Module VII Fiduciary Duties Chapter 17 Shareholder Litigation

Module VII – Fiduciary Duties Chapter 17 Shareholder Litigation Bar exam Corporate practice Law profession Citizen of world Corporations: A Contemporary Approach • Derivative vs. direct actions – Derivative action: 2 suits in 1 - enforce fiduciary duties to corporation – Direct action: representative suit - protect Sh rights – Distinction between two: who recovers? • Demand requirement – Board decides lawsuit’s merits – Aronson test: (1) director disinterest + independence, (2) decision protected by BJR Chapter 17 Shareholder Litigation Slide 1 of 17

1. Fundamentals 2. Corporations and policy 3. Corporate form 4. Corporate finance 5. Corporate externalities 6. Corporate governance 7. 10. Fiduciary duties Close corporations 7. 8. 9. 10. Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation – – Introduction to firm Corporate basics – – – Corporate federalism Corporate social responsibility Corporate political action – – – Organizational choices Incorporation Locating corporate authority – – Numeracy for corporate lawyers Capital structure – – – Piercing corporate veil Corporate environmental liability Corporate criminal liability – – – Shareholder voting Shareholder information rights Public shareholder activism – Shareholder litigation Planning – Board decision making Oppression – Board oversight Fiduciary duties – Director conflicts 1. Shareholder litigation – Executive compensation 2. Board decision making – Corporate groups 3. Board oversight Stock trading 4. Director conflicts 1. Securities markets 5. Executive compensation 2. Securities fraud class actions 6. Corporate groups 3. Insider trading Corporate deals – – – Sale of control Antitakeover devices Deal protection Close corporations – – Planning Oppression Slide 2 of 25

Enforcement of fiduciary duties … Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 3 of 17

Derivative suit (enforce duties to corporation) Delaware Supreme Court: “if an action is derivative, the plaintiffs are then required to Shareholder comply with the requirements of Court of Chancery Rule Corporation Fiduciaries (lawyer) 23. 1, that the stockholder: (a) retain ownership of the shares throughout the litigation; “on behalf of violation of (b) make pre-suit demand on the board; and corporation” corporate duties (recovery to corporation) (c) obtain court approval of any settlement. Further, the recovery, if any, flows only to the corporation. ” Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 4 of 17

Class action (enforce duties to shareholders) Sh rep (lawyer) Shareholder class violation of direct duties “on behalf of class” Insiders (recovery to shareholders) Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 5 of 17

Demand requirement … [in Delaware] Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 6 of 17

Aronson v. Lewis (Del. 1984) Meyers Parking gives its CEO (and 47% shareholder) a sweetheart employment and retirement package. Shareholders Plaintiff shareholder Sh Lewis (a serial plaintiff – really a plaintiff’s law firm) claims this is waste. Why is this a derivative suit? Who controls the corporation’s litigation decisions. Why doesn’t plaintiff ask the board to sue? Asking the board to sue all the directors is futile - no? Who dominates the board? Where does the court start its analysis? Why the BJR? Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Board Corporation Directors Slide 7 of 17

Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Hence, the Court of Chancery must make two inquiries, one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof. Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 8 of 17

1. Which of the following should be a derivative suit? a. Board issues new stock, without preemptive rights b. Board has Corp buy majority Sh’s art collection c. Board gives lifetime employment to CEO 2. Delaware requires Shs make demand on board … a. Always b. when time is of essence c. Unless excused as futile 3. Delaware excuses demand … a. When current board majority $$ interested b. When current board not independent c. When BJR not apply 4. In Aronson v. Lewis … a. Directors dominated because CEO was 47% Sh b. Directors interested because all directors were sued c. Demand was not excused 5. After Aronson v. Lewis a Sh must have particularized facts that … a. Current directors personally tied to interested director b. Current directors financially interested in challenged tx c. All directors interested/dominated 6. In Delaware, a Sh who makes demand on board … a. Concedes board is disinterested and independent b. Can still sue and show board interested and non-independent c. Can sue after waiting for 90 days for board to act Answers: 1 -b (c – either deriv, direct) / 2 -c / 3 -abc / 4 -c / 5 -b / 6 -a Corporations: A Contemporary Approach Chapter 29 Planning in CHC Slide 9 of 59

Universal demand board dismissal …. [under MBCA] Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 10 of 17

MBCA (demand in derivative litigation) § 7. 42 Demand No shareholder may commence a derivative proceeding until: (1) a written demand has been made upon the corporation to take suitable action; and (2) 90 days have expired from the date the demand was made unless … the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting …. § 7. 44 Dismissal (a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) … has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation. (b) … the determination in subsection (a) shall be made by: (1) a majority vote of independent directors present at a meeting of the board of directors if the independent directors constitute a quorum; or (2) a majority vote of a committee consisting of two or more independent directors appointed by majority vote of independent directors present at a meeting of the board of directors, whether or not such independent directors constituted a quorum. (c) None of the following shall by itself cause a director to be considered not independent for purposes of this section: (1) the nomination or election of the director by persons who are defendants in the derivative proceeding or against whom action is demanded; (2) the naming of the director as a defendant in the derivative proceeding or as a person against whom action is demanded; or (3) the approval by the director of the act being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director. Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 11 of 17

1. Which of the following should be a derivative suit? a. Board misleads Shs about impending merger b. Board has Corp buy CEO’s wife’s art collection c. Board announces revised dividend policy 2. MBCA requires Shs make demand on board … a. Always (except emergency) b. When time is of essence c. Unless excused as futile 3. MBCA requires dismissal of derivative suit … a. When current board asks b. When majority of independent, disinterested Ds ask c. When Sh makes demand 4. In MBCA derivative suit must be dismissed if in good faith and after reasonable inquiry … a. Ds constituting board quorum ask b. Special litigation committee (properly chosen/composed) asks c. Demand was not excused 5. In MBCA Ds are not independent … a. If they have personal ties to interested director b. If they have financial interest in challenged tx c. If they have been sued 6. In MBCA, a Sh who makes demand on board … a. Concedes board is disinterested and independent b. Can still sue to show current Ds interested and non-independent c. Can sue after waiting for 90 days for board to act Answers: 1 -b (c – either deriv/direct) / 2 -a / 3 -abc / 4 -b / 5 -b / 6 -c Corporations: A Contemporary Approach Chapter 29 Planning in CHC Slide 12 of 59

The end Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 13 of 17