2015 corporations - class 14 powerpoint
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CORPORATIONS 2015 GU FEINERMANTRANSCRIPT
HOLDEN v. CONSTRUCTION MACHINERY COMPANY
An action in equity was instituted, individually and derivatively, by the holder of 49.976% of the outstanding stock of a corporation, against the corporation, its officers and directors. The Black Hawk District Court held in part adverse to the defendants, and they appealed. The minority shareholder cross-appealed. The
Supreme Court held that where the majority shareholder was found to be a constructive trustee of another company's stock, purchased with a check from the corporation, an award to the corporation of the shares including shares acquired
by stock split and cash dividends appropriately stood as a judgment for restitution. The Court also held that where the majority shareholder, as president and general
manager of the corporation, personally engineered every phase of the deal by which the stock in the other company was acquired by a check from the
corporation, appropriated to his own use all dividends issued upon such stock, directed falsification of corporate records and other documents, and subsequently
endeavored to impress upon the whole transaction a coloration of honesty and also did all in his power to isolate the minority holder from any rights or privileges
pertaining to management, assessment of exemplary damages was compelled.
Affirmed on defendants' appeal; reversed in part, affirmed in part, affirmed in part as modified on plaintiff's cross appeal, and remanded with instructions.
HOLDEN v. CONSTRUCTION MACHINERY COMPANY (cont’d)
• Equity holds officers and directors of corporate entity, particularly management-controlling directors of closely held corporations, strictly accountable as trustees.
• Majority shareholder of corporation who was also president and general manager was strictly accountable to corporation for another company's stock purchased with check from corporation, or for fair market value of such stock, and for all increases, income, proceeds or dividends realized.
HOLDEN v. CONSTRUCTION MACHINERY COMPANY (cont’d)
Where majority shareholder, as president and general manager of corporation, personally engineered every phase of deal by which stock in another company was acquired with check from corporation, appropriated to his own use all dividends issued upon such stock, directed falsification of corporate records and other documents, and subsequently endeavored to impress upon whole transaction a coloration of honesty and also did all in his power to isolate minority holder of 49.976% of outstanding stock from any rights or privileges pertaining to management, assessment of exemplary damages was compelled.
In shareholder's derivative action, equity court may, in its discretion, award exemplary damages upon showing that some legally protected right has been invaded, such as by intentional act of fraud or other wrongful conduct.
Shareholder Derivative Litigation
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
• An action by shareholders to remedy an alleged wrong to the corporation.– A wrong by the directors or controlling shareholders
or– A wrong by a third party, such as a supplier
– The action is “founded on a right of action existing in the corporation itself, and in which the corporation itself is the appropriate plaintiff.” Daily Income Fund, Inc. v. Fox 464 US 523, 528 (1984)
Shareholder Derivative Litigation
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
• Two actions in one:
• A. A suit to compel the corporation to sue and• B. A suit by the corporation (asserted by the
shareholder –plaintiffs) against those liable to it
Shareholder Derivative Litigation
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
The stockholder’s right to litigate is secondary to the corporate right until such time as the corporation has refused to bring suit.
So…
Shareholder must first demand the corporation take action
Shareholder Derivative Litigation
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
• In addition to demand requirement, shareholders filing derivative action must first
• (in certain states) post a bond to pay the defendants’ costs if the plaintiffs lose or abandon the litigation;
• establish they are “adequate representatives” of the shareholder s in general and counsel is able to prosecute the action
Whose Ox Was Gored?
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
• Is the action “direct” or “derivative”?
• A direct action is available where– There is a special duty (such as a contract) between
the shareholder and the wrongdoer.– The shareholder suffers injury “separate and
distinct” from that suffered by other shareholders.
Direct vs. Derivative
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
Claim Direct Derivative
Δs conpired to deplete corporate assets √
Δs diverted corporate assets √
Δs paid dividends to only certain shareholders in class √ √
Δs conduct caused share value to decline √
Δs diluted minority shares for benefit of majority s/h √
Δs refused to allow inspection of corporate records √
Δs prevented shareholder from voting √
Δs proposed action is ultra vires √
Δs wrongfully failing to dissolve the corporation √
Δs are acting fraudulently √
Demand Futility
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
• Demand requirement waived if “futile”• Test is whether there is a reasonable doubt that– The directors are disinterested and independent (as
to the action proposed by the plaintiff) and – The transaction being challenged was the product of
the valid exercise of business judgment
The Corporate Response
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
• BJR shields directors as to – 1. Their response to the demand– 2. Decision to dismiss the derivative suit – 3. If suit is directed against them, the directors have the BJR
shield as a defense.
– PROVIDED:
– 1. Directors are disinterested as to any decision in question– 2. The directors have not been grossly negligent with respect
to their duty to inform themselves regarding the decisions(s)
Approaches to Demand Futility
Lec. 6 Sem 2, pp 785-835 Corps Prof. McCann
• Model Business Corporation Act: Absent a showing of irreparable harm if demand is required, a demand must always be made before a derivative action can be pursued. “Universal Demand.”
• New York: Demand required unless plaintiff shows:– 1. Majority of board are not disinterested as to the
transaction– 2. Board did not inform themselves as to the transaction; or– 3. Transaction is so egregious could not have resulted from
sound business judgment.
The Corporate Response
Lec. 7 Sem 2, pp 774-811 Corps Prof. McCann
• Auerbach (case for the next class): BJR shields directors as to – 1. Their response to the demand– 2. Decision to dismiss the derivative suit – 3. If suit is directed against them, the directors have the BJR shield
as a defense.
– PROVIDED:
– 1. Directors are disinterested as to any decision in question– 2. The directors have not been grossly negligent with respect to
their duty to inform themselves regarding the decisions(s)
The Rise of the ILC
Lec. 7 Sem 2, pp 774-811 Corps Prof. McCann
Corp Gets Named in Shareholder Derivative
Action (SDA)
Board Votes to Create Independent Litigation
Committee (ILC)
Board Expands Itself to Add Members and appoints only new
board members to be the ILC
Corporation seeks Stay of SDA proceedings in court to “investigate” the merits of the SDA
ILC “investigates” and reports back to the
board that the SDA is not in “best interests of the corporation”
Corp files motion to dismiss the SDA and/or for summary judgment
along with report.
The “Structural Problem” of the ILC
Lec. 7 Sem 2, pp 774-811 Corps Prof. McCann
• The “Independent Litigation Committee”– Who appointed them?– What will the appointees be doing once the ILC
disbands?– Whose Country Club do they belong to? Plaintiffs or
defendants?– How do they feel about rabble-rousing
shareholders?– “There but for the grace of God go I.”
Security Requirement
• In around 1/3 of states (though not Delaware), a derivative claimant with “low stakes” must post security for corporation’s legal expenses.
• Why do you think this requirement exists?– Effects on strategic or incentive problems among relevant parties (Shareholders, Managers, Attorneys)?
Demand Requirement
• Most states require S/hs in derivative suits first to approach Board of Directors and demand that they pursue legal action…
– … unless the S/h can claim a valid excuse.• When is demand requirement excused?• If not excused, what recourse does S/h have if Board
decides not to pursue?– Does making the demand affect one’s
subsequent rights to bring a derivative action?
EISENBERG v. The FLYING TIGER LINE, INC.
Action by stockholder, on behalf of himself and all other stockholders of corporation similarly situated, to enjoin effectuation of plan of reorganization and merger. The United States District Court for the Eastern District of New York dismissed the action after stockholder failed to post security for corporation's costs and stockholder appealed. The Court of Appeals held that action seeking to overturn reorganization and merger the effects of which was that business operations were confined to a wholly owned subsidiary of holding company whose stockholders were the former stockholders of defendant corporation was a "personal action" and not "derivative" within meaning of New York statute requiring posting of security for corporation's costs.
Reversed.
EISENBERG v. The FLYING TIGER LINE, INC. (cont’d)
• Action by stockholder, suing on behalf of himself and all other stockholders of corporation similarly situated, seeking to overturn reorganization and merger the effect of which was that business operations were confined to a wholly owned subsidiary of holding company whose stockholders were the former stockholders of defendant corporation, was a "personal action" and not "derivative" within meaning of New York statute requiring posting of security for corporation's costs.
• If the gravamen of the complaint is injury to the corporation the suit is derivative, but "if the injury is one to the plaintiff as a stockholder and to him individually and not to the corporation," the suit is individual in nature and may take the form of a representative class action.
EISENBERG v. The FLYING TIGER LINE, INC. (cont’d)
Eisenberg’s Complaint:– Deprivation of voting rights to former Flying Tiger
S/hs with respect to operating company.FTL’s Counter-argument:
– Eisenberg’s claim is derivative. Must post security under NY law.• Trial court:
– Held that Eisenberg was required to post security (as per NY’s law and FTL’s pre-trial motion)– Eisenberg refused to pay. Complaint dismissed.
Marx v. Akers
Appeal, by permission of the Court of Appeals, from an order of the Appellate Division of the Supreme Court in the Second Judicial Department, entered May 15, 1995, which affirmed an order of the Supreme Court granting motions by defendants to dismiss the amended complaint.
Affirmed.
Marx v. Akers (cont’d)In a shareholders' derivative action, plaintiff failed to state a cause of action with
respect to the allegations of the complaint that the board of directors wasted corporate assets by awarding excessive compensation to the corporation's outside directors, consisting of a retainer of $55,000 plus 100 shares of the corporation's stock over a five-year period which bore little relationship to duties performed or to the cost of living.
An allegation that directors have voted themselves compensation does not give rise to a cause of action, as directors are statutorily entitled to set those levels.
Moreover, a complaint challenging the excessiveness of director compensation must--to survive a dismissal motion--allege compensation rates excessive on their face or other facts which call into question whether the compensation was fair to the corporation when approved, the good faith of the directors setting those rates, or that the decision to set the compensation could not have been a product of valid business judgment.
Here, there are no factually based allegations of wrongdoing or waste which would, if true, sustain a verdict in plaintiff's favor. Plaintiff's bare allegations that the compensation set lacked a relationship to duties performed or to the cost of living are insufficient as a matter of law to state a cause of action.
Marx v. Akers (cont’d)In a shareholders' derivative action, a demand that the board of directors
initiate a lawsuit, Business Corporation Law § 626 [c], was excused as to the allegations of the complaint that a majority of the board was self-interested in setting the compensation of the corporation's outside directors because the outside directors comprised a majority of the board.
Directors are self-interested in a challenged transaction where they will receive a direct financial benefit from the transaction which is different from the benefit to shareholders generally.
A director who votes for a raise in directors' compensation is always "interested" because that person will receive a personal financial benefit from the transaction not shared in by stockholders.
Consequently, a demand was excused as to plaintiff's allegations that the compensation set for outside directors was excessive.