General Background

BuzzMaster Power Tools Corporation ("BuzzMaster") was one of the oldest and most well- respected companies in the power tool industry. Based in Hartford, Connecticut, BuzzMaster tools have been sold in all the great US departments stores and home improvement stores for over 75 years. The company's founder, Ned Needmore, Sr., coined the BuzzMaster trademark, "Made in America for Quality," and since the company's founding all BuzzMaster tools have been manufactured in the US, first in the Northeast and more recently in the South. But despite BuzzMaster's stellar brand, the company has seen a steady decline in its sales and stock price due to competition from lower priced power tools manufactured abroad. Ned Needmore, Jr., BuzzMaster's current CEO and Chairman of the Board, and Robert Rothman, a BuzzMaster board member and the head of BuzzMaster's main investment bank, Rothman and Co., put their heads together to figure out what to do.

Needmore and Rothman came up with a plan (the "Restructuring Plan") to turn BuzzMaster into a licensing company by selling off BuzzMaster's proprietary manufacturing facilities, terminating its production contracts with US suppliers and licensing foreign manufacturers to produce power tools under the BuzzMaster brand in exchange for a licensing fee. The problem was setting up a network for foreign manufacturers quickly enough to stop BuzzMaster's declining sales and regain the confidence of investors to boost BuzzMaster's stock price. As it turns out, Ned, Jr. had an idea about how this problem could be solved.

Despite his patriotic persona, Ned, Jr.'s father, Ned, Sr., had left Ned Jr.'s mother and the US when Ned, Jr. was still in college. Ned, Sr. moved to Southeast Asia where he fell in love and fathered another son, Chi Nguyen. Chi, whose name signifies "a man with purpose," followed in his father's entrepreneurial footsteps and built a large network of manufacturing facilities in low wage and low regulation jurisdictions across Asia. Each manufacturing facility was established as a separate corporation the only assets of which were the lease for the building, leases for the manufacturing equipment, and an insurance policy with a liability limit of $1,000,000 per incident. All the shares of these corporations (the "Subsidiaries") were held by CN Holdings, Inc. ("Holdings"), a Delaware corporation, which in turn was held 90% by Chi and 10% by Ned, Jr., who had helped his half-brother launch Holdings by supplying early capital. All manufacturing contracts (each a "Manufacturing Contract") were made with Holdings and sub-contracted to one or more of the Subsidiaries to make the required products. Each sub-contract (a "Sub-Contract") set the payment to the applicable Subsidiary to be sufficient to cover manufacturing and labor costs, the rent on the building and equipment leases, the liability insurance premium and a small amount of working capital. All the remaining value of each underlying Manufacturing Contract was retained by Holdings.

Shortly after devising the Restructuring Plan, Ned, Jr. approached Chi with a proposal. After explaining the declining sales and stock price of BuzzMaster and the Restructuring Plan, Ned, Jr. suggested that Holdings and BuzzMaster enter into an exclusive licensing arrangement whereby Holdings would manufacture all of BuzzMaster's power tools. As Ned, Jr. saw things, BuzzMaster would benefit from substantially lower production costs that would improve its competitive position and boost sales, Holdings would benefit from steady and lucrative manufacturing orders and BuzzMaster's shareholders would benefit from the sale of its US manufacturing facilities and a steady stream of licensing revenue leveraging the BuzzMaster reputation and brand. Before shaking hands on the deal, Ned, Jr. asked Chi if there was anything he should know about Holdings or the Subsidiaries. Chi replied "Ned, you know things work differently in Asia than in the US. I've been successful in this business a long time. Let me handle things on this side of the pond." Ned smiled, nodded and said "Ok, let's do it!"

At its next regularly scheduled board meeting, the BuzzMaster board had two items on the agendaa presentation by Ned, Jr. of the Restructuring Plan, including the proposed exclusive license agreement with Holdings (the "License Agreement"), and a report by Dick Desmond, the company's outside corporate counsel, regarding a shareholder proposal submitted by The Lightner Fund for the proxy statement of the next Annual Meeting urging the Board to adopt measures to ensure compliance with the anti-bribery provisions of the Foreign Corrupt Practices Act ("FCPA"), a federal statute precluding US companies and their foreign subsidiaries from bribing foreign government officials to obtain unfair business advantages.

With respect to the former, Ned, Jr. commenced his report with large graphic displays showing BuzzMaster's declining sales and the concurrent decline in the company's stock price which had fallen from $90 to $30 per share in the past five years. He then displayed a poster of the BuzzMaster logo with its trademark slogan "Made in America for Quality" and said "This slogan is killing us! No is willing to pay for American quality anymore! If we're to survive we've got to change!" He then made a large X across the logo and threw the poster to the ground. He continued: "Our future is our brand and leveraging that brand with low-cost manufacturing abroad. The Restructuring Plan and the License Agreement can secure that future." Ned then disclosed that he was a 10% stockholder of Holdings and explained how happy he was to bring BuzzMaster this much-needed relationship with Holdings and his half-brother Chi, its CEO.

At this point Dick Desmond, the company's chief outside counsel and a partner its main outside law firm, stated:

I don't want to jump ahead on our agenda today, but there can be large risks in manufacturing abroad, FCPA liability being only one of them. As we don't have any experience in this regard, it might be prudent to appoint a committee of the board to undertake due diligence on Holdings and its business practices. Don't get me wrong Ned. I'm not expecting to find anything, but with the Lightner Fund shareholder proposal, and with Department of Justice FCPA investigations all over the news, it might make sense. . ."

In mid-sentence, Ned stormed out of the boardroom. The rest of the Board sat in stunned silence. A few minutes later, Ned returned wearing a black t-shirt on the front of which was printed "This deal or die!" over a skull and cross bones and sat down silently in his chair at the head of the board table. With all eyes on Desmond, he said,

Ok, Ned. Your point is well-taken. I was going to recommend that a Compliance Committee make a report on FCPA and other liability risk of the Licensing Agreement before we bring the transaction to the board for a final vote, but maybe I'm just 'over-lawyering' here.

Ned then said he would like the Board to appoint Rothman and Co. to handle the negotiation of with Holdings as BuzzMaster's investment bank. Robert Rothman chimed in "we can take care of the diligence during the negotiation." Without further discussion, the Board unanimously approved the Restructuring Plan and approved the appointment of Rothman and Co. to negotiate the terms of the License Agreement with Holdings.

A few weeks later, the Board held a meeting to consider the proposed License Agreement with Holdings. Rothman made a presentation explaining the basic commercial terms of the deal and presented a chart showing the relative costs of production for some of BuzzMaster's most popular products in the US and through Holdings and its Subsidiaries, suggesting significant savings. Rothman did not present any information on the extent to which revenues and profits that had been previously captured by BuzzMaster through its proprietary manufacturing divisions would now be diverted to Holdings. He also did not present any information on revenue and profits projections comparing the status quo and BuzzMaster after the License Agreement. Nor did he present any projections as to the relative risks and benefits of the License Agreement versus BuzzMaster acquiring its own manufacturing facilities abroad or contracting with diverse foreign third-party suppliers rather than relying on an exclusive deal with Holdings.

Miles Margate, an outside director who was also the CEO of an international import/export business, said he had heard unsubstantiated rumors of persistent labor and safety violations at some of Holding's Subsidiaries. Rothman replied that "Holdings has been fully vetted through a diligence process and nothing turned up amiss." Rothman provided no report or other evidence at to the nature of the diligence process, and none was requested. The Board then voted five in favor, none against the License Agreement. Ned was present at the meeting, again wearing his "This Deal of Die!" t-shirt but did not speak or vote.

When the Restructuring Plan and License Agreement were announced to the media, the response was very positive. BuzzMaster's stock price climbed from its low of $30 per share to $45 per share. Rothman and Co. received a fee of $500,000 for its work in connection with the License Agreement.

BuzzMaster is a Delaware corporation and its common stock is publicly traded on the New York Stock Exchange. The Board of BuzzMaster for all relevant time periods is comprised of Ned Needmore, Jr., CEO and Chairman, Abigail Abicus, Chief Financial Officer, Dick Desmond, a senior partner in Great American's principal outside law firm, Miles Margate, a business school friend of Ned's and CEO and Chairman of the Board of Diversified International Import/Export Inc., Robert Rothman, a senior partner in Rothman and Co., BuzzMaster's principal investment bank, and Sonia St. Clair, the CEO of First Bank of Hartford, which serves as trustee for the Mia Needmore Trust (an estate planning entity that holds BuzzMaster shares for the benefit of Ned's daughter Mia Needmore) for which the Bank receives an annual fee of $10,000. Share ownership of BuzzMaster for all relevant periods is as follows: Ned, Jr. owns 25%, the Mia Needmore Trust owns 25%, employees and senior management own a total of 5% and the remaining 45% is owned by public shareholders. Included among the public shareholders is The Lightner Fund, a socially responsible investment fund managed by Linda Lightner, which for all relevant periods owns 2 million shares of BuzzMaster stock.

Holdings is a Delaware corporation with twenty wholly-owned Subsidiaries, each of which is itself a Delaware corporation doing business in a different location around Asia. As Holdings is a privately held company, there are no annual reports or other publicly mandated disclosure as to the finances or governance of Holdings or the Subsidiaries. Chi Nguyen's Holdings' business card lists his title as "Chief Executive Officer and Chairman of the Board."

Question 1

Eighteen months after approval of the License Agreement, the Restructuring Plan has been fully implemented and Holdings and its Subsidiaries are the exclusive manufacturers of BuzzMaster tools. The License Agreement with BuzzMaster accounts for 80% of Holdings' revenues and 95% of its profits.

Holdings' Cambodian Subsidiary, CN Cambodia Inc., produces only BuzzMaster tools under a Sub-Contract from Holdings.

Early one morning CN Cambodia's five-story factory building in Phnom Penh collapsed killing more than 1500 people and injuring thousands more. Potential liability for the factory collapse is estimated by the local papers and Cambodian officials to be in excess of $700,000,000. A legal representative of the injured and killed workers, Ms. Akara San, has contacted your law firm in New York to get your advice as to whether there might be any viable claim against Holdings, its shareholders Chi Nguyen and Ned Needmore or BuzzMaster for the liabilities of CN Cambodia. In the course of the conversation, Ms. San tells you additional information about Holdings, CN Cambodia and Chi. In particular, she reports that CN Cambodia had been frequently cited for safety and building code violations by the Cambodian authorities, but no formal action was ever taken by the government. She said that the City Engineer of Phnom Penh did an inspection and warned CN Cambodia in an official letter addressed to Chi at Holdings that the manufacturing equipment installed in the CN Cambodia building was too heavy for the structure and that substantial renovations would be necessary to avoid a risk of collapse. She also said that Chi was frequently seen around town driving a Ferrari and in the company of high-ranking Cambodian government officials at expensive restaurants and hotels. She also reported that when the factory site was finally excavated no corporate or financial records for CN Cambodia were found. Finally, she said that Chi was known for paying his workers regularly, if meagerly, but that despite many complaints, he never made any effort to address safety concerns regarding the CN Cambodia factory building.

Through your own research, you managed to determine that Chi appears to be the only board member of Holdings and each of the Subsidiaries. While each of the Subsidiaries, including CN Cambodia, does have an on-sight production manager, from what you have been able to gather from press clippings and other public documents, Chi is the only senior officer and director running Holdings and the Subsidiaries.

What would you tell Ms. San?

Question 2

You are an associate in plaintiff-side corporate litigation firm. The firm's named partner, Stanley Seer had been watching the developments at BuzzMaster for some time. He has been particularly interested in what seemed to him an obvious conflict transaction in the combination of the Restructuring Plan and the License Agreement in which Ned, Jr., his half-brother Chi and Holdings seemed to be the winners and BuzzMaster's shareholders the losers. With all the negative publicity surrounding the factory disaster at CN Cambodia for both Holdings and BuzzMaster, he thought it might be an opportune time to find an appropriate BuzzMaster shareholder to bring a derivative claim against Ned and potentially Rothman for breach of their duty of loyalty in connection with the License Agreement.

Seer calls you into his office and says:

Since we have Needmore on both sides of the License Agreement deal and Rothman stood to gain substantial fees for his firm if the deal went smoothly through the BuzzMaster Board, we would seem to have a prima facie case against them both. The real linchpin of the case is whether we can successfully plead that making a demand on the remaining BuzzMaster board members to bring the action against Needmore and Rothman would be futile because a majority of the BuzzMaster directors are either interested or not independent. If we can show they are disqualified for demand purposes, we would also have a good shot at showing that their approval of the License Agreement was not a procedural ratification in the underlying duty of loyalty claim. Dig up everything you can on the BuzzMaster directors other than Needmore and Rothman and write me a memo giving me your best assessment of our chances of surviving a motion to dismiss for failure to make a demand on the Board. Remember, we only make money in these cases if we win. So, no wild or novel theories. Focus on the arguments a mainstream court in Delaware would be willing to listen to and then tell me whether that court would likely find them persuasive.

Assuming you know everything described in this exam so far, what would you tell Mr. Seer?

Question 3

You are General Counsel for the Lightner Fund, and the Fund's CEO, Linda Lightner, comes into your office. In explaining the reason for her visit, she said:

I tried to warn those boneheads at BuzzMaster with my shareholder proposal that they needed to get their FCPA compliance house in order. I knew they would never be able to continue profitably without taking some of their production overseas. Now the company is in huge mess and the company's shareholders and exploited workers are paying the price! I've been pondering whether there is anything The Lightner Fund, as a shareholder, can do it about it? I understand the BuzzMaster charter contains a provision that says that directors can only be removed by shareholders "for cause" between Annual Meetings and goes on to define "cause" to include "any or all behaviors for which exculpation of liability of a director would not be permissible under Delaware law." The Delaware courts seem inclined to imply an inherent right for shareholders to call a special meeting to remove directors for cause so let's take that as a given. I'd like your advice as to the likelihood that a Delaware court would find any of the conduct by the BuzzMaster directors in connection with the Restructuring Plan and the License Agreement to constitute "cause" as defined by the BuzzMaster Charter? You know I hate long memos, so focus on the strongest claims. If we can't remove these directors now for "cause", we can try to vote them out at the next Annual Meeting.

What would you tell Ms. Lightner?