1
Corporations
Professor Bradford
Fall 2007
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. If
you have any questions about the exam or your performance on the exam, feel free to
contact me to talk about it.
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 2-7; Average = 4.39
Range 0-9; Average = 6.18
Range 3-9; Average = 6.21
Range 3-8; Average = 5.62
Range 4-9; Average = 6.54
Range 0-9; Average = 6.77
Total (of unadjusted exam scores, not final grades): Range 4.21-7.77; Average = 5.64
2
Question One
Holder has several potential different types of liability in connection with its sale
of Publix shares back to Publix.
Section 16(b)
Holder clearly is liable under § 16(b) of the Exchange Act. Publix is registered
pursuant to section 12 of the Exchange Act, and Holder is a 10% beneficial owner of a
class of equity securities. For a particular trade to be covered by § 16(b), Holder must
have been a 10% beneficial owner immediately before the trade. Immediately before the
Aug. 15 purchase, Holder owned 11% of Publix’s common stock (110,000 shares). Thus,
this purchase falls within §16(b). Holder was also a 10% shareholder immediately before
the Dec. 10 sale, so it also falls within § 16(b). Thus, there is a matching purchase and
sale of the same equity security within 6 months and Holder is liable to Publix for any
profit on that matching purchase and sale. The amount of the liability is $60 - $50 x
10,000 shares = $100,000. (The other 20,000 shares sold don’t match with any purchases
in the six-month period.)
Insider Trading
Holder will not be liable under Rule 10b-5 for insider trading. Holder had
nonpublic, inside information when he sold the stock back to Publix; it knew that the
balance sheet overvalued the assets. However, Chiarella says there must be a breach of
fiduciary duty for there to be liability under Rule 10b-5. Holder is not breaching any
duty to the source of the information, Publix, because Publix knows Holder has the
information. And the person who provided the information did not breach any duty that
might create tippee liability because it wasn’t done for personal gain. It was done so
Publix could buy back the shares. Because there is no breach of duty, there is no liability.
Even if there were a breach of duty, there is no deception because the purchaser, Publix,
already knew the information and that Holder was using it. See O’Hagan.
Duty of Controlling Shareholders
Donohue
Holder has no liability pursuant to the special, partnership-like fiduciary duty
recognized in Donohue. Donohue says that, when a corporation repurchases stock from
one shareholder, it has an obligation to purchase from other shareholders as well.
However, this obligation applies only in a closely held corporation, where the selling
shareholder is getting an opportunity to sell that wouldn’t be available to other
shareholders. Here, Publix is a public corporation, and the other shareholders have a
ready market for their stock (at the same price). Donohue doesn’t apply.
3
Sinclair
Some courts say that controlling shareholders (and their nominees on the board)
owe fiduciary duties of loyalty to the other shareholders. See Sinclair v. Levien. If
Holder controls Publix, then its sale to Publix is potential self-dealing and triggers
fairness review.
Holder, which owns only 12% of Publix’s stock, does not appear to control
Publix. And, if Holder does not control Publix’s board, there’s no conflict of interest that
should concern us when Publix decides to repurchase the stock. This would be subject to
ordinary business judgment review and Publix appears to have a valid business reason for
the repurchase—to avoid a significant drop in the market price of its stock.
If Holder does control of Publix, then Holder would be liable unless Holder could
show that the transaction is fair. Holder is receiving the same market price other
shareholders would receive if they should their stock, an argument that the price is fair.
However, based on Publix’s concerns about the price dropping, the trading at this market
price may be thin. Holder would not have been able to sell all of its stock at this price, so
Publix is giving it a greater price than it otherwise could have obtained. Thus, if Holder
does have sufficient control to create a duty of loyalty issue, there’s at least an arguable
claim that the price was not fair. The other element of fairness—fair dealing—is unclear
here, as the question doesn’t indicate how the transaction was arranged.
Limits on Distributions
Holder does not appear to be liable for violating the restrictions on distributions in
RMBCA § 6.40. A repurchase of stock is a distribution covered by § 6.40. See §
1.40(6). Therefore, it is allowed only if, after the distribution, the two tests in § 6.40(c)
are met.
The first test appears to be met, as the directors believe Publix will still be able to
pay its debts as they come due. Publix clearly has enough cash left to pay its short-term
liabilities and the board believes it will be able to pay the note when it comes due in 15
years.
The second test also appears to be met. After the distribution, Publix’s total assets
($50 million) still exceed its total liabilities ($48 million). If you consider the market
value of Publix’s assets ($47 million), that’s not true, but § 6.40(d) doesn’t say the board
must take fair market values into account. It indicates the board may base its
determination on either accepted accounting principles or a fair valuation. Assuming the
financial statements comply with generally accepted accounting principles, the
distribution is lawful.
4
Question Two
A distribution is a transfer of money or property from the business (Bell, LLC) to
the members (the investors). See RULLCA § 102(5). In effect, the company is
transferring part of its earnings to the investors. Those distributions aren’t automatic; it’s
a management decision, and you can’t individually force the payment of a distribution.
The language in quotations relates to what happens when Bell’s management
decides to make a distribution. The units you’re considering buying have a “$5.00/unit . .
. distribution preference.” Before Bell can pay money to other members, it must first pay
you and other people who own this type of investment $5 per unit.
That preference is “participating.” After Bell pays your $5.00 per unit, it can then
pay money to other members, but you get to share in that payment as well. In other
words, after your $5.00 per unit, you also receive the same amount per unit that everyone
else does.
Finally, that preference is “cumulative.” If Bell doesn’t pay you $5.00 per unit
this year, the amount it doesn’t pay carries over to the next year. Then, before they can
make a distribution to anyone else, they have to pay you $10.00. If they don’t pay that,
then it carries over and becomes $15.00 the next year. In other words, if Bell ever wants
to make a distribution to the members, it is first going to have to pay you $5.00 for each
year.
5
Question Three
Default Rules
In a manager-managed LLC such as this, except as otherwise provided in the Act,
the manager has the exclusive right to make any decision “relating to the activities of the
company.” RULLCA § 407(c)(1). However, even in a manager-managed company, the
default rule is that the consent of all members is required to sell substantially all of the
company’s property, outside the ordinary course of business. RULLCA § 407(c)(4)(A).
Road Kill’s ordinary business is operating the restaurant, so a sale of all the restaurant’s
assets is undoubtedly outside the ordinary course of its business. Thus, under the statute,
Martin could not do this without the approval of the other members.
Effect of the Operating Agreement
The operating agreement governs as to questions concerning the rights of a
manager. RULLCA § 110(a)(2). Section 110(c) specifies certain rules the operating
agreement cannot change, but the rules in § 407 are not among those.
Road Kill’s operating agreement provides that the manager “has the right to make
all business decisions on behalf of Road Kill.” Has that changed the default rule in
RULLCA § 407(c)(4)(A)? The words “business decisions” might mean only decisions
involving Road Kill’s ordinary business, which is to operate restaurants. Or it might
include all decisions on Road Kill’s behalf, including the sale of all its assets. The
language itself is unclear, so it might be appropriate to look at the intent of the members,
if there is any evidence of that.
The Act’s default rules apply “to the extent the operating agreement does not
otherwise provide for a matter.” RULLCA § 110(b). Absent any evidence of intent, one
could argue that the default rule applies, because the agreement does not clearly
otherwise provide. But is an interpretative rule favoring the default rules consistent with
the idea in section 110 that one should look to the agreement first, and only use the
default rules in the absence of any agreement to the contrary?
6
Question Four
Duty of Loyalty: Self-Dealing by Groucho
The first possible liability is Groucho’s potential breach of the duty of loyalty.
This is clearly a self-dealing transaction. Groucho has a 40% interest in Krazy, which is
contracting with Marx. Groucho clearly will benefit from any gain Krazy gets from this
contract.
Del. § 144
This is the kind of transaction covered by Del. § 144. It’s a contract “between a
corporation and any other corporation . . . in which one or more of its directors . . . have a
financial interest.” Section 144(a)(1) says that transaction is not voidable, and
presumably does not create liability, if Groucho discloses the materials facts about his
interest and the transaction and the disinterested directors in good faith authorize it.
There is no question that the other three directors are disinterested, and Groucho
disclosed all of the material facts when he provided the file, even though the board
members didn’t pay attention to those facts. But approving the transaction, knowing that
Groucho had a conflict of interest, without even looking at the file was probably not in
good faith. Del. § 141(e) says board members may rely in good faith on information and
opinions presented by the corporation’s officers, but surely it’s not good faith to rely
solely on Groucho’s opinion when they know he has a conflict of interest. Therefore, the
board’s approval probably is not protected by Del. § 144.
Fairness
Groucho may also avoid liability by showing that the transaction, at the time it
was approved, was fair to the corporation. Del. § 144(a)(3). Fairness has two elements:
(1) fair dealing and (2) fair price. Weinberger. The price might be fair, given the
information Groucho has about other companies charging the same price for similar
contracts (and the percentage-of-completion payment appears to be standard, so that’s
fair). It’s not clear that there was fair dealing. The deal was negotiated by Anne, who’s
Groucho’s assistant and therefore under his control. He has control over her
employment, so can we really trust her to negotiate diligently against Krazy? Neither fair
dealing nor fair price alone is determinative. HMG/Courtland Properties v. Gray. But
Groucho has the burden of showing fairness, and it’s not clear he can meet his burden
here.
Duty of Care
The self-dealing claim doesn’t make disinterested directors liable, but they are
probably liable for a breach of the duty of care in approving the transaction. Van Gorkom
7
says they have a duty to inform themselves before making a decision, and they did almost
nothing. They refused to review the materials Groucho had in his file, relying solely on
his statement that the transaction was fair. As previously discussed, Del. § 141(3)
probably would not protect reliance on a person who has a conflict of interest. This is
similar to Van Gorkom itself, where the court refused to allow the directors to rely on
another director who was himself uninformed.
Caremark Duty to Establish a Compliance System
The final question raised is whether the board is liable for Freddy’s theft of $5
million. No one on the board was aware of the theft, or had any suspicion about it. So
the directors had no duty to inquire further. Graham v. Allis-Chalmers. However,
Caremark says the board has a duty, even in the absence of any red flags, to establish a
system to monitor and report wrongdoing.
The directors do not appear to have violated that duty here. They acted carefully
and fully informed themselves when they established the system, and it appears to be a
reasonable one. They haven’t had any problems in five years and Freddy succeeded only
through a clever, unanticipated fraud.
Caremark says that, if the directors have established a corporate compliance
system, the business judgment rule protects their determination of the parameters of that
system, and they’re not liable just because wrongdoing slips through. The board appears
to have acted in good faith, and this is not the kind of “sustained or systematic failure to
exercise oversight” that Caremark says creates liability.
8
Question Five
Personal Liability
Leonard, Sheldon, and Raj, as partners of Geek, are jointly and severally liable for
the obligations of the partnership, including this judgment. RUPA § 306(a).
Possible Exceptions to Personal Liability
There are two exceptions that might apply here. One is if Penny agreed not to
hold one or more of them personally liable; the liability in § 306(a) does not apply if
“otherwise agreed by the claimant.” The second possible exception is if one or more of
the partners joined the partnership after the contractual obligation to Penny was incurred
(not after the date of the judgment, but after the contract). In that case, that partner would
not be liable, RUPA § 306(b), but the others still would be.
Judgment Against the Partners Individually
The judgment Penny has against the partnership is not sufficient to recover from
the personal assets of the three partners. To recover from Leonard, Sheldon, or Raj
individually, she must first obtain a judgment against them individually. RUPA § 307(c).
That judgment should be relatively easy to obtain; the partnership is liable as a result of
the judgment against it and § 306 therefore makes Leonard, Sheldon, and Raj liable. To
obtain that judgment, Penny may sue all three partners in the same action. RUPA §
307(a).
Unable to Collect from the Partnership
Even after she has judgments against the individual partners, Penny usually may
not levy execution on the partners’ individual assets unless she has first tried to collect
from the partnership and the writ of execution is returned unsatisfied. RUPA § 307(d)(1).
It is not enough that she thinks Geek will have insufficient assets to pay the entire
judgment. She may, however, look to the partners’ assets first if Geek is in bankruptcy, if
the partner in question agrees that she may, if she gets permission from a court to do so,
or if the partner is individually liable independent from his status as partner (if, for
example, he personally guaranteed the contract). RUPA § 307(d)(2),(3),(4).
9
Question Six
As an employee, Barney Fife clearly is an agent of Club Soda. However, that
alone is not enough to make Club Soda liable for his negligent tort. A master can be
liable for the torts of a servant, Restatement (Second) of Agency § 219, but is not usually
liable for the torts of a non-servant. RSA § 250. Two issues must be resolved: (1) is
Barney a servant of Club Soda?, and (2) If so, was Barney acting within the scope of his
employment?
Servant or Independent Contractor?
Whether Barney is a servant depends on the extent to which he is subject to the
principal’s “control or right to control” “with respect to the physical conduct of the
services.” RSA § 220(1).
RSA § 220(2) lists a number of factors to help make this determination. Club
Soda is in business, RSA § 220(2)(j); the work is part of Club Soda’s regular business,
RSA § 220(2)(h); Barney is employed on a regular, although part-time basis, RSA
220(f); Barney is paid by the hour, RSA § 220(2)(g); the work is done on Club Soda’s
premises, RSA § 220(e); and Barney is required to follow Club Soda’s extensive rules,
RSA § 220(2)(a). All of these point towards a servant relationship. On the other hand,
being a security guard is arguably a “distinct occupation,” RSA § 220(2)(b), and at least
some of the work is often done without direct supervision. RSA § 220(2)(c). These point
toward an independent contract relationship. On the whole, however, there seems to be a
stronger argument that Barney is a servant.
Scope of Employment
Even if Barney is a servant, Club Soda is liable for Barney’s torts only if he was
acting within the scope of employment. RSA § 219(1). None of the exceptions in §
219(2), providing for liability outside the scope of employment, appear to apply here.
Section 228(a) says that conduct is within the scope of employment only if four
requirements are met. This is the kind of thing Barney was hired to perform. RSA §
228(1)(a). He was breaking up a fight. Force was used, but the use of force was not
unexpected by Club Soda. RSA § 228(1)(d). Barney was specifically authorized to use
force. Barney’s conduct was probably actuated in part by a desire to serve the master.
RSA § 228(1)(c). Although not on Club property, these were undoubtedly patrons of the
club, and Barney’s job was to maintain order among the patrons. The real issue is
whether Barney’s conduct occurred “substantially within the authorized time and space
limits.” RSA § 228(1)(b). It was within the authorized time limits, as Barney was on the
job. However, it was not on Club property, but on the public sidewalk. The question is
what “substantially” means. Section 228(2), which says the master is not liable, talks
about conduct “far beyond” the authorized time or space limits. This is probably close
enough, given that activity on the public sidewalk outside the club could clearly spill over
10
and affect the club. Therefore, Barney was probably acting within the scope of
employment and Club Soda is liable for his negligence. RSA § 219(1).