Business Associations
Intro. to the Business as a For-Profit Entity/Ultra Vires Doctrine/Corporate Donations:
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Ultra Vires: Lacked the Power to Act/Do OR an Action Outside of the Corporation’s
Powers/Capacities.
Intra Vires: Had the Power to Act/Do OR Within the Powers Granted to It by Itself…
A “business” is some form of activity that is organized to “create value” for its owners.
Owners of a business are able to realize “value” through dividends or the sale of their stock.
Milton Friedman—“Stockowners are principals, while executives and those who work for the
corporation are agents.”
Agents are to act on behalf of the principals’ interests.
Fiduciary relationship—Agents have an obligation to look out for and take care of their principals.
How do principals keep agents faithful to their interests?
When agents give away or donate corporate money, they are in essence, actually acting as principals.
1. Old Common Law Rule – A.P. Smith v. Barlow
a. A.P. Smith’s Board of Directors donated $1,500 to Princeton University. Afterwards, the Board
instituted a declaratory action to test whether such donations were allowed as the company’s
certificate of incorporation did not provide for such donations.
b. Are such donations allowable as being within the powers given to A.P. Smith’s Board of
Director’s through its certificate of incorporation, which was silent OR by some inherent or
implied power given by the common law? Do the New Jersey statutes which expressly authorize,
but do not mandate such contributions constitutionally apply to A.P. Smith, a company which
was created long before the statutes’ enactments so as to justify the donation made here?
c. Modern conditions require that corporations discharge responsibilities that they have to society
through donations such as the one made here, so that the fact that A.P. Smith’s Certificate of
Incorporation is silent on the issue, is of no matter. Additionally, under the “entity theory of
corporations, companies have an obligation, really, to make such donations. So that even though
there is no monetary benefit to be derived from A.P. Smith’s donation to Princeton, it should be
allowed to stand. As an entity to be treated like a person, public benefit is derived from donations
such as the one here. Lastly, the U.S. Supreme Ct. has consistently held that state legislation
adopted in the public interest can apply retroactively to pre-existing corporations without
impairing the rights of stockholders or violating their constitutional guarantees.
d. The donation was sustained on the theory that such donations were within the powers given to
A.P.’s Board of Directors by itself—intra vires.
e. Restrictions on Donations by the Board:
i. Donations must be for a reasonable amount.
ii. Individual directors cannot have a personal interest in donations or use them for personal
benefit as such would constitute a breach of their fiduciary duties.
2. MBCA § 3.02 states that corporations have the power to:
a. (13) Make donations for the public welfare or for charitable, scientific, or educational purposes
b. (15) Make payments or donations, or do any other act, not inconsistent with law, that furthers the
business and affairs of the corporation
3. Restrictions:
a. Must be reasonable in amount
b. Not a “pet charity,” meaning it can’t be to benefit the directors/officers personally
4. Reasons to allow corporate donations:
a. Tax deductions (up to deductibility limit).
b. Lowers fund raising costs.
c. Social responsibility of corporations increases reputation with investors.
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5. MBCA § 3.04 – Can’t challenge actions as ultra vires except in a few circumstances…
 Today, a similar claim could be had in a derivative action for breach of fiduciary duties.
 To restrict the purposes/powers of the corporation or the Board of Directors today, such restrictions need
to be specifically included in the certificate/articles of incorporation; otherwise the purposes/powers of
the corporation or Board will be broadly construed.
 Thus, the Ultra Vires Doctrine is not used very much anymore as corporate powers are assumed to be
broadly construed unless otherwise limited in the certificate/articles of incorporation.
 Generally, corporate management is a function of the Board of Directors. Indeed, shareholders vote to
appoint directors to manage the company/corporation.
 Entity Theory v. Principal/Agent Theory
 Should corporations have responsibilities similar to those as citizens? This is a timeless question.
Basic Accounting:
1. Generally Accepted Accounting Principles:
a. Matching
b. Conservatism
 Balance Sheets show the company’s assets, liabilities, and the owner’s equity in the business.
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Three main Sections:
1. Assets: What the Company Owns: Cash, Land, Buildings, Accounts Receivable, Machinery,
Equipment…
 2. Liabilities: What the Company Owes: Accounts Payable, Wages/Salaries, Debts…
 3. Owner’s Equity = Assets – Liabilities OR Assets = Liabilities + Equity
 When liabilities exceed assets, the owner’s equity is negative and the company is insolvent.
Balance Sheet:
1. Assets = Liabilities + Equity or restated as Assets – Liabilities = Equity
2. Balance Sheets are a snapshot of the financial picture at a particular point in time, therefore you need to
know the point in time for it to be useful—i.e. a date.
3. All changes in the balance sheet have to have 2 entries (so that it will still balance).
a. Examples: Paying phone bill – Need to subtract cash from assets and remove phone bill from
liability. 2 assets can offset – Buy pizza, subtract cash but add pizza as asset (eating pizza would
decrease assets and liabilities would stay same so decreases equity).
b. An increase in bank borrowing (a liability/debt) also creates an increase in cash (an asset) when
the borrowed money is deposited into the company’s bank account.
4. List assets/property by their historical value (what was paid for it originally).
a. Example: land (even though it appreciates in value, you still list the purchase price on the
balance sheet, although the appreciation might be listed in a footnote). Company would be
worth more than shown on the balance sheet if land value appreciated.
5. Depreciation (decreases historical cost on balance sheet)
a. This is where you distribute the expected useful life of an item over the course of several years,
making your balance sheet more “realistic.”
b. It is entered as a negative asset, not a liability. The item depreciated is listed at its original
historical cost and then depreciation indicated by an entry below.
6. Accounts receivable is also designed to make the balance sheet more realistic.
7. Balance Sheets do not include certain liabilities such as possible law suits or unasserted claims.
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Income Statements compute the profit of a business for the period in question—typically one year.
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Income Statement:
1. This is a “motion picture” if a balance sheet is a snapshot, in that income statements cover a period of
time…
2. Income Statement Formula: Revenues – Expenses = Net Income
3. There is generally an expense entry for taxes.
a. After you subtract all expenses from revenue, then you get profit before taxes and you must
subtract taxes to get to net income.
b. Sales – Costs Of Sold Goods =Profit Before Taxes
c. Taxes need to be taken from the PBT to determine the Net Income.
d. Take out costs for salaries as well.
4. This is a tricky statement, because of the principle of matching. If you get a delayed payment, that can
throw off the picture. Costs or expenses should be booked in the same period as the revenues those
expenditures helped generate. Used to show profits accurately.
a. Example: Can’t charge whole cost of $5000 machine to first year because it will generate
revenues for several years. Must use a depreciation formula.
b. Matching is where the “dirty work” is done on income statements.
5. Depreciation: Reflecting cost over a period of time equal to the time used:
a. A $5,000 machine with a life span of five years, should be depreciated at $1,000 per year.
b. Straight-Line Depreciation—called so because the value of the equipment decreases by the same
amount each year. See example above…
c. Accelerated Depreciation deducts proportionally more of the cost of equipment in the earlier
years and less later on. This assists in decreasing tax amounts owed in the early years, while it
will increase the amount owed in later years. With the money saved from taxes, the company can
invest.
6. Decreasing Tax Amount:
a. Purchase more equipment to increase depreciation (this is attractive because depreciation is not
an “out of pocket” expense).
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A measure of how much cash a business has at the end of the year relative to how much it had at the
beginning of the year.
 An Income Statement with Depreciation?
 Cash Profit=Profit After Tax
Cash Flow Statement:
1. Basic formula: Profit After Tax + Depreciation – Investment = Cash Flow
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InvestmentWhen a business buys something that will be used for more than one year.
ExpenseWhen a business buys something that will be used within the year in which it was bought.
Examples of Expenses: Salaries, General and Administrative Expenses, Cost of Goods Sold, etc…
Agency:
Sole Proprietorship:
1. No separate entity created—you are the sole proprietorship and it is you! Thus, there is no legal
separation of the business between those who manage and those who own.
2. Sole proprietorships are the default and are defined by a single owner.
3. Sole proprietorships are not business associations.
4. The owner of a sole proprietorship is liable for all of the business’s debts and liabilities. Thus, the owner
can be sued personally for any claims against the business and any recovery from those claims will be
collected from the owner him/herself.
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5. Additionally, the owner of a sole proprietorship reports the business’s income on his personal tax return
and pays the taxes on that income.
6. There is no need to draft or file anything to start a sole proprietorship.
a. Except if use name different from owner’s legal name, have to file something (i.e., d/b/a ____)???
7. A sole proprietorship can have thousands of employees, but will still remain a sole proprietorship as
long as there is a sole, single owner.
8. The relationship between the owner of a sole proprietorship and his/her employees is largely one of
contract or agency law.
Agency Relationship:
 Agency law involves delegation, whereby the principal engages the agent to perform a task of make an
agreement on his/her behalf.
A. Agent acts on behalf of the principal, subject to the principal’s control.
1. A must consent, P must consent
B. Formation of an agency relationship [RS Agency § 1]
 “Agency is the fiduciary relation which results from the manifestation of consent by one person to
another that the other shall act on his behalf and subject to his control, and consent by the other so to
act.”
 “The one for whom the action is to taken is the P.”
 “The one who is to act is the agent.”
1. Manifestation of consent by the principal to the agent that the agent shall act on the principal’s
behalf and is subject to the principal’s control and consent by the agent to act.
2. Fiduciary relationship whereby the A owes duties to the P in discharging the act.
a. Control: P has right to control, P doesn’t necessarily have to exercise that control minute by
minute for example.
b. Both A and P must consent. Doesn’t have to be a K, can be just words or conduct. Does not
have to occur for business purpose, can occur in social situation like roommate getting
something for you at the store upon your request.
c. To act on P’s behalf: P bears the gain or loss from A’s conduct.
d. Duration is of no importance to the agency relationship.
C. If a person is not found to be an agent, they are an independent contractor. Typical reasons someone is
found to be an independent contractor:
1. Principal doesn’t have as much control (ex: hiring a painter, you tell them the job, but they have
discretion in how to go about it. Painter typically paid by the job and bears the risk of it costing
more or taking longer. If painter worked by the hour, then leans more toward agent).
2. Independent contractor is not acting on the principal’s behalf:
a. This means “primarily on behalf of.” The profit element of the painter’s work is going to the
painter, whereas the profit element of an agent typically goes to the principal, the agent gets
wages.
D. If there is an agency relationship, whatever the agent does, it is as if the principal has done it himself.
Thus, the agent’s signature is the principal’s. Rick Lynch by Ashley Leyda, for example.
E. Spouses and joint tenants are not agents for the other(s).
Types of Authority:
A. Authority = power of agent to bind the principle. No authority = P not bound/liable for A’s acts. RSA §
140
B. Actual Authority [RSA §§ 7, 26]
1. Authority created by manifestations from the principal to the agent that the agent reasonably
believes create authority. The principal simply tells the agent that the agent is empowered to act on
his/her behalf in accomplishing some task.
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2. For actual authority—either express or implied—communications or conduct between the principal
and the agent are all that matter—not communications or conduct with a third party.
3. RSA § 7 defines “authority” as the power of the agent to affect the legal relations of the principal by
acts done in accordance with the principal’s manifestatitons of consent to him.
4. Express Actual Authority:
a. Occurs when the principal has given the agent specific instructions. The agent is expressly
authorized to carry out those instructions. Details spelled out for a task.
b. The principal has expressly given his authority for the agent to act on her behalf through her
actual or written word.
5. Implied Actual Authority:
a. Occurs when the principal has given an agent a task, from which it can be implied that the agent
has permission to do things necessary to carry out the task, even though express authority has not
been given by the principal to do such things—ex. “make travel arrangements” gives authority to
buy plane ticket. What the agent thinks is reasonable to get the job done if not spelled out.
b. For implied authority, whether the third party was aware of communications or noncommunications between the principal and agent are of no concern where it could be implied
that the agent could act on behalf of the principal. Remember, for actual authority—either
express or implied—communications or conduct between the principal and the agent are all that
matter—not communications or conduct with a third party.
C. Apparent Authority [RSA §§ 8, 27]
1. Authority created by manifestations from the principal to third parties.
2. Created by words or conduct (manifestations) of P that, reasonably interpreted by TP, causes the TP
to believe that P consents to have the act done on his behalf by the person purporting to do the act
for him. (NOT created by manifestations by A TP). Manifestations of P to TP that lead TP to
reasonably conclude A is agent for P. Here, P does not really authorize A to act on his behalf,
indeed, P may have privately forbidden A to act for him/her.
a. Need some type of evidence that P has given authority and somehow communicated to TP.
3. Ways to find apparent authority:
a. Direct communication from P  TP (the easy way)…
b. Past Transactions: Where a P who has not authorized their A to do something pays for whatever
it is that the A has done anyways—authority after the fact or affirmance—“ratification.” This
can create a pattern that gives the TP reasonable belief that A still has the authority to act on
behalf of P even if that authority has been revoked—a series of ratifications may lead to
c. Job Title (The title “general manager” could convey the ability of the person with such title to
bind the principal)…
d. Industry norms/customs…
e. Advertisements and stationary are also ways of finding apparent authority.
4. A big aspect of agency law is reasonable reliance or expectation—agency law protects third parties
who have reasonable relied on past communications/behavior.
5. The way to avoid this type of authority is to make sure the third party knows the actual scope of the
agent’s authority.
6. An agent is subject to a duty to the principal not to act in the principals’ affairs except in accordance
with the principal’s manifestation of consent—RSA § 383.
7. As such, if an agent binds a principal in this way, the principal has a cause of action against the agent
for the unauthorized amount they had to pay the third party.
8. For apparent authority there must be communication from the P to the TP in order to bind the P with
A’s actions. For example, suppose that Agee (the cook) calls the Tuscaloosa News and tells the
advertising director that she is running Bubba’s Burritos for Propp, which is simply not true. She
then places a series of full-page ads for Bubba’s Burritos with the newspaper. Propp would not be
liable to the newspaper for these ads—see RSA § 140.
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Other Authority Concepts:
A. Inherent Authority—RSA § 8(A): the power of an agent which is derived not from authority, apparent
authority, or estoppels, but solely from the agency relation and exists for the protection of person
harmed by or dealing with a servant or other agent.
B. Estoppel—RSA § 8(B):
a. This is similar to apparent authority where the principal negligently creates a kind of impression
to a third party.
Liability of P for acts of A:
A. In the case of either actual or apparent authority, the principal is bound by the agent—RSA § 140.
Additionally, the principal can be bound by the agent by the fact that the agent has a power arising from
the agency relation and not dependent upon either actual or apparent authority—RSA § 140(c).
B. Contract Liability: Agent/Principal Relationship
1. If there is actual or apparent authority, P is liable to TP for A’s act—RSA § 140.
a. When is the A liable for his own act?
i. If Disclosed Principal: A is not liable on the K.
1) Disclosed P: RA § 4(1). At the time of the transaction, TP has notice that A is acting for
P and of P’s identity.
2) Unless otherwise agreed, a person making or purporting to make a contract with another
as agent for a disclosed principal does not become a party to the contract—RSA § 320.
ii. If Undisclosed Principal: A is personally liable on the K.
1) Undisclosed P: RA § 4(3). TP has no notice that A is acting for P.
2) An agent purporting to act upon his own account, but in fact making a contract on
account of an undisclosed principal, is a part to the contract—RSA § 322.
3) A becomes a party to the K, so personally liable.
4) P may also be liable per RSA § 140(c).
iii. If Partially Disclosed Principal: A is personally liable on the K.
1) Partially Disclosed P: TP has notice that A is acting on behalf of a P, but does not know
P’s identity.
a. When P knows that A is an agent for someone else, just not who that someone
else is.
2) Unless otherwise agreed, a person purporting to make a contract with another for a
partially disclosed principal is a party to the contract—RSA § 321.
iv. Warranty of Authority: If someone is making contracts with a third party on another’s behalf,
they warrant to the third party that they are authorized to make such contracts on the other’s
behalf.
v. Warrant of authority is implied.
vi. TP can sue A for breach of implied warranty of authority for representing that he had
authority when he didn’t (liable for misrepresentation).
vii. P can sue A for exceeding his authority (duty to obey).
viii. RSA § 326—Unless otherwise agreed to, a person who, in dealing with another, purports to
act as an agent for a principal whom both know to be nonexistent or wholly incompetent,
becomes a party to such a K.
C. Tort Liability (Vicarious Liability): Master/Servant Relationship
1. Some agency relationships qualify as master/servant relationships.
2. Independent contractors can either be agents or non-agents.
3. Servants are always agents, but not all agents are servants!
4. Independent contractors are never servants.
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5. RSA § 220(1) defines a servant as a person employed to perform services in the affairs of another
and who with respect to the physical conduct in the performance of the services is subject to the
other’s control or right to control. RSA § 220 also includes factors for determining whether one is a
servant or not—although these factors are not exclusive for determining such.
a. The critical factor for determining whether on acting for another is a servant of an independent
contractor is the extent of control which the “master” exercises over the details of the work—
RSA § 220(2)(a).
6. A master is only liable for the torts of his/her servants committed while acting within the scope of
the servants’ employment—RS § 219(1).
a. See RSA § 219(2) for exceptions to the above general rule.
b. Servants are also liable for their own torts—RSA § 343.
7. Must have a master/servant relationship to have vicarious liability!
8. Two questions that must be asked:
a. Is the agent a “servant” of the principal? [RSA § 220]
i. A servant is a person employed to perform services in the affairs of another and who with
respect to the physical conduct in the performance of those services is subject to the other’s
control or right to control.
ii. The important part is that the master has the right to control the details of how the servant
does the job!
1) Any full-time employee is subject to physical control of employer, therefore considered a
servant.
1. Attorneys who work for law firms are servants.
2. CEO’s are both agents and servants.
iii. RSA § 220 lists pertinent factors to this determination. The most important factor – extent of
control over details of work. Don’t have to meet all factors to be a servant. Just because
parties agree that not a servant, that is only one factor and still can be found to be servant.
b. Was the agent acting within the scope of his employment when the tort was committed? [RSA
§§ 228, 229]
i. RSA § 228(1): Conduct of a servant is within the scope of employment if, (a) it is the kind he
is employed to perform; (b) it occurs substantially within the authorized time and space
limits; (c) it is actuated, at least in part, by a purpose to serve the master, and (d) if force is
intentionally used by the servant against another, the use of force is not unexpectable by the
master
1) For example, suppose that Propp hires Agee to work as a cook. When Agee overhears a
customer criticizing her cooking, she hits the customer over the head with a skillet. Under
RSA § 228(d) such intentional force would be unexpectable by the master so that Agee
would not be found to have acted within the scope of her employment so that Propp
would not be held liable.
2) For another example, suppose that Freer hires Epstein as a bouncer for a party. Epstein
punches a party-goer in the nose. Although Freer did not instruct Epstein to do this, such
a tort might go with the territory so that Freer would probably be held vicariously liable.
ii. Under RSA § 228(2) conduct of a servant is not within the scope of employment if it is
different in kind from that authorized, far beyond the authorized time or space limits, or too
little actuated by a purpose to serve the master.
iii. RSA § 229(2) provides factors for determining whether conduct, although not authorized, is
generally within the scope of employment.
9. If both of these are found, the principal is “vicariously liable” for the torts of the agent.
10. Reasons for holding the master liable are because the master gets the benefit of the “good” things his
servants do for him, so that it is fair to “charge” the principal for the errors made by his servants. It
also encourages training and supervision on the part of the master. Additionally, the master is able
to more easily pass along the costs.
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11. The servant is also liable—RSA § 343, but generally the principal is sued because they have the
deep pockets.
D. Generally, employers are not held liable for torts committed by their employees on the way to and from
work.
1. There may however, be certain facts tending to show that an employee was acting within the scope
of the employment or under the control of the employer while going to and coming from work, so
that the employer should be held liable for the employee’s torts.
2. There are generally, exceptions to the going and coming rule. For example, employers have been
held liable for torts committed by their employees while commuting when (a) the employee was
engaged in a special errand or mission on the employer’s behalf (b) the employer requires the
employee to drive his or her personal vehicle to work so that the vehicle may be used for workrelated tasks and (c) the employee is on-call.
E. An attorney for a client is not an employee or servant, but they are still an agent, allowing him to subject
the client (principal) to contract liability.
1. [Hayes v. National Service Industries]
a. Attorney in this case called the opposing party in this case and informed them that he had the
authority to settle the case on behalf of his client. The case settled. Opposing the settlement, the
client claimed that her attorney did not have such authority.
b. Held: Attorney had the apparent authority to settle the case on behalf of the client, so that the
client was found to be bound by the settlement agreement.
c. Attorney’s authority generally determined by representation and client instructions.
d. Under Georgia law, an agent attorney’s authority is to be considered plenary unless limited by
the client and that limitation is communicated to opposing parties. Here the client had not
communicated any sort of limitation to the opposing party such. Note that apparent authority was
not created by the lawyer in this case telling the opposing party that he had authority to settle as
that would be ATP communication and not a PTP one.
e. The communication from P to TP that results in apparent authority is P’s act of hiring A
i. When you hire a lawyer in Georgia, under the law, you essentially communicate to everyone
that you attorney has the authority to act for you.
f. Generally, an attorney is not presumed to have settlement authority!!!
g. Lack of actual authority is not a defense to a contract made by apparent authority.
h. Actual and apparent authority give the A the power to bind the P. Apparent authority doesn’t
necessarily give A the right to bind the P (for example, the client may say don’t settle). Actual
authority gives A the right to bind the P.
F. Apparent Agency [Miller v. McDonald’s] NOT Important though as most courts do not find franchisees
to be agents of the franchise.
1. The plaintiff was injured when she bit into a sapphire that was inside of a Big Mac made by a
McDonald’s owned by 3K, Inc. The plaintiff sued McDonald’s Corp. rather than 3K, Inc.
2. The plaintiff alleged that 3K, Inc. was an agent of McDonald’s Corp—master/servant?
3. In order to hold McDonald’s Corp. liable, the plaintiff must show that there was control by
McDonald’s Corp. over 3K, Inc. and that 3K, Inc. acted on behalf of McDonald’s.
4. Here, there was certainly evidence of control over 3K, Inc. on the part of McDonald’s, but it is
questionable whether 3K, Inc. acted on behalf of McDonald’s Corp.—generally, courts find that
franchisee’s purpose is to make money on their own behalf.
5. In the franchisee contract, a provision was included which specifically denied an agency relationship
between McDonald’s Corp. and 3K, Inc. The court in this case seemingly ignored the provision.
6. The parties to an agency relationship do not have to realize that such a relationship exists or intend
the consequences of an agency relationship for a court to find that one existed.
7. Additionally, the plaintiff alleged that 3K was the apparent agent of McDonald’s Corp. for the
purpose of holding McDonald’s liable.
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8. Apparent agency is a distinct concept from apparent authority. Apparent agency creates an agency
relationship that does not otherwise exist, while apparent authority expands the authority of an actual
agent. Additionally, apparent authority relates to contract liability whereas apparent agency relates to
tort or vicarious liability.
9. This occurs when the principal holds someone out as his agent AND
a. This can be shown by advertising or restricting someone from holding themselves out as an
agent of another company
10. The third party justifiably relies on that holding out.
11. RSA § 267—“One who represents that another is his servant or other agent and thereby causes a
third person to justifiably rely upon the care or skill of such apparent agent is subject to liability to
the third person for harm caused by the lack of care or skill of the one appearing to be a servant of
the other agent as if he were such.”
G. In general, to hold the principal liable, you have to show agency (contract) or servant (tort), or find some
way to hold the principal directly liable (failure to supervise, failure to train)—see RSA § 140!
Sole Proprietor Financing:
A. If the business folds, the owner gets what is left after all creditors are paid.
B. Debt Financing:
1. Loan that business is legally obligated to repay whether or not earn profits. Must pay back fixed
amount plus interest. Creditor has first dibs on assets. Less risk to investor because debt secured,
but profits limited to interest rate.
2. Suppose that a sole proprietor borrows $10,000 from a lender, his balance sheet will show that he
has $10,000 more in cash and $10,000 more in equity.
3. If at the end of the year, the same proprietor lost the $10,000, his balance sheet would show that he
has $0 in cash, $10,000 in liability and -$10,000 in equity.
4. If he had instead secured $10,000 from an investor, but still lost the $10,000 , his balance sheet
would show that he has $0 in cash, $0 in liability, and $0 in equity.
C. Equity financing:
1. Investment that the business is not legally obligated to repay. Owner gives up share of control and
profits. Investor shares in profits/losses. More risky for investor because not entitled to be repaid.
Note, that in this situation, the business is no longer a sole proprietorship.
2. If the “sole proprietor” is able to convince another to invest in his company for $10,000, his balance
sheet will show that he has $10,000 more in cash and $10,000 more in equity.
D. Taking out a loan sometimes can give a business owner “leverage.”
1. Example: you have $100,000 and want to buy a rental house. You would get $15k profit from this
investment per year. That is a 15% profit.
2. If you can get a loan for $50k of the $100k investment at 10% interest, that would reduce your
annual income by $5k, but your profit would be $10k on a $50k investment, or 20%.
3. Because the interest rate is less than your profit margin, you make more money by borrowing some.
Partnerships:
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An association of two or more persons to carry on as co-owners a business for profit—RUPA § 202.
Determining When a Partnership Exists:
A. Partnerships are the default business association when two people enter into a joint venture.
B. Making profits is not determinative of a partnership. Simply coming together for the objective to make
profits is though.
C. If two people agree to share profits from a business (i.e. profit-sharing), such is prima facie evidence a
partnership exists unless it can be explained away as payment of:
a. Debt by installments or otherwise;
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b. Wages or rent;
c. Annuity to a widow of a deceased partner;
d. Interest on a loan; or
e. Consideration for the sale of goodwill or other property of the business.
2. Thus, profit-sharing creates a rebuttable presumption that a partnership exists.
3. Looking at profits is important because it shows ownership and owners typically share profits.
4. While profit sharing is strong evidence of a partnership, it is not a required element of the definition
of a partnership [Holmes v Lerner, Urban Decay]
5. An agreement to share profits or otherwise be partners need not be definite, as the Uniform
Partnership Act (UPA) provides fill-ins where the partners have them out. Indeed, a partnership need
not even exist for there to be a partnership.
6. There are two other factors to consider in determining if a partnership exists:
a. Right to control (i.e. who makes management decisions?) [Beckman v. Farmer]; and
b. Sharing of liabilities/losses.
7. Some courts require evidence that the parties associated together with the intent to carry on business
as co-owners for profit—[Beckman v. Farmer]. RUPA § 202 does not require such intent.
8. If one is not found to be a partner, they will likely be considered an employee.
D. RUPA Test [§ 202]
1. RUPA § 202(a): The association of two or more persons to carry on as co-owners a business for
profit forms a partnership, whether or not the persons intend to form a partnership.
a. Association: The parties must voluntarily come together…
b. There must be at least two persons.
i. “Persons” is defined in RUPA § 101(10) and includes corporations and other business
entities.
c. Must have a business for profit as opposed to a not-for-profit entity. (This really only rules out
clear non-profit intentions. If partners are simply lousy at the business and never make money,
such is still considered for profit).
d. As co-owners—this is at issue in most partnership litigation!
2. RUPA § 202(b): An association formed under a statute other than RUPA, is not a partnership—i.e.
a corporation or LLC.
a. Partnerships are the default entity. If parties try to form something other than a partnership—
such as an LLC or a corporation—and such fails, a partnership exists between them. Unless of
course there is only one owner—then it’s a sole proprietorship.
3. RUPA § 202(c) provides factors to determine whether a partnership has been formed.
4. RUPA § 202(c)(3) provides that a person who receives a share of the profits of a business is
presumed to be a partner in the business unless the profits were received in payment of…see iii
below!
a. Determining Whether a Partnership is Formed:
i. Co-ownership of property does not by itself evidence a partnership.
ii. Sharing of gross returns does not by itself evidence a partnership.
iii. RUPA § 202(c)(3) Profit-Sharing—Partnership Presumed, UNLESS payment:
1) Of a debt;
2) For services (i.e. independent contractor or an employee);
3) Rent;
4) Annuity/retirement;
5) Interest on loan; or
6) Sale of goodwill of a business or other property.
5. The intent to form a partnership is of no matter under RUPA § 202. The intent that is important is
the agreement to go into business as co-owners for profit. Such an agreement can be oral or written.
E. Things to look for when determining if a partnership has been formed (beyond the RUPA § 202(c)
factors):
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1. Investment of money; and
2. Control over operations (Such is not conclusive, but is strong evidence. If a creditor exercises too
much control, they might be found to be a partner). The ability to make management decisions and
exercise oversight is a very important factor.
F. If a partnership agreement expressly provides: “We agree that we are not partners…”
1. Such might not be influential as RUPA § 202 allows a partnership to be formed regardless of the
parties’ intent to form a partnership. The intent to become a co-owner is most crucial.
Partnership by Estoppel: [Cheesecake Factory]
A. A person can be treated as a partner and consequently exposed to personal liability for the corporation’s
debts, when representations were made that the enterprise was a partnership and the person a partner—
RUPA § 308.
B. Remember, that partners are on the hook for debts/liabilities, whereas shareholders are not.
C. Thus, even though an enterprise is actually a corporation, a person can be treated as a partner, and
consequently exposed to personal liability for the corporations’ debts, when representations are made
that the enterprise is a partnership and the person is a partner. The representations must be made by the
purported partner or with the purported partner’s consent.
D. There is a distinction between a representation that is private and one that it public.
1. When a representation is private, the plaintiff is required to establish that he/she has on the faith of
such representation, given credit to the actual partnership.
2. When a public representation is made, the plaintiff need only establish that the defendant made or
consented to public representations of his partnership status, regardless of whether such
representation was made or communicated to him/her and regardless of whether he/she relied on
such representation.
E. See RUPA § 308!
F. Partnership by estoppel looks a lot like apparent agency whereby reliance on the part of third parties is
heavily protected.
Partnership Agreements: RUPA § 103
A. Can be written or oral—RUPA § 101(7). A partnership agreement is not necessary to establish a
partnership.
B. To a large extent, provisions in the partnership agreement control the relationship among the partners,
rather than RUPA. [RUPA § 103(a): “…to the extent the partnership agreement does not otherwise
provide, this Act governs relations among the partners and between the partners and the partnership.”]
C. RUPA § 103(b) lays out what the partnership agreement cannot do. Partnership agreements trump
RUPA except in regards to the matters listed in RUPA § 103(b). RUPA provisions fill in any gaps not
addressed by the partnership agreement or to the extent that there is not a partnership agreement.
D. They key to a good partnership agreement is specificity. Say what you mean so there are no questions
later!
Misc. Partnership:
A. RUPA § 201 provides that a partnership is an entity distinct from its partners—this has important legal
consequences.
B. UPA generally embraces an aggregate theory of partnerships—that is, the partnership is not a separate
legal person, but the aggregate of its partners.
C. To the extent that UPA or RUPA does not provide, principles of law and equity govern—UPA § 5 and
RUPA § 104.
D. Case law is still an important part of partnership law.
E. The UPA and RUPA are fall-back provisions—that is, they apply only if the partners have not agreed to
the contrary—note though RUPA § 103.
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Partnership Property:
A. Property acquired by the partnership is property of the partnership and not of the partners individually—
RUPA §§ 203, 501 & UPA §§ 8, 25.
1. Thus, both UPA and RUPA envision the partnership as an entity for the purpose of owning property.
B. In order to figure out if partnership or individual property, look to RUPA § 204.
1. RUPA § 204(a)(1) provides that property acquired in the name of the partnership or in the name of a
partner with reference to their capacity as partner or that indicates the existence of the partnership
without reference to the partnership’s name is considered partnership property.
2. RUPA § 204(b) provides that property is acquired in the name of the partnership by a transfer to (a)
the partnership in its name, or (b) one or more partners in their capacity as partners in the partnership
if the name of the partnership is indicated in the instrument transferring title to the property.
3. Property acquired before formation of the partnership is only partnership property if the partner
transfers the property to the partnership—RUPA § 204(d).
4. If partnership assets are used to purchase the property, it is presumed to belong to the partnership—
RUPA § 204(c)
C. Remember, these provisions can be altered by the partnership agreement!
D. Sometimes it matters if something is partnership property, particularly in the case of creditors.
Partnership Decision Making:
I. Depends on what kind of dispute:
1. External: A dispute between the partnership and an outside party…
a. The issue here is whether a partner had the power to obligate the partnership to a third party.
b. Look first at relevant partnership statutes (300s) and then to the common law agency principals
such as actual and apparent authority.
2. Internal: A dispute among partners…
a. The issue here is whether a partner had the right to act on behalf of the partnership.
b. Look at the partnership agreement first, then to provisions of relevant partnership statutes (400s),
and then to common law agency principles.
B. Internal
1. Each partner has equal rights in the management and conduct of the business—RUPA § 401(f)—
unless the partnership agreement states otherwise.
2. RUPA § 401(j) states that decisions in the ordinary course of the partnership business can be
decided by a majority of the partners, but anything outside of the ordinary course of the partnership
business or when amending the partnership agreement requires unanimity.
a. You can tell what the ordinary course of business is by:
i. Partnership agreement (if there is a purpose clause);
ii. What other comparable businesses do; and
iii. Past transactions.
b. What about two person partnerships for the purposes of a majority? The courts are split—there
are some courts which find that both have to essentially agree on anything, while other courts
find that anyone can essentially do anything in a two person partnership.
3. A partner isn’t entitled to get paid for services performed for the partnership other than in winding it
up—RUPA § 401(h).
4. Need consent of all partners to add a new partner—RUPA § 401(i).
5. RUPA § 401 does not affect the partnership’s obligations to third parties—RUPA § 401(k)
6. The partnership shall reimburse a partner for payments made and indemnify a partner for liabilities
incurred by the partner in the ordinary course of business f the partnership or for the preservation of
its business or property—RUPA § 401(c).
7. Under RUPA § 401(a), each partner is deemed to have an account that is:
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a. Credited with an amount equal to the money plus the value of any other property, net of the
amount of an liabilities, the partner contributes to the partnership and the partner’s share of the
partnership profits; and
b. Charged with an amount equal to the money plus the value of any other property, net of the
amount of any liabilities, distributed by the partnership to the partner and the partner’s share of
the partnership’s losses.
8. Each partner is entitled to an equal share of the partnership profits and chargeable with an
equal share of the partnership losses in proportion to the partner’s share of the profits, unless
otherwise provided for in the partnership agreement—RUPA § 401(b).
C. External
1. RUPA § 301—parnters as agents of the partnership.
2. RUPA § 301 statutorily creates apparent authority for partners carrying on in the ordinary course of
the partnership’s business. The third party doesn’t need to know that the person he is dealing with is
a partner or that he is doing business with a partnership in order for the partner to have apparent
authority as it is seemingly created by statute—i.e. RUPA § 301(1).
a. As long as the third party doesn’t know that the partner is without authority, the partnership can
be bound under RUPA § 301. This is based on the title “partner” and its meaning to third
parties.
i. Knowledge: Really means “notice” under RUPA § 102.
b. Even if a partner was not given the authority to act by the partnership, he still has the power to
bind the partnership to agreements with third parties. The partnership could sue the partner, but
the deal he entered into is still binding on the partnership. (Ex. A has no authority to make leases
for the partnership, but does so anyway. A’s actions would bind the partnership to the lease
anyway.)—Check on this per language of RUPA § 301(1)—“…unless the partner had no
authority to act for the partnership in the particular matter AND the person with whom the
partner was dealing knew or had received a notificiation that the partner lacked authority.”
i. The partnership agreement can’t restrict the rights of third parties—RUPA § 103(10).
ii. Ex. whereby there were three partners who owned a real estate company. The partnership
agreement specified that unanimous decisions were required in order to purchase real estate.
Two of the partners wanted to purchase a piece of real estate and they did indeed do that to
the qualm of the other partner. They then tried to back out of the contract because the two
lacked authority to do so. The Iowa Supreme Court said too bad finding that there was
apparent authority to purchase the real estate as it was a real estate company buying real
estate and the third party did not know otherwise.
c. You can file a statement (with the Secretary of State?) under RUPA § 303 indicating who has
the authority to do certain things within the partnership.
i. This doesn’t do too much though. The third party is not deemed to know of the limitation on
authority anyway, so the transaction will still be binding even if the partner did not have
authority. RUPA § 303(f) exception: provides constructive notice to buyers of real
property—§ 303(e)
3. Basically, if there is an internal power struggle among the partners, the conflict is covered by RUPA
§ 401; if there is an external power struggle, the conflict is covered by §§ 300’s of RUPA.
4. Persons who are not partners can act as agents of a partnership—in which case, ordinary common
law agency principles would apply rather than UPA or RUPA—remember that UPA and RUPA
apply as to partners.
Partner Fiduciary Duties:
A. Meinhard v. Salmon
1. Salmon had wanted to rent a building from Gerry in NYC, but did not have the funds to make
improvements to it. For this, he contacted Meinhard who agreed to furnish the funds for the
improvements in exchange for a share of the profits from the building over a 20 year period. The
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agreement between Meinhard and Salmon provided that they would share any losses equally, but
that Salmon had the sole power to manage the building. Nearly 20 years into the joint venture, Gerry
came to Salmon with the opportunity to lease a much bigger area of property including the building
currently leased to him. (Gerry did not approach Meinhard as Gerry did not know of his
existence/importance). Salmon agreed to take on the project and signed a new lease without
involving or informing Meinhard. Meinhard eventually found out about the project and sued to be
included on the ground that the opportunity to renew the lease belonged to the joint venture.
2. Held: The court, through Cardozo, held that Salmon, as the managing partner, owed Meinhard, as
the investing partner, a fiduciary duty, and that this included a duty to inform Meinhard of the new
leasing opportunity. Joint venturers owe each other the highest duty of loyalty – "Not honesty alone,
but the punctilio of an honor the most sensitive" – and Salmon, as managing partner has assumed a
responsibility by which Meinhard must rely on him to manage the partnership. The court further held
that Salmon was an agent for the joint venture, and when Salmon agreed to the new business
opportunity—which was made available to Salmon only because he held that position with relation
to the joint venture—Salmon carried the joint venture into the new lease with him.
3. Dissent: Andrews contended that any duty flowing from the partnership ended at the end of the
twenty year period; because the partnership was created to manage the building for the twenty year
term, the dissent felt that deals involving events to occur after the expiration of that term were of no
matter to the partnership.
4. A joint venture is a sub-set of the world of partnerships, essentially it’s a partnership with a limited
purpose as there is a specific objective.
5. If a partner learns of a business opportunity because of his status as a partner, he has to duty to
disclose the possibility of the deal to other partners. The partner can’t simply take the opportunity
for himself.
a. Don’t necessarily have to bring a partner along in the deal; just have to disclose the opportunity
to them so that they can fairly compete if they wish. Must disclose to other partners even if
know that they would not want to compete.
6. Partners owe fiduciary duties to each other. Owe the highest duty of loyalty and utmost good faith.
a. Duty especially clear when someone like S has great control over the management and
information.
7. There has to be a nexus between the business of the partnership and the opportunity to give rise to
duty of loyalty.
a. Majority found that new lease was outgrowth of original lease even though for more property.
P/s created opportunity to expand the lease.
b. If lease would have been for unrelated property, then duty would not have arisen because
business of p/s was just the building. If p/s in bus of real estate generally, then duty would apply.
B. RUPA § 404 – Limits fiduciary duties from Meinhard to those of the duty of loyalty—which includeds
the duty to account for the appropriation of a partnership opportunity and the duty of care. If a duty is
not included in RUPA, then there is no such fiduciary duty. Thus, RUPA prevents courts from having
wide latitude to decide fiduciary duties under the common law as in Meinhard. Meinhard’s duty of
loyalty is rather broad and unclear, basically a smell test which requires a higher standard of conduct
than RUPA’s narrow definition. It was common under the common law to decide fiduciary duties on a
case by case basis.
1. The only duties owed by a partner to the partnership and the other partners under RUPA are those in
§ 404(b) and (c)—duty of loyalty and duty of care—RUPA § 404(a)
2. Duty of Care [§ 404(c)] – limited to:
a. Refraining from grossly negligent or reckless conduct, intentional misconduct, or knowing
violations of law.
b. This is easy to satisfy!
3. Duty of loyalty [§ 404(b)] – limited to:
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a. Accounting to the partnership for any property, profit, or benefit derived by the partner in the
conduct and winding up the partnership business or derived from the use by the partner of
partnership property, including the appropriation of a partnership opportunity [Meinhard] That
is, a partner cannot take partnership property as his/her own, including partnership opportunities;
b. Dealing with the partnership as or on behalf of a party having an interest adverse to the
partnership; and
c. Competing with the partnership before its dissolution.
4. Waiveability of fiduciary duties
a. RUPA § 103(b)(3) provides that the duty of loyalty can’t be eliminated in the partnership
agreement, except that the partnership agreement can:
i. Identify certain actions that wouldn’t violate the duty of loyalty as long as they are not
manifestly unreasonable.
ii. Allow all, a number, or a percentage of partners to authorize or to ratify, after full disclosure
of material facts, an action that would have otherwise violated the duty of loyalty—
retrospective forgiveness.
5. Duty of good faith and fair dealing—RUPA § 404(d)
a. In carrying out the duties of loyalty and care under RUPA § 404 or those included in the
partnership agreement, a partner must act consistent with the obligations of good faith and fair
dealing.
b. This is NOT a separate fiduciary duty, it simply attaches when a partner is discharging duties.
C. RUPA § 405(b) provides remedies for breaches of fiduciary and other duties.
D. Under RUPA, all partners are fiduciaries of eachother; however, managing partners might owe even
great fiduciary duties to each other!
Partnership and Partner Liability:
A. RUPA § 301 – all partners are agents of the partnership for the purpose of the partnership business.
B. How can the partnership be held liable?
1. Contract: RUPA § 301(1)—“An act of a partner, including the execution of an instrument in the
partnership name, for apparently carrying on in the ordinary course the partnership business or
business of the kind carried on by the partnership binds the partnership, unless the partner had no
authority to act for the partnership in the particular matter and the person with whom the partner was
dealing knew or had received a notification that the partner lacked the authority.
a. Apparent Authority!!!
b. Actual Authority—RUPA § 301(2)—“An act of a partner which is not apparently for carrying
on in the ordinary course the partnership business or business of the kind carried on by the
partnership binds the partnership only if the act was authorized by the other partners.
C. Tort: See RUPA §§ 301(1) and (2) above…the partner must be acting in the scope of the partnership’s
business.
1. If a partner commits a tort in the course of the ordinary business of the partnership (i.e. apparent
authority) or with the authority of the partnership (i.e. actual authority), the partnership is liable—
RUPA § 305(a).
2. For a third party to successfully sue a partnership for a tort committed by a partner, the party would
need to show that the partner was acting within the ordinary course of business of the partnership or
with authority of the partnership.
D. Under RUPA § 305(b)—If a partner receives money from a third party and misapplies it, the
partnership is liable for the loss.
E. All partners are jointly and severally liable for the obligations of the partnership unless the claimant
agrees otherwise—RUPA § 306(a). Thus, the plaintiff could recover the partnership’s entire
liability to him from just one partner. (Ex. ACE Partnership. A injures P. P can sue A personally. P
can also sue C or E because as partners they are jointly and severally liable under 306(a)—as long as
they are sued with ACE, the partnership—RUPA § 307(c)). Thus, § 307(c) prevents partners from
15
being bound by a judgment against the partnership, unless there is a separate judgment against the
partner him or herself.
1. If suing partners as well as the partnership, the plaintiff must establish that the partner is a partner of
the partnership which he/she has sued and that they were a partner during all relevant times when
the contract breached was entered into, for example. UNLESS, the partner in question was the
tortfeasor.
a. Should a plaintiff with an action against a partnership sue the partnership and the partners
together or should they file suits against each separately? The plaintiff should sue them together
or the issue might be precluded through issue preclusion, having already tried the issue.
b. Remember also, that a plaintiff must be aware of the relevant statutes of limitation.
c. However, RUPA § 307 doesn’t seem to imply that the partnership and partners must be sued
together in the same suit or that the partnership should be sued first.
2. A partner is not liable for any obligation incurred by the partnership before he/she became a
partner—RUPA § 306(b).
a. As to loan obligations or leases whereby payments are made over time though, a judge might
find a partner liable even though not a partner when the loan was made or the lease entered into.
3. In an LLP, only the partnership is liable—RUPA § 306(c).
4. Can always sue the tortfeasor personally regardless of the partnership statute!
F. These can’t be changed, because it would vary the rights of third parties—RUPA § 103(b)(10)]
1. May include in the partnership agreement that only partner A will be liable, but an injured plaintiff
can sue any or all of the partners regardless of the partnership agreement because the partnership
agreement can’t affect or limit the rights of third parties, so that the only effect of such a provision in
a partnership agreement would be to allow the other partners to be indemnified by A.
2. The partnership agreement does not bind third parties, only binds the internal relations of the
partnership, but a partner without authority can bind the partnership and if so may be sued by the
partnership or other partners.
G. Collecting a judgment against a partnership:
1. Unless a plaintiff also gets a judgment against a partner, he/she can’t go after the partner’s assets to
satisfy the judgment against the partnership—RUPA § 307(c).
2. If a creditor has a judgment against the partnership AND a partner based on a claim against the
partnership, the creditor still cannot go after the partner’s assets UNLESS the partner is personally
liable under § 306, according to RUPA § 307(d) AND one of RUPA § 307(d)(1)-(5) are satisfied.
Basically, the plaintiff must exhaust the partnership assets before he/she can go after the assets of the
partners.
a. A plaintiff can collect directly from partner if he/she was the tortfeasor because of dual
liability…as a tortfeasor and as partner. Liability as a tortfeasor is an independent basis for
liability that doesn’t require exhaustion of the partnership’s assets—RUPA 307(d)(5).
3. Indemnity:
a. RUPA 401(c) –- The partnership shall reimburse a partner for any liability incurred as a partner
in the ordinary course of business.
i. If the partners was grossly negligent, RUPA § 404(c) may be implicated in which there is no
right to indemnity then.
H. A personal guarantee for a loan or other contractual obligation by a partner can leapfrog all these
collection provisions. Many creditors require personal guarantees anyhow.
Partnership Finance:
A. Investment by the partners
1. RUPA does not require initial or subsequent capital contributions – must be in p/s agreement
2. There is generally a subsequent capital contribution section in the partnership agreement. In the
event a partner fails to make a contribution when required, the contributions of the other partners are
considered a loan.
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3. The issue here is who decides when capital is needed. – Majority under § 401 unless provided
differently in p/s agreement.
B. Third party lenders
1. Absent an extraordinary loan, this would be decided by a majority of the partners under § 401.
a. Lender may require personal guarantee so that can collect from partner w/o having to exhaust p/s
assets first under § 307.
C. New partners
1. Consent of all partners required under § 401(i) unless amended in the partnership agreement. New
partner not liable for existing obligations before admitted § 306(b)
D. Earnings from the business
1. Each partner is entitled to an equal share of the profits and is chargeable with a share of the p/s
losses in proportion to his share of profits unless altered in the partnership agreement [§ 401(b)].
2. Once again, majority rules under § 401(f) & (j) as to when the profits will be distributed and how
much will be distributed (and therefore how much reinvested).
How Partners Make Money:
A. Each partner has a hypothetical capital account credited with profits and contributions and charged with
distributions made to him as well as partnership losses—RUPA § 401(a).
B. A partner is not entitled to a salary unless so provided in the partnership agreement (or the partnership
hires you)—RUPA § 401(h)]. Additionally, there is no right to work for the parntership as an employee
unless such is agreed upon in the partnership agreement.
1. Salaries come out of assets and reduce equity – thus, the expense is borne by all partners.
C. If one partner thinks the salary being paid to the others is too high, that might be challengeable on duty
of loyalty grounds, as the amount of the partners’ compensation would be an adverse interest to the
partnership under RUPA § 404(b)(2).
1. Even if a majority of partners vote to give themselves a salary, such is probably not acceptable
because setting one’s own salary is an interest adverse to the partnership and might violate the duty
of loyalty. Raising one’s own salary as well as a majority of partners hiring themselves as
partnership employees would also violations of duty of loyalty.
2. It would be an acceptable modification under RUPA § 103 to the duty of loyalty to allow partners to
work for the partnership on salary if not manifestly unreasonable.
D. Profit Allocations:
1. If no contrary provision in the partnership agreement, all partners are entitled to an equal share of the
partnership profits, no matter how much they contributed—RUPA § 401(b). The % distribution of
profits also determines the % distribution of losses.
2. The majority decides when to distribute profits to the partners [§ 401(f) &(J)] because it is a
management decision.
E. Profits v. Distribution:
1. Profit: Money made. Partners can get a share of the money made.
2. Distribution: A partnership does not have to be making a profit in order for partners to receive a
distribution. Additionally, when a partnership does have a profit, the partnership does not have to
distribute all of the profit – it can instead choose to leave some in the partnership’s equity account.
Even if the partnership is losing money, a distribution can still be had from a partnership account
where excess profits are stored, thus reducing equity. This requires a majority vote though.
3. Each partner has to pay taxes personally on his share of profits whether distributed or not as the
partnership is a pass through entity. Usually some agreement to set % of profits distributed because
a partner could otherwise get stuck paying big taxes with no distribution to pay them off.
F. Sale of Partnership Interest:
1. A partner can’t sell his/her decision-making power in the partnership, just his/her interest in getting
profits and suffering losses—RUPA § 502. Thus, the transferee does not get any management
power under RUPA §503(a)(3).
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2.
3.
4.
5.
a. This is because the new person might not be someone whom the other partners want to deal with.
You can’t let a partner impose on you someone you didn’t want to be partners with in the first
place. Remember, consent to be partners is important for the purposes of a partnership.
b. In corporations on the contrary, parties who buy owner’s shares become owners themselves,
while the old owners are then out.
c. Based on a unanimous vote, a partnership may agree to allow the new person the voting and
management powers of the previous partner under RUPA § 401(j).
d. The act of selling one’s partnership interest to another does not by itself cause a dissolution and
winding up of the partnership business—RUPA § 503(2).
A partner is not a co-owner of partnership property and has no interest in such property that can be
transferred—RUPA § 501.
Upon transferring one’s interest in partnership distributions, he/she retains the rights and duties of a
partner, other than the interest in distributions, including the duty to share in partnership losses—
RUPA § 503(d).
Because of this very limited transfer right, the value of a partnership interest is low!
See RUPA § 503(b) for what the new person is entitled to.
SEE NOTES ON PARTNERSHIP FINANCES, PARTICULARLY ON LENDING!
SEE ALSO PART III OF THE SUPPLEMENT!
Dissociation:
I. Introduction
1. Article 6 – Dissociation
2. Article 7 – Buyout
3. Article 8 – Dissolution
II. Under, RUPA, dissociation is the leaving of a partner without a winding up of the partnership business—the
entity theory of partnerships makes this feasible.
III. Procedure
A. A partner has the right to dissociate at any time, rightfully or wrongfully [§ 602(a)]. You can’t put a
provision in the partnership agreement that you can’t dissociate. [§ 103(b)(6)].
1. Can use the partnership agreement to determine when dissociation occurs and what happens when it
occurs though. For example, a partner’s future disassociation can be agreed to—i.e when the partner
turns 65.
B. RUPA § 601 provides the events that can bring about dissociation. Some dissociating events also cause
dissolution of the partnership, but not all.
1. See RUPA § 801 to see if the event causes dissolution.
a. If event causing dissolution/winding up, then go to art. 8 (§ 603(a))
b. If does not cause dissolution/winding up, then go to art. 7 (§ 603(a))
c. Under UPA, the death of a partner caused dissolution/winding up, whereas under RUPA it does
not.
C. Determine if a dissociation is wrongful under RUPA § 602(b).
1. Consequences of wrongful dissociation:
a. RUPA § 701(h): you don’t have to pay the dissociating partner until the end of the term (if a
partnership for a definite term) unless the partner can show no undue hardship.
i. As an aside, a partnership at will is one which does not have a definite term or undertaking—
RUPA § 101(8).
ii. A partner’s choice to leave an at-will partnership will cause dissolution!
b. RUPA § 602(c): the disassociating partner is responsible for damages caused by the wrongful
dissociation—both to the partnership and to the other partners.
i. An example of this is if the partnership had to get a loan for an amount the dissociating
partner would have been obligated to pay.
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ii. You get the recovery as a reduction to the buyout price (set-off) under RUPA § 701(c).
iii. A disassociating partner is nto entitled to participate in the winding up of partnership
business if the partnership dissolves under RUPA § 803(a).
c. The partnership agreement can include or detail events which would not otherwise be wrongful
under RUPA as being wrongful for dissociation.
d. The partnership agreement can also seemingly detail events which will lead to dissociation as
well—Check on this!
D. The dissociating partner is entitled to be bought out by the partnership if his/her dissociation does not
cause dissolution—RUPA § 701(a).
1. “The buyout price of a dissociated partner’s interest is the amount that would have been
distributatble to the dissaociating partner under § 807(b) if on the date of diassociation, the assets of
the partnership were sold at a price equal to the greater of the liquidating value or the value based on
a sale of the entire business as a going concern without the dissociated partner and the partnership
were wound up as of that date”—RUPA § 701(b). Put another way, a dissociating partner gets the
greater of the partner’s share of book value if hypothetically liquidated or value based on a sale of
the entire business as a “going concern” without the dissociated partner. Distribution determined by
RUPA § 807(b) – basically, the dissociating gets the share that he/she would have received under §
807 if there had been dissolution.
i. Must offset all other obligations owed by the dissociating partner to the partnership,
including damages for dissociation—RUPA § 701(c)
ii. The dissociating partner is entitled to interest from the date of dissociation until the date of
payment—RUPA § 701(b)
b. If the dissociation also causes dissolution, the 800’s kick in!
c. In addition to the required payment, the partnership must provide the dissociating partner with
certain financial information about the partnership, such as how the estimated amount of
payment was calculated and notice that the payment is in full satisfaction of the obligation to
purchase—RUPA § 701(g).
d. If no agreement as to value of the dissociating partner’s interest is reached between the
partnership and the dissociated partner within 120 days after the dissociating partner provided a
written demand for payment, then the partnership basically informs the dissociating partner how
much they think his interest is worth and provides a statement of how the partnership reached
that figure—RUPA § 701(e).
i. A dissociated partner may bring an action against the partnership to determine the buyout
price of their interest within 120 days after the partnership has tendered payment or an offer
to pay or within 1 year after the partner provided written demand for payment if not payment
or offer has otherwise been tendered to the partner by the partnership—RUPA § 701(i).
e. Partners can include in the partnership agreement a specific way for valuing a dissociated
partner’s interest. [RUPA § 103] This is good because it saves time in litigation. Check on this!
IV. Effect of Dissociation (RUPA § 603):
A. If dissolution – Art. 8 applies. If no dissolution – Art. 7 applies
B. No right of participation in management (unless the partnership is also dissolving) [RUPA § 603(b)(1)]
C. Duties of loyalty and care terminate [RUPA §§ 603(b)(2),(3)] except with regard to matters occurring
before the partner’s dissociation.
V. Partner Liability after Dissociation (RUPA § 703):
A. A dissociated partner is still responsible for liabilities incurred by the partnership before he/she
dissociated, but not generally liable for partnership obligations incurred after dissociation except as
stated below in B. [RUPA § 703(a)]
1. However, a dissociated partner is not liable for pre-dissociation obligations of the partnership in the
following circumstances:
a. the partnership creditor and the remaining partners agree to release the dissociating partner from
liability. § 703(c).
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b. the partnership creditor, with notice of the partner’s dissociation and without the dissociating
partner’s consent, agrees to a material alteration in the nature or time of payment of the
obligation. § 703(d).
B. For 2 years after dissociation, if a third party reasonably believed a dissociated partner was still a
partner, didn’t have notice of the dissociated partner’s dissociation, AND isn’t deemed to have
knowledge of such under § 303(e) or notice under § 704(c), a dissociated partner can be liable for any
obligations created by the reliance of the third party—see RUPA § 702(a) and § 703(b).
C. Once again, you can’t change the rights of third parties in the partnership agreement.
D. Note: While generally, a partnership must indemnify a dissociated partner whose interest it has
purchased against all partnership liabilities, whether incurred before or after dissociation, the
partnership need not do so for liabilities incurred by an act of the dissociated partner under §
702—see RUPA §§ 701(d) and 702(a)/(b)!!!
VI. The power of a dissociated partner to bind the partnership after dissociation is discussed in RUPA § 702.
VII. Statement of Dissociation (RUPA § 704):
A. Under RUPA § 704(a), a dissociated partner or the partnership may file a statement of dissociation
stating the name of the partnership and that the partner is dissociated from the partnership.
B. Such a statement is to be filed with the Secretary of State.
C. For § 702(a)(30 and § 703(b)(3)—the knowledge/notice aspect of a third party for liability purposes
after dissociation—a third party is deemed to have constructive notice 90 days after the statement of
dissociation is filed.
D. It is sometimes beneficial for a partnership to file one of these—for example, if the dissociated or
dissociating partner was attempting to bind the partnership in any number of transactions.
Partnership Dissolution
VIII. RUPA § 801 lists the events that cause dissolution of the partnership.
1. These can be avoided by the partnership agreement, or you can add additional events that cause
dissolution. [RUPA § 103]
2. Under RUPA, death is not an event which necessarily triggers dissolution.
B. After dissolution, the partnership continues for the limited purpose of winding up its business—RUPA §
802
1. Continuation can last weeks to months to years depending on the nature of the business.
2. Once dissolution occurs, winding up is to begin, so that the partners must act appropriately and
cannot for example, buy a bunch of new inventory.
3. If for example, during the wind-up period, one of the partners were to buy a bunch of inventory from
a third party, the partnership will be bound under RUPA § 804.
4. Under RUPA § 805, a statement of dissolution can be had, but is not required. Such is similar to a
statement of dissociation
C. Any partner that has not wrongfully dissociated can participate in the winding up—RUPA § 803.
IX. Winding Up and Partnership Accounts
A. Partnership assets must first be applied to pay off creditors—including partners who are creditors. Any
surplus is then distributed to the partners under § 807(b). [RUPA § 807(a)]
1. Creditors can collect unpaid balances from the partners personally under RUPA §306, but must first
exhaust partnership assets under RUPA § 307.
2. Partner creditors are given the same priority as other external creditors.
B. When a partnership winds up, an accounting of the partnership accounts must be mad, and then they can
be settled. [RUPA § 807(b)]
1. Individual partner’s partnership account is not to be credited for the contribution of labor under
RUPA § 401(a) & (b), just money and property contributed to the partnership by the individual
partner. The same conclusion comes from the negative implication of RUPA § 401(h).
a. The partnership agreement can give credit for the contribution of labor though, it just cannot
eliminate parntership accounts.
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2. Examples of Settling accounts:
a. $200,000 in p/s account after paying creditors. A has $100,000 in his account, B $8000, and C
$2000. First each would get the amount in their account, so subtracting $110,000 would leave a
surplus of 90,000. Therefore each P would get an additional $30,000. Totals: A=130000,
B=38000, and C=32000.
b. Same facts except only $20,000 left in p/s account after paying creditors. Subtracting the
$110,000 would leave a deficit of $90,000. Therefore subtract 30,000 from each account.
Totals: A=70,000, B must pay p/s $22,000, and C must pay p/s $28,000. Since B&C had
negative accounts, they will have to write check to p/s which will be used to pay C’s 70,000.
c. If -20000 after creditors paid, then subtract the $110,000 for a total loss of $130,000 and divide
up loss in the same way. (equally in this case because default rules apply, therefore A would still
have a positive balance but other 2 would have to pay in.)
3. If a partner is unable to pay in his amount, the other partners must contribute and additional amount
in the proportion in which they share losses. (If A shares 10% of loss, B 20% and C 70% according
to p/s agreement and C can’t pay. A and B will have to pay the deficit. They are responsible for
30% of the total loss so A would have to pay 1/3 (10%/30%) and B 2/3 of the remaining balance)
C. Ways partnership accounts can be changed:
1. Amounts paid in (either in money or property).
2. Distributions not accepted (profit or loss).
SEE ACCOUNTING EXAMPLES FROM NOTES!!!
D. [Kovacik v. Reed]
1. In pursuit of a joint venture, the plaintiff had defendant had orally agreed that the plaintiff would put
up the money for the venture and the defendant the labor and that each would share in the profits
equally. No mention was made between the parties as to how losses were to be shared. After the
venture’s termination, a suit was brought whereby the plaintiff sought an accounting of the venture
and one half of the losses from the defendant. The trial court found the defendant liable for one half
of the losses and the defendant appealed.
2. The court held for the defendant finding that it could not be assumed that the parties had intended to
share the losses equally as well as the profits. The court noted that the defendant had lost what he put
into the venture—a job, so that the plaintiff was not the only one suffering a loss.
a. Where one partner supplies all capital and one supplies all labor, it is not to be assumed that the
partners have agreed to share the losses, even if they agreed to share profits.
3. Under RUPA § 401(b), were the partners have not agreed otherwise, each partner is chargeable with
a share of the partnership losses in proportion to the partner’s share of the profits. Thus, if the
partners had not otherwise agreed as to how to split the profits and losses, RUPA § 401(b) would
control so that the partners would be required to share in the profits and losses equally.
Partner Expulsion and Freeze Out:
I. Expulsion:
A. Under RUPA § 601(3)-(5), expulsion is an event of dissociation.
B. Additionally, RUPA § 601(3) recognizes the possibility that partnership agreements might provide for
the expulsion of partners.
C. If expulsion is not provided for in the partnership agreement its use will be seemingly limited.
D. [Bohatch v. Binion]
1. The plaintiff, who worked in a law firm, was expelled by the partnership after reporting the
overbilling practices of another lawyer in the firm. While the partnership agreement in question
allowed for a procedure to be followed when expelling a partner, it did not provide for situations or
reasons by which a partner could be expelled. The plaintiff sued alleging that the firm violated a
fiduciary duty owed to her in not expelling her for the alleged overbilling.
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2. The court held that there is no right to remain a partner and that it was not a breach of fiduciary duty
to expel the plaintiff. The court reiterated that partners get to choose with whom they wish to work
with and that partnerships are at will by their very nature.
E. RUPA:
1. § 601(3) states that the partnership agreement can provide a method for expulsion of partners.
2. § 601(4) states that a partner can be expelled for four reasons through a unanimous vote:
a. If it would be unlawful to carry on the partnership business with the partner; or
b. If the partner has transferred substantially all or his transferable interest other than that for
security purposes, or
c. If a corporate partner is dissolving, or
d. If a partnership partner is dissolving.
3. § 601(5) provides for expulsion of a partner by judicial determination in three circumstances.
F. The remedy for being expelled is simply getting bought out under RUPA § 701(b) as expulsion causes
dissociation.
II. Freeze Out – A situation in which a person who owns a majority interest in a business acts to compel a
minority owner of the business to sell or otherwise give up his interest.
A. Page v. Page
1. Two brothers operate a linen business to which both contributed equal capital, but A owns a $47,000
note for which B owes money. The brother’s business loses money for years until a new military
base was built near-by and the business then began to profit. A withdrew from the partnership
causing it to dissolve so that he could buy back the business for himself, thus cutting B out of the
profitable business.
2. The court held that as this was a partnership at will, there was no breach of duty on the part of A in
withdrawing or dissolving. The court determined that it would be a breach of duty for A not to pay a
fair price for B’s interest though. Thus, A could not intentionally underbid the business.
a. There is a right to withdraw/dissolve, but a partner cannot in bad faith attempt to appropriate to
his own use the new prosperity of the partnership without adequate compensation for the other
partner’s interest.
b. A partner may not, by the use of adverse pressure, freeze out a co-partner and appropriate the
business to his own use.
c. A partner may not dissolve a partnership to gain the benefits of the business for himself, unless
he fully compensates his co-partner for his share of the prospective business opportunity.
d. Partners can agree to compensation ahead of time in the partnership agreement. Thus, to prohibit
a low-ball buyout from happening, the partnership agreement in this case could have included a
push-pull provision whereby one partner names the price he is willing to sell at so that the other
partner either buys it at that price or agrees to sell his interest as well.
Limited Partnership:
I. Limited partnerships were the creation of statute whereas general partnerships were an outgrowth of
common law.
II. Two types of partners:
A. Limited Partners
1. Get limited liability.
2. Can’t engage in control of the limited partnership.
3. Passive investors who are not liable, but who also can’t exercise control.
4. Limited partners may be able to gain some management rights through the limited partnership
agreement. However, if the limited partners engage in too much control, they will likely be
considered a general partner, thus exposing them to the limited partnership’s liabilities. Safe harbor
provisions provided that a limited partner can do x, y, and z without engaging in control so that they
lose their no-liability status. Simply being an employee of the limited partnership will not otherwise
expose a limited partner to liability.
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5. Under ULPA § 303, “a limited partner is not personally liable, directly or indirectly, by way of
contribution or otherwise, for an obligation of the limited partnership solely by reason of being a
limited partner, even if the limited partner participates in management and control of the limited
partnership. Thus, under ULPA and other limited partnership statutes, unless a limited partner
exercises some kind of control which is relied on by a creditor, he/she will not lose his/her noliability status [Zeiger v. Wilf].
B. General Partners
1. Like partners in a general partnership – same liability rules.
2. Get control of the limited partnership, but also exposed to liability.
3. Limited partnerships must have at least one general partner. Remember, that all of the partners in a
general partnership are general partners.
III. Limited partnerships are subject to not only limited partnership laws, but also to general partnership laws.
Indeed, RULPA § 1105 provides that in any case not provided for in (RULPA), the provisions of the UPA
govern—likely RUPA as well.
IV. Limited partnerships are subject to federal and state securities laws!
V. Requires filing of what is generally called a Certificate of Limited Partnership to form with the Secretary of
State. ULPA § 201 sets out what must be included in the document. Limited partnerships must have
limited partnership in the name of the business per ULPA §§ 108, 201(1)(a). Also, the name of a limited
partner may not be included in the limited partnership’s name unless such name is also the name of a
general partner. Additionally, while the names of the limited partners need not be included in the Certificate
of Limited Partnership, the names and addresses of all of the general partners must be—ULPA § 201(a)(3).
VI. An advantage over the corporation as a business entity is that limited partnerships maintain the pass-through
tax status of partnerships and are taxed only once on the partners’ personal tax returns, whereas a
corporation is taxed on its income and individual involved with the corporation are taxed again when they
get paid, so that double taxing occurs.
VII. Limited partnerships are not really used anymore – they were originally used by persons who sought
more investors for their partnerships.
VIII. RULPA Provisions:
A. RULPA § 302 – Can grant limited partners the right to vote.
B. RULPA § 303 – A limited partner can be liable if:
1. Also a general partner; or
2. Exercises control of the business and a third part party actually believes that the limited partner is
actually a general partner.
a. (b) attempts to define what does not constitute control.
3. There are many statutory revisions of the original ULPA. The supplement includes the ULPA of
2001, which Iowa has enacted, but most other states have not.
IX. A common way to form a limited partnership so that no one can really be held personally liable is to form or
have a corporation serve as the one required general partner and then have those seeking to escape personal
liability act as limited partners—thus, the shareholders of the corporation acting as the general partner could
act as the limited partners. Although the corporation will now as a general partner, be personally liable for
the limited partnership’s liabilities, the owners of the corporation will not be as the corporate form protects
them from liability—see pg. 777 in the book for more. Under such a scheme, limited partnerships were
allocating minimal profits to the corporation, the general partner, (because of double tax) and allocating the
other 99% to the limited partners. The IRS caught this and got smart.
A. IRS looks at the four factors below to determine if the entity should be taxed like corporation or like a
partnership (pass-through) by determining whether the entity is more like a corporation or a partnership.
Corporation:
Partnership:
Limited Liability?
Yes
No
Centralized Management? Yes
No
Continuity of Life
Yes
No
Transferability of Interest
Yes
No
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a. If three of the four factors are present then the IRS will tax the limited partnership as a
corporation. If only two of the four factors are present then the IRS will still tax the limited
partnership as a partnership (pass-through).
b. Note that a partnership agreement could provide for the last three characteristics in a partnership;
however, in their default positions, those characteristics do not really apply to partnerships.
X. If a limited partnership failed to file the formation certificate? Then the limited partnership would actually
just be a general partnership despite the intent otherwise. Usually, though if there are only very minor errors
on the certificate, the limited partnership will still be found to be such.
XI. ULPA § 306(1) protects those who in good faith believed that they were a limited partner from liability
exposure if they are later discovered to in fact be a general partner.
XII. Generally, events which would lead to dissolution in a general partnership do not lead to dissolution in a
limited partnership; however, events effecting the general partner(s), especially if there is only one, are
much more likely to lead to dissolution of the limited partnership.
ALSO SEE SUPPLEMENT PART III.
Limited Liability Company (LLC):
I. LLC created to help avoid the tax confusion of limited partnerships. LLC’s receive pass-through tax status.
II. The Uniform LLC Act wasn’t created until after each state had already passed its own LLC statutes,
therefore it is not very useful or representative.
III. LLCs are the best of both worlds as they receive limited liability for all members and pass-through tax
status.
IV. The ULLCA is based primarily on RUPA principles.
V. Per ULLCA § 201, an LLC is a legal entity distinct from its members.
VI. One or more persons may organize an LLC consisting of one or more members, by delivering Articles of
Organization to the Secretary of State to be filed—ULLCA § 202.
A. Thus, it is possible for an LLC to have only one member.
VII. ULLCA § 203 informs what is to be included in the Articles of Organization including whether the LLC
is to be manager-managed in which case the names and address of each initial manager is to also be
included or member-managed—the Delaware LLC Certificate does not require this. Generally, only the
bare requirements are included in the Articles of Organization as they are public.
VIII. It is optional for an LLC to have an operating agreement, which is similar to a partnership agreement and
indeed, the operating agreement is the most important document to an LLC. This contrasts starkly to a
corporation in which the articles of incorporation are the most important.
A. Similar to RUPA, the ULLCA is only applicable where the operating agreement does not otherwise
provide.
B. Also similar to RUPA and partnership agreements, under ULLCA § 203(c), the operating agreement
may not vary the non-waivable provision of ULLCA § 103(b).
C. Additionally, if any provision of the operating agreement in inconsistent with the articles of
organization, the operating agreement controls as to internal matters within the LLC, whereas the
articles of organization control as to matters and persons outside of the LLC. This protects third party
reliance on the public, articles of organization.
IX. LLC Decision Making: ULLCA §§ 301, 404:
A. Manager-Managed: Authority of the manager(s) of a manager-managed LLC, is much like that of a
corporation with a board of directors, professional managers, and separation of owners and management.
B. Member-Managed: Authority of the member(s) is much like that of the partners in a general partnership.
C. Under ULLCA § 404(a), in a member-managed LLC, each member has equal rights in the management
and conduct of the LLC’s business.
D. Additionally, under a member-managed LLC, most matters except those provided in ULLCA § 404(c),
relating to the business of the LLC may be decided by a majority vote of the members—ULLCA §
404(a)(2).
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E. Under, ULLCA § 404(c), even in manager-managed LLC’s, the matters included in (c) must be
consented to by the members of the LLC. This is very different from the power of the limited partners in
limited partnerships, whereby the management rights of limited partners could be essentially wiped out
per the partnership agreement.
F. ULLCA § 405 contemplates that members share profits equally unless agreed to differently.
X. Liability: ULLCA § 302, 303:
A. Creditor protection is important in a LLC as well—so that if a LLC is insolvent it is illegal for the LLC
to make distributions to the members, without first paying the creditors of the LLC.
B. Creditors of an LLC can collect their claims from the earnings and assets of the company.
C. The members of an LLC are simply not liable for the company’s debts—see ULLCA § 303(a) and (b).
D. Contrary to corporation law, LLC law does not require formalities.
E. Sophisticated creditors often require members to sign personal obligations to pay, despite the otherwise
non-liability of members in an LLC.
XI. Can be manager-managed or member-managed.
A. According to ULLCA § 301(b), in manager-managed LLCs, a member is not an agent of the company
for the purpose of its business soley by reason of being a member.
1. Manager Managed: Manager=Agent; Member=Agent.
B. According to ULLCA § 301(a)(1), in member-managed LLCs, each member is an agent of the limited
liability company for the purpose of its business.
1. Member Managed: Member=Agent
C. Contrary to corporation law, LLC law does not require formalities.
D. Ex.: Epstein, Freer, Roberts, and Shepherd for a member-managed LLC named “EFRS LLC.” They do
so in a state that has adopted the ULLCA. Epstein orally employs your client, C, to design a fast food
restaurant for EFRS LLC. Epstein however did not make clear to C for whom he was acting. In the
course of preliminary discussions, Epstein gave his business card to C. The card contains Epstein’s
name and address which is the address listed on the LLC’s filed articles of organization. The letters
EFRS appeared above the address on the card, but there was no indication on the card that EFRS was a
LLC. C does the design work, from whom can C collect? If Epstein has not adequately disclose that
there was a principal in this case, EFRS, then Epstein can be held liable under the RSA § 322.
E. Thus, agency law is critical when LLCs are involved.
XII. Fiduciary Duties
A. ULLCA § 409:
1. Member Managed: Members owe duties of loyalty and care to the LLC and the other members.
2. Manager Managed: Members don’t owe fiduciary duties to the LLC. Managers owe fiduciary duties
to the LLC, which are the same duties owed by members in member-managed LLC—i.e. the duties
of loyalty and care.
3. These are default rules that can be changed in operating agreement pursuant to ULLCA § 103.
XIII. How do members of a LLC get money out of the company? ULLCA §§ 405(a) and 806(a).
A. Members have an equal right to distribution under ULLCA § 405.
B. Under ULLCA, § 404(c) there must be unanimous consent among members for distribution to be had.
C. Creditor protection is important in a LLC as well—so that if a LLC is insolvent it is illegal for the LLC
to make distributions to the members, without first paying the creditors of the LLC.
XIV. Selling one’s interest in an LLC:
A. A member can only sell his financial rights in an LLC, not his status as a member—thus, LLCS are
similar to partnerships in this way.
B. Only if the other members consent to an assignee as a member, will the assignee be a member and have
membership rights.
C. This default can be drafted around through the partnership agreement.
D. Additionally, members could withdraw from the LLC and ask for their money interest in the LCC or the
LLC could chose wind up.
1. Both of these follow from partnership law.
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XV. [Lieberman v. Wyoming L.L.C.]
A. Lieberman was fired from his position as Vice-President of Wyoming.com in which he was also a
member as he owned a membership interest. He then gave notice of his intent to withdrawl. With his
notice, he asked for his $20,000 capital contribution back as well as the value of his 40% interest, which
he valued to be worth approximately $400,000.
B. Lieberman argued three main points. First that his withdrawal should trigger dissolution of the LLC.
Second that his capital contribution should be returned to him. And lastly, that he was owed his
monetary interest in the LLC.
C. As to Lieberman’s first point, Wyoming statute required that upon the withdrawal of a partner a LLC
must dissolve unless the articles of organization provided for continuation, which in this case they did
upon the consent of all members except the withdrawing member.
D. As to the second point, the court agreed that Lieberman’s capital contribution should be returned as it
was rightfully owed him.
E. As to Lieberman’s final point, the court finds that Lieberman might be entitled to such if he could find
his membership card—accordingly in Wyoming all members of an LLC must be given a membership
card to prove the membership. Professor Dore thought it was quite odd that the court relied so heavily
on this point.
F. ULLCA § 701 is informative here. Sometimes LLCs provide in their operating agreements that if a
member withdrawals from the LLC, all he or she is entitle do is his/her original contribution to the
LLC—here such would be Lieberman’s capital contribution. Courts have upheld such provisions as long
as the withdrawing member wasn’t actually forced into withdrawal.
G. LLC statutes today do not necessarily provide for the buyout of a withdrawing member’s interest as the
default. Check on this!!!
LLC v. Limited Partnerships:
I. Limited Partnerships:
A. Need filing to form – otherwise would simply be a general partnership as the default form.
B. Need more than one member in order to create a limited partnership.
C. Must use business designation in name.
II. LLCs:
A. Can be created by only one member.
B. Requires filing – defaults to partnership if there is more than one member and no filing has occurred.
C. Must use business designation in name.
III. Both have liability shields: Not liable merely because of status as limited partner or an LLC member.
Exceptions: (Can be liable on independent basis like if you are the tortfeasor!)
A. Are a general partner or a limited partner exercising control whereby a third party is misled. (This
applies to limited partnerships only!)
B. Personal misconduct towards third parties—tortfeasors?
C. Personal guarantees.
D. Undisclosed principles or partially disclosed principles.
Limited Liability Partnership (LLP):
 These are not limited partnerships!
I. LLP created as way to convert general partnerships into limited liability entities without dissolving.
II. LLPS are still governed by most RUPA provisions as there is no LLP statute—however, in Iowa there is.
Thus, an LLP acts generally like a regular partnership, but WITH limited liability.
A. Registration under RUPA §§ 1001, 1002 converts a general partnership to an LLP.
B. Note, that a general partnership anticipating suit, cannot become an LLP to shield liability as such would
affect the rights of third parties.
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III. Almost all LLP statutes provide full liability shield as opposed to early ones which only provided a partial
shield—Iowa’s included.
A. Full shield: RUPA § 306(c) – “An obligation of the partnership incurred while the partnership is a
limited liability partnership, whether arising in contract, tort, or otherwise, is soely the oblivation of the
partnership. A partner is not personally liable, directly or indirectly, by way of contribution or otherwise
for such an obligation soley by reason of being or so acting as a partner.”
B. Thus, a partner would still be liable if there was an independent basis for liability such as tortfeasing or
personal guarantees, etc.
C. RUPA § 306(c) prevents LLP creditors from reaching individual partner’s assets in most situations.
D. Thus, partners in a LLP are really in the same position, for liability purposes, as a shareholder or a
member of an LLC.
E. Under Iowa’s LLP Act, the Iowa Uniform Partnership Act, to become an LLP requires a one-time
registration filing called a “statement of qualification” with the Secretary of State that need not be
renewed. The “statement of qualification” must contain: the name of the partnership which must end
with Registered LLP or an appropriate abbreviation thereof., the street address of the chief executive
OFFICE of the partnership, the partnership’s registered office and agent, and a statement that the
partnership elects to become an LLP. The status as an LLP becomes valid on the date of the filing of the
“statement of qualification” or on a later date as specified by the statement.
F. Additionally, the come an LLP, the partners must first vote to become an LLP and to amend the
partnership agreement to reflect such.
G. Unlike RUPA, Iowa’s Uniform Partnership Act does not include an annual report requirement for LLPs.
H. To realize an important difference between general partnerships an LLP take the following: Suppose that
a law firm originally practicing as a general partnership chose to register as an LLP. Before the LLP
election, any partner in the law firm who committed malpractice was personally liable for that claim, but
so were all the other partners. In a sense, the partners would have shared malpractice risks together. As a
limited partnership though, only the partner who committed malpractice would be personally liable on
such a claim if it exceeded insurance coverage. Thus, depending on the areas of practice of each partner,
such risks may be greater for some partners than others—i.e. those practicing in the area of wills and
estates.
I. What if an LLP from a full-shield state got sued in a partial-shield state? This isn’t an issue that comes
up with LLC’s and Corporations because all states are the same. The ultimate question would come
down to which state’s law was found to apply.
J. Downfalls to becoming an LLP:
1. You’re not literally “all in this together” in an LLP—see the above law firm example.
2. An LLC only needs one person to operate, whereas an LLP needs at least two.
K. Benefits to becoming an LLP:
1. All the rules of partnership law still apply to LLP’s. Thus, there is more case law and “knowns”
when it comes to LLP’s than LLC’s.
2. In an LLP, ALL partners are off the hook for the LLP’s obligations and liabilities.
L. If one of the partners withdraw in an LLP, such might lead to dissolution—similar as to what would
happen under the RUPA with a general partnership.
Things to Consider in Choice of Entity:
Limited Liability
Taxes
General P/S – No
LLC – Some *
L P/S – Some*
LLP – Some*
Corp. – Some*
Pass Through
Pass Through
Pass Through
Pass through
Double Tax
Centralized
Management
No~
Hybrid+
Yes
No
Yes
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Transfer of Interest
Continuity
No
Mixed – Int. matters
Mixed – Int. matters
No
Yes
RUPA – Not Really
Mixed
Mixed
No
Yes
Key:
* Some = Still can be personally liable for own torts or obligations, but not for the limited
partnerships\LLC’s/LLP’s obligations.
+ = Could be either member-managed or manager-managed.
~ = Could be centralized if agreed to in the partnership agreement.
SEE PAGES 35-39 IN BOOK FOR AN OVERVIEW!
Corporations:


Corporations have evolved over time, but have existed since America’s foundation.
Sources of Corporate Law:
o State Statutes
o Articles of Incorporation, Bylaws, and other Agreements
o Case Law
o Federal Statutes (i.e. Securities)
Contracting Before Incorporation: De Facto Corporations and Corporations by Estoppel
I. [Cantor v. Sunshine Greenery, Inc.]
A. Cantor and Brunetti, who was to be the President of Sunshine Greenery, Inc. contracted for the lease of
property owned by Cantor. Cantor leased the property knowing that Brunetti was starting the new
venture, did not make Brunetti sign a personal guarantee for the lease. When leasing, Cantor, knew and
expected that eth lease was being undertaken by the corporation and not by Brunetti. Brunetti submitted
articles of incorporation, but they were not filed for some administrative reason until after the lease was
completed.
B. The court determined that there was a de facto corporation when the lease was completed as Brunetti
had made a bona fide attempt to organize the corporation by submitting the articles of incorporation.
Also, Cantor knew that he had contracted with the corporation rather than with Brunetti personally—this
is similar to corporation by estoppel.
C. Other theories for holding Brunetti personally liable under the contract:
1. Agency: Breach of Warranty of Authority—to hold Brunetti personally liable.
2. Agency: Also, principal known to be nonexistent of incompetent—RSA § 326—“Unless otherwise
agreed, a person who, in dealing with another, purports to act as an agent for a principal whom both
know to be nonexistent or wholly incompetent becomes a party to such a contract.
D. Corporation by Estoppel:
1. A corporation cannot avoid a contract based on defective incorporation. Thus, in the above case,
Sunshine Greenery was not able to avoid its contract with Cantor—it is only the individual
shareholder’s personal liability that may be avoided. This represents a true estoppels—those
purporting to act for the corporation have represented to a third party that the corporation has been
lawfully formed; the third party changes his position based upon this representation; and the
corporation is not able to deny its corporate status at a later time.
2. Additionally, a third party may not avoid a contract with a corporation based on defective
incorporation. Thus, in the case above, Cantor could not have avoided his contract with Sunshine
Greenery.
3. Finally, the corporation by estoppel doctrine allows shareholders of a defective corporation to retain
their limited liability when a third party understands his contract to be with the purported
corporation. Thus, in the above case, Cantor was not able to sue Brunetti for Sunshine Greenery’s
debts.
a. When a third party looks to a corporate entity as the sole obligor on a contract, he receives what he
bargained for when only the corporation is liable.
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4. Both the corporation by estoppel doctrine and the de facto corporation doctrine protect shareholders’
limited liability.
5. However, in tort cases, only the de facto corporation doctrine can preserve the shareholders’ limited
liability.
6. The de facto corporation doctrine requires a colorable attempt to incorporate and some actual
exercise of corporate privileges.
E. [Robertson v. Levy]
1. Robertson and Levy entered into a contract for the sale of Robertson’s business to Levy, whereby
Levy was to form a corporation in order to buy the business. Levy submitted articles of
incorporation for his corporation, but the articles were eventually sent back, at which time Levy
resent them in and they were accepted. After receiving the articles back, Robertson and Levy
contracted whereby Levy purchased Roberson’s business and its assets. Later, Levy’s corporation
went belly up and he could not pay.
2. Requisites for a de facto corporation:
a. A valid law under which such a corporation can be lawfully organized;
b. An attempt to organize thereunder;
c. Actual user of the corporate franchise
d. Good faith in claiming to be and in doing business as a corporation—this is often, but not
always required.
3. The court in this case rejected the de facto corporation doctrine holding that a corporation comes into
Existence only when the certificate has been issued. Thus, the court held that Levy was subject to
personal liability for the corporation’s debt even though Robertson believed he was dealing with a
corporation and indeed intended to deal with a corporation.
F. [Stone v. Jetmar Properties, LLC]
1. A de facto corporation cannot be found where there was no good faith attempt to
incorporate/organize an LLC.
2. The corporation by estoppel doctrine while not protect a shareholder/owner who is otherwise
attempting to scam a third party, from personal liability.
G. Defenses (on the part of shareholders/owners):
1. De facto corporation
2. Corporation by estoppel
3. Knowledge, whereby the incorporator thought that the business had been incorporated, but where in
reality it had not.
Corporate Formation:
I. MBCA § 2.02(a) governs what is required to be in the articles of incorporation.
 The articles are essentially the constitution of the corporation and trump the by-laws.
A. The name of the corporation that complies with MBCA § 4.01.
1. Before incorporating, a lawyer should check with the Secretary of State to determine if the proposed
corporate name is already taken or too similar to another entity already incorporated in the state;
B. The number of shares the corporation is authorized to issue;
C. The street address of the initial registered office and the name of the initial registered agent there; and
D. The name and address of each incorporator.
E. This is all that MUST be included in the articles of incorporation!
II. MBCA § 2.02(b) lists what can be included in the articles, but is not required.
A. Names and addresses of those who are to serve as initial directors on the corporation’s board.
B. Provisions regarding:
1. Corporate purpose:
a. If no statement of purpose, then the corporation will be deemed to have the purpose of engaging
in any lawful purpose under MBCA § 3.01;
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b. Including a purpose clause might bring the ultra vires doctrine into play and thus, would invite
litigation.
2. Managing the business and regulating the affairs of the corporation;
3. Defining, limiting, and regulating the powers of the corporation, board, and shareholders;
4. Par value for authorized shares or class of shares;
5. Imposition of personal liability upon shareholders for the debts of the corporation to a specified
extent and upon specified conditions;
6. Any provision required or permitted by the MBCA to be set forth in the bylaws;
7. A provision eliminating or limiting liability of a director to the corporation or its shareholders for
money damages for any action taken, or any failure to take any action, as a director, except liability
for… there are four exceptions, listed below, for which the articles cannot limit the personal liability
of directors.
8. Exceptions – can’t limit liability for:
a. (A) the amount of a financial benefit received by a director to which he/she was not entitled;
b. (B) an intentional infliction of harm on the corporation or its shareholders;
c. (C) a violation of MBCA § 8.33 relating to unlawful distributions;
d. (D) an intentional violation of criminal law.
9. A provision permitting or making obligatory indemnification of a director for liability to any person
for an action taken or any failure to take any action as a director except liability for the four
exceptions above.
III. MBCA §3.02—Every corporation has perpetual duration unless provided otherwise.
A. This section also lists the default powers of a corporation, which need not be listed in the articles.
IV. There is no equivalent of RUPA § 103 in the MBCA. Each section has a portion like RUPA § 103 to vary
specific rules, but not overall, which otherwise applies to every rule.
V. MBCA § 8.01—Each corporation must have a board of directors unless provided for otherwise by the
shareholder agreement under § 7.32)
A. To get board or directors initially, can name them in the articles or a majority of the incorporators can
call a meeting to elect them [MBCA § 2.05].
VI. Must adopt bylaws… [MBCA § 2.06]
A. Generally address internal mechanics of the corporation. By-laws are easier to amend than the articles.
B. Corporate existence begins when the articles are filed unless a later effective date is specified [MBCA §
2.03].
C. Promoter Problems: When a corporation is formed, can the incorporators be liable for contracts before
the corporation is formed? See cases above…
D. All people purporting to act as or on behalf of a corporation, knowing there was no incorporation, are
jointly and severally liable for all liabilities created while so acting. [MBCA § 2.04].
1. MBCA COMMENTS:
a. “Incorproation under modern statutes is so simple and inexpensive that a strong argument can be
made that nothing short of filing articles of incorporation should create the privilege of limited
liability.”
b. “After a review of these situations, it seems appropriate to impose liability only on persons who
act as or on behalf of corporations “knowing” that no corporation exists”—this would not hold
liable those persons who in good faith believe that that the entity has been incorporated.
c. See additional comments to MBCA § 2.04.
E. De Facto Corporation Doctrine:
1. This occurs when one attempted to incorporate, but didn’t succeed in doing so.
2. Some courts exclude liability when there is an honest and reasonable, but mistaken belief that the
corporation had been formed.
3. Elements:
a. There is a valid law under which the particular corporation could have been lawfully organized.
b. There was an actual attempt to incorporate under that law.
30
F.
G.
H.
I.
c. There was an exercise of corporate power.
d. All of the above was done in good faith.
4. This doctrine acts to save those who tried to comply with the law, but did not succeed from personal
liability for the “corporation’s” obligations.
5. Opposite of de facto corp. is de jure corp. which occurs when one succeeds in incorporation through
proper filing.
Corporation by Estoppel:
1. A few courts will entertain this notion, but most will impose personal liability.
2. The third party at issue has dealt solely with the “corporation” and has not relied on the
incorporator’s personal assets and thus should not be allowed to hold him personally liable for those
transactions entered into because such would be giving him “more than he originally bargained for.”
Examples:
1. Propp enters into contracts for the “corporation” knowing that the corporation does not exist.
a. Propp Liability:
i. Liable under agency theory (no principle)—RSA § 326?
ii. Agency (warranty & misrepresentation).
iii. Liable under MBCA § 2.04.
b. A & C Liability: Argue that a partnership formed by default as the entity was not incorporated
and as such Propp and any other “partner” should be held joint and severally liable—this will
only will work for the third party if they sue A & C though.
c. Defenses:
i. A & C: Argue de facto corporation has been formed. Also argue MBCA §2.04—this is really
the best defense as the MBCA would superseded the other 2 doctrines in a jurisdiction
practicing under the MBCA.
ii. A, C & P: Argue estoppels as the other side thought that they were dealing with a corporation
and thus, shouldn’t get more than they bargained for.
2. Propp contracts for the “corporation” thinking that the entity has been incorporated, not realized that
the articles have not been filed.
a. Propp Liability:
i. Agency (no principle)—RSA § 326.
ii. Agency (implied warranty)—no misrepresentation though as Propp didn’t realize that the
“corporation” didn’t exist as such.
b. A & C Liability: Partnership theory as argued above.
c. Defenses: Argue de facto, estoppel, and § 2.04 for all (no one knew that the corporation did not
exist)…
3. Propp signs a contract as “corporation to be formed”…
a. Propp Liability: Agency (no principle)—RSA § 326 and MBCA § 2.04.
b. A & C liability: Partnership theory as argued above.
c. Defenses:
i. A & C: MBCA § 2.04
1) No de facto or estoppel as no one was acting on behalf of a “corporation.”
ii. A, C, P: No liability if the contract exonerates.
Ratification & Adoption
1. A principle can ratify a contract made by agent even when it was made without authorization. This
doesn’t work pre-incorporation? Problem because the corporation didn’t exist at the time of the
contract, so instead use the term adoption rather than ratify.
The easiest way to avoid all of this is by not doing anything on behalf of the corporation until it is
formed.
Issuance of Stock:
I. Governed by MBCA § 6.01(a-c), § 6.03(a) and (c), and § 6.21(a-d).
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II. Issuance of shares [MBCA § 6.21]
A. The board of directors decides when and how to issue shares unless such power is reserved to the
shareholders by the articles. [MBCA § 6.21(a)].
B. Consideration which can be received for shares is covered by MBCA § 6.21(b).
1. MBCA is very lenient in this regard—contracts for services to be performed in the future are
allowable as promissory notes are as well. Delaware § 152 is more restrictive and doesn’t seem to
allow the promise of future services or promissory notes to count as consideration.
C. The BOD determines the adequacy of compensation for the shares (i.e the Board sets the price for
shares.) [MBCA § 6.21(c)]…
1. “The Board’s determination in this regard is conclusive insofar as the adequeacy of consideration for
the issue of shares relates to whether the shares are validly issued, fully paid, and nonassessable.”
“Validly paid and nonassessable”: The corporation cannot come back and ask for more money for
the shares after the fact. Nor can the corporation charge the shareholder each year for more money
as a shareholder.
D. The issuance of shares creates an increase in assets and equity on the balance sheet. Shares authorized,
but not issued and outstanding do not show up on balance sheet as they are only potential assets.
III. Types of Shares:
A. Authorized, issued and outstanding shares [MBCA § 6.03] – shares which the directors have “sold.”
1. The corporation (BOD) can issue up to the number of shares authorized by the articles. [MBCA §
6.03(a)]
2. Once issued, shares are outstanding until they are reacquired, redeemed, converted, or cancelled.
B. Authorized, but unissued: shares which have been authorized, but are not yet sold by the corporation.
C. Authorized shares [MBCA § 6.01]
1. MBCA 6.01(a): The articles set forth how many shares the corporation may authorize, and must set
forth any classes of shares with differing rights—if any. (The corporation can’t issue more shares
than authorized by the articles. Need to amend articles to authorize more shares.)
a. If a corporation’s articles provide for more than one class of authorized shares, the articles of
incorporation should also describe the rights each class of shares will carry.
2. MBCA § 6.01(b): Deals with different classes of stock. The corporation need only issue one class
of stock—generally common stock. At least one class must:
a. Have unlimited voting rights;
i. “Unlimited Voting Rights”—the right of a shareholder to vote on any matter put before the
shareholders.
b. Have rights to net assets on dissolution:
i. Both can be in one class of stock or be met in multiple classes.
1) Can have as many classes as you want and rights associated with them as long as the two
criteria above are met.
1. Ex. Conversion Rights: The right to change stock to a different class.
2. Ex. Redemption Rights: Gives shareholder the right to demand that the corporation
buy back his/her shares.
a. Like paying dividends because such reduces assets and equity?
2) Preferred stock is that which generally is not privy to voting rights, but is privy to
dividends.
3. MBCA § 6.01(c): Provides ways in which the articles may divide up rights in different classes of
stock.
a. Voting Rights – The articles may determine the # of votes per share or whether a certain class
limited voting rights, or whether a certain class even has voting rights, etc.
i. Taken further, this means that if desired by the corporation (BOD), the articles could specify
that those who hold common stock have no vote—this would require though, that another
class of shareholders have unlimited voting rights.
b. Redemption Rights – The articles may determine if certain shares are redeemable.
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c. Preferred Distributions (including upon dissolution – first rights to assets of the corporation) –
i. Cumulative (If no dividend 1 year, that requirement carries over to the next year)
ii. Non-cumulative (if no dividend 1 year, same requirement next year)
iii. Partially cumulative (if illegal to pay a dividend, that doesn’t carry over. Otherwise it does)
IV. Legal Capital Rules – Delaware §§ 152, 153, 154:
A. “Shares of stock with par value may be issued for such consideration, having a value not less than the
par value thereof, as determined from time to time by the BOD, or by the stockholders if the certificate
of incorporation so provided. Thus, if a corporation has determined a par value for shares, the
corporation MUST issue them for at least the par value. The corporation can issue for more than par
value as determined by the BOD, but not less—DE § 153. If the shares do not have a par value, then the
value shall be determined by the BOD—DE § 153. The value determined by the BOD is conclusive.
a. DE § 162 allows a creditor to collect deficit from a shareholder who has not paid full par value
for his/her shares. This practice is commonly referred to as “watered stock liability.” This rule
seemingly applies to stock other than that with a par value as well.
B. Legal Capital Rule/Jurisdiction: DE § 154:
1. If all shares have a par value, then the number of shares issued multiplied by the par value is the
minimum stated capital. The BOD can decide to allocate more to the stated capital account if they
so desire. (Must be greater than or equal to aggregate par value).
a. If only some shares have a par value, then the stated capital must be greater than the aggregate
par value of the par value shares issued.
b. The danger of having no par value in a legal capital jurisdiction is that if directors did not specify
what part of consideration was legal capital, then full consideration is the stated capital amount
and can’t give dividends because there is no surplus account.
2. Any amount over par that was received for par value shares is capital surplus.
C. The MBCA in § 6.21 did away with the legal capital rules. Therefore MBCA jurisdictions do not apply
the above rules.
1. The MBCA is unclear as to whether directors can sell stock below par value. The MBCA allows for
par value, but only states that shares should be sold for an amount determined by the BOD. There
may be a common law action for selling shares below par value though.
Distributions/Dividends:
I. Paying dividends will reduce assets and equity
II. Board has wide discretion of when to issue dividends
III. Test for dividends in legal capital jurisdictions – DE § 170
A. Some jurisdictions state you can only pay dividends out of your earned surplus (minority view).
B. Most allow you to pay dividends out of either earned surplus (profits of the corp) or capital surplus.
Delaware Approach. – can only pay dividends out or earned surplus and capital surplus. Can’t
distribute stated capital.
IV. Statutory restrictions on dividend payments in MBCA Jurisdiction
A. MBCA is simplification compared to legal capital jurisdiction because don’t have to separate out stated
capital account and capital surplus account.
B. § 1.40(6) defines “distribution”
C. § 6.40(c) tells you how much is an excessive dividend (can’t give dividend if either “balance sheet test”
or “equity insolvency test” is not met. Need to meet both.)
1. You can’t pay a dividend if you will have a negative balance sheet § 6.40(c)(2) (i.e. can’t give
dividend so that assets would become less than liabilities. Under this “balance sheet test” can only
give dividend to the point where assets = liabilities A must remain greater than L.). OR
2. If the company won’t be able to pay its debts when they come due in the usual course of business
a. This is the “equity insolvency test” § 6.40(c)(1)
D. § 6.40(e) tells you date when effect of distribution is measured (time when you measure balance sheet
and solvency tests)
33
1. Date of authorization: if payment occurs within 120 days after authorization
2. Date of Payment: if payment occurs over 120 days after authorization
a. Purpose is to protect creditors. Don’t want corp. to promise big dividend that they can pay now
but uncertain as to solvency in future.
E. § 8.33 provides for director liability for making excessive dividend payments.
1. They are only liable if they approve a dividend that violates § 6.40 AND they don’t comply with §
8.30 (standards of conduct for directors). Directors personally liable for excess of distribution above
what is allowed under § 6.40.
2. Therefore, the shareholder has 2 steps:
a. Dividend was illegal
b. Decision to pay it violated the BJR
V. Preferred Stock and Dividends
A. Articles name the classes of stock and their respective rights – can give voting rights, dividend
preference, right to conversion etc.
B. Preference – typically given favorable treatment with respect to dividend rights, liquidation rights, or
redemption rights
1. Dividend preference: corp. can’t pay dividends until preferred shareholders are paid their dividend in
the stated amount of the preference. Leftover is divided among the common stock shareholders,
which may be more than preferred shareholders get. Only means that get paid first, not that corp.
must issue a dividend.
a. Cumulative – if a dividend is not paid one year, the amount carries over and adds up until corp.
issues a dividend – type of guaranteed dividend
b. Noncumulative – no carryover
c. Participating: this type of preferred stock allows the shareholder to collect dividend above just
the preference amount. Get the preference first, then also pooled with common shareholders to
divide up the remaining dividend money.
2. Liquidation preference: get 1st rights to assets upon liquidation
3. Voting preference: determines who gets vote and # of votes
VI. Stock dividend/stock split
A. Not considered a dividend because does not reduce assets or equity. Only effect is to reduce value of
shares, so no real economic consequence.
State of Incorporation and the “Internal Affairs Rule”:
1. Internal Affairs Rule: Laws of the state of incorporation govern the “internal affairs” of the corporation.
This doesn’t mean that a corporation must be sued in the state of incorporation for the “internal affairs
doctrine to apply.” A corporation can be sued in another state in which case the state of suit would need
to apply the laws of the state of incorporation to matters regarding the internal affairs of the corporation.
a. Internal Affairs: Rights and duties between directors, shareholders, officers, etc.
b. External Affairs: Relations of the corporation with third parties and the outside world.
i. Usually apply the law most closely related to the incident/wrong, which is usually the
place of the wrong.
c. Delaware law can be applied by a non-Delaware court—see explanation above.
2. Many corporations choose to incorporate in Delaware because they offer one of the least restrictive and
most favorable corporate codes for businesses and have a judiciary experienced in business law with
substantial precedent. However, businesses may incorporate anywhere they wish. Indeed many
incorporate within their home state.
a. Feet Rule: When a lawyer is incorporating a corporation he or she looks at his/her feet and will
generally incorporate where his/her feet lie.
b. The downside to DE incorporation is that one will have to register as a “foreign business” in
order to do business in another state, which costs money in addition to the fees owed to
Delaware.
34
i. It is cheaper to incorporate where one has most of his/her business so that he/she does not
have to register as a foreign corporation.
ii. If a business incorporates in Delaware, but operates in Alabama it will have to make
filings in and make payments in both states.
c. Taxes—there are variations among the states in how they tax corporations—the general rule
though is that corporations are not taxed in the state in which they are incorporated, but in the
state in which they are doing business.
d. If you want to incorporate in Delaware how do you do it? You need to file the appropriate
forms/fees with the Delaware Secretary of State—remember though that you must designate a
registered agent with a Delaware address—this registered agent may be a corporation.
e. If incorporating in Delaware, you do not need a Delaware lawyer, but it can be beneficial.
3. Qualifications to transact business in a foreign state require:
1. Obtaining authorization from the appropriate state agent of agency,
2. Appointing a registered agent in the state
3. Filing annual statements in the state, and
4. Paying fees and franchise taxes to the state.
Piercing the Corporate Veil:
I. General Rule: MBCA § 6.22 states that shareholders cannot generally, be held personally liable for the
debts of the corporation. Shareholders are not liable merely because of their status as shareholders. There is
no MBCA rule on piercing as it is a judicially created exception to the general rule.
A. Piercing is a way to disregard the corporate form when it becomes a mere alter ego of a dominant
stockholder for example—i.e. when a corporation becomes a facade for dominant stockholders. The
exception to the general rule is generally based on injustice or unfairness. The exception/doctrine seems
like a type of estoppel because if a “corporation” doesn’t act like a corporation, then it will not get
protection of a corp.
B. If veil pierced, courts try to distinguish and only impose liability on the responsible shareholders.
C. Piercing can be used on all limited liability entities and not just corporations— LLCs or LLPs. There
are no corporate formalities in LLCs or LLPs so there is more reliance by the courts on factors such as
undercapitalization and fairness.
II. Factors examined when making this determination:
A. From [Dewitt Truck Brokers v. Fleming Fruit Co.]—the court pierced in this case.
B. Multi-faceted determination—undercapitalization, non-observance of formalities, fraud or injustice,
unfairness, inequity, etc.
C. Undercapitalization (It is important to look at the needs of the business—calls for a case by case
determination—“the nature and magnitude of the business.” A corporation needs enough money to pay
expenses, cover costs, operate, etc. Courts like to see that the company has something at risk or at stake
as there is more incentive to gamble with creditor’s money when a company has little equity at stake if
the gamble fails. If a company loses money due to a business decision, the shareholders should not be
accountable as such is just the risk of doing business and thus, the veil should not be pierced.
1. This is the financial situation of the corporation, when there is little or no equity.
2. Not having enough money to pay creditors (other than the one suing) is another indicator.
3. Was there enough initial investment?
a. If the corporation was intentionally undercapitalized such is evidence that will likely led to
piercing.
b. In [Dewitt Truck Brokers v. Fleming Fruit Co.], the court focused on the fact that the corporation
was undercapitalized intentionally. The corporation was only incorporated with $5,000 as 5,000
shares were issued for $1.00 a piece. The court determined that such was not a sufficient amount
of initial investment as the business of the company was fruit for consumption—the court
considered the possible risks and lawsuits to be had in such a business.
35
c. At what point to you determine if the capital is sufficient or not? Generally, at the time the
corporation is incorporated if the business remains the same over time. If the corporation begins
to change quite a bit, then other times will be looked at as well.
4. If so, was there enough money left in the corporation?
5. Lack of insurance or too little is another indicator:
a. Having an insurance policy is usually considered an asset.
b. How much insurance should a corporation carry? The amount of insurance carried is usually
based on the worth of the assets. It is unfair for a corporation to create an essentially asset-less
company for the purpose of insurance.
6. Insolvency of the debtor corporation at the time
7. Dominant stockholder takes/siphons funds from corporation
D. No observance of corporate formalities
1. Nonpayment of dividends:
a. This is part of corporate formalities. On its face not paying dividends would be good because it
would mean keeping capital, but taking money out for oneself and not listing as dividend is bad
because it involves not observing corporate formalities.
b. In [Dewitt Truck Brokers v. Fleming Fruit Co.], the court observed that Fleming had taken
money out of the corporation without declaring a dividend for his own personal use.
c. This is also evidence of the blurring of lines between the personal and the corporate or between
corporations when such are shareholders of each other—and makes it more likely that a court
will pierce the corporate veil. At some time the individual and the entity become one in the
same—this is when the corporate veil is allowed to be pierced!
2. Lack of a functioning BOD & officers:
a. Does the corporation do things that that a corporation with lots of shareholders wouldn’t do?
This is common in piercing the corporate veil too and san be seen as an example of all of these.
3. Meetings, whether separate account for corporation. Look at the commingling of assets and whether
meetings have been held—this is implicated when one corporation owns another.
4. Absence of corporate records
5. Whether the corporation is a façade for dominant shareholder:
a. If someone creates a corporation to get away with something that they could otherwise not get
away with, this is usually thought of as fraud—thus, with other factors allowing for a piercing.
6. This is an indication that the corporation was formed just to get a liability shield—see above!
E. Injustice/Unfairness if the corporation is not pierced … (fraud, inequity, injustice):
1. Might depend on whether the third party (plaintiff) had a choice to engage in business with the
corporation.
a. Tort victim seems to have no choice, which seems to weigh in favor of piercing.
b. Contractor had chance to do credit check and not engage in business or to get personal guarantee,
so harder to pierce. Requires more of a showing of unfairness or misconduct.
c. There need not be fraud to pierce the corporate veil. It helps, but is not necessary as there was no
evidence of fraud in [Dewitt Truck Brokers v. Fleming Fruit Co.].
d. Usually an element of unfairness is required as well. In [Dewitt Truck Brokers v. Fleming Fruit
Co.], the court seemingly used Fleming’s oral promise to pay if the corporation couldn’t as
evidence of unfairness.
III. See the Taxi Cab case—whereby each taxi cab was incorporated individually—courts have approved this
compartmentalization when done for business purposes.
IV. Factors used when the corporation is owned by another corporation (when you are piercing a subsidiary’s
veil to get to the parent). Generally, a showing of “substantial domination” is required [In re Silicone Gel
Breast Implants Liability Litigation]…
A. Piercing factors vary by jurisdiction, but usually contain some formulation of the following, which
generally apply to all piercing cases not just those involving a parent corporation and its subsidy:
1. Undercapitalization
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a. Initial – depends on type of business
b. Maintenance – like taking out too much money
2. Formalities
a. Corporate meetings, keeping records, etc.
b. Documentation of participation by shareholder
c. Financial: commingling assets and finances
3. Other – Unfairness, inequity, fraud, misconduct, law or legal obligation, tort or K claim
B. Special consideration for subsidiaries
1. Formalities
a. Common directors/officers
i. This is a type of disregard of formalities
b. Common business departments
i. People might not know who they work for
ii. It is tempting to merge the business functions. To get around this, make contacts between the
various subsidiaries whereby consideration is exchanged. Document it.
c. Parent & subsidiary file consolidated financial statements (this is common & legal, so not very
probative)
d. Parent uses the subsidiary’s property as its own
e. Subsidiary receives no business other than that given to it by the parent
2. Undercapitalization
a. Parent finances the subsidiary—acts as the subsidiary’s bank.
b. Subsidiary operates with grossly inadequate capital
c. Parent pays the salaries and other expenses of the subsidiary—including bills and debts!
3. Fraud/inequity/unfairness
a. This is also somewhat similar to undercapitalization.
b. This isn’t required, particularly in a tort claim
c. In [Bristol], the court found it informing that Bristol’s logo/name was included on all packaging,
etc. of MEC
V. Piercing is generally a phenomenon of closely-held corporations.
VI. Other possible theories of personal liability, without piercing:
A. Direct Liability:
1. See MBCA § 6.22—“Unless otherwise provided in the articles of incorporation, a shareholder of a
corporation is not personally liable for the acts or debts of the corporation except that he may
become personally liable by reasons of his own acts or conduct.
a. If a shareholder’s conduct caused injury/resulted in liability, the corporate veil does not need to
be pierced.
b. Directors are not liable for the corporation’s misdeeds per the entity theory, unless there is
evidence of some conduct on the part of the director causing/resulting in injury/liability—see
above.
VII. Enterprise Liability:
A. This is a similar concept, except that it doesn’t pierce to go after the parent/shareholder, it is lateral,
going after other subsidiaries—think Taxi Cab case!
B. This occurs when one takes an entity which is naturally a business and separates it into different
entities/enterprises.
1. If it could be argued that Bristol is really one enterprise, then all of the brother and sister
companies—including subsideries—should be on the hook for the liabilities of the others.
2. Thus, enterprise liability pierces the walls of one corporation not to go after the assets of a
parent/shareholder, but to go after the assets of related companies.
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Corporate Decision Making/Management:
Employees
Officers
Directors
Shareholders
 The above should be seen as a pyramid with the shareholders, the owners, on the bottom—see below.
I. Shareholders elect the board of directors, who elect the officers who manage the company and appoint
employees.
II. Officers are agents of the corporation, but the directors are not.
III. MBCA provisions:
A. § 8.01 deals with the BOD.
B. §§ 8.40, 8.41 deals with Officers.
C. Chapter 7 deals with Shareholders.
IV. Board of Directors [MBCA § 8.01]
A. Except as provided in § 7.32 (shareholder agreement), each corporation must have a BOD. MBCA §
8.01(a) provides for a § 7.32 agreement, which can eliminate the BOD.
B. All corporate powers are to be exercised by or under the authority of the BOD and the business and
affairs of the corporation managed by or under the direction, and subject to the oversight, of the BOD,
subject to any limitations set forth in the articles or an agreement authorized under § 7..32—[MBCA §
8.01(b)]
1. “By or under the authority of” implies that either the BOD can do everything or that they can
appoint/elect people to act under the authority of the Board—i.e. officers.
2. For public companies there is a separation between ownership and control of the company. Thus, the
shareholders do not control the company in any meaningful way.
3. The Board’s job is to make key decisions and not has out the details.
4. Generally, closely-held/private corporations are managed by their Boards whereas the business and
affairs of public corporations are generally under the direction and subject to the oversight of the
Board.
a. Additionally, in public corporations, the trend is to have directors who are outside of the
corporation in that they are generally not officers/employees of the company.
C. The Board generally handles the overall operations and “big decisions.”
D. Directors are not agents of the shareholders – shareholders can’t tell the BOD what to do. Thus, a
shareholder is not a principle as there is no control.
E. The number of directors is to be set out in either the articles or bylaws—MBCA § 8.03(a).
F. The number of directors may be increased or decreased by amending the articles or bylaws—MBCA §
8.03(b).
G. There must be at least one director on the Board—MBCA § 8.03(a).
H. Generally, the number will be either fixed or variable.
I. Directors are to be elected during the annual shareholder meeting unless the terms of the directors are
staggered according to § 8.06—MBCA § 8.03(c). Thus, the default is that a director’s term is one year.
J. Meetings and Action of the Board:
1. MBCA § 8.20(a)—the BOD may hold regular or special meetings.
2. MBCA § 8.20(b)—“Unless the articles or bylaws provide otherwise, the BOD may permit any or all
directors to participate in a regular or special meeting through any means of communication whereby
all directors may simultaneously hear each other during the meeting—a director participating in such
a fashion is deemed to have been present at the meeting.”
3. MBCA § 8.21(a)—action can be taken by the BOD without a meeting if each direct signs a consent
describing the action to be taken and delivers it to the corporation.
4. MBCA § 8.22(a)—“Unless the articles or bylaws provide otherwise, regular meetings of the BOD
may be held without notice of the date, time, place, or purpose of the meeting.”
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5. MBCA § 8.22(b)—“Unless the articles or bylaws provide otherwise, special meetings of the BOD
must be preceded by at least two days notice of the date, time, and place of the meeting. The notice
however, need not describe the purpose of the meeting unless required by the articles or bylaws.”
6. MBCA § 8.23(a)—“A director may waive any notice required by this Act, the articles, or bylaws,
before or after the date and time stated in the notice. Except as provided by § 8.23(b), the waiver
must be in writing, signed by the director, and filed with the minutes or corporate records.”
7. MBCA § 8.23(b)—“A directors presence at a meeting waives any required notice to him unless
he/she objects promptly upon his/her arrival.”
8. MBCA § 8.24(a)—“Unless the articles or bylaws require otherwise, a quorum consists of:
a. A majority of the fixed number of directors if the corporation has a fixed board size;
b. A majority of the number or directors prescribed, or if no number is prescribed, the number in
office immediately before the meeting begins if the corporation has a variable-range size board.”
9. MBCA § 8.24(b)—The articles or bylaws may authorize a quorum of the BOD to consist of no
fewer than one-third the fixed or prescribed number of directors determined under § 8.24(a).”
10. MBCA § 8.24(d)—If a quorum is present when a vote is taken, the affirmative vote of directors
present is the act of the BOD.
11. See MBCA § 8.24(d)— A director is deemed to have assented unless he/she dissented or objected…
12. MBCA § 8.25 allows the BOD to create and appoint directors to serve on committees.
a. Committees are particularly common in public corporations.
V. Officers [8.40]
A. The bylaws determine how many officers a corporation will have and what their duties are. [MBCA §
8.40(a)]. In the bylaws the various officers of the corporation should be found.
B. The board elects or appoints people to fill offices. [MBCA § 8.40(b)]
C. One officer shall have responsibility to prepare and maintain minutes of the directors’ and shareholders’
meetings and corporate records. [MBCA § 8.40(c)]
D. The officers generally handle hiring decisions and other day-to-day operations as well as “small
decisions” of the corporation.
E. Officers are agents of the corporation and thus, have power to bind the corporation. Need to have actual
or apparent authority to bind. Board is the one source of authority – can pass resolutions giving
authority. Bylaws are another source of authority. Authority can be delegated from higher officers
down to lower tiers. Job title can be a source of apparent authority – TP needs to have reasonable belief
that have authority. Case law fairly settled that President/CEO have apparent authority for things in
regular course of business. Other officers, it is more of a factual determination.
 Authority of Officers (Express Actual Authority):
1. Bylaws: Typically include specific officers and describes their powers.
2. Director Action through Board Resolutions.
3. Senior Officer Power Delegation: unless the senior officers are prohibited from delegating
such authority.
 Authority of Officers (Implied Authority):
1. Through their Position Name or Description
F. General Manager/CEO/President—generally, under the law, whomever holds this position within the
corporation, has the authority to bind the corporation in essence, through their title. The assumption is
that a third party dealing with the CEO or President of a corporation should be able to assume that they
are dealing with the corporation. This holds unless the CEO or President acts outside of their general
authority, authority assumed to be given them through their title. Also, generally, under the law,
whomever holds the position of Secretary, has the authority to bind the corporation in matters relating to
the director/shareholder minutes.
1. If a President is signing loan documents on behalf of the corporation, how should the documents be
signed? The L Company by Ashley M. Leyda, for example. The directors or shareholders obviously
will not be the one who signs the loan documents on behalf of the corporation.
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
Authority of Officers (Apparent Authority):
1. The reasonable belief of the Third Party
 Make sure that the action is taken in the ordinary course of business—this will affect the
reasonableness of the third parties’ belief.
 Whether the third party has contracted with the particular supposed officer in the past will also
affect the reasonableness of the third parties’ belief.
G. Not required to have a certain number or any officers except for the record-keeper per MBCA § 8.40(c).
H. Contracts involving Corporate Officers:
1. If you have contracted with the Corporation to be the Chief Financial Officer for five years, and the
Board dismisses you after three years, while you have a contractual claim against the Corporation
per MBCA § 8.44(b), the Board can dismiss you validly with or without cause per MBCA §
8.43(b).
2. Remember, that the Board always has power over the Corporate Officers.
Shareholder (Voting) Agreements:
I. Common Law: [McQuade v. Stoneham]
A. There was a shareholder agreement in place between McQuade and Stoneham to vote for each other as
directors and as directors, to vote for each other as officers.
B. Shareholders can’t unreasonably restrict the discretion of the BOD. Thus, the court held that it was
against public policy to contract away the discretion of the BOD.
1. Agreements that limit the discretion/sterilize the BOD are against public policy and are void.
2. Shareholders can’t do the duties assigned to directors.
3. If however, the agreement didn’t tie the Director’s hands too much or if ALL of the shareholders had
agreed to the agreement, the court would have been more inclined to uphold it.
C. Stockholders are authorized to vote for directors by statute, therefore it is not against public policy to
agree to elect directors, but shareholders can’t agree to what they will do after elected as directors. This
would greatly blur the line between shareholders and directors.
D. Such agreements harm other shareholders—who essentially lose their voting power, perhaps other
directors, and creditors of the corporation.
E. Shareholders can agree to do anything that is within the power of shareholders to do. They just can’t
agree to do something that only directors can do.
1. Example: You can’t agree to elect yourselves as directors and further agree to appoint yourselves as
officers as was the case here. The second step (controlling what the directors will do) usurps the
power of the Board.
F. There is a difference between a contract between a corporation and an employee and shareholder
agreements.
1. A long-term contract with an officer would not sterilize the Board as the Board would still be able to
fire the officer pursuant to MBCA § 8.43(b) with or without cause.
a. Officer would still have a breach of contract claim [MBCA § 8.44(b)] though, even though
he/she could be fired by the Board on a whim.
II. After McQuade there was a movement away from this holding. Most now agree that it is beneficial for
shareholders in closely held corporations to be able to enter into agreements limiting the discretion of
directors.
A. States have remedied this by a couple of approaches
1. Closely-Held Corporation Supplemental Statutes; and
2. Statutory Authorization, such as MBCA § 7.32.
III. MBCA [§ 7.32]: Shareholder Agreements:
A. MBCA § 7.32(a) – substance – provides what shareholders can do in such agreements. Shareholders
can do any of the actions listed in (a). Some examples include:
1. Shareholders can agree to limit the discretion of the board [MBCA § 7.32(a)(1)]
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B.
C.
D.
E.
F.
G.
a. If you do this, the directors’ liability shifts to whoever gets the discretion [MBCA § 7.32(e)]
2. Shareholders can establish who will be directors or officers and/or set the terms for their selection or
removal [MBCA § 7.32(a)(3)]—this is quite contrary to McQuade v. Stone.
3. [Villar v. Kernan]: If you draft an agreement that does not comport with one of the agreements
provided for in 7.32(a), it is not necessarily invalid. You can argue that the agreement should be
upheld as long as it does not violate public policy!!!
In order for this agreement to be valid, it MUST comply with § 7.32(b) and must:
1. “…be set forth in the articles or bylaws AND be approved by all shareholders (unanimity) at the
time of the agreement OR be in a written agreement that is signed by all shareholders at the time
AND is made known to the corporation.”
2. It can only be amended by all those who are shareholders at the time of the amendment unless the
agreement provides otherwise!
3. Such agreements are valid for 10 years unless otherwise provided for in the agreement.
[MBCA § 7.32(c)] You also have to note the existence of the agreement on the stock certificates in
order to give notice to a prospective buyer that this is in place! If you don’t, they have a right of
rescission!!!
[MBCA § 7.32(d)] These agreements become invalid when the shares become listed on a national
securities exchange. This makes them peculiar and only applicable to closely-held corporations!
1. In a public company, if a stockholder is upset about the way the directors are running the company,
he/she could always sell his/her stock in it.
MBCA § 7.32(e) provides that if powers typically had by a director are delegated to another through an
agreement provided for in 7.32(a), the fiduciary and other duties typically owed by a director will
transfer to the other as well.
This kind of agreement can’t be used to support a piercing claim [MBCA § 7.32(f)].
As a prerequisite for adopting an alternative form of management, some state’s corporate codes
provided that the corporations using such alternative forms, must have met the statutory requirements of
a closed corporation before using such. Other states, such as Iowa, allowed any corporation having 50 or
less shareholders to adopt alternative forms of management by their choosing. Generally, the states who
had these requirements have since done away with them. So that for example, theoretically, any
corporation in Iowa, except a public one, can choose an alternative form of management, even if there
are more than 50 shareholders.
Straight v. Cumulative Voting [MBCA § 7.28]
I. Straight (Plurality) Voting:
A. Default voting method under MBCA § 7.28(a).
B. Each director is elected separately, and each share gets a vote. Each shareholder gets to vote all his
shares for each director. Ex. If A has 30 shares, A can cast 30 votes for each candidate of choice.
C. Under this system, a majority shareholder gets to elect every member of the board—at the very least; the
majority shareholder calls the shots in a closely held corporation.
D. In order to win, you need the most votes of those cast, not a majority. There are no run-offs. [MBCA §
7.28(a)].
1. Directors are elected by plurality under the default—i.e. the highest vote getters—each is simply
running for a seat on the board, not necessarily against each other.
2. There is some trend among public companies to require majority rather than plurality voting for
directors.
II. Cumulative Voting:
A. There is no right to cumulative voting unless it is provided for in the articles of incorporation. [MBCA
§ 7.28(b)]
1. This is an election “at large.”
a. Cumulative voting allows a shareholder to cumulate her votes by multiplying the number of
shares she has by the number of positions to be voted on. For example, if there are five directors
41
to be elected, the person with 18 shares would have 90 votes (18 x 5). Thus, that person could
put all their cards on one person. They could use all 90 votes on one person.
2. You get to divide up your total votes and can cast differing number of votes for different directors.
3. The highest vote getters win the seats.
B. This allows a minority shareholder to get representation on the board, i.e. if a minority shareholder
wishes, he/she can cast all of his/her votes for one director and thus, be able to elect a director.
C. The minimum number of shares required to elect 1 director under cumulative voting is: [NxS/(D + 1)] +
1, where N is the number of directors the shareholder wants to elect, S is the number of total shares
voting, and D is the number of directors to be elected. Generally N is one, however, can multiply S
times the number of directors you want to elect if more than one.
1. Remember it’s not just shares that are owned, but shares owned by shareholders present to vote!!!
2. The lesser the number of directors, the more votes needed to participate.
III. Possible Problems with Cumulative Voting:
A. Could create factions/dissention and can be complicated.
B. Additionally, majority shareholders are typically anti-cumulative voting as they essentially loose voting
power under it.
IV. States default rules are either opt-in or opt-out for cumulative voting. The MBCA is opt-in (default is
straight voting).
V. Ways to Reduce the Effect of Cumulative Voting (if you are a majority shareholder) (Article 8 deals with
Directors)…
A. MBCA § 8.03 – The # of directors is to be established by the articles or bylaws.
1. Change the number of directors on the board via the bylaws or articles.
a. If you reduce the number of directors, you can make it impossible for a minority shareholder to
get representation. The smaller the Board, the more shares it takes to elect even one director.
B. Stagger the Terms of the Directors (Note though, that this must be done in the articles) [MBCA § 8.06]:
1. Staggered Board—the Director’s terms do not expire at the same time—think U.S. Senate. This will
affect the formula and the votes needed to have a say in electing directors.
2. Thus, you re-elect only part of the board at each meeting.
3. Even though have a larger board, only voting for a few at a time, thus it’s like decreasing the amount
of directors for voting purposes and requires more shares to elect one director.
a. Ex. Nine-member BOD staggered voting so only vote on 3 at a time. This makes it as though
you’re voting for 3 person board each time around. Remember, the fewer the directors to vote
for, the more votes are required to elect.
4. This has to be provided for in the articles, not the bylaws.
5. This can also be used as a takeover defense, because the whole board can’t be taken over all at once.
6. Staggered Boards prevent takeovers (see above) and are quite common.
C. Grant Voting Power only to Certain Classes of Shareholders [MBCA § 8.04]—“Classified Board”:
1. For example, you can provide that class A shareholders get to elect 3 board members and class B
shareholders get to elect 2.
2. In essence, shareholders only vote for a certain director and not against a director. MBCA § 10.22
allows, in the case of a public corporation, for a shareholder to actually vote against a director.
VI. Removal of Directors [MBCA § 8.08]:
A. Shareholders can vote to remove directors, although this is not particularly common.
B. This can be done at any time, with or without cause (unless the articles provide that cause is needed). [§
MBCA 8.08(a)]
C. You have to have a shareholder meeting with removal as one of the stated purposes of the meeting in
order to remove a director at that meeting. [MBCA § 8.08(d)].
D. If straight voting is in effect, a director will only be removed when the number of votes cast to remove
him is greater than the number of votes cast not to remove him. Only counts the number of votes cast
and those abstaining are not factored in. Need a quorum, but whole quorum does not need to vote and
some can abstain. [MBCA § 8.08(c)].
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E. If cumulative voting is in effect, can’t remove director if # of votes sufficient to elect him under
cumulative voting is voted against his removal. [MBCA § 8.08(c)]
1. Otherwise would defeat purpose of cumulative voting because majority could just vote off directors
voted on by the minority.
2. MBCA § 8.09 provides for the possibility of the removal of a director by a court. In such a case,
cause is required—must be the kind of case noted in § 8.09(a).
Overview of Shareholder Action: MBCA 700’s address shareholders and meetings.
I. There are only a few things that shareholders can vote on, including:
A. Director election and removal;
B. Fundamental changes:
1. Amendment to the articles of incorporation;
2. Dissolution;
3. Merger with another corporation;
4. Sale of all or substantially all of the assets of the corporation.
C. Shareholders don’t get to vote on regular management decisions and therefore management decisions
other than fundamental changes don’t need shareholder approval.
II. Creditors are not given voting power by the MBCA. Thus, creditors will have to work out an agreement
with those borrowing from them, in order to have a say in the company.
III. Meetings:
A. Shareholders can act without a meeting if there is unanimous consent among the shareholders. Typically
this is only done in closely held corporations [MBCA § 7.04].
B. Annual Meeting [MBCA § 7.01]
C. Special Meeting [MBCA § 7.02]
1. If 10% of the shareholders so request, a special shareholder meeting shall be had; however, this
number cannot be raised by the articles to an amount higher than 25%--MBCA § 7.02(a)(2).
D. In order to have a valid meeting, notice must have been given [MBCA § 7.05] and there must be a
quorum.
1. Notice:
a. “A corporation shall notify shareholders of the date, time, and place of each annual and special
shareholders’ meeting no fewer than 10 nor more than 60 days before the meeting date.”
[MBCA § 7.05(a)]
b. “Unless the MBCA or the articles of incorporation require otherwise, the corporation is required
to give notice only to shareholders entitled to vote at the meeting.” [MBCA § 7.05(a)]
c. MBCA § 7.06 – Shareholders can waive the notice requirement by a writing, signed by
him/herself, and delivered to the corporation for inclusion in the minutes or records.
2. Record Date: [MBCA § 7.07]:
a. Because shareholders in a publicly traded corporation change rapidly, “record dates” are
commonly set. Shareholders as of the record, get notice and the right to vote at the upcoming
meeting. Acquiring stock after the record date will not entitle one to vote at the next meeting.
i. The bylaws can provide for the record date or provide for the manner in setting the record
date. If they don’t, the BOD can set one instead. [MBCA § 7.07]
ii. If neither the bylaws nor the BOD set a record date, it is assumed to be the day before the
notice is delivered to shareholders. [MBCA § 7.05(d)].
b. “Street Name” ownership of stock: The individual owner does not actually become the record
owner, he is just the beneficial owner. The record owner is actually a large brokerage firm.
i. In public corporations, paper certificates of stock ownership are uncommon—“street name
ownership.”
ii. CEDE & Co. (Depository Trust Company)—This company holds shares and keeps track of
their holdings for particular public brokerage companies, who then keep track of how many
43
shares they hold in Exxon, for example, for Mike Jones. This allows for the efficient transfer
of public shares without requiring paper certificates.
iii. Mike Jones in such a situation would be referred to as the “beneficial owner.”
3. Quorum/Voting:
a. Quorum at a meeting is a majority of shares [ MBCA § 7.25(a)] unless the articles provide for a
lesser or greater number. [MBCA § 7.27].
i. In order to get a quorum for a large corporation, you generally have to solicit proxies.
[MBCA § 7.22]
ii. If you have a quorum, you just need more votes in favor than votes against to pass.
Abstentions don’t count. [MBCA § 7.25(c)]
1) However, some corporate codes require a majority of a quorum vote in favor of
something for it to pass.
E. After the record date is set for a meeting, the corporation has to prepare a list of shareholders entitled to
notice of the meeting. [MBCA § 7.20(a)]
F. Each outstanding share is entitled to vote [MBCA § 7.21]
G. Each meeting shall be presided over by a chair [MBCA § 7.08]
Shareholder Power to Control Corporate Action: Amendment of Articles of Incorporation and Bylaws
I. Articles of incorporation can be amended under MBCA § 10.03.
A. Articles are harder to amend than bylaws as they require two levels of approval.
B. First, the directors adopt the proposed amendment [MBCA § 10.03(a)];
C. Then the shareholders must approve the amendment before it is effective [MBCA§ 10.03(b)]—other
than in the situations covered by MBCA §§ 10.05, 10.07, and 10.08!
1. Approval of the amendment requires the approval of the shareholders at a meeting at which the
quorum consisting of at least a majority of the votes entitled to be cast on the amendment exists.
[MBCA § 10.03(e)]
II. Bylaws can be amended under MBCA § 10.20.
A. Shareholders can amend or repeal the bylaws [MBCA § 10.20(a)].
B. The BOD can also amend or repeal the bylaws unless the articles reserve the power to the shareholders
OR the shareholders previously specified that a particular amendment/adoption they approved or
repealed could not later be repealed by the BOD. [MBCA § 10.20(b)].
C. The bylaws should really contain procedural things, and not substantive ones. Substantive things should
be included in the articles.
III. Power to Control Corporate Action through Amendments:
A. MBCA § 801 provides that the Board manages and the power of the BOD can only be limited in the
articles or in a § 7.32 agreement!
1. MBCA § 2.02(b)(2) allows provisions in the articles limiting the power of the BOD if not
inconsistent with the law.
2. § 7.32 agreements are only allowed in closely-held corporations, not public ones!!!
3. Can’t limit the authority of the BOD through the bylaws!
B. Moral of the Story: Shareholders can’t unilaterally limit the authority of the board because such can’t be
done through an amendment to the bylaws. Since such must be done through an amendment to the
articles, shareholders are going to have to have BOD approval as well.
Shareholder Proxies – MBCA § 7.22:
I. Voting by proxy means that the person who is entitled to vote authorizes another person to vote for him.
A. Shareholders are permitted to vote by proxy, but directors are not.
B. Voting by proxy is not the same as voting by an absentee ballot. A proxy actually appoints someone to
vote for you, whereas with an absentee ballot you vote for yourself. An absentee ballot is final and not
revocable.
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C. A proxy lasts for 11 months, unless otherwise provided for—this is because there is a shareholder
meeting annually.
II. Proxy power by default is generally revocable. [MBCA § 7.22(d)] This is based generally on agency law as
the proxy is the agent of the shareholder.
A. The only time a proxy is irrevocable is if the appointment form or electronic transmission states that it is
irrevocable and is coupled with an interest—see MBCA § 7.22(d)(1)-(5) for interests. [MBCA §
7.22(d)].
1. For example, suppose that Capel borrows $100,000 from First Bank and pledges his Bubba’s
Burrittos, Inc. stock as collateral for the loan. First bank wants to be able to vote the shares and so
requires that Capel execute an irrevocable proxy. Because First Bank has an interest in the stock, the
proxy would be irrevocable under common law.
B. An appointment made irrevocable is revoked when the interest with which it is coupled is
extinguished—MBCA § 7.2(f).
C. If you appoint a later proxy, that revokes the first one. You can also revoke a proxy by going and voting
in person.
III. The corporation is typically the one who solicits proxies.
A. Proxies are especially beneficial in the case of public corporations, as it would be difficult to reach
quorum otherwise.
B. The corporation must vote the way you indicate on your proxy card even if it is not the way the
corporation would wish you to vote and the corporation can’t revoke your proxy upon a negative
indication of your voting choice as you, as the shareholder, are the principal and the one who can
revoke.
C. Shareholders may also solicit proxies, resulting in a proxy contest.
1. Proxy solicitation rules apply both to shareholder and corporate solicitations for proxies.
a. 14a-7: Shareholders can either get a list of shareholders from the corporation to solicit proxies or
the corporation can mail out such materials at the shareholder’s own expense.
b. The choice of which is made by the corporation.
IV. A shareholder or his agent or attorney-in-fact may appoint a proxy to vote or otherwise act for the
shareholder by signing an appointment form or by an electronic transmission. An electronic transmission
must contain or be accompanied by information from which one can determine that the shareholder, the
shareholder’s agent, or the shareholder’s attorney in fact, authorized the transmission—MBCA § 7.22(b).
V. An appointment of a proxy is effective when a signed appointment form or an electronic transmission is
received by the inspector of election of the officer or agent of the corporation authorized to tabulate votes—
MBCA § 7.22(c).
VI. Proxy Materials:
1. Proxy Statement: Mandatory disclosure statement.
2. Proxy itself: The card or other instrument the shareholder actually signs.
Federal Proxy Rules:
I. Coverage of Federal Proxy Rules: Rules apply to companies registered under § 12 of the 1934 Act which
are publicly traded companies (traded on a national exchange) OR companies having more than 500 record
owners issued by a company with more than $10 million in assets???
A. If you are subject to SEC regulations, you must comply with the Rules promulgated under § 14a.
II. Two Main Securities Statutes:
A. Securities Act of 1933: Deals with offering Securities
B. Securities Exchange Act of 1934: Focuses on Trading and Proxy Voting:
1. Many rules promulgated under this Act. § 14a deals with proxies.
a. Cover many aspects of proxies like solicitations, disclosure requirements, proper form for proxy
card, shareholder proposals, etc.
i. 14a-9 – prohibits the use of false or misleading information when soliciting proxies.
ii. READ 14a(1)-(9)!!!
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III. Shareholder Proposals (Remember that the Rules only apply to publicly traded companies!):
A. What is a shareholder proposal? A shareholder proposal is a recommendation or requirement that the
company and/or its BOD take an action, which a shareholder intends to present at a meeting of the
company’s shareholders.
B. Shareholder proposals are different than proxy solicitations. If a shareholder proposal is “valid,” the
corporation MUST include the proposal with the proxy materials that it sends out. Most proposals fail,
but SEC still has rules governing their use and requiring that certain proposals to be included in proxy
materials.
1. A valid proposal must be included on the proxy card so that shareholders are given the opportunity
to vote on it.
C. To be eligible to submit a proposal, a shareholder must have continuously held at least $2,000 in market
value, or 1% of the company’s securities entitled to be voted on the proposal at the meeting for at least
one year by the date you submit the proposal. Additionally, the shareholder must continue to hold
his/her securities through the date of the shareholder meeting.
D. The proposal, including any supporting statements, may not exceed 500 words.
E. Proxy materials must include the next year’s deadline for submitting proposals. This puts shareholders
on notice of the deadline for submitting proposals.
F. If a shareholder fails to meet a procedural or eligibility requirement for submitting a proposal, the
corporation may exclude the proposal, but only after it has notified the shareholder of the problem
within 14 days from the date the corporation received the shareholder’s proposal and the shareholder has
failed to adequately correct the proposal’s deficiency within 14 days. A corporation need not provide a
shareholder of his/her proposal’s deficiency if it cannot be remedied. If the corporation intends to
exclude a shareholder’s proposal on such grounds though, it will need to provide the shareholder notice
of such decision and the reasoning for it.
G. Either the shareholder or the shareholder’s representative must attend the shareholder meeting to present
the proposal.
H. Most Shareholder Proposals Fall into 3 Categories:
1. Social Proposals: For example, a proposal re: the company’s policy on the ethical treatment of
animals.
2. Corporate Governance Proposals: For example, the salary of our CEO should not be more than $X.
3. Business Proposals
I. These are regulated by the SEC rules for proxies [Rule 14a-8]
J. If a shareholder meets the requirements of the Rules, the corporation must include the proposal with the
official proxy materials (although the BOD can recommend that other shareholders vote it down!)…
K. If a corporation determines that it is entitled to exclude a shareholder’s proposal, the corporation has the
burden to demonstrate such.
L. Grounds for a Company excluding a shareholder’s proposal are in 14a-8(i)…
1. Improper under state law—if the proposal is not a proper subject for action by shareholders under
the laws of the jurisdiction of the company’s organization;
2. Violation of law—if the proposal would, if implemented, cause the company to violate any state,
federal, or foreign law to which it is subject;
3. Violation of proxy rules—if the proposal or supporting statement is contrary to any of the
Commission’s proxy rules, including Rule 14a-9, which prohibits materially false or misleading
statements in proxy soliciting materials.
4. Personal grievance/special interest—if the proposal relates to the redress of a personal claim or
grievance against the company or any other person, or if it is designed to result in a benefit to the
shareholder, or to further a personal interest, which is not shared by the other shareholders at large.
5. Relevance—if the proposal relates to operations which account for less than 5 percent of the
company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net
earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to
the company’s business.
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6. Absence of power/authority—if the company would lack the power or authority to implement the
proposal;
7. Management functions—if the proposal deals with a matter relating to the company’s ordinary
business operations;
8. Relates to election—if the proposal relates to a nomination or an election for membership on the
company’s BOD or analogous governing body or a procedure for such nomination or election.
9. Conflicts with company’s proposal—if the proposal directly conflicts with one of the company’s
own proposals to be submitted to shareholders at the same meeting;
10. Substantially implemented—if the company has already substantially implemented the proposal.
11. Duplication—if the proposal substantially duplicates another proposal previously submitted to the
company by another proponent that will be included in the company’s proxy materials for the same
meeting;
12. Resubmissions—if the proposal deals with substantially the same subject matter as another proposal
or proposals that has or have been previously included in the company’s proxy materials within the
preceding 5 calendar years if …;
13. Specific amount of dividends—if the proposal relates to specific amounts of cash or stock dividends.
14. This is where most of the disputes occur. Be able to apply this section for the exam to see if the
corporation must include the proposal in its materials. Really this is the only rule that we are
concerned with.
15. 14a-9 also allows exclusion of information in proxy materials which is false or misleading with
regards to a material fact. A material fact is something that would affect the shareholder’s decision
on voting, or that the shareholder would have wanted to have available to them when deciding on
how to vote.
16. The Management/Business Exception to 14(a)-8 is typically read to relate to the Relevance
Exception.
SEE PROPOSAL PROBLEMS!!!
17. [Lovenheim v. Iroquois Brands, Ltd.]
A. Lovenheim, a shareholder of Iroquois/Delaware sought to include a proposal in the
Corporation’s proxy materials, that called for the Board of Directors to form a committee to
study the methods by which its French supplier produces pate de foie gras and report to the
shareholders its findings and opinions, based on expert consultation, on whether this production
method causes undue distress, pain, or suffering to the animals involved, and if so, whether
further distribution of this product should be discontinued until a more humane production
method is developed. Iroquois/Delaware has refused to allow Lovenheim’s proposal to be
included with its proxy materials. The SEC had written a no-action letter in favor of
Iroquois/Delaware and Lovenheim sued in District Court.
B. The District Court held that while the operations in question account for less than 5% of the
company’s total assets and net earnings and gross sales, in light of the ethical and social
significance of the proposal and the fact that it implicates a significant level of sales, the plaintiff
had show a likelihood of prevailing on the merits with regard to the issue of whether his proposal
is “otherwise significantly related” to Iroquois/Delaware’s business.
1. See the language of the exception—“and is not otherwise significantly related to the
company’s business.”
18. If the Corporation does not wish to include a shareholder’s proposal in its materials, typically the
Corporation seeks a “No-Action” Letter from the SEC. To do this, the Corporation simply sends a
Letter to the SEC outlining the facts, as well as any previous decisions of the SEC in the
Corporation’s favor. The shareholder is also allowed to send a letter to the SEC defending the
proposal and the SEC will render a decision. If ruling in favor of the Corporation, the SEC simply
writes a “No-Action” Letter basically stating that if the Corporation excludes the shareholder’s
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proposal from its materials, the SEC will take no action against the Corporation for the failure.
19. Proposed 14a-11, the SEC will facilitate shareholders, who own a significant amount of stock in a
company, nominating people for the Board of Directors. This may get adopted next year by the SEC.
Inspection Rights:
I. DE § 220
A. By a Director [DE § 220(d)]:
1. Any director has the right to examine the corporation’s stock ledger, a shareholder list, and other
books and records for a purpose reasonably related to the director’s position as a director.
2. There is a presumption that a director is entitled to inspect records.
3. Once a director shows that he has made a demand to inspect, and it was refused, he has made a
prima facie showing of entitlement, and the burden shifts to the corporation to show why inspection
should be denied.
B. By a Shareholder [DE § 220(b)]:
1. Distinguishes between inspecting “books and records” and “the corporation’s stock ledger or
stockholder list”…
a. For both, the shareholder must prove that he is a shareholder and that he has complied with the
proper form and manner of making a demand for inspection of such documents.
b. When inspecting books and records, the burden is on the shareholder to prove that it is for a
proper purpose.
i. It is not a proper purpose if the shareholder is not concerned about the profitability of the
company.
c. When inspecting a stock ledger or stockholder list, the burden is on the corporation to show that
it is for an improper purpose.
2. Shareholders can inspect “other books and records,”—this is broader than the MBCA.
II. MBCA Chapter 16
A. Directors [MBCA § 16.05]:
1. Inspection allowed to the extent reasonably related to the performance of the director’s duties as a
director, but not for any other purpose or in any manner that would violate any duty to the
corporation. [MBCA § 16.05(a)].
2. If refused, MBCA § 16.05(b) allows the director to sue to get inspection.
B. Shareholders [MBCA §§ 16.01, 16.02]:
1. [MBCA § 16.02(a)] A shareholder has the right to inspect and copy, during regular business hours at
a reasonable location specified by the corporation, any records required under 16.01(e) to be kept at
the corporation’s principal office. No requirement of proper purpose for these documents!!!
a. Articles of incorporation;
b. Bylaws;
c. Board resolutions regarding creation of classes or series of shares;
d. Minutes of shareholder meetings for the last 3 years;
e. Written communications to the shareholders for the last 3 years;
f. Names and business addresses of the current directors and officers;
g. Most recent annual report.
2. [§ 16.02(c)] If the shareholder makes a demand in (1) good faith and for a proper purpose, (2)
describes the purpose with reasonable particularity, and (3) the records are directly connected with
his purpose, the shareholder can also inspect records listed in MBCA § 16.02(b): (5 days written
notice must be given under 16.02(b)!)…
a. Excerpts from board meeting minutes or shareholder meeting minutes, etc.;
b. Accounting records of the corporation;
c. Record of shareholders.
3. These inspection rights can’t be limited by the articles or bylaws. [MBCA § 16.02(d)]
4. These rights can be exercised by a shareholder’s agent or attorney. [MBCA § 16.03]
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5. If a shareholder is denied inspection, he/she can sue for inspection. [MBCA § 16.04]
C. There are essentially three tiers of records for shareholder inspection under the MBCA:
1. Tier 1: § 16.01(e) records, whereby no purpose required.
2. Tier 2: § 16.02(b) records, whereby a shareholder must comply with 16.02(c) to inspect.
3. Tier 3: Everything else, whereby there is no shareholder inspection right to under the MBCA.
a. Under the third tier, a shareholder would probably have to fall back on a common law right to
certain documents he/she wishes to inspect.
D. The MBCA does not preclude a common law right to inspection.
III. Examples of Proper Purposes:
A. Determination of value of shares;
B. Communication with other shareholders for reasons related to the corporation (e.g., election of
directors);
C. Investigation of possible mismanagement.
IV. Examples of Improper Purposes:
A. To persuade the corporation to adopt social policy concerns, irrespective of any economic benefit to the
shareholders or the corporation [Honeywell case]; however, some courts hold social purposes to be
proper purposes.
B. To sabotage the corporation by making confidential information available to a competitor.
Shareholder Voting Agreements and Voting Trusts:
I. Voting Trusts [MBCA § 7.30]:
A. 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 and transferring their shares
to the trustee—MBCA § 7.30(a).
B. The voting trustee is a party to the agreement.
C. This entails a transfer of the shareholders’ shares to the trustee.
1. When you enter a voting trust, you are no longer the “record owner” of the stock. The trustee is the
“record owner” and you are the “beneficial owner.”
2. This separates the ownership of the shares from the voting power of the shares.
3. The trustee votes the shares in the trust pursuant to the agreement.
D. You don’t have to have unanimity of all shareholders to enter into a voting trust.
E. The shareholders in the trust get voting trust certificates.
F. A Voting Trust is valid for not more than 10 years after its effective date unless extended by signing and
extension agreement to which the trustee must consent in writing. [MBCA § 7.30(a) and (b)]…
1. Voting Trusts can be extended, but for no longer than 10 years at a time. [MBCA § 7.30(c)].
G. When the agreement is signed, the trustee is to give a copy of the agreement and a list of the
shareholders involved to the corporation’s principal office. [MBCA § 7.30(a)]
H. Profits and benefits of being a shareholder still remain with the “beneficial owner”—the shareholder.
This separates the voting and economic interests of the shares.
II. Voting Agreement [MBCA § 7.31]
A. These are much simpler and involve an agreement between two or more shareholders to vote a certain
way. Each shareholder involved still votes his/her own shares. [MBCA § 7.31(a)].
B. Do not have to have unanimity of all shareholders to enter shareholder voting agreement.
C. Remedy is specific enforcement of the agreement! [MBCA § 7.31(b)].
1. [Ringling Bros.-Barnum & Bailey Combined Shows, Inc. v. Ringling] (Del. 1947)
a. The shareholders involved had a voting agreement re: who each would elect as director(s), but
one of them breached the agreement.
b. To remedy, the court simply voided the invalid votes. The Delaware statute at issue did not
provide for specific enforcement like the MBCA does today.
2. It takes some time to get specific enforcement. Another way to accomplish the same result as a
voting agreement would be to create an irrevocable proxy under MBCA § 7.22—remember
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though, need an interest for such. Very similar to a voting trust, but here it can still be said that
voting rights, as well as the economic rights remain with the shareholder.
D. Voting agreements are not subject to the requirements of voting trusts under MBCA § 7.30.
E. Note that only one shareholder is needed to create a voting trust, while at least two are needed to create a
voting agreement.
Director’s Duty of Care and the Business Judgment Rule (BJR):
I. BJR Elements:
A. Business Decision (It can be a decision to take no action, but there has to have been a business decision
made)…
B. Good faith belief that the judgment is in the best interest of the corporation (good faith)…
C. Made by disinterested/independent directors…
D. Informed to the extent reasonably believed appropriate (due care)…
E. No abuse of discretion (used in a limited number of jurisdictions)…
II. The BJR serves to protect directors from liability based on business decisions. It also serves to protect
management decisions.
III. There is a dichotomy between the Duty of Care and the Standard of Liability.
A. Duty of Care: Case law and statutory standards.
B. Standard of Liability: BJR.
1. Some things may come in under the duty of care, which are not protected by the BJR!
IV. Reasons behind BJR from Joy v. North
A. Shareholders voluntary choose to invest in a company and in doing so they assume the risk of bad
judgment.
B. After the fact litigation is an imperfect device to evaluate corporate business decisions because hindsight
is 20/20.
C. Profit corresponds to risk and threat of liability would create overly cautious and conservative decisions.
D. A shareholder/investor could diversify his/her investments to protect against bad decisions in one of the
investments.
V. Commonality of all BJR Approaches:
A. Deals with the process of decision making. Court looks at the process and not the substance of the
decision.
1. Core element is whether there was a good faith effort to be informed and to exercise judgment.
VI. Common law holdings regarding the BJR:
A. [Shlensky v. Wrigley]: Judgment not to install lights at Wrigley Field. (Held: protected by BJR)
1. Under the BJR, there is a rebuttable presumption that the BOD acted in good faith and was
promoting the best interest of the corporation.
2. BJR doesn’t protect when there is evidence of:
a. Fraud
b. Illegal Conduct (Illegality)
c. Conflict of Interest (Ex. If Wrigley declared that the only thing item to be sold in the concession
stands is Wrigley’s gum. In such case, there would be a conflict as Wrigley owns Wrigley’s
gum.
B. [Joy v. North]: Argument that directors made bad decision to loan money. Held: decision not protected
by BJR because created a no-win situation. Different from Shlensky because there was a win in that
case – the park would be worth more in the long run without lights.
1. This was a derivative suit: shareholders suing on behalf of the corp. Corp. is the true π and
nominally the Δ because saying corp. should have sued the directors. Corp. not likely to sue on its
own because that decision is made by the directors.
2. Case distinguishes between outside directors and inside directors
a. Inside directors: full time employees of the corp. and have much more contact with the corp.
Arguably should be held to a higher standard.
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b. Outside directors – not full-time employees and less contact with the corp.
3. BJR doesn’t protect when:
a. Corporate decision lacks business purpose
b. Conflict of interest
c. No-win decision
d. Obvious and prolonged failure of oversight and supervision
C. Smith v. Van Gorkum: Deals with merger and shareholders complaining that not getting enough money.
Directors approved merger proposal after a 20 minute presentation by one of the directors.
1. Main thrust is that it adds another factor to Shlensky – Directors must be informed/have adequate
info to make a decision
2. BJR doesn’t protect when:
a. 3 Shlensky situations
b. Uninformed decision
i. Standard of care: gross negligence standard for determining whether informed decision
ii. Duty of directors to inform themselves of all info reasonable available.
c. Bad faith or not in the honest belief that it was in the best interests of the corporation
3. Holding: Directors not protected by BJR because they were not informed. Although DE § 141(e)
allows directors to rely on reports of others, court found that they should have been more informed
as to the basis of the report before relying on it. If would have informed themselves, then would
have learned of shoddy work to come up with the report and could not have relied on it in good faith.
4. Backlash to holding was adoption of DE § 102(b)(7) and MBCA § 2.02(b)(4), which allow for
limiting liability of director.
D. ALI BJR – decision needs to be disinterested, informed, and rational for BJR to apply
VII. There is a presumption that the judgment of the directors is in good faith and in the best interests of the
corporation. This is the business judgment rule.
MBCA Approach
I. § 8.30 Standards of care
A. The Individual directors shall act in good faith and in a manner the director reasonably believes to be in
the best interests of the corporation. [§ 8.30(a)]
B. Member of board when becoming informed in connection with their decision making function or
oversight function shall discharge their duties with the care that a person in like position would
reasonable believe appropriate under similar circumstances [§ 8.30(b)]
1. Seem to be a more relaxed standard. Seems to be more like negligence where Van Gorkum required
gross negligence.
II. When making a business judgment, a director can rely upon:
A. [§ 8.30(e)] Gives right to rely on others
1. Officers & employees that the director reasonably believes are reliable (or statements they provide)
[§ 8.30(e)(1)]
2. Experts retained by the corporation (accountants, attorneys) [§ 8.30(e)(2)]
B. A
committee that the director isn’t a member of [§ 8.30(e)(3)]
III. § 8.31 gives the standard of liability. In order for a director to be held liable, you (corporation or
shareholder) have to show:
A. The articles don’t bar liability under § 2.02(b)(4) [§ 8.31(a)(1)] AND
B. The challenged conduct was the result of:
1. Action not in good faith [§ 8.31(a)(2)(i)] OR
2. A decision either that the director didn’t reasonably believe was in the best interests of the
corporation OR that the director wasn’t informed about [§ 8.31(a)(2)(ii)] OR
3. Lack of objectivity or independence [§ 8.31(a)(2)(iii)] OR
4. Sustained failure of oversight [§ 8.31(a)(2)(iv)] OR
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5. Receipt of a financial benefit not otherwise entitled or other breach of the duty to deal fairly with the
corporation [§ 8.31(a)(2)(v)]
IV. Also, if you want to get money damages from a director, you have to show harm to the corporation or
shareholders caused by the director’s conduct [§ 8.31(b)(1)]
A. Clearly puts the burden on the π
V. Takeovers generally apply a narrower version of the BJR. Directors can’t get by with as much, partially
because the directors could lose their jobs if the takeover is successful.
Breach of Duty of Care for BOD inaction:
I. Differentiated from above cases because deals with inaction as opposed to a director’s decision that involves
taking action.
II. Barnes v. Andrews:
A. Director has a duty to keep informed in some detail of the affairs of the business – must inform self in
some particularity in the affairs of the business
B. Case famous for the proposition that a director can’t just be a figurehead.
C. In addition to showing lack of being informed, π must go further and prove causation to hold director
liable. Even if show failure to monitor, not liable unless can show causation.
1. Must show that director’s negligence caused the harm or that proper performance of the director’s
duties would have avoided the loss and what loss it would have avoided.
D. This is not management decision, therefore don’t apply BJR for failure to monitor.
E. See duty to monitor at MBCA § 8.31(a)(2)(iv)
III. In re Caremark: gives the test for being held liable for failure to act: (appropriate required level for
monitoring business) DE Standard
A. 2 types of claims can arise in this context of duty of attention
1. Director decision that was grossly negligent causes loss
a. Basically apply the BJR. Look at the process and not substance of the decision. No liability if
there was good faith effort to be informed and an exercise of judgment. No liability if rational
decision/good faith basis (duty to be informed though)
2. Not informed/failure to exercise oversight over business affairs and lower management (director
inaction)
a. Duty to monitor subordinates for wrongdoing
i. Duty to implement some monitoring/reporting system that is reasonably designed to provide
adequate info. Failure to do so can render director liable in some circumstances.
1) Only liability for sustained or systematic failure to exercise oversight establishes lack of
good faith, which makes it actionable – such as an utter failure to attempt to assure a
reasonable information and reporting system exits will establish the lack of good faith
that is a necessary condition of liability.
1. Reason for duty to monitor: more likely good faith if have monitoring system.
B. MBCA § 8.31(a)(2)(iv) is consistent with the Caremark standard
IV. McCall v. Scott
A. The failure doesn’t have to be intentional. Reckless is enough.
B. Provision in articles limited director liability
1. Allowed under MBCA § 2.02(b)(4)
a. Lists 4 situations that can’t eliminate director.
2. Allowed under DE § 102(b)(7)
a. Also has 4 exceptions to limiting liability of directors
C. Directors are not required to be experts, but are required to exercise the expertise that they do have
1. Directors are held to the level of expertise that they do possess. Can’t claim ignorance of accounting
matters if you are a CPA.
2. There is a minimum level of competence expected of all directors – not a defense to claim complete
ignorance.
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Duty of Loyalty:
I. Burdens of proof:
A. Duty of care – BOP on the π because BJR is presumption of good faith
B. Duty of loyalty – BOP of Δ. Δ must establish good faith
II. This generally comes up in 3 circumstances:
A. Director competes with corporation (didn’t spend much time on because does not arise much)
1. Regenstein v. Regenstein – some corp. directors were also directors of competing business
a. Corp. officers and directors, so long as they act in good faith toward their company and its
associates, are not precluded from engaging in a business similar to that carried on by their corp,
either on their own behalf or for another corp of which they are also directors or officers
i. So long as he violates no legal or moral duty that he owes the corp or its s’holders, an officer
or director is entirely free to engage in an independent competitive business
b. When acting in good faith, a director or officer is not precluded from engaging in distinct
enterprises of the same general class of business as the corp he is engaged in; but he may not
wrongfully use the corp’s resources nor enter into a competition business of such a nature as to
cripple or injure the corp
2. ALI Principals of Corporate Governance § 5.06 – More strict
a. Prohibits directors and senior executives from engaging in competition with the corp in order to
realize a pecuniary gain, unless there is no foreseeable harm to the corp or the competition is
authorized in advance
B. Director takes a corporate business opportunity (also applies to officers and employees)
1. Northeast Harbor Golf Club, Inc. v. Harris
a. Guth v. Loft Delaware test:
i. Opportunity presented to a corporate officer/director
1) Basically a but for test – wouldn’t have heard of the opportunity but for position as
director/officer
ii. Corporation financially able to undertake the opportunity
1) Should consider the corp.’s ability to get financing
iii. In the line of the corporation’s business and of practical advantage to it
iv. Corporation has an interest or expectancy
v. Is there an actual conflict with the corporation? Will officer/director interest be in conflict
with corp. interest? (defense that it didn’t really hurt the corporation)
1) Typically applied as a multifactor test – all factors don’t necessarily have to be present.
Very factual test.
b. Some jurisdictions classify the interest/expectancy test separate and different from line of
business test
i. Interest/Expectancy: Narrower. Requires a more tangible connection. Narrower property
approach. More approaching property interest.
1) Under the Interest or Expectancy test, a business opportunity is a Corporate Opportunity
if the corporation has a legal or equitable interest or expectancy growing out of a
preexisting right or relationship.
2) A director takes a corporation’s “interest” if she takes something to which the firm had a
contractual right.
3) An officer takes a corporation’s “expectancy” if she takes something that the corporation
could expect to receive in the ordinary course of events.
ii. Line of Business: Broader. Covers related business and potential business endeavors and
areas.
c. ALI test: Simpler test. Separated by (or’s), so only need to find one of the factors. Purports to
be more objective.
i. A corporate opportunity is one when:
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1) Officer/director becomes aware of the opportunity either:
1. (1)in connection with performance of functions as director or executive, or under
circumstances that should reasonably lead the director to believe that the person
offering the opportunity expects it to be offered to the corporation; or
2. (2) Through the use of corporate information or property, if the resulting opportunity
is one that the director/officer should reasonable be expected to believe would be of
interest to the corp. OR
2) It is an opportunity closely related to a business in which the corporation is engaged or
expects to engage in.
ii. (a) Director or senior executive may not take advantage of a corporate opportunity unless:
1) (1) First offers it to the corp and makes disclosure concerning the conflict of interest and
the corp opportunity, (automatic violation if not offered to the corp. first, whereas not
automatically a violation under Delaware test)
2) (2) Corp opportunity is rejected by the corporation, and
3) (3) Either:
1. (A) The rejection is fair to the corp,
2. (B) Opportunity is rejected in advance following disclosure by disinterest directors, or
3. (C) Rejection is authorized in advance or ratified following disclosure by
disinterested s’holders and the rejection doesn’t amount to corp waste
iii. ∆ can then defend on the basis that it was fair to the corporation
1) If approval wasn’t received in advance, fairness must be shown.
2) This is an exacting fairness standard, much more than the BJR.
C. Conflict of interest. Director has some personal interest in a corporation’s decision [DE § 144, Old
MBCA § 8.31] Not going to focus on new MBCA §§ 8.60-63 because universally held as poor
approach. DE and old MBCA very similar.
1. Delaware rule [§ 144(a)] – changes old common law making these transactions automatically void.
a. No contract or transaction between a corporation and:
i. One or more of its directors or officers OR
ii. Any other business organization in which one or more of its directors or officers are directors
or officers (competing duties of loyalty) OR
iii. Any other business organization in which one or more of its directors or officers have a
financial interest
b. Is void or voidable solely because one of these conflicts are present IF one of these occurs:
i. The facts of the relationship are disclosed or known to the board AND the disinterested
directors approve it anyway OR
ii. The facts of the relationship are disclosed to the shareholders and the transaction is approved
in good faith by them anyway OR
iii. The contract or transaction is fair to the corporation as of the time authorized.
c. To show fairness, they have to show fair dealing & fair price (entire fairness standard):
[HMG/Courtland v. Gray]
1) Two directors had buy-side interest in the transaction and only one of them disclosed this
interest. Both held liable because other knew of the other’s interest and did not disclose
it. The one who did not disclose his interest was the primary negotiator of the sale.
ii. Burden on directors to prove that it was fair
iii. Fairness only becomes a factor when there has been no disclosure
1) Fair dealing (procedures of approval)
1. Timing of transaction
2. How initiated, structured, negotiated, disclosed to the directors
3. How the approvals of the directors and stockholders were obtained
2) Fair price
1. Economic and financial considerations
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2. Court seems to be expecting the high side of fairness
a. Court seems to indicate that it has to be “very fair” to the corporation (the high
end of the range of prices that would be fair). Need to show that gave corp. a
really good deal and not just an arguable fair deal. Burden on directors to show
this.
d. Ways to avoid fairness inquiry
i. 1st disclose
ii. 2nd get approval by disinterested directors or shareholders
e. Applicability of BJR
i. If follow steps of § 144, then BJR applies to the decision. I.e. if disclose and get approval,
then ratification protected by BJR.
2. MBCA rule [Old § 8.31]
a. If a director or officer has a direct or indirect conflict with the other side of the transaction, it is a
conflict of interest transaction. [§ 8.31(a)] These aren’t voidable if:
i. Material facts disclosed to the board or committee and disinterested directors authorized or
approved the transaction OR
ii. Disclosure to the shareholders and approval OR
iii. Transaction was fair to the corporation.
3. Cookies Food Products, Inc. v. Lakes Warehouse Distributing Inc.
a. Applies Old § 8.31
b. Herrig was a Cookies’ director and principal s’holder. He also owned Lakes, which distributed
the sauce. S’holders alleged he awarded really good contracts to Lakes, which amounted to selfdealing. Also, Herrig paid himself a consulting fee.
c. Shareholder not typically not a fiduciary because don’t made management decisions.
Shareholder can typically interact with the business without conflict.
i. Exception: Majority shareholder has a fiduciary duty because of influence over the corp.
ii. Director is a fiduciary of the corp.
d. Burden of Proof
i. In duty of care cases, burden of proof is on the plaintiffs because the BJR affords directors a
presumption that their decisions are informed, made in good faith, and honestly believed by
them to be in the best interests of the corp.
ii. However, in duty of loyalty cases, the director has the burden to prove his good faith,
honesty, and fairness. Doesn’t shift like in DE.
1) In Delaware, if you get approval, the burden shifts from director to π to show violated
BJR.
e. Court finds that common law imposes a duty on director to show and additional element in
addition to § 8.31 – need to show that director acted in good faith, honesty, and fairness
i. Must show even if get approval.
ii. Delaware doesn’t necessarily require showing of good faith when get approval.
f. Self-dealing transactions must have the earmarks of arms-length transactions before a court can
find them to be fair or reasonable.
i. Corp profitability is not the sole criterion by which to test the fairness and reasonableness of
the deal
Derivative Suits:
A derivative suit is one where a shareholder is asserting the corporation’s cause of action. [MBCA § 7.40]
Thus, a shareholder is suing to vindicate a corporation’s claim. In such a case, the shareholder can be seen as
standing in the shoes of the corporation in asserting the claim.
There are 2 main types:
A. Where a director made a decision that was not in the corporation’s best interest; and
B. Where the corporation has a claim against a third party that it is not asserting through the BOD.
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II. Direct v. Derivative Suits:
A. The basic inquiry is whether there was an injury to the corporation or an injury directly to the
shareholder…
1. If the corporation was injured, such would involve a derivative suit. If a shareholder was injured
directly, such would involve a direct suit. If the corporation was injured and that injury flows to the
shareholder, such is still derivative.
a. A change in voting rights is an injury to the shareholder.
b. Violations of a director’s fiduciary duties are generally derivative claims.
c. The right to compel records/lists (i.e inspection rights) involves a direct claim.
d. The right to request a meeting is also a direct claim.
e. If the claim is that a director is trying to entrench him/herself in office, such would be a
derivative claim.
f. Tough cases are stock issuance claims…
g. If the claim is that a director is trying to entrench him/herself in office, such would be a
derivative claim.
h. Denials of preemptive rights involve individual claims.
i. The right of current shareholders to maintain their fractional ownership of a company by
buying a proportional number of shares of any future issue of common stock—MBCA §
6.30(a) and (b). Most states consider preemptive rights valid only if made explicit in a
corporation's articles—as does the MBCA in § 6.30(a).
ii. WHETHER A CLAIM IS DIRECT OR DERIVATIVE TYPICALLY DEPENDS ON THE
LIGHT IN WHICH A CLAIM IS SHED…
iii. Class actions in corporate law are reserved for direct claims!!!
III. In derivative suits, the Corporation is the Defendant because the shareholder is forcing the Corporation into
court; however, in theory the Corporation is the nominal plaintiff.
IV. It is more procedurally difficult to bring a derivative lawsuit.
A. In order to bring one, the shareholder must have standing: [MBCA § 7.41]
1. Thus, they must have been a shareholder at the time of the complained of act/omission or became a
shareholder through transfer by operation of law from one who was a shareholder at that time. (This
prevents “strike lawsuits” whereby a person learns of a wrong, buys stock, then sues derivatively);
AND
2. Fairly and adequately represents the interests of the corporation in enforcing the corporation’s right.
3. Under the MBCA, only shareholders are allowed to bring derivative suits. Even creditors and
employees are not allowed to bring them.
B. MBCA § 7.46(3) allows for fee shifting in that upon termination of the derivative proceeding the court
may order a party to pay an opposing party’s expenses if it finds certain things, such as that the motion
was not well grounded in fact or law.
C. Under NY law, a shareholder bringing a derivative suit is required to put up surety in case he/she looses
and is ordered to pay the corporation’s expenses.
D. Before a shareholder can bring a derivative suit, he/she must make written demand to the BOD to take
suitable action. Before filing suit, the demand either must be rejected or 90 days must have passed.
[MBCA § 7.42]
1. This is required to give the BOD a chance to follow the demand and take action thus avoiding
litigation.
a. The idea behind requiring demand is that typically, the decision to file a suit is one of
management, which is a function typically left to the Board.
2. There is a futility exception to the demand requirement whereby if demand would be futile, demand
will be excused. However, this exception is really only recognized in Delaware and New York.
Indeed the MBCA does not recognize the futility exception!
3. If a shareholder’s demand is refused, the refusal is subject to the BJR and thus the shareholder
probably will not be able to go forward with their suit.
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a. If a shareholder’s demand is denied, to continue, the shareholder must show that the BOD erred
in its decision not to sue on behalf of the corporation. Thus, the shareholder must allege that the
BOD violated the BJR.
b. The shareholder can show that the BOD erred in its decision by filing a complaint alleging with
particularity, facts establishing either
i. That a majority of the BOD did not consist of qualified directors at the time the
determination was made or
ii. That the BOD did not make its determination that the derivative suit would not be in the best
interest of the corporation, in good faith or after conducting a reasonable inquiry.
iii. Thus, the shareholder would have to show that the directors made their decision without any
on-the-record efforts to look like they were acting seriously or that the decision was tainted
by a conflict of interest
c. Thus, in some situations it may be better to plead futility and thus not make a demand
so as to avoid application of the BJR.
E. If a demand is rejected, the shareholder must allege either that [MBCA § 7.44(c)]:
1. A majority of the directors were not independent when the demand was rejected; OR that
2. The requirements of MBCA § 7.44(a) were not met by attacking the rejection process, for example,
that the decision was not made in good faith.
F. A shareholder need not make demand if he/she can plead that it would have been futile. In order to
show a demand would have been futile, he/she must show that a majority of the directors are either
interested or not independent as they are under the control of an interested party.
1. In DE, a shareholder must plead that:
a. A majority of directors were NOT disinterested or independent; AND that
b. The challenged transaction was NOT otherwise a product of valid exercise of business judgment.
2. In NY, you must plead one of these three:
a. That a majority of the BOD IS interested in the challenged transaction; OR
b. That the Board wasn’t fully informed about the challenged transaction to the extent reasonably
appropriate under the circumstances; OR
c. That the challenged transaction was so egregious on its face that it couldn’t have been the
product of sound business judgment.
3. In non-MBCA jurisdictions (whereby the futility exception exists), a shareholder is better off not
making a demand, because the board’s refusal to follow his/her demand is subject to the BJR. Also,
it can operate as an admission that a majority of the board is disinterested and independent.
V. The derivative suit may only continue so long as the Board is the same/still in charge.
VI. Litigation Committees in Common Law:
A. There is some question as to the independence of Special Litigation Committees…
1. Majority View: Just because special litigation committee members were appointed by fellow
directors does not disqualify them even though it is easy to see how they would want to do favors for
the (perhaps interested) directors who appointed them.
2. Thus, a majority of jurisdictions hold that special litigation committee decisions are sound.
a. Apply the BJR to their decisions.
3. Minority (Iowa) View: Courts must appoint those who serve on special litigation committees.
B. Under MBCA § 7.44(a) a corporation may file a motion to dismiss derivative litigation and a court may
grant it if a majority of the Board or of the SLC was qualified and after adequate investigation if the
qualified directors/SLC members determined that the suit would not be in the best interests of the
corporation.
C. MBCA §7.45 requires that settlements in derivative suits must be approved by a court—this is because
the settlement will likely effect many shareholders, even those who did not “bring” the suit so to speak.
D. It is always permissible for the corporation to buy an insurance policy which would pay damages or
expenses if sued in a derivative action. Public corporations are likely to have such insurance policies.
1. There are two types of insurance policies:
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a. Those where the corporation is paid/reimbursed for litigation expenses; and
b. Those where the damages are paid to the corporation if a director/“the corporation” looses.
E. Such policies require that directors act in good faith and sometimes require that a deductible be paid.
F. Indemnification: Directors can be indemnified for their liability in derivative suits and indeed MUST be
indemnified by the corporation under MBCA § 8.52 when he/she was successful on the merits.
Raising Capital:
I. Issuance of Shares:
A. Preemptive Rights [MBCA § 6.30]
1. If provided in the articles, shareholders have preemptive rights to buy shares when more are issued.
[MBCA § 6.30]. In MBCA jurisdictions, shareholders do not have preemptive rights unless such
rights are provided for in the articles of incorporation.
a. States vary—some have preemptive rights by default unless eliminated in the articles, but most
don’t.
b. Preemptive rights are really only practicable/applicable in closely held corporations.
2. A shareholder has the right to buy the % of the newly issued shares equal to his/her current
percentage of ownership. This is to keep one’s % ownership from being diluted. [MBCA §
6.30(b)(1)]
a. Just because one has preemptive rights does not mean they have to exercise them. Thus,
preemptive rights create the option to buy new shares, but do not make such a requirement.
3. MBCA § 6.30(b)(3) lists situations in which preemptive rights do not apply.
a. For example, shares which were issued within the first 6 months from the date of incorporation.
4. Shares with no voting rights do not have preemptive rights attached.
5. Even if their shares don’t have preemptive rights, a shareholder may still have a remedy for breach
of fiduciary duties or the like.
B. MBCA § 6.21 also affects preemptive rights.
1. MBCA 6.21(f): IF
a. The corporation is proposing to issue more than 20% of its issued voting stock AND
b. The shares are being issued for non-cash, THEN
c. The board has to have shareholder permission to issue the stock.
C. Questions to ask when issuing shares:
1. Are the shares authorized by the articles?
2. Are the shares issued so numerous to make MBCA § 6.21 kick in?
3. If preemptive rights exist, are the requirements of MBCA § 6.30 met?
D. [Byelick v. Vivadelli]: A majority shareholder owes minority shareholders fiduciary duties with respect
to the elimination of preemptive rights. If they approve eliminating such rights (via amending the
articles), the burden is on the majority shareholder to show:
1. Fairness to the corporation for the elimination of preemptive rights and for the sale of the shares; and
2. Fairness of the actual sale.
a. The elimination of fiduciary duties is also subject to fiduciary duties.
3. The court decided to treat Byelick’s claims as direct based on the fact that majority shareholders in a
closely-held corporation owe fiduciary duties similar to those owed in a partnership, to minority
shareholders. This is seemingly a shareholder to shareholder cause of action, which would be direct
not derivative.
E. Ways to maintain the rights of minority shareholders pre-purchase:
1. Require unanimous consent to amend the articles;
2. Shareholder agreements under § 7.32 restricting the discretion of the BOD—think McQuade;
3. Redemption option;
4. Cumulative voting;
5. Change the capital structure of the shares—make the Vivadelli’s stock preferred, so that they get
dividends, but not as much voting power.
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II. Venture capitalists often will buy a big block of shares to fund the corporation. In exchange, they get
preferred stock which allows for:
A. Dividend preference;
B. Share redemption rights;
C. Liquidation preference;
D. Sometimes control provisions;
E. Conversion rights – where the big money is at. If the company becomes successful, venture capitalists
can convert their preferred stock to common stock and sell it for a big profit. Ideally a venture capitalist
wants a corporation they’ve invested in to later “go public,” so that they can convert their preferred
stock to common stock, sell their shares to the public, and cash out.
F. Basically anything else you can assign to a class of shares under MBCA § 6.01(c).
III. Public Offering and Registration:
A. Underwriters assist in finding the money/financing a corporation needs to go public.
1. Firm Commitment Underwriting: This is the riskier of the two whereby the underwriter buys all of
the corporate shares and attempts to resell them to the public right away. There is a risk that the
underwriter will not find enough investors to resell the shares to.
2. Best Efforts: This occurs when the underwriter doesn’t buy the shares, but simply owes a duty to
make his/her best effort to find buyers for the shares.
B. Federal Approaches to Securities Regulation:
1. 1933 Securities Act:
a. § 5 requires the registration with the SEC for the sale of any security (stock/bond) through any
means of commerce. Such registration requires a lot of disclosures. The “prospectus” is the heart
of the registration statement/disclosures. One cannot issue securities until their registration is
approved by the SEC and becomes “effective.”
i. The statute has many exemptions to the registration requirement! Learn These!!!
1) There is an exemption if a company is located in one state as are all of the
investors/people and most all of the business is done within the same state.
2) If there is a small enough number of investors there is an exemption.
3) If most of the investors are venture capitalists there is an exception.
4) If the owner of a company is buying stock, there is an exemption.
ii. A company must give you a copy of its prospectus (i.e. the condensed part of its required
disclosures) if the company offers to sell stock to you.
iii. The SEC regulations do not prohibit a company from selling bad stock, they just require
adequate disclosure. Nor do the SEC regulations provide much regulation after a company
goes public.
2. 1934 Securities Exchange Act:
a. Triggered when a company goes public/makes a public offering. Requires compliance with
proxy rules. Additionally, the company must file periodic disclosure statements.
i. Rule 10b-5 is the statutory prohibition against securities fraud. There is always a common
law action for such fraud as well.
1) Rule 10b-5 applies both to those selling stock as well as to those purchasing stock!
1. This likely comes up when a buyer who has inside information as to stock—perhaps
as to the fact that the stock price is going to increase buys stock.
2) See pg. 439 in book!
3) Even if a company does not have to register with the SEC per the 1933/1934 Acts, they
still cannot commit fraud!
Corporate Salaries and Oppression – Closely Held Corporations:
I. Protection of Minority Shareholders:
A. Protect yourself – like through shareholder agreements.
B. Oppression Remedy (Statutory) – MBCA § 14.30.
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C. Breach of Fiduciary Duty – Common law.
II. In public corporations most decisions are protected by the BJR, but closely held corporations receive
somewhat different treatment.
A. Because there is no real market for the shares of a closely-held corporation, the shareholders can only
make money from dividends or by working for the corporation.
B. If a minority shareholder is being oppressed, he/she might have a cause of action to get his/her money
out through a judicially-forced buy-back.
III. [Hollis v. Hill] (adopts the Massachusetts’ view)…
A. Two 50/50 shareholders whereby Hill took many actions against Hollis that Hollis felt were
inappropriate thus suing Hill for a breach of fiduciary duty.
B. Fight between the Massachusetts Rule and the Delaware Rule…
1. Massachusetts: (Majority View)
a. The court compared a closely held corporation to a partnership, indeed terming it a defacto
partnership, and held that shareholders owe each other fiduciary duties akin to those owed by
partners in a partnership. The reason for this is that shareholder can’t get out if there is
oppression because there is no market for their shares and there is more potential for abuse of
power.
i. Liability for minority shareholder oppression as well, but typically only that of majority
shareholders.
ii. Precludes application of the BJR that would normally be present in such situations.
1) If a shareholder was sued in their capacity as a director instead of a shareholder, then the
BJR would apply.
2. Delaware View:
a. There are tools available to prevent the oppression of minority shareholders such as shareholder
agreements, therefore shareholders have a duty to protect themselves and thus, Delaware courts
do not allow causes of action for oppression as shareholders in a closely held corporation do not
owe each other fiduciary duties under Delaware law.
C. Two other Massachusetts’ Cases:
1. [Donahue]:
a. If a corporation offers to repurchase shares from one stockholder, it must offer to repurchase
from others on the same terms. If the majority shareholders are offered such benefit, then must
offer the same benefit to minority shareholders—in a closely-held corporations.
2. [Wilkes]:
a. Seemingly limits [Donahue]…
b. When firing a minority shareholder in a closely-held corporation, there must be a showing that:
i. There was a legitimate business reason for the employment decision; AND
ii. That the firing, etc. was necessary to accomplish the legitimate business purpose???
iii. The shareholder has a right to rebut such showings and to prove that the purpose could have
been accomplished without hurting the shareholder.
iv. If the majority shareholder does not make such a showing, it can be assumed that he/she
violated the fiduciary duty owed to the minority shareholder. Remember, that this is unique
to closely-held corporations.
D. Holding: Most shareholders invest in closely held corporations to become employees and get paid a
salary. Thus, terminating their employment effectively destroys the value of their investment.
1. Relief limited to instances in which a shareholder has been harmed as a shareholder.
a. Factors to Consider:
b.
c.
d.
e.
f.
Whether the corporation typically distributes its profits in the form of salaries?
Whether the shareholder-employee owns a significant percentage of the firm’s shares?
Whether the shares were received as compensation for services?
Whether the shareholder-employee expected the value of the shares to increase?
Whether the shareholder-employee has made a significant capital contribution?
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g. Whether the shareholder-employee has otherwise demonstrated a reasonable expectation that the returns
from their investment would be obtained through continued employment?
h. Whether stock ownership is a requirement of employment?
IV. [Exacto Spring Corp. v. IRS]
A. Not a minority shareholder case. The Corporation was sued by the IRS for paying its CEO too much in
salary, thus inappropriately deducting too much from its taxes as business/salary expenses.
B. An appropriate salary according to this court for the CEO:
1. The test implement compares the actual rate of return on investment with the expected rate of return
on investment by considering the financial performance of other similar companies. If the actual
return is higher than that to be expected, a higher salary is likely justified and should not be
questioned by a court.
C. Most courts will instead apply a multifactor test to attempt to determine what the CEO or corporate
employee ‘earned.’
V. [Giannotti v. Hamway]:
A. Suit to dissolve a corporation based on a statute prohibiting oppression. (The statute in question was
very similar to MBCA § 14.30). A shareholder sued the other shareholders for taking too high of a
salary for themselves.
B. Holding: The shareholder actions were found to be oppressive and the court dissolved the corporation.
C. Oppression is conduct by the corporate managers toward stockholders which departs from the standards
of fair dealing and violates the principles of fair play on which persons who entrust their funds to a
corporation are entitled to rely. Oppression does not necessarily mean fraudulent conduct.
D. Majority view: In addition to fiduciary duties of directors owed to shareholders, courts will find that
shareholders have fiduciary duties to each other in a closely held corporations. In such instances,
shareholders can sue directly rather than bringing a derivative suit on behalf of the corporation.
E. No fiduciary duties are owed between shareholders in public corporations.
VI. A more typical court remedy for oppression, is to force the majority shareholder to buy out the minority
shareholder at a reasonable price—MBCA § 14.34.
VII. MBCA § 14.30(2)(ii) provides a shareholder the right to force dissolution of the corporation if the
directors have acted oppressively.
VIII. [Zidell v. Zidell]:
A. Arnold Zidell, a minority shareholder of four related, closely held corporation sought to compel the
Board to declare a dividend. The majority shareholders consisted of Arnold’s brother and nephew.
Originally, all three worked for the company; however, after the Board decided not to increase
Arnold’s salary, he quit. The then requested that the Board declare a dividend, to which they did, but he
complained that it was too small of a dividend, particularly given the fact that Arnold’s brother and his
nephew significantly increased their own salaries after he quit.
B. The court recognized that those in control of corporate affairs have fiduciary duties of good faith and
fair dealing toward the minority shareholders. However, the court determined that in as much as the
dividend policy in question is concerned, the duty owed by his brother and nephew is discharged if the
decision is made in good faith and reflects legitimate business purposes rather than the private interests
of those in control—seemingly ? the BJR.
C. What if the test employed was the reasonable expectations test instead? Is it unreasonable for him to
expect that a dividend be given him? This might depend on the past practices of the corporation. Here,
the corporation really didn’t have a history of giving dividends.
SEE NOTES RE: DIVIDENDS!!!
Buy-Sell Agreements:
I. This is a contract between a corporation and shareholders or among shareholders
II. It doesn’t have to be in the articles
III. It can make an option or obligation to redeem (corporation) or purchase (other shareholder)
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IV. “Entity purchase” means the corporation is the buyer
V. “Cross-purchase” means other shareholders are buyers
VI. These are usually used as a protection against disability, death, or termination of employment. They are a
way to make sure you can get your money out of the corporation.
VII. § 6.27 expressly authorizes both obligations and options – governs the legal requirements
VIII. Reasons you might have a buy-sell agreement
A. Keep ownership among the existing shareholders (right of first refusal)
B. Get a minority shareholder’s money out
IX. Items to think about:
A. What are the triggering events?
1. Involuntary
a. Death
b. Retirement
c. Bankruptcy
d. Disability
e. Incompetence
f. Divorce
2. Voluntary
a. Want to sell to a third party
b. Mortgage of shares
c. Give them away
d. What if I went bankrupt and in bankruptcy proceedings, my creditors were able to get to my
shares.
B. What obligations or options are triggered?
1. Is it an obligation or option?
2. Is it to sell or buy?
3. Right of first refusal
C. At what price?
1. If a right of first refusal, you generally match the third party’s offer
2. Otherwise you have to decide how to value the shares
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