CONTENTS Preface Acknowledgments xxi xxv INTRODUCTION 1 ACTING THROUGH OTHERS: THE LAW OF AGENCY 7 1.1 INTRODUCTION TO AGENCY 7 1.2 AGENCY FORMATION, AGENCY TERMINATION, AND PRINCIPAL S LIABILITY 8 1.2.1 Formation 8 1.2.2 Termination 9 1.2.3 Parties Conception Does Not Control 9 Jenson Farms Co. v. Cargill, Inc. 9 1.2.4 Liability in Contract 13 1.2.4.1 Actual and Apparent Authority 13 White v. Thomas 14 1.2.4.2 Inherent Authority 16 Gallant Ins. Co. v. Isaac 17 1.2.5 Liability in Tort 22 Humble Oil & Refining Co. v. Martin 22 Hoover v. Sun Oil Co. 24 1.2.6 Liability in Tort Under the Apparent Authority Doctrine 27 1.3 THE GOVERNANCE OF AGENCY (THE AGENT S DUTIES) 27 1.3.1 The Nature of the Agent s Fiduciary Relationship 27 1.3.2 The Agent s Duty of Loyalty to the Principal 28 Tarnowski v. Resop 28 1.3.3 The Trustee s Duty to Trust Beneficiaries 30 In re Gleeson 31 1 xi
xii JOINT OWNERSHIP OF A BUSINESS: THE LAW OF PARTNERSHIPS AND LIMITED LIABILITY COMPANIES 33 2.1 INTRODUCTION TO PARTNERSHIP: WHY JOINT OWNERSHIP? 34 William Klein & John C. Coffee, The Need To Assemble At-Risk Capital 36 2.2 PARTNERSHIP FORMATION 39 Vohland v. Sweet 39 2.3 RELATIONS WITH THIRD PARTIES 42 2.3.1 Partnership Creditors Claims Against Departing Partners 43 2.3.2 Third-Party Claims Against Partnership Property 44 2.3.3 Claims of Partnership Creditors to Partner s Individual Property 45 2.4 PARTNERSHIP GOVERNANCE AND ISSUES OF AUTHORITY 46 National Biscuit Co. v. Stroud 46 2.5 TERMINATION (DISSOLUTION AND DISSOCIATION) 48 2.5.1 Accounting for Partnership s Financial Status and Performance 49 Sample Partnership Balance Sheet 49 Sample Partnership Income Statement 49 Accounting for Partners Capital 50 Adams v. Jarvis 51 2.5.2 Statutory Dissolution of a Partnership at Will 55 2.5.3 Opportunistic Dissolution and the Partner s Duty of Loyalty 56 Page v. Page 56 2.6 AGENCY CONFLICTS AMONG CO-OWNERS: FIDUCIARY DUTIES 59 Meinhard v. Salmon 59 2.7 LIMITED LIABILITY SUCCESSORS OF THE GENERAL PARTNERSHIP 63 2.7.1 The Limited Partnership 64 2.7.2 The Limited Liability Partnership 65 2.7.3 The Limited Liability Company 66 2.7.3.1 Taxation of LLCs 67 2.7.3.2 Contractual Flexibility 68 Pappas et al. v. Tzolis 69 2 THE CORPORATE FORM 75 3.1 INTRODUCTION TO THE CORPORATE FORM 75 3.2 CREATION OF A FICTIONAL LEGAL ENTITY 77 3.2.1 A Note on the History of Corporate Formation 78 3.2.2 The Process of Incorporating Today 82 3.2.3 The Articles of Incorporation, or Charter 83 3.2.4 The Corporate Bylaws 84 3.2.5 Shareholders Agreements 85 3
xiii 3.3 LIMITED LIABILITY 85 Frank Easterbrook & Daniel Fischel, Limited Liability and the Corporation 87 3.4 TRANSFERABLE SHARES 89 3.5 CENTRALIZED MANAGEMENT 90 3.5.1 Legal Construction of the Board 92 3.5.1.1 The Holder of Primary Management Power 92 Automatic Self-Cleansing Filter Syndicate Co., Ltd. v. Cunninghame 92 3.5.1.2 Structure and Function of the Board 95 3.5.1.3 Formality in Board Operation 97 3.5.1.4 A Critique of Boards 98 3.5.2 Corporate Officers: Agents of the Corporation 98 Jennings v. Pittsburgh Mercantile Co. 99 THE PROTECTION OF CREDITORS 103 4.1 MANDATORY DISCLOSURE 104 4.2 CAPITAL REGULATION 105 4.2.1 Financial Statements 105 4.2.2 Distribution Constraints 109 4.2.3 Minimum Capital and Capital Maintenance Requirements 111 4.3 STANDARD-BASED DUTIES 112 4.3.1 Director Liability 112 4.3.2 Creditor Protection: Fraudulent Transfers 115 4.3.3 Shareholder Liability 116 4.3.3.1 Equitable Subordination 116 Costello v. Fazio 116 4.3.3.2 Piercing the Corporate Veil 122 Sea-Land Services, Inc. v. The Pepper Source 123 Kinney Shoe Corp. v. Polan 127 4.4 VEIL PIERCING ON BEHALF OF INVOLUNTARY CREDITORS 131 Walkovszky v. Carlton 132 4 DEBT, EQUITY, AND ECONOMIC VALUE 143 5.1 CAPITAL STRUCTURE 143 5.1.1 Legal Character of Debt 144 5.1.2 Legal Character of Equity 145 5.2 BASIC CONCEPTS OF VALUATION 147 5.2.1 The Time Value of Money 147 5.2.2 Risk and Return 149 5.2.3 Diversification and Systematic Risk 152 5
xiv 5.3 VALUING ASSETS 154 5.3.1 The Discount Cash Flow (DCF) Approach 154 5.3.2 The Relevance of Prices in the Securities Market 157 In re Emerging Communications Inc., Shareholder Litigation 158 NORMAL GOVERNANCE: THE VOTING SYSTEM 163 6 6.1 INTRODUCTION: SHAREHOLDER VOTING IN THE NEW CORPORATE GOVERNANCE 163 6.2 ELECTING AND REMOVING DIRECTORS 166 6.2.1 Electing Directors 166 6.2.2 Removing Directors 169 6.3 SHAREHOLDER MEETINGS AND ALTERNATIVES 172 6.4 PROXY VOTING AND ITS COSTS 173 Rosenfeld v. Fairchild Engine & Airplane Corp. 175 6.5 CLASS VOTING 177 6.6 SHAREHOLDER INFORMATION RIGHTS 179 6.7 TECHNIQUES FOR SEPARATING CONTROL FROM CASH FLOW RIGHTS 181 6.7.1 Circular Control Structures 181 Speiser v. Baker 182 6.7.2 Vote Buying 188 Frank Easterbrook & Daniel Fischel, Voting in Corporate Law 188 Schreiber v. Carney 189 6.7.3 Controlling Minority Structures 197 Lucian A. Bebchuk, Reinier Kraakman & George G. Triantis, Stock Pyramids, Cross-Ownership, and Dual Class Equity 197 6.8 MITIGATING A COLLECTIVE PROBLEM TODAY: ACTIVIST INVESTORS 201 Marcel Kahan & Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control 202 6.9 THE FEDERAL PROXY RULES 203 6.9.1 Rules 14a-1 Through 14a-7: Disclosure and Shareholder Communication 203 6.9.2 Activist Investors and the Short Slate Proxy Contest 207 6.9.3 Access to the Company s Proxy Statement: Rule 14a-8: Shareholder Proposals 208 6.9.4 Rule 14a-9: The Antifraud Rule 214 Virginia Bankshares, Inc. v. Sandberg 216 6.10 FIDUCIARY SUPERINTENDENCE OF SHAREHOLDER VOTING 224 Schnell v. Chris-Craft Industries, Inc. 225
xv NORMAL GOVERNANCE: THE DUTY OF CARE 229 7.1 INTRODUCTION TO THE DUTY OF CARE 229 7.2 THE DUTY OF CARE AND THE NEED TO MITIGATE DIRECTOR RISK AVERSION 230 Gagliardi v. TriFoods International, Inc. 231 7.3 STATUTORY TECHNIQUES FOR LIMITING DIRECTOR AND OFFICER RISK EXPOSURE 233 7.3.1 Indemnification 233 Waltuch v. Conticommodity Services, Inc. 233 7.3.2 Directors and Officers Insurance 238 7.4 JUDICIAL PROTECTION: THE BUSINESS JUDGMENT RULE 239 Kamin v. American Express Co. 240 7.4.1 Understanding the Business Judgment Rule 243 7.4.2 The Duty of Care in Takeover Cases: A Note on Smith v. Van Gorkom 244 7.4.3 Additional Statutory Protection: Authorization for Charter Provisions Waiving Liability for Due Care Violations 246 7.5 THE BOARD S DUTY TO MONITOR: LOSSES CAUSED BY BOARD PASSIVITY 248 Francis v. United Jersey Bank 249 Graham v. Allis-Chalmers Manufacturing Co. 255 In the Matter of Michael Marchese 259 In re Caremark International Inc. Derivative Litigation 265 In re Citigroup Inc. Shareholder Derivative Litigation 272 7.6 KNOWING VIOLATIONS OF LAW 277 Miller v. AT&T 278 7 THE DUTY OF LOYALTY: CONFLICT TRANSACTIONS 283 8.1 DUTY TO WHOM? 284 8.1.1 The Shareholder Primacy Norm 284 A.P. Smith Manufacturing Co. v. Barlow 287 8.1.2 Constituency Statutes 289 8.1.3 Defining Corporate Purpose in the Charter: Benefit Corporations 290 8.2 SELF-DEALING TRANSACTIONS 292 8.2.1 The Disclosure Requirement 293 State ex rel. Hayes Oyster Co. v. Keypoint Oyster Co. 293 Melvin Eisenberg, Self-Interested Transactions in Corporate Law 296 8
xvi 8.3 THE EFFECT OF APPROVAL BY A DISINTERESTED PARTY 298 8.3.1 Early Regulation of Fiduciary Self-Dealing 298 8.3.2 Judicial Review of Self-Dealing Today: The Limited Role of Safe Harbor Statutes 300 Cookies Food Products v. Lakes Warehouse 300 8.3.3 Judicial Review When Transaction Has Been Approved by a Disinterested Majority of the Board 305 Melvin Eisenberg, Self-Interested Transactions in Corporate Law 306 Cooke v. Oolie 307 8.3.4 Approval by a Minority of Directors: Special Board Committees 309 8.3.5 Shareholder Ratification of Conflict Transactions 309 Lewis v. Vogelstein 310 8.4 CORPORATE DIRECTORS AND THE DUTY OF GOOD FAITH 311 8.5 CONTROLLING SHAREHOLDERS AND THE FAIRNESS STANDARD 313 8.5.1 Different Treatment for Controlling Shareholders? 313 Sinclair Oil Corp. v. Levien 314 Weinberger v. UOP, Inc. 318 8.5.2 Approval by a Board Minority of Independent Directors: Special Committees 326 8.6 CORPORATE OPPORTUNITY DOCTRINE 327 8.6.1 Determining Which Opportunities Belong to the Corporation 328 8.6.2 When May a Fiduciary Take a Corporate Opportunity? 329 8.7 THE DUTY OF LOYALTY IN CLOSE CORPORATIONS 330 Donahue v. Rodd Electrotype Co. 331 Frank Easterbrook & Daniel Fischel, Close Corporations and Agency Costs 336 Smith v. Atlantic Properties, Inc. 338 EXECUTIVE COMPENSATION 343 9.1 INTRODUCTION 343 9.2 THE CHALLENGE OF EXECUTIVE PAY 344 9.2.1 Creating Incentives That Align Managers with Investors 344 9.2.2 Political and Regulatory Responses to Executive Pay 347 9.3 ARE U.S. CEOS PAID TOO MUCH? 352 Lucian Bebchuk & Jesse Fried, Pay Without Performance: Overview of the Issues 355 Bengt Holmstrom, Pay Without Performance and the Managerial Power Hypothesis: A Comment 357 9.4 JUDICIAL REVIEW OF COMPENSATION 358 9.4.1 The Law of Executive Officer Compensation 358 9
xvii In re The Goldman Sachs Group, Inc. Shareholder Litigation 360 9.5 JUDICIAL REVIEW OF DIRECTOR COMPENSATION 368 Calma v. Templeton 369 SHAREHOLDER LAWSUITS 375 10.1 DISTINGUISHING BETWEEN DIRECT AND DERIVATIVE CLAIMS 375 10.2 SOLVING A COLLECTIVE ACTION PROBLEM: ATTORNEYS FEES AND THE INCENTIVE TO SUE 379 Fletcher v. A.J. Industries, Inc. 380 10.3 STANDING REQUIREMENTS 385 10.4 BALANCING THE RIGHTS OF BOARDS TO MANAGE THE CORPORATION AND SHAREHOLDERS RIGHTS TO OBTAIN JUDICIAL REVIEW 387 10.4.1 The Demand Requirement of Rule 23 388 Levine v. Smith 388 Rales v. Blasband 393 10.4.2 Special Litigation Committees 400 Zapata Corp. v. Maldonado 400 In re Oracle Corp. Derivative Litigation 406 Joy v. North 414 10.5 DEALING WITH AN ABUNDANCE OF SHAREHOLDER SUITS: EXCLUSIVE FORUM BYLAWS 418 10.6 SETTLEMENT AND INDEMNIFICATION 421 10.6.1 Settlement by Class Representatives 421 10.6.2 Settlement by Special Committee 422 Carlton Investments v. TLC Beatrice International Holdings, Inc. 422 10.7 WHEN ARE DERIVATIVE SUITS IN SHAREHOLDERS INTERESTS? 425 10 TRANSACTIONS IN CONTROL 427 11.1 SALES OF CONTROL BLOCKS: THE SELLER S DUTIES 429 11.1.1 The Regulation of Control Premia 429 Zetlin v. Hanson Holdings, Inc. 430 Perlman v. Feldmann 431 11.1.2 A Defense of the Market Rule in Sales of Control 437 Frank H. Easterbrook & Daniel R. Fischel, Corporate Control Transactions 437 In re Delphi Financial Group Shareholder Litigation 442 11.2 SALE OF CORPORATE OFFICE 448 11.3 LOOTING 449 11
xviii 11.4 TENDER OFFERS: THE BUYER S DUTIES 450 Brascan Ltd. v. Edper Equities Ltd. 452 11.5 THE HART-SCOTT-RODINO ACT WAITING PERIOD 456 FUNDAMENTAL TRANSACTIONS: MERGERS AND ACQUISITIONS 459 12.1 INTRODUCTION 459 12.2 ECONOMIC MOTIVES FOR MERGERS 460 12.2.1 Integration as a Source of Value 460 12.2.2 Other Sources of Value in Acquisitions: Tax, Agency Costs, and Diversification 461 12.2.3 Suspect Motives for Mergers 463 12.2.4 Do Mergers Create Value? 464 12.3 THE EVOLUTION OF THE U.S. CORPORATE LAW OF MERGERS 464 12.3.1 When Mergers Were Rare 465 12.3.2 The Modern Era 465 12.4 THE ALLOCATION OF POWER IN FUNDAMENTAL TRANSACTIONS 466 12.5 OVERVIEW OF TRANSACTIONAL FORM 469 12.5.1 Asset Acquisition 469 Katz v. Bregman 470 12.5.2 Stock Acquisition 474 12.5.3 Mergers 475 12.5.4 Triangular Mergers 477 12.6 STRUCTURING THE M&A TRANSACTION 478 12.6.1 Timing 479 12.6.2 Regulatory Approvals, Consents, and Title Transfers 479 12.6.3 Planning Around Voting and Appraisal Rights 480 12.6.4 Due Diligence, Representations and Warranties, Covenants, and Indemnification 480 12.6.5 Deal Protections and Termination Fees 482 12.6.6 Accounting Treatment 482 12.6.7 A Case Study: Excerpt from Timberjack Agreement and Plan of Merger 482 12.7 THE APPRAISAL REMEDY 487 12.7.1 History and Theory 487 12.7.2 The Appraisal Alternative in Interested Mergers 489 12.7.3 The Market-Out Rule 491 12.7.4 The Nature of Fair Value 492 12.7.5 Discounted Cash Flow Analysis 493 12.7.6 Current Developments in Appraisal 495 12.8 THE DE FACTO MERGER DOCTRINE 498 Hariton v. Arco Electronics, Inc. 499 12.9 THE DUTY OF LOYALTY IN CONTROLLED MERGERS 502 12.9.1 Cash Mergers or Freeze-Outs 503 Kahn v. Lynch Communications Systems, Inc. 505 Kahn v. M&F Worldwide Corp et al. 512 12
xix 11.9.2 Do Controlling Shareholders Have a Duty to Offer Only a Fair Price on the First, Tender Offer Step of a Two Step Freeze-Out? 520 In re CNX Gas Corporation Shareholders Litigation 521 PUBLIC CONTESTS FOR CORPORATE CONTROL 531 13.1 INTRODUCTION 531 13.2 DEFENDING AGAINST HOSTILE TENDER OFFERS 534 Unocal Corp. v. Mesa Petroleum Co. 534 13.3 PRIVATE LAW INNOVATION: THE POISON PILL 541 13.4 CHOOSING A MERGER OR BUYOUT PARTNER: REVLON, ITS SEQUELS, AND ITS PREQUELS 547 Smith v. Van Gorkom 548 Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc. 556 13.5 PULLING TOGETHER UNOCAL AND REVLON 560 Paramount Communications, Inc. v. Time, Inc. 561 Paramount Communications, Inc. v. QVC Network, Inc. 568 13.6 REGULATION OF TAKEOVERS IN OTHER LEGAL SYSTEMS 582 13.7 BRINGING TAKEOVERS LAW DOWN TO DATE 584 Lyondell Chemical Co. v. Ryan 584 C&J Energy Services, Inc. v. City of Miami General Employees and Sanitation Employees Retirement Trust 590 13.8 PROTECTING THE DEAL 593 13.8.1 No Shops/No Talks and Fiduciary Outs 596 13.8.2 Shareholder Lock-ups 597 Omnicare, Inc. v. NCS Healthcare, Inc. 597 13.9 STATE ANTITAKEOVER STATUTES 605 13.9.1 First- and Second-Generation Antitakeover Statutes (1968-1987) 605 13.9.2 Third-Generation Antitakeover Statutes 608 13.10 PROXY CONTESTS FOR CORPORATE CONTROL 610 Blasius Industries, Inc. v. Atlas Corp. 611 13 TRADING IN THE CORPORATION S SECURITIES 617 14 14.1 COMMON LAW OF DIRECTORS DUTIES WHEN TRADING IN THE CORPORATION S STOCK 617 Goodwin v. Agassiz 618
xx 14.2 THE CORPORATE LAW OF INSIDER TRADING POST-GOODWIN 621 Freeman v. Decio 622 14.3 16(b) AND RULE 16-b UNDER THE 1934 ACT 625 14.4 EXCHANGE ACT 10(b) AND RULE 10b-5 627 14.4.1 Evolution of Private Right of Action Under 10 628 14.4.2 Elements of a 10b-5 Claim 629 14.4.3 Early Rule 10b-5 Insider Trading Liability: The Equal Access Theory 630 SEC v. Texas Gulf Sulphur Co. 630 Santa Fe Industries, Inc. v. Green 636 14.4.4 The Equal Access Theory of Rule 10b-5 Liability 640 14.4.5 Elements of 10b-5 Liability: The Fiduciary Duty Theory 641 Chiarella v. United States 642 14.4.6 The Problem of Tippees after Chiarella 647 Dirks v. SEC 647 United States v. Newman 652 14.4.7 Note on Regulation FD 660 14.4.8 The Introduction of the Misappropriation Theory 663 United States v. O Hagan 663 14.4.9 Civil Liability, Civil Fines, and Criminal Penalties for Security Fraud Violations 666 Elkind v. Liggett & Myers, Inc. 667 14.5 THE OTHER SIDE OF 10B-5: FRAUD-ON-THE-MARKET CLASS ACTIONS 670 14.5.1 Materiality and Reliance in FOM Class Actions 671 Basic Inc. v. Levinson 671 14.5.2 Loss Causation in 10b-5 Class Actions 677 14.5.3 The Role of Class Certification in Recent Challenges to FOM Actions 680 14.6 INSIDER TRADING AND FOM CLASS ACTIONS: THE ACADEMIC POLICY DEBATES 683 14.6.1 The Insider-Trading Debate 683 14.6.2 The Academic Policy Debate over FOM Class Actions 687 Table of Cases 693 Index 699