Geis G. Corporate Law. Course Guidebook, 2020 PDF

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Professional Law
Law School
for Everyone
Corporate Law
Course Guidebook
Professor George S. Geis

University of Virginia School of Law
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George S. Geis
William S. Potter
Professor of Law
University of Virginia
School of Law
G
George S. Geis is the William S.
Potter Professor of Law at the
University of Virginia School of
Law. He is also the faculty director of the John W. Glynn, Jr. Law & Business
Program, and he previously served as the UVA School of Law’s vice dean.
Professor Geis received a BS in finance from the University of California,
Berkeley, and he earned a JD with honors and an MBA with honors from
The University of Chicago. Before his appointment to the UVA School of
Law faculty, Professor Geis taught at The University of Alabama School of
Law. He also spent five years as a management consultant with McKinsey &
Company, where he served clients on corporate strategy, merger planning,
and many other issues.
Professor Geis teaches courses on contracts, corporations, agency and

partnership, accounting, and corporate finance. He has won numerous
teaching awards, including the UVA School of Law’s 2019 All-University
Teaching Award. He has also taught courses as a visiting professor at The
University of Chicago, Georgetown University Law Center, the Indian School
of Business in Hyderabad, India, the University of Auckland in New Zealand,
and the University of Trento in Italy.
Professor Geis is the coauthor of Digital Deals: Strategies for Selecting and
Structuring Partnerships, a book on business partnership and alliance
strategies. His articles include “Traceable Shares and Corporate Law,” published
Professor Biography I
in the Northwestern University Law Review; “Internal Poison Pills,” published
in the New York University Law Review; and “Ex-Ante Corporate Governance,”
published in The Journal of Corporation Law. His work has also appeared in
many other leading academic journals.
Professor Geis’s research focuses on problems related to business alliances,

merger transactions, shareholder litigation, and other topics involving the
intersection of law and business.■
II Law School for Everyone: Corporate Law

TABLE OF CONTENTS
Introduction
Professor Biography . . . . . . . . . . . . . . . . . . . . . . . . . . . . I
Course Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Lecture Guides
1• Questions and Conflicts in Corporate Law . . . . . . . . . . . . . . . . . . 3
2• Corporations and Their Agents . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3• Things Corporations Can and Cannot Do . . . . . . . . . . . . . . . . . 18
4• Boards of Directors and the Duty of Care . . . . . . . . . . . . . . . . . 27
5• Business Opportunities and the Duty of Loyalty . . . . . . . . . . . 34
6• Executive Pay and the Duty of Good Faith . . . . . . . . . . . . . . . . 41
7• Shareholder Lawsuits: Goals and Limitations . . . . . . . . . . . . . . 48
8• Securities Regulation and Fraud . . . . . . . . . . . . . . . . . . . . . . . . . 55
9• Insider Trading Laws and Their Complexities . . . . . . . . . . . . . . 61
10• Corporate Control Battles and the Law . . . . . . . . . . . . . . . . . . . 69
11• Corporate Law of Mergers and Acquisitions . . . . . . . . . . . . . . . 77
12• Hostile Takeovers, Defenses, and the Future . . . . . . . . . . . . . . . 85

Quiz . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
Supplementary Material
Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Quiz Answers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
Image Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
Table of Contents III

DISCLAIMER
The legal information provided in these lectures is for informational purposes
only and not for the purpose of providing legal advice. These lectures may
not reflect the most current legal developments in any particular applicable
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230, any tax advice provided in these lectures may not be used to avoid tax
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The Teaching Company expressly DISCLAIMS LIABILITY for any DIRECT,

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OR LOST PROFITS that result directly or indirectly from the use of these
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IV Law School for Everyone: Corporate Law

LAW SCHOOL FOR EVERYONE
CORPORATE LAW
T
oday, corporations permeate nearly every part of our society; they
have a tremendous influence on our lives. Some celebrate this fact,
recognizing that corporations produce amazing products that make
our lives easier and more comfortable. Others worry about the darker side of
corporations, envisioning ravenous international conglomerates or loutish
corporate leaders. The truth, of course, is that corporations offer both benefits
and costs. How, then, should we set rules to govern corporations, and what
role should the law play in regulating corporate activity?
This course examines the legal treatment of corporations in the United

States. We will study how to create and run a corporation, and we will
examine how the law deals with the complex network of relationships that
arises in the modern corporation—the relationships between shareholders,
directors, managers, employees, and others. Corporate law is society’s means
of facilitating the good that corporations do while reining in bad behavior, so
we will explore ways to set the boundaries of fair play so the different players
can focus their energy and resources on productive activity.
Along the way, we will examine laws that help make corporations
so incredibly powerful as engines of innovation and wealth, as well as
some of their shortcomings. We will study the major points of conflict
among the key parties within corporations and how corporate law tries to
manage them.
Course Scope 1
Other topics include the duties of corporate leaders to run their organizations
responsibly and the powers of shareholders to take them to task when they
don’t. We will also look at the rules governing some of the most controversial
events in the corporate world: insider trading, proxy fights and control
battles, hostile takeovers, and corporate attempts to influence politics.
Taken together, the course provides an understanding why corporations do
the things they do and offers some valuable insights into American society
along the way.■
2 Law School for Everyone: Corporate Law

Lecture 1
QUESTIONS
AND CONFLICTS
IN CORPORATE LAW
C
orporations produce amazing products that make our lives easier and
more comfortable. They sell us basic food and necessities that we need
to live. They employ us and pay our salaries. And, in many cases, they
work for us. But corporations can also have a darker side, and human nature
sometimes causes corporate leaders to behave badly. Corporate law affects
everyone, and understanding it is very much in our interest.
STARTING A CORPORATION
To understand how a corporation works and to learn the goals of corporate law,
a hypothetical example can be helpful. Suppose you want to start a company.
The first thing you will need is money. No firm can get going without seed
capital, an initial investment to support its chosen activities.
Practically, many ventures have several different choices about where to get
this money—or, in corporate terminology, about what capital structure to
choose. You could tap into your own reserve savings or solicit your friends
and family for the initial investment. Or you might walk down to the local
bank to meet with a loan officer. Perhaps you could even call up your favorite
investment banker to launch an initial public offering of stock or sell some
corporate bonds.
Imagine now that your corporation has raised some money. Next, you will need
to make a series of decisions about how to spend this money. You might hire
some workers, or build a factory, or purchase some products to resell. Perhaps
you will even buy another company and take over its business activity.

THE BAD-MAN THEORY AND CORPORATE LAW
Law students often study a theory of law called the bad-man

theory, which was developed by the Supreme Court justice
Oliver Wendell Holmes Jr. The justice claimed that a bad
person’s view of the law represents the best test of exactly what
the law is because that type of person will carefully calculate
what the rules allow and operate right up to those limits.
Though this is not the only way to view corporate law,
much of corporate law can be described in a similar way.
As your company spends its money, the wheels of commerce begin to

turn. The business ticks along, and you sell products or provide services
to customers. Your investments in the various business inputs will hopefully
begin to generate profits as operations ensue. These proceeds can eventually
be returned to the firm’s financial backers in the form of interest payments,
cash dividends, and the like.
This entire process is known as the business system. As long as the money
produced from operations is a larger amount than the money from the initial
investment, then everyone should be happy. The company is creating value
and investors are making money. The cycle can begin anew.
ACADEMIC QUESTIONS
With this business system in mind, consider how several academic subjects
relate to the overall framework. Corporate finance deals with the “where”
question—that is, the choices firms make about where to get or where to
spend their money. A class on accounting deals with the question of how the
venture is performing by measuring all the results.
In this course on corporate law, by contrast, we will often be dealing with

the “who” questions including: Who is empowered to make and execute the
various decisions? Will stockholders have the final say on a given matter, or
will the board of directors call the shots? When might someone else step in
to decide what the corporation will do?
Lecture 1–Questions and Conflicts in Corporate Law 5

KEY PLAYERS
It is important to be familiar with the key players in a corporation, and some of

the problems that can arise from the relationships between and among them.
Investors in a corporation fall into two major categories:

stockholders and creditors. The investors are the ones who
give the firm some money and hope to earn even more
money after the business system generates profits.
Stockholders are also known as shareholders. They receive

stock—also known as shares—for their investment dollars,
and are considered the residual holders of the firm. This
means they have a claim on whatever is left over after
the corporation meets its other commitments.
Creditors, by contrast, are investors who loan the

corporation money. This might be in the form of a bank
loan or via a corporate bond investment (which is just
another type of loan to the firm). Creditors receive interest
payments and will eventually have the right to get repaid
on their loan, but they are not typically entitled to more
of the profits.
Stockholders will very rarely weigh in on most

corporate decisions. Instead, stockholders elect
a board of directors to serve as their representatives.
These directors are the ones who set the firm’s overall
strategy and make most of the high-level decisions.
However, even the directors are not able to do everything, and they will
typically appoint full-time managers to run the day-to-day business. Senior
managers, like the CEO or CFO, are called officers, and lower level managers
and staff are simply called employees. There are also some other parties in most
corporate ecosystems, including suppliers, customers, advisors, government
regulators, and so on.

STANDOFFS
LEVELS OF LAW
Several classic disputes can arise
in corporate law among the players US law is divided between
introduced above. First, consider the federal law and state law. Most
relationship between the managers corporate law is state law. State
and the stockholders. Managers and federal policies can differ, as
get to make decisions about how can policies from
to spend other people’s money, and state to state. All
trouble might arise. those differences
play a role in
This problem is known as the agency shaping how
cost problem, and it raises many corporations
different concerns. For example, behave.
managers might decide to take on
too much risk with a corporation’s
money. It can be tough for investors
to know when managers are not
spending the firm’s money as
prudently as they would spend their
own cash.
The second potential standoff is between stockholders and creditors. Though

stockholders do not make most corporate decisions, they might still influence
the board of directors or senior managers through their voting power.
Accordingly, stockholders might be able to get the firm to engage in some
activities that take money away from the debt investors and put it into the
pockets of the stockholders.
The third potential conflict results from disagreements between a very large
stockholder—sometimes called a controlling or majority stockholder—and
smaller stockholders who lack power because they are always outvoted.
In corporate law, one share usually means one vote, rather than one
person meaning one vote. This can present some very interesting problems
in merger deals and voting control battles. It is also central to this course’s
first legal case.

DODGE V. FORD MOTOR COMPANY
Even though Dodge v. Ford Motor Company was decided in 1919, it is

still studied in law schools across the country because it addresses some
fundamental questions in corporate law: What is a corporation for? How much
freedom does it have to run itself as it sees fit? And which of the key players
in the corporation get to make that decision?
The dispute arose in the early glory years of the automobile industry. Ford
Motor Company, run by Henry Ford, had become a goldmine. The corporation
had paid out tens of millions of dollars in dividends during recent years, it
still had over $50 million in cash, and profits continued to soar.
Henry Ford owned 58 percent of the common

stock and had complete control over who gets
elected to the board of directors. The two Dodge
brothers were among the other shareholders,
and they owned about 10 percent of Ford’s
stock. They were interested in starting a rival
car company of their own.
One day in 1916, Henry Ford made a big

announcement: Ford was no longer going to pay
out large dividends to the shareholders. Instead, it
was going to build a new factory, boost employee wages, slash the prices of
cars for consumers, and start running the company as a semi-charitable
organization.
The Dodge brothers were upset, and they sued to compel a larger dividend
distribution. The question became: Does Ford have to keep up its dividend
payments as a matter of corporate law? More fundamentally, must Ford
(and by extension, any corporation) be run to maximize shareholder profits,
or can it try to benefit other parties like employees or customers or the
broader public?

THE COURT’S RULING
The Michigan Supreme Court, where this case was ultimately decided, started
by acknowledging that dividend payment decisions fall squarely within the
authority of the board of directors. That principle remains widely accepted
in corporate law today.
However, the court went on to immediately order Ford’s board to reinstate the
much higher dividends that had been paid in recent years. After reviewing
the massive profits that the firm had generated—and after listening to Henry
Ford testify about his goals for the company—the court held that “a refusal to
declare and pay further dividends appears to be not an exercise of discretion on
the part of the directors, but an arbitrary refusal to do what the circumstances
require to be done.”
The court went even further by insisting that a corporation had to be run for
the purposes of maximizing shareholder profits. This principle, too, remains
widely accepted—and yet, the kind of intervention that the court made is
highly unusual.
There are several possibilities for what motivated Ford’s change and caused
the court to step in. It is possible Ford was trying to limit the payouts to the
Dodge brothers so they could not raise money for a competitive automotive
venture. There may be something to this, but it is likely that the Dodge brothers
could find some other place to raise money.
A second possibility is taxes. Tax rates at the time were high, and Ford might
have encouraged his board to halt dividend payments as taxes rose in order
to keep the money in the company and wait until tax rates came back down
to distribute the profits to stockholders.
But it is possible there was still more underlying Ford’s moves. Ford was
a savvy executive, and he wanted to protect Ford’s lead in the automotive
industry. First, he needed to drop car prices dramatically to fend off a slew
of competitors. Second, Ford needed to double employee wages in order to
fight off rampant absenteeism.

Moreover, Ford may have been motivated by pride. He appears to have been
worried about looking like a robber baron, so he tried to position his canny
corporate strategy as altruism. For example, in a newspaper interview, he
was quoted as referring to “awful profits” for the company. That came up in
court, which was damaging to Ford and his side of the case. The court went
on to overrule the board on the dividend reductions and redirect the firm to
focus on shareholder interests.
CONCLUSION
Shareholders cannot usually force their boards to pay out large dividends. But
as Dodge v. Ford Motor Company suggests, a corporation must generally be
run to maximize shareholder profits. The case is also a great example of some
tricky corporate governance problems in the law and of the tensions that can
arise when one group is trying to second-guess the actions of another group
in a corporate ecosystem.
Much of corporate law seeks to help actors obtain the benefits of centralized
business activity while minimizing the conflicts and other problems. This,
in a nutshell, is the primary goal of corporate law.
Suggested Reading
<< Dodge v. Ford Motor Co.
<< The Financial Crisis Inquiry Commission,

Inquiry Report.

Lecture 2
CORPORATIONS
AND THEIR AGENTS
T
he law of agency may be the most important area of law that most people
have never heard of. It is just as critical as subjects such as constitutional
law, criminal law, and civil procedure. Agency law is the area of law
that governs agents, such as Hollywood agents and sports agents. However,
anyone can have an agent.
OVERVIEW OF AGENCY
Agency is a legal concept that gives rise to a fiduciary, or special, relationship

between parties when three general factors are present:
1. There is an agreement between the parties, one of which is known

as the principal and the other as the agent.
2. The agent shall act on behalf of the principal.
3. The agent shall be subject to the principal’s control.
The control exercised by the principal implies a degree of responsibility for

the agent’s actions. The principal does not need to micromanage every detail
of the agent’s actions, but a principal must have a general right to direct what
the agent is doing.
For example, realtors will often serve as agents for someone who is buying or
selling a house. They may make contracts for their clients or conduct other
activities that will be charged to that principal party.

AGENCY LAW
Organizationally, agency law is usually broken down into four main topics.
The first topic is the formation of an agency relationship, covered above. The
other three topics all involve implications that can arise once you do have an
agency relationship.
The second topic covers situations where the principal may be responsible for
the torts, or legal wrongs, that an agent commits on a third party. The third
topic involves situations where the agent can bind the principal to a third
party in contract law.
The fourth topic involves special, heightened legal obligations that agents owe
to their principals. These are called fiduciary duties, and they also play a very
significant role in other areas of corporate law.
AGENCY-RELATIONSHIP LAWSUITS
Many lawsuits in agency law test the gateway issue of whether an interaction
between two people has created an agency relationship. The plaintiff is usually
trying to argue that an agency relationship has been created, so that the
principal will be responsible for something the agent has done. The defendant
is usually trying to deny an agency relationship and characterize the interaction
as something else.
In corporate law, it is often easy to see whether someone is an agent of the

corporation: Just look at whether they were properly hired as an officer
or employee of the company. With more informal working arrangements,
it is not always clear, but many corporate jobs continue to be performed
by agents. The rest of this lecture will assume that an agency relationship
is present and turn to consider the other implications: torts, situations
where the agent can bind the principal to a third party in contract law, and
fiduciary duties.
Lecture 2–Corporations and Their Agents 13

TORTS
An important consideration is under what circumstances will a principal be

responsible for the torts, or legal wrongs, of an agent. This known as vicarious
liability, and the main legal rule is called respondeat superior. This is a Latin
term that means “let the master answer” or “let the employer answer for torts
of the employee.”
In most respondeat superior lawsuits, a third

party has been harmed by an agent, and that
injured party is trying to recover directly from
the principal. Take, for example, a driver
whose car is rear-ended by a delivery truck.
The rear-ended driver may seek to recover
from the delivery company rather than
the truck’s driver.
Importantly, even when an agency relationship is created, a principal or

corporation is not going to be automatically liable for all torts of their agents.
Rather, to win a respondeat superior case, the plaintiff needs to prove two
extra things:
zz First, the agent must be an employee and not just an independent

contractor.
zz Second, the tort must be committed within the scope of employment.
Imagine three possible legal regimes. In the first, there is no tort liability for the
principal when an agent does something erroneous. In the second, principals
are liable for all torts committed by their agent, no matter what.
Respondeat superior seeks to establish a middle ground between the first two
regimes by asking if the misconduct of an agent is related closely enough the
business activity of the principal. If so, the law holds the principal responsible
in an effort to have them internalize the risk of harm and take sensible
precautions to minimize accidents.

BINDING THE PRINCIPAL TO A THIRD PARTY
The lecture’s next topic asks this question: What does it take for an agent to
bind a principal, such as their corporation, to a third party in contract law?
This is often why firms will hire agents. For example, a corporation cannot
really do anything on its own, so it needs to hire salespeople and managers
to conclude deals with others and make money for the firm.
Yet any given employee cannot bind a corporation to every conceivable type of
contract. For example, a low-level employee at Apple cannot agree to purchase
another company on behalf of Apple.
The reason is that the low-level employee lacks authority for this deal. There
can be several different types of authority in agency law, but for this lecture’s
purposes, it is enough to say that the agent must usually have instructions or
permission—either express or implied—to make the deal.
Sometimes implied authority is good enough for an agent to make a contract.

Consider the case of Karl Rove & Co. v. Richard Thornburgh. Thornburgh
was the US attorney general, but he resigned in 1991 to run for a Senate seat.
He hired a longtime aide named Murray Dickman to help direct his campaign,
and Dickman, in turn, made an agreement with a young political consultant
named Karl Rove to perform some direct mailing services.
Thornburgh unexpectedly lost the race. His campaign committee was broke,
and it did not paid Rove most of money that he was owed (about $200,000).
Rove decided to sue Thornburgh personally for breach on the contract.
It was clear that the contract had been established between Rove and the
Thornburgh committee. However, the committee was just an unincorporated
association. This meant that Thornburgh would still be liable personally if he
assented to the contract. He had not.

Rove argued that Dickman had acted as Thornburgh’s agent and had executed
the contract within the scope of his authority. If so, Thornburgh should be
bound personally, just as if he had assented to the deal himself. The court
bought this argument and ruled for Rove. In other words, Dickman had
implied authority to contract under Thornburgh’s name.
FIDUCIARY DUTIES
Fiduciary duties are an important aspect of corporate law, but they were
born in agency lawsuits. Looking at what is required here can provide an
introduction to the topic.
Agency relationships give rise to several special obligations on the part of the
agent. The big ones are a duty of care and a duty of loyalty. Essentially, agents
must act carefully in their duties, and they must not put their own interests
ahead of those of their principals.
One clear example of a of loyalty violation arises when an agent receives a bribe
or a payment from a third party in connection with some transaction between
the principal and that third party. However, this duty can be even broader,
which brings this lecture to the case of Reading v. Regem. Even through it
is a British case, it is still studied in law schools today because the facts are
amusing and the law remains the same in the US.
Reading was a sergeant in the British Army. He was stationed in Cairo, Egypt
right at the end of World War II, where he managed the medical supplies. The
court tells us that Reading’s background was modest and that he “had not had
opportunities, in his life as a soldier, of making money.”
But the entrepreneurial Reading found a way to make some money. He fell into
some bad company and met a group of smugglers in Cairo. Reading worked
out an arrangement where he would dress up in his full military uniform
after hours, hop into the front passenger seat of the smugglers’ truck, and
ride with them through the city. Because of his presence, the British guards
would just let the truck pass through the various city checkpoints without
conducting a search. Later, Reading would connect with one of his smuggler
buddies in a bar, where he would receive cash.

Eventually, the British Army caught wind of his scheme, and when it
investigated, it found out that Reading had about £20,000 and a very nice new
car. The British government took the money, and Reading sued to get it back.
The army argued that Reading breached his fiduciary duty of loyalty as
an agent. But Reading responded that this wasn’t so: “I didn’t take any
opportunity away from the army. The Army would never have wanted to be
a part of any transaction like this, so I haven’t breached any duty. I should
get my money back.”
He was incorrect. The duty of loyalty is broader than that. The court held
that if an agent takes advantage of his position to make a profit for himself
by using the assets of the principal or by taking an opportunity that he only
got because of his position as an agent, then that is not OK.
Reading only had this opportunity because of his role as a sergeant, and he
used his army uniform to “earn” his £20,000. It did not matter that the army
lost no profits because it would have never launched a smuggling business.
Reading could not keep the cash.
This is generally still the case in corporate law today, though employees can
sometime ask for permission in advance to do things that might otherwise
violate their duty of loyalty.
Suggested Reading
<< Manning v. Grimsley.
<< Reading v. Regem.

Lecture 3
THINGS CORPORATIONS
CAN AND CANNOT DO
T
his lecture looks at the history and nature of the corporation. It examines
questions such as: How did corporations begin in the United States?
What does it take to create a corporation today? What sort of things
can a corporation legally do after it has been established?
THE BEGINNING OF CORPORATIONS
Corporations existed well prior to the birth of the United States, and they were
an important part of life in the early United States. However, a person who
wanted to create a corporation had to get an act of state legislature granting
permission to do so.
This meant that many US corporations THE EAST INDIA
in the early 1800s were focused on COMPANY
centralizing resources to complete some
public service or infrastructure project. The powerful East India
For example, a state might approve Company was a British trading
a corporation to build a canal, bridge, or corporation formed in 1600 that
some other endeavor that was too large to eventually conducted about half
be funded by any one individual. of the world’s total trade. At the
height of its power in India and
Additionally, a corporation was not China, the East India Company
historically granted permission to do generated profits approaching
anything that it wanted. Its focus was 1,000 percent on its spices and
limited to some specific endeavor. This cotton and tea.
also meant that a corporation would not
typically last forever. Once the canal was
built or the bridge completed, then the corporation would wind up its business
affairs and dissolve. Some corporations, however, were permitted to engage
in ongoing manufacturing and commerce.
THE PROCESS TODAY
The need to petition state legislators for approval to create a corporation

led to some corruption. Competing parties might do whatever it took to get
their local politicians to approve their corporate petition—or to block a rival
petition from being granted or renewed.
This corruption, or perhaps just the perception of corruption, led to

a massive change in the approval process during the mid-1800s. States
began to establish general incorporation laws, under which any group of
businesspeople who met the requirements of these laws could automatically
create a corporation.
This remains the situation today. If you wanted to create a corporation

tomorrow, it would be very easy to do so. It might take you 30 minutes or so to
fill out the key form (called the corporate charter or, in some states, the articles
of incorporation) and file this with the appropriate state administrative agency.
Lecture 3–Things Corporations Can and Cannot Do 19

You will probably have to meet a few other requirements, such as naming
a state agent to receive notices and drafting supplemental rules, known as
the bylaws, for how the corporation will operate. You might want legal help
to do all this, but it is still a pretty easy process.
Your new corporation will not be limited to carrying on a specific type of

activity. Most corporate charters just state that the firm will engage in any
type of activity that is permitted by law. Finally, your new corporation is
presumed to be immortal—you do not need to ask for any special permission
to renew your corporation.
ALTERNATIVES
Two alternative legal entities to the corporation are partnerships and

LLCs, short for limited liability companies. A partnership is essentially an
arrangement where two or more people go into a business together and share
in the profits and losses.
The basic form of partnership is called a general partnership. Using

a partnership structure can provide tax advantages over a corporation because
corporate profits are taxed twice: first at the corporate entity level and then at
the individual level when the profits are paid out as dividends to shareholders.
Partnership profits, by contrast, are only taxed once, at the individual level,
so there might be more take-home pay.
But a corporation has a huge advantage over a general partnership because

investors in a corporation enjoy limited liability. This means that if the firm’s
business turns into a disaster, the most that stockholders can lose is the amount
that they invested in the corporation. With a partnership, by contrast, each
partner can become individually liable for business obligations.
This choice between lower taxes or limited liability had historically driven
the choice of entity decision. If you want lower taxes, take the partnership; if
you want limited liability, go for a corporation.

More recently, however, an alternative type of entity, the LLC, has offered
entrepreneurs the best of both worlds. With an LLC, you can have limited
liability and single-level taxation. There are also some other types of business
entities, like a limited partnership, that can behave in a similar manner.
Although it’s true that the LLC has surged in popularity in recent decades, the
corporation remains incredibly important to this day. Many large firms want
to have their stock traded on public markets, and it is usually much easier to
trade the securities of a corporation.
Additionally, it is not a simple matter to convert an established corporation

over to an LLC. Investors like the standardization that corporate law provides.
LLC governance, by contrast, can be more varied than corporate governance,
and investors may be worried about hidden terms or the fact that the law
relating to LLCs is still relatively new and undeveloped. The bottom line is
that corporations are still the most important legal entity.

LIMITED LIABILITY IN THE CORPORATE CONTEXT
For many people, limited liability is the driving reason to create a corporation.
For example, an investor would be much less likely to invest in a venture if
their personal savings were at stake should the business fail.
In the early days of the US corporation, this was incredibly important for
the development of the railroad industry, which required the mobilization
of large amounts of capital but also presented significant risks of business
failure or tort liability. Yet a grant of limited liability also imposes social costs.
Externalities—that is, costs to outside parties that nobody has accounted
for—can arise as risk is pushed outside of a venture.
Consider the case of Walkovszky v. Carlton, decided by the New York Court
of Appeals in 1966. It involved a taxicab magnate named William Carlton
who had discovered a way to take advantage of limited liability protection.
Carlton had about 20 taxis, but instead of creating just one corporation to
handle the business, he decided to create 10 different corporations. Each
one would have just two taxis and
would carry only the minimum
liability insurance of $10,000. PIERCING THE
Carlton also had each corporation CORPORATE VEIL
pay out almost all of its assets as
dividends on a regular basis. One important doctrine in corporate
law can be used to hold a shareholder
The plaintiff Walkovszky was personally liable in rare cases. It
hit by one of Carlton’s taxis, and is called piercing the corporate
he sought to recover damages veil. The logic goes that if someone,
for his injuries. By setting up as a shareholder, does not respect
10 different corporations and the formalities of a corporation and
pulling out all the assets of each uses the corporate form to perpetrate
on a regular basis, Carlton had a fraud or injustice, then the
engineered a structure where each shareholder will lose the protection
corporation has almost nothing to of the corporation by abandoning
take if an accident like this occurs. their limited liability.

Walkovszky decided to sue Carlton personally for his damages. The court
said no. While it was true that Carlton seemed to have taken advantage of the
limited liability law to make it very unlikely that there would be money left
in any of the 10 corporations to pay damages in a case like this, the majority
opinion essentially said that it was too bad. That was how the game was played,
and Carlton had figured out a sneaky strategy that worked.
Notably, the dissenting judge was furious. He wanted to hold Carlton personally
liable. The majority opinion rejected this.
WHAT CAN A CORPORATION DO?
Today, if a corporation’s founders want to limit a firm’s activity, then they

can do this in the articles of incorporation. For example, one could form
a company and expressly limit its purpose to selling old knick-knacks on eBay.
However, most new corporations today do not tie their hands by restricting
future activity. They usually adopt a very broad statement of purpose, saying
that the firm can engage in any lawful activity. Any limits on corporate activity,
then, will only arise as a matter of corporate law or other legal restrictions.

The law treats a corporation as separate legal person. This means that it has
the right to do all sorts of things in its own legal capacity. It can enter contracts
and own property. It can sue or be sued. It can lend money, borrow money,
buy insurance, and so on.
CORPORATE CONTROVERSY: PHILANTHROPY
Most corporate activity is not too controversial, but occasionally something

arises that tests how far the law is willing to take the concept that a corporation
is a separate legal person. One example is the right of a corporation to engage
in philanthropy.
In 1951, the board of directors of a New Jersey fire hydrant maker named
A. P. Smith Manufacturing Company adopted a resolution that approved
a corporate gift of $1,500 to Princeton University. Some shareholders objected
to this, and they filed a lawsuit claiming that making this charitable gift was
beyond the power of a corporation.
On the one hand, philanthropy could be understood as a smart corporate

investment. By giving Princeton money, the company might attract new
customers who like Princeton, gain access to new employees, and obtain
other less tangible benefits. On the other hand, if the leaders of a fire hydrant
company want to support Princeton, then why did they not pull out their
own wallets instead of spending cash that could have otherwise gone to the
firm’s shareholders? (The court in the fire hydrant case said that the gift
was fine.)
Additionally, the legal permissibility of corporate charity may differ

from state to state. Delaware, which is a major player in corporate law,
allows for charitable donations as long as they are made in pursuit of the
basic ends of the corporation. This is usually taken to mean maximizing
shareholder profits.

Pennsylvania goes even further THE BUSINESS
than Delaware, by explicitly JUDGMENT RULE
permitting corporations created
under its laws to consider the Under a doctrine known as the
interests of broader stakeholders business judgment rule, a court
in making donations, including will almost never second-guess
shareholders, employees, suppliers, the decisions of corporate leaders.
customers, creditors, and even There can be some exceptions to
the communities where the this, usually when firm leaders
corporation operates. Of course, seem to have violated a fiduciary
the directors might still face some duty. However, a peculiar corporate
hot water the following year if decision based on personal whims
enough shareholders are upset will almost never be second-guessed
about the gift that they vote the by a court.
directors out of office.
CORPORATE CONTROVERSY: POLITICS
More recently, the hot legal questions about permissible corporate activity
have started to center around our political process. The laws continue to
evolve, but as of the time of this course’s release, corporations are not able to
contribute directly to political candidates.
They are able to contribute indirectly, however, by funding a political action

committee (or PAC) and having the PAC spend money on its preferred
candidates. Corporations are also able to engage in lobbying and to conduct
issue campaigning.
The influence of corporate activity on our political process is controversial.

Many corporations do not disclose how much they spend in these areas, so
it is difficult to know whether corporate influence is pervasive or episodic.
There have been recent calls to have the Securities and Exchange Commission
require new disclosures about corporate political expenditures, but so far this
has not happened.

Moreover, the laws governing this type of activity arise from a complex array
of federal election law, constitutional law, and corporate law. It is probably fair
to assume, however, that many corporations try to make some investments in
the political process to skew a business or regulatory climate in their favor.
This area of corporate activity will likely continue to receive heavy scrutiny—
and possibly a complete reorientation—in the coming years.
Suggested Reading
<< A. P. Smith Mfg. Co. v. Barlow.
<< Walkovszky v. Carlton.

Lecture 4
BOARDS OF DIRECTORS
AND THE DUTY OF CARE
T
o gain the protection of the business judgment rule, under which a court
will almost never second-guess the decisions of corporate leaders,
a board of directors needs to meet its fiduciary obligations to the firm.
There are a number of different obligations in corporate law. This lecture
focuses on the first fiduciary requirement, which is known as the duty of care.
DEFINING THE DUTY OF CARE
As a general matter, the duty of care means what it sounds like: Directors need
to behave carefully when they make decisions about what their corporation
will do. They need to pay attention, give decisions some thought, consider
alternatives, run numbers, and so on.
Over the years, however, courts have FRANCIS V. UNITED

struggled with the exact contours of JERSEY BANK
the duty-of-care requirement and what
it takes to uphold it. The law has also An infamous case in corporate
changed over time. law was Francis v. United
Jersey Bank, in which one of
Generally speaking, if a company’s the directors had a drinking
directors are careful and thoughtful when problem. The board member
they make decisions, then they should not stayed at home in bed, drinking
owe the corporation anything—even if the gin and skipping the board
decision turns out poorly. If the directors meetings. She had no real idea
are sloppy, however, then it is possible that what the corporation was up
these leaders might have breached a duty to. The other directors were
of care that they owe to the corporation causing the corporation to do
itself. Shareholders might cause the firm some bad things, like siphoning
to sue the offending directors to recover off funds, and the gin-loving
damages from them personally. director was found to have
violated her duty of care: She
KAMIN V. AMERICAN was not paying attention.
EXPRESS COMPANY
There are many famous cases related to the board’s duty of care. The first
one this lectue covers is called Kamin v. American Express Company. This is
a New York case that was decided in 1976.
At the time of this case, the American Express corporation owned about
2 million shares of an investment bank named Donaldson Lufkin and
Jenrette (or DLJ). The investment had worked out badly for American Express:
It bought the DLJ stock in 1972 for a total of $29 million, and it was only worth
$4 million a few years later.

The board of directors for American Express decided to declare a special
dividend, under which the firm would distribute all the shares of DLJ to
the shareholders of American Express. On first glance, it would appear the
American Express shareholders would be happy to receive a dividend. But by
giving them the shares, American Express would lose the opportunity to obtain
a tax benefit under the laws in place at the time of the case. If American Express
sold its DLJ stock and recognized the $25 million loss on the investment, then
this loss could be used to offset some other investing gains that the company
had generated that year. This would then reduce its total tax bill.
However, if American Express gave the DLJ stock to its shareholders, they would
take the stock with a $4 million basis, and all the tax savings from realizing
the loss would disappear entirely. It was as if AMEX’s board had decided to
take millions of dollars and shovel this money into the incinerator.
A shareholder named Kamin thought this was a particularly bad decision and
decided to file a lawsuit alleging a breach of the board’s fiduciary duty of care.
However, the court said the board’s decision did not violate the duty of care.
It reasoned that that was not a situation where the directors had behaved
carelessly or failed to evaluate what to do. The board of American Express
seemed to worry that booking the loss within the firm would cause it to report
lower income for the period, which was true, and that these poorer earnings
would cause American Express’s own stock to drop. By sending the DLJ stock
directly up to shareholders as a dividend, the firm could sidestep this concern
and report higher earnings.
It was still a lousy decision, and Kamin was justifiably upset. But it wasn’t
a breach of the board’s duty of care to American Express. The board may
have made a poor decision, but it had given the situation some thought and
evaluated the different alternatives.
Perhaps some investors would not look favorably upon lower net income
figures, and the court was not willing to second-guess the board on this
decision. This case nicely illustrates this historical approach to the duty of care:
It was very difficult for a board to violate this obligation, and it probably did
not carry that much weight as a matter of corporate law.
Lecture 4–Boards of Directors and the Duty of Care 29

SMITH V. VAN GORKOM
Matters changed in what is probably the most important duty-of-care case

in all of corporate law. It is called Smith v. Van Gorkom, and it was decided
by the Delaware Supreme Court in 1985. The case transformed the duty of
care from something that almost no one worried about into the hottest topic
of the day in corporate law.
Jerome Van Gorkom was CEO of a large corporation named TransUnion.

The company was based in Chicago, and while it engaged in a variety of
activities, most of TransUnions profits were generated by leasing out railcars.
The firm’s stock was trading in the $30 to $40 price range. Van Gorkom was
approaching retirement age, and one day, he spoke with his chief financial
officer and some other senior executives about conducting a leveraged buyout
of TransUnion.
A leveraged buyout is the purchase of a company with a low amount of equity

and a high amount of debt. If the buyer can find a bank or financial institution
that is willing to extend credit secured by the target company’s assets, then
that buyer can often take over the company using very little personal funds.

VAN GORKOM’S ACTIONS
Van Gorkom and his senior officers were contemplating selling TransUnion
via a leveraged buyout at a premium to its stock market price. Current
shareholders should be happy to sell out at a profit, and the buyer might also
make a great deal of money very quickly if he could cut costs or boost firm
performance.
They concluded that a price of $50 to $60 per share would work for this type
of deal. This did not mean that this was a fair price for the company, only
that payments on the debt needed to execute a buyout at that price could be
supported by TransUnion’s expected future operations.
Without consulting his board, Van Gorkom decided to pitch the idea to a social
acquaintance named Jay Pritzker. Pritzker was a well-known takeover artist
in Chicago financial circles, and he had experience with deals like this. One
Saturday in 1980, Van Gorkom talked through the numbers and financial
projections with Pritzker and suggested that a buyout at around $55 might
make sense. Pritzker responded that $50 would be “a more attractive figure”
and agreed that he would think it over.
On Monday, Pritzker called Van Gorkom to say that he was interested in the
$55 cash merger proposal. He asked for more information about the firm.
Three days after that, Pritzker was ready to pounce. He wanted to execute
the deal at $55 per share, but he also insisted that that the TransUnion board
approve the deal within the next three days.
That Saturday, Van Gorkom held a special meeting of TransUnion’s board.

In a 20-minute proposal, he outlined the key terms of Pritzker’s offer.
Copies of the actual merger agreement arrived too late for the meeting. Van
Gorkom suggested that another buyer could still come along if the firm
was worth more and that stockholders should be given the chance to accept
or reject the $55 buyout. The board discussed this offer and approved the
proposed buyout.

That same Saturday night, Van Gorkom hosted a social event at the opening
night of the Chicago Lyric Opera. During an intermission of the opera
performance, he caught up with Pritzker, and they executed the merger
agreement in an alcove of the theater. At that time, neither Van Gorkom nor
any other board member had even read the merger agreement.
AFTER THE DEAL
After that deal became public, a few other possible suitors considered
making a higher bid for the company, but no one made a formal offer.
TransUnion’s shareholders approved the deal with a 70 percent vote, and the
LBO went through.
However, one group of shareholders, led by the plaintiff Smith, was unhappy
with this outcome. They filed a lawsuit against Van Gorkom and the other
TransUnion directors, alleging a breach of the duty of care. The problem,
as the plaintiffs saw it, was that the board did not have a good idea what
the company was really worth; rather, they just plucked $55 out of the air.
Additionally, the board was “grossly negligent in approving the ‘sale’ of the
company upon hours’ consideration, without prior notice, and without the
exigency of a crisis or emergency.”
The Delaware Supreme Court said the TransUnion board had violated its duty
of care to the corporation. In short, the deliberation was sloppy, careless, and
a violation of the board’s fiduciary duty. The Delaware Supreme Court sent
the case back down to the lower court for a determination of damages, and
the defendants settled for $23 million.
AFTER THE DECISION
The decision in Smith v. Van Gorkom generated massive incentives for a board
to obtain professional support for major decisions. In a case like this, hiring an
investment banker to offer a fairness opinion on the valuation would eliminate
any personal risk of director liability for a duty of care breach. Board processes
became much more deliberate after the case.

In fact, the case was such a big deal that some people begin to worry that highly
qualified directors might not be willing to work at Delaware corporations.
This could cause large firms to evade Delaware law entirely by reincorporating
their companies in another state. This concerned state Delaware lawmakers
and politicians, who rely on the recurring—and not insignificant—franchise
fees that corporations pay to maintain their status as Delaware firms.
The Delaware legislature decided to act to alleviate this anxiety. It amended

the state’s corporate statute to effectively allow corporations to scale back the
risk of personal director liability for a duty of care breach.
Overall, the duty-of-care pendulum swung from a relatively unimportant board

obligation to a critical obligation of corporate law. However, more recently,
the pendulum has swung back the other way: With the ability to disclaim
personal board liability in the corporate charter, the duty of care now does
not concern too many boards. Blockbuster duty-of-care cases are rare in the
current era of corporate law.
The issue is not dead. Some corporations, for instance, may not adopt charter
provisions to protect directors from personal liability relating to the duty of
care. But it is fair to say that the duty of care has become less important in
recent years. This means that the most important constraints on board activity
now arise through different types of obligations.
Suggested Reading
<< Kamin v. American Express Company.
<< Smith v. Van Gorkom.

Lecture 5
BUSINESS
OPPORTUNITIES AND
THE DUTY OF LOYALTY
T
he fiduciary duty of loyalty is a very important obligation for board
members and senior executives of every corporation. In essence, the
duty of loyalty says that agents cannot undermine the interests of their
principals by, for example, taking bribes to bring a deal to a third party or by
using their principals’ assets for their own benefit. This lecture looks at how
the duty of loyalty works in corporate law.
IMPLICATIONS OF THE DUTY OF LOYALTY
The duty of loyalty is most clearly implicated when a leader engages in

a self-dealing transaction with the corporation itself. That is an obvious
context for when the law should worry about an executive’s failure to remain
loyal to the company. There is another important variant of this problem,
however, that often arises in corporate law. It is known as the corporate
opportunity doctrine.
Imagine that the head buyer for a large department store, who is in charge
of deciding what products the store will offer, meets a fashion designer with
an amazing line of sweaters at a low price. However, instead of having the
department store buy the line of sweaters, the head buyer convinces
the designer to go into business with him personally.
This is a clear duty-of-loyalty problem. The head buyer was an executive at

the department store, and he usurped a corporate opportunity for himself.
The store trusted him to find good items for it to sell, and he should not be
able to pick the best deals for personal gain. He has to give this opportunity
to the department store.
That is a straightforward example of wrongdoing, but sometimes it can

be more difficult to decide whether an opportunity really belongs to the
corporation. Corporate law often looks to four factors to sort out gray-
area cases:
1. Is the firm financially able to take on the new opportunity?
2. Is the new opportunity in the firm’s current line of business?
3. Does the firm have an interest or expectancy in this type of business

opportunity?
4. Will the self-interest of the officer or director be brought into conflict

with that of the firm?
Lecture 5–Business Opportunities and the Duty of Loyalty 35

These factors might help,
but it still can be tricky to A CASE OF SINGING
know whether something is
an opportunity that belongs In 1942 and 1943, the Celanese
to the corporation. When Corporation of America paid the CEO’s
deciding whether to take spouse, Jean Tennyson, thousands of
on a business opportunity dollars for singing as part of an advertising
for oneself, the safest thing venture. A number of stockholders of
to do is probably to ask for Celanese did not think this was acceptable,
permission. If a person can and they sued. The New York County
get the CEO—or even better, Supreme Court ruled on the matter in the
the board—to say that the case of Bayer v. Beran.
firm most definitely does not
want to take on a business After carefully scrutinizing the situation,
opportunity (after disclosing however, the court found no breach of
all the relevant facts), then the duty of loyalty. Tennyson was an
a person is probably fine established professional opera singer, and
taking on the business the contract was viewed as fair to the firm.
opportunity.
THE CORPORATE OPPORTUNITY DOCTRINE
Sometimes, a corporate opportunity problem emerges in slow motion when

the same person sits on the board of two different firms. If the firms operate
in relatively different industries, then there should not normally be grounds
for concern. Indeed, it can be valuable to have a director bring best practices
from one type of company or industry into the boardroom of another
corporation.
However, sometimes two firms that start out as disparate ventures will begin
to move toward each other to become closer competitors. For example, in
2006, Eric Schmidt, a member of Google’s board (and Google’s CEO at the
time) was elected to serve on the board of directors at Apple.

Back in 2006, this probably did not raise any legal problems: Google was mostly
an internet search company, and Apple focused primarily on computers and
other consumer products. But over time, the two firms started to become very
direct competitors, as Google moved into the mobile phone business, and
both companies focused increasingly on rival software application platforms.
Schmidt’s position on Apple’s board became untenable due to the corporate

opportunity doctrine. Suppose that a software engineer demonstrates an
amazing new golfing app to Schmidt one day. If Schmidt brings the idea to
Google, then Apple shareholders will immediately have a strong corporate
opportunity lawsuit against him. But if he brings it to Apple, then the reverse
is true; his action has cost Google an opportunity. Recognizing this, Schmidt
decided to resign from Apple’s board three years later in 2009.
IN RE EBAY, INC. SHAREHOLDERS LITIGATION
This lecture now turns to an important case involving the duty of loyalty and
the corporate opportunity doctrine: a Delaware Court of Chancery lawsuit
from 2004 called In re eBay, Inc. Shareholders Litigation.
The background of this case goes back to the late 1990s and involves
a phenomenon known as spinning—that is, an investment practice where
investment banks might give senior business
executives at favored firms the right to buy
shares in an initial public offering (IPO). CASE TERMINOLOGY
IPOs occur when a corporation decides that
it is going to sell stock on the public markets In the case In re eBay, Inc.
for the first time. Shareholders Litigation, the
first two words, In re, are
When a company is ready to complete the a Latin phrase that means
IPO, it will set a price at which the initial “in the matter of.” Lawsuits
shares are sold to buyers. Those shares will will sometimes use this
then trade on public exchanges like the designation when there is
New York Stock Exchange or the NASDAQ. a proceeding where formally
Theoretically, the price of a stock can go up designated adversaries are
or down during the first day of trading as not named.
markets sort out what the company is worth.

In the late 1990s, IPO markets
were very hot, and it was CHANCERY COURTS
common to see huge jumps
in a tech company’s stock The institution of chancery courts derived
price on the very first day of from England, which featured a distinction
trading. Gains of 400, 500, or between courts of law and courts of equity.
even 600 percent in a single Courts of equity, often known as chancery
day were not unheard of. courts, had more flexibility, and they could
Many day traders and other sometime step in to render a just decision
investors would try to flip that might not be consistent with the harsh
shares in hot IPOs, purchasing results that would otherwise arise under
the shares initially and then common law.
reselling them just a few hours
later for a massive profit. In the United States, many states
eventually combined their courts into
It became difficult to obtain just one system, but a few states still have
shares in some IPOs, and a chancery court. Delaware is one such
the rights to purchase them state, and the Delaware Court of Chancery
started to be allocated maintains jurisdiction over corporate law
more strategically among matters.
all the interested buyers.

The investment banks who controlled the deals were not very transparent
in the way that they would parse out hot IPO allocation rights—and that is
where spinning came in.
Some banks were thought to award IPO allocations to senior executives at

important client companies in order to win or maintain their banking business
in other areas. Something like this might have been going on between the
investment bank Goldman Sachs and the senior leaders at eBay.
GOLDMAN SACHS AND EBAY
Goldman Sachs had served as the lead underwriter of eBay’s stock IPO in 1998,
which had done very well. The bank also earned eBay’s business for follow-on
stock offerings, and it served as the firm’s lead advisor when eBay decided to
acquire PayPal. Around this very time, Goldman Sachs also allocated shares
in many other IPOs that the bank was running to Pierre Omidyar, eBay’s
founder and chairman; Meg Whitman, its CEO; and several other senior
managers at eBay.
Some shareholders thought this seemed off, and they decided to sue. However,
at the time, spinning was a relatively common practice. Additionally, the price
on any given IPO was not certain to go up—there was always a risk that some
new stock issue would flop.
The plaintiff shareholders came up with the very clever argument that this
arrangement violated the corporate opportunity doctrine and that Omidyar
and the other senior executives had therefore violated their fiduciary duty
of loyalty to eBay. In other words, the opportunity to invest in the IPOs
should have gone to eBay and not to the individual corporate leaders in their
personal capacity.
This was an intriguing argument, but the question remained: Wasn’t

eBay in the online-auction business rather than the stock-investing
business? Why should the opportunity belong to eBay? The defendants
described these allocations as “‘collateral investment opportunities’ that
arose by virtue of the inside directors’ status as wealthy individuals.”

They also said “this is not a corporate opportunity within the corporation’s
line of business or an opportunity in which the corporation had an interest
or expectancy.”
The court disagreed. It started by recognizing that eBay, a cash-rich company,

had the financial wherewithal to take advantage of these IPO investments. The
court then said that eBay was in the investment business. According to eBay’s
own financial statements, it “had more than $550 million invested in equity
and debt securities.” This suggested that investing was a line of business for
the firm. Accordingly, the defendants’ conduct seemed problematic.
The court clearly thought that the whole scheme violated the directors’ duty
of loyalty to the firm. They were taking advantage of their positions to pocket
money for themselves at eBay’s expense. The directors settled the case by
paying several million dollars back into eBay. Interestingly, Goldman Sachs
contributed to the settlement as well.
Suggested Reading
<< Bayer v. Beran.
<< In re eBay, Inc. Shareholders Litigation.

Lecture 6
EXECUTIVE PAY
AND THE DUTY
OF GOOD FAITH
I
t is common to hear concerns about bloated executive compensation in
the United States, but it is difficult to establish a precise framework for
evaluating how much is too much. Today, courts analyze the issue by means
of a doctrine known as the duty of good faith.
BACKGROUND ON THE DUTY OF GOOD FAITH
One way to assess the situation regarding

executive pay is to construct a ratio of
CEO pay to that of the average corporate
employee. For example, if the CEO earns
$1 million at a firm while the average
worker earns just $50,000, then the
compensation ratio is 20:1.
A few years ago, one academic study

measured this number for large
corporations in the Unites States
between the years 1965 to 2013. The
most recent number from the study was about
300:1 for the largest firms. In that case, if the average employee salary
is $50,000 per year, then a CEO might pocket around $15 million each year.
That certainly seems like a lot of money, but the question remains: Is it legally
wrong for a CEO to earn 300 times as much as the average worker? Executive
compensation has proven to be a very difficult area for corporate law to
tackle. There is no magic number that a judge can latch on to as a trigger for
an excessive paycheck. Courts cannot easily say that $5 million is OK, but
$15 million is illegal.
This is because the business judgment rule will usually protect a carefully
considered board decision from judicial second-guessing. Yet the topic attracts
widespread attention, and corporate law has occasionally waded into executive
compensation disputes.
One conceivable limit arises though a legal doctrine known as waste.

A shareholder can try to bring a claim that a huge executive salary essentially
amounts to a waste of the firm’s resources. This is a very difficult argument
to pursue, however, and it rarely succeeds.

THE ORIGINS OF GOOD FAITH
The duty of good faith has interesting, and relatively recent, origins. Corporate
law has always been understood to support the notion that directors have to act
in good faith. However, the meaning of good faith was not precisely defined,
and most people simply assumed that that a board decision that satisfied the
duty of care and the duty of loyalty would not be subjected to a third inquiry
relating to good faith.
In Delaware, this all changed when the state’s supreme court dropped what
some have called the “triad bomb” of 1993. The court’s opinion stated:
[A] shareholder plaintiff challenging a board decision has the burden at

the outset to rebut the [business judgment] rule’s presumption. To rebut
the rule, a shareholder plaintiff assumes the burden of providing
evidence that directors in reaching their challenged decision, breached any
one of the triads of their fiduciary duty—good faith, loyalty, or due care.
As a practical matter for corporate law, Delaware courts seemed to be carving

out some additional space to create new legal obligations. The duty of care
was less likely to serve as a reliable constraint on corporate executives due to
legislative amendments passed in the wake of Smith v. Van Gorkom—the case
in which a CEO and board of directors approved a leveraged buyout of their
company without even reading the agreement.
Additionally, while the duty of loyalty still had teeth, it was only implicated
by self-dealing transactions. It did not cover leadership problems that did not
amount to self-dealing but still raised potential concerns. The nebulous and
open-ended concept of good faith could conceivably be used by lawmakers
to manage these types of problems.
EXECUTIVE COMPENSATION AND THE DUTY OF GOOD FAITH
The contours of the duty of good faith in corporate law have been slowly
evolving ever since. This lecture focuses on two of the most important contexts
for understanding what it means: executive compensation and the obligation
of a board to monitor its firm’s activities.
Lecture 6–Executive Pay and the Duty of Good Faith 43

One of the most interesting and important executive compensation cases in
all of corporate law involves The Walt Disney Company during the 1990s.
Michael Eisner took over as Disney’s CEO in 1984. Under his leadership, along
with that of President Frank Wells, Jeffrey Katzenberg, and some other key
managers, the company flourished.
Wells died in a tragic helicopter crash in 1994, and Eisner was forced to
undergo major heart surgery just a few months later. Katzenberg had left
the firm a few months earlier to form DreamWorks with filmmaker Steven
Spielberg and music industry impresario David Geffen. Accordingly, hiring
someone to take over for Wells and setting up a new executive succession plan
was one of the top tasks for the Disney board.
A leading candidate for this number two position at Disney was an outside
executive named Michael Ovitz. Ovitz was the cofounder of a prominent
talent agency in Los Angeles, and he was extremely well connected in the
entertainment industry. Eisner thought that Ovitz might be a good fit as
president of Disney.
Disney’s board and Ovitz entered into negotiations, but it soon became clear
that Disney might not be able to pay Ovitz enough to lure him. The chairman
of Disney’s compensation committee eventually devised a plan, with many
different option grants and other financial guarantees. However, he cautioned
that the plan’s stock options “would exceed the standards applied within Disney
and corporate America and would ‘raise very strong criticism.’”
After bringing in a consultant and some discussion, the entire Disney board
approved the deal. Ovitz’s tenure as Disney’s president, however, was a disaster.
Within a year, Eisner and the Disney board decided to fire Ovitz. Under his
compensation contract, however, Ovitz was entitled to a whopping $130 million
payout as long as the termination was not considered “for cause.” The board
paid him this money, and an angry group of shareholders sued. The case went
all the way up to the Delaware Supreme Court.

THE CASE IN COURT
The plaintiffs started with a claim that Disney’s decision making violated
the board’s duty of care. The court, however, said there was no breach of the
duty of care. The board may have played fast and loose with the compensation
details, but it certainly had a good reason to make the decision and gave it
sufficient attention.
The plaintiffs then argued that the board’s decision making had been
conducted in bad faith. The Delaware Supreme Court was now forced to
wrestle with what this really meant in the executive compensation context.
It considered several possibilities. First, a board could breach its duty of
good faith by actually intending to harm the
corporation, but there was no evidence the
board actually meant harm. CORPORATE PAY
AND GOOD FAITH
The court also accepted a second definition
of bad faith behavior: an “intentional As of this course’s taping, the
dereliction of duty, [or] a conscious duty of good faith has not
disregard for one’s responsibilities.” The served as a major legal check
court concluded, however, that there was on corporate pay.
also no evidence that Disney’s board had
violated this standard.
OTHER MEASURES
The Disney case was not the end of the story. The US Congress was also
concerned by executive pay, and it decided to wade into the issue by
implementing a federal law in this area when it enacted the sweeping
financial reform legislation known as Dodd-Frank following the financial
crisis of 2007–2008. Importantly, Congress did not set maximum pay rules
for corporate officers.
The primary strategy of the federal approach was to offer information to

shareholders about executive salaries and provide a way for shareholders to
tell the board whether they approved or disapproved of current pay practices.

The upshot of this was something called a say-on-pay vote. Every few years,
shareholders at corporations that file reports with the Securities and Exchange
Commission (usually larger companies) can review the pay packages of top
corporate executives and vote on whether they approve or disapprove of the
firm’s compensation.
Importantly, this vote is only advisory—shareholders cannot annul

a compensation contract, even if every one of them is furious. Still, a large
group of disgruntled shareholders could conceivably kick out the current slate
of directors during the next election cycle if they do not amend executive pay.
It is not clear, however, if say-on-pay laws have had much of an impact on
executive compensation.
CORPORATE ACTIVITY
Another important context for the duty of good faith involves a board’s
obligation to monitor corporate activity. This is sometimes known as the
board’s Caremark obligation after an important Delaware case establishing
such oversight duties. In Caremark, the Delaware Court of Chancery held
that the duty of good faith requires corporate directors to establish some
type of monitoring system that tries to ensure that the firm is not engaging
in illegal activity.

In a 2006 case called Stone v. Ritter, the Delaware Supreme Court adopted the
Caremark standard. Essentially, the court ruled that a board cannot ignore
corporate activities, but it does not have to catch absolutely everything, either.
Along the way, the Stone v. Ritter court also changed its mind about good
faith as a third board obligation. Instead, it described the failure to act in
good faith as a subset of the duty of loyalty.
The full extent of a board’s Caremark obligation is still unfolding. There was
an important case brought in the wake of the 2007–2008 financial crises,
for example, where shareholders at Citigroup sued for failure to monitor the
firm’s business investments closely enough.
Like many companies, Citigroup lost a lot of money. The plaintiff shareholders
argued that red flags had existed in a way that should have raised concerns
about the firm’s business strategy. They felt that the board had ignored the
firm’s risks in a way that violated Caremark.
The court rejected this expansion of monitoring duties. Instead, it returned to

the business judgment rule. Citigroup’s leaders, it held, were entitled to make
decisions about where to invest and how business risk should be embraced.
This was an interesting clash between oversight duties and the business
judgment rule, and the case might have led to a significant expansion of
a board’s monitoring obligations. However, the business judgment rule won
the day. For now, a board’s monitoring duties are limited to preventing illegal
behavior within the shadows of a corporation.
Suggested Reading
<< In re the Walt Disney Co. Derivative Litigation.
<< Stone v. Ritter.

Lecture 7
SHAREHOLDER LAWSUITS:
GOALS AND LIMITATIONS
T
his lecture explores shareholder lawsuits. Though it may seem
counterintuitive, shareholders sometimes sue their own company.
The answer to why they might do so is rooted in that most fundamental
aspect of the corporation: representation.
SHAREHOLDERS AND REPRESENTATIVES
Shareholders are the residual owners of a company, but they do not collectively
vote on every firm decision. Rather, they cede power to a small group of
representatives who are entrusted to call most of the shots.
Being human, these representative managers are flawed, and human nature
sometimes causes corporate leaders to behave badly. For this reason, suing
one’s company is a plausible strategy for promoting sound governance and for
stopping the mischief of a rogue leader. As such, it is a way for a shareholder
to protect his or her investment.
While corporate law accepts a role for shareholder lawsuits, establishing rules
to govern these claims effectively has proven difficult. Lawsuits by shareholders
have several key features that raise complicated legal questions, both with
respect to other shareholders and to the corporation as a whole.
First, the litigation itself is representative, because a single shareholder can

assert claims on behalf of, and therefore purporting to represent, the entire
body of shareholders. Second, the litigation is usually preclusive, because any
given resolution to a claim will typically bind all other shareholders.
Third, the litigation can be self-funding and therefore relatively easy to initiate.
This is because the plaintiff’s lawyers are often entitled to receive payment for
their services through contingency fee arrangements, or even payments from
the corporation itself through settlement.
TYPES OF SHAREHOLDER LAWSUITS
It is impractical to require a unanimous shareholder vote as a trigger to

any lawsuit, but a firm’s full roster of shareholders can run into the tens of
thousands or more. This is often a diverse group. Someone will disagree with
almost any corporate action, and certainly the legal system cannot be used
second-guess all business decisions.
Likewise, some shareholders have private grievances or worldviews that may

not be shared by most other owners. One way to solve this coordination
problem is to empanel a single shareholder to represent the entire group of
equity owners.
This plaintiff essentially takes over all the corporate decisions for a given legal
claim. This is called a shareholder derivative lawsuit, and it is a technique that
has become an important part of corporate law.
Lecture 7–Shareholder Lawsuits: Goals and Limitations 49

Shareholder derivative lawsuits are not the only type of large-scale shareholder
claim. It might also be possible for a group of shareholders to get together
to file a direct class action lawsuit against their firm. This lecture, however,
focuses on derivative litigation.
Sometimes it is not easy to determine whether a given lawsuit is a direct

suit—in which an individual owns the claim and is free to make any decision
desired in their personal capacity—or a derivative suit that really belongs
to the corporation. To determine whether a suit belongs to the corporation,
a court will ask two related questions to sort this out: Who is injured? Who
would receive relief?
If a shareholder is harmed personally, then the claim is direct. Shareholders

cannot claim direct harm, however, just because the price of their stock drops
as the result of firm mismanagement. By contrast, if the corporation itself has
been harmed, then the legal claim is probably derivative.
The second question is whether any recovery would go directly to the

shareholder or be paid into the corporation. If the shareholder would receive
the relief—either in the form of money damages or some other remedy—then
the claim will likely be direct. If, on the other hand, any recovery would belong
to the corporation, then the claim looks derivative.
DECISIONS ON PURSUING CLAIMS
In the case of a derivative claim, just because a corporation has suffered a legal
slight, it does not automatically follow that it is in the firm’s best overall interest
to pursue the claim. Corporate law allows top officers to decide whether the
company should pursue most legal claims.
However, in a very limited set of circumstances—where the legal problems

relate directly to top managerial action or inaction—corporate law does not
trust the inside representatives with unqualified discretion. The governance
compromise is the shareholder derivative lawsuit: the right of an individual
shareholder to prosecute a claim on behalf of the entire company when
something seems bad in the boardroom.

Additionally, in the most important corporate law jurisdictions, the question
of who should decide whether to pursue a claim is governed by something
called the shareholder demand requirement. Under this requirement, unless
the demand requirement is excused as futile, a shareholder who discovers
a possible claim is expected to approach the board and demand that it file the
lawsuit on behalf of the firm.
EXCUSING THE DEMAND REQUIREMENT
When the demand is made, control of the lawsuit passes to the board of
directors, which is now entitled to decide whether to pursue the litigation.
One might expect that the typical board response would be to not pursue
the litigation.
However, nearly every shareholder derivative claim involves allegations of

wrongdoing by the top corporate leaders. Shareholder-plaintiffs are not
interested in calling out breach of contract claims or other routine business
litigation; they want to police corruption or recklessness in the boardroom.
But if a concerned shareholder has to file a demand notice that immediately
transfers control of the claim to the insiders, can we really trust the board of
directors to make a sound decision about whether to sue themselves?

For this reason, informed shareholders almost never file demand with the
board. Rather, a shareholder-plaintiff tries to keep control of the lawsuit
by arguing that the demand requirement is excused under the facts and
circumstances of the case. In response, the corporation will typically file
a motion to dismiss the case for failure to make demand. Accordingly, for all
practical purposes, the seemingly technical issue of whether demand must
be made assumes central importance in the litigation dynamics.
The exact rules on excusing demand differ slightly from state to state, and
some jurisdictions even use different systems. Generally, however, courts will
excuse the demand requirement if a shareholder-plaintiff can offer detailed
evidence about one of the following three concerns:
1. A majority of directors are self-interested in a transaction at issue.
2. A majority of directors are unable to evaluate the dispute with

independence because they are controlled or dominated by a self-
interested insider.
3. The challenged transaction is so egregious on its face that it could not

have been the product of a sound business judgment of the directors.
BOARD DELEGATION
A corporation that loses on the demand motion has one last move that might
allow the corporation to reassert decision-making authority over the lawsuit
and tug back control from a shareholder-plaintiff.
To see how this works, it is necessary to start with the more general topic of
board delegation. A board of directors can usually delegate governance over
an explicit decision to a smaller committee of directors.
This possibility of board governance through subcommittee raises a tricky

question for shareholder derivative litigation. In a situation where demand
is excused, the board might nevertheless create a special committee of the
remaining, disinterested directors to wrest control of the litigation back from
a plaintiff-shareholder.

This move, if executed with proper procedure, would seem to shield any
subsequent decisions from the taint of conflicted directors. But even directors
with the highest integrity may still be tempted to protect their friends and
co-directors from a lawsuit.
Corporate law has concluded, perhaps a bit uncomfortably, that a special

committee can indeed yank back control of the litigation from a plaintiff
shareholder. However, judges will not give the committee carte blanche.
Rather, it must leap at least two hurdles.
First, the special committee must truly be comprised of disinterested directors.

Second, the committee must conduct a full and reasonable investigation of
the matter. If these steps are followed, then any ultimate decision to drop the
lawsuit can be clothed in the protection of the business judgment rule.
THE ORACLE CASE
One case shows how the dynamics of a special litigation committee can play
out. In 2002, the Oracle software company had an awkward legal problem.
Some shareholders believed that Oracle’s CEO, Larry Ellison, along with several
other board members, had engaged in insider trading by selling some Oracle
stock in advance of a poor earnings announcement by the firm.
Specifically, the shareholders thought that Ellison and the others obtained
inside knowledge of poor sales results throughout the quarter from weekly
sales reports. They were then allegedly able to use this info to dump some
stock for roughly $30 per share that would later fall to $16 per share when bad
news came out at the end of the reporting quarter.
Oracle decided to stave off the problem by bringing on two new directors,
who had not been around during any of the allegedly problematic behavior.
These directors, both professors at Stanford University, would comprise a new
special litigation committee (or SLC) that was granted full authority to decide
whether Oracle should press the plaintiff’s claims, settle the case, or call it all
off. In short, Oracle’s board wanted to take back control of the lawsuit from
the outside shareholders.

The SLC launched a full-blown investigation. The two professors hired a large
law firm to help them investigate, and they brought on a consulting firm to
help with the analysis. They interviewed more than 70 witnesses and pulled
together a 1,100-page report. Ultimately, the SLC concluded that the lawsuit
was just not worth it.
This would normally have been the end of the matter, but here is where the
case took an interesting turn. Recall that for the SLC to take back control, it
needed to have conducted a thorough review and be independent. Its review
certainly looked thorough, but the judge took a close look at the relationship
between Oracle and Stanford. He did not like the pressures that such a cozy
relationship might put on the Stanford professors.
He noted, for example, that one of the defendant directors was also a Stanford
professor. Another defendant had given Stanford a research grant that
supported work by one of the SLC professors. The court also noted Ellison
was quite wealthy and had made charitable contributions to Stanford.
For these and other related reasons, the court concluded that the SLC was not
sufficiently independent and that it could not reassert control of the case. This
is an unusual and debatable outcome, but the Oracle situation does nicely
illustrate how the dynamics of shareholder derivative lawsuits can work.
Suggested Reading
<< In re InfoUSA, Inc. Shareholders Litigation.
<< In re Oracle Corp. Derivative Litigation.

Lecture 8
SECURITIES REGULATION
AND FRAUD
F
ederal law has stepped in to regulate corporate fundraising and
trading activity. Ever since its birth in the 1930s, the Securities and
Exchange Commission has set rules to disseminate information and
try to halt fraud in connection with the stock markets. Private shareholder
suits have also played a significant role in policing fraud that might impact
trading markets.
THE EARLY 1930s
In the early 1930s, Congress was particularly worried about some shady
practices that were thought to permeate Wall Street. These included conflicts
of interest, the sale of worthless stocks and bonds, and outright lies. Federal
lawmakers sought to remedy these problems with two comprehensive pieces
of legislation: The Securities Act of 1933 and the Securities Exchange Act
of 1934. These laws created the US Securities and Exchange Commission
(SEC), became part of the New Deal, and continue to serve as the backbone
of securities regulation in the United States.
In spite of its substantial intervention in the markets, Congress did exercise

some self-restraint. Some people were pushing for merit reviews, or substantive
business requirements for the sale of stock, bonds, and other securities.
Congress rejected this approach in favor of a comprehensive disclosure regime.
Lawmakers were not going to judge the substantive quality or risk of a given
financial investment.
Rather, a firm that wanted to sell stock now had to go through a registration
process under the 1933 act in which it provided comprehensive information
about the firm’s historic and expected future activity. Investors could then
make up their own minds about the risk that an investment in that firm might
pose and whether they wanted
to buy into the company.
ACTING IN CRISIS
If Congress’s policy choice in
establishing the registration Congressional temptation to act
process was an instance of has always been strongest following
self-restraint, however, it still a financial crisis. The financial reform
has had a powerful and lasting legislation known as Dodd-Frank, for
effect. Indeed, this disclosure- example, was passed in the wake of the
oriented framework has Great Recession.
greatly influenced corporate
fundraising ever since.

A FOCUS ON FRAUD
Given this focus on information disclosure, securities laws are especially

concerned about fraud. If a firm lies in its registration statement to attract new
stockholders, then it will be in serious trouble under the 1933 act. The 1934
Exchange Act, by contrast, does not focus on initial fundraising activity. It tries
to protect trading in secondary markets like the New York Stock Exchange
or the NASDAQ.
However, fraud can still be a serious concern for ongoing trading markets as
well. For example, one day in 2018, Elon Musk, the CEO of Tesla, typed nine
words on his Twitter account that would cost him $20 million. Those words
were: “Am considering taking Tesla private at $420. Funding secured.” The
automaker’s stock had opened that day at about $340 per share. The stock was
up to $380 by the end of the day.
Yet as time passed, people began to wonder whether funding really had been
confirmed. Musk hinted that he had held discussions with financial backers,
but the proof that a commitment was reached seemed thin. Some Tesla
directors said they were blindsided by the idea.
Tesla had not hired investment bankers to raise this money. It did not help that
the price of the buyout, $420, appeared to have been chosen in part because
it has a special significance for marijuana smokers. That is what the SEC
maintained when it sued Musk for fraud. Over the next month, the price of
Tesla stock began to plummet, first to $300 and then down to $265.
RULE 10B-5
The Tesla incident matters because hypothetically, a person could plow their
money into Tesla stock, expecting a buyout at a higher price that never comes.
This is exactly that type of problem that Congress wanted to address in the
1934 Securities Exchange Act.
Lecture 8–Securities Regulation and Fraud 57

The specific law, Section 10b, states that “It shall be unlawful for any person
… [t]o use or employ, in connection with the purchase or sale of any security
… any manipulative or deceptive device.” This does not offer much guidance
about what is really prohibited, but Congress also directed the SEC in 1934
to make more specific rules to flesh out section 10b.
The SEC quickly complied, adopting Rule 10b-5, which makes the following
actions unlawful:
zz Employing “any device, scheme, or artifice to defraud.”
zz Making “any untrue statement of a material fact.”
zz Engaging “in any act, practice, or course of business which operates

or would operate as a fraud or deceit upon any person.”
These are unlawful as long as one of these acts is made “in connection with
the purchase or sale of any security.” Over time, federal courts have fleshed
out what this rule means for false statements. A plaintiff suing under 10b-5
now needs to demonstrate four main things:
zz First, the fraudulent statement was made with intent to deceive, or

at a minimum, with a reckless disregard for the truth.
zz Second, the plaintiff must show that the fraudulent statement caused
the harm.
zz Third, the plaintiff needs to show that the statement was material—
that is, a reasonable investor would likely consider the statement
important.
zz Fourth, the plaintiff must show that he or she relied on the

misstatement in taking the action that proved harmful, like buying
into the stock.

TESLA VERSUS THE SEC
The SEC certainly thought Musk did something illegal in his tweet.
Its complaint argued that he knew or was reckless in not knowing that his
tweet was false. It also alleged that “in truth and in fact, Musk had not even
discussed, much less confirmed, key deal terms, including price, with any
potential funding source.”
Musk pushed back against this characterization, and some thought that he
was prepared to fight the charges. But the SEC threatened one of its strictest
penalties: a lifetime ban on serving as an executive or director at any public
company. Eventually Musk decided to settle the case by paying $20 million
and resigning as chair of Tesla’s board. He stayed on, however, as CEO.
PRIVATE RIGHT OF ACTION
The SEC’s action against Musk to protect trading markets had a significant
impact on Tesla. However, it did not preclude aggrieved shareholders from
suing the company directly. Courts have also embraced something called
the private right of action for 10b-5 claims, allowing individual investors to
sue under the statute to try to recover their own losses in court. In effect, it is
a way to leverage the power of 10b-5 laws to enforce them beyond the limited
resources of the SEC.
This private right of action brings up the important development in this

area—a doctrine known as fraud on the market. One of the problems with
a private 10b-5 lawsuit is that one person’s loss may not be enough to make
it worthwhile to press charges. However, 10b-5 claims can also be brought
as class actions.
A case called Basic Inc. v. Levinson paved the way for broad class action
lawsuits in 10b-5 fraud claims. That case very much upped the ante on
securities fraud litigation. High-powered plaintiff’s lawyers began to file class
action lawsuits any time there was a large price drop coupled with possible
misinformation.
Lecture 8–Securities Regulation and Fraud 59

They would then explore the facts more closely and press the firm to settle
the case. Many firms felt great pressure to do so. Some subsequent legal
changes have made it more difficult to do this, but fraud on the market is
still the law. The Supreme Court revisited the theory back in 2014 and again
upheld it.
In the wake of Basic Inc. v. Levinson, many important shareholder fraud

lawsuits have explored how far fraud on the market should go. Following
his Twitter statement, Elon Musk was actually sued by short sellers who had
placed bets that Tesla’s stock would go down.
Short sellers borrow stock they do not own and sell that stock. They then
hope to buy the stock later, if and when the price declines, so they can return
the shares to the lender and make a profit. Musk and other CEOs often
complain that these investors put unwanted pressure on their firm’s stock
and drive down the price of shares.
Tesla’s stock jumped in value in the immediate aftermath of Musk’s Twitter

post. Short sellers who had to close their positions during that period thus lost
money because they needed to buy the stock (known as covering their position)
at a higher price. The question at hand is if these traders are protected by 10b-5.
Recent cases have said yes, so they decided to file a lawsuit against Musk. As of
this course’s taping, that suit is still undecided.
Suggested Reading
<< Basic v. Levinson.
<< Goldstein, “Elon Musk Steps Down as Chairman

in Deal With S.E.C. Over Tweet About Tesla.”

Lecture 9
INSIDER TRADING
LAWS AND THEIR
COMPLEXITIES
S
ome countries have enacted very explicit laws that simply say you
cannot trade the stock of a company if you possess important inside
information. The United States, however, takes a different approach.
Instead of a blanket prohibition on insider trading, America uses a strange and
often ambiguous patchwork of laws that allow some trades while prohibiting
many others. This lecture looks at how federal lawmakers and the Securities
and Exchange Commission (SEC) approaches insider trading.
SECURITIES AND EXCHANGE COMMISSION
V. TEXAS GULF SULPHUR
A good starting place in federal law is the case of Securities and Exchange
Commission v. Texas Gulf Sulphur. In the early 1960s, the mining firm Texas
Gulf Sulphur (TGS) was exploring some land in eastern Canada. The firm’s
stock was trading at about $19 per share. By late 1963, TGS came across a very
promising location: exploratory drilling revealed massive deposits of copper.
TGS wanted to keep this news secret so it could buy up the surrounding land
at a good price.
Over the next few months, the firm succeeded in purchasing all the land for
this new mine. Several leaders at TGS also succeeding in buying stock and
stock options in their firm for around $20 per share. By April of 1964, the
rumors were starting to fly.
In response, TGS’s president and some other leaders decided to put out
a statement dampening enthusiasm about a potential copper discovery. The
statement seemed to calm the markets. This also allowed several insiders to
buy more stock in TGS at an attractive price.
Four days later TGS issued an official announcement: The firm had indeed
struck a massive deposit of copper. It estimated a discovery of more than 25
million tons. TGS’s stock price skyrocketed on the news, soon jumping to
$58 per share.
The insiders made a lot of money, but the SEC discovered the trades and
decided to prosecute these executives for insider trading violations. The specific
law was Rule 10b-5. This rule prohibits any person from engaging “in any act,
practice, or course of business which operates or would operate as a fraud or
deceit upon any person” in connection with a trade.
The SEC thought that insider trading constituted deceit and pursued the case
through an appeal to the US Court of Appeals for the Second Circuit. In short,
the court said that the insiders either should have abstained from trading or
disclosed their information to the public. Additionally, they had to give the
public enough time to act on the information, too.

The ruling was a foundational decision on insider trading, and it set out the
traditional rule of abstain or disclose. However, the case used noble rhetoric
about establishing a level playing field for all investors, which swept farther
than the US Supreme Court has ultimately been willing to go.
CHIARELLA V. UNITED STATES
The next big opinion on insider trading law came about 10 years later in a case
called Chiarella v. United States. Chiarella worked for a Wall Street printing
company. Other companies and their advisors would hire the company when
they needed to produce documents that would be used to make a buyout offer
for another firm.
This was obviously highly sensitive information, and recognizing this, the
firms would use code names as they prepared the materials for printing. For
example, the buyer might be disguised as Sharkey, and the target company
might be code-named Minnow. The real company names would only be
substituted at the very last minute.
Chiarella knew how this game was played, and he was also smart enough to
make some educated guesses about who Sharkey and Minnow might really
be. One day, he decided to buy a bunch of Minnow’s stock, using the inside
information from his printing job. He became rich when his guess proved
correct. However, when the SEC brought a case against Chiarella for insider
trading, the US Supreme Court was unwilling to embrace a level playing field
theory that would have deemed his behavior illegal.
Instead, it said that the duty to abstain came from a relationship of trust
between a corporation’s shareholders and its employees. However, Chiarella
had no relationship with Minnow’s shareholders; he worked for a different
printing company that had been hired by the acquiring firm Sharkey. With
no duty to Minnow, Chiarella was free of responsibility. This type of activity
did not count as illegal insider trading in the eyes of the Supreme Court.
Lecture 9–Insider Trading Laws and Their Complexities 63

TIPPER-TIPPEE INSIDER TRADING
The next piece of the insider trading puzzle involves a problem known as
tipper-tippee insider trading. The US Supreme Court has agonized over when
to prohibit this activity, and there have been many important insider trading
cases about tipping.
The foundations of tipper-tippee criminality were created in a 1983

opinion named Dirks v. Securities and Exchange Commission. It established
the general framework for determining whether a tip would count as
insider trading.
Dirks worked for a brokerage firm that provided investment analysis to

its clients (mostly large institutional investors). One day, Dirks got a call
from someone named Ronald Secrist. Secrist had worked at a Los Angeles
insurance company named Equity Funding, and he was calling to tell Dirks
that Equity Funding was lying about its financial performance. Secrist had
already provided this information to several regulatory agencies, but they
had all failed to investigate.
Dirks decided to dig a little deeper. He flew out to LA to interview some of

the employees at Equity Funding. The senior leaders denied any wrongdoing
at the firm, but several lower-level employees corroborated Secrist’s story
of fraud.
Neither Dirks nor his firm owned any Equity Funding stock, but they
advised several large clients who did. On the basis of Dirk’s advice during
this investigation, these clients dumped about $16 million in stock. Over the
two-week period of the investigation, the price of Equity Funding fell from
$26 to $15 per share. Shortly thereafter, trading on the stock was halted, and
the California insurance authorities investigated.
They seized the firm’s records and found widespread evidence of fraud. The
Wall Street Journal published a front-page article, and the company went bust.
Secrist had been right all along.

DIRKS V. SECURITIES AND
EXCHANGE COMMISSION IN COURT
The SEC decide to “reward” Dirks for rooting out the fraud by bringing
criminal charges against him for insider trading. The theory was that Secrist
and other insiders had tipped Dirks, and that he had wrongfully tipped off
his clients so they could sell with inside information. The SEC thought this
behavior violated 10b-5. Essentially, it wanted a rule that any tippee would
simply inherit the duty of an inside tipper as soon as the tipper gave the tippee
confidential information. If Secrist could not trade under TGS, then neither
could anyone else down the chain.
The Supreme Court refused to go this far. Instead, it held that tippers
and tippees would only violate insider trading laws if two factors
were present. First, the tipper must have breached a duty to the firm when
disclosing the information to the tippee. Related to this, the court said that
a breach of the tipper’s duty only arose if he or she obtained a personal benefit
or gain. Second, the tippee must have known (or should have known) about
this breach of duty.

Having set out these critical requirements, the court then concluded that
illegal insider trading had not occurred under the facts of Dirks v. Securities
and Exchange Commission. Secrist and the other Equity Funding employees
who gave Dirks the information did not spill the information for personal
gain. Rather, they did so to expose and stop the fraud. Because they breached
no duty, there was no derivative breach by Dirks.
Even if there had been a problem—for instance, if Dirks had bribed Secrist to
get the info—the clients of Dirks’s advisory firm would probably be OK. If they
had no reason to know about the bribe, then they would not have known about
the breach—the second requirement under the Dirks test.
PERSONAL BENEFITS
The Supreme Court weighed the question of what counts as a personal benefit
under the Dirks test during 2016, with the case of Salman v. United States.
It involved a banker who gave confidential inside information to his brother
who then passed it on to their future brother-in-law, Salman.

The court said this: “By disclosing confidential information as a gift to
his brother with the expectation that he would trade on it, [the tipper]
breached his duty of trust and confidence to [his employer].” The court
then said that the trading brother-in-law acquired the duty and breached
himself by trading “on the information with full knowledge that it had been
improperly disclosed.”
Yet the court answered the question in a narrow way, as it so often does,
by focusing on a family member or close friend who might be given
a gift of information for trading. It is not so clear that any subsequent
trades from other types of interactions would break the law set out by Dirks
and Salman.
MISAPPROPRIATION
The SEC has been pursuing another angle—the misappropriation theory—to

try to close some gaps in the classical theory. It tried to use it in Chiarella,
but the Supreme Court declined to hear the argument back then because it
had not been presented earlier to the jury when the case was at the trial court
level. Finally, in 1997, the court considered this theory directly in a case called
United States v. O’Hagan.
The case involved an unethical attorney named James O’Hagan. O’Hagan

was a partner at a large law firm in Minneapolis. He had embezzled millions
from a pool of funds that the law firm held in trust for several of its clients.
However, O’Hagan had an idea for repaying these funds before his theft was
discovered.
Late one night, he decided to prowl around his law firm, poking into the
offices of his partners to try to find some useful information. He soon found
this information: One of his partners was helping a company called Grand
Met develop a buyout offer for the Pillsbury Company.

O’Hagan figured that the stock price of Pillsbury would go up when the
buyout offer was announced, so he purchased a huge amount of stock and
some options to buy Pillsbury stock in the future. He soon became the largest
owner of Pillsbury options in the world. When the deal became public, the
price of Pillsbury’s stock nearly doubled, and O’Hagan netted over $4.3 million
in profits—more than enough to conceal his earlier embezzlement.
When the SEC noticed that the largest Pillsbury option holder happened to be
a partner at the law firm that advised Grand Met on the buyout, it decided to
go after O’Hagan for insider trading. However, under the traditional theory,
O’Hagan’s actions didn’t seem to violate the law. He was not an insider at
Pillsbury, which was the company whose stock was traded. Although the
law also treats lawyers and other professional advisers as temporary insiders
when they get confidential information from their clients, O’Hagan was not
working on the Grand Met buyout. Even if he was, it was Pillsbury’s stock
that he purchased.
The SEC needed to use a misappropriation theory. It argued that 10b-5’s

prohibition on “deception … in connection with a trade” could be satisfied
by stealing or misappropriating information from one company and using
it to trade stock in another. This might be a bit of a stretch for the language
of 10b-5, but the Supreme Court accepted the theory, and misappropriation
is now illegal.
Suggested Reading
<< Dirks v. Securities and Exchange Commission.
<< Securities and Exchange Commission v. Texas

Gulf Sulphur Co.
<< United States v. O’Hagan.

Lecture 10
CORPORATE CONTROL
BATTLES AND THE LAW
T
his lecture explores internal shareholder fights for control. The lecture
covers how they work, what rules can tilt the balance of power, and how
a shareholder might still influence corporate activity even if he or she
cannot fully vote out the current board.
FIGHTS IN SMALL FIRMS
Control battles spring up at firms of all sizes, but they can be especially
contentious in smaller firms where the shareholders sometimes have
personal relationships with one another. For example, take the case of Ringling
Bros.-Barnum & Bailey Combined Shows v. Ringling. The most famous circus
in the world had a brutal shareholder control battle in 1947 that continues to
be studied closely by law students today.
The Ringling family started its circus back in 1882, and it bought out the
Barnum & Bailey in 1907. The circuses eventually combined and grew into
an enormously popular form of entertainment.
By 1936, the last original brother has passed away, and control was split into
a trio of different family groups. There were 1,000 total shares of stock. Group
1, headed by Edith Ringling, held 315 shares. Group 2, headed by Aubrey Haley,
held 315 shares. Group 3, headed by John North, held the remaining 370 shares.
During the economic struggles of the Great Depression, North negotiated

a $1 million loan from a bank and used this capital to keep things going.
As a condition of the loan, the bank demanded that all three factions set up
something called a voting trust.

A voting trust is an agreement in which the shareholders temporarily transfer
their stock to a separate legal entity, known as a trust. The trust will then vote
all the shares together under the terms of the trust agreement.
There were seven total director slots on Ringling Brothers’ board. The terms
of the trust dictated that family members from groups 1 and 2 would receive
three director slots and family members from group 3 (John North’s group)
would also receive three director slots. The bank would appoint the last
director. Thus, John North, with three seats, plus the bank, with one seat,
could outvote the other three directors on any decision.
With this deal in place, the $1 million came in from the bank, and John
North saved the circus from financial ruin. However, the other two family
groups soon grew to resent this arrangement. When the trust expired in 1943,
Edith Ringling and Aubrey Haley decided that they wanted to set up a different
voting arrangement to wrest control of the circus back from John North.
A CIRCUS DISASTER
Ringling and Haley realized that if they committed to voting together, they
could elect five out of the seven directors. They consulted with their lawyer
who said that the best way for them to commit to voting with each other was
to set up a new voting trust, with just their 630 shares.
After the two pushed back, their lawyer then recommended an alternative
idea, known as a vote pooling agreement. This was a contract in which they
agreed to vote with each other during director elections. With this new deal
in place, group 1 and group 2 grabbed back control of the board and took
over the circus.
Again, the year was 1943, and the United States was in the middle of World
War II. The new leadership team soon faced a tough decision: The circus
could no longer obtain flame-retardant canvas because it was needed for the
war effort.
Lecture 10–Corporate Control Battles and the Law 71

North, who was still a minority board member, counseled that they should
shut operations down until flame-retardant canvas was available. However,
John was no longer in control, and the rest of the family decided to press ahead
using normal canvas for the circus tents.
On July 6, 1944, the circus held an afternoon performance in Hartford,

Connecticut. Flames leaped to engulf a circus tent, spreading rapidly because
a mixture of paraffin wax and gasoline had been used to waterproof the canvas.
Two exits were blocked by chutes used to bring lions in and out of the ring.
In the end, 167 people died and more than 700 were injured. It remains one
of the worst fire disasters ever in the United States.
As the authorities investigated, they decided to charge some Ringling

employees with involuntary manslaughter. One of these defendants was James
Haley, the husband of group 2’s leader, Aubrey Haley. He was convicted,
allegedly without much support from group 1.
THE GROUPS GO TO COURT
Just a year or two after striking a voting deal with group 1, the family in group
2 was no longer interested in working with this side of the family whom they
felt treated James Haley so poorly. In 1946, group 2 decided to break their
deal with group 1 and rejoin John North and group 3.
They cast their shares together, and the new faction received five directors.
Group 1 then sued, arguing that group 2 had to vote with them under the
terms of their vote-pooling contract. The case presented an interesting clash
of corporate law and contract law.
Ultimately, the Delaware Supreme Court upheld the legality of the pooling
contract but said that the court would not order group 2 to vote in a specific
way. Instead, it annulled all the votes cast by this group. This actually had the
effect of giving John North’s group and group 1 a 3-3 tie, but by the time
the case was actually decided, the company was ready for another shareholder
vote, and groups 2 and 3 could take back over.

The moral to this story is that voting trusts and vote-pooling agreements are
OK, but they have limits. Many shareholders are nervous about pre-committing
to vote in a certain way or with another group, and that is not an irrational
fear. As the circus case illustrates, things can change.
PROXY FIGHTS
In larger corporations, shareholder control battles often play out with proxy
fights. Here is how it works: Imagine a shareholder of a company, named
Elizabeth in this example, does not like the
current board of a company. A few months
before the next annual meeting, when ONLINE PROXY
shareholders will vote on the company’s VOTING
directors, Elizabeth could announce that she
will be promoting a rival slate of directors. Many companies run
corporate elections via
All shareholders who agree with her vision the internet. If you have
of the firm’s best strategy can then support a broker, you might have
her slate of directors over the incumbents. If received emails from him
her group gets enough votes, it will take over or her telling you that firm
the board and start running the company. materials are ready for your
review. Any rival team will
One important consideration relates to the need to develop its own
number of votes needed to win a board proxy materials, which are
election. The rules for each corporation detailed and highly regulated
will be set in the firm’s bylaws, but many by federal law. If you like the
firms use plurality voting. This means that rival team’s candidates more,
whoever receives the most votes wins—even then you can send your
if the candidate does not obtain a majority. proxy materials in to them.
If you want to change your
Proxy fights can become very expensive. vote after you have sent your
Both sides will usually need to hire advisors materials in to one team, you
and lobbyists to argue their cases to the other can usually just submit a new
shareholders. In highly contested fights, this proxy to the other team—as
can run into millions of dollars. Accordingly, long as you do this before the
one of the key considerations in proxy fights voting is closed.
involves who pays for the expenses.

The cases of Levin v. Metro-Goldwyn-Mayer, Inc. and Rosenfeld v. Fairchild
Engine & Airplane Corp. have shaped how payment in these cases work. To
sum up, assuming the debate relates to a matter of policy and that the expenses
are reasonable, the firm may reimburse incumbents, win or lose. It may also
reimburse challengers, but only if they win and the shareholders ratify this
payment
This clearly offers an advantage to incumbents, who can escalate control battles
without the risk of pulling out their own wallets. However, it is difficult to
design a better rule. If there were
no reimbursement for anyone,
then it might undermine the NELSON PELTZ
interest and ability of qualified
managers to serve on a board. A person does not need to run a proxy
contest for the entire board. An activist
If automatic reimbursement shareholder named Nelson Peltz, for
were available for all sides, example, has held very public proxy
win or lose, then thousands of contests at many companies, including
insurgent groups may spring DuPont and Procter & Gamble, for
up to use the corporation’s a limited number of board seats.
resources to throw so-called
campaigning parties.
THE SHAREHOLDER PROPOSAL
The shareholder proposal is one other legal option that a shareholder might
use to influence managerial decision making. A shareholder proposal is
the legal mechanism for invoking broader participation in a firm’s activity.
A shareholder can put a proposal on the firm’s proxy statement so all the
shareholders can vote on whether they want to support it. The political analogy
is a voter proposition that seeks to amend the state constitution or present
some other issue for a popular referendum.
The rules for getting something on the ballot are relatively strict. Shareholder
proposals are mostly governed by federal law, not state law, because they appear
on a firm’s proxy statement, which is a field covered by the 1934 Securities
Exchange Act.

When a company receives a proposal, it has a choice. It might just add it to
the proxy, but often managers want to resist shareholder intrusion on decision
making. Under federal law, there are more than a dozen different reasons why
insider managers can reject a shareholder’s proposal.
For example, the board can exclude a proposal that is illegal or one that
is beyond the firm’s power to bring about. Additionally, one of the most
important federal provisions says that a firm can exclude a shareholder
proposal that relates “to the company’s ordinary business operations.”
In many cases, a firm may not know for sure whether an exclusion applies,
but it can write to the SEC for clarity. A firm can do this by drafting a request
for a no-action letter to the SEC.
The SEC will study the proposal, the law, and the firm’s arguments for why
the proposal should be excluded. It will then do one of three things: issue
the no-action letter, refuse to issue the letter, or say that it will do nothing
at present.

If the SEC refuses to issue the letter, then the company will probably add the
proposal and let shareholders vote on the issue. Conversely, if the company
obtains a no-action letter, then it will probably exclude the shareholder
proposal. The angry shareholder might still file a lawsuit seeking a federal
court order to get the proposal added.
Suggested Reading
<< Levin v. Metro-Goldwyn-Mayer, Inc.
<< Ringling Bros.-Barnum and Bailey Combined

Shows v. Ringling

Lecture 11
CORPORATE
LAW OF MERGERS
AND ACQUISITIONS
M
ergers and acquisitions are extreme events in the life of
a corporation. This lecture takes a close look at merger and
acquisition activity. Corporate law has adopted special rules to deal
with these extraordinary events.
TERMINOLOGY
Many people use the terms merger and acquisition synonymously. Sometimes,
a merger is used to refer to something called a merger of equals, where two
similarly sized firms come together. An example of this is the combination
of Daimler and Chrysler in 1998.
However, mergers of equals are rare, and it is more common for one larger
firm to take over a smaller company. In the Keurig/Dr Pepper deal, for
example, Dr Pepper shareholders wound up with only 13 percent of the
combined company, while
Keurig shareholders received
87 percent of the shares. REASONS FOR MERGING
A deal like Keurig/Dr Pepper Companies can merge for many reasons.
might be called either a merger Perhaps a small firm has discovered
or an acquisition. This was a new technology that the buyer wants to
a friendly deal, where both access and control. Alternatively, perhaps
parties thought it made sense. a corporation wants to buy a company in
Sometimes, there occurs a different industry to serve customers in
a hostile situation where some new or better way. Another reason
the target does not want to can be that two competing companies
be bought. These are almost in the same industry might want to join
always called acquisitions (not forces to become bigger, which is known
mergers). as a horizontal
merger.
BUSINESS SYNERGIES
From a strategic standpoint,

two merging firms will
usually want to obtain
business synergies. The firms
hope to get more out of the
combination than either firm
could get on its own.

Merger synergies are sometimes divided between cost synergies and revenue
synergies. Cost synergies occur when the combined firm can cut out
redundancies. Revenue synergies are different, in that the firms seek to boost
sales with newly opened markets and products.
EXECUTING THE DEAL
At a high level, mergers generally involve four steps. First, the firms will engage
in strategic planning where they sketch out a rationale for the merger. Second,
they will conduct negotiations about the buyout price, leadership issues, and
other key considerations. Third, they will form a contract and execute the
deal. Fourth, they will try to pull off the goals of the merger by implementing
the deal, a process known as post-merger integration. Lawyers can become
involved in each of these stages, but they usually play their biggest role in the
middle two steps: negotiation and execution.
STRUCTURING A MERGER
Legally, a firm will have several different options for structuring a merger.
For instance, corporate law provides for something called a statutory merger.
Two firms conducting this type of deal will file a plan of merger with the state
authorities. Among other details, this sets out what the shareholders of each
company will get when the deal is over.
Under most state laws, the boards at both firms and the shareholders at both
firms all need to vote their approval. For friendly deals, this may not be
difficult, but there can be situations where selling shareholders are unwilling
to go along.
In other cases, the shareholders may want to do the deal, but the board will
resist. In a case like this—where the target’s board resists, but the firm’s
shareholders seem willing—then the acquiring firm can propose a different
legal structure called a stock purchase deal.
Lecture 11–Corporate Law of Mergers and Acquisitions 79

Under this arrangement, the buying firm makes an offer, called a tender
offer, directly to the target firm’s shareholders. Because there is no need for
target board approval, this makes tender offers a common method for hostile
deals. On the buyer side, board approval is needed, but shareholder approval
may not be necessary because corporate laws do not always require this in
a stock purchase (unlike the statutory merger structure).
The third type of merger is an asset purchase deal. This is an arrangement

where a buyer agrees to purchase the target’s assets for a certain price. The
target can keep the purchase payment or may simply distribute everything
to its shareholders and dissolve. Board approval is needed at both firms,
and approval from the target shareholders is also required if the firm is
selling substantially all of the assets. Buyer shareholder approval is not
usually needed.
APPRAISAL RIGHTS
Depending on how the deal is structured, a minority shareholder who disagrees

with a merger may have something called appraisal rights. In corporate
law, appraisal statutes permit minority shareholders to dissent against
a merger, file a lawsuit, and receive the judicially determined fair value of
their shares. The doctrine dates from the early 1900s, when state lawmakers
granted appraisal rights to shareholders in exchange for an easing of merger
voting requirements.
Lawyers will sometimes try to structure a merger to eliminate appraisal rights.

One good example of this can be seen in the 1963 Delaware case of Hariton v.
Arco Electronics. Arco and another company named Loral Electronics Corp.
were both in the electronics industry. They decided to do a deal where Loral
would acquire Arco.
Both boards approved the deal, and most shareholders seemed happy as well.
However, the planners worried about some dissenting shareholders at Arco
who might object and file an appraisal lawsuit.

If they used a statutory merger, then dissenting shareholders would indeed be
entitled to seek appraisal. They decided to do an asset sale deal instead. Arco’s
board agreed to sell the firm’s assets to Loral for 283,000 shares of Loral stock.
It then called a shareholder meeting to approve the deal. About 80 percent of
the shareholders voted yes, and the merger went through.
Soon thereafter, Arco dissolved itself and distributed all the Loral stock (which
it now held) to the Arco shareholders. The effect of this was almost the exact
same as a statutory merger. However, because dissenting shareholders in an
asset sale structure did not receive appraisal rights under Delaware law, Arco
hoped to avoid the risk of a lawsuit on that issue.
THE DE FACTO MERGER DOCTRINE
The plaintiff Hariton was furious. He felt his company had undermined him
by structuring the deal to remove appraisal. He filed a lawsuit under the de
facto merger doctrine, arguing that this was really a statutory merger and that
he should therefore get appraisal rights.
The Delaware Supreme Court disagreed. It stated:
We now hold that the reorganization … is legal. This is so because

the sale-of-assets statute and the merger statute are independent of
each other. They are, so to speak, of equal dignity, and the framers of
a reorganization plan may resort to either type of corporate mechanics
to achieve the desired end
Under this holding, known as the rule of independent legal significance, the
plaintiff was out of luck.
From a practical perspective, this means that lawyers can often structure
mergers to avoid appraisal lawsuits. Some people have used this fact to
conclude that corporate law is often ridiculous. However, appraisal law has
rebounded in recent years because corporations may need to worry about
other considerations. For example, an asset purchase, like the one in Hariton,
may lead to a higher tax bill, so the planners might prefer to risk appraisal
lawsuits to paying more in taxes.

FREEZEOUT MERGERS
This lecture concludes with a special type of merger known as a freezeout

merger or a cash-out merger. Imagine the following situation: Your favorite
NFL football team, in this example the New England Patriots, is a public
corporation also known as Patriots Company. The owner of the team holds 70
percent of the shares and elects all the board members. The other 30 percent
of shares are distributed widely among investors and fans.
You and your family have owned some shares for decades. It is not a huge
stake, but you are proud to say that you are a co-owner of the team. One
fateful day, however, the Patriots’ owner decides that he wants to own all the
shares of the Patriots.
He sets up a new corporation called Better Patriots Company. Mr. Greedy

invests $10 million in cash in this new company and takes 100 percent of its
stock. He also appoints all the board members. Then, he decides to execute
a statutory merger between the Patriots Company and the Better Patriots
Company All the shareholders of Patriots Company will get $10 per share in
the merger. All the shareholders of Better Patriots Company will get a share
in the continuing firm.

The Patriots’ owner will own 100 percent of the football team, and you
and all the other minority shareholders will be cashed out at $10 per share.
Will this deal get approved? Perhaps. The owner controls the board at both
companies. He owns 100 percent of Better Patriot Company’s stock and 70
percent of Patriot Company’s stock, so a positive shareholder vote at both
firms is guaranteed. The owner has conducted a cash-out merger, and you
are the one being cashed out.
DEALING WITH FREEZEOUTS
It does seem a bit strange however, to allow the owner to set the price at which
you must sell him your shares. One legal approach to dealing with this might
be to prevent or limit a controlling shareholder’s ability to conduct cash-out
or freezeout mergers.
This was the strategy taken in Delaware for a short period of time: From
1977 to 1983, the court required majority owners to demonstrate that
a freezeout merger served a “valid business purpose.” Naked plots to take
over a firm were forbidden. However, this type of standard is exceptionally
difficult to administer, and the business purpose rule was quite sensibly
abandoned.
A second legal approach might be to require unanimous shareholder approval

for freezeout mergers. However, assigning this much power to minority
shareholders can lead to a holdout problem.
Yet, despite the gut reaction that something improper is occurring, there
is a justifiable rationale for using these transactions to break the holdout
problem described above. Not all freezeout transactions are legally sanctioned
theft. There are legitimate reasons to conduct these deals. For example,
a majority owner who does business with the firm may run into conflicts
of interest with contract pricing. Taking full ownership will eliminate
these conflicts.

In recent times, lawmakers have relied on three loosely related requirements
to strike a balance here. First, controlling shareholders have an obligation
to provide various disclosures to minority shareholders during a freezeout
transaction. Second, minority investors can pursue appraisal claims if they
believe that the price of the deal is unfair.
Finally, freezeout transactions can be challenged via fiduciary duty lawsuits

by minority owners. After all, this is a self-dealing transaction where the
controlling shareholder is involved in the purchase. A freezeout statutory
merger might lead to an intrinsic fairness review.
Yet most controlling shareholders are nervous about having their deal reviewed
under such an intrusive legal standard. The law offers an alternative. First,
Patriots Company could set up a special committee of disinterested directors
to make decisions about this deal. Second, it could subject the deal to approval
by a majority of the minority shareholders.
In other words, the owner would not vote at all, and more than half of the 30
percent minority shareholders would need to approve the buyout. If structural
protections like this are put in place, then the deal decision will enjoy the
protection of the business judgment rule—a highly deferential standard.
Suggested Reading
<< Hals, “Court Reverses Dell Buyout Ruling That
Alarmed Dealmakers.”
<< Hariton v. Arco Electronics, Inc.

Lecture 12
HOSTILE TAKEOVERS,
DEFENSES, AND
THE FUTURE
T
his lecture focuses on hostile takeovers and defenses against them.
Corporate law recognizes that mergers are extreme events, and it often
imposes a high standard of behavior on senior leaders of a target firm
that seeks to fend off a hostile takeover. To hone in on such situations, the
lecture looks at two cases in particular: Unocal Corp. v. Mesa Petroleum Co.
and Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.
BACKGROUND ON UNOCAL CORP. V. MESA
PETROLEUM CO.
By the 1980s, business magnate T. Boone Pickens had built his company, Mesa
Petroleum, into a hostile takeover firm. In 1981, he took over a company 30
times the size of Mesa. By 1985, Pickens was ready to take on one of the largest
oil companies in the country: Unocal Corporation.
Unocal launched a series of antitakeover defenses that would ultimately end up

in court. The resulting legal opinion, issued in 1985, established the modern
corporate law framework for deciding what a company can do to fight off
raiders like Pickens. Unocal Corp. v. Mesa Petroleum Co. is a famous case for
that reason.
Typically, the board and top managers of the target firm of a takeover do not
want to lose control of the company. However, the shareholders of the target
firm might not object. If the hostile raider can convince enough shareholders
to sell their stock, perhaps by dangling a large price in front of them, then
the raider can indeed take control of the company, fire the board, and execute
a new strategy.
The legal mechanism for hostile takeovers is usually something called a tender
offer. Someone like Pickens might buy up a small stake in the company. In the
Unocal case, for example, he had amassed 13 percent of the shares.
Then, he might make an open offer to buy the rest of the stock, conditional
upon having at least 37.1 percent of the total shares tender, or he might agree
to be bought out. If shareholders holding at least that percentage of shares
agree to sell to Pickens, the deal will close, and he will have majority control.
Because the target firm’s board does not have any say over whether each
shareholder decides to sell, they cannot automatically stop this transaction.
In the Unocal situation, Pickens did not make an open offer to all shareholders.
He was more devious. Pickens said that he would be willing to buy
approximately 37.1 percent of the stock for $54 in cash per share. (It was trading
around $46 at the time of the deal.)

If more than 37.1 percent of the shareholders tendered, then the right to sell
would be determined on a pro rata basis. (For example, if 74 percent of the
stock was tendered, then everyone could sell half their shares to Pickens for
the cash.)
Then, once he had majority control, he threatened to buy out the rest of the
shares, the back-end 49.9 percent of the stock, for $54 apiece in bonds with
a freezeout merger. However, the bonds would be junior to the company’s
other debt, making them junk bonds, so named because they have a higher
risk of default. Everyone recognized that $54 in junk bonds might actually
be worth much less than that amount.
UNOCAL’S RESPONSE
Unocal’s board saw what was going on, and it was extremely distressed. The
directors expected to be fired if Pickens took over, and they also thought
that Pickens was trying to grab the company for a cheap price. Their investment
bankers told them that the minimum price that shareholders could expect in an
orderly sale or liquidation was $60 per share. Pickens’s offer of $54 seemed
both inadequate and coercive.
One option for Unocal’s directors might have been greenmail—that is, offering
to buy Pickens’s 13 percent at a higher price, such as $60, to get him to move
on to another company. However, Unocal’s directors instead executed a self-
tender strategy. They offered to buy out the 49.9 percent of back-end shares for
$72, conditional upon the Pickens offer going through and excluding Pickens
from participation in the back-end offer.
Unocal’s self-tender would only kick in if 37.1 percent of the shareholders

tendered into Pickens’s offer. However, the idea was that no one would
tender into a $54 offer when they can just hold out and wait for the $72 self-
tender. At the end of the day, nothing happens: Nobody sells shares to Pickens,
the board’s $72 cash offer is never triggered, and the price of Unocal shares
stays at $46. That may seem like a lousy deal for shareholders, but it was a way
for the board and current managers to keep their positions without having
to buy any shares.
Lecture 12–Hostile Takeovers, Defenses, and the Future 87

Eventually, enough large shareholders complained about this to Unocal’s
board. When they threatened to support Pickens in a proxy fight to elect
a new board, Unocal dropped the condition that Pickens’s offer go through.
In other words, it would just make a large buyout for 49.9 percent of the shares
at $72 per share, but exclude Pickens.
THE CASE IN COURT
Pickens sued to prevent Unocal’s move, and the resulting case established
the new legal standard for determining whether a given hostile takeover
defense is legal. The Delaware Supreme Court said that a board had to prove
two things.
First, it must show that the defense it employs was enacted in good faith
and after a reasonable investigation. Second, it must show that the defense
is proportional or reasonable in relation to the threat posed. In the case, the
court determined that Unocal’s defense was acceptable.

Given the effectiveness of the discriminatory self-tender strategy, one might
think that this has become the gold standard for antitakeover defenses.
However, the SEC recognized the checkmate aspect of this defense and its
potentially negative impact on shareholders. It demonstrated its disapproval
by quickly enacting a new rule that prohibited issuer tender offers not made
to all shareholders. Accordingly, defending firms and their advisors have been
forced to create new antitakeover defenses. Like the old ones, these, too, must
meet Unocal’s legality standard.
TRENDS TO WATCH FOR
Here are five topics in corporate law worth keeping an eye on in the
coming years:
1. Lawmakers are likely going to continue tinkering with the duties that
directors owe to their firms, especially in the area of oversight and
monitoring.
2. We may see new frameworks in the law for evaluating or limiting

executive compensation. There might also be more laws or standards
for clawing back senior-leadership pay when things do not go so well at
a corporation.
3. It is worth watching the balance of power between a firm’s directors

and its shareholders. Directors often call most of the shots, but activist
shareholders are starting to influence corporate activity to a greater extent.
4. We may continue to see changes in the types of activities that are legally
permissible for corporations. Examples may involve religious liberty
protections, political activity, and speech rights.
5. Finally, it is always worth watching whether the source of corporate laws

changes, and if so, how and why. State statutes and case law provide the
majority of rules, but federal lawmakers have also weighed in for some
areas of corporate activity, such as securities regulation.

BACKGROUND ON REVLON, INC. V. MACANDREWS &
FORBES HOLDINGS, INC.
Another major development came with a different case decided just a year
after Unocal: that of Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. This
case establishes a second key legal standard for hostile takeovers.
This case involved an investor named Ron Perelman. Over the years, Perelman
had kept his eye on the cosmetics company Revlon. Eventually, he decided
to pounce. Revlon’s shares had been trading in the $35–$40 range. Perelman
hired a famous takeover lawyer at the law firm of Skadden Arps, and he set
up a meeting with Revlon’s CEO—a man named Michel Bergerac.
At the meeting, Perelman expressed interest in buying Revlon for a price in

the $40 to $50 range. Bergerac dismissed the offer as too low. In its opinion,
the court surmised that this refusal was also “perhaps in part based on
Mr. Bergerac’s strong personal antipathy to Mr. Perelman.”
As Perelman continued his overtures, threatening a hostile takeover at $45

per share, Bergerac decided to bring in some big guns to help with Revlon’s
defenses. He hired Marty Lipton, one of the premier lawyers in the area, along
with several prominent investment bankers. The bankers reviewed Revlon’s
business and concluded that $45 per share was a grossly inadequate price for
the company. They estimated that just breaking up the company and selling
it off would net $60 to $70 per share.
This finding meant that Bergerac could deem Perelman’s overtures as

inadequate and dangerous to shareholders, and justify defensive measures
under the Unocal standard. Following Lipton’s advice, Revlon adopted
something called a poison pill.

POISON PILLS
Poison pills change the circumstances facing a potential hostile acquirer by

causing something good to happen to all shareholders except the raider if
the pill is triggered. For example, a pill could give all the other shareholders
the right to receive another share of stock for free. This right would only kick in
if someone should happen to buy, for instance, 20 percent or more of the stock.
If the pill is triggered and takes effect, the raider is not allowed to receive the
free shares. This means that the raider’s ownership share is diluted because
the other shareholders now own twice as many shares of stock. Importantly,
however, the target’s board can redeem or get rid of the pill if it decides that
this antitakeover defense is no longer in the firm’s best interest.
The effect of a poison pill, then, is to force most would-be raiders to negotiate
with the target firm’s board to get it to redeem the pill. The poison pill had
been judged legal in Delaware right before the Revlon case.
Perelman recognized that this was a real impediment. He raised his tender
offer a little, to $47.50 per share, but this was conditioned on Revlon’s removal
of the pill. He was trying to create shareholder pressure on Revlon’s board.
The firm’s directors brushed off Perelman, and they implemented a couple
other antitakeover defenses.
Perelman kept raising his offer price, first to $50, then to $53, and finally to
$56.25. As the pressure on Revlon’s board grew, the company decided to look
for a white knight—that is, another potential buyer who might be willing to
take over the firm while also behaving in a more friendly way toward the
current directors or managers.
Revlon’s white-knight plan seemed to work. The company found a friendly

buyout firm named Forstmann Little and induced them to make a bid
for Revlon with some favorable terms. With these inducements in place,
Forstmann was willing to make a nice buyout offer of $57.25 per share—just
above Perelman’s offer.

PERELMAN SUES
Perelman then decided to sue Revlon, subjecting the firm’s defensive efforts to
new legal scrutiny. After an extensive review, the court said that Revlon’s
early antitakeover defenses were OK because they met the two-tiered test
that was established in the Unocal case. However, the later defenses that tilted
the playing field heavily towards Forstmann were not OK. The firm had gone
too far.
The court explained that the “The Revlon board’s authorization permitting
management to negotiate a merger or buyout with a third party was
a recognition that the company was up for sale.” Recognizing that the company
was up for sale made the directors’ role change from being “defenders of the
corporate bastion to auctioneers charged with getting the best price for the
stockholders at a sale of the company.”
With this in mind, the court found that the final measures taken by the board
went too far because they essentially amounted to a showstopper. Without
these favorable offerings to Forstmann Little, Perelman might have been
willing to bid even higher. The board had not sought to get the highest price
and therefore had not met what have become known as its Revlon duties.
Unocal and Revlon, then, offer bookends for much of the law relating to hostile
takeovers and antitakeover defenses. If a situation is unclear, then a raider
will try to argue that the higher Revlon standard has been implicated and
that a firm’s defenses go too far. The firm, by contrast, might try to argue
that it is still within the Unocal standard of review and that everything is
a reasonable and proportionate response. Some lawyers have made careers
working in this area of law.
Suggested Reading
<< Revlon, Inc. v. MacAndrews & Forbes
Holdings, Inc.
<< Unocal Corporation v. Mesa Petroleum, Inc.

QUIZ
1. Which of the following statements is accurate?
A. Bond investors are typically allowed to vote on director elections.
B. Shareholders typically vote on whether a corporation will make new
dividend payments.
C. Bank lenders are typically considered the residual holders (or ultimate
owners) of a corporation.
D. None of the above.
2. What is the primary source of corporate law in the United States?

A. Mostly state laws with an occasional contribution from federal laws.
B. Mostly federal laws with an occasional contribution from state laws.
C. Mostly international law.
3. What are the legal requirements to create an agency relationship?

A. An agency relationship is formed by an agreement that the agent will
serve as an employee for compensation.
B. An agency relationship is formed by agreement that the agent shall act
on behalf of the principal and be subject to his or her control.
C. An agency relationship is formed by an agreement that the agent
and the principal will go into business together and share the profits.
Quiz 93
4. After an agency relationship is created, what legal implications follow?
A. The agent may bind the principal to a third party in contract law.
B. The principal may be responsible for the torts of the agent.
C. The agent may owe the principal heightened legal duties.
D. All of the above.

A. Corporations were first established in the early colonial United States.
B. Corporations are usually entitled to make charitable contributions.
C. One of the benefits of a corporation is that profits paid to investors
are only taxed once.
6. Piercing the corporate veil allows a third-party plaintiff to do the

following:
A. Obtain private information about the corporation’s recent operating
activities.
B. Sue the firm’s senior managers for breach of fiduciary obligations
to the firm.
C. Recover directly from the equity investors of a corporation in
a lawsuit.
7. A corporation seeking to influence the political process may not engage

in which of the following activities?
A. Lobbying.
B. Contributing to a political action committee.
C. Contributing directly to a political candidate.

8. Which statement correctly describes the application of the business
judgment rule in corporate law?
A. Corporate directors are not normally subject to liability for a failed
business outcome so long as they satisfy their fiduciary duties.
B. Corporate directors are not normally subject to liability for a failed
business outcome so long as their business judgment is deemed
reasonable under the circumstances.
C. Corporate directors are not normally subject to liability for a failed
business outcome so long as a court agrees with the soundness of
their business judgment.
9. The case of Smith v. Van Gorkom was so important in corporate law

because of which reason?
A. It established that courts will not second-guess mindful decisions
by a firm’s board of directors.
B. It annulled the duty of care for corporate directors in Delaware.
C. It seemed to increase a board’s duty of care for corporate directors
in Delaware.
10. If a CEO enters into a personal contract with his or her corporation,
then which of the following results will follow?
A. The transaction will be understood as self-dealing but can still be
legally OK if it is fair to the corporation.
B. The transaction will be understood as self-dealing and is legally void
under the duty of loyalty.
C. The CEO may be fired within the next three months by a majority
vote of the shareholders.
Quiz 95
11. What is the business opportunity doctrine in corporate law?
A. A legal rule stating that the board must voice its approval of new
business opportunities before a firm may move forward with an
extraordinary investment.
B. A legal rule stating that directors and top corporate officers need
to consider new business opportunities carefully before a firm may
move forward with an extraordinary investment.
C. A legal rule stating that directors and top corporate officers need
to present new business opportunities to the firm and may not take
these opportunities for themselves.
12. What are the three primary fiduciary duties of directors in corporate
law?
A. Duty of care, duty of loyalty, and duty of good faith.
B. Duty of loyalty, duty of frugality, and duty of monitoring.
C. Duty of good faith, duty of oversight, and duty of avarice.

A. If a CEO earns more than 300 times the compensation of a median
employee, then a corporation will have presumptively violated the
waste doctrine.
B. Judges often rule that a pay package for a senior executive is excessive
and adjust the firm’s compensation to more reasonable levels.
C. Public outcry over high levels of executive compensation have grown
so loud that federal lawmakers have stepped in to set maximum
compensation levels for corporations that must file reports with
the SEC.

14. Under Delaware law, stockholders may keep control of a derivative
lawsuit under which of the following circumstances?
A. Demand is excused because a majority of directors are self-interested
in a transaction at issue.
B. The firm tries to take control of the litigation with a special
committee, and this committee is comprised of an independent
director who makes a thorough investigation.
C. Under any circumstances, because shareholders always keep control
of derivative lawsuits.
15. The US Congress enacted federal laws relating to corporate activity

after which historical event?
A. The stock market crash of 1929 and the resulting Great Depression.
B. The Enron and WorldCom accounting scandals in the early 2000s.
C. The financial crisis of 2007–2008.
16. Which of the following statements best describes the doctrine of fraud
on the market?
A. Managerial fraud at one corporation dissuades potential investors
from investing in other corporations due to concerns that the entire
market is corrupted.
B. Because the price of a company’s stock is determined by the available
material information regarding the company, misleading statements
defraud purchasers of stock even if the purchasers do not directly
rely on the misstatements.
C. The risk of fraud is already priced into stock prices, so specific
instances of fraud are unlikely to harm diversified investors.
Quiz 97
17. Which of the following actions are not illegal under insider
trading laws?
A. You learn about an upcoming buyout offer at your corporation
and buy 1,000 shares before the deal is announced.
B. You learn about plans to increased purchases of oil at
your firm and buy several thousand barrels of oil on the open market.
C. You uncover secret plans at your company to buy another corporation
and buy 1,000 shares of that other corporation before the deal
is announced.
18. Is a tippee who trades on material nonpublic information given to him

or her by an inside employee liable for insider trading?
A. Always.
B. Never.
C. Only if the tippee pays for the inside information.
D. Only if the insider receives a personal benefit and the tippee
knows about this benefit.

A. During a proxy fight for corporate board control, the firm is not
entitled to pay for any costs relating to the election battle.
B. During a proxy fight for corporate board control, the firm may wind
up paying the costs of both sides in the election battle.
C. Corporate proxy fights are no longer used because apathetic
shareholders rarely vote their shares for either side.

20. Shareholders who dislike a merger buyout price are entitled to do
which of the following?
A. Launch a competing bid to buy out the other shareholders.
B. File a lawsuit seeking appraisal of the share’s value.
C. Grumble about the lousy corporate managers to their spouse.
21. Under the Unocal standard, an antitakeover defense must generally

meet the following legal requirements to be permissible as a matter
of law:
A. It is fair, does not waste the corporation’s assets, and serves as
a meaningful deterrent to consummation of the deal.
B. It is reasonable, easy for the average shareholder to understand, and
leaves the firm open to competing takeover bids.
C. It is enacted in good faith after a reasonable investigation and
is proportionate to the threat posed.
QUIZ ANSWERS ON PAGE 106
Quiz 99
BIBLIOGRAPHY
BOOKS AND ARTICLES
Allen, William T., and Reiner Kraakman. Commentaries and Cases on the
Law of Business Organizations. 5th ed. Wolters Kluwer, 2016. A casebook with
emphasis on theoretical implications of corporate law.
American Law Institute. Restatement of the Law of Agency, Third. 2006. An

authoritative synthesis of agency law in the United States.
Apple press release. “Dr. Eric Schmidt Resigns from Apple’s Board of Directors.”
August 3, 2009. Available: https://www.apple.com/newsroom/2009/08/03Dr-
Eric-Schmidt-Resigns-from-Apples-Board-of-Directors/
Bainbridge, Stephen M. Agency, Partnerships and LLCs (Concepts and Insights).

2nd ed. Foundation Press, 2014. A prose overview of agency law.
———. Corporate Law (Concepts and Insights). 3rd ed. Foundation Press, 2015.
An excellent and readable prose overview of corporate law.
———. Mergers & Acquisitions (Concepts and Insights). 3rd ed. Foundation
Press, 2012. Overview of M&A laws.
Barstow, David. “Wal-Mart Hushed Up a Vast Mexican Bribery Case.” The

New York Times, April 12, 2012. Reporting on allegedly bribery at the firm.
Choi, Stephen J., and A. C. Pritchard. Securities Regulations: The Essentials.

Aspen Publishers, 2008. Overview of securities law in the United States.
Davis, Alyssa, and Lawrence Mishel. “CEO Pay Continues to Rise as

Typical Workers Are Paid Less.” Economic Policy Institute, June 12, 2014.
Compensation ratio analysis.

Geis, George T. “J. Fred Weston & the Origin of Synergy.” M&A Professor.
Available: http://maprofessor.blogspot.com/2009/07/j-fred-weston-origin-
of-synergy.html.
Goldstein, Matthew. “Elon Musk Steps Down as Chairman in Deal With

S.E.C. Over Tweet About Tesla.” The New York Times, September 29, 2018.
Reporting on the legal problems caused by Musk’s Twitter post.
Hals, Tom. “Court Reverses Dell Buyout Ruling that Alarmed Dealmakers.”
Reuters, December 14, 2017. Describes Delaware Supreme Court decision
overruling the Delaware Court of Chancery’s finding that Dell buyout was
underpriced.
Jensen, Michael C., and William H. Meckling. “Theory of the Firm: Managerial
Behavior, Agency Costs and Ownership Structure.” Journal of Financial
Economics, October 1976. Seminal academic article discussing the agency
cost problem.
Keurig press release. “Dr Pepper Snapple and Keurig Green Mountain to
Merge.” January 29, 2018. Available: https://news.keuriggreenmountain.com/
press-release/business/dr-pepper-snapple-and-keurig-green-mountain-merge-
creating-challenger.
Klein, William A., J. Mark Ramseyer, and Stephen M. Bainbridge. Agency,

Partnerships, LLCs, and Corporations: 2018 Statutes and Rules. Foundation
Press, 2018. Curated portions of the most important statutory sources of law,
including state codes and selected SEC rules.
———. Business Associations. 10th ed. Foundation Press, 2018. A comprehensive

casebook containing many of the cases discussed in these lectures.
Klein, William A., John C. Coffee, and Frank Partnoy. Business Organizations
and Finance. 11th ed. Foundation Press, 2010. A business-oriented treatment
of the law in this area.
Bibliography 101
Manning, Bayless. “The Shareholder’s Appraisal Remedy: An Essay for Frank
Coker.” The Yale Law Journal, 1962. Author made this statement: “Corporation
law, as a field of intellectual effort, is dead in the United States.”
Micklethwait, John, and Adrian Wooldridge. The Company: A Short History

of a Revolutionary Idea. Modern Library, 2005. Brief overview of the history
of the corporation by two writers for The Economist.
Oral, Ronald. “Nelson Peltz Is in a League of His Own When It Comes to

Activist Investing.” The Street, May 15, 2018. Discussing proxy fights of Peltz.
Seidel, George. The Three Pillar Model for Business Decision: Strategy, Law,
and Ethics. Van Rye Publishing, 2016. Describing the background of the Ford
legal decision.
Stewart, James B. DisneyWar. Simon & Schuster, 2006. Detailed saga of Disney’s
corporate governance and management battles.
Taibbi, Matt. “The Great American Bubble Machine.” Rolling Stone, April
5, 2010.
The Financial Crisis Inquiry Commission. The Financial Crisis Inquiry

Report. 2011. Available: https://www.govinfo.gov/content/pkg/GPO-FCIC/
pdf/GPO-FCIC.pdf
Winker, Adam. We the Corporations: How American Businesses Won Their

Civil Rights. Liveright, 2018. Examining the development of corporate first
amendment rights, include those granted by the Supreme Court in Citizens
United and Hobby Lobby.

CASES
A. P. Smith Manufacturing Co. v. Barlow, 98 A.2d 581 (N.J. 1953). Princeton

charity case.
Basic Inc. v. Levinson, 485 U.S. 224 (1988). Supreme Court accepts fraud on
the market.
Bayer v. Beran, 49 N.Y.S.2d 2 (N.Y. Sup. Ct. 1944). Duty of loyalty case with
opera singing.
Cede & Co. v. Technicolor, Inc., 634 A.2d 345 (Del. 1993).
Chiarella v. United States, 445 U.S. 222 (1980). Printing company employee
not guilty of insider trading.
Dirks v. Securities and Exchange Commission, 463 U.S. 646 (1983).

Foundational case on tipping and insider trading.
Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919). Court second-guesses
board on dividends.
Francis v. United Jersey Bank, 432 A.2d 814 (N.J. 1981). Duty of care case
where director fails to attend meetings.
Hariton v. Arco Electronics, Inc., 188 A.2d 123 (Del. 1963). Alternative merger
structure OK to deny appraisal rights.
In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch.

1996). Raising good faith monitoring duties.
In re eBay, Inc. Shareholders Litigation, 2004 WL 253521 (Del. Ch. 2004).

Business opportunity doctrine with IPO spinning.
In re InfoUSA, Inc. Shareholders Litigation, 953 A.2d 963 (Del. Ch. 2007).
Alleged CEO self-dealing; court dismissed shareholder demand requirement
due to CEO control.
Bibliography 103
In re Oracle Corp. Derivative Litigation, 824 A.2d 917 (Del. Ch. 2003). Alleged
insider trading; court found special litigation committee was not disinterested.
In re Walt Disney Co. Derivative Litigation, 906 A.2d 27 (Del. 2006). Applying
good faith in the executive compensation context.
Kamin v. American Express Company, 383 N.Y.S.2d 807 (N.Y. Sup. Ct. 1976).
Duty of care case with foregone tax savings.
Karl Rove & Co. v. Thornburgh, 39 F.3d 1273 (5th Cir. 1994). Power of agent
to bind the principal in contract.
Levin v. Metro-Goldwyn-Mayer, Inc., 264 F. Supp. 797 (S.D.N.Y. 1967). Proxy

fight battle; corporation can repay incumbent expenses.
Manning v. Grimsley, 643 F.2d 20 (1st Cir. 1981). Orioles pitcher throws
a beanball.
Reading v. Regem, 2 KB 268 (1948). Smuggler case illustrating breadth of

agent’s duty of loyalty.
Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).
Sale of company triggers higher standard of review for takeover defenses.
Ringling Bros.-Barnum and Bailey Combined Shows v. Ringling, 53 A.2d 441

(Del. Sup. Ct. 1947). Family control battle over the circus.
Rosenfeld v. Fairchild Engine & Airplane Corp., 128 N.E.2d 291 (1955). Proxy
fight battle; corporation can repay expenses for both sides.
Salman v. United States, 137 S. Ct. 420 (2016). Insider tipping and the personal
benefit requirement.
Securities and Exchange Commission v. Texas Gulf Sulphur Co., 401 F.2d 833
(2d Cir. 1969). Insider trading during massive copper strike.
Shlensky v. Wrigley, 237 N.E.2d 776 (Ill. App. 1968). Cubs night-lighting case.

Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). Duty of care game changer.
Stone v. Ritter, 911 A.2d 362 (Del. 2006). Applying good faith monitoring
duties.
United States v. O’Hagan, 521 U.S. 642 (1997). Accepting the misappropriation
theory of insider trading.
Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). Foundational
case for legality of takeover defenses.
Walkovszky v. Carlton, 223 N.E.2d 6 (N.Y. 1966). Taxi owner reaps benefits
of limited liability.
Zupnick v. Goizueta, 698 A.2d 384 (Del. 1997). Discussing waste and executive
compensation.
Bibliography 105
QUIZ ANSWERS
A. Bond investors are typically allowed to vote on director elections.
B. Shareholders typically vote on whether a corporation will make new
dividend payments.
C. Bank lenders are typically considered the residual holders (or ultimate
owners) of a corporation.
2. What is the primary source of corporate law in the United States?

A. Mostly state laws with an occasional contribution from federal laws.
B. Mostly federal laws with an occasional contribution from state laws.
C. Mostly international law.
3. What are the legal requirements to create an agency relationship?

A. An agency relationship is formed by an agreement that the agent will
serve as an employee for compensation.
B. An agency relationship is formed by agreement that the agent shall act
on behalf of the principal and be subject to his or her control.
C. An agency relationship is formed by an agreement that the agent
and the principal will go into business together and share the profits.

4. After an agency relationship is created, what legal implications follow?
A. The agent may bind the principal to a third party in contract law.
B. The principal may be responsible for the torts of the agent.
C. The agent may owe the principal heightened legal duties.

A. Corporations were first established in the early colonial United States.
B. Corporations are usually entitled to make charitable contributions.
C. One of the benefits of a corporation is that profits paid to investors
are only taxed once.
6. Piercing the corporate veil allows a third-party plaintiff to do the

following:
A. Obtain private information about the corporation’s recent operating
activities.
B. Sue the firm’s senior managers for breach of fiduciary obligations
to the firm.
C. Recover directly from the equity investors of a corporation in
a lawsuit.
7. A corporation seeking to influence the political process may not engage

in which of the following activities?
A. Lobbying.
B. Contributing to a political action committee.
C. Contributing directly to a political candidate.
Quiz Answers 107

8. Which statement correctly describes the application of the business
judgment rule in corporate law?
A. Corporate directors are not normally subject to liability for a failed
business outcome so long as they satisfy their fiduciary duties.
B. Corporate directors are not normally subject to liability for a failed
business outcome so long as their business judgment is deemed
reasonable under the circumstances.
C. Corporate directors are not normally subject to liability for a failed
business outcome so long as a court agrees with the soundness of
their business judgment.
9. The case of Smith v. Van Gorkom was so important in corporate law

because of which reason?
A. It established that courts will not second-guess mindful decisions
by a firm’s board of directors.
B. It annulled the duty of care for corporate directors in Delaware.
C. It seemed to increase a board’s duty of care for corporate directors
in Delaware.
10. If a CEO enters into a personal contract with his or her corporation,
then which of the following results will follow?
A. The transaction will be understood as self-dealing but can still be
legally OK if it is fair to the corporation.
B. The transaction will be understood as self-dealing and is legally void
under the duty of loyalty.
C. The CEO may be fired within the next three months by a majority
vote of the shareholders.

11. What is the business opportunity doctrine in corporate law?
A. A legal rule stating that the board must voice its approval of new
business opportunities before a firm may move forward with an
extraordinary investment.
B. A legal rule stating that directors and top corporate officers need
to consider new business opportunities carefully before a firm may
move forward with an extraordinary investment.
C. A legal rule stating that directors and top corporate officers need
to present new business opportunities to the firm and may not take
these opportunities for themselves.
12. What are the three primary fiduciary duties of directors in corporate
law?
A. Duty of care, duty of loyalty, and duty of good faith.
B. Duty of loyalty, duty of frugality, and duty of monitoring.
C. Duty of good faith, duty of oversight, and duty of avarice.

A. If a CEO earns more than 300 times the compensation of a median
employee, then a corporation will have presumptively violated the
waste doctrine.
B. Judges often rule that a pay package for a senior executive is excessive
and adjust the firm’s compensation to more reasonable levels.
C. Public outcry over high levels of executive compensation have grown
so loud that federal lawmakers have stepped in to set maximum
compensation levels for corporations that must file reports with
the SEC.
Quiz Answers 109

14. Under Delaware law, stockholders may keep control of a derivative
lawsuit under which of the following circumstances?
A. Demand is excused because a majority of directors are self-interested
in a transaction at issue.
B. The firm tries to take control of the litigation with a special
committee, and this committee is comprised of an independent
director who makes a thorough investigation.
C. Under any circumstances, because shareholders always keep control
of derivative lawsuits.
15. The US Congress enacted federal laws relating to corporate activity

after which historical event?
A. The stock market crash of 1929 and the resulting Great Depression.
B. The Enron and WorldCom accounting scandals in the early 2000s.
C. The financial crisis of 2007–2008.
16. Which of the following statements best describes the doctrine of fraud
on the market?
A. Managerial fraud at one corporation dissuades potential investors
from investing in other corporations due to concerns that the entire
market is corrupted.
B. Because the price of a company’s stock is determined by the available
material information regarding the company, misleading statements
defraud purchasers of stock even if the purchasers do not directly
rely on the misstatements.
C. The risk of fraud is already priced into stock prices, so specific
instances of fraud are unlikely to harm diversified investors.

17. Which of the following actions are not illegal under insider
trading laws?
A. You learn about an upcoming buyout offer at your corporation
and buy 1,000 shares before the deal is announced.
B. You learn about plans to increased purchases of oil at
your firm and buy several thousand barrels of oil on the open market.
C. You uncover secret plans at your company to buy another corporation
and buy 1,000 shares of that other corporation before the deal
is announced.
18. Is a tippee who trades on material nonpublic information given to him

or her by an inside employee liable for insider trading?
A. Always.
B. Never.
C. Only if the tippee pays for the inside information.
D. Only if the insider receives a personal benefit and the tippee
knows about this benefit.

A. During a proxy fight for corporate board control, the firm is not
entitled to pay for any costs relating to the election battle.
B. During a proxy fight for corporate board control, the firm may wind
up paying the costs of both sides in the election battle.
C. Corporate proxy fights are no longer used because apathetic
shareholders rarely vote their shares for either side.
Quiz Answers 111

20. Shareholders who dislike a merger buyout price are entitled to do
which of the following?
A. Launch a competing bid to buy out the other shareholders.
B. File a lawsuit seeking appraisal of the share’s value.
C. Grumble about the lousy corporate managers to their spouse.
21. Under the Unocal standard, an antitakeover defense must generally

meet the following legal requirements to be permissible as a matter
of law:
A. It is fair, does not waste the corporation’s assets, and serves as
a meaningful deterrent to consummation of the deal.
B. It is reasonable, easy for the average shareholder to understand, and
leaves the firm open to competing takeover bids.
C. It is enacted in good faith after a reasonable investigation and
is proportionate to the threat posed.

IMAGE CREDITS
Page Credit
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5 LC-DIG-hec-16408/Public domain.
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7 Payaercan/DigitalVision Vectors/Getty Images.
8 New York Public Library/Public domain.
11 Chris Ryan/OJO Images/Getty Images.
12 David Sacks/DigitalVision/Getty Images.
14 Cenkerdem/DigitalVision Vectors/Getty Images.
18 The J. Paul Getty Museum, Los Angeles/Public domain.
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Private Law Library

Professor George S. Geis

THE GREAT COURSES

4840 Westfields Boulevard Suite 500

Copyright © The Teaching Company, 2019

Printed in the United States of America

Professor Geis teaches courses on contracts, corporations, agency and

Professor Geis’s research focuses on problems related to business alliances,

II Law School for Everyone: Corporate Law

2• Corporations and Their Agents . . . . . . . . . . . . . . . . . . . . . . . . . . 11

3• Things Corporations Can and Cannot Do . . . . . . . . . . . . . . . . . 18

4• Boards of Directors and the Duty of Care . . . . . . . . . . . . . . . . . 27

5• Business Opportunities and the Duty of Loyalty . . . . . . . . . . . 34

6• Executive Pay and the Duty of Good Faith . . . . . . . . . . . . . . . . 41

7• Shareholder Lawsuits: Goals and Limitations . . . . . . . . . . . . . . 48

8• Securities Regulation and Fraud . . . . . . . . . . . . . . . . . . . . . . . . . 55

9• Insider Trading Laws and Their Complexities . . . . . . . . . . . . . . 61

10• Corporate Control Battles and the Law . . . . . . . . . . . . . . . . . . . 69

11• Corporate Law of Mergers and Acquisitions . . . . . . . . . . . . . . . 77

12• Hostile Takeovers, Defenses, and the Future . . . . . . . . . . . . . . . 85

Table of Contents III

The Teaching Company expressly DISCLAIMS LIABILITY for any DIRECT,

IV Law School for Everyone: Corporate Law

This course examines the legal treatment of corporations in the United

2 Law School for Everyone: Corporate Law

4 Law School for Everyone: Corporate Law

Law students often study a theory of law called the bad-man

As your company spends its money, the wheels of commerce begin to

In this course on corporate law, by contrast, we will often be dealing with

Lecture 1–Questions and Conflicts in Corporate Law 5

It is important to be familiar with the key players in a corporation, and some of

Investors in a corporation fall into two major categories:

Stockholders are also known as shareholders. They receive

Creditors, by contrast, are investors who loan the

Stockholders will very rarely weigh in on most

6 Law School for Everyone: Corporate Law

The second potential standoff is between stockholders and creditors. Though

Lecture 1–Questions and Conflicts in Corporate Law 7

Even though Dodge v. Ford Motor Company was decided in 1919, it is

Henry Ford owned 58 percent of the common

One day in 1916, Henry Ford made a big

8 Law School for Everyone: Corporate Law

Lecture 1–Questions and Conflicts in Corporate Law 9

<< The Financial Crisis Inquiry Commission,

10 Law School for Everyone: Corporate Law

Agency is a legal concept that gives rise to a fiduciary, or special, relationship

1. There is an agreement between the parties, one of which is known

2. The agent shall act on behalf of the principal.

3. The agent shall be subject to the principal’s control.

The control exercised by the principal implies a degree of responsibility for

12 Law School for Everyone: Corporate Law

In corporate law, it is often easy to see whether someone is an agent of the

Lecture 2–Corporations and Their Agents 13

An important consideration is under what circumstances will a principal be

In most respondeat superior lawsuits, a third

Importantly, even when an agency relationship is created, a principal or

zz First, the agent must be an employee and not just an independent

zz Second, the tort must be committed within the scope of employment.

14 Law School for Everyone: Corporate Law