed”: “Trading on information intended to be available
only for a corporate purpose, not possessed by other players in the
market, is beyond the rules of the sport, so to speak.”
Disclosure and Insider Trading
Law of insider trading
• Common law background
• The nature of insider trading prohibition
• Who is an insider?
➢ “A traditional insider is a person who, because of a fiduciary or
similar relation, is afforded access to nonpublic investment
information from her corporation.
➢ The paradigmatic insider is the senior corporate official or director in
a corporation, although professionals such as attorneys,
accountants, and investment or commercial bankers may also
become insiders, or temporary insiders, when they learn of nonpublic
information during the course of performing services for the
corporation.”
Disclosure and Insider Trading
Law of insider trading
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Tipper-Tippee liability
The misappropriation theory
The misappropriation theory in the Supreme Court
Tippees of misappropriators
Remedies and enforcement
SEC regulation FD
Disclosure and Insider Trading
The insider trading prohibition under state law
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Common law
Common law exceptions: The Kansas rule
Common law exceptions: Special facts doctrine
Modern expansion of the special facts doctrine
Finding harm to the corporation from the insider’s trading
Disclosure and Insider Trading
Regulation of insider trading under Section 16 of the securities
exchange
• Act of 1934
➢ Statutory provisions
➢ Parties plaintiff and calculation of damages
➢ Who is an officer for Section 16 purposes?
➢ Insider status at only one end of a swing
➢ Takeover players and Section 16(b)
Chapter 5
The Legal Model and Corporate Governance:
Themes and the Allocation of Power Under
State law
Legal Model and Corporate Governance
• Corporate governance is defined as:
➢ “the system by which companies are directed and
controlled.
➢ Under traditional corporate theory, control of a
corporation is vested in the board of directors elected
by the shareholders.”
Legal Model and Corporate Governance
Themes
• Themes that relate to the study and influence on
development of corporate law and governance
➢ Focus of corporate governance and stakeholders
➢ Publicly held corporation
➢ Stock markets
❖ Benefits of stock markets
❖ Shareholder protection and stock markets
➢ The efficient capital market hypothesis
Legal Model and Corporate Governance
Themes
➢ Role of ownership
❖ The Berle-Means Corporation-Separation of
ownership from control
❖ Institutional investors
❖ Political significance of share ownership
➢ Independent directors
➢ Gatekeepers
➢ Federalism
➢ Publicly held vs. closely-held corporations
Legal Model and Corporate Governance
Theories of the firm
• Different theories of firm and corporate law models for
publicly traded corporations
➢ Regulatory approach
➢ Management, Director, or Shareholder approach
➢ Law and economics approach
❖ Agency costs
❖ Markets
❖ Nexus of contracts
❖ Critics of contractual approach
❖ Behavioral economics
Legal Model and Corporate Governance
Legal model
• “The governing structure of a corporation is composed of
the shareholders as the owners of the company, and the
board of directors who oversee the management of the
company.”
• “The legal model allocates to directors and officers the
authority to manage while it provides the shareholders,
as owners, with some ability to monitor the manager’s
performance.143”
Legal Model and Corporate Governance
Shareholders
• “The co…