Brothers Paul and John and their third partner, George, have successfully launched their surfwear business and have opened a very successful storefront in Los Angeles. They have successfully incorporated their business as Fantastically Innovative Surfing, Inc. and have run the corporation for almost two years now. They have made more than $200,000 in net profit in year one and more than $350,000 in net profit in year two.

In the beginning days of the company, this business was simply a side job for all three individuals. As their business has grown more successful, however, they have realized that their surfwear business could be huge, thanks to Paul's sage business acumen, John's innovative surfwear technology, and George's excellent experience and skills in sales.

Paul has come to you with the following questions and concerns regarding Fantastically Innovating Surfing, Inc. Your responses to each of the following questions should be approximately one to two paragraphs. You should substantiate your responses by providing any appropriate references to the cases and model statutes that we are studying in our course; no outside references are required. You may feel free to incorporate additional facts and assumptions into the hypothetical scenario, as long as you clearly note them.

1.Paul, John, and George have an opportunity to open up a second storefront in San Diego, as a prime location has recently opened up. The dilemma is that their corporation does not have the capital to set up the store and pay rent, as all their cash is tied up in inventory. Lucinda, George's sister, has approached them about the possibility of becoming a fourth investor. John also has a good relationship with his local credit union, the Supremely Successful Credit Union of Southern California (for a possible loan).

2.What considerations should Paul, John, and George weigh in order to decide whether to take on another equity investor, take out debt, do neither, or do both?

During the same month, George has indicated he would like to aggressively expand and open up a second storefront in San Diego and a third store front in Santa Monica at the same time. John has serious concerns and thinks that the focus should solely be on slowly expanding the Los Angeles location. Paul does not have particularly strong views, but this disagreement between George and John has become more intense in recent years.

The corporation is about to hold its annual shareholders meeting with Paul, John, and George as the sole shareholders. They are also the only three directors of the corporation, though they are also contemplating adding two additional directors: Roberto, who is one of John's best friends and a software engineer who has helped the corporation with its website; and Denise, who is a local surfer, is an avid social media advocate for the corporation, and has close ties to the surf community in Santa Monica. Paul has serious reservations about adding any new directors at this time.

3.What considerations do the shareholders need to weigh at the shareholders meeting? What types of votes do they need to hold? What documentation do they need to prepare to thoroughly document their decision? What steps do they need to take to change the number of board members on the board?

Right after the shareholders' meeting, Chung, a wealthy angel investor and part-time surfer, approaches Paul about investing $1 million in the corporation on the condition that he receive a board seat. He has no prior personal or professional connections with Paul, John, or George, but George is excited about this potential infusion of capital and is thinking about giving up his board seat and having Chung take his place.

4.What questions should they ask Chung in order to determine whether he would be an appropriate fit for the Board of Directors? Should George resign from the board? If he does want to resign, what steps would need to be taken?

Three years later, Paul has returned to you with more questions and concerns. Now, the shareholders of the corporation consist of Paul, John, George, Roberto, Denise, and Chung. Paul, John, and George each own 1/4th of the corporation and the remaining 1/4th of the corporation was equally divided among Roberto, Denise, and Chung. All six also sit on the board; Paul is the CEO, John is the COO, and George is the CMO. By this time, the corporation has turned net profit of $3 million in the most recent fiscal year, and it is poised to double its profit in the upcoming year.

The corporation caught the eye of Surfs Up, Inc., a competitor, who approached George and offered $20 per share, valuing the corporation at $20 million. That same month, John's sister Andrea, a major shareholder in a large retail conglomerate, The Clothes Conglomerate, indicated that The Clothes Conglomerate would like to offer $25 per share, valuing the corporation at $25 million. Andrea texted to John that the Clothes Conglomerate did not trust in Paul's leadership, however, and that it would be "their little secret" that the Clothes Conglomerate would terminate Paul as CEO after the acquisition and replace him with John, to whom they would give a $1 million bonus if the transaction was successful.

Both George and John took their respective offers to the Board of Directors. The Board of Directors hired a local financial analyst to weigh the competing offers. In the meantime, Surfs Up, Inc. increased its offer to $30 per share, and The Clothes Conglomerate promptly matched the offer. The financial analyst studied the question for a week and recommended to the board to move forward with The Clothes Conglomerate, largely because they had more financial resources to grow the company. The financial analyst recommended that no additional offers be solicited, as both offers could go away soon. Denise and Chung expressed that they were "extremely uncomfortable" with not soliciting other offers, as they believed that the corporation could be worth as much as $50 per share.

During a contentious debate over which offer was better, John (who knew George preferred The Clothes Conglomerate already) pulled Roberto aside and indicated that if he voted in favor of The Clothes Conglomerate, he would allow Roberto to live in his large house in Malibu rent free for a year. John also indicated that The Clothes Conglomerate would have more resources to make the corporation more successful and that it would be detrimental to the corporation to have a 50-50 tie in the shareholder vote.

When the shareholders held a vote, John, George and Roberto (voting 58.3% of the shares) voted to approve of moving forward with the Clothes Conglomerate acquisition, while Paul, Denise and Chung (voting 41.7% of the shares) voted in favor of moving forward with Surfs Up, Inc.

Paul, Denise and Chung initiate a shareholder derivative lawsuit.

What issues do you think existing with respect to fiduciaries duties? What do you think the majority shareholders would argue, and what do you think the minority shareholders who initiated the derivate lawsuit would argue? Which party do you think will ultimately prevail? If the lawsuit is successful, what should the company now do?