This Document Contains Chapters 35 to 36 Chapter 35 MANAGEMENT STRUCTURE Corporate Governance Role of Shareholders Voting Rights of Shareholders [35-1] Shareholder Meetings [35-1a] Quorum and Voting [35-1b] Election of Directors [35-1c] Straight Voting Cumulative Voting Removal of Directors [35-1d] Approval of Fundamental Changes [35-1e] Concentrations of Voting Power [35-1f] Proxies Voting Trusts Shareholder Voting Agreements Restrictions on Transfer of Shares [35-1g] Enforcement Rights of Shareholders [35-2] Right to Inspect Books and Records [35-2a] Shareholder Suits [35-2b] Direct Suits Derivative Suits Shareholder's Right to Dissent [35-2c] Role of the Directors and Officers Function of the Board of Directors [35-3] Selection and Removal of Officers [35-3a] Capital Structure [35-3b] Fundamental Changes [35-3c] Dividends [35-3d] Management Compensation [35-3e] Election and Tenure of Directors [35-4] Election, Number, and Tenure of Directors [35-4a] Vacancies and Removal of Directors [35-4b] Compensation of Directors [35-4c] Exercise of Directors' Functions [35-5] Quorum and Voting [35-5a] Action Taken Without a Meeting [35-5b] Delegation of Board Powers [35-5c] Directors' Inspection Rights [35-5d] Officers [35-6] Selection and Removal of Officers [35-6a] Role of Officers [35-6b] Authority of Officers [35-6c] Actual Express Authority Actual Implied Authority Apparent Authority Ratification Duties of Directors and Officers [35-7] Duty of Obedience [35-7a] Duty of Diligence [35-7b] Reliance on Others Business Judgment Rule Duty of Loyalty [35-7c] Conflict of Interests Loans to Directors Corporate Opportunity Transactions in Shares Duty Not to Compete Indemnification of Directors and Officers [35-7d] Liability Limitation Statutes [35-7e] Cases in This Chapter King v. Verifone Holdings, Inc. Strougo v. Bassini Donahue v. Rodd Electrotype Co., Inc. Brehm v. Eisner Beam v. Stewart Chapter Outcomes After reading and studying this chapter, the student should be able to: • Compare the actual governance of closely held corporations, the actual governance of publicly held corporations, and the statutory model of corporate governance. • Explain the role of shareholders in the management of a corporation. • Explain the role of the board of directors in the management of a corporation. • Explain the role of officers in the management of a corporation. • Explain management’s duties of loyalty, obedience, and diligence. TEACHING NOTES CORPORATE GOVERNANCE *** Chapter Outcome*** Compare the actual governance of closely held corporations, the actual governance of publicly held corporations, and the statutory model of corporate governance. The statutory model of governance can be described as a pyramid with the shareholders at the base, their elected representatives — the board of directors — above the shareholders, and the officers who handle the day to day corporate business at the top of the pyramid. NOTE: See Figure 35-1. The statutory model, however, does not reflect reality in the majority of corporations, which are closely held. Typically, in closely held corporations there is little separation of ownership and management; most shareholders actively participate in management. The corporate formalities required by law are burdensome to closely held corporations. Some states have relaxed the formalities, and a Statutory Close Corporation Supplement to the Model and Revised Acts has been promulgated; it also relaxes nonessential formalities. In large, publicly held corporations, ownership and management are separate, shares are widely dispersed, and managers rarely own a significant proportion of shares. Typically, shareholders vote for directors by means of a proxy, which is the equivalent of an absentee ballot. Because shareholders know so little about the workings of a large corporation, they tend to vote as management recommends. Thus, in many large corporations, the reality is the opposite of the statutory model. The corporation’s officers (employees) are actually in control. Typically a strong CEO is not only a board member but also serves as chairman as well. There may be several other officers on the board; if so, their loyalty is to their chief. The CEO may hand pick his outside board members and keep their loyalty with generous compensation and perks. Thus, though voted in by shareholders, the directors are actually beholden to the CEO. One of the great business stories of the 1990s has been a shareholders’ revolt against officer-dominated boards, a revolt typically led by very large institutional owners of shares. In response to the business scandals involving companies such as Enron, WorldCom, Global Crossing, Adelphia, and Arthur Andersen, in 2002 Congress passed the Sarbanes-Oxley Act. The legislation seeks to increase corporate responsibility; adding new financial disclosure requirements; creating new criminal offenses; increasing the penalties for existing federal crimes; and creating a five person Accounting Oversight Board with authority to review and discipline auditors. Several provisions of the Act impose governance requirements on publicly held corporations and will be discussed in this chapter. In July of 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, the most significant change to U.S. financial regulation since the New Deal. One of the many stand-alone statutes included in the Dodd-Frank Act is the Investor Protection and Securities Reform Act of 2010, which imposes new corporate governance rules on publicly held companies. NOTE: See Figure 35-2 and Figure 35-3. ROLE OF SHAREHOLDERS The role of shareholders in managing the corporation generally is restricted to electing directors, approving certain extraordinary matters, approving corporate transactions that are void or voidable unless ratified, and bringing suits to enforce these rights. *** Chapter Outcome*** Explain the role of shareholders in the management of a corporation. 35-1 VOTING RIGHTS OF SHAREHOLDERS Voting is a fundamental right of shareholders in corporations. In most states, shareholders have one vote for each share they own, unless the charter provides otherwise. Also, incorporation statutes usually permit the issuance of one or more classes of nonvoting stock, in addition to the voting classes of stock. Whereas a great majority of institutional investors exercise their right to vote their shares, most individual investors do not. Nonetheless, virtually all shareholders who vote for the directors do so through the use of a proxy—an authorization by a shareholder to an agent (usually the CEO of the corporation) to vote his shares. 35-1a Shareholder Meetings Shareholders can vote at both annual and special shareholder meetings. The Revised Act requires annual meetings to be held at a time fixed by the bylaws. If the annual meeting is not held at the proper time, any shareholder may petition the court to require that a meeting be held. In contrast, the Close Corporation Supplement provides that no annual meeting of shareholders need be held unless a shareholder makes a written request at least 30 days in advance of the requested meeting date. Special meetings may be called by the board, by holders of at least 10 percent of the shares, or by others authorized to do so in the articles of incorporation. Written notice must be given in advance of meetings stating date, time, place, and, in the case of a special meeting, the purpose for which it has been called. Some states permit shareholders to conduct business without a meeting if all the shareholders consent in writing to the action taken. Some states permit shareholders to act without a meeting if there is written consent by only the number of shares required to act on the matter. 35-1b Quorum and Voting In order for a vote to be valid, quorum of all outstanding shares (not counting unissued shares and treasury stock) entitled to vote must be presented at the meeting, either in person or by proxy. A quorum is a simple majority unless the articles of incorporation specify a different figure. In many states and under the Model Act, a quorum may not be less than one-third of voting shares. Under the Revised Act and some states, there is no minimum. State statutes do not impose an upper limit, so it may be set higher than a simple majority and may even require all outstanding shares. Once a quorum is present (in person or by proxy), most states require shareholder actions to be approved by a majority of the shares represented at the meeting and entitled to vote. But many states permit the articles of incorporation to require a “supermajority.” Close corporations often use these to protect minority shareholders from oppression by the majority. 35-1c Election of Directors Directors are elected each year at the annual meeting. Most states provide that where there are 9 or more directors, the charter or bylaws may provide for the directors to be divided into 2 or 3 classes with a nearly equal number of directors in each. The classes serve staggered terms, one class being elected every other year if there are 2 classes or every third year if there are 3. The aim is to provide continuity of directors by avoiding electing them all at once. Also, if there are 2 or more classes of shares and the articles of incorporation authorize such an action, each class may elect a specified number of directors. Straight and Cumulative Voting — Straight voting means a shareholder has one vote per share owned, and the directors are elected by a plurality of votes. Cumulative voting, permissible in most states and under the Revised Act, entitles shareholders to multiply the number of votes they are entitled to cast by the number of directors for whom they are entitled to vote and to cast the product for a single candidate or to distribute the product among 2 or more candidates. Cumulative voting permits a minority shareholder, or a group of them acting together, to obtain minority representation on the board if they own a certain minimum number of shares. In the absence of cumulative voting, the holders of 51 percent of the voting shares can elect all of the members of the board. 35-1d Removal of Directors By a majority vote (except where cumulative voting is permitted), shareholders may remove any director or the entire board, with or without cause, in a meeting called for that purpose. 35-1e Approval of Fundamental Changes Extraordinary matters involving fundamental changes in the corporation require shareholder approval — including amendments to the corporate charter, sale or lease of all or substantially all of the corporate assets not in the regular course of business, most mergers, consolidations, compulsory share exchanges, and dissolution. 35-1f Concentrations of Voting Power Shareholders can combine voting power to obtain or maintain control or to maximize the impact of cumulative voting. Proxies — are shareholders’ authorizations to an agent to vote their shares. A proxy either may specify how the vote is to be cast or may authorize the agent to vote as he chooses. A proxy generally must be in writing and is typically limited to no more than 11 months. The proxy is revocable unless stated to be irrevocable and coupled with an interest, such as shares held as collateral. Solicitation of proxies by publicly held corporations is regulated by the Securities Exchange Act of 1934. Because the majority of shareholders who return their proxies vote as management advises, the nominating committee of the board of directors almost always determines the board’s membership. In 2009, the Revised Model Business Corporation Act (RMBCA) was amended to authorize the directors or shareholders of corporations to establish procedures in the corporate bylaws that (1) require the corporation to include one or more individuals nominated by a shareholder in addition to individuals nominated by the board of directors and (2) require the corporation to reimburse shareholders for reasonable expenses incurred in soliciting proxies in an election of directors. The Dodd-Frank Act authorizes the Securities and Exchange Commission (SEC) to issue rules requiring that a publicly held company’s proxy solicitation include nominations for the board of directors submitted by shareholders. The SEC has issued a new such rule. Voting trusts — are designed to concentrate corporate control in one or more persons by allowing shareholders to separate the voting rights of their shares from the ownership of them. In a voting trust, a shareholder confers on a trustee the right to vote or otherwise act by signing an agreement. Voting trusts are permitted in most states but are usually limited to 10 years’ duration. Shareholder voting agreements — (permitted in most jurisdictions) are written agreements by shareholders to vote in a specified manner for the election or removal of directors or on any other matter subject to shareholder approval. A shareholder voting agreement, unlike a voting trust, is not limited in duration. These agreements are frequently used in closely held corporations, especially in conjunction with restrictions on the transfer of shares, to provide each shareholder with greater control. NOTE: See Figure 35-4: Concentrations of Voting Power 35-1g Restrictions on Transfer of Shares Usually shares of stock are freely transferable, but there are some situations in which the shareholders may restrict such transfers in order to select who can be a shareholder or to limit the number of shareholders. These restrictions are upheld by common law if they are made for a lawful purpose. 35-2 ENFORCEMENT RIGHTS OF SHAREHOLDERS By law, a shareholder has enforcement rights: (1) the right to obtain information, (2) the right to sue the corporation directly or to sue on the corporation’s behalf, and (3) the right to dissent. 35-2a Right to Inspect Books and Records Most states have statutes granting shareholders the right to inspect, for a proper purpose, books and records in person or through an agent and to copy parts of them. The Revised Act provides that every shareholder is entitled to examine specified corporate records upon prior written request if the demand is made in good faith, for a proper purpose, and during regular business hours at the corporation’s principal office. However, a number of states limit this right to shareholders who own a minimum number of shares or to those who have been shareholders for a minimum period of time. A proper purpose for inspection is one that is reasonably relevant to that shareholder’s interest in the corporation. Proper purposes include determining the financial condition of the company, the value of shares, the existence of mismanagement, or the names of other shareholders in order to communicate with them about corporate affairs. The right of inspection will be denied if for an improper purpose. Examples of improper purposes: obtaining information for use by a competing company or obtaining a list of shareholders in order to sell the list of names. CASE 35-1 KING v. VERIFONE HOLDINGS, INC Supreme Court of Delaware, 2011 12 A.3d 1140 Jacobs, J. VeriFone, a Delaware corporation whose principal place of business is in San Jose, California, designs, markets, and services electronic payment transaction systems. On November 1, 2006, VeriFone acquired the Israeli-based Lipman Electronic Engineering Ltd. (“Lipman”), which was then the world’s fourth-largest point-of-sale terminal maker. That acquisition made VeriFone the world’s largest provider of electronic payment solutions and services. On December 3, 2007, VeriFone publicly announced that it would restate its reported earnings and net income for the prior three fiscal quarters. Both sets of numbers had been materially overstated due to accounting and valuation errors made while Lipman’s inventory systems were being integrated with VeriFone’s. After that restatement announcement, VeriFone’s stock price dropped over 45% ***. [Charles R.] King beneficially owns 3000 VeriFone shares, of which he has held at least 500 since December 11, 2006. On December 14, 2007, King filed a stockholder derivative action on behalf of VeriFone against certain of its officers and members of its board of directors (“Board”) in the California Federal Court, *** claiming that various VeriFone officers and directors had committed breaches of fiduciary duty and corporate waste. Specifically, King alleged that VeriFone’s officers and Board had: (a) made materially false financial statements to the SEC and the public; (b) abdicated their fiduciary duties by allowing VeriFone to operate with material weaknesses in its internal controls over financial reporting, while representing publicly that the company had effective internal controls; and (c) allowed eight VeriFone directors and/or officers, while possessing material insider information, to sell over 12.4 million of their VeriFone shares for a $462 million dollar profit. VeriFone moved to dismiss *** for failure to make a pre-suit demand upon its Board, as required by Federal Rule of Civil Procedure (FRCP) 23.1(b)(3). On May 26, 2009, the California Federal Court granted VeriFone’s motion, holding that King’s consolidated complaint failed to allege particularized facts that would excuse a pre-suit demand. That dismissal was without prejudice. In granting leave to amend the complaint, the California Federal Court suggested that King first “engage in further investigation to assert additional particularized facts” by filing a Section 220 action in Delaware. *** On June 9, 2009, King submitted to VeriFone a written demand to inspect specified categories of documents. The parties were able to resolve all of King’s requests except one—the Audit Committee Report (“Audit Report”), which contained the results of an internal investigation of VeriFone’s accounting and financial controls that had been conducted after the December 3, 2007 restatement announcement. [Unable to resolve the dispute through mediation, on November 6, 2009, King filed a Section 220 action in the Delaware Court of Chancery for an order permitting him to inspect the Audit Report and any documents relied upon in its preparation. VeriFone moved to dismiss the Section 220 complaint, claiming that King had “initiated this litigation backwards” by first filing his derivative suit in California. The Court of Chancery agreed and dismissed King’s action, holding that King lacked a “proper purpose” for inspection, as Section 220 requires. The Chancellor reasoned that because King had “elected” to file his California derivative action before conducting a pre-suit investigation (including resort to the Section 220 process), King was precluded from using the Delaware courts to obtain discovery that was unnecessary or unavailable in his federal derivative action. King appealed.] The sole issue on this appeal is whether a stockholder-plaintiff who has brought a stockholder’s derivative action without first prosecuting an action to inspect books and records under [Section] 220 is, for that reason alone, legally precluded from prosecuting a later-filed Section 220 proceeding. *** *** Section 220 expressly grants a stockholder of a Delaware corporation the right to inspect that corporation’s books and records. [Citation.] That right is not absolute, however, because to obtain inspection relief the stockholder must demonstrate a proper purpose for making such a demand. [Citation.] A “proper purpose” is defined as “a purpose reasonably related to such person’s interest as a stockholder.” [Citation.] To cite one example, investigating corporate mismanagement— the purpose stated by King—is a proper purpose for seeking a Section 220 books and records inspection. [Citation.] Delaware courts have strongly encouraged stock¬holder-plaintiffs to utilize Section 220 before filing a derivative action ***. By first prosecuting a Section 220 action to inspect books and records, the stockholder-plaintiff may be able to uncover particularized facts that would establish demand excusal in a subsequent derivative suit. [Citation.] A failure to proceed in that specific sequence, however, although ill-advised, has not heretofore been regarded as fatal. *** *** Although we reject the result reached by the Court of Chancery, and the brightline rule that drove it, we are sensitive to the policy concerns that animated both. We agree with the *** Chancellor that it is wasteful of the court’s and the litigants’ resources to have a regime that could require a corporation to litigate repeatedly the issue of demand futility. Undoubtedly the preclusion rule adopted by the Court of Chancery was intended as a needed prophylactic cure. In our view, however, a rule that would automatically bar a stockholder-plaintiff from bringing a Section 220 action solely because that plaintiff previously filed a plenary derivative suit, is a remedy that is overbroad and unsupported by the text of, and the policy underly¬ing, Section 220. *** *** *** For the Court of Chancery in a Section 220 pro¬ceeding to establish and impose a preclusive judge-made rule that finds no support either in the language or its underlying policy of Section 220, or in Delaware case law, was error. For the reasons stated above, the judgment of the Court of Chancery is reversed. 35-2b Shareholder Suits The ultimate recourse of a shareholder, short of selling her shares, is to bring suit against or on behalf of the corporation. Direct suits — In direct suits, a shareholder attempts to enforce a claim against a corporation, based on his ownership of shares. Any recovery goes to the shareholder plaintiff. Examples of direct suits: shareholder actions to compel payment of dividends properly declared, to enforce the rights to inspect corporate records and to vote, to protect preemptive rights, and to compel dissolution. A class suit is a direct suit in which one or more shareholders act as a representative for a class of shareholders to recover for injuries to the entire class. Derivative suits — are brought by one or more shareholders on behalf of the corporation to enforce a right belonging to the corporation. Shareholders may bring a derivative action when the board of directors refuses to act on the corporation’s behalf. Examples: actions to recover damages from management for an ultra vires act, to recover damages for a managerial breach of duty, and to recover improper dividends. In such situations, the board of directors may hesitate to bring suit against the corporation’s officers or directors. Thus, a shareholder derivative suit is the only recourse. Recovery usually goes to the corporation’s treasury, so that all shareholders can benefit proportionately. Usually, a shareholder must own his shares at the time of the transaction in question in order to bring a derivative suit. In addition, the shareholder must first make demand on the board of directors to enforce the corporate right before he brings suit. NOTE: See Figure 35-5: Shareholder Suits. CASE 35-2 STROUGO v. BASSINI United States Court of Appeals, Second Circuit, 2002 282 F.3d 162 http://scholar.google.com/scholar_case?case=3945168053066454973&q=282+F.3d+162&hl=en&as_sclt=2,34 Sack, J. * * * The plaintiff is a shareholder of the Brazilian Equity Fund, Inc. (the “Fund”), a non-diversified, publicly traded, closed-end investment company incorporated under the laws of Maryland * * *. As its name implies, the Fund invests primarily in the securities of Brazilian companies. The term “closed-end” indicates that the Fund has a fixed number of outstanding shares, so that investors who wish to acquire shares in the Fund ordinarily must purchase them from a shareholder rather than, as in open-end funds, directly from the Fund itself. Shares in closed-end funds are thus traded in the same manner as are other shares of corporate stock. Indeed, shares in the Fund are listed and traded on the New York Stock Exchange. The number of outstanding shares in the Fund is described as “fixed” because it does not change on a daily basis as it would were the Fund open-end, in which case the number of outstanding shares would change each time an investor invested new money in the fund, causing issuance of new shares, and each time a shareholder divested and thereby redeemed shares. Although closed-end funds do not sell their shares to the public in the ordinary course of their business, there are methods available to them to raise new capital after their initial public offering. One such device is a “rights offering,” by which a fund offers shareholders the opportunity to purchase newly issued shares. Rights so offered may be transferable, allowing the current shareholder to sell them in the open market, or non-transferable, requiring the current shareholder to use them him- or herself or lose their value when the rights expire. It was the Fund’s employment of a non-transferable rights offering that generated the claims at issue on this appeal. On June 6, 1996, the Fund announced that it would issue one “right” per outstanding share to every shareholder, and that every three rights would enable the shareholder to purchase one new share in the Fund. The subscription price per share was set at ninety percent of the lesser of (1) the average of the last reported sales price of a share of the Fund’s common stock on the New York Stock Exchange on August 16, 1996, the date on which the rights expired, and the four business days preceding, and (2) the per-share net asset value at the close of business on August 16. The plaintiff asserts that this sort of rights offering is coercive because it penalizes shareholders who do not participate. Under the Fund’s pricing formula for its rights offering, the subscription price could not have been higher than ninety percent of the Fund’s per-share net asset value. Thus, the introduction of new shares at a discount diluted the value of old shares. Because the rights could not be sold on the open market, a shareholder could avoid a consequent reduction in the value of his or her net equity position in the Fund only by purchasing new shares at the discounted price. This put pressure on every shareholder to “pony up” and purchase more shares, enabling the Fund to raise new capital and thereby increase its asset holdings. Such purchases would, in turn, have tended to increase the management fee paid to defendant BEA Associates, the Fund’s investment advisor, because that fee is based on the Fund’s total assets. At the close of business on August 16, 1996, the last day of the rights offering, the closing market price for the Fund’s shares was $12.38, and the Fund’s per-share net asset value was $17.24. The Fund’s shareholders purchased 70.3 percent of the new shares available at a subscription price set at $11.09 per share, ninety percent of the average closing price for the Fund on that and the preceding four days. Through the rights offering, the Fund raised $20.6 million in new capital, net of underwriting fees and other transaction costs. On May 16, 1997, the plaintiff brought this action against the Fund’s directors, senior officers, and investment advisor. * * * It alleges that the defendants, by approving the rights offering, breached their duties of loyalty and care at common law. * * * It asserts that these breaches of duty resulted in four kinds of injury to shareholders: (1) loss of share value resulting from the underwriting and other transaction costs associated with the rights offering; (2) downward pressure on share prices resulting from the supply of new shares; (3) downward pressure on share prices resulting from the offering of shares at a discount; and (4) injury resulting from coercion, in that “shareholders were forced to either invest additional monies in the Fund or suffer a substantial dilution.” [Citation.] On April 6, 1998, the district court dismissed the direct claims on the ground that the injuries alleged “applied to the shareholders as a whole.” * * * * * * The plaintiff now appeals. * * * In deciding whether a shareholder may bring a direct suit, the question the Maryland courts ask is not whether the shareholder suffered injury; if a corporation is injured those who own the corporation are injured too. The inquiry, instead, is whether the shareholders’ injury is “distinct” from that suffered by the corporation. [Citation.] * * * Thus, under Maryland law, when the shareholders of a corporation suffer an injury that is distinct from that of the corporation, the shareholders may bring direct suit for redress of that injury; there is shareholder standing. When the corporation is injured and the injury to its shareholders derives from that injury, however, only the corporation may bring suit; there is no shareholder standing. The shareholder may, at most, sue derivatively, seeking in effect to require the corporation to pursue a lawsuit to compensate for the injury to the corporation, and thereby ultimately redress the injury to the shareholders. * * * To sue directly under Maryland law, a shareholder must allege an injury distinct from an injury to the corporation, not from that of other shareholders. * * * Applying Maryland’s law of shareholder standing to the plaintiff’s four alleged injuries, we conclude that one that he alleges does not support direct claims under Maryland law. The remaining alleged injuries, however—describing the set of harms arising from the alleged coercion—do. The plaintiff alleges a loss in share value resulting from the “substantial underwriting and other transactional costs associated with the Rights Offering.” * * * Underwriter fees, advisory fees, and other transaction costs incurred by a corporation decrease share price primarily because they deplete the corporation’s assets, precisely the type of injury to the corporation that can be redressed under Maryland law only through a suit brought on behalf of the corporation. [Citation.] The plaintiff’s remaining alleged injuries can be read to describe the set of harms resulting from the coercive nature of the rights offering. The particular harm allegedly suffered by an individual shareholder as a result of the coercion depends on whether or not that shareholder participated in the rights offering. For example, when read in the light most favorable to the plaintiff, the alleged injury of “substantial downward pressure on the price of the Fund’s shares” resulting from the issuance of new shares describes the reduction in the net equity value of the shares owned by non-participating shareholders. [Citation.] Similarly, the alleged injury from the downward pressure on share prices resulting from the setting of the “exercise price of the rights * * * at a steep discount from the pre-rights offering net asset value” can be read to refer to the involuntary dilution in equity value suffered by the non-participating shareholders. [Citation.] * * * * * * On the other hand, participating shareholders may have suffered harm in the form of transaction costs in liquidating other assets to purchase the new shares, and the impairment of their right to dispose of their assets as they prefer if they purchased new shares to avoid dilution. * * * Thus, in the case of both the participating and non-participating shareholders, it would appear that the alleged injuries were to the shareholders alone and not to the Fund. These harms therefore constitute “distinct” injuries supporting direct shareholder claims under Maryland law. The corporation cannot bring the action seeking compensation for these injuries because they were suffered by its shareholders, not itself. * * * For the foregoing reasons, the judgment of the district court is vacated insofar as it dismisses the plaintiff’s class action claims. The case is remanded for further proceedings consistent with this opinion. 35-2c Shareholder’s Right to Dissent A shareholder has the right to dissent from certain corporate actions that require shareholder approval — including most mergers, consolidations, compulsory share exchanges, and a sale or exchange of all or substantially all of the assets of the corporation not in the usual and regular course of business. ROLE OF DIRECTORS AND OFFICERS By statute, management of a corporation is vested in the board of directors. The board determines general corporate policy and appoints officers to execute the policy and administer the day-to-day operations of the corporation. Both directors and officers owe certain duties to the corporation and to shareholders; if they breach their duties, they are liable. In some instances, controlling shareholders also are held to the same duties as directors and officers. (A controlling shareholder is one who owns a sufficient number of shares to have effective control over the corporation.) In close corporations, some courts impose on all the shareholders a fiduciary duty similar to that imposed on partners. *** Chapter Outcomes*** Explain the role of the board of directors in the management of a corporation. Explain the role of the officers in the management of a corporation. CASE 35-3 DONAHUE v. RODD ELECTROTYPE CO., INC. Massachusetts Supreme Court, 1974 367 Mass. 578, 328 N.E.2d 505 http://scholar.google.com/scholar_case?case=10488013111081435481 &q=328+N.E.2d+505&hl=en&as_sdt=2,34 Tauro, C. J. The plaintiff, Euphemia Donahue, a minority stockholder in the Rodd Electrotype Company of New England, Inc. (Rodd Electrotype), a Massachusetts corporation, brings this suit against the directors of Rodd Electrotype, Charles H. Rodd, Frederick I. Rodd and Mr. Harold E. Magnuson, against Harry C. Rodd, a former director, officer, and controlling stockholder of Rodd Electrotype and against Rodd Electrotype (hereinafter called defendants). The plaintiff seeks to rescind Rodd Electrotype’s purchase of Harry Rodd’s shares in Rodd Electrotype and to compel Harry Rodd “to repay to the corporation the purchase price of said shares, $36,000, together with interest from the date of purchase.” The plaintiff alleges that the defendants caused the corporation to purchase the shares in violation of their fiduciary duty to her, a minority stockholder of Rodd Electrotype. * * * We deem a close corporation to be typified by: (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation. As thus defined, the close corporation bears striking resemblance to a partnership. Commentators and courts have noted that the close corporation is often little more than an “incorporated” or “chartered” partnership * * *. Just as in a partnership, the relationship among the stockholders must be one of trust, confidence and absolute loyalty if the enterprise is to succeed. Close corporations with substantial assets and with more numerous stockholders are no different from smaller close corporations in this regard. All participants rely on the fidelity and abilities of those stockholders who hold office. Disloyalty and self-seeking conduct on the part of any stockholder will engender bickering, corporate stalemates, and, perhaps, efforts to achieve dissolution. * * * Although the corporate form provides * * * advantages for the stockholders (limited liability, perpetuity, and so forth), it also supplies an opportunity for the majority stockholders to oppress or disadvantage minority stockholders. The minority is vulnerable to a variety of oppressive devices, termed “freeze-outs,” which the majority may employ. [Citation.] An authoritative study of such “freeze- outs” enumerates some of the possibilities: “The squeezers [those who employ the freeze-out techniques] may refuse to declare dividends; they may drain off the corporation’s earnings in the form of exorbitant salaries and bonuses to the majority shareholder-officers and perhaps to their relatives, or in the form of high rent by the corporation for property leased from majority shareholders * * *; they may deprive minority shareholders of corporate offices and of employment by the company; they may cause the corporation to sell its assets at an inadequate price to the majority shareholders * * *.” [Citation.] In particular, the power of the board of directors, controlled by the majority, to declare or withhold dividends and to deny the minority employment is easily converted to a device to disadvantage minority stockholders. * * * The minority can, of course, initiate suit against the majority and their directors. Self-serving conduct by directors is proscribed by the director’s fiduciary obligation to the corporation. [Citation.] However, in practice, the plaintiff will find difficulty in challenging dividend or employment policies. Such policies are considered to be within the judgment of the directors. This court has said: “The courts prefer not to interfere * * * with the sound financial management of the corporation by its directors, but declare as a general rule that the declaration of dividends rests within the sound discretion of the directors, refusing to interfere with their determination unless a plain abuse of discretion is made to appear.” * * * Thus, when these types of “freeze-outs” are attempted by the majority stockholders, the minority stockholders, cut off from all corporation-related revenues, must either suffer their losses or seek a buyer for their shares. Many minority stockholders will be unwilling or unable to wait for an alteration in majority policy. Typically, the minority stockholder in a close corporation has a substantial percentage of his personal assets invested in the corporation. [Citation.] The stockholder may have anticipated that his salary from his position with the corporation would be his livelihood. Thus, he cannot afford to wait passively. He must liquidate his investment in the close corporation in order to reinvest the funds in income-producing enterprises. * * * In a large public corporation, the oppressed or dissident minority stockholder could sell his stock in order to extricate some of his invested capital. By definition, this market is not available for shares in the close corporation. In a partnership, a partner who feels abused by his fellow partners may cause dissolution by his “express will * * * at any time” [citation] and recover his share of partnership assets and accumulated profits * * *. To secure dissolution of the ordinary close corporation subject to [citation], the stockholder, in the absence of corporate deadlock, must own at least fifty per cent of the shares [citation] or have the advantage of a favorable provision in the articles of organization [citation]. The minority stockholder, by definition lacking fifty per cent of the corporate shares, can never “authorize” the corporation to file a petition for dissolution under [citation], by his own vote. He will seldom have at his disposal the requisite favorable provision in the articles of organization. Thus, in a close corporation, the minority stockholders may be trapped in a disadvantageous situation. No outsider would knowingly assume the position of the disadvantaged minority. The outsider would have the same difficulties. To cut losses, the minority stockholder may be compelled to deal with the majority. This is the capstone of the majority plan. Majority “freeze-out” schemes which withhold dividends are designed to compel the minority to relinquish stock at inadequate prices * * *. When the minority stockholder agrees to sell out at less than fair value, the majority has won. Because of the fundamental resemblance of the close corporation to the partnership, the trust and confidence which are essential to this scale and manner of enterprise, and the inherent danger to minority interests in the close corporation, we hold that stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. In our previous decisions, we have defined the standard of duty owed by partners to one another as the “utmost good faith and loyalty.” [Citations.] Stockholders in close corporations must discharge their management and stockholder responsibilities in conformity with this strict good faith standard. They may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to the corporation. We contrast this strict good faith standard with the somewhat less stringent standard of fiduciary duty to which directors and stockholders of all corporations must adhere in the discharge of their corporate responsibilities. Corporate directors are held to a good faith and inherent fairness standard of conduct [citation] and are not “permitted to serve two masters whose interests are antagonistic.” [Citation.] “Their paramount duty is to the corporation, and their personal pecuniary interests are subordinate to that duty.” [Citation.] The more rigorous duty of partners and participants in a joint adventure, here extended to stockholders in a close corporation, was described by then Chief Judge Cardozo of the New York Court of Appeals in [citation]: “Joint adventurers, like co-partners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties * * *. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” * * * Under settled Massachusetts law, a domestic corporation, unless forbidden by statute, has the power to purchase its own shares. When the corporation reacquiring its own stock is a close corporation, the purchase is subject to the additional requirement, in the light of our holding in this opinion, that the stockholders, who, as directors or controlling stockholders, caused the corporation to enter into the stock purchase agreement, must have acted with the utmost good faith and loyalty to the other stockholders. To meet this test, if the stockholder whose shares were purchased was a member of the controlling group, the controlling stockholders must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an identical price. * * * * * * If the close corporation purchases shares only from a member of the controlling group, the controlling stockholder can convert his shares into cash at a time when none of the other stockholders can. Consistent with its strict fiduciary duty, the controlling group may not utilize its control of the corporation to establish an exclusive market in previously unmarketable shares from which the minority stockholders are excluded. * * * The purchase also distributes corporate assets to the stockholder whose shares were purchased. Unless an equal opportunity is given to all stockholders, the purchase of shares from a member of the controlling group operates as a preferential distribution of assets. * * * The rule of equal opportunity in stock purchases by close corporations provides equal access to these benefits for all stockholders. We hold that, in any case in which the controlling stockholders have exercised their power over the corporation to deny the minority such equal opportunity, the minority shall be entitled to appropriate relief. * * * On its face, then, the purchase of Harry Rodd’s shares by the corporation is a breach of the duty which the controlling stockholders, the Rodds, owed to the minority stockholders, the plaintiff and her son. * * * Because of the foregoing, we hold that the plaintiff is entitled to relief. 35-3 FUNCTION OF THE BOARD OF DIRECTORS Directors are neither trustees nor agents of the shareholders or the corporation. But they are fiduciaries who must perform their duties in good faith, in the best interests of the corporation, and with due care. All corporate power is exercised under the authority of the board of directors. In some corporations, the board members actively manage the company’s business, but in most publicly held corporations someone else manages the daily affairs of the business, but still under the authority of the board. In publicly held corporations, directors who are also corporate officers or employees are known as inside directors, in contrast to outside directors, who are not officers or employees. Outside directors who have no business contacts with the corporation are unaffiliated directors; outside directors who do have such contacts with the corporation—such as investment bankers, lawyers, or suppliers—are affiliated directors. The board: (1) selects and removes officers, (2) determines the corporation’s capital structure, (3) initiates fundamental changes, (4) declares dividends, and (5) sets management compensation. Under the Dodd-Frank Act, the SEC must issue rules requiring publicly held companies to disclose in annual proxy statements the reasons why, if the company has chosen to separate or combine the positions of chairman of the board of directors and chief executive officer. 35-5aSelection and Removal of Officers In most states, the board is responsible for choosing the corporate officers and may remove any officer at any time. Officers are agents of the corporation; their responsibilities are delegated to them by the board of directors. 35-3b Capital Structure Determining the capital structure and financial policy of the corporation may include the power to fix the selling price of newly issued shares (unless the charter reserves that right to the shareholders); to determine the value of consideration received in exchange for shares it issues; to borrow money, issue notes, bonds, and other obligations, and to secure any of the corporation’s obligations; and to sell, lease, or exchange corporate assets in the usual and regular course of business. 35-3c Fundamental Changes The board has the power to amend or repeal the bylaws, unless the articles of incorporation reserve this power exclusively to the shareholders. The board initiates certain actions that exceed its power and require shareholder approval. For example, the board may initiate but must obtain shareholder approval to complete proceedings to amend the charter; to effect a merger, consolidation, compulsory share exchange, or the sale or lease of all or substantially all of the assets of the corporation other than in the usual and regular course of business; and to dissolve the corporation. 35-3d Dividends The board declares the amount and type of dividends, subject to the restrictions imposed by the state incorporation statute, articles of incorporation, and corporate loan and preferred stock agreements. The board also may purchase, redeem, or otherwise acquire shares of the corporation’s equity securities. 35-3e Management Compensation The board usually determines the compensation of officers. In addition, a number of states allow the board to fix the compensation of board members. The Dodd-Frank Act requires that, at least once every three years, publicly held companies include a provision in certain proxy statements for a non-binding shareholder vote on the compensation of executives. In a separate resolution, shareholders determine whether this “say on pay” vote should be held every one, two, or three years. Under the Sarbanes-Oxley Act, if a publicly held company is required to issue an accounting restatement due to a material violation of securities law, the chief executive officer and the chief financial officer must forfeit certain bonuses and compensation received, as well as any profit realized from the sale of the company’s securities, during the twelve-month period following the original issuance of the noncomplying financial document. These “clawback” requirements of the Sarbanes-Oxley Act are greatly expanded by the Dodd-Frank Act. Under the Dodd-Frank Act, the SEC must issue rules directing the national securities exchanges to require each listed company to disclose and implement a policy regarding any incentive-based compensation that is based on financial information that must be reported under the securities laws. If a company is required to prepare an accounting restatement due to the material noncompliance with any financial reporting requirement, the company must recover from any current or former executive officers who received excess incentive-based compensation (including stock options awarded as compensation) during the prior 3-year period. The amount of the recovery is the incentive-based compensation in excess of what would have been paid to the executive officer under the accounting restatement. 35-4 ELECTION AND TENURE OF DIRECTORS A director’s qualifications are determined by the incorporation statute, articles of incorporation, and bylaws. The statute, charter, and bylaws also determine the election, number, tenure, and compensation of directors. 35-4a Election, Number, and Tenure of Directors When a corporation is new, the articles of incorporation usually name the initial board of directors, which serves until the first meeting of shareholders, who then elect the next directors. Thereafter, directors are elected annually and hold office for one year unless their terms are staggered. State statutes traditionally required three or more directors; but the modern trend is to permit the board to consist of as few as one member. The number of directors may be increased or decreased, within statutory limits, by amendment of the corporate bylaws or charter. 35-4b Vacancies and Removal of Directors The Revised Act provides that a vacancy in the board may be filled either by the shareholders or by an affirmative vote by a majority of the remaining directors — even if those remaining constitute less than a quorum. The term of a director elected to fill a vacancy expires at the next shareholders’ meeting at which directors are elected. Some states have no statutory provision for removal of directors, although a common law rule permits removal for cause by action of the shareholders. The Revised Act and an increasing number of other statutes permit shareholders to remove one or more directors or the entire board, with or without cause, at a special meeting called for that purpose. However, the Revised Act also permits the articles of incorporation to provide that directors may be removed only for cause. 35-4c Compensation of Directors Traditionally, directors did not receive salaries for their service as directors, though they often received a fee or honorarium for attendance at meetings. The Revised Act and a number of state statutes now specifically authorize the board to fix the compensation of directors, unless a contrary provision exists in the charter or bylaws. 35-5 EXERCISE OF DIRECTORS’ FUNCTIONS Board members cannot bind the corporation when acting individually; they must act as a board, and only through a meeting of the directors or through an authorized written consent signed by all of the directors, if such consent without a meeting is not contrary to the charter or bylaws. Meetings are at a regular time and place fixed in the bylaws or called at special times. Notice of meetings must be given. Most states permit meetings to be held either in or outside of the state of incorporation. 35-5a Quorum and Voting A quorum is the minimum number of members that must be present at a meeting to transact business. It is usually a simple majority of the board members, but some States allow the articles of incorporation or the bylaws to authorize a quorum consisting of as few as one-third of a board's members and all states allow the articles of incorporation or bylaws may require a number greater than a simple majority. Directors may not vote by proxy, although most states permit them to participate by teleconference. 35-5b Action Taken without a Meeting The Revised Act and most states provide that, unless the charter or bylaws provide otherwise, any action the statute requires or permits to be taken at a board meeting may be taken without a meeting if all directors consent in writing. 35-5c Delegation of Board Powers Unless the charter or bylaws provide otherwise, the board of directors, by a majority vote of the full board, may appoint one or more committees, all of whose members must be directors. The committees may exercise all authority of the board, except with regard to certain matters specified in the incorporation statute, such as declaring dividends or authorizing the sale of stock. Commonly used committees include executive committees, audit committees, compensation committees, nominating committees, finance committees and investment committees. Delegating authority to a committee does not relieve any board member of his duties to the corporation. Under the Dodd-Frank Act, the SEC must issue rules directing the national securities exchanges to require that each member of a listed company’s compensation committee be independent directors. 35-5d Directors’ Inspection Rights Permits directors access to corporate records so that they can make informed judgments. 35-6 OFFICERS The board appoints officers to hold the offices provided in the corporation’s bylaws, which set forth the duties of each officer. Statutes generally require at minimum that officers include a president; one or more vice presidents, as prescribed by the bylaws; a secretary, and a treasurer. A person may hold more that one office at the same time but not simultaneously the offices of president and secretary. The Revised Act permits every corporation to designate whatever officers it wants — one of whom must be delegated the responsibility to prepare the minutes of directors’ and shareholders’ meetings and to authenticate corporate records. The Revised Act permits the same individual to hold all of the offices of a corporation. 35-6a Selection and Removal of Officers Most state statutes provide that the officers be appointed by the board and that they serve at the pleasure of the board; thus, officers may be removed with or without cause. However, if the officer has an employment contract that is valid for a specified time, then removing the officer without cause before the contract expires would constitute a breach of the employment contract. The board also determines the compensation of officers. 35-6b Role of Officers The officers, like the directors, are fiduciaries to the corporation. In contrast to directors, officers are also agents of the corporation. The roles of officers are set forth in the corporate bylaws. • President — principal executive officer, generally supervises and controls business affairs subject to the board of directors; presides at meetings; has authority to sign legal papers for corporation • Vice President — has same powers as president in his absence or upon his inability to act • Secretary — keeps minutes of meetings, sends notices, keeps records and the corporate seal, co-signs with the president • Treasurer — has charge and custody of corporate funds and controls receipts 35-6c Authority of Officers The Revised Act provides that each officer has the authority provided in the bylaws or prescribed by the board of directors to the extent such prescribed authority is consistent with the bylaws. Like that of other agents, the authority of an officer to bind the corporation may be (1) actual express, (2) actual implied, or (3) apparent. Actual express authority — when the corporation manifests its assent to the officer that the officer should act on its behalf. It is derived from the articles, bylaws, and board resolutions and can be from an officer authorized to prescribe the duties of other officers. Actual implied authority — is vested in officers to perform actions reasonably necessary to complete responsibilities expressly delegated. Apparent authority — is created where a third party believes authority exists due to previous actions by the corporation. Ratification — Finally, a corporation may ratify unauthorized acts of its officers. 35-7 DUTIES OF DIRECTORS AND OFFICERS Generally, directors and officers owe the duties of obedience, diligence, and loyalty to the corporation. Common law is the most significant source of directors’ and officers’ duties, but liability for specific acts may also be imposed on directors and officers by state and federal statutes. A corporation may not recover damages from its directors and officers for losses resulting from their poor business judgment or honest mistakes of judgment. Directors and officers are not duty-bound to ensure business success. They are required only to be obedient, reasonably diligent, and completely loyal. *** Chapter Outcome*** Explain management’s duties of loyalty, obedience, and diligence. 35-7a Duty of Obedience Directors and officers must act within their respective authority. For any loss the corporation suffers because of their unauthorized acts, they are held absolutely liable in some jurisdictions; in others they are held liable only if they exceeded their authority intentionally or negligently. 35-7b Duty of Diligence Most states and the Revised Act require that a director or officer discharge corporate duties (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and (3) in a manner the director or officer reasonably believes to be in the best interests of the corporation. A director or officer who performs her duties in compliance with these requirements is not liable for any action that she takes as a director or officer, or for any failure to act. In 1999 an amendment to the Revised Act was adopted refining the Act's standards of conduct and liability for directors. It substituted this for number 2 above: “When becoming informed in connection with their decision making function or devoting attention to their oversight function, directors shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.” As long as the directors and officers act in good faith and with due care, the courts will not substitute their judgment for that of the board or officer — the so-called business judgment rule. Conversely, directors and officers will be held liable for bad faith or negligent conduct or for failing to act. Reliance on others — Directors and officers are permitted to entrust important work to others and are not personally liable for the negligent acts or willful wrongs of those employees whom they selected carefully. Nevertheless, reasonable supervision is required. Directors may also rely on information provided them by officers or employees of the corporation, committees of the board, or legal counsel or public accountants. An officer is also entitled to rely upon this information, though often not as heavily as a director might, given the officer’s great familiarity with the corporation’s affairs. Business judgment rule — This rule precludes the courts’ imposing liability on the directors or officers for honest mistakes of judgment. (With respect to directors, the 1999 amendments to the Revised Act added a new section 8.31 codifying much of the business judgment rule and providing guidance as to its application.) Directors and officers are continuously called on to make decisions that require balancing benefits and risks to the corporation, and they may not always make the correct decisions, in light of subsequent events. To benefit later from the business judgment rule, a director of officer must make an informed decision without any conflict of interest, have a rational basis for making it, and reasonably believe it is in the corporation’s best interests. Furthermore, where this standard of conduct has not been met, the director’s action (or inaction) must be shown to be the proximate cause of damage to the corporation. Hasty or ill-advised action also can render directors liable, as in a recent important case, Smith v. Van Gorkom. CASE 35-4 BREHM v. EISNER Supreme Court of Delaware, 2000 746 A.2d 244 http://scholar.google.com/scholar_case?q=746+A.2D+244+&hl=en&as_sdt=2,34&case=2721397479365362562&scilh=0 Veasey, C. J. [On October 1, 1995, Disney hired as its president Michael S. Ovitz, who was a long-time friend of Disney Chairman and CEO Michael Eisner. At the time, Ovitz was an important talent broker in Hollywood. Although he lacked experience managing a diversified public operations had been interested in hiring him for high-level executive positions. The employment I agreement approved by the board of directors then | in office (Old Board) had an initial term of five years and required that Ovitz “devote his full time and best efforts exclusively to the Company,” with exceptions for volunteer work, service on the board of another company, and managing his passive investments. In return, Disney agreed to give Ovitz a base salary of $1 million per year, a discretionary bonus, and two sets of stock options (the “A” options and the “B” options) that collectively would enable Ovitz to purchase 5 million shares of Disney common stock. The “A” options were scheduled to vest in three annual increments of 1 million shares each, beginning at the end of the third full year of employment and continuing for the following two years. The agreement specifically provided that the “A” options would vest immediately if Disney granted Ovitz a non-fault termination of the employment agreement. The “B” options, consisting of 2 million shares, were scheduled to vest annually starting the year after the last “A” option would vest and were conditioned on Ovitz and Disney first having agreed to extend his employment beyond the five-year term of the employment agreement. In addition, Ovitz would forfeit the “B” options if his initial employment term of five years ended prematurely for any reason, even if from a non-fault termination. The employment agreement provided three ways for Ovitz’ employment to end. He might serve his five years and Disney might decide against offering him a new contract. If so, Disney would owe Ovitz a $10 million termination payment. Before the end of the initial term, Disney could terminate Ovitz for “good cause” only if Ovitz committed gross negligence or malfeasance, or if Ovitz resigned voluntarily. Disney would owe Ovitz no additional compensation if it terminated him for “good cause.” Termination without cause (non-fault termination) would entitle Ovitz to the present value of his salary payments remaining under the agreement, a $10 million severance payment, an additional $7.5 million for each fiscal year remaining under the agreement, and the immediate vesting of the first 3 million stock options (the “A” Options). Soon after Ovitz began work, problems surfaced and the situation continued to deteriorate during the first year of his employment. The deteriorating situation led Ovitz to begin seeking alternative employment and expressing his desire to leave the Company. On December 11, 1996, Eisner and Ovitz agreed to arrange for Ovitz to leave Disney on the non-fault basis provided for in the 1995 employment agreement. The board of directors then in office (New Board) approved this by authorizing a “non-fault termination” agreement with cash payments to Ovitz of almost $39 million and the immediate vesting of 3 million stock options with a value of $101 million. Shareholders brought a derivative suit alleging that: (a) the Old Board had breached its fiduciary duty in approving an extravagant and wasteful employment agreement of Michael S. Ovitz as president of Disney and (b) the New Board had breached its fiduciary duty in agreeing to an extravagant and wasteful “non-fault” termination of the Ovitz employment agreement. The plaintiffs alleged that the Old Board had failed properly to inform itself about the total costs and incentives of the Ovitz employment agreement, especially the severance package, and failed to realize that the contract gave Ovitz an incentive to find a way to exit the Company via a non-fault termination as soon as possible because doing so would permit him to earn more than he could by fulfilling his contract. They alleged that the corporate compensation expert, Graef Crystal, who had advised Old Board in connection with its decision to approve the Ovitz employment agreement, stated two years later that the Old Board failed to consider the incentives and the total cost of the severance provisions. The defendants moved to dismiss, and the Court of Chancery granted the motion. The shareholders appealed.] This is potentially a very troubling case on the merits. On the one hand, it appears from the Complaint that: (a) the compensation and termination payout for Ovitz were exceedingly lucrative, if not luxurious, compared to Ovitz’ value to the Company; and (b) the processes of the boards of directors in dealing with the approval and termination of the Ovitz Employment Agreement were casual, if not sloppy and perfunctory. [T]he processes of the Old Board and the New Board were hardly paradigms of good corporate governance practices. Moreover, the sheer size of the payout to Ovitz, as alleged, pushes the envelope of judicial respect for the business judgment of directors in making compensation decisions. Therefore, both as to the processes of the two Boards and the waste test, this is a close case. * * * This is a case about whether there should be personal liability of the directors of a Delaware corporation to the corporation for lack of due care in the decisionmaking process and for waste of corporate assets. This case is not about the failure of the directors to establish and carry out ideal corporate governance practices. All good corporate governance practices include compliance with statutory law and case law establishing fiduciary duties. But the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices. Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal requirements of the corporation law are highly desirable, often tend to benefit stockholders, sometimes reduce litigation and can usually help directors avoid liability. But they are not required by the corporation law and do not define standards of liability. [Citation.] The inquiry here is not whether we would disdain the composition, behavior and decisions of Disney’s Old Board or New Board as alleged in the Complaint if we were Disney stockholders. In the absence of a legislative mandate, [citation], that determination is not for the courts. That decision is for the stockholders to make in voting for directors, urging other stockholders to reform or oust the board, or in making individual buy-sell decisions involving Disney securities. The sole issue that this Court must determine is whether the particularized facts alleged in this Complaint provide a reason to believe that the conduct of the Old Board in 1995 and the New Board in 1996 constituted a violation of their fiduciary duties. Plaintiffs claim that the Court of Chancery erred when it concluded that a board of directors is “not required to be informed of every fact, but rather is required to be reasonably informed.” [Citation.] * * * The “reasonably informed” language used by the Court of Chancery here may have been a short-hand attempt to paraphrase the Delaware jurisprudence that, in making business decisions, directors must consider all material information reasonably available, and that the directors’ process is actionable only if grossly negligent. [Citation.] The question is whether the trial court’s formulation is consistent with our objective test of reasonableness, the test of materiality and concepts of gross negligence. We agree with the Court of Chancery that the standard for judging the informational component of the directors’ decisionmaking does not mean that the Board must be informed of every fact. The Board is responsible for considering only material facts that are reasonably available, not those that are immaterial or out of the Board’s reasonable reach. [Citation.] Certainly in this case the economic exposure of the corporation to the payout scenarios of the Ovitz contract was material, particularly given its large size, for purposes of the directors’ decisionmaking process. [Court’s footnote: The term “material” is used in this context to mean relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decisionmaking.] And those dollar exposure numbers were reasonably available because the logical inference from plaintiffs’ allegations is that Crystal or the New Board could have calculated the numbers. Thus, the objective tests of reasonable availability and materiality were satisfied by this Complaint. But that is not the end of the inquiry for liability purposes. * * * * * * The Complaint, fairly construed, admits that the directors were advised by Crystal as an expert and that they relied on his expertise. Accordingly, the question here is whether the directors are to be “fully protected” (i.e., not held liable) on the basis that they relied in good faith on a qualified expert [citation]. * * * * * * Plaintiffs must rebut the presumption that the directors properly exercised their business judgment, including their good faith reliance on Crystal’s expertise. * * * * * * [T]he complaint must allege particularized facts (not conclusions) that, if proved, would show, for example, that: (a) the directors did not in fact rely on the expert; (b) their reliance was not in good faith; (c) they did not reasonably believe that the expert’s advice was within the expert’s professional competence; (d) the expert was not selected with reasonable care by or on behalf of the corporation, and the faulty selection process was attributable to the directors; (e) the subject matter (in this case the cost calculation) that was material and reasonably available was so obvious that the board’s failure to consider it was grossly negligent regardless of the expert’s advice or lack of advice; or (f) that the decision of the Board was so unconscionable as to constitute waste or fraud. This Complaint includes no particular allegations of this nature, and therefore it was subject to dismissal as drafted. * * * We conclude that * * * the Complaint * * * as drafted, fails to create a reasonable doubt that the Old Board’s decision in approving the Ovitz Employment Agreement was protected by the business judgment rule. * * * * * * Plaintiffs’ principal theory is that the 1995 Ovitz Employment Agreement was a “wasteful transaction for Disney ab initio” because it was structured to “incentivize” Ovitz to seek an early non-fault termination. The Court of Chancery correctly dismissed this theory as failing to meet the stringent requirements of the waste test, i.e., “‘an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.’” Moreover, the Court concluded that a board’s decision on executive compensation is entitled to great deference. It is the essence of business judgment for a board to determine if “a ‘particular individual warrant[s] large amounts of money, whether in the form of current salary or severance provisions.’” [Citation.] * * * * * * Irrationality is the outer limit of the business judgment rule. Irrationality may be the functional equivalent of the waste test or it may tend to show that the decision is not made in good faith, which is a key ingredient of the business judgment rule. [Court’s footnote: The business judgment rule has been well formulated by Aronson and other cases. (“It is a presumption that in making a business decision the directors * * * acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation.”) Thus, directors’ decisions will be respected by courts unless the directors are interested or lack independence relative to the decision, do not act in good faith, act in a manner that cannot be attributed to a rational business purpose or reach their decision by a grossly negligent process that includes the failure to consider all material facts reasonably available.] The plaintiffs contend in this Court that Ovitz resigned or committed acts of gross negligence or malfeasance that constituted grounds to terminate him for cause. In either event, they argue that the Company had no obligation to Ovitz and that the directors wasted the Company’s assets by causing it to make an unnecessary and enormous payout of cash and stock options when it permitted Ovitz to terminate his employment on a “non-fault” basis. We have concluded, however, that the Complaint currently before us does not set forth particularized facts that he resigned or unarguably breached his Employment Agreement. * * * Construed most favorably to plaintiffs, the facts in the Complaint (disregarding conclusory allegations) show that Ovitz’ performance as president was disappointing at best, that Eisner admitted it had been a mistake to hire him, that Ovitz lacked commitment to the Company, that he performed services for his old company, and that he negotiated for other jobs (some very lucrative) while being required under the contract to devote his full time and energy to Disney. All this shows is that the Board had arguable grounds to fire Ovitz for cause. But what is alleged is only an argument—perhaps a good one—that Ovitz’ conduct constituted gross negligence or malfeasance. * * * The Complaint, in sum, contends that the Board committed waste by agreeing to the very lucrative payout to Ovitz under the non-fault termination provision because it had no obligation to him, thus taking the Board’s decision outside the protection of the business judgment rule. Construed most favorably to plaintiffs, the Complaint contends that, by reason of the New Board’s available arguments of resignation and good cause, it had the leverage to negotiate Ovitz down to a more reasonable payout than that guaranteed by his Employment Agreement. But the Complaint fails on its face to meet the waste test because it does not allege with particularity facts tending to show that no reasonable business person would have made the decision that the New Board made under these circumstances. * * * To rule otherwise would invite courts to become super- directors, measuring matters of degree in business decision- making and executive compensation. Such a rule would run counter to the foundation of our jurisprudence. * * * One can understand why Disney stockholders would be upset with such an extraordinarily lucrative compensation agreement and termination payout awarded a company president who served for only a little over a year and who under-performed to the extent alleged. That said, there is a very large—though not insurmountable—burden on stockholders who believe they should pursue the remedy of a derivative suit instead of selling their stock or seeking to reform or oust these directors from office. [Dismissal affirmed in part, reversed in part, and case remanded.] 35-7c Duty of Loyalty An officer or director must subordinate his interests to the interests of the corporation and is required to disclose fully any financial interest in any contract or transaction to which the corporation is a party. For breach of fiduciary duty a suit may be brought by the corporation, or a derivative suit may be instituted by a shareholder to require the fiduciary to pay to the corporation the profits he obtained through the breach. Whenever a director or officer breaches his fiduciary duty, he forfeits his right to compensation during the period he engaged in the breach. Conflict of interests — Transactions between an officer or a director and the corporation inherently involve a conflict of interests. In contracts between corporations having an interlocking directorate (the boards share one or more members), courts scrutinize the contracts and will set them aside unless they find the transactions were entirely fair and entered into in good faith. The original version of the Revised Act and most states provide that such transactions are neither void nor voidable if, after full disclosure, either the board of disinterested directors or the shareholders approve them or if they are fair and reasonable to the corporation. Loans to directors and officers — The Model Act and some states permit a corporation to lend money to its directors only with shareholders’ authorization for each loan. The 1988 amendments to the Revised Act subject loans to directors to the procedure that applies to directors’ conflicting-interests transactions. The Sarbanes-Oxley Act prohibits any publicly held corporation from making personal loans to its directors or its executive officers. The Act provides certain limited exceptions to this prohibition. Corporate opportunity — Directors and officers may not usurp any corporate opportunity that rightly should belong to the corporation. A director or officer is free to take personal advantage of any fully disclosed opportunity that the corporation rejects. CASE 35-5 BEAM v. STEWART Court of Chancery of Delaware, New Castle, 2003 833 A.2d 961, affirmed, 845 A.2d 1040 http://scholar.google.com/scholar_case?q=833+A.2d+961&hl=en&as_sdt=2,34&case=17647245391824322549&scilh=0 Chandler, Chancellor Monica A. Beam, a shareholder of Martha Stewart Living Omnimedia, Inc. (“MSO”), brings this derivative action against the defendants, all current directors and a former director of MSO, and against MSO as a nominal defendant. * * * * * * Plaintiff Monica A. Beam is a shareholder of MSO and has been since August 2001. Derivative plaintiff and nominal defendant MSO is a Delaware corporation that operates in the publishing, television, merchandising, and internet industries marketing products bearing the “Martha Stewart” brand name. Defendant Martha Stewart (“Stewart”) is a director of the company and its founder, chairman, chief executive officer, and by far its majority shareholder. * * * [S]he controls roughly 94.4% of the shareholder vote. Stewart, a former stockbroker, has in the past twenty years become a household icon, known for her advice and expertise on virtually all aspects of cooking, decorating, entertaining, and household affairs generally. * * * The market for MSO products is uniquely tied to the personal image and reputation of its founder, Stewart. MSO retains “an exclusive, worldwide, perpetual royalty- free license to use [Stewart’s] name, likeness, image, voice and signature for its products and services.” In its initial public offering prospectus, MSO recognized that impairment of Stewart’s services to the company, including the tarnishing of her public reputation, would have a material adverse effect on its business. The prospectus distinguished Stewart’s importance to MSO’s business success from that of other executives of the company noting that, “Martha Stewart remains the personification of our brands as well as our senior executive and primary creative force.” In fact, under the terms of her employment agreement, Stewart may be terminated for gross misconduct or felony conviction that results in harm to MSO’s business or reputation but is permitted discretion over the management of her personal, financial, and legal affairs to the extent that Stewart’s management of her own life does not compromise her ability to serve the company. Stewart’s alleged misadventures with ImClone arise in part out of a longstanding personal friendship with Samuel D. Waksal (“Waksal”). Waksal is the former chief executive officer of ImClone as well as a former suitor of Stewart’s daughter. More pertinently, * * * Waksal and Stewart have provided one another with reciprocal investment advice and assistance, and they share a stockbroker, Peter E. Bacanovic (“Bacanovic”) of Merrill Lynch. Bacanovic, coincidentally, is a former employee of ImClone. * * * The speculative value of ImClone stock was tied quite directly to the likely success of its application for FDA approval to market the cancer treatment drug Erbitux. On December 26, Waksal received information that the FDA was rejecting the application to market Erbitux. The following day, December 27, he tried to sell his own shares and tipped his father and daughter to do the same. Stewart also sold her shares on December 27. * * * After the close of trading on December 28, ImClone publicly announced the rejection of its application to market Erbitux. The following day the trading price closed slightly more than 20% lower than the closing price on the date that Stewart had sold her shares. By mid-2002, this convergence of events had attracted the interest of the New York Times and other news agencies, federal prosecutors, and a committee of the United States House of Representatives. Stewart’s publicized attempts to quell any suspicion were ineffective at best because they were undermined by additional information as it came to light and by the other parties’ accounts of the events. Ultimately Stewart’s prompt efforts to turn away unwanted media and investigative attention failed. Stewart eventually had to discontinue her regular guest appearances on CBS’ The Early Show because of questioning during the show about her sale of ImClone shares. After barely two months of such adverse publicity, MSO’s stock price had declined by slightly more than 65%. * * * In January 2002, Stewart and the Martha Stewart Family Partnership sold 3,000,000 shares of Class A stock to [an investor group] “ValueAct.” * * * * * * * * * [T]he amended complaint alleges that the director defendants * * * breached their fiduciary duties by failing to ensure that Stewart would not conduct her personal, financial, and legal affairs in a manner that would harm the Company, its intellectual property, or its business. The “duty to monitor” has been litigated in other circumstances, generally where directors were alleged to have been negligent in monitoring the activities of the corporation, activities that led to corporate liability. Plaintiff’s allegation, however, that the Board has a duty to monitor the personal affairs of an officer or director is quite novel. That the Company is “closely identified” with Stewart is conceded, but it does not necessarily follow that the Board is required to monitor, much less control, the way Stewart handles her personal financial and legal affairs. * * * * * * Regardless of Stewart’s importance to MSO, she is not the corporation. And it is unreasonable to impose a duty upon the Board to monitor Stewart’s personal affairs because such a requirement is neither legitimate nor feasible. * * * * * * [This count] is dismissed for failure to state a claim. * * * [T]he amended complaint alleges that Stewart * * * breached [her] fiduciary duty of loyalty, usurping a corporate opportunity by selling large blocks of MSO stock to ValueAct. * * * The basic requirements for establishing usurpation of a corporate opportunity were articulated by the Delaware Supreme Court in Broz v. Cellular Information Systems, Inc.: [A] corporate officer or director may not take a business opportunity for his own if: (1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation’s line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position [inimical] to his duties to the corporation. In this analysis, no single factor is dispositive. Instead the Court must balance all factors as they apply to a particular case. For purposes of the present motion, I assume that the sales of stock to ValueAct could be considered to be a “business opportunity.” I now address each of the four factors articulated in Broz. The amended complaint asserts that MSO was able to exploit this opportunity because the Company’s certificate of incorporation had sufficient authorized, yet unissued, shares of Class A common stock to cover the sale to ValueAct. Defendants do not deny that the Company could have sold previously unissued shares to ValueAct. I therefore conclude that the first factor has been met. An opportunity is within a corporation’s line of business if it is “an activity as to which [the corporation] has fundamental knowledge, practical experience and ability to pursue.” * * * * * * MSO is a consumer products company, not an investment company. Simply stated, selling stock is not the same line of business as selling advice to homemakers. * * * For the foregoing reasons, * * * the sale of stock by Stewart * * * was not within MSO’s line of business. A corporation has an interest or expectancy in an opportunity if there is “some tie between that property and the nature of the corporate business.” * * * Here, plaintiff does not allege any facts that would imply that MSO was in need of additional capital, seeking additional capital, or even remotely interested in finding new investors. * * * * * * “The corporate opportunity doctrine is implicated only in cases where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.” Given that * * * MSO had no interest or expectancy in the issuance of new stock to ValueAct, I fail to see, based on the allegations before me, how Stewart’s * * * sales placed [her] in a position inimical to their duties to the Company. * * * Additionally, Delaware courts have recognized a policy that allows officers and directors of corporations to buy and sell shares of that corporation at will so long as they act in good faith. * * * * * * On balancing the four factors, I conclude that plaintiff has failed to plead facts sufficient to state a claim that Stewart * * * usurped a corporate opportunity for [herself] in violation of [her] fiduciary duty of loyalty to MSO. [This count] is dismissed in its entirety * * * for failure to state a claim upon which relief can be granted. * * * IT IS SO ORDERED. Transactions in shares — If directors and officers cause the corporation to issue shares to them at favorable prices by excluding other shareholders, this action normally is a violation of the fiduciary duty. So is the issuance of shares to a director at a fair price if the purpose of the issuance is to perpetuate corporate control rather than to raise capital or to serve some other corporate interest. Duty not to compete — As fiduciaries, directors and officers may not compete with the corporation. A director or officer who does compete with the corporation is liable for damages caused to the corporation. Although directors and officers may engage in their own business interests, courts will closely scrutinize any interest that competes with the corporate business. Further, an officer or director may not use corporate personnel, facilities, or funds for her own benefit or disclose trade secrets of the corporation to others. 35-7d Indemnification of Directors and Officers Directors and officers incur personal liability for breaching any of the duties they owe to the corporation and to its shareholders. Under many modern incorporation statutes, a corporation may indemnify for liability a director or officer who acted in good faith and in a manner he reasonably believed to be in the best interests of the corporation, so long as he has not been judged negligent or liable for misconduct. 35-7e Liability Limitation Statutes Prompted by Smith v. Van Gorkom, more than 40 states recently have enacted legislation limiting the liability of directors. Most states, including Delaware, now authorize corporations, with shareholder approval, to limit or eliminate directors’ liability for certain breaches of duty. A few states also permit shareholders to limit the liability of officers. The Delaware statute provides that the articles of incorporation may contain a provision eliminating or limiting a director’s personal liability to the corporation or its stockholders for monetary damages for breach of directorial duty, provided that such provision does not eliminate or limit the liability of a director (1) for any breach of the director’s duty of loyalty to the corporation or shareholders, (2) for acts or omissions lacking good faith or involving intentional misconduct or a knowing violation of law, (3) for liability for unlawful dividend payments or redemption, or (4) for any transaction from which the director derived an improper personal benefit. In other approaches, states have limited or eliminated personal liability for money damages. The Revised Act authorizes the articles of incorporation to include a provision eliminating or limiting, with exceptions, the liability of a director to the corporation or its shareholders for any action he takes or fails to take as a director. Chapter 36 FUNDAMENTAL CHANGES Charter Amendments [36-1] Approval by Directors and Shareholders [36-1a] Approval by Directors [36-1b] Combinations [36-2] Purchase or Lease of All or Substantially All of the Assets [36-2a] Regular Course of Business Other Than In Regular Course of Business Purchase of Shares [36-2b] Sale of Control Tender Offer Compulsory Share Exchange [36-2c] Merger [36-2d] Consolidation [36-2e] Domestication and Conversion [36-2f] Going Private Transactions [36-2g] Cash-out Combinations Management Buyout Dissenting Shareholders [36-2h] Transactions Giving Rise to Dissenters' Rights Procedure Appraisal Remedy Dissolution [36-3] Voluntary Dissolution [36-3a] Involuntary Dissolution [36-3b] Administrative Dissolution Judicial Dissolution Liquidation [36-3c] Protection of Creditors [36-3d] Cases in This Chapter Alpert v. 28 Williams St. Corp Shawnee Telecom Resources, Inc. v. Brown Cooke v. Fresh Express Foods Corporation, Inc. Chapter Outcomes After reading and studying this chapter, the student should be able to: • Explain the procedure for amending the charter and list which amendments give rise to the appraisal remedy. • Identify which combinations do not require shareholder approval and which give dissenting shareholders an appraisal remedy. • Distinguish between a tender offer and a compulsory share exchange. • Compare and contrast a cash-out combination and a management buyout. • Identify the ways by which voluntary and involuntary dissolution may occur. TEACHING NOTES Certain changes which affect the basic structure of a corporation are so fundamental that they require shareholder approval. These include charter amendments, mergers, consolidations, compulsory share exchanges, dissolution, and sale or lease of all or most of the corporation’s assets. The 1999 amendments to the Revised Act significantly changed the voting rule: fundamental changes need only be approved by a majority of the shares present at a meeting at which a quorum is present. 36-1 CHARTER AMENDMENTS A charter may be amended, but the amended charter can contain only those provisions that might be contained lawfully in the charter as of the time of amendment. A common amendment is that increasing the number of authorized shares. Some amendments must be approved by both the board and the shareholders; others may be approved by the board only. 36-1a Approval by Directors and Shareholders Typically the board of directors adopts a resolution setting forth the proposed amendment, which then must be approved by a majority vote of the shareholders entitled to vote. Then, the corporation executes articles of amendment and delivers them to the secretary of state for filing. The 1999 amendments to the Revised Act eliminate the appraisal remedy for virtually all charter amendments. *** Chapter Outcome*** Explain the procedure for amending the charter and identify which amendments give rise to the appraisal remedy. The Revised Act permits the board of directors to adopt these amendments without shareholder action: (1) extending the duration of the corporation if it was incorporated when limited duration was required by law; (2) changing each issued and unissued authorized share of an outstanding class into a greater number of whole shares; and (3) making minor name changes. Dissenting shareholders are given an appraisal remedy only if an amendment materially and adversely affects the rights attached to the shares owned by the dissenting shareholders in one of the following ways: (1) the amendment alters or abolishes a preferential right of such shares; (2) the amendment creates, alters, or abolishes a right involving the redemption of such shares; (3) the amendment alters or abolishes a preemptive right of the holder of such shares; (4) the amendment excludes or limits the right of the holder of such shares to vote on any matter or to cumulate his vote; or (5) reduces the number of shares owned by the shareholder to a fraction of a share if the fractional share is to be acquired for cash. 36-1b Approval by Directors The Revised Act lets the board alone adopt certain amendments, such as (1) making minor name changes, (2) changing each issued and unissued authorized share of an outstanding class into a greater number of whole shares if the corporation has only one class of shares, and (3) extending the duration of a corporation that was incorporated when limited duration was required by law. 36-2 COMBINATIONS A few States and the 1999 amendments to the Revised Act have provisions authorizing a corporation to merge into another type of business organization, such as a limited partnership, limited liability company, or a limited liability partnership. There are many strategic reasons for one corporation to combine with another, and there are several methods for combining. In July of 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the most significant change to U.S. financial regulation since the New Deal. One of the many stand-alone statutes included in the Dodd-Frank Act is the Investor Protection and Securities Reform Act of 2010, which imposes new corporate governance rules on publicly held companies. (This Act is also discussed in Chapters 36, 44, and 47.) One of these provisions of the Dodd-Frank Act applies to proxy solicitations asking shareholders to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all the assets of a publicly held company issuer. In these proxy solicitations, publicly held companies must disclose, and provide shareholders with a non-binding vote to approve, any type of compensation that is based on or relates to these specified combinations. *** Chapter Outcome*** Identify which combinations do not require shareholder approval and give dissenting shareholders an appraisal remedy. 36-2a Purchase or Lease of All or Substantially All of the Assets When one corporation buys or leases all of another corporation’s assets, each corporation retains its legal personality and continues its existence. Only the ownership of the physical assets changes. (Typically, however, the corporation selling all of its assets will then dissolve.) Regular Course of Business — For the selling company, if the sale or lease of all of its assets is within the regular course of its business, approval by the board is required but shareholder approval is not. Other than In Regular Course of Business — If the sale or lease of all assets is not in the usual course of business, then this very significant change requires both board and shareholder approval — typically, by an affirmative vote by the majority of the corporation’s shares entitled to be cast at a shareholders’ meeting called for this purpose. In most states, dissenting shareholders of the selling corporation are given an appraisal remedy. 36-2b Purchase of Shares When one corporation purchases all or a controlling interest of the stock of another corporation, the legal existence of neither corporation changes. The acquiring corporation acts through its board of directors, whereas the corporation that becomes a subsidiary does not act at all, because the individual shareholders, not the corporation, make the decision to sell their stock. Because no formal shareholder approval of either corporation is required, there is no appraisal remedy. Sale of Control — When one or a few shareholders own a controlling interest, they may privately negotiate a sale of such interest, though they must do so with due care. *** Chapter Outcome*** Distinguish between a tender offer and a compulsory share exchange. Tender Offer — When stock ownership in the corporation being purchased is widely dispersed, the acquiring corporation may make a tender offer — that is, a general invitation to all shareholders of the target company to tender their shares for sale at a specified price. Shareholders are free to choose whether to tender their shares or not. Tender offers for publicly held companies are subject to federal securities regulation. 36-2c Compulsory Share Exchange One corporation becomes the owner of all the outstanding shares of one or more classes of shares of another corporation by an exchange that is compulsory on all owners of the acquired shares — allowed by the Revised Act and some states. The separate existence of the two corporations continues; requires approval from the both boards of directors and from the shareholders of the corporation being acquired (but not from the acquiring corporation). Dissenting shareholders of the company being acquired are given an appraisal remedy. 36-2d Merger Two corporations combine all of their assets; one survives and the other ceases to exist. The surviving corporation assumes the debts and other liabilities of the merged corporation. A merger must be approved by each corporation’s board of directors and a majority of each corporation’s voting shareholders. Many States and the 1999 amendments to the Revised Act permit the vote of the shareholders of the surviving corporation to be eliminated when a merger increases the number of outstanding shares by no more than twenty percent. Dissenting shareholders of each corporation have an appraisal remedy. In a short-form merger, a corporation that already owns at least a statutorily specified percent of the outstanding shares of each class of a subsidiary may merge the subsidiary into itself without approval by the shareholders of either corporation. Dissenting shareholders of the subsidiary have the appraisal remedy. 36-2e Consolidation This is a combination of all of the assets of two corporations. Each corporation ceases to exist, and a new corporation comes into existence, known as the consolidated corporation. A consolidation requires approval by each corporation’s board of directors and an affirmative vote of each corporation’s holders of a majority of the shares entitled to vote. Dissenting shareholders have an appraisal remedy. 36-2f Domestication and Conversion The Revised Act was amended in 2002 to provide for domestication and conversion into other entities without a merger. The domestication procedures permit a corporation to change its State of incorporation, thus allowing a domestic business corporation to become a foreign business corporation or a foreign business corporation to become a domestic business corporation. The conversion procedures permit a domestic business corporation to become a domestic or foreign partnership, LLC, or other entity, and also permit a domestic or foreign partnership, LLC, or other entity to become a domestic business corporation. In both of these transactions a domestic business corporation must be present immediately before or after the transaction. Dissenting shareholders have an appraisal remedy in (1) a conversion of a corporation to an unincorporated entity or to nonprofit status and (2) some domestications. *** Chapter Outcome*** Compare and contrast a cash-out combination and a management buyout. 36-2g Going Private Transactions These are used to take a publicly held corporation private, thereby eliminating minority interests and reducing the burdens of compliance with federal securities laws. There are several methods of taking a corporation private. Cash-out combination — forces minority shareholders to accept cash or property for their shares and is used after a person, group, or company has acquired a large interest in a target company through a tender offer. Management buyout — existing management increases its ownership of a corporation and eliminates its public shareholders. CASE 36-1 ALPERT v. 28 WILLIAMS ST. CORP. New York Court of Appeals, 1984 63 N.Y.2d 557,483 N.Y.S.2d 667,473 N.E.2d 19 http://scholar.google.com/scholar_case?q=473+N.E.2d+19&hl=en&as_sdt=2,34&case=6454009735176964074&scilh=0 Cooke, C. J. The subject of contention in this litigation is a valuable 17-story office building, located at 79 Madison Avenue in Manhattan [New York]. In dispute is the propriety of a complex series of transactions that had the net effect of permitting defendants, who were outside investors, to gain ownership of the property and to eliminate the ownership interests of plaintiffs, who were minority shareholders of the corporation that formerly owned the building. This was achieved through what is commonly known as a “two-step” merger: (1) an outside investor purchases control of the majority shares of the target corporation by tender offer or through private negotiations; (2) this newly acquired control is used to arrange for the target and a second corporation controlled by the outside investor to merge, with one condition being the “freeze-out” of the minority shareholders of the target corporation by the forced cancellation of their shares, generally through a cash purchase. This accomplishes the investor’s original goal of complete ownership of the target corporation. Since 1955, the office building was owned by 79 Realty Corporation (Realty Corporation), which had no other substantial assets. About two-thirds of Realty Corporation’s outstanding shares were held by two couples, the Kimmelmans and the Zauderers, who were also the company’s sole directors and officers. Plaintiffs owned 26% of the outstanding shares. The remaining shares were owned by persons who are not parties to this litigation. Defendants, a consortium of investors, formed a limited partnership, known as Madison 28 Associates (Madison Associates), for the purpose of purchasing the building. * * * Madison Associates formed a separate, wholly owned company, 28 Williams Street Corporation (Williams Street), to act as the nominal purchaser and owner of the Kimmelman and Zauderer interests. * * * [T]he partners of Madison Associates approved a plan to merge Realty Corporation with Williams Street, Realty Corporation being the surviving corporation. Together with a notice for a shareholders’ meeting to vote on the proposed merger, a statement of intent was sent to all shareholders of Realty Corporation, explaining the procedural and financial aspects of the merger, as well as defendants’ conflict of interest and the intended exclusion of the minority shareholders from the newly constituted Realty Corporation through a cash buy-out. Defendants also disclosed that they planned to dissolve Realty Corporation after the merger and thereafter to operate the business as a partnership. The merger plan did not require approval by any of the minority shareholders. The merger proposed by the directors was approved at the shareholders meeting, held on November 7, 1980. As a result, the office building was owned by the “new” Realty Corporation, which, in turn, was wholly owned by Madison Associates. In accordance with the merger plan, Realty Corporation was dissolved within a month of the merger and its principal asset, title to the building, devolved to Madison Associates. * * * The plaintiffs instituted this action * * * [seeking] rescission of the merger. The propriety of the merger was contested on several grounds. It was contended that the merger was unlawful because its sole purpose was to personally benefit the partners of Madison Associates and that the alleged purposes had no legitimate business benefit inuring to the corporation. Plaintiffs argue that the “business judgment” of the directors in assigning various purposes for the merger was indelibly tainted by a conflict of interest because they were committed to the merger prior to becoming directors and were on both sides of the merger transaction when consummated. Further, they assert that essential financial information was not disclosed and that the value offered for the minority’s shares was understated and determined in an unfair manner. * * * On this appeal, the principal task facing this court is to prescribe a standard for evaluating the validity of a corporate transaction that forcibly eliminates minority shareholders by means of a two-step merger. It is concluded that the analysis employed by the courts below was correct: the majority shareholders’ exclusion of minority interests through a two-step merger does not violate the former’s fiduciary obligations so long as the transaction viewed as a whole is fair to the minority shareholders and is justified by an independent corporate business purpose. Accordingly, this court now affirms. * * * In New York, two or more domestic corporations are authorized to “merge into a single corporation which shall be one of the constituent corporations,” known as the “surviving corporation” [citation]. The statute does not delineate substantive justifications for mergers, but only requires compliance with certain procedures: the adoption by the boards of each corporation of a plan of merger setting forth, among other things, the terms and conditions of the merger; a statement of any changes in the certificate of incorporation of the surviving corporation; the submission of the plan to a vote of shareholders pursuant to notice to all shareholders; and adoption of the plan by a vote of two-thirds of the shareholders entitled to vote on it [citation]. Generally, the remedy of a shareholder dissenting from a merger and the offered “cash-out” price is to obtain the fair value of his or her stock through an appraisal proceeding [citation]. This protects the minority shareholder from being forced to sell at unfair values imposed by those dominating the corporation while allowing the majority to proceed with its desired merger [citations]. The pursuit of an appraisal proceeding generally constitutes the dissenting stockholder’s exclusive remedy [citations]. An exception exists, however, when the merger is unlawful or fraudulent as to that shareholder, in which event an action for equitable relief is authorized [citations]. Thus, technical compliance with the Business Corporation Law’s requirements alone will not necessarily exempt a merger from further judicial review. * * * * * * In reviewing a freeze-out merger, the essence of the judicial inquiry is to determine whether the transaction, viewed as a whole, was “fair” as to all concerned. This concept has two principal components: the majority shareholders must have followed “a course of fair dealing toward minority holders” * * * and they must also have offered a fair price for the minority’s stock. * * * * * * Fair dealing is also concerned with the procedural fairness of the transaction, such as its timing, initiation, structure, financing, development, disclosure to the independent directors and shareholders, and how the necessary approvals were obtained * * *. Basically, the courts must look for complete and candid disclosure of all the material facts and circumstances of the proposed merger known to the majority or directors, including their dual roles and events leading up to the merger proposal. * * * The fairness of the transaction cannot be determined without considering the component of the financial remuneration offered the dissenting shareholders. * * * In determining whether there was a fair price, the court need not ascertain the precise “fair value” of the shares as it would be determined in an appraisal proceeding. It should be noted, however, that the factors used in an appraisal proceeding are relevant here. * * * This would include but would not be limited to net asset value, book value, earnings, market value, and investment value * * *. Elements of future value arising from the accomplishment or expectation of the merger which are known or susceptible of proof as of the date of the merger and not the product of speculation may also be considered. * * * * * * In the context of a freeze-out merger, variant treatment of the minority shareholders—i.e., causing their removal—will be justified when related to the advancement of a general corporate interest. The benefit need not be great, but it must be for the corporation. For example, if the sole purpose of the merger is reduction of the number of profit sharers—in contrast to increasing the corporation’s capital or profits, or improving its management structure—there will exist no “independent corporate interest” [citation]. All of these purposes ultimately seek to increase the individual wealth of the remaining shareholders. What distinguishes a proper corporate purpose from an improper one is that, with the former, removal of the minority shareholders furthers the objective of conferring some general gain upon the corporation. Only then will the fiduciary duty of good and prudent management of the corporation serve to override the concurrent duty to treat all shareholders fairly [citation]. We further note that a finding that there was an independent corporate purpose for the action taken by the majority will not be defeated merely by the fact that the corporate objective could have been accomplished in another way, or by the fact that the action chosen was not the best way to achieve the bona fide business objective. In sum, in entertaining an equitable action to review a freeze-out merger, a court should view the transaction as a whole to determine whether it was tainted with fraud, illegality, or self-dealing, whether the minority shareholders were dealt with fairly, and whether there exists any independent corporate purpose for the merger. * * * Without passing on all of the business purposes cited by [the trial court] as underlying the merger, it is sufficient to note that at least one justified the exclusion of plaintiff’s interests: attracting additional capital to effect needed repairs of the building. There is proof that there was a good-faith belief that additional, outside capital was required. Moreover, this record supports the conclusion that this capital would not have been available through the merger had not plaintiffs’ interest in the corporation been eliminated. Thus, the approval of the merger, which would extinguish plaintiffs’ stock, was supported by a bona fide business purpose to advance this general corporate interest of obtaining increased capital. Accordingly, the order of the Appellate Division should be affirmed. 36-2h Dissenting Shareholders The shareholder’s right to dissent, a statutory right to obtain payment for shares, is accorded to shareholders who object to certain fundamental changes in the corporation. The Revised Act, as amended, provides this right when (1) the proposed corporate action as approved by the majority will result in a fundamental change in the shares affected by the action and (2) uncertainty about the fair value of the affected shares raises questions about the fairness of the terms of the proposed corporate action. Transactions Giving Rise to Dissenters’ Rights — The Revised Act grants dissenters’ rights to (1) dissenting shareholders of a corporation selling or leasing all or substantially all of its property or assets not in the usual or regular course of business; (2) dissenting shareholders of each corporate party to a merger, except in a short-form merger, where only the dissenting shareholders of the subsidiary have dissenters’ rights; (3) any plan of compulsory share exchange in which their corporation is to be the one acquired; (4) any amendment to the articles of incorporation that materially and adversely affects a dissenter’s rights regarding her shares; (5) conversion of a corporation to an unincorporated entity or to nonprofit status; (6) some domestications; and (7) any other corporate action taken pursuant to a shareholder vote with respect to which the articles of incorporation, the bylaws, or a resolution of the board of directors provides that shareholders shall have a right to dissent and obtain payment for their shares. Section 13.02. The 1999 amendments to the Revised Act narrowed the scope of the appraisal remedy: in a merger, only shareholders whose shares have been exchanged have dissenters’ rights, and the appraisal remedy for virtually all charter amendments has been eliminated. Procedure — A shareholder who dissents and strictly complies with the provisions of the statute is entitled to receive fair value for his shares. Entitlement to payment must be preceded by a written objection to the board requesting a shareholder vote, a refusal to vote in favor of the proposed action, and a written demand for payment on a form provided by the corporation. Appraisal Remedy — These shareholders will be paid fair value for their shares, which is generally defined as share value immediately before the corporate action to which the dissenter objects takes place, excluding any appreciation or depreciation in anticipation of such corporate action unless such exclusion would be inequitable. This is known as the appraisal remedy. The 1999 amendments to the Revised Act provide that fair value is to be determined “using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal without discounting for lack of marketability or minority status except, if appropriate, for amendments to the articles.” CASE 36-2 SHAWNEE TELECOM RESOURCES, INC. v. BROWN Supreme Court of Kentucky, 2011 354 S.W.3D 542 http://scholar.google.com/scholar_case?q=354+S.W.3D+542&hl=en&as_sdt=2,34&case=295706676174884700&scilh=0 Abramson, J. [In December 2003, Shawnee Technology, Inc. (Shawnee Tech), a Kentucky corporation, merged into Appellant Shawnee Telecom Resources, Inc. (Shawnee Tel), also a Kentucky corporation. The merger plan provided that one of Shawnee Tech’s shareholders, Kathy Brown, would receive cash for her shares instead of shares in the new company, a so-called cash-out merger authorized by the Kentucky Business Corporation Act. Under that statute’s dissenters’ rights provisions, Brown demanded from Shawnee Tech the “fair value” for her shares. Disputing the amount of Brown’s entitlement, Shawnee Tech brought an action in a Kentucky trial court for an appraisal of Brown’s interest in the company. The trial court referred the appraisal to the Master Commissioner, who heard testimony from both parties’ experts concerning the value of the business and the value of Brown’s shares. To arrive at the value of Brown’s shares, Shawnee’s expert discounted his estimate of the company’s total value by 25% to account for the fact that shares of a closely held corporation do not enjoy a ready market and thus would sell for less than the more easily traded shares of a publicly held company. Thus discounted, the total value of the company’s shares was $969,750, and the value of Brown’s 24% interest was $232,740. Brown’s expert, on the other hand, arrived at a value for Brown’s interest of at least $576,232. The Commissioner was not entirely satisfied with either expert’s analysis. Instead, the Commissioner, borrowing from both experts’ analyses, found a capitalized earnings value of $2,304,178 and a net asset value of $1,343,860. The Commissioner did, however, discount the capitalized earnings value for lack of marketability. Although he acknowledged that the current version of the Model Business Corporations Act (MBCA) precludes marketability discounts, the Commissioner nevertheless ruled that such discounts are allowed under Kentucky’s version of the MBCA. The Commissioner then averaged the two values, giving the net asset value twice the weight of the capitalized earnings value, and arrived at a value for Brown’s 24% interest of $353,633. The trial court adopted the Commissioner’s report without change, and both parties appealed. The Court of Appeals agreed with Brown and held that marketability discounts are inappropriate in fair-value proceedings under the dissenters’ rights statute and should not have been applied in this case. Agreeing with Brown as well that in this case the net asset valuation amounted to an impermissible market value determination, the Court of Appeals reversed the trial court’s judgment and remanded for a determination of the fair value of Brown’s shares without reference to the company’s net asset value and without any discount for lack of marketability. Shawnee appealed.] At common law, [citation], prior to the advent of corporation statutes, unanimous shareholder consent was required to effect fundamental changes in the corporation. The minority’s veto power enabled it to create a nuisance value for its shares, so to counteract such abuses the early corporation statutes provided that even fundamental changes could be effected by majority, rather than unanimous, vote. [Citation.] To compensate minority shareholders for the loss of their veto, every state adopted in some form a statute that gave them instead, in the event of a wide variety of fundamental corporate changes, a right to withdraw their investment for its value as determined by a judicial appraisal. [Citation.] The purpose of the appraisal remedy was twofold. It was meant to provide a sort of liquidity for the shares of investors who found themselves trapped in an altered corporate investment of which they no longer approved, and it was meant to protect minority shareholders from majority overreaching. [Citation.] * * * * * * Indeed, the remedy is now invoked primarily in situations not where the minority shareholder wants out, but where he or she is being forced out. * * * Dissenters’ rights statutes, as noted above, exist in some form in every state, and in the vast majority of the states protection is accorded by an appraisal remedy pursuant to which the dissenting shareholder is entitled to the “fair value” of his or her shares. * * * [U]nder [the Kentucky statute which is based on the Model Business Corporation Act], “fair value” for dissenters’ rights purposes is simply defined as “the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.” [Citation.] * * * As long as liquidity seemed the purpose of the appraisal remedy, courts often understood “fair value” to mean essentially fair market value and understood their task as identifying a sort of quasi-market price for the dissenting shareholder’s particular shares. [Citation.] Since a block of shares that does not convey a controlling interest in the company would ordinarily sell for less than a block that did, in arriving at this hypothetical market price, courts sometimes applied a discount for lack of control, a so-called minority discount. [Citation.] Similarly, since shares of a private corporation generally sell for less, other things being equal, than shares of a public company for which there is a ready market, when appraising shares of a private company courts sometimes applied a discount for lack of liquidity, a so-called marketability discount. [Citation.] Because these discounts apply to share value, as opposed to the value of the company as a whole, they are referred to as shareholder-level discounts and are contrasted with so called entity-level discounts, discounts meant to account for factors that affect the value of the going concern, such as a company’s reliance on one or a few key managers or dependence upon a limited customer or supplier base. [Citation.] As the appraisal remedy came more clearly to focus on the anti-oppression as opposed to the liquidity purpose, courts increasingly construed “fair value” for that purpose not as the hypothetical price of the dissenting shareholder’s shares, but rather as the shareholder’s proportionate interest in the company as a going concern. Since the price of the particular dissenter’s shares was not being estimated, the shareholder-level discounts used to arrive at that price came to be regarded as inapplicable. * * * * * * * * * [T]he vast majority of states to consider the appraisal remedy for ousted minority shareholders have * * * held that “fair value” in this context means the shareholder’s proportionate interest in the company as a whole valued as a going concern according to accepted business practices. [Citation.] Because an award of anything less than a fully proportionate share would have the effect of transferring a portion of the minority interest to the majority, and because it is the company being valued and not the minority shares themselves as a commodity, shareholder-level discounts for lack of control or lack of marketability have also widely been disallowed. [Citations.] Recognizing and endorsing the trend against such discounts, in 1994 the American Law Institute’s Principles of Corporate Governance recommended that in dissenters’ rights appraisal proceedings “fair value” should be the value of the shareholder’s “proportionate interest in the corporation, without any discount for minority status or, absent extraordinary circumstances, lack of marketability . . . [F]air value should be determined using the customary valuation concepts and techniques generally employed in the relevant securities and financial markets for similar businesses in the context of the transaction giving rise to appraisal.” Principles of Corporate Governance: Analysis and Recommendations § 7.22(a) (ALI 1994). In 1999 the American Bar Association’s Committee on Corporate Laws followed suit and revised the Model Business Corporation Act’s definition of “fair value” to provide that value was to be determined “using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal; and . . . without discounting for lack of marketability or minority status except, if appropriate, for amendments to the articles pursuant to section 13.02(a)(5).” Model Business Corporation Act § 13.01(4)(ii)(iii) (2006). As of 2010, ten states had adopted the 1999 Model Act revision, [citation], but even in states, like Kentucky, that continue to use the 1984 version of the Model Act, “fair value” has been construed as the dissenting shareholder’s pro rata share of the company as a whole, without shareholder-level discounts for lack of control or lack of marketability. [Citations.] These Courts have found no legislative significance in the failure of their legislatures to adopt the 1999 revision; have emphasized the statute’s use of “fair value” as distinct from “fair market value” as indicating an express rejection of a market value standard; and have endorsed the * * * view that if the appraisal remedy is to be effective, as the legislature must have intended, then shareholder-level discounts should not be applied. * * * * * * The [Kentucky] legislature’s choice of “fair value” as the measure of the minority shareholder’s entitlement is significant in that it does not limit the remedy to the fair market value of the dissenter’s shares, as Shawnee would have it, but contemplates that “fairness” may entail other considerations. Beyond this general intent to protect minority interests, however, the Kentucky statute is largely silent. Although the statute specifies as of when “fair value” is to be determined, it does not specify how, and so, to understand what is apt to have been the General Assembly’s intent with respect to the “how” questions at issue here, we are must look outside the language of the statute itself. When we do, as the discussion above indicates, we find a broad consensus among courts, commentators, and the drafters of the Model Act that “fair value” in this context is best understood, not as a hypothetical price at which the dissenting shareholder might sell his or her particular shares, but rather as the dissenter’s proportionate interest in the company as a going concern. Arrived at only in the long course of many cases balancing the interest of the corporate majority in controlling their investment with the interest of the minority in fair treatment, this understanding reflects a reasonable balance of those competing interests. It does so by helping to insure that the majority’s freedom to eliminate minority shareholders is not employed to transfer a portion of the minority interest to the majority, a result fully in keeping, we believe, with the General Assembly’s intent. Because a hypothetical market price for the dissenter’s particular shares as a commodity is thus not the value being sought, market adjustments to arrive at such a price, such as discounts for lack of control or lack of marketability, are inappropriate. This principled conclusion accounts for the broad consensus of courts writing in this area. * * * * * * Although appraisers and courts remain free to consider market, income, and asset approaches to valuation and may employ a weighted average of the results of those approaches if the evidence supports such averaging, there is no suggestion in the statutes that the General Assembly meant to require that approach. We have no hesitation in understanding instead a legislative intent that the value of the going concern be determined by any valuation technique generally recognized in the business and financial community and shown to be relevant to the circumstances of the particular company at issue. We hold, in sum, that in a[n] * * * appraisal proceeding the dissenting shareholder is entitled to the fair value of his or her shares as measured by the proportionate interest those shares represent in the value of the company as a going concern, a value determined in accord with generally accepted valuation concepts and techniques and without shareholder-level discounts for lack of control or lack of marketability. * * * Accordingly, for the reasons stated, we reverse in part and affirm in part the decision of the Court of Appeals and remand this matter to the trial court for further proceedings consistent with this Opinion. 36-3 DISSOLUTION Even if a corporation is chartered with perpetual existence, its life may still be terminated if the directors and a majority of shareholders agree to do so. Incorporation statutes usually provide for both voluntary and involuntary dissolution. *** Chapter Outcome*** Identify the ways by which voluntary and involuntary dissolution may occur. 36-3a Voluntary Dissolution Requires two steps: (1) the board must pass a resolution to dissolve the corporation and (2) the resolution must be approved by the holders of a majority of the shares of the corporation entitled to vote at a shareholders’ meeting duly called for this purpose. Shareholders usually have no right to dissent and no appraisal remedy. In addition, in many States dissolution without action by the directors may be effected by unanimous consent of the shareholders. The Revised Act authorizes shareholders in closely held corporations to adopt unanimous shareholders’ agreements requiring dissolution of the corporation at the request of one or more shareholders or upon the occurrence of a specified event or contingency. NOTE: See Figure 36-1: Fundamental Changes Under Pre-1999 RMBCA. 36-3b Involuntary Dissolution Is of two kinds: Administrative dissolution — the secretary of state dissolves a corporation that has not met certain required formalities. Judicial dissolution — a court orders dissolution in an action that may be initiated by the state attorney general, a shareholder, or a creditor. CASE 36-3 COOKE v. FRESH EXPRESS FOODS CORPORATION, INC. Court of Appeals of Oregon, 2000 169 Ore.App. 101, 7 P.3d 717 http://scholar.google.com/scholar_case?q=7+P.3d+717+&hl=en&as_sdt=2,34&case=18255907503494215009&scilh=0 Armstrong, J. Terry J. Cooke (plaintiff) is the former husband of defendant, Joni Quicker (Joni); defendant Allen John Quicker (John) is Joni’s father. In the early 1980s John and Joni began a business distributing fresh produce. Plaintiff soon left his job and began working with John and Joni full time. The business was originally a partnership, with John having a half interest and Joni and plaintiff together having the other half interest. The business grew throughout the 1980s. In June 1990 John, Joni, and plaintiff incorporated the business as Fresh Express Foods Corporation, Inc. (Fresh Express). John received 50 percent of the stock, and Joni and plaintiff each received 25 percent. John was the president of the corporation, Joni was the vice-president, and plaintiff was the secretary and treasurer. They also constituted the three members of the board of directors. Fresh Express was the primary source of income for all three parties. Part of that income came from their salaries, but substantial additional amounts came as loans that the corporation made to them for various purposes, including paying their individual taxes on their portions of the corporation’s retained earnings. Because Fresh Express elected to be a subchapter S corporation, which for tax purposes does not pay taxes itself but passes its income through to its shareholders, plaintiff and defendants were liable for taxes on those retained earnings whether or not the corporation actually distributed them. Without the loans, they would have had no corporate money to pay the taxes on that corporate income. Joni and plaintiff separated at about the time of the incorporation. The tension between them increased significantly beginning in June 1993 when, after starting a relationship with a Fresh Express employee, plaintiff filed for dissolution of the marriage. Plaintiff managed the company’s delivery system, which included supervising the operation of its trucks. In December 1993, while plaintiff was on vacation, John discovered a notice on plaintiff’s desk from the Public Utilities Commission (PUC) that showed deficiencies resulting in a fine of $6,000 and additional penalties of $4,000. Plaintiff had not paid those amounts, and that failure threatened Fresh Express with the loss of its PUC authority to operate. When plaintiff returned from vacation, John, acting as president of the company, gave plaintiff a written notice of termination that included the statement that “Fresh Express Foods Corporation has suffered monetary loss associated with [plaintiff’s] position and this constitutes a Breach of Fiduciary Responsibility to the Corporation.” It did not refer to a threatened loss of PUC operating authority. After the termination, plaintiff received his unpaid wages and two weeks’ severance pay. Before the termination, the corporation distributed money to all of its shareholders that it treated as shareholder loans. It continued to make those distributions to John and Joni, but it did not make them to plaintiff after his termination. Although plaintiff remained a corporate officer and director for almost two years, he was never again informed of or consulted about corporate business. The court entered a judgment dissolving plaintiff’s and Joni’s marriage in August 1994, awarding Joni approximately $27,000. Because the corporation had never issued any stock certificates, Joni was unable to use plaintiff’s ownership interest in the corporation to satisfy the court judgment. In order to provide Joni a stock certificate to garnish, John called a directors’ meeting for November 2, 1995, for the purpose of electing officers. At the meeting John and Joni first reelected John as president and Joni as vice-president; then they also elected Joni as secretary and treasurer. Plaintiff abstained from all three votes. A few days later Joni issued a stock certificate to plaintiff. Instead of sending the certificate to plaintiff, she immediately delivered it to the sheriff under a writ of garnishment on her judgment against plaintiff. In September 1996, defendants called a special shareholders’ meeting, at which they reduced the number of directors to two, over plaintiff’s dissenting vote, and elected John and Joni to those positions. During an informal discussion, plaintiff asked John’s attorney if the company intended to pay the considerable amount of money it owed to him. After consulting with John, the attorney responded that John had decided not to make any more distributions to shareholders at that time. After the shareholders’ meeting ended and plaintiff left the room at their request, John and Joni held a directors’ meeting at which they first removed plaintiff “from all of his positions as an officer, employee and agent of the corporation.” John and Joni then agreed, despite the attorney’s statement to plaintiff, to distribute the corporation’s entire accumulated adjustment account to the shareholders by using it to reduce the outstanding shareholder loans. Finally, they agreed to purchase automobiles for John and Joni, and to increase John’s salary from $54,000 per year to $120,000. [The plaintiff brought suit against the corporation, John, and Joni. The trial court found that John would not have terminated Joni for a comparable error. It concluded that the purpose for firing plaintiff was to exclude him from participating in the corporate business or receiving any benefits from the corporation. The court found that the reason for the exclusion was the breakdown of the marriage and the animosities that followed. The trial court found that the defendants had acted oppressively toward plaintiff in the management and control of defendant Fresh Express. As a remedy, the court ordered defendants to purchase plaintiff’s interest in Fresh Express at a price set by the court. The defendants appealed.] Plaintiff argues that these actions together constituted a course of oppressive conduct and that defendants breached their fiduciary duties to him by freezing him out of all participation in the corporation and depriving him of all of the benefits of being a stockholder. ORS 60.661(2)(b) provides that a court may dissolve a corporation when the directors or those in control “have acted, are acting or will act in a manner that is illegal, oppressive, or fraudulent[.]” Although there is not, and probably cannot be, a definitive definition of oppressive conduct under the statute, at least in a closely held corporation conduct that violates the majority’s fiduciary duties to the minority is likely to be oppressive. [Citations.] Cases that discuss either oppressive conduct or the majority’s fiduciary duties are, thus, relevant to this question. A number of cases make it clear that when the majority shareholders of a closely held corporation use their control over the corporation to their own advantage and exclude the minority from the benefits of participating in the corporation, [in the absence of] a legitimate business purpose, the actions constitute a breach of their fiduciary duties of loyalty, good faith and fair dealing. [Citation.] A finding that the majority shareholders have engaged in oppressive conduct under ORS 60.661 permits the court either to order a dissolution of the corporation or to award lesser appropriate relief, including requiring the majority to buy out the minority’s interest at a price that the court fixes. [Citation.] Because many things can constitute oppressive conduct or a breach of fiduciary duties, what matters is not so much matching the specific facts of one case to those of another but examining the pattern and intent of the majority and the effect on the minority of those specific facts. [Citation.] The facts of this case show a classic squeeze-out. * * * Defendants withheld dividends and other benefits from plaintiff while preserving benefits for themselves. * * * [W]itholding dividends can be especially devastating in an S corporation as all corporate income is passed through to the shareholders for tax purposes and shareholders are required to pay taxes on that income, but if no dividends are declared, the shareholders will have no cash from the enterprise with which to pay those taxes. [Citation.] * * * In addition, the “abrupt removal of a minority shareholder from positions of employment and management can be a devastatingly effective squeeze-out technique.” [Citation.] Finally, majority shareholders may siphon off corporate wealth by causing a corporation to pay the majority shareholders excessively high compensation, not only in salaries but in generous expense accounts and other fringe benefits. * * * The existence of one or more of these characteristic signs of oppression does not necessarily mean that the majority has acted oppressively within the meaning of ORS 60.661(2)(b). Courts give significant deference to the majority’s judgment in the business decisions that it makes, at least if the decisions appear to be genuine business decisions. * * * The court must evaluate the majority’s actions, keeping in mind that, even if some actions may be individually justifiable, the actions in total may show a pattern of oppression that requires the court to provide a remedy to the minority. * * * Finally, * * * defendants acted to ensure that they would permanently receive all benefits of the corporation. They began by replacing plaintiff as a director and reducing the number of directors to two. Although that was not necessarily improper in itself, their first actions as the sole directors of Fresh Express showed their purpose to exclude plaintiff from any share in the corporation other than his tax liabilities. They first removed defendant from any office or agency with the corporation and then took a number of actions to direct all corporate income to themselves. Despite having told plaintiff that there would be no corporate distributions, defendants distributed the entire retained earnings through a paper transaction that ensured that the corporate books would show no source for making any cash distribution to plaintiff. They then more than doubled John’s salary, with the result that he received his income from the corporation as an expense that would reduce its profits rather than as a distribution of profits. Finally, they had the corporation pay for their recently purchased automobiles, again adding to the corporation’s expenses and reducing its profits for their benefit. * * * In summary, we conclude that defendants consistently acted to further their individual interests, not the interests of the corporation, and without regard to their fiduciary duties to plaintiff. They did so either knowing or intending that their actions would harm plaintiff, among other ways by excluding him from any benefits of his ownership of one quarter of the corporate stock. They thereby violated their fiduciary duties to him and engaged in oppressive conduct. Under ORS 60.661, the trial court had the authority to choose a remedy for defendants’ actions; we agree with it that requiring defendants to purchase plaintiff’s shares is the preferable option. A purchase will disentangle the parties’ affairs while keeping the corporation a going concern; dissolution would not benefit anyone, and plaintiff did not seek it at trial. * * * * * * * * * [B]ecause defendants must purchase plaintiffs shares as a remedy for their misconduct, and the price for plaintiff’s shares is therefore based on their fair value rather than their fair market value, either a minority or marketability discount would be inappropriate. [Citation.] Affirmed. 36-3c Liquidation Once a corporation is dissolved, it is required to wind up its affairs and liquidate its assets; proceeds are used first to pay the expenses of liquidation and creditors with the remainder distributed proportionately to shareholder. Voluntary liquidation is carried out by the board of directors; involuntary liquidation, usually, by a court-appointed receiver. 36-3d Protection of Creditors Statutory provisions protect creditors, often by requiring the corporation to mail notice of dissolution to known creditors, to make a general publication of notice, and to have a mechanism for paying valid claims at a later date, should creditors come forward then. Instructor Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637
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