Chapter 22 Duties within Corporate Groups

1. Module VII – Fiduciary Duties Chapter 22Duties within Corporate Groups Bar exam Corporate practice Law profession Control within corporate groups Definition of control Possible abuses of control: intra-group activities, squeeze-outs of minority shareholders Dealings with subsidiaries Sinclair Oil case Comparison to director duties Cash outs of minority shareholders Weinberger – entire fairness standard Nature of fair dealing Nature of fair price (exclusivity of appraisal) Lynch II - effect of disinterested approval Short-form merger Appraisal exclusive Pure Resources: review of tender offer + SO merger Citizen of world Chapter 22 Duties within Corporate Groups

2. Review of fiduciary duties …(directors) Corporations: A Contemporary Approach Chapter 21 Executive Compensation Slide 2 of 27

3. Fiduciary duties(directors) Oversight Bestinterests Decision-making Business Judgment RuleShlensky v Wrigley Inattention CorpoppFarber WasteAronson / Vogelstein GrossneglVan Gorkom ConflictinterestRemillard IllegalityMiller v AT&T (Allis-Chalmers) 102(b)(7) 102(b)(7) IllegalityCaremark Malfeasance(bad faith)Francis DisinterestedindependentBenihana Bad faithDisney Corporations: A Contemporary Approach Chapter 21 Executive Compensation Slide 3 of 27

4. Corporate groups Shareholders Affiliate? Wholly-owned vs. Partially-owned sub? Parent Company Public shareholders Subsidiary Company Subsidiary Company Subsidiary Company Chapter 22 Duties within Corporate Groups

5. Corporate groups Shareholders Difference between division / sub? Parent Company Division Division Subsidiary Company Subsidiary Company Subsidiary Company Chapter 22 Duties within Corporate Groups

6. Corporate groups Shareholders How much necessary for control? Parent Company Public shareholders Subsidiary Company Subsidiary Company Subsidiary Company Chapter 22 Duties within Corporate Groups

7. Law of corporate groups … Chapter 22 Duties within Corporate Groups

8. Sinclair Oil v. Levien (Del 1971) • Issues • Dividend policy • Intra-group dealings • Allocation of business opportunities Chapter 22 Duties within Corporate Groups

9. Shareholders Dividend policy Sinclair Oil Minority public shareholders Sinclair Venezuelan Sinclair International Sinclair Alaska Chapter 22 Duties within Corporate Groups

10. Dividend Policy If a plaintiff can meet his burden of proving that a dividend cannot be grounded on any reasonable business objective, then the courts can and will interfere with the board's decision to pay the dividend.  The dividends resulted in great sums of money being transferred from SinVen to Sinclair.  However, a proportionate share of this money was received by the minority shareholders of SinVen. .. Delaware Supreme Court Chapter 22 Duties within Corporate Groups

11. Shareholders Sinclair Oil Minority public shareholders Sinclair Venezuelan Sinclair International Sinclair Alaska Intra-enterprise Contract Chapter 22 Duties within Corporate Groups

12. Dealings between subs Sinclair caused SinVen to contract with International whereby SinVen agreed to sell all of is crude oil and refined products to International at specified prices.  The contract provided for minimum and maximum quantities and prices.  .... International's payment lagged as much as 30 days after receipt.  International did not comply with the [fixed minimum] requirement. Under the intrinsic fairness standard, Sinclair must prove that its causing SinVen not to enforce the contract was intrinsically fair to the minority shareholders.  Delaware Supreme Court Chapter 22 Duties within Corporate Groups

13. Shareholders Business opportunity Sinclair Oil Minority public shareholders Sinclair Venezuelan Sinclair International Sinclair Alaska Chapter 22 Duties within Corporate Groups

14. Allocation of opportunities Sinclair made no real effort to expand SinVen.  [While] Sinclair actively pursued a company-wide policy of developing new sources of revenue through its subsidiaries, SinVen was not permitted to participate and was confined in its activities to Venezuela.  .... with which subsidiaries should these opportunities have been shared?  No evidence indicates a unique need or ability of SinVen to develop these opportunities.  The decision .... was one of business judgment. ... Delaware Supreme Court Chapter 22 Duties within Corporate Groups

15. Cash-out mergers “Cash out” merger? Reasons for squeezing out minority? Standard of review? Remedies? Chapter 22 Duties within Corporate Groups

16. Cash-out merger (Weinberger) Shareholders Get rid of minority? (legally) Signal Companies Minority shareholders 50.5% 49.5% UOP Chapter 22 Duties within Corporate Groups

17. Cash-out merger (Weinberger) Shareholders Shareholders Cash Signal Companies Signal Companies Minority shareholders = + What protection? 100% UOP Merger Merger Sub UOP Chapter 22 Duties within Corporate Groups

18. Standard of review … Business purpose Fair price (intrinsic fairness) Entire fairness Chapter 22 Duties within Corporate Groups

19. "When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous, inherent fairness of the bargain.....  There is no dilution of this obligation where one holds dual ... directorships, as in a parent-subsidiary context. Delaware Supreme Court • What is • Inherent fairness? • Entire fairness? Chapter 22 Duties within Corporate Groups

20. Weinberger blueprint "The concept of fairness has two basic aspects:  fair dealing and fair price • "... The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained." • "... The latter aspect of fairness relates to the economic and financial considerations of the proposed merger, including ... assets, market value, earnings, future prospects ...  • Structure a squeeze-out • (1) Who and when initiate? (2) How structure? (3) Who negotiates? (4) What sub directors told? (5) How sub Ds approve deal? (6) How sub SHs approve deal? • Business purpose? • What about appraisal? Chapter 22 Duties within Corporate Groups

21. Independent directors Footnote 7: "Although perfection is not possible, or expected, the result here could have been entirely different if UOP had appointed an independent negotiating committee of its outside directors to deal with Signal at arms' length.  Chapter 22 Duties within Corporate Groups

22. How much $$ …(which valuation method?) Chapter 22 Duties within Corporate Groups

23. Delaware black method Chapter 22 Duties within Corporate Groups

24.  "... the discounted cash flow method [ie - earnings potential of UOP] was essentially the focus ... of Messrs. Arledge and Chitiea in the evaluation of the merger. "We believe that a more liberal approach must include proof of value by any techniques or methods which are generally considered acceptable in the financial community ... " Delaware Supreme Court Chapter 22 Duties within Corporate Groups

25. WONDERFUL NEWS (or slightly less wonderful than you thought) You have just won $1,000,000 in the state lottery.  You will be able to repay some of your student loans! You will receive your prize in installments -- $50,000 each year for 20 years Discount rate:  10% 5% Year 1: $45,455 $47,619 Year 2: $41,322 $45,351 Year 3: $37,566 $43,192 Year 4: $34,151 $39,176  ..... ..... ..... Year 19: $ 8,175 $19,787 Year 20: $ 7,432 $18,844 TOTAL  $425,678  $623,111 Chapter 22 Duties within Corporate Groups

26. Discounts in appraisal …(remember minority lacked control) Chapter 22 Duties within Corporate Groups

27. Discounts in appraisal $120 million At what price? • What is Corporation’s “going concern” enterprise value? • What is Minority’s pro rata interest in the company? • “lack of control” discount? • “lack of marketability” discount? Enterprise Value Chapter 22 Duties within Corporate Groups

28. Discounts in appraisal At what price? • What is Corporation’s “going concern” enterprise value? • What is Minority’s pro rata interest in the company? • “lack of control” discount? • “lack of marketability” discount? $50 million Pro rata (minority) Chapter 22 Duties within Corporate Groups

29. Discounts in appraisal At what price? • What is Corporation’s “going concern” enterprise value? • What is Minority’s pro rata interest in the company? • “lack of control” discount? • “lack of marketability” discount? Lack of control $35 million Chapter 22 Duties within Corporate Groups

30. Discounts in appraisal At what price? • What is Corporation’s “going concern” enterprise value? • What is Minority’s pro rata interest in the company? • “lack of control” discount? • “lack of marketability” discount? Lack of control Lack of marketability $20 million Chapter 22 Duties within Corporate Groups

31. The end Chapter 22 Duties within Corporate Groups