forming the business as: a corporation? a partnership? a limited liability company?

Saudi Construction Case Study

Asad and three business associates have decided to start a business: Saudi Construction. They will do work for oil companies in Saudi Arabia at first, but he hopes the firm will grow within two or three years to gain heavy construction contracts throughout the Middle East. Asad wonders whether he should form a corporation, a partnership, or maybe a limited liability company under Saudi Companies Law.

Asad believes they will initially need about $10 million in capital to run the business and have sufficient financial reserves to do large-scale projects. After two years, they will need an additional $20 million in capital.

Asad will be in charge of business operations. He realizes they need a business plan that will address how to value the corporation in order to raise the necessary capital in two years. It also needs to address how Saudi Construction can legally protect its assets in an industry where lawsuits are a common hazard.

Meanwhile, his associates have pressured Asad to kick-start the business by signing a couple of lucrative contracts right away; they tell him he shouldn’t worry about the administrative paperwork. They say that nobody ever looks at the paperwork once a business is formed and it’s no big deal.

Action Items

In at least a two-page paper, fully respond to the following:

Asad has hired you as his business consultant to help him make good decisions. Give him advice on his questions:

What are the advantages and disadvantages of forming the business as:

a corporation?

a partnership?

a limited liability company?

What is his potential liability as an individual and what can he do to limit his risk?

What issues might arise from following his business associates’ advice?

What other factors should he take under consideration?

In helping Asad with the business plan, explain:

How he can value his business

What the business can do to reduce its risk

How the owners can limit their liability

What the business should (and should not!) do to protect against lawsuits

What factors he must consider on how to raise capital

What mix of capital the business should have

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
•
•
•
•
•
•
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
•
•
•
•
•
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 common shareholders, as owners of the
corporation, are viewed as residual claimants because
their claim on assets (upon liquidation) and profits
follows creditors and preferred shareholder, who usually
have fixed claims with priority.
• “A significant issue in corporate law is the allocation of
power between the shareholders and the directors and
officers.
❖ The primary source for the allocation of power within
a corporation is state law.147”
Legal Model and Corporate Governance
Shareholders
• Shareholders have the following rights:
➢ Right to vote
❖ Cumulative voting
➢ Rights of expression
➢ Proxy voting
➢ The proxy fight
❖ Change management
❖ Replace directors to facilitate an acquisition
Legal Model and Corporate Governance
Shareholders
❖ Change policy
▪ Shareholder proposals
▪ Withholding votes
▪ Nominating directors in management’s proxy
statement
❖ Collective action problem
❖ Proxy expenses
➢ Shareholder democracy
❖ Fiduciary duty
➢ Vote buying
➢ Right to information
Legal Model and Corporate Governance
Board of directors
• “The board of directors in publicly traded corporations
must give managers flexibility to run the business, while
monitoring them to limit self-dealing and
mismanagement.261
• Most of the legal monitoring devices are aimed at trying
to get the board to monitor managers without too much
interference from shareholders.”
Legal Model and Corporate Governance
Board of directors
• Board structure
➢ Number of directors is set by the bylaws or articles of
incorporation.
➢ Directors are elected by the shareholders.
➢ Actual role of the board is dependent upon many
factors including the make up of the board.
• Meetings
➢ Board acts at meetings
➢ Actions without a meeting
Legal Model and Corporate Governance
Officers
• Daily operations are delegated by the corporate officers,
who can be appointed by the board of directors.
• Officers have fiduciary duty to the corporation since they
are agents of the corporation.
• Authority
➢ Power originates from the board of director’s
➢ “Determining the power of the officers to bind the
corporation is an important issue that is usually
based upon agency law principles.”
Legal Model and Corporate Governance
Financial scandals
• Stock market crash of 1929
• The Sarbanes-Oxley Act of 2002
• Dodd Frank-Act of 2010
Chapter 14
Corporate Litigation
Corporate Litigation
• Two types of corporate litigation
➢ Direct
❖ “If one or more shareholders sue the corporation
alleging that the corporation has denied them a
contract right associated with shareholding (rights
to dividends or disclosure, for example), the action
is direct.
❖ If the shareholder alleges a special or distinct
injury over and above a diminution in the value of
shares, the action is also direct.”
Corporate Litigation
• Two types of corporate litigation
➢ Derivative
❖ By contrast, if shareholders sue to vindicate the
violation of a duty owed to the corporation either
fiduciary duties owed by corporate directors or
officers, or obligations of a third party pursuant to a
contract with the corporation, the action is
derivative.
❖ Any recover goes to the corporate treasury.”
Corporate Litigation
The nature of the derivative suit: Direct versus derivative,
pro rata recover, and other preliminary issues
• The nature of the derivative suit
➢ Action brought by shareholders on behalf of the
corporation.
• Direct vs. derivative – Special or distinct injury rule
• Direct vs. derivative – Denial of contract rights associated
with shareholding
• Direct vs. derivative – Closely held corporation exception
• Pro rata (individual) recovery in derivative actions
• The Tooley test in Delaware
Corporate Litigation
Qualifications of a proper plaintiff-shareholder
•
Types of qualifications:
➢
➢
➢
➢
➢
➢
➢
Record ownership
❖ “The vast majority of shares in publicly traded corporations
are held in nominee, or “street” (Wall Street) name, rather
than in shareholders’ names, or “record” ownership.55”
Contemporary ownership
Possible exception: Undisclosed wrongdoing
Continuous owner
Clean hands requirement
Adequate representation requirement
Selection of lead counsel
Corporate Litigation
Qualifications of a proper plaintiff-shareholder
•
Demand rule:
➢
➢
➢
➢
Demand refused
Demand accepted
Demand excused
❖ The futility exception
❖ Threat of irreparable harm
❖ Closely held corporation
❖ Delay
Demand on shareholders
Corporate Litigation
The termination of litigation: The advent of the special
litigation committee device
•
•
Background
➢ 1960s and 1970s: US corporations made illegal
payments to procure business abroad.
➢ SEC gave corporations the opportunity to investigate
their own affairs to reduce the court case load.
❖ By doing this, corporations that disclosed the
amounts of the illegal payments, received only a
slap on the wrist from the SEC.
Application of the business judgment rule
Corporate Litigation
The termination of litigation: The advent of the special
litigation committee device
•
Two approaches to dismissing litigation
➢ Auerbach business rule judgment approach
➢ Zapata approach
•
Structural bias and other considerations
➢ Structural bias is defined as “inherent prejudice
against any derivative action resulting from the
composition and character of the board of directors”
and of special litigation committees.178”
Corporate Litigation
Proposed reforms of the modern strike suit era
•
Pro defendant
➢ Business judgment rule application of Auerbach
➢ ALI position
•
Pro shareholder
➢ Zapata v. Maldonado theory
Corporate Litigation
Right to trial by jury, attorneys’ fees, and miscellaneous
issues
• Right to trial by jury
➢ “Fiduciary duties have their genesis in trust law, at the
heart of the Chancery Court’s jurisdiction.
➢ The derivative action itself was the creation of the
equity courts.
➢ For many decades, the prevailing view was that
derivative actions belong exclusively to the equity
courts; there was no right to trial by jury.
➢ US federal law altered the theory that derivative
actions belonged to the equity courts.”
Corporate Litigation
Lawyering problems in corporate litigation
•
•
•
•
Attorney-client privilege
Attorney-client privilege in derivative litigation
The corporation as a client
Sabanes-Oxley Act: The conflict between “reporting up”
and the prohibition of disclosure of client confidences
Corporate Litigation
Indemnification and insurance
• “Before agreeing to serve as director, especially on the
board of a publicly held corporation, an individual will want
to know what protections she will have if she is named as
a defendant in a class action, derivative suit, or
governmental proceeding involving the corporation’s
affairs.
• Protection includes a payment for, or provision of, legal
services to the director.
• Protection also includes full or partial payment of any
settlement or judgment in proceedings against the
directors.”
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.—–
1.
2.
3.
4.
5.
6.
7.
8.
Duty of loyalty is protected under business judgment rule.
False
A corporate fiduciary who unfairly profits from her corporate role is committing
Abuse of position.
True
Fiduciary rules are stricter on duty of care than on duty of loyalty.
False
The right to vote for directors is the most significant right that the shareholders
of publicly traded corporations possess.
True
Publicly held corporations have fewer shareholders than closely held
corporations.
False
Shareholders must approve the sale of the assets of the company that is being
merged.
True
Defunct corporations can be reinstated.
True
Under business judgment rule, courts will review the decision itself, not the
decision making process.
False
9.
Breach of duty of care can arise in two kinds of situations; nonfeasance arises
when there is a failure to act or monitor where a loss could have been prevented.
However, malfeasance occurs when there is a decision made in a negligent
manner.
True
10. The allocation of power between the shareholders and the directors and officers
is a significant issue in corporate law.
True
11. Piercing the veil vertically occurs when the claimant try to reach down to the
assets of another corporation which is the sibling of the corporation first sued.
False
12. Insider trading is the use of the information to trade or give other people tips
that a trade is going to occur.
True
13. Attorneys, accountants, and commercial bankers may become insiders, or
temporary insiders, when they learn of nonpublic information during the course
of performing services for the corporation.
True
14. Directors are responsible to carefully review all contracts made by promoters
on behalf of the corporation.
True
15. When a corporation sells its shares to a large number of investors, it becomes
privately held.
False
16. Enforcement of fiduciary duty is used to reduce mismanagement of the
company or unfair self-dealing.
True
17. “Corporate governance is “”the system by which companies are directed and
controlled.”
True
18. Control group cannot monitor potential mismanagement.
False
19. Controlling shareholders can use their control to self-deal unfairly with the
assets of the corporation.
False
20. Judicial scrutiny may be higher if controlling shareholders are involved in the
sale of a corporation.
True
21. Owner is personally liable for the obligations of the business in sole
proprietorship.
True
22. “In a duty of good faith cases involving a conflict of interest, there is more
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Law 401- Companies Law
judicial involvement and scrutiny than in duty of care or loyalty cases.”
False
23. Any recovery from derivative litigation goes to the corporate treasury.
True
24. Compensation paid to executives and directors may raise both duty of care and
duty of loyalty issues.
True
25. A tipper has the same liability as an insider who actually trades.
True
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Law 401- Companies Law
1. The owner of
are protected from anyone going after the company.
a. a corporation
b. a partnership business
c. a Limited liability Partnership business
d. a Limited liability
2. One qualification of a proper plaintiff-shareholder is that of the
, that the plaintiff not have any complicity in the
wrongdoing.
a. Clean hands requirement
b. Adequate representation requirement
c. Contemporaneous ownership requirement
d. Record ownership requirement
3. Which of the following roles are NOT classified as part of the incorporator
duties?
a. The incorporator is responsible for filing the articles of incorporation.
b. Organizing the initial meeting of the board of directors and
shareholders.
c. Run “day-to-day” business of firm
d. Raise capital
4. Which of the following statements is true?
a. Defective incorporation occurs when a clerk not filing paperwork or
the government agency sending back the paperwork.
b. “The concepts of Piercing the Corporate Veil is due to abuse of the
corporate form, shareholders should be held liable.”
c. Preferred stock has lower priority and greater risks of loss.
d. a & b are correct.
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Law 401- Companies Law
5.Fiduciaries are bound by:
a. Duty of loyalty only
b. Duty of care and duty of loyalty
c. Duty of good faith
d. b & c.
6.
is primary factor to be weighed against potential return in
deciding among business investment opportunities.
a. Lost opportunities.
b. Risk.
c. Inflation.
d. All of the above.
7.
a.
b.
c.
d.
are often referred to as residual claimants.
Corporate directors.
Preferred shareholders.
Creditors of the corporation.
Common shareholders.
8. Which of the following statements is correct?
a. Shareholders are held liable for the defunct corporation.
b. Shareholders and their attorney can reinstate a company after the two
year period have elapsed.
c. Shareholders are not held liable for the defunct corporation.
d. Defunct corporations cannot be reinstated.
9. Which of the following is defined as the minimum price at which a share must
be sold?
a. Book Value
b. Liquidation value
c. Par value
d. None of the above.
10. “If one or more shareholders sue the corporation alleging that the corporation
has denied them a contract right associated with shareholding, the action is :”
a. Private Litigation
b. Direct litigation
c. Derivative Litigation
d. None of the above
11. Salaries, bonuses, pensions, fringe benefits, restricted stock, severance
packages, golden parachutes, and stock options are all forms of
.
a. The strong form approach
b. Common law
c. Judicial review
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Law 401- Companies Law
d. Executive compensation
12. Which of the following is (are) factors that result to pierce the corporate veil?
a. Lack of corporate formalities
b. Inadequate capitalization
c. Intermixture of affairs
d. All of the above
13. If a shareholder, or a group of shareholders acting together, own a majority of
voting shares of a corporation, it usually means
for most
shareholder decisions.
a. Deadlock votes
b. Non-participation
c. De jure control
d. De facto control
14. Which SEC rule covers a wide variety of fraudulent activity, including ‘insider
trading’?
a. Rule 14a-9
b. Rule 144
c. Rule 10b-5
d. Rule 17a-3
15. existence of the business.
a. A director
b. A subscriber
c. A shareholder
d. A promoter
is someone who takes responsibility for the
16. Traditionally, the duty of loyalty was raised when the fiduciary had a (n)
with the corporation, which could involve a use of position for
personal gain, taking something that belongs to the corporation, or some form
of self-dealing with the corporation.
a. Duty of disclosure
b. Lawsuit
c. Conflict of interest
d. Promoters’ liability
17. A transaction in which a director contracts unfairly with her own corporation,
creating a conflict of interest, is called a (n)
.
a. Unfair contract
b. Interested director transaction
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Law 401- Companies Law
c. Director mishandling
d. Tender offer
18.
occur when purchasers bought the controlling interest
at a premium to loot the primary assets of the company.
a. Pro rate sharing rule
b. Mandatory bid rule
c. Tender offer
d. Looting
19. A corporate fiduciary who unfairly profits from her corporate role is
committing
.
a. Legal advantages
b. Directorship benefits
c. Subsidiary action
d. Abuse of position
20. Shareholders have the following rights, except:
a. Day-to-day business operations
b. Proxy fight
c. Proxy voting
d. Right to information
21. A pro rata sharing rule allows a purchaser to buy as many shares as she wants
to obtain control without being required to buy 100%, but she must make that
offer at the same price to
.
a. All shareholders
b. Controlling shareholders
c. The subsidiary
d. The parent
22. Which of the following is not a type of qualifications of a proper plaintiffshareholder?
a. Adequate representation requirement
b. Selection of lead counsel
c. Record ownership
d. Fringe benefits
23. What is the term for 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’?
a. Parent corporation
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Law 401- Companies Law
b. Insider trading
c. Merger
d. Shareholder control
24. Under………………………………..Purchaser may buy as many shares as they want
to achieve control without buying 100% of the shares.
a. Mandatory bid rule
b. hostile takeover
c. Pro rate sharing rule
d. looting
25. “Daily operations of a business are delegated to
appointed by ……………………… ”
a. “the corporate officers, the board of directors.”
b. “the board of directors, the corporate shareholders.”
c. “the corporate promoters, the board of directors.”
d. “the corporate shareholders, the corporate officers.”
*******End of Exam*******
Good Luck
Of – 8 – Page 8
, who can be
Week 9 (Chapter 8)
1. Examples of Lack of good faith include:
a) An intentional 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 a duty to act
d) All of the above
Answer: D
Source: Paragraph 8.06
2. What of the following is an example of Fiduciary Duty?
a) Duty of disclosure
b) Duty to act lawfully
c) Duty to monitor
d) A and B only
e) A and B and C
Answer: E
Source: Paragraphs 8.06, 8.07, & 8.08
3. Identify the major policy approaches and methods used to enforce fiduciary duty:
a) Litigation as a means of enforcing duty
b) Civil penalties and criminal law as a means of enforcing duty
c) Contracts between shareholders and Directors/Managers as a means of enforcing duty
d) A and B only
e) A and B and C
Answer: D
Source: Paragraph 8.02
4. Breach of the Duty of Care can arise:
a) Failure to act or monitor where a loss could have been prevented
b) Decision made in a negligent manner
c) A and B
d) None of the above
Answer: C
Source: Paragraph 8.03
5. The purpose of the business judgment rule is:
a) Set a standard of conduct
1
b) Limits judicial inquiry into the substance of a Director’s business decisions
c) Allow judicial inquiry into the substance of a Director’s business decision
d) Does not allow a judicial review of the process of a business decision
Answer: B
Source: Paragraph 8.03
Week 10 (Chapter 9)
1. The following is an example of a duty of loyalty and a conflict of interest:
a) A Director who contracts fairly with his own corporation in buying corporate assets
b) An Officer who contracts unfairly with the corporation in buying corporate assets
c) A Director who contracts unfairly with the corporation in buying corporate assets
d) C and D
Answer: D
Source: Paragraph 9.03
2. In corporate law, “waste” is referred to as a transaction, such as an example of options for
executive compensation,
a) Which is a gift
b) Involves nominal, or almost no consideration (payment or services)
c) Unnecessary
d) All of the above
Answer: D
Source: 9.04
3. Different approaches in dealing with Interested Director transactions could include:
a) Fairness in process and substance test (business judgment test)
b) Use of a disinterested Board to approve the transaction plus fairness in process and
substance (business judgment) test
c) Use of a disinterested Board approval, but no fairness test
d) All of the above
Answer: D
Source: Paragraph 9.03
4. Shareholders may vote on a transaction to:
a) Voting on amendments to the articles of incorporation as required by Statute
b) Optional voting, to potentially minimize judicial scrutiny
c) To ratify a transaction already completed
2
d) All of the above
Answer: D
Source: Paragraph 9.06
5. In evaluating corporate opportunity and abuse of position cases, the courts have used which of
the following tests in their evaluation:
a) Interest or Expectancy test
b) Line of Business Test
c) Fairness Test
d) A and C only
e) A and B and C
Answer: E
Source: Paragraph 9.05
Week 11 (Chapter 10)
1. What of the following are disadvantages for shareholders in a corporation with a control group:
a) Many of the monitoring devices when there is separation of ownership and control are not
available
b) Truly independent directors are less likely to serve on the board of directors
c) A and B
d) None of the above
Answer: C
Source: Paragraph 10.01
2. Which of the following are examples of unfair dealing by controlling shareholder:
a) Self-dealing unfairly with the assets of a corporation when not acting solely as a
shareholder, but in its control of the Directors
b) In a Parent-Subsidiary structure, contracting fairly with the subsidiary as determined under
an intrinsic fairness test
c) In a sale of an entire company, securing the best value reasonably attainable for all
shareholders
d) All of the above
Answer: A
Source: Paragraph 10.02
3
3. Which, if any of the following represent sale of control?
a) Selling shares by the controlling group for a premium to allow the purchaser to loot the
corporation of its liquid assets
b) The contribution of shares by a control group into a holding company and the subsequent
public sale of the holding company
c) The purchase of less than 51% of the Company, but due to wide dispersion of shares, de
facto exists sufficient to replace directors of the corporation by resignation instead of a
shareholder vote
d) All of the above
Answer: D
Source: Paragraph 10.04
4. Which of the following are steps in a Freezeout Merger:
a) Controlling shareholder creates a subsidiary (“Newco”)
b) Controlling shareholders of old corporation vote to merge into Newco
c) Merger agreement provides for minority shareholders to receive cash or securities
d) A and B only
e) A and B and C
Answer: E
Source: Paragraph 10.03
5. Which of the following factors generally exist in a Management Buyout (“MBO”)
a) Management who did not control the corporation, decide to take the Company private by
buying the shares of public shareholders at a premium
b) Heavy borrowing to finance the acquisition, usually by using the assets of the corporation as
security (leverage)
c) A and B
d) None of the Above
Answer: C
Source: Paragraph 10.03
Week 12 (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
4
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
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
5
Week 13 (Chapter 13)
1. Identify which of the following is a requirement in a private right of action in a Disclosure Action
under Rule 10b-5
a) Purchaser-Seller Standing Rule
b) Reliance (Transaction Causation)
c) Loss Causation
d) All of the Above
e) None of the Above
Answer: D
Source: Paragraph 13.02
2. Which of the following support the proposition that prohibition of insider trading is good?
a) Profits made by insiders through their insider trading reward their entrepreneurial efforts
b) Insider trading profits aligns corporate officials’ interests and shareholders owners
c) Would-be investors would believe the cards are stacked against them if insider trading were
to be permitted
d) All of the Above
e) A and B only
Answer: C
Source: Paragraph 13.03
3. The following are ways Insiders are defined for purposes of the Disclose or Abstain
Requirement:
a) Classical Insider (For example, Fiduciary Relationship)
b) Temporary Insider (For example, Attorney, Accountant)
c) A Tipper or a Tippee who meets the receipt of a benefit test and Tipper Breach of Fiduciary
Duty for Tipper-Liability
d) A Misappropriator, or their Tippee (“fraud on the source”)
e) All of the Above
f) None of the Above
Answer: E
Source: Paragraph 13.04
4. What elements are required to meet the definition of Tipper?
a) Insider
b) Passes information to Another
c) Knowing he will trade
d) A and B only
6
e) A and B and C
Answer: E
Source: Paragraph 13.4
5. Regulation FD (Fair Disclosure) under SEC Rules requires the following from multiple speakers of
a corporation:
a) The exact same words
b) The exact same substance
c) May have differing positive or negative interpretations on material information available to
the public
d) A and B
Answer: C
Source: 13.04
Week 14 (Chapter 14)
1. In a Direct lawsuit, a Shareholder can be bring an action:
a) When there is a special duty
b) When there is a contractual duty
c) Establish Denial by the Corporation or Directors of a right relating to Shareholding
d) All of the Above
e) None of the Above
Answer: D
Source: Paragraph 14.02
2.
The following are signs of an Indirect (“Derivative”) lawsuit:
a) Mismanagement or self-dealing that has caused a decrease in shareholder value
b) The harm is directly to the corporation
c) The recovery is directly to the corporation, not the shareholders
d) None of the Above
e) All of the Above
Answer: E
Source: Paragraph 14.02
3. The nature of a Derivative lawsuit includes:
a) An action brought by the shareholders on behalf of the corporation
7
b) It is founded on a right of actions existing in the corporation itself
c) The shareholders must make demand on the corporation, which is refused by the
Corporation
d) A and B only
e) A and B and C
4. The standard of review for a special Litigation Committee (SLC) in Delaware Courts include:
a) Disinterested Board of Director Members
b) Degree of due diligence in process
c) Rational basis for Decision
d) In recent cases where demand is excused, the Court’s business judgment rule (Merits of the
Case before Special Litigation Committee)
e) All of the Above
Answer: E
Source: Paragraph 14.06
5. If a Shareholder can establish a cause of action for both a direct and derivative lawsuit, which
lawsuit may he file with the Court?
a) Direct lawsuit
b) Derivative lawsuit
c) Both Direct and Derivative Simultaneously
d) Either Direct or Derivative lawsuit or Both Simultaneously
Answer: D
Source: Paragraph 13.02
8
9
Chapter 8: Introduction to Fiduciary Duty: The Duty of Care and the Business Judgment Rule
Overview of the Duty of Care and Loyalty-Much of corporate law is about fiduciary duties and
their parameters. In the corporate context, directors and officers are in a fiduciary relationship
to their corporation and its shareholders. Controlling shareholders may also be characterized as
fiduciaries. The primary problems faced by shareholders are mismanagement of the business or
UNFAIR SELF-DEALING by the people who are fiduciaries. The requirements and enforcement of
fiduciary duty serves as a monitoring device to limit those harms.
The characterization of someone as a fiduciary means that the individual has to obey certain
duties and look out for the interests of whomever is owed the DUTY. Most of the duties have
been developed by the common law. A fiduciary is bound by a duty of care and duty of loyalty.
The duty of care requires directors to perform their duties with the diligence of a REASONABLE
PERSON IN SIMILAR CIRCUMSTANCES which vary depending on the context. Most decisions
involving the duty of care are protected under the business judgment rule which creates a
presumption or SAFE HARBOR that limits courts in questioning business decisions. The focus of
the judicial inquiry will usually be on the decision making process RATHER THAN THE DECISION.
The plaintiff has the burden of proof on the issue of breach of the duty of care and courts rarely
look at the substance of the decision. The BUSINESS JUDGMENT RULE does not protect
nonfeasance lack of good faith, conflicts of interest, or an irrational or wasteful decision. A lack
of good faith is a duty of loyalty violation and can involve actual intent to harm the corporation
or an intentional DERELICTION OF DUTY and a conscious disregard for one’s responsibilities. The
traditional duty of loyalty focuses on conflicts of interest where the fiduciary’s or those
associated with her personal interests may be advanced OVER corporate interests. Generally,
the court will scrutinize a duty of loyalty conflict of interest transaction to determine if it is fair.
The court may not only shift the burden of proof to the directors to show fairness but will
inquire as to both the process and substance of the decision that is fairness. 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. The difference is justified because in a duty of care case, the courts
protect business decisions that are intended to enhance corporate gain, but in a duty of loyalty
involving a conflict of interest case the directors are motivated by personal gain.
Sliding Scale-There is a sliding scale of different fiduciary duty rules. Some cases fall between
those duties because the legal standards and burdens may differ in a given case from traditional
loyalty conflicts of interest and care.
As the Delaware Supreme Court indicated in Guth v. Loft, fiduciary duty is subject to NO FIXED
SCALE. The courts, in establishing the legal rules of fiduciary duty, attempt to balance the need
of the fiduciary to act with the protection of the shareholders. There is a tension between the
judicial hands off approach reflected in the business judgment rule and the extensive judicial
scrutiny of a fairness inquiry in duty of loyalty cases. The extent of judicial scrutiny is the key
issue in these cases with plaintiffs seeking extensive judicial scrutiny arguing loyalty conflicts of
interest and defendants seeking minimal judicial scrutiny arguing for application of the business
judgment rule.
Plaintiff shareholders would prefer the courts use a loyalty analysis of conflicts of interest
BECAUSE the defendants have the burden of proof and there is active judicial scrutiny of both
the fairness of substance and process.
Defendants seek limited judicial involvement under the protection of the business judgment
rule which places the burden on the plaintiff to prove that the rule should not apply.
Some courts will MODIFY THE LEGAL STANDARD or shift the burden of proof. For example,
Delaware courts e sometimes scrutinize the implementation of defensive tactics involving
corporate CONTROL and apply a modified business judgment rule or PROPORTIONALITY TEST
with some burden of the directors and some judicial scrutiny of REASONABLENESS. But if the
directors’ primary purpose was to impede or interfere with the effectiveness of shareholder
voting in a contested election, Delaware courts applied a strict duty of loyalty and defendants
needed to prove not fairness but a compelling justification.
Policy Issues-The fiduciary duty of those who manage or control is to the corporation and
shareholders and shareholders have the right to enforce it through litigation. Controlling
shareholders also have some right to use their control for their own personal benefits. Not all
self-dealing is necessarily unfair to the minority shareholders but there needs to be some check
on the power of those who control the business because all of the shareholder’s money is at
risk. The interests of the managers or control persons and the owners are aligned because a
successful business benefits everyone.
Law and Economics Approach-The debate about fiduciary duty rules reflects the differences in
theories of and approaches to corporate law. Some commentators who approach corporate law
from the law and economies perspective view the relationship between the shareholders and
managers as a matter of contract. Under this view, investors could actually contract for this
obligation but the law instead imposes the responsibility because it would be expensive and
time consuming to negotiate detailed contracts delineating managers’ obligations. The law
eliminates the need to actually enter a contract and provides standardized rules which lower
transaction costs of actually contracting. Given the need for managerial flexibility, these
fiduciary rules are rarely detailed. At the same time, since they are based on contract, these
rules are like default rules and should be able to be modified by the parties in order to allow for
efficient private ordering. Thus, under this view, legal rules, and particularly fiduciary duty, can
be contracted away. If needed, there are market mechanisms available that are more effective
in enforcing fiduciary duty.
Duty of Care-Traditionally, liability under the duty of care required finding duty, breach,
proximate cause and loss. The directors’ fiduciary duties have developed primarily through case
law although the duty of care is often described in some state statutes. The traditional statutory
provision indicates that directors must discharge their duties in good faith, with the care an
ordinarily prudent person in a like position would exercise under similar circumstances and in
manner reasonably believed to be in the best interest of the corporation. Nonfeasance-The duty
of care requires directors to undertake certain responsibilities. In Francis v. United Jersey Bank,
the New Jersey Supreme Court set out a model of how directors should act. This case involved
nonfeasance involving a family owned and closely held corporation which operated as a
reinsurance broker. These brokers arrange for the sale among insurance companies of some of
the insurance risks under their policies facilitating the diversification of that risk. RULE: In
general, the relationship of a corporate director to the corporation and its stockholders is that of
a fiduciary. Shareholders have a right to expect that directors will exercise reasonable
supervision and control over the policies and practices of a corporation. The institutional
integrity of a corporation depends upon the proper discharge by directors of those
duties. FACTS: Pritchard & Baird Intermediaries Corporation (P&B) was a broker between ceding
insurance companies and reinsurance companies. They earned a commission on the
transactions between the two entities. Typically, brokers in the reinsurance business hold funds
from the ceding and reinsuring companies in a separate account and pay each party from that
account. The former CEO of Pritchard & Baird Intermediaries Corporation (P&B), Charles
Pritchard, Sr. (the husband of Lillian Pritchard) did not practice this method, but he still ensured
that the funds deposited by third parties were never used as personal funds. Charles Pritchard,
Sr., eventually stepped down and his two sons controlled the business. Once the sons had
control they took out personal loans from the account but never paid back the loans or any
interest. This practice of misappropriating funds continued until P&B could no longer meet their
obligations, and they went into bankruptcy. During the entire period that the sons controlled
P&B, Lillian was the majority shareholder and sat on the Board as a director. During her tenure
as director, she never participated in any business matters of P&B. Defendant argued that Lillian
was elderly and sick, and therefore should be excused for her absence.
ISSUE: Is Lillian Pritchard personally liable for negligently failing to prevent the misappropriation
of P&B funds by her sons? ANSWER: Yes.
CONCLUSION: Lillian Pritchard, as a director on the Board, had a duty of care in managing the
business. She did not have to know every detail of day-to-day operations, but she needed to
have a baseline understanding of the finances and important activities. If she did not understand
the activities, then she was obligated to consult counsel for advice. Her absence from the
business did not excuse her duties. The court determined that if she did intervene in the
dubious financial decisions of her sons, or at least consulted an attorney or expert, it may have
prevented her sons from fleecing the company. Therefore, her lack of care was a proximate
cause of the damages to the company and the third parties who relied upon the company.
Because of the nature of the business (holding assets of third parties), she was liable to the third
parties for any damages.
Malfeasance and the Business Judgment Rule-Due care for directors requires that they be
INFORMED AND DELIBERATE WHEN MAKING a decision. When directors are accused of violating
the duty of care by making a negligent or ill-advised decision which can even involve a decision
not to act they are accused of MALFEASANCE.
Causation-The fact that a director breaches her duty and is negligent does not often end an
inquiry because traditionally the negligence must be the PROXIMATE CAUSE OF THE LOSS. There
must be a finding of causation in fact that the defendant’s actions or omissions were a necessary
antecedent of the LOSS.
The Smith v. Van Gorkom Case- RULE:
The business judgment rule is a presumption that in making a business decision, the directors of
a corporation acted on an informed basis, in good faith and in the honest belief that the action
taken was in the best interests of the company. Thus, the party attacking a board decision as
uninformed must rebut the presumption that its business judgment was an informed one.
FACTS: In a class action against defendant Trans Union Corporation (“Trans Union”) and its
board of directors, plaintiffs, who are shareholders of Trans Union, claimed that the approval of
the cash-out merger of their corporation violated Del. Code Ann. tit. 8, § 251, and did not
warrant business judgment rule protection. It appeared that Trans Union, though generating
hundreds of millions annually, has difficulty offsetting large investment tax credits (ITCs), thus,
Trans Union pursued a program of acquiring small companies to increase taxable income that
may offset the ITCs. Thus, a cash-out merger was entered between Trans Union and New T
Company (“New T”), a wholly-owned subsidiary of the defendant, Marmon Group, Inc.
(“Marmon”). The merger was largely due to the efforts exerted by Defendant Jerome W. Van
Gorkom, Chairman and CEO of Trans Union, who struck the deal with Jay A. Pritzker, a known
corporate takeover specialist and owner of Marmon and its subsidiaries. Van Gorkom
successfully convinced the board of the $55 price per share cash-out merger. The price was
merely assumed by Van Gorkom and is not supported by any valuation information. Following
trial, the former Chancellor granted judgment for the defendant directors. Judgment was based
on two findings: (1) that the Board of Directors had acted in an informed manner so as to be
entitled to protection of the business judgment rule in approving the cash-out merger; and (2)
that the shareholder vote approving the merger should not be set aside because the
stockholders had been “fairly informed” by the Board of Directors before voting thereon. The
plaintiffs appeal.
ISSUE: Were the rulings of the Court of Chancery correct?
ANSWER: No.
CONCLUSION: The Court here concluded that both rulings of the Court of Chancery are clearly
erroneous. The Board’s decision to approve the proposed cash-out merger was not the product
of an informed business judgment since they based their decision on one Van Gorkom’s
representations, which did not constitute a report on which they could reasonably rely under
Del. Code Ann. tit. 8, § 141(e), and that they did not seek documentation of either the merger
terms or the adequacy of the proposed price per share. The court also found defendant
directors were grossly negligent in permitting the agreement to be amended in a way they had
not authorized. Finally, the directors of Trans Union breached their fiduciary duty to their
stockholders (1) by their failure to inform themselves of all information reasonably available to
them and relevant to their decision to recommend the cash-out merger; and (2) by their failure
to disclose all material information such as a reasonable stockholder would consider important
in deciding whether to approve the Pritzker offer the court found that the stockholders’ vote did
not ratify the action, because the stockholders weren’t aware of the lack of valuation
information, and because defendant directors’ statements were misleading.
The Demise of the Duty of Care-Plaintiffs bringing duty of care cases are rarely successful in
court. They have to prove some form of negligence and in some cases CAUSATION.
Delaware General Corporation Law Section 102(b)(7)-With the enactment of Delaware General
Corporation Law Section 102(b)(7) Without the possibility of damages, plaintiffs’ attorneys were
less willing to bring duty of care cases to court since their fees are paid from those damages
recovered in a lawsuit.
Since damages for both duty and loyalty and acts or omissions not in good faith are explicitly
excluded from the statutory limitation on damages, plaintiffs would try to allege either to avoid
the limitation on damages. Intentional ignorance or willful blindness to problems may be
sufficient to show a conscious disregard of fiduciary duty and thus bad faith.
Good Faith-Plaintiffs have tried to avoid the limitation on damages in a duty of care case as a
result of the provisions from Delaware’s Section 102(b)(7) by arguing that the defendants did
not act in good faith. Lack of good faith is a duty of loyalty violation.
Disney Litigation and Good Faith- RULE:
Fundamentally, the duties traditionally analyzed as belonging to corporate fiduciaries, loyalty
and care, are but constituent elements of the overarching concepts of allegiance, devotion, and
faithfulness that must guide the conduct of every fiduciary. The good faith required of a
corporate fiduciary includes not simply the duties of care and loyalty, but all actions required by
a true faithfulness and devotion to the interests of the corporation and its shareholders. A
failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts
with a purpose other than that of advancing the best interests of the corporation, where the
fiduciary acts with the intent to violate applicable positive law, or where the fiduciary
intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard
for his duties.
FACTS:
Plaintiff stockholders alleged that defendant directors breached their fiduciary duties in
connection with the 1995 hiring and 1996 termination of a corporation’s president. The
president was hired in large part due to the efforts of the company’s chief executive officer
(CEO).
ISSUE:
Did the directors comply with their fiduciary duties in connection with the president’s hiring and
termination?
ANSWER:
Yes.
CONCLUSION:
The court found that the president did not commit gross negligence or malfeasance while
serving as president. As a result, terminating him and paying a no-fault termination payment
(NFT) did not constitute waste because he could not be terminated for cause. The directors did
not act in bad faith, and were at most ordinarily negligent, in connection with his hiring and the
approval of the employment agreement. The CEO stretched the outer boundaries of his
authority by acting without …