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Business Organizations Outline: Fall 2011:

Agency Relationships:
1. Common Law: consensual relationship: one person acts on behalf of another person with power to affect the
legal rights and duties; not necessarily a K.
a. Principal: bound/obligated and part of the transaction because they gave the A power to make them
bound.
b. Agent: authorized to act for the P.
c. Third party: who the A deals with.
2. Restatement Provisions to Know:
a. 1.01: defines agency: relationship that arises when P manifests assent to an A that acts on Ps behalf,
subject to Ps control, and the A manifests assent to act for the P.
i. Elements of How to Create Agency:
1. Manifestation of assent to the Agent by the Principal to act
2. On the Ps behalf; and

3. Subject to the Ps control (and for the Ps benefit)


ii. Ps right to control the A is critical. A person may be an A if the P has some aspect of control
over what the A does relating to the results or ultimate objectives of the agency relationship.
iii. If the P does not control the A, there is probably not an agency relationship. The more control
the P has over the A, the more likely it will be considered an agency relationship.
iv. There must be an agreement for the creation of a fiduciary relationship with control by the
beneficiary.
b. 1.02: agency relationship only arises when elements are present. It is the way the people act, not the
words they may or may not form between each other. Even if they call the relationship something
else, it is still an agency.
c. 1.03: manifestation: no specific form or words are necessary to create an agency. Its the conduct of
the parties that determines whether something is an agency relationship.
i. You look at the manifestation of assent by the principal to see if a reasonable person in the
agents shoes would have believed that he had the power to act on the Ps behalf.
ii. The principals subjective intent is irrelevant.
d. 1.04: Types of Agents
i. Co-Agency: Two independent agents where neither agent is the others agent, but they each
owe duties to the same P.
ii. Dual Agent: One Agent who works for multiple Ps and owes a duty to each. (Each
relationship requires a manifestation of consent from each P to create this agency)
iii. Sub-Agency: A authorized to hire others who will be their As, assisting and carrying on
work for P. The P will be bound by the new As that the original A hires.
e.

iv. Gratuitous Agency: no contractual feel, lack of consideration.


1.04: Types of Principals
i. Undisclosed P: Third party neither knows there is a P or whom P is, even if it is contrary to
the instructions of the A.
ii. Unidentified P: Third party knows there is a P, but not his identity.

iii. Fully Disclosed P: Third party knows there is a P and who P is.

1. NOTE: what facts have been manifested to the third party so that he would
reasonably believe the A is acting for the P. This is an objective view.
f. 1.04: Definition of Person: human or business organization that has the capacity to be a holder of
legal rights and the object of legal duties (be able to be a P or A).
g. 1.04: Power of Attorney: instrument stating an As authority.
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i. Generally, these are strictly construed and are held to grant only those acts that are clearly
delineated.
h. 2.02: Scope of Authority: objectively reasonably A has actual authority to take whatever actions
are incidental to follow through with the Ps manifestations.
Actual and Apparent Authority:
1. Restatement Provisions:
a. 2.01: Actual Authority: The objective manifestations of P to A makes him reasonably believe that
he has the power to act on Ps behalf. The focus is on Ps manifestations to A.
i. Ps subjective intent is irrelevant.
ii. Authority that the P, expressly or implicitly, gave the A.
iii. Look at the reasonableness of Ps manifestations from As point of view.
iv. Express - The P directly grants agency through written or spoken communication.
v. Implied - Agency is implied from conduct, previous words, or from the agents role in the
company.
b. 2.03: Apparent Authority: The objective manifestations of P to the third party make the third
party reasonably believe that A had the authority to act on Ps behalf.
i. A has app auth sufficient to bind P when the P acts in such a manner as would lead a
reasonably prudent person from the third partys viewpoint to suppose that the A had the
authority to bind P.
ii. A has the app auth to do things that are usual and proper to the conduct of the business.
iii. Ps objective manifestations are made to a third party.
iv. Agents cannot create apparent authority. It is not enough that the A created the appearance
of authority; there has to be some sort of manifestation from the P to be considered app auth.
v. If an agent has actual authority, but that authority is revoked, the P needs to tell the third
party of the revocation because its possible that the apparent authority will still exist.
2. Ratification: Even if there wasnt authority on the front end, the P will be bound by the As actions if the P,
with knowledge of all material facts:
a. Receives, accepts, and retains benefits from the K,
b. Remains silent, acquiesces, and fails to repudiate or disaffirm the K, or
c. Otherwise exhibits conduct demonstrating an adoption and recognition of the K as binding.
3. Inherent Authority (Restatement 2d): When a company hires someone and puts them in a position of power,
it is likely that they have created apparent authority in that person.
a. It is reasonable for the CEO of a company to have the authority to bind the company, even if they
dont have actual authority.
b. The Restatements 3d took this out and just included it in apparent authority.
4. Implied Authority: actual authority circumstantially proven that the P actually intended the A to possess
and includes such powers as are practically necessary to carry out the duties actually delegated.
Estoppel, Restitution and Ratification:
1. Restatement Provisions:
a. 2.05: Estoppel to Deny Agency: When a P doesnt make any objective manifestations to create an
agency relationship, the P can still be bound by another persons actions if the equitable doctrine of
estoppel prevents the P from denying that the agency relationship existed.
i. This usually occurs when there is no agency relationship, but there is someone who is out
there acting as if he is an agent and the P fails to do anything about it.
ii. The P needs to know of the alleged A or at least have reason to know of the A.

iii. If the third party reasonable believes that the A had the authority due to the circumstances
and due to the lack of P exercising ordinary care, the P will be estopped from denying the
agency.
iv. Here, there arent going to be any actions by the P, but most likely there will be omissions of
the P that will lead the third party to believe the A was authorized.
v. E.g. - Someone is pretending to be a salesman in your store and you dont stop him from
doing it. If that person gets a customer to give him money for a sale, you can be estopped
from saying he wasnt your A.
b. 2.07: Restitution: A P who is unjustly enriched at the expense of a third party by the action of an A
or a person appearing to be an A is subject to a claim for restitution.
i. The P must receive a benefit at the third partys expense, and it must be unfair for the P to
keep it.
ii. Officious Intermeddlers cannot seek restitution. If my neighbor isnt happy with my house
color, he cant have it repainted and then expect me to pay for it.
iii. With restitution, there is not going to be any manifestations by the P to anyone to think that
the A had authority. Its just that it isnt fair for him to keep the benefit.
c.

4.01: Ratification: When a P has knowledge of all material facts, he can ratify the actions of a
person who wasnt an agent at the time the transaction was made by manifesting an acceptance of
the actions after the fact.
i. The P can ratify through written or spoken acceptance of the actions or through his conduct.
1. If the basis for ratification is the Ps conduct, it must be blatantly clear.
ii. Ratification must be timely - Its not effective unless it precedes the occurrence of
circumstances that would cause the ratification to have adverse/inequitable effects on the
rights of third parties including:
1. Any manifestation of intention to withdraw made by the third party,
2. Any material change in circumstances causing it be inequitable to bind the third
party; and
3. Specific time that determines whether a third party is deprived of a right.
iii. The principal must have existed at the time the transaction was entered into. If a company
was not formed at the time of the transaction, they cannot later ratify the actions.

iv. ELEMENTS: Ratification requires:


1. There has to be a prior act
2. Done by another
3. The other person cant have had actual or apparent authority
4. Has to be done on behalf of or purportedly on behalf of the person seeking to ratify
5. The purported P has to assent or manifest assent to the entire arrangement.
6. Has to be done at a time when there is objective knowledge of all material facts.
d. 4.08: Estoppel to Deny Ratification: P makes a manifestation that P has ratified anothers act and
the manifestation as reasonably understood by third party, induces the third party to make a
detrimental change in position, and thus P may be estopped to deny the ratification.
Creating and Terminating Authority
1. Restatement Provisions:
a. 3.01: Creation of Actual Authority - Actual authority is created by a Ps manifestation to an A
that, as reasonably understood by the A, expresses Ps assent that A take action on Ps behalf.
i. There is an absolute right to terminate agency, even if there is a writing that says otherwise.
ii. This could be a breach of that contract, but it would be effective in terminating the agency.

b. 3.02: If the law requires a writing to bind an A, P is not bound in the absence of such writing. P,
however, may be estopped to assert lack of the writing when a third party has detrimentally relied on
Ps manifestations that A had the authority to bind P.
i. This will come up with statute of frauds shit and proxy voting rights, etc.
3.06: Terminating Actual Authority: As actual authority may be terminated by:
i. 3.07 - As death
ii. 3.07 - Notice given to A or to third party of Ps death
iii. 3.08 - Notice given to A or to third party of Ps loss of capacity
iv. 3.09 - Agreement between A and P to revoke the agency relationship.
v. 3.10 - Manifestation of revocation by the P to the A.
vi. 3.10 - Manifestation of renunciation by the A to the P.
vii. Occurrence of circumstances by statute
d. 3.08: Ps Loss of capacity terminates As actual authority when A has notice that loss of capacity is
permanent. If the A isnt sure if the incapacity is permanent, then he still has authority.
i. Written instrument may make an As actual authority effective upon a Ps loss of capacity, or
confer it irrevocably regardless of the loss.
e. 3.09: Termination by Agreement: As actual authority terminates as agreed by A and P, or upon the
occurrence of circumstances on the basis of which the A should reasonably conclude that P no longer
would assent.
2. 3.11: Termination of Apparent Authority: Apparent authority ends when it is no longer reasonable for the
third party to believe that the A has power to bind P.
a. Even if actual authority is terminated, the A may still have apparent authority if revocation isnt
made known to the third party.
3. Equal Dignities: If the act that the A is attempting to perform on Ps behalf is required to be in writing, then
the appointment of the agency must also be in writing.
a. Things that fall within the Statute of Frauds; and
b. Whether the statutes in the jurisdiction impose the requirement that an equivalent level of formality
must establish a grant of authority to an A, which would allow the A to enter into such obligations.
c. A majority of states require some sort of equal dignities requirement for most kind of Ks.
c.

Irrevocable Powers
1. There are some agency relationships that are not subject to the normal termination rules. These are called
irrevocable powers.
2. Statutory Irrevocable Powers: Health care power of attorney, or power of attorneys in the case of death.
3. Restatement Provisions:
a. 3.12: Power Given as Security and Irrevocable Proxies:
i. Power given as security is when a person authorizes someone to act for the benefit of the
holder or a third party. It isnt an agency relationship because the principal isnt benefitted.
1. This is given to ensure that another obligation will be satisfied.
2. Distinct from actual authority that the holder may exercise if the holder is an agent.
ii. Power to Exercise voting rights associated with securities or a membership interest may be
conferred to a proxy through a manifestation of actual authority.
b. 3.13:: Termination of Power Given As Security/Irrevocable Proxy:
i. PGAS/IP is terminated by an event that:
1. Discharges the obligation,
2. Makes its execution illegal or impossible,
3. Constitutes an effective surrender of the power/proxy
ii. Neither a PGAS nor a IP is terminated by:
1. Manifestation revoking the power/proxy, or
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2. Surrender of the power/proxy by the holder, unless that person consents; or


3. Loss of capacity by the creator or holder, or
4. Death of the holder, unless it terminates the interest secured by the power/proxy, or
5. Death of the creator.
4. Powers Given as Security/Powers Coupled as an Interest: must be held for the benefit of the holder or a third
party. In order to benefit himself or someone else, not the grantee: either to protect legal or equitable title or
in order to secure the performance of a duty. Cant benefit only the P because the P could then back out.
a. If the power is given as a security for the performance of a duty, it must be supported by
consideration;
b. If the power is given to facilitate transfers of title to the power holder, it doesnt need consideration.
c. If there is already an agency relationship in existence, and this power is given in furtherance of that
agency, it is not given as security, and is revocable.
d. The easiest way to distinguish between agency and given as security is to see if the agent only
receives a commission from performing the duty or if ownership is handed over.
i. If agent gets a fee for performing a duty, it is just an agency relationship and is revocable.
ii. If the agent gets to sell the item and receives all of the benefits, it is given as security.
5. Irrevocable Proxies: One of two things must happen here:
a. Grant of the proxy must be made irrevocable in accordance with the statute, or
b. Grant must be in accordance with common law requirements concerning powers given as securities.
c. Minority says: it is necessary that the power holder possess a proprietary interest in the subject
matter of the agency itself.
6. Termination of a Power Given as Security:
a. Discharge of the obligation
b. An event that makes the executive illegal or impossible; or
c. An effective surrender by the person for whose benefit the power was created.
Relationship Between Agent and Third Parties:
1. Restatement Provisions: (All relate to how much substantive knowledge the third party had at the time of
the K.
a. 6.01: Disclosed P: When an A has actual or apparent authority to act on behalf of P, and the third
party knows this, and also knows the identity of P, then A is not a party to the contract.
i. P must be disclosed at the time of contracting, otherwise it will not be considered disclosed,
or even unidentified and thus the A will be liable.
b. 6.02: Unidentified P: When A has actual or apparent authority to act on behalf of P, and the third
party only knows there is a P and not Ps identity, A is a party to the contract unless A and the third
party agree otherwise.
i. It is the duty of the A to disclose not only that he is acting in a representative capacity, but
also the identity of his P. It doesnt matter that the identity of a principal is publicly known.
ii. Actual Knowledge is the Test.
iii. P is still a party to the contract.
iv. If A signs As agent and not personally liable this is probably enough to disclaim liability.
v. This also applies if A identifies an agent, but that identification is wrong.
c. 6.03: Undisclosed P: When A has actual or apparent authority to act on Ps behalf, but the third
party is unaware of this relationship, the P and A are parties to the contract.
i. The third party can sue either one of them for performance of the contract.
d. 6.04: P Doesnt Exist or Lacks Capacity: Unless the third party agrees, a person who makes a K with
a third party purportedly as an A on behalf of a P becomes a party to the K if the purported A knows
that the P doesnt exist or lacks capacity to be a party to a K.
i. If A is acting for a company, but the company isnt formed yet, the A is liable.
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e.

6.11: As False Representations:


i. When an A for a disclosed or Unidentified P makes a false representation about the As
authority to a third party, P is not subject to liability unless A acted with actual or apparent
authority in making the representation and third party doesnt know it is false.
2. Attorney/Client Agency: if a client owes a service that the attorney, as an agent, obtains for that client, the
attorney owes that service person an express disclaimer of responsibility if the attorney doesnt want to be
bound as a party to the K.
a. Modern Trend: hold the attorney liable in the absence of an express disclaimer or other indication
not to be bound, because an attorney knows better.
3. Warranty of Authority: the moment an A acts purportedly on behalf of someone else, by implication the A
is warranting that he/she has the authority to do the act.
a. If A represents that he has the authority, but may not, and induces the third party to believe that he
does and there is a detrimental change, but the A fully disclosed that he was an A and fully disclosed
the P, he is still personally making an implied warranty that he has authority.
i. It doesnt make A part of the K, but does give an independent basis for liability against him.
ii. A would be liable for the damages caused by his breach of warranty.
b. Acting outside scope of Agency - When an A represents himself as an A of a disclosed P in excess of
his authority to do so, he becomes personally subject to liability to the other contracting party.
i. He is liable even if he acts in the utmost good faith and honestly believes he was authorized.
ii. The A doesnt receive the benefits of the contract, but he is liable if the P defaults.
Liability for Torts of Another
1. Restatement Provisions: The A is always liable for his own tortuous conduct.
a. 2.04 & 7.07: Respondeat Superior: employer is subject to liability for torts committed by employees
while acting within the scope of their employment.
i. Employee acts within the scope of employment when performing work assigned by the
employer or engaging in a course of conduct
ii. Two steps:
1. Identify that the person is an employee and not an independent contractor.
2. Make sure they were acting within the scope of employment.
b. 7.01: As Liability to Third Parties: A is subject to liability to a third party harmed by As tortuous
conduct. Unless a statute provides otherwise, an actor remains subject to liability although the actor
acts as an A/employee, with actual or apparent authority, or within the scope of employment.
c. 7.03: Ps Liability Generally:
i. P is subject to direct liability to third party harmed by As conduct when:
1. A acts with actual authority or the P ratifies the As conduct and
a. As conduct is tortuous, or
b. As conduct would subject to the P to tort liability
2. P is negligent in selecting, supervising, or otherwise controlling A; or
3. P delegates performance of a duty to use care to protect persons or property to an A
who fails to perform the duty.
ii. P is subject to vicarious liability to a third party harmed by As conduct when:
1. A is the employee who commits a tort while acting within scope of employment; or
2. A commits a tort when acting with apparent authority in dealing with third party on
behalf of P.
d. 7.04: A Acts with Actual Authority: P is subject to liability to third party harmed by A;s conduct
when As conduct is within the scope of As actual authority or ratified by P; and either the As
conduct is tortuous, or the As conduct would subject P to tort liability.
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e.

2.

3.

4.

5.

7.05: Ps Negligence in Conducting Activity Through A; Ps Special Relationship with Another


Person:
i. P is subject to liability for harm to a third party caused by As conduct if the harm was
caused by Ps negligence in selecting/training/retaining/supervising/controlling the A.
ii. When a P has a special relationship with another person, P owes that person a duty of
reasonable care with regard to risks arising out of the relationship.
f. 7.06: Failure in Performance of s Duty of Protection: P required by K to protect another cannot avoid
liability by delegating a performance of the duty, whether or not the delegate is an A.
Employee v. Independent Contractor: An employer is not liable for the torts of an independent contractor. An
independent contractor is an agent of the employer, but that doesnt mean he is liable for his torts.
a. The more control the employer has over the employee, the more likely they will be considered an
employee and not an independent contractor.
b. Factors to Consider:
i. Level of control,
ii. who determined business hours,
iii. Who determined and paid wages,
iv. Who controlled over hiring and firing decisions,
v. who controlled advertising, etc.
vi. Who trained employees?
vii. Who controlled pricing?
viii. Who controls the inventory offered?
c. This will likely come up when a franchise is being sued. So, if someone is injured at McDonalds,
McDonalds will say that store was an independent contractor, while the Plaintiff wants them to be
employee because McDonalds is going to have more money than just that one franchisee.
i. Some courts say that a franchising agreement is a phenomenon and that the franchise
should not be liable for all of their torts. (Murphy v. Holiday Inn)
ii. Others dont care about the franchising aspect and apply traditional rules. (Dominoes)
Scope of Employment: the conduct of an employee is within the scope of the employment if, but only if, it is
actuated, at least in part by a purpose to serve the employer.
a. Test: Whether or not the motivation was at least in part to serve the ultimate objectives of the
employer and whether the conduct of the employee was foreseeable?
Doctrine of Frolic and Detour: Employers are not liable for torts committed while an employee is on a frolic,
but they are liable if the employee was only on a detour.
a. Frolic - If the employee goes off and does something completely unrelated to his employment for an
extended period of time, this will be considered a frolic.
b. Detour - If it is a minor departure from your scope, it is a detour, then because it is so close and
foreseeable, the employer is still probably liable.
Restatement (3d) Torts: Liability for Physical and Emotional Harm (draft only)
a. 55: Liability in Negligence of Those Who Hire Independent Contractors: activity that creates a risk of
physical harm is subject to liability when the actors negligence is a factual cause of any such harm
within the scope of liability. (Not respondeat superior/vicarious liability- way to hold the principal
liable for the principals own fault). If the P is negligent in hiring or training or supervising an agent
or independent contractor he is at fault.
b. 56: Duty Limitation as to Work Entrusted to an Independent Contractor: actor owes a duty of care
only with respect to any part of the work over which the actor has retained control.
c. 58: Work Involving Abnormally Dangerous Activities: actor knows or should know involves an
abnormally dangerous activity is subject to vicarious liability when harm is within the scope.
d. 59: Activity Posing a Peculiar Risk: actor knows or should know poses a peculiar risk is subject to
vicarious liability for harm when the independent contractor is negligent within the scope.
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e.

60: Work on Instrumentalities Used in Highly Dangerous Activities: Actor is subject to vicarious
liability if the actor carries on an activity that the actor knows or should know poses a high risk of
harm unless the instrumentalities used are carefully constructed and maintained, they hired an
independent contractor to construct, and the contractors negligence in constructing the
instrumentalities is ham within the scope.
f. 61: Activities Constituting a Trespass, Nuisance, or Withdrawal of Support: actor is subject to
vicarious liability for harm if the actor knows/should know that the activity is likely to involve one of
these things, the contractor does the thing, and it is the factual cause of harm within the scope.
g. 63: Precautions Required by Statute or Regulation: actor is subject to vicarious liability for physical
harm to others if the statute imposes an obligation on the actor and the contractors failure to comply
is the factual cause of any such harm within the scope of liability.
6. P is Liable for Independent Contractors:
a. Generally, P would never be liable for the negligence of the contractor or his employees. Exceptions:
i. P is liable for its own negligence in selecting, training, supervising the contractor; this is not
vicarious liability, just actual liability.
ii. P is liable for the breach of a non-delegable duty, even if the P chooses an independent
contractor to accomplish that duty (vicarious liability).
iii. P may be liable for abnormally dangerous activities, those involving peculiar risk, and highly
dangerous activities even if those activities are delegated to an independent contractor. (A
jury usually determines whether an activity is considered an inherently dangerous activity)
iv. P may be liable for activities constituting a trespass, nuisance, or withdrawal of support;
v. P is liable if an independent contractor ails to take precautions required by statute; and
vi. P is liable if the tort is intended or actually authorized. (actual liability).
b. To Minimize Risk of Personal Liability:
i. Hire only competent, financially responsible contractors,
ii. Insist that the contractor immediately remedy hazardous job sites,
iii. Take steps to ensure that the contractor employees are trained
iv. If there are inherent, foreseeable risks from the contractors activities, take precautions
v. Establish reasonable procedures to safeguard the condition of your own equipment
vi. Dont retain the contractual right to control the work (then it will be respondeat superior)
Notice and Notification:
1. Generally, notice of any material fact that is given to or by an agent is binding on the principal, unless the
third party knows or has reason to know that the agent will act adversely to the principal.
2. Restatement Provisions:
a. 5.02: Notification Given By or to an A:
i. A notification given to an A is effective as notice to the P if A has actual or apparent
authority to receive the notification unless the third party knew that the A had reason to act
contrary to Ps interests.
ii. Notification given by an A is effective as notification given by the P if the agent has actual or
apparent authority to give the notification.
b. 5.03: Imputation of Notice of Fact to P: Notice of a fact that an A knows or has reason to know is
imputed to the P if knowledge of the fact is material to the As duties to the P, unless the A either
acts adversely to the P, or is subject to a duty to another not to disclose the fact to the P.
c. 5.04: A who Acts Adversely to a P: Notice of a fact that an A knows or has reason to know is not
imputed to the P if the A acts adversely t the P in a transaction or matter. Notice is imputed either
when necessary to protect the rights of a third party dealing with P in good faith, or when P ratifies
the act or knowingly retained a benefit from As action.
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Fiduciary Nature of the Agency Relationship (8.01 - 8.15):


1. Restatement Provisions: Generally, an A has a fiduciary duty to the P at all times.
a. 8.02 - 8.05: A has a duty not to acquire a material benefit from a third party in connection with
transactions on behalf of P, not to deal with the P on behalf of an adverse party, to refrain from
competing with the P, and not to use property of the P for the As own purposes.
b. 8.06: Ps Consent:
i. Conduct by an A that would otherwise constitute a breach doesnt constitute a breach of duty
if P consents to the conduct, provided that:
1. In obtaining consent, A: acts in good faith, discloses all material facts, and otherwise
deals fairly with P; and
2. Ps consent concerns either a specific act/transaction of a type that could reasonably
be expected to occur in the ordinary course of agency relationships.
ii. A who acts for more than one P in a transaction has a duty to:
1. Deal in good faith with each P;
2. Disclose to each P: fact that the A acts for the other P, and all other facts that the A
knows, would reasonably affect the Ps judgment; and
c. 8.08: A has a duty to the P to act with the care, competence, and diligence normally exercised by As
in similar circumstances.
d. 8.09: An A has a duty to take action only within the scope of his actual authority. An A has a duty to
comply with all lawful instructions received from the P.
e. 8.10: A has a duty, within the scope of the agency relationship, to act reasonably and to refrain from
conduct that is likely to damage the Ps enterprise.
f. 8.11: A has a duty to use reasonable effort to provide the P with facts that the A knows, has reason to
know or should know when: the A knows that the P would wish to have the facts or the facts are
material to the As duties; and the facts can be provide to the P without violating a superior duty
owed by A to another.
g. 8.12: A has a duty: not to deal with the Ps property so it appears to be As; not to mingle the Ps
property with anyone elses; and to keep and render accounts to the P of money.
h. 8.13: P has a duty to act in accordance with the express and implied terms of any K.
i. 8.14: Duty to Indemnify: P has a duty to indemnify an A:
i. In accordance with terms of any K; and
ii. Unless otherwise agreed:
1. When the A makes a payment:
a. Within the scope of the As actual authority, or
b. That is beneficial to the P; or
2. When the A suffers a loss that fairly should be borne by the P.
j. 8.15: P has a duty to deal with the A fairly and in good faith.
2. All of this shit basically means that agents have a duty to conduct the affairs of the P with a certain level of
diligence, skill and competence.
a. An A cannot be held liable to the P simply because he failed to procure for him something to which
the latter is not entitled.
3. Duty of Loyalty: An A occupies a relationship in which trust and confidence is the standard. When an A
places his own interests above those of the P, there is a breach of fiduciary duty to the P.
a. Fiduciary is a duty bound to make a full, fair and prompt disclosure to his employer of all facts that
threaten to affect the employers interests or to influence the employees actions in relation to the
subject matter of the employment.
b. Where an A seeks to recover compensation growing out of the same transaction in which he was
guilty of being disloyal to his P, the court is justified in denying the compensation, and the equitable
principle applicable to the fiduciary that he is to profit from his own wrong comes into play.
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Chapter 2: Problem of Unlimited Personal Liability (generally only Sole Proprietorship and General Partnership)
Sole Proprietorships:
1. Definition: business owned and operated by a single individual. Proprietor is the sole owner of the business
and can be sued for personal liability for debts arising out of the business. Also, business assets can be seized
to pay for personal debts of the proprietor. The sole owners liability is endless.
2. One Owner: There can only be one owner. If husband and wife own a business, its not a sole proprietorship.
3. Formalities: If a sole individual goes into business without filing any paperwork, he has created a sole
proprietorship.
4. Earnings: The earnings are considered to be the sole owners are taxed accordingly.
5. Assumed Name: Legally, the name of business is the name of the sole owner. If the proprietor wants to do
business under a different name, he has to file with the county clerk.
6. State and Local Business Licenses: Many professions are regulated by the state, so if your sole
proprietorship is one of these professions, you need to get your license.
7. Labor Laws: employers are required to comply with employment condition laws.
8. Verification of Employment Eligibility: employers are required to verify the work authorization of each
person hired within 3 days of their date of hire. This is to make sure you arent hiring illegal aliens.
9. Employer Federal Taxpayer ID#: new businesses must obtain a number to use on tax returns.
10. Employers Payroll Withholding Taxes: generally an employer must withhold both income and SS tax from an
employees taxable wages, and furnish a W2 to the employee each year.
11. Estimated Tax Installments: Federally and in AR, proprietor must pay estimated taxes in installments every
4 months.
12. AR Workers Compensation: this subjects an employer to liability for industrial accidents, regardless of
negligence, while at the same time precluding employee lawsuits that might result in large damage awards.
Easy to get workers compensation insurance for the company.
13. Advantages: easy and quick to form, no filing fees, expenses are deducted from personal income and all
earnings are your own.
14. Disadvantages: unlimited personal liability, liable for torts of employees which can be taken out of your
personal assets, there can only be one owner, and there is uncertainty in estate planning.
General Partnerships and Joint Ventures:
History of UPA v. RUPA:
1. UPA: modeled on traditional common law principles and adopted a number of rules that proved somewhat
problematic over the years. Partnership was to be treated as an association of persons, thus any change in
the membership of a partnership results in technical dissolution of the partnership, and any new
association is considered a new partnership.
2. UPA also imposed for joint and several liability for certain types of obligations and joint liability for
everything else. Joint liability meant that each partner was liable only for her pro-rata share of the
obligation.
a. AR legislature adopted a provision making joint liability joint and several for all purposes.
3. Common Law: two or more individuals came together trying to operate a business together. This didnt work
because what would happen if an individual wants to go K with a corporation? The UPA decided to call it a
joint venture and make it easy to allow two partners to go into business with a corporation. Association of
persons.
4. Early on, the principal drafters say that any legal person or entity can be a partner. Person is broad and
allowed corporations to be one. Courts didnt like this, so they figured out what joint venture meant in stare
decisis and it turns out that it only means a partnership for a single purpose.
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5. 1993: They came up with the RUPA: revised UPA.


6. 1994: RRUPA, and then it was revised again and again. So, we now see a changing in the way they name the
UPA. Official name of the model legislation will include the date of the new revision.
7. 1996: UPA (1996). AR adopted this in1999 and it went into effect in 2000 and then was mandatory in 2005.
This is the official name of AR laws. A person who receives a share of profits is presumed to be a partner. It
is rebuttable if you can show that it is for debt or services, or whatever.
8. Nomenclature:
a. UPA: uniform version of the Uniform Partnership Act, promulgated by NCCUSL in 1914
b. UPA (1996): uniform version of the Uniform Partnership Act as promulgated by the NCCUSL in
1996. Amendments will have the year amended attached to that section.
c. Arkansas UPA (1996): the AR version of RUPA (1996), codified at Ark. Code Ann. 4-46-101. It is
essentially identical to the uniform version of UPA as it existed in 1996.
Partnership Formation:
1. 4-46-101(6): Partnership: association of two or more persons to carry on as co-owners a business for profit
formed under 202.
a. 101(10): A Person can be an individual, corporation, business trust, estate, trust, association, etc.
2. 4-46-202: Formation of Partnership:
a. Association of two or more persons to carry on as co-owners of a business for profit
(whether or not the partners intend for that to happen; intent of profits is necessary)
i. There are no words, writings, or intent needed to form a partnership.
b. Rules governing formation:
i. A joint owner of property doesnt itself establish a partnership, even if they share profits.
ii. Sharing gross returns doesnt establish a partnership even if all partners have an interest.
iii. Person who receives a share of the profits of a business is presumed to be a partner, unless
the profits are received in payment:
1. Of a debt;
2. For services as an independent contractor;
3. Of rent;
4. Of an annuity;
5. Of interest or charge on a loan; or
6. For the sale of the goodwill of a business.
c. Sharing profits is prima facie evidence that a partnership exists. You can rebut this by saying that
the other person was your employee and that the profits were really just compensation for the
employee, and showing evidence to support this.
i. Owning land together or sharing the bills is not enough to get a presumption of partnership.
Nature of Relationship:
1. 4-46-305: Partnership Liable for Partners Actionable Conduct: A partnership is liable for loss/injury caused
as a result of a wrongful act committed by a partner acting in the scope of business of the partnership or
within the authority of the partnership.
2. 4-46-306: Partners Liability: (Joint and several liability): All partners are liable jointly and severally for all
obligations of the partnership unless otherwise agreed by the claimant or provided by law. A person
admitted as a partner into an existing partnership is not personally liable for any partnership obligation
incurred before admission.
a. Normal rule: Partners are liable jointly and severally for all obligations of the partnerships unless
otherwise agreed. Not liable for stuff before you become a partner.
b. Joint Liability: Everyone is liable for their percentage of fault and the P has to collect from each one.
11

c.

Joint and Several Liability: all collectively liable and can pick who to obtain the liability from and
then let the rest of the Ds figure out who owes what.
d. Under the UPA, partners were to be jointly liable for debts unless it arose out of any wrongful act of
any partner acting in the ordinary course of the business.
e. AR: partnership liability is to be joint and several (adopted to prevent stupid tort claims). But tort
law says that damages shall only be several (pro rate share) and not joint and several.
i. We dont know which one trumps the other. It could go either way.
3. 4-46-307: Actions by and Against Partnership and Partners: Partnerships may sue and be sued in its name.
Action may be brought against the partnership and any or all partners in the same action. A judgment
against a partnership doesnt necessarily mean a judgment against a partner. A judgment creditor of a
partner may not levy execution against the assets of the partner to satisfy a judgment based on a claim
against the partnership unless the partner is personally liable under section 306.
4. 4-46-308: Liability of Purported Partner: If a person purports to be a partner in a partnership, he is liable to
a person to whom the representation is made, if that person enters into a transaction with eh actual or
purported partnership. If no partnership liability results, the purported partner is liable with respect that
liability jointly and severally with any other person consenting to the representation.
Liability of Partners in a Partnership:
1. Original Common Law Duty - (Meinhard v. Salmon) - Partners have a duty to disclose everything with the
other partners that deals in any way with the partnership. The duty isnt honesty alone, but the punctilio of
honor the most sensitive is the standard of the fiduciary duty.
a. Justice Cardozo - Fiduciary duties are Stricter than the rules of the marketplace.
b. Partners have an affirmative duty to disclose everything and must use the utmost care and honor to
your partners.
c. Many states thought this was too strict, so they amended the fiduciary duty by statute.
2. 4-46-103: Effect of Partnership Agreement: Nonwaivable Provisions:
a. Relations among the partners and between them and the partnership are governed y the partnership
agreement. If the agreement doesnt say anything, this chapter governs.
b. Partnership Agreement may not:
i. Eliminate the duty of loyalty, but the partnership agreement may identify specific types or
categories of activities that dont violate the duty (unless unreasonable);
ii. Unreasonably reduce the duty of care;
iii. Eliminate the obligation of good faith and fair dealing, but the partnership agreement may
prescribe the standards to which it is to be measured (unless unreasonable).
3. 4-46-104: Supplemental Principles of Law: the principles of law and equity supplement this chapter.
4. 4-46-404: Fiduciary Duties Under UPA 1996:
a. Only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty
and the duty of care.
b. Duty of Loyalty: limited to:
i. Account to the partnership and hold as trustee for it any property/profit/benefit derived by
the partner in the conduct and winding up of the partnership;
ii. Refrain from dealing with the partnership in the conduct or winding up of the partnership n
behalf of an adverse party; and
iii. Refrain from competing with the partnership in the conduct of the partnership business
before dissolution of the partnership.
c. Duty of Care is limited to refraining from engaging in grossly negligent or reckless conduct,
intentional misconduct, or a knowing violation of law.
i. Ordinary negligence is not a violation of the duty of care.
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d. Partner shall discharge the duties to the partnership and exercise any rights consistently with the
obligation of good faith and fair dealing.
e. A partner doesnt violate these duties merely because the partners conduct furthers his own
interests.
f. A partner may lend money and transact other business with the partnership.
Partnership Management
1. All rights of management of the partnership are subject to change in the partnership agreement except:
a. Statutory Apparent Authority
b. Fiduciary Duties
c. Right of a Partner to quit the partnership. The partner always has a right to quit the partnership,
but this doesnt mean he has the right to terminate it.
d. Rights of Third parties. An agreement cannot change the rights of people outside of the agreement.
2. 4-46-203: Property acquired by a partnership is property of the partnership, not the partners.
3. 4-46-204: Property is Partnership Property:
a. Property is partnership property if acquired in the name of: the partnership; or one or more partners
with an indication transferring title to the partnership in his capacity as a partner.
4. 4-46-301: Partners Ability to Bind Partnership - Each partner is an agent of the partnership for the
purpose of its ordinary business. An act that carries on the ordinary course of the partnership business
binds the partnership unless the partner had no authority to act for the partnership and the third party
knew that the partner lacked authority.
a. Statutory Apparent Authority - Being a partner, alone, is enough to have apparent authority. He
doesnt need any express grant of authority as long as he is carrying out business in the ordinary
way of the partnership.
i. But, if he didnt have authority and the third party knew this, it is not binding.
ii. Also, if the partnership files a Statement of Partnership Authority, and it limits a partners
ability to bind the partnership, a third party cannot rely on statutory apparent authority.
b. An act of a partner that is not in the ordinary course of business binds the partnership only if all the
other partners authorized the act.
c. If the partnership is new, and there is no precedent for ordinary way they conduct business then
you look to similar partnerships.
5. 4-46-302: Transfer of Partnership Property:
a. Partnership property may be transferred: subject to a statement of partnership authority and
executed by a partner in the partnership name.
b. A partnership may recover partnership property by a transferee only if it proves that execution of the
instrument of initial transfer didnt bind the partnership and that the transferee knew that the
person lacked authority.
6. 4-46-303: Statement of Partnership Authority: this can be filed and include the name of the partnership,
the street address of the CEO, the names and addresses of all partners, and the names of the partners
authorized to execute an instrument transferring real property.
a. It also may state additional people who can bind the partnership, but it cannot eliminate the
statutory apparent authority of a partner.
b. There are more statements regarding filing a partnership agreement and authority.
7. 4-46-304: Statement of Denial: A partner may make a statement that denies the fact that he is a partner.
8. 4-46-401: Partners Rights and Duties:
a. A partnership shall reimburse a partner for payments made and indemnify a partner for liabilities
made in the ordinary course of business.
b. A partnership shall reimburse a partner for an advance beyond the amount of capital the partner
agreed to contribute or anything that gives rise to a partnership obligation constituting a loan.
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Each partner has equal rights in the management and conduct of the partnership business;
i. If two partners come together and contribute different amounts, this is still default rule.
d. A partner may use or possess partnership property only on behalf of the partnership.
e. A person may become a partner only with consent of all partners.
f. A difference arising as to a matter in the ordinary course of business of a partnership may be decided
by a majority of the partners.
9. 4-46-501: Partner NOT Co-owner of Partnership Property: a partner has no interest in partnership property.
c.

10. Management Authority - Generally, all partners have equal management authority. A statement of
authority may state limitations and thus will be affirmative proof of expanded authority, rather than to
protect a partnership by limiting one or more of the partners authority.
a. If partners disagree about a decision concerning the ordinary course of the partnerships business,
there must be a majority approval by the partners.
i. If there are two partners, the decisions must be unanimous. One cannot overrule the other.
So, the business would continue on in the same manner it was operating.
b. If the act is outside the normal course of business, the partnership can only proceed with the
unanimous vote of all partners.
Sharing Profits and Losses:
1. General Rule of Allocation of Profits - Absent agreement otherwise, all partners share equally in the
profits and losses of the enterprise after return of each partners contributions.
a. Allocation deals with how much each partner will eventually be entitled to in the event of a
termination or buyout.
b. Each partners allocation is kept in his respective capital account.
2. 4-46-401: Each partner has an account that is credited with the partners contributions in cash and the
market value of any property contributed. When determining profits, each partner gets that amount paid to
them. After that, the remaining profits are distributed equally between the partners.
a. Each partner is entitled to equal share of the profits and chargeable with equal share of losses in
proportion to the partners share of profits.
b. E.g. - Cal contributes $10,000 and an invention (market value at the time it was contributed was
$5,000). Fred contributes $5,000. The partnership is bought out with a resulting profit of $50,000.
Cal gets $30,000 ($10,000 + $5,000 + $15,000 ( of remaining $30,000) and Fred gets $20,000.
c. The same is true for losses.
3. 4-46-807: Settlement of Accounts and Contributions Among Partners: In winding up, the assets of the
partnership must be applied to discharge its obligations to creditors. Any surplus must be applied to pay in
cash the net amount distributable to partners in accordance to their right to distribution.
a. Each partner is entitled to a settlement of all partnership accounts. Profits and losses that result
from the liquidation of the assets must be credited and charged to the partners accounts.
b. After settlement of the accounts, each partner shall contribute, in the proportion in which the
partner shares partnership losses, the amount necessary to satisfy the obligations that were not
known at the time of the settlement and for which the partners is personally liable.
Problem of Partner Who Contributes Services
1. Generally: partners are required to pay back all creditors first, then pay back all the partners their initial
contributions and then will get to share in the profits (or losses) of the partnership.
a. An issue arises when there are two partners and one agrees to contribute cash and the other agrees
to contribute services. Do the services receive a monetary value upon wind-up or termination?
2. Courts are split on how to deal with service-only partners:

14

a. Richert v. Handly - The enterprise failed, and there was not enough money to reimburse the party
who contributed money (Richert) of his contributions. Handly only provided services. Because there
was no agreement otherwise, Handly had to pay for half Richerts lost contributions.
i. Here, all losses are shared and no value is given to the services.
b. Kovacik v. Reed - Kovacik and Reed agreed to spilt profits 50/50, but there was no agreement on how
to split losses. The enterprise lost money, and Kovacik wanted Reed to pay half the losses. The court
held that, upon loss, the services and money contributions cancel out.
i. Because the parties agreed to split profits equally, they agreed that the services and cash
contributions were equal. So, upon loss, they lose both. Reed loses his time in performing the
services and Kovacik loses his cash contributions.
ii. This only applies for losses up to what the money-contributing partner put up. So, if Cal puts
up $10,000 and Fred offers services, and somehow we lose $20,000, Cal is liable for $15,000
(His $10,000 investment + $5,000 (1/2 of remaining $10,000) and Fred owes $5,000.
3. So, if this arises, put specific instructions on how this is to be handled in the partnership agreement.
Transferability of Partnership Interests
1. Partnerships are different than corporations in the sense that an owner of a corporation can sell his
ownership whenever he wants. The general rule for partnerships is that he cannot sell his ownership. He can
sell his economic interest (right to profits or losses), but the assignee would not become a partner, he would
only have limited rights.
a. Every partner can bind the partnership, so there are greater restrictions on how ownership can be
transferred. Because of this, many people choose not to create partnerships.
b. A partner has an economic interest (right to money and distributions); property interest (right to use
partnership property for the benefit of the partnership); and a management interest (right to an
equal portion of management).
c. Upon transfer, the original partner retains managerial and voting rights, and is still considered a
partner. Thus, he still owes the company fiduciary duties.
i. The assignee, therefore, is not owed a fiduciary duty by the other partners.
d. A transferee can become a partner with the unanimous approval of all partners.
e. The agreement can prevent the partners from being able to transfer their economic interest.
2. Statutes:
a. 4-46-502: Partners Transferable Interest in Partnership: Only transferable interest of a partner in a
partnership is the partners rights to profits and losses of the partnership.
i. The interest in profits and losses is personal property that can be transferred.
b. 4-46-503: Transfer of Partners Transferable Interest: a transfer of a partners transferable interest
in the partnership is permissible; doesnt cause dissociation or dissolution by itself; and doesnt
entitle a transferee to participate in the management or allow access to information or inspect books.
i. Transferee of an interest has a right to seek judicial determination that it is equitable to
wind up the business.
ii. Transfer of right to profits doesnt trigger dissolution and doesnt give the transferee any
rights besides the rights to the money, even if it is liquidated.
Withdrawal and Other Events of Dissociation: dissolution winding up termination
1. Anytime a partner disassociates, the partnership goes into dissolution. There can be a clause in the
agreement that say the remaining partners can continue the business under the same name, but its just
that, technically, this is a new partnership.
a. Dissolution refers to the beginning of the end of a partnership. Dissolution does not mean that the
partnership has been terminated, it only means the process has begun.
15

b. When the partnership is in dissolution, and is in the winding up process, it still exists and the
partners still owe each other fiduciary duties.
2. Statutes:
a. 4-46-601: Disassociation of a Partner: A partner is dissociated when:
i. Partnerships having notice of partners express will to withdraw;
ii. An event agreed to in the partnership agreement;
iii. Partners expulsion pursuant to the partnership agreement;
iv. Partners expulsion by unanimous vote of other partners;
v. If a partner requests, he can seek judicial dissociation of a partner for misconduct.
vi. Partner becomes a debtor in bankruptcy; executes an assignment for the benefit of creditors;
vii. At the partners death, or judicial determination of incapacity;
b. 4-46-602: Partners Power to Dissociate: Wrongful Dissociation:
i. Partner has the power to dissociate at any time, rightfully or wrongfully. A wrongful
withdrawal just means that the party may face legal consequences.
ii. A partners dissociation is wrongful only if:
1. It is in breach of an express provision of the agreement; or
2. If there is a specific duration of the partnership, and before the expiration of the
term or completion of the undertaking the partner does any of the following:
a. The partner withdraws by express will;
b. Partner is expelled by judicial determination;
c. Partner is dissociated by becoming a debtor in bankruptcy; or
d. Partner is dissociated because it willfully dissolved/terminated.
3. The Demise of a Partnership has Three Steps:
a. Dissociation of a Partner: dissolution is one or more partners ceased to be associated with the
partnership. It is usually the start of the winding up process.
b. Winding Up: process that begins to eventually terminate and liquidate the partnership.
c. Termination: No more partnership.
4. Types of Partnerships:
a. Partnership at Will: partnership agreement didnt specify a particular term or undertaking.
Partners have the power and right to disassociate at any time for any reason.
b. Partnership for a Particular Undertaking: specific tasks (Page v. Page)
i. All partnerships are ordinarily entered into with the hope that they will be profitable, but
that alone doesnt make them all partnerships for a term and obligate the partners to
continue in the partnerships until all of the losses over a period of many years have been
recovered.
c. Partnership for a Definite Term: specific timing.
i. Partners who go bankrupt, die or become legally incompetent are no longer partners.
ii. Remember: partners always have the power to dissociate, but may not have the right to.
Dissolution to Termination:
1. When one or more partners withdraw from the partnership, that triggers dissolution.
a. Once dissolution is triggered, you want to look and see if the partnership wants to wind up or
continue its business. The partnership has two options:
i. The partnership can wind up and terminate all of its business operations.
ii. The partnership can go through a technical wind up and termination, with the remaining
partners continuing the business.
b. This is going to be governed by the partnership agreement. If the agreement is silent, you have to
look at statute and see what kind of partnership it was.
16

i. Partnership at Will - Unless otherwise specified in the agreement, a party can withdraw
whenever they want, and can force the partnership to wind up, sell its assets, and terminate.
ii. Partnership for a Definite Term - Withdrawal before the end of the term is considered to be
wrongful and that the remaining partners can continue.
iii. Partnership for Particular Undertaking - Same as Definite Term.
1. The Court can imply a term or undertaking in the agreement, but it must be obvious
from the facts of the case and the purpose of the agreement.
2. In the second two, the wrongful withdrawing partner is entitled to receive his
interest in the partnership, but he must pay any damages caused by his leaving.
c. Once termination is complete, and the last asset is sold, the partners no longer owe each other any
fiduciary duty. However, the parties must carry out the existing contractual obligations in good-faith
and fair dealing.
2. Statutes Governing Dissolution:
a. 4-46-406: Continuation of Partnership Beyond Definite Term or Particular Undertaking:
i. If a partnership for a definite term/particular undertaking is continued without an express
agreement beyond the expiration, the rights and duties of the partners remain the same so
far as is consistent with the partnership at will.
ii. If the partners continue the business without any settlement, they are presumed to have
agreed to a partnership at will and it will continue.
b. 4-46-603: Effect of Partners Dissociation: Upon a partners dissociation:
i. Partners right to participate in management terminates;
ii. Partners duty of loyalty terminates; and
iii. Partners duty of loyalty and duty of care continue only with regard to matters arising and
events occurring before dissociation.
c. 4-46-701: Purchase of Dissociated Partners Interest: (rights to what the withdrawing partner gets)
i. If a partner is dissociated from the partnership without resulting in a dissolution and
winding up, the partnership shall cause the dissociated partners interest to be purchased for
a buyout price.
ii. Buyout price: amount that would have been distributable to the dissociated partner if the
assets were sold at a price equal to the greater of the liquidation value or the value based on
a sale of the entire business.
iii. Damages for wrongful dissociation must be offset by the buyout price.
iv. Partnership shall indemnify a dissociated partner whose interest is being purchased against
all partnership liabilities, incurred before or after the dissociation.
v. If no agreement for the purchase of a dissociated partners interest is reached, the
partnership shall pay cash to the dissociated partner the amount of the partnership
estimates to be the buyout price and interest.
d. 4-46-702: Dissociated Partners Power to Bind and Liability to Partnership:
i. A partnership is bound by an act of the dissociated partner for two years after that partner
dissociates if the third party reasonably believed the dissociated partner was then a partner,
didnt have notice of dissociation, and had no knowledge of it.
1. If the partnership files a Statement of Dissociation under 4-46-704, the third-party
will have notice after the 90 days of the filing. On the 89 th day, the third-party would
not have notice.
ii. But, the partner will be liable to the partnership for any damages caused.
e. 4-46-703: Dissociated Partners Liability to Other Persons:
i. A partners dissociation doesnt itself discharge the partners liability for a partnership
obligation incurred before dissociation.
17

f.

4-46-704: Statement of Dissociation: a dissociated partner may file a statement of dissociation


stating the name of the partnership, the name and address of the dissociated partner, that the
partner dissociated, and date of dissolution.
3. Statutes Governing Wind-Up:
a. When a business winds up, they basically just pay all debts and sell all assets, turn everything into
cash and then pay off all of the partners with whats left. Here is the order of the Process:
i. Force Liquidation and Sell all assets;
ii. Pay off Creditors, including Partners who are creditors;
iii. Give back Contributions of Partners
iv. Split up whatever is left.
b. 4-46-801: Events Causing Dissolution and Winding Up of Partnership: A partnership is
dissolved, and its business must be wound up, only upon:
i. In a partnership at will, the partnerships having notice from a partner of his express will to
withdraw;
ii. In a partnership for a definite term/particular undertaking:
1. After dissociation of a partner, will of at least remaining partners to wind up;
2. Express will of all partners to wind up;
3. Expiration of term/completion of the undertaking;
iii. An event agreed to in the agreement resulting in winding up;
iv. Event making it unlawful for the partnership to continue;
v. Judicial determination to wind up;
c. 4-46-802: Partnership Continues After Dissolution: a partnership continues after dissolution only for
the purpose of winding up the business.
i. At any time after dissolution and before winding up is completed, all partners may waive the
right to have the business wound up and terminated:
1. Partnership would carry on its business if dissolution never occurred and any
liability incurred by the partnership has never occurred; and
2. The rights of third parties accruing out of the conduct on reliance of the dissolution
before the third party knew of the waiver may not be adversely affected.
d. 4-46-803: Right to Wind Up Partnership Business: After dissolution, a partner who has not
wrongfully dissociated may participate in winding up.
i. A legal representative of the last surviving partner may wind up the business.
ii. Person winding up the partnerships business may preserve the partnership business or
property for a reasonable time to settle disputes and close up business.
e. 4-46-804: Partners Power to Bind Partnership After Dissolution: A partnership is bound by a
partners act after dissolution that: is appropriate for winding up; or would have bound the
partnership before dissolution.
f. 4-46-805: Statement of Dissolution: After dissolution, a partner who has not wrongfully dissociated
may file a statement of dissolution stating the name of the partnership and that the partnership has
dissolved and is winding up.
g. 4-46-806: Partners Liability to Other Partners After Dissolution: After dissolution, a partner is
liable to the other partners for the partners share of any liability incurred. A partner who incurs
partnership liability by an act not appropriate for winding up is liable to the partnership for any
damage.
h. 4-46-807: Settlement of Accounts and Contributions Among Partners: In winding up the business,
the assets of the partnership must be applied to discharge its obligations to creditors, including other
partner/creditors. Any surplus must be applied to pay in cash the net amount distributable to
partners in accordance with their right to distributions. Each partner is entitled to a settlement of
18

all partnership accounts, profits and losses that result from the liquidation of the partnership assets,
etc.
4. Generally: partners always have the power to quit and get out of the partnership, but they dont always have
the right to do it. It is wrongful to leave for a particular term or express undertaking before it is fulfilled.
a. If one partner wants to continue the partnership, he will be allowed access to the partnership assets
that will enable him to continue the business. (Pav-Saver v. Vasso).
b. In the absence of partnership agreement under UPA, if partners agree to terminate the partnership,
then they must wind down existing business. If they take the pending business with them to their
new employ, any profits from those pending ventures is the property of the old partnership and
should be distributed accordingly.
i. First: participate in the winding up of the business, then divide the assets and profits
according to the partnership agreement.
ii. Quantum Meruit: what one has earned; the reasonable value of services. (Jewell v. Boxer).
iii. This comes out different under RUPA because RUPA allows for reasonable fees in winding up
the business.
c. You may prepare to withdraw from a partnership as long as you do not violate your fiduciary duty
during the course of the preparations such as approaching clients before notifying the partnership.
i. Basically, you can prepare to compete with the partnership, but you cant actually compete.
1. E.g. Leasing a new building, preparing letters, informing clients you are leaving is
ok, but soliciting clients to go with you, lying to partnership about leaving is not ok.
ii. If you can prove clients would have gone with you whether or not you breached your fiduciary
duty there is no causation of harm and therefore you dont have to share profits.
iii. Factors that are relevant to whether a client freely exercised his right include:
1. Who was responsible for initially attracting the client to the firm;
2. Who managed the case at the firm;
3. How sophisticated the client was; and
4. Whether the client made the decision with full knowledge; and
5. What was the reputation and skill of the removing attorneys?
d. In a partnership at will, one partner can withdraw, force liquidation, and then once wind-up is
complete, buy all of the assets of the previous partnership.
i. Before the partner engages in business, he must make sure that the wind-up process is
complete or he may breach fiduciary duties.
Limited Liability Partnerships: (LLP)
1. History: developed in the early 1990s to modify the general partnerships. The only difference is formation &
liability. Partners are not liable for the personal misconduct of other partners.
a. AR passed the first generation of statutes and then two years later we adopted a version of RUPA.
2. Generally: LLPs are exactly like general partnerships in every aspect, but they give partners limited liability
and thus arent personally liable for the debts of the business (unless you sign a guarantee).
a. There are no limited partners in LLPs; everyone is still a general partner and can bind the
partnership if they are carrying out the ordinary business and not committing torts and shit.
b. The only difference is that all general partners get limited liability.
3. Statutes:
a. 4-46-1001: Statement of Qualification: A general partnership may be come a LLP pursuant to this
section.
i. Terms and Conditions on which a partnership becomes an LLP must be approved by the vote
necessary to amend the partnership agreement.
ii. After approval of the agreement, the partnership may become an LLP by filing a statement of
qualification containing:
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1.
2.
3.
4.
5.

Name of the partnership; (this also must be on all advertising and business cards)
Street Address of CEO;
If different than above, the address of an office of the LLP within the state;
Statement that the partnership elects to be an LLP; and
A deferred effective date, if any.
a. There may also be a filing fee.
iii. Status of a partnership as an LLP is effective of the date of filing or date in the statement.
b. 4-46-1002: The name of the LLP must end with LLP or RLLP.
c. Additional Statutory Requirements in Some States, but not in Arkansas:
i. Annual Report to be Filed
ii. Maintain insurance
4. Liability for Partners in LLPs: Generally, partners are not individually liable in an LLP, but there are
certain things that they will still be held personally liable for:
a. Piercing the Veil
b. Personal Conduct
c. Personal Guarantees
d. Contributions to the Partnerships
5. Internal Affairs Doctrine: applies to all business associations:
a. When you have a cause of action related to rights of parties, management rights, rights to transfer
interest, anything related to the internal operations of the business, then it is governed by the state
of the law of formation.
i. Remember that ever state recognizes LLP, but it doesnt offer the same protection.
6. Overall Distinctions between the types of partnerships:
a. General Partnership: all owners are general partners and they are all personally liable;
b. Limited Liability Partnership: only general partners participate but they all have limited liability as
provided in the applicable statute;
c. Limited Partnerships: both general partners with personal liability and limited partners with no
personal liability but somewhat limited rights/responsibilities as well;
d. Limited Liability Limited Partnerships: both general and limited partners, just as with a limited
partnership, but none of the partners have personal liability

Chapter 3 - Limited Partnerships:


1. A Limited Partnership is a partnership with at least one general partner and one limited partner. This is the
bare minimum requirement.
a. General Partner has same rights and duties as he would in a general partnership.
b. A limited partner is not subject to the same type of personal liability as a general partner.
2. Generally: used to be a good thing for businesses: allowed for:
a. Centralized management (for general partners)
b. Limited liability for passive investors, and
c. Taxation as a partnership rather than a corporation.
i. Advantages of an LLP are on Pg. 3.2
3. Restatement Provision:
a. 4-47-108: The name must contain limited partnership or LP and cannot contain LLLP.
b. 4-47-109: The exclusive right to use of a name may be reserved by the person intended to organize a
limited partnership, or a limited partnership. The person applies to reserve a name with the
Secretary of State.
c.

4-47-110: Nonwaivable Provisions: The partnership agreement governs relations among the
partners, but there are certain things the agreement cannot do, including:
20

i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
x.

Vary a LPs power to sue, be sued, and defend in its own name;
Vary which states law is applicable to a LP (state of formation);
Vary the filing requirements for an LP with Secretary of State;
Eliminate the duty of loyalty, but it can identify specific types of activities that dont violate
the duty as long as those acts are not unreasonable.
Unreasonably reduce the duty of care;
Eliminate the obligation of good faith and fair dealing, but can specify the standards;
Vary the power of a person to dissociate as a general partner;
Vary the requirement to wind up the business;
Unreasonably restrict the right to maintain an action;
Restrict the right of a partner to approve a merger;

d. 4-47-111: Required Information: A LP shall maintain at its office:


i. Current list with name and addresses of each partner with their title (GP/LP);
ii. Copy of the certificate of LP and all amendments;
iii. Copy of any filed articles of conversion/merger;
iv. Copy of LPs tax returns/reports;
v. Copy of any partnership agreement recorded;
vi. Copy of any financial statement;
vii. Copy of three most recent annual reports delivered to the Secretary of State;
viii. Copy of any record made by the LP or any vote taken of any partner;
ix. Records stating: amount of cash and value of each partners contributions; times at which
any additional contributions were made; specification of any transferable interest a partner
has; any events that the partnership is supposed to dissolve and wind up.
e. 4-47-112: A partner may lend money/transact with the partnership and has the same rights and
obligations as a person who is not a partner.
f. 4-47-113: A person may be both a GP and LP. They have the same rights, powers, duties and
obligations as the capacity that they will act in.
i. People usually do this for tax reasons.
g. 4-47-202: To amend a certificate, the partnership must deliver it to the Secretary for filing with the
name, date of initial filing, and changes. You must amend the certificate if: there is a new GP,
dissociation of a GP, appointment of someone to wind up. A GP that knows any information that was
false in the certificate must amend it.
h. 4-47-203: A dissolved LP that has completed winding up may deliver a statement of termination
stating the name, date of initial certification, and any other information needed.
i. 4-47-206: This talks about delivery to and filing the records by the Secretary: time and date.
j. 4-47-207: A LP may deliver to the Secretary for a correction of a record previously filed.
k. 4-47-208: If a delivered record is false, a person that suffers loss by reliance on that information may
recover damages from the person who signed, or a general partner who had notice that the
information was false.
l. 4-47-209: Secretary may file a Certificate of Existence or Authorization.
m. 4-47-210: LP authorized to transact business must file an annual report stating: name, information
required by section 4-20-105, address of principal office, and anything else.
4. Original ULPA: risky for limited partners to engage in any form of management because they risked losing
their limited liability status.
a. If the limited partner was involved in management, he risked being turned into a general partner.
b. Then: lawyers got involved and formed a corporation that would actually be the general partner
allowing the individuals to personally escape liability. This made everything crazy.
5. RULPA: 1976 the NCCUSL made changes to what a limited partner could do and what their role was.
21

a. OK for an LP to participate in management as long as they didnt do it in the capacity of general


manager.
b. They can be an employee, agent, represent a general partner, attend meetings, etc.
c. Same rule, however, if you area limited partner and a third party deals with you and thinks you are
a GP because of your exercise of control, you may lose liability.
i. ULPA 2001: the modern uniform act that AR adopted in 2007 under 4-47-101.
6. Liability: Limited partners, however, can still be held liable for losses.
a. They cannot claim to be creditors if the partnership goes bankrupt,
b. They can be held liable for their own torts,
c. They can be held liable if they have a K or guarantee,
d. They dont get extra liability for entity level debts, and
e. They are liable for their own contributions or debts.
f. The main issue, however, is whether they are allowed to have management and control.
Formation: You have to have it in writing, pay a fee, and file that document. You must file the document before you
get limited liability.
1. 4-47-201: To form a LP, a certificate of limited partnership must be delivered for filing stating containing:
a. The name of the LP, with LP in it. The name must be distinguishable from existing LPs.
b. Street Address and Name of Agent, for service of process
c. Name and address of each general partner,
d. Whether it is a LP or LLLP.
e. $50 Filing fee.
i. It becomes effective when the Secretary of State files the certificate.
2. Courts dont generally care whether third parties knew if a limited partnership filed the document, so you
dont have to prove reliance. (Dwinnel) BUT if a limited partnership filed their documents after they sign K
with creditors, then they will just have a general partnership.
3. 4-47-306: Persons Erroneously Thinking They are a Limited Partner - An LP is a creature of statute, so if
the statute isnt complied with, you are a general partnership. If someone thinks they are a limited partner,
but really are a general partner, they are liable as a general partner would be.
a. This usually comes up when the appropriate filings have not been issued and complied with.
i. The partner will be liable even if the third party thought they were dealing with a limited
partnership.
b. However, if you reasonably believe that you are a limited partner, then you will not be held
personally liable for the enterprise if you do one of two things:
i. Cause the partnership to become an LP; or
ii. Withdraw from the partnership after learning its not an LP.
c. If you try, in good faith, to get a corrective amendment issued, but the other partners refuse to sign
on, then you can still be relieved of liability because of the good-faith effort to correct.
d. But, if you enter into an agreement before the mistake has been cleared up with the Secretary of
State, and the third party reasonably believes you are a general partner, you will be held liable as a
general partner.
i. So, if the partner shows that they reasonably believed they were a limited partner, and try to
withdraw from the partnership, the burden shifts to the third-party to show that they
reasonably believed they were dealing with a general partner.
Role of General Partners:
1. General partners have the same roles, rights, duties and liabilities as partners in general partnerships have.
a. All management powers are vested solely in the general partners. They can do whatever they want
with profits or any other decisions as long as its in good-faith and subject to a valid business purpose.
22

b. Even if the limited partners are paying 100% of the taxes on the profits and only receiving 25% of
them, this would be ok as long as the other 75% is being reinvested or something valid.
i. This can be amended or changed by the partnership agreement.
2. Statutory Provisions:
a. 4-47-401: You are a GP if:
i. Provided in the partnership agreement;
ii. Under section 801 following the dissociation of a LPs last general partner;
iii. As a result of a merger under Chapter 11; or
iv. With the consent of all the partners.
b. 4-47-402: Each GP is an agent of the LP for the purposes of its activities. An act of a GP that is not
apparently for carrying on in the ordinary course of the LPs activities binds only if it was authorized
by all partners.
c. 4-47-403: LP is liable for loss as a result of a wrongful act of a GP acting in the ordinary course of
activities or with authority of the LP.
d. 4-47-404: All GPs are liable jointly and severally for all obligations of the LP. A person that becomes
a GP is not personally liable for anything the LP did before the person became a GP.
e. 4-47-406: Each general partner has equal management rights. Consent of all GPs is required to
amend the partnership agreement or certificate of limited partnership, or sell property.
i. The LP shall reimburse a GP for payments made in the ordinary course of business. A GP is
not entitled to remuneration for services performed.
f. 4-47-407: A GP may inspect and copy during business hours the LPs officer, and location of all
records. Each LP may furnish to a GP any info about the LPs activities.
g. 4-47-408: Fiduciary Duties: Only duties that a GP has to a LP are a duty of loyalty and care.
i. Duty of Loyalty is limited to: refrain from dealing with the LP adversely and to refrain from
competing in the conduct or winding up of the LPs activities.
ii. Duty of Care: in conduct and winding up is limited to refraining from engaging in grossly
negligent or reckless conduct or knowingly violating the law.
Role of Limited Partners:
1. A limited partner is limited in two ways: liability and right to participate in control of the partnership. It
allowed people to enter into business ventures without incurring personal liability.
a. An obligation of the LP is not the obligation of the limited partner, even if he participates in the
management and control of the LP.
i. But, if the limited partner exercises too much participation or control in the partnerships
management or day-to-day operations, he may be turned into a general partner.
ii. Excessive Participation is what turns a limited partner into a general partner.
iii. Remember, a limited partner may also have some other sort of capacity. He could also be an
agent of a general partner. If he is exercising excessive participation in his capacity as an
agent, and not a limited partner, then this participation shouldnt be an issue.
b. E.g. - Cal and Fred form Fral, Inc. and become directors and officers of Fral, Inc. Then, they form an
LP. The general partner is of the LP is Fral, Inc. and Cal and Fred are the only other two partners,
being limited partners. Cal and Fred may control all aspects of the LP in their capacity as agents of
Fral, Inc. and not as limited partners and never be personally liable.
i. Cal and Fred must be careful to act within the scope of their agency. If they sign documents
without indicating they are agents of Fral, Inc, this may not work.
2. Statutory Provisions:
a. 4-47-301: Ways to become a limited partner:
i. As provided in the partnership agreement;
ii. As a result of a merger; or
23

iii. With consent of all partners.


b. 4-47-302: A limited partner doesnt have the right to act for or bind the LP.
c. 4-47-303: An obligation of the partnership is not the obligation of a limited partner, even if they
participate in the management.
d. 4-47-304: Limited partner has a right to information of the business, but it is pretty limited.
e. 4-47-305: Limited partner owes no fiduciary duty to the partnership or other partners, but he must
perform his duties under the partnership agreement in good faith and fair dealing.
Dissolution, Disassociation, and Termination of a Limited Partnership
1. Voluntary Dissolution can happen in one of three ways:
a. The unanimous consent of all general partners and to limited partners who own a majority of the
rights to distributions in the LP.
b. If a partner disassociates and at least one general partner remains, dissolution will not occur as long
as within 90 days there is consent to for dissolution by the partners (limited or general) who own a
majority of the rights to distributions.
c. If a partner disassociates and no general partner remains, dissolution will occur unless within 90
days, a similar vote taken where they agree to continue the business and to add a general partner.
2. In the majority of cases, the LP will not dissolve just because a limited partner disassociates.
a. If the last limited partner disassociates, then the LP will enter dissolution unless a new limited
partner is admitted within 90 days.
3. Withdrawal Rights for Limited Partners:
a. There is no right to withdraw from an LP. Limited partners still have the power to withdraw, but
that power can be taken away by agreement.
i. Limited partners are not personally liable, so there isnt a downside to preventing someone to
dissociate and really they can just convert their interest as an assignee.
b. 4-47-601: A limited partner person is dissociated upon the occurrence of:
i. The LP has notice of the persons express will to withdraw;
ii. An event agreed to in the agreement occurred;
iii. Expulsion as a limited partner pursuant to the agreement;
iv. Expulsion by unanimous consent of the other partners if:
1. Its unlawful to keep him on as a limited partner;
2. He has transferred all of his interest in the LP
3. The person is a corporation and it has dissolved or license has been revoked;
v. At the persons death
c. 4-47-602: Effects of disassociation of a limited partner:
i. He has no further rights
ii. Obligation of good faith is limited to acts occurring before dissociation; and
iii. Doesnt discharge the person from any obligation to the partnership that he incurred while a
partner.
4. Withdrawal Rights of General Partner:
a. 4-47-603: A general partner is disassociated with a LP upon the occurrence of all of the same things
as listed for the limited partner, with the addition of:
i. Going into bankruptcy
ii. Appointment of a guardian
iii. Judicial determination of incompetence
b. 4-47-604: Wrongful Disassociation of a General Partner: A general partner has the power to
disassociate at any time, just like in a general partnership.
i. The disassociation is wrongful for the same reasons as in a general partnership.
24

Comparison Between General Partnerships and Limited Partnership


1. Statutory Provisions:
a. 4-47-502: A partners obligation to contribute money or property or perform services is not excused
by death, disability or inability to perform.
b. 4-47-503: Distribution by a LP must be shared among the partners on a basis of value of the
contributions received by each partner.
i. NOTE: this is different than a general partnership where they split everything equally.
ii. You receive the percentage of profits that relates to how much you contributed to the LP.
iii. Also, this can be changed by the partnership agreement.
c. 4-47-504: A partner doesnt have a right to distribute before dissolution or winding up.
d. 4-47-505: A person doesnt have a right to receive a distribution on dissociation.
e. 4-47-507: Limited partners obligation to make a distribution is subject to any offset for any amount
owed to the LP by the partner or dissociated partner.
f. 4-47-508: An LP may not make a distribution in violation of a partnership agreement. It may not
make a distribution if after the distribution the LP wouldnt be able to pay debts, or its total assets
would be less than total liabilities. LP may base a determination that a distribution is not prohibited
under financial statements.
g. 4-47-509: General partners that consents to a distribution made in violation of 508 is personally
liable to the LP for the amount. A partner that received a distribution knowing it was in violation of
508 is personally liable as well.
LLLP: Limited Liability Limited Partnership
1. This gets not only the limited partners limited liability, but the general partners as well.
a. It doesnt turn them into limited partners, however.
b. All of the same laws, rights, etc. that apply to LPs, also apply to LLLPs.
c. They are easy to form: When you send in your certificate of limited partnership or if you amend your
current LP certificate, indicate that you want to be an LLLP instead of a LP.
d. You must include LLLP in the name, and it cannot have LP in it.
2. This is the fastest way to protect the partners from liability, so attorneys will use it as a quick method.
a. Not every state recognizes LLLPs, so this could be a problem if you do business and commit a tort in
a state that doesnt recognize them.
b. Many people use this instead of an LLC because they are familiar with partnership law already.
3. Generally, they exist for estate planning. When there is a big asset (usually property) and the owners die, all
the assets go to the estate and then the other partners (usually heirs) dont have to pay estate taxes. Usually
the old folks are the GPs and the heirs are LPs.

Chapter 4: The Benefits of Partnership Taxation


Introduction and Comparison with Corporate Taxation Models:
1. Tax Options for business entities:
a. Disregarded: The business is disregarded; the owner is responsible for all payments and is treated as
a mere extension of the individual. There is no separate taxable entity or filings for the business.
(Usually sole proprietorship)
b. Tax Partnership: can include any business entity with at least two members unless it is a
corporation that elects to be a corporation or they meet the requirements of a corporation.
c. Association Taxable as a Corporation: default rule is that it will be taxed under sub-chapter C of the
IRC, unless you are a small business that can be taxed under sub-chapter S.
i. You can either be incorporated by state law, be publicly traded, or elect to be taxed as corp.
ii. If you elect to be taxed as a corporation, you are bound by this for 5 years.
25

2. History: Corporate Resemblance Test


a. To determine whether an association looked more like a corporation or a partnership to classify it for
tax purposes ask:
i. Whether the business has centralized management,
ii. Free transferability of interests,
iii. Continuity of life,
iv. Limited liability for owners.
b. Any business that possesses more corporate characteristics than it lacked would be taxed as a
corporation. Everything else would be a tax partnership. When legislatures enacted LLC and LLP it
got blurry.
3. NEW Approach: Check the Box
a. Anything between a general partnership to a LLC is considered a tax partnership if they want to be,
unless they choose otherwise.
b. Really you dont want to check the box if you dont want to be taxed as a corporation.
c. If you are incorporated under state law or if you have gotten so big that you are publicly traded, you
must be taxed as a corporation. Everything else you elect, but it is binding for 5 years.
d. If you won a corporation, every year it has to calculate, file, and pay taxes. It is a taxable entity
under sub-chapter C of the IRC.
i. Calculate the income, deduct allowable expenses, and then pay out the remainder. When they
give the after tax profits/dividends to the shareholders, they are considered income to the
shareholder (even though the percentage is about half of the normal income taxation). This is
double taxation. The corporation can carry forward a loss and cannot be used as a benefit for
the individual shareholders.
4. Partnership Taxes:
a. Every penny that a partnership owns in a year must be taxed in that year, regardless of whether it is
distributed. It must be allocated to capital accounts, and those allocations are taxed, even if the
partner never actually receives the money.
i. The partnership, itself, does not pay taxes.
ii. Partners pay taxes upon allocation, not on distribution.
iii. If its distributed before its allocated, you have to pay taxes, unless you call them draws.
b. The partnership entity just files an informational statement showing the losses or profits of the
partnership with the IRS, but doesnt have to actually pay anything because all the money goes
through the owners.
i. The owners then have to file the income through their personal taxes once it is distributed.
ii. If the partner fails to pay taxes on the allocations, he will probably be audited because the
informational statement will not match up with the tax returns.
c. If there are two or more partners, with a partnership income of $100,000, the partnership must
report this to IRS and disclose how this would be allocated if they were to make a payment.
i. They do not have to pay it out, but they have to allocate it to the partners capital accounts.
5. Definitions:
a. Allocation/Allocative Share/Distributive Share: the amount that we would pay you if we decided to
pay it out. The amount that the specific partner would be entitled to if the partnership was to pay
each partner (no matter if they actually gave them the money or not).
i. Distributive Share is governed by the agreement. If the agreement is silent, it is determined
by the partners interest in the partnership.
ii. For partnerships, the allocations are equal among all partners. For LPs, its based on each
partners share of contributions.
b. Basis: the cost you give for property is generally your basis. When a partner contributes assets to the
partnership, the partnership then takes the same basis as the contributing partner had, and that
26

partner gets a basis in his partnership interest equal to the basis he used to have in the contributed
property.
c. Distribution: When the money is actually paid out to the partners.
6. Capital Accounts: this is what keeps track of the partners basis in the partnership interest.
a. Every partnership is required to keep separate capital accounts for each partner. This keeps the
accounting record of how much each partner has invested in the partnership and how much is owed.
i. The capital accounts basically keep track of how much money each partner would receive if
the partnership was liquidated at that point.
b. Accounts begin with the partners initial contributions, and are increased by allocation of profits or
by subsequent contributions. They are decreased by allocations of losses and by distributions.
7. Corporations:
a. C Corporation: separately reports profits and losses and is taxed at that level. Losses remain with
the corporation and profits are paid to the shareholders in dividend form. Then the shareholders are
taxed on their dividends as ordinary income (double taxation).
b. S Corporation: the corporation doesnt pay the first level of tax. It files an informational return (like
partnerships) and then it passes on the income to the shareholders (who include it for income taxes).
i. It cant have more than 100 shareholders
ii. No business entity can be a shareholder
iii. No foreigner can be a shareholder
iv. It can only have one class of stock.
Chapter 5 - Registered Agents
Modeled Registered Agents Act
History of Registered Agents in Business Statutes:
1. If you had limited liability for any partner, there was a requirement that you have a registered agent with a
registered office.
a. You would look at the articles or certificate or statement or public organic document that created the
business form. BUT, there was a $50 filing fee every time you had to change your address or have
anything new filed.
b. So, they made a new Act.
Our (AR) New Model Act: Applies to all entities other than a general partnership.
2. Statutory Provisions:
a. 4-20-102: Definitions: Look these up.
b. 4-20-103: Fees: Secretary of State collects on them (actual list of fees in the statute).
i. $50 for commercial registered agent listing statement or termination statement.
c. 4-20-104: The agents address must be an actual street address within the state, not a P.O. Box.
d. 4-20-105: Registered agent filing must state: name of the represented entitys commercial registered
agent, or the name and address of the noncommercial registered agent with his title of an office with
the entity if service of process is to be sent to that person holding that office and the business office
address. Secretary then makes the list of filings that contain the name of a registered agent.
i. Commercial Registered Agent - The name of the entity
ii. Noncommercial Agent - Name and address of agent
iii. Title of Officer - If the agent is simply CEO of Rose, LLP you must list the address of the
business office where that position can be found, and the position must be an office within the
entity that is being served.
e. 4-20-106 - 112: Requirements for change of address, termination of agency, resignation by the agent,
and how to register as a commercial agent.
f. 4-20-113: Service of Process when the Agent cannot be reached.
27

g. 4-20-114: Duties of a Registered Agent:


i. Forward to the entity at the address most recently supplied to the agent by the entity any
process served;
ii. Provide notices required to the entity;
iii. Noncommercial RA: keep current the information required by 105; and
iv. Commercial RA: keep current the information listed under section 106.

Chapter 6: Limited Liability Companies (LLC)


History:
1. Tax Issues: the tax code (corporate resemblance test) allowed for partnerships and corporations to be
distinguished by just a few factors (Must have majority of the 4 stated below).
a. Factors:
i. Existence of centralized management like a board of directors;
ii. Continuity of life apart from the participation of owners;
iii. Free transferability of ownership interests;
iv. Limited liability for owners.
b. It is generally preferred to have partnership tax status as opposed to corporate.
2. Lobbying: AK had Icelandic lobbyists that proposed a new form of business that looked like a partnership
but had limited liability. AK refused to adopt this idea, so WY did in 1977 to try and raise money for their
government.
a. IRS saw this as a tax dodge and proposed regulations providing that all members with limited
liability be classified as a corporation for tax purposes, but this was put on hold while the issue was
studied.
b. Few businesses decided to do this because the IRS were a bunch of assholes.
c. FL then adopted it in 1982 to up the economy.
d. The IRS issued a revenue ruling allowing partnership tax status and thus every state enacted this
legislation.
3. Uniform Acts: two different acts were initiated
a. Prototype LLC Act: foundation for many LLC acts but it was never promulgated in the final form
because the NCCUSL asked them to stop.
b. Uniform Limited Liability Company Act: founded by the NCCUSL to coordinate with subsequent
developments in federal tax guidelines and create uniform legislation for the states. Unfortunately,
they were too late and all the states have their own guidelines. (AR amended theirs several times).
Formation:
1. Statutory Provisions:
a. 4-32-103: The name of each LLC must contain LLC or LC somewhere in it and must be
distinguishable upon the records of the Secretary from the name of any other company in AR. If the
company is a professional service, you can use PLLC after it.
i. Must make sure that the filing of it is perfect because if not, they wont take it.
b. 4-32-104: The exclusive right to use or reserve a name.
i. This costs $25 for someone who wants to register an LLC name.
c. 4-32-108: No LLC shall conduct any business under a fictitious name unless approved by the
Secretary. (Rules for allowing the filing of a fictitious name are included in this section).
d. 4-32-109: Names of foreign LLCs: Registering the name for a foreign LLC and it is exclusive upon the
effective date of application.
e. 4-32-201: 1 or more persons may form an LLC by signing articles of organization and delivering them
to the Secretary for filing.
i. The person who signs it does not have to be a member, it can be an attorney.
28

f.

4-32-202: Articles of organization set forth the name for the LLC, information required to have a
registered agent, and if the company is member managed or manager managed.
g. 4-32-203: Articles may be amended by filing articles of amendment with the Secretary including:
name of the LLC, date the articles or organization were filed, and the amendment. It may be
amended in any respects as desired so long as it contains the requirements. They can be restated if
filed as well. Difference between an amendment and a restatement is:
i. The amendment may just amend one single section of the document whereas a restatement
will restate the entire document.
h. 4-32-204: Any document required by this chapter to be filed with the Secretary shall be executed: by
any manager or member (depending on whether it is manager or member managed). The person
executing the document shall sign and state the signature and capacity on the document (even if
attorney-in-fact).
i. If member managed, any member can sign them.
ii. If manager managed, the manager must sign them.
iii. It can be an agent of that person, but that person must state his capacity in signing it.
i. 4-32-205: Original signed copy needs to be delivered to the Secretary with all required filing fees.
Documents are deemed to have been filed at the time of delivery if the Secretary determines that:
i. Documents conform to the filing provisions, or
ii. The documents have been conformed within 20 days after notification of nonconformance.
j. 4-32-206: An LLC is formed when the articles are delivered to the Secretary for filing, even if he is
unable at the time of delivery to make a determination. If they dont conform, the LLC has 20 days to
make them conform.
k. 4-32-1312: A person commits an offense if he signs a document ne knows is false and is a Class C
misdemeanor.
2. Articles of Organization: they contain relatively little information and there is an online form that is one
page long. Basic Requirements include:
a. Name of Company, including LLC , LC, L.C., or L.L.C. If its a professional organization, it must
contain PLLC.
b. Name and street address of registered agent.
c. Signature by one or more persons;
d. Original signed copy of the articles and a duplicate copy;
e. If the LLC is to be manager managed, it must state this.
f. Must comply with the statute (and can contain more provisions if they want); and
g. Filing fee of $50 (or a discount of $45 online).
h. LLC is formed when the articles are delivered for filing (should do return receipt mail).
i. Before 2001, the statutes required that the Articles had to set forth the latest date that the LLC
would dissolve, but this has been removed.
i. You can include a maximum term for which the LLC will last, but that doesnt mean that the
LLC cannot go through dissolution before that. Also, a maximum date doesnt necessarily
mean that the LLC cant continue on after that date.
ii. Including a fixed date of dissolution will be to withdrawal rights of any members who dont
wish to continue beyond the maximum date and it puts creditors on notice that the company
is about to end.
j. The articles are formed on the day that they are delivered, regardless of whether the Secretary of
State filed them.
i. You should always advise your client to file the articles with return receipt requested.
ii. If you fuck something up in your article, you have 20 days to fix it.
3. Operating Agreement: this is the heart of the LLC and is the written agreement that shall be entered into
among all members as to the conduct of business of the LLC.
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a. The statutes require that an operating agreement be signed, but there are no requirements for what
is contained in the agreement. It could just be blank.
b. If there is no operating agreement, or it is blank, the LLC act provides default provisions.
4. Agency v. LLC Rules:
a. The statutory notice provision applies only where a third party seeks to impose liability on an LLCs
members or managers simply due to their status. When a 3 rd party sues a manager or member of an
LLC under agency principles, they apply over the statutory notice provisions. (Thus an agent will be
liable on the K if they enter into it on behalf of the principal and the principal wasnt fully disclosed).
b. The member isnt liable by being a member, he is liable because he is an agent for an undisclosed
principal. So, always make sure when you are acting as a member to inform the third party that they
are dealing with an LLC and not you personally.
c. In member managed, all members have actual and apparent authority. In manager managed, all
managers have actual and apparent authority.
i. Apparent authority is controlled by the articles, and actual authority is governed by the
operating agreement. If you have a manager managed LLC, and it says so in the articles, a
member can never have apparent authority. He can have actual if granted in the agreement.
5. Improper Formation: There are no cases on this, but there are 3 possibilities of liability if a member acts on
behalf of the LLC before it is successfully formed:
a. Persons may be liable as promoters on agency principles.
b. Persons may be found to have inadvertently formed a general partnership, or
c. They may use estoppel to deny the existence of the LLC. This would create a de facto LLC allowing
the LLC to be formed in the fact, even though it could not be a legal or de jure LLC because it
doesnt meet the requirements.
Ownership and Limited Liability:
1. Contributions - Basically, anything can be given as contributions for becoming a member of an LLC.
a. 4-32-501: LLC interest may be issued in exchange for property, services rendered, or a promissory
note or obligation to contribute or perform.
b. 4-32-502: A promise to contribute by a member is not enforceable unless it is set if forth in writing. If
obligated to perform, the member is required to follow through with the promise even after death,
disability or other reason.
i. If the member doesnt perform, he is obligated to give cash equal to that contribution. To go
against this would require a unanimous vote from the members.
ii. The promise can be in the future, as long as it is writing.
c. There is no minimum capital requirement and the interests dont need to be documented by
certificates. The statutes allow for virtually unlimited freedom to choose the type and amount of
contributions acceptable.
2. Becoming a Member: (a lot taken from partnership law)
a. 4-32-701: Property transferred to an LLC is property of the LLC and not the members individually.
It may be acquired, held, and conveyed in the name of the company.
b. 4-32-703: The nature of the LLC interest is considered personal property.
c. 4-32-704: Unless the operating agreement says otherwise, a members LLC interest is assignable in
whole or part:
i. It entitles the assignee to receive only the distributions;
ii. It does not dissolve the LLC;
iii. It doesnt entitle the assignee to participate in the management and affairs of the LLC;
iv. Assignor continues to be a member and have power as a member;
v. Assignor still has the liability as a member; and
vi. The assignee has no liability.
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d. 4-32-705: If a member has a judgment against him requiring him to give his interest in the LLC up
to a judgment creditor, he will only assign his rights under the judgment, not obligations as a
member.
e. 4-32-706: Assignee of an LLC may only become a member if all other members unanimously consent
and it must be evidenced in writing and signed by the members. An assignee who becomes a member
has to the extent assigned the rights and powers and is subject to restrictions and liability of a
member. He is also liable for an obligations of the assignor to make contributions. The assignor
ceases to be a member when the assignee becomes a member in his shoes.
f. 4-32-707: If a member dies or is incompetent, his legal representative will have all the rights of an
assignee.
g. 4-32-801: Effective time of admission of a member to an LLC shall be the later of the date the LLC is
formed; or the time provided in the operating agreement.
3. Limited Liability:
a. 4-32-304: A person who is a member, manager, agent or employee of a LLC is not liable for a debt,
obligation, or liability of the LLC or for the acts or omissions of other members.
b. 4-32-305: A member of the LLC is not a proper party to the proceeding against the company.
c. Exceptions to Limited Liability:
i. Member will be liable for tortuous misconduct
ii. Member stands to lose the investment if the business fails
iii. Member is liable if he otherwise is contractually obligated to accept liability; and
iv. Member is liable if the courts pierce the veil of limited liability.
4. Piercing the Veil: This occurs when the member doesnt appreciate the separate nature of the entity, and
since the member didnt respect it, neither do creditors.
a. The doctrine of piercing the veil is founded in equity and is applied when the facts warrant its
application to prevent injustice. Common instances of piercing the veil include:
i. Evading payment of income taxes;
ii. To hinder, delay and defraud creditors;
iii. To evade a K or tort obligation;
iv. Evade the obligations of a federal or state statute; or
v. Perpetrate fraud and injustice generally.
b. There are two tests fro piercing the veil:
i. Instrumentality Test - Is the LLC a mere instrument of the member? There are three
elements that must be met:
1. Control - The member must exercise complete control over the LLC.
2. Fraud - The control was used to commit fraud or violate statutory provisions.
3. Causation - The control and breach of duty must have proximately caused the harm.
ii. Identity Test - The LLC and member have such a unity of interests, that they are the same.
1. The plaintiff must show that there was such a unity of interest and ownership that
the independence of the corporation had ceased or had never begun, so that adhering
to the fiction of separate identity would serve only to defeat justice and equity.
2. If the owner pays his personal debts out of the LLC, this could indicate that the two
are not independent.
iii. Factors to look for:
1. Failure to comply with the documentation requirements,
2. Dont keep records and books,
3. Failure to keep different business entities separate,
4. Failure to keep corporate minutes,
5. Comingling of Funds
6. Inadequate Capitalization
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iv. Some jurisdictions require the presenc e of fraud, while others dont. Even Arkansas has
caselaw that goes both ways on this. Always try to identify fraud.
Management:
1. All of the statutory guidelines dealing with management can be altered in the operating agreement.
Generally speaking, every member has actual and apparent authority to bind the LLC, unless changed.
2. Statutory Provisions:
a. 4-32-301: Every member is an agent of the LLC for the purpose of its business and the act in the
name of the LLC that carries on in the usual way of business binds the LLC unless the member does
not have authority to act for the LLC in that manner and the third person knows it.
i. If the articles state that the management is vested in a manager (not a member):
1. No member is an agent to the LLC; and
2. Every manager is an agent for the purpose of its business and the acts carried on in
the usual way of business or affairs of the LLC (unless he knows he has no authority)
will bind the LLC.
ii. An act of a manager/member not for carrying on in the usual way of business for the LLC
doesnt bind the LLC unless authorized with the operating agreement with actual authority.
b. 4-32-401: Unless otherwise provided in the agreement, managers:
i. Shall be designated, appointed, elected, removed, or approved by more than members.
ii. Managers need not be members of the LLC or natural persons; and
iii. Unless they resign or are removed, shall hold office until they have successors.
c. 4-32-402: Unless provided in the operating agreement: a member/manager shall not be liable to the
LLC or its members for any action taken on behalf of the LLC unless it constitutes gross negligence
or willful misconduct.
d. 4-32-403: Unless provided in the operating agreement, you need a vote of the managers to decide
any matter connected with the business of the LLC. 100% vote is required to: amend an operating
agreement, or authorize a manager to do anything that contravenes the operating agreement
e. 4-32-405: Keeping Records. All kinds of shit they have to keep, just look up in statute.
3. Member Management: The default rule is that an LLC will be managed by its members, and each member
has equal managerial power. The members have actual authority and apparent authority to take acts that
apparently carry on in the usual way of the business of the company.
a. Members have fiduciary duties to one another.
b. In AR: a member who lacks actual authority from the other members still can bind the LLC by
apparent authority and thus will be a risk that the LLC will have to take in the default model.
c. If there is nothing in the articles or the operating agreement, all actual and apparent authority is
vested in the members. This is like partnership law and became the default rule for the corporate
resemblance test.
d. If the articles and the operating agreement differ as to who has authority to manage, the operating
agreement governs in regard to members/managers and the articles govern for third parties.
e. In a member managed LLC, the members will have apparent authority regardless of what the
operating agreement says.
4. Manager Management: If specifically stated in the articles, the members have no statutory management
rights and no apparent authority to bind.
a. Managers have both actual and apparent authority. Even if the operating agreement says otherwise,
managers have apparent authority.
b. Managers have fiduciary duties.
c. The operating agreement always controls in regard to the LLC, but articles govern for third parties.
d. Must include a provision in your articles allowing for managers and the operating agreement is
consistent.
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e. Managers do not have to be members.


f. Managers can be removed, elected, appointed by a vote of a majority of the managers.
5. Hybrid Approaches to these management authorities:
a. Nothing in the articles mention who is to manage, but there are things in the operating agreement
that vests power in managers.
i. Apparent authority may only be taken away from the articles, so technically this is
considered member management.
ii. Actual authority, however will vest in the managers because that is what is stated in the
agreement.
b. Articles say the LLC will be manager managed, but the operating agreement doesnt mention
anything. This means that it will be manager managed, but no manager is identified. When this
happens, all members are considered managers.
i. It basically just turns it into a member management.
6. Voting:
a. Any Business Decision: requires more than of the managers/members. There are no formal
requirements in LLCs for voting. Notice does not have to be given to anyone. As long as a majority of
the members/managers vote a certain way, it is decided.
i. The majority can make all decisions without informing the other members/managers.
ii. But, members/managers can bind the LLC through their actions with apparent or actual
authority, so the voting requirements really only come into play when the members/managers
have disagreed about a particular action beforehand.
iii. If you want specific things to always be voted on, put it in the operating agreement. But, even
if you do this, the LLC can be bound by apparent authority b/c the third party doesnt have
access to the operating agreement.
b. Unanimous Agreement of the Members for:
i. Authorize something in violation of the operating agreement.
ii. Compromise an enforceable obligation of a member to make a contribution to the LLC;
iii. Admit as a new member a person who acquires an LLC interest;
iv. Admit an assignee of an LLC interest;
v. Retain a member even though they attempted to dissociate;
vi. Voluntarily dissolve the LLC; or
vii. Continue the LLC despite dissociation of a member.
c. Most states allow members to have voting power with their relative contributions.
i. AR rule: per capita voting approach where approval of more than members is required.
Remember, however, that you can change this by the operating agreement.
ii. Each member gets one vote regardless of how much they contributed.
7. Default Management Acts:
a. Actions apparently in the usual course of business: members/managers who lack actual authority
can bind the LLC as to third parties without knowledge of the lack of authority
b. Those that are not in the usual course of business.
8. Fiduciary Duties:
a. The fiduciary duties owed to the members and the LLC are to refrain from grossly negligent or
willful misconduct, but the operating agreement can change all of this.
b. If an operating agreement allows for competition between members, then there is no breach of
fiduciary duty.
Sharing of Profits and Losses:
1. In Arkansas, the default rules say that all members share profits and losses equally. This is the most
common thing that the operating agreement changes.
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2.

3.

4.
5.
6.

7.

8.

a. The majority rule is that the members share partners equal to their contributions, and this is what
most LLCs in Arkansas change it to.
Statutory Provisions:
a. 4-32-601: Distributions of cash or assets shall be shared among the members as provided by the
operating agreement. If it doesnt say anything all members share equally.
b. 4-32-602: Upon dissociation, but not dissolution, a dissociating member is entitled to receive any
distribution that the member is entitled to receive prior to dissociation. If the operating agreement
doesnt say how much that should be, the member shall receive within a reasonable time the fair
value of his interest in the LLC as of the date of dissociation.
i. Note: there is no specific default provision concerning the timing of interim distributions.
c. 4-32-603: Unless provided in the operating agreement, a member has no right to demand and receive
distribution from the LLC in anything other than cash; and the member may not be compelled to
accept a distribution of any asset in kind to the extent that the percentage of the asset distributed
exceeds the percentage that he would have shared in a cash distribution equal to the vale of the
property at the time of distribution.
d. 4-32-604: at the time the member becomes entitled to receive a distribution, he is also entitled to all
remedies available to a creditor of the LLC with respect to the distribution.
Default Rule: pay back your contributions and then your part of the profits and losses are equally split. Most
states, however, have the default rule modeled on corporate or limited partnership models. Thus, members
will share with the value of the contributions (AR has the default rule).
a. Generally, the parties are free to divide up the economic pie in whatever manner they choose, and
the flexibility is a very attractive feature of the LLC.
Distributions: actual payouts of a members interest in profits.
Allocative Share/ Distributive Share: the members interest in the profits and losses.
a. All profits have to be allocated in the year they are owned, but they dont have to be distributed.
Taxes: for tax purposes, an LLC is either a coproation or a tax partnership. The members will need to know:
a. What their reportable shares of profits or losses are;
b. Determinations of their allocable share of the economic profits and losses of the entity; and
c. Determinations of their rights to share in distributions made to the LLC as to its members.
d. Note: this is because the members will report it whether there are tax profits actually distributed to
partners or not. A members basis is increase and thus at the end of the taxable year, the member
will be required to report it and pay taxes on it even if they dont get an actual cut of the money.
i. If interim distribution during the year simply represents the undistributed share of
previously taxed profits, no additional gain should be recognized on the distribution.
ii. If all previously taxed profits have already been distributed, and the interim distribution is
from the current years earnings, gain may be recognized. This is like an advance against
current earnings. The taxpayer must include those gains in their basis for the year to reflect
the earnings if it exceeds the members profit share for the year.
When drafting the LLC operating agreement, you need to remember:
a. Mechanism for determining how much in the aggregate is available for distribution on an interim
basis;
b. Mechanism for determining how much of what is available for distribution in any given year;
c. Mechanism for determining the manner in which the available amounts will be allocated; and
d. Mechanism for determining when these distributions will be made.
Creditors: they usually have a higher claim to assets than members have and their claims will not be
discharged until they are actually or constructively notified and given an opportunity to present claims.
a. AR Fraudulent Transfer Act: operates to prevent members from distributing assets to members on
interim distributions leaving creditors out to dry. The creditors will have remedies ranging from the
right to avoid any transfers to injunctions or appointing receivers.
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Withdrawal:
1. Statutory Provisions:
a. 4-32-707: If a member dies or becomes incompetent, the legal representative shall have all the rights
of an assignee of the members interest.
b. 4-32-802: A person ceases to be a member of an LLC upon the occurrence of a lot of shit:
i. Member withdraws in accordance with the articles,
ii. Member sells his entire interest and the assignee is accepted as a member;
iii. Member is removed in accordance with the agreement or he transfers his interest;
iv. Member becomes bankrupt;
v. 120 days expire after the member seeks reorganization;
vi. Member dies or legally incompetent; or
1. Note: by written consent of all members, you can still be a member if you are dead.
vii. Non-individual member dissolves/terminates.
viii. The operating agreement can provide other ways for disassociation.
2. Voluntary Withdrawal: AR basically says that you cant voluntary withdraw unless the articles/agreement
state an event when you can.
a. Other states have eliminated the rights to withdraw voluntarily as a default rule.
b. Some states have enacted legislation that provides that in the event of withdrawal, there is no right
to be paid off, but the withdrawing member continues to be an assignee.
c. Some states have chosen to discourage voluntary withdrawal by eliminating a withdrawing members
rights to distributions at the time of withdrawal.
Dissolution and Winding Up:
1. Statutory Provisions:
a. 4-32-901: LLC is dissolved and affairs shall wind up when:
i. At the time of the events specified in the articles/agreement. If no time specified, then it has
perpetual existence (like a corporation).
ii. The written consent of all members;
iii. When there are no more members; and
1. Unless the personal representative of the last member decides within 90 days to
become a member and then is added.
iv. When a judge says they have to dissolve.
b. 4-32-902: A circuit court may decree dissolution of an LLC whenever it is not reasonably practicable
to carry on business in conformity with the operating agreement.
c. 4-32-903: Unless otherwise provided in the agreement:
i. Business of the LLC may be wound up:
1. By members/managers who have authority to manage prior to dissolution; or
2. If one or more members engaged in wrongful conduct.
ii. Persons winding up the business of the LLC may on behalf of the LLC:
1. Prosecute and defend suits;
2. Settle/close business of the LLC;
3. Dispose of and transfer the property of the LLC;
4. Discharge the liabilities of the LLC; and
5. Distribute to the members any remaining assets of the LLC.
d. 4-32-904: After dissolution of the LLC, each of the members having authority to wind up the
business and affairs can bind the LLC: by an act appropriate for winding up the LLCs affairs or
completing unfinished transactions, and by any transaction that would have bound the LLC if had
not been dissolved if the other party doesnt have notice of the dissolution.
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i. Filing of articles of dissolution shall be presumed to be notice of dissolution.


ii. If the LLC authorizes an act of a member that would ordinarily be not binding.
iii. An act of a member that would be binding wouldnt be authorized if there is a restriction of
authority and the persons have knowledge of the restriction.
e. 4-32-905: Upon winding up of the LLC, the assets shall be distributed:
i. Payment shall be made to creditors including members who are creditors;
ii. Members or former members well get distributions according to their interest in the LLC;
iii. Members and former members will get the return of their contribution and then their
respective rights to share in distributions from the LLC prior to the dissolution.
f. 4-32-906: After the dissolution of the LLC, the LLC may file articles of dissolution with the Secretary
of State, stating:
i. Name of the LLC;
ii. Date of filing articles of organization/amendments;
iii. Reason for filing dissolution;
iv. Effective date of the articles of dissolution if they arent effective on date of filing;
v. Any other information the members/managers file the certificate think it needs.
g. 4-32-907: Upon dissolution, an LLC may dispose of known claims against it by filing the articles of
dissolution and following the procedures.
i. The LLC shall notify its creditors in writing of the dissolution at any time after the effective
date of dissolution. Notice must:
1. Describe information that must be included in the claim;
2. Provide a mailing address to send the claim;
3. State the deadline (120 days) of which the LLC should receive the claim; and
4. That the claim will be barred if not received by the deadline.
ii. A claim is barred if a claimant doesnt deliver their claim by the 120 day deadline, or the
doesnt commence a proceeding to enforce their claim within 90 days after the LLC rejects
the claim.
h. 4-32-908: LLC may publish notice of dissolution pursuant to this section that requests that persons
with claims present them in accordance with the notice. The notice must:
i. Be published once in a general circulation newspaper in the area where the company is
located;
ii. Describe the information that must be included in the claim and give a mailing address; and
state that a claim will be barred unless a proceeding to enforce it is commenced within 5
years of publication of the notice.
iii. If the LLC publishes the notice in the newspaper and files articles of dissolution, the claim of
each of the claimants is barred unless the claimant commences a proceeding within 5 years.
iv. A claim may be enforced against the LLC to the extent of its undistributed assets; or against
a member of the LLC if the assets were distributed.
2. Default Rules:
a. At the time of events specified in writing in the articles/agreement;
b. Upon written consent of all members;
c. When there are no more members.
i. Unlike a partnership, the LLC doesnt dissolve simple because a member disassociates.
3. Articles of Dissolution: the LLC needs to file these and give out a notice to creditors that they are dissolving
and they have 120 days to get their bill in or they wont get paid.
a. For creditors you dont know, you have to make a publication notice and will give you a 5-year
statute.
b. If you do not comply with the statutory provisions of dissolution, you may become personally liable.
This is not the same as piercing the corporate veil.
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i. If you dont give notice, you dont get statutory protections. So if you also dont pay creditors
first, and follow order of payments, then you will be liable to a creditor.
4. Paying out/Distributing the assets: this is just like corporate law. They have to liquidate everything and sell
everything off. Priority of the assets shall go to:
a. Creditors, including members;
b. Members and former members for amounts owed as declared distributions;
c. Members as a return for their contributions; and
d. Members in accordance with their interest in profits.
e. Note: Basically to shield yourself from liability, you need to notify your creditors and make sure they
get paid when you are distributing assets.

Chapter 7: Corporations:
Historical Overview:
1. Nature of the Corporation: England started corporations when the crown would give special charters to those
who petitioned and were authorized. You would get the right to go into a certain business in a certain area
and it was reserved for those who had money and power.
a. America stole the idea, but went to the state legislatures when petitioning. Churches were the first
corporations so they could members to give them property and have rights as a person.
b. Goforth believes that it is unrealistic to believe that the entities should be protected by freedom of
speech like a person, but should have rights to obtain property like a person.
c. Corporations make decisions that may not represent the majority of their constituents or even a tiny
segment of such individuals. Congress reached a consensus that there was danger in allowing direct
participation in federal elections, BUT:
i. Citizens United holds that corporations have a right of free speech under the 1 st amendment
because we misunderstood what the original corporations are compared to modern ones.
d. Close Corporations (recently): Corporations with very few shareholders and no shareholder market.
Usually, the shareholders have an active role in the business operations.
i. A growing number of states have adopted special provisions applicable to close corporations.
ii. Statutory Close Corporation: special statutes must be elected by the business, usually by
including very precise language in the articles of incorporation.
1. Statutory close corporations are not the same thing as close corporations.
2. Corporate Personhood (7.16): the history of how a corporation turned into a person:
a. 19th Century: strengthened access to federal courts because they had domicile (citizen of the state
in which they were incorporated for jurisdictional purposes).
b. Late 19th Century: corporations have equal protection under the 14 th amendment, and then the 5th.
Corporations became real, rather than purely fictional, entities.
c. Early 20th Century: corporations have broad access to the Bill of Rights, including 1 st amendment.
d. 2010: Citizens United strengthened corporate free speech rights.
Management of Corporations
1. The Board of Directors oversees all business operations, although in practice, other corporate officials are the
ones in charge of day-to-day operations.
2. Generally, shareholders do not have an active role in management. If they dont like the way management is
doing things, they are encouraged to sell their shares.
3. The Board of Directors basically has unbridled authority to make whatever decisions they want in regard to
the management and operations of the corporation.
Closely Held Corporations:
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1. A business organization typified by a small number of stockholders, the absence of a market for the
corporations stock, and substantial shareholder participation in the management of the corporation.
a. Shareholders often expect employment and a meaningful role in the decision-making process. Family
or other personal relationships often link them.
b. Cons Include:
i. More intimate relationships (maybe good?)
ii. Lack of marketability of shares;
iii. Greater reliance placed on the corporation by its stockholders than public corporations.
2. Conventional Rules:
a. Board of directors controls day-to-day activities and management decisions.
b. Board is ordinarily elected and controlled by the shareholders holding majority of the voting power.
Freeze Out- When the majority prevents the minority from experiencing any gain (refusing to pay
dividends and removing them as an employee), and then also tries to force them to sell their shares
at unreasonably low prices.
i. These are typically illegal and violate fiduciary duties.
d. In Arkansas, there is one set of corporate statutes that govern all corporations, not just closely held
ones or public ones. However, subsection (c) of the statute specifically grants close corporations
special rights that public held corporations do not enjoy.
i. 4-27-801: Requirement for and Duties of Board of Directors (exception to the statutes):
1. Each corporation must have a board of directors.
2. All corporate powers shall be under the authority of the board of directors with any
limitations to be set forth in the articles of incorporation.
3. A corporation with less than 51 shareholders may dispense with/limit the authority
of the board by describing the limitations in the articles of incorporation.
a. Technically, a close corporation could get rid of a board of directors entirely,
but no corporation in Arkansas has done this.
ii. Problem: if you go to a bank and want to open a corporate account, you need your certificate
from the state and a copy of your directors of resolution.
e. Majority shareholders owe minority shareholders the duty of good faith and fair dealing and loyalty.
i. Furthermore, directors are held to a good faith and inherent fairness standard of conduct and
cant serve two matters, but just for the corporation.
ii. The majority cannot benefit them at the expense of the minority unless there is a valid
business purpose.
3. Statutory Close Corporation: corporation organized in compliance with statutory provisions applicable only
to close corporations that elect to be subject to special rules. Only a few states can have these because they
have free-standing close corporation statutes.
a. Benefits Include: usually presumed to operate with less formalities; and the shareholders have a
right to assume direct responsibility for the management of their corporation.
b. Unfortunately: only a few states can register as this and there are usually stringent requirements so
that a corporation could still be considered to be closely held but not eligible to register.
i. If a corporation wants to be a statutory close corp., it must include a provision in the articles.
ii. Only corporations with a limited number of shareholders are eligible.
c.

Corporate Taxation:
1. C Corporations: any corporation that has not made a valid S election under the IRC for federal income tax
purposes.
a. An entity formed as a corporation under state law may not elect to be taxed as a partnership under
tax regulations, but non-corporate entities may elect to be taxed as corporations.
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b. Double Taxation: the income gets an entity level tax and then when it is distributed to the
shareholders in dividends, they become ordinary income to the shareholder and are thus taxed again
(but only at a max of 15%).
i. A corporation that retains excess earnings in order to avoid the second level of tax is subject
to a special tax to prevent them from simply retaining earnings.
ii. Small corporations may have shareholders as primary employees and thus can pay
themselves larger salaries or bonuses, or rent property to the corporation, or lend money to
get around double tax.
c. Corporate Losses: not deductible at the shareholder level, but the corporation can carry them
forward to offset future income.
2. S Corporations: simply an otherwise ordinary corporation that is eligible for and elected to be taxed under
subchapter S of the IRC and the equivalent state code.
a. Formed like any other corporation, the only differences come from rules/restrictions imposed by
subchapter S.
b. Benefits: the S corporation is a flow-through entity, so there is no double taxation because there is no
entity level tax. The income/loss flows through the shareholders and are taxed as shareholder level.
c. Disadvantages:
i. Considerably less flexible than C corporations
ii. Can have no more than 100 shareholders (some families are considered single shareholders).
The moment the corporation has more than 100 shareholders; it will be taxed as a C
corporation.
iii. Only one class of shares allowed
iv. All shares must have equal rights to share in profits/losses of the corporation.

Chapter 8: Corporate Formation and Formalities of Operation


Proper Formation:
1. Statutory Provisions: Corporations are creatures of statutes!
a. 4-27-120: Filing Requirements: To be filed with Secretary of State, any document must:

b.
c.

d.

e.
f.
g.
h.
i.

i. Must be typewritten or printed


ii. Be in English, other than the corporate name as long as its in English letters.
iii. Executed by a director, incorporator (if directors havent been elected), or trustee.
iv. The signature should also bear the persons capacity
4-27-123: A document accepted for filing is effective at the time and date it was endorsed by the
Secretary of State; or the time specified in the document. It may specify a delayed effective time.
4-27-124: A corporation may correct a document filed if the document contains an incorrect
statement or was defectively executed. Corp must prepare articles of correction that describe the
incorrect document, specify the incorrect statement and why it is incorrect, and correct it.
4-27-125: If the document satisfies 120, the Secretary shall file it by stamping Filed with the
official title, date and time of the receipt on the original and copy and deliver the copy with receipt to
the corporation. If the Secretary refuses to file it, he shall return it within 5 days with a reason why.
4-27-126: If the Secretary refuses to file the document, the corporation may appeal the refusal to the
Pulaski County Circuit Court and the court may order the Secretary to file it.
4-27-127: A certificate attached to a copy of a document filed by the Secretary is conclusive evidence
that it is on file with the Secretary.
4-27-128: Certificate of Existence
4-27-129: A person commits a class C misdemeanor if he signs a document he knows if false in any
material respect with intent to be filed with the Secretary.
4-27-202: Articles of Incorporation
39

j.
k.
l.

m.

n.

o.

p.
q.

i. Must set forth:


1. Corporate name with the words corporation, limited, co., corp. or ltd.;
2. Number of shares authorized to issue, classes of the shares, par value of the shares,
or a statement that all of the share are without par value;
3. Name and street address of registered agent
4. Name and address of each incorporator; and
5. Primary purpose, for which the corporation is organized, provided to the Secretary
for information.
6. Filing Fee
ii. May set forth:
1. Names and address of directors;
2. Provisions not inconsistent with the law regarding limitations on the purpose for
which the corporation is organized, management of the business, powers of the
corporation/board of directors/shareholders, and the personal liability on
shareholders for debts of the corporation.
3. Provisions eliminating personal liability of a director to the corporation/stockholders
for damages for breach of fiduciary duty as a director.
a. It shall not eliminate liability of a director for breach of his duty of loyalty,
acts/omissions not in good faith, for any transaction that the director gained
improper personal benefit, or any action causing third party liability; and
4-27-203: Existence begins when the articles of incorporation are filed and is conclusive proof tat the
incorporators satisfied all conditions precedent to incorporation.
4-27-204: All persons acting on behalf of the corporation, knowing there was no incorporation, are
jointly and severally liable for all liabilities.
4-27-205: After incorporation: if directors were named in the articles, the directors shall hold an
organizational meeting and appoint officers, bylaws, and other business. If directors werent named,
the incorporators shall hold the organizational meeting to elect directors and complete the
organization.
4-27-206: Incorporators/directors of a corporation shall adopt initial bylaws for the corporation.
Bylaws may contain provisions for managing the business and regulating affairs of the corporation
not inconsistent with the articles of incorporation or laws of the state.
4-27-207: Emergency bylaws - Unless the articles provide otherwise, the board may adopt bylaws to
be effective only in an emergency and they are subject to amendment/repeal by the shareholders. All
provisions of the regular bylaws similar to emergency bylaws are still effective.
i. An emergency exits if a quorum of the directors cannot readily be assembled because of some
catastrophic event.
4-27-401: Corporate Name: must contain corporation, company, limited, incorporated or their
abbreviations. The name must be distinguishable on the records.
i. A corporation may use the name of another corporation if they merged together or were
reorganized together.
4-27-404: Fictitious Names: no corporation may use a fictitious name unless it files it with the
Secretary. There is a lot of other shit in the statute.
4-27-601: Authorized Shares:
i. Articles must prescribe the classes of shares, number of them in each class, and a statement
of the par value of the shares. All shares of a class must have preferences, limitations and
rights identical as others shares of the same class.
ii. Articles must authorize one or more classes of shares that have unlimited voting rights, and
that are entitled to receive the net assets of the corporation upon dissolution.
40

r.

iii. Articles may authorize a classes of shares that have special voting rights (or none); are
redeemable/convertible as specified in the articles or cash or whatever; entitle the holders to
distributions calculated in any manner; and have preference over any other classes of shares.
iv. Board of directors of an investment company may increase/decrease the aggregate number of
shares of stock of any class that the corporation has the authority to issue. If the board does
this, before issuing any of the newly authorized stock, shall file supplemental articles with
the Secretary that include: numbers before and after increase/decrease; total number of
shares the corporation has authority to issue; number in each class; par value of the shares of
each class; and aggregate par value of all of the shares of all classes.
4-27-602: If the articles provide, the directors may determine the preferences of any class of shares
before the issuance of shares of that class or series. Each series must be given a designation. All
shares of a series must have preferences identical with those of other shares of the same series.
Before issuing shares of a class/series, the corporation must file articles of amendment with the
Secretary that are effective without shareholder action and set for the name, text of the amendment,
date adopted, and statement that the directors adopted it.

Pre-Formation Acts: Promoter and Enterprise Liability:


1. Statutory Provisions:
a. 4-27-620: A subscription for share entered into before incorporation is irrevocable for 6 months
unless the agreement provides a longer/shorter period or all subscribers agree to revocation.
i. Board of directors may determine the payment terms of subscription for shares that were
entered into before incorporation, unless the agreement says otherwise. It must be uniform.
ii. Shares issued pursuant to subscriptions are fully paid and non-assessable when the
corporation receives the consideration specified in the agreement.
iii. If a subscriber defaults under the agreement, the corporation may collect the amount owed as
any other debt. If the agreement says otherwise, the corporation may rescind the agreement
and may sell the shares if the debt remains unpaid for more than 20 days.
b. A subscription is an agreement to buy a corporations shares before the corporation has been formed.
2. Promoter: someone who goes out and acts for the corporation knowing that it is not formed yet is liable,
jointly and severally. Additionally, they may be liable under agency and partnership law.
a. Sometimes courts will treat it with agency rules in that if a person acts on behalf of a principal that
doesnt exist is liable. This also breaches the warranty of authority, thus the agent will be liable
himself.
i. It is possible under agency that the promoter will receive unlimited personal liability!
ii. The person must take an affirmative act to be held liable; sitting back and allowing someone
else to act on behalf of the unformed corporation is not enough to be personally liable.
b. Sometimes courts will treat it as a Partnership: if there is no corporation, then there may be a
general partnership and the partners will all be generally liable for their actions. If you intend to go
into business together with a purpose, then you will be liable.
c. Generally, however, the mere fact of acting as an organizer is usually not enough to make someone
liable.
i. Signing the articles of incorporation, alone, is not enough to be held personally liable.
d. In modern day Arkansas: the statute requires knowledge that the person acting on behalf of the
corporation actually knows that the corporation did not yet exist. A promoter can always argue that
he didnt know, in good faith, that he wasnt a corporation yet.
i. Even if the third party knew that the corporation wasnt formed yet, the promoter will be
liable if he also knew it wasnt formed.
e. Some jurisdictions state that the general rule is a promoters personal liability on a pre-incorporation
K entered with a third party is determined by the intent of the parties at the time of the contract.
41

f.

Although promoter liability really only applies to corporations, it can be applied to other entities.
Breach of implied warranty of authority is basically the same thing and applies to other entities.
g. If the court determines there was a corporation de facto or a corporation by estoppel, the promoter
will not be held personally liable.
3. Purpose of the Statutes: to eliminate problems inherent in the de jure, de facto, and estoppel concepts. This
is supposed to be a bright line, default rule regarding whether or not you were a corporation. *Where both
parties know that the principal is not in existence, they probably intended the agent to be liable. Exceptions:
a. Restatement 3d: recognizes the estoppel theory under certain circumstances: there is a presumption
that the promoter will be liable if he knows that there is no corporation, but facts and circumstances
can change how these rules are applied.
i. Example: if the third party knows that there is no formed corporation at the time of
contracting but agreed to look solely to the corporation for performance, the promoter is not a
party to the K.
4. Subscription Agreement: an agreement to purchase share sin a company to be formed, when the corporation
is in fact formed, and sometimes with certain other contingencies as well.
a. Far from being the only type of pre-formation K.
5. Enterprise Liability: if a third party isnt interested in going after a promoter, but wants to go after the
actual entity because they have all the money, the entity will only be liable if it adopted the actions of the
promoter.
a. If the corporation adopts the contract, they can be sued on that contract. This can be done by an
express or implied adoption, novation, or in restitution.
b. Restatement 2d:
i. Ratification: Affirmance of a prior act that didnt bind him but was done on his behalf.
1. A corporation cannot ratify anything if it wasnt in existence at the time of the act.
ii. A person on whose account another acts may become a party to the transaction by
manifesting consent in the following three ways:
1. Adoption: affirmance of a K that can be manifested by acquiescence or other conduct.
a. This is basically just that the corporation adopts the contract that the
promoter entered into.
2. Novation: An agent acts without telling the third party he is an agent. Upon learning
of this, if both parties agree to substitute the principal, they can do so.
3. Restitution: person not subject to liability because of ratification may have benefits
from the act of an agent under the circumstances is inequitable for him not to pay a
third person for their value.
a. This doesnt release the promoters from liability.
c. Restatement 3d:
i. Ratification: affirmance of a prior act done by another. A person ratifies an act by manifesting
assent, or manifesting conduct that justifies a reasonable assumption.
ii. Ratification is NOT Effective: in favor of a person who causes it by misrepresentation, in favor
of an A against a P, or to diminish the rights or other interests of non-parties to the
transaction.
1. A person may ratify an act if the actor acted as an agent on the principals behalf.
2. A person may ratify an act if the person existed at the time of the act, and the person
had the capacity.
3. A person is not bound by a ratification made without knowledge of material facts.
4. Ratification is not effective unless it encompasses the entirety of an act.
6. Corporation De Facto: a promoter treats the business entity as having been formed in fact, even though
the legal requirements have not technically been met. MUST have a substantial good faith effort to meet the
statutory requirements.
42

a. Requirements:
i. Substantial efforts to file;
ii. Good Faith (both subjectively and objectively);
iii. Equitable (more equitable to treat this as a de facto corporationexamples: delay was only a
few days, it was a requirement that you couldnt find in the statutes, etc.).
iv. The third party knew he was dealing with a corporation, and substantial compliance with the
requirements was made.
b. This is opposed to a corporation de jure, which means that all requirements were met and the entity
is a corporation in eyes of the law.
These dont work anymore! It is a lot easier to form a corporation, so courts dont really recognize
de facto corporations anymore.
i. It is unknown whether Arkansas will still recognize a de facto corporation.
Corporation by Estoppel: an equitable notion that one who holds himself out as dealing with a corporation is
estopped from denying it exists. It operates as a shield and the promoters are not liable.
a. Requirements:
i. Both sides must voluntarily agree to deal with the entity as if it were a corporation.
ii. It has to be equitable to estop one party from denying the corporation.
iii. The third party must have thought that they were dealing with a corporation at all times.
b. This can apply to other types of business organizations, and you should argue that non-compliance
was a mere technicality.
c. Situations when this may arise include:
i. Mere Technicality: if your articles arent filed until the day after you sign a K but thought
they were.
ii. Demands of Traditional Estoppel: someone relied to their detriment on your word that it was
a corporation. This can work either for or against the corporation.
iii. Party who caused the problem: if a person knows there isnt a corporation and demands the
K be signed now anyways. If it was a creditor that caused this, then he may be estopped from
denying the existence.
d. Unfortunately, most courts will not ally either a corporation de factor or a corporation by estoppel
because it is so easy to form a de jure corporation and follow the statutes.
c.

7.

Piercing the Veil: (no publicly traded company has ever been pierced, so all close corporations).
1. Statutory Provisions:
a. 4-27-622: Liability of Shareholders:
i. Unless otherwise provided in the articles, a shareholder is not personally liable for acts of the
corporation except by his own acts or conduct.
1. Piercing the veil isnt mentioned in the statute, but is applied in equity.
b. A party can pierce the veil as to the individual shareholders or to sister companies of the corporation.
In fact, most cases involving piercing the veil allow a parent company to held liable for a subsidiary.
c. Most jurisdictions require the presence of fraud.
2. Elements of Piercing the Veil:
a. The Court will look to whether the corporation was just a mere instrumentality of the shareholders
and whether the shareholders have respected the independent existence of the corporation.
i. Was the corporation a mere shell of the insiders or shareholders?
b. Factors for Piercing the Veil:
i. Gross Undercapitalization: not required in order to pierce and by itself is not enough.
There must have been the gross kind of undercapitalization at the time of the K. This is often
mentioned but this has only happened in about 13-14 cases ever.
ii. Absence of corporate records;
43

iii. Fraudulent misrepresentation by the corporations shareholders or directors:


actual misrepresentation may be enough;

iv. Use of the corporation to promote fraud, injustice, or other illegal activities;
v. Payment by the corporation for individual debts over creditors;
vi. Co-mingling of any kind of assets or affairs;
vii. Failure to observe required formalities (to issue shares, follow bylaws, record minutes,
etc.)
viii. Other shareholders acts or conduct ignoring, controlling or manipulating the corporation.
1. Also, most, but not all, courts require a showing of fraud.
2. The shareholder needs to be using his control to promote fraud or injustice. Limited
liability is a vital aspect, and should only be bypassed in rare instances.
3. Courts have been more willing to pierce the veil in tort cases than in contract.
c. Piecing the veil is always appropriate when the corporation is used in furtherance of a crime, to
facilitate fraud, or to justify a similar wrong.
3. Burden of Proof: the one attempting to pierce the veil will always have the burden. He must allege specific
facts showing how the shareholder acted in bad-faith, and why the veil should be pierced.
a. Legal conclusions are not enough; need specific facts.
b. The more facts that you can show that the individual wasnt treating the corporation as a separate
entity, the more likely you will be able to succeed in piercing the veil.
4. Successor Corporations: held liable IF:
a. Agreement to assume the obligation of the previous corporation;
b. Fraudulent sale of assets;
c. De facto consolidation and merger;
d. Mere continuation of the other corporation (same company, different name).
5. AR Cases have two approaches:
a. Rigid, fraud requirement on the second prong of the elements;
b. Equity in the alter ego prong only.
c. Basically, AR cant make up its mind on how much of a fraud requirement there is in order to pierce
the veil.

Chapter 9: Capitalization and Dividend Policy


Form of Contribution in Exchange for Shares:
1. Statutory Provisions:
a. 4-27-601: Authorized Shares:
i. Articles must prescribe classes of shares, numbers in each class and a statement of the par
value of each class of shares. Additionally, it must state the designation for each class and
any limitations on it.
ii. Articles must authorize one or more classes that have unlimited voting rights, and one or
more classes that are entitled to receive the net assets of the corporation upon dissolution.
iii. Articles can give conditions to different classes of shares.
iv. Board of directors may increase or decrease the aggregate number of shares of stock in any
class unless it states otherwise in the articles (legally at least).
b. 4-27-603: A corporation may issue the number of shares of each class authorized by the articles.
Shares are considered outstanding until they are reacquired, redeemed, converted, or cancelled.
i. There must be one or more shares that have unlimited voting rights and are entitled to
receive net assets upon dissolution outstanding.

44

c.

4-27-621: Board of directors may authorize shares to be issued for consideration. Promissory notes
and future services isnt valid consideration. Share having a par value may not be issued for
consideration less than par value of the shares. Board gets to determine what is accurate
consideration. Share may not be issued until the full amount of consideration has been paid.
i. This is contrary to normal rules and other normal business. The actually received part is at
least.
d. 4-27-622: A purchaser from a corporation of its own shares is not liable to the corporation with
respect to the shares except to pay full consideration. A shareholder is not liable for the corporation.
2. Definitions:
a. Authorized Shares: total number of shares, without any further amendment of the articles, which
the directors can issue or sell.
b. Issued: the moment the directors have received consideration for shares, they are sold and issued.
c. Outstanding Shares: lawfully sold and distributed shares that are in the hands of the shareholders.
d. Treasury: when a corporation buys shares back from a shareholder and they are held in the
corporation.
e. Cancelled: when a corporation buys them back from a shareholder and decides not to re-issue them
ever again.
3. Majority Rule: you can contribute anything of value for shares (including promissory notes).
a. AR Minority Rule: you can only issue shares in exchanged for something you have received.
i. Courts will say that property doesnt mean something bought or sold, and thus it doesnt
have to be tangible so long as it has value and is recognized/realized at the time the shares
are issued. Thus, the value of services already performed is considered
property/consideration for shares.
ii. A promise to do something in the future cannot be exchanged for shares.
iii. The court will not weigh consideration, just as long as some consideration was given.
Par Value and Watered Stock:
1. Important points:
a. Par value is the minimum price that the shares can be sold for. It can be set at very low rates; and is
NOT the actual sales price or fair market value.
i. It is an arbitrary minimum for which a share can be sold. Most of the time, corporations set
it at $.10.
b. No-Par Value stock is possible, but this is dumb. Non-par stock is taxed at $25 a share, so this is not
what you want to do.
c. Directors should always prepare a resolution that authorizes the issuance of stock, and lists the
consideration to be received, recites that the value is at least equal to par or specifies the agreed
upon value and the fact that consideration has been received.
d. If director have a reasonable, good faith basis for valuation, this type of resolution should protect the
shareholders against additional liability unless the form of consideration is invalid.
2. History of Par Value: it was the amount set by the charter at which shares were to be sold. They could
appreciate but could never legally be issued at a lesser price.
3. AR statutes include a hidden trap from costs that are not easily obviously associated with any decision to
issue no-par stock. This comes from the AR Franchise Tax.
4. Annual Franchise Tax: this imposes a minimum tax of $150 per year and a maximum tax of $1,075,000.
High par stock leads to the possibility of higher franchise tax because they are calculated by multiplying .
30% of the par value of all outstanding stock. No-par shares are deemed to have a value of $25.00 per share.
a. Thus it is always a benefit to issue cheap par-value stock in AR because you can get slammed if you
dont.
45

b. If you have 100 shares at $1 share, you would pay $150 because thats the minimum. If you had
1,000,000 shares with a par value of $1, you would pay $300 (1,000,000*.003). This is why people set
their par value at $.10. Then 1,000,000 shares would equal $150 because of the minimum.
c. No-par shares become a problem if you issue more than 2,000 shares.
d. A corporation can issue 500,000 shares of $1 stock before they go over the minimum.
e. Theres no logical reason not to make your par value 1 cent, but people dont do it for some reason.
5. Watered Stock: A cause of action when a corporation issues shares for less than par value.
a. If someone paid less than par value in exchange for issuance of stock, you would bring a cause of
action based on watered stock theory seeking the difference between what the par value was and
what was actually given.
i. You could get cancellation of stock for issuance of it below par value under this theory.
ii. If they are illegally issued, the agreement is void or voidable.
iii. Usually you can recover up to par value unless there is a resolution setting a higher agreed
upon value.
b. Usually, a creditor will sue the shareholder for the difference in what he paid and par value.
c. AR has no cases on this theory.
6. Statement of Value: If property is given in exchange for shares, the board of directors should adopt a
resolution that specifically states the agreed upon value of the property received.
a. It is binding upon the courts and creditors, unless it is fraudulent.
b. Stated Value is Par Value, but sometimes courts will use both.
Dividend Policies:
1. Directors Discretion:
a. Statutory Provisions:
i. 4-27-801(b): All corporate powers shall be exercised under the discretion of the board.
ii. 4-27-640 (a): The board may authorize the distribution to its shareholders subject to the
articles.
1. (b): If the board doesnt fix the record date for determining shareholders, it is the date
the board authorizes the distribution.
2. (g): If the articles provide, the board may delegate to a committee of directors the
authority to declare and distribute dividends.
b. Definitions:
i. Distribution: any payment to shareholders with respect to their ownership. Includes
redemption, but not payment for being an employee.
1. Stock dividends or stocks split of that corporation are not considered distributions.
ii. Dividend: when the directors pay out $$ to an entire class of stock on a per share basis. All
dividends are distributions.
1. In Kind Dividend: a dividend other than in cash such as property, or more stock.
a. Stock Split: for every share that you have now, you are going to get a whole
number of new shares. You give your shares back and get new ones.
b. Stock Dividend: you keep your old shares but just get new ones.
c.

Reverse Stock Split: you wind up with fewer shares than you used to (freeze
out technique).

2. Cumulative Dividends: those in which add up in years in which they are not paid,
so that if dividends are not paid for 5 years, the Class A preferred stock would get
money before the common shares could get anything.
a. Anytime you get paid for all prior years that you werent paid is a cumulative
dividend.
46

b. If you want a class of stock to get cumulative dividends, make sure to clearly
express this in the articles of incorporation.
c. The presumption is that dividends are not cumulative.
3. Preferred Stock just means that those shareholders have some kind of superior rights
to the common shareholders. They could receive cumulative dividends, or they could
have superior voting rights.
a. You have to draft your dividend policy very clearly. Arrearage of dividends is
not the same thing as cumulative dividends.
c. Generally, directors can do what they want and have sole power/discretion in issuing dividends.
There are limitations, however, as you cant just sit on a bunch of money and never pay them out.
Courts may entertain the idea that dividends have policies are in bad-faith in close corporations.
i. Courts will step in is when there is showing of bad faith and there is no business purpose.
1. If its clear that the policies are for the purpose of fraud or misappropriation of funds.
ii. They refuse to declare a dividend when there is a surplus of net profits that can be paid, or
iii. When refusal would be an abuse of discretion causing fraud, or breach of good faith.
iv. Courts must look at the totality of the circumstances surrounding the policy decision for not
issuing dividends in light of financial conditions and requirements of the corporation.
1. Corporations cannot issue dividends if it would leave the company without enough
money to pay their creditors.
v. The purpose of a corporation is to make the shareholders money, so if the company has a shit
ton of money just sitting around and they arent using it for a valid business purpose, the
directors need to issue a dividend.
1. You cannot thwart the reasonable expectations of the minority shareholders to
receive dividends unless there is a valid business purpose.
d. Directors will be held personally liable for unauthorized or unlawful distributions. As long as the
director makes their decision in good-faith based on reasonable calculations, he is protected.
2. Limitations in Corporate Code:
a. Statutory Provisions:
i. 4-27-140(6): Distribution: direct/indirect transfer of $$ or property of incurrence of
indebtedness by a corporation to the shareholders in respect of his shares.
ii. 4-27-623: Unless the articles say otherwise, shares may be issued as dividends. Shares of one
class cannot be given to another class as a dividend unless the articles allow it, the majority
of the class whose shares are being issues approve it, or there are no shares of that class.
iii. 4-27-631: A corporation may acquire its own shares. If the articles prohibit it, the number of
shares acquired reduces the number or authorized shares.
iv. 4-27-640(c): No distribution may be made if the corporation would not be able to pay its debts
as they become due in the usual course of business, or the total assets would be less than
total liabilities plus the amount to satisfy all shareholders who have rights to distribution.
1. (d): The board may base a determination that distribution is not prohibited on
financial statements with accounting practices that are reasonable.
2. You have to have more assets than debts. After making a distribution, you have to be
able to pay your debts as they become due.
v. 4-27-833: A director who votes for distribution made in violation of the articles or the laws is
personally liable to the corporation for the amount of distribution that exceeds the violation
amount. A director held liable is entitled to contribution to any other director that voted for
distribution or any shareholder that accepted knowing it was made in violation.
vi. 4-27-830: A director shall discharge his duties in good faith, with care an ordinarily prudent
person would, and in a manner he reasonably believes to be in the best interests of the
corporation.
47

1. A director is entitled to rely on information by other employees/officers, legal counsel,


or a committee that the director is not a member of.
2. A director is not acting in good faith if he has knowledge concerning the matter in
question that makes reliance otherwise permitted.
3. A director is not liable for any action taken as a director if he performed with good
faith.
b. Insolvency Test: it is illegal to make a distribution except of your own shares if the corporation would
be left insolvent after the distribution.
i. Directors are personally liable for illegal contributions and shareholders who personally
receive them are liable for those amounts.
ii. There are two tests in Arkansas, and the distribution must satisfy both.
1. Test 1: Bankruptcy Insolvency:
a. Whether, after giving effect to the distribution, the corporation has more
assets than liabilities: look to the balance sheet and if it puts the corporation
in the red, you cant do it.
2. Test 2: Equity Insolvency:
a. You cant pay the distribution if, after giving it effect, it wont be able to pay
debts once they come due. If you pay money to shareholders, and you dont
end up with enough cash flow to meet current needs. This doesnt prohibit:
i. Stock Dividends: because it only increases the outstanding number of
shares and hasnt harmed creditors.
ii. Stock Split: a corporation sells shares when trading at certain prices.
If they are too high, people cant afford them, and when the price gets
to a certain rate, for every share they get a certain new number.
b. This is hard to determine because you have to look to the corporations
expected future earnings and cash flow, so the statute says that the directors
decision to pay dividends is protected if it was based on a fair valuation of
reasonable expectations.
3. Fraudulent Conveyances: Pages 9.23-9.25 have statutes regarding the issue.
a. If you make a payment and it leaves the corporation with unreasonably small assets for its
operations, then the transfer is fraudulent.
b. There are lots of factors for the court to look at to scrutinize and a bunch of different remedies
including making the persons personally liable.
Chapter 10: Allocation of Power Between Shareholders and Directors:
Requirement of the Board of Directors:
1. Statutory Provisions:
a. 4-27-801: Each corporation must have a board of directors. All power shall be exercised under the
directors, subject to any limitations in the articles. A corporation with less than 50 shareholders may
limit/dispense the authority of the board by describing it in the articles.
i. The last sentence is the protection given to close corporations.
ii. Banks dont deal well with corporations without boards.
b. 4-27-803: Board must consist of one or more people in accordance with the articles. The board has
the power to fix/change the number and may increase or decrease by 30% of the number of directors
as approved by the last vote of the shareholders.
i. It is unlikely that you will see a board of less than 3, but it is not prohibited.
ii. To increase/decrease by more than 30%, the shareholders must approve it.
c. 4-27-805: normally the directors are elected for 1 year. If there are at least 9 directors, there can be
classes of 3 directors that can be elected for 3 years (Terms like senators).
48

i. Modern statutes say that you can get rid of directors whenever you want, with or without
cause.
d. 4-27-807: A director may resign at any time by delivering notice to the board and it is effective when
the notice is delivered unless it specifies something else.
e. 4-27-811: Board of directors may fix the compensation of the directors.
f. 4-27-820: Board may hold regular/special meetings. Under the articles, the board may permit any or
all directors to participate.
g. 4-27-821: Unless the articles say otherwise, action required under the sections can occur without a
special meeting if all of the directors sign on to a written consent to the act.
h. 4-27-822: Regular meetings may be held without notice of date, time place, or purpose. Unless the
articles provide for longer/shorter periods, special meetings must be preceded by at least two days
notice.
i. 4-27-823: A director may waive notice before or after the date and time stated in the notice. Waiver
must be in writing, signed and filed with the minutes. Directors attendance waives any required
notice of him.
j. 4-27-824: A quorum of a board of directors consists of: the majority of the fixed number of directors;
or the majority of the number of directors prescribed. Articles may authorize a quorum to consist of
no fewer than 1/3 of the fixed directors. If quorum is present when the vote is taken, the affirmative
vote of the majority present is the act of the board.
k. 4-27-825: The Board may elect committees to act for the Board. The committee must have at least 2
members of the board on it. The committee can exercise the authority of the board. The committee
cannot:
i. Authorize distributions, propose anything to shareholders, fill vacancies on the board, adopt
or amend bylaws, amend or adopt articles, etc.
2. General Rule: all management authority is to be exercised under the authority of the board of directors.
a. Shareholders dont actually delegate authority to the board, the statutes do.
b. If shareholders dont like what the board is doing, they can vote to remove them, but they cant just
tell the directors what to do.
Shareholder Rights:
1. Statutory Provisions:
a. 4-27-701: The corporation shall hold an annual shareholder meeting at a fixed time. They may be
held wherever the bylaws say or at the principle officer. Failure to hold the annual meeting doesnt
affect the validity of a corporate action.
b. 4-27-702: Corporations shall hold special meetings when the board calls for one.
c. 4-27-703: The circuit court of a county may order a meeting to be held according to this statute.
d. 4-27-705: Corporation shall notify shareholders of the date, time and place of annual meetings no
fewer than 60 or more than 75 days before the meeting. Notice doesnt need to include the purpose of
the meeting unless it is a special meeting.
e. 4-27-706: A shareholder may waive any notice before or after the date and time stated in the notice.
It must be in writing, signed and delivered to the corporation for inclusion in the minutes.
Attendance at a meeting waives objection to lack of notice or consideration of a particular matter at
the meeting not within the purpose.
f. 4-27-720: After fixing the record date, the corporation shall prepare an alphabetical list of all
shareholders entitled to notice and arranged by voting group. It must be available for inspection of
any shareholder. The corporation shall make it available at the meeting, but refusal to make it
available doesnt affect the validity of the action taken at the meeting.
g. 4-27-721: Each outstanding share is entitled to one vote on each matter voted on at a shareholders
meeting.
49

h. 4-27-722: A shareholder may vote his shares in person or by proxy.


i. He can appoint a proxy to vote by signing an appointment form.
ii. An appointment is effective when received by the secretary that tabulates votes and is valid
for 11 months, unless specifically contracted for a longer duration.
iii. Appointment is revocable by the shareholder unless it states that it is irrevocable and it is
coupled with an interest including the appointment of: pledgee; person who purchased the
shares; creditor of a corporation; employee of the corporation whose K requires appointment;
or party to a voting agreement.
iv. Death/incapacity of a shareholder that appoints a proxy doesnt affect the right of the
corporation to accept the proxys authority.
i. 4-27-808: Shareholders may remove one or more directors with or without cause unless the articles
provide that directors can only be removed with cause. A director may be removed by the
shareholders only at a meeting called for the purpose of removing him and the meeting notice must
state that the purpose, or one of the purposes, of the meeting is removal of the director.
j. 4-27-809: Judicial Removal of a Director
2. Generally, the doctrine of permitting close corporations to act informally is recognized as an exception to the
general rule that directors must act as a board at duly convened meetings. Corporations with few
stockholders dont act with lots of formalities, and shouldnt necessarily be in trouble for it.
3. Election of Directors:
a. Statutory Provisions:
i. 4-27-728: Cumulative Voting: directors are elected by a plurality of the votes cast by the
shares entitled to vote in the election at a meeting at which a quorum is present.
1. Shareholders dont have a right to cumulate unless the articles provide.
2. Articles must say that all shareholders are entitled to cumulate their votes for
directors meaning: shareholders are entitled to multiply the number of votes they are
entitled to case by the number of directors for whom they are entitled to vote and cast
the product for a single candidate or distribute the product among two or more.
3. Shares may not be voted cumulatively at a particular meeting unless the notice or
proxy statement states conspicuously that the voting is authorized; or the
shareholder who has the right gives notice of his intent to cumulate his votes.
ii. 4-27-804: If the articles authorize dividing the shares into classes, the articles may also
authorize the election of all or a specified number of directors by the holders of one or more
classes of shares.
iii. 4-27-806: If there are 9 or more directors, the articles can stagger director terms by dividing
them into groups of or 1/3 of the directors for up to 3 years.
iv. 4-27-810: If there is a vacancy on the board, the shareholders or majority of the board can fill
the vacancy. If the director was elected by a voting group of shareholders, the holders of
shares in that group are entitled to vote to fill it.
b. Public Corporations: the old board usually nominates a new candidate and nominations from the
floor are worthless because proxies have already pretty much decided it.
Generally, the shareholders have the right to elect the Board.
i. By-laws usually contain the number of directors to elect.
ii. Unless you provide otherwise, the election is by a plurality vote.
iii. The initial directors in the articles serve as directors until the first annual shareholder
meeting.
d. Closely Held Corporations: If the voting is based on a plurality system, majority shareholders get to
decide the board every time. If someone owned 51% of shares, they would elect every director.
c.

i. Cumulative Voting: if you include this in the articles, it may help out the minority.
50

1. Vote for all the directors at the same time and you get to case as many votes as you
have shares times the number of directors to be elected.
2. If you own 10 shares, and there are 3 directors to elect, you get 30 votes.
3. This still requires coordination among minority shareholders.
4. Doesnt work in public corporations because almost always the old board will pick
nominees for the new board and thus the right to elect the board doesnt really mean
anything.
5. Proxy Fight: corporation sent out slate and someone else sends out a slate (hard to
win).
e.

Proxy Voting:
i. Proxy: written document granting someone else to vote for you. It is always revocable,
unless: the proxy conspicuously states that it is irrevocable and it is coupled with an interest.
1. Coupled with and Interest: includes

a. A pledge (someone to whom the stock is pledged to secure a debt of the


shareholder/pledgor);
b. A person who purchased/agreed to purchase the shares;
c. Creditor of the corporation who extended its credit under terms requiring
appointment;
d. Employee of the corporation whose K requires appointment;
e. Party to a voting agreement.
f. Shareholders have a RIGHT to elect the board, and so even if the board acts in good faith to change
up the board or add new directors or something without a significant business purpose, they cant
overcome the statutory rule that allow shareholders the power to elect. Any strategy designed to keep
a board member in power or keep someone else off the board for an invalid business purpose is not
allowed.
i. If the board of directors amends the bylaws to change their tenure, this is allowed if they
have a valid business purpose, other than maintaining their power.
g. Shareholders Right to Remove: most states say that the shareholders can get rid of any director for
any reason with majority vote. By-laws usually change this and say that you can only remove for
cause.
4. Voting Agreements:
a. Statutory Provisions:
i. 4-27-731: 2 or more shareholders may provide for a manner in which they will vote by
signing an agreement for that purpose. It is not subject to the provisions of 730.
b. Voting agreements are enforceable as a regular K and any votes cast in violation of the agreement
dont count (in some courts). The problem with these is that they are not self-enforcing and thus the
judge will equitably create a remedy (specific performance may be the remedy).
i. The judge can create whatever remedy he wants in response to a violation of a voting
agreement.
c. What is it?

Voting Agreement
Agreement
Between Shareholders
About how to vote

Voting Trust
Agreement
Between Shareholders
Transferring Right to Vote
Retaining Beneficial (economic)
interest
Not Revocable at will
51

Purpose to Affect Control


i. You dont have to call it a voting trust, you dont have to name anyone as a trustee, and you
dont have to intend for it to be a voting trustit will be one if it follows these rules.
ii. If you are transferring ownership, it isnt probably a voting trust.
iii. Statutory requirements are much more strict for a voting trust.
iv. You cannot sell your vote because it is against public policy.
v. You cannot convey your vote for private benefits because this is against public policy too.

d. Is it Enforceable?

Shareholder Agreement
Must be in a signed writing
Subject to ordinary contract
defenses (fraud, duress, etc)
Cant violate public policy by
oppressing the minority
Cant sterilize the directors

Voting Trust
Must be in a signed writing
No contract defenses (fraud, duress, etc.)
Cant violate public policy by oppressing the
minority
Cant sterilize the directors (unduly interferes
with the directors discretion)
Must be filed with corporation
Trustee must be owner of record of shares
Limited Duration: Cant last more than [10]
years (AR approach is 10 years, most states
have range of 7-25)
May have limited renewability
AR doesnt have this
**example: can only renew in the last two
years of the voting trust or may not let them
extend

5. Voting Trusts:
a. Generally, there are a lot more formalities required to form a voting trust than a voting agreement.
But, a voting trust is much easier to execute. If a trustee doesnt vote in accordance with the
agreement, he has violated fiduciary duties.
b. Statutory Provisions:
i. 4-27-730: 1 or more shareholders may create a voting trust, conferring on a trustee the right
to vote, by signing an agreement and transferring their shares to the trustee. The trustee
shall deliver copies of the owners of the beneficial interests in the trust to the corporation. It
becomes effective on the date the shares are subject to the trust and is not valid for more
than 10 years unless the parties signing an extension agreement and obtaining the trustees
written consent to the extension extend it.
1. It must be filed with the company, it most last for a set duration, and ownership of
the shares must be transferred on the books of the company.
c.

Elements of a Voting Trust:

i. Agreement between 2 or more shareholders


ii. They keep the economic right, but transfer ownership to trustee (most important)
iii. Intended to be irrevocable for a period of time;
iv. Transfer voting power
v. With the purpose to gain voting control.
d. Once you have determined that the agreement it is a voting trust, it must meet the following
requirements in order to be enforceable:
i. In writing
52

ii. Signed by 1 or more shareholders


iii. No contract defense or private benefit
iv. It cant sterilize the board
1. This means that the shareholders cannot have an agreement that gives them powers
that are normally held by the board. E.g., shareholders cant elect officers.
v. It must be filed with the corporation (cant be secret)
vi. Ownership of the shares must be transferred on the books of the corporation
vii. It must be for a limited duration, not to exceed 10 years.
e.

f.

It doesnt matter if it was called an agreement because substance controls over form.
i. Statutes impose limits on trusts because otherwise they are self-enforcing and it makes it
difficult to get out of them, so there are some public policy limitations.
ii. Purpose: to pool votes to achieve voting control.
iii. It doesnt matter what you call it, or what you intended it to be, if it satisfies the elements of
a voting trust.
iv. Failing to file the agreement doesnt determine what type of agreement it is, it just
determines if the agreement is legal or not.
Voting trusts must meet the statutory requirements. There is not such thing as a common law voting
trust; they are creatures of statute.
i. A voting trust cannot be revocable at will.

Sterilizing the Board: Sometimes, shareholders want to get together and agree on how to run the corporation
without the board, but this isnt generally cool with the courts.
1. Generally, day-to-day decisions are to be made by the board including setting salaries and appointing
officers. Amending the bylaws, however, are within the powers of the shareholders.
a. If all the shareholders agree to something, however, and the interference isnt too great with the
directors power, the court wont really be willing to strike it down.
b. If shareholders attempt to organize together to set salaries, appoint officers, etc. without anything in
the articles, it will be void.
2. Overall, courts dont want shareholders to sterilize the board.
a. Trend: courts will enforce shareholder agreements that may sterilize the board as long as they leave
some reasonable control in the hands of directors.
b. If the only people affected by the agreement are the parties to the contract, the courts are more
willing to uphold the agreement.
c. When there are only 2 shareholders, and they are also the only 2 directors, an agreement between
them will usually be upheld as long as it doesnt affect their creditors.
3. AR Law: allows small corporations to restrict the powers of the board by putting it in the articles that the
shareholders have the right to decide dividends, salaries, amendments, etc.
4. If the agreement says that no decision can be made without the vote of the minority shareholder, this is
about as sterilizing as it gets.
a. Some courts enforce them as long as all the parties agreed to it.
b. Some dont because this is the definition of sterilizing the board.
i. Arkansas could go either way.
5. Revised Model Business Code: special set of statutes regarding voting agreements in small corporations. If
all shareholders sign and acknowledge that no shareholder will be prevented from knowing the terms of the
agreement. These agreements will be ok if:
a. Unanimously signed; and
b. Acknowledgment that it will be public.
Closely Held Corporations and Modern Statutory Reforms:
53

1. Close corporations statutes can do away with the board or limit is power by placing limitations in the
articles. It must, however, reflect a change in the public policy.
a. So, the shareholders can elect to remove the board, and a sterilizing the board theory wouldnt
work.
2. To change or limit the power of directors, there are usually special rules including:
a. Corporation must have a relatively small number of shareholders; and
b. The share are not publically traded.

Chapter 11: Duty of Care:


Statutory Formulations:
1. Generally, directors have a great deal of discretion in running corporations and it is necessary because:
a. Sometimes risk is necessary in order to maximize gain;
b. It would be difficult if not impossible to attract good directors if every judgment mad was subject to
being second guessed;
c. If every decision could lead to litigation, corporations would be paralyzed;
d. Courts are not in the business of making corporate judgments and shouldnt be asked to substitute
their judgment for that of trained directors;
e. Hindsight is always 20-20; and
f. Shareholders in a public company lead to directors either quitting or changing their policies, so we
dont need the courts to enforce strict standards of care.
2. 4-27-830: Standards for Directors: A director shall discharge his duties as a director in good faith, with care
of an ordinary prudent person in like circumstances, and in a manner he reasonably believes to be in the
best interests of the corporation.
a. The effectiveness or successfulness of the decisions is irrelevant. The court doesnt care if the decision
is the best decision or if it there was a better alternative, as long as it was in good-faith, not in self
interest, and with a reasonable belief that it was in the best interest.
3. Elements:
a.
b.
c.
d.

Directors must act in good faith;


With that degree of care of an ordinarily prudent person;
With a reasonable belief that it is in the best interest of the company.
Note: this is an affirmative burden on the directors
i. Shareholders lose a lot here because the courts dont like to interfere and if you are a
shareholder in a public corporation, you can just sell your stock, and if you are a shareholder
in a close corporation, you can just attempt to elect new directors.
ii. Courts will not interfere unless a clear case is made out of fraud, oppression, arbitrary
action, or breach of trust.

Business Judgment Rule:


1. The presumption is that directors, in making a judgment, have acted in accordance with the statutory
standards. This is a court created doctrine and acts as a defense for the board when one if their decisions is
challenged, either by the shareholders in a derivative suit, or by creditors of the corporation.
2. Elements of the Business Judgment Rule - A director will prevail in any suit challenging a decision if:
a. Directors (or those they appoint)
b. Made a business judgment (must be an affirmative decision, and anything made for a personal
reason doesnt count).
c. With no proof of bad faith on the part of the directors
d. Isnt motivated by self-interest (and has no conflict of interest)
54

e.

There is no evidence that the directors were not reasonably informed (directors have the obligation of
being reasonably informed before exercising a judgment); and
f. The director reasonably believed that the decision was made in the best interest of the corporation.
g. ALIs Sixth Element - The directors decision must be rational. (There are no cases about this and
Arkansas doesnt have this element. Only use this if she specifically asks for ALIs rule).
i. If the directors meet all of the elements, then they are presumed to have acted in good faith.
ii. If the challenging party produces evidence to negate any of the elements, the burden of proof
shifts to the directors to prove they used ordinary care in the best interest of the corporation.
1. Examples - If theres evidence of self-interest, but directors have evidence showing
they met the statutory standard of care, they win. Also, if evidence shows they were
not reasonably informed, but it was the best decision they could have made, they win.
iii. Additionally, the challenging party must prove the violation proximately caused the harm.
3. Two Prong Test:
a. Business Judgment Rule (must be applied objectively) (if no element is missing, stop here and
shareholders lose)
b. If an element is missing, then go to the statutory rule and shift the burden to the directors to show:
i. Good faith;
ii. Ordinarily Prudent Person;
iii. Reasonableness
4. Rules From Cases:
a. When only one of the directors has a conflict of interest, this probably wont negate the protection of
the business judgment rule for the entire board.
i. However, if that same director is the only director who is reasonably informed, this will
negate the business judgment rule.
b. Directors need to have fundamental understandings of the business of the corporation because they
are bound to exercise ordinary care. Thus, they cant use a defense of lack of knowledge and cannot
just shut their eyes to corporate misconduct and claim they didnt see it or have a duty to look.
i. They must at least attempt to be well advised in their company and may be charged with
assuring that bookkeeping methods conform to industry standards.
ii. Directors may not shut their eyes to corporate misconduct and then claim that because they
did not see the misconduct, they did not have a duty to look. (Francis v. United Jersey Bank)
iii. The directors must be reasonably informed to make a valid business decision. If they are not,
they do not receive the protection of the business judgment rule.
iv. This is an objective standard. If you are a director, you cannot just say that you never went to
college and dont understand the business.
c. Normally, if the shareholders ratify the decision, such as a merger, the board will be protected,
unless the shareholders were also not reasonably informed.
i. Always look to see if the person who is supplying the board with the information is the
person with a conflict of interest. If this is present, and the board doesnt do any additional
research, they will probably not receive the protection of the business judgment rule.
5. ALIs Business Judgment Rule: These are what a majority of jurisdictions say:
a. A director has a duty to the corporation to act in good faith, in a manner that he believes to be in the
best interest of the corporation, and with care of an ordinarily prudent person would be expected to
exercise.
i. This includes an obligation to make inquiry when the circumstances would alert a reasonable
director to. A director is entitled to rely on materials and persons including directors, officers,
employees, experts, committees, etc.
b. The board may delegate any function to committees of the board; and directors may rely on the
committees in fulfilling the duties of the BJR.
55

c.

A director who makes a business judgment in good faith fulfills the duty if the director:
i. Is not interested in the subject of the judgment;
ii. Is informed with respect to the subject or reasonably believes it to be appropriate under the
circumstances; and
iii. Rationally believes that the business judgment is in the best interests of the corporation.
d. A person challenging the conduct of a director has the burden of proving a breach of the duty of care.

Chapter 12: Duty of Loyalty by Directors:


Statutory Standards and Common Law:
1. Directors owe a duty of loyalty to the corporation. At early common law, directors could never enter into a
contract with the corporation. But, often, everyone was benefitted from these transactions, so modern courts
allowed for directors to enter into them, as long as it was fair or ratified by the directors or shareholders.
a. Although this is similar to business judgment rule, the business judgment rule does not apply when
there is a conflict of interest. Instead, we are dealing with duty of loyalty.
b. There is a two-step analysis for a breach of the duty of loyalty:
i. Was there a conflict of interest?
ii. Was it ratified or was it fair to the corporation?
2. Statutory Provisions:
a. 4-27-831: Conflict of Interest: A conflict of interest transaction is one in which a director of the
corporation has a direct or indirect interest. It is not voidable by the corporation solely because of the
directors interest in the transaction if any one of the following is true:
i. Material facts of the transaction and the directors interest were disclosed/known to the
board of directors or a committee and the disinterested directors authorized it;
ii. Material facts of the transaction and the directors interest were disclosed/known to the
shareholders and they voted to approve it; or
iii. The transaction was fair to the corporation.
1. Fairness requires not only fair consideration/price, but also a fair process.
(Sometimes only one or the other is required).
iv. A director has an indirect interest and it should be disclosed to the board if he has a material
financial interest in, or is a general partner, officer, or director of another entity that is a
party to the transaction.
3. Was there a Conflicts of Interest: When there is an interest that is reasonably likely to prevent the
director form making an impartial decision, such as family relationships, financial relationships, and
fiduciary duties.
a. The conflict can be direct or indirect:
i. Direct Conflict: director of family member to the K
ii. Indirect Conflict: director is officer in another entity that is a member to the K.
b. The conflict must be substantially significant to make it likely that the director would be impartial.
i. De minimus interest would not implicate the conflict of interest rules.
4. Was it Approved: If it is determined that there was a conflict of interest, the duty of loyalty will not be
violated if the transaction was approved. Conflict of interests transactions can be approved by:
a. Affirmative vote of the majority of the disinterested directors (at least 2); or
b. Majority vote of the shareholders (excluding shares by interested parties).
c. Fairness - If the contract was fair at the time it was entered into, it will be approved.
i. Fairness is not defined in most statutes.
ii. If all of the shareholders/directors have an interest, the fairness test is the only one that can
be used.
5. Fairness:
56

a. Fairness is supposed to be a third, independent way of approving the transaction, but most courts
continue to require fairness, even when the directors or shareholders ratify it.
i. Courts have interpreted the statute in the following ways:
1. Ratification only shifts the burden to the plaintiffs to prove it was unfair.
2. Ratification only takes away conflict of interest claim, not duty of care claim, which
requires fairness.
3. Statute is in addition to the common law common law requirements of good faith or
fairness.
b. Even if the result is fair, some courts require the process of entering the transaction also be fair. The
end result being fair, alone is not enough, the process must also have been fair.
i. Substantive: fair terms of a fair deal; and
ii. Procedural: fair process. This usually just requires disclosure.
1. Most courts dont require both - Usually they dont require the procedural fairness.
6. Burden of Proof is always on the directors to show that they disclosed all material facts, and did everything
they could for disinterested directors/shareholders. Some courts will say that the burden then moves back to
the plaintiffs to show it was unfair.
a. The Plaintiffs have the burden of proving a conflict of interest, and once they prove that, the directors
have the burden of proving that it was accepted or that it was fair.
b. Even if they prove it was ratified, often the court will shift the burden back to the plaintiffs to show
that the transaction was unfair.
c. These courts say that satisfying the ratification statute doesnt prove the case, but just shifts the
burden back to the plaintiff to prove that it wasnt fair.
Corporate Opportunity Doctrine:
1. The corporate opportunity doctrine deals with this situation: When a director learns of an opportunity that
is similar to the business that the corporation is engaged in, does the opportunity belong to the director, as
an individual, or does it belong to the corporation?
a. This also applies to partnerships, LLCs, LPs, etc.
2. There are actually TWO inquiries to make regarding corporate opportunities:
a. Does the opportunity belong to the corporation? Tests:
i. Expectancy/Corporate Purpose: Is this an opportunity that the business would have expected
to get? Directors will have misappropriated a corporate opportunity only if the director has:
1. Acquired property in which the corporation had an interest; or
2. Directors interference will thwart the corporation from achieving its purpose.
a. Courts apply this test liberally, in an expansive manner.
ii. Line of Business: Whether the opportunity was in the corporations line of business. (Usually
applied with other tests, like capacity).
1. This is a pretty strict test, and requires the line of business to be exactly the same.
iii. Line of Foreseeable Businesses: This includes any opportunity that the corporation might
reasonably be expected to participate in the foreseeable future. (Applied with other tests).
1. Broader than previous test. If the business sells mens clothing and a director opens a
womens clothing shop, it would violate this test, but not the line of business test.
iv. Line of Business or Fairness: Whether the director has appropriated opportunities to which

the corporation has an expectancy; OR which in fairness should belong to a corporation.


(Broad approach)

57

v. Line of Business AND Fairness: Whether the opportunity was so closely associated with the
corporations existing business that directors should fairly have acquired opportunity for the
corporation. (This is a narrow version of the last approach).
vi. Capacity in Which the Opportunity is Received: if the opportunity comes to the director in
capacity as a corporate representative, then it is a corporate opportunity; if it arises because
of personal status or relationships, it is a personal opportunity.
1. This list is not exclusive and the courts will apply all of them or some of them,
depending on the court and on the circumstances.
2. If you determine it was no a business opportunity, the analysis is done.
b. Even it belonged to the corporation, is it acceptable for the insider to take the opportunity? Any of
these tests can be used, and Arkansas has used all of them.
i. Right of First Refusal (Most common approach): This requires full disclosure and to offer the
corporation the first opportunity to take any transaction that is reasonably incident to its
existing or prospective operations.
1. A director can only take a corporate opportunity if there is full disclosure and the
corporation reasonably rejects the opportunity, OR if the corporation unreasonably
refuses to allow the director to accept it himself.
2. What happens if the corporation refuses to allow the director from accepting the
offer? If the director can prove that the corporation was unable to accept (lacked
financial ability, third party wouldnt have accepted) then he can accept the offer.
a. Director has burden of proving that the corporation could not accept.
3. If the business doesnt have the ability or interest in the opportunity, disclosure does
not have to be accomplished in a formal meeting. The director can just ask a couple of
the other directors if they want to take the opportunity.
ii. Fairness Test: Whether it would be fair to allow the director to accept the opportunity.
Whether the directors acts unfairly take advantage of a corporations opportunity.
1. Simply saying that the corporation was unable to accept the offer, absent disclosure,
is not enough. If they would have known, maybe they could have raised capital.
2. There is no real test; you just have to make an argument that it wouldve been fair.
iii. Other ALI Formulations: directors can only take if the financial benefit outweighs the cost.
1. This test sucks and is never used by itself.
3. A director can always take the opportunity without informing the company, but if he does this, he will be
held liable if the opportunity was found to be a business opportunity of the company.
a. If he firsts discloses, and the company declines, then he has protected himself from liability.
b. He can always argue, after the fact, that it wasnt an opportunity or that it was fair for him to take it,
but he is taking a big risk.

Chapter 13: Duties of Control Shareholders


In Operations of Closely Held Corporations:
1. Generally, the majority shareholders cannot benefit themselves at the expense of the minority shareholders,
unless it was a valid business purpose.
2. Problem: Those in control may treat minority shareholders unfairly, and they dont have access to a ready
market for their shares.
a. Control/Majority shareholders owe minority shareholders the same fiduciary duty in the operation of
the enterprise that partners owe to one another. AKA With the Utmost Good Faith and Loyalty.
i. They may not act out of avarice, expediency or self-interest in derogation of their duty of
loyalty to the stockholders and the corporation.
b. Duties Owed to the minority shareholders:
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i. Cant make a decision that benefits themselves at the expense of the minority;
ii. Cant thwart the reasonable expectation of the minority;
iii. Cant freeze out the minority.
3. Burden of Proof:
a. Plaintiff (usually the minority shareholder) must prove:
i. Someone else was in effective control (either a majority or an effective minority)
1. If a shareholder only owns 25% of the stock, but the articles require 80% approval, he
is in control.
ii. This was a close corporation
iii. AND those in control either:
1. Benefitted themselves at the expense of the minority; OR
2. Thwarted a reasonable expectation of the minority:
a. You look at why the shareholder invested in that business.
b. If everyone joined the business in order to be employed by that business, then
you cant just fire one of the minority shareholders.
c. Usually a secret expectation is not going to work.
3. Freeze Out: To deprive the minority of having an effective role in the corporation.
This can be done economically, or managerial.
a. Minority shareholders usually depend on salary as the return on investment
because the earnings are distributed in salaries, bonuses, and benefits.
b. Usually, a freeze out also requires the majority to make an unreasonably low
offer to buy the minoritys shares.
b. This will shift the burden to the control group to prove that there is a legitimate business purpose.
i. Just saying, I did this to improve the company is not enough. There has to be a specific
purpose, and there must be evidence that you were taking steps toward that purpose.
ii. If you fired the shareholder who has a reasonable expectation to be employed, then the
burden shifts to you to prove it was for a valid business purpose.
c. If control group proves that, the burden shifts back to the plaintiff to prove there was a less harmful
alternative.
i. If three of shareholders fire the fourth one because they wanted to save money or couldnt
afford to pay four, this is not a legitimate defense because there was a less harmful
alternative - All four of the shareholders could have taken a pay cut. (Wilkes)
4. Employees and Shareholders: Fiduciary duties are owed to shareholders, but are not owed to employees.
a. Often, employees-at-will are offered the opportunity to buy shares in a close corporation. This makes
them a minority shareholder. This creates a problem when the employee is fired.
b. If he is fired, does he have rights under the fiduciary duty owed to him as a shareholder, or the
termination allowed because he is an employee at will?
i. If the shareholder status is derivative of his employment status, he can be fired at will
because he contracted to be an employee-at-will. (Ingle v. Glamour Motors)
ii. The employee/shareholder is owed a limited fiduciary duty - he cannot be fired in bad-faith,
just in order to gain a benefit at the employees expense. (Jordan v. Duff)
c. For these cases, you just have to look at the employment contract and the shareholder agreement. If
there are specific clauses giving the employer the ability to fire the shareholder/employee for any
reason, it will be effective.
i. If the contracts and agreements provide the employee/shareholder with a reasonable,
objective expectation that his employment will continue and that he will get to experience
the benefits of the shares, then he is owed fiduciary rights.
Sales of Control: Control Premiums:
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1. General Rule: Absent special circumstances, a shareholder can sell his shares, whenever he wants, for
whatever he can.
a. Exceptions: Known Looter: If you know the reason they are paying so much is because they are
going to come in and steel everything good from the company.
i. Knowledge is tested objectively. It is what a reasonable person would have known under the
given circumstances.
1. If the majority shareholders lose all their money in the transaction, this is subjective
evidence that they didnt know, but this is irrelevant if they should have known.
ii. If a reasonably prudent person would have been put on notice that the sellers could be looters
or that something, in general, was fishy, they violate their fiduciary duty if they do not
investigate.
1. If you are receiving an exceptionally high price and the buyer wont give you access to
their books, or if the books are fucked up, it would put a reasonable person on notice.
iii. The main issue here is always going to be how much facts need to be present before the
majority shareholder should have known that the buyer was going to loot.
iv. Damages are equitable, so they will be whatever the judge thinks is fair to make the minority
shareholders/creditors whole because the majority were fucking idiots.
2. Some courts say that if a premium is paid for a control block of shares in order to gain control over a
company asset, this is a valid reason to pay the premium.
a. However, in some circumstances, the court will require the majority shareholders to pay back some of
the premium they received to the minority.
b. Example - Steel producer has a market advantage during the war due to supply shortage, majority
shareholder sells the shares at a premium to a steel buyer, thereby eliminating that advantage. If
the court finds that the market advantage was a company asset, the majority shareholder has to
share the premium with the minority. (Perlman v. Feldman)
i. You cant sale company assets and keep all of the profits for yourself. So, the minority should
always make an argument that some part of the agreement was an asset. In the above case,
the business has a corporate plan to use the proceeds from their market advantage to make
improvements and increase capacity. This plan was considered an asset.
c. Most courts wont follow this approach.
Sales of Directors Positions:
1. It is common practice that when someone buys a control block of shares, part of the purchase agreement
requires the seller to make his directors resign, and replace them with the buyers directors.
a. Normally, they would have to wait until the next annual shareholder meeting, or even 2 or 3 years if
the directors are elected in staggered terms. But, the purchaser wont want to wait that long.
b. There is no issue if the buyer is purchasing 51% of the stock. Requiring him to wait for the next
meeting would be a ridiculous formality and would discourage transactions.
i. But, if they are only buying a control block (less than 51%, but enough to have effective
control of the board), we have problems.
2. Effective Control: Effective control is when you have less than 51%, but you have control of a significant block
of shares, with longstanding control over significant representation on the board.
a. In a publicly traded company, 28.3% is probably enough.
b. Just because the majority of your appointments happen to have been voted onto the board, does not
mean you can sell your shares when you dont have control. There has to be longstanding control.
i. 3% shareholder had 7/10 directors - He cannot sell his shares at premium for those seats
because he is selling the seats, and not a control group. (Caplan v. Yates).
3. Rule: you can sell directors seats only when you sell enough stock to change control.
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a. It is illegal and thus void against public policy to sell directors seats or corporate offices by itself
(without stock, or insufficient stock to have a voting control).
b. If the stock that is being sold carries with it the ability to elect a majority of the directors, the sell is
not for the directors seats itself, but the ability to elect the directors just comes along with it.
4. Tests:
a. Majority Approach: As long as you are selling a percentage that is usually enough to get you control
(28.3% in a publically traded corporation), there is a presumption that it is OK to sell the director
positions as well.
b. Judge Friendly Opinion: there is a presumption the other way: unless you are selling a clear (>50%)
majority of the stock, then we will assume that you havent sold enough and put the burden on the
other side.
5. Summary: When a majority shareholder is selling his shares at a premium, you have to look at three things:
a. Looting
b. Selling a Corporate Asset
c. Sale of Directors Positions

Chapter 14: Sale and Resale of Shares


Overview of Securities Laws:
1. Securities Act of 1933: All offers and sales of securities are illegal unless the shares are registered with the
SEC or they are exempt from registration.
a. If its a close corporation, you always have to find an exemption.
b. The penalties of violating security laws are extreme. A person can buy the shares, run the company
into the ground, and then rescind the purchase because it didnt comply with regulations.
2. Securities and Exchange Act of 1934: if you do register, these are your compliance provisions. You have to
report all your stuff to the securities department and give proxy statements, etc.
a. This act has all of the ongoing reporting requirements.
3. Definitions:
a. Security: unless the context otherwise requires, securities are usually notes, stock, bonds,
investments, etc. It doesnt matter what you call it, its the economic substance of the thing that
makes it a security:
i. Stock: federal courts say that if this is an interest that has at least some of the traditional
attributes of stock and it is called stock, then it is regulated. Traits include:
1. Freely transferrable;
2. Right to go up in value;
3. Voting rights tied to shares;
4. Possibility of sale;
5. No management rights;
6. Ability to pledge the interest.
ii. Promissory Notes: even though checks are considered notes, they arent securities. These
are performing long term notes or bonds.
1. Family Resemblance Test: short-term promissory notes, ordinary short term
indebtedness, personal checks, credit card transactions, and something that bears a
family resemblance to something that has never been a security will not be regulated
like one.
iii. Investment Ks: if you invest in something; the test requires:
1. An investment (why would they put $ in? to become owners?);
2. Of money or something of value;
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3. In a common enterprise (everyone pools their $ together);


4. Where you expect profits from the management efforts of others. **This is KEY**
a. If you are a passive investor, you need the protections of security laws. If you
are an active manager, you do not.
b. Most of the time when we are dealing with securities that arent stock, you
are dealing with an investment contract.
c. Basically, if you buy something with the expectation to make money, and the
profits are going to come from the work of others, its an investment contract.
iv. Looking at Partnerships and LLCs:
1. General Partners: not a security because you are managing yourself.
2. Limited Partners; no power/managerial rights, so usually it is a security and must be
registered unless the limited partner is given substantial actual authority.
3. LLC depends on member-managed or manager-managed.
a. If member-managed, not a security.
b. Damages for not complying with registering or available exemptions may result in the seller
incurring liability to the buyer for damages. Buyer may seek rescission, or it would result in
injunctions against further sales, imposition of civil penalties, or criminal penalties.
Exemptions From Registration
1. There are all kinds of exemptions for registration, and they are usually used for close corporations.
a. 3 Exempts certain kinds of securities. So, this kind of security will always be exempt.
b. 4 Exempts certain kinds of transactions. Here, a certain transaction may be exempt once, but that
doesnt necessarily mean it will be exempt the next time.
2. Intrastate Offering Exemption (3(a)(11)): Issuances where the issuer is doing business in one state, profits
come from that state, and the shares only offered to people within that state. (Transactional exemption, not a
security exemption, despite being in 3).
a. Any offer to a non-resident destroys this exemption.
b. The issuer must identify every offeree and actually prove his or her residence.
c. This only applies to the issuance. Once a security comes to rest (the original purchaser owns it for
two years), he can sell it someone outside of the state.
i. Before that, it might destroy the exemption.
d. Safe Harbor Rule: As long as all of the factors are 80% within the state, it complies with the
exemption. 80% of profits, offers, and assets have to be within the state.
3. Private Offering Exemption (4(2)): This is an exemption for a small, closely held corporation making an offer
to a limited number of knowledgeable purchasers, without advertising. (most popular exemption).
a. To qualify for this exemption, the issuance must meet these guidelines:
i. It must be a private offering.
1. If the offering was to a limited number of persons it isnt public. Originally, the
exemption required it to be offered to less than 25 people. Now, it just has to be to a
reasonably limited number of individuals. Factors to consider:
i. Number of offerees and their relationship;
ii. Number of units offered;
iii. Size of the offering; and
iv. Manner of the offering.
2. A Transaction will be considered a public offering if at the time of the transaction, it
is not public, even though the issuer subsequently decides to make a public offering or
file a registration statement.
ii. No advertising or solicitation of the issuance!
iii. Offerees must be qualified.
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1. You are appropriately qualified if you have a prior relationship with the company, you
are sophisticated or knowledgeable, or all information has been fully disclosed.
2. Sliding Scale - The more knowledgeable, the less information that needs to be
disclosed. The less knowledgeable, the more information has to be disclosed.
b. If qualified purchasers sell to unqualified purchasers, it may destroy the exemption, so many times
restrictions are placed on transferability until the shares vest.
4. Regulation D and the Limited Offering Exemptions: These provisions are safe-harbor provisions for other
exemptions.
a. Preliminary Notes: the exemption applies only to registration provisions, not to anti-fraud
requirements; reliance on a particular exemption is not a binding election; and the regulation is only
available to the issuer, not affiliates.
b. Rule 502: conditions:
i. Integration of offerings;
ii. Information requirements;
iii. Limits on the manner of offering and resale.
c. Rule 503: filing requirement to give the SEC notice that a Regulation D offering is being conducted.
d. Rule 504: 3(b) Exemption for offerings up to $1 million. Not available for large, publicly held
companies.
i. No limits on the number of purchasers, no specific affirmative disclosure requirements, and
no limits on re-sales.
e. Rule 505: 3(b) applies to offers and sales not exceeding $5 million in any 12 month period and is
limited to 35 nonaccredited purchasers.
f. Rule 506: Safe Harbor: strict compliance with all elements may not be necessary to comply with
actual exemption of section 4(2). No limit on offering size, but no more than 35 purchasers.
i. Rule 506 is the only provision that applies to section 4(2), which is federal law. This is
important because if you satisfy federal law, you also satisfy state law.
g. Rule 508: Substantial compliance is acceptable to get the exemption, but failure to observe dollar
limits or number of purchaser limits is not substantial compliance.
5. Section 4(6) Exemption: exempts offers/sales solely to one or more accredited investors if the price doesnt
exceed $5 million, no advertising/public solicitation, and the issuer files a notice.
a. Better to just rely on rule 506 because it doesnt have a dollar limit and has a 6-month safe harbor.
b. The purchasers must be worth more than $1 million and made $200,000 in previous year.
6. Regulation A: Authorizes the SEC to grant exemptions for a prospective (just used to test the market) sales
of securities not exceeding $5 million.
a. Rules: Over any 12-month period, total sales cannot exceed $5 million.
b. Rule 251(a): requires filing of an Offering Circular prior to first offer/sale.
i. Notification allows the SEC to determine if the exemption is available
ii. Offering Circular: a concise disclosure document plus unaudited financial for last two years.
c. Rule 262: Bad Boy: disqualifications for issuer that have had prior problems with securities.
d. No limitations on resale or solicitations.
7. Rule 701: Exemption for small businesses to issue securities to employees as salary and benefits.
a. Designed to meet the need for a completely separate compensation exemption that is not restricted
with respect to the number or qualifications of eligible purchasers and is not conditioned upon
delivery of expensive disclosure documentation.
b. Conditions: available to a non-public issuer offering its own securities when:
i. The issuer has a written compensation benefit plan established for its employees, directors,
officers, etc. or pursuant to a contract with the participant. Each participant must be:
1. Given the appropriate document - actually received it; and
2. The amount of securities is limited.
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a. There are a number of ways of calculating the limits (14.11), but the absolute
ceiling is $5 million.
c. Capital-raising issuances are not covered, even if they technically meet the requirements.
8. Blue Sky Exemptions: State laws regulating the sale of securities and they differ from state to state.
a. Common Exemptions: sell to 7 shareholders or up to 25 shareholders a year but you have to make a
huge filing.
b. AR Approach:
i. You can issue securities up to 7 people in connection with forming a new business;
ii. Interests in a professional association are exempt (law firm stock);
iii. If you comply with a federal exemption pursuant to 4(2), you will be exempt under AR law.
Share Transfer Restrictions:
1. Generally, shares are freely transferable unless an agreement otherwise provides. Shares can have
restrictions placed on them, but only if they are reasonable, fully disclosed, and the parties agree to them.
a. Normally, a shareholder can transfer his shares to anyone he wants, whenever he wants, without
approval of any other person.
b. Any restriction must be placed on the share itself, and must give notice to the shareholder.
c. When you sell a share, the buyer receives all interests, not just economic interest as in partnerships.
d. In close corporations, it is common that the shareholder agreement restricts free transferability.
These restrictions will be valid if they are reasonable and comply with statutory requirements.
e. Even if the articles are silent, parties are free to enter into agreements to restrict transferability.
2. Statutory Provisions:
a. 4-27-627: Restriction on Transfer of Shares/Securities:
i. Articles/bylaws may impose restrictions on share transfers. Restrictions do not affect shares
issued before the restriction was adopted unless the holders are parties to the agreement.
ii. It is valid and enforceable against the holder if the restriction is authorized.
iii. A restriction is authorized to maintain the corporations status when it is dependent on the
number or identity of its shareholders; to preserve exemptions; or any other reason.
iv. A restriction may: obligate the shareholder to first offer the corporation or other persons the
opportunity to acquire the restricted shares; obligate the corporation or others to acquire
them; require the corporation, holders of any class of shares, or another person to approve the
transfer; or prohibit the transfer of the shares if not unreasonable.
3. Three Common Restrictions:
a. Right of First Refusal: The shareholder agreement states that, before you offer your shares to
someone else, you must offer the same deal to the existing shareholders.
i. Courts construe these very narrowly, so they will only apply them to the strict reading of the
agreement.
ii. Time Issues: how much time do they get to act? When drafting, you should include the time
frame for how long they will get before they can sell to another.
iii. This is to prevent dilution. If the corporation is willing to pay the same price as the
prospective buyer, then it is reasonable.
b. First Option: Before you sell your shares, you must offer them back to the corporation upon the
occurrence of a specified event or at a previously agreed, specified price.
i. The price you receive from the corporation is independent of the deal you would be offering
any other buyer. What you can get elsewhere is irrelevant.
ii. There are three methods of calculating the price at which the shares are to be sold:
1. Fair Market Value: no such thing in closely held corporations. This can provide
arbitration mechanisms, formulas, or bases for the court to determine what this is.
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2. Book Value: creates lots of arguments that some thought this meant FMV and
judges will buy that argument, so you need to specify what book value means in the
agreement/articles.
3. Specified Value: Provide in the bylaws that the directors will set a value at the
annual meeting.
iii. Reasonableness Test: were the terms, at the time of entering into the agreement, reasonable
and did you understand what you were getting into.
1. So, if the parties enter into an agreement where the shares have to be resold at the
price they were purchased, it doesnt matter that the shares triple in value, because
the restriction was reasonable at the time they agreed to it.
2. Changes in value are not enough for a restriction to be unreasonable.
c. Consent Restraint: Before you sell your shares, you must get the other shareholder/directors to agree.
i. Modern rules look at the reasonableness of all three restraints, and absent some external
public policy consideration, most of the agreements are upheld.
4. Issues to recognize when drafting: there are lots of issues when the restrictions arent drafted properly in the
agreements/articles/bylaws.
a. Application to transfers such as gifts, bankruptcy, intestate, and divorce.
b. Notice - You should always specify how much notice is needed and in what manner if you have one of
these restrictions.
c. Price in a First Option Agreement
d. Partial Acceptance - You should also specify what happens when half of the shareholders agree to
buy them back and the other half dont.

Chapter 15: Shareholder Derivative Suits:


Nature of Derivative Suit
1. Generally, when there is a harm done to the corporation the people who normally decide to sue (directors) for
the harm dont sue because they would end up suing themselves. So, a shareholder can bring one in a
derivative action on behalf of other shareholders for the harm, if he has standing to bring the suit.
a. The courts have to balance two competing theories when dealing with derivative suits:
i. The shareholders interest in receiving protection from the misconduct of the directors.
ii. The corporations interest in avoiding strike suits and unnecessary litigation.
1. Strike suits - The only purpose is to waste the corporations assets/time in order to
receive a settlement.
2. States and courts have created hurdles in order to discourage people from filing
frivolous derivative actions (filing fees, pay for attorney fees if it was unreasonable).
b. It is important to first figure out whether the action was a derivative or direct action.
2. Statutory Provisions:
a. 4-27-740: Procedures in Derivative Suits:
i. A person cant bring a derivative suit unless he was a shareholder when the transaction
occurred, or received ownership by operation of law from someone who was a shareholder at
that time.
ii. A complaint must allege with particularity the demand made to the board and state either
that the demand was refused or why he didnt make demand. If the corporation initiates an
investigation of the charges, a court may stay the suit until the investigation is over.
iii. A proceeding may not be settled or discontinued without court approval.
iv. A court may require the plaintiff to pay any defendants reasonable expenses (attorney fees)
incurred in defending the suit if it finds that it was commenced without reasonable cause.
b. FRCP Rule 23.1: (This works for an LLC or LLP as well as a corporation).
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i. Test: brought to enforce a right of the corporation. Must be the kind of claim where there is
harm to the corporation and it could have brought it. Requirements include:
1. Complaint must be verified (notarized where the plaintiff signs under penalty of
perjury that everything he alleges is true)
2. Plaintiff must be a shareholder at the time of the transaction
3. Action is collusive
4. If a class, it is represented by the plaintiff fairly; and
5. The action must be brought as a right of a corporation.
3. Derivative v. Direct: In order for the cause of action to be brought in a derivative suit, the harm alleged
must have occurred to the individual in his capacity as a shareholder, not in his personal capacity.
a. The harm must have occurred to the corporation, and not to the person. An action that occurs to the
shareholder in his personal capacity is a direct action, and cannot be maintained as a derivative suit.
b. Derivative v. Direct Suits:
i. Derivative Actions Include:
1. Suits to recover improper dividends.
2. Suits to recover damages against outside third parties.
3. Suits to recover from directors and officers for breach of fiduciary duty.
ii. Direct Actions Include:
1. Suits for breach of a contract entered into with that shareholder.
2. Suits to compel investigation of corporate records to that shareholder.
3. Suits for the enforcement of voting rights.
a. If a corporation takes away the voting rights of all shareholders, this is a
direct action because there is no harm to the corporation, itself.
c. Just because a harm applies to many shareholders does not mean its derivative. There can be a class
action direct suit against the corporation.
d. You should try to classify the action as direct, in order to avoid the demand requirements.
4. AR Case Law: a derivative suit must be undertaken on behalf of the corporation. If the harm occurred to the
corporation, then it will be derivative.
a. If the harm is done to both the individual and the corporation, a shareholder may sue directly.
b. Other courts narrowly defined direct suits stating that: individual, direct, suits are permitted only if
the wrongdoer owes a special duty to the shareholder or he has suffered a distinct injury.
c. Arkansas tends to use the Who was harmed test first, and the Could the company have brought
the suit test if thats not dispositive. Arkansas courts look to the following factors:
i. Was the corporation harmed?
ii. Who is going to benefit from the remedy?
iii. Could the corporation have brought the suit on its own?
5. Internal Affairs Doctrine: the laws of the state that the corporation was incorporated apply to the case, not
necessarily the state in which the case was brought (if in federal court).
a. This is almost always going to be Delaware.
Standing to Bring a Derivative Action
1. Only shareholders are entitled to bring suits on the corporations behalf. Generally, this includes all
beneficial owners, unregistered holders, holders of a voting trust, etc.
a. Some states define a shareholder as: the shareholder of record and the beneficial owner of the shares.
The trustee then can bring them if they are the legal owner of the voting trust.
b. Shareholders of a holding company or parent corporation that own a majority of the shares of the
subsidiary can bring suit if there are no other shareholders to bring it. (Usually, the parent must own
abut 75% of the subsidiary to be essentially controlled)
i. This is called a shareholder in interest.
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2. Contemporaneous and Continuing Ownership: Shareholders must bring suit at the correct time:
a. The shareholder must have owned his shares at the time the harm took place. Also, the shareholder
that brings the suit must own at least one share throughout the suit until the final judgment.
i. Once judgment is entered, he can sell his shares. He doesnt have to wait for the enforcement
of the judgment.
b. Exceptions to Contemporaneous requirement:
i. Operation by Law: if the shareholder acquired the shares through inheritance, divorce,
bankruptcy, or some other way by law, he can bring a derivative suit.
ii. Continuing Harm Exception: if the incident occurred before you were a shareholder but it
continues to harm the corporation, the shareholder can bring suit.
1. If a company entered into a shitty, 10 year contract, and you buy shares in year 2 of
the contract, you can bring the action because you will be harmed in the next 8 years.
iii. Exception: if the statute negates the contemporaneous requirement (34 Act).
3. No Personal Defenses: Unclean Hands: if a shareholder owns a share in the correct corporation at the
correct time, he may be precluded from bringing suit if he knew that something was wrong.
a. This is an equitable doctrine and includes the following:
i. Unclean hands;
ii. Waiver;
iii. Estoppel; and
iv. Laches
b. Tainted Share Rule: someone that has unclean hands with his shares and then sells them to
someone who didnt permit in the wrong can still not bring a derivative action because the shares are
tainted. (Majority rule).
4. Requirement of Being Representative: (AR does not have this requirement, but Federal Rule 23.1 does).
a. The shareholder/plaintiff must fairly and adequately represent the rest of the shareholders in
correcting the harm. He must have the capability and resources to represent them.
b. If a shareholder is found to have a relationship with one of the defendants and it hints as being
elusive, or if a law firm drummed up a suit (collusion), the court will probably say there is not
adequate representation.
i. Courts will presume that anyone willing to be the representative meets these standards
unless there is a challenge. Even with a challenge, there must be strong evidence.
c. The shareholders dont have to agree with the suit being brought in order for the person to represent
their interest. Just because the other shareholders consent to the wrongdoing, doesnt mean their
interests are being represented.
5. Corporation as an Indispensable Party: Generally, a corporation must be joined as a party.
a. There is no way to force them to be a plaintiff, so procedurally; you will join them as a defendant,
even if they are the ones that actually benefit.
Recovery in Derivative Litigation:
1. Generally, recovery in derivative suits belongs to the corporation and is ordered to be in the full amount
necessary to recoup the harm suffered by the corporation.
a. Modern suits show that a pro-rata recovery limited to the innocent shareholders would be more
appropriate (since the directors who were wrong may actually get a cut out of the remedy).
b. Most courts say, however, the mere fact that the wrongdoer, as a substantial shareholder, will
indirectly benefit from the award to the corporation doesnt mean that the recovery should be given
directly to the corporation, and not a pro rata share to the shareholders.
i. Usually, pro rata will only be given when there has been a windfall.
Demand on Directors:
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1. Requirement of Demand:
a. Historically, shareholders must make the written demand on the board of directors and the
shareholders, containing the complaint and specific problem, and asking for relief.
i. Today, most statutes only require demand to be made on the board of directors.
ii. Complaint must allege with particularity your demand efforts and why demand didnt work.
iii. Demand is excused if it is considered to be futile.
b. Consequences of not making Demand: if you dont make demand and the court later determines that
you should have, your suit will be dismissed because you dont have standing to bring the suit.
c. Consequences of Making Demand: If you make demand, you have admitted that demand was
required and that it wasnt futile.
i. Basically, if you make a demand, you are conceding that the directors acted appropriately
under the business judgment rule.
ii. This includes making decisions without being reasonably informed, disinterested directors,
conflicts of interest, etc. So, if any of these are your basis for the derivative suit, you better be
really sure of your claims.
1. If the court decides that you dont have enough particularized facts that the business
judgment rule wasnt complied with, your case will be dismissed. Then you have to
make a demand, which they deny, and now you have admitted they were protected.
2. Extremely high burden to satisfy. (Think of the Disney case).
iii. Also, you tip off the other side so they may destroy evidence, run away with money, develop
their defenses, and slow things down.
2. Demand Futility: Demand is excused when it is futile. The issue is always: when is demand futile?
a. Rationale: if you have a cause of action based on illegal bad faith conduct by the directors, you
wouldnt bother making demand on the wrongdoers.
b. Must Allege: particularized facts that create a reasonable doubt that the board is independent or
that the directors violated the business judgment rule.
i. This is a very high burden to satisfy.
c. Delaware: If the plaintiff sets forth particularized facts that create a reasonable doubt as to whether
the directors did not have a conflict of interest, or that the business judgment rule would not protect
their actions, demand is excused.
i. If there was a conflict of interest, or otherwise, even if there was no conflict, but you could
show that the BJR wouldnt protect the directors with some other problem including:
1. Failed to be adequately informed;
2. Illegal conduct;
3. Irrational conduct;
4. Nothing in good faith;
5. Anything to prove the BJR.
ii. The business judgment rule is presumed to protect these types of decisions.
d. New York Law: Demand is excused as futile if:
i. A majority of the directors are interested (board is so controlled and dominated that they are
no longer disinterested directors);
ii. Failure to inform themselves (there was a lack of reasonably necessary investigation under
the circumstances) ; or
iii. Directors failed to exercise business judgment by either sitting back and doing nothing, or
bad faith.
e. Demand may also be excused if it were an emergency (narrow):
i. The statute of limitations is about to run, and there was a valid reason for missing it;
ii. To prevent additional irreparable harm; or
iii. Jurisdiction: the person to be sued is about to leave the country.
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3. Universal Demand: A shareholder that brings a derivative suit must make demand on the directors, no
matter what.
a. This is a growing trend, but it definitely the minority rule.
b. Courts like this rule because it is much easier to apply.
c. Exception: When the requirement of demand will cause irreparable hardship, such as insufficient
time before the statute of limitations will run, demand is excused.
Committee Recommendations to Dismiss:
1. After a derivative suit is filed, there will often be a committee of disinterested directors to investigate and
decide if the lawsuit should go forward (usually it will recommend dismissal).
a. Then the corporations attorney will take the committees recommendation and use it as a basis for
the motion to dismiss stating that the lawsuit isnt a good idea and why.
b. The issue here is how much weight should the court give the committees recommendation?
2. There are two approaches (split by jurisdictions):
a. Business Judgment Rule Only: if all of the elements are met we will listen to the committees
judgment and dismiss the suit.
b. Business Judgment + Courts Independent Analysis: a board decision to cause the suit to be
dismissed as it is detrimental to the company, after demand was made and refused, will be respected
unless it is wrong. This will be judged by a two step process:
i. Inquire into the independence and good faith of the committee and its basis for its
conclusion, and whether the decision was protected by the business judgment rule.
1. Was the committee disinterested?
2. Reasonably informed?
3. Act in Bad-Faith?
4. Did they reasonably believe it to be in the best interest of the company?
ii. Then, under the trial judges discretion, inquire to determine whether:
1. The committee is not independent;
2. The committee has not shown any reasonable basis for its conclusion; or
3. Court has any other reason it isnt satisfied.
iii. THEN, the motion to dismiss will be denied.
Settlement and Attorneys Fees:
1. Settlement requires judicial approval.
a. Purpose: to prevent collusive settlements where the individual plaintiff is bought off.
b. Court will determine if there was enough discovery to know what they were doing and whether both
parties were reasonably sure of how to go about this type of suit.
c. If no one objects, however, the court will pretty much approve it.
2. Notice of a Settlement:
a. AR Standards: if settlement is going to affect another shareholder, you have to notify them and they
have a chance to object to the settlement.
b. Federal Standards: the court must approve the actions and notice must be given to all shareholders.
c. Notice: most courts require that notice be given to all shareholders, but some courts dont make it
easy for a shareholder to object to the proceeding.

Chapter 16: Indemnification and Insurance:


1. Statutory Provisions:
a. 4-27-850: Any person who is a party to a lawsuit because of his capacity as a director, officer,
employee, or agent of the corporation can receive indemnification for attorney fees, costs, judgments,
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2.

3.

4.

5.

6.

and fines that are reasonable and actually incurred, if he acted in good-faith and in a manner that he
reasonably believed to be in the interest of, or not oppose to the best interests of the company.
i. (a): deals with direct causes of actions.
ii. (b): deals with derivative causes of action. These claims are in different subsections because
derivative suits are subject to court approval.
iii. (c): if you are successful on the merits, you shall get indemnification against actual and
reasonably incurred expenses in connection with the lawsuit.
iv. For criminal suits brought against the person, he must have reasonably believed that his
actions were not criminal in order to receive indemnification.
Indemnification: a promise that if a director has any expenses in litigating civil or criminal actions, they will
be reimbursed.
a. Directors, officers, employees, and agents can receive indemnification in any suit where they are sued
as their capacity relating to the corporation, including:
i. Where a director is sued for committing a tort during the scope of his employment.
ii. Suits brought by shareholders, employees, etc. who are unhappy with a particular decision.
iii. Derivative suits.
b. Directors & Officers Insurance steps in to make sure there are funds available to indemnify.
c. Almost any cost reasonably incurred can be indemnified, but:
i. Bad faith costs,
ii. Unlawful criminal actions, or
iii. Possibly gross negligence, recklessness, and anything intentional.
d. People wouldnt agree to serve as directors if the corporation didnt indemnify them.
Process: If a person is seeking indemnification, the expense must have actually and reasonably incurred. The
process works in three steps:
a. The person must make a request to the company to be indemnified.
b. If the court says it is permissible, then there are three ways to get indemnification:
i. A majority quorum of the board of disinterested directors (those who werent a party to the
action) vote to allow it;
ii. Independent, disinterested legal counsel can give an opinion with standards in a written
opinion of why he should get indemnification;
1. If the attorney issues an opinion that is wrong, he can be liable for damages.
iii. After full disclosure, a majority of the stockholders will allow indemnification for a director.
Involuntary Indemnification: If the officer, director, employee, or agent is sued and is successful on the merits
of the case, the corporation must give him indemnification.
a. This is mandatory and cannot be changed by the articles.
b. If you are dismissed from the suit, you are considered to be successful on the merits.
Traditional, American Law: you bear your own costs for litigation and if you get sued as a director you have
to pay for it out of your own pocket.
a. Statutory Changes: in derivative suits (only regarding K cases in AR), the court may get either party
an award of attorneys fees.
b. Purpose: we want good people to be directors, thus we want to indemnify them, especially if they
didnt do anything wrongful.
The operating agreement can provide additional ways in order to give the officers or directors
indemnification.
a. But, you cant have contradicting rights. You cannot get rid of the requirements of good-faith.

Chapter 17: Dissolution and Termination of the Corporation:


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Terminology: when you are talking about dissolution you are talking about the process of termination/dissolution,
not the withdrawal of shareholders or directors from the enterprise. This is the first step in the winding up process.
Even after dissolution, a corporation continues to exist. A corporation is dissolved when the statutory requirements
are met, they liquidate assets, pay off debts, and distribute excess to owners.
1. Statutory Provisions:
a. 4-27-1402: A corporations board may propose dissolution to the shareholders and reasons why. Then
if the shareholders give a majority vote at the shareholder meeting, it will be approved.
b. 4-27-1403: At any time after dissolution is authorized, the corporation may dissolve by filing articles
of dissolution with a bunch of facts in them.
c. 4-27-1404: A corporation may revoke the dissolution within 120 days and must be authorized in the
same manner as dissolution was authorized. (Must state a bunch of facts as well).
d. 4-27-1405: A dissolved corporation continues its corporate existence but may not carry on business
except to wind up and liquidate all its assets.
e. 4-27-1406: A dissolved corporation may dispose of known claims by notifying the claimants in writing
of the dissolution with a deadline of 120 days to file a claim or it will be barred. It is barred if the
claimant doesnt file within that time, or if the company rejects the claim, the claimant doesnt file
suit within 90 days after that rejection.
f. 4-27-1407: A dissolved corporation may publish notice of the dissolution and request that unknown
creditors present them with notice. It must be published in a general circulation newspaper in the
area of the corporation and describe the information to send in a claim as well as the fact that they
have a 5 year statute of limitations to get the claim in before they are barred. It may be enforced
against the dissolved corporation, or the assets that were liquidated and given to shareholders.
g. 4-27-1420 - 1423: These statutes deal with Secretary of States ability to administratively dissolve a
corporation if it doesnt pay taxes, delivers annual franchise report, corp. is without registered agent,
period of existence has passed, etc. and the procedures for reinstatement.
h. 4-27-1430: Circuit court may dissolve a corporation if:
i. In a proceeding with the AG, it is established that:
1. The corporation used fraud in its articles; or
2. The corporation exceeded/abused its authority by law.
ii. In a proceeding with a shareholder, if it is established that:
1. Directors are deadlocked in the management and shareholders are unable to break it
causing irreparable injury to the corporation and business affairs cant be conducted
anymore.
2. Directors have acted or will act in an illegal, oppressive, or fraudulent manner.
3. Shareholders are deadlocked on picking directors and for 2 consecutive meeting dates
they have been unsuccessful in electing directors; or
4. Corporate assets are misapplied or wasted.
iii. In a proceeding against a creditor, if it is established that: The creditors claim has been
reduced to judgment, returned unsatisfied and the corporation is insolvent; or
iv. In a proceeding by the corporation to have its voluntary dissolution continued under court
supervision.
i. 4-27-1431: Venue lies in Pulaski County. It is not necessary to make shareholders a party to dissolve
a corporation.
j. 4-27-1433: After dissolution exists, the court may enter a decree dissolving the corporation and
specifying the effective date of dissolution to be filed with the Secretary. After entering this decree,
the court can wind up and liquidate for the corporation.
Dissolution Before Shares are Issued or Business Started:
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1. 4-27-1401: A majority of incorporators or directors that hasnt issued shares or commenced business may
dissolve by filing articles of dissolution including the name, date, and some other facts.
2. If you accidentally form a corporation and you dont want to do anything with it, you can dissolve it quickly
without having a directors meeting or anything.
3. Articles of Dissolution: state the name and date of the corporation when it was incorporated and an
affirmative statement that there are no shares or debts or liabilities and a majority of the incorporators have
voted to dissolve.
Ordinary Dissolution (4-27-1402 & 1403)
1. Voting and Procedures: The corporations directors must meet and get a majority vote to propose dissolution
to the shareholders.
a. Then, shareholders, after properly being disclosed, get to vote to approve it. (Thus shareholders
cannot themselves dissolve). Usually requires a majority, but can be changed in articles.
b. Then, appropriate officials are authorized to prepare and file articles of dissolution and commence
wind up. Once filed, the corporation is dissolved.
2. Articles of Dissolution must include the following information:
a. The name of the corporation
b. Date of dissolution
c. Voting information - If approved by shareholders, it must include the number of votes entitled to be
cast to approve the vote, and either the total number of votes cast for and against it, or the total
number of votes approving dissolution and a statement that the number was sufficient.
i. Once the articles are filed, the business continues to exist, but can only engage in business
that is appropriate to wind up the company. (4-27-1405 deals with what they can do).
3. Creditors: There are two types of creditors:
a. Known Creditors: send them notice of dissolution and ask for a bill within 120 days. If they dont
send it the claim is barred. If the claim is sent, the corporation has 90 days to pay it or deny it. If
they refuse to pay, the creditors have 90 days to file claim in court otherwise it is barred forever.
i. This is optional, but every corporation should do it in order to receive the protections.
b. Unknown Creditors: you file your articles of dissolution and publish notice in the newspaper noting
that there is a 5-year statute of limitations and where to make a claim. If they come and you are
already dissolved, they can take any liquidated assets from the shareholders that were given as part
of the winding up process.
i. Again, you dont have to do this, but if you dont, you have an unlimited statute of limitations.
If you dont do this, and you pay out to the shareholders, the creditor can come in and sue all
of the shareholders.
Administrative Dissolution: when a state comes in and administratively revokes the corporations charter for failure
to pay taxes or failure to maintain an agent for 60 or more days.
1. Secretary will give notice to the corporation saying it has grounds for dissolution.
2. Corporation has 60 days to comply, but if they dont the Secretary can file a certificate of dissolution.
3. Potential Liability: not good.
a. If the articles are revoked, and you continue to act, you are probably liable for:
i. Acting on behalf of a corporation you know doesnt exist;
ii. Breach of Implied warranty of authority
iii. Acting on behalf a partially disclosed principal
iv. Partnership law.
4. Because of the severity of liability that was presented by this type of dissolution, you have 2 years from the
actual dissolution to be retroactively reinstated.
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a. Reinstatement acts as if dissolution never occurred. If its after 2 years, the corporation is done, it can
never come back.
b. You have to file a request with the Secretary of State. Info is on page 17.4 and comes from 4-27-1422.
c. If you dont make it within 2 years you lose and have to file a new corporation.
d. Can still argue corporation by estoppel, but that sucks.
Judicial Dissolution:
1. Happens Usually When:
a. Directors refuse to dissolve; or
b. Majority is violating the rights of the minority; or
c. There is a continued misappropriation of funds or waste.
2. Categories of Persons who May Sue for a judicial dissolution:
a. State Attorney General: never happens, but the attorney general can shut it down if the articles were
procured through fraud or there are continual illegalities with the corporation.
b. Creditors: almost never done because it is a waste of time. A creditor who has a judgment by the
corporation and hasnt been paid can go and attempt to dissolve the corporation. If this happened,
the corporation would just file for bankruptcy.
c. Shareholders: LOTS of litigation here (4-27-1430).
i. If there is a deadlock between either shareholders voting on directors, or between directors
and the deadlock prevents the corporation from continuing business;
ii. If there is illegal, oppressive, or fraudulent behavior from the directors.
iii. Voting deadlock to elect directors for 2 consecutive annual meetings;
iv. Corporate assets are being misapplied or wasted.
1. Irreconcilable differences even among an evenly divided board of directors dont
always mandate dissolution.
2. Standard of Behavior: control shareholders will not thwart the expectation of the
minority (this is what oppressive conduct is). Control shareholders will also not
freeze out the minority.
a. Both of these are taken from fiduciary duties.
3. Statutes do little for close corporation because there is no open market for their shares. Freeze out is a
problem for them and thus this claim for relief is what shareholders can do.
a. The minority shareholder cannot petition for dissolution, so his only hope is a judicial dissolution.

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