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UNINCORPORATED BUSINESS ORGANIZATIONS

I. AGENCY

THE AGENCY RELATIONSHIP

(1) ELEMENTSAgency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act. Rest. §1.

1. principal’s consent (express/implied, formal/informal)2. agent’s consent (express/implied, formal/informal)3. that agent will act on behalf of the principal (often by dealing with 3rd parties) 4. subject to principal’s control→ fiduciary relationship

ConsentConsent is judged by an objective standard (outward manifestations); the parties’ subjective intent is irrelevant. The parties have an agency relationship where they intended to enter into a certain category of business/interpersonal relationships even where the parties did not intend/contemplate the legal consequences of the relationship. Parties’ attempts to claim or disclaim agency status by contract are relevant to determining whether an agency relationship exists, but not dispositive. Formalities (e.g. communicating the consent) are not required for the formation of an agency relationship.

Gratuitous AgentsThese are agents that consent without receiving any consideration from the principal – i.e. no consideration is required.

ControlHow much control is required to give rise to an agency relationship? At minimum, the principal must have the right to control the goal of the relationship. The control need not be total or continuous. Whether the agent consented to the principal’s control is determined by how the relationship actually operated.

Acting On Behalf of the Principal The principal’s interests are the primary purpose of the relationship and the agent must recognize and consent to as such. Acting on behalf of is different from acting such that it benefits someone else.

(2) AGENCY RELATIONSHIP COMPARED TO OTHER RELATIONSHIPS

BUYER – SELLER RELATIONSHIPThis is not an agency relationship – it is generally an arms length transaction in which each party acts in his own interest. However where the seller (manufacturer) exercises enough control over the buyer (distributor), [examples: quality control, marketing, etc.] and the distributor can be said to be acting on the manufacturers behalf, a court may - under the circumstances - find an agency relationship.

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DEBTOR CREDITOR RELATIONSHIP (CM p. 18) Generally, a debtor and a creditor deal with one another at arms length and each is acting on his own behalf. Thus creditor is not subject to liability for the debtor’s obligations. Principals are however liable for agents in an agency relationship. Through negotiating, creditors often require certain actions from debtors (e.g. require by K that the debtor not take on any more debt). At some point, if there is enough control, this relationship might become an agency relationship under the circumstances.

AGENCY vs. BAILMENT A bailment = the rightful possession of goods by one who is not the owner. An agent is often a bailee for the principal.

AGENT vs. ESCROW HOLDER

FRANCHISE RELATIONSHIPA franchise = a license from the owner of a trademark/name that permits another to sell the product/service under that name/mark. It usually includes the exclusive right to sell the product within a specified territory. Franchise agreements usually include certain controls over the franchisee. However, there is no agency relationship, and the franchisor is not liable for the actions of the franchisee as though he were a principal because the parties to the agreement are acting in their own interests. The controls are merely part of the consideration given for the use of the trademark/name.

CORPORATE RELATIONSHIPS Parent Subsidiary CM p. 21 The parent and subsidiary are separate legal entities. The parent is not liable to third parties except where there are grounds for piercing the corporate veil. If the parent has asked, directed, requested that the subsidiary engage in certain transactions (or series of transactions) an additional argument (besides piercing the corporate veil) for parent liability is that the subsidiary was acting as an agent for the parent.

(2) THE AMBIGUOUS PRINCIPAL PROBLEM

EXAMPLE – EMPLOYER ADMINISTRED GROUP HEALTH INSURANCEWhere an employer obtains health insurance policies for its employees, there is a question as to whether the employer is the agent of (acting on behalf of) the employee or whether the employer is the agent of (acting on behalf of) the insurance company. This determines who is liable for the employer’s acts and omissions.

APPROACHES Majority: the employer is acting in its own interests and/or those of the

employee, and the insurance company’s interests are adverse (therefore the employee is bound by the employer’s acts/omissions)

Minority: decided case by case from the perspective of the employee - the insurance company is the principal, but only where

o the policy is “employer-administered,” o the insurance company chooses as such, o and the insurance company is in a position to exercise control over the

employer’s administration of the policy,

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o the employee has no choice, o and the employee’s expectations have been frustrated

RIGHTS AND DUTIES BETWEEN PRINCIPAL AND AGENT

(1) DUTIES OF PRINCIPAL TO AGENT (CM p. 22)Legal relationships between two people give rise to rights and duties (analogous to contract law). The rights and duties are subject to negotiation, but there are certain rights and duties implied by the relationship itself (default).

Commencement of Agency Relationship (See elements of agency relationship above)

DUTY OF EXONERATION AND INDEMNIFICATION The principle generates profits by using the agents, who are exposed to risks and losses [such as: travel, repair, litigation, speeding ticket, computer crash, sudden injury, insurance premiums, office supplies, materials, equipment, rent, injured by 3rd party]. Is the principal responsible for reimbursing and compensating for such risks and losses?

Is there a previous agreement governing the situation? If not, What are the reasonable expectation of the parties (See p. 77, top) depending on:

o the nature of the parties’ relationship is there a business custom to indemnify?

o the nature of the expense – was it of benefit to the principal? was it the result of the agent’s negligence?

DUTY TO PAY COMPENSATION

Express Contract b/t Principal and Agent Usually there is an express agreement with terms that provide for compensation. Where there is ambiguity in the express terms of the K, the court may look to other evidence under K law to determine the outcome: course of performance, course of dealings, trade usage.

Implied Contract Has A requested that, or let, B perform services for her?

If so, it is inferred that A will pay compensation to B for the serviceHas B offered to perform services for A?

If so, it is inferred that B will perform the services gratuitously – no compensation is owed by A. (gratuitous agent)

Unless the following indicate otherwise: the nature and extent of the service the relationship b/t the parties

Note: Services rendered by family members The law presumes that these are gratuitous favors prompted by kindness.

TO EXERCISE REASONABLE CARE

General Rule

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The principal is under a non-delegable duty of due care to protect its agents (provide a safe workplace). This duty arises from the principal’s control over the work environment. In the event of breach, the principal is strictly liable to pay compensation.

Exceptions (common law defenses to strict liability of employer) contributory negligence – bars recovery whenever the agent’s own

negligence helped cause the injury assumption of risk – bars recovery for injuries arising from the ordinary

dangers of the work fellow servant rule – bars recovery from masters for the torts of a “fellow

servant,” broadly defined (anyone related in labor and whose negligence presents a special risk of harm to the agent).

Worker’s Compensation Legislation The defenses above have been substantially diminished by the enactment of worker’s compensation laws, which provide relief regardless of contributory negligence/assumption of risk/fellow servant negligence. Under these laws, workers pay premiums for insurance that is used to compensate employees injured in the course of employment (according to a detailed schedule of recovery). The compensation includes

medical care, cash payments to the employee (or dependents) for lost wages from

disability or death (calculated as a % of the employee’s salary), but does not include pain and suffering.

DUTY TO DEAL FAIRLY AND IN GOOD FAITH

Issue: Who owes the above duties? This can be an issue where there is a co-agent vs. a subagent:

Co-agent: Co-agents have agency relationships with the same principal. A co-agent may be appointed by the principal or by another agent actually or apparently authorized by the principal to do so. Rest. 3d. §1.04(1) → the principal owes the duties of compensation, indemnification, etc.

Subagent: A subagent performs functions undertaken by an agent for a principal. An agent so empowered may appoint a subagent and agrees with the principal to be primarily responsible for the subagent’s conduct. Rest. 3d. §1.04(9) → the agent owes the duties of compensation, indemnification, etc.

(2) DUTIES OF AGENT TO PRINCIPAL All of the duties between agents and principals are subject to negotiation, and will then be governed by K law.

Commencement of Agency Relationship (See elements of agency relationship above)

DUTY OF GOOD CONDUCT/DUTY TO OBEY

DUTY TO INDEMNIFY PRINCIPAL FOR LOSS CAUSED BY MISCONDUCT

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As a practical matter employers don’t seek the indemnification remedy (holding employees personally liable) because as a matter of policy it would discourage people from working, becoming directors of a corporation, etc.

DUTY TO ACCOUNT

FIDUCIARY DUTIES Duty of care, duty of loyalty, duty to disclose.

(1) Duty of Care An agent must exercise reasonable care in carrying out his duties. Agents that breach this can be held personally liable for losses to the principal. This is judged from both an objective standard and a subjective standard; for example, a highly specialized agent will be held to a higher standard of care than a lower level employee.

(2) Duty of Loyalty

During the relationship Various ways of breaching this duty (CM p. 27):

not acting in the best interests of the principal self-dealing interested director transactions with the principal without fill

disclosure competing with principal corporate opportunity doctrine: the agent can not preempt

(sabotage?) business opportunities misuse of inside information Dual agency: The dual agency rule is that an agent cannot act on

behalf of the adverse party to a transaction connected with the agency without the permission of the principal. If the principals are unaware of the double employment, the transaction between them is voidable.

After the relationship (post-employment activities)1) Is there an express agreement (or statute) that controls? If not, implied duties govern the agent.2) Has the ex-agent misappropriated a legitimate property interest of the ex-principal? (e.g. trade secret, client lists, strategy, formulas, development, product design, etc.) Note: the principal must show that the information was confidential and non-public.

If so, there has been a breach of the duty of loyalty If not,

3) Is the ex-agent merely a business competitor of the ex-principal, who is merely exercising his right to engage in his choice of work and using his general knowledge/expertise/experience?

If so, there has been no breach of the duty of loyalty.

Disclosing Trade SecretsSee CM p. 29 Most often the employment agreement sets forth the scope of what the employee is allowed to do both during and

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after the relationship. Trade secrets are property interests of an employer.

Covenants Not to Compete If there is an express agreement protecting the employer’s interests, can it be enforced? This depends on whether it is reasonable. Balancing test:

o employee’s interest in freedom to engage in work using relevant experience vs.

o legitimate property interests of the employer

(3) Duty of Disclosure An agent has a duty to disclose material information to the employer. To the extent that loss has incurred as a result of the agent’s failure to disclose, the agent is personally liable. The duty to disclose is not a separate duty.

In the context of the Duty of Care: Where the agent fails to disclose material information and the principal incurs losses as a result, the agent has breached his duty of care. The burden is on the principal to prove her losses and to establish that the agent was negligent (breached).

In the context of the Duty of Loyalty:Where the agent fails to disclose that there is a conflict of interest and a transaction is executed, and the principal incurs losses as a result, the agent has breached his duty of loyalty. The principal must only show that the agent executed a transaction with conflict of interest, and without disclosing such to the principal. Then the burden of proof shifts to the agent to show either that he did in fact disclose or that disclosure was not required (i.e. that there was no conflict). If the agent cannot carry his burden, the principal entitled to seek appropriate remedies.

REMEDIES FOR AGENT’S BREACH 1. terminate/suspend the relationship2. reduce or modify the agent’s authority3. demote or discipline the agent4. be indemnified for losses incurred or liability for damages5. refuse to compensate (or reduce compensation)6. disgorgement of profits acquired by agent (for example but placing a constructive

trust on past/present/future profits

VICARIOUS TORT LIABILITY - PRINCIPAL vs. 3 RD PARTIES

The theory upon which to hold the principal vicariously (i.e. strictly) liable for the torts of the agent is respondeat superior. The 3 elements of this doctrine are:

1. the agent’s tort has caused physical injury to a person or property2. a master/servant relationship (vs. independent contractor) – key issue is control 3. the tortuous activity was within the scope of the agent’s employment

→ The principal is liable for the agent’s misconduct regardless of whether the principal authorized, expressly forbade, or even used all reasonable means to prevent the misconduct.

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JUSTIFICATIONS/THEORIES (CM p. 31)1. Benefit theory – risk absorption: e.g. a hospital: the risk is placed on the hospital who

will distribute the risk on the patient’s – beneficiaries 2. Loss-Spreading Theory: risk distribution 3. safety incentive theory: risk assumption 4. Just & Equitable Theory – employer is not at fault here at all – injured person, person

who acted, 3rd person

Rationale: The general rule is that the principal is liable for actions of the agent within the scope of agent’s employment, because the principal is thought to control the agent’s activities. (Note principal has no control over independent contractors, and is not liable for their torts.)

(1) THE MASTER-SERVANT RELATIONSHIP vs. INDEPENDENT CONTRACTORSIf there is a master-servant relationship (and the conduct is within the scope of the agent’s employment) the principle will be vicariously liable for the torts of the agent. If the “agent” is really an independent contractor, the principle is not vicariously liable for the torts of the agent.

Trend: Employers are contracting out many functions to avoid being responsible.

DETERMINING WHETHER THERE IS A MASTER/SERVANT RELATIONSHIP OR AN INDEPENDENT CONTRACTORA servant is subject to the master’s control (or right to control). In determining whether there is a master-servant relationship the following factors are relevant: Rest. 2d. §220:

extent of master’s control whether the agent is engaged in a distinct occupation type and nature of occupation (is it usually done under the direction of a master

or by a specialist without supervision?) skill required by occupation whether the employer supplies the equipment and place for doing the work length of time of employment method of payment (per hour/per task) whether the work is part of the employer’s regular business the parties’ subject beliefs about the relationship whether the principal a business person

Modern Factors, see CM p. 32

Issue: Actual control vs. right to controlActually exercising control over the agent is not necessary to a master-servant relationship; having the right to control the agent is sufficient.

EXCEPTIONS/LIMITATIONS TO THE INDEPENDENT CONTRACTOR EXCEPTION CM p. 33 (Exceptions to the Exceptions)

Employer Negligence Technically, where the employer is negligent, this is no vicarious tort liability, but the employer is directly liable. Courts have increased employers

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responsibility (e.g. do a background check for drunk driving, etc.) to ensure that potential employees are trained/experienced/qualified.

e.g., negligent hiring, e.g., negligent supervision

Inherently Dangerous Activity (public policy) There are activities that increase the risk of harm/injury to 3rd persons, e.g. transporting hazardous materials.

Non-delegable Duty (public policy)The duty that an employer has to a group of 3rd persons is so important, that the court/law won’t allow them to contract the function away. This applies to a wide variety of situations (CM p. 34).

law firm’s duty to client car owner’s duty to 3rd persons to maintain the car’s saftey

Apparent Relation If the business hires another business, and if it appears to 3rd parties that there is a relation, the hiring business may be estopped from claiming IC relationship and avoiding liability. Even if no relation exists, there still may be liability on the grounds of estoppel or apparent relation, if the reliance was reasonable.

Issue: unincorporated organizations/associations, joint enterprisesThese don’t have a separate legal identity. If one of the members is negligent, the association/organization can not be potentially liable. However, the members may be individually liable depending on how extensive their participation in the organization/association is: The roles different individuals play must be examined to determine liability.

mere membership vs. active participation and control

o active participation/control may be subject to liability.

ACTIVITY - SCOPE OF EMPLOYMENTGenerally, the employer will be liable for only those actions that are within the scope of

employment (i.e. within the employer’s control). Whether the conduct is within the scope of employment is a matter of degree:

there must be a nexus between the act and the employment, In reality, this test is so vague that judges have wide discretion to decide the case based on what is fair.

GENERAL RULEIf the act that injures a 3rd party is fairly and reasonably connected to the employment - incidental to the employer’s business – the act is within the scope of employment, and the employer is liable for the employee’s negligent and intentional misconduct.

Factors nature of the employee’s actions time of the employee’s actions (during work hours?) place of the employee’s actions (in the workplace?) purpose of the employee’s actions §228 Rest.

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DETOUR vs. FROLIC (TANGENTIAL ACTS)If the act is a slight deviation from the employee’s duties, it is merely a detour, which is considered to be within the scope of employment. If the act is a substantial/gross deviation from the employee’s duties, it becomes a frolic which is considered outside the scope of employment.

Detour: within the scope of employment (expected)

Frolic: not within the scope of employment (not expected)

The Re-entry RuleThis is where the agent ends a frolic and decides to return to his/her employment. At some point, because the frolic is over, the agent is once again acting within the scope of employment, and respondeat superior will result in liability for the employer/principal.

Issue: When exactly is the employee reentering the employment? (merely deciding to return is insufficient for reentry): it usually depends on how far removed the agent is from the time/place of employment.

SITUATIONS - Negligent Torts (handout)

Travel Cases (CM p. 36) Someone is driving somewhere and injures another person. If they go straight there, the employer will be held liable. If they frolic the employer will not be held liable. If there is a slight deviation (detour), the employer might be held liable because this is expected. Then there is huge grey area.

Employee Disobedience Cases The courts have held that employee disobedience doesn’t have anything to do with whether the employee was within the scope of employment. Disobedience does not render the conduct outside the scope of employment.

Personal Habits/Conduct There are 2 approaches: The narrow approach rationalizes that the personal habits of employees have nothing to do with the business, therefore the employer shouldn’t be held liable. The permissive view rationalizes that the habits are expected (if they are slight deviations, e.g. bathroom breaks) and employers have to assume liability for such deviations.

smoking breaks? If the employer bans smoking breaks, they are exercising control, and are thus likely to be held liable.

Issue: Counter-intuitive? The stricter the controls/regulations the employer places on the employee are (to prevent injuries to 3rd parties) [i.e. the more careful the employer is], the more likely the employer is to be held strictly liable.

EMPLOYER’S LIABILITY FOR INTENTIONAL TORTSMost resopondeat superior cases involve torts of negligence, but the doctrine also applies to intentional torts. Where the agent acts within the scope of employment to commit an

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intentional tort causing physical harm, the principal is vicariously liable. The main issue is whether the intentional tort is within the scope of employment. Various approaches to determine whether the tort was within the scope of employment are:

The Motive Test: Is the agent’s purpose/motive to serve the master?

Foreseeability/characteristic of the business: Is the conduct foreseeable from the nature of the employment and duties relating to it?

Outgrowth of the Work Environment: Is the risk of such misconduct fairly typical of – or broadly incidental to – the employer’s business?

Policy Analysis: (application of vicarious liability justifications) Benefit Theory – risk absorption: e.g. a hospital: the risk is placed on the

hospital who will distribute the risk on the patient’s – beneficiaries Loss-Spreading Theory – risk distribution Safety Incentive Theory – risk prevention Just & Equitable Theory – employer is not at fault here at all – injured

person, person who acted, 3rd person

CONTRACTUAL POWERS OF AGENTS (CONTRACT LIABILITY) PRINCIPAL vs. 3 RD PARTY

GENERAL RULE A principle is contractually liable for transactions of the agent where

there is an agency relationship the transaction at issue was within the agent’s scope of authority – see below for

theories of authority (This is a narrower test than the scope-of-employment test for tort liability.)

[Commencement of Agency Relationship (See elements of agency relationship above)]

(1) ACTUAL AUTHORITY manifestation by principal reasonable interpretation by agent of the principal’s manifestation agent believes he has authority to act

EXPRESSThe manifestation can be oral or written; e.g., resolution of the board, power of attorney, by-laws, etc. IMPLIEDWhatever is usual, incidental, reasonably necessary to carry out the agent’s responsibility or authority is impliedly authorized:

transaction was necessary (emergency) transaction was reasonably contemplated by the principal and agent implied by agent’s position/title

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implied by past conduct (i.e. principal’s acquiescence) implied by business custom implied by documents or other indicia of authority

(2) APPARENT AUTHORITY

GENERALLYThe test for apparent authority is whether, based on the circumstances, it is reasonable - from a 3rd party’s perspective - to believe that the agent had authority. (Unreasonable belief is insufficient.) The reasonable person is judged by both objective and subjective standards. Reasonableness factors:

principal’s manifestation to the 3rd party (active or inactive) agent’s position/title past dealings with the 3rd party business custom documents or other indicia of authority 3rd party inquiry

→ If it is determined that it was reasonable for the 3rd party to believe the agent had authority, the K will be enforced.

(3) ESTOPPEL (Rest. §8(b)(1))This imposes liability on the principal even where there was no manifestation attributable to the principal. If the 3rd party reasonably believes that the agent has authority to bind the principal, and changes his/her position in reasonable reliance of such belief, and the principal negligently fails to notify 3rd party of the scope of authority.

The key difference between this and apparent authority is that the 3rd party changes position (i.e. actual reliance)*→ principal is estopped from challenging the agent’s authority * → principal must pay compensatory damages to the 3rd party for their loss *

* differences between apparent authority and estoppel

(4) INHERENT AUTHORITY (Rest. §8A) – FairnessA principal is liable for those transactions that a general agent (e.g. the President) enters into, although unauthorized (perhaps even forbidden), if those transactions usually accompany or are incidental to the business and the 3rd party reasonably believes the agent is acting with authority. This amounts to enterprise liability because the principal has entrusted the agent with ongoing responsibilities.

Issue: Whether the agent is a “general agent” Ongoing responsibility is the key to whether an agent is a general agent. If the principal authorizes an agent to conduct a series of transactions involving “continuity of service,” the agent is a general agent. If the principal authorizes the agent only to conduct a single transaction, or to conduct a series of transactions that do not involve “continuity of service” the agent is a special agent, not a general agent.

ELEMENTS1. transaction by a general agent (i.e. there is “continuity of service” or ongoing

responsibility – vs. special agents who have authority only to conduct a single transaction.)

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2. reasonably incidental to the particular nature of the business (and in the interest of the principal)

3. 3rd party reasonably believes (objectively & subjectively) that the agent had authority

RATIONALE - fairnessIt is unfair for an enterprise/principal to have the benefit of the work of its agents without making it responsible to some extent for their failures to act carefully.

Issue: Who should bear the risk of loss?A third party, or the business?

LIMITATIONS1. where the 3rd party knows there is no authority (because this defeats the fairness

rationale)2. where the agent is acting on his own behalf, not in the principal’s interests

(because this defeats the enterprise rationale)

PolicyTo place the burden of risk on the principal for the agent’s misconduct and to treat the general agent and principal as an enterprise.

Note: Acceptance Most courts have not accepted this theory because the same result is possible under an expanded application of apparent authority.

(4) RATIFICATIONThis is after-the-fact acquiescence of the transaction.

EXPRESSThe principal specifically affirms that it will honor the transaction.

IMPLIED The principal communicates by its conduct that it will honor the transaction (i.e. pays, or uses the K), or fails to object to the transaction.

THE UNDISCLOSED PRINCIPAL: PRINCIPAL vs. 3 RD PARTIES

DUTIES OF THE 3 RD PARTY/RIGHTS OF THE PRINCIPAL

GENERAL RULEGenerally, undisclosed principals can enforce contracts against 3rd parties.

EXCEPTIONS Under the following circumstances, a principal will not be able to enforce a contract against a 3rd party, because the 3rd party has special interests in who he/she is contracting with.

Express Limitation

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Where the K contains an express limitation against undisclosed principals, the principal will not be able to enforce the K, and the 3rd party will be excused from his/her obligations under the K.

Personal servicesWhere the 3rd party is expecting/contracting for personal services, and the principal was not disclosed, the undisclosed principal will not be able to enforce the K and the 3rd party will generally be excused from his/her obligations under the K.

False DenialWhere the 3rd party asks the agent is asked if the agent is acting in his/her individual capacity, or on behalf of an undisclosed principal, and the agent falsely denies as such, the undisclosed principal will not be able to enforce the K and the 3rd party will generally be excused from his/her obligations under the K. By asking, the 3rd party demonstrates a legitimate interest in with whom he/she is contracting.

Knowledge vs. Mere Suspicion Where the agent/principal has knowledge that a 3rd party will reject the contract if the principal’s identity is disclosed, the undisclosed principal will not be able to enforce the K and the 3rd party will generally be excused from his/her obligations under the K. However, if the agent/principal has a mere suspicion that a 3rd party will reject the contract if the principal’s identity is disclosed,

Kelly Asphalt Block Co. v. Barber Asphalt Paving Co. p. 355 The plaintiff (Kelly Asphalt) was the undisclosed principal, and Booth was its agent. Booth executed a K with another party on behalf of the undisclosed principal. The undisclosed principal is suing the other party to the K for to enforce the K. There was a suspicion/belief that, if the identity of the principal were disclosed, the K would never have been made. The 3rd party argued that this should constitute an exception to the general rule that the undisclosed principal can use for performance of the K. The issue was whether the 3rd party had a legitimate interest at stake, requiring relief from his/her obligations under the K. The court that mere suspicion is not enough: there was no misrepresentation, and there was no manifestation by the 3rd party of his interest in the identity of the principal.

DUTIES OF THE UNDISCLOSED PRINCIPLE/RIGHTS OF THE 3 RD PARTY

GENERAL RULEBecause a principal can generally enforce a contract against a 3rd party, in the interest of fairness, a 3rd party can also enforce a contract against an undisclosed principal.

THE ELECTION DOCTRINE Who should the 3rd party sue? (CM p. 53)

The English [Traditional] RuleA 3rd party only has one cause of action for enforcement of the contract. If the 3rd

party obtains a judgment against an agent, he/she can not bring a lawsuit against

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the principal regardless of whether the 3rd party is even aware of the principal’s existence.

The American [Majority] RuleA 3rd party only has one cause of action. However a 3rd party can only make a valid election if he/she is aware of the principal’s existence at the time he/she initiates the suit. If the 3rd party is unaware of the principal and obtains a judgment against the agent, he/she not precluded from suing the principal. If the 3rd party is aware of the principal and obtains a judgment against the agent, he/she is precluded from suing the principal.

The Growing Minority RuleThere are no restrictions on who the 3rd party may sue. A 3rd party can sue both the agent and the principal, obtain judgments against both, and seek enforcement of those judgments against both until he/she fully recovers his/her damages.

Grinder v. Bryans Road Building & Supply Co. p. 364 (CM p. 55) Grinder had a construction business and had an open account with Bryans to buy supplies. Originally Grinder was a sole proprietor, but he decided to incorporate. After incorporation Grinder was operating as an agent of the corporation. Bryans never knew of the incorporation. Bryans sued Grinder (in his capacity as a sole proprietor) for unpaid bills. Grinder claimed that because he was just the agent of the corporation/principal, he was not liable. Bryans added the corporation to the compliant, but also argued that Grinder was still personally liable on the theory that agents of undisclosed principles are personally liable. A judgment was entered against both Grinder and the corporation. Grinder then argued that, under the American Rule, if you bring an action against the agent, knowing the existence of the undisclosed principle, there is no valid election, and Grinder is not liable. The court rejected Grinder’s argument and adopted the minority approach above. Bryans could sue Grinder personally and sue the new corporation, until performance of the K is satisfied.

LIABILITY OF AN AGENT TO 3 rd PARTIES CM p. 56

(1) AUTHORIZED TRANSACTIONS The agent has executed a contract with authorization. The parties to the K are the principal and the 3rd party. The agent has merely carried out his/her function and is not a party to the K. If the principal breaches the K, the agent is not liable to a 3rd party for these acts of the principle.

DISCLOSED PRINCIPAL Where the identity of the principal is disclosed, the K is between the 3rd party and the principal, and the agent is not liable for performance of the K.

Exceptions Express Assumption – the agent assumes liability Implied Promise

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Custom – for example, it is customary for expert witnesses to seek payment from the attorney even though the attorney is merely the agent for his/her client

signature (see below)

UNDISCLOSED PRINCIPLE Agents who execute contracts on behalf of undisclosed principals (e.g. an unincorporated business that forms a corporation) are personally liable. The 3rd party can elect who to sue (see above). An agent must provide notice that he/she is acting on behalf of a principal. The 3rd party is not required to inquire.

PARTIALLLY DISCLOSED PRINCIPLE The agent will be liable to the 3rd party.

Issue – Signatures The manner in which an agent signs a contract (promissory note) may affect his/her liability. If the agent clearly signs as an agent, and disclose the identity of the principal, he/she has put the 3rd party on notice, and the agent will not be liable, for performance of the K. If the agent clearly signs his/her own name and makes no reference to agent status or the identity of the principal, the agent will be liable for performance of the K, and no parol evidence will be admissible to show otherwise. If the agent’s signature is ambiguous (e.g. CAD, agent or CAD, president) parol evidence will be admissible to determine the parties’ intent.

(2) UNATHORIZED TRANSACTIONS (WARRANTY OF AUTHORITY)The agent has entered into an unauthorized K on behalf of the principal. The law implies a warranty of authority where an agent purports to bind another to a K. If there was no authority, the agent is thought to have breached the implied warranty, and will be liable for damages.

EXCPETIONS Disclaimer – the agent disclaims (to the 3rd party) having authority to bind Uncertainty – the agent expresses doubts (to the 3rd party) about his/her authority

to bind. 3rd party knows the agent has no authority

However, if the agent manages to bind the principal through implied authority, apparent authority, estoppel, or inherent authority, the warranty of authority is not breached and the agent will not be held liable. The 3rd party will have gotten what he/she bargained for.

(3) NONEXISTENT PRINCIPALIf the incorporation formalities are defective, the corporation has not yet been formed, or the 3rd party is dealing with an unincorporated association of individuals, the principal may actually be nonexistent. The agents are potentially liable.

EXTENT OF AGENT’S DUTY TO 3 RD PARTY Obligations on the contract (depends on disclosure of principal) Warranty of authority (depends on whether there was authority) Obligations in tort Agent’s breach of duty to the principal is not, by itself a breach to a 3rd party (there must

be a duty and breach directly to the 3rd party)

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II. GENERAL PARTNERSHIPSUPA, RUPA, Case Law, Agency Law

NATURE & CREATION

(1) NATURE Is a partnership is an aggregate of individuals (that has no separate legal status) or a separate legal entity? The general rule is that a partnership is a separate legal entity.

AGGREGATE THEORYThis still applies to the federal tax system’s treatment of partnerships, liability, and dissolution. For these topics, the focus is on the individuals as though the partnership doesn’t exist.

ENTITY THEORYThis applies to enforcing contracts, title to property, and filing lawsuits. The partnership itself is involved.

COMPARED WITH OTHER BUSINESSES

AdvantagesPartners equally own and manage the firm. Taxation is on a flow-through basis – partners are taxed once individually.Partners can exit the business at will. No formalities are required. Flexibility

Disadvantages Partners are personally liable for the debts of the firm.

APPLICABLE LAWUPA and RUPA are the state laws that govern partnerships. They determine/govern:

whether a partnership exists the relationship of the partners and partnership with outsiders relationship between the partners (but subject to the partnership agreement) when a partnership ceases to exist, what happens to the partners’ interests, the

partnership’s assets, and the partnership’s liabilities. They have both mandatory and default provisions. The mandatory provisions govern the partnership’s relationship with outsiders. The default provisions govern the partners’ relationships with one another.

PARTNERSHIP AGREEMENTThis is not required, but is useful where the partners want more flexibility than what the default provisions (governing their relationships with one another) allow. In order to adopt a partnership agreement that changes the default rules, there must be unanimous approval. (Thereafter, the partnership agreement can provide for its own amendment on a less-than-unanimous basis).

(2) CREATION

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A partnership is created by consent where 2 or more persons manifest an intention to associate as co-owners of a business for profit. No formalities are necessary. Consent can be express or implied in conduct. Intent to form a “partnership” is not required. If the business structure has the essential characteristics of a partnership, the business is a partnership.

IMPLIED PARTNERHSIPS - IS THERE A PARTNERSHIP? IF SO, WHO ARE THE PARTNERS?This question comes up where (1) a 3rd person (tort creditor, contract creditor) is suing a partnership, thus suing all the partners themselves; (2) the parties themselves are involved in a dispute, e.g., over who is entitled to interests in the partnership; and (3) a government agency has challenged the existence of the partnership.

Major Factors Include (but no one factor is dispositve):

Sharing ProfitsULPA §7 & RUPA§202 establish a presumption that receiving a share of the business profits is prima facie evidence that you are a partner of the business. This presumption is rebuttable where the person receiving the profits can show that he/she is receiving payments as a creditor, wages as an employee, rent as a lessor, an annuity as a beneficiary of a deceased partner, consideration for a sale, etc. Note: joint ownership of property (see § 202) is not dispositive of a partnership).

Profit Sharing vs. Revenue Sharing There is a difference – an employee who is paid on commission is sharing in the revenue of the business, but not the profits (which = revenue – business expenses).

Mutual Right of ControlThe incentive to exercise control originates from the right to share profits.

Co-owners of the BusinessOwnership interests originate from the right to share profits.

Indicia of “partner” status agreements to share in profits & losses participation in substantive management, decision-making right & duty to act as an agent fiduciary relation with other partners unlimited liability for partnership debts/losses made true capital contributions to the partnership comparable ownership interest in partnership co-owner of partnership property right to examine books and records

Partnership by Estoppel (or Liability of a Purported Partner) §16, §308Even where no partnership in fact existed, someone who misrepresents his/her identity as a partner (or allows someone else to misrepresent his/her identity as a partner) will be estopped from denying the partnership if 3rd party relies on the misrepresentation. He/she will be liable to the 3rd party for the transaction, and so

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may the partnership, other partners, or supposed partners, depending on the scenario:

Liability of the person whose status is misrepresented – General Rule: if

a person misrepresents him/herself as a partner, (or consents to someone else doing so) and

a 3rd party relies on the misrepresentation by entering into a business transaction with the supposed partnership

→ the person whose status is misrepresented is liable to the 3rd party

Liability of the partnership – General Rule: if an actual partnership exists, and all the partners* make (or consent to) a misrepresentation of a

person’s status as partner, and a 3rd party relies on the misrepresentation by entering into a

business transaction with the supposed partnership→ the partnership is liable on the transaction*→ the partners are each personally liable

*Variation: If there is a partnership, but not all of the partners made (or consented to) the misrepresentation, the partnership is not liable; only those responsible for the misrepresentation are liable on the transaction.

Liability of the supposed partnership where none in fact existed – General Rule: if

no actual partnership exists, and supposed “partners” make (or consent to) a misrepresentation of

a person’s status as partner, and a 3rd party relies on the misrepresentation by entering into a

business transaction with the supposed partnership→ the supposed “partners” who made (or consented to) the misrepresentation are each personally liable

Issue: Consent Declarations of partnership by another in your presence, under circumstances in which you know, or should know, that a denial is necessary to avoid misleading a 3rd party creditor, are considered adoptive admissions that you are a partner. Failure to deny partner status or silence = consent to representation. J&J Builders v. Caffin p. 574.

Issue: RelianceThe reliance element requires that the 3rd party know of the representation at the time he/she enters into the transaction. I.e., the 3rd party can’t find out about the representation later and use it to enforce the transaction.

FINANCIAL STRUCTURE & PARTNERS’ CONTRIBUTIONS/DISTRIBUTIONS

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(1) CONTRIBUTIONS CM p. 73

TYPES There are no restrictions in UPA or RUPA on the nature and amount of the partners’ contributions to the partnership. A partner can contribute anything of value, subject to negotiations and agreement among the partners.

Labor services (present & future)

Capital cash real/personal property securities promissory notes

Intangible contacts (“rainmaker”) name/reputation experience expertise

WAYS PROVIDED There are 3 ways that partners can provide capital to the partnership:

1. they may contribute it – transfer ownership interest2. they may furnish it – retain ownership interest, but partnership has permission to

use 3. they may lease or loan it – retain ownership interest

Under UPA the partner’s intent determines what type of contribution he/she made. Under RUPA, title determines what type of contribution he/she made.

RETURN

When This generally occurs when a partner leaves the partnership, or when the partnership comes to an end. UPA§18(a) requires that each partner be repaid his/her contributions after all liabilities are satisfied.

HowRemuneration for property provided to the partnership depends on the way it was provided (see above).

Leased/Loaned – A partner who leases or loans property to the partnership receives compensation according to the terms of eh lease/loan agreement. When the lease/loan period ends, the property returns to the partner.

Furnished – A partner who furnishes property to the partnership receives no compensation beyond a share in the profits; allowing the partnership to use the property is what the partner contributes in return for his profit

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share. When the partnership ends, the property returns to the partner who furnished it.

Contributed – A partner who contributes property to the partnership receives no on-going compensation beyond a share in the profits. When the partnership ends, the partnership owes the contributor the value of the contribution, measured as of the time of the contribution. Unless otherwise agreed, the contributor has no right to have the property itself returned.

APPRECIATIONIf the partner contributes property, and it appreciates while the partnership is in existence, the appreciation belongs to the partnership. The contributor has no claim on the appreciation.

LOSS SHARINGUnder both UPA and RUPA loss sharing is mandatory. If one partner contributes all capital and the other contributes all labor, and the partnership loses money, the partner that contributed the labor will get nothing (because there are no profits) and will have to pay the other partner his/her equal share of the losses.

(2) DISTRIBUTION OF PROFITS

HOW MUCHWhat percentage of profits each partner gets is not tied to the amount he/she contributes (like corps). Regardless of the nature and amount of property contributed, all partners get an equal share of the profits (after contributions, and advances/loans, and withdraws are settled), unless otherwise agreed. UPA §18(a), RUPA §401(b)

WHENNeither UPA nor RUPA have default rules on when/how often profits are paid out to partners. Tax law requires that profits and losses are added up annually, and this generally influences when profits are distributed in most partnerships. The specifics are generally subject to agreement. A partner has no right, however, to receive a current distribution of profits.

(3) OTHER

INDEMNITYThe partnership must indemnify every partner for payments made and liabilities incurred in the ordinary and proper conduct of partnership business or for the preservation of partnership property. UPA §18(b).

WAGESThere is no right to compensation for labor, wages, or salary other than a partner’s share in the profits of the business (default), unless otherwise agreed.

OPERATION & MANAGEMENT

PARTNERSHIP’S/PARTNER’S DUTIES TO 3 RD PARTIES

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TORT LIABILITY The partnership is liable for the torts of the partners under UPA §13 and RUPA §305(a). The only difference between these rules and vicarious liability in agency law is that no showing of the master’s right to control is necessary.

CONTRACT LIABILITYSee “binding the partnership”, under “management rights” below.

PARTNERS RIGHTS AND DUTIES TO THE PARTNERSHIPThese are subject to agreement among the partners. Where no agreement is made the default rules below will apply.

A. PARTNER’S RIGHTSTo be entitled to these rights, you must be a partner in a partnership.

is there a partnership? who are the partners?

(i) Share in Profits(see above)

(ii) Property Rights (below)

(iii) Share in Management

a) Decision-Making & Veto Power – Management rights include the right to participate in decision making and the right to veto certain types of decisions. In partnerships (vs. agency) there are laws in place that will control whether there is authority to make certain decisions unless otherwise agreed (default laws).

Basics – In partnerships, where there is disagreement among the partners on a certain course of action, the disagreement is resolved by vote. Each partner gets 1 vote (regardless of the amount he/she contributed), and some decision require unanimous approval, while others merely require a majority.

Extraordinary Decisions – These require unanimous approval. RUPA , UPA case law

admission of a new partner amending the partnership agreement substantial changes to the nature of the partnership’s

business “acts in contravention of any agreement between the

partners” UPA

Ordinary Decisions – These only require a majority. anything that is “in the ordinary course of business”

RUPA any “ordinary matters connected with the partnership

business” UPA

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Deadlock – If no majority is possible because of an even number of partners, the status quo prevails. I.e., those who oppose the change win.

b) Binding the Partnership – Management rights include the right (authority) to bind the partnership to 3rd parties.

Scope of Actual Authority – Partners may define the scope of actual authority in the partnership agreement.

UPA: each partner is an agent for the purpose of conducting partnership business, and therefore has implied actual authority to bind the partnership where it is reasonably necessary to accomplish the proper objectives of the partnership.

RUPA: each partner has actual authority to bind the partnership where it is reasonably necessary to accomplish any task within the ordinary course of business.

Limit: If a partner knows or should know that another partner would object to a proposed commitment, the first partner has no actual authority (unless otherwise agreed). the decision to bind must then be put to a vote (see above).

Partnership by Estoppel – Even if the 1st part of the analysis fails (i.e. there is no partnership, and the person is not actually a partner, and thus has no actual authority), the partnership may still be bound if it allowed or consented to the misrepresentation. (See rules above.)

(iv) Right to access books and recordsThis right is available to all partners and is unqualified. Under RUPA it is also available to former partners, but limited to those books and records that pertain to the period during which they were partners, in order to protect a dissociated partner’s legitimate interests. UPA §§19, 20, RUPA §403.

no proper purpose is required (like in corps) because a partner is subject to the risk of unlimited personal liability

abuse of this right is a breach of the duty of good faith and fair dealing

this right may not be unreasonably restricted by the partnership agreement RUPA §103(b)(2)

DUTIES :Remember, this can be contracted out. SEE CCM 102Note: § 103 prevents one from contracting out certain rights. SEE STATUTE BOOK PAGE 49 = § 103 says you may be able to limit some of the partner duties, but can’t completely waive them.

(i) To Perform – Care

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No duty to perform is presumed by partner status (i.e. passive partners who only contribute assets are not violating any duty). But where a partner does perform, he/she is subject to a duty of reasonable care that is only breached on a showing of gross negligence – there is no breach of this duty of are where the partner makes an ordinary mistake in judgment. This is the partnership version of the BJR. The duty of care ends when the relationship ends – no duty is owed to former partners.

(ii) Loyalty UPA §21, RUPA §404There is a duty of loyalty between partners and the partnership. Partners are prohibited from:

competing with the partnership RUPA §404(b)(3), §UPA 21 taking business opportunities away from the partnership using the partnership’s property for personal gain engaging in a conflict of interest transaction, or self-dealing

unless the other partners give informed consent.

Remember, these can be contracted out somewhat, but not entirely based on § 103.

Remedy for breach – Disgorgement of gain, and/or damages

Scope – Under UPA the duty of loyalty begins during the formation of the partnership under §21, and continues until after the partnership terminates. However under RUPA, the duty of loyalty does not extend to the formation of the partnership, §404(b)(1), which is treated as an arm’s length transaction. Under RUPA the duty not to compete ends upon dissolution, but the other duties extend until the partnership terminates.

(iii) To DiscloseThis is a special kind of duty of loyalty that applies where partners’ interests are potentially or actually adverse.

Situations formation of the partnership (only under UPA; not RUPA) renegotiation of profit shares sale or purchase of a current partner’s interest exercise of management rights where the result disadvantages

one partner

Requirements - In partner v. partner transactions where the partners’ interests are adverse there must be:

Full disclosure of material information – This means that the person who has the material information must disclose it. Material information is information that

relates to the value of the partnership interest could not be learned by examining the books and records (relates to the partnership’s ability to properly conduct

the business of the partnership in the context of the duty of care)

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Materiality depends on the facts and circumstances: sophistication of the investors, access to the information, nature of the information, etc. Walter v. Holiday Inn p. 640

Good faith and fair dealing (generally not a duty, but an obligation instead) – This means that partners deal with each other candidly, without coercion (process), and that partners have a duty to provide a fair price in the transaction (substance).

Issue: Acting in self interest (to protect ones own interest) in the above situations is not a breach of any duty of loyalty, see RUPA §404(e), and is acceptable as long as it is not excessive.

(iv) To Account This arises where one partner alleges breach of duty against another partner. UPA §22 provides for the right to an accounting of partnership affairs (where adequate books and records have not been kept) and §20 provides for a duty to provide information. RUPA §405(b)

Issue: What if the partnership agreement reduces or eliminates these duties? This is an unclear area of the law. Although UPA and RUPA generally allow major customizing of the relationships between the partners using the partnership agreement, there are some limits on what the partnership agreements may change with regard to partners’ duties.

the partnership agreement can not totally eliminate fiduciary obligations to one another,

The more fundamental the duty that is being altered, the more likely it will be subject to judicial scrutiny

fundamental changes to the partnership that significantly alter the nature of the partnership, or the partner’s stake (liability) may require unanimous consent, no matter what the partnership agreement says (e.g., choosing to become an LLP – see RUPA §1001).

RUPA §103(b) lists restrictions on customizing the partnership agreement: o it can not unreasonably restrict the right of access to books and recordso it can not eliminate the duty of loyalty

However, partnership agreements that authorize partners to compete with the partnership, or self-dealing by a managing partner are commonplace and ordinarily enforceable. Balancing the competing interests at stake - freedom of contract (as long as it is legal) vs. protection of fiduciary nature of the partnership relation& partners’ interests – has produced inconsistencies in the law.

PARTNER’S PROPERTY RIGHTS - CREDITORS RIGHTSCreditors’ rights are built into the partnership statutes.

PARTNERSHIP PROPERTY vs. INDIVIDUAL PARTNER’S PROPERTY. It is often not clear whether a partner is contributing the use of his property (i.e. furnishing the property), or ownership of the property itself. E.g., a partner may use his own laptop/car/property for business use. Ideally all the property will be clearly designated as separate property or partnership property, but often it is not.

[Who cares about this distinction?

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Creditors who may disagree with the individual and the partnership Partners who are departing/joining may disagree with the partnership Upon dissolution, the partners who may disagree with one another Heirs who are trying to settle the estate of a deceased partner The government for taxation purposes]

GENERAL RULES If the property is acquired during the partnership, it belongs to the partnership.

UPA §8, RUPA §203 If the property is purchased by the partnership (using partnership assets), it

belongs to the partnership. If the property is contributed to the partnership, it belongs to the partnership.

UPA§8. (The value of such property at the time of contribution is returned to the partner who contributed the property).

If the property is merely furnished by a partner to the partnership for the partnership’s use, the property is separate property belonging to the partner.

If the property is leased to the partnership by a partner, the property is separate property belonging to the partner.

TESTS FOR DISTINGUISHING B/T SEPARATE AND PARTNERSHIP PROPERTY

Under UPAThe intention of the parties controls.

Under RUPA Title to the property controls.

Relevant Factors purchased by? used/possessed exclusively? record title? who pays for the taxes, improvements, repairs? recorded as partnership asset? payment of an underlying loan? other factors

PARTNERS PROPERTY RIGHTSPartners generally have 2 kinds of property rights: their rights to specific (tangible) partnership property (assets) and their rights to an economic (intangible) interest in the partnership itself.

IN SPECIFIC PARTNERSHIP PROPERTY (ASSETS)Ownership vs. Use/Possession

Under UPA Partnership property is considered to be co-owned by the partners –but

they don’t own it to the point where they can assign it. (reflective of the aggregate theory). §25

Each partner has the right to use/possess partnership property for the purposes of the business, but not for other purposes. §25

Under RUPA

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Partnership property is considered to be owned by the partnership (reflective of the entity theory). §501

[same as UPA] A partner may use/possess partnership property only on behalf of the partnership. §401(g).

IN THE PARTNERSHIP ITSELF This is an intangible “economic” right in the partnership itself that includes a share of the partnership’s profits, and reimbursement for the value of contributions.

Under UPAEach partner is entitled to an equal share in the profits (unless otherwise agreed) and to receive, usually when the partnership ends, the value of any property he/she contributed to the partnership. §26

Under RUPA[same as UPA] Each partner is entitled to an equal share in the profits (unless otherwise agreed) and to receive, usually when the partnership ends, the value of any property he/she contributed to the partnership. §502

RIGHTS OF THE INDIVIDUAL PARTNERS’ CREDITORSScenario: A creditor has a claim against an individual partner. Issues: Can the creditor reach the partner’s interest in specific partnership property? Can the creditor reach the partner’s economic interest in the partnership itself?

PARTNERSHIP PROPERTY

Under UPA the partner’s right to use/possess specific partnership property (for the

purposes of the partnership’s business) is not assignable and is not subject to attachment by creditors of the individual partner

Under RUPA the partner’s right to use/possess specific partnership property (for the

purpose of the partnership’s business) is not transferable and is not subject to attachment by creditors of the individual partner

INDIVIDUAL PARTNER’S INTEREST IN THE PARTNERSHIP ITSELF

Under UPA A partner can assign this interest as collateral for debt (§27) If the creditor if the individual partner has a charging order (§28) – i.e. a

court order that requires the partnership to any amounts owed to the partner directly to the partner’s creditor instead – the creditor can reach a partner’s economic rights in the partnership (right to profits & right to value of contribution).

Under RUPA A partner can assign this interest as collateral for debt (§502, 503) If the creditor if the individual partner has a charging order (§504) – i.e. a

court order that requires the partnership to any amounts owed to the partner directly to the partner’s creditor instead – the creditor can reach a

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partner’s economic rights in the partnership (right to profits & right to value of contribution).

PARTNERSHIP CREDITORS’ RIGHTSScenario: A creditor has a claim against the partnership itself. Issue: Can the creditor reach the specific partnership property? Can the creditor reach the partners’ rights to use/possess specific partnership property? Can the creditor reach the partners’ economic interest in the partnership’s profits?

PARTNERSHIP PROPERTY A partnership can assign its assets as collateral for debt §25(2)(B) The assets of the partnership are subject to attachment, §25(2)(C), RUPA §307

INDIVIDUAL PARTNER’S PROPERTY (i.e. profits & value of contributions)Under UPA

majority –§15: Partners are personally liable for the obligations of the partnership so partnership creditors can levy on a partner’s individual property

minority – follows the RUPA approach below

Under RUPA The partnership creditor must exhaust the partnership’s assets before levying on a partner’s individual property where the partner is personally liable for the partnership obligations under §306 (i.e. as long as the obligation was not incurred before the partner’s admission). §307(d).

DISSOCIATION OF A PARTNER, DISSOLUTION & TERMINATION OF A PARTNERSHIP

INTRO TO TERMINOLGY Dissociation – a partner leaves (RUPA) Dissolution

o Under UPA, a partner leaves; either the winding-up process begins or the business continues

o Under RUPA, the beginning of the winding up process Continuation – though there has been a ‘dissolution’ under UPA (a partner leaves), or a

‘dissociation’ under RUPA, the business will continue without the member who caused the dissociation/dissolution

Winding-Up Process – there has been a dissolution (which triggers this process) and necessary steps must be taken to end the business

Liquidation – this is where all of the assets are sold, and the financial affairs settled Termination – this is a ‘catch-all’ term that refers to any method of disposing of the

business (including liquidation, sale, etc.)

DISSOCIATION (A Partner Leaves) Under the UPA, the term ‘dissolution’ applies to both the end of a partnership and where there is a change in the composition of the partnership. In an effort to resolve the resulting confusion, RUPA uses 2 separate terms: ‘dissolution’ and ‘dissociation’.

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GROUNDS UNDER UPA §31 No fault grounds -

The expiration of a term (or undertaking) where the partners have agreed that the partnership will carry on for a definite term or for a particular undertaking.

If the partners have not agreed to continue the partnership until the end of a term or undertaking, each partner has the right to leave at will. See Prentiss v. Sheffel (p. 798)

Express will of all the partners (mutual agreement). Expulsion of a partner pursuant to the partnership agreement.

Wrongful grounds - If it violates the partnership agreement (e.g., a premature departure where the

partners have agreed that the partnership will carry on for a definite term) and if there are no other applicable grounds under this section

Neutral causes - Involuntary withdrawal of a partner such as death or bankruptcy Where carrying on the business would be unlawful. Court order for dissolution, § 32 – partner declared crazy, incapabale, of

performing, guilty of prejudicial conduct affecting the business, p/s can only be carried on at a loss, cirumstances that render a dissolution equittable.

GROUNDS UNDER RUPA §601 notice of a partner’s at-will withdrawal any event specified in the partnership agreement as causing dissociation expulsion of a partner as provided by the partnership agreement expulsion by unanimous vote (under certain circumstances §601(4)) expulsion by court order where there has been serious misconduct involuntary withdrawal due to insolvency, death, disability

CONSEQUENCES OF A MEMBER LEAVING There are 2 possible consequences: (1) winding up of the business (discussed below); and (2) continuation of the business.

(1) Winding-Up Process(discussed below)

What Determines That the Winding-Up Process is the Consequence? Under UPA, when a partner is authorized to leave the partnership (either under the partnership agreement, or under the default rules above), the partnership automatically enters the winding-up process, unless otherwise agreed in a continuation clause. Under RUPA, if one of the events specified in §801 has occurred, only then does the partnership enter the winding up process. (see below)

(2) Continuation (CM p. 85)

What Determines That Continuation is the Consequence? Under UPA, when a partner wrongfully leaves the partnership, the remaining partners have the right to continue the business UPA §38(2)(b) as a new partnership. Alternatively, when a partner is authorized to leave the partnership (either under the partnership agreement, or under the

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default rules above), and the partnership agreement contains a continuation clause, the partnership continues. Under RUPA, when a partner leaves the partnership under any of the circumstances above, it is presumed that the partnership will continue without that partner.

Requirement of Continuation Clause –

Under UPA, in order for the partnership to continue after an ‘authorized’ dissolution, the partnership agreement must provide as such. If there is no continuation clause in the partnership agreement, termination automatically follows from dissolution. UPA §38(1). If the partnership anticipates dissolution from the beginning, and provides for continuing the business in the partnership agreement, it can evaluate and distribute the departing partner’s interest in a way that is convenient to the business and fair to the partner.

Under RUPA, there is no requirement that the partnership agreement contains a continuation clause; continuation of the partnership is automatic where a partner dissociates (unless one of the events listed in §801 has occurred).

Incoming vs. Withdrawing Partner – When someone leaves or joins the partnership, there must be some exchange of money for the value of the interest in the partnership. However, there are no shares of stock that you can buy and sell. Each partner is designated a percentage of interest both upon entering the partnership and upon leaving. There are various business valuation methods to determine the value of the partnership in order to figure out the dollar value of the partner’s interest. The method should be chosen in advance and specified in the partnership agreement.

Methods of Valuing the Partnership – CMM p. 124, 125 liquidation (will result in the lowest valuation) book value (equity = assets-liabilities) FMV appraised value (relies on an independent opinion) mutual agreement capitalized earnings (doesn’t look at assets and liabilities

like the book value method: looks at earning power/profit-making potential of the business)

Issue: Intangible assets - these contribute to the worth of the business but don’t show up on the balance sheet

Default Provisions RUPA §701: If a partner dissociates, the partnership will buy out the leaving party’s interest at the ‘buyout price’ which can be determined by the partners. If they don’t agree, (b) suggests FMV as a price but doesn’t really specify. The issue is ripe for dispute.

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UPA §§38(1), 42: Buyout is allowed where a partner retires or dies and the value is measured as at the date of dissolution.

Partnership Creditor’s Claims

Under UPAThere is continuity of the partnership’s obligations to creditors where there is some continuity of partners in the new firm. UPA §§17, 41 (reflective of the aggregate theory)

Under RUPARelationships between a partner and its creditors are not affected by the dissociation of a partner or by the addition of a new partner, unless otherwise agreed. RUPA §703 (reflective of the entity theory).

What Happens to the Partner Who Enters/Leaves Authority – A leaving partner may still have lingering apparent authority to bind the partnership, where the 3rd party has no knowledge of the dissociation. (UPA §35, RUPA §702(a)) A partnership can protect itself from being bound by the ex-partner by putting 3rd parties on notice. This is practically impossible under UPA § 35, but RUPA §704 provides that constructive notice (by filing a statement of dissolution with the state) can suffice to relieve the partnership from liability. This is a big improvement over UPA because it’s more formal/official.

Actual v. Apparent – CMM p. 126, 127

Fiduciary Duties

Liability – A leaving partner can negotiate with a 3rd party creditor of the partnership to get a release from liability. (UPA §36, RUPA §703) Otherwise the partner remains subject to personal liability. An incoming partner is not personally liable for obligations that the partnership incurred prior to becoming a partner (UPA §17).

WINDING-UP PROCESS/DISSOLUTION

CAUSES OF DISSOLUTION

Under UPA §31 & 32 expiration of a term (specified in partnership agreement) express will of partner express will of all partners expulsion of a partner (pursuant to partnership agreement) express will, even when in violation of partnership agreement illegality of continuation death bankruptcy by court order

RUPA §801

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express will of a partner (other than dissociation) (???) death of a partner + express will of other partners express will of all the partners expiration of a term event agreed upon illegality of continuation court order (under certain circumstances)

EFFECT OF DISSOLUTION – THE WINDING-UP PROCESS The partnership continues after dissolution. (RUPA §802) Dissolution merely triggers the winding-up process. The partnership is not terminated until the winding up process is completed.

AuthorityUpon dissolution, transactional authority (other than the authority partners need to carry out the winding up process) ends. (statement of dissociation – RUPA §804) Any partner has the right to participate in the winding up process. (RUPA §803) Any partner may bind the partnership for any act that is appropriate for winding up the business or if the 3rd party has not been put on notice that the partnership is winding up. (RUPA §804)

Fiduciary Duties

Liability RUPA §306

Settling the Partnerships Accounts – Liquidation UPA §40 Order of Priority:

pay all the creditors (other than partners) pay the partnership back for loans to a partner (outside creditors have

priority over partner creditors) pay the partners back their capital contributions (If partners contributed

services, property, etc. they should put a price tag on it in the partnership agreement to protect the person at this stage from being cheated of the value of his contribution.)

pay all the partners an equal share of the partnership profits (regardless of original contributions unless otherwise provided) – or divide up the losses

Note: The federal bankruptcy laws apply to partners (re: creditors rights issues) and override the UPA.

RUPA §807 pay inside (partners) and outside creditors equally - this elevates the

status of the partners payment to partners of their liquidating distribution (includes

contributions and profits).

TERMINATION OF THE PARTNERSHIP

Possible scenarios – CMM p. 131

NOTICE TO 3RD PARTIES

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§805 Statement of Dissolution: Under RUPA there is a formal statutory mechanism for putting people on constructive notice that the business is ending. The statement of dissolution (permissive, not mandatory) provides this. It is in the partnership’s best interests to file one.

III. LIMITED LIABILITY PARTHERNSHIPS (LLPs)

INTRODUCTION: CMM p. 144A creation of the law, this makes limited liability available for all partners of a general partnership. A proper filing must be made with the state. Under UPA §15, partners are subject to personal liability in the event that the partnership can not meet its obligations. If a partnership invokes the limited liability partnership provisions of its governing statute it can eliminate (partially or completely) the automatic personal liability for partnership obligations.

NATUREGenerally, LLPs are no different from general partnerships; most of the characteristics of a general partnership (such as fiduciary duties, etc.) also apply to LLPs. The major difference is in terms of the personal liability of the partners. Under RUPA §306(c) an obligation of the partnership is solely an obligation of the partnership (reflecting the entity theory) and does not subject the partners to personal liability. §306(c)

CREATIONProtection from personal liability requires that the partnership to meet certain requirements (in order to put 3rd parties on notice of the limited liability):

1. The partnership must file a statement of qualification with the state. RUPA §1001. There are certain requirements for what must be included in the statement of qualification.

2. The partnership must notify all 3rd parties with whom it had dealt in the past of the new LLP status. RUPA §1002

a. Name issue (must write “LLP” after name to ensure protected status).3. The partnership must then file an annual report with the state in order to retain its LLP

status. RUPA $1001

Issue – defective LLP If there is some defect in the process of becoming an LLP, there is no protection from liability.

Issue – effective dateThe partnership can not erase old obligations by filing the statement of qualification. Therefore, 2 classes of creditors are created: debts and obligations incurred pre-registration are subject to full partnership liability and do not enjoy the new LLP status. (see §306).

FILING There are certain requirements for what must be included in the statement of qualification. §1001

NOTIFICATION TO 3RD PERSONS OF NEW STATUS There is an obligation to notify all 3rd persons with whom the partnership had dealt with in the past of the new LLP status (similar to agency law and partnership law) in order to maintain the protection. RUPA §1002 – the letterhead, etc. must contain the initials

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‘LLP.’ You are not required to explain the full legal implications, but you have to disclose the status.

ANNUAL FILING REQUIREMENTUnder RUPA §1003, an annual report must be filed with the state so that they can monitor. Failure to file the report – does this affect liability protection? No, doesn’t automatically fail your status as LLP, that must be done by Sec of State. Look instead to state statutes. See comments to §1003, though they are not binding on a judge.

APPLICATION TO PROFESSIONAL FIRMSThere are other special requirements that apply to professional firms, established by licensing boards/regulatory bodies, which will govern the LLP, e.g., duties to clients, etc. This may give courts an opportunity to ignore the statutory provisions that offer liability protection, and find liability regardless of LLP status. Some statutes expressly provide for this.

FOREIGN LLC RUPA §1102Incorporated in one state but does business in another.

ADVANTAGES AND DISADVANTAGES

ADVANTAGES OF LLP STATUS (CM p. 94) You maintain the tax advantages of a partnership Partners are better protected from liability It’s easy to covert form a general partnership to an LLP (simply a matter of filing

forms, registering) Major redrafting/restructuring of your partnership agreement is not necessary The exiting general partnership norm – apart from the liability question – still

applies. i.e. maintains existing general partnership norm. The business remains governed by partnership law (stability, consistency, predictability).

Incorporates existing body of general partnership law/decisions

SPECIAL PROBLEMS WITH LLP’S (CM p. 93) There are requirements to establish an LLP, and to maintain it; e.g., filing an

annual report. A violation of these requirements (if they are considered substantive) could deprive the partner’s of the LLP protection.

All partnership rules apply: in the absence of a partnership agreement governs the relationship between the partners, the default provisions will apply.

Partner CYA behavior: Given the fact that there are distinctions being made w/ respect to the partners’ liability, partners may be interested in rearranging the relationship between the partners, e.g., demand more compensation for being exposed to higher risk.

Professional Firms: Is there a possibility that LLP protection doesn’t apply to professional firms because of the duties/rules imposed by state regulatory & licensing bodies?

SCOPE OF LIABILITY PROTECTION

FULL SHIELD PROTECTION

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There is no vicarious liability for either tort or contract obligations. See, e.g., RUPA §306(c) (providing protection from liability for both the partnership’s tort and contract obligations).

PARTIAL-SHIELD PROTECTION CMM p. 140Partners remain (personally) vicariously liable for contract debts, but are protected from vicarious liability for the torts of other partners (negligence, malpractice, etc.). See, e.g., CM p. 96, Delaware Statute.

Issue: Is a partner’s contribution to the partnership insulated by partial shield protection?

PERSONAL MISCONDUCT There is no difference between general partnerships and LPPs: partners who commit torts can still be held directly liable for their actions. LLP protection only extends to those who are innocent, but who (under the law of general partnerships) would have been personally liable for the misconduct of their fellow partners.

LIABILITY OF THE PARTNERSHIPThere is no difference between general partnerships and LPPs: the partnership itself remains vicariously liable for the torts of its partners and for the contract obligations undertaken on its behalf by its partners. LLP protection only applies to personal liability of the partners, not vicarious liability of the entity.

SUPERVISORY RESPONSIBILITYEven though under both full-shield and partial-shield statutes, the partner is protected from liability for the tortuous misconduct of other partners, many statutes contain language that suggests partners are liable for the negligence of those whom they supervise (i.e., an action for negligent supervision is implied). For a supervisory partner to be found liable under this exception, he/she probably must have some knowledge of what’s going on, or share some benefit, or have direct supervision over the negligent partner. The exact scope of liability for negligent supervision is yet undefined, but could have a serious effect on the supervisory partners’ relationships with the supervised partners.

INNOCENT PARTNER (no knowledge, no involvement)Helping colleagues serve clients may be dangerous in an LLP because if you become involved, you might take on potential liability for the work.

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IV. LIMITED PARTNERSHIPS

NATURE & ORGANIZATION

OVERVIEWThere are managing partners, and passive partners (investors). The managing partner may be an entity, such as a corporation or an LLC.

ADVANTAGES This form is useful where the business needs investors, but doesn’t want to bring

outsiders into the management. This form is more attractive for investors than a general partnership, because they

will not be subject to personal liability. This form retains the tax benefits of the partnership form (partners are taxed once

individually) This form draws a clear distinction between partners (in theory) so that partner’s

know what their roles are. Legal precedent is widely available Exit privileges are restricted for limited partners (stability)

STATUTES ULPA RULPA ‘76 RULPA ‘85 RE-RULPA’01

The UPA also functions as the gap-filler. If the RULPA doesn’t provide for a particular situation, the UPA provisions will govern.

Issue: Possible Application of Securities LawsOne of the key issues is whether the 1933 and 1934 Acts (issuance and trading of securities) apply to limited partnerships requiring registration, etc. This hinges on whether there is a security. An investment contract falls within the definition of security if it satisfies the elements of the Howey test (see CM p. 68). There is also a test, (the Williamson test) to determine whether securities laws apply to limited partnerships.

CREATIONUnlike a general partnership, the LP requires certain formalities. It is created by filing a “certificate of limited partnership” with the state specifying two classes of partners: the general partner (who has management authority and is subject to personal liability) and the limited partner (who only invests and receives profits from the partnership in an ownership capacity – like a shareholder - and who is not subject to personal liability). (See RULPA §201 –’76 version w/ the ’85 amendments). The certificate must indicate the name of the LP, and some other basic requirements.

SUCCESSFUL CREATIONIf the certificate of limited partnership substantially complies with the ULPA, filing the certificate brings the LP into existence either immediately, or on a later date specified in the certificate. The LP is a legal entity, distinct from its co-owners (not an aggregate of partners).

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DEFECTIVE CREATION If there is substantial non-compliance with the creation requirements, the LP will legally remain a general partnership. This presents a problem for the limited partners who believe that they are protected from personal liability, and rely on the general partners to manage the details. If the limited partner believes in good faith that he/she is a limited partner rather than a general partner, and takes action, - either files a the certificate of limited partnership or files a certificate of withdrawal - then that limited partner would not be subject to personally liability as though he/she were a general partner. §304.

RELATIONSHIP b/t LIMITED PARTNER & GENERAL PARTNER

GOVERNING DOCUMENT Under RULPA, the document that governs is the partnership agreement. Every issue is subject to negotiation and customization. The partnership agreement details the rights, responsibilities, and relationships of the partners.

THE LIMITED PARTNER vs. THE GENERAL PARTNER

PERSONAL LIABILITYGeneral partners are subject to full personal liability for tort and contract obligations of the partnership. Limited partners have more limited liability.

TRADITIONAL RULE A limited partner is not liable to 3rd parties for partnership transactions or debts unless he/she takes part in the control of the business. ULPA §7.

Degrees of Participation/Control

Mere Consultant, Advisor - This does not amount to control, therefore does not subject the limited partner to liability for partnership obligations.

Personal, Active Participation - This does amount to control, therefore does subject the limited partner to full liability for partnership obligations.

Participation as an Employee – Grey area.

No Participation, but Full Financial Control - Grey area.

Indirect Participation as an Officer in a Corporation - I.e., one of the general partners is a corporation, and the limited partner is an officer of that corporation. Grey area.

Creditor Reliance - Split of Authority: Whether 3rd party reliance is required in order to hold the limited partner liable depends on:

whether the purpose of the rule is to punish the limited partner

o in which case only the extent of the limited partner’s participation determines liability

o no 3rd party reliance is required

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o and the 3rd party creditor gets the benefit of a windfall

whether the purpose of the rule is to protect creditors o in which case the creditor’s reliance is required

Courts were split on what the purpose of the rule was.

CURRENT RULE - RULPA §303 (’76 w/ ’85 amendments) This has been adopted in all jurisdictions, and provides generally that a limited partner is not liable to 3rd parties for the obligations of the partnership unless:

1. he/she participates in the control of the business and 2. based on his/her conduct, the 3rd party entered the transaction in reliance or [partnership by estoppel] he/she permits his/her name to be used in the name

of the limited partnership and a 3rd party (who has no actual knowledge that the limited partner is a limited partner) enters into a transaction with the partnership

This rule specifies a number of “safe-harbor” activities that do not constitute “control” for the purposes of finding liability under the 2nd exception.

Reliance IssueUnder this rule, whether or not 3rd party reliance is required to hold the limited partner liable is based on the extent of the partner’s participation: The more fully the limited partner participates, the less likely it is that 3rd party reliance is required. (CM p. 104-5).

NEW RULE - RE-RULPA § 303 (2001) This provides full, status-based liability for limited partners for the partnership’s tort and contract obligations, regardless of whether the limited partner participates in the management and control of the partnership.

MANAGEMENTThe general partner(s) manage the partnership and have the power to bind the partnership. General partners owe fiduciary duties of loyalty and care to the partnership in carrying out their management function. See §105 (requiring that the general partnership keep certain books and records as a responsibility to the limited partners).

Issue: Extent of General Partners’ Fiduciary Duties There is an overriding duty of good faith and fair dealing. General partners also owe a duty of disclosure, but how far does it go? Do general partners have to voluntarily disclose or disclose only on demand? What responsibilities to limited partners have to inquire when there are clear red flags? Appletree Square I Limited Partnership v. Investmark, Inc. p. 813

DEFAULT RULE Limited partners are passive – they merely invest in the partnership. If the limited partner doesn’t agree with management decisions being made by a general partner, he/she has forfeited the right to participate/control, and the BJR would give deference to the general partner.

OPTION TO ENLARGE THE MANAGEMENT ROLEHowever it is not unlawful for the limited partner to participate as long as there is agreement that precludes the application of the default rule. Traditionally, such participation exposed the limited partner to liability (see above).

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DERIVATIVE ACTION In extreme circumstances, limited partners can bring derivative suits to assert partnership claims against the general partners. RULPA §§1001-1004.

PROFIT/LOSS SHARINGThis deviates substantially from general partnership law which provides (a default rule) that partners share profits equally, regardless of the amount they contribute.

AMOUNT DISTRIBUTED Subject to the partnership agreement (which can provide that managing partners be compensated for labor), profits and losses are allocated and distributions are shared in proportion to the value of partners’ contributions.

LIMITS ON DISTRIBUTIONS §607 If issuing distributions would render the partnership insolvent, the distributions can not me made.If your liabilities exceed your assets, you’re insolvent (at least on paper).

TRANSFER OF PARTNERSHIP INTERESTS

TRANSFER OF MANAGEMENT AUTHORITYUnless otherwise agreed, no partner (general or limited) may transfer his/her management authority to another person without the consent of all the partners. (I.e., unanimous approval is required.)

TRANSFER OF FINANCIAL INTEREST IN THE PARTNERSHIP(i.e. the right to receive dividends) Unless otherwise agreed, this is freely assignable/transferable.

DISSOCIATION/DISSOLUTIONGeneral partners’ powers to dissociate from the partnership are discussed above. Limited partners do not have the same power to dissociate and are subject to certain limitations. Whether a limited partner may dissociate depends on whether the partnership agreement provides as such (or provides a term for the partnership). The default rule is that a limited partner may only withdraw by giving at least 6 months notice to the general partners. The default rule for when the partnership is for a particular term is that the partner may not withdraw until the expiration of that term (unless otherwise agreed0.

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V. THE LIMITED LIABILITY COMPANYULLCA [Corporations & Partnerships, “the best of both worlds”], Agency Law

NATURE & CREATION

NATURE The LLC is a separate legal entity, §201. The owner’s are called ‘members.’ It can consist of merely one person, §202.

MAJOR FEATURES Taxation is flow-through: members are taxed once. Members are protected from personal liability The LLC statute bears a close resemblance to RUPA Major customizing is possible – the statute governs mostly as a default rule.

CREATION‘Articles of organization’ must be filed with the state in order to create an LLC. They must identify the name of the firm (which must contain the initials LLC), the address of its principal place of business, the name of the registered agent for service of process purposes, and that the firm is an LLC. Most states require the LLC to file annual reports.

FINANCING THE LLC (same as partnerships under RUPA)An LLC is funded by contributions from members which may include tangible or intangible property, or any other benefit to the company, including contracts for services performed, see ULLCA §401. Other financing is obtained through loans from partners &/or 3rd party creditors.

CONVERTING ANOTHER ENTITY INTO AN LLCGenerally, the LLC assumes the rights and obligations of the converted entity as its “successor in interest.” Like, LLPs under RUPA, 2 sets of creditors are created. For pre-LLC transactions (entered into on behalf of the organizers) the members will be subject to personal liability, unless the LLC ratifies the transactions. For post-filing transactions, the members are shielded from personal liability.

Issue: Member’s Personal Guarantees in exchange for LLC Credit Regardless of whether you set up an LLC (or incorporate), creditors may require a personal guarantee from the members as a condition of extending credit to the LLC, which undermines the protections these forms have against personal liability.

Issue: Member Misconduct Are members personally (individually) liable for their own misconduct? Compare Curole with Estate of Countryman (handout): Estate of Countrymen held that a member who participates in the tortuous misconduct of an LLC is not protected from personal liability (i.e. that members are liable for their own torts). In contrast, Curole held that in order for a member to be held personally liable for his own misconduct, such misconduct must occur outside the scope of the member’s employment (i.e., that members are not liable for their own torts if the torts are committed in the member’s capacity as a member of the business).

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Notice to 3 rd Parties When converting another entity to an LLC, substantial compliance with the formalities that are required by the statute (e.g. filing requirements, etc.) puts 3rd parties on constructive notice of the limited personal liability. However, where there has been non-compliance (e.g. omitting the initials “LLC” from the name of the business, etc.) constructive notice may be defective. The undisclosed principal doctrine of agency law would then apply to determine whether the agent can be held personally liable for the obligations of the LLC to a 3rd party. Water, Waste & Land, Inc. v. Lanham p. 836.

DEFECTIVE ORGANIZATION Where there is a failure to form an LLC pursuant to the statutory requirements, the court will generally find that a partnership exists, and hold the “members” (who are actually merely partners) personally liable. See Compton v. Kirby (handout), Harvey v. Covington (handout).

THE OPERATING AGREEMENT The operating agreement is especially important because it governs out the relationship between the members. It is elective (see ULLCA §103), not required, but failure to draft one results in the application of the LLC statutes’ default provisions.

GENERAL HIERARCHYThe rules that govern LLCs are generally ranked in the following hierarchy:

state constitution, state statute, articles of organization, operating agreement internal policies

OPERATING AGREEMENT vs. STATE LLC STATUTES Where the state statute allows customizing, the operating agreement controls, even if it departs from the default state law provisions. Elf Inc. v. Jaffari p. 842The parties to an LLC agreement may contract to avoid the applicability of the default statutory provisions that would govern in the absence of the agreement. Some states, e.g., DE, have express policies behind their LLC laws to give maximum effect to freedom of contract.

OPERATING AGREEMENT vs. STATE CONSTITUTIONSAn LLC can not be created to undermine anything in a state constitution.

OPERATING AGREEMENT vs. ARTICLES OF ORGANIZATIONWhere these are in conflict, the operating agreement will control internal matters but the articles will control matters involving 3rd parties who rely on the articles to their detriment.

OPERATIONLike corporations, §112 provides for broad powers and allows the LLC to “do all things” that an individual can do in order to carry on its business or affairs.

LIABILITY

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LIABILITY OF THE ENTITY TO 3RD PARTIESTort Liability Contract Liability

PERSONAL LIABILITY OF THE MEMBERS Generally, members of an LLC are not personally liable for the obligations of the LLC.

Exceptions:Under some (narrow) circumstances, a court may find that members are subject to personal liability.

Professional Firms - The same issues that apply to LLPs, apply to LLCs; duties imposed by state licensing bodies may deprive professionals of limited liability

Piercing the LLC Veil – (or reverse piercing)The LLC liability protection is not absolute, and courts will apply this doctrine where it is necessary to prevent injustice.

Factors: the entity was the alter ego or mere instrumentality of an

owner the owner used the entity not merely to protect

him/herself from liability, but to promote some type of fraud or injustice

the entity was undercapitalized (lacked enough assets to meet reasonably foreseeable obligations)

the owner o disregarded the entity’s economic separateness

(commingling of assets)o misappropriated entity fundso disregarded the entity’s governance formalities

Personal Guarantee – (see above)

LLC = the undisclosed principalIf a member (agent) conducts a transaction on behalf of the LLC, but does not disclose the identity of the LLC (as principal) the undisclosed principal doctrine of agency law applies to subject the agent/member to personal liability. (see notice to 3rd parties above)

MEMBERS’ RIGHTS AND DUTIES Relationships between members and the LLC are generally governed by the operating agreement, but in the absence of an agreement the default rules apply.

(a) MANAGEMENT AUTHORITYThe ULLCA distinguishes between a manager-managed LLC and a member-managed LLC.

Manager-Managed

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If the LLC is manager-managed, members to not have apparent authority to bind the LLC. ULLCA §301(b)(1): in a manager-managed LLC, “a member is not an agent of the company for the purpose of its business” solely because he/she is a member. [Note: a major difference b/t an LLC and a partnership – partners do have apparent authority to bind the business simply because of their status as partners.]

Member-ManagedIf the LLC is member-managed, the authority of the members is similar to that of partners in a partnership. Compare ULLCA §301(a) with UPA §9 and RUPA §301.

When is an LLC manager-managed versus member-managed? Unless the articles of organization specify that LLC is manager-managed, it will be considered member-managed. ULLCA §203 – Comment.

Scope of Authority Members (member-managed) and managers (manager-managed) have actual authority and apparent authority to bind the company to 3rd parties (unless the operating agreement restricts actual authority). Apparent authority extends to all acts for carrying on in the ordinary course of the company’s business and business of the kind carried on by the company. Beyond this, actual authority created before, or ratified after, the act must exist in order for the act to bind the company.

Statutory Provisions Conferring AuthorityWhere a statutory provision confers authority for specific acts, and conflicts with the LLC’s operating agreement, the statutory provision will govern/prevail. (I.e., customizing is only allowed where it does not conflict with/undermine other statutory provisions.)

(b) FIDUCIARY DUTIES OF MEMBERSGeneral partners owe broad fiduciary duties, while limited partners owe no duties solely as a result of their limited partner status.

The general rule for when someone owes fiduciary duties is where the person has authority to act on behalf of the business, where the person has been given management authority, or where the person otherwise occupies a position of trust.

In the context of the LLC, members fiduciary duties depend on whether it is a member-managed or manager-managed LLC. Fiduciary duties of loyalty and care are imposed on members of member-managed LLC’s. They are not imposed on members of manager-managed LLC’s solely based on the member’s member status. ULLCA §409.

Remedy for Breach of Fiduciary DutyIf a member has a cause of action (e.g., for personal injury) against the LLC, he/she is bringing it in his/her own capacity. Any recovery would belong to the member bringing the direct suit. The plaintiff/member must bear his own expenses and is not required to follow any procedural steps to pursue the litigation besides what is usually required.

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Because an LLC is an entity separate and distinct from its members, most breaches of the fiduciary duty will directly harm the LLC (rather than its members). If the person responsible for the harm to the LLC is the same person who normally manages the LLC (i.e. acts on behalf of the LLC), the other owners can bring a derivative suit on behalf of the LLC (over the objections of management). All proceeds from a derivative suit belong to the entity (not the owners who bring the suit). Reasonable legal expenses would be paid by the defendant (manager) if the derivative suit was successful. A breach of the operating agreement, on its own, does not necessarily create grounds for a derivative claim.

Procedural Requirements for a Derivative Action: ULLCA, §1101-04 - In order to bring a derivative action on behalf of the LLC

The plaintiff must be an existing member The plaintiff must have been a member at time of wrong (to

prevent someone from buying into a lawsuit) Either the managers who normally have authority to act on

behalf of the LLC have refused to act, or a demand that they act would be futile (i.e. the BJR applies – deference is given to management)

the pleading must conform to ULLCA §1103

MEMBERS’ PROPERTY RIGHTS IN THE LLC (handout) The ULLCA approach, which is identical to RUPA, is contained in Article 5.

MEMBERS’ PROPERTY RIGHTS IN THE LLC

Distributional Interest§501, 502: the members are not co-owners, but they have a distributional interest that may be transferred subject to §§502, 503.

Interest in Member Status Members can not transfer their ownership of your member status. In order to do so, unanimous approval is required (unless otherwise agreed in the operating agreement).

LLC CREDITORS RIGHTS Creditor’s who have a claim against the LLC can not hold the members personally liable for the claim.

INDIVIDUAL MEMBER’S CREDITORS’ RIGHTS

Member’s Voluntary Assignment of Distributional Interest§502: A transferee/creditor only has the right to receive the distributions that the transferor/member would have been entitled to, not the right to act as a member, (unless otherwise agreed) The LLC doesn’t owe the same duties to the transferee that it owes to the member/transferor (unless the LLC was abusive). The transferee/assignee is locked in and can only wait for distributions, because

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he/she is not entitled to participate in management, have access to information, etc.

§ 503(b): It is possible for a transferee to become a member, but it depends on the operating agreement which would probably contain a mandatory contribution provision for membership in the LLC.

Member’s Involuntary Transfer of Interests to a Judgment Creditor§504: The judgment creditor is not allowed to upset the LLC, but can file a separate action in a court, for a charging order to charge (charging order = lock step with RUPA) the distributional interest of the member, to the extent that distributions are made. This puts the judgment creditor in the same position as the voluntary transferee/assignee. No duties are owed by the LLC to the judgment creditor.

DISSOLUTIONArticles 6, 7, and 8 of ULLCA provide for dissociation, continuation, and winding-up/termination of the business. They are almost identical to the RUPA approach discussed above. They are default provisions, and can be displaced by provision in the operating agreement.

DISSOCIATIONThere are certain causes of dissociation, and certain grounds for dissociation. When a member leaves, the LLC continues. The LLC must sell or buyout the dissociated member’s distributional interest. Article 6, Article 7.

DISSOLUTION“The entity is not terminated upon dissolution, but continues until all business issues are resolved.” There are certain grounds for dissolution. Dissolution triggers a 3 part process: dissolution (all new business ends), winding-up (all members’ actions must be towards winding up the uncompleted transactions of the LLC), and termination (contact business connections and file something with the state for constructive notice). Uncompleted transactions of the LLC at the time of dissolution are assets of the LLC and subject to distribution among the members. Article 8.

VI. IN THE FUTURE

THE MODEL ENTITY TRANSACTIONS ACT (META)

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