Corporations Law Outline – Gabaldon – Fall 2010

I. Professional Responsibility Issues in Corporation Law

1. Conflicts of Interest o ABA Model Rule 1.7 (Handout) (When representing 2/concurrent clients)

1) A Lawyer cannot represent a client if conflict of interest exists, and one does exist if: Representing one client directly adverse to another Risk that representing one will be materially limited by responsibilities to another

2) Exception The Lawyer reasonably believes he will be able to provide competent/diligent representation It is not prohibited by law Representing one does not involve assertion of one client against another Each gives written informed consent

Generally Not an issue, and can concurrently represent

2. Business Transactions o Are presumptively fraudulent with cliento Model Rule of Professional Conduct 1.8

A Lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security, or other pecuniary interest adverse to the client unless:

1) The transaction and terms on which lawyer acquires interest are fair and reasonable and fully disclosed, in writing to the client, in way which can be understood

2) The client is given a reasonable opportunity to seek the advice of the independent counsel in the transaction (Lawyer must advise client to seek independent counsel)

3) The client consents to it in writing 3. Note:

o If you are barred in 1 state, you may give advice on the law of another state Where you are located by “seat of your pants” doesn’t limit you, only your competence does

II. Basic Principles, Policies, and Theories of Corporation Law

1. Formalities and Filing Requirement o Certain business organization types require a filing with state to “create”o Filings can get very expensive

Revenue Stream for the State 2. Factors Evaluated On

o Control of Businesso Filing Requiremento Limited Liability for shareholders for tort, contractual, debt obligations o Federal Tax Implications

3. Limited Liability Concept o Greatly dependent on the corporate structure selectedo “Limit” is deceiving

liability is limited, but not lost…merely shifted to 3rd parties ,entities, etc…o Original Intentions:

Limited Liability accompanied Passivity More Control of management Less Limited Liability The more passive control, the more liability was limited Policy:

o Encourages Investmento Limits Risk Averse Investors risk they are takingo Creates Revenue Stream for state with filing fees to gain LL

o Modernly: There has been a shift away from LL being based on control of business Now, if you “file” appropriate paper work, you gain limited liability

1

o Proponents/Opponents of Limited Liability Proponents

Creates agglomeration of Capitalo Stimulates by investing in 1 large entity

Diversificationo By limiting liability, allows you to invest in companies which may be riskiero Don’t need to worry about the risks of the company, monitoring what they do day to dayo Can invest in more risky companies than

Necessary to permit active tradingo People with different amounts of personal wealth will value certain investments less, if there is

more to lose, through liability by investing in ito By limiting liability, allows those with much and little $ to value investments the same,

permitting more active trading Opponents

Creates Aglomeration of Capitalo Too big to fail type companies

Moral Hazardo Allows risk taking, without risk on the risk-takero Only upside potentialo Downside risk is passed along to third parties (Gulf Coast, Workers, etc…)

May not be entirely true Still have risk of losing $ in investment

4. Theories of Corporation Law: o Traditionalist:

Business is a fictional person Board brain Shareholders Stomach Officers Hands and Fingers

o Contractarian: Established in the 1980s through the Law and Economics Movement “Nexus of Contracts”

The corporation is not an “entity,” but instead an assembly of contrcts between shareholders, employees, directors, business, etc…

All are acting within their own best interest, with a common goal The Rules, then, attempt to apply the most efficient outcome they would have chosen attempt to

substitute their bargainso Progressives:

Established in 1990s at GW Argued that with the prior 2 theories, there was not enough interests represented when rules were

designed Argued that there were many more social stakeholder, that Social Corporate Responsibility needed to be

representedo Team Production Theory:

Established in 200s Focused on the Board of Directors as the “Mediating Heirarchy”

o Mediating the team inputs Business is a team, made up of stockholders, employees, managers…which Board mediates Directors encourage investment by mediating all interests, and assets

III. Basic Business Forms

1. Sole Proprietorship o Control Single Individualo Filing No Filing

2

Created at start of business… As soon as you start making shoes in your garageo Limited Liability None for Sole Proprietor

Liable for torts of employees, contract, debt obligationso Two Methods

EG: A & B A as Proprietor, B as employee

A is liable, B is not A as Lender, B as Sole Proprietor

B is liable, A is noto Federal Tax Direct Tax to individual tax return

2. General Partnership o Defaulto Def: An association of 2 or more people to carry on a business as co-owners for profito Control General partners Controlo Filing None required…just two or more people entering businesso Limited Liability None for general partnerso Ending GP:

“Dissociation” UPA (1997) §601: Ends when partner gives express notice of withdrawalo Federal Tax

3. Corporation o Def: A type of juridical person; can do most things human beings can

Have constitutional protections: Freedom of speech, due process, etc… A Creation of the state by filing articles of incorporation

o Control Directorso Filing Article of incorporation must be filed

Can be very expensiveo Limited Liability Yes, for shareholders and participants o Federal Tax

2-Tier Structure (not for S-Corp (see infra)) Income Taxed in year earned by corporation Dividend payouts to shareholders is also taxed as income to shareholder

4. Limited Partnership o 2 Types of Partners

A partnership (2 or more people who carry on business as co-owners for profit) with an association of 2 different types of partners

Must Include 1 or more general partners 1 or more Limited Partners

o Traditionally Limited Partners could not participate in “control of business”

Back to the idea of Limited Liability being function of Passive Control Creature of statute, if not followed correctly, reverted to GP If Limited Partners participated in control of business, became General Partner

o Amended by ULPA (1976) §303:o Control General Partners…Limited Partners cannoto FilingYeso Limited Liability Yes for Limited Partner, No for General Partnerso Federal Tax

5. Limited Partnership with Corporate General Partner o Same as Limited Partnership, except that the general partner is a corporation

Therefore, the Corporation (GP) has limited liability The shareholders of the Corporation are usually the limited partners, effectuating control over the GP, while

maintaining limited liabilityo Contrary to idea of passivity with Limited Liability

3

o Control Directors of Corporation (GP/LP)o Filing 2 Filings

File for Limited Partnership File for Corporation

o Federal Tax 6. Limited Liability Company

o A “person” formed by the stateo History

First appeared in 1980s, in Wyoming After evaluated the factors that the IRS was judging how to tax businesses, several people figured out a way to

meet the factors of gaining conduit tax, while still having limited liability The IRS agreed, and the LLC was borne…quickly spread to all states

o Passivity With the LLC, you could manage the business, and gain limited liability This went away from the idea of Passivity to create investment rewarding it with limited liability

o Control Two Types, depending on agreement Member Managed

Can vote to decide business matters with majority Each member is an agent with respects to matters pertaining to business

Manager Managed Managers have the right to control if 1 manager, or if more, by majority Members are not agents in Manager Managed LLC, Mangers are

o FilingRequired, ULLCA §202-203o Limited Liability For memberso Federal TaxCheck the Box

7. Limited Liability Partnership o General Partnership, which all members have Limited Liabilityo ControlGeneral Partnerso Filing Required, GP’s get LLo Limited Liability Yes

8. Limited Liability Limited Partnership o All partners gain limited liability

A result of legislature seeing that LP, the GP’s could not get LL, but LLP could Limited Partnership simply files for Limited Liability

o Control General partnerso Filing 2 Filings

File for Limited Partnership File for LL for the general partners

o Limited Liability For GP and LP 9. Historical Alterations to Business Forms

o The above list is in chronological order From 1960s-1980s, much changed in attempt to gain Limited Liability Change also from attempt to get most beneficial tax form and limited liability

o Federal Tax Changes With the creation of the LLC, the IRS eventually gave in to change in corporate structures and taxing them As lawyers pushed to get the benefits of tax, while also getting Limited liability, IRS gave in Eventually granted “Check the Box Tax”

Allows unincorporated businesses to choose their own tax form Not for publically traded businesses

10. Modernly

Type Filing Control Limited Liability Federal TaxSole Proprietor No Individual No Direct TaxGeneral Partnership No General Partners No Conduit gave way

4

to “Check the Box”Corporation Yes Director Yes for shareholders

and participants2-Tier Tax

Limited Partnership Yes General Partners For Lmtd. Partners Conduit “Check the Box”

LP with C. G. P. Yes x 2 General Partner (Shareholders of corporation who is GP)

Yes for LP and corporations shareholders

Conduit and 2 tier “Check the Box”

LLC Yes Members/Managers Yes Conduit “Check the Box”

LLP Yes General Partners Yes Check the BoxLLLP Yes x 2 General Partners Yes for both GP and

LP“Check the Box”

IV. Agency Law in Business Transactions

The Law of Agency is implicated in all corporate law 1. Why?

o Creates liability for principal when agent acts on their behalf Tort, Contract, Tax

o Implicates Employer versus Independent Contractor Vicarious Liabilityo Corporations/Business Entities

Can only act through an agent, although they can be both principal and agent 2. Basics

o Agent : Acts on behalf of the principal, who has manifested assent for agent to act on his behalf, and agent has accepted to do so creating a fiduciary relationship

Agent is subject to the Principals controlo Principal : One for whom the agent acts, who is in control of agent, authorizing Agent to act on Principals behalfo Authority Created in Agent

Actual: Arises from express manifestation of Principal to the Agent, that he has power Agent is not liable for obligations he makes within scope of authority Principal is bound and liable

Apparent: Arises from manifestation from Principal to a 3rd Party, that another (Agent) is authorized to act on his behalf, as his agent

3rd Party’s Reasonable Belief: If 3rd party acts on this apparent authority, he must have a reasonable belief that agent is authorized

o If he knows or has reason to know Agent is not authorized, authority ends Both can be simultaneous Scope of Authority created in Agent:

Agent can act as designated (Actual), or implied, necessary and incidental to achieve the principals objectives the agent reasonably understood

o Inherent Authority - Arising from the type of agency Binds principal EG: Agent is manager of store

Manager has inherent things that go along with this type of positiono Incidental Authority- Authority to do things incidental to completing transaction that was

authorized Implied Authority - Based on conduct, implied manifestation may create:

o Implied Actual Authorityo Implied Apparent Authority

Remember: With apparent, 3rd party must have reasonable belief that agent has the authority

o So, Authority does not have to be express but can be implied to the agent or 3rd party

5

Authority is terminated the same way it was createdo C. Fiduciary Relationship

Agent is accountable for all profits arising from his transactions; cannot act adversely to or assist adverse party to principal

Breach of Duty if he acts for himself or someone other than principal Agent must act with reasonable care, meeting standard of care in locality

o D. Vicarious Liability A Principal is liable for his Servant/Employee’s torts Not those of Independent contractor Must Determine if Master/Servant (Employee) or Independent Contractor

Servant/Employee: Physical conduct is controlled by the mastero Always an Agent of the Principal

Master: Controls the servant, or has the right to control, by employing the servant’s service Independent Contractor: Person who contracts to do something, but who’s physical control is not

controlled by the othero Sometimes an Agent, but not always

If Principal can control, but not control physically Factors to Determine if EE or IC :

The extent of control the master may exercise over the details of the work The kind of occupation, reference to locality, and if it is done typically by employed at discretion of

employer, or a specialist without supervision Skill required to perform occupation Does the Workman or the employer supply the instrumentalities

o EG: IC brings tools to job, which has planned outcome, but register worker comes and uses employers clothes, area, register, etc…

Length of time employed Method of payment- by time or job? Is work part of regular business of employer? What the parties think But- Simply denominating the job as EE or IC will not create that

o Look to the factors and definition to determine EG: Is Professor Gabeldon a EE or IC?

School could control, even though they choose not to They give her the class, student, room, pay her salary Part of regular business of employer

o Employee Overall, it really does not take much control to be considered an Employee EG:

General Partners are Agents of Partnership and each othero UPA (1997) §301: “Partners are mutual agents of partnership for purposes of the partnership”

Limited Partners are not LLC- Depends on Member/Manager managed

o Look at filing to determine who is agento E. Liability

Tort Principal is liable for agent’s tort

o Intentionalo Negligento Authorizedo EE/Servant

Agent is always liable for his own tort 3rd party will not be liable to Principal for tort on Agent

o Makes no sense…no tort was committed on principal Contract

3 types of Principals only matter here, when dealing with Contract liability

6

o Disclosed Principal: When 3rd party knows who agent and principal areo Undisclosed : When 3rd party does not know who principal, or agent is acting on behalf of

someone 3rd party thinks A is doing it for himself Generally no apparent authority (3rd party doesn’t even know there is P)

o Partially Disclosed/ Unidentified: 3rd party knows Agent, and that there is a principal, but not who the principal is

Stock-broker When is Principal liable for K Agent enters in to?

o Disclosed P: P is liable (assuming there is authority)o Undisclosed P: P is liable (assuming there is authority)o Partially Disclosed P: P is liable (assuming there is authority)

When is Agent Liable for K he enters into on behalf of Principal?o Disclosed P: Agent is not liable

the Bloomingdales clerk is not liable to return your $ back Exception: if A personally guarantees then A may be liable, assuming contract law is

satisfied (consideration, O&A, SOF)o Undisclosed P: Agent is Liable

When Disney’s people go into countryside to buy, but people don’t tell buyer that they are buying for Disney, agent is liable

Makes Sense Fair that Agent liable in suit 3rd party thinks they’re making contract with Agent

o Partially Disclosed P: Agent is liable Exception: If A specifically disclaims, clarifying that he is not liable

o Overall, A will most likely be liable, unless P is Fully Disclosed When is 3rd Party liable to Principal for the contract he made with Agent?

o Disclosed P: 3rd party is liableo Partially Disclosed: 3rd party is liableo Undisclosed P:

3rd party will be liable, unless 1) Fraudulent Concealment by Agent:

o Agent specifically says he is not buying for Disney 2) Knowledge of Principal is Material to the K:

o If $, knowledge of who P is probably won’t be material, unless you say it is specifically

o If personal services K, more likely to be material Overall, 3rd party will be bound to Principal unless Fraud or Materiality Ratification

o When the agent does something, the Principal can ratify it EG: Officer of company purchases land. The Board can ratifiy this purchase

o Express: Formally ratifying Agent’s action (above example)o Implied: Accepting the benefits of the contract o Ratification can create additional authority

Actual or Apparent depending on what is said, implied to Agent or 3rd party

V. The Partnership

*Definition: UPA (1914) §6: 2 or more people carrying on as co-owners, a business for profit *

1. General: o We will deal with law that applies to General Partners

Also Applies to: General Partners within LLP General Partners in a Limited Partnership

7

o UPA (1914) §6/UPA (1997) §202 Both say to use the UPA to fill in gaps between GP and LP General Partners within a LLLP

o Remember : The UPA is not law, until it is adopted by the state It is a group of scholars who get together to create laws with uniformity

The idea was that partnerships are casual, used in many states and across state boundaries, so we should have uniform laws governing them

This is also true of Restatements and Model Acts (which we will deal with in Corporations)o Subject to Agreement Language:

UPA (1914) § say “subject to agreement” §13, 14, 15 may not change liability to 3rd parties

UPA (1997) §103 Creates blanket “subject to agreement” for all sections, rather then writing it out at the beginning of each

sectiono Applies to all except for Section §103 (B)

Limits ability to contract out of fiduciary duty owed to partner (infra) §103 (b) (10) Agreement cant change liability to 3rd parties

2. Writing o No writing is requiredo But is advisable:

Avoids potential disagreements about what agreement was Without it, UPA governs/applicable statute, and it may not represent best interest/desires

Note THE UPA IS THE DEFAULT IF THERE IS NO WRITTEN AGREEMENT Creates Fee income for lawyers, and avoids possibility of malpractice suit Will be Required, However:

If the Statute of Frauds applies to the provision, then a writing will need to exist for that provision to be enforceable

o Year or more, Real-Estate, etc…

o A partnership is created by it fitting into definition Even if intentions show not wanting to be one If by definition you are, then you are partnership UPA (14) §6 / UPA (97) §202 Note:

See Inadvertent Partnership Section

3. Sharing of Profits, Losses / Capital Contribution & Liability to 3 rd Parties of General Partners: o A. Profits:

Default Rule : UPA (1914) §18 / UPA (1997) §401 Partners Share Equally in the Profits Agreement may substitute this default rule There are many different ways in which to share profits

o Based on % income you’re accountable for, etc…o B. Salary:

Default Rule: UPA (1914) 18(f) No partner is entitled to remuneration for acting in partnership business

o Default rule is no salary for partnerso Agreement may substitute this default ruleo EG: Example of A & B, B had agreed to a salary of $5,000, in addition to half profits

UPA (1997) §401(h)o No Salary for Partners

§103: “Subject to Agreement”o C. Losses:

Default Rule: UPA (14) §18:

8

Each partner must contribute towards the losses, according to his profit share So, the losses follow the profits Default, then, is to split losses 50/50 (default for profits is 50/50) Historically, many people will disconnect profits and losses for tax purposes

Loss Distribution of Partners, when 1 or more cannot, will not pay: Proportional sharing of partners who cannot/won’t contribute to loss, by ones who can EG : A, B, and D have partnership

o Agree to split profits 60/20/20o There is a loss of $8,000 to partnershipo D will not Payo UPA (1914) 40 (d) / UPA (1997) 807 (c)

“The other partners shall contribute their share of the liabilities, an in the relative proportions, in which they share profits the amount necessary

Calculate by: Find Total % able partners are sharing here, 80% (60+20) Divide original share of each by total combined share

o A pays: 60/80=75% of D’s shareo B pays 20/80=25% of D’s share

EG 2 : Loss of $40,000 profits were split 50/20/30, and B will not payo A owes 50/80=62.5% of B’s share- 5,000o D owes 30/80= 37.5% of B’s share- 3,000

o D. Liability to 3 rd Parties: UPA 1914 and 1997 are different in how they create liability for partners Cannot alter rights of 3rd Parties Under 1914 (15) or 1997 (103) (b) 10 by agreement UPA (1914) § 15 :

§15 (a): Partners are liable Jointly and Severally for § 13 and 14o §13: Partnership liable for act or omission of partner during ordinary course of business of

partnershipo §14: Partnership liable to make good on loss of money

So, 15 makes Partners J&S liable Tort/Wrongful Act J & S liable for torts of each other

§15 (b) Partners are only liable jointly for all other debts/obligations of partnership Section 15, cannot be altered by agreement it is the Rule

o Some states have amended their Partnership act to represent the 1997 version in liability that is J & S for all obligations

More Efficient/Prudential Implications:

o So under 15 (1914), joinder would be required of all partners to sue for contract obligations, but not for Tort

o This could make enforcement of provision difficult to serve process on all, and issues of jurisdiction

UPA (1997) § 306 : 305 (a) Parthership is liable for loss or injury caused to person, as result of wrongful act of partrner

during the ordinary course of business of the partnership 306 (a): Partners are Jointly and Severally liable for all partnership obligations

o so, liable for tort and contractual obligationso Ends need to join all partners to sue, and can now sue one instead of having to sue allo Is not subject to agreement, so partners cannot vary liability to 3rd parties

But, Under UPA 1997:o 307 (d): requires that before the creditor go after the partner, it must exhaust partnership assets

first Note: Idea that partners are not principal debtors, but guarantors

9

Why the Difference in Liability Treatment for UPA 1997 and 1914: o Original idea was that you have a choice over your contracts, while you cannot choose to be hit

by a car (tort), and therefore UPA (1914) 15, made those liable who chose K (all partners)o However, it is simply more practical to make Joint and Several Liability for All partners

Liability and Silent Partners Many times, there can be a general partnership without one partner being known of

o A & B own store together, called B’s Store This does not change liability of partners

o Neither UPA (1914) nor UPA (1997) differentiate between silent and knowno UPA (1914) §9:

All partners are agents of the partnership Indemnification:

UPA (1914) §18 (b) o 18(b) Requires that the partnership indemnify every partner with respect to payouts made and

personal liabilities reasonably incurred o 18 (c) requires that partner get $ back + interest on ito Indemnification is treated as a loss:

Partnership indemnification/payout is treated as a loss, and therefore reverts to default rule of losses

o EG: A & B are partners, and A says he will contribute nothing more to partnership then $100,000 which is spent as capital in business

X falls, and sues A for $100,000, because B is gone A Pays $100,000 Partnership pays A back with interest and that indemnification is treated as loss

o Default A & B split loss of $100,000 50/50 A pays $50,000 B pays $50,000

o But remember, A& B can agree differently on losses, and in example within Book, A agreed to pay nothing more then $100k in capital which had already been spent B then, would be liable to partnership in losses for $100,000 loss in fall

UPA (1997) 401 (c) o Partnership shall reimburse a partner for payments made, and indemnify him for liabilities

incurred by the partner in ordinary course of the businesso E. Repayment of Capital Contribution

UPA (1914) §18/ UPA(1997) §401 Each Partner shall be repaid his contribution…

Richert v. Hadley: F- Had a joint venture (GP for special purpose, with specific end date), and π invested all starting capital,

while ∆ invested none. The court had difficulty applying §18.o These provisions say: “Each Partner shall be repaid his contribution, and share equally in profit,

and contribute to loss according to his share of profit” R-

o Richert Rule o 1) Calculate Sales – Expenses Net Income (Loss)o 2) Capital Contribution – Net Income (loss) Loss on Capital (Gain)o 3) Once loss on capital is calculated, split it between the partners based on share of profit

(default rule) or agreement o Subtract the % of Loss on capital from each Capital Contribution

Here Sales 41,629.83 Expeneses 26,909.61 Net Earnings 14,720.22

o Capital Contributed 26,842

10

o Subtract NET I. (14,720.22) Capital Loss= 12,121.78

With Net Loss of 12,121.78 apply the default loss rule, or rule they agreed to Default Rule Split Losses based on profit sharing (50/50) Each has loss of 6,060.44 Pays back to partnership

18 (a) says Get Capital Contribution (26,842) – Loss of (6,060.44) back = 20,781.11 is owed from partnership

Public Policy of Salary and Capital Contribution The UPA Default rule does not compensate for any human capital that ∆ invested. Time, labor, etc… It

only compensates $.o This is clearly evident in the default rule of no salary for general partnerso Courts do not want to deal with clutter of valuing human capital, the market value of the

time and labor, estimating how much was actually put in Function of Judicial Economy This puts the burden on the General Partners to negotiate a salary

Minority Rule (California) Does not apply Richert/UPA Implies an agreement, that the General Partners split capital contribution by valuing the human capital

and financial capital Application of Richert:

Richert Rule says that each partner shares according to default (or agreement) in losses, and then Capital is paid back, subtracting those losses

o A Invests $100,00o B $0

When Fire comes through and burns down building, destroying all investments, B owes A $50,000

Each partner is responsible for $50,000 in losses A gets Capital (100)- Losses Back = $50,000 B owes A $50,000

4. Management of General Partnershipo This is a question of a partners authority to create liability

Analysis: Determine if They are within the scope of the partnership business…If so, they have actual and apparent

authority to act Default Rule: General Partners, by default are agents of the partnership, having inherent actual and apparent

authority to act within the scope of the business Have actual and apparent authority UPA (1914) §9

Every partner is an agent of the partnership for purpose of its business Every partner, for apparently carrying on in the usual way the business of partnership,

binds the partnership §9 (2)

o An act of a partner which is not apparently for the carrying on of the business of the partnership in the usual way does not bind partnership unless authorized by partners

§301 (1997)o Same as 1914

Default Rule: All partners are, by default equal managers of the partnership UPA (1914) §18 (e)

o All Partners have equal rights in the management and conduct of the partnership business UPA (1997) §401 (g)

o Same as 1914 versiono Each partner has equal rights in the management and conduct of the partnership business

Default Rule: The Agency and Managerial capability cannot be unilaterally changed UPA (1914) §18 (h)

o Any difference arising as to ordinary matter connected with partnership business may be decided by majority of the partners

11

Need majority to change ordinary mattero No act in contravention of any agreement between partners may be done without consent of all

the partners Need unanimity to change agreement

UPA (1997) §401 (j) o Clarifies the 1914 versiono A difference arising as to a matter in the ordinary course of business of partnership may be

decided by a majority of partners. An act outside the ordinary course of business of partnership and amendment to the partnership may be undertaken only with consent of all the partners

Scope of the Business is Important Actual and Apparent authority, that are default rules, are only applicable if within the scope of the

businesso The Scope of the Business can only be altered by all partners unanimity

18 (h) & 401(j): An act outside of the ordinary course of business of partnership…may be undertaken only with the consent of all partners

3 Tests proffered to determine Scope: o 1. Look at past dealings, transactions of particular firm in questiono 2. Look to ordinary course of conduct of those engaged in it, in that localityo 3. Did 3P reasonably believe service requested undertaken as part of P’ship. Business? (Roache

v. Meade change based on ethics)o Partnership by Estoppel:

If partner watches someone exceeding scope, or representing themselves as partner, and “consents” it will make that person and those who consent liable

See §16 / §308 (97)EG: Rouse v. Pollard

Not Based on Ownership interest o If all 3 partners share differently in profits, this does not affect agency and management

authority of partnerso The UPA says that “Each Partner”…o This can be subject to an agreement, and changed however

Default Rule: Apparent Authority Survives Dissolution Note:

o See § 35 within Dissolution Section Authority remains, if without notice (1914) or statement of dissolution not filed (1997)

Application of Rules: Actual Authority to Bind Partnership in Contract Nabisco v. Stroud

o F- ∆ and Freemen were general partners. ∆ told Nabisco that he was no longer liable for groceries the partnership purchased. Freemen, a GP, then went to Nabisco and purchased bread for the General Partnership.

o I- Is ∆, who told π he was no longer liable, still bound by Freeman’s act?o R- Yes

1) Stroud unilaterally tried to change the rules, but never got majority of Partnership to agree

o ½ is not majority of partnerso If Freeman was an employee, or agent, then Stroud would have

effectively limited the apparent authority of Freeman and would not be bound…EE don’t have default actual authority

2) But they are General Partners Stroud ended the apparent authority, but they never agreed, via 18 (h) to change

Freemans actual authority, which §9 gives by default Freeman still has actual authority to bind partnership

o * Remember cannot agree out of §15, or 306, liability to 3rd party, but can agree to change authority of the partners, which would not bind the partnership

12

Apparent Authority to Bind Partnership in Contract Smith v. Dixon F- π is member of family who is a General Partnership. The family authorized him to sell the house for

$225K, but he entered into contract to sell for $200K. I- Does π have authority to do so, binding partnership, making partners liable? R-Yes

Either Apparent or Actual Authority is sufficient to Bind He may have had apparent authority to bind partnership, if “carrying on usual way of business”

o How do we determine if partner is acting “for apparently carrying on in the usual way the business of partnership”

Look to past dealings, transactions indicating customs peculiar to firm in question Ask in community Remember Agents cannot create their own authority by telling you, so must derive

from some sourceo So here, GP had apparent authority to contract, as MP, he had done so before

For a GP to protect themselves from vast apparent authority: o 1) Hire trustworthy agents Select Trustworthy partners

Those who won’t go against the actual authority they’ve been grantedo 2) Agree to a veto power for that particular transaction: although only limits actual authority

Apparent authority to make Partnership Liable in Tort Rouse v. Pollard F- lawyer dealt with π, receiving $28,000 to invest on her behalf in mortgages, but he kept money for

himself. Law firm dissolved, and he went bankrupt. I- Is this type of business within “scope of the business of partnership” such that it can make Partnership,

and subsequently GPs liable for tort? R- While he had actual authority and apparent authority to act, authority was only within the scope of the

businesso Is the GP within the Scope of the Partnership Business?o Scope:

Determined by the usual & ordinary course of conduct by those engaged in it, in that locality

Here law firms in New Jersey do not work in discretionary securities brokerage Not within Scope of Business, so lacked Apparent Authority

Unfortunately, Partnership and subsequently GPs are not liable then because ∆ exceeded any apparent authority he had.

o Partnership by Estoppel When a partner is not acting within the scope of his business, one may be able to argue

that, even though was outside of it, if another partner knew about it…Those 2 are Partners by Estoppel in the false partnership act and will be responsible…UPA (1914) §16

Apparent Authority to Make Partnership Liable in Tort Roache v. Meade F- ∆ told by π attorney that if he gave him $20,000, he’d invest it for him. ∆ did not repay money and

went bankrupt. ∆ in testimony, stated he saw this as legal advice on the loan I- Was ∆’s activity within the scope of business, so that he had authority to bind Partnership? R-

o Was within Partnership Business: Here, because π specifically saw it as legal advice Within scope of the business of a

law firmo Test to Determine Scope:

If the 3rd party reasonably believes that the service requested is undertaken as part of the partnership business, partnership is bound

Reasonableness of the belief is answered by looking at facts of each case o Remember:

If determined that it is within the scope of the partnership business, the Partner is within the actual or apparent authority of the partnership by default, and the Partnership will be bound

o Does this change Rule of Apparent Authority from P 3P?

13

Roche Represents 2 things: Evolved argument…that the π saw the ∆ attorney’s act as legal advice…putting

it directly into the scope of that business, which could be reasonably seen as apparent authority from law firm to public…so because within scope, partnership bound

Evolved and Changing of Ethics Model Rule 1.8: because of this ruleo Burden of Proof in Suit to bind principal

The Burden of Proof is on the person asserting that the agent is within the scope of his authority Nabisco BOP on Nabisco Smith Lady, claiming she was told it and it was authorized

o UPA 1997, and Apparent Authority UPA (1997) §301 is the corollary to §9(1914), giving each partner, by default, actual and apparent

authority as an agentbut, it is subject to effect of “statement of authority” UPA (1997) § 303

o This statement of authority shows 3rd parties the apparent authority of an agent The following is a list of the effects of “statement of authority”

UPA (1997) 303: Statement of Authority

Non- Real Estate Real Estate

Grant of Authority in Statement 303 (d) 1: conclusive in favor of the grant (unless notice to contrary)

Conclusive in favor, if statement is recorded in chain of title

Limit of Authority in Statement 303 (f): limits in the statement are irrelevant, unless the 3rd party knows

Constructive notice against the 3rd party if recorded within the chain of title

Counsel to 3 rd party: o Should look at the statement, in states that allow, for purposes of certainty and to avoid litigation

Counsel to potential filers: o Should file, as it smoothes way for agent who can show his authorized grant (sealed from state);

makes easier on 3rd party in dealings 5. Duties of Partners to Each Other

o At CL Meinhard v. Salmon F- Partners were in lease together for 20 years, and towards end of lease ∆ entered into new lease on same

property for a period of up to 80 years, with much economic benefit for him. I- Did the ∆ owe his partner a duty to disclose this information, and give him a chance to join? R-

Cardozo View: o Duty:

Duties of Partners together are highest possible Fiduciary “Punctilio of Honor, the Most Sensitive” Cannot act adverse to the partnership, or prefer self interest over partnerships’ At the Very Lease: Partnership must disclose Partnership must know of choices and choose “Preemptive Opportunity” Not ok to unilaterally do or take anything that comes out of the partnership business

o When Applies: When the opportunity comes out of the business, or is an enlargement of the business of

the partnership Look at business involved in

14

If opportunity arises out of it, out of the partnership, and wouldn’t have otherwise…Fiduciary duty applies…

o Probably Does not Apply: If new opportunity is unconnected to the partnership business

o EG: When lawyer is dealing with businesses, and is approached about joining or contributing capital investment?

This arises out of the partnership (Corporate Law Firm’s) business, and because of which, the opportunity is the partnerships

Partner owes it to partnership to have them consider it Andrews View (Unaccepted Minority):

o Agrees with High Duty, buto Look at the scope of the particular business involved…if the opportunity is within scope of

business it applies, if not, then opportunity can be unilaterally taken More restrictive approach of the high duty owed

o UPA (1914) §21: §21: (1) Every Partner must account to the partnership for any benefit, and hold as trustee for the partnership, the

profits he derived from transaction connected with the formation, conduct, liquidation of partnership, or use of partnership property…

Note: Essentially stands for the Cardozian view “Punctilio of honor, the most sensitive” Does not define “Fiduciary” in specifics, because drafters wanted to make point that its understood

Result of Breached Duty: If partner gets $ out of something that was partnerships Accounting: court looks at gains, losses, etc… and evaluates trying to allocate, but also implying

agreement the partnership may have hado EG: maintaining management %

o UPA (1997) §404 §404: The only fiduciary duty a partner owes is duty of loyalty and duty of care

Duty of loyalty is limited to:o Account to partnership, hold as trustee any property, profit, benefit derived from partnership

property, or appropriation of partnership opportunity… Note:

Drafters used “limited” to specify Cardozo’s view (High Duty), but to avoid any confusion of the judiciaries’’ holdings…like what exactly a “punctilio…” is

Wanted to be perfectly clear Note: The Contractarian View is imbedded in the UPA 1997

o UPA (1997) 103 (b)3 i: Partnership may not eliminate duty of loyalty, but: The partnership agreement may identify specific types or categories of activities that do

not violate duty of loyalty, if not manifestly unreasonable Allows P’Ship to contract around duties owed…

o UPA (1997) 103 (b) 5: Partnership may not eliminate obligation of good faith but: May prescribe standards by which performance will be measured

o So, Contractarian view was encouraging contracts and agreements between the partners…within view that business is “nexus of contracts”

Cannot get rid of duty entirely, but can negotiate their own view of duty of loyalty, unless “manifestly unreasonable”

o Note : Fiduciary in Practice You Represent A & B, and A tries to use you to go around B. What do you do? Split of Rules:

ABA Ethics Rule The Partnership is an entity, and you do not owe each of the partners a duty State Rules You owe each partner a duty of care Notify A of his fiduciary duty, explain it to him, and make sure he knows he may be sued for an

accounting

15

o Note: The Fiduciary duty owed does not change merely because the partners disagree or have strained relationship

o EG: Partner secretly takes $1,000 from partnership and invests it in another venture If Gain Use §21/ §404 to get an accounting for the profits owed the partnership If Loss Argue that GP is not liable…that partner did not have actual authority to bind the partnership, and

lacked apparent authority because outside of the scope of business if someone trying collect debt from partnership Get Accounting under §21, because he had no authority, and no consent or actual authority, to get money

back

6. Partnership Property o Overall

There is a difference between property owned by the partnership and property owned by the partner The only personal interest the partner has is in his share of the profits, income Has no interest in partnership property…although can use it

Conveying that interest, the assignee only gets the right to that income or profit There are no inadvertent partnerships 18 (g) “no person becomes partner without consent of all”

o What is it? UPA (1914) §8: all property originally brought into partnership or acquired by purchase on account of partnership

is partnership property §10: If property in partnership name, can be conveyed by any partner

But, partnership may recover property unless partners acts bind partnership under §9.o UPA (1914) §24-28

§24 Rights of Partnership Partners have their rights in specific partnership property, interest in partnership, and right to participate

in management o Note: right to management is meaningless, and excluded from UPA ‘97

§25 Rights in Partnership Specific Property A) Partners have right to possess partnership property for partnership purposes, but not other way B) Cannot assign your right, unless assignment of rights of all partners in property D) On Death, partner’s right to partnership property

§26 Partners Interest Partners interest in partnership and personal property is share of profits (His Interest)

§27 Assignee’s Rights Conveying interest to assignee entitles assignee only to receive profits which assignor would have

gotten…income & distribution Does not give right to interfere with management, etc…

o Policy of §27: based on 18 (g) no person can become member of partnership without consent of all partners Do not want to burden other partners because of 1 partners issues

§28 Individual Creditors of Partners If there is personal creditor of partner

o (1) Creditor can get “Charging order” Enjoins partnership from distributing to Partner Allows Partners share of $ to be sent to creditor Does not give right to dissolve partnership assets

o (2) Creditor can get foreclosure of interest court ordered judicial sale, if and only if, court convinced that creditors claim won’t be

satisfied by diverting income to creditor But Assignee only gets rights under 27

§40 (h); (i) Partnership Creditors (h) “Jingle Rule”

o Partnership creditors have priority in partnership propertyo Individual Creditors have priority in individual property

Note:

16

o §40 (h) was preempted by Federal Bankruptcy Law Partnership Creditors have priority on partnership property and parity on individual

property…’97 doesn’t acknowledge…o EG:

A&B have $0 assets, but A has personal assets of $100 Creditor of A, owed $100 gets

1914 $100 FBL $50

Creditor of Partnership, owed $100 gets 1914 $0 FBL $50

o UPA (1997) § 203, 204, 302, 501-04 203: What is Partnership Property

property acquired by a partnership is property of the partnership and not of the partners individually 204: When Property becomes the partnerships

if acquired in name of :o partnership or one or more partners with indication that its transferred to persons capacity as

partner if transferred to:

o partnership in its name oro one or more partners in their capacity as partners in partnership

Presumed partnership property if purchased with partnership assets … 302: Transfer of Partnership Property

Subject to 303, statement of authority Partnership property may be transferred by partner in partnership name Partnership can get property back from transferee if:

o Initial Transfer lacked authority Under 301 ando Transferee had notice that transferor lacked authority (lacked actual and apparent authority)

502: Partners transferable interest in partnership only interest the partner can transfer in partnership is his share of the profits and losses of

partnershippersonal property 503: Assignee’s Rights

gets right to receive income, and distributions Does not get management or any other right then right to income

504: Individual Creditors of Partners Same as 1914

7. Partnership Accounting: o Balance Sheet Principles

A= L+ SE Equity:

o Amount contributed, earned, lost, through partnership operations less distributionso Equity is also known as Net Worth, Capitalo Can be Negative

Partner’s Capital Account: o §401: Each partner has his or her own capital account, which is represented on balance sheet in

Equity account, p.75-81.o Equals amount contributed (+/-) profit or loss from operations – distributions

o Income Statement Principles Sales-COGS= Profit/Loss

Contribution nor distribution are represented in the income statemento Balance Sheet Valuation and Sale of Business:

Sale of Assets market value of assets- liabilities will be value Balance sheet is Book Value/Historic Value, which will be different than market value

Sale of Business as Continuation

17

Take into account rate of risk Income of Business= (Rate of Return on similar risked asset) x (Unknown Value of it) EG: If equally risky asset earns 20%, and your business earns $60,000/year .2 X = 60,000 You’d pay 300,000 to buy this business

o Accounting Principles: Going Concern

Assumed that the business is an indefinite operation Accounting Period

Calendar Year Fiscal Year

Accounting Standards 1) When Entry Made

o Cash Basis Entry on statement when cash received o Accrual Basis Entry on statement when entitled to receive

2) Carrying Value of Assets o Traditional Historical cost of the asset is what is represented on balance sheeto Modern While modernly historical cost is still used, Marked to Market is used in certain

industries, to mark assets to the market value at the time the statement is issued Can lead to volatile values in volatile market times

o Relationship of Accounting and Sharing of Profits and Losses If there is a total loss, how is capital returned? UPA (1914) 18/40

Simply Applies Richert Rule and does not look at gains to capital share from profit:o EG: o A Contributed $100,000 : B Contributed $0o Business has total Loss o Apply equal loss sharing rule (100/2= $50,000 back to A)o A gets $50,000 back from B

UPA (1997) Looks at the amount contributed, and Profits earned and not distributed

o EG: o A Contributed $100,000 : B Contributed $0o Business has total loss, but there is $30,000 in each capital accounto So Total Loss= $160/2 , $80,000 loss to eacho A Gets 130-80 = $50,000o Same result as the 1914 version, but takes into account the income earned to each partner

o Distributions of Income: Each Partner has the equal right to manage, and withdrawal when they desire their interest May not be the most efficient business move depending on cash, accounts receivable and accounts payable

Only recourse partner has, which might be extreme, is dissolution

8. Dissolution of Partnership o General:

Dissolution is the changing of a relationship between partners Begins the process of terminating the partnership, and winding it up Equitable

o A. Under UPA (1914) §29-42 §29 Definition: A Dissolution of a partnership is the change in the relation of the partners caused by any partner

ceasing to be associated in the carrying on as distinguished from the winding up of business

§31 What Can Cause the Dissolution: 1. Rightfully: Without violating partnership agreement (Power and Right)

o These methods of dissolution either coincide with partnership agreement or are allowed because it is an at-will partnership

18

o a) By termination of definite term or particular undertaking o b) Express will of all partners in specified term or particular undertaking, either before or aftero c) Deatho d) By expulsion of any partner from business, when power to expel comes from partnership

agreemento e) By Express will of any partner when partnership is at will

2. By Court Order: Court order needed when wrongful dissolution (contravening partnership agreement)

§32 When Court will Order Dissolution: When a partner applies for court order to dissolve, court will grant it when:

o 1. Partner is incapable of performing his part of contracto 2. Partner willfully or persistently commits breach of partnership agreement…o 3. Business can only be carried on at a losso 4. Other circumstances make it equitableo ….

The Process to Analyze a Dissolution Power v. Right: 1) Determine what type of Partnership it is

o At Will: Partner always has the Power and Right to Dissolve it at any time, by any partner

Note: Power and Right makes dissolution ok by either partner without penalty §31: “By the express will of any partner when no definite term or particular

undertaking is specified”o For A Term or Particular Purpose :

This type of partnership will have agreement If dissolution occurs against the contracted terms, you will be in breach and will owe

damages While you always have the power to dissolve, you do not always have the right

and therefore, may be liable to other partners Damages can be avoided if you get a court order to dissolve

Collins v. Lewis: F: π and ∆ were partners to form cafeteria, where π invested all capital and ∆ had all management

authority. While original estimates were $300,000 in costs to create and manage, π ended up paying over $600,000. Π refused to pay any more, unless business was profitable, although agreement had him investing money needed.

I: Can a breaching partner get court ordered dissolution? Rule: While he has power to dissolve, breaching partner does not have the right to, and when in breach of

agreement will only get court ordered dissolution if equitableo Here

Π breached agreement in particular undertaking, so only way to get right to dissolve is court order

But The Breaching Partner was cause of lack of profit, because he gave less then what he agreed to…Courts will take into account what is fair, but breaching partner who is cause of partnership problem has “unclean hands” and cannot get equity…

Has Power to dissolve, but not right and owes damages…Courts will not grant Right to Breaching Partner

Authority and Liability after Dissolution : 1. §33

o Dissolution terminates all actual authority, except to wind up the partnership business 2. §35: Apparent Authority still exists

o UPA (1914) § 35 1(b): Partner can bind partnership by act that normally would have bound partnership:

3P knew of partnership before dissolution and didn’t know about dissolution How to end apparent authority:

Notify that 3rd party

19

For general public, publish notice in newspaper, that partner has been dissolved, and this will end apparent authority…

3. §36:o Ends liability to 3P when they know and continue dealing, or release yousee infra

Creditors and Dissolution: §41: Creditors of dissolved partnership

o If the Partnership does continue, under either §38 or §42, creditors of the prior partnership continue to the new partnership

§36: Novation Rule: o 1) Dissolution does not discharge existing liability of dissolving partner, but:

If the business continues, the dissolving partner’s liability will be discharged if creditor agrees, or knows partner dissolved and continues to do business with partnership

Consequences What Occurs at Dissolution to Wind up: First, Look to the partnership agreement to determine if it addresses dissolution and the effect of winding

upo If there is one, it will be controlling instead of UPA

A. If there is No Agreement, UPA applies, giving 2 options

1) §38 Liquidate Partnership property according to:o Each partner may have partnership property applied to discharge its liabilities, and surplus

applied to pay in cash owed to the respective partner 1) If dissolving partner is wrongful:

Can use §38 to Apply property: o [% Share of Proceeds – Damages owed to partners from wrongful

dissolution]…o This is way whether continued or dissolved

2) Non-wrongful dissolving partners: Get Damages owed to them Can continue business

2) Applies to all dissolving partners: by death, dissolution or otherwise… 3) §37 gives the non-dissolving partner, one who is still alive or remaining the right to

wind up meaning, remaining partner is one who sells property (Total or piecemeal) Note: Remember Fiduciary Duty!!

Remaining partner has obligation to account for assets as fiduciary under §21, to act in other partners best interest in profits derived from “liquidation of the partnership”

2) §42 If Business Continues, claim as Creditor o Get FMV of your interest at date of dissolution ando 1. Interest on it, along with your interest back

Interest calculated by statutorily mandated interest rate Jurisdictionally dependent

Oro 2. Share of Profit

* Double Counting Issue * With appreciating assets, there can be a double counting issue Also will occur with accounts receivable As rule is written, this means you’d get your interest at the date + profit share

double counting your share Make sure to alert court to this, so that they can adjust and not double count

Policy of Choice: The Partner can choose between the two very late, and has the benefit of

hindsight to determine which value is greater This is because his interest is still at risk after he dissolved of bad business

decision…

20

Rule When accounting action is brought, and chosen between these two options, the court costs/fees are attributed to the partnership…split according to shares then

These Proceeds are used to Pay Back in a Specified Order §40

o Liabilities in order of: 1) Creditors other then partners 2) Owed to Partners other then for capital and profits 3) Partner Capital 4) Partner profit

o If Loss, each contributes amount necessary to satisfy liabilities in accordance with share If one cannot Others contribute extra See Infra § on Loss

B. Effect of an Agreement on Dissolution: o In both the 1914 and 1997 UPA, the provisions for dissolution (dissociation) say “unless

otherwise provided,” so an agreement can substitute themo What can be agreed to and how much latitude is there?

If the agreement is so one sided, may be issues of Contract Law: Unconscionable Unreasonable Duress Public Policy Argument Punitive (Penalty) provision

Court will evaluate these to determine that while there is freedom to contract, there are limits…

Fiduciary Duty in UPA (1914) §21 Fiduciary Duty applies during the formation of a partnership

Note: o UPA (97) did away with it because courts have ignored it because

they’re negotiating an agreement, dealing at arms length and courts have let them freedom to contract, subject only to contract law

o Freedom to Contract: Generally, Courts will allow Freedom to Contract to whatever is desired, subject to the

above Contract Doctrine Limits Jarvis court said “if agreement provides for continuation, method to pay

withdrawing partner, and doesn’t jeopardize creditors’ rights, its valid”o Adams v. Jarvis:

F: Agreement between partners had a “Withdrawal” provision, that specified the partnership would continue (Continuation Agreement). Agreement provided that the Accounts Receivable would remain the sole property of partnership. So, π didn’t even have option to try and collect them

R: Court held that §38, §42 are subject to agreement, so their agreement controls,

barring anything court disagrees with Court held only that, Fiduciary duty applies with the Accounts Receivable

o Some of these are his profits, and fiduciary duty applies in liquidating partnership assets.

o So existing partners need to “apply good faith effort to liquidate them, consistent with good business practices”

EG: If there were no agreement, and he elected Option #2, to be creditor and receive profit share, the *double counting * issue would arise with accounts receivable as well

Note:

21

o Jarvis is an example of a continuation agreement. Meaning, after partial dissolution, the agreement sets forth that winding up will not occur.

Expulsion: Is a type of dissolution that you may provide for in the agreement But:

o In an at-will partnership without an agreement, there is no way to expelo Dissolve and Recreate

Will be ok because not wrongful, and with no agreement any partner’s express will can dissolve partnership

o Majority Rule: Courts will accept a good, no, or bad reason to dissolve partnership

As simple as not liking each other any more Maybe

Public Policy issue in certain context EG, we want to dissolve because he is a whistle blower…court will not accept

o B. Under UPA 1997 §600-800 General:

Key Differences: o 1) Dissociation v. Dissolutiono 2) No Profit election in windup up for dissociating partnero 3) File statements to cut off liability (Dissociation and Dissolution)

The UPA 1997 adapts the continuation view. Meaning, It should be possible for a partner to leave partnership, and partnership continue

Dissociation stands for dissolution in 1914 version Dissolution is winding up

o So you dissociate from a partnership and it may continue, but dissolution ends the partnership Dissociation: 1. § 601 Dissociation:

Caused by:o 1) Partner giving notice of express will to withdrawo 2) An event occurs which was agreed too 3) Expulsion pursuant to the agreemento 4) Deatho …

2. §602 Wrongful Dissociation: Partner has the power to dissociate, but it is wrongful if:

o 1) It is in breach of partnership agreemento …o 2) Partner who wrongfully breaches is liable to partnership and other partners for damages

caused by the dissociation If Business Continues §700s

Unless otherwise agreed §701 Amount Partner gets back, when business continues

o 1) Buyout A. The partner’s interest in partnership is subject to a buyout price determined by the

value of the liquidation or going concern value of business if it had been sold on date of dissolution

B. Interest must be paid from date of dissolution C. Must be within 120 Days

**Unlike UPA 1914, which allows partner to choose between profit or interest…only interest in UPA (1997)!

Takes Care of the Double Counting Problem If wrongful dissociation, damages must offset the buyout price

22

o 2 Application of Partnership Property -- §702/703 Dissociated Partners Authority and Liability

o The Dissociated partner has, for 2 years, the power to bind partnership, if it would have prior to dissociation (act within scope of partnership business), and:

If 3P reasonably believed that dissociated partner was a partner Didn’t know of dissociation Didn’t have notice under §704 Statement

o The Dissociated partner is liable as partner for 2 years after dissociation, if partner would have been liable (partnership obligation) prior to dissociation, and:

3P reasonably believed he still was partner Didn’t know of dissociation

§704 Statement of Dissociation o The dissociated partner or partnership can file a statement of dissociation which limits the

authority of the partnero Person is deemed to have notice of the dissociation after 90 days of it being filed

If Business does not Continue, and is Wound Up: §801 Causes of Dissolution:

o In At-Will partnership, express notice of a partner causes dissolutiono In definite term or particular undertaking, the express will of all partners, termination of term or

undertaking, or within 90 days of dissociation of another partner, ½ partners express they want to wind up

o Oro Judicial Determination to wind up, granted if:

§802 Halting Dissolution: o At any time after dissolution, all partners may waive the right to wind up

Resumes carrying on as if dissolution never occurred §804/806 Partners authority and liability after dissolution

o Partnership is bound by partner after dissolution if Would have bound prior to dissolution, if 3P did not know of dissolution

o Partner is liable for his share of liability caused by post-dissolution action (§804)o Partner is liable to partnership for any damage he caused to partnership arising from liability

§805 Statement of Dissolution o Is a limitation on authority, and cancels out a §303 statement (Original apparent authority limit)o Deemed to have notice in 90 days

§807 Winding Up o Assets of partnership must be applied to discharge obligations of creditors, partners who are

creditors, and surplus is distributed in accordance with each share Each partner’s account then gets settled, as a result of the liquidation of partnership

assets Partner has to contribute if there are still losses in accordance with share If partner cannot contribute amount required, all partners pay share in proportion to

their share of the loss 10. Inadvertent Partnership

o General: A determination of if there is, in fact, a partnership so that the default rules can or cannot apply

o Actual Inadvertent Partnershipo Test we Look Through:

1) Start with Definition of Partnership 2) Profit Sharing is presumed partnership, but not if it is a loan 3) Stated intent is not determinative as to actual partnership 4) But, Intent to have that type of relationship as co-owners of business

Did they intend to have a relationship equal to co-owners? 5) Look at Affirmative versus Negative Powers

Look at the “Right to Bind” (Smith v. Kelley), which may coincide with an affirmative power

23

o Provisions that apply: §6 (1914) “a partnership is an association of two or more persons to carry on as co-owners a business for profit”

2 or more Sharing Profit Co-Owners

§7 (1914) In determining if there is a partnership:

o 1) Joint Tenancy, TIC, TBE do not automatically establish a partnership just because two people owning sharing profit do not

o 2) Sharing of Returns does not establish partnership Revenue (Pre-Profit) sharing

o 3) Sharing of Profits is prima facie (legally sufficient) evidence if partnership Inference of partnership But, inference of partnership ends if:

1) profits are received as debt by installments 2) wages of an employee or rent 3) as interest on a loan though it may vary with profits

o Martin v. Peyton: F- KNK was having financial difficulties. So friends of π agreed to loan him money to right the sinking ship. Π

argues that they became partners, and are responsible for obligations now. He does not argue partnership by estoppel.

R- Stated they did not intend to be partners Here, ∆’s share profit Cannot manage Can inspect books, veto power of speculative business practice

Apply Test: 2 people, sharing profit, but are they co-owners?

o Determine co-owners through Power Had:

Affirmative Powers v. Negative Powers

Initiate transactions, bind the firm, have authority

Veto Power

These will permit finding of partnership

Will not find partnership

Here only had veto power, and no affirmative power So they were not co-owners No Partnership

o Smith v. Kelley: F- Appellees were partners, and hired ∆ to join them. For 3 years they represented him to the public as partner, in

tax returns he was partner, he was paid $1,000 a month, and a small amount out of profits. When he left, he claimed he was partner, entitled to 20% share of interest. He had no authority to bind the firm.

R- No Affirmative Authority While Intent to form a partnership is not dispositive

o intention to form the relationship that satisfies partnership definition can be looked at here, no affirmative power and never had intention to form relationship in

partnership definitiono EG:

Understanding of Partner with no management authority and liability

24

Default Rule: is that partners have inherent actual and apparent authority to bind the partnership within the scope of business

If A and B have partnership, but A has no management authority (actual), and only contributes capital, while B has all management authority (actual), assuming he is a partner

Between Each other argue they have intention to form relationship between them of definition of partnership…so they contracted for the statutory rules

If B commits Tort or Contractual obligation to a 3P who doesn’t know about Ao Can argue that B is liable, and A is liable as principal giving B the actual authority to act through

basic Agency Law If B commits Tort or Contractual obligation on 3P who knows of A

o Can argue that A, as partner has the apparent authority, although no the actual authority If A commits Tort or Contractual obligation

o Must argue apparent authority…because he has no actual authority o Partnership by Estoppel:

Key Differences: 1) 1914 “Holding out to someone who has given credit” 2) 1997 “Holding out to someone who has relied, entering into a transaction”

o For the most part, these are the same thing with modernized language UPA (14) §16:

1) When a person represents himself, or consents to being represented as a partner, he is liable to any person who has given credit to the actual or apparent partnership

o if partnership liability resultshe is liable as partnero When no partnership liabilityhe is liable jointly with other people who consented to him

2) When a person is represented to be a partner, he is an agent of the persons representing him, binding them for people who rely on representation.

o If all partners consent partnership acto If less then all obligation of person acting and person consenting

UPA (97) §308: Same thing but “relying on representation”

You would argue partnership by Estoppel if you could not argue an inadvertent partnership was created, or in other words, the person was not a partner…but he still may be an employee

Arguments:o 1) He is partner, either obviously, or through Inadvertent Partnershipo 2) Ok, He is not a partner, but he is partner by Estoppel, making him, others or whole

partnership liableo 3) If not, determine if he is an employee, and if within the scope of his business, Partnership is

vicariously liable Only use 16/308 to argue partnership of non-partner

EG: A & B are partners, and hold C out as a partner (even though he is not) 1) If C orders supplies

o Argue 3P has “relied” or “given credit” under UPA 16/308o Could argue inherent authority as employee (If manager?)

2) If A orders supplieso C may not be bound, but may be if relied or given credit

3) If C is driving too fast to clients houseo A & B will be liable as employers, vicarious liability

4) A drives too fast on way to clients house o C will not be liable…no one relied or gave credit

5) C commits malpracticeo Argue that A & B liable, as 3P relied on representation

6) A commits malpracticeo Argue that C has been relied on as being partner…probably not though

25

VI. Limited Liability Partnership

o Definition: A General Partnership that has filed for Limited Liability (§UPA (1997) 306 (c))o History:

In 1980s, S&L crisis, the real estate and energy market collapsed, and Texas had tough time As a result of the crisis, claims went out against lawyers and accountants for malpractice and negligence Certain types of partnerships, for ethical reasons, were not allowed to have LL usually due to service being

individualized, so limiting liability was against public policy *Remember GP’s are liable Joint and Severely, under 1914 and 1997, at least for tort So wealthy innocent partners were nervous that they would be liable though partnership

As a result, the legislature and Texas Supreme Court helped created Limited Liabilityo Two Types of LLP’s Created:

Narrow Shield LLP: Doesn’t affect the basic partnership rules; except when dealing with Tort Limited Liability for Tort

o Required Showing of Proof of Insurance so at least some minimum capital amount $ would be there for claims

Unlimited Liability for other; primarily contract EG:

o Victor Slips, falls suing GP with assets of $100,000 for $200,000 Gets $100,00 from Partnership No more from GP’s

o Connie sues for 200,000 breach of Contract Gets $100,000 from partnership Gets $100,000 from partners (J or J&S depending on statute)

Broad Shield LLP: Affects basic partnership rules whenever Partnership unable to satisfy all obligations from Assets Limited Liability for all obligations

o Does not require Proof of Insurance EG:

o Victor Gets $100,000 from partnership, but no moreo Connie Gets $100,000 from partnership, but no more

Rules of the LLP: Basic Rule: UPA (1997) §306(C) Created the LLP

o An obligation of partnership incurred while partnership is LLP, in contract, tort, or otherwise, is solely the obligation of the partnership. Partner is not personally liable…by way of contribution or otherwise

o Issues with Rule: Could be read to mean partners don’t have to share in losses or contribute to loss of

capital Or, could be read because in section dealing with Partnership relations to 3rd parties,

that it means dealing with 3rd parties Overall

Has been, in 1 case, understood to still apply Richert Ruleo Partners must contribute to losses and capital

How to Create Article 10 UPA (1997) §1001 (a) / §1002o LLP must be approved by majority vote to change partnership agreemento Filing Requirement

After this, must file a statemento §1002: Naming Requirement

Name must end with acronym LLP Alerting those that they are dealing with a limited liability entity This assumes that people understand this, however, and know it means Partners are not

jointly or jointly and severally liable for obligations

26

Foreign LLP Article 11 o When dealing with an LLP created in another state, how does that apply in this state?o There are those who argue, if LLP enters another state that does not recognize LLP, it may lose

Limited Liability LLC, then recognized as being best choice All 50 States recognize

o UPA (1997) §1101 (a) The Law under which a foreign LLP is formed governs relations among the partners

and between the partners and partnership State Z, where business occurs recognizes State B’s law where LLP formed

o UPA (1997) §1102 Before doing business in the state, a foreign LLP must file statement in that state

Notify state your doing businesso UPA (1997) §1103

If you do not file- you may not maintain an action or proceeding in the state your doing business until you file

Banned from using courts until filing occurs

VII. Federal Income Tax:

1. Progressivity: o Our tax system is progressive, meaning you pay at a higher rateo Additional income is taxed at an increasingly higher rate

2. There is a Difference between the Marginal Tax Rate and Effective Tax Rate:o Marginal Tax Rate:

Incremental income over the effective tax rate is taxed at an incrementally higher rate Additional tax paid when over base bracket amount

o Effective Tax Rate: Tax Paid/Total Income= Effective Tax Rate (X)

3. Capital Gains: o The Tax Rate on the sale of property to produce income for a minimum period of timeo Generally, Securities held for > 1 year are taxed at 15 %

Note: Capital Gains tax is much lower then Federal Income Tax Rate

o What is Capital Gain versus Income: Ordinary Income Salary, lease payment received, dividends on stock Capital Gain From sale of a qualifying stock or asset

o Capital Loss Treatment: Can offset CG up to $3,000 a year, and me be carried over to future years

o Calculation: Definition:

Basis: Investment the seller has in the property, represented by the cost paid to acquire Adjusted Basis: [The Basis + Improvements + Other Costs] Realize: FMV received for the property

o Amount realized includes Mortgage that may be assumed The debt someone pays for you is something you received EG:

If you sell house you paid $100,000 for with $50,000 mortgage for $125,000 your taxable Gain is $25,000

Includes the Assumed Debt + Cash to get Realized Value Gain/Loss: Realized – Adjusted Basis

Capital Gain = [Realized Value – Adjusted Basis] 4. Estate Tax:

o Key Points: Historically, there has been one 2010 there is none

27

There are usually many exceptions/exclusions as to what applies, with regards to the size of the estate that is taxable

Grantor pays the tax and Recipients get a “Stepped up Basis”o Stepped Up Basis:

The basis of the property received is stepped up to the FMV at time of death The Step up negates any income that the recipient would have to pay * So, at death the unrealized gain is forgiven, unless held for long enough time for property to appreciate

5. Corporate and Partnership Taxation:o Historically:

Businesses were evaluated on 4 Factors to determine if they would be taxed as a Partnership or a Corporation: “Kitner Factors”

1) Continuity 2) Central Control 3) Free Transferability 4) Limited Liability

o If lacked any 2, would be taxed as a partnershipo If not, taxed as a corporationo But, people were modeling their business entity to avoid Continuity and LL to avoid Corporate

Taxo Modernly: The IRS in 1997 ended use of factors, and created a simplified version:

1. If you are publically traded you must be taxed as a C-Corp

2. If you are created under a statute that describes entity as an incorporated business § C or S

3. If you are un-incorporated entity you may choose “Check the Box” Cannot be created under statute that describes as incorporated business You can elect § C, § S or partnership Tax under § K If you don’t formally elect Treated as § K Partnership Taxation Applies to GP, LP, LLP, LLLP, LLC

o Forms: 1. Individual Income Tax

Has its own Tax Schedule that is different from Corporate/Partnership Tax 1. Sole Proprietor Tax:

Gets Direct Taxation:o Income/Loss is reported on the sole proprietors person tax return

File: o Form 1040: individual tax returno Schedule C: attached to the 1040, recording the gain or loss

Then the income or loss of proprietorship is added to or subtracted from the proprietors other income to determine the final taxable income

2. Partnership Tax (§ K): Passed Through/ Conduit to the partner The partnership computes the taxable income, and then passes that onto each partner in accordance with

their share This amount is included on partners tax return

o The tax is based on the partnerships total taxable income, NOT tax on individuals share Option of all unincorporated businesses

3. § C-Corporation Tax: **2 Tier Taxation:

o Taxed at Corporate Rate: Corporation is taxed according to the Corporate tax schedule on the Income Statement Earnings After Tax

o Taxed at Individual Rate: Shareholders are then taxed for $ dividend distributed to them according to their income tax schedule

o Required of Publically Traded Businesses

28

o An option of those entities that can “Check the Box”o Note:

An exception to the 2-Tier taxation is for inter-corporate dividends ** Lawful Tax Avoidance and the §C-Corporation:

o Because of the cost of the 2-tier taxation system, there are methods…o 1) §S Corporation discussed infrao 2) “Zeroing Out Method”

Goal lower taxable income of corporation, and pass the income onto shareholders through salary, interest…: therefore, taxed at income rate only

Avoids Corporate Tax Schedule if done right How

“Zero Out” the taxable income, by paying the income in salary to shareholders There is a limit, however, in that you must stick to the FMV of what that

position would be paid…with leeway… So Sole tax is shareholders income tax

o 3) “Accumulation and Bail Out Strategy” Goal take advantage of the lower Capital Gains Tax, avoiding income tax of salary How

Rather then paying a dividend to shareholders, Retain the earnings of the company, and give people shares that way when they are redeemed, they are taxed only at the Capital Gains Level

Note: o Best “Bail Out Method” is if the shareholder dieso Why?

Stepped Up Basis to FMV at death means that there will be “no” CG to tax at CG level…

4. § S- Corporation Tax: Birthed as a result of dislike of the C-Corp’s 2-Tier taxation Requires an affirmative election by a corporation Requirements :

o 1) No More then 100 Shareholders o 2) Only 1 stock class may be issued,

May be different classes if only give different voting rights Cannot change financial attributes

o 3) No Non-Resident aliens may be shareholdero 4) No Artificial Entity may be Shareholder

Are some exceptions Taxation of § S-Corp:

o Modified Conduit/Pass through taxation of partnership taxation Process: Corporation files a tax return showing earnings of each shareholder, when then

include this amount on their income tax return Same basic feature of Partnership § K Taxation

VIII. The Limited Partnership:

Definition: A partnership, 2 or more people carrying a business as co-owners for profit, made up of two types of partnerso 1 or more General Partners

Remember the General Partner can be a “Corporation”o 1 or more Limited Partners

The Limited Partner has Limited Liabilityo Policy:

Use of this, in the limited circumstances it is modernly used, is a Symbol to the Limited Partners that they are Passive Investors…explicitly conveys that to them

Creation:o Filing Requirement Must file to become Limited Partnership

29

o Naming Requirement Must have LL within your named titleo The UPA is a gap filler for the General Partners

This includes General Partners in Limited Partnership, filing for an LLP creating an LLLP UPA (1997): §306 (c)

o Profit/Loss Sharing: Profits and Losses are proportionate to your capital contribution

This is different then the partnership rule, where profits and losses are based by default 50/50 or agreement

o Tax: Check the Box Taxation ( See Supra)

Controlling Statute:o ULPA 1916:

The original Limited Partnership Statute o Re-Rulpa 2001:

has been very sparingly used The UPA does not become gap-filler Limited Liability is automatic for General Partners Limited Partners may participate in control

o These provisions make the Limited Partnership, by definition, almost extinct essentially ending a need for a Limited Partnership Probably why not in use at all

o RULPA/ULPA 1976 (w/ 1985 amendments): this is the controlling statute

UPA is a gap filler for General Partners Liability May Be Lost:

§ 303: (a) A Limited Partner is not liable for partnership obligations of the limited partner, unless:o 1) He is also a general partner , or in addition to being a Limited Partner he o 2) participates in the control of business

If limited partner does participate in control of business, only liable to those persons who transact business with LP reasonably believing he was a GP

§303 (b)o A limited Partner does not participate in the control of the business by :

1) Being a contractor or agent of the Limited Partnership, or of a general partner, or officer, director, or shareholder of a general partner Corporation

2) Consulting and advising a general partner with respect to business of the limited partnership

3) bringing a derivative action in the right of limited partnership 4) Requesting or attending a partnership meeting 5) Proposing, approving, or disapproving:

a) the dissolution, and winding up of partnership b) sale, exchange, lease of LP assets c) amendment to partnership agreement or certificate of limited partnership d) Matters related to business of LP not otherwise enumerated, which

partnership agreement states in writing may be subject to approval or disapproval of Limited Partners

6) A limited partner who knowingly permits his name to be used in the name of the Limited Partnership is liable to creditors who extend credit to the LP without actually knowing that the LP is not a GP

only applies to Contract…NOT tort!o A limited Partner has Limited Liability unless:

1. He is a General Partner §303 (a) Formally De-Facto Limited Partner is Principal and General Partner is Agent Examples:

o A Limited Partner who also acts as a General Partner will have Liability

30

X (GP) XYZ (LP) Sample, LPo De- Facto General Partner:

If the agreement specifies that the Limited Partner has the full right to manage, although he is a Limited Partner This violates §303 (a)

The Limited Partner would also be a General Partner, and loses LLo If General Partner is subject to one Limited Partner’s Control:

Although perhaps not within statute, and Limited Partner has not become a General Partner

Under Basic Agency Law General Partner is Agent of the Limited Partner who is Principal

So, LP, as principal will be liable for General Partner’s contracts/torts If Undisclosed, Principal is Liable

2. He Participates in the General Partnership’s Control §303 (b) Only applies in contract, to those who “reasonably believed he was general partner But there are exceptions in §303 (b)

o 1. A Limited Partner who is a officer, director or shareholder of a Corporate General Partner retains Limited Liability

X (Director)---Corporation (GP) XYZ (LP)Sample, LP

o 2. If Limited Partner has clause in Limited Partnership Agreement that the General Partner may not spend over $100,000 without consent of Limited Partner OK, the LP retains LL

§303 (b) 6 (ix) “Partnership agreement may subject to approval/disapproval of LP”

3. Name Confusion: If a Limited Partner uses, or allows use of his name in the Limited Partnerships name will be liable to those in Contract only…not tort

§303 (d) 4. X (GP) XYZ ( LP) Sample, LLLP

Here, LLLP gives the General Partners within the Limited Partnership Limited Liability Even though X is a general partner here, and violates §303 (a) as controlling the business, General

Partners within an LLLP have LL, so X probably will have Limited Liability, even though he did turn into a General Partner

o The Limited Liability Limited Partnership [LLLP] Definition:

A Limited Partnership, wherein the General Partners file for Limited Liabilityo About 22 states recognize it

Foreign LLLP: In a state that does not have an LLLP, you may lose your Limited Liability as a General Partner

o Limited Partnership with Corporate General Partner, then, makes more sense Filing:

2 Filings:o File for Limited partnershipo General Partners must then file for Limited Liability

Modernly:o Based on the Tax structure change, and creation of the LLP and LLC, the use of the Limited Partnership and Limited

Liability, Limited Partnership has greatly decreased o Policy:

Use of LP and LLLP, in the limited circumstances it is modernly used, is a Symbol to the Limited Partners that they are Passive Investors…explicitly conveys that to them

o Highly Specialized Use: 1. Venture Capital Fund:

VC The GPo Although, typically don’t stay GP, but instead are Corp, or LLLP

31

o Free to manage the portfolio investment Investors the Limited Partners

o Retain the passive investment status with no possibility of liability

X. Limited Liability Company [LLC]

History: o A company was dealing with a foreign partner, who had LL. Company wanted same entity, so lobbied for it in Alaska first,

and was denied and ended up working in Wyoming in 1977.o Once passed, all eyes were on IRS Which deemed it could be taxed as partnershipo By 1995 100% of States had an LLCo There were efforts to standardize statutes, but states created them quickly and differently, so standard statute is not widely

accepted In Fact Only 8 states recognize ULLCA

General:o Gets partnership Taxation, with Management Choice and Limited Liability for allo An Unincorporated entity with limited liability for all members (managers), with “check the box” option to receive

partnership taxation Differences Between LLP and LLC:

o Not Much Managers/Members v. Partners Both Birthed out of the Taxation and Limited Liability changes 100% of Jurisdictions accept LLC, while not all accept LLP Higher Filing Fee for LLC then LLP, typically

Basic Rules: o Generally:

LLC statutes are drawn from the partnership and corporation statutes A Hybrid entity, then embodying both types of law Remember ULLCA is only accepted by 8 states

Jurisdictionally dependent, jurisdictions classify the LLC differently, some more like a partnership and others more like a corporation

o Tax: “Check the Box Taxation”

Unless statute it is created under refers to it as an “incorporated entity” or is publically tradedo See Federal Income Tax §, supra

o Filing: ULLCA §202

File Articles of Organization to create Typically, filing fees are higher for LLC then LLP

o Naming Requirement: ULLCA §105 (a) Name must contain LLC

o Management: 1. Look to the LLC Agreement 2. If none, look to the default rules of the state

ULLCA is very partnership oriented, making member managed by defaulto ULLCA §404:

In Member managed, each has equal rights to manage In Manager managed, each has equal rights to manage

Jurisdictions differ, however, being more corporation oriented in some and partnership in otherso Agency:

ULLCA §301: If Member managed, each member is agent of LLC for purpose of its business to carry on ordinary course

of businesso Have actual and apparent authority

If Manager managed, member is not an agent of company for the purpose of its business

32

o Each manager is an agent for the purpose of its businesso Members may not have actual authority, but may still have apparent athority

The LLC is a Hybrid, Treated Differently in Different Situation (Partnership v. Corporation): o 1. Entity v. Aggregate of Members

Because it is a hybrid, courts will distinguish between an Entity (Corporation) or an aggregation of its members (Partnership)

1. Elf Atochem v. Jaffarri & Malek, LLC (Delaware 1999) F: π and ∆ formed a Joint venture through an LLC entity. Articles of Organization were filed in

Delaware, and Agreement signed after, specified that Forum Selection would be in San Francisco, California. Π brought derivative suit ∆ for breach of fiduciary duty, among other things.

I: Does the LLC have to be specified as Party on Agreement to bind, and can parties Contract for Forum Selection Clause?

R:o 1. The Delaware LLC Act’s policy is “maximum effect to LLC agreement”

Substantial Freedom to Contract exists Can Contract around the Forum of Delaware, in Delaware Law, because freedom to

Contract is looked upon highlyo 2. Just Because LLC was not named Party to Agreement, it is still bound

a. LLC cannot physically sign it, so its members must do so b. The LLC signed the articles of organization, so it signing the agreement later is

formalistic c. The members are the real parties, and Delaware Act contemplated this

Here, LLC treated as Aggregate of the Memberso Overall LLC does not have to be specified on Agreement in Delaware to be bound

Practically: Should put name on, just to be safe…

EG: Members of LLC enter into K with 3P, but don’t put LLC’s name Intent to bind or not, Basic Agency law would apply and members are agents of

the LLC, thus binding an undisclosed principal (LLC) LLC would be bound…

2. Poore v. Fox Hollow Enterprises (Delaware 1994) F: ∆, member of LLC filed answer, but was not barred in Delaware and had no Delaware counsel. Π filed

motion to dismiss because corporations in Delaware are not allowed to be represented pro-se, and LLC is like corporation

R: o 1. Delaware Supreme Court held Corporation is an Entity, and artificial

Because of this, can only act through agent, who must be barred in Delawareo 2. Is LLC more like Corporation, or Partnership (Which can have Pro-Se?)?

While partnership taxation, LL of LLC is like Delaware Corporation and has corporation like management and voting

Therefore, it is an Entity (not Aggregate of members), and needs an attorneyo Whats really going on:

Courts probably did this to foster Delaware Bar Also if General Partnership is sued, all Partners would come to court and represent

themselves…because they have harm at stake Corporate and LLC shareholders won’t be harmed because of LL, so they don’t

typically show up need attorney o 2. Freedom to Contract:

Large Part of LLC policy Desire to allow the LLC to structure whatever it wants, based on the LLC agreement Tailored to their needs

See Elf Atochem, suprao 3. Fiduciary Responsibilities

May be treated differently in different Jurisdictions

33

In Delaware Can eliminate Fiduciary duty if desired…o 4. Analogy:

Meyers v. Oklahoma: F: LLC wanted to get a liquor license, but Corporations in Oklahoma constitution were banned from

getting liquor license. Is LLC analogous to Corporation, thus not being allowed to get Liquor License? R:

o Court Interpreted Framers Intent to assign personal responsibility for compliance with Liqour Laws

Thus Partnerships are allowed to get License, because they can be held personally responsible, but corporations cannot because they have no personal liability

So, LLC , with no liability for members, shields those from responsibility that Constitution intended to have responsibility

It is thus, analogous to corporationo EG:

LLP probably would have same outcome o Overall:

We will see throughout class a ‘back and forth’ as to what exactly an LLC is treated as Sometimes a partnership and other times a corporation

XI. Advising Clients on Entities and Comparing Unincorporated Forms:

General: o 1. Choose LLP over General partnershipo 2. Choose an LLLP over a Limited Partnershipo 3. LLP v. LLLP v. LLC?

1. Is the LLP or LLLP available in that jurisdiction? If No Choose LLC or choose LP with corporate general partner LLLP largely symbolic to the Limited Partners that they are passive

2. Is intense centralization of control important? If Yes Choose LLLP or LP with corporate general partner

o General partners have sole ability to manage 3. If not LLP or LLC?

LLC:o more available and better interstate recognition 100% of Jurisdictionso Less precedent, less predictabilityo Filing fee may be higher, because of popularity

LLPo More Predictable, more precedento More Case law, because General Partnership law applies o Interstate Issues:

May lose LL, if operating in Foreign Jurisdiction that does not recognize LLC may be better option

o Fee Advantage?

XII. Corporate Law

1. Generally: o Corporation:

Traditionally seen as a human being a separate juridical person “Fictional Human Being” its own Entity Juridical Person Note: This is unlike the “nexus of contracts theory”

A corporation is its own entity, who has duties and who may be owed duty by the board of directors or officers

34

Uniform Laws: Not really in corporate law

o More important when dealing with unincorporated entity o Public or Private:

1. Public: A. Not Close A. Registered under Securities and Exchange act of 1934

o If Traded on Stock Exchange o If > or equal to 499 shareholders of a class of shares + $10M in assets

B. May mean that there are a lot of shareholders and a fair trading marketo But may not require an SEC filing

2. Private: No Filing under 1934 Securities and Exchange Act Not Public Not many shareholders No active trading market Similar to close corporation

Closely Held Corporation Donahue Definition: 1. A small number of shareholders, 2. With no open market to sell shares, and 3. The

majority participates in management, operation Created under a specific Close Corporation Statute Colloquial meaning is that very few shareholders who overlap as managers Closely Held corporations are private, but not all private corporations are closely held

o Shareholders (Stockholders): The owners of the corporation

Unlike Partnership: Wherein, owners do have authority to bind as general partners, here stockholders do not (If public)

Are not agents of corporation, and have no inherent authority to act Exception: If the shareholder is manager with shares, or officer with shares

Different Classes of Shares: Common Stock:

o May be broken down into different classes, whereas one has more ownership or voting rights Preferred Stock:

o May get preferred dividends After earnings come out, bond holders get coupon, then preferred get their preferred

dividends then common stock shareholders get their dividend May give specified rights after dissolution Voting rights may be part of preferred But typically it is financial rights differences

onlyo Board of Directors:

Except for the initial incorporation under § MBCA, shareholders elect the board of directors by vote Make Management Decisions

Is not agent (Not subject to corporations control) Is fiduciary to the Corporation

o Duty of Care & Loyalty is owed to the corporation, and its shareholders o As a matter of law, the board of directors must act in the best interest of the corporation not

themselves See infra, section on directors issuing and withholding dividends (in Distributions §)

Chair of Board: Optional Only created if designated in the Article of Incorporation or the bylaws Elected by the board, and duties created by the board

o Officers: Elected by the Board of Directors

35

Is Agent of the Board of Directors (subject to the control of the board of directors, manifested by board of directors decision)

President: By laws will specify

Secretary: Under MBCA, it is the only required officer

o Must have a secretary, or someone acting in that capacity to perform the function of authenticating the corporate records

Other Common Officers: CEO, CFO, COO, General Counsel, Comptroller Dependent on what the corporation has decided to create in the articles of incorporation

o Articles of Incorporation: The Superior law of the corporation:

No by-law can contravene the articles of incorporation Location of the very important issues are located in Articles of Incorporation because it is extremely

difficult to amend To Amend: Must have-

o 1. Board Recommendationo 2. Shareholder Voteo 3. Filing with the state

o By Laws: General housekeeping rules generally unimportant information which no care is given

Notice required of meetings Location of meetings Description of the offices Certain other unimportant common information

Easily Amended: By the board of directors or, for some subject matter, by the shareholders

2. The Development of Corporate Law: o Federalism Implications:

States have traditionally had the formation power of corporations Supreme Court has recognized this: “Corporations are creatures of state law…” Allows for particularized regulation for that state’s needs

However: As time has gone on, there has been a push to centralize and Federalize Corporate Law Slowly, it has gone closer to a Federalized system…

o Exemplified by Sarbanes Oxley and Dodd-Frank Acts Corporate Law remains a state function

Internal Affairs Rule:o Large reason corporate law has remained a state functiono Where you are incorporated is important

Foreign courts apply the law of the state of incorporation to issues relating to the internal affairs of the corporation

o Progressive Liberalization of Corporate Law: Historically:

Incorporation was not commonly allowed, out of fear and trepidation of the corporate entity—fear of large amounts of money, labor and monopoly

o Brandeis View in Ligget v. Lee: Corporations were limited in total capital, scope of business, total debt, limit of purpose

But there began to slowly erode… Modernly:

These restriction and conerns have eroded There has been a “Race to the Bottom” or “Race to Lax” the corporate laws with the idea to entice

incorporation there for the economic incentives it brings o This actually may feed into argument of need to federalize

36

o Delaware’s Prominence in Corporate Law: General Facts:

51% of all US Companies incorporated ~ >50% of NYSE 63% of Fortune 500 ~45,000 new incorporations per year

Why? 1. Well Established law

Delaware’s history of law created has been defined by court, and there is a lot of precedent already 2. Liberal Corporate Code

Delaware is very pro-management Managers choose, typically, where to incorporate so it is an obvious best-choice

o Especially given the internal affairs rule 3. Legislature

Responds quickly to new corporate matterso Even calling emergency special sessions

Legislature were corporate lawyers in Delaware, and some judges, so there is relationship 4. Delaware Courts

Court of Chancery is specialized to entertain corporate matters Judges come out with rulings that coincide with legistature’s pro-corporate and management intentions Judges practiced at the top firms, wrote the corporate law as legislatures

o Self Perpetuating Cycle 5. Experienced Bar Overall The experience of the legislature, bench, and bar coincide to create

Experienced History Something other states simply do not have 3. Where to Incorporate:

o Analysis: an inquiry into whether one should incorporate in Delaware, or their home state Where will your Principal Place of Business Be? 1. If in home state, cost to incorporate within home state

If you incorporate in Delaware, additional costs:o A. You will have to pay the incorporation fees of Delaware, + franchise taxes of the Delawareo B. You will also need to “Qualify to do Business” in your home state, where your principal place

of business will be Must file statements within states you will operate paying these fees as well so 3

possible fees or 1, if you will do business in 1 area This is similar to LLP foreign practice rules (see infra)

2. Substantive advantages or disadvantages of corporate law in that state o Generally:

If you are a small, privately owned business who will conduct business in 1 state and Shareholders and Management largely overlap

Incorporate locally This lowers franchise fee cost, and ends need to “Qualify to do business,” lowering costs in general Also For 1933 Securities Act exemption, makes sense

4. How to Incorporate :o 1. Professional Responsibility:

From the outset, you should as a corporate attorney, specify whether you are representing the corporation (Fictional Person) or the real people

o 2. The Process: Incorporating is very easy

Postcard, or online filing costing very little and taking very little time But, while services offer quick methods, “You get what you pay for” and should use an attorney

whenever particular needs must be met 1. Incorporator and Promoter:

Promoter: Person who directly or indirectly takes the initiative in founding and organizing the business or enterprise

37

o Person that comes in wanting to make a corporation: The business persono Can be the incorporator…but may not be

Incorporator (MBCA §2.02): someone, a lawyer or secretary, who files the articles of incorporation with secretary of state

2. What the Incorporator Does: 1. File in Secretary of State’s Office:

o Incorporator files the document, which is in English and typed (Article of Incorporation with all requirements of §2.02) file in the secretary of state’s office MBCA § 1.20 (a, b, c, d, e, f, i)

Foreign name is ok, as long as in English letters 2. Must Sign:

o The incorporator executing the document must sign it, and state the capacity he is signing it in MBCA § 1.20 g

3. Must Pay:o The correct filing fee, franchise tax, license fee, or penalty required must be paid MBCA §1.20 j

4. Incorporator is Contact Point throughout the processo MBCA § 1.20 f

3. What Secretary of State Does: 1. File the Article of Incorporation

o MBCA § 1.25 a 2. Deliver a copy of the document to corporation or representative with date/time of filing

o MBCA §1.25 b 3. If refuses to file, must return within 5 days

o While the process is not very difficult, sometimes it may take longer then 5 days 4. The Corporation existence begins when the articles are filed

MBCA §2.03:o The Secretary of State’s filing is conclusive proof that the incorporators satisfied all conditions

precedent to incorporate, except in a proceeding by the state to cancel or revoke the incorporation

MBCA §1.23:o (a)Document is effective at the time and date of filing, as evidenced by means the secretary of

state may use to record the date and time Filing can be manifested by a stamp or certificate

o (b) at the time specified in the documento (c) The document may specify a delayed time and date, and if does, it becomes effective at that

time and date. Delayed date cannot be greater then 90 days after filing. If no time, then close of business on the date

5. What the Articles of Incorporation Filed must contain: MBCA §2.02 (a) :

o 1. Corporate Name for Corporation that satisfies §4.01 §4.01(a):

1. Required Word: word corporation, incorporated, company, limited or abbreviation of corp., inc., co., or ltd.

2. Cannot violate §3.01o a. If you have a limited purpose in your articles, you cannot name

your corporation beyond that purpose Note: If you are a boat company only, cannot name yourself

Taco Stand co….o b. A regulated business, subject to regulation under another statute

may incorporate only if you follow that statute §4.01 (b):

Corporate name must be “distinguishable upon the records” of the secretary of state from:

38

o 1. Corporation name already incorporated or reserved Note:

o MBCA only looks to possible confusion of names SOS runs down list, to see if confusion

o If, to the naked eye, it is distinguishable you should be oko Historical: the historical function was to evaluate “deceptively

similar” names, dealing with unfair competition etc… Now, the name is for confusion only, and deception or

competition is another class… §4.01 (c):

if it is not “distinguishable upon the records,” the secretary of state shall authorize the name if:

o 1. Other corporation consents to use in writing and changes its name to something distinguishable

o 2. Or, applicant delivers secretary of state copy court judgment that applicant can use the name

§4.02 Reserved Name: A person can reserve the use of a corporate name by delivering application to

secretary of state for filing. Application must have

o 1. Name and Address of Applicanto 2. Name desired to be reserved

If accepted, reserved for 120-day period §4.03 Registered Name:

Foreign Corporation may register its corporate name if it is distinguishable upon the records

Application must:o 1. Have its corporate name and description of businesso 2. Have Certificate of existence from state or country of incorporation

o 2. The Number of shares the corporation is authorized to issue: The Number of shares and Class of shares §6.01: The classes of shares, and if more then 1 class must provide distinguishing

designation for each (A & B) (see infra, section on shares) The terms, rights and limits of each class

o 3. Street address of the corporation’s initial registered office and name of initial registered agent

Ensures that the corporation has a publically stated place for service of process The agent there must meaningfully be able to respond to process Note: Many law firms recommend that their office be it—this avoids any confusion or

mix ups with legalese o 4. Name and Address of Each Incorporator

Uncertainty if this means the home address or not Call and ask each state for their preference

Discretionary Additions—MBCA § 2.02 (b):o The Articles of incorporation may include:

1. Names of initial directors 2. Purpose of corporation 3. Powers of Corporation

Note:o These last two are limits on the broad allowance of §3.01 (purpose of

corporation to do any lawful business) and § 3.02 (broad powers)o Recommend to client to not have any limits…defaults are broad

enough 4. Par Value of Shares

39

5. Implementing or Eliminating Limited Liability of director or shareholder 6. Mandatory indemnification of director if any liability ensues

6. After Incorporation Initial Meeting Occurs: §2.05

o 1. If initial directors were named in articles, they shall hold organizational meetingo 2. If initial directors were not named, the incorporator shall hold the meeting to

a. Elect directors and complete organization or b. Elect board of directors who shall complete organization

In Meeting:o 1. Create By-Laws: an internal set of operating rules (§2.07)o 2. Elect officers and set their salarieso 3. Minute Book and Corporate Seal

May be seen, in jurisdictions, as presumptive evidence of corporate actiono 4. Issue Stock Certificates (although uncommon and not required)\o 5. Accept “subscription of shares”

Begin looking at who wants to buy shares, and selling to themo 6. Open a Bank Account

Set limits on who has authority to write certain check sizeso 7. Reimburse the Promoter

typically the promoter is a director, and is compensated

o 8. * Ratify Pre-Commencement Contracts of promoter* If promoter has entered into any contracts, bought any land, etc…the Corporation must

Ratify that contract to be bound 5. The Decline of Ultra Vires:

o Beyond the Scope of Power a Corporate Charter allowso Only applies to formed corporation, not faulty or pre-incorporationo General History:

Historically, Ultra Vires was utilized out of fear of the Corporation. The historical view of the corporation was one fraught with fear, and this was used to limit corporate acts.

Due to the historically limited purposes of corporations, Ultra Vires would be raised to argue a corporation did not have the power, and therefore no contract ever occurred, because beyond purpose

No matter whether all shareholders, directors consented to it Ashbury v. Riche:

Corporate Articles had that it was an engineering company, but it entered into contract to buy railroad Held: This was beyond the power of the company, therefore Void

Historical Implications: Resulted in unfairness, setting aside transactions that didn’t work out, and since has been strictly

circumscribed in scopeo Application to Corporation or Partnership:

Doctrine applied to corporations because of their limited scope Does not apply to Partnerships, because inherently they had power to act within scope of their business

Can agree to whatever you want in partnershipo Modernly:

As restrictions and limitations on corporation purpose and power eroded, the doctrine of Ultra Vires declined… MBCA §3.01 allows for any lawful purpose of business MBCA §3.02 sets out the broad powers corporations have and the perpetual duration of them

1. Rule: MBCA § 3.04: A. The validity of a corporation’s act cannot be challenged that it lacked power unless:

o 1. Shareholder against corporation to enjoin the acto 2. By corporation, directly or derivatively against an incumbent or former director, officer, or

employee or agent of corporation… o 3. By Attorney General

Court ordered dissolution of corporation [MBCA §14.30]

40

B. If shareholder does bring suit under option #1, the court may enjoin or set aside a corporate act, if equitable and may award damages for loss suffered by corporation or other party as a result of enjoining

2. 711 Kings Highway v. FIM’s Marine Repair F: π brought suit claiming ultra vires of corporation, arguing that §3.04 did not apply to π and was only

applicable to ∆’s defense. Rule

o §3.04 applies to both π and ∆ There is limited standing to utilize Ultra Vires; the only 3 options listed are the only three “shields” or “swords” ultra vires can be used as

3. If a corporation does have limited purpose and power Tallahatchie Valley v. Miss. Propane Ass’n:

o F: Shareholders brought ultra-vires suit against ∆ who purchased a subsidiary outside of scope of business

o R: Ultra Vires is Equitable principle and court will not enjoing something unless it is

equitable Here: Wholly owned subsidiary was legally operating within its scope Rule May be able to use a subsidiary to do what you, due to your limited

power/purpose, cannot do 4. Purpose and Power of Corporation:

§3.01 MBCA all corporations have purpose to engage in any lawful business §3.02 MBCA every corporation has powers, as individual to do all things necessary and convenient

to carry out business affairso Lists many powers They are extremely broad, and plenary (unlike historical view, supra )o These broad powers may be limited by “necessary and convenient”o 1. Sue and be suedo 2. Make and amend by-lawso 3. Purchase, lease, receive, acquire…propertyo 4. Sell, convey, mortgage…its propertyo 5. Contract, guarantee, incur liability…etc…o 6. Lend, invest, receive…o 7. To make Donations for public welfare for charitable scientific, or educational purposes

Corporations have power to donate to non-profit Although it may not be within their purpose they have the statutory power to do

so Can they sell all assets to donate?

o Maybe not “necessary or convenient” o But can donate up to deduction limit

Corporation Illegal Acts: Shareholders may seek to enjoin, through §3.04 (b) 1 suit, a corporation’s illegal

acts Corporate Crime:

Similar to illegal acts, may be an ultra-vires argument This may, however, with damages payment punish the shareholder for

corporations crimes 6. Premature Commencement:

o Prior to the formation of the corporation, liability may arise for promoter in certain contexts The promoter may enter into contracts, expecting to be compensated later (In Original Meeting)

o Promoter has Duties to and may be liable to: 1. Duty owed to Co-Promoter

Fiduciary duty is owed between them (Analogous to Partnership Fiduciary Duty)o May be treated as analogous to a General Partnership (Joint Venture), so fiduciary duty applies

between the General Partners o Must have good faith and honesty with co-promoters

41

2. Duty to avoid fraud A. To Prospective investors

o Must give them information that may influence their decisions o State Law Civil Fraud o Federal Law Securities laws

B. To Creditorso Idea is that promoter converted corporate assets from creditors to own useo Illegal

EG: You sell something to a corporation you are a director for May be self-dealing issue, and if creditor funds used, may be liable

C. To the Corporation:o A Fiduciary duty is owed the corporationo May be issues of Self Dealing (discussed infra)o Old Dominion Case:

F: Promoters took their land, and sold it to their corporation for 3x price paid which was 2x FMV. They used the heightened price to boost assets shown to shareholders, but when shareholders identified problem they sued

o “Old Dominion Split” Majority Rule:

Fraud may exist if potential future investors are contemplated Promoter is in fiduciary relationship with the corporation, and future investors

treated as though they were there when happenedo No one was around to bring suit at time of fraudo Idea that inflated property values defraud the future shareholderso Note:

If there were no future investors contemplated, then this may not apply

Minority Rule: Fraud does not exist for potential future investors, because at the time you only

defrauded yourself 3. Other Liabilities of the Promoter:

Pre-Mature Commencement Rule o A promoter for a non-existent corporation is bound, when the 3P Knows corporation

doesn’t exist, unless 3P agrees to contrary (Agent for non-existent Principal) Note:

When the 3P knows:o Defective Incorporation doctrine (infra) doesn’t kick in

When 3P doesn’t know:o Defective Incorporation Doctrine kicks in (See infra)

o However: Nuances in language and conduct may give the Court reason to find an “agreement to

contrary” To avoid this—be as clear as possible in the drafted Contract Bob Hope—“For corporation to be formed later” doesn’t discharge default rule

You are an agent for non-existent princpal…you (promoter) is liable o 4 Alternative Constructions to argue:

1. May be understood that 3P is making a revocable offer to the non-existent corporation which will be a contract if corporation is formed and ratified

Promoter Not Liable 2. May be understood that 3P is making an irrevocable offer for limited time. Must

have consideration to keep open. Consideration can be the promoter’s promise to organize corporation and use his best efforts to cause it to accept offer

Promoter not liable, unless didn’t use best efforts

42

3. May be agreed that promoter is bound by the present contract but, with agreement that liability ends if corporation forms and ratifies

4. May be agreed that present contract, even though corporation does become a party, the promoter remains liable primarily or as surety

o Burden of Proof is on the Promoter to show some other agreement existed then defaulto Stanly How v. Boss:

F: π entered into contract with ∆ promoter, who only paid part of contract. Then, corporation that was supposed to be formed did not. ∆ signed “/s/ Edward Boss, agent for corporation to be formed later, who will be obligor”

R: These words show future obligation, but not who is presently obligated Testimony didn’t show corporation was sole obligor Not enough to show a different intention, other then the default rule, the

promoter is liable unless third party agrees otherwise… “Who will be” alerted to corporation being liable later, but didn’t clearly show if

that would end promoter liability, or what happened pre-incorp.o Proper method of Signing for a corporation

A signature should show that you are signing in an agency capacity on behalf of corporation Incorrectly signing may show that you are signing personally, making yourself liable (Like above)

Correct way: o ABC Corporation

By: /s/ Bob Hope Its: Typed Title (Agency Capacity)

o Make sure you sign in agency capacity, and not: /s/ Harry Snow

Harry Snow, President of ABC Corpo Here, Court said that ambiguous and shows that he is signing for

himself, simply noting he is corporate officer /s/ Edward Boss, agent for corporation to be formed later

You are an agent for a non-existent Principal…you are liable hereo Effect of Contracts created prior to incorporation on Corporation

1. The corporation is not bound immediately to the contract the promoter created Must Ratify it

o Express: May be expressly ratified at initial meeting

o Implied: May be informally ratified by accepting the benefits of the contract

o Lawyer Fees of Promoter 1. The Promoter is Bound, unless contrary agreement occurs

o Contracts are retroactive to time they were created 7. Defective Commencement:

o General: When the 3P doesn’t know the incorporation is non-existent, defective incorporation doctrine kicks in These doctrines are used to either create Limited Liability, even though the corporation does not exist yet, or

decline Limited Liability to the Promoter who knows the corporation doesn’t exist, but acts as though it does…o At Common Law:

1. De Jure Corporation: Court would determine that while not correctly created, complied with all mandatory conditions Effect Limited Liability against:

o Good against the whole world…not even state can challenge charter 2. De Facto Corporation:

4 Elements:o 1. There is valid law to create a corporation

43

o 2. Attempt to incorporate in Good Faitho 3. Actual use and operation as a corporation in good faith

Effect Limited Liability against: o Good against all except the stateso State can bring ‘quo warranto’ proceeding, to revoke corporate charter

3. Corporation by Estoppel: Idea that someone has dealt with the corporation, but attempts to sue to hold an individual in corporation

personally liable Mainly, it estopps a 3P from claiming he dealt with an individual and not corporation

o By passing any limited liability o 2 Elements :

1. Holding out 2. Change in position, in reliance on the holding out

o Effect Limited Liability against: Good against the person estopped

Note: There has been studies that have shown the CBE, and De Facto corporation have intertwined in

application by judiciaries… When the Court imputes these doctrines, it imputes that Limited Liability exists for the person

o But see De Facto/Estoppel in who the LL is effective against o Modern Defective Corporation: MBCA:

1. §2.03 “Conclusive Evidence Statute” The corporate existence begins when the articles of incorporation are filed

o Prior to you are not corporation The Secretary of State’s filing is conclusive proof that incorporators satisfied all conditions precedent to

incorporation… 2. §2.04 “Purport to Act”

All persons who purport to act as or on behalf of corporation, knowing there is no incorporation under Act are jointly and severally liable for all liabilities

Note: MBCA says that incorporation is so easy that nothing short of incorporation should give privilege of

Limited Liability Makes clear If you know, and purport to act…you are liable Makes Clear If you don’t know, and act…probably not liable Technically, does away with De Facto Corporations and Corporations by Estoppel But: 2 ways to go if Promoter Does not Know

o Literal Application of Statute If you didn’t “Know” No J&S Liability EG: lawyer screws up the filing…you can say you didn’t know, or perhaps didn’t

“purport to act” o Revert to Common Law:

It only says what to do if you “know,” and not if you don’t know So Common Law doctrines have re-emerged, and still apply in this context

Note: States challenge a corporations charter, but doesn’t challenge the validity of a corporation’s contracts

o MBCA § 14.30- AG can get Judicially ordered dissolution for many reasons—none dealing with that

specific corporation’s contracts Note:

What if there are two promoters, one of which is completely passive?o 1. Literal Application: Under §2.04, if 1 promoter didn’t know, co-promoter didn’t know then

No J&So 2. Co-Promoter Partnership Analogy:

Could argue that co-promoters, even if one is wholly passive had a general partnership (Joint Venture). Therefore, if one partner is acting with the scope of the business, he is

44

within his authority to act, and he may therefore incur partnership liability making them both liable

8. Disregard of the Corporate Entity o General:

Disregard or Piercing of Corporate Veil: Merely a theory the court uses to set aside the shield a Corporation creates for a shareholder, holding the

shareholder personally liable for corporate obligation in certain scenarios o Should a specific shareholder be liable personally for a specific corporate obligation

Policy: o When Court pierces, it sets aside legislative intent to create Limited Liability through the

corporate formo But—in limited circumstances, the court deems it an acceptable tool

There is no 1 method of Piercing or Disregarding, and therefore difficult to advise or apply Studies have shown it is done mostly with Closely Held:

It is mostly done with closely held, or 1 person corporations Never with publically traded corporations

Jurisdiction Type of ∆ Contract or Tort Result Approach

NY Org. Contract No Pierce Fraud, Misrepresentation, Misleading acts

SC Individual Contract Pierce Factors + Injustice

SD Individual Tort No Pierce Factors (Corporate Formalities must have causal connection to π’s damage) indicating Injustice

Mo. Org. Tort No Pierce 3 Step Test and Capitalization includes amount of insurance & Regulators assessment

9th Cir, PA Og. Statutory No/Yes Court will use policy approach, not to pierce, but to disregard the corporate entity to implement the underlying statutory policy

o New York Approach—Bartle v. Homeowners: F: ∆ was parent corporation of π. Π seeks to hold ∆ liable for contract debts it made. ∆ created π to provide at-cost

housing for the ∆ shareholders. Building costs, however, got too high and went into bankruptcy. I: Should the Corporate Veil be pierced, holding ∆ corporation liable? R:

Majority: o Piercing is used to prevent fraud or achieve equityo To pierce—Look at fraud or misleading action of parent corporationo Look at depletion of assets causing injury to creditors o If no Fraud or Misleading action No Piercing of Corporate Veil

Dissent: o It is uncommon to create a corporation to sell at cost, so that it can solely break eveno Unorthodox corporate usage gave the stockholders cheap, at cost homes, but the π’s got the

liability pushed to them Argues that the savings in cost to the ∆ shareholder-corporation was an ‘illicit

dividend,’ and since π cannot pay its debts, shouldn’t pay dividend to parent corp.o Agency Theory:

The parent corporation is the principal and the subsidiary is the agent Liability for agents contractual deeds Parent Corporation Should be liable

o South Carolina Approach—Dewitt Truck Brokers v. W. Ray Flemming Fruit Co.:

45

F: ∆ Flemming was essentially the sole shareholder of his corporation, taking fruit from growers and giving it to the transporters—he was a fruit broker, essentially. Π is a trucker, who brought suit to receive his transportation costs he was owed. The corporation, indebted cannot pay, and π wants piercing of corporate veil to hold ∆ shareholder personally liable.

R: The Corporation is a separate entity, a legal fiction The court declines to recognize it, piercing the veil, when would produce injustice Test: Factors + Injustice to the π

o Factors Evaluated: 1. “Alter Ego” Instrument Theory: When substantial ownership of all stock in single

individual, combined with other factors Courts will treat corporation as you “incorporating your job” Treat the Corporation as a Façade for the operations of dominant shareholder Treat the Corporation as your alter ego, piercing the veil

2. Undercapitalization: When lacks the capital to perform the corporate undertaking, it shifts risk to the

3P from the corporation because corporation cannot pay out and 3P cannot recover

Note:o Some cases hold that undercapitalization in a contract case, with a 3P

who continues to do business without getting assurance of personal guarantee of shareholder cannot gain pierce

o Varies whether the onus should be on the 3P to check or on the corporation to keep track of their own capitalization

Note: Not just undercapitalization o Being undercapitalized, by itself, and unable to pay a claim does not

automatically mean piercing occurs—would happen too often…so there must be more

3. Failure to Observe Corporate Formalities: Court expects you to follow the rules—if not, they’ll disregard the form you

seek protection under Having meetings, keeping records establishes legitimacy Butoverall, this doesn’t seem to exactly link to a π seeking piercing…

4. Non-Payment of Dividends: this is an irregularity, that corporation isn’t doing what it is meant to

5. Insolvency: Was the corporation insolvent when the transaction was entered into?

6. Siphoning of Corporate Funds: 7. Lack of Records:

exhibits an irregularity with the corporate form 8. Lack of Functional Officers:

exhibits an irregularity with the corporate form Also must exhibit an element of injustice

Courts generally require a manifest injustice, fraud of some kind…o ∆ personally guaranteed owed amount:

Oral guarantees are common in piercing cases If you are guaranteeing that you will be responsible if corporation is unable to, Statute

of Frauds may apply—somewhat fraudulent of corporate shareholder then, to do orally to induce continued commitment

Creditors commonly get in writing o South Dakota Approach—Baatz v. Arrow Bar:

F: π’s were injured when patron of ∆ bar hit them. Π sued ∆ corporation due to their allegedly serving patron alcohol while he was intoxicated already. Individuals owned corporation and didn’t have insurance.

R: Looks for factors that indicate injustice

46

o Factors identical to above 1. Personal Guarantee

o Here, ∆ individuals personally guaranteed a corporate loan—but it was to a creditor, and not to the π tort claimant…cannot be used as promise to tort claimant (Frivolous)

2. Alter Ego Theory:o Sometimes used to argue the corporation was the agent for the shareholdero When the corporation is the alter ego of the shareholder, may disregard the entity to treat both as

one entity But here Didn’t establish any facts that ∆’s were merely using the corporation as

their alter ego 3. Capitalization:

o You must show that the capital is inadequate to satisfy corporate liabilitieso Here didn’t show it

4. Formalities:o The lack of formalities must have a causal connection to the injury

Here The factors were not met, and did not indicate any injustice o Missouri Approach—Radaszewski v. Telecom Corp. :

F: π was on motorcycle when hit by a driver of Centrux, Inc. Centrux is a subsidiary of Telecom Corp. π sought to pierce veil of corporation to reach the Parent corporation

R: 3 Part Test:

o 1. Control, complete domination of finance, policy, and practice, so that entity had no separate existence from shareholder

o 2. Control must have been used to commit fraud or wrong, violate legal duty or dishonest and unjust act

o 3. Control and breach of duty must proximately cause the injury To determine if Control used to commit a fraud look to undercapitalization

o Stands for the idea that parent corporation was deliberate or reckless in creating a business that cannot pay its bills or satisfy judgments against it

If so fraud/wrong and veil may be piercedo To value Capitalization: Is it Financially Responsible?

Capital + Value of Insurance meets this Compliance with Regulations Weighty in Assessment of Piercing:

o Judiciaries will accept, and defer to a legislatures/Regulators assessment of a corporations o If Regulator/Legislature sets an amount that is acceptable, and you meet it this will signal the

corporation being financially responsible and properly capitalized o Commonly accepted by judiciaries

o Supreme Court—United States v. Best Foods: F: Corporation, Ott, was discharging toxic waste and contaminating land. CPC then purchased as a subsidiary for

stock. It was eventually bought and sold a few more times, but court concentrated on CPC’s connection to subsidiary Ott. EPA brought suit under CERCLA to hold CPC liable for cleanup costs.

I: Does CERCLA create liability for parent corporation from owning subsidiary? R:

1. The state common law is that merely owning a corporation or subsidiary does not create personal liability

o In CERCLA, Congress was silent on overriding this bedrock principle…so it standso No derivative liability for Parent Corporation other then Piercing

Owner of Subsidiary Operator of Subsidiary

Parent owner of subsidiary is only liable if the corporate veil is

Parent operator is liable if veil is pierced orParent operator directly operates that facility

Not merely overlapping personnel of parent corporation’s

47

pierced people serving for subsidiary this is commonly practiced and would create personal liability for parent corporation all the time…would undo common law doctrine of LL for owners

Presumption that overlapping personnel are acting for subsidiary (corporate personalities remain distinct

But, Overlapping personnel may create problems Must show that Parent corp. personnel were acting for the

parent corp, or had no other possibility then managing facility for the parent corp.

Difference in oversight of subsidiary and control of its facility so that you parent corp was the one operating and can be held liable

o Here: ∆ parent-corporation had Williams, who was only on their payroll, was not an officer,

employee, or director of the subsidiary, but was involved in the plants operations This was sufficient to impose direct liability on the Parent Corporation,

responsible for its own actionso The Parent Corporation Subsidiary Context:

While it makes sense for a corporation’s owners, shareholders, to have limited liability, why should a Corporation get Limited Liability for its subsidiary?

Economically makes sense to wall off each entityo For all the reasons we stated much earlier supra

Enterprise Liability/ Horizontal Piercing EG:

o Instead of owning 1 corporation with many different cabs, lets assume 1 person incorporates each cab so that he has 16 corporations.

o Lets also assume each has the statutorily mandated minimum insurance so that they are all well capitalized

Thereforeliability of each corporation is limited to the cab+ insurance What if liability exceeds that, however—should we pierce?

Enterprise Liability / Horizontal Piercing: o Prevents the artificial dividing up of 1 entity, into make entities to gain limited liabilityo If too many small corporations, courts may utilize the same factor tests above to merge all into 1

corporationo While corporation gives the Limited Liability we want, we don’t want people creating artificial

entities for the sole purpose of limited liability, shifting risk on person injured o Policy View of Piercing the Corporate Veil:

Generally: While courts will evaluate the methods described above, courts may also look at underlying policy to

pierce or not pierce a corporate veil Utilize this method other then the factors The underlying policy or statute may be grounds to disregard corporate entity

Stark v. Flemming: F: π placed all of her assets, farm and duplex house in a corporation. She drew a $400 a month salary

from it. Because of the salary, she was able to gain social security benefits. However, the Secretary of Health, Education ruled it a sham and ended her qualification for social security.

R:o Under typical piercing case, she met all the factors and would not have been piercedo Congress, within social security statute, did not preclude corporations social security status

Therefore, we cannot disregard what the statute didn’t specifyo However:

48

The salary may be off what a market rate would be, affecting her social security benefits, but the interpreted statute has nothing regarding piercing a corporate veil for it

Roccograndi v. Unemployment Bd. Of Review: F: All 3 appellents were family members, and owned over 1/3 of stock. During periods of insufficient

income, the corporation would hold a meeting, and lay off the 3 “who’s turn it was.” 3 were laid off, filed for unemployment and were denied. Denied, because they were self employed within the meaning of the statute

R:o The statute specified that if self-employed, could not gain unemployment benefits because you

had the power to lay yourself off…exactly what they dido Because clearly within meaning of statute, disregard corporate entity to avoid taking advantage

of statuteo A court will disregard a corporation, solely owned that employs its shareholders, because statute

may be taken advantage of Overall:

While the typical disregard tests may not exactly apply, courts may utilize an underlying policy/statutory objective to disregard the corporate entity

Methods of holding Shareholder Liable

Pure pierce or Disregard of Corporate Entity Other Shareholder Liability

1. Fraud, misleading method 1. Personal Guarantee (In Writing—Flemming)

2. Factors + Injustice to π method3. Factors that = Injustice4. Control + Fraud (Undercapitalizion = Capital + Insurance) + Cause -Causal Relationship between factor and injury

5. Disregard for Policy Purpose

2. As Agent for corporation Tort: If shareholder commits tort,

agents are liable for own tort Contract: Shareholder may enter

contract, failing to disclose corporation as principal (Agent for undisclosed principal liable in K)

These 2 options diminish LL the corporate entity gives 1 shareholder (if only 1)

3. Corporation acting as Agent for Shareholder Shareholder, as principal is liable EG: You employ your own

corporation (A) to work for you—as P, your liable (P liable for A torts)

4. Because Statute Says So

CERCLA Watered Stock Liability/ Statute

o Reverse Piercing the Corporate Veil: Generally:

Process: o Look at the Purpose to be served from the reverse pierce

Rarely used Disregarding the corporate entity, treating the shareholder as the alter-ego, or simply as same as

corporation for some purpose other then liability

49

o Courts will perform a ‘reverse pierce’ and disregard the corporate entity in the name promoting good policy

Potential Consequences: Although extremely rare to be used, it may harm the creditor

o The corporate form protects the shareholder from person liability from creditors, but when reverse piercing occurs, it also keeps corporate assets out of creditors reach as well

Sort of ‘best of both worlds’ for shareholder Cargill v. Hodge:

F: ∆ created corporation, and put his farm in the corporation. He purchased supplies from the π (didn’t tell π about corporation, but shareholder liable as Agent for undisclosed principle, and principle liable). When ∆ defauled on payment, π bought back farm. The homestead law allowed for individual to get their dwelling back equitably…but corporation didn’t qualify

I: Should a corporation reverse pierce occur? R:

o Reverse Piercing may be used to give shareholder benefit of not being a corporation Factors evaluated:

Alter-Ego/Instrumentalityo The more alter-ego, the more likely to reverse pierce

Degree to which creditor harmed Policy

o Punishing person solely for being incorporatedo Depriving him of some right?o Sympathetic to shareholders situation?

Factors + Policy + Sympathyo Here:

∆ was going to lose his home…the court disregarded the corporate entity because he owned all the stock, it was his alter-ego, and he was being deprived a constitutional right

o Equitable Subordination: General:

Court’s ability to re-order the payments in which creditors get paid Is not piercing Differentiation between Corporate and Partnership Law:

o While in partnership law, UPA §40 (1914) partners are statutorily subordinated automatically, corporate creditor shareholders are not automatically

This is because the partners made themselves liable to pay off, so it makes sense you’d pay them last

In a corporation, shareholder bargained for limited liability, so not as clearo Application:

Equitable subordination may occur more often with fewer shareholders, but the more shareholders who don’t control decisions, less likely they’ll be subordinated

Pepper v. Litton: F: ∆ owend the π royalties under contract. When π brought suit, ∆ confessed, and forced a sale of

corporations asets. ∆ then bought back the assets, filed for bankruptcy to attain the proceds not used to satisfy the judgment, to by corporation debt free.

R:o Officers always have a duty of good faith to the company

If they have a claim as creditor, sometimes court may disallow or subordinate Rule:

Violation of fairness, good faith conscience and breach of fiduciary duty to shareholders, corporation or creditor

Burden is on the ∆ to prove he dealt in good faith and fairness with corp. Community of Interests

o The protection is for the creditor & shareholdero Fiduciary duty owed to both, and enforceable by both

50

Courts will also evaluate piercing factors: o To determine ‘fairness,’ courts will look to factorso Undercapitalization, siphoning of funds, and fairness to determine if

fairness/good faith were violated

o Piercing and Alternative Entities Generally:

Corporate jurisprudence will be looked for as a guide Many common factors

o However: Corporate Formalities factor is not as applicable, because in an LLC/LLP there simply

are not as many formalities Furthermore, given that some courts require causality between the formality and injury,

it is even less likely they’d be utilized in analysis to pierce an alternative entity Not applicable to General Partnerships

o They already have liability 8. Financial Matters and the Corporation:

o A. Debt and Equity Capital: Debt:

Borrowed $ that must be repaid at some point in time, regardless of success of business Made up of Principal and Interest ‘Fixed Claimants:’ entitled to repayment of principal and interest

Equity: “ownership” composed of contributions by original entrepreneurs, capital contributed by subsequent share purchased

and retained Earningso Retained Earnings + Capital Account = Equity

‘Residual Claimants:’ that have claim to left over after debt holders are paid offo B. Types of Equity Securities:

Share: MBCA §1.4(22): ‘units in which the proprietary interests in a corporation are divided §6.01: Articles of Incorporation must set out:

o (a) Amount of shares, classes of shares, and series of shares Each class must have a distinguishing designation All shares in same class must have identical rights

o (b) Common Stock 1. One or more classes of shares that have unlimited voting rights 2. One or more classes of shares that together are entitled to receive net assets upon

dissolutiono (c)

Articles of incorporation may set out Holders of stock entitled to distributions or dividends One or more classes that have special, condition, limited rights Redeemable, convertible Cumulative, non-cumulative, partially cumulative Preferred

§6.03 (c) o At all times, shares of corporation outstanding, one or more that have unlimited voting rights and

one or more that together entitled to receive net assets of corporation upon dissolution must be outstanding

Common & Preferred: Common:

o Class that has fundamental rights of voting and receiving net assets of corporation on dissolution May be within same class, or may split differently

o Have right to inspect books, right to sue on behalf of corporation

51

o Differing Classes: May have different financial, voting rights, etc…

Preferred: o Typically has priority of preference to common stocko The scope of rights of preferred shareholder is set out in articles of incorporation o Attributes:

Priority in either dividend or distribution of capital Dividend distribution from current/retained earnings Distribution payment out of capital

o Special Rights of Preferred Share: Cumulative Dividend Right:

If PSH not paid dividend, it accumulates, and must be paid later, prior to a common shareholder’s dividend

Simply a priority right over dividend to common shareholders Non-Cumulative:

o If dividend is not declared, PSH simply loses the right to that dividend

Partially Cumulative:o Cumulative to the extent of earnings in a year, but non-cumulative if

none Voting:

Preferred stock is typically non-voting But, it may provide that shares gain the right to vote for election of specified

number of directors, if preferred stock dividends are omitted

Liquidation Preference: Often specified at a per-share price, it is payable at dissolution of corporation

prior to paying any dividend to common stock Fixed amount in Articles of Incorporation

Redemption Right: “Callable” Some preferred shares are callable at the corporations request, at any time for

any reason at a fixed price Shareholder must accept

o If refuses corporation deposits $ in bank account and does not recognize shares

Conversion Right: Preferred shareholder may get the right to convert their share into another

security, at holders option Typically a fixed ratio for conversion While may also be redeemable/callable, the conversion right typically stays

open after a redemption call “Forced conversion” Protective Provision:

Sinking Fund: Corporation sets aside money to buy back Dilution provisions]

Participating: A Participating Preferred Share is one that gets the preferred dividend in

addition to a pre-determined piece of additional capital made Non Participating Preferred Share gets the dividend, liquidation preference but

does not matter what earnings are does not share in them Classes:

Preferred shares may be in different classes with an assortment of rights above varying throughout

As preferred, however, they are senior in status to claim over common stock Series:

52

MBCA §6.02 states “Board of directors, if articles of incorporation permit, may…reclassify any unissued shares of any class into one or more…series within a class”

o Series within a class arose so that Board of Directors could issue newly priced shares, based on market value, without going back an amending the articles of incorporation everyime they wanted to issue more shares

o Now Articles of Incorporation authorize “Class of Shares” without financial terms, so that Board of Directors may create differently priced series from that class

o C. Par Value, Watered Stock Liability, and Ineligible Consideration: Historical (No Longer Good Law):

Par Value: was an arbitrary number that was typically higho Purpose Served:

1. Assured that everyone paid the same amount 2. Assured creditors that there was capital in the corporation to recover from

Watered Stock Liability: o Stock Holders are liable for an amount paid less then par

Generic Term for: Discount Stock Paid for, with cash less then par Watered Stock Paid for, with property less then par Bonus Stock Not paid for at all

Ineligible Consideration: o Promissory Note and Future services were banned as consideration for shares

Purpose: Fear that party receiving stock wouldn’t actually get paid

1969 MBCA Generally:

o Still Good Law: Still used in Delaware and New York Par Value: §21

o With Par: If corporation issues with par value, the corporation shall constitute consideration received as ‘stated capital’ and excess if any in ‘capital surplus’

Equity Account: Earned Surplus / Retained Earnings (Net Income) Paid In Capital

o Stated Capital Account [Par Value x # of Shares] o Capital Surplus Account [Amount sold for greater then par]

o No Par: If Corporation issues with no par value, the entire consideration constitutes “stated capital” unless the corporation determines in 60 days after issuance of any shares with no par, the Board of Directors allocate to capital surplus any portion of consideration received

* However: Cannot allocate to capital surplus, if any preferred stock had liquidation

preference o Effect: Corporations will make the liquidation preference equal to the

par value That way, the liquidation price of a preferred share will be in the stated capital account and any excess can still be put into capital surplus

Equity Account: Earned Surplus / Retained Earnings (NI/NL) Stated Capital sales price of no par, unless allocated by BOD Capital Surplusamount allocated by the BOD, subject to preferred share

limits

53

o Distribution Limits: Earned Surplus: May pay a dividend Capital Surplus: Distributable to SH, if AIC allow Stated Capital: Undistributable

Reasons for/against No-Par:

1. Avoids Watered Stock Liability (Although, statute obligation to pay consideration BOD determines)

2. Foreign Jurisdiction Issueso Should have par, because some states will require

3. Eases Trading and Capital Raising 4. Changes Franchise Tax

o Taxed on % of par, or if no par % of issue price (much higher) Ineligible Consideration:

o §19 Consideration for shares may be paid, cash, property, tangible or intangible, or labor or

services actually performed Ineligible consideration

Promissory Note or Future Serviceo Purpose:

1. Protects Creditors who rely on a corporations capital—that it’s actually there 2. Protects investors from dilution of their share interests

o Determination of Consideration: §18 MBCA (69):

Shares with par value may be issued for consideration, not less then par, that is determined by the board of directors

Shares without par may be issued for consideration determined by the board of directors

Watered Stock Liability: o 1. If you pay less then par, then Watered Stock Liability existso 2. Modernly:

Statute obligates you to pay consideration deemed due for the share So, while not technically Watered stock liability with a no-par share (as you

cannot pay less then par) you still owe the consideration required…if you pay with ineligible consideration, statute makes liable as well

§ 25 MBCA (69): Shareholders are only liable to corporation or creditors only for the obligation to pay the consideration which the shares were issued for

o Harewald v. Bryans, Inc: F: Shares were issued to 2 shareholders, who did not pay. Creditor foreclosed on

amount owed on note. I: Are shareholders personally liable? R:

1. Shareholder is not liable for capital beyond contribution 2. Statute §25 obligates you to pay, however, for your share which gives you LL

o Creditor May directly enforce against shareholdero Shareholder is liable up to capital contribution owed

Example of watered stock liability [paid-par] and statutory required consideration

Only Applies to Initial Offering Not Treasury Stocko Treasury Stock: Stock issued, and then required

1984 MBCA: No Par Value Mandated

o MBCA 1984, par value has no legal significance, and up to corporation to adopt it §2.02 (b): Corporation may set forth a par value for authorized shares or class

54

No Mandatory Equity accounts if No Par: o Paid In Capitalamount of capital raised from share saleo Earned Surplus Net Income or Net Losso Distribution Limits:

Insolvency Tests to determine when dividends may be paid (*infra) Tax:

Distributions from earned surplus are the subject of 2-Tier Taxation If there is par:

o Paid in Capital: Stated Capital: Amount = to Par Value Capital Surplus: Amount above par value

Eligible Consideration: o §6.21:

b) Board of Directors may authorize shares to be issued for consideration of cash promissory note, services performed, contracts for future services

c) Board of Directors determines what consideration is adequate e) Corporation may place in escrow shares issued for future services or promissory

note, or other way to restrict stock until future service occurs or is paid for o Overall-

There are no limits on eligible consideration **But: Check state constitutions May still have limit (North Dakota)

Watered Stock Liability: o Does not Existo But: Statute still makes you responsible to pay the consideration the Board deemed adequate

§6.22: Shareholder only liable to pay the consideration shares were authorized for in §6.21

o D. Debt: Seniority:

Debt is the senior most claim at dissolutiono Secured Bondso Unsecured Debentureo Preferred Stocko Common Stock

Note:o If someone has common stock. And is a creditor that has extended debt to the corporation,

equitable subordination may come into play… Leverage:

Borrowing Money to maximize your gain Taxing of Debt:

Interest: deductable by the corporation as an expense, taxable to the recipient Dividend: Not deductable, taxable to the recipient

Undercapitalization and Recharacterization: Sometimes, debt of a company will be recharacterized to equity, if undercapitalized If Shareholder has loaned corporation money, for purpose of tax advantage

o Beneficial with ‘zeroing out’ method of tax avoidance With 2-Tier taxation, interest expense increase lowers taxable income

Analysis: o Debt / Equity Ratio:

10:1 / 4:1 IRS will look at debt, analyze if shareholder disguising as debt to gain tax advantage Did you do it for tax purposes?

o Effect: 1. Loss of interest deduction 2. Becomes second class of stock

55

Lose §S-Corp election, unless Safe harbor Straight Debt Safe Harbor in § S Corporation

o In an S-Corporation, the safe harbor avoids recharacterization, and loss of §S-Corp if: Congressional Statutory Creation

o ‘Straight debt’ will not be recharacterized if: 1. Interest payment is not conditional on profits

Borrower has no discretion 2. No convertibility to stock 3. Creditor is an eligible §S-Corp shareholder

o E. Capital Structures of Corporation Factors Considered: Methods to Accomplish Goals:

-Eligible Consideration Issue -Fairness at Dissolution -Watered Stock Liability -Dilution-Obligation to pay by statute -Control/Voting-Taxation: -Profit-Sharing -Salary deduction -Undercapitalization -Interest deduction -D/E Ratio -§ S -Recharicarization - Personal Tax -Piercing/Subordination (bargain purchase of shares may be treated as income, taxed in year received shares)

-Deferred Issue of Stock-Different Classes of Shares

VotingLiquidation preferenceDividends

-Different Price-Debt-Zeroing Out-Low par/No Par shares-Escrow account for shares

56

See Notes in Folder, regarding problems p. 344-347 Alternative Entities:

If LLP or LLCo Gain check the box taxationo Then: Flexibility is greater

May contract to design control, profit shares, dissolution All may be done, without messing up tax structure

o F. Public offering and Securities Laws: Purpose:

Raise immense capital for corporation Liquidity for original shareholders Effect:

o Regulationo Deal with analysts and shareholders o Standards of Accounting (FASB, GAAP)

1933 Securities Act:o Focused on the initial distribution of securities by an issuer to the public

Initial registration is the whole point and whole process If shares are offered to public, you must comply (unless exemption)

Exemption in 1933 is not exemption in 1934 While 1933 registration typically leads to register under 1934, not always…

o Full disclosure to public o Definitions:

Underwriter: Any person who purchases from issuer to offer, sell, distribute a security Issuer: Any person directly or indirectly controlling or controlled by issuer

Effect is to impose the same requirements on the issuer as those controlled by issuer

So, sole shareholder in corporation cannot avoid 1933 registration by selling his own shares…he is controlled by issuer

o §5 Registration: Must register:

1. Prospectus 2. Other documents needed for SEC

Process: Expect a cost ~$800,000, on average for attorneys fees (not including CPA, IB) Choose an investment bank, but most won’t consider offering less then $10M Typically must get certified financial statements by CPA Choose Lawyers

o Securities lawyers have highest mal-practice insuranceo Because of detail of work, it is very complex and tough

Once Corporation side is doneo Sent to SECo Division of Corporation Finance reviews it, and makes commentso Red Herring go’s out, but no securities may be sold until registration

finalo 6 weeks -3/4 month wait

While after 20 days rule says ‘filed’ each comment SEC makes, restarts process

Final Registration/Prospectus Issued Requirements And Exemptions under 1933 Securities Act:

§5: Registration Requirement:o It is unlawful to offer, sell, or carry in interstate commerce, any security, unless it is registered

Violation:o 1. Willful Violation: Justice Department may bring criminal action

57

o 2. S.E.C. may bring civil enforcement o 3. Private Enforcement:

a. §11: Private right for misrepresentation in registration b. §12 (a) 1: Private right for violation of § 5 c. §12 (a) 2: Private right for misrepresentation in prospectus

Exemptions:o §3 Exemptions:

General: These exemptions are security specific, other then §3(a) 11, which pertains to

the transaction So, all initial issues of security must be registered, unless there is an applicable

exemption 1. § 3 (a) Exempt Securities:

1. Government Bonds (Federal, State, muni) 2. Commercial Paper

2. §3 (a) 11 Intrastate Offering Exemption: Any security, part of an issue, offered and sold only to residents of a single

state, where issuer of security is a resident and doing business within that state, or incorporated in that state

o Exempt from 1933 securities act registrationo Only Evaluates the location of investor

Unlike §4(2), where investors knowledge is evaluatedo 1 Bad Apple Doctrine:

* 1 non resident will end exemption* o Reason:

While the Federal Securities laws will not apply, local state “blue sky” securities laws still will apply

Intended to allow issuers with local operations to sell securities as part of plan of local financing, where investors would likely be familiar with the business and management

Rule 147: o Amended Created to help define §3 (a) 11o If you comply, you are guaranteed to have met §3 (a) 11o 3 80% Tests for ‘Doing Business within State’

1. 80 % of Revenue from the state 2. 80% of your assets within the state 3. 80 % of proceeds distributed there

o Integration Issue for ‘Issue’: A question of what the issue is…for purposes of the exemption: Must evaluate 5 Factors determine if 2 or more share issues should be treated as 1:

1. Sales part of 1 plan or financing 2. Sales involve issuance of same class of securities 3. Sales made about or at the same time 4. What type of consideration is received 5. Made for same general purpose If class and time are separated enough, securities lawyers

will deem the transaction probably ok to avoid integrationo Residence:

“Come to Rest” can only determine exemption once the securities have come to rest within a state or territory

Person determined resident when securities have come to rest within the state

o EG: X & Y executives, incorporated in Maryland, does business

in Maryland…

58

Buy securities from Corp. and claim §4(2) 1 Week later, sell to public under § 3 a (11) Should these be integrated to avoid the §3 a (11) exemption,

and §4(2) because they were close in time…therefore avoiding exemptions?

3. §28: Exemption for issue of any security at SEC’s discretion

o §4: Transaction Specific Exemptions: 1. §4 (1):

Exemption for transactions by someone other then an issuer, or underwriter or dealer

o This means secondary market: You, me… 2. §4 (2):

Exemption for transactions by an issue that does not involve public offering SEC v. Ralston Purina, Co. F: ∆-manufacturing company had a policy that allowed employees to inquire

about buying company stock. They sold about $2M worth of stock, without soliciting the sale from people.

o Corp—argues its exempt because not public, only to subset of employees

o SEC—argues for a fixed number, that makes an offering ‘public’ I: What is a ‘public offering’ as not exempted in §4(2)? R:

o 1. Public: The Act’s purpose is to protect investors, by full disclosure of information

Public= If investor is in need of protection the Act affords

Court declines to attach a fixed #, so even 1 person may be..o 2. Knowledge: If you have the knowledge that the Act would have

afforded…you can fend for yourself, and thus, are not ‘public’ for meaning of §4(2)

If not you are ‘public’ in need of Act’s protectiono 3. Burden Of Proof:

Is on the pleader of the exemption to show they are not ‘public’

Exemptions Applied: 1. Corporate Officer buys stock from company, and begins selling without §5:

o NO: He turns into an underwriter, by definition o Cannot claim §4(1) or § 4(2) exemption ***

2. 2 owners of corporation issue themselves stocko they probably can ‘fend for themselves’ and have the knowledge that

1933 ACT wants to give…this would be private 3. Issuer sells to uncle within state

o if he is within state too, may qualify for §3(a) 11 exemption remember 3(a) 11 only looks at location…while §4(a) 2

looks at knowledge of information Regulation D Exemptions:

o In response to Ralston Purina, rule 147 and §3 (a) 11’s effect on small businesses by complicating the exemption, Congress created regulation D

o In effect, after so many years, Congress has ‘legislatively acquiesced’ to SEC’s rule interpretation, effectively making Regulation D the controlling statute

Has essentially deemed ‘accredited investors’ to have knowledge, and put ‘bright line’ number on ‘public’ at 35

504/505 are pursuant to 3 (b)—506 is pursuant to (4) 2o General:

59

501 Terms 502 General Conditions 503 Notice required to claim Reg. D exemption 504 Exemption pursuant to §3(b) up to $1M 505 Exemption pursuant to §3(b) up to $5M 506 Exemption pursuant to §4(2) Private Offering Exemption 507 Consequences of Failing to File Notice 5081 Bad Apple Doctrine

o §501 Terms: “Accredited Investor” : any of the following, or who issue reasonably believes is one of

the following: Bank, S&L Broker or Dealer, insurance company, investment company development

company Director, Executive Officer, General Partner of issuer of securities Any person with individual net worth of $1,000,000, excluding primary

residence Calculating Number of “Purchasers” under §505/506

Exclude Accredited Investorso 502 General Conditions:

Integration: Depending on factors set forth, offerings of shares may be treated as 1 offering for purposes of exemption. Look at:

1. Whether sales are part of single plan or financing 2. Whether sales involve issuance of same class of securities 3. Whether sales have been made about or at the same time 4. Whether the same consideration is received for both 5. Whether sales are made for same purpose

Information Requirements: Sales under 505 or 506 to non-accredited investor, require that issuer furnish

information…basic information Limit on Manner Offered:

Cannot generally solicit or generally advertise securities o No ads, articles, newspaper, magazine…o No seminar or meetings invited by general solicitation

Limit on Resale: Regulation D securities are treated as §4(2) exempted—cannot be resold

without registration under Act Issuer should assure purchaser isn’t underwriter, and should show:

o 1. Reasonable inquiry to determine if acquiring security for him or to redistribute

o 2. Written disclosure to each purchaser that securities have not been registered and cannot be resold unless registered

o 3. Place this on stock certificate o §504 Exemption

Exemption: applies pursuant to 3(b) 1. Satisfy the general conditions of 501, and 502 a, c, d, except that c, d will not apply

if: 1. If you register offering with state that has statute which requires public filing

to investors of substantive disclosure 2. Sell under state law that allows general solicitation (c) so long as sales are

only to accredited investors 2. Specific Conditions:

1. Price of securities may not exceed $ 1Mo Aggregation: including all 3(b) exemptions made in past 12 months

Note:

60

Not available to companies that register with the 1934 Acto §505 Exemption (Exempt pursuant to 3 (b)):

Exemption: pursuant to 3(b) 1. Satisfy General Conditions of §501/502

Integration Information Limit on Manner Offered Limit on Resale Accredited investor is not a purchaser

2. Specific Conditions: 1. Price of Securities cannot exceed $ 5M

o Aggregation: including all 3 (b) exemptions in past 12 months 2. May be no more then 35 purchasers of securities

o Systemic risk is minimized in §505, because $ limit is lowero §506 Exemption (Exempt pursuant to §4(2)):

Safe Harbor §506 is a safe harbor to § 4 (2)

Exemption: Offers and sales of securities that satisfy 506, are exempt pursuant to §4(2) and not considered ‘public offering’

1. Satisfy General Conditions of §501/502 Information Limit on Manner Offered Limit on Resale Accredited Investor is not a purchaser

2. There is no dollar limit on a §506 exemption 2. Specific Conditions:

1. There may be no more then 35 Purchasers 2. Nature of Purchasers:

o Each purchaser who is not an accredited investor must have knowledge so that he can evaluate merits and risks of prospective investment, or issuer reasonably believes he comes within this description

o Financial Sophistication o **Effect of this provision is to minimize systemic risk—because there

is no $ limit, making sure investors understand terms…more sophisticated

o Purchaser Representative: If you can get someone to advise the purchaser, on financial

merits, then sophisitication requirement is met o Regulation D Hypothetical:

Issuing $ 4M in common stock to: 5 banks, 5 multi millionaires, 6 executive officers, 34 joes and janes off street 50 Total investors Which Exemption Applies:

504 above 1M threshold, so does not apply 505 limit of 35 purchasers (bank, millionares, EO’s are AI don’t apply) so 34

purchasers…which is within limit…505 applies 506 under the 35 purchaser limit, and no $ amount but, lack of financial

sophistication because lay people off of the street…doesn’t apply o Integration and Aggregation:

Aggregation: §504 an 505 deal with aggregation: §506 does not

61

o Aggregation is a limit on the amount of §3(b) exemptions allowed in past 12 months

Note:o When there is a 504 and 505 transaction, within 12 months, check if

there is an aggregation problem EG:

o If in January you issue a §505 for $1.5M and in August a §505 for $4M

Aggregate in august of past 12 months is $5.5M You are over by $500,000

EG: o Jan. 2 §505 for $2Mo Nov. 1 §504 for $1M

504 aggregating previous 12 months worth of §3(b)’s is over $1M limit of 504…by $1M

EG: o Jan 2 §504 for $1Mo Nov. 1 §505 for 4 M

Aggregating previous §3(b) transactions was $1M, leaving $4M available in 505 This is ok

Integration [§502]: General:

o Applies to all exemptionso If there are different issuances under exemptions, the SEC may treat

them as 1 issue, integrating them, if certain factors are met: Framework:

o Check Integrationo If Fails Look for an exemption that still applies

Safe Harbor: If transactions are separated by 6 months there is no integration…it is safe

If Within 6 months of each other, look at factors:o Single Plan or Financingo 1 Class of Securitieso Same Consideration o Purpose o At or about same time

EG: o June 1 $1.5M stock to 5 unaccredited investorso August 1 4M stock to 34 unaccredited investors

Perhaps because of time, these will be integrated If so, there are 39 unaccredited investors and are over the

limit of 35 Have to register…

EG: o Nov. 1 $1M §504o Dec. 1 $10M §506

No aggregation issue because §506 Integration Within 6 months…, so if integrates, we are up to $11M That means only a §506 could apply, but people must have

sophistication requirements

504 (3 b) 505 (3 b) 506

$1 Million Limit $5 Million Limit Unlimited $

62

Not available with companies who register under 1934 ActAggregate with 504/505

Meet General Requirements35 purchasers (without sophistication)Unlimited accredited investorsAggregate with 505/504

Meet General Requirements35 Purchaser who are ‘sophisticated’Unlimited Accredited investors

Regulation A: o Is pursuant to §3(b)

Must be aggregated to 504/505 exemptions theno $5 Million ceiling o Involves Registration:

Need to file a copy with a regional office of SEC Issue of ‘Is it a Security’

o The 1933 act pertains to offering, selling, and carrying of ‘securities’o What exactly a security is, however, that needs to comply with 1933, sometimes is greyo 1. Begin with the Statute:

Context Clause: “Unless the context otherwise requires”

o Gets rid of any question about what may or may not be a security “Note” from your mom In context, not the ‘note’ they

were conceiving Statute then sets out what a ‘security’ is

Begins specifically:o Note, stock, treasury stock. Future, bond. Debenture

Gets more general:o Investment Contract

o 2. Investment Contract: Generally:

May, depending on test, make things that at first wouldn’t seem like securities, actually securities that need to be registered under the 1933 Securities Act

Worms, Cows, Real-Estate, Chinchillas, Orange Trees… Howey Investment Contract Test:

1. An investment of $o or other consideration

2. Expectation of profit in a Common Enterpriseo Vertical Commonality:

Not all Circuits accept Interests of Investor and Promoter are ‘interwoven’

o Horizontal Commonality: All circuits accept All investors have ‘interwoven interest’

3. Where the principal efforts made by person other then investor are significant, essential to managerial efforts

o Original test said “sole” effort, but 9th circuit modified o Purpose:

Efforts of others is analogous to passivity Attracts money for manger to manage

Effect: o If something meets this test It is an investment contract, and

therefore a security by definitiono Securities must be registered before sold or offered!o Rescission:

If something is deemed an investment Contract, and is a security but not registered

63

§12 Investor may rescind Howey Test Applied Smith v. Gross:

F: ∆ offered investors the ability to raise earth worms, with little effort, and that he would buy back the earth worms.

I: Is this an investment contract? Requiring registration? R:

o 1. There was an investment of $o 2. They had a vertical common enterprise

Dependent upon ∆ buying them back…o 3. Court changed from “sole” to “primary”

Here, although the investors still had to raise the worms, and feed them…the ‘principal managerial efforts’ were from the promoter

He put scheme together So although not the ‘sole effort’ ∆ did put primary effort

o Was investment contract May rescind SEC v. Howey:

F: ∆ was at resort selling orange groves to investors. He sold them, he did all the work for them, and they received proceeds of effort.

I: Was this an unregistered security investment contract? R:

o Passed all elements of the Investment Contract Howey Test Howey Test applied to Business Entities:

1. Is an interest in a General Partnership an Investment Contract?o If Defalut management rule #3 not meto If agreement to contary # 3 may be met, if principal efforts are

other persons 2. Is a Limited Partnership an Investment Contract?

o General Partners interest Noo Limited Partners Interes Probable is an investment contract

Limited partners are waiting on GP to exert their effirts 3. LLP:

o Same as General partnership 4. LLLP

o Like Limited Partnership, Limited Partners’ interest may be a security 5. LLC

o 1. Look at Management If Manager Managed Probably a security If Member Managed probably not

o 2. Some statutes state: If no reasonable expectation that the members will manage

then it may be an investment contract Sale of Condominium:

Ocassionaly, people selling condo’s at resorts are enforced by the SEC as selling unregistered securities

Life Insurance of Terminally Ill: 1. If Person accumulates pool of cash first, and then tries to locate sick people

o this is seen as a security 2. If person finds sick people first, and then accumulates cash

o This has not been seen as a security—principal managerial efforts have occurred before any investment of $...

Franchise Agreements: When a franchisor begins to sell franchises, does it become a security?

o Depends on # 3 of Howey Test: ‘Principal managerial efforts’

64

o If Franchisee retains discretion, the principal managerial efforts may not be of franchisor no security

o EG: McDonalds McDonalds franchises out many restaurants, and retains very strict control over them…perhaps principal managerial efforts…Butmakes sure that franchise has discretion ‘At Participating Franchises’

1934 Securities and Exchange Act: Created the S.E.C. Focused on the secondary market and reporting

o Registration: 1. Any security traded on a national exchange, or 2. Any security held by >499 shareholders by company with > $10M in assets

***What is registered?o Only need to register the class of shares that meets these criteria

EG: 575 common shareholders 9 preferred shareholders Only need to register common shareholders

Effect of Registration under 1934 Act: Report Proxy Solicitation Tender Offer Report by holders of certain size (>5%) Report by Company (10k, 10Q)

o Only of the ‘registered class’o G. Court/ Statutory limits on Preemptive Rights, Issuing Shares, Distributions to shareholders :

1. Preemptive Rights: Historically:

o Stokes v. Continental Trust: F: ∆ was a bank and had original outstanding shares of 5,000 at $100 par. Π owned 221

of those. A bank came and solicited from ∆ to increase the amount of authorized shares, and to sell it $500,000 worth of stock at $450. At time of suit they were worth $550. The Board recommended it to shareholders, they approved. Π, however demanded his proportionate share of stock

I: Whether shareholder has preemptive right to proportionate share of stock? R:

1. The Nature of a shareholders right is votingo The Right to vote for directors is his powero When new shares are issued, his voting right gets diluted

Shareholders have an inherent preemptive right to proportional value of their shares issued for money [not property]

Damages: o Gets the market value of new offering (550)- sale price of new

offering (450) Gets the right to acquire shares at the price set by the

board of directors Not Market Value – Par

MBCA §6.30 o Default: No Preemptive Righto a) “Shareholders do not have a preemptive right to acquire corporations unissued shares except

when the articles of incorporation provide Note:

The MBCA is an ‘opt in’ statuteo This means, that corporation must choose the have preemptive rights,

or else the shareholders do not get that right

65

o This is because It is a hassle to be required to offer all new shares to shareholders first, and wait for decision…much easier to get from market

With Closely Held corporation, it is more important to have the righto Protects interests more, while in big corporation does not matter as

mucho b) 3: There is no preemptive right for:

1. Shares issued as compensation to directors, officers, agents or employees 2. Shares sold for other then money

Note: o If corporation offers shares for property, land, there is no preemptive

righto This is consistent with §6.21, and the Board’s ability to set the

consideration for shareso Also, if consideration is ‘land’ shareholder most likely cant pay

anywayo The exceptions are essentially for the board of directors

convenience 3. Common shareholders have no preemptive rights on preferred, and preferred

shareholders have no preemptive rights on common stock.o Note:

Check the state statute for Preemptive rights as some states are ‘opt out’ rather then ‘opt in’ like the MBCA

Check state constitutions…They may also contain preemptive right information Freezing out or taking advantage of the Minority shareholders

Done by the majority in different ways: Issuing shares at P<BV to directors, Refuse dividend, pay high salary to board

o All concern the unfair holding of the minority hostage…at the control of majority Dillution and Unfair Usage of Preemptive Rights:

o Katowitz v. Sidler: F: The π and 2 ∆’s were the 3 shareholders in a corporation. There was a rift between

them, and ∆’s wanted the π out. ∆’s called ‘board meeting’ issued 75 new shares, and followed the preemptive right, offering it first to the π. The price of the new shares were 1/18th Book Value. Π did not exercise ‘preemptive right’ and immediately ∆’s had 30 shares and π still only had 5. Then company liquidated, and equity paid back was disproportionate, with ∆’s being 6x.

R: 1. The Preemptive right is to protect dilution of voting and equity 2. New offerings of stock must be fair

o When sold below BV, existing shareholders who do not want to exercise their preemptive right, or can’t are badly diluted.

Rule:o 1. Merely recognizing preemptive right, and abiding by it is not

enough Directors have a duty to issue shares in manner that is fair

to existing shareholders When existing shareholder doesn’t want to buy, or cant

buy…doesn’t help him anyway Gets dilutedo 2. When issuing shares, to themselves, the board of Directors

must treat existing shareholders fairly. Must have a valid business reason to issue shares below

BV

Burden of proof on Board of Directors

66

If not valid business reason, dilutes equity, voting rights, and gives Board windfall price

o What is Valid Business reason: 1. Retiring Debt: is valid business reason, but you still must

justify the price of the stock Rarely will Sale Price < BV be ‘valid’…but there are

times…For instance, when assets of business price fluctuates, the BV may be actually more then the ‘real value’ of the shares. In that case, there would be a valid business reason to sell shares at less then book value.

Here Directors wanted stock, knew π didn’t, and offered at below BV…got a deal, ‘Freezing Out’ ∆

o Overall: If there is a scheme to dilute a shareholder, or minority shareholder (Freeze Out), courts

will prohibit it Preemptive Rights, and Unfairness in use are especially important in close corps EG: In Close Corporation—A has 1/3 stock, B has 1/3 stock and C has 1/3 stock. They

are only 3 shareholders and are on board of directors. What if A and B amend Articles of Incorporation (pursuant to rule because on Board), and end preemptive rights, in scheme to dilute C?

While legally they may be able to do…C should protect his interest with having a provision “Only amend with super majority (75%)” that protects C, because he has to vote!

2. Distributions/Dividends: Gottfried v. Gottfried (Withholding Distributions):

o F: Minority shareholders had worked for ∆ corporation for 14 years, and had been enjoying the ‘zeroing out’ taxation method, to avoid 2-Tier taxation. They were fired, don’t get the high salary anymore, and want dividends. There were 3 classes of stock, all owned in proportional shares

o I: Have ∆’s withheld dividends inappropriately?o R:

1. If there is an adequate surplus available, the Board of Directors may not withhold distribution in bad faith Duty to act in good faith

To Determine Bad Faith: Have directors acted for reasons other then for the corporate welfare?

o Bad Faith Factors: Acted for themselves Hostility between Majority and

minority, exclusion of minority from employment, high salary or bonuses to director/majority,

Axiom: Court will not substitute its judgment for the Board of Directors if acted within the corporate welfare

o If within corporate welfare, court will not compel dividend Here:

While bitterness between majority/minority, and salary was high ∆’s had retired the preferred class of shares, and each π got his pro-rated share

valueo Because used Retained earnings to retire preferred, there was no

earnings to distribute anyway…they essentially got their dividend This was within corporate welfare No Bad Faith

Dodge v. Ford Motor Co (Policy view of shareholders and corporate welfare): o F: Ford had distributed regular dividends of 60% of initial capital (amounting to 1.2$M) and

special dividends (above and beyond, at BOD’s discretion) regularly. However, they now wanted to increase production, reinvest in plant with retained earnings. So, they ended special dividends. They issued a stock dividend. The effect of this, is to increase stated capital by the par value of the stock issued. So, they issued a $98M stock dividend, increasing stated capital to

67

$100M, and retained earnings to $14M. This has the effect of locking up the $ in the company, because cannot pay out of stated capital—keeps $ in company. But, π’s argue that their 1.2$ dividend was not 60% of the new stated capital.

o R: Court Policy:

The Board of Directors primary duty is to maximize shareholder valueo 1. They owe fiduciary duty to shareholders o 2. Their power and discretion must be directed at that goal, the goal

of corporate welfare The Board has discretion to determine the corporate welfare

o 1. The court, as axiomatic above in Gottfried, will not interfere with the board of directors decision to act for the corporate welfare, as long as it is acting in corporate welfare

Price of vehicles, plant location, etc…o 2. This primary duty to maximize shareholder value is not contrary to

Justice Douglas view in Equitable subordination, that the Board owes a fiduciary duty to shareholders and corporate creditors you can act primarily for shareholders, while having a limit/boundary on that goal…fairness/fiduciary duty police the limits then

Corporate Law Theory: Does the Courts view square with theory? Nexus of Contracts : Yes shareholders bargain for this, or anticipate this by

taking on large amounts of unsecured risk… Progressive Theory : No corporate social responsibility has a larger primary

interest in mind…not merely stockholders, but stakeholders and the community at large—this probably does not square with the theory

How does this effect Corporate Gifting: o Is an asset for shareholders, increasing value and for progressives fits

squarely in line with their corporate social responsibility idea Overall:

The court held that withholding special dividends was not within the corporate welfare, but for other then corporate welfare

Because there was reason other then corporate welfare, Court moved in to compel dividend

o Here, there was testimony that Ford may have withheld to quell competition that was Dodge brothers car company…Antitrust flavor to the case, in addition to mentioning “American people”

Because had interest ‘other then’ corporate welfare/maximizing shareholder value invalid

Effect of Issuing shares as Dividend:

o Effect #1: The Effect of issuing shares as a dividend, is that stated capital increases by the par amount of the issued stock

68

o Effect #2: This keeps cash in the company, because dividends cannot be paid out of stated capital Locks $ up

Director Salary Wilderman v. Wilderman: o Generally:

Directors salary is another potential scheme to squeeze the minority shareholderso F: π and ∆ got divorce. During tenure of corporation, both were zeroing out income, from

paying ∆ high salary. After divorce, however, she didn’t get benefit anymore, filing suit to return excess salary to corporation. ∆ was authorized to be paid $400/week, $20K a year. But pain much more.

o R: 1. Quantum Meruit

Reasonableness of Corporate Compensationo The burden (like other fiduciary issues: Promoter liability, dividend

withholding) is on the recipient of the salaryo Directors owe fiduciary duty to corporation and shareholder

Consider Factors:o Evidence of other executives similar salary, abilities/efforts of

executive, IRS recognition that deduction is unreasonable, salary related to corporate success, amount previously received

Here: ∆ did not meet burden…he was well above authorized amount—but, court

added some $ on to the authorized amount based on his abilities, and efforts

Reacquiring Shares: o 1. A corporate reacquisition of stock is a distribution

It is a payment to the shareholder Treasury Shares:

Shares are either retired permanently, and authorized stock decreases, or resold in future

o 2. If proportionate to all shareholders Fair, and acceptable means

o 3. If only reacquisition/distribution to 1 shareholder May violate ‘strict duty of good faith’ in distributions

o Donahue v. Rodd Electric Co: F: ∆ was director of company, and kids were on board—the board voted to repurchase

∆’s stock for $800 a share. Πs, minority shareholders, asked for same deal, and were refused

R: 1. A Close Corporation is:

o 1. A small number of shareholders, 2. With no open market to sell shares, and 3. The majority participates in management, operation

o Similar to Partnership: But, partners are free to dissolve, while minority

shareholders are at mercy of Majority o Minority can be freezed out/trapped

2. In a Close Corporation, all shareholders owe same fiduciary duty as in a Partnership to each other (Majority to minority)

o *Strict duty of Good Faith and Loyalty o Because they are like partners, in that shareholders (min. and maj)

must trust each other…minority at will of majority o A more strict duty then Directors owe to corporation in

Gottfried/Ford, where the director has a chance to justify his decision (Valid business purpose/Corporate Welfare)

69

o Applies both ways o Why more strict in close corporation?

There is substantial overlap with shareholders and directors Because of this court is actually raising the duty owed

from directors to minority shareholders, raising duty owed in close-corporation

3. In Close Corporation, all Shareholders have Equal Opportunityo When close corporation reacquires stock, shareholder directors must

act with this strict duty in mind…offering same to other SHo All shareholders have right to have their shares repurchased

If not majority unfairly benefited with a secondary market to resell, and an uneven distribution to that shareholder that minority doesn’t get

No matter if there is valid business reason to repurchase only 1 shareholder or not all have Equal Right

o Applies to Minority and Majority o May Contract out of Equal Opportunity

4. Reciprocal of Stokes:o Stokes holds that all shareholders have preemptive right to purchase

new shares—this case holds all have right to have shares repurchased. o However, in those states that statutorily do not have preemptive right,

having Equal Opportunity would seem logically to have Stokes rule too—states have cut this off, by statute, using this rule for fairness

o Exceptions to Donahue Rule: 1. Delaware: does not follow, and does not have special judicially created rules for

close-corporation A Minority Approach (But Important state)

2. Employment: Because of the heightened level of duty in a close-corporation, some have argued that a minority shareholder/officer being fired cannot be

Massachusetts Rule: Cuts off the use of duty, above, in employment for new test…court was worried it strictly applied would interfere with some valid business action

o 1. If there is a ‘legitimate business purpose’ for firingo 2. When met, minority shareholder then may attempt to show

that the same ‘legitimate business purpose’ could have been met another way

o H. Legal Restrictions on Dividends: 1969 MBCA:

1. § 45: **Always subject to Equity Court’s Insolvency Test**o “ Insolvency ” (§2 N) inability to pay corporate debts as they become due”o “Corporation may pay dividends, in cash, property, shares except when:

1. It is insolvent 2. Would make it insolvent 3. Would be contrary to a restriction in the Articles of Incorporation”

o Evaluate: Financial statements Short term debt due date Sufficient income to meet existing and reasonably foreseen liabilities Amount, time of payment, etc…

2. §45 May Pay out of Earned Surpluso *Taxable to Shareholder (In C-Corp at income level)o Dividends out of earned surplus is always ok

Note:

70

Earned Surplus/Retained Earnings account may have $X in it, but check assets—if equity is tied up in other assets, may need to be sold to pay off

If all of cash in earned surplus is paid out, may make it insolvent too 3. §46 If 1 of 3 Conditions met, May pay out of Capital Surplus

o 1. If ability is within Articles of Incorporationo 2. If Shareholder’s Vote on it oro 3. Done to satisfy Preferred share’s cumulative dividend claim

as long as notice given that it is from capital surplus, and not earnings 4. §46 Nimble Dividends:

o If there is an accumulated deficit (loss) Dividends may still be paid out of earnings of current year and the next year, combined

EG: 3 years ago, $1M lost. Last year you made $400K, and this year you made $400K. Your total accumulated deficit (loss) is $200K

A nimble dividend of $800K may be paid under §45 (’69 MBCA)o Reason:

Developed in Delaware, to give investors a reason to invest in a company that had bad year

Attracts capital and also attracts bank loans 5. Shifting of Account Values:

o 1. §69: From Stated Capital to Capital Surplus A corporation may shift money from stated capital to capital surplus

By getting shareholder vote If Articles of Incorporation do not contain

o Amend Articles of Incorporation But, cannot impair preferred share’s preference, or common stock par-value Purpose:

Because not permitted to distribute from Stated Capital, shifting money from that account to Capital Surplus is intended to distribute

o Must meet 1 of 3 criteria above o 2. §70: From Earned Surplus to Capital Surplus

A. Board may transfer part or all of earned surplus to capital surplus Purpose:

o Locks up money B. Capital Surplus may be used to reduce any Accumulated Deficit (Loss)

So, may transfer Capital Surplus back to earned surplus to reduce/ end loss §48-Director Liability:

o Director who allows a dividend/distribution above what is permitted within the act Is liable to corporation for the amount above what was permitted

1984 MBCA Remember:

o 1984 holds no legal significance to the Equity Accountso Does not determine by which count is named what…but instead, a formula below

§6.40o Board of Directors my authorize a distribution/dividend to shareholders, subject to Articles of

Incorporation

71

o No distributions out of Stated Capital o 2 Part Test: No Distribution may be made if:

1. The Corporation would be insolvent as a result Evaluate:

o Financial statementso Short term debt due dateo Sufficient income to meet existing and reasonably foreseen liabilities o Amount, time of payment, etc…

2. Balance Sheet Test: Assets must be ≥ Liabilities + Preferred Share Liquidation preference Allowable Dividend= Assets – [Liab. + Preferred Share Liquidation preference]

o Note Again, remember that the preferred share liquidation

preference is typically set at par This is because under ’69 MBCA, you must keep that

amount in stated capital if no par anyway…and if par, you have that amount locked up in Stated Capital

Typically Par Value = Liquidation Preference §6.40 (d): Must base your determination on reasonable accounting practices

o GAAP is not required, but always reasonable Revaluation of Assets:

o In the use of reasonable accounting practices, May revalue assets on the Balance sheet—increasing the Assets value, and increasing the maximum available dividend that may be paid

o Must revalue all assetso If Assets depreciate, do not have to revaluate, unless GAAP provides

§6.40 (F) Debt issued to reaquire shares (A distribution)

o Debt holder gains parity with corporate unsecured debtors §6.40 (G)

Debt issued to reaquire shares is not a liability in calculation Treats debt holder as senior most shareholder, but junior to secured shareholders

§8.33 Director Liability o If a director allows a distribution above what is allowed above

Personally liable to the corporation for that amount above permitted distribution Delaware:

1. Insolvency Test 2. “May pay dividend out of any surplus account”

o *No dividends out of state capital 3. Revalution Surplus

o Delaware allows revaluation of assets, and provides its own account for that valueo “Revaluation Surplus” is within the Equity Account

4. Nimble Dividend is available New York:

1. Insolvency Test 2. “May pay, but may not impair stated capital”

o same as Delaware then—may pay out of any surplus account 3. No Nimble Dividends may be paid 4. Revaluation Surplus is available

Management of the Corporation o Shareholders:

Overall: Below are devices used for Shareholder Control or to minimize shareholder power

o Shareholder Agreements

72

o Quorumo Voting Requirementso Cumulative votingo Staggered /Classified Board Structureo Voting Trustso Class Voting: Each class has different voting powero Restrictions on Transfer o Voting Agreements

Framework of Analysis for Shareholder Agreement: 1. Does the Agreement trespass on Board of Directors? 2. Does it oppress or is there bad faith on the minority? 3. Is it a Voting Trust, and is it illegal/non-compliant with statute?

o By Statute or Abercrombie test?o Or, is it a Voting Agreement, in which case it doesn’t have to comply with Voting Trust statute,

according to MBCA §7.31 (a)?o 1. Shareholder Agreements and Traditional Role of Management and Shareholders:

A. General Approach: Strict Adherence to traditional statutory allocation

o McQuade: applies to public companies and companies with a non-consenting minority McQuade v. Stoneham (NY):

o F: Shareholders/directors entered into agreement that shareholder/directors would use best efforts to vote themselves as officers. When 1 of them had disagreement and was ousted, he sued to enforce agreement

o R: Shareholders Traditional Role:

Vote for Directors and Remove Directors Inspect the books Approve or disapprove of amendments to articles File Derivative Suits Ultra Vires Actions May adopt resolutions

Directors Traditional Role: Vote for officers Set Salaries Declare Dividends Corporate Policies

When Public Company or Non-consenting minority, shareholders may not make agreement about matters within the directors purview

Directors Fiduciary duty to exercise independent judgment may not be constrained by such an agreement

o They Have independent judgment over the corporation, by nature of their position

o Efficiency of centralized Management by Board Note:

Does not apply to close-corporations Still controlling for public corporations, and non-consenting minority

Clark v. Dodge (NY): o Allowed such agreement, only if:

Unanimous Slight invasion on Board of Directors No harm to minority, creditors, or public

Long Park (NY): o Allow agreement if:

Unanimous Doesn’t sterilize

73

If allocates total management authority to Shareholders, not ok Overruled by Zion

B. Special Approaches: For a close corporation with no complaining minority shareholders 1. Common Law:

o Galler v. Galler (Illinois): F: π (Emma and Ben) entered into a shareholder’s agreement with ∆s. It was designed

to protect the spouse of first dying shareholder. It provided that the wife could then elect directors, nominate directors, elect officers, and declare dividends. ∆’s, following death would not comply with agreement, and π brought suit

R: While voting for directors and nominating them is within shareholder purview,

declaring dividends, and officers is a Board of Directors Purview Close Corporations are uniquely vulnerable

o Shareholder Agreements are practical, and necessary to protect minority interests

o Shareholders in Close Corporation are more then investors Donahue holds they owe same fiduciary duty to each other

as partners doo Shareholders are typically the directors anyway

In Close corporation context, then, Shareholders Agreements may infringe on Directors purview of duties (Management) as long as:

No Damage suffered or threatened by Creditor Minority Shareholder or Public/Public Policy

o Here: Shareholder agreement harmed no one, no one complained,

and while imposing on Management/Directors duties of officers/salary/dividends it’s ok

o Note: As in Wilderman, supra, the ∆’s who pay an amount out of corporation to themselves

will need to show that it was reasonable under Quantum Meruit

o Note: Galler explicitly called for legislatures to separately regulate Close Corporations, due to

the unique characteristics and issues they dealt with 2. Modern Close Corporation Statutes:

o 1. Integrated Close Corporation Statute: A Separate sub-chapter, requiring ‘close corporation’ in name and Articles of

Incorporation Is an ‘opt in’ statute, allowing shareholders to participate in management Delaware and New York follow this type of approach

Delaware: o Allows ending of BOD entirely But you must opt ino Restriction of director discretiono Essentially, blending the alternative entities with that of the corporate

structureo 2. Provision in Articles of Incorporation:

By amending, or placing in Articles that certain authority, normally in board, will be with shareholders

o 3. MBCA §7.32: (a) A shareholder agreement that complies with 7.32, is effective among shareholders

even if it is inconsistent with any other MBCA provision

74

It can eliminate the board of directors, or restrict its discretion and power Can govern authorization of making distributions, subject to limitations Establish who shall be officers Govern general corporate matters

Agreement must be: In Articles of incorporation or Bylaws and Unanimous Agreement (Signed by all shareholders at time) Conspicuous Notice on stock certificate

o Policy: To protect creditors, minority shareholders (by making

unanimous) and unsuspecting Public who needs to understand they may, based on the agreement, not be allowed as typical to vote for their representative on the board

If Public Corporation Does not apply, and becomes invalid

(e) A Shareholder agreement under this section imposes on the shareholders the same duties and liabilities of directors

(f) A Shareholder agreement, although changing corporate formalities, cannot be used against a shareholder as evidence in proving Piercing Corporate Veil

New York Approach to Close Corporation Statute : Zion v. Kurtz (NY): F: 2 shareholders of LBW, entered into shareholder agreement where ∆ agreed to only buy LBW stock. Π

had veto power over any other corporate action. When ∆ entered into 2 other agreements, π sued to enforce shareholder agreement.

R:o Pursuant to Delaware Law, close corporations are specifically allowed to have an agreement that

restricts the power or eliminates all power of Directors Even though the ∆ failed to comply with close corporation statute, the statue shows the

public policy of Delaware, which is freedom to contract, and that is not contrary to New York’s Law

May agree to whatever desiredo NY Law overrules McQuade and Long Parko Follows Galler style approach of What Limits there are on agreement

o If you could have been an electing close-corporation, you will be treated as though you were Whether you failed to follow the close corporation statute isn’t relevant Agreement is allowed, and estopped from arguing you failed to register for close-corp Galler Approach Applies

Delaware Approach: Zion Dissent: Delaware law was there for a reason…it must be followed, and registration and close-

corporation requirements, and conspicuously noted shareholders agreement on stock alerts public Delaware followed the Dissent:

o Must Follow the close corporation statute, and file, or you do not gain its power to create broad shareholder agreements

Allows broad agreements which restrict shareholder discretion Or end board of directors But, you must follow its procedural requirements

Policy Reasons: The unanimity of MCBA, or harm/threat of harm at common law, or Delaware’s requirement that such an

agreement be noted conspicuously, are all designed to protect minority shareholders, creditors and the public/public policy

Overall: Shareholder Agreement may be used to get around the profit sharing issue Merging it with alternatives Articles of Incorporation may add to what a shareholders abilities are as well

o 2. Action of Shareholders—What Can they do: Shareholders May:

75

Make recommendations to the Board By Statute:

o Elect Directorso Remove directors for cause or without cause

Amend Articles of Incorporation Check the Books Derivative Actions and Ultra Vires claims Other Look throughout MBCA to determine what else shareholders may do…

o 3. How do Shareholders Act—Voting of Shareholders: MBCA Terminology and The Voting Process:

Record Holder: Person who is registered owner of stock on corporation bookso Has the Right to notice of meetings, vote Shareso Right to receive distributions

Beneficial Holder: o Owner of stock benefits, who may not have registered on corporate books

1. Holding through a Stock Holder in Street Name EG: you own stock through a broker…the broker may be the registered Holder,

while you are the beneficial ownero More Convenient then always re-registering…

2. Have not re-registered new holder yeto Has the Right to Vote Shares through Proxyo Right to Receive Distributions from Record Holder

Proxy: o §7.22

Someone who is appointed to vote on your behalf May Direct Person to vote in certain way May Discretionarily allow person to use judgment

o The Beneficial Owner has the Power to Compel Record Holder to Be his Proxy Record Date:

o §7.07 The Bylaws of Corporation may provide the manner which record date is determined,

to tell which shareholders get notice of meeting, can vote… Record Date may not be more then 70 days before the meeting or action requiring

shareholder determination Based on the records of the corporation, these Record Holders are the ones who get

notice of meeting and right of dividend/distribution and right to vote Beneficial Holder may seek proxy, or distributions

Shareholder List for Meeting: o §7.20

After the record date is fixed, corporation makes an alphabetical list of names who are entitled to be at meeting

Notice Of Meeting: o §7.05

Corporation must give all Record Shareholders notice of the date, time, and place of annual and special shareholders’ meetings at least 10 and no later then 60 days before meeting date

Unless Articles of Incorporation require, notice of annual meeting does not need to include description of purpose

Waiver of Notice: o §7.06

Shareholder may waive notice Must be in writing, signed by shareholder and delivered to the corporation

o Attendance at Meeting waives objection to lack of notice or defective notice, unless shareholder objects to meeting at beginning

76

o Attendance at Meeting waives objection to consideration of particular matter at the meeting

Annual Meeting: o §7.01

Corporation shall hold annual meeting Held in state or out, and if no place fixed, held at Corporation’s principal office

Election Inspector: o MBCA §7.29

Any other corporation, may appoint an inspector at shareholder meeting…: Ascertains number of shares outstanding and voting power of each Determines the shares represented at each meeting Determine Proxy Validity Count all Votes Determine Result

Election Inspector, Record Holder, and Beneficial Owner:o Salgo v. Mathews:

F: PCC Corp owned stock of GEC Corp. PCC was the Record Holder, but was in receivership from bankruptcy. The Receiver, agent to act on PCC’s behalf, transferred the stock to Don Shepherd. Shepherd gave proxy to Mathews. Meer was the Election inspector, and would not recognize the proxies as they were not Record Holder’s to vote

R: 1. The Corporation does not go beyond the corporate records to determine

identity of those entitled to voteo Beneficial Owner Has Recourse:

1. Get Proxy from Record Holder 2. Get Transfer on Books 3. Court Ordered Injunction or Mandamus

2. The Election Inspector has the discretion and authority to preliminarily determine the identity of those entitled to vote, by looking at corporate record

o Election Inspector has final judgment o Even if he is wrong

Promotes efficiency Doesn’t interrupt election

o The Election inspector’s judgment remains final, until go to court Here:

o The Proxies from the beneficial owner were correct…However, the Election Inspector has the preliminary discretion to make his ruling…which is final until judgment of court sought

Voting Requirements for Non-Director Issues: o Quorum:

§7.25 (a) A Quorum of shares must be present to vote Default Quorum A Majority

o May not go below Default §7.27: “The Articles of Incorporation may provide for a

greater quorum then MBCA requires o Quorum Cannot be Broken:

§7.25 (b) Once a quorum exists at the meeting, it is present for the remainder of the

meeting EG:

o Once in a meeting, a shareholder who doesn’t like the way a vote is going cannot simply leave, breaking the quorum

77

o If A quorum exists, action other then for electing directors is approved if votes cast in favor of action exceed votes cast opposing the action

Simply Majority Votes Wins The Ayes win

o EG: 100 shareholders

51 Quorum 40 abstain and refuse to vote 6 vote yes – 5 vote no

o A Majority of the non-abstaining votes win, once quorum has been met

Amending Voting Requirements In Articles of Incorporation: o §7.27 (b): An amendment to the AIC that adds, changes, or deletes a greater quorum must meet

the same quorum sought to be changed or proposed whichever is greater

§7.28 Voting For Directors & Cumulative Voting: o (a) Directors are elected by a plurality of the votes, cast by shares entitled to vote

Directors run ‘at large’ so directors with the most votes win open spotso (b) Shareholders do not have the right to cumulative voting, unless elected in AIC

An Opt in Statute for Cumulative Voting o (d) To Vote Cumulatively:

1. Shareholder has the right to cumulate in AIC, and gives notice to the corporation at least 48 hours before set meeting that shareholder will cumulatively vote

o 4. Straight Voting and Cumulative Voting: 1. Straight Voting:

You may vote = # shares per officeo EG:

A Owns 60 Shares B Owns 40 Shares

A has 60 votes per office and B has 40 votes per office The Majority Wins every time

2. Cumulative Voting: Total Votes = # Shares x # of Directors Once Total Votes calculated, the shareholder may allocate his votes per director as he sees fit

o EG: A Owns 60 Shares x 3 Directorships open = 180 votes B Owns 40 Shares x 3 Directorships open = 120 votes Peter—Paul—Mary—Douglas are on ballot

B votes all 120 for Petero B is guaranteed 1 Director theno It is not mathematically possible for A to vote more then 120 votes for

3 other candidates to beat out Petero Because at large, Directors with most votes win

A votes 121 for Paul and 50 for Mary and 9 for Douglaso Paul, Mary, Peter are on Board of Directors

Arguments For and Against Cumulative Voting: o Proponents:

1. Minority has ability for representation 2. Even if a minority of Board represents him, allows for a hold out if vote needs to be

unanimous, or the ability to sway or persuade majority Directors 3. Desirable to have as many viewpoints as possible 4. May discourage conflicts of interest with minority representative

o Opponents: 1. Difficult to actually vote correctly

78

2. Allows for a minority, insurgent group to attempt to takeover If Public Corporation

Easier for a faction to begin to takeover State Constitution

o Always check the state constitution, as the right to cumulative voting may in fact be there as a protection of the minority

§ 8.05 (e) Deadlock Votes, Holdover Directors:o If Cumulative Voting leads to deadlock votes for all candidates

Revert to the Old Board of Directorso If Cumulative Voting leads to plurality vote on some directors and tie with others

If the others cannot come to an agreement §8.05 (e) even if the director’s terms has expired, director continues to serve until a

successor is elected Removal Of Directors:

o §8.08 (a) Shareholders may remove director with or without cause, unless the articles o

incorporation provide cause is required (c)

If cumulative voting authorizedo director may not be removed if number of votes sufficient to elect

him is voted against removal If cumulative voting is not authorized

o Director can only be removed if number of votes to remove> number to not remove him

(d) Director may only, however, be removed by the shareholders a meeting called for that purpose, and notice of meeting must state that purpose

The Cumulative Vote Formula: o The Following formula will determine how many shares/votes are needed to elect 1 director

o Key: S Total Number of Shares voting D Total # of Directors +1 n Number of Directors You Want to Elect

o EG: 3 Directors and 100 shares outstanding

[100/3+1]+ 1 = 26 Shares needed to assure 1 director 3 Directors and 100 shares outstanding

[(2x100)/3+1] +1 = 51 shares to assure 2 directors If you Have 40 Shares, How many Directors can you get?

40 = [n100/3+1]+1

n S + 1 Shares Needed = D+ 1To Elect n Directors

79

39x4=100n 156/100=n n=1.56 directors

o 5. Staggered Directorships / Classification, and Other Methods to Neutralize Cumulative Voting and Minority §8.06:

The Articles of Incorporation may provide for staggering of terms of the directors by dividing the total number of directors into 2 or 3 groups….

Each Director, then, comes up for reelection at different time Humphrys v. Winous Co:

F: there were 2 state statutes. 1 allowed for staggering of directorships and the other allowed for cumulative voting. Here, 3 directors each had their own class. So, even with cumulative voting, minority could not vote director in

R:o 1. Effect of Staggered Directors on Cumulative Voting:

Neutralizes Cumulative votingo 2. Other methods to neutralize Cumulative Voting:

1. Amend Articles of Incorporation, or Do not Opt in 2. Remove the Minority Directors without Cause (8.08) 3. Reduce Number of Directors

o 3. Cumulative voting is a right but does not ensure that representation of minority will occur or guarantee its effectiveness

Advising Your Client: o 1. Put In AIC that no Staggered Directors Allowed

Require a Super Majority to Amend the AIC***o 2. File AIC in State with a Constitutional Right

In these states, Constitutional Right to Cumulative voting will trump a staggering statute

o 3. File in a state that has a limited number of directors that may be staggered per class So, does not totally restrict minority MBCA is similar to Humphrys statute; without restriction on number of directors

Arguments for Staggering: o 1. Neutralizes Minority o 2. Continuity of Board of Directors and direction of Corporation

Like the Senate, with staggered voting, this allows some of past directors to stay on, to help guide the new members rather then completely starting anew

o 3. Anti-Takeover Defense: Staggering Directors only allows voting to change 1 director at a time With 3 Directors, it will take 2 years to get a majority…this slows down any desire to

takeover Combine with “No Removal for Other then Cause”

This avoids Takeover party coming in, and simply getting ability to fire directors

o 6. Voting Trust: Generally:

1. Common of Creditors:o Creditors who are unsure of shareholder judgment (for instance, shareholders above voted for

directors who ran company into bankruptcy) may require that all shares be placed into a trusto Creditor may then select the Trustee of the Trust to vote the shares o Trustee vote may be for Trustee as Director, to control Management

2. Shareholders May also create to combine votes 3. Structure:

o Shares are Placed in the Trust, with the Trustee having power to voteo Trustee is the Record Holder

80

o Shareholder’s are Beneficial owners—entitled to dividends/distributions §7.30 MBCA Voting Trusts:

(a) Placing shares in voting trust confers to Trustee the right to vote, and shares are transferred to trusteeo Shareholders are the beneficial owners of the trust, and a list is prepared of the names of those

beneficial owners o List must be given to the Corporation’s Principal Office

(b) Voting Trust is valid for 10 years (c) May extend the trust for additional terms, but not more then 10 years…and extension only binds those

parties that sign it Note:

o If you follow the statutory requirements, it is a Voting Trust… Illegal Voting Trust?:

In some instances, a voting agreement may be argued that it is an illegal voting trusto The court will utilize the test below to determine if an agreement is in fact a voting trust, and if

so, illegal because it fails to comply with the statutory requirements of a Voting Trust

Test to Determine if there is Voting Trust and its Legality: Lehrman v. Cohen:

o F: π and ∆ had a dispute over directorship vote. Agreed to create a 3rd class of stock, which was entitled to vote for 1 director to avoid deadlock. 3rd class given to D, who voted himself into director. Then, left, and voted friend for director who voted him president.

o I: Is this a Voting Trust, and if so is it Legal?o Rule:

1. Abercrombie Test for Voting Trust: 1. Voting Rights separated from other attributes, and 2. Voting Rights granted irrevocable for period of time, and 3. Purpose is to vote to gain control of corporation

2. If Voting Trust, Is it Legal in complying with Statute Requirements? Time period, etc… If No Illegal

Trustee is a Fiduciary to Beneficiaries: Brown v. McLanahan:

o F: Business went bankrupt: Common Shareholders received Common stock, Bond Holders received Debenture and preferred shares, and sold preferred, and Debenture Holders got common stock. The Common Stock and Preferred stock were put into a “Voting Trust” for 10 years. Towards end of 10 Years, the Directors who were Trustee’s, who were Ex-Bondholders amended the AIC to eliminate the Preferred Shares right to vote—giving Debenture holders sole right to vote, and control

o R: Trustee’s who are Directors may amend the Articles of Incorporation for the benefit

and proper purpose of Corporation A Trustee may not exercise his power, to breach Fiduciary duty he owes to

beneficiaries (shareholders of trust) to favor one class over another, or themselves

o 7. Class Voting as Limit on Shareholder : Lehrman v. Cohen:

F: Corporation created a solely voting class of shares, in an effort to prevent a tie breaker with the right to elect 1 director. The stock had no right to dividends, etc…purely voting. Eventually the holder of this extra class voted someone else as director, who hired him as CEO with large salary.

R:o Additional Class of Stock is not a Voting Trust:

Here, additional class did not separate voting rights from other attributes of other stock…other stock retained all rights…didn’t pass Abercrombie test

Although the new class of shares dilutes voting power, it does not separate the Right to vote Requirement 1 is not met

81

o Public Policy Argument: 1. Purely Voting Stock is acceptable

Although arguably, voting with a financial interest in the company may lead to better decisions for company…Solely voting interest isn’t against public Policy

Contrary is ok too—solely property interest, without voting right 2. Purpose of Voting Trust:

To avoid secrecy, and uncontrolled combinations of shareholders to form ability to acquire voting control of corporation to detriment of minority shareholders

3. Directors may not delegate their duties to manage corporation But, when shareholders vote to amend AIC, to add stock that change

management…its not the directors delegating it Voting Requirements and Unusual Voting Power as Limit on Shareholder:

Delaware and the MBCA allow for odd types of share voting schemeso MBCA §6.01 (e):

Allows any terms of shares to vary among shareholders, in the same class or series, as long as those variations are in the Articles of Incorporation

Note: although this contradicts §6.01 (a), last sentence “that shares must be identical in same class or series,” (e) was an amendment, that trumps (a)

Unusual Voting, like only portion of shares count for full vote, or that “tenure voting plan,” the longer you hold the more votes count, or more votes per share you get Specifically used as Anti-Takeover Defense

o 8. Restrictions on Stock Transfer: §: 6.27 MBCA

(a) The AIC, by laws or a shareholder agreement may restrict transfer of shares. Does not affect shares issued before restriction adopted…unless holders are parties to agreement

(b) Must Be Conspicuouso The Restrictions must be noted conspicuously on the front or back of a certificate

If no certificate, must be contained in information statement required by 6.26 Conspicuous (1.40(3)):

Written so that a reasonable person should have noticed it Italics, bold, color, capitals, underlined is conspicuous

If Not Conspicuous Need Actual Knowledge: Conspicuous provides constructive notice Actual Notice will also suffice…look to the facts to determine

(c) Restriction authorized to:o 1. Maintain corporation’s status when depends on # or ID of shareholders

§ S Corporation o 2. Preserve Federal Securities Laws exemptionso 3. For any other reasonable purpose

(d) Restriction can:o 1. Buy/Sell Agreement:

Obligates the shareholder to First offer either the corporation or other shareholders the right to acquire shares

Note on Advising your Client: For Close Corporations, buy/sell agreements are strongly advisable Allows for what happens at death/retirement, etc…

o …o 4. Prohibit Transfer of restricted shares, if not manifestly unreasonable

Restrictions on Shares subject To Restraints on Alienation Issues: Like general property law, total restrains on alienation are not preferred by the Courts

o Against Public policy In MBCA, “Reasonableness” applies Many legislatures allow total prohibition, however, with stock if notice of the restriction

Ling v. Trinity S&L:

82

F: ∆ sued man for deliquent balance on loan, which was secured by π’s stock. However, was a restriction on transfer. ∆ argues invalidity.

R:o 1. Conspicuousness:

Reasonable person must notice Here, front had note to back, back had note to AIC…this was ok But, not conspicuous enough

o 2. Reasonablenesso 9. Voting Agreement:

1. §7.31 MBCA: (a) Two or more shareholders may provide the manner which they will vote, by signing agreement

o If Voting Agreement Not subject to Voting Trust Rules in §7.30 So, even if something seems to be a voting trust, as a result of Abercrombie, if it is a

Voting Agreement, it does not need to comply with 7.30, and legality isn’t an issue (b) Voting Agreements are entitled to specific performance

o Note: Although the MBCA says that the shareholder agreement gives the shareholders the

right to specifically enforce their agreement, courts may not be willing to oblige They don’t necessarily like being told what to do, and may use their equitable power as

they see fit Ringling Brothers v. Ringling:

F: Ringling and Haley, 2 shareholders of Ringling came to a voting agreement—voting together cumulatively, they could gurantee 5 directors for themselves. In their voting agreement, they had an arbitrartor if they ever came to a deadlock on voting. Arbitrator here made a ruling during a deadlock, and Haley refused. Haley then voted against the Arbitrators rule.

R:o This is a Shareholder Agreement, not a Voting Trust:

Here, the voting power was not separated from other rights of stock So Abercrombie test not met

o The Arbitrator was not given irrevocable proxy Here, the agreement between the shareholders did not bestow on the arbitrator the

power to vote for them…it merely bound them to each other while having an arbitrator between them

o Shareholder Agreements: May exercise a wide liberality in voting

May vote together, contract to vote in future, have clause for when no determination on vote can be made

o Advising your client: To have an actually enforceable arbitrator agreement

Give Proxy to Arbitrator that is irrevocable Methods Voting Agreements are Enforced By:

1. Dissallowance of non-compliant votes 2. Specific Performance per MBCA 3. Self Executing with irrevocable proxy to arbitrator

Proxies and Irrevocable Proxies: Typically Proxies are revocable no matter what However, Proxies may be irrevocable:

o Public Policy: 1. When Irrevocable, the proxy owner with no financial interest, but merely voting

power may vote contrary to the interest of all shareholders Shareholders with a pecuniary interest typically vote for the best of company

This is the reason that proxies are not irrevocable, unless coupled with an interest MBCA § 7.22:

o (d) An appointment by proxy is revocable unless…it is coupled with an interest, which include:

83

1. A pledgee 2. A person who purchased or agreed to purchase the shares 3. Creditor of corporation who extended credit under terms 4. Employee of corporation whose employment contract 5. A party to a voting agreement under §7.31

So, here a party in the voting agreement like an arbitrator may be given an irrevocable proxy

New York: o §609

Also couples the interest with irrevocable proxyspecifically stating that “a person designated by agreement for voting agreement”

Allows you to designate an arbitrator that’s irrevocable

Irrevocable Proxy and Voting Agreement: Note that, if an irrevocable proxy was given to an arbitrator in a voting agreement…it arguably would

pass the Abercrombie testo Therefore, a Voting Trust would be created and the potential for illegality would occur: BUT:

However §7.31 (a)o A Voting Agreement made under 7.31 is not subject to §7.30

So if it is a shareholder agreement, an arbitrator could have an irrevocable proxy and it could go for longer then 10 years, or avoid other requirements of §7.30 Voting Trust

o 10. Vote Selling: A Voting agreement where consideration is personal to a shareholder and the shareholder divorces discretionary

voting power as directed by the person paying him Schreiber v. Carney:

shareholder agreed to withdraw his opposition to a merger in exchange for a loan from the merging company

Hewlet v. HP: Company paid an investment bank for their votes out of the corporate treasury. Founding shareholder was

opposed and argued this was illegal vote buying. Public Policy:

Similar to the idea of irrevocable proxy, selling the vote for a financial interest to that shareholder unalligns the financial interest and voting interest…the potential is that the corporation won’t be run optimally

2 predominate Tests:

1. Illegal per se if it defrauds or deceives the shareholders 2. When management buyer of vote, subject to inherent fairness with burden on management to

proveo New York Jurisdictions:

§609 (e): prohibits vote sellingo MBCA

Silent…but doesn’t mean that it wouldn’t be against public policy…up in airo 11. Shareholder Action without a meeting:

§7.04 MBCA: Action that would otherwise require a meeting may be taken without a meeting, if there is unanimous

shareholder written consent…signed by all Why Unanimity:

o If everyone agrees, they may just sign instead of meetingo If not, the meeting gives those dissenting shareholders a chance to convince one another

Note:o This is something you put in your AIC to give the ability or end ability to do so

Delaware: Does not require unanimous written consent Just needs to be signed by a quorum

84

Directors and Officers: o Directors:

General Decision Making Power §8.01 MBCA: All corporate powers are exercised by the BOD or under the authority of the BOD, and the business

affairs of the corporation is managed by or under BOD supervision

Planning Phase: Directors act by: 1. Formally: They authorize acts of agents either specifically or generally before the fact or by

ratificationo A. Meeting (§8.20)

BOD holds regular or special meetings in or out of state Either Physically there, or where each can hear the other (Telephone/Conference Call)

**No Proxy Vote for Directors We want to see the Board of Directors as a collective decision making body Not even Delaware allows devices where BOD cannot hear each other

Must be Notice of Meeting (§8.22) Waiver of Notice (§8.23)

Director may waive notice of meeting if in writing, signed and filed in corporate minutes

Quorum Requirementso B. Unanimous Written Consent (Action without Meeting) (§8.21)

No meeting is needed if unanimous written consent of all directors o Ratification:

If an officer does something, at the meeting, a board approval of that action may be a ratification—in turn, may create actual authority to officer and if a 3P knows about it create apparent authority

BOD Acting after the fact: Can Act Formally through meeting or informally, by failing to act, or acquiescence If the Company wants to be bound:

o Formal Ratification at a meeting (Physical, Telephonic, or Consent) If 3P Wants to bind company:

o Argue Apparent Authority Created by acquiescence or an act that affirms it (Ratification)

o Estoppel Holding Out+ Reliance to Detriment

o Officers: Note:

While most corporate statutes have a requirements of President, Treasurer and Secretary, the MBCA does not explicitly require these titles (except it requires someone to perform a secretarial duties, although does not have to be called that)

Empowered By Where to look for Express Actual Authority of Officers: 1. Articles of Incorporation 2. Employment Contracts 3. State Corporate statute

o §8.40 MBCA: (a) Corporation has officers described in bylaws…

4. By the Board of Directorso §8.40 (b) Board of Directors elects and fills the offices o §8.41 MBCA:

Each Officer has the authority to perform functions that are in the bylaws, or prescribed by the Board of Directors…

4. By Laws Implied Actual Authority:

Board of Director Actions or Inactions

85

Ratification Apparent Authority

May be inherent in title of positiono President and Secretary, below, both have inherent apparent authority

May be due to ratification by the board of directors The Office of Secretary:

Note: o The MBCA only explicitly describes the duties of this office

In Re Drive in Development Corp: o F: Officers of subsidiary guaranteed a bank payment so that bank would loan to its parent.

Officer did so as the ‘chairman’ and the secretary of corporation gave a signed statement of authority of Board Meeting that was certified with corporate seal. There was never any meeting

o R: Secretary has statutory inherent apparent/actual authority to certify resolutions/

authenticate records §8.40 (c) MBCA: “shall assign to one of the officers responsibility for preparing

minutes, and for maintaining and authenticating records…o Although MBCA does not require the secretary be called that, it does

require a position with this inherent authority Apparent Authority

o Is representation to 3P…so depends on 3P reliance or interpretationo 3P does not have to investigate beyond representation

If change in position Estoppel If merely reliance Apparent authority

o Remember What is reasonable for 3P to perceive Here:

o The Secretary obviously didn’t have actual athuroty to make up a document…but she did have apparent authority to authenticate records…which is what she did…corporation bound

What to do to assure a person has authority to bind Corporation: 1. Executed with Corporate Seal 2. At the closing table for mega-deals

o a. Articles of Incorporation, certified by secretary of Stateo b. Certificate of good standing, certified by secretary of Stateo c. By-Laws certified by the secretary through companyo d. Board Resolution, certified by secretary o e. Secretary certified certificate of incumbant signer/officero f. To assure secretary is who he purports to be someone must sign to assureo g. Opinion o Counselevaluate all above to make sure authority is evident

At this point, authority of the transaction/officer should be ok! President:

Lee v. Jenkins Bros. o F: President of Jenkins Bros. entered into a contract with π, purporting to give him a pension. ∆

corporation is arguing that President did not have the authority to do soo R:

Presidents have the authority to bind in contract in the usual and ordinary course of business

But may not bind in extraordinary natureo What is ordinary and usual versus extraordinary is a factual inquiryo Factors:

Nature of the Contract involved Officer negotiating it

86

Corporations usual manner of business Size and Number of shareholders Circumstances surrounding the contract Reasonableness of contract Amount

o Life Time Employment Contract Factors: Life Time employment K’s are extraordinary Unduly restrict shareholders / BOD managerial capacity Subjects corporation to liability Run for indefinite duration

Extraordinary Transactions are not within Presidents purview Presidents Ability to Initiate Lawsuit:

o Cases seem to have found consistently, that the Board of Directors must initiate litigationo Also seem to consistently find that President has no inherent authority to do so…

Duties of Officers and Directors: o Duty of Care:

Rule Framework: Generally: While MBCA has attempted to create a rule, it is typically a Common Law Issue Duty of Care:

o Calls for skill, diligence, and prudence o Standard judged by a reasonable person acting with respect to his own business

Most Jurisdictions: Looking for Negligence Delaware: Gross negligence

Business Judgment Rule:o Presumption that director/officer acted in good faith and reasonable process

Protects substance of Informed Decisions Presumption that act is in good faith and reasonable You do not have to be right, as long as acted with:

Duty of Care of reasonable persono When Does not Apply:

Fraud, Bad-Faith, Conflict of Interest Decision not informed (EG: flipping coin to decide) Show total lack of rationality or waste of corporate assets At this point Court will inquire into Duty of Care

Litwin v. Allen: F: Shareholders brought derivative suit against the Directors who purchased bonds, at the top of the

market and eventually sold them at the bottom of the market. Throughout this ordeal, the person they had purchased from had an option to buy them back at face value—par. So all of the risk was on the company and all the potential gain (other then coupon payment) was on the seller.

R: o Duty of Care: Requires Directors to exercise prudence, diligence, and skill

Judged by the ordinary prudent man Evaluated by what occurred at that time, and not in hindsight Directors can be negligent, but not if they simply make a mistake while being prudent,

diligent and skillful Prudence Diligence more dealing with the process of understanding Skill what you bring to the table

very rarely is there an issue with skill Here:

Was an issue of prudence…buying bonds with such an option that make you bear all risk is not a prudent investment

o It is contrary to fundamental conceptions of prudence in that industry

Liability extends to what Directors are the proximate cause of

87

Shlensky v. Wrigley: F: π brings suit alleging that director has failed in his duties due to the fact that has not installed lights at

Wrigely field. Because he hasn’t, the corporation is losing market share due to the fact that they cannot play at night.

R:o The Business Judgment Rule

Directors have a presumption that business transactions and judgment are formed in good faith (For the Corporate Wellfare)

Deference by the Courts to the Directorso The action must be or border on:

1. Fraud 2. Illegality 3. Self Dealing

o If the action does not fall into those 3, Court will not even look at it Note:

o Other then Corporate Welfare is self interest, or interest other then that of corporation and shareholders

The Effect of Smith v. Van Gorkom: This was a Delaware Supreme Court case, dealing with the sale of a company that took 2 hours, and had

no attorneys or financial experts present. The company was sold.o Court Held:

Delaware’s Standard was ‘Gross negligence’ That this Director act was Grossly Negligent

This scared directors to death, and many subsequently left boards in Delaware Legislature reacted, adopting §102

o §102 Delaware Corporations Law: A Corporation’s Articles of Incorporation may contain a provision eliminating or

limiting personal liability for breaches of Duty of Care All states followed, and before long, many corporations amended their AIC to have it MBCA § 2.02 (b) 4

o These “Raincoat Provisions” have essentially ended litigation of “Duty of Care” Issueso Now, people attempt to bring suit under Duty of Loyalty

o Duty of Loyalty: Generally:

A transaction that risks the corporation being treated unfairly by a parent corporation or fiduciary director or officer

Note: See Promoter Fraud, Dilution, Shareholder Salary, Duty of shareholder in close corporation, Equitable

Subordination 2 Types of Duty of Loyalty issues:

1. Duty to avoid unfair self-dealingo Remedy Void the interested decision maker’s transaction

2. Duty to avoid usurping corporate opportunitieso Remedy Imposition of Constructive Trust, where the interested party holds benefit for

beneficiary and gives back Type 1: Duty to Avoid Unfair Self-Dealing

Sometimes Self-dealing will be clearo Sometimes Sinclair test will need to be employed

Director/Officer Context: o At Early Common Law (No Longer Effective)

All transactions that were self-dealing, or interested were automatically void by corporation

o Delaware Common Law:

88

Self Intersted transactions are voidable if unfair to corporation Burden is on the ‘interested party’ to prove fairness

o Del. C. § 144: No transaction or contract between corporation and director/officer shall be void or

voidable solely because it is self-interested, if: 1. Facts disclosed or known to Board of Directors, and Board votes a majority

of the disinterested directors, or 2. Facts disclosed or are known to Shareholders, and is approved by them in

voteo Note:

Most statutes say “disinterested” shareholders 3. Transaction Fair to corporation at time it is authorized by board or

shareholders Effect:

Ends Strict CL View self-dealing cannot solely be reason to void When applicable, “Intrinsic Fairness” still looked at Won’t entirely cleanse unfairness, but helps to have disinterested decision

maker Quorum

o Interested directors can be counted for determining presence of quorum at meeting of directors

Marciano v. Nakash: F: π’s argue that the ∆ interested transaction is void, under §144. That §144 is

the sole method, and there was no shareholder or director approval. Therefore, under §144 it is void.

R:o §144 is utilized in addition to Intrinsic Fairness Test

It is not the exclusive method of review In those instances where disinterested parties cannot

approve, common law test applieso Current Test:

Self- Dealing Transactions are voidable, unless shown to be fair, or With Burden on ∆ to prove fairness

Approved by a Disinterested Decision Maker In which Case, the burden shifts to the π to prove unfairness

o Sarbanes Oxley Act and Self dealing: The SOX act creates rule that “no loans or arranging of loans for executive officers or

directors of a 1934 Act company”** Self Dealing in Parent Subsidiary Context:

o Sinclair v. Lewein: F: Parent Corp owned 97% of Sinven. And forced it, by voting directors, to grant

dividend even though had no retained earnings, and caused a contract to be breached R:

Is it Self-Dealing?o Occurs when parent causes subsidiary to act in a way that the parent

receives benefit to the exclusion and detriment of minority shareholders of subsidiary

If Yes:o “Inherent Fairness Test” applies

Burden on ∆ to show the fairness to minority shareholders If No:

o Business Judgment Rule Applies Court wont interfere unless gross overreaching

Here:

89

o Dividends were $108M, and done in deficit state—but went to minority too…no exclusion of minority

o Contract: breach occurred, parent corporation got benefit, but minority shareholders did not get anything from contract

Type 2: Duty to avoid unfair usurpation of Corporate Opportunity: 4 Variations of Corporate Opportunity Test:

o 1. Delaware “Line of Business Test” Corporate opportunity presented to officer/director

Which Corporation is financially able to undertake Is “In Line of Business”

o Looks at competition that arises within line of businesso If Director would then compete with his corporationo If competition is outside line of business—may not be helpful

o 2. Massachusetts “Fairness Test” Looks at unfairness, taking advantage of an opportunity for personal profit

o 3. Minnesota “2 Step” 1. Is opportunity within corporations line of business? 2. Is it Fair?

o 4. The ALI Test: 1. Is it Corporate Opportunity?

A. Director/Officer should reasonably believe offer made to corporation B. Closely related to corporations business C. Occurs by using corporate property D. Reasonably expect that corporation would be interested E. Brings into competition of duties

If No: Officer can accept it

If Yes: 1. Must Offer to Corporation, with full disclosure

o If Accepted They get it 2. If Rejected, must be:

o 1. Fair to the corporation, oro 2. Rejected by disinterested directors in way that satisfies the business

judgment rule, oro 3. Rejection by disinterested directors is not waste of corporate assets

If you Didn’t Offer:o Constructive Trust Imposed

What if Rejected, but not fair to corporation: Arguably, waste or irrationality might come into play Might inquire into whether it is self-dealing or not or directors really are

disinterested May violate the inherent duty not to compete with your corporation

ALI Test also has safe-harbor: 1. Good faith, but defective disclosure

o Cured by original Rejecton of opportunity being ratified 2. If no offer to corporation, no recovery if it was:

o In good faith belief it wasn’t opportunity ando In reasonable time, it is offered to corporation and rejected

Applied to Partnership:o Remember, partnerships too have fiduciary duty to not appropriate partnership opportunity

Cardozo view of opportunity anything that occurs as result of P-ship At least need to notify…if not constructive trust

Andrews anything that occurs which is within scope of partnership Corporate Opportunity Applied to Parent/Subsidiary:

90

o Sinclair: F: Sinclair owned 97% of subsidiary, Sinven. Parent was giving opportunites to other

locations, instead of Sinven. R:

Appropriation of Opportunityo Line of Business Test:

No opportunity came to subsidiary that was usurped Was parent corporation making business decisions on who

to implement program with… Didn’t have the financial capacity to perform anyway

Self Dealing:o Nothing was taken from subsidiary to detriment of minority

shareholderso BJR applies

Application of ALI Test:o May be corporate opportunity that is closely related, competitiono Was never offered…may be more likely to be a usurpation of

corporate opportunity

Insider Trading:

Rule 10 (b)o Unlawful for any person…by any means (Purchase or Sale) (Not Act Specific…doesn’t matter if 33 or 34), to

To use any manipulative or deceptive device in contravention of SEC Rules Applies to any transaction

Rule 10 (b) 5:o Unlawful for any person, by any means of interstate commerce, mails, etc…to

1. Use a device, scheme, artifice to defraud 2. Make any misrepresentation or ½ truth of material fact 3. Or, engage in any fraudulent conduct

Note:o 1 and 3 are paired to apply to insider tradingo 2 is used, but doesn’t apply when no communication. o Overall Applies to that conduct, and foreseeable effect

SEC v. Texas Gulf Sulphur: o F: ∆ company was engaged in exploratory drilling, and found biggest mine ever. Kept results quiet, until test could be used

to verify findings. Officers were told to keep quiet, and didn’t even tell directors about it. Some officers tipped friends and wives about find—stock and options began to be purchased. Price skyrocketed, and call purchases grew tremendously.

o R: 1. There is duty to disclose material inside information to investing public, or, abstain from trading or

recommending securities while it remains undisclosed Officers as Fiduciary to Corporation had this duty Non-disclosure is fraudulent where there is a duty and you do not abstain from trading Applies from Officer to Corporation

o Here, accepted stock options without disclosing information to Board of directors o Had duty of disclosure, or abstaining from trading they didn’t fulfill

2. Applies to open market: From Officers to the Public Shareholders Extends this duty to all shareholders in public market

o Punishes trading on information that is advantageous, and unfairo Buying or Selling…it is the trading on information that is not available…prohibited

Note: These 2 duties are judicial creation of 2d Circuit The first, is based on a duty of unfair self-dealing The second is completely judicial creation…extending fiduciary duty from officer to shareholders

3. Duty Applies to Material Inside Information:

91

Duty of disclosure or abstinence from trading arises when:o situation of ‘extraordinary nature and that has reasonable certainty to have substantial effect

on market price of security if disclosed’ Evidence:

o Look at share price jump when disclosedo Look at volumeo Officer’s rush to beat the news, marketplace…conduct (Late night orders here)

4. Insiders with such information may act when Disclosure Occurs Fair Dissemination Insiders may act when:

o Material information has been effectively disclosed in manner sufficient to ensure its availability to public

Probably cannot act as soon as news is given Depends on context—bigger company, more followed, may be available to public

quicker Modernly, may be faster dissemination

5. Liability A person acting on this, or recommending/tipping liable If they cannot trade, tippees cannot…liable for those trades also

o Securities Regulation Theory: Following this case, people looked at “Equal Access Theory” eminating from language

“Policy of justifiable expectation of securities marketplace that all investors trading…have relatively equal access to material information”

Litigants sought to extend this duty to everyone, not just officers Chiarella Case:

Tender Offer was being made to target company for acquisition Documents sent to printer, of which an employee read, and made trades Supreme Court said this is not insider Trading

o Fraud is only evident when duty to disclose applies, and this employee did not have duty to disclose

o Only applies to Officers/Directorso Equal Access Rejected

O’Hagen: Accepted Dissent of Chiarella Similar facts—acquierer using law firm, of which an attorney took information and made trades

o Court extended duty Said this was insider trading

Misappropriations Theory o Anyone who misappropriates information liable

o Modernly: Traditional, Classic Insiders (Sulfur) People Misappropriating (O’Hagen) + Their Tippees

All are eligible for ‘insider trading’ liability

92