BUSINESS ASSOCIATIONS ~ FALL 2009
BUSINESS ORGANIZATION
PURPOSES

Make money for shareholders
AP Smith Mfg Co. v. Barlow


Donation to Princeton
Action was within the purposes and powers of corporation
o MBCA §§ 3.01 & 3.02
Ultra Vires: refers to actions taken by corporation or one of the officer, agents, or directors of the corporation. An
action is ultra vires (beyond the powers) if it contradicts an express or implied term in the corporation’s charter.
ACCOUNTING & FINANCIAL STATEMENTS
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Assets = Liabilities + Owner’s Equity
Balance Sheet = snapshot in time
Income statement
o Income (before tax) = Sales – COGS – Salaries - Depreciation
Cash flow statement
o Cash flow = profit after tax + depreciation - investment
AGENCY
Sole Proprietorship


Default business for a business with one owner; no legal structure
Person and business are same thing
For P and A to have a relationship of Agency, they need:
RSA § 1
1) Fiduciary relation
2) Manifestation of consent from the principal
3) Consent by the agent so to act
Agent  Acts on principal’s behalf and subject to control the principal

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Nothing in RSA says there needs to be a contract; no formality required
Relationship does not need to last for a particular amount of time
Always need evidence of mutual consent in agency relationship
Need to know on whose behalf a person is acting; are they really acting for someone else, or for himself.
There is an objective standard used to determine consent. We look to outward manifestations that might indicate
consent. Can look at words, conduct, or beginning the requested task.
Botticello v. Stefanovicz (from TWEN Supplement)

Husband and wife each have ½ interest in property. Husband sells property.
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Marital status alone does not prove agency relationship.
Court determined that there was not an agency relationship because although the wife made statements
regarding price that might constitute consent, this did not authorize husband to act.
AUTHORITY
§ 26: Authority Created: Actual authority is created by “written or spoken words or other conduct of the principal”


Express  can point to specific words
Implied  need to look to circumstances; can be based on custom or past dealings (R2d § 35)
§ 27: Apparent Authority: third party must be able to point to at least some piece of manifestation attributable to
the apparent principal.
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In order to cut-off apparent authority, P needs to tell TP that A no longer has authority.
Modes of manifestation: through intermediaries, authority by position, inaction, past transactions, job
titles, customs, advertisements, stationary, business cards
Hayes v. National Service Industries


Hayes’ attorney settles case; Hayes said attorney didn’t have the authority to do this.
Hayes is bound by settlement agreement because attorney Rogers had apparent authority.
o Hiring Rogers as the attorney is Hayes’ communication giving apparent authority.
o If principal doesn’t take steps to limit apparent authority, she may be stuck with results that she
doesn’t
LIABILITY OF PRINCIPAL TO 3rd PERSON
Contract Liability
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RSA § 140: The liability of a principal to a third party based upon a transaction by an agent flows from:
Actual authority, Apparent authority, Some other power to act on behalf of agent
RSA § 4: differentiates between a disclosed (named), partially disclosed (said I’m working for someone but
not named, and undisclosed (no information) principal
RSA § 320: if disclosed, principal is liable on contract and agent not party to contract
RSA § 321: agent becomes party to the contract if does not name the principal unless third party and
agent agree to not make the agent liable
RSA § 322: an agent becomes a party to the transaction and personally liable if he fails to disclose the
existence of a principal
Fiduciary Duties


RSA § 383: agent has a fiduciary duty to principal to act only within his consent
RSA § 385: an agent has a fiduciary duty to obey the direction of the principal even if employment
contract says principal will not give such instruction
Ratification
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If principal gives consent to transaction after entered into consent retroactively applies to the time
contract was made
Only kicks in if principal gave consent with all material and relevant facts
Makes agent free from liability for violation of fiduciary duty
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Partially Disclosed Principal: Know I’m working with an agent, but don’t know who they are acting for. Principal is
on hook for contracts made by agent; agent, however, is also on the hook.
BINDING THE PRINCIPAL IN TORT
For vicarious liability to flow to the principal, there needs to be a MASTER/SERVANT relationship. Such
relationships include: master/servant, attorney/client, employer/employee, real estate agent.
Note: A building contractor is a non-agency relationship, so no vicarious liability.
RSA § 219: Principal liable if agent is:


Subject to control of principal and is not an independent contractor AND
Within the scope of employment
§ 220(2): Criteria to distinguish servants and non-servants
o
Implies a certain level of control- namely the degree of control the principal has over physical
conduct.
§ 343: just because an agent committed a tort under authority of the principal he is not relieved of personal
liability
3 reasons for vicarious liability: enterprise liability, risk avoidance, and risk spreading.
SCOPE OF EMPLOYMENT

Vicarious liability results only if the tort occurred within the scope of employment
§ 228: 4 preconditions to determine whether something falls within the scope of employment
a)
b)
c)
d)
it is of the kind he is employed to perform;
it occurs substantially within the authorized time and space limits;
it is actuated, at least in part, by a purpose to serve the master, and
if force is intentionally used by the servant against another, the use of force is not unexpected by the
master.
Unauthorized conduct can be within the scope of employment if it is “incidental” to the conduct authorized. (As
long as the relevant conduct fits within the general guidelines of § 228).
COMING-AND-GOING IN EMPLOYMENT
Frolic: Not within scope of employment
Detour: Within scope of employment
Spencer v. VIP


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Court looked at payment to cover gas, etc., this was a special project, where accident occurred (in this
case, not on job site)
Justifications for vicarious liability:
o Employer is benefiting from employee’s actions
o Control over the employee at the time
Right of control important because employer may have been able to exercise control in a manner that
would have prevented the accident.
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o
Risk spreading – VIP can pass costs onto its customers; employee can’t pass costs on
INTENTIONAL TORTS

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The intentional nature of the tort does not preclude vicarious liability.
PURPOSE TEST: Will consider whether the tort was motivated at least in part by a desire to serve the
master.
NEGLIGENCE OF APPARENT SERVANTS
Miller v. McDonald’s
Apparent Agency

McDonald’s held 3K out to be its agent; this master-servant relationship can make McDonald’s vicariously
liable for 3k’s negligence in preparing the hamburger.
§ 267: “One who represents that another is his servant or other agent and thereby causes a third person justifiably
to 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 or other agent as if he were such.”
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Not just holding 3K out as agent, but also requires that people rely upon skill and care of 3K
Kind of makes it appear that the franchisee is an agent of McDonald’s
Defense: Sign at restaurant said it was independently owned and operated
DUTIES & OBLIGATIONS OF AGENT TO 3rd PARTIES
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If principal disclosed, agent not liable on a contract.
If principal is only partially disclosed, the agent is almost always liable on a contract.
o Ex: art dealers, land purchasers
If principal NOT disclosed, agent is liable because as far as the other party knows, the contract is with the
agent and no one else.
PARTNERSHIPS
RUPA
There are two types of rules within RUPA:
1.
2.
Default rules: can be changed by agreement among partners (express or implied, written or oral)
Mandatory rules: cannot be changed by agreement among partners; third party consent also necessary
§ 202 Partnership Elements (like § 6 in UPA):
(1) “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, whether or not the persons
intend to form a partnership.”
(2) If we intentionally form another entity via other statue or formal steps with state, they are not
partnerships.
(3) Steps to use to determine if partnership is formed.
Holmes v. Lerner

Urban Decay; Holmes claims she is a partner, Lerner disagrees. Lerner’s other venture, “& Capital” owns
94% of the interest. Holmes owns a 1% interest.
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o

Evidence that Holmes is a co-owner: working at warehouse and not being paid (expects profits
instead), participation on board (decision making structure), shared control
 Didn’t put any money into the company; this ok because not everyone is in a position to
contribute capital, but might be able to contribute something else that is of value (ideas,
work, etc.)
Court held that Holmes was a partner in the business as a result of her contributions noted above.
PROFITS/LOSSES
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Profit is not determinant of status as partner, but it can be used as evidence.
Sharing in revenues does not satisfy the profit-sharing prerequisite
o Paying of wages, debt, and rent is not profit sharing.
§ 401: Losses are shared in the same proportion profits are shared if loss sharing is not mentioned in the
partnership agreement.
Under § 401(h), a partner receives nothing beyond his share in profits- no wages, salary, or extra
compensation
PARTNERSHIP TYPES
1) Partnership at will
2) Partnership for a term
3) Partnership for a particular undertaking
a. Joint ventures might fall under this category
ESTABLISHING THE EXISTENCE OF PARTNERSHIP
Beckman v. Farmer


Evidence that Farmer was a partner: memos referring to business as partners, partnership tax returns,
bank loan or lease that was signed, some consulting and participation in decision making.
Are any of these things conclusive?
o Sharing of control is a key element that is required
o Profits presumption
Elements that Support Partnership:
1)
2)
3)
4)
5)
Control
Express Loss Sharing Agreement
Contribution
Importance of Profit Share
Parties’ own characterization of their relationship
PARTNERSHIP BY ESTOPPEL
Cheesecake Factory v. Baines
 Purported Partner Liability – RUPA § 308 (clearer explanation of rules than UPA 16)
o If representation made in public manner, § 308 says it doesn’t matter who received that
representation. Still have to believe person was represented to be a partner for liability to result.
PARTNERSHIP AGREEMENTS
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RUPA § 103: Partnership Agreement
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A partnership agreement can be written, oral, or implied;
Limits imposed:
o (a) Partner agreement will control
o (b) Exceptions: 1-10
PARTNER PROPERTY
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A partner’s contribution is valued as of the date of contribution; when the partnership dissolves, the
partner is entitled to the return of that amount of value (not necessarily the contributed property itself).
§ 203: Property acquired by partnership belongs to partnership as an entity
§ 204: Property is partnership property if acquired in the name of the partnership (either paid with
partnership assets or acquired by partners as partners) or transferred to partners in role as partners
§ 401(g) Partner may use or possess partnership property only on behalf of the partnership
§ 501 Partner not a co-owner of partnership property
o Treating partnership as entity protects partnership property. An individual’s personal creditor
cannot reach partnership assets that have no relation to business.
§ 504: If a judgment creditor applies for a charging order to be issued against a certain partner, a lien can
be placed on the partner’s assets in the partnership.
Note that 307(d) applies to claims brought against partnership. 504 regards a partner in his individual
capacity for circumstances not relating to the partnership.
MANAGEMENT/DECISION MAKING

§ 401(f): Any partner has the right to make management decisions; if there is disagreement between two
partners, default rule is that majority will decide (§ 401(j)).
o Certain decisions, however, cannot be decided by majority rule. These include fundamental
decisions and amendments to partnership agreement.
§ 301 Partners and Apparent Authority
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
Each partner is an agent of the partnership for the purpose of its business.
Under § 301, need actual authority AND third party must know or be on notice that partner lacked
authority.
Actual Authority?
Partnership bound?
YES
Yes
NO
Uncertain
Partner directly
liable w/r/t
contract?
No, unless the
partnership is
undisclosed
Yes, for breach of
warranty of
authority
Partner liable to
partnership for
damages?
No
Partner entitled to
indemnification
from partnership?
Yes
Yes
No, in most cases
Authority can be evidenced by:
1)
2)
3)
4)
5)
Business of a partnership (act was within ordinary course of business)
Person being a partner
Past transactions (apparent authority)
Scope of transaction
Partnership agreement
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§ 303: mainly used in Real Estate transactions
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(a) and (b) authorize partners and partnerships to file statements of authority (with secretary of state); if
this statement says one partner has certain power, this is binding.
If a statement says someone doesn’t have authority, however, there is no binding effect.
(d) & (e): With real property held in name of partnership, you could file copy of authority statement in
real estate records and this would also be binding.
FIDUCIARY DUTIES IN PARTNERSHIP
“Not honesty alone, but the punctilio of an honor the most sensitive, is the standard of behavior.”
- Justice Cardozo, Meinhard v. Salmon
§ 404(a): The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty
and the duty of care.
Meinhard v. Salmon
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Because Meinhard had a right to participate in the expanded lease of the Bristol property, Salmon
violated fiduciary duties when he didn’t disclose the opportunity to Meinhard.
Judge Cardozo says something across town wouldn’t implicate fiduciary duties; establishes the nexus of
relation test: must be something in relation to partnership to trigger duty
o In this case, Bristol was connected to the property, it involved the same lessor, etc.
Judge Andrews says not just a renewal of existing lease; it’s bigger than that.
Fiduciary Duty of Partner as Third Party
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§ 404(f) A partner can be a third party if they lend money or transact other business with the partnership.
§ 404(b)(2) A partner cannot be an adverse party to the partnership.
Reconciling conflict of interest between 404(b) and 404(f):

103(b) permits partners to consent to things that would otherwise be a breach of fiduciary duty. If all
partners consent to the loan by a partner, then this wouldn’t be a violation of partnership duty.
WAIVING FIDUCIARY DUTIES
Under § 103(b), the partnership agreement may not eliminate the duty of loyalty. It may, however, identify specific
types or categories of activities that do not violate the duty of loyalty OR all partners (or a # or %) may authorize or
ratify a specific act or transaction that would otherwise violate the duty of loyalty.
PARTNERSHIP LIABILITY
§ 306: All partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by
the claimant or provided law.

Under § 306(a), a partner may be held liable merely for the fact that he is a partner.
An Important Distinction:
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Joint & several: several liability allows us to pick one partner by himself and sue only him
o Much better from plaintiff’s perspective
Joint: all liable and all can be sued; this, however, requires getting jurisdiction over all partners
o Defense can be that not all required parties are brought in, which can be hard for plaintiff to
fulfill or overcome
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Contract Liability
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Under § 307(a), a partnership can be sued in its own name.
o Exceptions: partner may be forced to satisfy judgments if:
 Partnership has insufficient assets
 Partnership in bankruptcy
 Agrees to be liable
 Courts grant permission to get partner
 Liability imposed independent of partnership
Need to show that the person making the contract was an agent.
Tort Liability
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Need to show that the person committing the tort was a servant & that the tort was committed in the
course of employment.
Under § 305(a) a partnership is liable if a partner commits a tort in while acting within the scope of the
partnership business.
Individual partners can also be held liable.
RIGHTS OF 3rd PARTIES

Under § 103(b)(10), the partnership agreement may not restrict the rights of third parties.
PARTNERSHIP FINANCE

Nothing in RUPA requires the contribution of capital from partners.
Paying a Partner
401(h) says a partner is not entitled to payment for working in the form of a salary; instead, you he is paid with
profits. The only way a partner could be paid via salary is by a provision of the partnership agreement.
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If you’re being paid a salary, not great incentive to worry about profitability; it would just come out of the
business expenses.
Also remember that a partner can be paid for doing NO work – merely his role as a partner.
Profit Sharing
§ 401(b): Default rule is that partners will share profits equally in absence of partnership agreement.
Capital Accounts
§ 401(a): Each partner has an account that is:
(1) Credited equal to:
(cash contribution + property contributed – liabilities) + share of profits
(2) Charged equal to:
any value distributed + share of losses
SALE OF PARTNERSHIP INTERST TO 3rd PARTY
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§ 502: Partner’s financial interest can be sold to someone else
§ 503(a)(3): Partnership status associated with management and decision making cannot be sold or
transferred to third party. Transferee is not entitled to information.
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§ 503(d): Upon transfer, transferor retains the rights and duties of a partner other than the interest in
distributions transferred.
o Need consent from partners to admit the transferee as a partner so he has the rights that the
transferor had.
DISSOCIATION

§ 601: List of 10 things that cause a partner to be dissociated.
Wrongful Dissociation
§ 602(b): A partner’s dissociation is wrongful only if:
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
(1) breach of express provision in partnership agreement
(2) before the expiration of the term or the completion of the undertaking
Consequences of wrongful dissociation:
1) Liable to partnership and other partners for damages caused by dissociation;
2) Possibility of partnership dissolution if, within 90 days, the express will of at least ½ the partners is to
wind up the business;
3) Wrongfully dissociated partner not entitled to payout until the end of the original term unless partner
establishes he did not cause undue hardship;
4) If dissociation results in dissolution, wrongfully dissociated partner has no right to participate in winding
up.
“Switching Provision”
§ 603(a): If a partner’s dissociation results in dissolution and winding up the business, article 8 applies. Otherwise,
article 7 applies.
Dissolution/winding up  Article 8 triggered
Otherwise  Article 7 triggered
Article 7
§ 702(a): A dissociated partner’s apparent/ordinary power to bind the partnership continues up to 2 years after
dissociation if:
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
before dissociation the act would have bound the partnership under § 301; AND
at the time the third party enters transactions it is:
o less than 2 years since the dissociation;
o the other party doesn’t have notice of dissociation and reasonably believes the dissociated
partner is still a partner;
o fewer than 90 days have passed since filing statement of dissociation; and
o if real property transfer done with property in name of partnership, no certified copy of the
statement of dissociation in the recording office.
§ 703: Dissociated Partner’s Liability to other persons


Under (a), partner still liable for obligations incurred before dissociation.
Under (b), there is lingering liability to third parties for transactions entered within two years after the
partner’s dissociation, but only if:
o Partner liable for obligation under § 306 AND
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o
At the time of the transaction the other party
(1) reasonably believed the dissociated partner was a partner;
(2) did not have notice of partner’s dissociation; and
(3) is not deemed to have knowledge under 303(e) or notice under 704(c).
Buyout of Dissociated Partner
Buy-out value is the greater of liquidation (sometimes book value of assets) or value for going concern (includes
reputation). It is in the partner’s best interest to liquidate or sell for the highest value.

Buyout options are a classic thing partners should think about in their partnership agreement. § 103(b)
doesn’t prohibit the partnership from altering the buyout provisions of RUPA, which means that you can
essentially agree around § 701 of RUPA.
DISSOLUTION
§ 801: Events Causing Dissolution & Winding Up of Partnership Business
1)
2)
3)
4)
5)
6)
Partnership at will and notice to partnership
Expiration of term
Event stipulated to cause dissolution
Unlawful to continue business
Judicial determination following application of partner
Judicial determination following application of transferee that it is equitable to wind up the business.
§ 802(b): All of the partners (excluding a wrongfully dissociated partner) can waive the right to have the
partnership’s business wound-up and the partnership terminated. This requires unanimous agreement.

If the dissociating partner wants the business wound-up, 802(b) doesn’t permit the other partners to
carry-on.
Creel v. Lilly
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Creel forms partnership with Lilly & Altizer
After Creel’s death, his wife wants to wind up the business
Under RUPA, death is not a cause for dissolution. It is merely a cause for dissociation. If partner dies, look
to Article 7 and do buy-out as stipulated under § 701(b).
Other partners may continue to carry on the business.
§ 804: Partner’s Ability to Bind Partnership After Dissolution. Things that partners do in the scope of winding up
are partnership obligations and there is “lingering apparent authority.”

If a partner makes a transaction that is NOT appropriate for windup (such as buying more inventory when
it is not necessary), need to look at § 301 to see if there was authority and if dealing with past supplier
would have made the transaction seem appropriate.
§ 805: Statement of Dissolution. Can put people on notice that dissolution has occurred by filing document; not
required, but can prevent partnership from being bound to third party transactions.
§ 807: Settlement of Accounts Among Partners.


§ 807(b): If more credits than charges, you get $ from partnership. If more charges than credits, then you
would pay the partnership or take a loss in your payout.
Make sure to understand winding up of partnership accounts. Good examples in notes.
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PARTNERSHIP LOSSES
Default position of law: if you don’t agree on losses but you’ve agreed on profits, the share of losses will be applied
in the same proportion as it is with profits.


Intent of drafters of RUPA is to reject the rule of Kovacik v. Reed.
o In Kovacik, the Court held that when the party that contributed money loses money, it is not
entitled to recover any part of this loss from the party who contributed only services.
RUPA doesn’t contemplate risk of loss of services that could produce losses.
o Reason is that valuation of goods and services can be difficult. Valuing cash is easy.
Remember that Kovacik is just one way a court might determine losses. Other courts have held that someone
contributing services do have to share losses, even if they are monetary.
FIDUCIARY DUTIES & EXPULSION
Bohatch v. Butler

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The fiduciary duty that partners owe one another does not encompass a duty to remain partners or else
answer in tort damages.
If Meinhard v. Salmon requires partners to be treated fairly, does it violate that notion if we expel
Bohatch for a mistake regarding McDonald’s billing to Pennzoil?
o No violation (yes expel) argument: this was a serious accusation, firm loses respect of client
Pennzoil
o Yes violation (do not expel) argument: Bohatch was wrong (if she had been right, this would be
different), whistle-blower protection, Bohatch being retaliated against for trying to look out for
best interest of client
Can’t expel a partner for self-gain (ex: expel a partner so we can have increased profit share between
other partners)
Some courts, however, have determined that you can expel an economically unproductive partner
consistent with fiduciary duties.
PARTNER EXPULSION UNDER § 601
(3): Partner expulsion pursuant to partnership agreement
(4): Expulsion by unanimous vote of partners
(5): Expulsion by judicial determination
NOTE: If no partnership agreement, don’t necessarily have a “right” to expel a partner
FREEZE-OUT
Page v. Page



One partner cannot use relative wealth advantage to force out another partner.
Fiduciary duty can be breached by misappropriating partner’s share of the business and if fair price is not
paid for the business (at auction, for example).
o If the brother with the money underbids at auction and doesn’t pay a fair price for the business,
he is almost stealing the other brother’s share of the business.
Poorer brother can be protected in partnership agreement by:
o Adding a provision that allows the poorer brother to buy on credit; this way he might be able to
make a fair bid against the wealthier brother.
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o
Adding a “Push-Pull” provision. Here, one partner is willing to sell his interest for a fixed price,
and the other partner will either accept and buy at that price, or will have to be willing to sell at
that price.
REPRESENTING A PARTNERSHIP
If an attorney takes 3 individuals as clients to form a partnership, the attorney-client privilege now
functions so all 3 individuals know what each of the others say. There also needs to be consent in order to ensure
that there is not a conflict of interest.
LIMITED PARTERNSHIPS
Governed by RUPA and RUPLA
* RUPLA is in TWEN Supplement NOT book
2 types of partners:


General partner (at least 1)
o same rights & responsibilities as partners under RUPA; § 403 RULPA
Limited partners
o No personal liability
o Limited control/management
o Limited liability
FORMATION OF THE LP REQUIRES 2 THINGS:
1) General & Limited Partners
2) Certificate of Limited Partnership
a. Requirements for this certificate under RULPA § 201; even if some errors, as long as there is
“substantial compliance” you will be deemed an LP.
RULPA § 102: Name requirements
MANAGEMENT
RUPLA § 403(a): A general partner of a LP has the rights and powers and is subject to the restrictions of a partner
in a partnership without limited powers.
LIABILITY
RUPLA § 303(b): Limited partners are not in control of business for activities that fall under the “safe harbor”
provisions of this section.

This is an important section because “control” can often trigger liability, and limited partners are not to be
held liable under a limited partnership entity.
Zeiger v. Wilf


Trenton LP
o Trenton, Inc. is general partner to Trenton, LP
 Wilf an officer of Trenton, Inc.
 Wilf is a limited partner to Trenton, LP
Zeiger wants to sue Wilf as general partner (because he can’t get to him as a limited partner)
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


o Zeiger’s claim based on his contention that Wilf engaged in control of Trenton, Inc. and is liable.
Under 303 safe harbor provisions, however, Wilf was not in control as an officer of the corporation.
In addition to control, Zeiger has to believe that Wilf is a general partner.
o Zeiger cannot meet this requirement- he knew that Wilf was not a general partner
A key reason to structure the operation as an LP is for tax purposes.
o Partnerships don’t pay taxes, but pass taxation on to the partners.
o Corporations, however, have a double tax liability. Once by itself as a corporation and once by its
shareholders when dividends are paid.
Note: 2001 version § 306: Limited protection possibility for someone who erroneously believed he/she was a
limited partner. One choice is to fix problem and have certificate to be filed at this time; other choice is to
withdraw as a partner.

Need to recognize that if the partnership incurred a liability before the situation is remedied, there is no
protection for the person who thought he/she wasn’t a partner. See 306(b) in 2001 UPLA
TAX TREATMENT OF LPs
IRS compares corporations and partnerships in determining how to treat LPs:
1)
2)
3)
4)


Does state law give limited liability to partners? Corp (Yes); P/S (No)
Centralized management? Corp (Yes); P/S (No)
Continuity of Life? Corp (Yes); P/S (No)
Transferability of interests? Corp (Yes); P/S (No)
This reveals that corporations and partnerships are essentially polar opposites.
IRS said that if a limited partnership has 3 or more characteristics of a corporation, it would be taxed like a
corporation.
LIMITED LIABILITY COMPANY (LLC)
CHARACTERISTICS





Hybrid between partnership and corporation
Exists as legal entity, separate from its owners
Full corporate-like liability shield to protect its owners
Can be member-managed or manager-managed
ULLCA §202: Can be formed by a single person (different from partnership, which requires 2 or more)
FORMATION & DOCUMENTS


Need to file “Articles of Organization”
o Articles need to include those things listed in ULLCA § 203
The most important document in creating an LLC is the “Operating Agreement” (§ 103)
o Can opt-out of default structures via operating agreement
o This operating agreement does NOT have to be in writing; of course it is always a good idea to
put things in writing.
Operating Agreement  Controls as to OWNERS
Articles of Organization  Control as to 3rd PARTY
LLC DECISION MAKING
Business Associations – Fall 2009
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

Member management  similar to partnership
Manager management  similar to corporation or limited partnership
GOVERNANCE
§ 404



Member-managed: members have equal rights to management; matters relating to business may be
decided by a majority of the members.
Manager-managed: managers have equal rights in management; any matter may be exclusively decided
by the manager, or if one or more, by a majority of managers.
Consent by members is required for important decisions, even if we normally say managers run the
company. There are 12 matters listed.
LIABILITY
§ 201: An LLC is a legal entity distinct from its member; this makes it so members are not liable.
§ 303:
(a) Member or manager not personally liable for debt, obligation, or liability of the company solely by reason
of being or acting as a member or manager.
(b) Failure to observe formalities or requirements relating to company powers is NOT grounds for imposing
personal liability on the members or managers of the LLC.
a. No liability under “piercing theory”
(c) Permits LLC members to say they would agree to be personally liable for everything. Seems like you might
as well just form a partnership.
FIDUCIARY DUTY
§ 409(h)


Member of member-managed: members have fiduciary duties.
Member of manager-managed: no fiduciary duties.
DISTRIBUTIONS
§ 405: Distributions made in equal shares
IMPORTANT: In LLC, where nobody is personally liable, law can restrict the LLC to pay money out since this is the
money creditors would go after in the case of insolvency.
§ 806(b): Share distributions after we pay back members for contributions if we are dissolving the company.

No provision for settling losses if LLC loses money; partners don’t have to pay into a fund so all partners
are left with equal losses. This is materially different from partnership.
Selling Your Interest:


§ 501: Member’s distributional interest
o Transferable
Transferees do not automatically become members; must be consented to by remaining members.
WITHDRAWAL
Article 5 of ULLCA uses partnership ideas in response to transfers of interests or withdrawing from the LLC.
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Liberman v. Wyoming.Com LLC




Liberman (VP) was fired; he had contributed capital so he was also a member
To determine what Liberman is entitled to, they look at LLC Act, the operating agreement and articles of
organization.
o There is not a lot of case law regarding LLCs because this area is such a new part of the law. Can
also be difficult to look to other states due to differing laws.
o Courts can “rule by analogy” if something seems to parallel particular parts of partnership or
corporate law.
In many LLC statutes, may have to look to articles for opting out of default rule. Modern trend is that
operating agreement is where “opt out” provisions are located.
Liberman can recover the initial $20,000, but how any other value of his interest will be attributed was
left for remand.
Under ULLCA Articles 6, 7, & 8 are similar to those in RUPA
§ 701: Depending if at-will or term, member bought-out at FMV. If term, would have to wait to get bought out.
If an operating agreement has an express provision saying that if a member withdraws he only gets what he
contributed, a court will usually uphold this because the member consented to this term of the agreement when
he signed it.
Limited Liability Partnership
Apply RUPA rules for LLPs, except 306(a) is substituted with 306(b). Aritlce 10 of RUPA is specifically for LLPs.


Emerged in 1990s as a way for partners to protect themselves from personal liability for the malpractice
or bad deeds of other partners.
Partial shield protection: If you qualify as an LLP, partner is not liable for torts unless they commit them;
also not liable for torts of others. No liability from contract.
RUPA § 306(c) An obligation of a partnership incurred while the partnership is a LLP, whether arising in contract,
tort, or otherwise, is solely the obligation of the partnership.
LIABILITY PROTECTION
Contract v. Tort Liability

If A, as a partner in the LLP, is authorized to execute a contract on behalf of ACE, he is protected in
contract realm because he is acting as an agent of the LLP and not in an individual capacity. A must still
disclose that he is signing contract on behalf of ACE.
Capital Contribution

The partners capital contribution is not protected from creditors
Consider: With LLP option, do we still need LLCs?
What’s different about LLC?


Can have a 1 person LLC; need 2 or more people for LLP
Management
o In LLP, any partner can bind the partnership via apparent authority.
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o
o
In LLC that is manager-managed, members can bind the partnership
If we want to create an entity where certain people don’t have authority, we would want to use
an LLC. It’s a subtle difference.
Do we Need LLC if LLP came first?


If you had LLP first, there wouldn’t have been a push to create LLC
Once, however, LLC was created first (which it was), there was not a big theoretical objection to be raised
with respect to LLPs.


LLLP  protects everyone in an LP from liability, including general partners.
This was the extent of this section!
LLLP
BA Outline – Part II – START AT DIVIDENDS P. 17
CORPORATIONS
INCORPORATION PROCESS


Articles
o
o
Bylaws
o
o
o
Externally filed with Secretary of State
Trump bylaws
Internal to the business
Can cover topics including shareholder meetings, board of directors, officers, amendments
Have to conform with Articles
 § 2.06(b)
CHOICE OF LAW


Internal Affairs Doctrine
o Choice of law rule where the law of the state of incorporation governs the relationships among
the parties in the corporation.
 Includes disclosure of information, buyout rights, fiduciary duties
Feet rule: where your feet are, is where you will incorporate.
ORGANIZATION
§ 2.05: Says what to do if directors are named or unnamed
Initial meeting topics: ratification of bylaws & articles, election of officers, approve stock certificate, appoint
someone to keep minute book (paper record of board meetings)
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PRE-INCORPORATION LIABILITY
§§ 2.03 & 2.04

Defective Incorporation Defenses
o De facto corporation
 Requires: (1) Law permitting incorporation, (2) good faith attempt to organize, and (3)
exercise of corporate power.
 A de facto corporation can be challenged by the state, but not outside parties
o De jure corporation
 As to outsiders, a de jure corporation has all the attributes of a de facto corporation,
including limited liability.
 It cannot be challenged by anyone, including the state.
o Corporation by Estoppel
 Arises when the parties have dealt with each other on the assumption that a
corporation existed, even though there has been no colorable attempt to incorporate.
 Outsiders who rely on representations by said corporation are estopped from denying
corporate existence or limited liability.
Cantor v. Sunshine Greenery

Court applies de facto corporation doctrine to deny recovery to plaintiff. Brunetti (who is incorporating
SG) is off the hook for personal liability.
Roberton v. Levy

Because there was a bright line for when corporation’s existence began and Levy was aware that the
corporation is defectively organized, court won’t allow corporation by estoppel defense.
o § 2.04: if a person acting on behalf of a corporation knows that there was no incorporation, there
is liability.
Adoption/Ratification of lease or contract
An unincorporated corporation cannot conceptually ratify a lease that is entered when the corporation did not
exist. Once incorporation takes place, the corporation can adopt or ratify a lease or contract that existed prior to
incorporation.
CAPITALIZATION
§ 6.01(a): MOST IMPORTANT SECTION WHEN ADVISING CLIENT WHO IS FORMING A CORPORATION. The number
of authorized shares is set forth in articles of incorporation.
§§ 6.03 & 6.21: Board approves issuance of “issued and outstanding shares”

Board can also authorize issuance of shares for consideration consisting of any tangible or intangible
property or benefits to the corporation. (§ 6.21(b))
Classes of Shares



§ 6.01 requires authorized capital to include one or more classes of shares that are entitled to vote and
are entitled to the net assets of the corporation upon dissolution.
§ 6.01(c) says how the classes of stock may differ
Preferred stock has defined priority rights to distributions. May also have:
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o
o
o
o
o
o
Dividend priorities
Liquidation preference
Conversion rights (preferred to common)
Redemption
Cumulative dividends
“Participating” preferred shares
 Also get same dividends as common stock holders
Delaware (Traditional Legal Capital/Par Value Rules) v. MBCA




In Delaware, par value is minimum issuance price and found in Articles
o MBCA does not require par value to be set
Delaware § 153: Cannot set stock price less than par value.
o Under Delaware § 162(a), if par value is not paid and corporation has financial troubles, stock
payer can be assessed to pay the difference.
Delaware § 154: Addresses accounting for capital surplus if you charge more than par value
o Stated capital = # of shares issued x par value
o Anything in excess of stated capital is capital surplus
In Delaware, you must show par value on balance sheet
Giving an Opinion re: Stock

Make sure it is:
o Duly authorized (look at Articles)
o Validly issued and outstanding (board minutes would show approval)
o Fully paid and non-assessable (§ 6.21(d): look for evidence that corporation received
consideration from shareholders)
PIERCING THE CORPORATE VEIL
Courts likely to pierce in the following situations:








Business is a closely held corporation
Plaintiff is an involuntary (tort) creditor
Defendant is a corporate shareholder
Failure to follow corporate formalities
Commingling business assets/affairs with individual assets/affairs
Undercapitalization
Defendant actively participated in the business
Insiders deceived creditors
Dewitt Truck Brokers v. Ray Flemming Fruit Co.

Undercapitalization, not following corporate formalities contribute to piercing corporate veil
Bristol-Myers



Bristol is parent company of MEC and holds 100% of its stock
Court held Bristol liable because Bristol controlled the subsidiary’s board, annual budgets, financial
arrangements, employment policies, regulatory compliance, manufacturing quality control, and public
relations.
One factor the court considers is assumption of the risk
o Some courts will not pierce if plaintiff assumed some sort of risk and could have prevented it in
some manner.
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
Trouble here is that Bristol and MEC were not preserved as separate entities. They should have signed a
contract for services to make them more distinct.
Possible liability theories:



Direct liability
o Under § 6.22(b) a shareholder can be held liable for the acts or debts of the corporation by
reason of his own acts or conduct.
Agency
o At some level MEC seems like Bristol’s agent if ignoring corporate formalities.
Enterprise Liability
o If Bristol an enterprise, all brother and sister companies should be considered one enterprise.
 Walkovsky v. Carlton: Taxi case. This case shows that you can artificially create an entity
that doesn’t have a lot of assets and doesn’t need a lot of insurance. This makes it hard
for a plaintiff to recover a large sum or an adequate amount.
Reverse Piercing: Sometimes it might be advantageous for a party to allow piercing.
CORPORATE MANAGEMENT
§ 8.01(a) & (b)


(a) Board of directors mandatory
(b) Board duties – business and affairs of corporation are managed BY board OR UNDER the direction and
oversight of the board
o BY  closely held corporation with inside directors
o UNDER  public corporation with outside directors
Board of directors  NOT agents of the corporation. The agents are officers and their subordinates.
Board will provide management (smaller corporation) or oversight (large corporation) functions.
Logistics




# of directors in Articles or Bylaws
o § 8.03: can be fixed or a range
Meetings
o §§ 8.20 – 8.25: quorums, notice
Dissent & abstention
o § 8.24(d): Deemed to have assented unless you (1) object to entire meeting, (2) make sure
minutes reflect your abstention or voted “no”, or (3) you deliver written notice of dissent or
abstention before meeting is adjourned.
Committees:
o § 8.25: board can divide into committees
 But there are some limits on what can be delegated
Officers



Look at bylaws for provisions regarding officers
o § 8.40(c): need to designate somebody to keep minutes at meetings
Agents of the corporation; their subordinates are also agents.
Contracts involving corporate officers
o § 8.43(b): an officer can be removed at anytime without cause
o § 8.44(b): removal doesn’t affect officer’s contract rights
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SHAREHOLDER AGREEMENTS - MBCA § 7.32
Shareholder Agreements governed by MBCA § 7.32






(a) shareholders can
o Limit powers of board
o Govern distributions
o Establish/remove officers or directors
o Division of voting power
o Transfer or use of property
o Gives corporate power to shareholders
o Dissolution upon request
o Other things
(b) requirements for valid agreement
o Authorized by bylaws
o Authorized by articles
o Authorized in written agreement AND
o All shareholders consent
(c) if you sell your shares the agreement cannot be enforced against the new owner unless it can be
proven that they knew about the agreement
(d) if shares traded publically no agreements because only apply to closely held corporations
(e) if agreement limits board then those it gives the power to become liable for the decisions rather
than holding the directors liable
(f) says this cannot be held against a corporation on a piercing claim
McQuade v. Stoneham


3 shareholders agree to elect themselves as directors and then appoint themselves as officers with
specified salaries.
Court held the restrictions on directorial discretion were invalid as a matter of public policy and
invalidated the entire agreement.
o Sterilizes the board.
Villar v. Kernan


Agreement must be in writing & must comply with mechanics of statute.
o Agreement in this case fails on these grounds.
Agreement in this case also violates principles of McQuade because it prohibits hiring one of the board
members for a salary. This ties the hands of the board.
SHAREHOLDER ELECTIONS


§ 8.03 Annual director elections
§ 7.28 Counting votes, difference between straight and cumulative voting
Plurality Voting


Someone with 51% interests will outvote all other shareholders. Can basically choose all directors.
If 49% or less interest, no power to have representation in closely held corporation.
Cumulative Voting


Has to be granted in Articles
MBCA has “opt-in” provision
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Number of shares needed to elect a director = [(N x S) / (D + 1) + 1



N = number of directors shareholder wants to elect
S = number of shares voting
D = number of directors being elected
Ex: D owns 82 shares, S owns 18 = 100 total shares; 5 seats on board.
[(100 total shares x 1 wanting to elect) / (1 + 5 positions)] + 1 = 17.66 votes needed to elect one board member.


S will therefore be able to elect one board member
D can elect the remaining 4
DIRECTORS




§ 8.04 Classified Board: Election of all or a specified number of directors by holders of one or more
authorized shares. Classification with respect to voting rights.
§ 8.06 Staggered Board: Terms expire at different times. Articles provide these terms. Will need more
shares to elect directors on a staggered board.
§ 8.05 General Terms of office
§ 10.22 allows states to provide a default rule for public companies that allows shareholders to vote
AGAINST a director.
Removal of Directors


Under MBCA, directors can be removed without cause.
o In some states, however, you must have cause.
§ 8.08 Removal of Directors by Shareholders
o (c) Protects a director from being removed under cumulative voting
o (d) Notice must be given that removal is purpose of meeting
MEETINGS

§ 7.03(a)(1): shareholders can get court to order that the annual meeting be held if it has not been held.
Notice


§ 7.05(a) Time limits: no less than 10 days before and no more than 60 days before
o If you mail something, notice is deemed to be given 5 days after you put it in the mail.
§ 7.06: shareholders can waive notice
Quorum


Look at bylaws; default requires majority of shares.
o If more or less than a majority, need to put in articles.
§ 7.25(c): a motion will be approved as long as the votes in favor exceed votes not in favor.
o Can also disregard abstentions under this rule.
SHAREHOLDER VOTING


Creditors don’t have voting power. Can influence what corporation does via contractual relations and
conditions within contracts.
§ 7.28(a): Directors are voted by plurality
Record Owner/Record Date: Freeze record on some date so we can have list of shareholders.
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Beneficial owners: Investor is deemed beneficial owner even if a brokerage company holds their investments.
PROXIES


§ 7.22: Allows proxy voting; example of a common law agency relationship
o (b): To be valid, need to identify the shareholder, their agent, and have it signed. Can be in
written or electronic format.
o (c): Proxy is effective when signed proxy is received by person counting votes.
 Only lasts for 11 months
o (d): A proxy is revocable unless it states it is irrevocable.
 A later proxy will revoke an earlier proxy.
 If you revoke and corporation doesn’t know, proxy can still be used until corporation
knows.
§ 14(a) of Securities Exchange Act prohibits solicitation of proxies with respect to securities (for publicly
traded companies).
SHAREHOLDER PROPOSALS


§ 10.20(a): Shareholders can amend bylaws
§ 10.03: Directors can amend Articles; must get shareholder approval
Shareholders can vote on recommendations to the board, but these recommendations are not binding on the
board.

If you want to include a shareholder proposal in a mailing, § 14a-8 of the Securities Exchange Act requires:
o Need to hold at least $2000 worth of stock and have owned them for at least 1 year and through
date of the meeting
o Limited to 500 words
o Have to be at meeting to introduce your proposal (or have someone else do it for you)
If a company doesn’t want to include a shareholder proposal, they can submit a statement to the SEC. SEC will
then issue a “no action” letter, which is a recommendation of SEC staff that the full commission not challenge the
specific conduct.
Iroquois Brands



Shareholder wants to challenge how company is force feeding geese to make pate.
Company says proposal irrelevant because not a significant amount of their economic interest.
o Shareholder cites 14a-8(c)(5) which says, “otherwise not significantly related to the issuer’s
business”
Court holds that the meaning of ‘significantly related’ is not limited to economic significance.
Shareholder’s can’t put the following proposals in company’s proxy materials:




Proposals that are improper under state law
Shareholders telling directors what to do in course of “ordinary business decision”
Proposals that are false or misleading
Something that is already substantially implemented by the company
SHAREHOLDER INSPECTION RIGHTS

Keeps corporation accountable to shareholders
Delaware § 220(d) provides for Director inspection right
Business Associations – Fall 2009
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

Can look at stock ledger, list of stockholders and other books and records for a purpose reasonably
related to his position as a director.
Corporation has burden of proof to show inspection is improper.
Delaware § 220(b) provides for shareholder inspection



Need written demand, stating purpose of inspection and purpose must be proper
o Can then inspect corporation’s stock ledger, list of stockholders, and other books and records
Purpose has to be reasonably related to interests of stockholder.
Corporation has burden of establishing proper purpose if it refuses to permit inspection.
Kortum v. Westabo Sunroofs


Inspection for valuing shares is proper purpose.
Have to make sure records you ask for are reasonably related to the purpose you wish to inspect the
records.
Pillsbury v. Honeywell

Court says it’s improper for shareholder to seek access to records if doing it for personal political purposes
and not for the interest of the company.
MBCA Shareholder Inspection



§ 16.01: must keep records of bylaws, resolutions, articles, meeting minutes, accounting records,
shareholder registration, etc.
§ 16.02: gives shareholders access to minutes, shareholder records, accounting records
o (c): Have to show a proper purpose, what that purpose is, and how the records requested
directly connect to that purpose.
§ 16.04: can file suit if corporation denies access to records.
3 Tiers of Records under MBCA
1.
2.
3.
Things you can get anytime: 16.01(e)
Things you are entitled to if you can show proper purpose: 16.02(c)
Everything else might have to fall back on corporate common law rights of inspection.
SHAREHOLDER VOTING AGREEMENTS


§ 7.31: Keep ownership of shares and retain voting power, but agree to vote shares in a certain way.
o Combining 7.22 and 7.31 could ensure that voting agreement is carried out.
o Can give revocable or irrevocable proxy under a voting agreement.
Remedy is specific performance.
Voting Trust - § 7.30





Trustee will vote for you.
Requires:
o A writing
o Shares transferred to trustee
 This will make the transferor the beneficial owner
Limited to 10 years and must be disclosed
And shares transferred to a trustee
Then the trustee would vote the shares in accordance with the writing
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Ringling


Haley’s refused to go along with a voting agreement to vote in combination with Edith but Edith wanted a
ruling that the directors were improperly elected so their appointed officers were not valid either.
Court invalidates the improper votes.
DIRECTOR FIDUCIARY DUTIES
DUTY OF CARE
Shlensky v. Wrigley



Cubs don’t have lights at Wrigley Field; shareholder brings derivative suit
Court says it is assumed that directors are acting in good faith and in best interest of corporation unless
plaintiff can rebut the assumption by showing something illustrating:
o Fraud
o Illegality
o Conflict of interest
Plaintiff has not stated a claim alleging any of these things; court dismisses complaint.
Dodge v. Ford Motor Co.




Ford decides not to pay special dividend in order to finance a new smelting plant while paying abovemarket wages and reducing price of Ford cars.
Minority shareholders claim this was against purpose of corporation – to maximize the return to
shareholders.
o The court agreed.
Court didn’t like that Ford was putting the workers and customers ahead of shareholders.
This is a rare case where court steps in and second-guesses dividend policy.
Joy v. North


BJR doesn’t protect directors if decision has no business purpose, reflects conflict of interest, is a no win
situation, or reflects failure of oversight.
Court also recognizes that it is a voluntary decision for investors to undertake the risk of bad business
decisions.
Versions of Business Judgment Rule


Ford
Courts not to meddle in
director’s decisions (p. 128)
Might need to intervene when
changing general purpose from
serving interest of shareholders
to serving broader community
(p. 130)

Shlensky
Need to plead on fraud,
illegality, or conflict of interest
in order for director’s decisions
to be challenged
Joy
BJR won’t protect directors if:
 No business purpose
 Conflict of interest
 No win decision
 Prolonged failure of
oversight
*Corporate law favors the shareholder and shareholder profit.*
Constituency Statutes
Business Associations – Fall 2009
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

Pennsylvania
o In considering best interests of corporation, board not required to regard any corporate interest or
the interests of any other particular group affected by such action as a dominant or controlling
interest or factor.
 Extends to all decisions
Iowa
o Only applies to a director when considering offer or proposal of acquisition, merger, consolidation or
similar proposal.
 Limited to takeover decisions
Derivative Suits


Shareholders bring lawsuit on behalf of corporation; corporation at some level a nominal defendant, but a
true plaintiff.
Money awarded in derivative suits goes back to corporation
Demand Rule


Before you bring derivative suit, have to ask management of corporation to bring suit. Only if they refuse
may you proceed.
If directors are defendants:
o Clear conflict of interest; don’t want to sue themselves
o Law of demand suggests that the more obvious it is directors did something bad, the more likely the
demand or director’s decision to deny demand will not be respected.
Special Litigation Committee


Can be appointed to investigate whether lawsuit has merit.
In Joy v. North, 2nd Circuit doesn’t think we need to give deference to SLC’s recommendation.
Smith v. Van Gorkom








Merger case
CFO said $55 per share was fair for Trans Union stock although had been $37 before
Called a special meeting and Board of Directors approves merger transaction.
Court looks at fiduciary duties of directors
Under BJR, we presume directors are acting in a manner that is:
o Informed
o In good faith
o With best interest of company in mind
Plaintiffs in this case establish that directors did not act in an informed manner
o If plaintiffs can show gross negligence, BJR will not protect directors
 This is because gross negligence is the standard for being uninformed
Directors found to be not adequately informed.
o They didn’t read the merger agreement and the merger agreements were not provided prior to the
meeting.
o Also never questioned Van Gorkom’s investigation
Argument supporting directors:
o Directors can rely on other people’s reports (Delaware § 141(e))
o Can base their decision off info reported to them.
Business Associations – Fall 2009
25

This is an important case because it adds EXPECTATIONS to BJR, particularly that board members have to
be informed. The standard of gross negligence, however, is good news for directors because it’s a pretty
broad standard.
MBCA Sources of Director’s Liability
§ 8.30 Standards of Conduct:






(a) Each director to act (1) in good faith and (2) as he reasonably believes to be in the best interests of
corporation.
(b) Becoming informed requires care that a person in a like position would reasonably believe appropriate
under similar circumstances.
(c) Duty of disclosure; if you know important info concerning decision being made, you have to tell others
what you know that might be pertinent.
(d) Reliance on other people; we can assume that a person will do the job they were given
(e) Reliance on information relayed by another person; have to reasonably believe that the info is reliable
and competent
(f) Says who directors can rely on in association with (d) and (e); includes other officers or employees of
the corporation, legal counsel, CPAs, or a committee of the board of directors.
§ 8.31 Liability Standards


(a) Plaintiff must show:
o (1) inapplicability of defense AND
o (2) Challenged conduct was the result of:
 (i) not in good faith
 (ii) not informed
 (iii) director not disinterested, conflict of interest
 (iv) failure to carry out ongoing oversight OR
 (v) duty of loyalty problems
(b)(1) Plaintiff has burden of proof to show that conduct in part (a) caused harm.
Barnes v. Andrews






Company makes starters for Ford; costs end up eating all of company’s money
Barnes (receiver) claims that Andrews was not well informed and only attended 1 of 2 board meetings. No
liability for missing meetings.
Where Barnes goes wrong is MONITORING.
o Not monitoring except through corporate president = inadequate
o Failure to ask detailed questions also a problem
Degree of expertise
o Doesn’t matter if you’re an expert; just need to have proper info to make decisions
Andrews not held liable because he is not cause of harm.
o Would have to link lack of oversight to harm. Can’t be done in this case.
If a director has greater knowledge, § 8.30 will hold you to a higher standard of knowledge.
Francis


Not a defense that woman was a housewife and never participated in business.
There is a minimum level of conduct expected of directors to be informed, attend meetings, etc.
Caremark

Caremark alleged to have undertaken illegal referrals from doctors to defraud Medicare/Medicaid
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



Cause of action was failing to properly supervise and maintain employees.
Defense was that the employee supervision process was reasonable and undertaken in good faith and
they had no reason to suspect illegal conduct.
BJR not looking at substance of the decision, but rather GOOD FAITH and INFORMED PROCESS.
o Graham said there is no duty for directors to look for corporate criminal activity. As long as there
is a reasonable employee supervision and information system in place directors cannot be liable.
o Only liable for prolonged system of failure to monitor.
Caremark gives a lot of discretion to directors; sets a pretty high threshold in monitoring systems that is
favorable to directors.
McCall v. Scott



One allegation is that senior management sets growth targets at 15% to 20% (3 to 4 times) the industry
average and could not be achieved without violating Medicare/Medicaid laws and regulations.
Directors do not need to act intentionally in a failure to monitor.
o Board should have investigated the origins of profits; if they had they might have found that
criminal activity was at the root of problems.
Directors violated their duty of good faith even though they were informed and the behavior benefited
the corporation in the form of high profits.
Exculpatory Clauses, Raincoat Provisions




Only apply to prevent being sued for MONEY DAMAGES
§ 2.02(b)(4): Exculpatory clause found in the Articles of Incorporation
o Waiver of director liability in articles that limits the monetary liability of directors fro what would
otherwise be breach of fiduciary duty.
 Exceptions to which exculpatory clause DOES NOT APPLY:
 Financial benefit received
 Intentional infliction of harm on shareholders
 Violation of § 8.33 (liability for unlawful distributions)
 Intentional violation of criminal law
o MBCA shield is tighter (no bad faith opening) and the plaintiff has to prove that shield is not
applicable.
Delaware
o Certain things can’t be covered by exculpatory clause: duty of loyalty, acts or acts or omissions
not in good faith or intentional violations or knowingly violating law, restrictions on dividends,
and transactions from which director derives improper personal benefit.
o Plaintiff first has to assert that the behavior is not protected by the Business Judgment Rule.
Then it becomes the director’s burden to prove that their behavior is covered by liability shield.
BJR will not apply if:
o Directors do something that directly contradicts corporate charter
o There is no benefit to corporation (no-win) or waste of corporate assets
o Illegal conduct
DUTY OF LOYALTY
Competing with the Corporation
Jones Co. v. Frank Burke, Jr.


Plaintiffs work for defendant but thinks he is bad so start to contact clients and form new business, taking
the clients along with them.
These plans were made while plaintiffs were still fiduciaries of defendant.
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
o Fiduciary duties stop when you leave company, unless there is a covenant not to compete.
Key is not to do anything harmful to the employer during planning period. Otherwsie you breach duty of
loyalty.
Corporate Opportunity
Northeast Harbor Golf Club v. Harris





Harris president of Golf Club. While president she personally buys 2 pieces of property adjacent to golf
course.
Board sues Harris for injunction and says she violated corporate opportunity doctrine by buying land.
Most states use Guth “line of business” test. Court here does not.
Court uses § 5.05 ALI Test
o Need to meet one of the first three things:
 (b)(1)(A)  Looks at how opportunity comes to your attention; this like the PRESENTED
element in Guth.
 If we are plaintiff and can meet this element, we have established that there
was a corporate opportunity.
 OR (b)(1)(B)  If you use corporate info or property to find opportunity, this is
determinative and we can stop analysis.
 OR (b)(2)  Only applies to senior executives.
If there is a corporate opportunity and you’re a fiduciary (like Harris), you need to disclose that you want
to take the opportunity AND have the corporation reject the opportunity in order for you to take it.
Guth “line of business” test

Guth elements (not all elements have to be present):
o Business opportunity
o Present to officer/director
 Need to consider if offered to director as an individual, or as director on behalf of
corporation
o Financial ability
 Just because corporation doesn’t have capital to take opportunity doesn’t mean
corporation should be denied opportunity
o Line of business
 If opportunity is completely unrelated to what corporation is doing, fiduciary shouldn’t
get in trouble for doing this.
 Ex: In Guth, court felt that Pepsi formula was related enough to company’s
business to be within line of business test.
o Interest or expectancy
 Can exist in property ownership or things a corporation makes an effort to obtain a
property right in.
 Conflict
MBCA & Corporate Opportunity


The MBCA has nothing that defines corporate opportunity. Look to case law. Possibly § 8.70
§ 8.70: Safe-harbor provision; if the director discloses opportunity to corporation and then the
corporation rejects opportunity, director cannot be held liable.
Conflict of Interest


Focus on transactions
2 types of conflicts
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o
o

Direct: director has property/services and selling to corporation
Indirect: sitting on board of two corporations and those corporations do business with each
other; or if spouse does business with corporation
Transaction might be able to stand if director can show it was fair to corporation
HMG/Courtland Properties v. Gray






Gray & Fieber directors of a corporation selling real estate. NAF was buyer and Fieber had an interest
which he disclose but Gray, the chief negotiator, did not disclose. Gray knew but didn’t say anything
either.
BJR doesn’t apply because direct conflict of interest.
G&F have to show that their action was FAIR to the corporation.
Fairness is found in fair dealing (procedural) and fair price (substantive).
Delaware § 144 conflict of interest transactions are not voidable if parts (1), (2), or (3) are satisfied.
o Need to disclose conflict of interest AND
 (1) Get majority of disinterested directors to OK; OR
 (2) Disclose conflict to shareholders and get contract or transaction approved by
shareholders; OR
 (3) Establish that transaction is fair to corporation
If compliance with Delaware §144 and a majority of non-interested directors approve knowing of the
conflict of interest:
o The burden of proof shifts to plaintiff to show unfair
o BJR now applies and plaintiff has to negate this too
Cookies Food Products v. Lakes Warehouse Distributing





When Herring becomes majority shareholder, he has fiduciary duties and any transactions need to be
analyzed for conflict of interest.
o There is direct conflict with respect to salary
o Also conflict regarding distribution contract because he is director and owner of that corporation
There is disclosure in this case, but still need authorization from uninterested directors.
Even if disclosure, court still looks at good faith and fair dealing.
Defendant has burden of proof to show that he acted in good faith, honesty, and fairness.
Court rules in favor of Herrig.
Shareholder Derivative Suits


Direct: Suit by shareholder as an individual
o Ex: corporation declares dividends but does not pay them, compelling inspection rights, compel a
meeting of corporation when corporation refuses, transferability of shares and preemptive
rights.
Derivative: Suing on a claim the corporation has where gravamen of the complaint is injury to the
corporation. Shareholder injured indirectly.
Eisenberg v. Flying Tiger Line


This is a direct suit because shareholder’s voting rights were affected when he no longer had ownership
interest in holding company.
Eisenberg doesn’t have to post bond because this is not a derivative suit.
Derivative Suit Procedures


Corporation is both π and ∆
Courts can limit corporations to passive role in derivative litigation
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Standing Requirements
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

§ 7.41 (1): shareholder can only bring derivative suit if he/she was shareholder at time the act occurred or
became a shareholder by transfer of law from one who was an owner at the time of the act.
§ 7.41 (2): shareholder has to fairly and adequately represent the interests of the corporation.
Creditors cannot bring derivative suits; only shareholders.
Securities for Expenses


A shareholder may have to post bond for expenses of litigation if he/she doesn’t have large enough stake
in company.
§ 7.46: If π did not bring suit for proper purpose, costs and attorneys fees can be shifted to them.
Demand/Futility


Need to make demand to board to initiate suit or show why it was futile.
Futility
o Can’t overcome demand simply by naming directors as defendants.
 Law looks if there is some serious risk if majority of board will be held liable.
 If majority would be held liable, demand is excused
o MBCA – no exception to making demand.
o Delaware – π needs to raise reasonable doubt that majority of board had some conflict of
interest or that they weren’t protected by BJR.
o NY – similar to Delaware but no reasonable doubt requirement
Special Litigation Committee





Generally recommend dismissal of litigation following investigation
Courts in IA will appoint members of SLCs. Thinks these groups cannot be impartial to their peers.
In Delaware, court will review if people on SLC were truly disinterested; Corporation has BoP to show SLC
was disinterested.
§ 7.44: Allows a corporation to file a motion to dismiss derivative litigation.
o Court looks at whether qualified directors made the decision and whether an adequate
investigation occurred.
Plaintiff has BoP to prove that investigation was adequate.
Indemnification for Director Liability


§ 8.52: If derivative suit litigated to conclusion and directors defendants didn’t do anything wrong or win
on other ground (procedural flaws), directors get reimbursed.
o § 8.53 & 8.54 permit corporation to advance expenses under certain circumstances.
§ 8.51: permissive indemnification – WON’T BE TESTED ON THIS!
Settlement

§ 7.45 requires court approval if settlement is reached in derivative suit.
o Damage awards go to corporation.
Insurance

§ 8.57 permits a corporation to buy insurance against director liability
o Insurance can pay costs of litigation and sometimes even damages
RAISING CAPITAL
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Pre-emptive Rights
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

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§ 6.30(a): Look at Articles to see if pre-emptive rights exist.
o MBCA is “opt-in” – you don’t have pre-emptive rights unless articles say you do
§ 6.30(b)(1): Right to keep your ownership % the same when new shares are issued
§ 6.30 (b)(3) gives exceptions to preemptive rights
o Issued as compensation to directors
o Shared issued to be convertible or option rights for compensation of directors
o Shares issued within 6 months of incorporation
o Shares issued for non-monetary consideration
§ 6.21(f) gives a voice to shareholders on issuance of shares but only if going to dilute shareholders by
more than 20%
Public companies typically eliminate pre-emptive rights
Byelick v. Vivadelli




By amending bylaws, V’s authorized 50,000 more shares of stock and B’s ownership interest went from
10% go 1%
Under MBCA § 6.30 says preemptive rights in articles to needed to amend articles to get rid of them (not
bylaws)
Court finds this is a direct suit about fairness to B.
Majority shareholders in a closely held corporation have a fiduciary duty to minority shareholders.
Venture Capital


People pool their money to invest in the company
Usually issued preferred stock (requires creation under Articles)
o Might have option to convert preferred to common when IPO occurs.
Going Public


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
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Enlist help of a securities firm that will “agree” to take company public
File registration statement pursuant to 1933 Securities Act (go back and forth with SEC until all
requirements are met)
o § 5 of 1933 Act: Can’t sell or offer any security if you use any means of interstate commerce
UNLESS you register the security
o Registration requires:
 Registration statement
 Contains prospectus; every purchaser has to get a copy
o Penalties for not registering:
 Investor can rescind the security
Solicit offers to buy
When SEC declares registration statement effective, it is legal to sell the stock.
o Exemptions that might get around federal securities regulation:
 Amount of money raised (the more $ you raise, the greater your burden to establish
your right to exemption).
 Intrastate offerings
 Private placement offerings
 Depends on # of investors and their sophistication
Initial public offering at price agreed upon by underwriters and corporation
Underwriters buy at named price (often at a discount)
Underwriters re-sell on public trading market
Shares and traded and this triggers ongoing requirements of 1934 Securities Act
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o
o
o
o
Requires registration of stock
 Generally registers the CLASS of stock that trades
Requires continual updating of information
Can incorporate by reference earlier filings
Anti-Fraud Rules under §10b-5
 Have to have interstate commerce connection
 Buying or selling security with fraudulent means is a violation of 10b-5
 You can bring a private cause of action under 10b-5
OPPRESSION
Hollis v. Hill
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Hollis sues Hill alleging oppression.
o Hollis seems to be stuck in corporation because he can’t sell his shares or get out any other way
o Court treats this as reason to recognize fiduciary duties
 Why?
 Closely held corporation like a partnership
 Expectations of investors
o Minority holder has some expectation of return on investment via
salary or payment for employment; majority can keep this from them
 Inability to exit
o No market or ability to cause dissolution “traps” minority shareholder
 BJR/Duty of Care/Duty of Loyalty
o Insufficient protection
Without special fiduciary duties running between shareholders, Hollis will lose because nothing Hill has
done seems to overstep the line of BJR review.
Court concludes that NV would recognize that in a closely held corporation, shareholders owe each other
a fiduciary duty of good faith and fair dealing.
Wilkes: 2 part test to fire minority shareholder
o Majority must show legitimate business purpose for decision AND
o Minority shareholder must be given opportunity to demonstrate that there was a less harmful
option.
Dissent: Argues shareholders don’t owe fiduciary duties
o Nixon v. Blackman
 Jungle rule
 Have to protect yourself from the outset. If you have the tools to protect
yourself and don’t, tough luck.
 Once you’re in you’re stuck in on the terms you agreed to when you got in.
§ 14.30 and § 14.34: Statutory cause of action for oppression
Meinhard: Test for a partner’s fiduciary duty in this case is that you owe “the punctilio of an honor the most
sensitive” – the highest duty of honor.
Exacto Spring Corp. v. Comm’r of IRS


At issue in case is reasonableness of amount of CEO salary
Looking at rate of return company receives on assets
o If above normal, high salary might be justified
 This can be rebutted, however, if it is not reasonable
Giannotti v. Hamway
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



Minority owners in corporation complaining that salaries paid to majority shareholders are too high.
MBCA § 14.30 Grounds for judicial dissolution
o Statute authorizes dissolution if you can prove ANY of the 4 things under (a):
 1. Directors deadlocked
 2. Acts that are oppressive, illegal, or fraudulent
 3. Shareholders deadlocked
 Corporate assets misapplied or wasted
o Doesn’t apply to public corporations. Remedy is limited to closely held corporations.
Court puts burden on defendants to prove the reasonableness of their salaries.
o Analyze conduct that is being challenged in terms of reasonable expectation of the shareholder.
Court concludes that these salaries were not fair.
§ 14.34: Election to purchase in lieu of dissolution

If plaintiff elects to sue for dissolution under 14.30, that triggers an option to propose to buy plaintiff out
at a fair price.
DIVIDENDS

Board of directors decides whether to pay dividends.
Zidell v. Zidell



A sues E and J about level of dividends; this is a direct claim
Court looks at whether there was bad faith. Not just being fair to minority shareholder, but also making
sure the duty of good faith was not violated.
o Not just looking at process, but substance as well.
 Not just asking if rational, but if there were good reasons for keeping money in
corporation.
 To find bad faith, looking for evidence to affirmatively hurt someone like A.
“A” doesn’t establish that dividend was withheld in bad faith and loses.
Ford v. Dodge

Court found that Ford should have paid a dividend as it always had. It had a duty to shareholders, not to
employees and community at large.
Distributions to Shareholders
§ 6.40 Restriction


(c): No distribution may be made if:
o (1) the corporation would not be able to pay its debts as they become due in the normal course
of business OR
o (2) the corporation’s total assets would be less than the sum of its total liabilities plus the
amount needed if the corporation were to be dissolved and had to satisfy preferential rights of
shareholders.
This is a liquidity type test; you have to compare assets to liabilities. Also should be able to pay liabilities
as they come due.
Delaware

Legal capital jurisdiction
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

Need positive balance sheet, pay debts as they come due, but HAVE TO HAVE ENOUGH IN SURPLUS TO
PAY DIVIDEND
“Paid in” capital is basically untouchable.
Liability Consequences

§ 8.33: Directors can be liable for unlawful distributions
o Protects creditors
Share Dividends/Splits
MBCA Jurisdiction



§ 1.40(6): Definition of distribution does not include a distribution of company’s own shares. This is not a
financial transaction.
Share dividends and splits not a concern for creditors. Doesn’t change amount of capital.
Don’t have to apply legal tests for solvency.
Difference between MBCA and Legal Capital Jurisdictions

In Legal Capital Jurisdiction, have to adjust balance sheet to reflect the additional shares under stated
capital; value of state capital will also increase.
Redemption of Stock


This is a financial transaction and a distribution
Have to apply § 6.40 to see if there’s enough money to do this transaction.
TRANSFERABILITY OF SHARES
Donahue


Rodd transitioning off board and board approves redemption of 45 shares of stock. Donahue says this is a
breach of fiduciary duty majority shareholders owed her as minority shareholder.
Equal opportunity rule: if you’re going to make redemption available to majority shareholder, have to
make this same right available to all other shareholders.
Buy-Sell Agreements


Default rule: In P/S. can’t sell your status as partner – only financial rights.
In corporation, however, can sell 100% of your status
o Buy-sell agreements serve as a way to restrict transfers
MBCA § 6.27



Can put buy-sell agreement in articles, bylaws, or agreement
o If in agreement, only binds parties to agreement
o If in bylaws or articles, restricts all transfers
(b): If transferee doesn’t know about restriction, not bound by it.
o Will be bound if he has notice (could be legend on shares or stock certificate)
(c): Restrictions authorized include:
o Maintenance of corporation’s status when dependent on # or identity of shareholders (i.e. SCorp for tax purposes)
o To preserve exemptions under state or federal securities laws
o Any other reasonable purpose
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
(d): Restrictions on transfer or registration of shares may:
o Prohibit or prevent transfer to certain types of people
o Require approval of transfer
o Obligate corporation, shareholder, or others to acquire the restricted shares
o Give corporation, shareholder, or others the opportunity to acquire the shares
FUNDAMENTAL CORPORATE CHANGES




Amend articles
Dissolution
Merger
Asset Sales
Common Procedures
1.
2.
3.
4.
5.
6.
Board must approve change
Board must notify shareholders of its recommendation that change be approved
Special meeting of shareholders must be held at which they vote on deal
Vote
Appraisal
Filing
Shareholder Voting Tests



Majority of shareholder votes cast
Majority of shareholder votes present at meeting
Majority of shareholder votes that are eligible to vote
Amending Articles

Approval Requirement: § 10.03(e)
o To amend Articles - majority of shareholders present at meeting
o Out of votes cast, just need more in favor than against
Dissolution




§ 14.02: plan of dissolution required
§ 14.03: file articles of dissolution with Secretary of State
§ 14.05: Effects
o Corporation still continues in existence but only for purpose of winding up
o Winding up includes paying off creditors, then shareholders with whatever remains
Approval Requirement: § 14.02(e)
o To Dissolve - majority of shareholders present at meeting
o Out of votes cast, just need more in favor than against
Mergers



Ex: X and Y merge and X is survivor.
ADVANTAGE
o X gets all of Y intact without minority shareholders or the need for Y to transfer individual assets
or for X to assume individual liabilities.
When two corporations merge, only one will be deemed the “survivor”
o Plan of merger will say who will be survivor
o Will also have to say what Y shareholders get for their stock if X is survivor
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


Approval Requirement: § 11.04(e)
o To merge - majority of shareholders present at meeting
o Out of votes cast, just need more in favor than against
§ 11.04(g): Who votes?
o Only shareholders of corporation that doesn’t survive get to vote
o Surviving corporation’s shareholders vote ONLY IF any changes to right or dilutive share issuance.
After Articles of Merger filed, X owns everything that used to be Y’s (assets and liabilities)
Asset Sales




ADVANTAGES:
o X only buys what it wants from Y
o X doesn’t have to have shareholder vote
DISADVANTAGES:
o Y will still have to deal with any assets X did not acquire or liabilities it did not assume
o Y transfers individual assets to X (a lot of paperwork!)
Approval Requirement: § 12.02(e)
o To approve asset sales - majority of shareholders present at meeting
o Out of votes cast, just need more in favor than against
Does 20% thing apply???
Selling a Corporation




ADVANTAGES:
o Y is acquired intact, so no need for Y to transfer individual assets or assign individual liabilities
o If X buys Y as subsidiary, X is insulated from Y’s liabilities
DISADVANTAGES:
o X may not get 100% of Y stock
o Because Y acquired intact, X gets ALL liabilities of Y (as subsidiary)
If X buys Y as a subsidiary and uses X shares for consideration, this doesn’t require voting by anybody.
X shareholders would only have to vote if it X issues shares that dilute current shareholders by more than
20% by offering X shares for consideration.
Reincorporation

Can use shell corporation (X2) to change X corporation’s jurisdiction of incorporation
Appraisal Rights

§ 13.02: If shareholder disapproves of a fundamental transaction but it passes anyway, that shareholder
has an option to have corporation buy shares at value they had immediately before transaction.
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