CORPORATIONS
Professor Brant
Spring, 1995
Final Examination
DIRECTIONS
1. This is an open book examination. You may bring in and use the Hamilton textbook, a statutory supplement containing the RMBCA and your class notes.
2. You are also permitted to bring into the examination any outlines that you played a substantial part in preparing. Nutshells, treatises, black letter law guides and the like may be used in preparing your own outline, but may not be brought into the examination.
3. If you leave the examination room for any reason during the course of the exam, you may not take anything with you. Any materials you bring into the room must remain there until the examination is over.
4. You will have three (3) hours to complete the examination. Blue books will not be passed out for thirty (30) minutes. This time should be spent reading the examination and outlining your response on the scratch paper provided. All scratch paper must be turned in with your examination.
5. DO NOT CITE A CASE OR STATUTE WITHOUT FURTHER DISCUSSION! There is no presumption that use of a case name or statutory section indicates familiarity with its contents. Discuss and analyze any cases or statutory provisions you plan to use in your answer.
6. For purposes of this examination, assume that all relevant conduct has occurred in a state which has no corporate law of its own, so that its courts are free to borrow the law of any other state. All federal securities laws apply in this state.
7. If you believe that additional facts are required for your answer, state specifically what additional information is required, why it is needed, and how it would affect your answer.
8. Be sure to turn in your examination copy and scratch paper with your answers. You should write your exam number on this examination now.
Final Examination Question
After finishing their Corporations class in 1994, Jim Julep and Sarah Safire decided that there was more money to be made taking a start-up company public than they could ever hope to earn as lawyers. They decided to form a corporation to build small convertibles with hot rod engines. Sarah's father had worked on the "Playboy" convertible in the early 1950's, and was able to advise them on the process of manufacturing and hand assembling a quality automobile. Their plan was to produce a half dozen cars, made to extremely high standards, obtain good reviews in the automotive press, and then sell their company to one of the Big Three U.S. automobile manufactures: Ford, General Motors or Chrysler.
Jim advertised for an automotive design specialist in the trade publications, and was able to lure Alonzo Quick, a designer previously employed by Mazda, who had worked on the Mazda Miata. Al was a first rate designer with a reputation for jumping from company to company. He had many ideas for improving the Miata design that Mazda had never taken seriously, and he was excited by the promised 10% stake in the company's common stock that Jim offered him. Other workers who had experience with Honda's Marysville plant and Toyota's Georgetown, Kentucky plant were easily recruited. Sarah obtained a lease on the old Armory building in Ada as their "factory assembly" building, and soon the car was taking shape.
Jim and Sarah entered into half a dozen contracts that summer, both employment and supply related. Each of these contracts was signed by both Jim and Sarah, with Jim signing as President and Sarah signing as Treasurer of "the American Classic Car Company, a corporation to be formed in the future." (hereafter the "ACC Co.") Jim and Sarah waited to file the incorporation papers for this corporation until October, 1994, by which time they had all their employees on board and their supply contracts in place.
The corporation was authorized to issue 10,000 shares of common stock and 5,000 shares of convertible preferred, both at a par value of $1 per share. The preferred stock was convertible into common stock at the option of the company on a 5 for 1 basis. Jim and Sarah each received 4,000 shares of common stock and Al Quick received 1,000 shares. The preferred stock was purchased by Sarah's parents, who also invested in 1,000 shares of common stock. The Board of Directors consisted of Jim, Sarah, Al and Mike Morrison, a classmate who served as legal advisor to the corporation.
In May of 1995, the "Crago" car was finished, and Jim and Sarah began taking it around to national automobile shows. The reaction of the press was tremendous. "The most intriguing, exciting domestic sports car since the Mustang," said Car and Driver. "An incredible driving experience!" said Road and Track. Suddenly, Jim and Sarah's phone was ringing off the hook with invitations to dinners, breakfasts and golf games with leading executives of the major car companies, all of whom wanted a stake in the Crago.
It became clear that the American Classic Car Company was about to be worth a great deal of money. Jim began to regret having involved Sarah's family members in the company. He proposed a resolution for the company to repurchase all the outstanding preferred stock and convert it into Class B common stock, with no voting rights and 50% of the dividend and dissolution rights of the existing common stockholders. Sarah opposed this resolution, but Al and Jim's votes were sufficient to override her objections. Sarah then resigned her position as Director and Treasurer, and told Jim that held be sorry he had ever crossed her path.
Jim and Mike then made arrangements to take the corporation public, and obtained a listing on the prestigious New York Stock Exchange. The initial public offering, held in July of 1995, was wildly oversubscribed and raised a total of $4 million. Jim and Mike were issued 10,000 shares and 18,000 shares respectively. An initial trading price was set at $11 per share, but this quickly shot up to $21 per share in heavy trading. The newly public company was authorized to issue 150,000 shares of common stock and 100,000 shares of preferred. There was no limit on the number of subscribing shareholders. Mike told Jim that this offering was exempt under Regulation D, and thus there was no need to comply with the registration requirements of S12 of the 1933 Act.
Several months after the public offering, Jim began to consider competing offers to buy out the company. Chrysler offered to turn the company into a separate division of Chrysler, modeled along "Saturn" lines, with employee ownership and a dedicated plant for manufacturing the Crago, located in Ada, Ohio. Chrysler was offering $60 per share and would give Jim a 30% stake in the new company. Jim estimated the value of his stock ownership in the new company at around 3.5 million dollars. Chrysler was also willing to keep Jim on as President, but wanted complete control of the Board of Directors and the ability to hire and fire all other employees. That was fine with Jim.
Another offer, from Ford, involved a payment of $70/share. However, Ford intended a simple takeover, in which the Crago would be produced and manufactured by Ford's existing plants, and none of the current management of the ACC company would be involved. Jim would receive only the premium price for his shares, which amounted to $700,000.
Jim discussed these offers with Al, who strongly favored the Ford offer. Jim told Al that he had no intention of seriously considering Ford's proposal, and if Al had any plans to be "disloyal," then he had better skip next week's Directors' meeting. Al said that under the circumstances held better resign as a Director and employee, effective October 1. On September 30 first thing in the morning, Al purchased 5,000 shares of ACC. Over breakfast, he told his wife Brenda that the company was "in play." Brenda passed this information on to Julian, her hairdresser, that same afternoon. Julian immediately cashed in his retirement portfolio and purchased 30,000 shares of ACC.
Jim met with his Board of Directors (all Hardin County residents) on October 5 and discussed these two offers. Jim spent 45 minutes discussing the Chrysler proposal, emphasizing the creation of jobs in the Hardin County community as well as the advantages of remaining a relatively independent division of Chrysler in terms of maintaining design integrity and quality control. No financial information was discussed, and fairness letters were not obtained from the company's financial advisors or attorneys.
At the end of this discussion, Jim mentioned that there had been a competing offer from Ford, whose terms were "superficially attractive," but that the specifics of the deal "left a lot to be desired." No price was mentioned with respect to the Ford proposal, and the Directors did not ask Jim any questions about it. The Board discussed the Chrysler proposal for 20 minutes, then unanimously voted to accept Chrysler's offer. A press release was issued on October 10, which described the Chrysler proposal as the "best available offer" and an "extremely fair" price. All trading in ACC stock was suspended by the NYSE to prevent a mass feeding frenzy. Proxy solicitations were sent to all ACC shareholders the same day, using language identical to that in the press release. The buyout was promptly approved by 68% of the company's shareholders, and the deal was scheduled for consummation on October 18.
Al, Brenda and Sarah (all of whom voted against the Chrysler deal) filed a derivative suit against the ACC Company and its Board of Directors on behalf of all shareholders opposed to the Chrysler buyout. This suit was filed on October 15, and included a demand for a temporary restraining order to prevent the Chrysler buyout from occurring. Appraisal rights were sought in the event that the TRO was denied. The suit alleged that ACC Board members had breached their fiduciary duty to shareholders, and should be jointly and severally liable in damages. The plaintiffs' position was that the Ford offer should have been considered at the Board meeting, described in the proxy solicitation materials, and recommended to shareholders in preference to Chrysler's offer, which they claimed had been "materially misrepresented" in the proxy solicitation. Al included a claim for breach of his employment contract, since his 10% stake in the company had been significantly reduced when the company went public. Jim and Mike were also charged with self dealing. The plaintiffs did not make any request upon the Board members to remedy this situation before filing their lawsuit, due to the pace of unfolding events.
As soon as Jim and Mike were served with a copy of this complaint, both men placed "sell" orders with their broker, instructing him to sell off their entire stock holdings in the ACC company as soon as trading in the company was reopened. This was done at 8:01 a.m. on October 16. The news of the lawsuit became public late that afternoon, and ACC's stock dropped $10 per share in heavy trading over the next twenty-four hours.
Discuss and resolve all issues presented by the facts, as well as all issues likely to be raised in the litigation.