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2. Tax Treatment:
Tax treatment is a federal income tax law.
The bad news about the sole proprietorship is that the owner is personally
liable for all of the businesss debts and obligations. This is because there is no
legal separation between the sole proprietorship and the sole proprietor.
Two or more partners who start a business without being required to file with
the state.
In terms of liability, the general rule is that partners in a partnership are jointly
and severally liable for the debts and obligations of the partnership. It is worth
pausing here to consider how serious joint and several liability is for
defendants. If defendants are jointly and severally liable for a claim, the
creditor may recover the full amount owed from any single defendant.
o Limited Partnership (LP): limited liability for limited partners, who invest into
the entity they are passive investors, and if there are big liabilities within the
partnership, the limited partners will lose their investment but they wont have to
be individually liable.
LPs are similar to general partnerships in that they have flow-through tax
treatment. But in an LP there are two different types of partners:
General Partners, and
Limited Partners
Typically in an LP there must be at least one general partner (or perhaps a few)
and several limited partners.
The advantage of being a general partner is control:
o Except to the extent otherwise provided in the limited partnership
agreement, the general partner has full decision-making authority over
the LP.
In the real world, a partner itself can be another business entity, so what
ends up happening is that the general partner is an entity with limited
liability.
o Limited certain members wont have to pay the business debt
Generally, the law of the state where the entity is formed will govern the
internal affairs of the entity, that is, the relations between the owners of the
entity and the managers of the entity.
EX: assume that a corporationis incorporated under Delaware lawbut is
physically located in anddoes all of its business in Texas. Delaware law will
control itscorporate governance, as well asany disputes between the
corporations shareholders, directors and officers. Thus, if the shareholders
sue the directors claiming that the directors breached the fiduciary duties
that they owe to the corporation, then Delaware law will apply in that
lawsuit. One does not have to litigate the matter in a Delaware court, but
the court in which the lawsuit is filed must apply Delaware law to the case.
o The rules for how a business entity is governed, and for resolving disputes
between the businesss owners and its managers, are found in the law where the
business is incorporated or organized, not where it is physically located.
Many US corporations are organized in Delaware because it has the most
developed case law in business law, so it dominates with publicly traded
companies.
External affairs are governed by the state in which the company operates (FL,
not Delaware), because a third-party is involved.
Balance Sheet & Income Statement:
Balance Sheet:
o Statement of assets and liabilities
o Purpose is to show the financial condition of a business as of the date of the
statement.
o Assets Liabilities = Owners Equity
o Assets = Liabilities + Owners Equity
Income Statement:
o Statement covering a period of time.
o Purpose is to give a summary of earnings between balance sheet dates.
A and B Partnership Company Balance Sheet
Assets
Liabilities & Equities
Cash
$5,000
Note
$5,000
Property
$2,000
Inventory
$1,000
+ Equities
$5,000
Machinery
$2,000
$10,000
$10,000
Assets
$10,000
Liabilities
$5,000
Liabilities
$5,000
+ Owners Equity $5,000
Equity
$5,000
Assets
$10,000
Income Statement Following the First Month of Business
Sales
Expenses
Profit
$3,000
Cost of Goods Sold
$1,000
$1,000
+ General Expenses
$1,000
Total Expenses $2,000
New Balance Sheet Giving Effect to the $1,000 Profit
Assets
Liabilities & Equities
Cash
$6,000
Liabilities
$5,000
Property
$2,000
Inventory $1,000
+ Equities
$6,000
Machinery $2,000
$11,000
$11,000
Assets (cash) have gone up by $1,000 because of the $1,000 profit
Total assets have gone up to $11,000, liabilities have stayed the same, so owners
equity must go up to $6,000 to balance the two sides.
Assets
Cash
$8,000
Property
$2,000
Inventory $1,000
Machinery $2,000
+ Equities
$6,000
$13,000
$13,000
Borrowing $2,000 increases our assets (cash) by $2,000
Liabilities also go up by $2,000 owners equity stays the same
Assets
Cash
$6,000
Property
$2,000
Inventory $1,000
Machinery $2,000
+ Equities
$4,000
$11,000
$11,000
Cash goes down to $6,000 liabilities are the same, so owners equity must decrease
by $2,000
Agency Law
An agent has implied actual authority when the principal does not
expressly confer authority but the principals words or conduct,
reasonably interpreted, causes the agent to believe that he has authority.
the context, including circumstances of which the agent has notice and the
agent's fiduciary duty to the principal.
An agent has apparent authority in dealing with a third person when the
principals words or conduct, reasonably interpreted, causes the third person
to believe that the agent has authority.
An agent may have apparent authority to act even though as between himself
and the principal, such authority has not been granted.
Agency law involves the relationship between at least two, but usually
three, persons:
o The principal, which is the person on whose behalf work or some task is being
done;
o The agent, which is the person doing the work or performing the task; and
o The third party, which is the person with whom the agent deals on behalf of the
principal.
Strictly speaking, only the first two categories involve a true agency
relationship (and even apparent authority may be held by a person who is
not an agent).
o In other words, a principal may be estopped from denying liability resulting from
the acts of a person who was technically not her agent.
o Similarly, a principal may ratify the unauthorized actions of a non-agent (or an
agent), in which case the actions will be treated as if they had been authorized.
Problem 2-1: Your wealthy uncle recently died. In his will, he established a
testamentary trust for your benefit and funded it with $1 million. The will directs the
trustee of the trust to prudently invest this money on your behalf, to use it to pay
your educational expenses and, when you have completed your education or
reached the age of 30 (whichever occurs first), distribute any remaining amounts to
you. Big National Bank was designated as the trustee of this trust and has accepted
this position. You are currently in law school and are 24 years old. Is Big National
Bank your agent?
o This is a fiduciary relationship, but the element of control is lacking.
o A beneficiary is not a principal the beneficiary has no control over the bank as
an agent
o This is a trust relationship, not an agency relationship.
Problem 2-2: John is an adult who suffers from mental delusions, which greatly
worries his relatives. Johns father, Bill, petitioned the probate court to have a
guardian and conservator appointed for John. The court appointed Bill as Johns
guardian and conservator. Is Bill an agent for John?
o Not an agency relationship.
o This is a Guardian & Ward relationship.
o This is not a principal-agent relationship. The ward cannot be in control of the
guardian.
o So, not all fiduciary relationships are agency relationships.
Problem 2-4: ABC Catering hired Jessica as an office manager. Is Jessica an agent
for ABC Catering?
o Yes an office manager is an agent of the employee.
Employment relationships are a subset of agency relationships. All
employment relationships are agency relationships but not all agency
relationships are employment relationships.
An employee has a fiduciary responsibility to the employer.
The employee, by agreeing to work there, is agreeing to be subject to the
control of the company.
This doesnt mean that all employees have a lot of authority, but they are still
agents of the employer.
Problem 2-5: Yesterday, your roommate mentioned that she was going to go to the
hardware store today. Before you left the apartment this morning, you put a note and
a $10 bill on the kitchen table. The note said: Use this money to buy me a good
screwdriver. After she awoke and read the note, your roommate took the money and
went to the hardware store. Is your roommate your agent? If so, for what purpose?
Does it matter that she is not being paid for her actions?
o Yes, by taking the $10 the roommate is under the control of the other
roommate.
o The fact that she wasn't compensated does not take away the agency relationship
it is gratuitous.
o By taking the note and the money, the agent has accepted to be subject to the
principals control.
Problem 2-6: Johann was planning to sell his car, but didnt get around to doing so
before he left for a vacation in the Bahamas. Before he left, Johann asked his friend
Rhonda if she would be willing (for a $100 fee) to help him sell his car. Rhonda
nodded her head, and Johann handed her the keys to his car, telling her that she
should negotiate the best price she could, but not less than $8,000. When Rhonda
went to pick up the car from Johanns house, she discovered it was covered with mud
and full of fast food wrappers and other garbage. Thus, Rhonda decided to take the
car to the car wash, where she got the super wash, which cost $15. Instead of
paying the $15, Rhonda convinced the car wash to bill Johann for it upon his return
from vacation. Rhonda also decided that the car would look nicer with flames painted
on its sides. Thus, Rhonda agreed with Tom, the owner of Local Auto Garage and
Detailing, that he would paint flames on the car, at a cost of $1,000. Rhonda gave
Tom a $50 deposit and told him that Johann would pay the rest of the bill. Tom
agreed to paint the flames by the next week. Under the theory of actual authority, is
Johann obligated to pay for the car wash? Is he obligated to pay for the painted
flames? (If not, what happens to the $50 deposit?)
o Agency relationship created (manifestation is head nod, taking keys, etc.)
o Johann is the principal and Rhonda is the agent with respect to selling this car for
no less than $8,000.
o Johann is obligated to pay for the car wash because he impliedly authorized
Rhonda to clean it
o Actual express authority is to sell the car, but its implied that the car needs to be
made suitable for sale.
o Adding the flames to the car was not reasonably implied as necessary to achieve
Johanns goal.
o Assuming there was no apparent authority, Johann is not obligated to pay for the
flames unless he later ratifies the act.
o Problem 2-8: Does your answer to Problem 2-7 change if the purchase price had
been $1.1 million rather than $875,000?
Yes, because the actual express authority was to buy the kite for no more than
$1 million.
Purchasing the kite for $1.1 million means Pam is acting outside her express
authority.
There are no facts that indicate the presence of apparent authority.
o If Maynard does not ratify the $1.1 million purchase, Suzanne cannot
look to Maynard to pay for the kite. Suzannes only course of action
would be against Pam.
o Problem 2-9: Does your answer to Problem 2-7 change if Pam had told Suzanne
that she wanted to buy the kite for herself rather than on behalf of a wealthy
friend?
No this would be an undisclosed principle, and assuming that the purchase
price was under $1 million the purchase would be expressly authorized.
o Problem 2-10: Recall Johann and Rhonda from Problem 2-6 above. Assume that
Rhondas friend Samantha was present when Johann asked Rhonda to help him
sell his car and handed her the keys. A few days later, however, Johann called
Rhonda from the Bahamas and told her that he had changed his mind and that
she should not sell the car. Nonetheless, when Samantha asked Rhonda later that
day whether the car was still for sale, Rhonda said yes. Samantha then offered
Rhonda $8,000 for the car, and Rhonda accepted her offer. Is Johann obligated to
sell the car to Samantha? If so, is Rhonda liable to Johann? See Section 8.09 of
the Restatement.
Rhonda did not have actual authority to sell the car because Johann revoked
the authority.
There could be a case for apparent authority and that would bind Johann to sell
the car to Samantha.
If Johann must sell the car to Samantha, then Rhonda could be liable to Johann
for breach of her fiduciary duty.
No. The identity of the principal does not have to be known to the third party in
order to enter into a binding contract. This would be an undisclosed principal.
Assuming the purchase price was $875,000, this would be expressly authorized
and would be binding on M and S.
Why use an undisclosed principal?
o Real estate, if youre trying to acquire several properties at one time and
dont want people to hold out on selling their property because of an
increase in property values (say the purchaser was Disney)
o Problem 2-11: ABC Caterers hired Sam to work as an office assistant, answering
the telephone and performing other clerical tasks. One day, while Sam was alone
at the office, Maggie walked in and said that she needed a caterer for her
wedding, which was to take place two days later. (Maggies prior caterer had
suddenly gone out of business.) She then proceeded to explain to Sam the very
elaborate menu that was needed. Sam told Maggie that ABC Caterers would be
happy to cater her wedding and they each signed ABCs standard contract,
which Sam retrieved from a drawer in his desk. Is ABC Caterers obligated to cater
Maggies wedding?
Assuming Sam had no actual authority, did he have the apparent authority to
do this?
Sam was alone in the office, the sign on the door said ABC Catering, Sam
had access to the contracts leads to reasonable belief that there was
apparent authority.
o BUT, it was an elaborate menu, to be done two days later was this the
kind of thing that ABC normally did?
Could Maggie have reasonably believed that Sam had the authority to enter
into this contract?
This issue is more important than the final conclusion (can be argued either
way)
o Problem 2-12: Would your answer change if the owner of ABC Catering had
explicitly forbidden Sam from agreeing to catering contracts, but Maggie didn't
know that? What if Maggie knew that?
Apparent authority can be created without there being any actual authority, so
it doesnt matter that Sam had been forbidden. What matters is what Maggie
could reasonably believe.
If M knew that S had been forbidden, there is no apparent authority (if the third
party knows the actor has no authority, he cannot reasonably believe that
there was authority)
o Problem 2-13: International Conglomo Inc. (ICI) is a very large, multi-national
corporation. The President of ICI, Wendy Wilson, has negotiated for ICI to obtain a
$2 million loan from Big National Bank. Big National Bank has agreed to make the
loan. Does Wendy have authority to sign the loan agreement on behalf of ICI? If
you were legal counsel to the bank, what would you do? Would your answer
change if ICI were a very small company?
President could have authority to do such a thing in his job description, in the
corporate bylaws.
In corporate law, authority is generated from BOD, in bylaws, in contract,
etc.
The bank must ask for resolutions from the Board of Directors showing that W
has actual authority to enter into this contract, because the risk the bank runs
is assuming that the President has the authority to do something that it does
not have the power to do. Relying on apparent authority can be problematic.
If its a multi-national corporation, it might be reasonable to believe that the
corporation has the power to sign a $2mil contract. But if it were a smaller
company, there is no such reasonable expectation.
o Problem 2-14: Section 2.03 of the Restatement refers to apparent authority as a
power held by an agent. Is there a difference between a power and a right? Again,
consider Section 8.09 of the Restatement.
Power: our agent will be able to bind the principal without having the right to
do so, meaning that if the agent has apparent authority, it has the power to
bind the principal to the contract, but if it is not in right to do that, it has
breached a fiduciary duty to the principal
The risk from the third partys perspective is that the principal may not ratify.
In order to ratify, the principal must know the material facts of the contract.
o Must know what they are ratifying.
Problem 2-20: Casey Counselor recently graduated from law school and joined a
large law firm. Around the same time, she bought a house. Because she had very
few items of furniture and was too busy to buy more, Caseys house was largely
empty, other than a futon, an old couch, a dresser, and a few tables and chairs.
Knowing of Caseys situation, Caseys mother, Beth, decided to order some furniture
for her from the Lazy Shopper catalog. Beth convinced Lazy Shopper that she was
acting at Caseys request (which was not true), and that they should deliver the
furniture to Casey C.O.D., meaning that payment would be due upon delivery. Four
to six weeks later, Casey was relaxing on the old couch in her living room when the
doorbell rang. Two deliverymen were there with several cardboard boxes containing
furniture from Lazy Shopper. Is Casey obligated to purchase this furniture? What
facts would she need to know before she may ratify this transaction?
o No. There was no agency relationship.
o The only way we could have a binding agreement is if Casey ratifies it, which
would require her knowing the material terms of the contract and paying for the
furniture.
o She can also send it back, after which Lazy Shopper would have to look to Beth
for relief (Beth violated an implied warranty of authority).
Disclosed, Unidentified vs. Undisclosed Agency
Disclosed Principle:
o When the third party has notice the agent is acting for a principal and has notice
of the principals identity.
o Liability of Disclosed Principal:
The Agent has actual or apparent authority.
The Principal is bound to Third Party
The Third Party is bound to Principal
There is a contract between the Principal and the Third Party, and the Agent is
not a party to the contract and cannot be held liable for anything.
Agent is NOT a party to the contract unless agreed by third party and agent.
Unidentified Principle:
o When the third party has notice that the agent is acting for a principal but doesnt
have notice of the principals identity.
o Liability of Unidentified Principle:
The agent has actual or apparent authority
More likely actual, because apparent authority is given by the principal
which would be difficult in this situation.
Principal is bound to third party.
Third Party is bound to principal
There is a contract between the Principal and the Third Party.
They can seek performance from each other.
The agent is a party to the contract unless the agent and the third party
agree otherwise.
o Because the third party should be able to look to the agent for
performance because they dont know who the principal is.
Undisclosed Principle:
o When an agent and a third party interacts, and the third party does not know that
there is a principal at all; as far as the third party knows, he is dealing with the
agent.
o Liability of Undisclosed Principal
The agent has actual authority.
The Agent cant have apparent authority because the third party is not
aware of the existence of the principal.
The Third Party is in contract with both the Principal and the Agent.
The Agent has to be on the hook because, as far as the Third Party is
concerned, that is the person theyre dealing with.
The Principal is bound to the Third Party who justifiably detrimentally relied and
the Principal didnt take reasonable steps to notify.
o Exceptions:
Misrepresentation of the lack of agency.
The agent misrepresents the lack of agency (saying there is no agency
affirmative misstatement), and where the principal and the agent
reasonably know that the third party would not have dealt with the principal
had the principal known
Problem 2-21: Mrs. Hatfield is known far and wide as making the best wedding
cakes east of the Mississippi River. Julia McCoy wanted to order one of Mrs. Hatfields
cakes for her upcoming wedding but knew that, if she were to walk into Mrs.
Hatfields shop she would be turned away, due to a longstanding feud between the
Hatfield and McCoy families. Instead, Julia asked her friend Wendy Mullins to order a
cake from Mrs. Hatfield for delivery in two weeks, specifying the type of cake that
she wanted. Wendy went to Mrs. Hatfields shop and ordered the cake and Mrs.
Hatfield agreed to prepare and deliver the cake to the address that Wendy gave her.
When asked by Mrs. Hatfield, Wendy stated that the cake was for her own wedding.
If Mrs. Hatfield discovers that the cake is really for Julias wedding, may she refuse to
perform the contract? What if she finds out after the cake has been delivered (and
eaten)?
o Undisclosed Principal (Mrs. Hatfield thought she was dealing with Wendy (through
an affirmative act).
o Wendy had actual authority to order the cake (she was expressly told to do so)
o Contract between the principal and the third party and between the third party
and the agent
Defense: Misrepresentation
o Julia and Wendy had reason to believe that Mrs. Hatfield would not have made the
cake for Julia due to the longstanding feud
o The third party can raise the defense of misrepresentation and avoid the contract
o If she finds out after the cake has been delivered and eaten, its too late to do
anything about it
Problem 2-22: Would your answer to Problem 2-21 change if Wendy had instead
stated that she was ordering the cake for a friends wedding?
o Unidentified Principal
o No misrepresentation because there has not been a misstatement
o No defense on behalf of Mrs. Hatfield.
Problem 2-23: Recall Maynard Moneybags, Suzanne Franklin, and Pam Pretentious
from Problem 2-7. Assume that Pam had explained to Suzanne that she was acting
on Maynards behalf and that Suzanne agreed to sell the famous kite to Maynard for
$875,000. However, although the kite was delivered to him, Maynard never paid the
purchase price and has now disappeared, taking the kite with him. May Suzanne
recover the purchase price from Pam?
o Disclosed Principal
o No contractual relationship between Pam and Suzanne because Suzanne knew
who the principal was and Pam had actual authority to buy the kite
o The contract exists simply between the principal (M) and the third party (S); the
agent (P) cannot be held liable
Problem 2-24: Would your answer to Problem 2-23 change if Pam had not told
Suzanne that she was acting on Maynards behalf, but had only told her that she was
acting on behalf of a wealthy friend?
o Yes because you have an unidentified principle.
o The agent and the third party are parties to the contract, so the third party can
recover from the agent.
Problem 2-25: Would your answer to Problem 2-23 change if Pam had simply told
Suzanne that she was buying the kite for her own personal collection?
o Nope, we have a contract between the Agent and the third party so we have an
undisclosed principle.
Undisclosed Principal there exists a relationship between the agent and the
third party, so the third party can recover from the agent
Problem 2-26: If there are different results in the prior three problems, what is the
policy reason for these differences? If you were acting as an agent, what steps
should you or would you take to minimize your chances of being held liable on the
contract?
o In the case of the disclosed principal, the third party has all the relevant facts and
can judge the credibility of the principal in deciding whether to enter into a
contract. In the case of unidentified or undisclosed principals, the third party does
not have all the facts and cannot judge the credibility of the principal.
Situation where agent or other actor states that he is acting on behalf of a principal,
but it turns out that there is no actual or apparent authority
SOMEONE has to be on the hook. A purported agent who represents to another party
that he is working on behalf of another; he is giving the sense of having authority. If
that authority does not actually exist, the agent would be responsible for breach of
that warranty and any damages it may cause to the third party.
Problem 2-27: Recall Casey Counselor and her mother, Beth, from Problem 2-20
above. Assume that Casey decides to reject the furniture and send it back to Lazy
Shopper. May Lazy Shopper recover any damages from Beth?
o Yes, because someone has to be on the hook. Beth, by ordering on Caseys behalf,
had made a warranty that she had implied authority to act on Caseys behalf. A
breach of that warranty means Beth is responsible for loss or damages to the third
party.
Partnership Law
Partnerships
o Sometimes called a default form of business because it isnt necessary to take
any formal steps to form a partnership.
All that is required is that the business meets the statutory requirements of a
partnership.
Partnerships do not need to file any documentation with the state to form a
partnership.
Partnerships may be formed inadvertently when two people decide to
associate for a profit-making venture.
Problem 3-1: May ABC Corp. and DEF Corp. form a partnership?
o Yes two persons creating an association for profit (two corporations can form a
partnership)
Problem 3-2: If Amir, Bob, and Catrina form a partnership but later decide to
incorporate their business, will the business be both a corporation and a partnership?
o No an entity cannot simultaneously be a corporation and a partnership
Formation of a Partnership
o Is it possible that two (or more) people can form a partnership without intending
to do so? (Problem 3-3).
o Who would argue that a partnership has been formed when the partners did not
intend to do so? (HINT: Under RUPA 306, partners are jointly and severally liable
for the debts of the partnership).
Yes Why would anyone want to argue that a partnership exists if the parties
did not subjectively believe they were creating a partnership? Partners are
jointly and severally liable for each others debt. From the creditors
perspective, it means they can collect 100% of what they are owed from just
one of the partners. So, a creditor might argue that a partnership has been
formed. It may have transacted business with one of the purported parties who
is now gone or insolvent, so it wants to collect from someone who was a
partner with that person.
Default: If you have a partnership, the partners may not have agreed on anything
re: how theyre going to govern their business; in any instance in which they have
not agreed on a certain matter, the RUPA will fill in the gaps and will be the
partnership agreement. If the partners dont like what the default rules say, they
need to create an explicit partnership agreement
Default rules are rules that are going to apply generally to the partners, internally
The partners as between themselves may generally agree to do whatever they want,
but there are some restrictions
The relationship of the partners with third parties will have MANDATORY rules the
third parties rights cannot be affected
Under the RUPA, is a partnership an entity separate from its owners? May
a partnership hold title to property in its own name?
o RUPA 201: Partnership as Entity
A partnership is an entity distinct from its partners.
A limited liability partnership continues to be the same entity that existed
before the filing of a statement of qualification under Section 1001.
o RUPA 203: Partnership Property
Property acquired by a partnership is property of the partnership and not of the
partners individually.
o RUPA 204. When Property Is Partnership Property
a) Property is partnership property if acquired in the name of:
1) The partnership; or
2) One or more partners with an indication in the instrument transferring
title to the property of the person's capacity as a partner or of the
existence of a partnership but without an indication of the name of the
partnership.
b) Property is acquired in the name of the partnership by a transfer to:
1) The partnership in its name; or
2) One or more partners in their capacity as partners in the partnership, if
the name of the partnership is indicated in the instrument transferring
title to the property.
c) Property is presumed to be partnership property if purchased with partnership
assets, even if not acquired in the name of the partnership or of one or more
partners with an indication in the instrument transferring title to the property
of the person's capacity as a partner or of the existence of a partnership.
d) Property acquired in the name of one or more of the partners, without an
indication in the instrument transferring title to the property of the person's
capacity as a partner or of the existence of a partnership and without use of
partnership assets, is presumed to be separate property, even if used for
partnership purposes.
Authority of Partners
Are partners agents of the partnership? See RUPA 301(1).
o Yes, partners are agents of the partnership.
Under what circumstance is the partnership liable for any loss or wrongful
act of a partner? See RUPA 305(a).
o A partnership is liable for loss or injury caused to a person, or for a penalty
incurred, as a result of a wrongful act or omission, or other actionable conduct, of
a partner acting in the ordinary course of business of the partnership or with
authority of the partnership.
Are partners personally liable for liabilities of the partnership? See RUPA
306(a).
o All partners are liable jointly and severally for all obligations of the partnership,
unless otherwise agreed by the claimant or provided by law
o NO LIMITED LIABILITY
If a partner pays more than his share of partnership debt, does he have
any recourse? From the partnership? From the other partners?
o RUPA 401(b): Each partner is entitled to an equal share of the partnership profits
and is chargeable with a share of the partnership losses in proportion to the
partner's share of the profits.
o RUPA 401(c): A partnership shall reimburse a partner for payments made and
indemnify a partner for liabilities incurred by the partner in the ordinary course of
the business of the partnership or for the preservation of its business or property.
Exhaustion Rule: judgment creditor has to go after the assets of the partnership
unless the partner was personally liable (ex: was the tortfeasor)
o The exhaustion rule applies only if theyre not individually liable or have cosigned on a contract to be liable.
o Indemnification: whatever partnership agreement says affects internally but it
cant alter the rights of a third party.
o Contribution: If the partner pays more than his share of the debts they may
seek contributions from other partners.
What about the new partners capital contribution? Could the new partner
lose his or her capital contribution to a pre-existing debt?
o The new partners capital contribution could be used/they can lose it and it is
owned by the partnership (can be used to pay off old obligations if the partnership
chooses).
o Look to where the debt was incurred not owed.
As a default rule, how do partners share profits and losses? Does it matter
how much capital a partner has contributed to the partnership?
o RUPA 401(b): Each partner is entitled to an equal share of the partnership
profits and is chargeable with a share of the partnership losses in proportion to
the partner's share of the profits.
If so, does that entitle the transferee to be partner? See RUPA 503.
o The transferee does not become a partner. He does not have fiduciary duties.
Creditor of a Partner
Is a judgment creditor of a partner permitted to attach or levy against the
partnerships property?
o RUPA 501: Partner Not Co-owner of Partnership Property
A partner is not a co-owner of partnership property and has no interest in
partnership property, which can be transferred, either voluntarily or
involuntarily.
RUPA 504(d): This act does not deprive a partner of a right under exemption
laws with respect to the partner's interest in the partnership.
Can the judgment creditor seize the partners partnership interest and
become a partner in the debtor partners place?
o No, the creditor can get a charging order.
o RUPA 504(e): This section provides the exclusive remedy by which a judgment
creditor of a partner or partner's transferee may satisfy a judgment out of the
judgment debtor's transferable interest in the partnership.
Withdrawal of a Partner
Dissociation of a Partner: Leaving of a partner from the partnership.
Dissociation
What events cause dissociation? See RUPA 601.
o Partners express will to withdraw
Cant be prevented from leaving the partnership RUPA 103(b)
Might be wrongful dissociation, but they CAN quit.
o Event agreed to in the partnership agreement as causing dissociation
o Partners expulsion pursuant to the partnership agreement.
o Partners expulsion by unanimous vote of the other partners
o Partners expulsion by judicial determination
o Partner becoming a debtor in bankruptcy
o The partners death
o Termination of a partner NOT an individual, partnership, corporation, trust or
estate.
o Buy out the partner who leaves. Youd have to evaluate their share.
Wrongful Dissociation
Does a partner always have the right to dissociate?
o The partnership agreement cannot prohibit a partner from dissociating. You can
require them to do so in writing, but the partner will always have the power to
dissociate. However, the partners may not have a right to dissociate. This is called
wrongful dissociation and there are consequences for wrongful dissociation.
Article 8 Dissolution
Does a partners dissociation always result in dissolution? See RUPA
603(a).
o If a partner's dissociation results in a dissolution and winding up of the
partnership business, Article 8 applies; otherwise, Article 7 applies.
Article 7 Buyout
What happens if a partner dissociates, but the partnership does not
dissolve? See RUPA 701(a).
o The buyout price is the greater of liquidation value or the value based on a sale of
the entire business as a going concern with the dissociated partner and the
partnership were wound up as of that date
If a partner is bought out, how is the buy out price set? See RUPA 701(b).
o Going Concern: the partnership is of value, but has no value in terms of hard
assets their value is in their reputation
Can the dissociated partner and the partnership agree to set a buy out
price? See RUPA 701(e).
o If the parties can agree on a value, that is binding
What happens if they cannot agree on a price? See RUPA 701(e), (i).
o If they cant agree, the dissociated partner can make a demand for payment.
o Within 120 days, the partnership can pay out what it estimates it owes.
o If the dissociated partner is not satisfied, he has 120 days to go to court.
When does a wrongfully dissociating partner receive the buy out? See
RUPA 701(h).
o If there is a term or undertaking of the partnership, the buyout will not happen to
the end of the term.
o Exception: the dissociated partner must go to court and show that there is no
undue hardship in making the partnership pay before the end of the term (not
likely).
If a partner has to pay a partnership debt after he is bought out, does the
partner have any recourse against the partnership? See RUPA 701(d).
o If that dissociated partner has to pay that post-dissociation liability, he can get
indemnity from the partnership
Settlement of accounts:
Once the partnership is dissolved and its business wound up, how are
partnership assets applied and distributed? See RUPA 807(a) & (b).
o RUPA 807(a): In winding up a partnership's business, the assets of the
partnership, including the contributions of the partners required by this section,
must be applied to discharge its obligations to creditors, including, to the extent
permitted by law, partners who are creditors. Any surplus must be applied to pay
in cash the net amount distributable to partners in accordance with their right to
distributions under subsection (b).
o RUPA 807(b): Each partner is entitled to a settlement of all partnership
accounts upon winding up the partnership business. In settling accounts among
the partners, profits and losses that result from the liquidation of the partnership
assets must be credited and charged to the partners' accounts. The partnership
shall make a distribution to a partner in an amount equal to any excess of the
credits over the charges in the partner's account. A partner shall contribute to the
partnership an amount equal to any excess of the charges over the credits in the
partner's account but excluding from the calculation charges attributable to an
obligation for which the partner is not personally liable under Section 306.
Who is paid first? Creditors? Partners? What about creditors who are also
partners?
o Creditors are paid first.
o Next settle accounts.
o If there is anything left over, pay the rest equally.
o Partners are liable for their debts.
o Shareholders may lose investment if a creditor cant be paid- thats why theyre
paid first.
Introduction to Corporations
What is a corporation?
o A separate legal entity formed under the authority of a state statute.
o Existence depends on filing with state.
Corporate Structure
Shareholders
o Shareholders are the owners of the corporation. They do not directly manage the
business and affairs of the corporation. The Board of Directors does. The
responsibility of the shareholders is to elect the board of directors. They also have
the right to vote on certain fundamental changes, one of which is a merger.
Officers
o Officers manage business and affairs on a day-to-day business. Traditionally,
these were the President, VP, Secretary, and Treasurer. The modern terms are
Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operating
Officer (COO), etc.
This structure works well in the context of very large, publicly traded companies.
The Model Business Corporation Act applies regardless of the size of the company
(although there are some provisions that apply only to the small corporations), but
many of the rules contemplate large companies.
When a company is small, it is possible that there can be one individual who makes
up the entire Corporate Structure (One shareholder, who is also the Director and the
Officer).
Case Law
o Case law is important when we talk about the fiduciary duties of directors and
officers. Directors may have conflicts of interest.
Federal statutes
o Federal Securities Laws: Securities Act of 1933 and the Securities Exchange Act of
1934 concerned with the issuance of securities (which are broader than just
stocks)
State of Incorporation
May a corporation incorporate in any state?
o Yes. A corporation may incorporate in any of the 50 States, D.C., or even
overseas.
o If you are going to represent a mom-and-pop business that will only operate in FL,
it wouldnt make sense to look to another state to incorporate in. (Small business,
or closed corporations form the corporation in the state where the corporation is
located)
Formation of a Corporation
1. The Incorporator(s) file the Articles of Incorporation.
o Legal Name
o Number of authorized shares-shares you are entitled to issue at any time
What word or words must the name of a corporation contain? See MBCA
4.01. Why do you suppose the name must contain one of these words?
o Must include corporation suffix: ie. Corp., co., inc. (MCBA 4.01)
o This is so the third party understands that they are dealing with a LLC.
Could you choose Apple Computer, Inc. as the name of your new
corporation? See MBCA 4.01(b).
Must a corporation adopt bylaws under the MBCA? See MBCA 2.06(a).
o The incorporators or board of directors of a corporation shall adopt initial bylaws
for the corporation.
Promoters
Promoter: Someone who purports to act as an agent of the business prior to its
incorporation
o He is acting on behalf of the corporation that hasnt yet been formed
o Gets the corporation up and running (advance team)
o He is an organizer, acting as an agent, but isnt really an agent (cannot be an
agent of something that does not yet existremember he is a promoter preincorporation)
o Promoter retains liability on pre-incorporation contracts unless and until promoter
gets a novation
o Pay promoter either with stock or money
o EXAM: Whenever have promoter, look for liability he might enter contract on
behalf of the corporation, but the corp has not yet been formed
Example: Promoter would like to get a deal for office space for a 3 year
period
o Corporation he is working for has yet to be incorporated
o Promoter signs as an agent for yet to be formed corporation but he has not been
authorized [because corporation does not yet exist]
o Promoter believes that the corporation will ratify his contract [before this point
promoter is an unauthorized agent and liable for all of this debt]
What is an issuance?
o Issuance of shares requires approval at a meeting at which a quorum exists if its
issue for something other than cash AND if the stock offering is more than 20% of
the stocks currently outstanding (voting shares). I.e. Merger, typically not needed
Stock
May a corporation have more than one class of stock with different
dividend and liquidation preferences, voting rights, and so on? See MBCA
6.01.
o Yes
Common Stockholders
o Ordinarily, common stockholders have the exclusive right to elect the board of
directors who manage the corporation
o They may also get to vote on mergers and other important matters.
o In return for their investment, common stockholders receive DIVIDENDS declared
by the board of directors
o Common stock is frequently the only class of stock outstanding;
o It generally represents the greatest proportion of the corporations capital
structure and bears the greatest risk of loss should the enterprise fail
But in return for this position of subordination, the common stockholders have
an exclusive claim to the corporate earnings and assets that exceed the claims
of creditors and other shareholders
Therefore, the common stockholders bear the major risks of the corporate
venture, yet stand to profit the most if it is successful.
They can benefit either from appreciation or cast/stock/property dividends.
shares are first issued. Corporations usually redeem shares when the current
interest rate falls below the dividend rate on the preferred stock.
As soon as the corporation has the contractual right to redeem stock it will
*Only thing that makes preferred stock less valuable
What is par value? Must stock have a par value under the MBCA? See
MBCA 2.02(b)(iv).
o Minimum amount you can issue a share for (ex. $1/share)
Problem 5-19: ABC Corp. has two classes of stock: (1) common stock, of which
there are 10,000 shares outstanding, and (2) preferred stock, of which there are
5,000 shares outstanding. The preferred stock has a $10 per share liquidation
preference. ABC Corp. has dissolved. After liquidating its assets, it had $200,000 in
cash. However, it owes creditors $50,000. How will this money be divided among
(1) creditors, (2) holders of preferred stock, and (3) holders of common stock, if the
preferred stock's liquidation preference is non-participating? How does your answer
change if the preferred stock's liquidation preference is participating?
$200,000
x 50,000
Creditors
150,000
x 50,000_____ Preferred (5000 PS x $10/share =50,000)
100,000
Common Shares (100k 10k common shares = $10/share)
Outside Creditors -> Inside Creditors -> Preferred Stockholders -> Common
Stockholders
Dividends & Distributions
Dividends: when you receive a percentage of the stock that you own after a year. i.e.
if you are a preferred stockholder, and you put in $1,000, and the shares are 3$
apiece, youd get $3,000 at the end of the year
o This decision is always within the discretion of Board
o Never open to SH discussion
Appreciation: only realized after you sell your stock (which has become more
valuable)
Should a board declare a dividend? Its ALWAYS a BJR for the BOARD to
decide!!
o Decided on a case by case basis by some companies
o Dividends are always paid by some companies, never paid by others
o Is the decision of a board to pay or not to pay dividends open to shareholder
debate?
o NO this would be a usurpation of the Boards authority (Always within the
discretion of the board to declare a dividend)
*DEFINITION OF BUSINESS JUDGMENT
Problem 5-22: The only outstanding shares of Grape Corp. stock are 2,000 shares
of common stock. Grape's most recent balance sheet shows that it has $100,000 of
assets, $70,000 of liabilities, and shareholders' equity of $30,000. What is the
maximum amount of dividends that Grape Corp. could pay on its common stock and
pass the balance sheet test of MBCA 6.40(c)(2)? What is the per-share amount of
that dividend?
Problem 5-23: Same facts as Problem 5-22, except that Grape Corp. also has 1,000
shares of preferred stock outstanding, which have a $5 per share liquidation
preference. What is the maximum amount of dividends that Grape Corp. could pay
on its common stock and pass the balance sheet test of MBCA 6.40(c)(2)?
o Assets Liabilities = Shareholder Equities
o 100k -70k = 30k Shareholder Equities
30k Shareholder Equities
5k Pref. Shareholder Shares
25k Common Shares
Problem 5-24: The only outstanding shares of Orange Corp. stock are 7,000 shares
of common stock. Orange's most recent balance sheet shows that it has $160,000 of
assets and $70,000 of liabilities. What is the maximum amount of dividends that
Orange Corp. could pay on its common stock and pass the balance sheet test of
MBCA 6.40(c)(2)?
o $160k - $70k = $90k Shareholder Equity
Problem 5-25: Same facts as Problem 5-24, except that Orange Corp. also has
3,000 shares of preferred stock outstanding, which has a $7 per share liquidation
preference. What is the maximum amount of dividends that Orange Corp. could pay
on its common stock and pass the balance sheet test of MBCA 6.40(c)(2)?
o 3,000 x 7/share = $21k
o $69k common
Problem 5-27: The board of directors of Strawberry Corp. was advised by the
company's accountants and lawyers that the maximum amount of dividends that the
corporation could pay was $10,000. Nonetheless, the board declared total dividends
of $15,000 and the corporation paid this amount to its shareholders. What is the
board's liability, if any? If the board members are liable, to whom are they liable?
Will any of the shareholders who received the dividend be liable to repay it?
o There is an illegal distribution of $5K
o The directors who voted or assented to the illegal distribution are jointly and
severally liable to have to repay the amount to the corporation
o The shareholders who received the dividend will not be liable to repay it (unless
there is a shareholder who was also director, in which case his liability is based on
his being a director, not a shareholder)
In General
Because a corporation is a legal entity distinct from its shareholders, the rights and
obligations of a corporation are normally separate from those of the shareholders.
Under the corporate statutes, a shareholder normally has no liability for corporate
debts or other obligations. Instead, her liability-more accurately, her risk-is limited to
the loss of her investment.
One common formulation is that a corporate entity will be disregarded, and the veil
of limited liability pierced, when two requirements are met.
o First, there must be such unity of interest and ownership that the separate
personalities of the corporation and its shareholder or shareholders no longer
exist.
o Second, circumstances must be such that adherence to the fiction of separate
corporate existence would sanction a fraud or promote injustice.
In determining whether a corporation is so controlled by another to justify
disregarding their separate identities, the cases focus on four factors:
1. The commingling of funds or assets,
o A commingling of the corporation's assets and the shareholders' personal
as- sets occurs when the shareholders have dealt with the assets of the
corporation as if those assets were their own, e.g., by using corporate
funds to pay private debts, or by using corporate assets for other private
purposes.
2. The failure to maintain adequate corporate formalities,
o Also relevant to piercing the corporate veil is whether basic corporate
formalities were followed (e.g., whether stock was issued, corporate
records maintained, directors or officers elected, and regular meetings of
directors and shareholders held).
3. Undercapitalization, and
o An extremely important factor in deciding whether the corporate veil
should be pierced is whether the corporation was organized with
sufficient resources, by way of capital, liability insurance, or both, to
meet the obligations that reason-ably could be expected to arise in its
business.
The issue here is not whether the shareholders have respected and
maintained the corporation as a separate entity; rather, the issue is
whether the shareholders should reasonably have anticipated that the
corporation would be unable to pay the debts it would be likely to
incur.
The rationale of piercing the veil on the basis of undercapitalization is
that the legislature, in conferring limited liability, assumed that
shareholders would in good faith put up unencumbered capital (or
insurance) reasonably adequate for its prospective liabilities.
Limited Liability for Owners (when done correctly) owners are shareholders
o Owners liability for firm debts is capped by individual contributions (shares)
The most you can lose is what you put in and own
Creditors if run out of money before run out of creditors, creditors go away
o MBCA 6.22(b): Unless otherwise provided in the articles of incorporation, a
shareholder of a corporation is not personally liable for the acts or debts of the
corporation except that he may become personally liable by reason of his own
acts or conduct.
If you behave yourself as a shareholder the most you can lose is the value of
your shares [In sharp contract to a partnership]
Shareholders that behave properly are not personally liable for the acts or
conduct of the corporation (unless you become personally liable by reason
of your own acts or conduct then can pierce the corporate veil)
Bottom Line: Is it UNFAIR to allow the corporate shield to stand= this is the main
question
o When the corporate veil is pierced then the shareholder is personally
liable.
The doctrine of piercing the corporate veil only applies if the debtor corporation is
closely held.
What if the shareholder of the debtor corporation isnt an individual, but is itself a
corporation?
o If a majority of a corporations stock is owned by another corporation, then the
first corporation is a subsidiary (child) and the second corporation is a parent.
o Parent/Child Corporation
Subsidiary= more than owned by the parent corporation.
Parent-Sub Piercing:
Whether subsidiary was adequately capitalized
Whether there are separate records being kept.
Whether subsidiary observed corporate formalities
Whether the parent siphoned off subsidiarys funds.
Whether the subsidiary acted as a faade for the parent.
Whether parent and subsidiary have common directors and officers
(common control).
Involuntary creditors (i.e., tort creditors) may be more likely to pierce the
corporate veil than voluntary creditors (i.e., contract creditors). Why do
you suppose this is the case?
o Because involuntary creditors do not willingly embrace unsecured status, and
creditors who contract for unsecured status voluntarily but in ignorance of
security's threat.
Enterprise Liability
Enterprise liability only works when the companies that you have brought
into the corporation have other assets (Horizontal Veil Piercing)
o Looks at a unity of interest between corporations and allows you to sue each as a
single entity
o Enterprise liability allows you to scoop up assets horizontally (through corporation
to related corporation)
o PCV allows you to get at individual shareholders.
Board of Directors
What is the board of directors?
o The board of directors is the ultimate source of decision-making authority in the
corporation.
Meetings:
o Who has the power to call or convene the meeting?
The board of directors
o What kind of notice, if any, is required to be sent to directors informing them of
the forthcoming meeting, including:
How soon before the meeting must it be sent?
Two or more days notice required of date, time and place but not the
purpose of the meeting. MBCA 8.22
o Notice: must be in writing unless verbal notice is
Regular Meeting:
o Meetings that are fixed in the bylaws of the corp.
o No notice requirement because notice is in the bylaws already.
Special Meeting:
o Two or more days notice required of date, time and place but not the
purpose of the meeting. MBCA 8.22
o Notice: although formal notice is unnecessary for a regular meeting,
special meetings require notice to every director of the date, time,and
place of the meeting.
Can a director waive right to notice? If so, when? Before or after the meeting?
If a director attends a meeting, does he waive right to notice? See MBCA
8.23.
o Usually, notice can be waived in writing before or after a meeting.
Attendance waives notice unless the director attends only to protest the
meeting.
o Model Act does not specifically say what officers are needed; some states will
require a President, Vice President, Secretary, and Treasurer. Now CEO, CFO, COO,
etc.
Look to corporations bylaws to see what officers it has, how they are
appointed, and what authority they have.
Shareholders Meetings
Must shareholders hold an annual meeting? See MBCA 7.01. What
typically take place at an annual meeting?
o Annual Meeting Requirement
Elect directors during this meeting
Conduct other business as necessary
Can elect directors annually or staggered.
o Special Meeting
Remove a director
The board can, for cause or no cause, fire a director subject to approval of the
shareholder approval.
o The failure to hold an annual meeting on the date in the bylaws does not affect
the validity of the corporate action.
Who can call a special meeting of the shareholders? See MBCA 7.02(a).
o Holders of 10% of the shares of the corp.
o CEO
o President
Must shareholders receive notice of a meeting? If so, when and what must
the notice contain? Are the requirements different for an annual meeting
and a special meeting? See MBCA 7.05. May a shareholder waive right to
notice? See MBCA 7.06.
o Not less than 10, no more than 60 days before the meeting date for both annual
and special meetings
o Right to notice can be waived.
o They can act by written consent without a meeting.
o Board has to set a record date, 70 days, to figure out who gets mailed the notice.
Record Date: the day the board elects to see who owns the shares for voting
purposes.
Record Holder: the person holding the shares on the record date.
o Notice needs to contain
Time of the meeting
Place of meeting
Date
Purpose for SPECIAL meeting, NOT ANNUAL
Election of Directors
As a general rule, how do shareholders elect directors? What is straight
(plurality) voting and how does it work? MBCA 7.28(a).
o Plurality Voting: G/R
You can vote up to your number of shares for each candidate.
Ex: If you had 100, you could vote 100 for each candidate or no votes for
any candidate or any combination thereof.
You may NOT accumulate your votes you cant vote 200 on a candidate.
o Cumulative voting: Special if in Articles
With Cumulative voting each shareholder can accumulate all votes and cast
them for any one or more candidates.
Default
DELAWARE
Requirements:
Appointment must be in writing and signed.
Absent an irrevocable proxy they can revoke it at any time for any reason or no
reason at all.
A proxy is normally revocable by the shareholder at any time, althoughit
may be made irrevocable if expressly stated and coupled with aninterest in
the shares themselves (or in some states, an interest in the corporation).
Absent written notice to the corporation, the death or incapacity of a
shareholder does not revoke a proxy. A shareholder may revoke a proxy by
notifying the proxy holder, giving a new proxy to some- one else, or by
personally attending the meeting and voting.
Cumulative Voting
What is Cumulative Voting?
o Formula: PUT THIS ON CHEAT SHEAT
[(N x S) (D+1)] + 1 = X
N = number of directors the shareholder wants to elect
S = total number of shares voting
D = total number of directors to be chosen at the election
Example:
o Britney owns 80 voting common shares of ABC, Inc. At its next shareholders'
meeting, the common shareholders will vote to fill the eight spots on the board of
directors. What is the total number of votes that Britney will have?
80 x 8 Directors up for election = 640 votes
o Which of the following is acceptable voting by Britney under MBCA 7.28?
Britney casts all 640 votes for John Smith, the candidate she likes best.
Yes
Britney casts 80 votes each for eight different candidates
Yes.
Britney casts 1 vote each for 640 different candidates.
Yes
Britney casts 640 votes each for eight different candidates.
No
Removal of Directors
May the shareholders remove a director without cause? See MBCA
8.08(a)
o Yes, the shareholders may remove one or more directors with or without cause
unless the articles of incorporation provide that directors may be removed only for
cause.
Under the MBCA, once quorum exists, how many votes are necessary to
pass a measure? See MBCA 7.25(c).
o MBCA 7.25(c): If a quorum exists, action on a matter (other than the election of
directors) by a voting group is approved if the votes cast within the voting group
favoring the action exceed the votes cast opposing the action, unless the articles
of incorporation or this Act require a greater number of affirmative votes.
Does the MBCA provide for a plurality, simple majority, or absolute majority
vote?
Fiduciary Duties
What is the duty of care?
o MBCA 8. 30(a): Each member of the board of directors, when discharging the
duties of the directors, shall act:
In good faith, and
In a manner the director reasonably believes to be in the best interests of
the corporation
Duty of Care
What is a directors duty of care? See MBCA 8.30(a) & (b).
o MBCA 8.30(a): Each member of the board of directors, when discharging the
duties of a director, shall act:
In good faith, and
In a manner the director reasonably believes to be in the best interests of
the corporation.
o MBCA 8.30(b): The members of the board of directors or a committee of the
board, when becoming informed in connection with their decision-making function
or devoting attention to their oversight function, shall discharge their duties with
the care that a person in a like position would reasonably believe
appropriate under similar circumstances.
Causation
o Plaintiff must show that defendants failure to meet the duty of resulted in harm
to the corporation
Majority/MBCA: plaintiff must show proximate causation
Delaware: once the plaintiff shows that the defendant breached his duty of
care, the burden shifts to the defendant to show that his actions were fair to
the corporation
If the directors completely fail to act (or are oblivious), are they entitled to
use the BJR as a defense?
o BJR only applies when managers have made conscious decisions.
o BJR may not apply to managers who are interested in the decision.
o BJR does not apply if the decision itself constitutes illegal conduct.
May directors rely upon advice from experts and still receive the
protections of the BJR? See MBCA 8.30(d)-(f).
o The individual directors dont have to be experts.
o They are entitled to rely upon experts inside or outside the corporation so long as
they believe they are reliable and competent.
o The directors can appoint a committee and if the committee does their homework
the directors can rely on them.
Upon whose advise can the directors rely? See MBCA 8.30(f).
o A director is entitled to rely, in accordance with subsection (d) or (e), on:
One or more officers or employees of the corporation whom the director
reasonably believes to be reliable and competent in the functions performed or
the information, opinions, reports or statements provided;
Legal counsel, public accountants, or other persons retained by the corporation
as to matters involving skills or expertise the director reasonably believes are
matters (i) within the particular persons professional or expert competence or
(ii) as to which the particular person merits confidence; or
A committee of the board of directors of which the director is not a member if
the director reasonably believes the committee merits confidence.
Applies to:
o Directors
o Officers- agents of the corporation
o Does not apply to shareholders generally
Violate By:
o Competing with the corporation,
o Self-dealing/conflicting interest,
o Usurping a corporate opportunity (stealing an opportunity)
Sanitizing Statute
Under MBCA 8.61(b), a directors self-dealing transaction will be permissible if:
o Procedural fairness (the process for approving the transaction was fair)
Directors action respecting the transaction was at any time taken in
compliance with section 8.62 [qualified director approval]; or
Shareholders action respecting the transaction was at any time taken in
compliance with section 8.63 [qualified shareholder approval]; or
Substantive fairness (i.e., the substance of the transaction is fair)
o The transaction, judged to the circumstances at the relevant time, is established
to have been fair to the corporation.
DCIT: (DIRECTORS CONFLICT OF INTEREST TRANSACTION)
Unlike decisions of neutral, fair, and impartial directors, once a conflict of interest
exists, the BJR does not automatically apply.
Procedural Fairness
Qualified Director Approval
At least 2 directors voting in favor
Making up an affirmative vote of a majority of the qualified directors
o Who is a qualified director?
Is not engaged in self-dealing (i.e., a directors conflicting interest
transaction).
Does not have a material relationship with another director who is engaged in
the self-dealing transaction. MBCA 1.43(a)(3).
After required disclosure. Must Disclose:
o The existence and nature of the directors conflicting interest, and
o All facts known to the director respecting the subject matter of the transaction
that a director free of such conflicting interest would reasonably believe to be
material in deciding whether to proceed with the transaction. MBCA 8.60(7).
Qualified directors must deliberate and vote outside presence of other directors.
MBCA 8.62(a)(1)
IF WE HAVE APPROVAL=BJR APPLIES
A majority of the qualified directors qualifies as quorum for this particular vote.
Substantive Fairness:
Under the ALI Principles, what happens if the corporate fiduciary never
gave the corporation the right of first refusal to take the corporate
opportunity? See 5.05(a)(1) & (e) ALI Principles.
o ALI 5.05(a)(1): General Rule
A director or senior executive may not take advantage of a corporate
opportunity unless:
The director or senior executive first offers the corporate opportunity to the
corporation and makes disclosure concerning the conflict of interest and the
corporate opportunity.
o ALI 5.05(e): Special Rule Concerning Delayed Offering of Corporate
Opportunities
Relief based solely on failure to first offer an opportunity to the corporation
under 505(a)(1) is not available if:
Such failure resulted from a good faith belief that the business activity did
not constitute a corporate opportunity, and
Not later than a reasonable time after suit is filed challenging the taking of
the corporate opportunity, the corporate opportunity is to the extent
possible offered to the corporation and rejected in a manner that satisfies
the standards of Subsection (a).
Under the ALI Principles, who bears the burden of proof? What must that
party show?
o ALI 5.05(c): Burden of Proof
A party who challenges the taking of a corporate opportunity has the burden of
proof, except that if such party establishes that the requirements of Subsection
(a)(3)(B) or (C) are not met, the director or the senior executive has the burden
of proving that the rejection and the taking of the opportunity were fair to the
corporation.
Derivative Suits:
What is a derivative suit?
o One brought by a shareholder (plaintiff) on behalf of the corporation, to remedy
harm that the corporation has suffered.
MCBA 7.40(1): a civil suit in the right of a domestic corporation.
Forces the action that BOD doesn't want to take.
Shares are indirectly affected
We care because there are procedural hurdles.
Why is a derivative suit necessary? HINT: Who makes the decision whether a
corporation sues its directors for breach of duty of care or duty of loyalty?
o It's the way we keep directors honest.
o Can be used against a corporation because the Board, for instance, refuses to sue
a third party
o Most likely situation is where you have conflicts of interest or any other breach of
fiduciary duty
o If directors have ripped the corporation off, the corporation (through its
shareholders) have a cause of action, because they stole from the corporation
(shareholders are indirectly impacted)
o Its an action to force the corporation to go after themselves or after a specific
director
Demand
o MBCA:
Thou shalt make a demand ALWAYS
In writing
To the board
Board has up to 90 days to respond. Apply BJR.
o Delaware:
If making a demand would be futile then demand is excused.
Futile if the plaintiff must allege particularize facts, which create a
reasonable doubt that the directors are disinterested and independent or
the challenged transaction was otherwise the product of a valid exercise of
BJ.
MBCA DISMISSAL:
o A derivative proceeding shall be dismissed that is:
Within good faith and
After reasonable inquiry
o Burden of Proof:
If qualified majority, plaintiff must show either
Lack of good faith,
No reasonable inquiry,
SLC was grossly negligent
DELAWARE DISMISSAL:
o Demand Required Cases- court defers to BJR
o Demand Excused cases- courts give a second look to SLC decisions:
Step 1: the corporation will have to show facts that the special litigation
committee was:
Really independent,
In good faith and
Shareholder Agreement:
o Has to be in writing and signed before its enforceable.
o Have to put the world on notice of the shareholder agreement.
Have to conspicuously note on the shares the shareholder agreements
presence.
If they take without notice then they would be a bona fide purchaser for value
not bound by the provisions of the shareholder agreement.
o Agreement ceases when they become publicly traded.
o Its valid for 10 years unless the agreement provides otherwise.
o Board: Can eliminate the board altogether.
Another way is to guarantee a shareholder is elected as director.
If shareholders can agree among themselves how they will vote their
shares, can they also agree on how the corporation will be managed?
o Old cases say shareholders cant agree to make board of directors to act in a
certain way
Steps:
o Step 1: Legitimate business purpose.
Once the plaintiff shows prima facie case of a freeze out the burden is on the
majority (corporation) to show a legitimate business purpose.
If there is no legitimate purpose the plaintiff (minority) prevails.
MBCA Oppression
Oppression: Frustration of the reasonable expectations of the shareholder at the
time they became a shareholder (Kemp and Beatley)