1
Business Associations
Professor Bradford
Fall 2010
Exam Answer Outline
The following answer outlines are not intended to be model answers, nor are they
intended to include every issue students discussed. They merely attempt to identify the
major issues in each question and some of the problems or questions arising under each
issue. They should provide a pretty good idea of the kinds of things I was looking for. In
some cases, the result is unclear; the position taken by the answer outline is not
necessarily the only justifiable conclusion.
I graded each question separately. Those grades appear on your printed exam. To
determine your overall average, each question was then weighted in accordance with the
time allocated to that question. The following distribution will give you some idea how
you did in comparison to the rest of the class:
Question 1:
Question 2:
Question 3:
Question 4:
Question 5:
Question 6:
Range 3-9; Average = 5.42
Range 0-9; Average = 6.63
Range 4-9; Average = 7.08
Range 0-9; Average = 6.05
Range 4-9; Average = 6.68
Range 2-9; Average = 4.50
Total (of unadjusted exam scores, not final grades): Range 3.72-8.46; Average = 5.52
If you have any questions about the exam or your performance on the exam, feel
free to contact me to talk about it.
2
Question 1
Shemp could be liable for breach of his duty of loyalty to Stooge if the copper
mine investment is a corporate opportunity that belongs to Stooge, and if Shemp has not
fulfilled the requirements of MBCA § 8.70 to avoid liability.
Corporate Opportunity?
If this is not a corporate opportunity, Shemp is not liable. Stooge is an MBCA
corporation, but the MBCA does not define what constitutes a corporate opportunity, so
the issue is left to case law.
There is no single accepted test for whether something is a corporate opportunity.
Courts consider several factors in determining whether something is a corporate
opportunity. See Northeast Harbor Golf Club. v. Harris; Broz v. Cellular Information
Systems, Inc.
1. Financial ability: One factor is whether Stooge is able financially to exploit
the opportunity. Stooge does not appear to have any financial problems here,
so that would not keep this from being a corporate opportunity.
2. Presented in the director’s corporate or individual capacity: Another factor
is whether the opportunity was presented to the director in his corporate or his
individual capacity. That’s a difficult question here. Shemp was on a
corporate trip, but learned of the opportunity at a cocktail party and,
moreover, learned of it from a personal friend. On the whole, this seems to
point against it being a corporate opportunity.
3. Interest or expectancy: Another factor is whether the company has an interest
or expectancy in the opportunity. Stooge had no prior dealings with Shemp’s
friend, so the only thing that might create a weak interest or expectancy is that
Shemp was on a corporate trip. Again, this points against it being a corporate
opportunity.
4. Essential to the corporation: Another factor is whether the opportunity is
essential to Stooge; that does not appear to be the case here.
5. Use of corporate resources: Another factor is whether the director used
corporate resources to pursue or exploit the opportunity. Shemp used his own
funds to purchase both the option and to make the eventual investment. But,
on the other hand, Shemp arguably did become aware of the opportunity
because of a use of corporate resources—his use of company funds to take the
trip in the first place.
6. Line of business: Another factor is whether the opportunity is within the
company’s line of business. This investment arguably is; Stooge is a mining
company and this is an investment in a mine. However, it does not appear
that Stooge usually invests in other people’s mines; the question says it buys
land and extracts the minerals itself. So this is at least a little different from
its usual line of business.
3
7. Inimical to position as director: Another factor is whether taking the
opportunity will put the director in a position inimical to his duties to the
corporation. There is no evidence that taking this particular opportunity will
put Shemp in a position adverse to the interests of Stooge.
8. Involvement of an officer: Finally, some courts are more willing to find a
corporate opportunity when an officer is involved. See ALI Principles of
Corporate Governance § 5.05(b)(2). Shemp is only a director, not also an
officer.
Protection by MBCA § 8.70
Even if the copper mine investment is a corporate opportunity of Stooge’s, Shemp
would not be liable if the action by the board meets the requirements of MBCA § 8.70.
Shemp must use the § 8.70 procedure “before becoming legally obligated respecting the
transaction.” MBCA § 8.70(a). Shemp meets this requirement. Although he acquired
the option before he brought the opportunity to the board, he was not yet obligated on the
investment itself.
Section 8.70(a)(2), dealing with action by the shareholders, is not applicable here.
Although the opportunity was discussed at the shareholder meeting and shareholders
were given an opportunity to object, no shareholder vote was conducted, and § 8.63(a)
clearly requires a vote.
Section 8.70(a)(1) says that a director is not liable for taking a corporate
opportunity if action is taken by qualified directors in compliance with § 8.62. Section
8.62(a) requires the affirmative vote of a majority of the qualified directors who voted on
the transaction, but no fewer than two. Moreover, those qualified directors must
deliberate and vote outside the presence of any non-qualified directors. § 8.62(a)(1).
And that vote must come after “required disclosure,” § 8.62(a), which is defined to
include disclosure of the nature of the conflict of interest and “all [material] facts known
to the director respecting the subject matter of the transaction.” § 8.60(7).
Neither Shemp nor his brother Curly participated in the board’s deliberations or
vote; both recused themselves. And the question indicates that Shemp told the board
everything he knew about the offer and the option he had purchased, so the “required
disclosure” requirement also appears to be satisfied. Thus, if the other two directors are
qualified directors, the requirement of § 8.62(a)(1) is satisfied.
A “qualified director” is a director for whom the transaction would not be a
director’s conflicting interest transaction if this were a self-dealing transaction and who
does not have a material relationship with anyone for whom it is. MBCA §
1.43(a)(3),(4). Neither Moe nor Larry appear to have a sufficient relationship to the
transaction or to Shemp to make this a director’s conflicting interest transaction. Neither
is a party, § 8.60(1)(i); neither has a financial interest in the deal, § 8.60(1)(ii); and
neither is a “related person” to Shemp, as defined in § 8.60(5). Thus, they are qualified
directors unless they have a material relationship with Shemp.
4
A “material relationship” is a “familial, financial, professional, employment or
other relationship that would reasonably be expected to impair the objectivity of the
director’s judgment.” MBCA § 1.43(b)(1). Moe does not have a familial relationship
with Shemp, and he does not have a current professional or employment relationship with
Shemp, but he has represented Moe in the past. That creates at least the possibility of
future legal work and that could potentially affect Moe’s judgment, but is a $2,000 fee
sufficiently material that it would impair Moe’s objectivity? If so, he’s not a qualified
director. Moe also serves on another board with Shemp, but that alone doesn’t constitute
a material relationship. MBCA § 1.43(c)(2).
Larry appears to be a qualified director without question. The fact that Shemp
nominated Larry to Stooge’s board does not prevent Larry from being a qualified
director, § 1.43(c)(1), and Larry has no other ties to Shemp.
Thus, if Moe is qualified, the requirements of § 8.62 are met and Shemp is not
liable. MBCA § 8.70(a)(1). If Moe is not qualified, § 8.70 does not help Shemp.
In some jurisdictions, to avoid liability, a director must first present the
opportunity to the corporation before taking it. See ALI Principles of Corporate
Governance § 5.05(a); Northeast Harbor Golf Club v. Harris. However, other
jurisdictions do not accept this as an absolute requirement. See Broz v. Cellular
Information Systems, Inc. Failure to use the procedures in § 8.70 does not create any
unfavorable inferences or alter the burden of proof, MBCA § 8.70(b), but merely
relegates the Shemp to what the case law would otherwise say.
5
Question 2
Caremark requires the board of directors to implement a corporate information
and reporting system designed to provide the board with information about both the
corporation’s compliance with law and its business performance. However, Caremark
indicated that directors are not liable merely because the company’s compliance and
monitoring system fails to detect a problem.
The design of any corporate compliance system is a question of business
judgment, protected by the business judgment rule. If the board adequately informs itself
before establishing such a system and acts in a good faith belief that the system
established is appropriate, they won’t be held liable. Caremark indicates that only “a
sustained or systematic failure of the board to exercise oversight,” “such as an utter
failure to attempt” to establish such a system, will result in liability. Thus, if the board in
good faith establishes such a system, no liability is likely, even if the system fails to catch
wrongdoing or other problems.
6
Question 3
The Effect of the Transfer
A partner in a general partnership may transfer only her financial interest—the
share of profit and losses and the right to distributions. RUPA § 502. The transferee
does not become a partner or receive the right to vote. RUPA § 503(a). Absent a
provision in the partnership agreement, and there is no agreement, Buyer may become a
full partner with governance rights only with the consent of all the partners. RUPA §
401(i). No one objected to the transfer, but there’s no evidence that Alpha and Omega
consented to Buyer becoming a partner.
Therefore, when Seller sold her interest to Buyer, Buyer did not acquire any
voting rights. Any votes he cast are irrelevant. Instead, Seller retains her rights as a
partner other than the transferred financial rights. RUPA § 503(d). Seller still has the
right to vote and, therefore, her votes are counted.
The Vote to Make a Distribution
Considering the votes of Alpha, Omega, and Seller, the vote to make the $50,000
distribution was 2-1 in favor of the distribution. Whether to make a distribution like this
is a matter in the ordinary course of business of the partnership, and therefore subject to
majority rule. RUPA § 401(j). The distribution was approved.
The Allocation Vote
The default rule is that partners are entitled to an equal share of profits and losses.
RUPA § 401(b). Therefore, the distribution should be shared equally by Alpha, Omega,
and Buyer (who has Seller’s financial rights as per § 502). Changing that default rule
would require an amendment to the partnership agreement, or in this case, a partnership
agreement in the first place. See RUPA § 103(a). That requires the consent of all the
partners. RUPA § 401(j). The vote to give Alpha 50% was only 2-1, ignoring Buyer’s
ineffective vote. Thus, this vote is ineffective.
As a result, the distribution is approved, but it will be distributed according to the
default rule—with equal shares to Alpha, Omega, and Buyer.
7
Question 4
This is a Delaware corporation so, under the internal affairs rule, Delaware
corporate law applies. Delaware § 170(a) says dividends may be paid out of surplus or, if
there is no surplus, out of net profits from the current and previous years.
Omega has no surplus. Surplus is the excess of the net assets over capital
(meaning stated capital), and net assets is defined simply as total assets less total
liabilities. Del. § 154. Omega’s net assets are $15,000 ($95,000 – $80,000). Its capital
is the amount in the common stock account, $20,000. Therefore, its surplus is a negative
number, -$5,000. Even if the assets and liabilities are revalued to their fair market value,
which Delaware common law allows, there still is no surplus. Net assets would then be
$20,000 ($100,000 – $80,000), and surplus would be $0 ($20,000 – $20,000).
However, section 170(a) says that, if there is no surplus, dividends may be paid
“out of its net profits for the fiscal year in which the dividend is declared and/or the
preceding fiscal year.” The profit so far in this fiscal year is $15,000. Omega had a net
loss of $5,000 in the preceding fiscal year, but that loss does not need to be netted against
this year’s profit because § 170 says out of this year’s “and/or” last year’s profits; we
may combine the two years or look at each separately. Therefore, Omega may pay a
dividend of $15,000.
8
Question 5
Under RULPA § 602, a general partner in a limited partnership may withdraw at
any time by giving written notice. Geena has done that, so she is no longer a general
partner. RULPA § 402(1). She is liable for damages if her withdrawal breaches the
partnership agreement, § 602, but there is no partnership agreement here, so she will have
no such liability.
Upon withdrawal, Geena is entitled to be paid (1) any distribution to which she is
entitled under the partnership agreement and (2) unless otherwise provided in the
partnership agreement, the fair value of her interest in the partnership as of the date of
withdrawal. RULPA § 604. The first provision is inapplicable since there is no
partnership agreement, so Geena is entitled to receive from the partnership the fair value
of her interest as a general partner. The value of her interest is based on her right to share
in distributions. RULPA § 604. Since there is no partnership agreement, her
proportionate interest would be the same as her proportion of unreturned capital
contributions. RULPA § 504.
The second consequence of her withdrawal is that the limited partnership may be
dissolved and wound up. The withdrawal of a general partner results in dissolution
unless there is another general partner and the agreement permits continuation. RULPA
§ 801(4). Here, there is no other general partner, so § 801(4) should cause the
partnership to dissolve. If so, the creditors should be paid, after which any remaining
assets would be distributed to the partners. RULPA § 804. Since there is no partnership
agreement provision to the contrary, those distributions would be proportionate to the
unreturned capital contributions of each partner. RULPA § 504.
However, the partners may avoid dissolution if all partners—presumably the three
remaining partners—agree in writing to continue the business and agree to the
appointment of one or more general partners to replace Geena. RULPA § 801(4). This
must happen within 90 days of Geena’s withdrawal. RULPA § 801(4). Thus, if Anne,
Betty, and Carla can agree, the partnership will not be dissolved, although Geena must
still be paid the fair value of her interest.
9
Question 6
There are three potential theories of liability. First, Parent and Sub’s operations to
produce the IV bags may constitute a partnership. Second, Sub may be acting as an agent
of Parent. And, third, it may be possible to pierce the corporate veil of Sub and hold its
shareholder, Parent liable.
Partnership
A partnership is an association of two or more persons to carry on as co-owners a
business for profit. RUPA § 202(a). Parent and Sub are persons, RUPA § 101(10), and
the IV operation is clearly a for-profit business, but is their relationship one of coownership?
Sub receives a percentage of the profits from the IV sales, and profit-sharing
usually creates a presumption of partnership. RUPA § 202(c)(3). However, that
presumption does not apply where the profits are received as payment for services as an
employee or independent contractor. RUPA § 202(C)(3)(ii). Thus, the issue is whether
the relationship between Parent Sub is properly characterized as an ordinary customersupplier relationship or one of co-ownership. One indicia of co-ownership is joint
decision-making; in this case, each of the companies separately controls its business.
If Parent and Sub are partners, then Parent is clearly liable for Sub’s negligence.
A partnership is liable for the wrongful act or omission of a partner acting in the ordinary
course of business of the partnership or with authority of the partnership. RUPA §
305(a). Sub’s actions are within the course of the IV-bag business and are authorized by
Parent, so the partnership would be liable. And, if the partnership is liable, the partner,
Parent, is also liable. Partners are personally liable, jointly and severally, for all
obligations of the partnership. RUPA § 306(a).
Agency
A second possible argument is that Sub is acting as an agent on behalf of Parent.
If Parent and Sub are in a master-servant relationship, Parent is liable for torts of the
servants committed while acting in the scope of employment. RSA § 219(1). If Sub is a
servant, its actions are clearly within the scope of its employment. See RSA § 228(1).
Sub is doing exactly what it is supposed to do under the contract—make the plastic
bags—and it is doing so to serve Parent’s interests—the bags will be provided to Parent
and used to manufacture the IV bags.
The key question in determining whether Sub is a servant is the extent of control
Parent has over Sub’s physical conduct of the bag manufacturing. RSA § 220(1). Sub is
operated independently; Parent does not directly set its policies or control any of its
employees. But the contract does give rather substantial control to Parent over the
manufacture of the bags; it specifies the exact ingredients to be used, the precise formula
10
to follow, and quality standards. It also allows Parent’s employees to visit the plant to
make sure those standards are followed, and the contract is subject to immediate
cancellation if the requirements are not followed. Thus, although Sub itself is directing
its employees, most of the decisions are made by Parent through the contract. In
addition, Parent, the principal, is in the business that Sub is engaged in, RSA § 220(2)(j),
and the relationship is a long-term one, RSA § 220(2)(f), both factors that point towards a
servant relationship. On the other hand, Sub supplies its own equipment and place of
work, RSA § 220(2)(e); and Sub is paid by the job, and not on a time basis, RSA §
220(2)(f). All of these factors point against a servant relationship. This is a very
uncertain area, as indicated by the Miller v. McDonald’s case, and the answer is unclear,
but there could be sufficient control to make Sub a servant. If so, Parent is liable for
Sub’s negligence.
Piercing the Veil
The final possible theory of liability is piercing the corporate veil. Shareholders
are not usually personally liable for the obligations of a corporation, but courts sometimes
pierce the veil to hold them liable. Factors the courts commonly consider in deciding to
pierce the corporate veil are undercapitalization, failure to follow corporate formalities,
fraud, a lack of separation between the shareholder and the corporation, and excessive
direct control by the shareholder. Undercapitalization is not an issue here, and there also
does not appear to be any fraud.
The parent of a wholly-owned subsidiary would naturally exercise some control
over the sub’s actions, but, if there is too much control and intermingling, courts are
willing to hold the parent liable. See Silicone Gel Breast Implants Liability Litigation.
Parent’s and Sub’s operations are not completely separate. Sub’s funds are kept in
Parent’s account; the two companies prepare consolidated financial statements and tax
returns; they have common insurance and retirement accounts; and Sub sends monthly
reports to Parent. However, although Sub’s funds are kept in Parent’s account, Sub has
complete control over those funds and Sub receives all the interest on its funds.
Moreover, Parent pays the cost of the common insurance and retirement, so Sub’s
creditors are actually in a better position as a result of this arrangement. And, although
courts have sometimes pointed to the consolidation of financial statements and tax returns
to justify piercing, consolidation is required by tax and accounting rules.
Unlike the Silicone Gel case, the two companies follow corporate formalities in
other respects. Sub has regular board and shareholder meetings and Sub’s officers and
directors have complete control over Sub’s actions, except for what the contract requires
with respect to the IV bags. This does not appear to be as strong a case for piercing as in
the Silicone Gel case.