Business Organizations Outline_nima

8/8/2019 Business Organizations Outline_nima

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BUSINESS ORGANIZATIONS OUTLINE

INTROI. Agency: one person working with another with certain powersII. Partnership: when two equals come together

III. Forms of Business Organizationsa. Proprietorshipsi. Single-person businesses

ii. Most businesses are theseb. Partnerships

i. General partnerships- account for about 50%ii. Limited partnerships

iii. Limited liability partnerships- smallest groupiv. Limited liability companies- second largest group; hybrid that

offers benefits of partnerships without as much of the downsidesc. Corporations

i. Second largest group of businessesii. Account for over 75% of receiptsIV. Types of Authority/Agency

a. Actual- manifestation of consentb. Apparent- viewed from 3rd party perspectivec. Implied- viewed from agents perspectived. Inherent- catch all; undisclosed principal & agent exceeding authoritye. The legal consequences of an agents act do not depend on the type of

authority the agent possessedV. On exam question, always ask how the court is trying to make things more

efficient- make whole economy more efficient

VI. Important to hire a transactional lawyer in order to get best deal for client andto lower transactional costs for all, thereby making more money for all

CHAPTER 1: AGENCYI. Who Is an Agent?

a. Gorton v. Doty

i. Facts: son injured in wreck on way to football game in car drivenby coach; car belonged to defendant

ii. Establishes PAT Triangle: principal, agent, third partyiii. Legal standard for agency: agency is a relationship that results

from1. the manifestation of consent by P to A that A shall act

a. on Ps behalfb. subject to Ps control

2. As consent to so activ. Doesnt have to be a contract for there to be an agency relationship

b. A. Gay Jenson Farms v. Cargill

i. Facts: plaintiffs were farmers who sold their crops to Warren.Warren was the local firm that operated the grain storage facility.

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Cargill was a world-wide grain dealer. Warren bought grain fromfarmers and sold to Cargill- was Warren an agent for Cargill?Warren became insolvent and farmers sue Cargill.

ii. Principal is liable on contracts made by an agent on principalsbehalf

iii. You can form an agency relationship without even knowing it-may not realize that the elements for agency are presentiv. There must be an agreement, but not necessarily a contract; no

consideration neededv. Creditor becomes a principal at the point at which it assumes

defacto control over the conduct of the debtorvi. Restatement: one who contracts to acquire property from a third

person and convey it to another is the agent of the other only if it isagreed that he is to act primarily for the benefit of the other and notfor himself

1. court says that under this approach it must be shown that

the supplier has an independent business before it can beconcluded that he is not an agentvii. How could Cargill have avoided this?

1. reduce level of control2. do nothing3. take on additional control and become more like a franchise

viii. policy issues1. Cargill got the benefit of controlling Warrant while evading

legal obligations that accompany control2. holding Cargill liable is a way of forcing it to internalize

the social costs of how it turns its businessII. Liability of Principal to Third Parties in Contract

a. Restatement: principal is subject to liability upon contracts made by anagent within his authority if made in proper form and with theunderstanding that the principal is a party

b. Authority Introi. Authority is the key; agents acting with authority may bind

principalsii. Authority is the starting point for analysis of contract actions

iii. Authority vs. Power1. agent may bind the principal even when the agent lacks any

form of authority2. an agents power to bind the principal is broader than an

agents authority to bind the principal3. authority means that the agent has legitimate power to do

so; power is just doing itc. Actual Authority

i. must be authority from the principal to the agent in order to act onthe principals behalf

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ii. requires manifestation of consent- written or spoken words or otherconduct of the principal which reasonably interpreted causes theagent to believe that the principal desires him to so act on theprincipals account

iii. express actual authority- P to A: do this

iv. implied actual authority- authority that is inherent in the office; seebelowd. Implied Authority

i. Is actual authority circumstantially proven which the principalactually intended the agent to possess and includes such powers asare practically necessary to carry out the duties actually delegated

ii. Often highly contextual, often depending on prior practices orindustry customs

iii. includes authority to do those things that usually accompany or arereasonably necessary to the actions authorized

iv. also called incidental authority

v. viewed from the agents perspectivevi. Mill Street Church v. Hogan1. Facts: church hires Bill to paint. Bill normally gets Sam to

help and church knows this. Sam gets hurt on the job. DidBill have authority to hire Sam?

2. Bill (agent) had both implied and apparent authority3. Bill had implied authority- had used Sam in the past, knew

needed 2 people to do job; reasonably necessary to hireanother person and to hire Sam; no instructions to thecontrary

vii. Can have implied actual authority and implied apparent authority1. implied actual: act of putting an agent in such a position

leads agent to reasonably believe he has authority2. implied apparent: act of putting agent in such a position

that leads third party to reasonably believe agent hasauthority

e. Apparent Authorityi. Viewed from the third partys perspective- manifestations by

principal to third partyii. Lind v. Schenley Industries

1. must be a manifestation by the principal to the third party2. this court got it wrong because it confused the forms of

authority3. notice will defeat apparent authority4. must prove agency relationship existed and then what

kind(s) of authority agent possessed5. burden on principal to have good agents

iii. to avoid apparent authority, must take away third partysreasonable belief

iv. Three-seventy Leasing v. Ampex

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1. apparent authority exists only when there is someconnection between the third party and the principal

2. you must always look at how the third party learned of theagents alleged authority and ask whether the principalreasonably can be said to have been the source of that

knowledgef. Inherent Agency Poweri. Classic situations: undisclosed principals, agent exceeds authority

ii. Used to impose liability on the principal when there is neitherauthority nor apparent authority

iii. Also imposes liability on agent, but usually agent has disappearediv. Is a catch-all categoryv. Doesnt derive from authority but solely from the agency

relationship and designed to protect third partiesvi. Watteau v. Fenwick

1. Facts: defendants got an agent to run a beerhouse for them

2. undisclosed principal- principal is liable for all acts whichare within the authority usually confided to an agent of thatcharacter

3. inherent authority is usually a policy issuevii. Kidd v. Thomas A Edison

1. Facts: singing tour case. Agent exceeded scope of authorityby promising third party Kidd the full tour when principalonly hired agent to travel around

2. not actual, implied, or apparent authoritya. not actual because principal expressly told agent he

did not have this power; not implied actual eitherb. not apparent because no communication between

principal and third party3. inherent authority existed- must establish that reasonable

for third party to believe agent had authority (industrystandard for agent to have this authority)

viii. Nogales Service Center v. Atlantic Richfield Co

1. 3 types of situations in which inherent agency existsa. General agent does something similar to what he is

authorized to do, but in violation of ordersb. Agent acts purely for his own purposes in entering

into a transaction which would be authorized if hewere actuated by a proper motive

c. Agent authorized to dispose of goods and departsfrom the authorized method of disposal

2. most commonly at issue: customary for agent conducting atransaction to have authority to make incidentalarrangements, but principal has made contrary instructions

3. p. 35 problem 2- good exam questiong. Ratification

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i. Agent acts without authority of any kind and there is no groundsfor estoppel

ii. Requirements:1. a valid affirmation by principal

a. can be express or implied

b. principal must know or have reason to know allmaterials/information2. to which the law will give effect

iii. will be denied legal effect where necessary to protect the rights ofinnocent third parties

iv. Botticello v. Stefanovicz

1. martial status is not enough to establish agencyv. Ratification is a means by which the principal can say, my agent

didnt have the right to enter into this contract, but Im glad she didso. Accordingly, Ill affirm the transaction and agree to be boundby the contract

vi. ratification cases involve 2 questions:1. what types of acts constitute an affirmation by theprincipal?

2. what effect should we give to that affirmation?h. Estoppel

i. Hoddeson v. Koos Bros

1. Facts: guy pretended to be salesman and pocketed money2. no actual authority3. no implied authority4. no apparent authority (no manifestation by principal to

third party; silence can be manifestation but no holding outhe was its agent here)

5. estoppel elementsa. acts or omissions by the principal, either intentional

or negligent, which create an appearance ofauthority in the purported agent AND

b. the third party reasonably and in good faith acts inreliance on such appearance of authority

6. estoppel only binds the principal, never the third partya. the third party changed her position in reliance upon

the appearance of authorityi. Agents Liability on the Contract

i. Atlantic Salmon A/S v. Curran

1. if agent doesnt disclose principal (inherent agency), agentis treated as a contracting party

2. partially disclosed or undisclosed principal:a. agent is treated as though a party to the contractb. third party must elect who to sue- principal or agentc. agent has usually disappeared, so third party is left

with suing principal

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3. actual knowledge is the test4. the duty rests upon the agent, if he would avoid personal

liability, to disclose his agency and not upon others todiscover it

III. Liability of Principal to Third Parties in Tort

a. Servant Versus Independent Contractori. A master-servant relationship exists where the servant has agreed(a) to work on behalf of the master and (b) to be subject to themasters control or right to control the physical conduct of theservant

1. Two types of independent contractors (differ in degrees ofcontrol retained by principal)

2. agent-type ICa. one who has agreed to act on behalf of another, the

principal, but not subject to the principals controlover how the result is accomplished

b. can hold principal liable here3. non-agent IC:a. one who operates independently and simply enters

into arms length transactions with othersb. usually cannot hold principal liable here

ii. generally, principal liable for conduct of his employee but not thatof IC

iii. IC usually paid by the job, not by the houriv. Gas Station Cases-Humble Oil v. Martin, Hoover v. Sun Oil

1. similar facts: gas station with repair shop is tied to an oilco; somebody gets hurt and sues the oil company becausethey have the deep pockets

2. 3 possibilities: gas station isa. Completely independent station that buys from

many oil companiesb. Wholly owned by oil companyc. Franchise: intermediate between wholly owned and

independent3. look at the level of control; the more control franchisor has

more likely will be liablev. Murphy v. Holiday Inns

1. Facts: plaintiff slip and fell at a Holiday Inn2. Court found there was not sufficient control by Holiday Inn

to amount to agency- didnt give defendant right to controlthe methods or details of doing the work

3. control is the essential element for agents and ICrelationships

4. key distinction between the servant and IC types of agentsis the differing natures and degrees of control exercised bythe principal

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b. Tort Liability and Apparent Agencyi. Miller v. McDonalds

1. Facts: plaintiff bit into sapphire in Big Mac2. court found both actual and apparent authority- apparent

because third party had no idea if this McDs owned by

corporate McDs or a franchisee3. the RIGHT to control is key, not actual controlii. problem p. 62- good exam question

c. Scope of Employmenti. Ira S. Bushey & Sons v. US

1. Facts: sailor on boat, drunk, plays with valves and ends updamaging boat and dock; dock owner sues

2. Restatement: a master is subject to the liability for the tortsof his servant committed while acting in the scope of hisemployment

3. this case discards the purpose test (whether the conduct was

motivated at least in part by a purpose to serve the master)4. this court adopts foreseeability test: if some harm isforeseeable, master liable even if the particular type ofharm was unforeseeable

a. virtually amounted to a rule of strict liability for thetorts of employees as long as any connection in timeand space could be made between the conduct andthe employment

b. not adopted by all courtsii. General rules about scope of employment

1. Was the conduct of the same general nature is that whichthe servant was employed to perform?

2. Was the conduct substantially removed from the authorizedtime and space limits of the employment?

3. Purpose test (Restatement): whether the conduct wasmotivated at least in part by a purpose to serve

iii. Manning v. Grimsley

1. Facts: baseball player heckled by fans and intentionallythrew ball at them in the stands

2. Are intentional torts within the scope of employment?a. Not in early CLb. Restatement: intentional torts involving the use of

force result in liability if the use of force is notunexpected by the master

c. Restatement: consciously criminal or tortious actsnot per se excluded from scope of employment

3. here, court held principal liable for players intentional tortbecause the cause of the tort was due to fans interferingwith the agent/players duty and scope of employment-playing baseball

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iv. Law and economics perspective (Lee likes this better)1. occasionally employees will do bad things and if hold

principal liable will be able to pay person for injuries2. deep pockets in the best position to do this because they

can spread the cost around could prevent at lowest cost

and absorb cost betterd. Statutory Claimsi. Statutes can alter the requirements under CL suit- such as extend

the scope of employmentii. Can usually sue both under CL (tort) and statute (if a statute exists

in your jurisdiction)iii. Arguello v. Conoco

1. Facts: plaintiffs sue under 1981 alleging racialdiscrimination while purchasing gas

2. 5 factors in considering whether an employees acts arewithin the scope of employment (Restatement)

a. The time, place, and purpose of the actb. Its similarity to acts which the servant is authorizedto perform

c. Whether the act is commonly performed by servantsd. The extent of departure from normal methodse. Whether the master would reasonably expect such

act would be performede. Liability for Torts of Independent Contractors

i. Majestic Realty v. Toti Contracting

1. Facts: wrecking ball case2. Generally principal is not liable for torts of IC3. 3 exceptions

a. Where the landowner retains control of the mannerand means of the doing of the work which is thesubject of the contract

b. Incompetent contractorc. Inherently dangerous activity

4. law and economic analysis: contractor in best position toabsorb and pass on the costs

IV. Fiduciary Obligations of Agents

a. 2 components: care and loyaltyi. care: use power granted with due care

ii. loyalty: with respect to power of principal granted to agent, agenthas a duty of loyalty to principal with exercise of his authority

1. no kickbacks2. no secret profit

a. from transactions with principalsb. use of position (Reading)

3. no usurping business opportunities from principal (Singer)4. no grabbing and leaving (Town & Country)

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b. Duties During Agencyi. Reading v. Regem

1. Facts: soldier used his uniform to get truck through securitywithout having it searched

2. remedy for breach of loyalty: disgorgement of profits

3. think about it in terms of authority given-a. in this case authority to wear uniform- wearinguniform gives faade of government approval andabusing it by converting it to own purpose

b. vs not using that authority for own advantage, not inpayment of authority

c. cant do anything that would profit yourself; if doso breach duty of loyalty and doesnt matter ifcompany not actually hurt

ii. General Automotive Manufacturing v. Singer

1. Facts: agent/defendant learned of business opportunity

while working for plaintiff and didnt tell company about itand took it for himself2. agent has a duty to exercise good faith by disclosing to

principal all the facts3. here, agent took away opportunity from employer; if he had

told them about the deal probably wouldnt have been aproblem

4. agent wasnt the decision maker, but held himself out as thedecision maker

5. would have been harder for principal to bring breach of Kaction because would have had to shown that agentbreached an express term of K (such as not working therequired time each week)

c. Duties During and After Termination of Agency: Grabbing and Leavingi. Town & Country House & Home v. Newbery

1. Facts: couple of employees want to start own business andtake customer list with them; had access to customer listfrom authority give by principal and used it for ownbenefit- access to trade secret and took it

2. its how you get the trade secret information- if followedtrucks and wrote down addresses wouldnt be usingauthority to gain info

3. duty continues even after relationship ends

CHAPTER 2: PARTNERSHIPSI. What is a Partnership? And Who Are the Partners?

a. Introi. 2 bodies of law

1. UPA 1914- NC still has this one2. UPA 1997- most states have this one

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ii. UPA partnership definition: partnership is an association of two ormore persons to carry on as co-owners a business for profit

1. co-owners is the keyiii. Is on on-going entity- cant make it dormant like you can a

corporation

iv. Can dissolve when any partner wants to as long as it isnt apartnership for term or for a specific purposeb. Partners Compared with Employees

i. Fenwick v. Unemployment Compensation Commission

1. Facts: Defendant had a beauty shop and promotedemployee to partner status

2. Partnership traitsa. Sharing of profits- this is prima facie evidence of

partnership but not determinativeb. Right to control

3. works in reverse to agency: for partnership to exist must

have some agreement, but doesnt have to intend to be apartnership agreement and doesnt have to be writtenc. Partners Compared with Lenders

i. Martin v. Peyton

1. rule of partnership makes each partner potentially liable forall the debts of the partnership; question of who is a partneris important

2. facts: defendants made investments in plaintiffs firm;defendants claim were creditors, not partners

3. court says defendants didnt have sufficient right to control,but very close to it

ii. Southex Exhibitions v. RI Builders Association

1. dissolution case, diving up of assets2. Facts: RIBA enter into agreement with SEM for future

productions of RIBA home shows3. business for profit existed, but what about right to control?4. court found no partnership, but Lee thinks court may have

been wrong- Southex made lions share of decisions butRIBA had right to come in

d. Partnership by Estoppeli. Young v. Jones

1. Facts: plaintiffs, group of investors, relied on an opinionletter from PW-Bahamas, which was negligently prepared;sue PW-NY because thats where all the money is

2. court found no partnership because individual entitieslicensing PW name

3. in order to have partnership by estoppel, must proveplaintiffs relied- here, didnt rely on it being a PWH firm;reliance is an essential element

II. Fiduciary Obligations of Partners

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a. Introductioni. Fiduciary duty between partners is extreme

ii. Meinhard v. Salmon

1. Facts: S formed partnership with M to manage hotel; aslease on building expired S negotiated to take the reversion

and develop a new building without telling M- in effect Strying to form new partnership2. legal standard

a. duty of finest loyaltyb. punctilio of an honor most sensitivec. the though of self was to be renounced

3. if a fiduciary learns of a corporate opportunity duringemployment, opportunity belongs to the firm, not theindividual

4. S must permit M to participate in reversion only throughdisclosure could opportunity be equalized

5. fiduciary duty even after leave partnershipb. After Dissolutioni. Bane v. Ferguson

1. facts: plaintiff retires from law firm, firm merges withanother, firm dissolved; plaintiff claims that they actedunreasonably in deciding the merge the firm

2. a partner is a fiduciary of his partners, but not of his formerpartners- partners owe no duty to former partners becausethey have left the partnership

3. if plaintiff could have shown that there was bad faith, mighthave had K claim, but there was no money there anyway(bad faith: fraud, intentionally taking away benefits)

c. Grabbing and Leavingi. Meehan v. Shaughnessy

1. Facts: Meehan and Boyle partners of PC; decide to leavebecause didnt like pension plan and overall compensationand start own firm

2. M & B breached their duties to partnership by contactingclients before they left in a way that didnt fairly give theclients a choice to stay with PC; until Dec. they lied to theirpartners about their plans to leave- denying plans whenasked is critical

d. Expulsioni. Lawlis v. Kightlinger & Gray

1. Facts: alcoholic partner in firm gets in trouble, agreementreached explicitly providing he would have no secondchance; began drinking again and firm gave him a secondchance with conditions he must meet; when he proposedhis units of participation be increased, firm want to expelhim

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2. when expel a partner, technically dissolve partnership3. plaintiff claims wrongful dissolution; court rejects it

because even though default position under act requiresshowing cause, their partnership agreement contained aguillotine clause in which dont have to show cause for

terminationIII. Partnership Propertya. Putnam v. Shoaf

i. Facts: one partner sells her half to another person. Bookkeeperembezzling money and discover this. Former partner claimsentitled to half of recovery from bookkeeper

ii. A partnership is a separate legal entity and not an aggregate of thepartners; is a separate legal entity that owns the property

IV. Raising Additional Capital- Problema. You need to draft partnership agreement so that you can raise additional

capital without problems

b. Can have a service partner- provides something other than cashc. Capital account is a running balance reflecting each partners equityinterest; ways to change capital account:

i. Allocation of profits increases a capital accountii. allocation of losses decreases capital account

iii. taking a draw (distribution) decreases the accountd. Profits and Losses under the UPA

i. default rule if agreement doesnt provide otherwiseii. profits are divided pro rata, and then equally

1. After pay off outside creditors, next pay back partners theamount they initially contributed

2. After do this, if there is anything left over, that money isdivided equally between the partners

iii. Losses are more ambiguous- it says losses follow profits1. interpreted that partners equally bear2. a partner that did not contribute any capital initially does

not have to bear any lossesV. The Rights of Partners in Management

a. UPA default: all partners have equal rights in the management andconduct of the partnership business

b. National Biscuit Co v. Stroud

i. Facts: 2 partners, no agreement, running grocery store. One partneragrees to buy more bread, other says no. Nabisco sues for payment

ii. What either partner does with a third party is binding on thepartnership

iii. If partner who didnt want bread had 51% control, could restrictother who wanted the bread

iv. If Nabisco knew that one partner didnt have authority, wouldnthave been binding

c. Summers v. Dooley

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i. Two equal partners. Dooley hires another worker to take his placebecause unable to work. Summers wanted to hire a third guy, butDooley didnt; Summers hires anyway and tried to bill thepartnership

ii. Summers loses- partnerships, absent an agreement to the contrary,

decided by a majority vote; hiring an employee requires a majorityvote and Summers doesnt control the majorityiii. What Summers could have done- terminated partnership, get rid of

guy Dooley hirediv. Reconcile this caseNational- that one dealt with dispute with third

party regarding existing K whereas this one deals with disputebetween partners regarding new K

v. Cant freeze out a partnerd. Moren ex rel. Moren v. JAX Restaurant

i. Facts: mother and sister have partnership in restaurant; mothertook son to work at restaurant; son injured on dough making

machine and father sues partnershipii. Issue: whether making pizza dough part of the normal course ofbusiness- yes, so partnership liable

iii. UPA: partnership shall indemnify a partner for liabilities incurredby the partner in the ordinary course of the business of thepartnership

e. Day v. Sidley & Austin

i. Facts: plaintiff in charge of firms DC office which he founded, butnot on firms executive committee. Firm merges with another DCfirm which plaintiff agrees to. DC offices merged and plaintiff nolonger in charge. Even though he signed off on merger claimsmisrepresentation.

ii. Illustrates extent to which courts allow partnership agreements toderogate from statute

iii. Partnership agreement gave operational control to executivecommittee, so no cause of action even though it seems extremelyunfair to plaintiff

VI. Partnership Dissolution

a. The Right to Dissolvei. Owen v. Cohen

1. Facts: O and C partners in bowling alley; O put up moneywhich was to be repaid out of businesss profits and treatedas a loan; C is pain to work with and O sues for dissolutionbecause wants to be paid back

2. dissolution is not the same as going out of businessa. dissolution is simply the change in relationship of

the partners caused by any partner ceasing to beassociated with the carrying on of the firmsbusiness

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b. can occur by one or more partners, operation of law,or by court order

c. always have power to dissolve partnership, but notalways have right

i. can always dissolve partnership, but if

wrongful will be penalized3. court allowed dissolution- found bad blood, partnership nolonger functional

ii. Collins v. Lewis

1. facts: partnership for cafeteria; C to provide all necessaryfunds, L to plan, supervise, and manage; cafeteria losingmoney and C wants out

2. court denies dissolution. C must continue to financiallysupport cafeteria because he agreed to contribute moneyuntil partnership made a profit

3. in order for C to get out, must show turned a profit or not a

viable business4. when a partner advances a sum of money to a partnershipwith the understanding that the amount contributed was tobe a loan to the partnership and was to be repaid as soon asfeasible from the prospective profits of the business, thepartnership is for the term reasonably required to repay theloan

iii. Page v. Page

1. issue was whether the partnership was for term or a will;plaintiff wanted to dissolve because not making money andargued was a partnership at will and could dissolve at anytime; defendant argued it was partnership for term andplaintiff couldnt dissolve

2. court found that defendant failed to prove any facts fromwhich an agreement to continue the partnership for a termmay be implied

3. UPA: partnership at will may be dissolved by the expresswill of any partner, but this power, like any other powerheld by a fiduciary, must be exercised in good faith

4. a partner may not dissolve a partnership to gain the benefitsof the business for himself, unless he fully compensates hisco-partner

b. The Consequences of Dissolutioni. Intro

1. time line:dissolution-------------winding up------------final termination2. after dissolution, partnership must be wound up, absent

agreement among partners to carry on business

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3. assuming that the business will not continue, the windingup process generally contemplates that the firms assetswill be distributed to the partners

4. authority of partners to act on behalf of partnershipterminates except in connection with winding up of

partnership business5. Continuation per agreementa. effect on the partnership

i. technically creates a new partnershipii. creditors of former partnership automatically

become creditors of new partnershipb. effect on departing partners

i. entitled to an accountingii. remains liable unless released by creditors

c. effect on new partnersi. also liable for the firms old debts, but such

liability can only be satisfied out ofpartnership property- capital he contributedii. can only be held personally liable for old

debts if expressly agreed toii. Prentiss v. Sheffel

1. Facts: 2 majority partners file for dissolution because didntlike Prentiss; trial court granted dissolution becausePrentiss frozen out; Prentiss claims that other 2 gotdissolution in order to buy him out cheaply

2. court says that Prentiss failed to show he was injured fromthe dissolution and that if anything the judicial sale helpedhim

iii. Disotell v. Stiltner- skipped in classiv. Pav-Saver Corp. v. Vasso Corp.

1. Facts: Dale owns PSC, Meersman owns Vasso. PSC and Vform PSMC. PSC contributed patents, V cash. PSC wantsout and wants to take patents with it

2. Had dissolution section in written agreement, but could beread two ways- does this clause create right to terminate?

3. early dissolution of a term partnership is a wrongfuldissolution; court says wrongful dissolution so PSC canttake patents with it and remaining partners have right tocontinue business

c. The Sharing of Lossesi. Kovacik v. Reed

1. Facts: K fronted money, R is the brains; profits to beequally divided, no salaries; K dissolves on groundspartnership losing business

2. court ruled that parties dont equally bear loss whencontribute different amounts

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3. 1997 UPA section 18 overrules this case- must equallyshare losses unless otherwise agreed

d. Buyout Agreementsi. Intro

1. Buy-out agreement is an agreement that allows a partner to

end his relationship with the other partners and receive acash payment, or series of payments, or some assets of thefirm, in return for his interest in the firm

2. Many possible approaches; here is a brief outline:a. trigger events: death, disability, will of any partnerb. obligation to buy versus option

i. firmii. other investors

iii. consequences of refusal to buy: if there is anobligation, if there is no obligation

c. price: book value, appraisal, formula (ex: 5 year

earnings), set price each year, relation to durationd. method of payment: cash, installmentse. protection against debts of partnershipf. procedure for offering either to buy or sell: first

mover sets price to buy or sell, first mover forcesothers to set price

ii. G & S Investments v. Belman

1. Facts: partnership to own and manage apts. One partnerNordale live in one apt and use cocaine- other partnerswant to buy out his interest and file complaint fordissolution; then Nordale dies.

2. court says that if Nordale hadnt died, his conduct wouldamount to wrongful dissolution

3. limited partnerships allow for managing partner and otherpartners to participate in profit but not in day to dayoperations

4. issue: when did partnership dissolve- Court says filingdidnt dissolve partnership and not dissolved until courtsays so

5. next issue- how much is Nordales estate entitled to?a. Partnership buy out agreement states entitled to

capital account, but estate claims its meaning isambiguous and should mean the FMV

b. Court says not ambiguous and clearly means thepartners capital account as it appears on thepartnership books

e. Law Partnership Dissolutionsi. Jewel v. Boxer

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1. trial court came up funky scheme awarding partners foramount of time worked on cases- this leads to partnersfighting over cases

2. appellate court overrules and says that since there was nowritten partnership agreement, UPA governs

a. no partner entitled to extra compensation forservices rendered in completing unfinished businessb. partners awarded compensation based on

interest/percentage owned in partnershipii. Meehan v. Shaughnessy

1. see above for facts- M and B decide to leave PC and formown law firm

2. issue as to whether partnership agreement or UPA appliedregarding removal of cases-

a. although provision in the partnership agreementwhich divide the dissolved firms unfinished

business didnt expressly apply to the removal ofcases which did not come to PC through the effortsof a departing partner, court believed that partiesintended this provision to apply to these cases also

b. court ruled that partnership agreement applied (Mand B would have faired better if UPA applied)-upon payment of a fair charge, any case may beremoved regardless of whether the case came to thefirm through the personal efforts of the departingpartner

3. M and B breached their duty to PC; on remand if judgedetermines that as a result of this breach certain clients leftPC, M and B must give PC any profits they receive fromthese cases and pay PC the fair charge for removal

VII. Limited Partnerships

a. Introi. Formed by two or more persons and having one or more general

partners and one or more limited partners1. general partners: liable for all the debts of the partnership2. limited partners: not liable for the debts of the partnership

beyond the amount they have contributed UNLESS takeactual control

ii. ULPA: a limited partner shall not become liable as a generalpartner unless in addition to the exercise of his rights and powersas a limited partner he takes part in the control of the business-actual control

iii. Can only be created where there is a written agreement among thepartners and a formal document is filed with state officials

b. Holzman v. De Escamilla

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i. Facts: R and A limited partners; issue: where they involved in themanagement with input in crop planting and ability to writechecks?

ii. Court says yesiii. Had agreement that allowed them to do this even though formal

structure didnt have them in control- actual operation had them incontrol and formality doesnt matter

CHAPTER 3: THE NATURE OF THE CORPORATIONI. Intro

a. Historically to form a corporation had to ask state to charter corporation;had to articulate a public purpose and have a public benefit; today this hasbeen done away with and only need to state purpose as business for profitand the public benefit is to create profit

b. Corporations account for the bulk of receipts in the US although theyare only about 5% out of the total

c. Public corporationi. Ex: IBM, Microsoftii. Characterized by a public secondary market in which shares of the

company are listed for traded. Close corporation

i. Characterized by absence of a secondary market for its stock;closely held

ii. Often, not always, a relatively small number of shareholders whoactively participate in the firms management

iii. May display characteristics of partnershipsiv. Ex: banks

e. Critical attributes of a corporationi. Legal personality

ii. Limited liabilityiii. Separation of ownership and controliv. Liquidityv. Flexible capital structure

f. Rule of thumb: boards ACT, shareholders REACTg. What shareholders are entitled to vote on

i. Election of directorsii. Any amendments to the articles of incorporation and generally

speaking by-lawsiii. Fundamental transactionsiv. Odds and ends, such as approval of independent auditors

h. Incorporation processi. Chose a state of incorporation- find a state which laws that best fit

your needsii. More than 300,000 companies incorporated in Delaware

1. no minimum capital requirements- dont have to put up acertain amt of capital to start a corporation

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2. only need 1 incorporator (entity)3. favorable franchise tax4. favorable for companies doing business outside of

Delawarea. no corporation income tax

b. no sales tax, personal property tax, or intangibleproperty taxc. no taxation on shares of stock held by non-residents

and no inheritance tax on non-resident holders5. may keep all of its book and records outside of Delaware

and may have principal place of business/address outside ofthe state

6. highly competent judiciary in company law and detailedcase law on this subject

iii. pick a company name and now also pick a domain name forinternet

iv. Draft Articles of Incorporation ;1. required things:a. address for service of processb. names of promotersc. proxy if going to allow it

2. filing this with the Secretary of State initiates incorporation3. can be amended at any time after the filing- must be

approved by majority vote if any class of stockholderswould be adversely affected

v. have incorporation meeting in which name board of directors1. President, Secretary, and Treasurer are required

vi. then make the by-laws of the incorporationvii. state may not exclude a foreign corporation (out-of-state) engaged

in interstate commercei. Post-incorporation

i. draft by-lawsii. organizational meeting

j. authorized sharesi. how many shares state authorizes business to have

ii. created in articles of incorporationk. treasury shares

i. is an old termii. once issued and outstanding, but now repurchased

l. Intro to corporation law and economics: why are there firms?i. In a capitalist society, there are 2 principal ways of conducting

economic activity:1. across markets2. within firms

a. gives one person specialized job of providing theservice

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b. much more efficientc. reduces transaction cost of having officer to find

next job- one person in charge of landing next dealwhile the rest work on the deals

m. Liability for pre-incorporation activity

i. Promoter: someone who purports to act as an agent of the businessprior to its incorporationii. a corporation doesnt become a party to a K until the corporation

adopts the K- either expressly or implicitlyiii. promoter retains liability until released by the other party to the

unless there is an agreement to the contrary; remains liable on K ifarticles of incorporation arent filed

iv. during this time the promoter has a fiduciary obligation to the to-be-corporation

n. Corporation Formalitiesi. These are factors, not elements, so court will evaluate and weigh

ii. Effort to make a real corporation or is it just an alter ego?iii. Annual meetings- required by statuteiv. Keeping books separatev. The businesss actual operation

vi. Annual report- required by statuteII. Promoters and the Corporate Entity

a. Southern-Gulf Marine Co. v. Camcraft

i. Facts: promoter and Camcraft entered into K before corporationformed, corporation supposed to be in TX but in Caymans instead.Camcraft tries to get out of K and SG trying to enforce K

ii. Rule: A third party (Camcraft) who deals with a firm as though itwere a corporation and relied on the firm, not the individualdefendant, for performance is estopped- must honor K

iii. One who contracts with what he acknowledges and treats as acorporation is estopped from denying its corporate existence,particularly when the obligations are sought to be enforced

iv. Bottom line: doesnt matter if one party not incorporated; Kenforceable

III. The Corporate Entity and Limited Liability

a. Walkovszky v. Carlton

i. General rule: shareholder not personally liable for the acts/debts ofthe corporation

ii. Shareholder can lose the amount he investediii. Shareholder can become personally liable for his own acts or

conductiv. There are 3 legal doctrines that the plaintiff can invoke in case like

this1. Enterprise liability

a. D didnt respect the separate identities of thecorporation

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b. to recover P must show assignment of drivers, useof joint bank accounts, ordering supplies

c. although seemingly independent of each other,theses corporations are alleged to be operated as asingle entity, unit, and enterprise with regard to

financing, supplies, repairs, employees, andgaragingd. horizontale. Corporation that committed tort actually part of a

larger corporation which actually conducts thebusiness

f. brother-sister corporationsg. Court is more likely to allow a creditor to recover

assets from the ten corporations collectively than topierce the veil against the individual shareholder

2. Respondeat superior (agency)

a. a principal (employer) is responsible for the actionsof his/her/its agent (employee) in the "course ofemployment"

b. this is always a possibility when the shareholdersare acting on behalf of the corporation

3. Disregard of the corporate entity (piercing the veil)a. Verticalb. The corporation is a dummy for its individual

stockholders who are in reality carrying on thebusiness for their personal capacities for purelypersonal rather than corporate ends

c. 3 requirements to pierce the corporate veili. Lack of formalities AND

ii. Under capitalization ANDiii. Injustice will result fraud or wrongdoing

d. Alter ego is another term used to describe thisv. isnt a problem to incorporate to the express purpose of avoiding

personal liability- whole reasoning behind having corporationsvi. it isnt a problem to split a single business into multiple

corporations to avoid liability eitherb. Sea-Land Services v. Pepper Source

i. Pierce and reverse pierce action1. reverse pierces are VERY RARE2. reverse pierce occurs when you go vertically up to hold

shareholder(s) liable, and then go down to all their othercorporations and hold them liable

3. this is unfair to other creditors of corporations when you godown the other side-

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ii. Facts: SL ship peppers for PS, the PS stiffed SL on the bill. PS hadbeen dissolved, but SL sought to pierce PSs corporate veil andrender Marchese personally liable and then reverse pierceMarcheses other corporations so that they too would be liable

iii. Not only were the corporations alter egos of each other, but they

are also alter egos of Marcheseiv. The corporate entity will be disregarded and the veil of limitedliability pierced when 2 requirements are met:

1. unity of interest AND2. fraud/injustice

a. some element of unfairness, something akin to fraudor deception or the existence of a compelling publicinterest

v. 4 factors to determine unity1. failure to maintain adequate corporate records or to comply

with corporate formalities

2. the commingling of funds or assets3. undercapitalization4. one corporation treating the assets of another corporation as

its ownc. Roman Catholic Archbishop v. Sheffield

i. Piercing the corporate veil refers to situations where there has beenan abuse of corporate privilege, because of which the equitableowner of a corporation will be held liable for the actions of thecorporation

ii. Alter ego is another name for piercing the corporate veiliii. Here, it was not sufficient injustice that the plaintiff will not be

able to collect if the corporate veil is not piercedd. In Re Silicone Gel Breast Implants Products Liability Litigation

i. Control issue was at stake- was the parent operating the subsidiaryas the alter ego?

e. Frigidaire Sales Corp. v. Union Properties- skipped in classi. Beginning in the 1960s limited partnerships came into widespread

use for tax shelter purposes- show losses for tax purposes eventhough they may be successful economically

ii. Also in the 1960s lawyers for the promoters of tax shelterinvestments developed a variation on the basic limited partnership-a limited partnership with a corporation as the sole general partner

iii. Facts: general partner was a corporation, limited partners wereindividuals, but they also controlled the corporation

iv. Rule: when the shareholders of a corporation, who are also thecorporations officers and directors, conscientiously keep theaffairs of the corporation separate from their personal affairs, andno fraud or manifest injustice is perpetrated upon third personswho deal with the corporation, the corporations separate entityshould be respected

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IV. Shareholder Derivative Actions

a. Lees background Introi. Derivative actions exited at CL, so have been around a long time

ii. First question: who brings the action and on whos behalf?1. Direct

a. cause of action belongs to the shareholder in hisindividual capacityb. injury is directly to the shareholderc. done in equity and at lawd. examples:

i. action to enforce the holders voting rightsor to prevent some other shareholder fromimproperly voting his shares

ii. compel payment of dividendse. easier to bring a direct action because there are less

procedural rules to follow than derivative

2. Derivativea. brought by the shareholder on corporations behalfb. cause of action belongs to the corporation and arises

out of an injury to the corporationc. examples: breach of duty of care or duty of loyaltyd. may be a reason why the corporation decides not to

suee. usually brought because board has breached their

fiduciary duty of careb. Intro

i. Cohen v. Beneficial Industrial Loan Corp

1. Facts: NJ statute required P/shareholder to pay legalexpenses if suit fails if the shareholder owns less than 5%or less than 50K worth of stock. Corporation may ask courtto require that a bond be posted before the suit goesforward. P claims this law unconstitutional. D claims thatbond posting mechanism is a way to limit frivolous suits

2. bond posting mechanism constitutional3. shareholder derivative action- are actions in equity because

fix injustice and shareholder doesnt have standing to sueunder the law

ii. Eisenberg v. Flying Tiger Line

1. Facts: after companys reorganization, P claims votingrights diluted because now can only vote for boardmembers

2. Issue in the case was whether the suit was direct orderivative. Court found it to be direct

3. Gordon Test: whether the object of the lawsuit is to recoverupon a chose in action belonging directly to thestockholders, or whether it is to compel the performance of

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corporate acts which in good faith requires the directors totake in order to perform a duty which they owe to thecorporation, and through it, to its stockholders

4. Test refined in this case - suit is individual in nature if theinjury is one to the plaintiff as a shareholder, and to him

individually and not to the corporation. Proceduralinstrument is class action. A suit is derivative only if it isbrought in the right of a corporation to procure judgment inits favor.

iii. Note on Settlements and Attorney Fees1. if a derivative action is settled before judgment, the

corporation can pay the legal fees of the plaintiff and of thedefendants

2. if a judgment for money damages is imposed on thedefendants, except to the extent that they are covered byinsurance, they will be required to pay those damages and

may be required to bear the cost of their defense as well3. with a derivative action, court must approve any settlementiv. Note on Individual Recovery in a Derivative Action

1. sometimes a court awards an individual recovery in aderivative action

c. The Requirement of Demand on the Directorsi. Intro

1. The role of the demand requirementa. innocuous procedural step that has become a sieve

to separate cases in which the board is allowed tocontrol the suit from those in which shareholder isallowed to do so

b. board gets first shot at litigation- demand noticemust be filed by P before filing suit unless demandexcused

c. complex law, not uniform state to state2. Demand futility- demand excused when futile

a. Grimes rule is the majority rule and in Delawareb. Marx is the NY rulec. Example: if board holds shareholder meeting and

doesnt give notice of it3. see slide print-outs for flow chart4. what really happens: usually P wont file demand and then

the issue is whether the demand was excused which allowsyou to get to the substance of why P suing

ii. Grimes v. Donald- Delaware Demand Rule1. derivative and direct action2. general rule: if asking for injunction, its a direct claim3. Delaware demand requirement established (majority)

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4. P must allege particularized facts (pre-discovery using thetools at hand) creating a reasonable doubt that the boardis capable of making a good faith decision on the suit

a. Majority of board has a material financial orfamilial interest (loyalty) OR

b. Majority of board lacks independence (dominationand control by wrongdoers) (loyalty) ORc. Challenged transaction is not the product of a valid

exercise of business judgment (care)i. Requires you to show how the crazy

outcome was reachedii. Essentially, says that the business judgment

rule does not applyiii. Marx v. Akers- New York Demand Rule

1. alleged breach of fiduciary duty to excessive directorcompensation and excessive executive compensation

2. NY demand requirement (3-prong disjunctive standard)a. Majority of directors interested in challengedtransaction (loyalty), OR

i. Essentially is a way around the businessjudgment rule

b. Directors failed to inform themselves to a degreereasonably appropriate (care), OR

c. Challenged transaction could not have been theproduct of sound business judgment (care)

i. Basically requires that you file withparticularity that the outcome of the boardsdecision was crazy- able to draw aninference of bad behavior from the outcome

ii. This requirement is what makes NYsunique- DE doesnt have this factor

iv. Difference between DE and NY demand requirements1. DE

a. Decision-making process was the problemb. DE breaks up NYs 1st factor into 2 factors

i. NY: majority of directors interested inchallenged transaction

1. DE: majority of board as a materialfinancial or familial interest

2. DE: majority of board lacksindependence

c. This standard doesnt look at the outcome- cantmake any inferences and must be able to prove badconduct which led to bad outcome

2. NYa. Outcome was the problem

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b. This standard tends to hold boards moreaccountable

c. This standard doesnt require that allegationspossess specific particularity

d. The Role of Special Committees

i. Auerbach v. Bennett1. Facts: GTE made 11 million in illegal bribes andkickbacks. GTE shareholder brought derivative actionagainst GTE, directors, and outside auditor for beaches ofduties to the corporation. Board responded by appointing aspecial litigation committee

2. court assumed that the demand was excused3. special committee didnt include any members who

committed the fraud and none who personally benefitedfrom kickbacks

4. court will only look at special committees decision making

process; it is a business judgment of the board to pursuelitigation5. almost impossible to pursue action after special committee

decides not to- only way is to show committee biased6. followed NY Rule

ii. Zapata Corp. v. Maldonado

1. Facts: excessive compensation claim. Demand not madebut excused as futile. Board appoints special litigationcommittee composed of new board members andrecommends dismissal.

2. 2 step process:a. One

i. Inquiry into the independence and good faithof the committee

ii. Inquire into the bases supporting thecommittees recommendations

iii. Limited discovery may be orderediv. Corporation has the burden of proving

independence, good faith, and reasonableinvestigation

b. Twoi. Court may go on to apply its own business

judgment as to whether the case is to bedismissed- if no basis for special committeedismissing suit

e. The Role and Purposes of Corporationsi. A.P. Smith Mfg Co v. Barlow

1. Facts: company gave 150K to Princeton. Shareholdersbring derivative action

2. company must be giving money for the general public good

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3. there must be a separation of interest between the companydirectors and the charity- cant give to charity that directorfounded because its his pet charity

ii. Dodge v. Ford Motor Co.

1. Facts: FMC very successful, Henry Ford dominated with

58% of stock and wants to cut dividends back. Dodge boyssue with 10% of stock2. standard of review

a. courts will generally leave dividend decisions to thedirectors discretion, but will intervene if refusal topay amounts to such an abuse of discretion aswould constitute fraud or breach of good faith

b. inherent in the boards fiduciary duties is protectingthe shareholders ownership rights:

i. right to participate in future earningsii. right to control

3. shareholders have a right to money made by theirinvestment4. a corporation is organized and carried on primarily for the

profit of the stockholders5. powers of the directors are to be employed to that end6. limits to the for profit of shareholder rule

a. compliance with the lawb. charitable giving

7. expansion issue- the court did not enjoin the expansion ofthe plant because this decision implicates the businessjudgment rule and is beyond the courts scope

8. duty of care:a. each member of the board when discharging the

duties of director shall acti. in good faith AND

ii. in a manner the director reasonably believesto be in the best interest of the corporation

b. application to this casei. did HF reasonably believe that building the

new plant was in the best interest of FMC?Dont know for sure

ii. could he have reasonably believed this?Yes- could have been to avoid competitionwith Dodge boys

iii. Shlensky v. Wrigley

1. Facts: S minority shareholder in corporation that ownedCubs and operated Wrigley Field. W owned 80% of stockand refused to install lights on field

2. W wins

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3. in the absence of a showing of fraud, illegality, or selfdealing by the directors, their decision is final and notsubject to review by the courts- business judgment rule

4. since the courts wont review such decisions, P has nostanding

iv. Reconciling duty of care and the business judgment rule1. duty of care tells directors dont be negligent2. business judgment rule insulates directors from negligence,

only liable for fraud or self dealingv. MBCA provisions: standards of conduct vs. standards of liability

1. standard of conduct is aspirational2. liability is legal trouble

Chapter 4: The Limited Liability CompanyI. Intro

a. Partnership with no personal liability

b. Cross between a partnership and corporationi. Tax advantages of partnershipsii. Limited liability of corporations

iii. None of the restrictions- number and type of shareholders that areapplicable to corporations

c. Typically look to partnership laws when membership agreement is silent,but this is rare

d. The ULLCA is very similar to the UPAe. Funding

i. Members typically contribute capital (just like partnership)ii. Contribution may be cash, property, services rendered, promissory

notef. Liability

i. Members stand to lose capital, but not their personal assetsii. because LLCs did not exist at CL, it is not possible to have a LLC

by estoppel- therefore, you must have a document in order to findan LLC exists

g. Tax consequencesi. Income passes through to members

ii. LLC itself doesnt pay taxesh. Formation

i. File articles of organization in the designated state office1. filing fees and $800 minimum franchise tax

ii. other tasks1. choose and register name: LLC statutes generally require

the name of the LLC to include the words LLC or similarphrase

2. designate office and agent for SOP

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3. draft operating agreement- basic contract governing theaffairs of the LLC and stating the various rights and dutiesof the members

4. good idea to also have annual reporti. Conversion of existing entities: partnership

i. ULLCA authorizes conversion of partnerships or limitedpartnerships into LLCsii. Can also convert debts of partnership to debts of LLC- this has the

effect of insulating the LLC members with limited liability to thesurprise of creditors- now lenders make conversion an event ofdefault

iii. IRS treats as a potential recognition event/no tax consequencesj. Conversion of existing entities: corporations

i. No ULLCA provisionii. IRS treats as a potential recognition event

k. Members interests

i. Include financial interests (ex: right to distributions and liquidationparticipation)ii. And management rights

l. Financial interestsi. Profit and loss sharing

1. absent contrary agreement, most statutes allocate profitsand losses on the basis of the value of memberscontributions (versus partnership default is equal)

ii. withdrawal1. member may withdraw and demand payment of his interest

upon giving the notice specified in the statute or LLCoperating agreement

m. Management rightsi. Absent contrary agreement, each member has equal rights in the

LLC management1. most matters decided by majority vote2. significant matters require unanimous consent

n. Assignment of LLC Interestsi. Unless otherwise agreed upon, member may assign his financial

interest in the LLCii. an assignee of a financial interest in an LLC may acquire other

rights only by being admitted as a member of the company if allthe remaining members consent or the operating agreement soprovides

o. Fiduciary Dutiesi. Manager-managed LLC

1. treated like a corporation: members are like shareholdersand managers and like board directors

2. the managers have a duty of care and loyalty

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3. usually, members have no duties to the LLC or its membersby reason of being members other than their shareholderduties

ii. Member-managed LLC1. treated more like a partnership

2. all members have a duty of care and loyaltyiii. derivative actions: member may bring an action on behalf of theLLC to recover a judgment in its favor if the members withauthority to bring the action refuse to do so

iv. LLC agreement can limit and even eliminate fiduciary duties, butmust be specific- cant just say there is no duty of care or loyalty

p. Liabilitiesi. No member or manager of a LLC is obligated personally for any

debt, obligation, or liability of the LLC solely by reason of being amember or acting as a manager of the LLC

ii. But veil piercing may apply

II. Formationa. Water, Waste & Land Westec v. Lanham

i. Must give notice its an LLC in order to be shielded from liabilityii. If no notice, then members personally liable

iii. Extension of the agency rule regarding undisclosed principalIII. The Operating Agreement

a. Elf Atochem North America v. Jaffari

i. Operating agreement is very flexibleii. As long as code doesnt specifically prohibit something LLC

agreement can do whateverIV. Piercing the LLC Veil

a. Kaycee Land and Livestock v. Flahhive

i. Failure of a LLC to observe formalities or requirements relating tothe exercise of its company powers or management of its businessis not ground for imposing personal liability

ii. Nothing in ULLCA that allows for veil piercing members can beliable for their own acts

iii. Sometimes statutes say that corporate law applies to LLC if sothen corporate veil piercing applies to LLC

iv. This court found that there is no reason to treat LLCs differentlythan corporations

b. Possible to pierce the LLC veil; 3 approachesi. most courts apply the rules for corporate piercing to LLCs

ii. have modified the Uniform Act to allow for LLC piercingiii. some have either not addressed LLC piercing or do not allow it

V. Fiduciary Obligation

a. McConnell v. Hunt Sports Enterprises

i. An LLC operating agreement may limit or define the scope of thefiduciary duties imposed upon its members

ii. ULLCA governs when agreement doesnt address

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VI. Dissolution

a. New Horizons Supply Cooperative v. Haack

i. If you properly wind-up members are not liableii. Wind-up: pay off outside debts, then member debts, then distribute

any assets

1. in this case, member paid off her own debts first2. wind- up for LLC is just like a partnershipb. generally follows partnership rules, but is more flexiblec. because LLCs are a creature of statute, there is no such thing as an LLC

for term

Business Judgment Rule

I. 2 ways of thinking about the business judgment rule:a. As an abstention doctrine- Lee likes this one

i. Court will not review a board decisionii. Preconditions

1. no fraud2. no illegality3. no self-dealing4. decision not egregious

b. As a standard of liabilityi. No liability for negligence

ii. Instead, liability is based on fraud, illegal conduct, self-dealing,and perhaps egregious conduct

II. Rule saves many actions from being held to be violations of the duty of careIII. How BJR relates to the duty of care:

a. The duty of care imposes a fairly stern set of procedural requirements fordirectors actions

b. Once these procedural requirements are satisfied, the BJR then supplies amuch easier to satisfy standard which respect to the substance of thebusiness decision

IV. Basically provides that a substantively-unwise decision by a director or officerwill not by itself constitute a lack of due care. However, there are 3requirements (two of them procedural) which a decision by a director orofficer must meet before it will be upheld by application of the rulea. No self dealingb. Informed decisionc. Rational beliefd. Exceptions: illegal or pursuit of own goals

Chapter 5: The Duties of Officers, Directors, and Other InsidersI. Duty of Care (Obligations of Control)

a. Introi. Definition: the director or officer must behave with that level of

care which a reasonable person in similar circumstances would useii. Competence

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iii. Excessive compensation is usually a duty of care problem, unless itboard is granting its own salaries at which point it becomes a dutyof loyalty issue

iv. Can get insurance for breach of duty and loyalty for boardmembers (in order to attract a wide variety of people)

v. Most breaches for both care and loyalty are intentionalvi. Very rare for directors and officers to be found liable for breach ofcare- when this happens its usually because there is some taint ofself-dealing, but not enough to cause the court to find a formalviolation of the duty of loyalty

b. Kamin v. American Express Companyi. Board does not act negligently when it results in a bad judgment;

negligence means the failure to exercise judgmentii. Here, the court wouldnt substitute its judgment. The court only

needed to look at the process, not the substantive decision. Only 4out of the 20 directors had a personal stake. If only the minority is

tainted you have to be able to show that this minority affected theoutcomec. Smith v. Van Gorkom

i. Prior to this case, BJR was a blanket protection against boardii. Issue here was breach of care- board rushed through decision-

making process; willful blindness of deal transactioniii. The board should have gone to an investment bank and gotten an

external opinion on how much stock worthiv. The need for expert opinion in major corporate decisions comes

from this casev. Forces board to have some type of actual decision making process

1. court will review this process and it must be reasonable2. even if there is a defect in the decision-making process,

must show caused actual injury to corporation3. no protection for uninformed decision because that is an

defect in the decision-making processvi. party attacking the board has the burden of proof

1. must prove gross negligence by directors (in failing toadequately inform themselves of the decision

2. directors failed to inform itself of all material informationreasonably available to them

d. Brehm v. Eisner

i. Corporate waste: transaction that is so one sided that no businessperson of ordinary sound judgment could conclude that thecorporation has received adequate consideration

ii. Compensation is a matter of business judgment unless there issevere irrationality court will not review

iii. Delaware General Corporation Law 141(e) allows boardmembers to in good faith rely on corporations records

1. preconditions to this defense: duty of inquiry

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2. possibility that it wont apply when decision is beyond thepale

iv. Duty of good faith was a separate cause of action in this casev. To prove a violation of due care, must show that the board was

grossly negligent in failing to inform itself of all material

information reasonably available to it1. even if board doesnt do this, board can hire an expert toconduct a study and board can in good faith rely upon theexperts findings- this would avoid liability

e. Illegality is treated as a violation of the duty of caref. Relationship between duty of care and the business judgment ruleg. Francis v. United Jersey Bank

i. The business judgment rule has no application where directorshave failed to exercise a business judgment- i.e. have failed tomake a judgment at all

ii. If the business judgment rule doesnt apply, the defendant director

is not automatically liable- plaintiff must show that defendantbreached duty of careiii. Here, defendant breached duty of care because she was inattentive,

inactive, listless, a drunk, ignorant, and sons were dominate figuresiv. Court expected a duty to be informed (under the duty of care)

1. obligation of basic knowledge and supervision2. read and understand financial statements3. object to misconduct and if necessary resign

h. In Re Caremark International Derivative Litigationi. The business judgment rule did not apply in this case because there

was a lack of oversight and no board decisionii. Court did not decide whether board breached duty of care, but it

probably didnt because there was no evidence of sustained failureto exercise oversight

iii. Duty of care requiresiv. Must attempt in good faith to assure a corporate information and

reporting systemv. Elements of a corporate compliance program

1. policy manual2. training of employees3. compliance audits4. sanctions for violation5. provisions for self reporting of violations to regulators

vi. if the board decides not to adopt a corporate compliance program,the business judgment rule applies since they made a decision; noliability if they acted in good faith and followed a rational process

vii. before this case, unless the board had affirmative knowledge of awrongdoing there was no liability. After this case, there is a duty tomake rational, informed choices about whether to have a system inplace

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II. Duty of Loyalty

a. Introi. Definition: a persons duty not to engage in self-dealing or

otherwise use his position to further personal interests rather thanthose of organization

ii. Business judgment isnt involved here because it concerns loyalty-not making judgment to benefit company, but decision to benefityourself, so its not a business judgment at all

iii. Direct interested director transactions1. K between director and corporation

iv. indirect interested director transactions1. there is 1 director and 2 corporations, person is in some

fiduciary position to both2. director is benefiting through a 3rd party

b. Directors and Managersi. Bayer v. Beran

1. plaintiff must make prima facie case that a interestedtransaction existed, then board has an opportunity torespond

2. ultra viresa. this occurs when a transaction is beyond a

corporations power and thus is illegalb. normally, it would be beyond scope if one director

acted, but here court found it wasntc. formal actions/proceedings by board is preferable in

order to be within scoped. now corporate laws have changed and corporations

can do just about anything without being beyond itsscope

ii. Lewis v. SL&E Inc- skipped in classc. Corporate Opportunities

i. Broz v. Cellular Information Systems

1. doctrine of corporate opportunitiesa. usurpation by an officer or director for personal

gain of some prospective business venture ordevelopment in which the firm has a property right

2. Under Delaware law, a corporate opportunity exists wherea. Corporation is financially able to take the

opportunityb. Opportunity is in the corporations line of businessc. Corporation has an interest or expectancy in the

opportunityi. This is critical

ii. Interest is something to which the firm has abetter right

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iii. Expectancy: takes something which in theordinary course of things would come to thecorporation

d. Embracing the opportunity would create a conflictbetween the directors self interest and that of the

corporatione. Not clear whether these 4 things are factors orelements- courts call them factors but then impliesthat absence of any one is enough

3. relevance of board approval or lack thereof- not required,but board approval creates a safe harbor because there is nolonger a conflict

d. Dominate Shareholdersi. Intro

1. shareholders acting as shareholders owe one another nofiduciary duties

2. controlling shareholders owe fiduciary duties to theminority shareholders3. parent and subsidiary corporations

a. subsidiary can be wholly owned by parentb. if parent owns 50.1%, then the subsidiary is called a

majority controlled subsidiaryc. if parent owns less than 50%, then subsidiary is

called a minority-controlled subsidiaryd. transactions between parent and subsidiary

corporationsii. Zahn v. Transamerica Corporation

1. Facts: Transamerica was the controlling shareholder of AF.There were two classes of stock; Transamerica owned 2/3of Class A Stock and owned almost all of the Class Bstock. Class B stock contained the voting rights. Class Acould be converted into Class B and that is whatTransamerica did without disclosing intent to liquidate

2. The majority has the right to control; but when it does so, itoccupies a fiduciary relation toward the minority, as muchso as the corporation itself of its officers and directors

3. when a director/stockholder votes as a director, herepresents all the stockholders in the capacity of a trusteefor them and cannot use his office as director for hispersonal benefit at the expense of the stockholders

4. in this case, the directors of AF were the instruments ofTransamerica, were directors voting in favor of theirspecial interest, Transamerica, and could not and did notexercise an independent judgment in calling the Class Astock, but made the call for the purpose of profiting theirtrue principal, Transamerica

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5. importancea. can create different classes of stock with different

rightsb. minimum fiduciary duties of shareholders to each

other

Chapter 6: Problems of Control- Proxy FightsI. Intro

a. Because few shareholders of public corporations attend the annualmeeting, the outcome will generally depend on which group has collectedthe most proxies. Under corporate law, shareholders may appoint an agentto attend the meeting and vote on their behalf. Because the outcome of themeeting depends on the number of votes cast, the person with the mostproxies usually wins

b. Generally, the incumbent members of a large firm will solicit proxies fromshareholders directly

c. Proxy fights result when an insurgent group tries to oust incumbentmanagers by soliciting proxy cards and electing its own representatives tothe board

d. In designating a proxy (proxy card) can specify how shares are to be votedor give agent discretion; are revocable

e. Incumbent directors must provide annual report before soliciting proxiesfor annual meeting; anyone who solicits a proxy must prove a writtenproxy statement BEFORE soliciting the proxy

f. The management can use corporate funds to pay for expenses they incur inconducting their own proxy solicitation as long as the amounts arereasonable and the contest involves policy questions rather than just apurely personal power struggle

i. Reasonable expenses: disclosure statement to shareholders,telephone solicitations, in person visits to major shareholders,giving corporate contract to major shareholder

g. The insurgent can only use corporate funds to pay for the expenses itincurs in conducting their proxy solitation if approved by shareholders

h. Proxy contests are relatively rare because they are costly and shareholdersare apathetic

II. Strategic Use of Proxies-Levin v. Metro-GoldwynIII. Shareholder Proposals

a. Introi. Shareholder proposals allows qualifying shareholders to put a

proposal before their fellow shareholders- and have proxiessolicited in favor of them in the companys proxy statement andthe expense is borne by the company

ii. Grounds for exclusion1. allows exclusion of proposals that relate to operations

which account for less than 5% of firms assets, etc and isNOT otherwise significantly related to the firms business

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b. Lovenheim v. Iroquois Brands, Ltd

i. Otherwise significant related includes ethical and/or socialsignificance

IV. Shareholder Inspection Rightsa. Intro

i. Shareholders have a legitimate interest in using the proxy systemto hold the board accountableii. Delaware Statute

1. shareholder must make a written demand setting forth aproper purpose

2. a proper purpose is one reasonably related to such personsinterest as a stockholder

iii. proper purposes1. investigate alleged corporate misconduct2. collect information relevant to valuing shares3. communicate with fellow shareholders in connection with a

planned proxy contestiv. improper purposes1. attempting to discover proprietary business information for

the benefit of a competitor2. secure prospects for personal business3. institute strike suits

b. State Ex Rel. Pillsbury v. Honeywell, Inc.

i. Plaintiff/shareholder lacked a proper purpose for requestingshareholder list or corporate records- the purpose was based solelyon his pre-existing social and political views rather than anyeconomic interest

ii. Essentially, a proper purpose is an economic purposeiii. The suit might have been appropriate when a shareholder has a

bona fide concern about the adverse effects of abstention fromprofitable war contracts on his investment in Honeywell

V. Control in Closely Held Corporations

a. Introi. A close corporation is one in which the stock is held in a few

hands, or in a few families, and wherein it is not at all, or onlyrarely, dealt in by buying or selling- no secondary market forshares

b. Ringling Bros v. Ringing

i. Corporation used cumulative voting to elect directors1. cumulative voting is a mechanism by which the minority

gets to elect some directors2. directors are elected all at once3. each shareholder gets the number of votes equal to the

number of board vacancies times the number of sharesowned

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4. may cast all votes for one (or more) member of the board ofdirectors

5. ex: H owns 100 shares and there are 3 slots available. Hmay cast all 300 votes for 1 candidate, thereby making itmore likely that as a minority shareholder he will get a

director electedii. facts: 2 parties had a written agreement under which they wouldvote together. The effect of the agreement was that the third partywas only able to elect 2 directors and the 2 parties were able toelect 5 directors by combining their votes. In the event of adeadlock, the disagreement was to be determined by an arbitrator-they disagreed. Arbitrator made a decision, but one of the partiesdefected

iii. the court ruled that the agreement was valid, but the defectingpartys votes were not counted

iv. importance: can have voting agreements

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TERMS FROM OLD EXAM AND REVIEW SHEET1. Greenmail:

A situation in which a large block of stock is held by an unfriendly company. Thisforces the target company to repurchase the stock at a substantial premium toprevent takeover

Like blackmail, this is a dirty tactic, but its very effective

Defensive strategy

One corporation is trying to take over another and has one person buy up a bunchof the others stock

2. Stalking Horse

See Smith v. Van Gorkham for example

Test market prices for the shares by offering to buy them at a particular priceusually with guarantees of stock options so that the stalking horse gets somethingno matter what

3. Articles of Incorporation- (see above)

Comes before the by laws

Document filed at the time of incorporation with the state Very simple, plain

Critical that there is contact information for the incorporators/promoters and whois the agent for service of process

4. Leveraged Buyout

Taking on debt; borrow against some assets; secure loan with some asset

One corporation attempting to buy out another and buying the shares

Typical strategy: secure the loan with the assets of the targeted corporation.

Ex: A wants to buy B. B has money in its treasury. A promises lender that if thetakeover is successful A will secure loan with Bs assets. If takeover is successful

Bs assets are As assets5. Preferred Stock

Stock issued after common stock; different rights from those originally issued

Generally no voting rights, but has a premium on dividends

First on liquidation6. Cumulative Voting Rights- seeRingling Bros.

Voting strategy for electing board by accumulating votes

Must be provided for in the by laws

Aggregate votes toward one person rather than spreading them out7. Black Shoals Valuation

Used to evaluate stock

The thing being valued is the present value of stock options

I can buy 100 shares of IMB 6 months from now at $20/share- how do I knowhow much thats worth 6 months from now?

Traditional way of dealing with this problem is to ignore it

These are often found in executive bonus packages

If youre an investor investing in the company and there are a lot of stock optionsout there you have no idea what a company is worth

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With this valuation investors can tell what its worth8. Actual Express Authority- see above

you are my agent and you can do _____9. Actual Implied Authority- see above

Something is necessarily included in your express duties

authority implied from actual authority- according to Lee Ex: manager of pie shop will have implied authority to buy dough10. Apparent Authority- see above

Show a holding out between principal and third party

Manifestation by principal to third party

It is within the scope of his authority- very broad standard

Third partys reliance must be reasonable (what would a reasonable lawn servicebelieve was the customary authority of a manager of a housing community)

11. Customary authority

Usually proper to the conduct of the business for that particular position12. Inherent Authority- 13. Ratification- 14. Inherent Agency Power- is the same as inherent authority15. Annual General Meeting

A mandatory yearly meeting of shareholders that allows stakeholders to stayinformed and involved with company decisions and workings

This yearly meeting is the single event whereby shareholders are able to gatherand ask the board of directors questions pertaining to corporate health andstrategy. Proper notice must be given to shareholders with regards to meetingtimes and agenda

16. Proxy

A formal document signed by a shareholder to authorize another shareholder, orcommonly the companys management, to vote the holders shares at the annualmeeting

The proxy discloses important information about issues to be discussed at anannual meeting

17. Proxy Fight

When a group of shareholders are persuaded to join forces and gather enoughshareholder proxies to win a corporate vote. This is sometimes also referred to asa proxy battle

This term is mainly used in the context of takeovers. The acquirer will persuadeexisting shareholders to vote out company management so that the company will

be easier to takeover18. Proxy Statement

A document containing the information that the company is required by the SECto prove shareholders so they can make informed decisions about matters that willbe brought up at an annual stockholder meeting

Issues covered in a proxy statement can include proposals for new additions to theboard of directors, information on directors salaries, information on bonus andoptions plans for directors, and any declarations made by company management

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Required by law, statement that explains why the proxy is being requested, whoare the new members, what are, the issues, and what will be voted on

19. Tender Offers

An offer to purchase some or all of shareholders shares in a corporation. Theprice offered is usually at a premium to the market

Tender offers may be friendly or unfriendly. SEC laws require any corporation orindividual acquiring 5% of a company to disclose information to SEC, the targetcompany, and the exchange

20. Shark Watcher

A firm specializing in the early decision of takeovers. The firms primarybusiness is usually the solicitation of proxies for client corporations. A sharkwatcher monitors trading patterns in a clients stock and attempts to determinewho is accumulating shares

21. Quorum

The minimum acceptable level of individuals with a vested interest in a companyneeded to make the proceedings of a meeting valid under the corporate charter

This clause within a companys charter ensures that there is a sufficientrepresentation of stockholders present at meetings before any changes can bemade by the board

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