Understanding Corporate Law, Fourth Edition (2013)

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Understanding Corporate Law, Fourth Edition, is designed to assist students by offering a clear and comprehensive treatment of key concepts in corporate law. It is a popular study guide for students and has been used by professors to supplement their casebook or as recommended reading.

Significant business, economic, and policy issues are highlighted in connection with a thorough analysis of the important cases and statutory provisions used in the study of corporations. It includes the major theoretical approaches used in current corporate law literature.

In each chapter, the authors identify important policies and discuss the relationship of the law as it has developed to those policies. Statutory issues are addressed under both the General Corporation Law of the State of Delaware and the Revised Model Business Corporation Act. In addition, significant sections from the Principles of Corporate Governance of the American Law Institute are covered. The corporate scandals of 2001 and 2002, the enactment of the federal Sarbanes-Oxley (2002), Dodd-Frank(2010), and JOBs (2012) Acts, and the financial crisis of 2008 are also covered. Chapter 11 now incorporates significant new material on limited liability companies (LLCs).

Professors and adjunct professors may request complimentary examination copies of LexisNexis law school publications to consider for class adoption or recommendation. Please identify the book(s) you wish to receive, provide your institutional contact information, and submit your request here.

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Table of Contents

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CHAPTER 1 INTRODUCTION AND FORMATION, 1
1.01 INTRODUCTION, 1
1.02 SOURCES OF CORPORATE LAW, 3
1.03 HISTORICAL BACKGROUND, 4
1.04 CHOICE OF FORM, 5
[A] Sole Proprietorship, 6
[B] Partnership vs. Corporation, 6
1.05 TAXATION, 9
[A] Double Taxation, 9
[1] Subchapter S Corporation, 10
[2] Limited Liability Companies, 11
1.06 LIMITED PARTNERSHIPS, 12
1.07 INCORPORATION AND ORGANIZATION, 13
1.08 CHOICE OF LAW, 14
[A] Delaware's Dominance, 15
1.09 ULTRA VIRES, 17
1.10 CORPORATE SOCIAL RESPONSIBILITY, 18
[A] Philanthropy, 18
[B] Stakeholders, 19

CHAPTER 2 PROMOTERS' LIABILITY AND DEFECTIVE INCORPORATION, 23
2.01 INTRODUCTION, 23
2.02 PROMOTERS' LIABILITY ON PREINCORPORATION CONTRACTS, 23
[A] Overview, 23
[B] Liability of the Promoter, 24
[C] The Strict View of Promoters' Liability, 24
[D] Reliance On the Intent of the Parties, 25
[E] Liability of the Newly Formed Corporation, 28
[F] Promoters' Fiduciary Duties, 29
2.03 DEFECTIVE INCORPORATION, 30
[A] The Problem, 30
[B] The De Facto Corporation Doctrine and Corporation by Estoppel, 31
[C] Statutory Abolition of the De Facto Corporation Doctrine, 33
[D] Does Corporation by Estoppel Survive the Model Business Corporation Act?, 34
[E] Model Business Corporation Act Compromise, 35

CHAPTER 3 PIERCING THE CORPORATE VEIL, 37
3.01 THE CONCEPT OF LIMITED LIABILITY, 37
3.02 THE LIMITED LIABILITY DEBATE, 39
3.03 GROUNDS FOR PIERCING THE CORPORATE VEIL, 41
[A] Introduction, 41
[B] Intermixture of Affairs, 42
[C] Lack of Corporate Formalities 43
[D] Inadequate Capitalization, 44
[1] Overview, 44
[2] What is Capital for These Purposes?, 45
[3] When is Capital Adequate?, 46
[4] Is Inadequate Capitalization Alone a Sufficient Ground?, 46
[5] Does a Duty Ever Arise to "Top Off" the Original Capital?, 48
[E] Evasion of a Contract or Statute or Use of a Corporation Solely to Work a Fraud, 49
[F] Instrumentality Theories, 50
[G] Torts Versus Contracts, 52
3.04 EQUITABLE SUBORDINATION, 53
3.05 PIERCING THE CORPORATE VEIL: PROCEDURAL CONTEXTS, 55
3.06 STATUTORY LIABILITY UNDER ENVIRONMENTAL LAWS, 56
3.07 SUCCESSOR CORPORATION LIABILITY IN PRODUCTS LIABILITY, 58
3.08 PIERCING THE CORPORATE VEIL - STRUCTURAL SETTINGS, 58
[A] Personal Shareholder Liability, 58
[B] Parent-Subsidiary Settings, 61
[C] Brother-Sister (Sibling) Corporation Settings, 63
[D] Enterprise Liability, 66
[E] Summary, 67

CHAPTER 4 FINANCING THE CORPORATION, 69
4.01 INTRODUCTION, 69
4.02 SECURITIES, 70
[A] Debt, 70
[B] Common Shares, 71
[C] Preferred Shares, 72
4.03 LEVERAGING AND CAPITAL STRUCTURE, 73
4.04 LEGAL CAPITAL RULES, 74
[A] Preemptive Rights, 75
[B] Par Value, 76
[C] Dividends and Repurchases of Shares, 77
4.05 VALUATION, 78
[A] Liquidation Value, 79
[B] Book Value, 79
[1] Cost Based Accounting, 80
[2] Depreciation, 80
[3] Intangible Assets, 81
[C] Earnings Approach, 81
[1] Capitalization of Earnings, 82
[2] Cash Flow as Earnings, 83
[3] The Rate, 84

CHAPTER 5 THE LEGAL MODEL AND CORPORATE GOVERNANCE: THE ALLOCATION OF POWER UNDER STATE LAW, 87
5.01 INTRODUCTION, 87
5.02 THEMES, 88
[A] Publicly Held Corporation, 89
[B] The Stock Markets, 89
[1] Benefits of Stock Markets, 90
[2] Shareholder Protection and Stock Markets, 91
[C] The Efficient Capital Market Hypothesis, 92
[D] Separation of Ownership from Control, 94
[E] Institutional Investors, 95
[F] Independent Directors, 96
[G] Gatekeepers, 98
[H] Federalism, 99
[I] Publicly Held vs. Closely Held Corporations, 100
5.03 THEORIES OF THE FIRM, 101
[A] Regulatory Approach, 101
[B] Management Approach, 101
[C] Law and Economics Approach, 102
[1] Agency Costs, 102
[2] Markets, 103
[3] Nexus of Contracts, 104
[4] Critics of Contractual Approach, 104
[5] Behavioral Economics, 105
5.04 THE LEGAL MODEL, 105
5.05 SHAREHOLDERS, 106
[A] Right to Vote, 106
[1] Cumulative Voting, 108
[B] Proxy Voting, 110
[C] The Proxy Fight, 111
[1] Change Management, 111
[2] Change Directors to Facilitate an Acquisition, 112
[3] Change Policy, 112
[4] Collective Action Problem, 113
[5] Proxy Expenses, 114
[6] Fiduciary Duty, 115
[D] Shareholder Democracy, 115
[E] Vote Buying, 119
[F] Right of Expression, 120
[G] Right to Information, 120
5.06 BOARD OF DIRECTORS, 123
[A] Board Structure, 124
[B] Meetings, 124
[1] Actions Without A Meeting, 125
5.07 OFFICERS, 126
[A] Authority, 126
5.08 THE SARBANES-OXLEY ACT OF 2002, 128

CHAPTER 6 MERGERS AND ACQUISITIONS, 133
6.01 INTRODUCTION, 133
6.02 MERGERS, 133
[A] Triangular Merger, 135
[B] Reverse Triangular Merger, 136
[C] Short Form Merger, 137
6.03 SALE OF ASSETS, 137
6.04 TENDER OFFER, 138
6.05 OTHER LEGAL ISSUES, 139
6.06 APPRAISAL REMEDY, 140
[A] Delaware Block Approach, 142
[1] The New Methodology, 144
[B] Stock Market Exception, 145
6.07 DEFACTO MERGERS, 145

CHAPTER 7 INTRODUCTION TO FEDERAL REGULATION AND THE PROXY RULES, 147
7.01 INTRODUCTION AND OVERVIEW, 147
7.02 SEC JURISDICTION AND PERIODIC REPORTING BY PUBLICLY HELD CORPORATIONS, 149
[A] SEC Jurisdiction, 149
[B] Periodic Reporting - An Overview, 151
[C] Certifications, Code of Ethics Disclosure, and Penalties for Earnings Restatements, 151
[D] Private Securities Litigation Reform Act (PSLRA) Safe Harbor for Forward Looking Statements, 153
[E] Management Discussion and Analysis (MD&A), 153
[F] Earnings Management and Revenue Recognition Issues, 154
7.03 SECURITIES ISSUANCE, 155
[A] The Federal Disclosure Philosophy, 155
[B] Registration Requirements, 156
[C] The Registration Process, 159
[D] Exemptions From Registration, 161
[1] Scope, 161
[2] The Intrastate Exemption, 161
[3] The Private Offering Exemption, 161
[4] Regulation D Exemptions, 164
7.04 PROXY REGULATION, 165
[A] Introduction, 165
[B] A Proxy Solicitation Hypothetical, 167
[C] Proxy Contests, 168
[1] The Shareholder's Role, 168
[2] Inadvertent Solicitation and Other Problems, 169
[3] Regulatory Burdens and Costs, 171
[4] Proxy Contest Procedures and Further Costs, 172
7.05 THE SEC SHAREHOLDER PROXY PROPOSAL RULE: SEC RULE 14a-8, 173
[A] Proposals, 173
[B] Eligibility and Procedure, 175
[C] Background on the Nature of the Proposals, 175
[D] Mechanics of the Shareholder Proxy Proposal Process, 177
[E] The 14a-8, Question 9(7) Ordinary Business Operations Exclusion, 180
[F] Other Rule 14a-8 Exclusions, 182
7.06 THE PROXY RULES' GENERAL ANTIFRAUD RULE: AN INTRODUCTION TO GENERAL DISCLOSURE LAW CONCEPTS, 183
[A] Introduction, 183
[B] SEC Rule 14a-9, 185
[C] Implication of Private Rights of Action, 186
[D] Standing to Sue, 189
[E] Materiality of the Omission of the Misleading Statement, 190
[F] State of Mind (Fault) Required, 192
[G] Causation, 193
[H] Remedies, 198

CHAPTER 8 INTRODUCTION TO FIDUCIARY DUTY: THE DUTY OF CARE AND THE BUSINESS JUDGMENT RULE, 199
8.01 INTRODUCTION, 199
[A] Overview of Duty of Care and Loyalty, 200
[B] Sliding Scale, 200
[C] Duty of Disclosure, 202
8.02 POLICY ISSUES, 203
[A] Law and Economics Approach, 204
8.03 DUTY OF CARE, 205
[A] Failure to Monitor, 207
[B] Duty to Monitor and Legal Compliance, 208
[C] Business Judgment Rule and Decision Making, 209
[1] Good Faith, 211
[D] Causation, 212
8.04 THE SMITH v. VAN GORKOM CASE, 214
8.05 THE DEMISE OF THE DUTY OF CARE, 217
[A] Delaware General Corporation Law 102(b)(7), 217
8.06 DUTY TO ACT LAWFULLY, 219

CHAPTER 9 THE DUTY OF LOYALTY, 221
9.01 INTRODUCTION, 221
9.02 POLICY, 221
9.03 INTERESTED DIRECTOR TRANSACTIONS, 223
[A] Common Law, 225
[B] Statutory Responses, 226
[1] Weak Form Approach, 229
[2] Semi-Strong Approach, 230
[a] The New York Approach, 230
[b] The Current California Approach, 231
[3] Strong Form Approach, 231
[a] Delaware Approach, 231
[b] The MBCA Approach, 233
9.04 EXECUTIVE COMPENSATION, 234
[A] Stock Options, 236
[B] Waste, 239
[1] Delaware's Waste Standard, 239
9.05 CORPORATE OPPORTUNITY, 241
[A] Legal Tests, 242
[1] Interest Test, 242
[2] Line of Business Test, 243
[3] Fairness Test, 244
[4] The ALI Test, 244
[B] Financial Inability, 246
[C] Multiple Boards, 246
[D] Use of Information and Competition, 247
[E] Undisclosed Profits, 248
9.06 SHAREHOLDER RATIFICATION, 248
[A] Required Voting, 249
[B] Optional Shareholder Voting, 250

CHAPTER 10 CONTROLLING SHAREHOLDERS, 253
10.01 INTRODUCTION, 253
10.02 USE OF CONTROL, 255
[A] The Zahn Case, 255
[B] Parent-Subsidiary Dealings, 256
[C] Sale of Corporation, 258
10.03 FREEZEOUTS, 259
[A] Policy Issues, 260
[B] State Law, 263
[C] Cases, 264
[1] The Weinberger Case, 265
[2] Post Weinberger Cases, 268
[a] The Controlling Shareholder's Tender Offer, 269
[D] Federal Law, 271
[1] SEC Rule 13e-3, 271
[2] SEC Rule 10b-5, 271
10.04 INDEPENDENT DIRECTORS OR DISINTERESTED SHAREHOLDER RATIFICATION, 273
[A] Independent Directors, 274
[B] Shareholder Ratification, 276
10.05 SALE OF CONTROL, 277
[A] Looting, 279
[B] The Perlman Case, 280
[C] The California Approach, 281
[D] Sale of Office, 284

CHAPTER 11 SPECIAL PROBLEMS OF THE CLOSELY HELD CORPORATION, 287
11.01 INTRODUCTION AND OVERVIEW, 287
11.02 OBTAINING AND MAINTAINING A MEASURE OF CONTROL, 289
[A] Preview, 289
[B] Shareholder Voting Agreements, 290
[C] Irrevocable Proxies, 292
[D] Voting Trusts, 294
[E] Class Voting, 296
[F] Cumulative Voting, 297
[G] Summary, 298
11.03 PROTECTING SHAREHOLDER EXPECTATIONS IN CLOSELY HELD CORPORATIONS EX ANTE, 298
[A] Contract, 298
[B] Long-Term Shareholder Tenure and Salary Agreements, 299
[C] Less Than Unanimous Shareholder Agreements, 301
[D] Other Agreements Affecting Directors' Discretion, 302
[E] Comprehensive Shareholder Agreements, 304
11.04 RESTRICTIONS ON SHARE TRANSFERABILITY, 306
[A] Introduction, 306
[B] Umbrella Test - Unreasonable Restraint Upon Alienation?, 307
[C] Other Legal Aspects of Share Transfer Restrictions, 309
[1] Legal Capital and Funding, 309
[2] Procedural Aspects, 309
[3] Disparity Between Buy-Out Price or Formula and Fair Price, 310
[4] Notice, 311
11.05 OTHER GOVERNANCE FEATURES OF THE CLOSELY HELD CORPORATION, 311
[A] Overview, 311
[B] Greater Than Majority Quorum and Voting Requirements, 312
[C] Informal Action By Shareholders and Directors, 314
11.06 CLOSE CORPORATION STATUTES, 314
11.07 PROTECTING SHAREHOLDER EXPECTATIONS IN THE CLOSE CORPORATION EX POST, 315
[A] Resetting the Problem, 315
[B] Heightened Fiduciary Duty in the Close Corporation Setting, 317
[C] Heightened Fiduciary Duty in Other Jurisdictions, 320
[D] Two Worlds Collide: The Donahue Principle Meets Employment at Will, 321
[E] Involuntary Dissolution Statutes, 323
[F] Cases of Deadlock, 324
[G] Oppression Grounds, 326
[H] Remedies in Involuntary Dissolution Cases, 328
[I] Valuation Issues in Court Ordered Buyouts, 331
[J] Conclusion, 332

CHAPTER 12 HOSTILE TENDER OFFERS, 333
12.01 INTRODUCTION, 333
12.02 THE RISE AND FALL OF HOSTILE TENDER OFFERS, 333
12.03 POLICY ISSUES, 336
[A] Proponents, 336
[B] Opponents, 337
12.04 TACTICS, 339
[A] Bidder Tactics, 340
[B] Target Tactics, 342
[1] Poison Pills, 343
12.05 STATE LAW, 347
[A] Delaware Approach, 348
[1] The Cheff Case, 348
[2] The Unocal Test, 348
[3] The Revlon Test, 350
[4] The Time Case, 352
[5] The QVC Case, 354
[6] The Unitrin Case, 356
[7] Shareholder Voting and Tender Offers, 358
[8] Summary, 359
12.06 FEDERAL SECURITIES LAW - THE WILLIAMS ACT, 360
[A] History, 361
[B] Disclosure Rules, 361
[C] Other Rules, 362
[D] Section 14(e), 363
12.07 STATE TAKEOVER STATUTES, 364
[A] Introduction, 364
[B] Policy Issues, 365
[C] Constitutionality, 366
[1] The Edgar Case, 367
[2] The CTS Case, 367

CHAPTER 13 SEC RULE 10b-5 DISCLOSURE AND INSIDER TRADING, 371
13.01 SEC RULE 10b-5 DISCLOSURE AND INSIDER TRADING, 371
13.02 DISCLOSURE CONCEPTS AND ELEMENTS OF A CAUSE OF ACTION UNDER RULE 10b-5, 373
[A] Implication of Private Rights of Action, 373
[B] Standing to Sue, 374
[C] Materiality, 376
[D] State of Mind, 378
[E] Pleading State of Mind, 381
[F] Reliance (Transaction Causation), 383
[G] The Fraud on the Market Theory Reliance Substitute, 386
[H] Loss Causation, 388
[I] The "In Connection With" Requirement, 389
[J] Privity, 389
[K] Secondary Liability for Disclosure Violations, 390
13.03 THE PROHIBITION OF INSIDER TRADING: IS IT GOOD OR BAD?, 392
13.04 THE LAW OF INSIDER TRADING, 394
[A] Common Law Background, 394
[B] The Nature of the Insider Trading Prohibition, 395
[C] Who is an Insider?, 397
[D] Tipper-Tippee Liability, 399
[E] The Misappropriation Theory, 402
[F] The Misappropriation Theory in the Supreme Court, 405
[G] Tippees of Misapporiators, 408
[H] Pushing the Insider Trading Envelope, 409
[I] Remedies and Enforcement, 410
13.05 THE INSIDER TRADING PROHIBITION UNDER STATE LAW, 414
[A] Common Law, 414
[B] Common Law Exceptions: The Kansas Rule, 415
[C] Common Law Exceptions: Special Facts Doctrine, 415
[D] Modern Expansion of the Special Facts Doctrine, 416
[E] Finding Harm to the Corporation from the Insider's Trading, 416
13.06 REGULATION OF INSIDER TRADING UNDER SECTION 16 OF THE SECURITIES EXCHANGE ACT OF 1934, 417
[A] Statutory Provisions, 417
[B] Parties Plaintiff and Calculation of Damages, 418
[C] Who is an Officer for Section 16 Purposes?, 420
[D] Insider Status at Only One End of a Swing, 420
[E] Takeover Players and Section 16(b), 421

CHAPTER 14 CORPORATE LITIGATION, 423
14.01 INTRODUCTION, 423
14.02 THE NATURE OF THE DERIVATIVE SUIT: DIRECT VERSUS DERIVATIVE, PRO RATA, 425
[A] The Nature of the Derivative Suit, 425
[B] Direct Versus Derivative - Special or Distinct Injury Rule, 427
[C] Direct Versus Derivative - Denial of Contract Rights Associated With Shareholding, 429
[D] Direct Versus Derivative - Closely Held Corporation Exception, 431
[E] Pro Rata (Individual) Recovery in Derivative Actions, 432
14.03 QUALIFICATIONS OF A PROPER PLAINTIFF SHAREHOLDER, 435
[A] Record Ownership, 435
[B] Contemporaneous Ownership, 436
[1] Introduction, 436
[2] Basis for the Rule, 436
[3] Possible Exception: Undisclosed Wrongdoing, 438
[4] Exception: Continuing Wrong, 438
[5] Exception: Double Derivative Actions, 439
[C] Continuous Owner, 439
[D] Clean Hands Requirement, 441
[E] Adequate Representation Requirement, 441
[F] Selection of Lead Counsel, 443
14.04 REFORMS OF THE EARLIER STRIKE SUIT ERA, 444
[A] Overview, 444
[B] Verification Requirement, 444
[C] Security for Expenses Requirements, 445
14.05 THE DEMAND RULE, 447
[A] Overview, 447
[B] Demand Refused, 447
[C] Demand Accepted, 448
[D] Demand Excused, 450
[1] Introduction, 450
[2] The Futility Exception, 450
[a] Introduction, 450
[b] Disabling Conflicts of Interest, 451
[c] Lack of Independence, 452
[d] Legal Tests for Demand Futility, 454
[3] Threat of Irreparable Harm, 456
[4] Closely Held Corporations 456
[5] Delay, 456
[6] Neutrality, 457
[E] Demand On Shareholders, 457
14.06 TERMINATION OF LITIGATION: THE ADVENT OF THE SPECIAL LITIGATION COMMITTEE DEVICE, 458
[A] Background, 458
[B] Application of the Business Judgment Rule, 460
[C] Delaware and the Zapata Second Step, 461
[D] Structural Bias and Other Criticisms, 462
[E] Recent Cases, 465
14.07 PROPOSED REFORMS OF THE MODERN STRIKE SUIT ERA, 469
[A] The ALI Proposals Briefly Considered, 469
[B] The American Bar Association (Model Business Corporation Act) Proposals, 470
[C] Summary, 471
14.08 RIGHT TO TRIAL BY JURY, ATTORNEYS' FEES, AND MISCELLANEOUS ISSUES, 472
[A] Right to Trial By Jury, 472
[B] Attorneys' Fees in Derivative Actions, 473
[1] Entitlement: Common Fund Versus Common Benefit Cases, 473
[2] The Cosmetic (Collusive) Settlement Problem, 475
[3] Computation of Fee Amounts: Lodestar Versus Percentage of Recovery Methods, 475
[4] Objectors and Intervenors, 477
[C] Statute of Limitations or Laches?, 478
14.09 THE REPRISE OF THE SHAREHOLDER CLASS ACTION, 479
[A] The Death of the Derivative Action and the Rise of the "Stock Drop" Class Action, 479
[B] The Private Securities Litigation Reform Act (PSLRA) of 1995, 480
[C] The Securities Litigation Uniform Standards Act (SLUSA) of 1998, 482
14.10 LAWYERING PROBLEMS IN CORPORATE LITIGATION, 484
[A] Attorney-Client Privilege, 484
[B] Attorney-Client Privilege in Derivative Litigation, 485
[C] The Corporation as Client, 486
[D] Sarbanes-Oxley Act (SOA) 307: The Conflict Between "Reporting Up" and the Prohibition on Disclosure of Client Confidences, 488
14.11 INDEMNIFICATION AND INSURANCE, 489
[A] Overview, 489
[B] Indemnification Statutes, 489
[C] Advance of Fees and Other Expenses, 491
[D] Fees on Fees, 491
[E] Implementation By Contract, 491
[F] Non-exclusive Versus Exclusive Statutes, Public Policy Limits, and Consistency Limitations, 492
[G] Insurance, 492
[H] Summary, 493

Table of Cases, TC-1
Table of Statutes, Rules and Regulations, TS-1
Index, I-1