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Business Associations
Professor Bradford
Fall 2015
Exam Answer Outline
The following answer outlines are not intended to be model answers,
nor are they intended to include every issue students discussed. They
merely attempt to identify the major issues in each question and some
of the problems or questions arising under each issue. They should
provide a pretty good idea of the kinds of things I was looking for. In
some cases, the result is unclear; the position taken by the answer
outline is not necessarily the only justifiable conclusion.
I graded each question separately. Those grades appear on your
printed exam. To determine your overall average, each question was
then weighted in accordance with the time allocated to that question.
The following distribution will give you some idea how you did in
comparison to the rest of the class:
Question 1:
Question 2:
Question 3:
Question 4:
Question 5:
Question 6:
Question 7:
Question 8:
Question 9:
Question 10:
Question 11:
Range 3-9; Average = 6.29
Range 0-8; Average = 5.07
Range 2-8; Average = 5.64
Range 3-9; Average = 7.18
Range 0-8; Average = 5.75
Range 2-9; Average = 6.00
Range 3-8; Average = 6.18
Range 0-9; Average = 7.11
Range 0-8; Average = 5.68
Range 0-9; Average = 5.00
Range 0-9; Average = 6.18
Total (of unadjusted exam scores, not final grades):
Range 3.24-7.83; Average = 6.00
All of these grades are on the usual law school scale, with 9 being an
A+ and 0 being an F.
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If you have any questions about the exam or your performance on the
exam, feel free to contact me to talk about it.
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Question 1
Hogwarts’s Liability
Hogwarts is liable on the contract only if Luna had authority to bind
it.
Luna’s status as a member of the LLC does not by itself make her an
agent of the LLC or give her authority to act on its behalf. RULLCA
§ 301(a). But the LLC can still be bound by the member’s action
under ordinary principles of agency law. See RULLCA § 301(b).
As an employee, Luna clearly was an agent of Hogwarts, but that
doesn’t answer the basic question: did she have the authority to enter
into this contract? A principal such as Hogwarts can be liable on a
contract if the agent, Luna had actual, apparent, or inherent
authority. Restatement (Second) of Agency § 140.
Luna clearly has neither actual nor inherent authority. Actual
authority is created by conduct of the principal that, reasonably
interpreted, causes the agent to believe the principal desires her so to
act. RSA § 26. Hogwarts gave Luna only the authority to receive
customer orders and pack them for shipment. No reasonable person
could interpret that to include commissioning artwork for the lobby.
Luna also has no inherent authority. Inherent authority is authority
that is inherent in the position. Ordering artwork is not inherent in
the position of fulfilling customer orders and RULLCA § 301(a)
makes it clear that no authority is inherent in being a member of an
LLC.
Apparent authority is created by conduct or words of the principal
that reasonably cause a third person to believe that the principal
consent to have the action done on its behalf. RSA § 27. Apparent
authority is created by the principal; Luna’s statement that she was
authorized cannot create authority.
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The secretary arguably indicated that Luna had authority, although
her statement (“I’m sure it’s OK”) is a little ambiguous. But, unless
the secretary herself had authority to say that on behalf of Hogwarts,
her statement is not a statement by the principal that the third party
could rely on. Granting authority is not inherent in the position of
secretary, especially with respect to a transaction of which the
secretary was unaware, and no person would reasonably rely on a
secretary’s statement of an employee’s authority.
Therefore, Hogwarts is not liable.
Luna’s Liability
If Hogwarts is somehow liable, then Luna would not be. The agent is
not bound on a contract where the principal is disclosed. RSA § 320.
Hogwarts is a disclosed principal because Alan is aware that Luna is
acting for a principal and knows the identity of the principal. RSA §
4(a).
If Hogwarts is not liable on the contract, then Luna would be liable
to Alan. When she purports to make a contract on behalf of
Hogwarts, Luna warrants that she has the power to bind Hogwarts.
RSA § 329. If Hogwarts is not bound, then Luna is liable to Alan for
breach of warranty.
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Question 2
This provision is invalid. Section 16.02 of the RMBCA grants
shareholders a right to inspect the compan y’s books and records. That
inspection right is not conditioned on approval by the board of
directors. And § 16.02(e) says that right of inspection “may not be
abolished or limited by a corporation’s articles of incorporation or
bylaws.”
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Question 3
Omega may lawfully exclude this proposal only if it falls within one
or more of the exclusions in Rule 14a-8(i), because all of the other
requirements appears to be met.
Other Requirements
Marty appears to be eligible to use Rule 14a-8 because he owns at
least $2,000 in market value of Omega’s voting securities. Rule 14a8(b)(1). The test is phrased in the alternative, so it ’s irrelevant that he
doesn’t own 1% of the stock. However, he must have held this stock
continuously for at least one year, which isn’t apparent from the
question. If not, Omega may exclude his proposal.
He is submitting only a single proposal and it’s less than 500-words,
so he meets the requirements of (c) and (d). The SEC staff has
indicated that material available at a hyperlink isn’t counted against
the limit, as long as the hyperlink itself falls within the 500 -word
limit.
Finally, the problem indicates that Marty complied with the
subsection (e) deadline set by Omega.
Possible Exclusions
(8) Director Elections
This proposal could be excluded under subsection (i)(8)(ii). It would
require existing directors to resign before their terms expire. It might
also violate (i)(8)(i) by disqualifying current nominees from election,
although it’s unclear if the amendment would apply to the current
election. It also many fall within (i)(8)(iii). The statement about the
current directors’ beliefs arguably questions “their competence . . . or
character.”
(3) Violation of Proxy Rules
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The proposal might be excludable under subsection (i)(3). The
proposal indicates that some directors believe the sun revolves around
the earth, and that’s untrue. This could be proxy fraud in violation of
Rule 14a-9, and thus a violation of the proxy rules. However,
exaggeration like this might not be materially misl eading; one could
argue that shareholders would see it for the exaggeration it is.
(2) Violation of Law
It’s possible that the proposal could be excludable under subsection
(i)(2), if there is an applicable state and federal law that prohibits
discrimination in employment because of beliefs of this type. But we
would need to know if there is any such law.
(1) Improper Under State Law
This is probably not excludable under subsection (i)(1), even though
it’s mandatory. Shareholders have the power to amend the bylaws
under Delaware law, Del. § 109, and director qualifications are the
time of process-oriented provision that the Delaware Supreme Court
says are appropriate for inclusion in the bylaws. See CA, Inc. However,
the requirement that existing directors resign my go beyond pure
procedure and intrude on the removal provisions in Del. § 141(k).
(10) Substantially Implemented
The proposal would not be excludable under subsection (i)(10), even
though Omega already has qualifications for directors, because it
doesn’t have these particular qualifications, so such a requirement has
not been substantially implemented.
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Question 4
1. Cumulative Voting. One possibility is to provide for cumulative
voting in the articles. If the corporation has cumulative voting, Larry,
with 40% of the shares, is guaranteed to be able to elect at least two
people to the board.
2. Class Voting for Directors. Another possibility is to issue two
classes of shares, identical in every respect except for voting for
directors. The articles could provide for two directors to be elected by
the class that Larry holds, with the remaining three directors either
chosen just by the class held by Curly and Moe or chosen by the
holders of both classes.
3. Voting Agreement or Voting Trust. Another possibility is to have
the three shareholders enter into a voting trust or voting agreement
that obligates the trustee (in the case of a voting trust) or the
shareholders (in the case of a voting agreement) to vote for two
directors designated by Larry each year before the election.
4. Irrevocable Proxy. Curly and Moe could give Larry an irrevocable
proxy to vote their shares. The problem with this method is that it
would allow Larry to elected not just two directors, but all of the
directors.
5. Shareholder Agreement. If they’re incorporated in a jurisdiction
that has something like MBCA § 7.32, they could enter into an
agreement providing who will be directors, in lieu of an election. See
MBCA § 7.32(a)(3).
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Question 5
The basic idea underlying Donahue—that those in control of the
corporation should not be able to use their control to take unfair
advantage of minority investors—seems right. But the cost of trying
to protect against such unfairness exceeds the benefit of having such a
rule.
First, the investors themselves have chosen the corporate form. If
they wanted partnership-like fiduciary duties, they could have formed
a partnership. Or, even if they chose a corporation, the minority
shareholder could have insisted on contractual protections against
majority abuse. Applying the enhanced fiduciary duty in cases where
a partnership was not chosen and no contractual protections were
included upsets the bargain that the parties themselves made. This is
justified by a vague assertion about what rights the minority investor
would have wanted, without any actual evidence in most cases that
the investor had such an expectation.
The Donahue rule also guts the traditional business judgment
deference that applies to corporate decision-making. The judge is
forced to decide whether the action taken was for a legitimate
business purpose or to freeze out the minority shareholder and then
must engage in difficult balancing between the needs of the business
and the interest of the shareholder in receiving a return on his or her
investment. The result is exactly what the business judgment rule
seeks to avoid: court scrutiny of every business decision and second guessing of business judgments by courts lacking expertise in
business.
The Donahue rule also results in ad hoc decision-making and
uncertainty. The standard—general ideas of “fairness” and “fair
play”—is vague and ambiguous. Even courts that agree on the
application of the Donahue test can’t agree on exactly what it requires
in particular circumstances. This makes it difficult for people running
small businesses to know in advance what’s allowed and what isn’t
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and encourages litigation by minority shareholders. This increases the
legal risks and costs incurred by small businesses.
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Question 6
A. Maximum Amount of Dividends
Under Delaware law, a corporation may pay dividends either out of
surplus or, if there is no surplus, out of the net profits for the current
and/or immediately prior fiscal year. Del. § 170(a). The second ,
nimble-dividends provision doesn’t matter because there is a surplus
and there have been no net profits either this year or in the prior year.
Beta lost money both years.
Surplus is defined as the excess of the net assets over stated capital,
and net assets is defined as “the amount by which total assets exceed
the total liabilities. Del. § 154. The stated capital is the sum of the
capital accounts for both types of shares, based on the par value for
those shares: $1,000 for common stock and $1,000 for preferred stock.
See Del. § 154. Net assets is $155,000 - $140,000 = $15,000. Thus,
surplus, is $15,000 - $2,000 = $13,000. The maximum amount of
dividends is $13,000.
B. Allocation of the Dividend
The preferred stock has a $1/share dividend preference. Thus, each
preferred shareholder must be paid $1/share before the common
shareholders receive anything. However, that preference is
cumulative, and no dividend was paid last year, so the preference is
now a total of $2 for the two years of Beta’s existence. Thus, before
any dividends are paid to the common shareholders, each preferred
shareholder must be paid $2/share, for a total of $2,000. The
preferred stock is non-participating, so that’s all they get; they don’t
share in the payments to the common shareholders.
The remaining $11,000 is split among the 2,000 common shares, so
each common shareholder would receive $ 5.50/share.
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Question 7
Delaware allows a provision in the articles like this that limits the
liability of directors for money damages. Del. § 102(b)(7). However,
there are four categories of liability that may not be limited: (1)
breaches of the duty of loyalty; (2) action not in good faith or that
involves intentional misconduct or a knowing viol ation of law; (3) a
violation of the dividend restrictions; or (4) any transaction from
which the director derives an improper personal benefit.
None of the directors has any personal interest in the decisions
concerning Gamma’s security system, so there’s no improper personal
benefit and no violation of the duty of loyalty (except possibly for the
“bad faith” part of the duty of loyalty, discussed below). This
question also does not involve a violation of the dividend restrictions.
Finally, there does not appear to be any intentional misconduct by the
directors or a violation of law.
Thus, the provision in the articles will protect the directors from
liability unless their action was not in good faith. Bad faith includes
several categories of behavior by directors. The first is conduct
“motivated by an actual intent to do harm” to the corporation. In Re
Walt Disney Company Derivative Litigation. There’s no evidence of
anything like that here. The directors were trying to save money for
the corporation, not to intentionally harm it. Bad faith also includes
an intentional violation of applicable positive law. Disney. There’s no
evidence of that here either. Nothing in the question indicat es the
company was legally bound to institute additional security
procedures.
The final element of bad faith is when the directors “intentionally fail
to act in the face of a known duty to act, demonstrating a conscious
disregard” of their duties. Disney. Here, the directors failed to
institute additional security procedures, bu t they weren’t completely
disregarding their duties. They already had security procedures in
place; they just decided that additional procedures were too costly
given the risk. That, in retrospect, was a stupid decision, but “gross
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negligence without any malevolent intent is not within the meaning
of “bad faith.” Disney.
The directors are liable only “if they knowingly and completely failed
to undertake their responsibilities,” Lyondell Chemical Co. v. Ryan, and
they haven’t done that here. They have some procedures in place and
they evaluated whether to put additional procedures in p lace and
decided not to. That, in retrospect, was a bad decision, possibly even
a grossly negligent one, but it’s not bad faith.
Since the directors are not guilty of any breach of duty that can’t be
disclaimed in the articles, they will not be liable.
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Question 8
The partnership is dissolved.
Xerxes has a right to withdraw at any time by giving written notice.
RULPA § 602. Xerxes has withdrawn, if his notice was written. He’s
liable for damages if his withdrawal breaches the partnership
agreement, id., but there’s nothing relevant in the partnership
agreement, so he has no liability as a result of his withdrawal.
The withdrawal of a general partner dissolves the partnership unle ss
there is at least one other general partner at the time and the
partnership agreement permits the business to be carrying on with the
remaining partner. RUPA § 801(4). Xerxes was the only partner, so
the exception does not apply. There’s a second exception that could
apply, however. Within 90 days of Xerxes’ withdrawal, the
partnership can continue if all partners agree in writing to continue
and to appoint a new general partner. Id. That has not happened
because Alpha did not agree to appoint Zelda as a general partner.
Since a limited partnership must have a general partner, RUPA §
101(7), the partnership is dissolved under § 801(4). (The 90 days has
now expired.)
Lotta must be wound up, with the creditors paid and assets
distributed to the partners in accordance with their allocation of
profits and distributions. RUPA § 802(a); 807(a). If the partnership
has insufficient assets to pay its creditors, Xerxes is personally liable
for the difference. Section 403(b) imposes on him the liabilities of a
partner in a general partnership and that includes personal liability
for the obligations of the partnership. RUPA § 306(a).
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Question 9
Because of her ownership of 50% of the stock of Regal, Mary clearly
has a material personal interest in the lease transaction. If she were a
corporate director, her involvement while failing to disclose that
interest would clearly breach her duty of loyalty. See, e.g.,
HMG/Courtland Properties v. Gray. Further, absent disclosure, the
approval by a disinterested person such as Chief would not protect
her if she were a corporate director. Id. Full disclosure is necessary
for approval by a disinterested body to cleanse the conflict of interest.
See Del. § 144.
However, this is not a corporation, but a manager-managed LLC. In a
manager-managed LLC, the manager owes a fiduciary duty of loyalty.
RULLCA 409((g)(1), but a member has no fiduciary duty solely by
reason of being a member. RULLCA § 409(g)(5). There is no
indication that Mary has any other relationship to the LLC, so
Mary’s interest and non-disclosure would not breach any duty of
loyalty.
However, even in a manager-managed LLC, members owe an
obligation of good faith and fair dealing. RULLCA § 409(d). That
obligation applies whenever a member is discharging any duty or
exercising any rights under the operating agreement. When Mary is
urging the LLC to rent from Regal, she is exercising her right under
the agreement to consult with Chief before major decisions. Arguing
for the Regal contract without disclosing her personal interest in the
deal might be a violation of the contractual obligation of good faith
and fair dealing. It depends on how far a court is willing to extend
this duty. Extending it to basically encompass a duty of loyalty,
however, seems inconsistent with the drafters’ rejection of such a
duty for members.
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Question 10
Before partners are paid, the partnership’s assets “must be applied to
discharge its obligations to creditors.” RUPA § 807(a). Creditors have
priority over the partners’ equity interests. Thus, $20,000 of the
remaining cash must be used to pay the debts. The remaining amount
of $80,000 is distributable to the partners.
The partners’ existing interest in the partnership is a total of $100,000
+ $20,000 + $10,000 = $130,000. Since there is only $80,000 left, that
means the partnership has suffered a loss of $50,000. That loss, like
any other partnership loss, must be charged against the partners §
807(b). See also RUPA § 401(a)(2) (losses charged to partners’
accounts).
The partnership agreement says nothing about the allocation of
losses, so the default rule applies: partners bear losses “in proportion
to the partner’s share of profits.” RUPA § 401(b). The partnership
agreement does provide for the sharing of profits, so those same
percentages will be used for losses: Able 50%; Baker 25%; and Charlie
25%.
$25,000 of the loss is subtracted from Able ’s account, leaving a
balance of $75,000. $12,500 is subtracted from Baker’s account,
leaving a balance of $7,500. And $12,500 is subtracted from Charlie ’s
account, leaving a balance of -$2,500.
Partners are entitled to a settlement of their accounts upon winding
up. If the balance in the account is negative, the partner must pay that
amount. If the balance is positive, the partner is entitled to receive
that amount. RUPA § 807(b).
Thus, Able is entitled to receive $75,000; Baker is entitled to receive
$7,500; and Charlie must pay $2,500. Once those payments are made,
the balance should be $0, and the partnership is terminated.
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Question 11
No one is liable under Rule 10b-5 for trading on material, nonpublic
information unless there is a breach of fiduciary duty. Chiarella.
Absent a breach of fiduciary duty, trading on nonpublic information
does not constitute fraud. But any duty of confidentiality is sufficient;
it does not necessarily have to be to the company whose stock is
traded. O’Hagan.
Debra clearly owes no fiduciary duty to Magna or SlowCopy. She has
absolutely no relationship with either of those companies.
Debra also owes no duty of confidentiality to Larry. She did not
promise to keep the information secret and there ’s no evidence of a
history of sharing confidences between the two of them so neither
Rule 10b5-2(b)(1) or (b)(2) apply. She’s not a family member of Larry,
so Rule 10b5-2(b)(3) also does not apply.
She might, however, be liable as a tippee of Larry. Larry, as an
employee of SlowCopy, owes it a fiduciary duty. In addition, because
of SlowCopy’s contractual relationship with Magna and its promise
of confidentiality, SlowCopy is a temporary insider as defined in fn.
14 of Dirks. Because of that, SlowCopy and Larry owe a duty of
confidentiality directly to Magna.
Dirks says that a tippee can be liable if two requirements are met: (1)
the tipper breached a fiduciary duty; and (2) the tippee knew or
should have known that the tipper was breaching a fiduciary duty.
A tipper such as Larry breaches a fiduciary duty within the meaning
of Dirks only if he provides the information for personal gain. Larry
received no direct gain of any kind in providing the information to
Debra. However, Dirks says that a gift of confidential information to a
friend or family member can be a personal gain. Larry gave the
information to Debra as a favor to her dad, his long-time friend.
Although Larry didn’t intend for the father to trade on that
information, he did intend to provide a benefit to him. That may be
sufficient under Dirks.
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The second requirement is that Debra must know or should have
known of the breach of duty. Debra knew that Larry ’s information
was nonpublic and came from Magna. She also knew that Larry was
not supposed to disclose the information. However, to know that
Larry breached a duty in the Dirks sense, she must also know that he
did it for personal gain. Assuming that the gift to the father is
sufficient personal gain, that requirement is probably met because
Larry told her exactly why he was giving her the infor mation.