This is an email I sent to some students about my final exam in my basic bankruptcy class. In question 2, Fred the debtor owed a lot of subcontractors for work they did for him, a bank for money he borrowed to build a home, and a homeowner for a deposit that was given to him to build a house that he spent without building the house (so far at least). Hundreds of thousands of dollars in total. The issue was whether any or all of this debt would be discharged in a bankruptcy case.

Hi students,

I’ve been thinking about our conversation yesterday, especially question 2.  I think if you asked 100 people, 99 of them would tell you that it’s completely crazy to let this debtor simply walk away from all this debt.  That can’t be right!  My mother would laugh and snicker at me if I gave her this hypo and told her the guy keeps all of his property, probably continues with his life as a contractor, and walks away from the debts, by filing a few forms.    

But Congress says he can absolutely walk away.  It makes the rules.  Law school is really about learning to focus on the rules and not jump right into what’s fair and reasonable and moral and right etc. 

This guy can fill out some forms and walk away from the debts unless he committed fraud.  That’s the first rule. That what Congress said. There are no facts suggesting embezzlement, willful and malicious injury etc.  So it comes down to what’s fraud?  State the rule and then see what facts you are given to figure out if he committed fraud.  Fraud is a misstatement of material fact made to the people he owes money to; made to entice them into giving him something.  I don’t think there are any facts suggesting he cheated anyone.  Having said that, one or two in ten bankruptcy judges would deny his discharge for the reasons you all discussed in your answers.   Judges are human too.  

Anyway, that’s the lesson.  I think if you would have laid out the rule about what fraud is, then looked at the facts, you would have gotten closer to the right answer. 

One last thought, for some of you, your writing is going to hold you back, not a ton for most of you but some.  I assume it’s simply a failure to carefully review what you have written rather than a lack of skills.  But be careful with what you write.  Practice, practice, practice.  Even this email; I’ll bet I have reread it 6-8 times.  I carefully review texts I send to make sure there are no typos (which there always are some anyway of course).  In law school and on the bar exam, what you write is your entire grade.  

So good luck.  It was a fun class.  I appreciated your efforts.  JH

I have been fiddling with my material for my Fall 2023 Business Organizations class at UWLA, my 18th year of teaching the class. I decided to remind myself about which corporations qualify as “pubic companies.” A public company, to my way of thinking, is a corporation which is required file a bunch of different kinds of reports with the Securities & Exchange Commission (“SEC”). The reports require an immense amount of disclosure about every conceivable aspect of the company operations which are then available to the public, thus the public company. When Elon Musk bought Twitter, it was no longer a public company and the disclosures have stopped. The public can no longer easily see what is going on behind the curtains.

So which companies are required to report to the SEC? The answer is corporations with at least $10 million in assets and with at least 2,000 different shareholders. I wanted to make sure my memory was right and that the SEC had not changed the rule since I last looked. I needed the appropriate SEC regulation which I did not have handy.

I decided to take a short cut and did a google search of “What is a public company?” I clicked on probably ten different sites before I finally saw the SEC reg that gave me the answer. What struck me however is the number of sites that had definitions for public companies which were wrong and some very wrong. And these are sites that have at least facial credibility.

Investopedia for example defined public company as “a corporation whose shareholders have a claim to part of the company’s assets and profits.” Huh? First of all, to the extent that statement is true, it applies to every corporation. Second, I would not say that shareholders “have a claim” to corporate assets or profits. I suppose it’s true in an ultimate sense but it is misleading in any event and has nothing to do with public corporations.

A site called Britannica (and a few other sites) defined public company as “a company that issues shares of stock to be traded on a public exchange or an unlisted securities market. . . . in all cases public companies list their shares on a public market.” Shares are not “issued to be traded on a public exchange.” Shares give the owner certain rights set forth in the Articles of Incorporation. After that, the shares, with whatever rights that they have, may or may not be traded on an exchange or other market. The promoters of the corporation may have an eye to selling enough shares to get listed in some trading market but that is not what makes it a public corporation. And not all public companies “list their shares on a public market” although, obviously, many do.

Others: Masterclass.com says “A public company is an incorporated entity that sells ownership shares in capital markets.” Corporatefinancialinstitute.com says, “Public companies are entities that trade their stocks on the public exchange market. . . . The company is considered public since any interested investor can purchase shares of the company in the public exchange to become equity owners.” Many public companies’ shares are traded on stock exchanges but that’s not what makes them a public company.

The SEC website says, “‘Public companies,’ often referred to as reporting companies, are subject to reporting requirements and must file certain reports, including annual, quarterly, and current reports, with the SEC on an ongoing basis.” Thank you.

Anyway, my purpose for this blog post is to show the danger to students of doing short cut legal research on the internet. My experience is that more and more students, when it’s time to answer a law school question, simply do a quick internet search and copy and paste the first thing they find. I can usually tell immediately when the student is doing that because, first, the answer given is not what we discussed in class. Second, the rule propounded in the student’s answer is usually somewhere between partially right and completely wrong. The most common error, by the way, with website legal advice is that the website does not set forth the rule but instead explains the effect of the rule. That’s really what most people who search the internet are trying to find I assume. The statement that the shares of many public companies are traded on various stock exchanges is a true statement. But it does not tell us the rule; does not answer “what is a public company.”

We are lawyers. Most rules are blackletter statements given to us by Congress, our legislatures, or other governmental agencies. Some rules are given to us by courts. We use the rule to answer a specific question for our client. It is important that we start with the correct rule. You will rarely find the correct rule on the internet. Hopefully (although rarely in my experience), you will find the statute, the code section which is the rule.

On November 21, 2016, Tesla purchased 100% of the outstanding shares of SolarCity Corp. Tesla paid for the shares with Tesla stock, giving SolarCity shareholders Tesla stock valued at about $2.6 billion. A few Tesla shareholders sued the seven-person Tesla Board of Directors (“BOD”) for breach of their fiduciary duties. The shareholders argued in part that the shares of SolarCity were worthless when acquired, or at least worth a lot less than the amount paid.

At first blush, the business judgment rule (“BJR”) would make the court’s task easy. The directors win if they did their due diligence, i.e., made an informed decision, and there was no conflict, fraud, waste or bad faith. Suffice it to say they did a lot of due diligence.

But let’s dig a little deeper into the facts. Elon Musk was the largest shareholder of both Tesla and SolarCity owning about 22% of the publicly traded stock of each. He was also Chairman of the Board of SolarCity which he founded with his two cousins, Peter and Lyndon Rive. Elon, his brother Kimbal Musk, and one other person, Antonio Gracias, sat on both boards. Three other Tesla directors owned some SolarCity stock directly or indirectly. Hmm? Conflicts maybe? Loyalty issues?

So a huge portion of the amount paid for SolarCity went into Elon’s pocket. Other amounts went to his brother and four of the other Tesla directors. Only one Tesla director, Robyn Denholm, was completely disinterested financially.

But digging a little deeper still, this time focusing on the process of getting to the price Tesla paid, the Tesla BOD did not form a committee and did not exclude Elon from the negotiations. But it did hire an expert to opine on the valuation. Further, when it reached the purchase price, it submitted the issue to the disinterested shareholders. The disinterested shareholders approved the deal which closed the next day.

The unhappy shareholders, i.e., the plaintiffs here, argued that Elon dominated the BOD and since their directors had their own conflicts anyway (being shareholders of SolarCity), the BJR did not apply and therefore the matter must go to trial to determine if they used appropriate care, i.e., good faith business judgment and care of a reasonably prudent person under similar circumstances. They argued further that since six of the directors were putting money in their own pockets, the court must have a trial to determine if the price paid was fair to Tesla. Lastly, they argued that Elon, as a controlling shareholder, dominated the disinterested shareholders so the vote of those shareholders should carry no weight or any favorable presumption.

The crux of the matter then is whether the transaction was fair to Tesla and its shareholders. The Delaware court set the issue of care to the side at the outset. If the transaction was fair to the now-diluted Tesla shareholders, there are no damages and care would not be an issue. As to fairness, the court noted that the analysis is two-fold. It observed:

“The concept of fairness has two basic aspects: fair dealing and fair price.‘  Fair dealing (or fair process) ‘“’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.’  Fair price ‘relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock.’” The burden of persuasion lies generally with the defendants.

The court conducted an 11-day trial. In a very lengthy and detailed memorandum, it concluded that the price was intrinsically fair to the Tesla shareholders and entered judgment in favor of the defendants. As to the process, the court found that “Elon was undoubtedly involved in the deal process in ways he should not have been, but fortunately, the Tesla Board ensured nevertheless that the process led to a fair price. For example, it said no to the proposed merger twice at the outset. And Elon did not push back against them—there were no threats, fits or fights.  While involved, Elon did not impede the Tesla Board’s pursuit of a fair price.”

As to the price, it found that the price was intrinsically fair. It considered the testimony of various parties and experts and concluded the price was fait to Tesla. It commented also that “approval of a merger by disinterested stockholders is ‘compelling evidence that the price was fair.’  Here, nearly 85% of the votes cast by Tesla stockholders—largely extremely sophisticated institutional investors—were in favor of the Acquisition.”

The court therefore did not rule on the duty of care since there could not be any breach when the process getting to the purchase decision was fair, i.e., what was done was something a reasonably prudent person would have done under similar circumstances. Also again, since the price was fair, there could not be any damages.