Business Associations Outline SECTION 1: Agency Relationship I. Agency: --- R.

Agency, 1: Agency is the fiduciary relation which forms from the manifestation of consent by one person to another that the other shall act on his behalf -- Cmt. b: 3 Elements of an agency relationship: (1) Manifestation by P that A will act for him (2) Acceptance by A of the undertaking (3) Understanding between the parties that P will control the undertaking --- Created by written words, spoken words, or other conduct of the P, which, reasonably interpreted, causes the agent to believe that the P desires the agent so to act on the Ps account --- R. Agency, 26: P is responsible for acts and agreements of As which are within actual or apparent authority (1) Actual: (a) Express = Principal explicitly tells agent what to do (b) Implied = Powers incidental and necessary to carry out express authority -- Must be reasonably necessary to carry out express authority Cook: Assistant to another doctor in medical building had neither express nor implied authority to accept service of process on D doctors behalf - Assistant answered phone and accepted certified mail for D, but these tasks did not encompass the power to receive service --- Custom and relation of the parties establish the boundaries of implied actual authority -- Evidence of an agent historically engaged in related conduct, without limitation, provides enough evidence to submit to a jury Essco Geometric: Purchasing manager for D had actual authority to enter exclusive, non-cancelable requirements contract despite Ds limitation that company president initial all contracts - Purchasing manager believed that he had the authority at time of contact - Performance evaluation required more active role of purchasing manager - Former purchasing managers negotiated with and selected venders - President never failed to sign off on a requisition (2) Apparent: Created by the conduct of the principal, (words or actions) which causes a TP reasonably to believe that the purported agent has the authority to act for the principal AND: For the TP to reasonably and in good faith rely on authority held out by the principal (a) Express = P expressly tells TP that the second person has authority to act on Ps behalf (b) Position = P allows a second person to occupy a position that carries authority in certain trade (c) Prior Acts = P allows a second person to carry out similar transactions with TP in the past Essco Geometric: Purchasing manager for D had apparent authority to enter exclusive, non-cancelable requirements contract despite Ds limitation that company president initial all contracts - Former purchasing manager had negotiated with plaintiff Plaintiff was not made aware of Ds new limitation on contracts - Purchasing agents had entered exclusive oral agreements in past dealings

--- TP has no duty to investigate a purported agents authority if a person of ordinary prudence, accustomed to the business, could reasonably believe that the agent had such authority Essco Geometric: P was under no duty to investigate purchasing managers authority to enter exclusive, non-cancelable requirements contract --- Existence of agency must be proved by the plaintiff by a preponderance of the evidence Botticello: Marriage of D and husband who entered contract for sale of property did not prove an agency relationship Hoddeson: P bore the burden of proving that individual was agent of D store, where individual took cash from P, claiming to be store clerk, but stole money --- Appearance of authority must be shown to have been created by the manifestation of P, not alone by those of the supposed A BUT: Duty of business proprietors requires reasonable care to protect customers from deception of those claiming to be agents of the business Hoddeson: Court returned case for trial where P claimed that D store had not exercised due care to prevent individual from posing as clerk and taking money (3) Inherent Agency --- R. Agency, 8A: Power of an agent which is not derived from other forms (1 or 2), but solely from the agency relation and exists for the protection of persons harmed by A --- R. Agency, 194: Undisclosed principal is liable for acts of an A done on his account, if usual and necessary in such transactions, although forbidden by P --- P is liable for acts of A that are within the authority usually confided to an A of that character AND: May not be limited expressly by terms between P and A that are unknown to the TP -- KEY: TP must not be aware that A is acting on behalf of any P Watteau: D hotel owner was liable for debt where D was undisclosed principal and manager ordered many goods under credit, but had explicit authority only to order bottled ales and waters -- No apparent authority = no communication between owner and TP - The hotel cannot make the representation -- Secret limitation between P and A cannot defeat the action against P

(4) Estoppel: Where someone by the dereliction of duty allows an impostor to pretend to be his agent and supposedly transact his business AND: the impostor does so in such a way as that a person of reasonable intelligence believes the impostor was actually the agent

THEN: The law does not let the proprietor use the impostor's lack of authority and escape liability for the loss by the customer (5) Ratification: --- R. Agency, 82: Affirmance by a person of a prior act which did not bind him but which was done on his account whereby the act, is given effect as if originally authorized by him --- R Agency, 83: Affirmance is either: (a) A manifestation of an election by one on whose account an unauthorized act has been done to treat the act as authorized OR (b) Conduct by him justifiable only if there were such an election -- Must take an affirmative act, cannot simply fail to act (up to a point) Requires acceptance of the results of the act with an intent to ratify AND: Full knowledge of all the material circumstances Botticello: D wife, whose husband entered option contract to sell land at end of leasing period, did not ratify sale of land, as she observed tenant occupying land -- Wife never agreed to price, so husband was not acting as A for wife Without professed agency, there can be no later ratification -- Receipt of rental payments from tenant did not ratify, because wife was not aware of material circumstances of potential later sale

II. Contract Liability of the Agent: 2 Ways for Agent to be held liable (1) --- R. Agency, 4: (1) Disclosed principal = At the time of the transaction, the other party knows that A is acting for P and knows Ps identity -- R. Agency, 320: An agent making a contract with another for a disclosed principal does not become a party to the contract (2) Partially disclosed principal = Other party knows that A is acting for P, but does not know who P is -- R. Agency, 321: An agent making contract with another for a partially disclosed principal becomes a party (3) Undisclosed principal = Other party does not know that A is acting for any P -- R. Agency, 322: An agent making contract with another for an undisclosed principal becomes a party --- It is the duty of A to disclose that he is acting for a specific P in order to avoid liability Not the duty of the other party to inquire into whether A is acting for any P --- A person purporting to make a contract with another for a partially disclosed P is party to the contract = A is liable if the identity if the P is not disclosed Atlantic Salmon: D was purchasing salmon from several companies, claiming to be an agent of Seafood Exchange, while he was actually an agent of Marketing Designs; but never informed the plaintiffs of this company

- Even though the plaintiffs were aware that D was acting for some P, the D was still liable for the debt incurred CONSIDER: Risk v. Reward for Atlantic Salmon = Did they seek compensation for knowingly taking a risk? (2) IMPLIED COVENANT OF AUTHORITY --- Where agent induces TP to act in reliance upon express or implied representation of authority, the agent, and not the TP, assumes the risk of non-existence of authority Where one undertakes to bind a P without being authorized, he renders himself personally responsible, even if acting in good faith BUT: Where the TP knows that A lacks the authority of P, A does not assume the risk Robinson: Wife, falsely believing that she had power of attorney over her sick husband, entered contract for sale of jointly held property as her husbands agent; but was liable for breach of contract damages when it was discovered that power of attorney was improperly filed

III. Termination of Agency Power (A) Conditions --- 105: Time Lapse -- Authority for a specific time terminates at the expiration of that time BUT: If no time is specified, authority terminates after a reasonable period --- 106: Accomplishment -- Authority for a specific act terminates when the act is done or the result is accomplished by the agent or another BUT: If the act is not accomplished by the agent, manifestations by P to A determine when authority terminates or when the agent has notice of it --- 107: Specified Events -- If agency is authorized until an event, the agency continues until the event or when the agent has notice of the event, depending on the principals manifestation --- 108: Unspecified events -- Authority terminates when the agent has notice of the happening of an event from which he should reasonably infer that the P does not consent to further exercise of authority BUT: Agents authority revives if the original situation returns within a reasonable time and the agent has no notice that Ps position has changed --- 109: Change in value or business conditions -- Authority terminates when the agent when he has notice of a change in value of the subject matter or change in business conditions from which he should infer that P would not consent to further exercise of authority

--- 110: Destruction of subject matter -- Loss or destruction of the subject matter terminates the agency, either at once or when the agent has notice of it, depending on the principals manifestations (B) Revocation --- 117: Mutual consent -- Authority terminates in accordance with the terms of the agreement between P and A so to terminate it --- 118: Revocation or renunciation -- Authority terminates if the P or the A manifests to the other dissent to its continuance AND: 119: Any manner of dissent is sufficient when the other party has notice Either party can break agency, even if the agreement says otherwise 2 ISSUES: (1) Does agent have power to act for principal? May be revoked at any time, regardless of agreement -- Authority of agent to act is ended: Agent may be liable to the TP for breach of contract (2) Is principal or agent liable for damages to the other for breaching agency contract? HOW TO MAKE AGENCY IRREVOCABLE: (a) Parties agree that it is irrevocable (b) Agent has an interest in the subject matter of the agency (Power coupled with interest) Ex: Security interest under 139 Bank holding mortgage can buy insurance on behalf of owner --- Where the agent has no interest in the subject matter of the agency, the principal has the power to revoke the agency at any time BUT: Valid mutual contract for agency, for a definite period of time is binding on the principal Agent can treat the contract as rescinded and bring an action for the value of service provided Chamberlain: D granted exclusive right to plaintiff real estate brokers to sell hotel for one year, but breached contract by selling hotel themselves and not compensating P - P spent $ working to sell the property, and are entitled to compensation - D breached agreement to pay commission if sold without broker BUT: If agent acts in good faith and incurs personal expense, but is not given reasonable opportunity recoup such from the undertaking, the principal will be required to compensate him for such expense Beebe: D seller of truck equipment was liable for services rendered where P agent was hired under an indefinite oral contract and spent money to sell trucks, but was fired immediately afterwards (C) Incapacity of P or A --- 120: Death of the Principal -- Death of principal terminates the agency without notice to A --- 121: Death of the Agent -- Death of A terminates the agency

--- 122: Loss of capacity of P or A: Unless created with durable language (1) Loss of capacity by P has the same effect as the principals death (under 120 = terminates agency) (2) Agents loss of capacity to do an act for P terminates or suspends his authority CONSIDER: Springing power of attorney = only effective where principal is incapacitated BUT: No way for TPs to know when principal is in certain state (D) Impossibility --- 124: Termination of agents authority when: (a) to deal with a particular subject matter when it is destroyed (b) to affect the principals interest in a subject matter, when the principal has lost his interest in it (c) to enter transactions with a particular person, when they die or lose capacity (d) to effectuate results, when the transactions which the agent is authorized to conduct do not effectuate such results (E) Effect of termination on apparent authority --- 124A: Termination of authority does not thereby terminate apparent authority --- 125: Apparent authority, not otherwise terminated, terminates when the TP has notice of: (a) the termination of As authority (b) a manifestation by P that he no longer consents (c) facts, the failure to reveal which, were the transaction with the P in person, would be ground for rescission by the P --- 130: Indicia of apparent authority -- If A is given writing that manifests authority and is intended to be shown to TPs, the termination of the agents authority by causes other than incapacity and impossibility does not prevent apparent authority as to TPs who have no notice of the termination --- 131: Agents representing nonexistence of terminating facts -- Occurrence of terminating event does not terminate apparent authority where the A is apparently authorized to represent its nonoccurrence and so represents to TP, who has no notice of the occurrence (F) Termination of powers given as security --- 139: (1) Power given as security is not terminated by: (a) revocation by the creator of the power (b) surrender of the holder of the power, if he holds it for the benefit of another (c) the loss of capacity during the lifetime of either the creator or the power holder (d) death of the holder of the power AND: If duty does not terminate at death of creator, the death of the creator as well (2) A power given as security is terminated by its surrender by the beneficiary

IV. Tort Liability of the Principal and Agent --- 2: (1) Master = controls or has the right to control the physical conduct of an agent (2) Servant = physical conduct in performance of the service is subject to the control of the master (3) Independent contractor = person who contracts with another to do something for him, but is not subject to control of the other with respect to his physical conduct in the performance. May or may not be an agent --- 220: Is the agent a servant or independent contractor? (2) Consider the following factors, among others: (a) extent of control which, by agreement, the master may exercise over the details of the work -- Consider: Controlling specifications of the final product vs. the way it is done (b) whether or not the one employed is engaged in a distinct occupation (c) the kind of occupation, with reference to whether the work is usually done without supervision in the locality (d) the skill required in the occupation (e) whether the employer provides the instrumentalities (f) the length of time for which the person is employed (g) the method of payment, by time or by job (h) whether or not the work is part of the regular business of the employer (i) whether the parties believe that they are creating a master-servant relationship (j) whether the principal is, or is not in business --- Key factor in determining if a mater-servant relationship exists is whether the principal controls the day-to-day operations of the agent Humble Oil: Gas station operator was a servant of the owner where: + Owner paid of the utility bills - Not considered master + Owner provided station and equipment + Owner paid operating costs + Owner controlled hours of operation + Contract language (reports and duties) - Owner was employees boss - Express agreement - No control over hires

Hoover: Gas station operator was an independent contractor where: + Station and equipment owned by owner - Min/Max monthly rental + Advertise under heading of ownership - Purchased products from owner + Attended school for ownership - No obligation to follow advice + Weekly visits by ownership - No reports to owner --- Franchise agreement does not insulate the parties from an agency relationship

-- Right to control the method or details of doing the work is still determinative Murphy: No master-servant relationship existed where Hotel chain franchised out name with numerous regulations Standardization purpose of regulations; not control of daily activities + Motel built to specifications - Business expenditures + System employs names, signs, etc. - Set customer rates + Training for managers - Hired / set employee wages --- Fact that an employer has control over the amount of work OR has reserved power to make alterations to the plan does not necessarily have the effect of creating a master-servant relationship Kourik: No master-servant relationship between Insurance company and adjuster where adjuster controlled own means of settling claims, but deferred to judgment of company in difficult situations Insurance company is not liable for the acts of their independent contractor + Same duties as traditional adjusters - Adjusters use own vehicles + Company instructs in difficult situations - Own judgment to pay out rewards - Determine who gets awards - Get assignment from general agent --- 219: When is the master liable? (1) Master is subject to liability for the torts of his servants committed while acting in the scope of their employment (2) Master is not subject to torts outside of the scope of employment, unless: (a) the master intended the consequences (b) the master was negligent or reckless (c) the conduct violated a non-delegable duty of the master (d) the servant purported to act or speak on behalf of the principal and there was reliance upon apparent authority OR he was aided in accomplishing the tort by the existence of the agency --- 228: What conduct falls within the scope of employment? (1) Conduct of a servant is within the scope of employment, only if: (a) it is of the kind that he is employed to perform (b) it occurs substantially within the authorized time and space limits (c) it is actuated, at least in part, to serve the master Sufficient, but not necessary (See Bushey test) (d) if force is intentionally used by the servant, the use of force is not unexpected by the master --- Master is liable for acts of servant that are reasonably foreseeable within the scope of the enterprise BUT: Does not reach into areas where the servant creates the same risks as the community in general -- Business enterprise cannot justly disclaim responsibility for accidents which may fairly be said to be characteristic of its activities Ira S. Bushey & Sons, Inc: Seaman returning to shore leave while intoxicated was within the scope of his employment with the government when he turned wheels on drydock wall and caused damage to the dock

- Foreseeable that seamen crossing the drydock might do damage, in some way - Did not matter that the action was not taken to serve the master (under 228(c)) No way to tell here = master would be off the hook POLICY: Least-cost avoider dock owner could implement safety measures easily BUT: This alone is not enough to impose cost on the dock owner

--- 229: When is unauthorized conduct incidental to authorized conduct? (1) To be within the scope of employment, conduct must be of the same general nature as that authorized, or incidental to the conduct authorized (2) To determine if unauthorized conduct is incidental to authorized conduct, consider: (a) whether the act is commonly done by servants (b) the time, place and purpose of the act (c) the previous relations between the master and servant (d) the extent to which the business of the master is apportioned between different servants (e) whether or not the act is outside the enterprise of the master, or if within the enterprise, not entrusted to the master (f) whether or not the master has reason to expect that such an act will be done (g) the similarity in quality between of the act done to the act authorized (h) whether or not the instrumentality by which the harm is done has bee furnished by the master (i) the extent of departure from the normal method of accomplishing the authorized result (j) whether or not the act is seriously criminal Clover: Employee of ski resort who ignored sign instructing skiers to slow down and injured a guest may have created liability for the employer (1) Had he resumed employment (After skiing for fun between jobs)? (2) Was deviation (skiing for fun) substantial enough to constitute a total abandonment of his employment? --- 230: An act, although forbidden, or done in a forbidden manner may be within the scope of employment --- 231: An act may be within the scope of employment although consciously criminal or tortious -- Where P seeks damages for intentional tort of agent, P must demonstrate that the agents action was in response to the Ps conduct which was presently interfering with the agents ability to perform his duties Manning: Team owner could be liable for damages where pitcher threw ball at spectator who had been heckling him - Jury could have found that throw was due to continuing annoyance that was preventing the pitcher from performing his duties --- A master is not liable for unauthorized tortuous conduct of his servant, even when done in connection with the employment, where the wrongful act was unforeseeable, in view of the duties of the servant Wellman: Oil company was not liable for service attendant shooting a customer who returned to argue about his broken trunk

- Principal could not have anticipated that the attendant would act so excessively violent; therefore the act was outside of the scope of his employment BUT: Dissent: (Majority of states?): Principal is liable for intentional torts of his agent if the incident that gave rise to the violent act was an incidental attendant to the principals business

--- Court will consider several factors in determining if use of force was within scope of authority: (a) Expected interaction between employee and public (b) Act occurred within an authorized time and place (c) Whether the agent acted on personal motive Brown: Company was liable for action of night janitor, who assaulted customer after disagreement over making change for customer to leave parking garage - Not outrageously violent as in Wellman - Agent was expected to interact with public; was in authorized place, and had no personal motive for the attack Was collecting money for employer LIMITED LIABILITY FOR PRINCIPALS EMPLOYING INDEPENDENT CONTRACTORS --- Principal is not liable for acts of independent contractors, unless: (a) the act was done in a manner directed by the principal (b) the result was intended or authorized by the principal Kourik: Principal insurance company was not liable for traffic accident of adjuster, where adjuster was an independent contractor - Business trip was not specifically authorized by the insurance company (1) Ordinarily: Principal is not liable for the acts of an independent contractor unless the principal: (a) retains control of the manner and means of doing the work (b) engages an incompetent contractor (c) activity contracted for is a nuisance per se -- Work that would necessarily require the creation of a condition involving particular risk of harm to others unless special precautions are taken if the contractor fails to take those precautions Majestic Realty Associations: Principal landowner may be liable for acts of construction crew where demolition of wall above the TP tenants business led to damage of TPs building and goods - Landowner was not financially irresponsible in hiring crew - Jury could find that work of demolishing a building in the city is inherently dangerous, subjecting principal to liability (2) Ultra-hazardous: Principal is liable for acts of the agent when the activity: (a) necessarily involves a serious risk to harm to the person, land, or chattels of others, which cannot be eliminated by the exercise of the utmost care (b) is not a matter of common usage

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LIMITED LIABILITY FOR AGENTS --- There can be no recovery from an agent for non-feasance alone BUT: If the agent has assumed and commenced such exclusive control of an operation as to warrant saying that he failed to discharge the duty he had assumed Franklin: Building manager may be liable for damages for failing to fix defects where P was injured in revolving door, if the manager was in complete and exclusive control of the building - P must allege that the agent is in complete and exclusive control ISSUE: When has the agent commenced a duty for which he can be found liable? Misfeasance vs. Non-feasance (a) Control = managerial power over duty as issue (b) Acceptance or commencement of assigned duty --- 438: When should the principal reimburse the agent for expenditures? (1) A principal is under a duty to indemnify the agent in accordance with the terms of the agreement with him (2) Principal has a duty to indemnify the agent where the agent: (a) makes a payment authorized of made necessary in executing the principals affairs OR, unless he is officious, one beneficial to the principal (b) suffers a loss which, because of their relation, it is fair that the principal should bear Ex: Drivers expected to make difficult turns on a daily basis IV. Duties of Agents --- Duties of the agent -- 382: Keep and render account of money or other things received or paid on behalf of the principal -- 383: Act in the principals affairs only in accordance with the principals manifestation of consent -- 384: Not to render service which subjects the principal to risk of expense if it reasonably appears to him to be impossible or impracticable for him to accomplish the objects of the principal -- 385: (1) Obey all reasonable directions in regard to the manner of performing the service (2) Not to act in manners entrusted to him on account of the principal contrary to the directions of the principal --- 388: Duty to return profits Agent who makes profit in connection with transactions conducted by him on behalf of the principal is duty to give such profit to the principal under a

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--- If servant makes profit for himself, and his service plays a predominant part in his obtaining the money, then he is accountable for it to the master Consider: Assets under his control, position he occupies, and facilities he enjoys BUT: Service cannot merely provide the opportunity to get profit (ex: Engaging in trade on the job) Reading: Army officer wore uniform on private ship in order to pass the Cairo civilian police without inspection and was paid for escorting the ship - Government (as employer) was entitled to money, because wearing of the uniform was the sole cause of the officer receiving the payments SECTION II: Choice of Entities
General Characteristics / Management Sole Proprietorship Single person engaging in business by himself -- Aggregate of individual partners -- Each has authority to bind others Federal Income Taxation Taxed as income to individual -- Taxed as income/loss to partners = 1 tax --Pass through taxation -- Partnership return filed; but no tax paid -- Certain events may dissolve the partnership -- Either partner has power to dissolve (breach) -- Assignee receives limited right, unless other partners agree General partners: May dissolve Limited partners: Only cause dissolution and winding up by court decree -- May dispose, but assignee receives limited rights Depends on the terms of the operating agreement; -- More freely transferable than partnerships; not as free as corporations Continuity of life / Transferability Formality / privacy Registration with valid name Few legal requirements -- But, can be very complicated for large entities

Formation

Liability Unlimited for owner; agency law applies to all employees hired

Agreement between the parties

Partnership

358.150(1): Unlimited for partners; jointly and severally liable for all partnership debt

Limited Partnership

General partners: Share authority Limited partners: No authority

Based on agreement; but also must file certificate with state

General partners: Joint and several liability for debts Limited partners: Liability limited to investment

Few legal requirements

Limited Liability Company (L.L.C.)

-- Any # of members -- No loss of power to board of directors -- Member managed: Owners, like partners, have power to bind --

Based on agreement; but also must file certificate with the state

347.057: Members (owners) not personally liable for company debts

Depends on how members, partners or shareholders file first taxes

Must maintain registered agent in the office; in between partnerships and corporations

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Corporation

--Separate legal entity -- Controlled by directors who have no financial interest Limited to 75 shareholders; must all be individuals

Grant of charter by the state

351.275(1): Liability limited to shareholder investment; not liable for corporate debts

S Corporation

-- Special rate -- Distributions to shareholders are taxable to holders -- Entity level taxation; corporation taxed as well -- Only shareholders pay; entity level does not exist

-- Perpetual existence; shareholders have no power to force dissolution -- Assignee receives full rights

-- Directors; president; secretary -- Minutes kept and annual report filed -- Must file in each state

II. Limited liability issues: --- Corporations: Limited liability may make investment by creditors unappealing Think: Failure to internalize risks -- Possible for shareholders to personally guarantee debt; essentially eliminates personal liability Piercing the corporate veil = allows creditors to avoid limited liability (very rare cases) REMEMBER: Incorporated small businesses will not protect owners who are also workers, who are personally negligent --- Partnerships: Unappealing form of business due to personal liability to partners -- Possible to obtain insurance to protect assets BUT: Not possible to be insured for catastrophic liability (Think: Fire in nightclub) --- Professional corporations: Set up LLC, then enter agreement to be jointly and severally liable -- Protect enterprise over individuals -- Instill client confidence by showing personal responsibility -- Separate malpractice liability leads professionals to not risk minimal involvement (i.e. take a phone call and quickly answer a client question) CONSIDER: Buying shares in other corporations or LLCs prevents liability from rising to share-buying entity (Liability is imposed on corporations and LLCs themselves) TREASURY REGULATIONS: Kitner regulations determine if an entity is a partnership or a corporation -- Does some person have unlimited liability? ; Yes = partnership NOW: Check the box taxation: Enterprises determine how they want to be taxed -- Unless they are actually corporations, where they must choose C or S AND: States created statutes permitting LLCs in order to allow enterprises to have limited liability and single taxation

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Section III: Partnerships I. Formation of a partnership: --- 358.060(1): Association of two or more persons to carry on as co-owners a business for profit --- Burden of establishing partnership falls on party alleging that it exists (Fenwick) -- If denied, it may be proved by written instrument, testimony as to a conversation, or by circumstantial evidence (Martin) (A) Partners compared with employees --- Court will consider numerous factors in determining if a partnership relationship exists: (a) Intention of the parties though the agreement itself is not conclusive (b) Right to share in profits (c) Obligation to share in losses (d) Ownership and control of partnership property and business (e) Community of power in administration exclusive control of management is telling (f) Language of the agreement (Call themselves partners?; Are ordinary powers enumerated?) (g) Conduct of the parties towards third persons (h) Rights of the parties on dissolution (End business, or does one party continue easily?) (AND) Degree of activity of the business indicates partnership --- Sharing of profits is not a prima facie evidence of a partnership where profits are shared as wages of an employee --- Intent of the parties as evidenced by the title of the agreement is not conclusive Fenwick: Secretary sought additional pay and was granted 20% interest, but did not share any other characteristics of a partner, and was not considered a partner (See list) - Look at relationship between the parties, not just what they call themselves

(B) Partners compared with investors protecting interest Martin: P was creditor of firm, seeking to enforce debt against Ds who invested in the firm, but agreement did not sufficiently involve the lenders to be considered a partnership Factors merely showing protection of investment, not necessarily a partnership:

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-- Loaned $2,500,000 worth of liquid securities -- Lenders receive 40% of the profits (Between $500,000 and $100,000) -- Securities were not mingled with firm securities -- Life insurance on manager of the firm, manager named by lender - Manager has power to fire partners -- Trustees may inspect books, and are to be consulted on important matters -- Trustees may veto to safeguard loan, but may not bind the firm -- Lenders were given option to enter firm BUT: No power to trustees to maintain partnership, may be dissolved at any time

(C) Partnership by estoppel: --- 358.160: (a) Person who represents himself or permits another to represent him -- Must be an act of the defendant; cannot be held liable as partner without doing something to make himself look like a partner (b) to anyone as a partner in an existing partnership or with others not actual partners (c) is liable to any such person to whom such a representation is made (d) who has on the faith of the representation given credit to the actual or apparent partnership AND: If such representation is made in a public manner, he is liable even if such representation has not been communicated to such person giving credit Young: P lost $ in investment after PW-Bahamas provided audit of SAFIG, but P sought to sue PW-US as a partner of the Bahamas branch, because Price Waterhouse was held out to the P - Different branches of PW hold shares in common LLC (PW-WW); P claims that brochure cast PW as worldwide firm BUT: P did not rely on that representation in doing business with PW-Bahamas AND: No credit was extended to PW

name

(D) Other rules: --- 358.070: Rules to determine if a partnership exists (2) Joint tenancy, tenancy in common, tenancy by the entireties, or part ownership does not conclusively determine that a partnership exists, whether or not the parties share profits generated by the property (3) Sharing of gross revenues does not itself establish a partnership, whether or not there is a common interest in the property from which revenue is generated (4) Receipt of profits of a business is prima facie evidence that he is a partner in the business BUT: No such inference shall be drawn if profits were received as payment: (a) As a debt by installments or otherwise (b) As wages of an employee or rent as a landlord (c) As an annuity to a widow or representative of a deceased partner (d) As interest on a loan (e) As the consideration for the sale of a goodwill of a business or other property

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--- Sharing profits is prima facie evidence of a partnership -- Sharing of profits is different from sharing expenses; but sharing of expenses can be an element of profit and can be considered as such Stewart: Agreement where doctor was purchasing 4% interest in medical center included provision whereby doctors received payment based on expenses and total center revenue - Payment formula leads to profit-sharing; presumption of partnership agreement

II. Fiduciary obligation of partner --- 358.210: Every partner must account to the partnership for any benefit: AND: Hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the partnership or from any use by him of its property --- A partner is held to something stricter than the morals of the marketplace; not honestly alone, but the punctilio of an honor the most sensitive Meinhard: P invested with D as manager in a joint venture with a long term lease on hotel property, but D renewed the lease including additional property with a different investor without informing P -- D had a duty to concede the new plan to his partner in the first venture, because benefit of the first venture was ability to renew lease - P should have been able to compete for lease -- Opportunity to renew lease was derived from the operation of the current partnership CONSIDER: Opportunity came from Ds abilities rather than the current business --- Pre-resignation solicitation of clients may breach fiduciary duty to partners should only occur after notice to leave is given -- Do as much as possible after giving notice Graubard: Partner in law firm gave notice of transfer to another firm, but proceeded to solicit large client to move with him to another firm before actually transferring -- OKAY = Locate alternative space and affiliations while still in partnership - May inform clients of impending departure, but, ideally, only after giving notice to the firm of the partners plans to leave -- NOT OKAY = Secretly attempting to lure clients to the new association or lying to partners about plans to leave NOTE: Client lists: Depends on factual context -- Partners own clients and own list = okay -- Taking whole firm list, or those of others; stealing lists from others = not okay III. Rights of partners in management

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(A) Agency in Partnership: Apparent authority to TPs --- 358.090: (1) Every partner is an agent of the partnership for the purpose of its business AND: The act of every partner, for apparently carrying on in the usual way of business of the partnership binds the partnership UNLESS: The partner so acting has no such authority to act for the partnership in the particular matter and the person with whom he is dealing has knowledge that he has no such authority Ex: If majority of partners vote against action under 358.180(8) and TP is aware of this REMEMEBER: Even if partners vote no and one partner enters agreement anyway, all partners are bound to the agreement as long as it is usual way of business -- Need not be a daily activity; interpreted broadly No qualitative change in business (2) An act of a partner which is not for the carrying on of the business of the partnership in the usual way does not bind the partnership unless authorized (3) Unless authorized by the other partners or unless they have abandoned the business, all partners must agree in order to: (1) Assign the partnership property in trust for creditors (2) Dispose of the goodwill of the business = Value of the business name / logo, etc. (3) Do any act which makes it impossible to carry on the ordinary course of business (4) Confess a judgment (5) Submit a claim to arbitration (4) No partner acting in contravention of a restriction of authority shall bind the partnership to persons having knowledge of the restriction (B) Rights and Duties of Partners: Actual authority for partners to act --- 358.180: Rights and Duties of Partners Subject to any agreement between the partners: (1) Each partner shall be repaid the partners contributions AND: Share equally in the profits and contribute toward the losses (2) The partnership must indemnify every partner in respect of payments made and personal liability reasonably incurred by the partner in ordinary and proper conduct of business (3) Partner who advances more than his share, shall be paid interest (4) Partner shall be paid interest on capital contributed only from the date when repayment should have been made (5) All partners have equal rights in management and conduct of the partnership (6) No partner is entitled to remuneration for acting in the partnership business (7) No person can become a member of a partnership without the consent of all partners

17

(8) Any difference as to ordinary matters connected with the partnership business may be decided by the majority of the partners BUT: No act in contravention of the partnership agreement may be done rightfully without consent of all partners --- 358.270: Assignment of a partners interest Conveyance by a partner of his interest does not dissolve the partnership BUT: Does not entitle the assignee to interference in management or to require any information about the partnership -- New partner only receives profits to which the assigning partner would be entitled KEY: Look to power partners had before dealing with TP = agreement + ordinary course voting -- For actual (express or implied) authority: DISPUTE BETWEEN PARTNERSHIP AND TP: --- In the absence of a majority vote among the partners, each partner retains the power to bind the partnership in all matters In cases of even division as to whether or not an act within the scope of the partnership should be done, third parties can still enforce agreements, even if the TP has knowledge of the dispute among the partners --- Minority of partners cannot remove themselves from liability by informing TPs of objection to acts of other partners National Biscuit Company: Co-partners in grocery store disagree over continued use of bread vendor and one partner informs vendor of his objection, but the other continues business with the vendor -- Each partner retained the right to bind the partnership and the TP has a claim against the partnership as a whole, including both partners DISPUTE BETWEEN PARTNERS ONLY: --- If partner acts without partnership authority under 358.180, but acts with apparent partnership authority under 358.090, then partnership is still liable to the TP BUT: Partner who acted without authority is liable to others partners for the debt --- If partner acts without consent of other partners (Think: Split vote), then the partnership is still liable to TP BUT: Acting partner will not be reimbursed for expense, if he acted without actual authority OR: Non-consenting partner may sue for damages to compensate partnership Summers: Partners in trash collection business each worked and personally hired replacement when they could not work; one partner sought to permanently hire help, but the other partner disagreed. When partner chose to hire another person the non-acting partner was not required to reimburse the acting partner for the cost -- Hiring was not for the benefit of the partnership itself, but only for one partner

extra anyway,

18

-- P did not have actual authority to hire permanent worker, because it was not in the ordinary course of business; therefore no reimbursement from D BUT: Had TP not been paid, partnership would be liable as a whole --- Partnership agreement can define the bounds of partnership authority and duties EXCEPT: Apparent authority to act for partnership / Partner liability for partnership debt -- Change in management does not require unanimous consent of partners Sidley & Austin: P Senior partner in Washington office had position adjusted with merger approved by the executive committee and brought claims of wrongful dismissal and breach of fiduciary duty -- Under partnership agreement executive committee could adjust internal structure of partnership with only a majority vote (admission / severance) -- P had no legal right to his position IV. Liability of Partners --- 358.110: Partnership bound by admission of partner An admission or representation made by any partner concerning partnership affairs within the scope of his authority is evidence against the partnership --- 358.120: Notice to a partner Notice to any partner of matter relating to partnership affairs, and the knowledge of any other partner who reasonably should have communicated it to the acting partner operate as notice to the partnership EXCEPT: In the case of fraud on the partnership committed by or with the consent of that partner --- 358. 130: Partnership bound by partners wrongful act Partnership is liable to the same extent as the acting partner where, by any wrongful act or omission in the ordinary course of the business of the partnership, or with the authority of the co-partners, loss or injury is caused to any person not in the partnership -- Negligent in ordinary course of business (scope of employment) = partnership liable -- Wrongful act is more difficult to find in the ordinary course (Remember: tortuous acts cases) REMEMBER: Gross negligence is no different than ordinary negligence - BUT: Then it is more difficult to find it to be within the scope of the business --- 358. 140: Partnership bound by breach of trust Partnership is bound to make good the loss: (1) Where the partner acting within the scope of his apparent authority receives money or property of a third person and misplaces it (2) Where the partnership it the course of its business receives money of a third person and it is misapplied while in the custody of the partnership --- 358.150: Liability of Partners All partners are jointly and severally liable for everything chargeable under .130 and .140 and for all other debts of the partnership AND: Any partner may enter into a separate obligation to perform a partnership contract --- 358.170: Liability of incoming partner Person admitted as a partner to an existing partnership is liable for all the obligations of the partnership arising before his admission, except that this liability shall be satisfied only out of partnership property 19

--- Liability of Limited Partnerships: Require formal state filing --- Limited liability partnerships: 358.440 -- No partner liability for partnership debt --- Limited partnerships: 359.020, etc. -- Limited partners (investors): No personal liability - Could not be active in the business or lose personal protection (Issue: When active?) - Now: Either partner type can be active without losing limited liability: 359.201 -- General partners (managers): Unlimited personal liability V. Dissolution of a partnership: Change in the relation of the partners caused by any partner ceasing to be associated in the carrying on, as distinguished from the winding up of the business (358.290) -- On dissolution, partnership continues until winding up of partnership affairs is completed (358.300) --- Conveyance by a partner of his interest does not dissolve the partnership: 358.270 BUT: Does not entitle the assignee to interference in management -- New partner only receives profits to which the assigning partner would be entitled --- 358.310: Causes of dissolution (1) Without violation of the agreement between the partners: (a) By the termination of the definite term of particular undertaking specified in the agreement (b) By the express will of any partner when no definite term or particular undertaking is specified -- May always end partnership, but could face liability under (2) (c) By express will of all partners who have assigned their interests (d) By expulsion of any partner from the business bona fide in accordance with such power conferred in the agreement (2) In contravention of the agreement between the partners, where the circumstances do not permit a dissolution under any other provision of this section, by the express will of any partner BUT: 358.380: Each partner who has not wrongfully caused dissolution, may sue for damages AND: Partner who has not wrongfully caused dissolution may continue the partnership (3) By any event with makes it unlawful for the business of the partnership to be carried on (4) By the death of any partner (5) By the bankruptcy of any partner or the partnership (6) By decree of the court under 358.320 --- 358.320: Dissolution by decree of the court BENEFIT: Permits immediate court ruling on issues of partnership debt and capital return -- Court can apportion fault to ensure that P is not harmed due to Ds misbehavior (1) On application by or for a partner court shall issue a decree of dissolution whenever: (1) A partner is shown to be mentally incapacitated (2) A partner become in any other way incapable of performing his part of the partner agreement

20

(3) A partner has been guilty of such conduct as tends to prejudicially affect the carrying on of the business (4) A partner willfully or persistently commits a breach of the partnership agreement OR: So conducts himself in matters relating to partnership business that it is not reasonably practicable to carry on the business with him (See Owen below) (5) The business of the partnership can only be carried on for a loss (6) Other circumstances that render dissolution equitable (2) On the application of the purchaser of a partners interest under 358.270-.280 (1) After the termination of the specified term or undertaking (2) At any time if the partnership was a partnership at will when the interest was assigned or when the charging order was issue --- Courts of equity may order dissolution where there are quarrels and disagreements of such a nature and to such extent that all confidence and cooperation between the parties has been destroyed OR: Where one of the parties by his misbehavior hinders a proper conduct of the business Owen: One partner sought to be dominating figure in bowling alley business by undermining the other partners authority on business matters -- One partner cannot constantly minimize the importance of the other without undermining the basic status upon which a successful partnership rests -- Sought court dissolution, because express will of one partner cannot dissolve where partnership is in particular undertaking: Loan to be paid back over time --- Right to wind-up partnership business: 358.370 Unless otherwise stated in the partnership agreement, partners who have not wrongfully dissolved the partnership have the right to wind up partnership affairs -- Power of partner to bind partnership after dissolution (Winding up partners): 358. 350 (1) Partner can continue to bind partnership for any act appropriate for winding up the partnership (3) Partnership is not bound by acts of a partner after dissolution (1) Where the partnership is dissolved because it is unlawful to carry on the business UNLESS: The act is appropriate for winding up partnership business (2) Where the partner has become bankrupt (3) Where the partner has no authority to wind up partnership affairs --- Dissolution Settling accounts: 358.400 (2) The liabilities of the partnership shall rank in order of payment Count each as partnership debt (a) Creditors other than partners (b) Partners other than for capital and profits (Think: Loans / advances to partnership) -- Liability not owed to partner under (b), if paid to TP by partner without authority (c) Partners in respect to capital (d) Partners in respect to profits (4) Partners shall contribute as provided by 358.180 to satisfy all liabilities -- Each partner must contribute towards the losses, whether of capital or otherwise, sustained by the partnership according to the partners share in the profits

21

(b) If partner is insolvent others must contribute to his share of liability in proportion to their share of profits --- In the absence of an agreement, partners participate equally in profits and losses, irrespective of any inequality in the amounts each contributed to the capital BUT: Where one partner contributes capital and another labor, neither is liable to the other for any loss -- Both partners are still liable for debts owed to third parties Kovacik: One partner in kitchen remodeling business contributed $10k investment, while the other acted as superintendent, but contributed no funds; agreed to spit profits 50-50 -- D is not liable to P for his loss of investment, because each contributed different assets to the business and shared in losses as such NOTE: Straying from Kovacik (strict construction) any deviation from complete money / labor division suggests that losses will be split evenly SECTION IV: CORPORATIONS I. Choice of law issues --- R. 2d. Conflicts, 296: Business corporation must comply with the requirements of the state in which incorporation occurs, regardless of the location of activities, shareholders or officers --- 302: Corporation liabilities Issues involving the rights and liabilities of a corporation are determined by state law of the state the most significant relationship to the occurrence at issue

with

--- 307: Shareholders liabilities The local law of the state of incorporation will be applied to determine the existence and extent of a shareholders liability to the corporation Choosing a state of incorporation: --- MO Practice Guide 10.3: If the corporation is closely held and its business is to be conducted in MO, then incorporation in MO is preferable (1) Cost of incorporating in DE and doing business in MO from there is too high (2) Business must maintain both foreign and domestic qualifications in DE BUT: When a corporation intends to make a public offering, cost is only a minor factor -- Ease of operation and liberalness of corporation statutes favors DE -- Appeals to investors -- Understood common ground of corporate law REMEMBER: Race to the bottom is over not too many ways that DE law is actually better -- Benefit is that DE law has been fully developed on issues of corporate law -- DE court system is more streamlined for corporate cases II. Formation of a corporation: --- Articles of incorporation: Form filed with secretary of state in order to have certificate of corporation issued (351.060)

22

--- 351.055(1): Requirements of the Articles: (1) The name of the corporation under the provisions of 351.110 --- 351.110: (1) Shall contain the word corporation, company, incorporated or limited or such abbreviation (2) Shall not contain any word or phrase which indicates or implies that it is a governmental agency or organized for any purpose for which a corporation cannot be organized (3) Shall be distinguishable from the name of domestic corporations existing under the law of this state or foreign corporations authorized to transact business in this state --- Possible to transact business in another name than name under incorporation; but must register fictitious name (417.200) (2) Registered office and registered agent with addresses -- If no actual office, then find business to forward information to operational corporate office in another state -- Use home address of incorporator, if no location is operational in state of business (3) If aggregate number of shares, or total par value exceeds $30,000, the articles must indicate the number of shares of each class as well as and special rights associated with each class -- Must at least state par value, to determine if aggregate if over 30k -- Articles usually lay out information regardless of statutory requirement (4) The name of the physical business or residence address of each incorporator -- Incorporators must be people over the age of 18 (351. 050) (5) The number of years the corporation is to continue, which may be any number or perpetual (6) The purposes for which the corporation is formed -- Draft broadly: The purpose shall be to engage in any lawful business (351.020) --- 351.055 (2): Optional provisions in articles Required steps after formation in (1) (1) The number of directors to constitute the board of directors May also state who will serve of first board of directors --- If not stated, then the incorporators, by unanimous vote at a meeting or by written consent, shall have the power to adopt bylaws (set number of directors) and name persons to constitute the first board of directors [351.080(1)] -- Or at subsequent meeting, if not done at first meeting --- If incorporator does not adopt original bylaws, the directors may do so after being appointed [351.290(1)]

23

(2) The extent to which the preemptive right of a shareholder to acquire additional shares is limited or denied -- Default is preemptive rights, unless otherwise stated in articles (3) Eliminating or limiting the personal liability of the director for breach of fiduciary duty Ex: Limited only to gross negligence, not simple negligence (4) Any other provisions not inconsistent with law --- Articles must then be signed by the incorporator (351.050) --- Articles are then delivered to the Secretary of State [351.060(1)] --- SOS will file and issue a certificate of incorporation [351.060(2)] III. Powers contained in the articles: Define shareholder privileges --- A shareholder in a corporation tacitly consents to any subsequent amendment of articles of incorporation designed to enable the corporation to conduct its business in a more profitable manner -- Corporate articles may permit majority shareholders to alter articles, even to the extent that it may deny minority shareholders of a property right Gaddy: Minority shareholders sought to prevent reverse stock split that required all shareholder with less that one share (after 1,000 to 1 conversion) to sell shares to majority at set price -- Mandatory sale deprived stockholders of property right BUT: Articles of incorporation permitted majority holders to amend the articles - Minority holders consented to such changes by purchasing stock in corporation with such article provisions; including reverse split IV. Pre-formation transactions: Should not generally occur due to ease of forming corporations (A) Liability for TPs contracting with future corporations: --- One who contracts with what he acknowledges to be and treats as a corporation, incurring obligations in its favor, is estopped from denying its corporate existence Southern-Gulf Marine Co.: P corporation sued D for breach of contract in the sale of a ship, where President of corporation entered agreement prior to incorporation; D claimed that corporation was not yet formed and eventually incorporated in Cayman Islands, not Texas as stated -- Legal status of corporation is not material for contract issues; D is liable -- Change in location was accepted by D, when P made D aware of the change (B) Liability for promoters: --- 351.053: Liability for pre-incorporation transactions All persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this chapter, are jointly and severally liable for all liabilities created while so acting

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--- Promoters are personally liable on contracts, though made on behalf of a corporation to be formed UNLESS: the contract is made on behalf of the corporation and the other party agrees to look to the corporation and not to the promoters for payment = Intent of parties is key -- Other party must know that the promoter is acting on behalf of a corporation, otherwise the default rule applies Look to language of contract Is the corporation the contracting party? Quaker Hill: P sold nursery stock to D Parr, as President of Denver Memorial Nursery, but a corporation in this name was never formed -- Parr was not personally liable, because P insisted that Parr use the corporate name during contract formation, and Parr did not represent himself as an agent of the corporation - P looked to the corporation alone to fulfill the terms --- 3 contractual arrangements involving a promoter: R.Agency 326, cmt. b: (1) An offer or option to the corporation to be formed with will result only if it is accepted by the corporation when formed Remember: Option needs to be supported by consideration (2) Promoter is bound, but his liability terminates if the corporation manifests its willingness to become a party = Future Novation -- Must be an agreement in the contract to relieve promoter of liability; it is not enough that the corporation later becomes a party - Payments by corporation similarly do not relieve promoter without agreement -- Authorization by the corporation must be made by proper corporate action (3) Corporation later becomes a party, but promoter remains liable either primarily or as a surety Stanley J. How & Assoc., Inc: Architect sued developer of hotel for services rendered where developer named Boss acted as agent and signed on behalf of corporation, formed, who will be the Obligor. -- Will be obligor suggests that corporation would take liability in the future -- Promoter must have liability to begin AND: Because it was not expressly stated, adoption by the corporation does not necessarily relieve the promoter --- May also be approached this way: Promoter undertakes obligation to form the corporation, then corporation is liable under contract -- Promoter breaches his duty under contract if the corporation is never formed (C) Liability for the corporation and non-promoting investors: Caveat Emptor: Venders beware (1) Board of directors must adopt contracts entered by promoters OR: Accepts the benefits = adoption by action

to be

25

(2) Signers of articles of incorporation thereby gives no authority to his cosigners and does not make them agents, prior to the conclusion of incorporation cosigners are not liable to TPs for acts of others -- TP must inquire as to a signers authority to act for the others -- Others not liable without express or implied authority given to acting investor Mendenhall: Ds signed articles to incorporate a drug store, but prior to incorporation, one investor entered a contract with P to purchase good without the others knowledge -- Goods were delivered to yet-to-form corporation, but Ds not liable -- No apparent or implied actual authority based only on attempted incorporation --- 351.075: If certificate is issued by SOS, the corporation exists --- If the promoter acts on behalf of a corporation that fails to properly form = Defacto corporation -- Legality of the corporation cannot be attacked collaterally where (1) There is a special statute under such a corporation may lawfully exist (2) A bona fide attempt to organize under the law and colorable compliances with the statutory requirements (3) Actual user or exercise of corporate powers in pursuance of such law and attempted organization V. Corporate Purposes & Ultra Vires; Purpose dictates the powers available --- 351.020: Corporations for profit may be organized under this chapter for any lawful purpose --- 351.385: Corporation powers (2) Sue and be sued (4) Purchase, take, lease, deal, etc. in property (8) To invest its surplus from time to time and to lend money (9) Conduct business within and without this state (14) To have and exercise all powers necessary convenient to enact the purposes for which the corporation is formed (15) To make contributions to any corporation organized for civic, charitable, benevolent, scientific or educational purposes OR: To any incorporated or unincorporated association, community chest or community fund, not operated or used for profit (A) Intended beneficiary --- Present state legislation embodies incidental powers under common-law principles allowing corporations to make charitable contributions -- Gift must be made to advance corporate goals or general community benefit; cannot be made indiscriminately, excessively, or to further personal aims of board members A.P. Smith Mfg. Co.: Corporate board of pipe manufacturing company sought to make donation to Princeton University, but shareholders enjoined gift, arguing that charitable gifts are not within corporate purpose -- State statute permitted gifts within specified range (1% of capital) -- Gift to university furthers corporate aims community development and workforce enhancement even though not in specific industry

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(B) Amount of gifts --- Business judgment rule: Courts will not interfere in management of the directors, unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds Includes gifts to pet charities designed to serve interest of directors, not business OR: If they refuse to declare dividend when the corporation has a surplus of net profits --Generally, directors have the power to declare a dividend of the earning and the amount Dodge: President and majority shareholder (58%) sought to end payment of dividends in highly profitable automobile business in order to save additional funds and reinvest in another plant to spread wealth, but 10% shareholders enjoined construction of new plant and demanded payment of dividends -- Dividends should be paid, because a corporation must operate for the benefit of shareholders and adequate funds are available to do so BUT: New plant can also be built, because it advances corporate interests

(C) Ultra Vires Beyond the purpose of the business --- 351.386: Corporate Purposes Every corporation may engage in any lawful business, unless a more limited purpose is set forth in the articles of incorporation BUT: Corporation is not restricted to this limited purpose, unless it has stated that it is so restricted its powers in the articles of incorporation --- 351.395: Conveyance of property by board of directors Ultra Vires is not ground for either party to set aside the contract BUT: Directors without authority could face liability --- No act of a corporation is invalid because corporation lacked capacity for conveyance BUT: Lack of capacity may be asserted: (1) In a proceeding by shareholders against the corporation to enjoin the doing of any acts or the transfer of property (2) In a proceeding by the corporation, whether acting directly or through a representative, or shareholders against officers of the corporation (3) In a proceeding brought by the attorney general to dissolve or enjoin the corporation --- Corporation lacks standing to sue itself where action was not within corporate purpose to prevent financial transaction Charter: D agreed to loan Investment Co. $200 million, but only if the loan was secured by property owned by Charter; but Charter received no consideration and later sought to avoid foreclosure of property

27

-- President of Investment Co. was involved in both companies, leading Charter to secure loan for no reason -- Charter cannot avoid obligation by claiming ultra vires --- Benevolent intent of directors (rather than expected profit-seeking behavior) is not enough to interfere with business management -- Courts cannot interfere with corporate decisions unless they are tainted with fraud or a breach of good faith Shlensky: Minority shareholder in Cubs organization failed to state a cause of action for negligence and mismanagement, where corporation failed to install lights in park (supposedly losing revenue), because the President did not want to cause deterioration of the neighborhood with night games -- State of surrounding neighborhood is reasonable business consideration -- No evidence that lights, including costs, would be beneficial

IV. Shareholders: (1) Financial matters Types of Stock --- 351. 180: Issuance of Shares (1) Corporation may issue: One or more classes of stock, or series within a class -- Classes may have voting rights, limited voting rights, or no rights at all -- Classes may have special qualifications, or restrictions - Rights must be defined in articles of incorporation or bylaws (see below) - Facts outside formal documents may be used to determine if rights/preferences/restrictions apply, but only if reference to such facts is made in formal documents LIMITATION: Cannot guarantee profits from shares --- Categories must be specified in articles of incorporation OR: By board if such power is vested in the board in the articles -- (7) Certificate of designation must be filed with SOS -- Authorized shares: Number stated in the articles of incorporation; sets an outer limit that can only be changed with amendment to articles -- Issued shares: Number of shares sold by corporation, first time around -- Outstanding shares: Number of shares currently held by someone other than the corporation -- Treasury stock: Shares issued by the corporation and later bought back Outstanding (less than or equal to) Number of issued (less than or equal to) authorized

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(A) DEFINITIONS: --- 351.015(17): Stated capital means the sum of: (a) The par value of all shares, then issued, having a par value (b) The consideration received for all shares issued without par value; unless stated elsewhere under law (c) Amounts not covered that were transferred to capital account from issue of shares of dividends or otherwise, minus formal reductions permitted under law --- 351.015(11): Net assets do not include shares owned by the corporation itself -- Treasury stock: Shares issued by the corporation and later bought back Corporation does not have voting rights when holding own share [351.245(2)]

(B) REDEMPTION: --- 351.200(2): Any corporation, by resolution of its board, may redeem shares --- 351.180(2)(1): The stock of any class may be subject to redemption by the corporation or at the option of the holder, provided that the corporation shall have a class of outstanding shares with full voting powers that shall not be subject to redemption -- Call right: Right held by the corporation to redeem a share at any time - Usually requires a specified payment -- Put right: Right held by shareholder to force corporation to redeem a share at any time (C) PAR VALUE -- Why have penny par? --- No par share: All consideration goes into stated capital -- Cannot pay dividends out of stated capital board could move funds, but why bother? --- Penny par share: Only par value counts as stated capital, actual consideration received counts as paid-in surplus Minimal floor of stated capital prevent deficit spending on dividends --- 351.185(1): Minimum price at which a corporation can issue a share, fixed by board of directors -- If redeemed and resold, then shares may be sold at any price --- 351.245: Directors liable if sell par value stock below par value = watered stock

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--- 351.015(12): Paid in surplus = Amount over par value taken as consideration for par value shares

(D) DIVIDENDS: Assets Liabilities Stated capital (Accounting for paid in surplus) = Amount available to pay dividends --- 351.220(1): Dividends can be paid out of assets (earned surplus) --- 351. 220(2): Dividends may be paid out of paid in surplus, but restrictions apply --- 351.210(3): Each distribution shall be identified as a liquidating dividend and the amount per share shall be disclosed to shareholders receiving the same, concurrently with payment thereof --- 351.345: If dividends are paid out of stated capital, then the directors are liable to the amount of the improperly paid dividends AND: Cannot pay dividends into insolvency Although stated capital is low (penny par), places limit

--- Other issues in paying dividends: (a) STOCK SPLIT: Basically a non event, because assets remain unchanged --- 351.220(6): Stock split is not considered a dividend restrictions do not apply (b) STOCK DIVIDEND: --- 351.220(3): If dividend is payable in its own shares having a par value, such shares shall be issued at the part value thereof and is transferred to stated capital at the time paid -- Stock dividend is considered a dividend, so restrictions apply TYPES OF DIVIDENDS: Defined in the articles of incorporation --- Preferred shares: Paid dividends before dividends are paid to common stock --- Common stock (Participating dividend): Paid residuary of dividend total --- Preferred Participating: Preferred shares a paid first and are paid along with common shares as well --- 351.180: May have different classes of stock and series within each class, with different rights ONLY LIMIT: Cannot call a share, unless there is an outstanding class with full voting rights that is not callable --- MBCA 6.01(b): (1) One or more classes of shares with unlimited voting rights (2) One or more classes of shares that are entitled to receive the net assets of the corporation upon dissolution

--- Convertible right: Right on the share to change from one type of share to another

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-- Option to change between preferred and common shares -- Share change based on extrinsic event LEVERAGED INVESTMENTS: Risk higher, but reward greater --- Borrow money to invest, such that interest earned is greater than interest paid on debt

(2) Voting Rights of Shareholders: (A) Voting control: Limited powers by shareholders --- Articles of incorporation may define the voting rights to each class of stock -- May limit right to receive dividends, but still permit shares the power to vote Stroh: IL constitution guaranteed stockholders the right to vote based shares held; D issued class B shares, entitled to no dividends or proceeds at liquidation -- Shareholder cannot be deprived of voice in management under the IL constitution, but need not retain an economic interest --- Directors may not abrogate their independent judgment by agreements entered into with stockholders or with each other -- Agreement among stockholders cannot divest directors of power to discharge an unfaithful employee, because it is against public policy Similarly, shareholders cannot force directors to elect/retain officers or fix salaries McQuade: D was majority shareholder and sold shares to P under agreement that D would help retain parties as directors and officers at specified salary, but could appoint other directors as D saw fit; P eventually fell out of friendship with D and was not elected as a director - Illegal against public policy to restrain directors from choosing officers

they

--- Though directors must exercise independent judgment, shareholders may combine to elect directors -- It is not illegal or against public policy for two or more stockholders owning the majority of the shares of stock to unite upon a course of corporate policy, or upon the directors whom will elect -- Shareholders have the right to combine their interest and voting power to secure such control of the corporation and the adoption of and adhesion by it to a specific policy and course of business CONSIDER: As directors, corporation can enter contract to agree to keep one director as officer and will be subject to breach if he is removed

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--- Where the directors are the sole stockholders, they may enter agreements to vote for certain officers BUT: Cannot sterilize the board of directors, may only set reasonable restrictions on director authority (1) All Directors are involved (2) Limitations are reasonable Good for the corporation If retention is based on performance of the corporation, then all provisions in McQuade could be valid Ex: If not inconsistent with the fiduciary duties of the directors, then McQuade is to be retained as a director and officer. Clark: P (Clark) owned 25% of stock and D (Dodge) owned 75% in 2 corporations; parties entered agreement, whereby P was to continue as director with set salary to leave formula for medicine to Ds son upon his death; P sued for breach not keep him as director -- No harm to public due to closely held nature, agreement can be enforced -- Agreement only required that P be retained if acting efficiently -- Court limited salary of P to % of net income, so directors are not completely restrained by this provision

and was when D did

(B) Meetings --- Duly Called Meeting Rule: If event occurs (vote, etc.) at a gathering that is not a properly called meeting, then anything happening at the meeting is invalid -- Also true if a meeting does not have a quorum --- 351.225: Shareholders Meetings Meeting shall be held at the place defined in the bylaws, or at the registered office -- Must hold annual meeting to elect directors (If no date set by bylaws, meet on 2nd Mon. in Jan.) - Required to keep minutes, so the corporation must have a meeting (351.215) -- Special meeting may be called by directors, or by persons defined in bylaws or articles - May be called to remove a director by a vote of the shareholders (351.315) -- MBCA 7.02(a): A corporation shall hold a special meeting: (1) On call of its board of directors (2) If holders of at least 10% of the votes entitled to be cast on an issue proposed to be considered call for a meeting and deliver written demands to the secretary of the corporation -- % requirement may be changed in articles, but not higher than 25% --- 351.230: Notice requirement Written or printed notice of meetings must be given between 10 and 70 days before the meeting to each shareholder of record entitled to vote at the meeting (See below on the books before closing) -- Attendance constitutes waiver of notice --- 351.250: Closing of Transfer Books

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Board of directors may close the transfer books within 70 days of a meeting or payment of dividend BUT: If no date is set, then only shareholders entitled to vote 20 days before meeting are entitled to notice of the meeting and have power to vote -- Those who dispose of shares between the record date and meeting date can vote -- Shares can be paid dividends based on side agreement if sold after record date - Ex dividend = without dividend - Cum dividend = with dividend --- 351.265(1): Quorum Requirement Unless stated in articles of incorporation or bylaws, a majority of outstanding shares entitled to vote at a meeting constitute a quorum (Proxy voters in attendance count) BUT: At least a majority of shares are required to have quorum (articles cannot lower requirement) -- Shares owned by the issuing corporation are not outstanding for quorum purposes [351.245(2)] (2) Majority of shares entitled to vote on a subject matter at a meeting is a valid act of the shareholders, unless stated otherwise by law, the bylaws or the articles -- Corporate action may be taken without a meeting if written consent is given by all shareholders with right to vote (351.273) --- 351. 268: Temporary Adjournment Meeting may be adjourned to a specified date not longer than 90 days after adjournment, unless otherwise stated in bylaws (C) Election of directors / voting powers --- 351.315 (1): A board of directors shall consist of one or more individuals with the number specified in the articles or bylaws --- 351.245(1): Unless otherwise provided in the articles, each outstanding share is entitled to vote on all matters (2) Shares owned by the issuing corporation do not vote (3) Unless stated in articles or bylaws, in electing directors, each shareholder casts: (Number of votes held) times (# of directors elected) -- May be cast in any distribution the voter sees fit -- Cumulative voting is permitted unless otherwise stated in the articles or bylaws -- Directors are elected by a plurality of the votes of shares DETERMINING NUMBER OF SHARES TO ELECT A DIRECTOR = Number of outstanding shares + .xxx Number of directors up for election +1 EX: Candidates Shareholder #1 (10) = 30 votes (Inefficient) A 25 B 5 C 0 D 0

33

Shareholder #2 (5) = 15 votes

-- Straight voting: Directors are permitted to cast total number of shares as votes for each -- Directors are elected by a majority of votes EX: Candidates Shareholder #1 (10) = 10 votes Shareholder #2 (5) = 5 votes A 10 0 B 10 0 C 10 0

candidate

D 0 5

Tie vote on last position: Run-off with open seats (# tied in first vote) +1 -- Majority shareholder who causes tie, allows minority to use all votes in first election, as well as run-off PROXIES: --- 351.245(4): A shareholder may vote in person or by proxy: -- Assumed to be revocable, unless stated that it is irrevocable and coupled with an interest -- Only valid for 11 months unless otherwise specified -- Proxy may be revoked by: intentional revocation or implicitly: death of the principal, execution of a later proxy, personal attendance at the meeting -- Proxy is assumed valid if regular on its face, unless challenged (5) Shareholder may grant proxy by: (1) Written and signed authorization (2) Authorization by electronic communication -- Proxy solicitation is often required for a quorum; any communication allowed -- Heavily regulated by FED securities law -- MCBA 7.22: An appointment of a proxy is revocable unless the appointment or transmission states that it is irrevocable and is coupled with an interest -- Interests include: (1) A Pledgee (2) Person who has purchased or agreed to purchase the shares (3) A creditor of the corporation who extended it credit under terms requiring appointment (4) An employee of the corporation whose employment requires the appointment

34

(5) A party to a voting agreement created under 7.31 (D) Duty owed by directors / rights of minority shareholders (a) Duty owed by directors: Good faith and inherent fairness standard of conduct. -- Are not permitted to serve two masters whose interests are antagonistic -- Paramount duty is to the corporation and their personal pecuniary interests are subordinate to that duty (b) Duty owed to minority stockholders in a closely held corporation: Same as duty owed by partners -- Closely Held Corporation: (1) Small number of stockholders (2) No ready market for the corporate stock -- Not listed on stock exchange or otherwise traded (3) Substantial majority stockholder participation in the management, direction and operation of the corporation PROBLEM: Minority shareholders have no power to control dividends, salaries for officers, sale of assets to officers, etc. + have no ability to sell shares - Majority holders may squeeze minority to sell at low price - Minority has no judicial remedy against the discretion of the majority shareholders, unless bylaws or articles happen to provide one --- A partner is held to something stricter than the morals of the marketplace; not honestly alone, but the punctilio of an honor the most sensitive (See Meinhard above) -- Single controlling group cannot cause a corporation to buy shares from the controlling group without making the offer to other holders (without legitimate business purpose) father P Donahue: Ds in same family owned majority of shares, with P as the only other, minority shareholder; Ds held shareholders meeting and voted to buy out at high price as he retired, but refused to offer same price for stock held by - D family is a single controlling group in closely held corporation - Sale to father of Ds breached duty owned to minority shareholders Ds must return shares or offer same price to P Tag along rights may be written as contract in sale, if majority shareholder sells shares, minority holder must be given the same opportunity to sell (Here, court imposes) --- Business judgment rule: Courts will not interfere in management of the directors, unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds P needs to sue the directors, not the shareholders (Rejects Donahue) -- Pre se rule of equal treatment of minority shareholders only applies where a controlling group votes to sell its own shares to the corporation (Reshapes Donahue)

35

shares at

Delahoussaye: Corporation was closely held, with about 100 stockholder and 550,000 shares and Wallace and Newhard families were permitted to sell above market price (though they did not vote), but P family offered shares similar price and was denied -- Redemption of shares was to eliminate dissension and divided loyalties - Well within judgment of directors for best interest of business -- Selling families did not control a majority of shares and did not vote

--- Absent looting of corporate assets, conversion of corporate opportunity, fraud or other acts of bad faith, a controlling stockholders is free to sell, and a purchaser free to buy, a controlling interest at a premium price -- Extra cost is paid for the privilege of control Zetlin: P owned 2% of business, where members of controlling family sold 44% interest and controlling share for $15 a share when price on market was only $7 -- P did not have right to similar price

(3) Shareholder Agreements REMEMBER: McQuade directors cannot abrogate their independent judgment to shareholders --- Stockholders may enter agreements to limit the alienation of shares if declared in the stock certificate -- Ownership is not just property, but also a chosen relationship BUT: Restrains on alienation must be reasonable -- Absolute restrictions are per se invalid Consent restraint: Requires affirmative vote of the owners - Cannot be unlimited in time or unfairly withheld Purchase option restraint: Requires a seller to offer purchase to the other owners before finding an outside buyer Witte: P received share of stock as part of divorce proceeding and did not receive full benefits without proper transfer of stock to her name; bylaws of corporation state that all assignments or transfers, inheritance or otherwise are subject to terms. -- Transfer of shares in Investment Co. are limited to current members of a Social club, who will have first option to buy + Admission to club by prospective owners requires vote

but whether by

36

- Restrictions prevent ownership or sale by P - Restraint devises act as absolute restriction = invalid KEY TO REASONABLENESS: Is the restraint sufficiently needed by the enterprise to justify overriding the general policy against restraints on alienation? FACTORS: (a) Size of the corporation (b) Duration of the restriction (c) Formula imposed to determine the option price of the shares subject to restrain on transfer - Right of first refusal; holder must offer at set price (d) Likelihood that the restriction will promote the best interests of the enterprise -- Court will only enforce the plain meaning of the restrictions employed -- Restrictions prevent voluntary transfers, but limitations on involuntary transfers (death, bankruptcy, dissolution of marriage) must be specified to be enforced Witte: P received share of stock as part of divorce proceeding and did not receive full benefits without proper transfer of stock to her name; bylaws of corporation state that all assignments or transfers, inheritance or otherwise are subject to terms. -- Transfer of shares in Investment Co. are limited to current members of a Social club + admission to club requires vote - Language of restriction only applies to voluntary transfers - P received by involuntary transfer; takes full ownership

but whether by

--- Knowledge of restrictions is assumed where stock is certificated OR registered owner has notice -- UCC 400.8-204: A restriction on transfer of a security imposed by the issuer, even if otherwise lawful, is ineffective against a person without knowledge of the restriction unless: (1) The security is certified and the restriction is noted conspicuously on the certificate (2) The registered owner has been notified of the restriction

Pool

-- MBCA 7.31: Two or more shareholders may provide for the manner in which the will vote their shares by signing an agreement for that purpose (b) Specifically enforceable Court can order corporation to count the votes of arbitrator, as proxy for party in breach of agreement --- Stockholders may enter agreement in writing to deposit stock with trustee to vote on behalf of the stockholder for a period not exceeding 10 years -- Trustee incurs no responsibility as stockholder, beyond individual malfeasance BUT: Pooling agreements are different stockholders enter contract to act in accord -- Shares are not to be voted on by another, it is merely a contractual relationship

37

be

Ringling Brothers: P and D were major shareholders in circus company; they entered agreement to exercise voting rights in accord in order to elect 5 of 7 directors instead of only 4, with a provision that all disagreements were to settled by an arbiter, whose decision shall be binding --- When disagreement occurred arbiter ruled that both should vote for adjournment of meeting to settle conflict, but D voted to continue -- Arbitrator had not power to vote on behalf of D to enforce his ruling -- D merely breached contract with P by ignoring arbitrators decision -Remedy: Court may reject votes in breach of contract, but may not count votes entered by another party without proxy

Trust -- MBCA 7.30: One or more shareholders may create a voting trust conferring on a trustee the right to vote or otherwise act for them, by signing an agreement setting out the provisions of the trust -- Voting trust is not valid for more than 10 years after its effective date --- 351. 246: Shareholders may create a voting trust for the purpose of conferring upon a trustee the right to vote or represent their shares, for any period -- Solves problem of enforcement of pooling agreements -- Look to voting trustee holding shares for voting powers, not the owners

LIMITS ON THE AGREEMENTS OF SHAREHOLDERS -- MBCA 7.32: An agreement among the shareholders that complies with this section, even though inconsistent with provisions of this act in that: (1) Eliminates the board or restricts its powers (2) Governs making of distributions whether or not in proportion to ownership of shares (3) Establishes who shall be directors, their terms, or manner of selection or removal (4) Governs the exercise of voting powers (b) An agreement under this section shall be: (1) Set forth in the articles or bylaws, as approved by all persons who are shareholders at the time of the agreement OR: In a written agreement signed by all shareholders at the time of the agreement (2) Subject to amendment only by all persons who are shareholders at the time of the amendment (3) Valid for 10 years, unless the agreement provides otherwise (c) The existence of the agreement shall noted conspicuously on each certificate BUT: Failure to note agreement does not affect the validity of the agreement

38

(d) Agreements under this section are ineffective when corporation is listed on the national securities exchange or traded by national association --- 351.315: Agreements of shareholders limited (2) The articles of incorporation may confer upon holders of any class or series of stock the right to elect one or more directors who shall serve for such term and shall have such voting powers as shall be stated in the articles of incorporation. --- Cannot agree to allow shareholders to remove/appoint directors CLOSE CORPORATIONS: --- 351.755: A statutory close corporation is a corporation whose articles of incorporation contain a statement that the corporation is a statutory close corporation. (2) A corporation having fifty or fewer shareholders may become a statutory close corporation by amending its articles of incorporation --- 351.800: All the shareholders of a statutory close corporation may agree in writing to regulate the exercise of the corporate powers and the management of the business and affairs of the corporation or the relationship among the shareholders of the corporation. (2) An agreement authorized by this section is effective although: (1) It eliminates a board of directors; (2) It restricts the discretion of powers of the board of directors or authorizes director proxies or weighted voting rights; (3) Its effect is to treat the corporation as a partnership; or (4) It creates a relationship among the shareholders or between the shareholders and the corporation that would otherwise be appropriate only among partners. (4) Dilution and Preemptive Rights Should be spelled out in articles of incorporation, because statutory support is weak --- 351. 305: The preemptive right to acquire additional shares may be limited or denied in the articles -- Stockholders have default ability to exercise preemptive rights -- MCBA 6.30: Shareholders do not have preemptive rights to acquire additional shares except to the extent provided in the articles (b) Statement in articles that corporation elects to have preemptive rights means: (1) Shareholders have right to acquires proportional amounts of unissued shares upon the decision of the board to issue them (2) Shareholders may waive preemptive rights (3) No preemptive rights for shares issued as compensation or as conversion rights

39

(5) Organic Changes & Appraisal Rights Appraisal rights cannot be limited in the articles or incorporation (A) Merger and consolidation --- 351. 420: Submitted to shareholders Merger or consolidation plan must be submitted to a vote at shareholders meeting, after notification of that purpose is given to shareholders --- 351.425: Voting Requirement 2/3 vote of the outstanding shares, of each of the corporations, are needed to merge --- 351. 455: Appraisal Rights to dissenting shareholders Shareholder who objects to merger in writing prior to the vote, and does not vote in favor of merger has 20 days to make written demand for fair value of shares -- Gets value of shares on the day prior to the date of the vote on merger --- 351.447: When 90% of the outstanding shares are owned by another corporation, the corporation may merge the other into itself, without a vote of the other shareholders

did

--- Agreement between 2 corporations is subject to merger rules when: Fundamental Change Rule: The change in corporate character and the interest held by P shareholder therein is such that, to refuse him the rights of a dissenting shareholder would force him to give up his stock and accept shares in another -- Look to agreement, as well as consequences of the transaction FACTORS: (1) Total assets and debt (2) Common management and control of directors (3) Ps proportionate interest, based on new shares issued (4) Value of shares financial loss to plaintiff (5) Type of corporation before vs. after the change Glen Alden: P shareholder objected to agreement between his corporation and another, whereby his corporation took control of the other, but the directors not comply with the merger rules of notification before the voting meeting --- Ds claimed that it was an acquisition of assets, not subject to merger rules -- Merger rules should have been followed: Control of company changed, total debt and assets changed, the value of Ps stock changed - Actions of corporation are de facto merger

40

are

--- Corporation may use the asset sale statute to effectuate the same result as a merger, because the two statutes are equally valid and independent (Conflicts with Glen Alden) BUT: Use of asset sale only calls for appraisal rights if provided by state law Hariton: P shareholder sought to stop agreement of corporation to sell assets to another corporation and dissolve, such that shares in the buying corporation given to the selling stockholders = same result as merger --- DE law gives no appraisal rights for sale, only merger -- Agreement is not illegal, though it deprives stockholders of appraisal -- Agreement is a de facto merger, but does not carry appraisal rights

(B) Disposition of Assets --- 351. 400: Dispossession of Assets Sale, lease, or exchange, or disposition other than by mortgage, or deed of trust, of all or substantially all of the corporate assets, if not made in the usual course of business may be made if: (1) Board may adopt resolution recommending such sale, directing it for submission to the shareholders (2) Notification of a meeting for that purpose must be given to shareholders (3) 2/3 of outstanding shares are needed for sale (4) Board may still abandon sale in its discretion --- 351. 405: Appraisal right of dissenting shareholders Shareholder who objects to sale in writing prior to vote, and does not vote in favor of merger has 20 days to make written demand for fair value of shares -- Gets value of shares on the day prior to the date of the vote on merger

(6) Shareholder Derivative Actions CRITIQUES: (a) Plaintiffs attorneys are compensated disproportionately compared to the shareholders and, in the absence of traditional client monitoring, this leads to early settlements (b) Directors are naturally biased against bringing an action against other officers due to risk aversion, fear of personal liability, and group cohesion among directors (c) Non-defendant directors are little better suited to make decisions concerning suits than are defendant directors, but judicial judgment cannot be exercised without costly litigation to determine the corporations best interest first (d) Shareholders receive very few direct benefits from derivative suits, however, indirect benefits like changing corporate leadership occur more often -- Rule 52: Brought by one or more shareholders against corporation, alleging that the corporation failed to enforce a right that may be properly be asserted by it (a) P was a shareholder at the time of the transaction of which there is a complaint -- May also have succeeded to ownership by operation of law, such as by will (b) Allege with particularity the efforts of P to obtain the action desired from the directors -- Must make earnest and real effort OR show that appeal would have been useless

41

-- May have to appeal to other shareholders if they have authority to approve action and it is not duplicative (Often excused) (c) P must fairly and adequately represent the interests of the shareholders -- Director/shareholder cannot bring suit, in order to lose (d) Case may not be settled without approval of the court --- Jurisdictional Issue: State law placing limits on derivative actions (such as requirement of % interest) will be applied in federal courts as a substantive, rather than procedural matter -- Financial interest measures individual injury and provides measure of good faith of claim Cohen: NJ law required shareholder with less than 5% to issue security to indemnify corporation against claim - State law is valid and should be applied in FED court as substantive, because it creates liability for claimant --- Direct Action: Stockholder must allege more than an injury resulting from a wrong to the corporation -- Must state a claim for an injury which is: (a) Separate and distinct from that suffered by other shareholders or (b) A wrong involving a contractual right of a shareholder which exists independently of any right of the corporation Consider: The nature of the wrong alleged and the remedy if P succeeds EX: Failure to pay dividends --- Derivative Action: Stockholder alleges harm to the corporation on behalf of the corporation Directors have harmed corporation, with indirect harm to shareholder bringing suit -- Attorneys fees: If successful, plaintiffs fees paid by the corporation (drives suits) -- If unsuccessful, plaintiff must pay own fees Grimes: Shareholder claimed compensation package given to manager abdicated the duties of the board and was a breach of due care on the part of the board in the form of waste - Abdication claim is a direct claim, in that P sought no monetary recovery, only declaration of the court - Derivative claim was not properly filed, because P failed to plead why the boards refusal to act on his demands was wrongful DEMAND REQUIREMENT: -- Must allege either: (a) Board rejected pre-suit demand that the board assert the claim (b) With particularity that such demand would be futile by virtue of: (1) A majority of the board has an interest in the transaction (i) Self interest Receive a direct financial benefit that is different from the benefit to stockholders generally Pay raise is always self interested (ii) Loss of independence to interested director

42

(2) Board of directors did not fully inform themselves about the transaction to the extent reasonably appropriate (3) Transaction is so egregious on its face that it could not have been the product of sound business judgment (very tough) --- It is not sufficient merely to name a majority of the directors as parties defendant with conclusory allegation of wrongdoing or control by wrongdoers Marx: Shareholder claimed compensation package to executives and all outside directors was waste of resources -- Majority of board did not have interest in executive compensation, because only 3 directors (also executives) received compensation under that part of the agreement at issue - P failed to allege facts showing that business judgment was not properly exercised -- Majority of board was self interested in salary raise for all outside directors; but fails to allege excessiveness in violation of valid business judgment --- If demand is refused, shareholder cannot claim futility; must show that it was wrongfully refused -- Again, business judgment rule governs the decision of the board (Grimes) Board will seek endorsement of outside counsel to bolster argument of validity No longer plead with particularity standard; must defeat business judgment rule --- 351.355(3): Indemnity for non-liable directors/officers/agents Unless stated in the bylaws or articles, when a director, officer or other agent of the corporation successfully defends any action (civil, criminal, administrative, investigative), he shall be indemnified against expenses, including attorneys fees (7) Amendment of Corporate Documents APPROVAL OF FUNDAMENTAL CHANGES (See below for description) --- 351. 090(3): Shareholders can decrease the number of directors to under 3 -- Requires vote (So that minority share would not be able to elect a director under cumulative voting) --- Other Amendments to the articles of incorporation = majority of voting shares --- Amendments to the bylaws = majority of voting shares -- Unless prohibited in the articles of incorporation --- 351.400: Sale of property and assets = 2/3 of voting shares --- 351.425: Mergers and acquisitions = 2/3 of voting shares --- 351.466: Dissolution of the corporation = unanimous consent of all shareholders --- 351.464: Dissolution of the corporation with prior approval of the board of directors = 2/3 of voting shares --- 351. 085: Amendment of Articles of Incorporation Corporation may amend its articles, provided that the name of the incorporator is not changed -- Cannot eliminate essential provisions of articles

43

-- Valid from the date of amendment --- 351.090: How Amended (1) Before receipt of payment for shares: Board may adopt amendments by executing certificate -- 351. 095: Majority of board may adopt and submit to secretary of state (2) After the receipt of payment for shares: May be adopted by board and submitted to shareholders or may be directly submitted without board adoption -- Written notice must be sent to each shareholder entitled to vote, with proposal -- Requires majority vote of outstanding shares in each class and a majority of the total shares entitled to vote thereon Shareholder may directly submit to others, without shareholder approval (3) When directors are elected by cumulative voting, the articles or bylaws cannot be amended to lower the number below 3, when the number of votes cast against the proposal is sufficient to elect a director (5) May vote on any number of amendments at the same meeting (7) When a corporation has 10 or fewer shareholders: Cumulative voting may only be abolished by vote of 2/3 of the outstanding shares --- 351.093(1): Class voting on amendments Holders of non-voting shares may vote as a class on a proposed amendment when it proposes: (a) Increase or decrease the total number of shares in that class (b) Increase or decrease the par value of shares in that class (c) Create a new class of shares with superior rights and preferences (d) Alter or change the rights of the class in an adverse manner (e) Change the rights of another class, such that its rights and preferences are superior --- 351.290: Bylaws How Amended Power to amend bylaws is vested in the shareholders, unless it is vested in the board by the articles -- Presumably, by a majority of a quorum (8) Directors and Officers --- 351.310: The business of a corporation shall be controlled by a board of directors --- Qualifications may be set in articles or bylaws (Usually set only to age 18) --- 351.315: Number of directors As set by the articles or bylaws: --- Board shall consist of 1 or more directors --- Directors may be elected for between 1-3 years BUT: There must be an annual election for such number of directors as may be found upon dividing the entire number by the number of years comprising a term --NOTE: Classified voting diminishes the cumulative voting power of the minority --- Director holds office until he is succeeded at a subsequent meeting (ex: Board fails to meet annually) --- 351.315(3): Removal of director by the shareholders

44

At a special meeting of the shareholders: one or more directors may be removed, with or without cause, by a vote of the holders of a majority of the shares entitled to vote at an election of directors, unless stated in the articles or bylaws -- In cumulative voting, if less then the entire board is removed a director cannot be removed unless vote against removal is insufficient to elect that director --- 351.317: Removal of director by the board for cause Any director may be removed for cause, by a majority of the entire board if the directors, if at the time of removal, the director: (a) Fails to meet the qualifications stated in the articles or bylaws for election as a director (b) Is in breach of any agreement between the director and the corporation -- Fiduciary duty creates broad contractual requirements (Ex: No stealing supplies) Cause is subject to business judgment rule --- Special notice must be given prior to regular or special meeting for this purpose VACANCY: --- 351.320: Vacancies may be filled by a majority of the directors then in office, although less than a quorum, until the next election of directors by the shareholders, unless stated in articles or bylaws -- NOTE: Board without a quorum can fill vacancy, but cannot do anything else MEETINGS: --- 351. 325: Board Quorum A majority of the full board of directors shall constitute a quorum, unless a greater number is required by the articles or bylaws (Cannot require less than 51%) -- Act of a majority of the majority of those present at a meeting shall be the act of the board, unless a greater number is required by the articles or bylaws --- 351.340: Board meetings notice requirement Regular meetings will be held according to the terms of the bylaws, with or without notice --- Special meetings of the board shall be held upon notice as prescribed in the bylaws Must have some level of notice -- Attendance at a meeting constitutes a waiver of notice, unless present only to object to meeting OFFICERS --- 351.360: Officers How chosen / powers and duties Every corporation must have a President and Secretary, as chosen by a majority of quorum of board -- Two or more offices may be held by the same person, unless stated in the articles or bylaws -- Authority and duties are defined by bylaws, or by resolution of the board --- 351.365: Removal of officers / agents An officer elected by the board may be removed by the board to serve the corporations interest BUT: Corporation may be liable for damages where officer has a contract for employment (9) Corporate Agency (See Section I for full description) --- Officers are agents of the corporation, with the board of the directors as the principal Actual (a) Express authority = Acts expressly authorized by the board of directors

45

usage or Apparent

(b) Implied authority = Powers incidental and necessary to carry out express authority -- President is empowered to transact business without special authorization from the board, if such acts are of an ordinary nature, which are incident to his office by necessity Extends to binding the corporation to debt on contracts BUT: Does not extend to the extension of credit for a third person (not ordinary) (c) Apparent authority = Created by the conduct of the principal, (words or actions) which causes a TP reasonably to believe that the purported agent has the authority to act for the principal AND: For the TP to reasonably and in good faith rely on authority held out by the principal (d) Estoppel = Principal has knowledge of the transaction and acquiesces therein Molasky Enterprises: Brothers endorsed a personal note as officers of Carps, Inc., but failed to obtain authorization from the board; P cosought collateral from Carps after brothers defaulted -- No express authority without formal authorization of board in a duly called meeting -- No implied authority, because brothers acted outside the ordinary course of business as officers -- No apparent authority, because Carps never held out brothers as agents to either the bank or the P -- No estoppel, because Carps had never given prior similar endorsements to personal notes In re Drive-In Development: D corporation guaranteed loan to another subsidiary of Tastee Freeze (Drive-In was 1 of 4) and Secretary of D provided corporate seal as certification that the board has authorized guarantee, but the minute book did not indicate affirmative vote -- D is estopped from denying the Presidents express authority to sign the guarantee, because such authority was suggested by act of the Secretary

signer

the the

(10) Business Judgment Rule --- It is not the function of the court to resolved questions of policy and management; courts cannot interfere with corporate decisions unless they are tainted with fraud or a breach of good faith -- Irrationality is the outer limit of the business judgment rule (Brehm) Shlensky: Minority shareholder in Cubs organization failed to state a cause of action for negligence and mismanagement, where corporation failed to install lights in park (supposedly losing revenue), because the President did not want to cause deterioration of the neighborhood with night games -- State of surrounding neighborhood is reasonable business consideration -- No evidence that lights, including costs, would be beneficial

46

--- Due care in decision-making context is process due care only = directors must consider all material information reasonably available -- Directors may demonstrate due care by relying in good faith on an expert to fully inform BUT: Presumption of due care may be rebutted by a showing that: (a) Directors did not, in fact, rely on the expert (b) Reliance was not in good faith (c) Did not reasonably believe the that experts advice was within his professional competence (d) Expert was not selected with reasonable care (e) Subject matter that was material was so obvious that the boards failure to consider it was grossly negligent, regardless of the experts advice (f) Decision of the board was so unconscionable as to constitute waste or fraud Brehm: Shareholders of Disney brought derivative suit against directors claiming that board failed to exercise judgment by approving employment agreement of President without all facts and wasted resources by allowing no fault that resulted in huge severance package -- Corporate expert advised the board on creation of package; complaint failed to allege any factors rebutting presumption of due care in -- Board has numerous ground not to challenge the no fault dismissal; matter for business judgment

dismissal reliance

--- Directors must discharge their duties in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances (a) Directors should become familiar with the business, because lack of knowledge of the is not a defense for a failure to exercise the ordinary degree of care (b) Directors should keep informed about the activities of the corporation, because willful blindness is no defense for failure to perceive misconduct (Includes familiarity with finances) (c) Directors may rely upon the opinion of counsel or independent reports Upon the discovery of illegal action, to avoid liability, a director must: (i) Object to the action, and if the corporation does not follow demand, to resign -- Dissenting vote may be sufficient to avoid personal liability (ii) Take reasonable means to prevent the illegal action, including threat of suit

47

--- Directors do not owe a fiduciary duty to third party creditors (under above standard), until insolvency UNLESS: The corporation is acting as a depositor (bank/trust) Francis: D inherited 48% interest in reinsurer from deceased husband, but failed to oversee the corporation as a director as son raided the assets held in trust and took loans over $12 million; creditors sought Ds funds due to breach of fiduciary duty as a director -- D should have been involved enough to prevent apparent misappropriation of corporate funds; personally liable --- 351.327: Financial interest of corporate officers (1) No contract or transaction between a corporation and a director or officer shall be void solely because of the interest of the director if: (1) The material facts as to his interest are know to the board of directors and the board in good faith authorizes the contract my a majority vote of the majority of disinterested directors, though disinterested directors be less than a quorum (2) The material facts as to his interest are disclosed or known to the shareholders entitled to vote thereon, and the contract is specifically approved in good faith by a vote of the shareholders (3) The contract is fair to the corporation at the time it is authorized by the board or shareholders (2) Interested directors may be counted in determining the presence of a quorum which authorizes the contract --- 351. 355: Indemnification of officers (1) A corporation may indemnify any person who is party, or threatened to be party to pending litigation, by reason of the fact that he was a director, officer, employee or agent of the corporation if: (a) He acted in good faith in a manner he reasonably believed to be in, or not opposed to the best interest of the corporation (b) In a criminal matter, he had no reason to believe that the his conduct was unlawful (2) No indemnification shall be made as to such person adjudged to be negligent or misconduct in the performance of his duty to the corporation (3) To the extent a corporate agent is successful on the merits in defending a suit, he shall be indemnified against reasonable expenses incurred, unless stated differently in the bylaws or articles (4) Indemnification under Sections 1 and 2 shall be authorized by a majority of a quorum of the directors not subject to the action

48