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a. The organization of businesses
i. Choices made in organizing business reveals different legal consequences
1. Law plays a significant role in organization
2. Historical development plays a significant role in organization
3. Clients play a significant role in organization
ii. Goals of business
1. Maximize operational efficiency of business
2. Minimize risks to investors
iii. Limited Liability v. Personal Liability
1. Limited liability: investor risks ONLY the assets that the investor agreed to invest
in the business
2. Personal Liability: investor risks assets personal assets BEYOND those agreed to
iv. Third Party Creditor Reliance
1. INVESTORS: Absent notice to the contrary, one who deals with an individual in a
business capacity can assume that the person stands by the business/product etc.
and will defend against a claim (liable for wrongs against a third party)
a. Investors exercising control over the business raises a reasonable
expectation in a third party that the investor will be personally liable
b. To avoid personal liability
i. Provide NOTICE
1. Notice cuts off 3rd party creditor reliance BUT
2. Notice costs money AND
ii. Refrain from exercising control over the operations of the business
2. MANAGERS: Vicarious Liability
a. Liability on one party (manager) for wrongs committed by another (employee)
i. Independent Contractors
1. Manager is not liable for the torts of an independent
contractor BUT manager can exercise NO control over the
independent contractor
a. Exception to liability for torts: Manager will be held
liable for torts of the independent contractor if IC is
engaged in inherently dangerous activities (strict
liability theory)
ii. Nonservant Agents
1. Manager is liable for CONTRACTS entered into within the
scope of the nonservant agent's employment BUT not liable
for torts outside of the scope of authority granted to the
nonservant agent (ex: frolicking)
b. Government's Impact on Business Organization
i. Government regulates business to protect consumers and investors
ii. Regulation is a business expense
1. Regulation effects the initial costs of business
a. Permit applications
b. Pro Forma Registration
c. Franchise fees
d. Certificate of Public Convenience (Utility Companies)
2. Ongoing Business Requirements
a. Inspections
b. Accreditation for schools
c. Securities
3. Changes in laws regulating liability
a. Federal securities law
b. Child advertisement prohibitions
c. Discrimination laws
a. The single most important consideration when organizing a business.
i. Double Bite Example
1. C-Corporations' Revenues are taxed AND
2. When revenues dispersed as dividends, the dividends are also
ii. Sole Proprietorship avoids double bite
b. Avoiding tax liability: EXAMPLES
i. Zeroing Out: Once revenues enter the corporation, distribute all
revenues to SALARY payments rather than dividends
1. Problems: Only Employees get salaries (Investors who are not
employees get nothing) AND the IRS can step in and require
a double bite
ii. Capital Gains
1. Allow revenues to be dispersed as stock rather than
dividends per year to reduce the tax rate
iii. Basic Business Deductions to limit tax liability
iv. Conduit Taxation
1. Allow losses to pass through to investors
c. Case law
i. Fowler v. Penn Tire: dispute over ownership of tires—Penn Tire claims they have ownership
over the tires; creditors of Fowler claim Fowler had ownership and thus the value of the
tires are subject to liquidation and disbursement to creditors
ii. Possible Business organizations
1. Simple sales contract
a. Fowler pays capital up front
b. Title passes to Fowler
c. Penn Tire would not be liable because Fowler is an independent contractor
d. Risks v. Benefit
i. Low control over resale of Penn Tires BUT no liability
2. Consignment
a. Fowler pays no capital up front
b. Fowler gets no title, but only possession
c. Risk v. Benefit
i. Penn Tire risks being labeled as giving Fowler a loan
ii. IF Penn Tire insures the product rather than Fowler, a MORAL
1. Economic agent does not have to bear consequences of their
own conduct because another has insurance
3. Company-owned Retail Outlet
a. Risk v. Benefit
i. Reduce the risk that an outside retailer will not properly sell the
ii. Long term contract risks opportunistic behavior (exclusive dealing
1. Bargaining with a guile—not disclosing true intentions
(Texaco Example)
iii. Held: on the basis of the 4-corners of the agreement, the tires were under consignment—
Penn Tire had no control over the tires according to the agreement.
iv. Dissent: on the basis of the conduct and course of dealings, Penn Tire had actual control and
therefore the tires were a simple sale

1. IF Consent or agreement
a. Agreement may be expressed or implied under § 26
i. Facts, circumstances, course of conduct and course of dealing
2. That agent acts on behalf of the principal AND
3. That the agent is controlled by the principal
ii. LEGAL CONSEQUENCES: fiduciary duties exist
1. As a matter of law
a. The agent ALWAYS owes fiduciary duties to the principle
2. As a matter of fact
a. The principal will owe fiduciary duties to the agent
i. Definition of a Fiduciary
1. The beneficiary
2. Reposes trust and confidence in the fiduciary
3. Under facts and circumstances such that the fiduciary
4. In equity and good faith
5. Must act with highest regard to the interest of the
3. Principal will be vicariously liable for the agent's act within the agent's scope of
a. Scope of authority is a fact intensive analysis
4. Agency relationship does not require consideration
5. Agent CANNOT create any authority
6. Control and the Liability of Creditors—Jenson Farms v. Cargill—Warren stored 90%
of Cargill's grain, and Cargill also gave Warren lines of credit subject to information
and reports by Warren to Cargill. Cargill is sued as principal for Warren's default
on other loans. Cargill was liable as principal:
a. Creditor Liability (Balancing Test)
i. Avoid liability by
1. Insisting on receiving information and reports
2. Providing business advice and counseling on discrete matter,
not entire business plans
3. Recommend consultants
ii. Liability imposed on creditor IF
1. Veto power over important decisions

2. Coercing debtor to put person designated by creditor to
control operations
3. Provide other creditors with assurance of payment
7. Employee v. Independent Contractor—Humble Oil v. Martin—Humble Oil liable as
principal for acts committed at service station by manager: manager was "employee"
not independent contractor—Humble bore all the risk of loss, required a % of all
sales, could terminate all employees at will, and set employees hours. Hoover v.
Sunoco—Sunoco NOT liable as principle for act committed at service station:
manager was "independent contractor" not employee—Local manager bore all risk of
loss, Sunoco only required a set minimum and maximum % of sales for use of Sunoco
products and both Sunoco and manager could terminate relationship after 30 days
a. Factors the court in both cases considered
i. Residual return—leftovers after all expenses paid
ii. Who bears risk of loss
iii. Rent
iv. Termination
v. Employee salaries set by principal or agent
vi. Utility payments
vii. Employee hours
viii. Threat of Termination
b. Humble—agent was not acting on behalf of Humble because agent was not
selling oil but servicing a car
c. Sunoco—agent was acting on behalf of Sunoco because he was selling gas
i. Work-For-Hire Doctrine: Agent may be acting as Independent
Contractor, employee, or nonservant agent at DIFFERENT times
during the alleged agency relationship
iii. Agents
1. General Agent § 3(1) Restatement of Agency
a. Series of transactions
b. Involving a continuity of service
c. Broader scope of authority
2. Special Agent § 3(2) Restatement of Agency
a. Single transaction OR
b. Series of transactions NOT
c. Involving a continuity of service
d. Narrower scope of authority
iv. Express Actual Authority § 26
1. Written or spoken words by principal to agent creating agent's authority
v. Implied Actual Authority § 26
1. Conduct of the principal
2. Reasonably interpreted
3. Causes agent to believe that P consents to A acting on his behalf
vi. Incidental Authority § 35 (necessary and proper)
1. Unless otherwise agreed
2. Authority to conduct a transaction INCLUDES authority to do other acts
a. Incidental to
b. Usually accompanied by OR
c. Reasonably necessary
3. To accomplish the original transaction
i. Outward manifestations by a principal to a third party
1. Direct: Restatement § 27
a. Written or spoken words from principal to a third person
2. Indirect: Restatement § 27
a. Any conduct of the Principal
b. Reasonably interpreted
c. Caused the third party to believe that the principal consents to having the
agent act on his behalf
3. Power of Position (Indirect)
a. IF Principal puts the agent into OR
b. Knowingly permits the agent to occupy
c. A position of power
d. THEN the third party who deals with the agent in that position
e. Is justified in inferring that the agent has the power of that position
f. ABSENT notice to the contrary
ii. Lind v. Schenley—Chain of command: Brown (CEO of T&P); Herfeldt (VP); Kaufman
(Supervisor); Lind (employee Π ). By letter, VP tells Lind that supervisor will give him a new
salary increase by 1%. Supervisor was in a position to administer new salaries. Lind never
gets salary and sued T&P. T&P argue that Kaufman had no power to give new salary. Lind
argues that Kaufman had apparent authority to increase salary.
1. Manifestations:
a. Direct: letter from VP to Π that Kaufman would give new salary to Π
b. Indirect (Power of position): Company put Kaufman in a position where Π
could justifiably presume that Kaufman could administer new salaries
iii. 370 Leasing—370 owned and operated solely by Joyce; tells Kays (friend and employee of
Ampex) to set up deal to buy computers; Kays tells boss about deal; boss tells Kays to draft
documents; Joyce, Kays, and boss meet; Joyce writes to boss and says he'll only deal with
Kays; Ampex backs out. Held: apparent authority established

1. Power of agent to bind the principal

2. Not derived from authority
3. Emanates solely from the agency relationship
4. Solely for the protection of persons dealing with agents
a. Strangers to the transaction
i. Persons who do not reasonably anticipate transaction costs
ii. Generally, tort victims
ii. Transactions where principal will be liable
1. All transactions for which the agency relationship was created
2. Other transactions that are foreseeable
iii. Transaction where principal will NOT be liable
1. Transactions that are NOT foreseeable
a. Transactions that are criminal
iv. If principal's transaction costs can be reasonably overcome, start with number 1. It is fair
to pay transaction costs for transactions that the agency relationship was created
v. If principal's transaction costs cannot reasonably be overcome, go with number 2. It is fair
to pay transaction costs for transactions that are foreseeable from the agency relationship
vi. Status of Principals Restatement of Agency § 4
1. Undisclosed Principal
a. Parties do not know that the principal exists
2. Partially Disclosed Principal
a. Parties know the principal exists, but do NOT know the identity of the
3. Disclosed Principal
a. Parties know that a principal exists AND the identity of the principal
4. Status of the principal controls the extent to which the agent will be liable
vii. Watteau—Brewers owned a store formally owned by Humble. Brewers gave Humble no
power to order cigars and non-alcoholic beer but power to order alcoholic beer and other
items. Π suppliers go to Humble and Humble orders cigars and non-alcoholic beer. Humble
defaults on the money and Π sues the brewers. There was no actual agency between
Brewers and Humble regarding the cigars and non-alcoholic beer because it was prohibited.
No apparent authority because the Brewers made no manifestation to the Π s nor did the
Brewers put Humble in a power of position (told Humble that he was unable to transact for
cigars etc.). BUT
1. Since suppliers could not reasonably find out to contact the principal AND
2. There was no notice otherwise AND
3. It would be unreasonable to contract in advance to avoid transaction costs,
4. The Brewers should be liable because Humble's transaction was reasonably
foreseeable to the Brewers via their relationship with Humble
i. Last resort to show liability by agency relationship
1. Elements
a. Principal is subject to liability to persons
b. Who have changed their position
c. Based on a belief that a transaction was entered into on behalf of the
principal IF
i. P intentionally or recklessly caused such belief
ii. P knowing such belief might change their position because of it AND
P did not reasonably notify the parties
i. Where agent enters into transaction outside of his or her scope of authority BUT
ii. Principal wishes to ratify for
1. Reputation OR
2. Because the agent made a good deal
iii. TEST to ratify:
1. Contract or act must have been valid if the agent would have had authority
2. Principal exists and is legally competent to ratify
3. Contract or act must be executed or performed on behalf of the principal
4. Ratification must be executed the same way as if done rightfully in the first
instance AND
5. Principal must have knowledge of all material facts

1. Trademark License
2. Franchisee must pay a royalty to Franchisor
3. Franchisor provides management assistance to franchisee
ii. General Rules
1. Contractual standard by itself DOES NOT equal CONTROL over the franchisee to
establish an agency relationship UNLESS
2. Standards go beyond the articulated goals and leave NO discretion to the
franchisee (agent)
a. Franchisor exercises RIGHT of control BUT
3. Mere power of termination in and of itself is NOT enough to allege an agency
i. Parties CANNOT contract around fiduciary duties
1. Once agency is established, agent owes principal fiduciary duties as a matter of law
2. Once agency is established, principal owes duty fiduciary duties as a matter of fact
(see above)
a. Examples
i. Principal assures safe working environment
b. For NONSERVANT agents, it is less likely that the principal will owe
fiduciary duties as a matter of fact
ii. Clauses used to Identify Agent's fiduciary duty to principal
1. Covenant not to compete
2. Solicitation of customers and employees
3. Trailer clauses
a. Anything thought up during employment belongs to the employer after
employee leaves
4. Confidentiality
5. Trade Secret Agreements
iii. Fiduciary Duties of Agent to Principal: Restatement §§ 379-396
a. Unless otherwise agreed, agent owes duty to act with the standard care and
skill in that line of work AND to exercise any special skill the agent has
a. Unless otherwise agreed, agent acts solely for the benefit of the principal
a. Unless otherwise agreed, agent must disgorge to the principal all profits
made on behalf of the principal
a. Unless otherwise agreed, agent cannot deal with principal as an adverse
party in a transaction connected with the agency without the principal's
a. Where principal knowingly deals with agent, agent must deal fairly with the
principal and disclose ALL facts reasonably affect the principal's judgment
UNLESS Principal manifests that he knows of the facts OR does not care to
know the facts
a. Unless otherwise agreed, agent cannot act on behalf of an adverse party in a
transaction connected with his agency without the principal's knowledge
a. Where agent acts for two principals AND both know of such action, agent
must act with fairness to each and disclose all facts that would affect each
principal's judgment UNLESS they manifest that they know the facts or
don't care to know the facts.
a. Unless otherwise agreed, an agent cannot compete with the principal
concerning the subject matter of the agency
a. Unless otherwise agreed, agent cannot act for anyone with interests
conflicting with the principal's for matter which the agent is employed
a. Unless otherwise agreed, agent cannot use or communicate confidential
information given to him by the principal, acquired during the course of the
a. Unless otherwise agreed, after termination, agent does not have duty not to
compete with principal BUT
i. Has a duty to the principal not to disclose trade secrets or
otherwise confidential information if competing with principal
ii. Has a duty to account for all profits made by sale or use of trade
secrets AND
iii. Has a duty not to take advantage of confidential relation created
during agency relationship
iv. Case law
1. Automotive—Singer, as agent, dealt with outside business and did NOT disgorge
profits to principal
a. Opportunity of outside source should have been disclosed to principal
b. Profits, secrets from outside business should have been disgorged
c. IF agent would have disclosed outside business opportunity to principal AND
principal would decline the opportunity, agent MAY have had the opportunity
to pursue the business himself
i. Must allow the principal to decline the opportunity first
d. EVEN IF no harm to the principal, the agent MUST disclose
2. Bancroft-Whitney—agent failed to disclose information when asked directly and
failed to disclose relevant information. Agent was serving two employers at one
a. Once principal questions agent about information, agent MUST disclose
b. Agent must disclose all relevant information although not ALL information
3. Town and Country—agent took customer list from principal
a. Customer list is a trade secret if it cannot be made public
b. Trade secrets: FACTORS
i. Extent to which the information is known outside of one's business
ii. Extent to which info is known by employees and others in one's
iii. Extent of measures taken to keep info secret
iv. Value of the information to business and competitors
v. Amount of effort and money spent developing info AND
vi. Ease or difficulty with which information could be acquired or
duplicated by others
1. Examples:
a. Expiration dates of insurance policy lists

a. Introductory Materials
i. Partnerships are generally attractive because of the tax benefits involved BUT
ii. Disfavored because of personal liability
1. Too much control over day-to-day operations leads to personal liability
iii. Partnerships are mutual agencies: each partner is an agent to the other partner
iv. Partnership Study
1. Principles involve hybrids of corporations and partnerships
2. MUST learn to avoid defaulting into a partnership to avoid personal liability
b. UPA § 6: Elements of Partnership
i. Association of two or more "persons"
1. "Persons" can be individuals, partnerships, corporations, or other associations
ii. Who Carry on as co-owners
iii. A "business" for profit
1. Business can be every trade, occupation, or profession
iv. Prima facie showing of partnership
1. Sharing of profits by two or more persons creates rebuttable presumption of
v. Rebutting the existence of a partnership: UPA § 7
1. § 7(2): common interest in land by itself is not sufficient to establish a partnership
2. § 7(3): sharing gross revenues without sharing residual is not sufficient to establish
a partnership
3. § 7(4) where one shares profits, it is prima facie evidence that he is a partner
UNLESS the profits were received:
a. § 7(4)(a): As payment for a debt or line of credit
b. § 7(4)(b): As wages to an employee or rent to a landlord
c. § 7(4)(c): As payment for annuity to a widow of a deceased partner
d. § 7(4)(d): As interest on a loan
e. § 7(4)(e): As payment for the sale of the "good will" of a business
vi. Fenwick—Partners v. Employees—Owner of salon drafted agreement with sales clerk that
she was a "partner" to avoid paying unemployment costs to the state, but essentially owner
wanted to raise her wage so she would stay. Court held that there was no partnership.
1. Intent of parties
2. Right to share profits
3. Sharing losses
4. Control/ownership of property
5. Community of power
6. Language in the agreement
7. Conduct of Parties to 3rd persons
vii. Martin v. Peyton—Partners v. Lenders—lenders may default into partnership agreements if
elements are met—CONTROL (see Jensen v. Cargill above)
c. Fiduciary Obligations of Partners
i. UPA § 19: unless otherwise agreed, books of the partnership shall be placed at the principal
place of partnership's business AND all partners shall have access to the books at any time
ii. UPA § 20: all partners shall render information affecting the partnership to other partners
iii. UPA § 21: every partner must account to the partnership for ANY benefit and hold in trust
all profits derived by or for the partnership
iv. RUPA § 404(a): Duty of loyalty and duty of care
1. § 404(b): Duty of loyalty
a. (b)(1): every partner must account to the partnership for ANY benefit and
hold in trust all profits derived by or for the partnership
b. (b)(2): refrain from dealing with P'ship in conduct or winding up as or on
behalf of an party with adverse interest to the P'ship
c. (b)(c): refrain from competing before dissolution
2. § 404(c): Duty of Care
a. Refrain from engaging in gross negligence, reckless conduct, intentional
misconduct, or knowing violation of the law
3. § 404(d): required partners to act in good faith and fair dealing
4. § 404(e): partner CAN further his own interests
5. § 404(f): partner may lend money and transact business of P'ship
v. Meinhard v. Salmon—Salmon and Meinhard were partners; S agreed to manage and M agreed
to finance real estate deal; P'ship subject to a limited term; S secretly renews real estate
contract with 3rd party without consulting M. HELD: S breached fiduciary duty owed to M.
1. It was foreseeable to S that M would be harmed financially
2. Since it was foreseeable, S had a duty to tell M about the new business opportunity,
give M a chance to compete for it, or S and M could jointly enter into a new
partnership regarding the new business opportunity
vi. Law Firms
1. Gibbs—Departing lawyer takes files from firm; tells prospective employer the
details of salaries; lawyer leaves firm. HELD: breach of fiduciary duty
a. When lawyer sent the memo to the prospective employer, he was still a
partner with the old firm and therefore he breached his fiduciary duty BUT
b. Lawyer was entitled to take his chronological files
2. Departing partner may solicit employees to depart AFTER notice and before
departure BUT
3. Departing partner may NOT solicit clients
a. Departing and remaining partners must send a joint letter giving the client a
choice between one or the other
4. Termination/Firing
a. Lawlis—Alcoholic partner fired after given two opportunities to clean up
i. Arguments of the fired partner: (1) termination was a constructive
firing; (2) termination was an unlawful attempt to increase
partnership profit; (3) termination was a breach of fiduciary duty
ii. HELD: (1) partnership agreement controls the procedure for
termination, and since it was followed, there was no constructive
firing; (2) if done in good faith, increasing partnership profit by
terminating is OK—here, it was OK; (3) no breach of fiduciary duty
because there is no requirement to continue the partnership unless
agreed otherwise
b. Bohatch—Whistleblower was fired after snitching on another partner; court
held that there was no breach of fiduciary duty owed to the whistleblower
5. Three approaches: Reasons for Termination and the Means of Termination
a. Reasons for termination
i. Unless otherwise agreed, partnership can be terminated for any
reason OR
ii. Termination must be REASONABLE, but termination will entitle the
terminated partner to damages OR
iii. If a partner alleges the misconduct of another partner, partner can
terminate IF the allegation is incorrect (if it's correct, cannot fire)
b. Means of Termination
i. Good faith/Bad faith: so long as notice before termination is given
ii. Means must also be REASONABLE, but the termination will entitle
the terminated partner to damages OR
iii. If a partner alleges the misconduct of another partner, partner can
terminate IF the allegation is incorrect (if it's correct, cannot fire)
d. Management of Partnership
i. UPA § 18: Absent agreement otherwise
1. § 18(e): all partners have equal rights in the management and conduct of the
2. § 18(h): difference arising as to ordinary business practices are decided by majority
vote of partners
ii. § 9(1): Absent agreement otherwise
1. Any act of the partner acting within the scope of the partnership binds the
iii. Two person Partnerships: Considerations
1. Cardozo—51%/49% determination of voting rights
2. Divide and Conquer agreements
a. Each partner has majority vote on certain matters (ex- partner A has
majority vote for service issues, partner B has majority vote for financing
b. Tie Breaker Arrangements
i. Ask a third party to be the tie-breaker
1. If you are the lawyer and the tie-breaker, you have big
problems because you'll probably lose the client whom you
voted against
iv. There is no "legal right" to management of partnerships because partners can "agree
otherwise" (Sidney & Austin)
e. Partnership Property
i. Generally
1. UPA § 8(1): all property acquired by the partnership is partnership property
2. UPA § 8(2): all property acquired with partnership funds is partnership property
unless a contrary intention appears
3. UPA § 8(3): Real estate may be acquired in the partnership name and if so, can only
be conveyed in the partnership name
ii. UPA § 24: Extent of Property Rights of a Partner
1. Specific partnership property
a. Non-transferable
2. Interest in Partnership property
a. Personal property of partner
3. Rights in management
a. Non-transferable
iii. UPA § 25: Specific Partnership Property
1. UPA § 25(1): Partner has co-ownership of specific partnership property and holds as
a tenancy in partnership
a. UPA § 25(2)(a): individual partner has equal right to possession of specific
partnership property
i. Individual partner can only use specific partnership property for
partnership uses UNLESS others give consent to non-P'ship use
b. UPA § 25(2)(b): individual partner cannot assign rights to specific
partnership property
c. UPA § 25(2)(c): individual partner cannot attach specific partnership
property if he is sued for a debt
d. UPA § 25(2)(b): when an individual partner dies, his interests in specific
partnership property vests in the other partners
i. If the last partner dies, the interest vests with his estate
iv. UPA § 26
1. An individual partners interests in partnership property is
a. Share of the profits
b. Surplus AND
c. Personal property
2. All are assignable and attachable
v. Putnam v. Shoaf—partner sold his interest in the partnership to A. A found out that an
employee of the partnership was embezzling partnership funds (unknown contingent asset),
and seeks to collect the loss from former partner.
1. Sale of partnership interest includes the sale of unknown contingent assets
a. When a third party buys the interest of a partner, the third party buys
vi. UPA § 18(g):
1. No person can become a partner unless all partners give consent
vii. UPA § 17: Incoming Partner
1. Incoming partner is liable for all pasts debts of the partnership BUT
a. Not personally liable for past debts—the debts would be paid from
partnership property
b. Incoming partner WILL be personally liable for future partnership debts
viii. RUPA § 204(d)
1. Partners can designate their own property for partnership use
a. Partner keeps the property in his name
b. Upon dissolution, partnership does NOT won the property, only the right to
use the property
c. Partnership DOES NOT acquire the property
2. IF partner designates property but BREACHES the agreement, under § 38 the
property can be used for continuing the business
f. Dissolution of Partnership
i. UPA § 31: Causes of Dissolution (not by decree of court)
1. UPA § 31(1) No violation of the partnership agreement AND
a. (1)(a): Partnership agreement sets the time for dissolution and it expires OR
b. (1)(a): The partnership's particular undertaking specified in the agreement
is over
i. IF neither
1. The partnership is a "partnership at will"
c. (1)(b): If the partnership is at will
i. Express will of any partner to dissolve the partnership will dissolve
the partnership
d. (1)(c): Express will of ALL partners who have to assigned any of their
e. (1)(d): Expulsion of any partner
i. Done in good faith
1. without violating fiduciary obligations AND
ii. In accordance with the partnership agreement
2. UPA § 31(2): Violation of the Partnership agreement AND
a. Circumstances do not allow dissolution under §§ 31(1)(a)—(d)
b. Express will of any of the partners at any time
3. UPA § 31(3): Partnership is dissolved IF
a. It is now unlawful to carry on the business
i. Example: prohibition
4. UPA § 31(4): Death of any partner dissolves partnership
5. UPA § 31(5): Partnership goes bankrupt
6. UPA § 31(6): Decree of court orders dissolution
ii. UPA § 32: Dissolution by Decree of Court
1. UPA § 32(1): Any partner applies to court AND
a. UPA § 32(1)(a): another partner is mentally incompetent
b. UPA § 32(1)(b): partner is incapacitated
c. UPA § 32(1)(c): Partner is guilty of conduct that prejudicially affects
partnership business
i. Good faith is implied in every contract
ii. Partner may breach good faith requirement and prejudicially affect
the business BUT
iii. Bad business strategy that is NOT a breach of good faith OR breach
of any fiduciary obligations
d. UPA § 32(1)(d): breach of the partnership agreement
i. Willful breach
ii. Persistent breach OR
iii. Partner conducts himself such that it is not reasonably practicable
to carry on the business in the partnership with this partner
e. UPA § 32(1)(e): partnership will make no more profit
f. UPA § 32(1)(f): equitable reasons
iii. UPA § 38: Rights of Partnership after Dissolution
1. UPA § 38(1): Unless otherwise agreed
a. No fault/no violations by any partners and no expulsion
i. Partners will be treated equally
1. Assets will be liquidated to pay debt
2. Surplus will be disbursed equally among the partners
b. No fault/no violations by any partner and Expulsion
i. Good faith expulsion
ii. Expelled partner gets the amount due to him AND
iii. Remaining partners get to continue the partnership business
2. UPA § 38(2): Breach of Partnership Agreement (Partners cannot agree otherwise)
a. Non-breaching partners
i. Get damages for breach of agreement AND
ii. The rights in § 38(1)
b. Non-Breaching Partners get the rights to continue business
c. Breaching party is NOT entitled to the value of the "good will" of the
partnership when he gets what is owed to him
iv. UPA § 40: After Dissolution: Rules for Distribution
1. UPA § 40: Unless otherwise agreed (subject to any contrary agreement)
a. UPA § 40(a): Partners gather all assets of the partnership
i. Partnership property and
ii. Contributions of the partners
b. UPA § 40(b): Order of Payment
i. Non-Partner Creditors
1. Examples: banks, employees (non partner employees),
ii. Non-Capital, Non-Profits owed to partners
1. Partners who are employees, partners who loan money to the
partnership (separate from capital and profits)
iii. Capital Investments
1. All investments by partners
iv. Profits
1. Distributed Evenly amongst partners
2. Partners MUST contribute equally throughout the distribution
a. Example: partner who loans the partnership money may have to pay back his
own loan with partnership assets
v. Winding Up
1. Sharing Losses
a. General Rule—partners share all losses
b. Exception—Kovacik v. Reed—one who contributes only services is NOT
responsible for paying capital contributions of the other partner
i. Losses by financing partner does not require payment by partner who
contributed only services
1. Equitable Court Principle
c. Planning Ahead:
i. Pay the service contributing partner money for each service
performed and accrue it as capital contributions
2. Buyout Agreements
a. Trigger Events
i. Death
ii. Disability
iii. Will of any partner
b. Obligation to buy versus option to buy
i. Firm
ii. Other Investors
iii. Consequences of Refusal to buy
1. If there is an obligation to buy
2. If there is no obligation to buy
c. Price
i. Book Value
ii. Appraisal
iii. Formulas
iv. Set price each year
v. Relation to duration
1. Example: lower price if bought within the first five years of
the partnership
d. Method of Payment
i. Cash
ii. Installments (Interest)
e. Protection against debts of partnership
f. Procedure for Offering either to buy or sell
i. First mover sets price or forces others to set price
i. Defined ULPA (Exist by virtue of statute)
1. One or more general partners AND
2. One or more limited partners
ii. Formation
1. Register a certificate with the state department
2. Include "LP" in the name (PA does not require as such)
iii. Members
1. General partners and limited partners
iv. Governance
1. General partners engage in governance
2. Limited partners are investors and can get rid of general partners
v. Management
1. General partners conduct day-to-day operations and owe fiduciary duties
vi. Default Rules
1. ULPA and RULPA is governing statue and provides default rules for governance and
vii. Flexibility
1. General partners alone can participate in management
viii. Costs
1. Costs include formation costs
a. Filing with appropriate agencies (state department, etc.)
ix. Liability
1. General Partners are personally liable
2. Limited partners can be personally liable if 3rd parties reasonably rely on the
limited partner and 3rd parties reasonably believe that the limited partner is a
general partner
a. Safe harbors
i. Limited partner will not be considered general partners solely by
doing any of the following
1. Acting as agent
2. Consulting with general partner
3. Acting as a surety or guarantor for the limited partnership
4. Borrowing, lending, providing collateral
5. Requesting or attending meetings of partners
6. Serving on committees
x. Tax
1. Same benefits as partnerships
a. Tax shelters
i. General partners are usually corporations
ii. Limited partners are generally individual
b. Make the general partner a limited partner as well so the money can be
distributed to the partners
i. Prevents zeroing out
xi. Transferability
1. Limited partners can transfer or sell interests BUT
2. General partners cannot transfer or sell their interests
xii. Continuity
1. Same continuity as general partnerships
i. Kitner Factors—Determining Tax liability: All organizations have factors (1) and (2). If
business organization does NOT possess at least 2 of the remaining four, it will be taxed as
a partnership
1. Associates
2. An objective to carry on a business and divide the gains therefrom
3. Continuity of life
4. Centralization of management
5. Limited liability
6. Free transferability of ownership interests
ii. Formation
1. Certification
a. Operation agreement AND
b. Buy/Sell agreement
iii. Membership
1. Need only one member
iv. Control
1. Members control
2. Can be limited by agreement
v. Management
1. Kitner Factors (See above)
a. All members could be involved in day-to-day business
i. Hire management
ii. Have one Member conduct management OR
iii. Create management committees
vi. Default Rules
1. Title 15, Chapter 89 (Pennsylvania)
vii. Flexibility
1. Dependent upon the structure of the LLC
viii. Cost of Formation
1. Filing Fees
2. Oprating agreements
3. Buy/Sell Agreements
ix. Liability
1. Limited Liability
x. Taxation
1. "Check the box"
xi. Transferability of Interests
1. Prohibited unless all members agree
a. Statute determines scope of transferability
xii. Continuity
1. Same as partnerships
a. Certificate of dissolutions
i. Two Types of Statutes
1. Narrow Shield
a. Partners are shielded from personal liability for torts committed by the
partners UNLESS
i. Partners directly supervise BUT
b. Partners are still liable for the CONTRACTS of other partners
2. Full Shield
a. Full shield from personal liability
i. Contracts AND
ii. Torts
ii. Formation
1. Register with state department
2. Include LLP in name
iii. Members/Default Rules
1. Statutorily defined
iv. Flexibility
1. Same as limited partnerships
v. Costs
1. Must pay insurance
2. Annual registration fees
vi. Tax
1. "Check the box"
vii. Transferability
1. Same as partnerships
viii. Continuity
1. Fail to have insurance or registration
a. Default into a genera partnership
i. Partner will be liable for torts of other partners
ix. Hypothetical
1. Family attorney and a divorce attorney own a business and need to keep it. How
would they form their business
a. Partnership is undesirable because of personal liability
b. Limited partnership would not be desirable
i. One party would be the general partner
ii. The other would be the limited partner
1. They will encounter voting problems
c. Limited Liability Partnership may be desirable
i. Corporation itself is an entity
1. Consists of Board of Directors and officers
2. Shareholders
ii. Large Corporations
1. Board, officers, and shareholders are usually distinct
iii. Small Corporations
1. One person can wear all the hats (Corporation, director, shareholder, officer,)
a. Difficult to distinguish liability
i. Each capacity carries distinct rights
iv. Formation of Corporation
1. Go online and fill out a form
a. Pay annual filing requirements
2. Call up a corporation company and request packet from the state where your client
wants to incorporate
3. Send forms to the secretary of state and wait for the certificate of incorporation
a. This grants you limited liability

4. While waiting, start adopting by-laws and buy/sell agreements, plan first
organizational meeting
a. Prepare an agenda
b. Record minutes
5. At organizational meeting
a. Adopt by-laws
b. Appoint directors
c. Have directors elect officers
d. Talk about stock, securities law, etc.
i. Defined
1. An entrepreneurial individual who gets things together so that the corporation can
get started
a. Loans, location, buying and gathering assets
b. Forms contracts BEFORE the articles of incorporation are finalized
c. If corporation does not form, the entity might default into a partnership if
the corporation is up and running
2. Promoter owes the yet-to-be existing corporation fiduciary duties
ii. Promoter Liability
1. Based on agency concepts—based on a warranty that the corporation will be formed
AND promoter will use his best efforts to create the corporation
a. Promoter as Disclosed Agent
i. Agent discloses the identity of the principle
1. Agent is not liable for the contracts
b. Promoter as a Partially Disclosed Agent
i. Agent discloses agency existence but NOT the identity of the
1. Agent is individually liable OR
2. Agent is liable as a co-promisor or surety
a. Co-promisor
i. Individual shares responsibility with principle
if principle defaults—Co-promisor is first in
line to get sued; principal is next
b. Surety
i. One who promises to answer for the duty of
ii. If surety defaults, principal and surety will be
c. Promoter as Undisclosed Agent
i. Agent neither discloses the agency relationship nor the identity of
the principle
1. Agent is liable on a variety of theories that protect the
reasonable expectations of third parties
iii. Protection of Promoters
1. Novation—agreement between the principal and third party to voluntarily substitute
a new contract with an old one that either changes the subject matter of the old
agreement or the parties of the old agreement
a. ALL parties MUST be identified before a novation takes place
2. Novation AFTER the transaction has taken place
a. Novation of Subject Matter
i. Example—agreement provides for car x; Novation changes old
agreement from car x to car y
b. Novation of Parties
i. Changing the names of the parties to the contract
3. Novation BEFORE the transaction (Difficult)
a. Draft document to account for novation AFTER transaction occurs
i. Works with partially disclosed agents
iv. Protecting Third Parties Dealing with Promoters
1. When corporation does not yet exist
a. Analogize the contract between promoter and third party as and OFFER to
the corporation
i. Acceptance would be an agreement by the board of directors to
accept the offer AFTER the corporation has been formed
ii. Problem—offeror can revoke, offeree (corporation) can reject
b. Analogize the contract between promoter and third party as an OPTION
CONTRACT running to the corporation
i. Restrict the third party's power to revoke offer
ii. Consideration
1. Based on the implied promise by the promoter
2. Implied promise is promoter's "best efforts" to have
corporation adopt the contract
c. Analogize the contract between the promoter and third party as a PRESENT
CONTRACT Between Promoter and Third Party
i. Agreement that corporation will be formed
ii. Agreement that corporation will adopt the contract between the
third party and promoter
iii. Agreement that corporation will novate
iv. Agreement that corporation will deal with third party
v. Case Law
1. Southern-Gulf v. Camcroft—Third party (A) contracts with promoter (B) of non-
existent corporation (C). Contract provides that A will build for a Texas
corporation, but after C becomes incorporated, C is a corporation in the Cayman
Islands. A defaults on the contract and argues that C did not exist. C sues.
a. HELD: A is estopped from denying the existence of C
i. Promoter could have enforced the contract against A himself as co-
ii. Implied novation by letter to A regarding C's new status
i. Statutory Provisions
1. MBCA § 2.03
a. Corporation exists when article of incorporation is filed
b. When secretary files articles of incorporation, it acts as conclusive proof
that the corporation exists
2. DGCL § 106
a. Corporation exists on the date the articles of incorporation are filed with
the secretary of state
ii. De Jure Corporation
1. Once articles of incorporation are filed, limited liability attaches
iii. Where articles of incorporation are NOT filed
1. De Facto Corporation (Use facts From the Corporation's Perspective)
a. Good faith effort to incorporate
i. Articles of incorporation have been sent to department of state
b. Legal Right to incorporate AND
c. Operating as a corporation
2. Corporation by Estoppel (Use facts from the third party's perspective)
a. If the person dealing with the alleged corporation
i. Thought it was a corporation AND
ii. Would get a windfall if personal liability was imposed on the alleged
b. THEN the 3rd party is estopped from contesting the existence of a
i. Corporation by estoppel cannot be maintained if the third party is a
tort victim because the tort victim typically does NOT know or
believe he or she is dealing with the corporation; tort victims are
generally strangers to transactions
iv. Case Law
1. Walkovsky v. Carlton—Cab Company (A) owned 10 smaller corporations. Π (B)
injured by cab of smaller corporation. Each smaller corporation had only two cars
and the minimum amount of insurance (A organized this way to limit liability—when a
cab from smaller corporation get into trouble, the Π can only sue and attach the
assets of the smaller corporation, not the whole corporation)
a. Available remedies
i. Piercing the Corporate Veil (NO)
ii. Agency (NO)
iii. Partnership (NO)
iv. Enterprise Liability (YES)
1. Common employees
2. Common record-keeping
3. Centralized accounting
4. Payment of wages by one corporation to another's employees
5. Common business name
6. Employees of one corporation render services for another
7. Undocumented transfers between corporations
8. Unclear allocation of profits and losses
9. Same officers
10. Same shareholders
11. Same phone number
2. Piercing the Corporate Veil: Attach Personal Liability to Shareholder of Corporation
a. Unity of Interest/Ownership
i. Inadequate maintenance of records such that SH disregards
corporate entity
ii. Commingling of Funds and assets
iii. Undercapitalization
iv. Treating corporate assets as its own
b. Injustice
i. Courts usually require that the Π be barred from recovery AND
something in addition to that (Sealand Services v. Pepper)
1. Unjust enrichment

2. Parent-Subsidiary relationship: where parent takes all assets
of subsidiary leaving no funds for Π s
ii. Fraud
3. Usually, Π s pierce the corporate veil to get to the assets of the shareholder.
Sometimes, the creditors of the shareholder's seek to recover from the
shareholder, but the assets have no value (such as SH stock that cannot be sold on
the market). In this situation, the Π will "reverse pierce:" go through the SH to
get to the assets of the company.
a. Π must still meet the elements of piercing the corporate veil
4. PRES v. MPI—MPI, Inc., and PRES, Inc., form a partnership and create 2 real estate
companies. After the partnership ceased, PRES is sued by a third party and seeks
indemnity from MPI. MPI has no assets, so PRES seeks to pierce the corporate veil
to get the assets from Mike, the president of MPI.
a. HELD: Courts are less willing to pierce the corporate veil for contractual
liability because the parties knowingly and voluntarily negotiate.
i. Introduction
1. DGCL § 141 and MBCA § 8.01
a. Board of directors conduct, manage, direct the business of the corporation
b. Directors can appoint officers and form committees
2. Inside directors
a. Directors of a corporation who are also an officer or other employee of the
3. Outside Directors
a. Directors of a corporation who are NOT employed as officers or employees
ii. Directors owe fiduciary duties to shareholders
1. Shareholders have limited power
a. Elect directors
b. Approve major transactions
2. Two Ways to Make Money on Shares/Stock
a. Directors issue Dividends
b. Capital appreciation on stock over time

Directors Time Period I Time Period II Shareholder

Actions/Inactio Wealth
Dividends Issued $100 Directors issue $10 Dividend $110
Appreciation Over $100 Stock Appreciates $10 $110
Appreciation and $105 Stock Appreciates $5 and Directors issue $5 $110
Dividends Issued Dividend


i. Introduction
1. Purpose of Corporations: Ford Motor Co.—Ford reduced price of cars and declined
to issue dividends in order to make employee wages sky-rocket and make every car
available to everyone. Ford admitted that the sole purpose of this action was
benefit the general public, NOT to make profits for the company.

a. HELD: the SOLE purpose of a corporation and its board of directors is to
make profits and increase shareholder wealth.
b. Changing the purpose of the corporation can be considered a breach of good
faith that will trigger the duty of loyalty analysis.
c. Charities
i. Donation to charities are proper so long as the donation somehow
furthers the interest of the corporation AND is incidental to the
purpose of making profit and increasing shareholder wealth
ii. Business Judgment Rule
1. Judgment of Directors has the benefit of a presumption of good faith
a. Court has no institutional competence when it comes to business decisions
2. Regardless of whether the court disagrees with the decision of directors, the court
will not substitute its business judgment for that of the directors
a. Directors have WIDE discretion
i. The standard, once the business judgment rule attaches, is whether
NO reasonable person in like circumstances would have reached the
same decision.
3. The business judgment rule turns on whether directors made a "well-informed"
a. Smith v. Van Gorkom—Directors breached their duty of care because they
approved a sale of the corporation for cash without considering the
possibility o other proposals at higher prices, even though they sold at
$55/share when the trading price was only $38/share.
i. Directors did not inform themselves or seek expert advice—price
was actually designed to benefit purchasers, not the shareholders
ii. Corporations financial staff told the directors that $55 was at the
low end of the fairness range
iii. Court inferred that CEO was eager to sell shares and retire in a
hurry and therefore declined to extend the protection of the
business judgment rule.
4. Result of Van Gorkom: Well-informed Decisions: DGCL § 141(e) and MBCA § 8.03
a. Directors must make reasonably good efforts to hire experts AND
b. Directors limited the advice of experts to advice that is within the expert's
5. Examples
a. Directors A and B decide to lower the level of quality of their product in
order to forego profits. This would be an example of breach of good faith,
triggering the duty of loyalty analysis, because the directors are arguably
changing the purpose of the corporation from making profit to foregoing
b. Directors A and decide to lower the level of quality of their product. They
hire financial experts to determine whether lowering the quality would be
profitable, and make their decisions based on that expert's analysis. The
expert concludes that there is a reasonable chance that profits will come.
This would still have the benefit of the BJR because the directors are
arguably well informed.
6. Excess Cash of a Corporation and Possibilities
a. Invest extra cash
i. Invest in the Stock Market
1. Consequence: Corporation will lose the cash it has on hand
ii. Invest in Other Businesses
iii. Reinvest in the Corporation itself
b. Issue Dividends
i. Consequence: Issuing dividends may have negative tax implications:
recipients of dividends may be bumped into a higher tax bracket
c. Repurchase Stock
i. Consequence: If corporation repurchase stock at the trading price,
corporation foregoes possibility to sell at a premium and make profit
d. Sell the Corporation at a premium
7. Leveraged Buyout (LBO)
a. Assets of corporation are sold to pay off debts of the corporation
8. Management Buyout (MBO)
a. Management of Corporation buys out the company
9. DGCL §§ 251 and 271
a. Directors AND shareholders MUST approve certain transactions
i. Sale of Ownership of Corporation § 251
ii. Sale of Substantially all Corporation Assets § 271
10. Entire Fairness Test: Cinerama
a. If the BJR does not attach, the burden shifts to the directors to show that,
despite their failure to arrive at a well-informed decision, the transaction
was entirely fair to the corporation—the transaction involved a fair price
and fair dealing.
11. Francis v. United NJ Bank—Director failed to keep herself informed about the
business of the corporation (Reinsurance Industry, similar to banking industry)
a. HELD: Directors must aspire to meet their continuing obligation to be well
b. Distinguish between BJR and Fiduciary Duties
i. The law relaxes the standard of fiduciary duties of fictional entities
(corporations) with the exception of the banking industry, which
owes fiduciary duties to third parties (the public)
ii. Fiduciary duties are typically aspirational goals held by individuals
and owed to other individuals
iii. The BJR is PROCEDURAL, not aspirational, and focuses on
methodological obligations rather than aspirational obligations
1. Examples: Directors of low risk companies (such as utilities)
should NOT take high risks. Likewise, Directors of High Risk
Companies (software industry) are expected to take high
2. As such, the BJR look only to whether a reasonable person in
like circumstances would make the same decision
12. Disney—(1) Employment agreement between Corporation and CEO gave CEO a
lucrative severance package, which provided that the CEO would be paid MORE for
leaving the company rather than working. Π s challenged the agreement. Court held
that Π could not rebut the presumption of the BJR because their complaint sucked
but granted leave to amend complaint
a. Employment agreement was never scrutinized by an expert regarding the no-
fault termination clause, which would have paid the CEO more money to leave
rather than to stay and work
b. Possible waste because corporation paid CEO more money to leave than to
c. Illustrates that BJR is a strong presumption even though the decision of
directors look ridiculous
13. Caremark International—Directors had a policy for monitoring violations of law in
their industry. Mechanism that the directors used was the wrong mechanism for
monitoring the violations. Π s challenged both the action of implementing a
mechanism that did not work and the inaction of failing to monitor under the policy.
a. Inaction—arguably, BJR CANNOT apply because no decision has been made.
i. However, if directors make a well-informed decision NOT to take
action, the BJR arguably applies to this decision
ii. Notice That Compliance Procedures are Required:
1. Industry lends itself to violations of the law
2. Industry involves area of law that is complex
a. Directors know or should know that violations of law
will occur BUT
b. Cost-Benefit Analysis
i. If the Directors know that violations of law
will occur but it is too costly to implement a
program that will eliminate ALL violations,
such a decision will arguably be protected by
the BJR
i. Introduction
1. Shareholder derivative suits are suits where one or more shareholders claim injury
to the corporation and shareholders assert the rights of the corporation.
a. Derivative suits are suits in equity
b. Derivative suit generally seeks court to compel the corporation to file a
i. Complaining SH generally must demand the board to file lawsuit on
behalf of corporation
ii. SH have limited power—elect directors
iii. SH Derivative suit seeks to make directors accountable
2. Direct suits are suits where the shareholder seeks to enforce rights based on an
injury directly affecting the individual shareholder, not the corporation
a. Generally no demand required
i. Right to inspect books = direct suit
ii. Refusal to issue dividends = both direct and derivative
ii. Problems with shareholder derivative suits
1. "Strike Suits"
a. Frivolous lawsuits filed by SH where Π s attorney benefits by settlement
iii. Determining Direct or Derivative Suits
1. Cohen—Statute required SH bringing derivative suit to obtain security bond if SH
held less than 5% interest in stock. If corporation wins, SH pays fees of
corporation. If corporation loses, corporation pays the SH fees
a. HELD: Derivative suit where wealth from the lawsuit accrues to the
corporation, not the individual shareholder
2. Flying Tiger—Test for determining whether suit is direct or derivative
a. Whether the judgment would be in the corporation's favor
b. HELD: the action was a direct suit because the SH's were seeking voting
iv. Demand Requirement
1.Test for Bringing Derivative Suit
a. Demand Required
i. Approved by Bd. of Directors  Corporation Sues on Behalf of
ii. Refused by Bd. of Directors  BJR attaches  Corporation does not
sue  SH must challenge the Refusal as wrongful
b. Demand Excused
i. SH must specifically allege (without discovery, only the "tools at
hand" such as books, minutes of meetings, newspapers, etc.)
1. Conflict of Interest of a majority of the directors
2. Directors are dominated or controlled such that there is no
independence among them OR
3. Particularized facts showing that the directors breached the
duty of care (failed to use the proper methodology)
2. Grimes—Board of directors contracted with incoming CEO that allowed CEO to make
decisions without interference from board, and if the board interfered, CEO could
terminate agreement and receive a lucrative severance package. SH had two claims,
only one of which he demanded the board to bring on behalf of corporation
a. Direct—Abdication Claim: SH has individual right to independent exercise of
management authority by board
b. Derivative—Excess payments to CEO: wealth of judgment, if obtained, would
accrue t the corporation
i. HELD: If SH has a direct and derivative suit, both must go through a
demand analysis—SH cannot claim demand was excused for one and
not the other.
3. Rationale behind the Demand Requirement
a. Alternative Dispute Resolution
b. Corporation controls the Litigation
c. If demand is refused or denied wrongfully, then the SH will control the
d. RESULT: SH will NEVER make demands on the corporation—SH will
ALWAYS claim demand is excused
4. Marx v. Akers—NY standard for Demand Excused
a. Conflict of Interest
b. Duty of care violated (improper methodology) OR
c. Absolutely no director would have reached the same conclusion in similar
5. Revised MBCA § 7.42
a. Written demand is REQUIRED in all cases
i. If 90 days pass, SH can file suit
b. Review of Demand
i. Quorum of Disinterested Directors make decision whether to bring
suit OR
ii. Independent directors appoint special committees composed of 2 or
more directors to make a decision whether to bring suit
c. No Review
i. SH can proceed with derivative action if 90 days pass and no
decision has been made by board of directors
v. Committees
1. Introduction
a. Authorized by DGCL § 141(d)(2) and MBCA § 8.25
i. Board can delegate decision-making authority to committee
ii. Board is not abdicating because decision to create committee is
2. Test For Committees
a. Auerbach: Where committee is created at the initiation of a derivative SH
suit and attempts to dismiss the SH derivative action
i. Committee decision whether or not to file suit is entitled to the
protection of the BJR
b. Where Committee is create AFTER SH derivative suit commences and
attempts to dismiss a SH derivative action, court applies a cost/benefit
analysis in one of two ways
i. Zapata Test
1. Committee must show that
a. Committee members are disinterested and used
proper methodology
b. The committee is independent
c. Proceeded in Good faith AND
d. Reasonably investigated the claim
2. Committee must show that the lawsuit will harm the
corporation more than benefit the corporation
ii. Joy Test
1. Court makes an independent judicial finding that the lawsuit
is not beneficial to the corporation
3. Planning Points for Committees
a. Set up a special committee in advance and notify SH that the committee will
handle ALL lawsuits
b. IF SH files suit and a committee is set up afterwards to step in and
terminate the suit
i. Make sure committee is disinterested AND
ii. Make sure committee can show the lawsuit will harm the corporation

i. Defined
1. Undivided Loyalty
ii. Triggering Mechanisms
1. Conflict of Interests (self-dealing)
2. Fraud
3. Illegality
4. Breach of Good Faith
iii. Directors and Managers
1. Bayer v. Beran—CEO had his wife audition and gave her a part in new advertising
enterprise for company. Π s challenge the transaction as a conflict of interest
a. HELD: Duty of loyalty means undivided loyalty
i. Money used for the new ad enterprise—BJR attaches
ii. CEO's wife as singer in the add—Maybe a conflict, HOWEVER
1. Board met its burden by showing the intrinsic fairness of the
iv. Ratification
1. Fliegler v. Lawrence—Director of A corporation came upon a business opportunity to
buy real estate. Director and A Corp agreed that A Corp could not afford to buy.
Directors of A Corp. formed USAC and transferred the property there to avoid
financial risks A Corp. would face if it bought the property. Then A Corp and USAC
entered into agreement where A Corp would acquire USAC if the properties were
valuable. A Corp exercised its option and delivered 800,000 shares in exchange for
all USAC shares. SH approved and ratified, but Directors of A Corp. were also
majority SH who voted to approve the deal as well.
a. HELD: Duty of Loyalty—Directors formed a business that dealt with their
i. Burden is on directors to show entire fairness
b. HELD: Ratification—Ratification is not a complete defense. SH must be
disinterested and well-informed to properly ratify a transaction
c. HELD: DGCL § 144(a)
i. Transaction between director and corporation is not void or voidable
1. Director discloses conflict, disinterested committee makes
decision with protection of BJR
2. SH ratification OR
3. Directors show entire fairness
2. Wheelabrator—A and B corporation merged. Each directors voted to approve the
transaction. Proxy statement submitted to the SH for approval and SH so
approved. SH claims that proxy statement was materially misleading, board
deliberated only three hours.
a. HELD: Directors followed proper methodology even though they deliberated
for only three hours AND
b. HELD: SH did not meet burden of proving that the transaction was wasteful
3. Solomon v. Armstrong—Duty of Loyalty applies to officers of corporation as well as
directors of corporation
i. Test
1. IF Directors and Officers
2. Come across a business opportunity
a. Corporation is financially able to take opportunity
b. Corporation is in that line of business AND
c. Reasonable expectancy that corporation will take the opportunity
3. THEN Director or officer CANNOT seize the opportunity for him/herself
ii. Director or Officer cannot resign after receiving the opportunity because the fiduciary
duty arises during the relationship with the corporation
iii. Planning Points:
1. Always disclose completely to the board AND
2. Have the board ratify their decision
3. Problems
a. Other members and the corporation will take the opportunity OR
b. Litigation if director or officer takes the opportunity without disclosing
iv. Directors of Target Companies
1. Directors have a duty to see that the target company is as valuable as possible
v. ALI § 5.05: Corporate Opportunity DEFINED
1. Any opportunity to engage in a business activity in which director or senior
executive becomes aware

a. While functioning as a director or senior executive OR under circumstances
that reasonably lead director or senior officer to believe that the person
offering the opportunity expects it to be offered to corporation OR
b. Through use of corporate information or property if reasonably expected
that opportunity would be of interest to the corporation
2. Any opportunity to engage in business activity of which a senior executive becomes
aware and knows is closely related to a business in which the corporation is engaged
or expects to engage
i. Dominant SH owe fiduciary duties to minority SH
1. Example: Sinclair—A owned 97% of stock in B, S's subsidiary.
2. Rationale
a. Dominant SH controls the board of directors by voting
b. SH votes required to approve major transactions; thus, controlling SH must
owe fiduciary duties to minority to prevent SH domination of all major
transactions to the detriment of minority SH
ii. Shares
1. General Rule
a. Must be one class of stock/shares that contains
i. Voting rights AND
ii. Residual Rights (leftover assets)
2. Types
a. Common Stock
i. Voting Rights
ii. Residual rights to assets after dissolution
iii. Value of common stock appreciates and depreciates over time; thus,
it is a riskier investment
b. Preferred Stock
i. Holder has preferential rights to dividends
ii. Holder has preferential rights to amounts paid after liquidation OR
iii. Holder has both
iv. No voting rights
v. Value of Preferred stock does NOT appreciate or depreciate over
time; thus, it is a less risky investment
c. Cumulative Dividends on Preferred Shares
i. Obligation to pay preferred amount carries over to next year if
dividends are not issued
1. Example—Year I $100 par value, $5 preferred value. No
dividends issued. Year II, if dividends are issued, holder of
preferred stock MUST receive $10 (Year I + Year II
d. Non-Cumulative Dividends on Preferred Stock
i. Obligation to pay preferred amount does NOT carry over to the next
year if dividends are not issued
e. Cumulative to the Extent Earned
i. Obligation to pay preferred amount carries over to next year IF
Corporation has earned enough to pay the cumulative amount
ii. Obligation to pay preferred amount does NOT carry over to next
year IF corporation has NOT earned enough money to pay cumulative
f.Participating Preferred
i. Preferred SH participates in excess dividends OR residual rights
1. Example: Preferred SH holds share at $100 preferred
amount + 50% any amount over $250
a. IF assets = $300
i. Preferred receives $100 par value + 50% of
$50 (the amount over $250) which = $125
3. Conversion of Interests

Low Risk: 1. Bonds

2. Debentures
3. Preferred Stock
High Risk 4. Common Stock

a. Upstream Conversion
i. Moving yourself from a risky to less risky position to the detriment
of others is prohibited
1. Example—converting common stock into preferred stock is
b. Downstream Conversions
i. Moving yourself from a less risky position to a riskier position is
1. Example—converting from preferred stock into common
stock is permissible
ii. Why downstream conversions are appealing
1. Value of common stock, while riskier than holding preferred
stock, has the possibility of increasing above the level of
preferred stock
iii. Dominant Shareholders
1. Sale of Stock at Premiums
a. Zetlin—Controlling SH can sell shares at a premium above the market price
i. Exceptions
1. Looting corporate assets
2. Conversion of Corporate Opportunities
3. Fraud OR
4. Acts of Bad Faith
2. Increases in Director Salary
a. Results in DECREASE in value of shares/stock
b. Why Not inflate salary?
i. Tax implications—increase in salary increases individual income tax
whereas keeping same salary and selling shares maintains capital
gains tax
3. Freeze Out
a. Depressing stock for the purposes of buying out minority is impermissible
4. Equal Opportunity Provisions
a. Majority SH must give right of first refusal to minority SH
b. IF minority declines, majority SH must buy shares at the same price the
majority is selling to minority
c. Works as a poison pill
5. Golden Parachute
a. Lucrative Severance Packages
6. Golden Handcuffs
a. Lucrative salary so director will NOT leave or think about leaving
iv. Shareholder Voting
1. Staggered Elections
a. Election of a certain amount of directors at intervals
i. Problem—possible poison pill because once a SH obtains controlling
interest, staggered elections impact on the ability to elect directors
2. Straight Voting
a. Amount of shares determines amount of votes per director
i. 10,000 shares + 3 directors = 10,000 votes for each director
ii. Problem—possible poison pill because SH will need at least above
50% interest to oust the minority
1. Ability to assume control might depend on who controls the
2. Ability to assume control might depend on whether minority
SH are voting or not
3. Cumulative Voting
a. Amount of shares and number of directors up for vote determines amount of
i. 10,000 X 3 Directors = 30,000 for any ONE director
b. Protects minority SH
c. More Directors = more shares required to elect Directors
d. Formula
i. _ S__ +1 = # of Votes Required to Elect One Director
(D + 1)
ii. S = # of TOTAL SHARES in Corporation
iii. D = # of Directors SH wants to elect
4. Removing Directors: NY § 706
a. Any director may be removed for cause
b. Removing directors without cause in a Cumulative Voting Scheme
i. Even if a majority of SH vote to remove a director, if minority SH
produces enough votes that would be sufficient to elect under
cumulative voting scheme, the director will not be removed
5. Ways to obtain Controlling Interest WITHOUT Majority Interest in Shares
a. SH has % of shares that is greater than minority because minority interest
is spread out—many minority SH with minimal interest OR
b. SH has control of the proxy mechanism
i. Perlman v. Feldman—37% SH was dominant—sought to sell controlling
interest at premium. Limited holding: Market Shortage—steel
industry—government regulations: Controlling SH required to share
premium with minority SH
v. Shareholder Agreements
1. General Rule
a. Agreements between and among SH to elect directors are permissible
i. Directors CANNOT agree, in capacity as director, on their manner
of voting

1. Directors must act independently
2. Essex v. Yates—A sold controlling interest to B at premium under agreement that
directors of A's corporation resign seriatim (to fulfill quorum requirement). Before
agreement went through, A backed out because market price rose above premium. A
is sued, and A claims that agreement was unlawful—HELD: contract lawful
3. Rule—SH can sell controlling interest in a corporation and add an agreement that
calls for removing old directors and replacing with new directors
vi. Dissent And Appraisal
1. Limited statutory right granted to minority SH when SH objects to a fundamental
a. Merger or sale of substantially all assets, followed by board approval,
followed by requirement that SH approves. What if SH does NOT approve?
2. Judicial Appraisal of Shares
a. Court determines the Fair Market Value of Shares
i. Court appraises value of stock based on financial evidence
ii. Corporation must pay in cash
3. Two-Step Merger
a. Buyer acquires majority interest of corporation
i. Acquires control by buying majority interest at premium above
market value
1. Controls board of directors (voting) AND
2. Controls SH
ii. Smart business decision because buyer avoids buying ALL shares at
once for price above market value
b. After acquisition of majority interest, buyer effectuates a merger with
another entity (buys out the minority interest, usually)
4. Weinberger—(1) Signal buys 51% interest of UOP @ $21/share (premium)—UPO sold
1.5 million authorized but unissued stock; 4.3 million shares were acquired by tender
offer; (2) Signal acquires 49% by cash-out merger @ $21/share. Directors of both
UOP AND Signal conducted feasibility study based on information from UOP, used
for benefit of Signal, that indicated the price could go as high as $24/share
(difference of $17m to shareholders)
a. HELD: The remedy to dissenting SH is appraisal by court UNLESS board of
directors violates its duty of loyalty
i. Feasibility study was NOT disclosed
ii. Lehman Brothers report was rushed and it was not disclosed to the
SH that the report was rushed
iii. Signal dictated the ENTIRE bargaining process
iv. UOP directors said had they voted, they would vote to approve the
b. HELD: Board also failed to prove entire fairness of the transaction
i. Fair Price
1. Appraisal of value of stock determined by any acceptable
accounting in the financial community
ii. Fair Dealing
1. More than mere formalities of ratification
c. Practice Point: Avoid the Duty of Loyalty Problem in Appraisals
i. Set up Committee comprised of disinterested directors
ii. Make sure board of each company is NOT informed on certain issues

iii. If outside experts are utilized, make sure they have no relationships
with either company
5. Rabkin—Controlling SH—A purchases 64% stock from controlling SH @ $25/share
under agreement that A would also purchase minority stock @ $25/ share IF
purchased within one year. A waits until one year lapses and buys the rest @
a. Π argues that there was no fair dealing because as a controlling SH, A owed
a duty of loyalty to the minority SH
b. HELD: Duty of Loyalty of a controlling SH prevents procedural process from
harming the position of the minority SH
i. Introduction/Background
1. Goal of securities law is to assure all disclosures are made
2. Statutes
a. Securities Act of 1933 applies to IPO
b. Securities Exchange Act of 1934 applies to ongoing trading on securities and
market exchange
3. Disclosure Requirements
a. Exempt securities are exempt from registration BUT disclosure required for
certain antifraud provisions of the statutes
b. Nonexempt securities are NOT exempt from registration and prospectus
requirements and require MANY disclosures of all prior transactions
4. Federal securities law focus on procedures
5. States have "blue sky laws" that focus on the merits of the transaction as well
6. An "issuer" is an entity that issues securities
7. An "underwriter" is an investor that guarantees that all stocks will be purchased
ii. Securities Defined in § 2—Court does NOT look at labels
1. Stock Resemblance Test: United Housing v. Forman (1975)
a. Right to receive dividends contingent upon an apportionment of profits
b. Negotiability
c. Ability to be pledged or hypothecated
d. Voting rights in proportion to number of shares owned
e. Ability to appreciate in value
2. Note Resemblance Test: Same Factors as Forman
3. Investment Contract Test: SEC v. Howey (1946)
a. Investment of money
b. In a common enterprise
c. With profits coming solely from the efforts of others
4. Risk Capital Test
a. Whether the security is an investment at risk
i. Federal courts question this test
ii. Used at the state level
iii. Exemptions
1. Class of Securities that are Exempt
a. SEC Regulation D Exemptions
i. Small offerings
ii. No advertisement or general solicitation used
iii. Accredited investors are participating in the transaction
1. Rationale is that accredited investors do NOT need the
benefit of securities law
b. SEC Regulation A Exemptions
i. Where one requests exemption and SEC grants exemption
c. Intrastate Exemption
i. Where Securities are sold intrastate
2. Exempt Transactions
a. Transactions by issuer NOT involving a public offering (§ 42)
i. Selling stock to employee is NOT exempt IF
1. Employees would be in the class of people that need
protection from the securities laws
iv. Registration Requirements
1. Filing with the SEC or local state office
2. Prepare Prospectus to actual and potential investors
v. Remedies
1. Securities Act of 1933
a. § 11 Remedy
i. IF registration statement and prospectus contains a misleading
statement of material fact, Π can recover damages
b. § 12(1) Remedy
i. IF securities should have been registered (non exempt) AND
ii. Was not registered
iii. THEN ANY purchaser can rescind and recover money spent
c. § 12(2) Remedy
i. IF ANY material statement or omission made
ii. In connection with sale of security
iii. THEN purchaser gets damages UNLESS
1. Seller can show due diligence AND
2. Seller was unaware the statement was false
2. Securities Exchange Act of 1934
a. § 10(b) and Rule 10(b)-5 antifraud provisions
b. § 16(b)
i. Officers, directors, and 10% SH of issuing company
1. Must file monthly reports showing wither they bought/sold
2. Must disgorge short swing profits to issuing company
i. Introduction
1. Insider gets information about value of stock
a. Buys stock low, stock goes up, insider sells
i. Seller of the stock loses because seller would NOT have sold if he
had the information
2. Insider gets information about the value of stock
a. Sells high before stock price drops
i. Buyer of the stock loses because buyer would NOT have bought if he
had the information
3. In both scenarios, however, the corporation does not lose because it still exists and
it is still making money
ii. Theories in Favor of Prohibiting Insider Trading
1. Corrective Justice
a. Using SH's information to harm the SH
2. Investor Confidence (Level Playing Field)
3. Corporate Harm
4. Market Failure
a. Where there is no adequate incentive to disclose information, considered a
"market" failure
i. Example—tobacco industry has no adequate incentive to disclose the
harm of tobacco
iii. Common Law Theories of Liability
1. No-Duty Test: There is NO duty to disclose information to shareholders UNLESS
a. Actual fraud is present
2. Disclosure Test: DIRECTORS have a duty to disclose information to shareholders
3. Special Facts Test: Disclosure is required IF
a. Concealment of identity in the transaction AND
b. Inside information would have a dramatic impact on stock value
4. Case Law
a. Goodwin—∆ Director had geologists theory about prospect of oil; ∆ bought
700 shares on the market from Π SH
i. HELD: anonymous purchase on the market ok, especially where info
was highly speculative
iv. Fiduciary Duties of Insiders: Owed to:
1. Corporations (at common law)
2. Shareholders of Corporations
3. Actual or Potential Purchasers
4. The "Market" as a whole
v. Corporation's Perspective
1. Proprietary Information
a. Corporation will be willing to disclose proprietary information if it will help
the corporation make money HOWEVER
b. Corporation will not be willing to disclose certain proprietary information
such as trade secrets
i. SEC recognizes and allows proprietary information to be kept secret
2. General Public Information
a. Information that everyone knows
vi. Rule 10b-5 Liability
1. Insiders
a. Insiders Generally
i. Owe fiduciary duties to the issuing company (company whose shares
are being bought and sold)
b. Temporary insiders
i. Attorneys, accountants, etc. hired for certain transactions relating
to the issuing company leads to material nonpublic information
c. Tipper
i. Owes fiduciary duties to issuing company AND
ii. Personally benefits from disclosing the inside information
d. Tippee (normally has no fiduciary ties to issuing company)
i. Will be considered an "insider" if
1. Tipper personally benefits from giving the inside information
to tippee AND
2. Tippee knows or has reason to know that the tipper is
breaching a fiduciary
3. Protects market analysts
2. Prohibited conduct
a. Employ device, scheme, or artifice to defraud
b. Makes an untrue statement or omits statement of a material fact
i. Materiality
1. Reasonable investor would attach importance in determining
choice of action in the transaction
2. Can be inferred
3. Never litigated because everything is material OR
c. Engage in any act, practice, or course of business that operates as fraud or
deceit upon any person
i. Misappropriation Theory
1. Insider owes duty to SOURCE of information
2. Information is misappropriated to benefit of insider
3. WITHOUT disclosure to the source of information
4. In connection with purchase/sale of security
a. Diminishing protection of the market analysts
3. Causation Requirement
a. Must be in connection with the sale of a security
i. Inside information caused purchase or sale of security
4. If person acquires inside information:
a. Person must disclose such information OR abstain from trading
i. Must wait until information is disseminated before trading
1. Issue of fact
5. Tender Offers under 14e-3
a. Tender Offer
b. Material nonpublic information acquired from
i. Offering company OR
ii. Target Company
c. Must abstain from trading or refrain until such information is made public
vii. Case Law
1. SEC v. TGS—High mineral content kept secret from public; rumors begin; company
makes press release to quell rumors; stock goes up; selling goes on before
information is available to the public.
2. Chiarelli—A makes tender offer to B corporation; A hires printer; printer figures
out that B is the target company; buys B shares low and sells high after tender
offer raised price of stock. HELD: Printer was NOT an insider because printer had
no fiduciary duties to the issuing company, B, and information came from the
acquiring company
3. Dirks—Dirks (analyst/tippee) learns about A Corp. fraud from B (employee/tipper)
and Dirks tells clients and investors. Stock price dropped, Dirks prosecuted for
securities violations. HELD: Dirks was not an insider even though he was a tippee
because he did not know that B would personally benefit or B was breaching
fiduciary duties. POLICY: court is promoting disclosure of fraud to compensate for
market failure
4. O'Hagen—O worked for A law firm, B Corp. hires A for merger with C. O buys
target company stock before market price rises and made $4m in profit. HELD:
under misappropriation theory, O is liable—he owed fiduciary duties to A and failed
to disclose to A that he was using information from A to his benefit. Court follows
corrective justice approach

Whose Interest is What Underlying What Information is What Protects the Market Analysts?
at Stake? Theory? at Stake?

Corporation Corrective Justice Proprietary Labor and market information leads to material, nonpublic information
market analysts are advantageous to the analysts and their clients
Market Failure Non-proprietary
Shareholders Labor of market analysts might be UNFAIR advantage
Investor Confidence
(level playing field)

Market as a whole


i. Introduction
1. Section 16(b) applies to:
a. Officers, directors, or 10% "beneficial owner" of ANY class of stock
b. Restricted to 5M in assets and minimum 500 SH in a national exchange
c. Equities and convertibles
d. More than one purchase
e. Within 6 months
2. Remedy
a. All gains must be returned to the corporation
b. Court will construe transaction to get MOST money for corporation
3. Rationale
a. Investor Confidence Theory
i. Appearance of impropriety when directors, officers, and 10%
beneficial owners start buying and selling (churning)
ii. Prevent Churning the market and sending false signals
ii. TEST:
1. IF Officer, director, or 10% beneficial owner of stock
a. Beneficial owner of stock
i. Applies to convertible subordinated debentures
1. Debenture is an unsecured loan
2. Convertible into stock
3. Subordinate to other debentures
2. Participates in two "covered transaction" within six month period
a. Purchase  sale transaction
i. Buyer MUST be a 10% beneficial owner BEFORE the PURCHASE
ii. Buyer MUST be a 10% beneficial owner BEFORE the SALE
b. Transaction
i. Whether transaction is a "sale or purchase" depends on whether
transaction is one that gives rise to speculative abuse
1. Prevent insiders from trading on nonpublic, material
information (current law)
2. Whether transaction is a sale or purchase depends on
whether transaction is "churning" the market such that
others rely on the market activity (alternative theory)
c. Tender Offers
i. Buyer should wait until ALL shares are tendered before purchasing
to prolong the starting date of the 16(b) covered transactions
3. THEN gain realized from the transactions MUST be returned to the corporation
REGARDLESS of intent
iii. Case Law
1. Reliance Electric—A bought 13.2% B shares in a tender offer; A sold 3.24 shares;
then A sold remaining 9.96 shares—all within six months
a. HELD: A was liable for profits for selling 3.24 shares in first transaction
BUT A was NOT liable for selling remaining 9.96 shares because they were
NOT 10% beneficial owner of 10% shares at the time of the sale
2. Foremost—A wants to buyout B; Transaction 1: $40m and $7.25m in A debentures
transferred to B in October; Transaction 2: 25m shares in public sale and $22.25m
transferred to B. B then sells to underwriters—all within six months
a. HELD: B's purchase of A debentures in October were NOT covered
transaction because B was NOT a beneficial owner of 10% interest BEFORE
purchase of A debentures
3. Old Kern—A makes tender offer for 500,000 of B shares; extends offer to
1,000,000 which closes on June 1; B negotiates a "defensive merger" with C where
all B stocks convertible to C preferred stock; A, as owner of C stock grants D the
option of buying all C stock six months and one day after the original tender offer
was closed
a. HELD: neither the option agreement nor the merger was a covered
transaction because
i. A never had any inside information about anything

i. Proxy Fights
1. Soliciting Proxies
a. SH appoints agent to vote on behalf of that SH
i. Agent owes fiduciary duty to the SH relating to corporate
b. Subject to many regulations, both state and federal
ii. Case Law
1. Stroh—Promoters issue Class A and Class B stock; Class A (500,000 outstanding)
sold for $4/share and has residual rights and voting rights; Class B (500,000
outstanding) sold for $0.01/share and has only voting rights. Promoters bought up
all the Class B to have voting control. Minority SH of Class A sued to have court
declare that Class B stock was not stock so holders of Class B could not vote.
a. HELD: general rule is that one class of stock MUST have
i. Residual Rights AND
ii. Voting Rights
b. HERE, Class A had both; therefore, Class B could take any form under the
articles of incorporation
iii. Preemptive Rights
1. Power of existing SH to purchase a proportionate part of any newly issued shares
a. Rationale:
i. Protects voting power of existing SH by preventing dilution of vote
ii. Protects economic rights of existing SH by preventing the value of
SH stock to decrease
b. General Rule: Three Sources Where Preemptive Rights Attach
i. Newly authorized shares
ii. Previously authorized but not previously issued
iii. Treasury shares
c. Exception: Modern law allows corporation to dispense with preemptive rights
d. General Rule: Preemptive Rights DO NOT exist between classes of shares
i. Example of Preemptive Rights Scenario—A Corp issues 100,000 Class
A newly authorized shares. A 10% owner of Class A stock has rights
to 10% of newly authorized shares in A Corp, BUT would NOT have
rights to Class B shares
iv. Oppressive Issuance of Shares
1. Where SH issue number of shares knowing that other SH cannot buy, resulting in
dilution of the latter SH's vote
v. Blasius Standard: Duty of Loyalty Analysis for Shareholder Voting Issues
a. Π SH must show that the board acted for the primary purpose of thwarting
the exercise of a SH vote
i. Failing to give SH full and fair opportunity to vote
b. ∆ Board has the burden to demonstrate a compelling justification for its
c. IF Π SH fails to meet its initial burden of showing Board's primary purpose,
the BJR attaches (Duty of Care Analysis) UNLESS Π can show fraud,
illegality, conflict, etc. (Which would trigger the duty of loyalty analysis)