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Business Associations Outline: Professor Post

(Exam: one very long hypo, which covers everything we do over the semester and has 20 or so questions attached to it; there will be an extra credit question on Corporate Responsibility)

I. Intro:
A. Business Associations: the study of the means and devices by which business id conducted by either a single individual or cooperatively by a few or many individuals. The subject is broken down into unincorporated associations such as agency and partnership, and corporations. The Statutes: 1. The Uniform Partnership Act (1914) UPA* 2. The Uniform Partnership Act (1997 RUPA* 3. The Uniform Limited Liability Company Act (1996) 4. The Model Business Corporation Act (1969) particularly the financial provisions MBCA 5. The Model Business Corporation Act (1984) - RMBCA
*The Uniform Partnership Act (UPA) and the Revised Uniform Partnership Act (RUPA) are uniform acts model statutes proposed by the National Conference of Commissioners on Uniform State Laws ("NCCUSL") for the governance of business partnerships by U.S. States. Several versions of each have been promulgated, the earliest having been put forth in 1914, and the most recent in 1997. The 1914 version of the UPA was subsequently enacted into law in every state except Louisiana. The most recent revision has been enacted into law by more than 40 states.Both the UPA and the RUPA attempt to cover every conceivable detail of the business partnership, including formation, the ownership of partnership assets, the assessment of fiduciary duties, the settlement of partnership disputes, and termination.

In NJ, we have UPA 1997 (with some variations in numbering), and the statutory provision on this is tile 42 section 10 Ownership vs. Control in a Corp. The corp form allows for separation between beneficial economic interests and control. Day-to-day operations and long term strategy are typically handled by management, officers, directors and sometimes dominant shareholder(s). The division between ownership and control can be merely formal and in reality overlap a lot, as in the case of a closely held corps (but, closely held corp form is being replaced with LLCs). A Shareholder can pretty much have complete control w/o owning 100% of the shares (ie Ford-60%, Microsoft 40%) Since the shareholders have a riskier investment than bondholders, they usually get some sort of voting power, whereas bondholders dont. But bondholders can exercise negative control though indentures/covenants that prevent the corp from making risky investments for the sole benefit of the shareholders. Risk and return is better organized under the corp form.

Suppliers of corporate capital: Investors, providers of equity (shareholders) Lenders (bondholders, banks) Labor/Human capital (employees, contractors) Coordinators (managers) fiduciaries, like owners quasi-agents, they are employees closely aligned w/investors (ie officers and directors)
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Business Organization Choices: INSERT CHART FROM PAGE 180 OF THE CASE BOOK HERE

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Agency problem: irreducible divergence of interest between managers and owners (i.e. aligning with other employees on an issue, opposing a merger, level of compensation, sometimes less risk averse); solutions: stock options, other profit sharing schemes. Core questions turn on corporate governance. Who gets what? Who bears which risk? How is control exercised and transferred? Sole Proprietorship Owner of the business carries on the business as an individual. Debt Owner directly liable for all debts of the proprietorship. Tax Owner reports the tax as his own. Partnerships General Partnership UPA definition: an association of two or more persons to carry on as co-owners a business for profit Creation By operation of law Partnership can come into existence by operation of the law, without any filing of papers. Creation by estoppel If two people represent to the outside world that they are in partnership. See UPA 16. 1. Limited scope Applies only where 3d party extends credit to the partnership. Other forms of reliance inapplicable. Life Span Dissolution: Dissolves upon death, bankruptcy, or withdrawal of any partner. Absent an agreement, any partner may withdraw and demand liquidation. Liability to Outsiders Partners have unlimited liability, personal assets at risk for partnership obligations. Under some statutes liability of partnership contracts is joint, so partnership assets must first be exhausted. LLP Statutes Limit liability of partners for partnership debts and obligation, unless partner supervised another partner or agent engaged in wrongful conduct. Financial Rights Partners share equally in profits and losses, which are divided on dissolution. No statutory right to profits. No statutory right to compensation for services. Firm Governance Binding the firm: Each partner is an agent of all other partners and can bind the partnership, either by transacting business as agreed by the partners (actual authority) or by appearing in the eyes of 3d parties to carry on partnership business (apparent authority). Control of firm Unless otherwise agreed, majority vote needed to decide ordinary partnership matters. 1. Extraordinary matters or those contravening agreement require unanimity. Transferability of Ownership Interests Partner cannot transfer interest unless all remaining partners agree or partnership agreement permits it. Partner may transfer his financial interest in profits and distribution, entitling the transferee to a charging order. Limited Partnership Formation Must be created with written agreement among the partners and certificate filed
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with state official. RULPA 201. Dissolution Limited partnership lasts as long as the partners agree or, absent agreement, until a general partner withdraws. Nature 2 kinds of partners General Each liable for all debts of the partnership; 1. Corporate general partner General partners may be corporations. Limited Not liable for debts of partnership beyond their proportional share of contributions. 1. No mgmt. participation Liability to Outsiders General Partner Must be at least one unlimited liability Limited Partners Liable only to the extent of their investment. 1. No participation in control Firm Governance Binding firm: General partners have authority to bind the partnership to ordinary matters. 1. Limited partners have voting authority over specified matters, but cannot bind the partnership. Transferability of Ownership Interests General Partner Cannot transfer interest unless all remaining partners agree or partnership agreement permits it. Limited Partner Interests freely assignable. Both can assign their rights to profits and distributions. Limited Liability Company (LLC) Hybrid entity between corporation and partnership; Partnership aspects Members of LLC provide capital and manage the business according to their agreement; Interests are not freely transferable; Corporation aspects Members not personally liable for the debts of the LLC entity. Life Span LLC arises with the filing of a certificate or articles of organization with a state official. i) Many LLC statutes require at least two members. ii) Duration Not limited by statutes. Liability to Outsiders LLC members, both as capital contributors and managers, are not liable for LLC obligations. i) Veil-piercing Some LLC statutes suggest that members can become individually liable if equity or justice requires. Firm Governance i) Two Possibilities: (1) Member-managed; (2) Manager-Managed. Member-Managed Members have broad authority to bind LLC in much the same way as partners; Manager-Managed Members have no authority to bind. ii) Voting Generally in proportion to members capital contribution. Transferability of Ownership Interests Most LLC statutes provide that members cannot transfer LLC interests without all other members consent. i) Standing Consent Some LLC statutes permit the articles of organization to provide standing consent for new members.
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(ii)

Transfer of financial rights Many LLC statutes permit transfer of financial rights to creditors, who can obtain charging orders against the members interest.

Avoiding Double Taxation: S-Corporation What is it? Incorporated under state law and retains all its corporate attribute, including limited liability. But it is not subject to an entity tax. All corporate income, losses, deductions, and credits flow through to shareholders. Eligibility: Domestic S-Corp. must be domestic; 75 Shareholders No more than 75 indiv. shareholders; Certain tax-exempt entities can be shareholders, e.g. stock ownership plans, pension plans, charities. Aliens No shareholder can be a nonresident alien; One class of stock There can only be one class of stock. Limitation When heavy losses are anticipated, the S-Corp. may be less desirable than a partnership; S-Corp. shareholders can only write off losses up to the amount of capital they invested. Loss can be carried forward and recognized in future years. Rules on deductibility of passive losses may limit deductions for S-Corp. shareholders, just like partners in a partnership. Limited Partnership with a Corporate General Partner Combination Flow-through tax treatment + Limited liability Limited partner investors have limited liability. Participants Shareholders, directors, or officers of the corporation have limited corporate liability. Uncertainty When limited partners take on roles in corporate management participate in control by virtue of their corporate positions some courts interpreted early limited partnership statutes to make limited partners liable if they acted as directors and officers of a corporate general partner. Payment to shareholders of deductible compensation or interest Corporate tax in a small, closely held C-corporation can be zeroed out by paying shareholders deductible compensation or interest. Deductible compensation Shareholders-employees can receive salaries, bonuses, and contributions to profit-sharing plans, as long as they are reasonable. Constructive dividends If compensation is not related to the value of services, IRS can treat excess compensation as constructive dividends and the corporation loses its deduction, e.g. secretary gets $200K per year. Deductible interest Shareholder-lenders can receive deductible interest, rather than non-deductible dividends.
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Accumulating corporate earnings If corporate earnings are reinvested in the business and not distributed to shareholders, no federal income tax. Under current tax law, any gains from selling assets that have increased in value are taxed at the corporate level before the proceeds are distributed to shareholders, where they are taxed again. Nonetheless, it may be advantageous to let earnings accumulate in a business, at sometimes lower corporate tax rates.

B. Agency (See also the Restatement on p. 4-6 of the Casebook)


1. Introduction: Agency is a legal relationship that is crucial to any common law legal system because most of the work in the world is done by agents working for their principal. The law of agency covers both personal activities and business activities. You dont need the formalities of a contract or consideration in order to have an agency relationship, though they are very often present. Agency is a conductor of liability. Agency is an agreement by one person (an agent) to act for a principal at the principals direction and control. Either the principal or the agent can terminate the agency at any time in no event can the agency continue over the objection of one of the parties. 3 subdivisions of agency: the servant-agent the non-servant agent, and the non-agent Consequences of agency: One of the most crucial consequences is that any agency relationship creates heavy fiduciary duties running both ways. From the agent to the principal: is a duty to promptly and accurately account and disclose, the fiduciary duty of loyalty, which includes a duty not to compete with her principle, also anything the agent obtains as a result of her employment belongs to the principal, thus effectively a barring the retention of secret profits, advantages, and benefits absent the principals consent . From the principal to the agent: is a duty to compensate the agent, including reimbursing her for out of pocket costs, unless the parties contract otherwise. The principal also has a duty to cooperate with the agent and aid her in the performance of her duties. Remedies Available to the Principal: Damages: in tort for breach of fiduciary duty Action for secret profits: the actual profits recovered from them Rescission: any transaction that violates the agents fiduciary duty is voidable by the principal Other: include an accounting, or imposition of a constructive trust on property the agent obtained in violation of his fiduciary duties Remedies Available to the Agent: The agents lien: A lien is a charge upon, or interest in, property. Its a rough form of coownership. For example, your attorney is your non-servant agent. You cant tell her how to do her job. You can control the result, but not the exact process. A general rule is that an agent not paid what the principal promises to pay him may (emphasis on may) have a lien on property of the principal in his possession. Agents liens are crucial and attorneys liens are one of the most important. Who is an agent?: the manifestation of consent requirement is objective it doesnt matter what the principal truly intended, but rather, the agency relationship depends on what the agent
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believed the principal intended. Thus an agency relationship can arise even where the principal subjectively intended no such relationship. Moreover, agency power to bind the principle can arise even absent true mutual consent. Ways for an actual agency relationship to be formed: By agreement By ratification: occurs when the principal accepts the benefits or otherwise affirms the conduct of someone purporting to act for the principal, even though no actual agency agreement exists Agency by Estoppel: a principal may act in suach a way that a 3rd party reasonably believes that someone is the principals agent/ this is called agency by estoppel

2. Liability of Principal to 3rd Parties in Contract: after establishing that an agency relationship exists, a 3rd party wanting to hold the principal liable must demonstrate the scope of the agents authority to act for the principal. There are several sources of authority: i) Actual Authority: may be expressly conferred on the agent, or reasonably implies by custom, usage, or by the conduct of the principal to the agent. Such authority may be either expressed or implied. The principal is bound. a. Express Authority: is actual authority contained within the agency agreement (i.e. expressly granted by the principal); i.e. I want you to do/be responsible for tasks x, y, and z b. Implied Authority: comes from the words or conduct between the principal and the agent. It is often labeled to signify how it has arisen: a) incidental to express authority; b) implied from conduct; c) implied from custom/usage/habit; and d) implied because of emergency ii) Apparent Authority: results when a principal manifests to a 3rd party that an agent is authorized, and the 3rd party reasonably relies on the manifestation. There must be some holding out by the principal that causes a 3rd party to reasonably rely on the principals manifestation; suit by 3rd parties against the agent will disappear if the principal expressly, implicitly, or by conduct ratifies or adopts the contract. This action will make it as if there was actual authority from the beginning. But if the board of directors does not ratify, 3rd party has a cause of action in restitution against agent. Current approach in the courts: they stretch and strain to protect the expectations of 3rd parties even when the principals manifestations of consent were illusory at best. a. Rationale: it is easier/more efficient to make the principal responsible for keeping track of her agents as opposed to having the court do it iii) Inherent Agency Power: not well defined, but is thought to be analogous to the doctrine or respondeat superior in torts. Recognizes that it is inevitable that in the course of performing her duties, either by mistake, negligence, or misinterpretation of her instruction, an agent may harm a 3rd party or deal with one in an unauthorized manner. It is an agency power that raises even in the absence of actual or apparent authority or by estoppel. It arises from the designation by the principal of a kind of agent who ordinarily possesses certain powers. The doctrine is based on a reasonable foreseeability rationale. The test is whether the principal could reasonably foresee that an agent would take the action she did; often based on the agents title (i.e. if youre a Buyer, you can be expected to have the power to buy stuff) iv) Ratification: A person may affirm of ratify a prior act supposedly done on his behalf by another by another that was not authorized at the time it was performed. Ratification causes the agents act to be treated as if the principal had authorized it at the outset.
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v)

Authority by Estoppel: When a principal negligently or intentionally causes a 3rd party to believe that his agent has authority to do an act that is actually beyond his authority, and the 3rd party detrimentally relies on the principals conduct, the principal is estopped from denying the agents authority. Estoppel is different from apparent authority in that apparent authority makes the principal a contracting party with the 3rd party with rights and liabilities on both sides. In contrast, estoppel only compensates the 3rd party for losses arising from the 3rd partys reliance; it creates no enforcement rights in the principal against the 3rd party.

3. Agents Liability on the Contract: an agents liability on a contract depends on the statue of his principal i) Disclosed Principal: an agent who purports to contract for a disclosed principal is not personally liable on the contract. In such a case, the agent negotiates the contract in the name of the principal, and the agent is not a party to the contract. The parties intent is that the principal be bound. Undisclosed or Partially Disclosed Principal: both the fact of agency and the principals identity are not disclosed. In the partially disclosed principal cases, the 3rd party knows that the agent is acting as an agent, but does not know the identity of the principal. An agent acting on behalf of an undisclosed principal is personally liable on the contract itself. Courts generally apply the same rule in partially disclosed principal cases. If the agent has signed or described himself as an agent for an undisclosed person, he is personally liable on the contract unless otherwise agreed.

ii)

4. Liability of Principal to 3rd Parties in Tort: issue is a question of fact i) Master-Servant: involves a servant, who, under the control of her master, renders some sort of service. The master- servant relationship is precisely the same thing as common law employee. This relationship is more commonly referred to as Employer-Employee now. Control is the essential feature of this relationship. The employer retains control over the manner in which the employee performs services. If the principal has legal power to control the agents time allocation as well as how and when the agent works, then the person is a servant-agent. This comes up in tax and other statutes that refer to the word employee. Notice to a sufficiently important agent of a principal is notice to the principal itself at common law a. Respondeat superior: Respondeat superior Let the master answer. What is this doctrine? If you have (1) a servant-agent, (2) acting within the scope of employment, (3) who commits a tort, the actor is liable, but, in addition, the master (the principal) is liable even if the master is without fault. The related tort doctrine says that if the principal was negligent in hiring, training, or failing to fire the agent, then you can sue the principal in tort. b. Application to Corporate Board Members: If a person is a director and only a director, then that person is not any type of agent because an agent is one who agrees to act for the principal and at the principals control and direction. This definition doesnt fit a director, because they are the ones who determine the principals policies! This has practical ramifications: there is no wage withholding from the pay of directors. They get a check from the company and they have to pay by declaration of estimated tax. Furthermore, in almost all states, a person who is a director and only a director is not covered by Workers Compensation or Equal Employment statutes. Is the top officer of a corporation a servant-agent? Yes. If you carefully go through the definition, youll find that the principal is the board of directors in this case. They have the legal power to allocate the time of the president. The president of a
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corporation is a servant-agent. The presidents salary is withheld, and the president is covered by Workers Comp and Equal Employment statutes. c. Application to General Partnerships: The partners, acting together, determine the partnership policy. Thus, a partner of a partnership is not an employee of the partnership and has no wage withholding. ii) Independent Contractors aka Non-Agent Servants: arises when a principal retains someone to do a certain job or achieve a specific objective. The principal retains no right of control over the independent contractor as to how the work is performed. The independent contractor determines for herself how she will achieve the end goal. a. Respondeat superior: is built upon the premise that where there is a servant-agent over whom the principal has the legal power over their physical activities, the principal is liable whether or not he is negligent in hiring and training that agent. On the other hand, respondeat superior doesnt apply to a non-servant agent, though some other theory like negligent hiring may apply. Officers of corporations are servantagents, but directors or outside law firms are not servant-agents. b. Defining servant versus independent contractor: Restatement 1. The extent of control to which, by the agreement, the master may exercise over the details of the work. 2. Whether or not the one employed is engaged in a distinct occupation or business. 3. The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the employer or by a specialist without supervision. 4. The skill required in the particular occupation. 5. Whether the workman or the employer supplies the instrumentalities, tools, and place of work for the person doing the work. 6. The length of time for which the person is employed. 7. The method of payment, whether by time or for the job. 8. Whether or not the work is part of the regular business of the employer. 9. Whether or not the parties believe they are creating the relationship of master and servant. 10. Whether the principal is or is not in business.

The Partnership statutes change the Agency relationship every partner is an agent of the partnership and of every other partner Hypothecate: To pledge property as security for a debt without giving up possession or title. The pledged property is said to be hypothecated. For example, a savings or trust account that is pledged or assigned as collateral for a loan is called a hypothecated account.

II. Partnerships Intro: A partnership is treated both as a separate entity from its partners (for some purposes) and as though
there is no separate entity but merely an aggregate of separate, individual partners. The partners are jointly and severally liable for the obligations of the partnership per UPA 15. And for federal income tax purposes, the income and losses of the partnership are attributed to the individual partner; the partnership itself does not pay taxes. RUPA 201 expressly states that a partnerships is an entity, thus simplifying many partnership rules such as those on property ownership and litigation.

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Uniform Partnership Act: UPA 6, 7, 9, 15, 16, 18 controlling law governing general partnerships most states adopt UPA even though it is a matter of state law greater uniformity than corp law you cant avoid general partnership status just by labeling if youre associated as joint owners; statements that no partnership is intended are not conclusive UPA 6: Partnership Defined an association of two or more personas to carry on a business as co-owners for profit. A lawful partnership cannot be formed for nonprofit purposes. Agreement to Form a Partnership: Formalities: if the partnership is to continue beyond one year, the Statute of Frauds requires that the agreement be written Duration: If no term is specified, then the partnership is terminable at the will of any partner Capacity to become a partner: persons must have the capacity to contract; some states hold that corporations cannot be partners Consent of the parties: a prospective partner must have the consent of all of the other prospective partners UPA 18(g) Intent of the parties: where there is any question, the intent of the parties involved is determined from all of the circumstances per UPA 7 UPA 7: Formation (1) Persons who are not partners as to each other are not partners as to 3rd parties Receiving a share in the profits is prima facie evidence of a partnership Contract can be either express or implied No filing is necessary Knowledge that youre partners is not necessary UPA 9: Relationship between partners and the partnership every partner is an agent, which carries with it a fiduciary duty to act fairly and honestly UPA 15: Liability Joint and severable unlimited personal liability; misconduct of one partner could result in the financial ruin of fellow partners UPA 18: starts with language subject to any agreement between partners (a): Profit/Loss evenly divided, equally allocated; each partner is a residual claimant; even where one person is providing only capital and the other only services (e): Ownership & Management equal (g): New Members unanimous consent of all the partners is required (h): Dispute Resolution ordinary matters = majority decides; other matters = requires unanimity UPA 31: Exit Right at will dissolution (if no writing for the original agreement) UPA 33: Exit Effect dissolution terminates all authority of any partner to act for the partnership RUPA 202 Formation of Partnership requires only a statutorily specified mutual manifestation of consent (a): The association of 2 or more persons to carry on as co-owners a business for profit forms a partnership whether or not the persons intended to form a partnership (b): An association formed under a statute other than this one, a predecessor statute, or a comparable statute of another jurisdiction is not a partnership under this Act
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(c): In determining whether a partnership is formed, the following rules apply o (3) if you share profits, you are presumed to be a partner unless one of the exceptions applies (exception= where profit sharing does not = partner) see second box below (d)(2): Sharing profits/returns does not by itself establish a partnership

To establish partnership: 4 Part Test (all parts must be met) 1. an agreement to share profits 2. an agreement to share losses 3. a mutual right of control or management of the business; and 4. a community of interest in the venture *Used in the absence of an agreement Way to tackle the question of whether a partnership exists move from UPA 7 to 6 1. Partnership is a matter of contract 2. And so it is a matter of objective intent of the parties 3. Is there a prima facie case of partnership; did they share risk like co-owners; did they share control the way co-owners do? Set up all the facts that lead you to your conclusion 4. What are the possible other classifications/whats the other side of your agrument finding a partnership 5. Talk about the defintion of a partnership Problems with Partnership Law: a partnership can be formed by conduct, rather than conscious decision If you share risk and share control can be treated as a partner absent explicit agreement outside of exceptions RUPA 202(c)(1)-(3)(i)-(vi) o (i) as a debt by installments or otherwise, o (ii) as wages of an employee or rent to a landlord, o (iii) of rent o (iv) as an annuity to a widow or representative of a deceased partner, o (v) as interest on a loan, and o (vi) as the consideration for the sale of a good-will of a business Once a partnership is created, each partner shares losses with unlimited liability [ie sued, all bear losses] To avoid these problems, best to have a partnership agreement so that those who are partners know it and those who arent also know The Need for a Written Agreement: Although there is no requirement that a partnership agreement be in writing, there are several advantages to doing so It may avoid future disagreements Can be readily proved in court May point out potential trouble spots Facilitates allocation of tax burdens among themselves Resolves death and/or retirement issues Clarifies whether investments are lent rather than contributed Satisfies the Statute of Frauds where real estate is involved Assumed name statutes: If you are doing business under an assumed name, you are supposed to file an assumed name certificate. As to a partnership, the statute is especially demanding in that, if you are a
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partnership and the firm name contains less than all of the names of all of the partners, the county recorder is not to accept real estate documents unless there is an assumed name certificate filed. If the firm name is Smith & Jones and there is only Smith and only Jones, youre okay. Sharing of Profits and Losses: I. Profits of a business may be divided by agreement in numerous possible ways including: The partners may share on a flat percentage basis without regard to any other factor. Profit sharing ratios for each partner may be established in the partnership agreement itself. They may also be established by issuing partnership units to each partner and determining the profit-or loss-sharing ratio for each partner by dividing the number of units owned by that partner by the total number of units outstanding. One or more partners may be entitled to a fixed weekly or monthly salary. The partners may share on a percentage basis: o with the percentages recomputed each year on the basis of the average amount invested in the business during the year by each partner. o with the percentages recomputed each year on the basis of total income, the sales or billing by each partner, time devoted to the business, or on the basis of some other factor. In large partnerships, each partner may be entitled to a fixed percentage applied against perhaps 80 percent of the income. The remaining 20 percent is allocated among the junior partners as a form of incentive compensation etc. The agreement may remain silent on the division of profits, it being contemplated each year that the partners will work out the division of profits by agreement on a mutually acceptable basis. RUPA 401(b) creates the presumption that profits are to be divided equally among partners Note: If no partnership agreement, look to the default rules. The default rule per UPA 18(a) is: profits are shared equally. Losses are shared in the same manner as profits. II. Responsibility for losses RUPA 401(b) provides that losses are divided according to each partners assigned share of the profits LLP: its unique feature is that by electing LLP status partners may avoid personal liability for partnership claims that cannot be satisfied from partnership assets. o Always some possibility that partners may become liable to third persons because of their own conduct. Joint liability requires joinder of all partners as defendants in litigation. o Joint and several liability permits suit to be brought against one or more of the partners without them all. Judgment creditors/3rd parties are required to first exhaust partnership assets before proceeding directly against the assets of one or more of the partners. RUPA 301-8 o There is liability for a 3rd party who enters into a contract with the partnership when the contract is for something in the ordinary course of that partnerships business o The partnership can contest and avoid liability if it can show there was, in fact, no authority or there was notice that there was no authority
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A partnership is an entity separate from the original partners (important for procedural requirements) In some cases, dealing with the partners not discussing the sharing of losses, the courts have ruled that the absence of an express agreement to share losses indicated that no partnership was ever created in the first place. o However, some courts have recognized that an express agreement to share losses is not essential for the existence of a partnership. {see UPA 7 and RUPA 202(c)(3)). Richert v. Handly I (p. 30) o Issue: Who bears the loss when a partnership enters into an agreement where the partners agreed to share equally in the profits and the losses from a venture, the venture suffers a loss and one of the partners sues for reimbursement of his capital contribution? o Rule: The cause must be remanded with directions to make findings regarding the basis on which the parties agreed that the losses were to be shared and whether the claims of one partner were to take priority over the claims of the other. Richert v. Handly III (p. 33) o Issue: Should one party be compensated over the other party in a partnership suffering a loss when there was no agreement between the parties to whether the parties losses would be shared, whether one partys losses were to take priority over the other, whether one of the parties was to be compensated for his services, or an agreement showing how the loss of capital by one party was to be borne? o Rule: Since the agreement did not specify how the losses would be shared or whether one partners claims were to take priority over the claims of the other, UPA 18(a), 18(f) are controlling. UPA 18(a): Each partner shall be repaid his contributions, whether by way of capital or advances to the partnership property and share equal in the profits and surplus remaining after all liabilities, including those to partners, are satisfied; and must contribute towards the losses, whether of capital or otherwise, sustained by the partnership according to his share in the profits. UPA 18(f): No partner is entitled to remuneration for acting in the e partnership business, except that a surviving partner is entitled to reasonable compensation for his services in winding up the partnership affairs. (service/capital ) Ct. screwed up the math. Should return capital, then force contribution. Class notes: o Leasing remains the same in capital account o Partnership law runs into problems when one person puts in capital and the other partner puts in services. Solution: you can put into the written agreement that capital account will go up with services provided. (try to give credit for labor in written agreement) In Kessler v. Antinora, Agreement said will share profits 60/40 but silent on losses. Court allowed labor to contribute. Employee or Partner?: If there is confusion as to whether one is an employee, look to employment K If no K, do analysis:
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o Is employee sharing losses? o Is employee sharing control? Might be think about what actions they do contribute to business o Policy: Cuts in favor of not making employee a partner unless explicit K because people might otherwise avoid certain jobs if it means risking losses

A. Fiduciary Obligations of Partners


The RUPA approaches the fiduciary duty issue very differently from the UPA; it attempts to diminish the vague, broad statements and uncertainty of the latter. Fiduciary Duties: UPA 20-22; RUPA 403-405; 603 (duties during dissolution) The Duty of Care: not big in partnerships because the assumption is that all partners are actively involved in the running of the business; The standard here is gross negligence rather than just negligence; essentially the duty of care owed in corporate law applied to partnerships o Business Judgment Rule: a presumption created that business judgment makers were doing their best for the business; so, it is the Ps burden to rebut this presumption; good-faith, fully informed, & acted in the best interest of the corporation The Duty of Loyalty: RUPA 404(b) a partners duty of loyalty to the partnership and the other partners is limited to: o (1): Cant appropriate a partnership opportunity o (2): Cant act as or on behalf of an adverse party o (3): Cant compete with the partnership/partners Bane v. Ferguson (p. 49): Issue is whether retired partner has claim against firm for loss of pension. Firm merged into larger firm and went out of business. P first theory of recovery was under UPA 9(3)(c) one or more partners can not commit act that would make it impossible to carry out ordinary business of partnership. 2nd was violation of fiduciary duty to him. Held: Bane was no longer partner, therefore no fiduciary duty was owed to him. Business judgment rule: if judgment is exercised within reasonable range of business judgment and turns out to be the wrong decision, there is no liability; Rationale: no second guessing and allows people to make decisions. Meinhard v. Salmon (p. 67): A person named Gerry leased Hotel Bristol to Salmon. Salmon needed monies and asked Meinhard for funds. Meinhard agreed and Salmon was to pay him a portion of the profits upon a time basis. The two were coadventurers. The majority of the duties fell upon Salmon. They were not partners on paper. After the end of the lease of the Hotel, the new owner of the hotel wanted to do some construction and the owner needed someone to help w/ his idea. Owner approached Salmon and went ahead w/ a deal w/ Owner w/out informing Meinhard. Meinhard found out after the fact about the deal and he sued Salmon for profits on the new deal. Analysis: Rule: Joint adventurers, like co-partners, owe to one another, while the enterprise continues, the duty of loyalty. Salmon owed a duty of loyalty to inform Meinhard of the deal to allow Meinhard to compete. RUPA 404 (a & b1) General Standards of Partners Conduct Holding/Rule:
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Court found that Salmon breached his duty of loyalty to Meinhard, who the court looked at as a partner. Meinhard recovers under fiduciary duty. Salmon had a heightened duty/obligation to Meinhard b/c Salmon had the day to day dealings of the business or control of the business. Joint adventurers owe to one another, while their enterprise continues, the duty of finest loyalty, a standard of behavior most sensitive Dissent: Disagrees on the basis that the arrangement between Meinhard and Salmon was a limited arrangement, limited to the adventure and there was not duty.

Should you be able to contract out of your fiduciary duty? No, partnership is the one business agreement where the parties are totally vulnerable to each other; to disallow contracting out would protect each from the other; to allow it would invite unscrupulous behavior There are certain relationships that carry legal fiduciary duties (lawyers & clients, trustees & clients, and partnerships) mostly because of this issue of vulnerability RUPA 103(b)(3) says that partners cant agree to void fiduciary duties except: They may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable; or All, a number, or a percentage of the partners may authorize or ratify, after full disclosure of all material fact, a specific act or transaction that otherwise would violate the duty of loyalty NJ Statue on fiduciary obligations: Partners cant restrict access to books and records unreasonably to other partners Duty of Loyalty cant agree to let one partner intentionally harm the partnership; cant be reduced so as to allow a partner to do anything injurious to the other Duty of Care cant unreasonably reduce the standard of care B. Partnership Property - UPA 24-28 A frequent issue involves whether property is partnership property of the individual property of a partner. All property originally brought into the partnership or subsequently acquired, by purchase or otherwise, for the partnership is partnership property per UPA 8(1). Where there is no clear intention expressed as to whether property is partnership property, then courts consider all of the facts related to the acquisition and ownership of the asset in question. Some of the factors considered are: How title to the property is held Whether partnership funds were used in the purchase of the property Whether partnerships funds have been used to improve the property How central the property is to the partnerships purposes How frequent and extensive the partnerships use is of the property; and Whether the property is accounted for on the financial records of the partnership Rights and Interests: Individual partners interest in the partnership: the property rights of an individual partner in the partnership property are 1) her rights in specific partnership property; 2) her interest in the partnership; and 3) her right to participate in the management of the partnership UPA 24
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o Rights in specific partnership property: each partner is a tenant-in-partnership with her co-partners as to each asset of the partnership per UPA 25(1). The incidents of this tenancy are as follows: Each partner has an equal right to possession for partnership purposes The right to possession is no assignable, except when done by all of the partners individually or by the partnership as an entity The right is not subject to attachment or execution except on a claim against the partnership The right is not community property, hence it is not subject to family allowances, dower, etc. On the death of a partner, the right vests in the surviving partners 25: o (1): A partner is co-owner with his partners of specific partnership property holding as a tenant in partnership o (2): This means that (a): Each partner, subject to this act and any agreement between the parties, has an equal right to possessor specific partnership property for partnership purposes; but he has no right to possess such property for any other purpose without the consent of his partners (b): The right of a partner as co-owner in specific partnership property is not separately assignable (c): Partnership property cannot be attached/executed towards the debts of an individual partner; if the property is attached/executed towards the debts of the partnership as a whole, it cannot be protected via the homestead or exemption laws (d): On the death of a partner, the other partners and not the executors of the deceased partners will/estate can have a right to wind up the partnership affairs except when the deceased partner was the last surviving one, when his right in such property vest in his legal representative Partners interest in the partnership: is her share of the profits and surplus, which is personal property per UPA 26 even if it is real property that the firm owns o Consequences of classification as personal property: the partners rights to any individual property held by the partnership are equitable (the partnership holds title), and this equitable interest is converted into a personal property interest. This can be important in the inheritance situations where real property may be given to one heir and personal property to another o Assignments: a partner may assign her interest in the partnership (unless there is a provision in the partnership agreement to the contrary), and unless the agreement provides otherwise, such and assignment will not dissolve the partnership per UPA 27(1) The assignee has no right to participate in the management of the partnership (i.e. he is not a partner ) But the assignee is liable for partnership obligations

Creditors rights: a creditor of an individual partner may not attach partnership assets. He must get a judgment against the partner and then proceed against the individual partners interests Third party claims against partnership property:
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UPA 25(1) Partnership owned by partners as tenants in partnership. 25(2) Partner cannot possess or assign rights in partnership property, partners heirs cannot inherit it, and a partners creditors cannot attach or execute upon it. UPA Contributors of equity capital do not own the assets themselves but rather own the rights to the net financial returns that these assets generate, as well as certain governance or management rights. 26 and 27 Individual creditors of partners (e.g., banks that have made personal loans to partners) are permitted to obtain charging orders which are liens on partners transferable interests that are subject to foreclosure unless redeemed by payment of debt. 28

RUPA RUPA abandoned the transparent fiction of joint partner ownership of property entirely in favor of straightforward entity ownership in 501 and 502. 501 states that partners are not co-owners of partnership property. 502 states partners transferable interest in the partnership. RUPA Contributors of equity capital do not own the assets themselves but rather own the rights to the net financial returns that these assets generate, as well as certain governance or management rights. 502 and 503 Individual creditors of partners (e.g., banks that have made personal loans to partners) are permitted to obtain charging orders which are liens on partners transferable interests that are subject to foreclosure unless redeemed by payment of debt. 504

A general partners personal assets are considered part of the general fund to which a bankruptcy estate may look to satisfy partnership debts. Jingle Rule (used by UPA) Partnership creditors have first priority in the assets of the partnership. Individual creditors have first priority in the assets of the individual. Parity Rule (used by RUPA) Partnership creditors have first priority in the assets of the partnership. Partnership creditors are placed on parity with individual creditors in allocating assets of an individual partner when a partnership is bankrupt.

C. Inadvertent Partnerships: There is no such thing as an inadvertent LLC or corporation.


A recurring issue in partnership law is whether an arrangement between persons may unintentionally constitute a partnership so that a creditor who dealt with A may force B to pay its claim. At common law, a sharing of profits was often deemed conclusive of the existence of a partnership. UPA states that profit sharing is prima facie evidence of a partnership RUPA states that a person who receives a share of the profits of a business is presumed to be a partner UPA 16 (1)-(2)

Martin v. Peyton (p. 125): Facts: Peyton (D) and others (D) loaned a partnership money so that it could carry on its brokerage business. Rule: While words are not determinative, where a transaction bears all of the aspects of a loan, no partnership arrangement will be found.
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Smith v. Kelly (p. 129): Facts: Smith (P) was hired by Kelly (D) and Galloway (D), partners in an accounting firm. Smith later claimed to be a partner in the firm, with a right to share in its profits. Rule: Unless the rights of third parties are involved, a partnership cannot exist in the absence of an intention to create it. Young v. Jones: Facts: Investors claim that they lost $550,000 in capital as a result of Price WaterhouseBahamas (D) negligent conducting of an audit and related documents upon which the investors (P) relied to their detriment. Rule: Persons who represent themselves, or allow others to represent them to third parties as a partner in either an existing partnership or with other parties who are not their true partners, are liable to any third persons who relied to their detriment on the existence of that apparent partnership. UPA 7(1): Persons who are not partners as to each other are not partners as to third persons. UPA 16(1): Partnership by Estoppel One who holds herself out to be a partner, or who expressly or impliedly consents to representations that she is such a partner, is liable to any 3rd person who extends credit in good-faith reliance on such representations Liability of partners who represent others to be partners: if persons making above representations is part of an actual partnership, then she is an agent of that partnership and binds the partnerships to contracts she makes if there is no such partnership in existence, only agent is bound to the contract

A. Managing the Partnership


Absent an agreement to the contrary, partners in a partnership have equal rights to participate in the management of the business. The default rule is that if there is a vote taken on specific matters, each partner has one vote and the majority decision controls in the absence of an agreement to the contrary. The partnership agreement may create classes of partners with different voting and financial rights. Partners have apparent and actual authority to bind the partnership to obligations relating to the business of the partnership. Thus, a partner may bind the partnership on obligations he or she was not authorized to create.

National Biscuit Company v. Stroud (p. 55): Here we have a 50-50 two-man partnership running a grocery store. The first partner said: Dont buy from X. The second partner continued to buy from X, who knew about the dispute. There could be no apparent authority. Instead, it sounds like inherent authority. One partner can bind the partnership since the other partner didnt control the majority (even if they have a 2 party partnership). If theyve got a disagreement and a 3rd person has knowledge of it, the partnership can, but usually wont, be bound. If 3rd party didnt know of the disagreement, it is clear that it will be binding on the partnership. Rule: They read UPA 18(e) & (h), which says that when you have a deadlock among partners on this particular issue, any partner has actual authority for any typical transaction. Substantially the same result would have been reached under restitution. But the court upheld the contract. The acts of a partner, if performed on behalf of the partnership and within the scope of its business, are binding upon all co-partners UPA 15: all partners are jointly and severely liable for the acts and obligations of the partnership. Smith v. Dixon (p. 56): Under UPA 9, limits are imposed on partnership. Facts: Smith (D), manager of a partnership consisting of his family members (D), agreed to sell land to Dixon (P). the other members of the
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partnership later refused to convey the property. Rule: The acts of a partner are biding upon the partnership if he acted within the scope, or apparent scope, of his authority only. Rouse v. Pollard (p. 59): Facts: Here we had a very prestigious New Jersey firm. A partner, Fitzsimmons (D), decided he wasnt making enough from the firm alone. He started confidential conferences with rich old ladies and told them he was running his own private investment operation on the side. D promised to invest Mrs. Rouses (P) money for her but, in fact, converted it to his own use. P sues partnership. Rule: Partners are liable for the acts of the co-partners only if those acts are within the scope of the partnerships business. Roach v. Mead (p. 62): Facts: Berentson (D) contended he was not vicariously liable for the negligent acts of his partner, Mead (D), because such acts were outside the scope of the partnerships business. Rule: Each partner is responsible to 3rd parties for the acts of the other partners when such could reasonably have been thought by the 3rd party to fall within the purpose of the partnership. Partnership Accounting: A capital account essentially sets forth the partners ownership interest in the partnership. A partners capital account equals the capital contributed by the partner less the amount of any distributions to the partner plus the partners share of the profits less the partners share of the losses. The standard set of accounting principles that forms the norm for financial reporting in the United States is known as Generally Accepted Accounting Principles (GAAP). o GAAP accounting is accrual accounting. If you sell something on credit, you take in the income and you increase the capital account immediately. In other words, you accrue immediately. For tax purposes, any business using an inventory must use the accrual method. What does the Internal Revenue Code provide as to professionals? For service professions, regardless of income, you can use the cash method, that is, accounts receivable are neither an asset nor income until they are collected. The capital account will not reflect unrealized receivables. If you are on the accrual method, the capital account will reflect such receivables. Independent CPAs will certify statements on the cash method, but they will put legends on the statements saying that a non-GAAP method is being used. The pure cash method is not a traditional GAAP method. These principles must also be followed by most publicly held corporations when publicly reporting results Accounting in large business involves two basic functions: o The entering of records of transactions as they occur and o The subsequent determination and reporting of results of operations on a periodic basis (quarterly or annually) Equity = Assets - Liabilities. This means that the net worth of a business is equal to its assets less its liabilities. There are four fundamental premises underlying financial accounting: o Financial accounting assumes that the business that is the subject of the financial statements is an entity o All entries have to be in terms of dollars o A balance sheet has to balanced o Every transaction entered into by a business must be recorded in at least two ways if the balance sheet is to continue to balance.
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The Balance Sheet: Assets = Liabilities + Equity (Balance sheet equation.) The asset side of a balance sheet is sometimes referred to as the left-hand side. The liability/equity side is sometimes called the right-hand side. A balance sheet must balance and must be in terms of dollars. Transactions must be recorded in at least two ways. Left hand side (assets) may be divided into two categories: o Current assets: consist of cash plus other assets that normally may be expected to turn into cash w/in a year, including cash (and cash equivalents, such as certificates of deposit, Treasury bills, etc.), marketable securities, accounts receivable, and inventories (raw materials, partially finished goods, finished goods); and o Non-current assets: consist of all assets that are not classified as current and include a variety of different items, including fixed assets (property, buildings, equipment). Because these things depreciate, accumulated depreciation appears as an offset. Right hand side (current liabilities) include: accounts payable, notes payable, accrued expenses payable -Long-term liabilities include: mortgages and debentures Stockholders equity is the balancing factor between assets and liabilities on the balancing sheet. Balance sheets do not say much to the true value of the business - they do not include intangible assets (i.e. any item of intellectual property is an intangible asset) Accounting for Profits and Losses: Income = Revenues Expenses Profit and loss items are reflected on the balance sheet as changes in owners equity. Income Statement: measures what a company burns or gains from day to day over a period of time. Journal Entries: Debit means left-hand; credit means right-hand. Ledger or T Accounts: All debits go on the left side, all credits go on the right side. Usually there is a separate T account for each item on the balance sheet, and as entries are made in the journal they are also entered on the appropriate T account. Law Firm Partnerships: in recent years, possibly because of economic pressure, law firms have begun to swing away from lock-step systems of partner compensation. Less emphasis is being place don tenure and seniority, and more consideration is being given to merit performance and attraction of new business. Among the various compensation schemes, several factors govern the size of individual allocations. The following are perhaps the most common: Productivity and billable hours: with special recognition of those who regularly contribute the most billed and collected hours New business: credit given for production of new business is usually a percentage of the total fees generated by the new business and continues for a predetermined period of time Client liaison: recognition given for efforts to retain the larger clients, although those efforts dont produce an discernable, tangible results Practice economics: recognition for prompt billing, client matter planning & control, accounts receivable follow-up & cash collection, fees received from clients, other fees directly resulting from partners work, profitability by type of law, avoiding write-offs, and overhead control
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Management, administration, training, and supervision: recognition given to effective work delegation, supervision and good staff relations Marketing advancement: recognition for firm promotion, enhancement of the firms public and professional image and the pursuit of specific marketing opportunities (i.e. figure heads)

Leveraging: firms have thus had every incentive to grow rapidly by increasing the number of associates relative to the number of partners, this process is known as leveraging Two-Tiered Partnerships: caused by the downswing in the economy Income Partners: are paid a salary that is not contingent on their firms profits; are entitled to many of the same benefits as equity partners, but there are differences; they attain partnership status without assuming any risk; their rights are many and can be found on p. 41 of the casebook Equity Partners: are owners of their firms and share in the profits The Gunderson Effect: throwing more money at first year associates to attract and keep them which spread across the country and into all areas of legal practice; the various effects of this phenomenon can be found on p. 45 of the casebook Sweat Bonuses: widely used arrangements within law firms by which associates receive extra bonuses in a year if they record more than a specified number of billable hours. Lampert, Hausler & Rodman PC v. John F. Gallant, et al (p. 103): what is the issue in this case? Their business is practicing law; fighting with each other over the righ to the proceeds from contingency cases; everything depends on what the partners initial agreement was and what fiduciary duties each owes to the other; law practices cant enforce non-compete covenants on each other b/c it interferes with the clients right to choose their own counsel Meehan v. Shaughnessy (p. 104): This is an unusual partnership agreement in that it lumps rightful and wrongful dissolution together and provides what is going to happen. The court looks at the agreement and basically ratifies the agreement. It sees no conflict between the agreement and the UPA. In this case, some of the partners went to young associates and solicited business for their new firm. They held that the old per se rule of setting up shop while being employed didnt apply to a law firm because at a law firm the main parties to be protected are the clients, and the clients cant get good service unless there is work up front. The court found a violation, holding that the old partners had a right to have their solicitation sent to the clients at the same time that the departing partners sent theirs. Note that you cant forcibly take clients with you. Gibbs v. Breed, Abbott & Morgan (p. 107): question is how do you play nice when you are breaking up? and whats required to be nice?; In Gibbs, a case involving the question whether departing law firm partners had breached fiduciary duties they owed to the partnership; Two attorneys, Charles F. Gibbs and Robert W. Sheehan, were partners of Breed, Abbott & Morgan (Breed, Abbott) specializing in trusts and estates. They withdrew from Breed, Abbott in 1991 to join Chadbourne & Parke (Chadbourne). At the time, they were the only active partners in the Breed, Abbott trusts and estates department. What are the rules with respect to soliciting clients when leaving a firm? Issue No. 1: Commencing at a point before they announced their intent to others in their firm, the fiduciaries (partners in the Gibbs case; officers and directors in Duane Jones and Lord, Geller) discussed among themselves plans to depart and take some of the business of the enterprise with them (a law practice in Gibbs; an advertising business in Duane Jones and Lord, Geller). Issue No. 2: The departing fiduciaries took with them confidential information relating to firm clients.
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Conclusion: The Appellate Division decision in Gibbs is troublesome for two reasons: (i) It recognizes a right of partners withdrawing from a law firm to plan among themselves their departure and their taking of clients of the firm (and to discuss these plans with competing law firms) without first announcing to their partners their intention to do so. (ii) The decision allows departing partners to take with them confidential information involving firm clients without first reviewing that information with their partners. Historically, the standard of fiduciary duty owed by departing law partners to their firm has taken into account the public policy of supporting clients' freedom of choice among lawyers. This public policy does not apply to executives in business enterprises generally. Similarly specific agreement should be made with regard to the process of review of any files and other material that is confidential in nature. Obviously, law firms are under constraints as to what they can do in this regard that general business enterprises are not. General business enterprises, in contrast to law firms, frequently require no-compete agreements as well as non-solicitation and confidentiality agreements. It behooves all enterprises seeking to protect their businesses to review what they can and cannot do under applicable law and to implement reasonable agreements to protect the enterprise in this regard.

B. Dissolution UPA 29-43


Dissolution: the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business UPA 29 Dissolution of a partnership does not immediately terminate it; the partnership continues until all of tis affairs are wound up per UPA 30 RUPA 601-603 & 701-705 o Refers to what UPA calls dissolution as Dissociation o Dissolution in the RUPA is used to refer only to an event that leads to the winding up of the business Major facet that distinguishes partnerships from corporations is that each partner has the power to dissolve the relationship at any time Causes of dissolution: unless otherwise provided for in the partnership agreement, the following may result in a dissolution Expiration of partnership term: o Fixed Term: even where the partnership is to last for a fixed term, partners can still terminate at will (but it will be a breach of the agreement by the terminating partner, which may result in damages charged to the terminating partner) o Extension of term: the partners can extend the partnership by creating a partnership at will on the same terms Choice of a partner: any partner can terminate at will; however, if it is motivated by bad faith, it may be a breach of the agreement Assignment: an assignment of a partners interest is not an automatic dissolution, nor is the levy of a creditors charging order against a partners interest. But an assignee or the creditor can get a dissolution decree on expiration of the partnership term or at any time in a partnership at will per UPA 30-32 Death of a partner: the surviving partners are entitled to possession of the partnership assets and are charged with winding up the partnership affairs without delay per UPA 37; the surviving partners are also charged with a fiduciary duty in liquidating the partnership and must account to the estate of the deceased partner for the value of the decedents interest
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Withdrawal or admission of a partner: most agreements provide that losing or admitting a partner will not result in dissolution; new partners may become parties to the pre-existing agreement by signing it at the time of admission to the partnership per UPA 13(7); when an old partner leaves, there are usually provision for continuing the partnership and buying out the partner who is leaving Illegality: dissolution results from any event making it unlawful for the partnership to continue in business Death or bankruptcy: without a provision in the partnership agreement to the contrary, the partnership is dissolved on the death or bankruptcy of any partner per UPA 31(4) & (5) Partner expulsion: in a term partnership, if the majority ousts the deficient partner, this dissociation could be deemed wrongful, exposing the ousting partners to substantial liability; unless otherwise provided, the right to expel will be governed by partnership law, including fiduciary duties; UPA 31(1)(d) o The one narrow exception to a firms ability to expel someone is if it can be shown that they expulsion was so that the profits wouldnt have to be shared with that person anymore Dissolution by court decree: a court, in it discretion, may in certain circumstances dissolve a partnership; these circumstances include per UPA 32: o Insanity of a partner o Incapacity o Improper conduct o Inevitable loss o and/or wherever it is equitable

The Consequence of Dissolution: Distribution of Assets o Partnership debts: these must be paid first o Capital accounts: these are paid next; paid to the partners in the form of their capital contribution plus accumulated earnings and less accumulated losses o Current earnings: if there is anything left over, the partners receive their agreed share of current partnership earnings per UPA 40 o Distributions in kind: where there are no partnership debts, or where the debts can be handles from the cash account, partnership assets may not be sold, but they may be distributed in kind to the partners o Partnership losses: where liabilities exceed assets, the partners must contributed their agreed shares to make up the difference per UPA 18(a) Rights of the Partners o No violation of agreement: if the dissolution does not violate the partnership agreement, then the partnership assets are distributed as set forth above, and no partner has any cause of action against any other partner o Dissolution violates agreement: if the dissolution does violate the partnership agreement (i.e. the fixed term of the agreement), then the innocent partners have rights in addition to those listed above Right to damages: innocent partners have a right to damages (i.e. lsot profits due to dissolution, etc.) against the offending partner per UPA 38(2) Right to continue business: the innocent partners also have the right to continue the partnership business (i.e. not sell off and distribute the assets) by purchasing the offending partners interest in the partnership per UPA 38(2)(b); alternatively, of course, the innocent partners may simply dissolve and wind up the business, paying the offending partner her share, less damages Effects of Dissolution 23 CarmenCorralSpring06

o Partners are liable until debts discharged: the liability of partners for existing partnership debts remains until they are discharged o New partnership remains liable for old debts: when there has been a dissolution due to death, withdrawal, or admission of a new partner and the partnership business is continued, the new partnership remains liable for all the debts of the previous partnership per UPA 41 o Retiring partners liability for debts incurred by partners continuing the business: dissolution end the power of a partner to bind the partnership except to the extent necessary to wind up its affairs per UPA 33; if, however, 3rd parties do not know of the dissolution, contracts entered into with a partner bind the partnership; so, a retiring partner must make sure that presecribed procedures are followed to terminate any possible liability for partnership obligations; the UPA provides that notice of withdrawal or dissolution may be published in a newspaper of general circulation per UPA 35(1)

UPA Dissolution (29): Any change of partnership relations, e.g., the exit of a partner. Winding up (37): Orderly liquidation and settlement of partnership affairs. Termination (30): Partnership ceases entirely at the end of winding up.

RUPA Disassociation (601): A partner leaves, but the partnership continues, e.g., pursuant to agreement. Dissolution (801): The onset of liquidating of partnership assets and winding up its affairs.

Collins v. Lewis (p. 85): Facts: Lewis (D) persuaded Collins (P) to enter into a partnership for the operation of a cafeteria; the venture failed to make money, allegedly because of Collins lack of cooperation. Rule: A partner who has not fully performed the obligations imposed on him by the partnership agreement may not obtain an order dissolving the partnership. Cauble v. Handler (p. 89): Facts: Cauble and Handler (D) were business partners until Cauble died. The administratrix (P) of his estate thereafter sought Caubles share of the partnership assets. Rule: If a partnership continues to do business after it has been formally dissolved, the non-continuing partner of his representative may elect to receive his share of the profits earned by the firm after the date of the dissolution per UPA 42 Adams v. Jarvis (p. 93): Facts: Adams (P), Jarvis (D), and a third doctor (D) entered into a partnership for the practice of medicine; P later withdrew and claimed a right to share in the partnerships existing accounts receivables. Rule: A partnership agreement which provides for the contribution of the firms business despite the withdrawal of one partner and which specifies the formula according to which partnership assets are to be distributed to the retiring partner is valid and enforceable. 8182 Maryland Associates, Limited Partnership v. Sheehan (p. 98): A fast-growing mid-sized law firm, where one of the lawyers (D) did financial work. They saw growth in the area and decided to sign a longterm lease. Legal business was great for a while in the 1980s, then it turned sour in the late 1980s for about four years. When that lawyer left, what was the effect on the dissolution of the firm? landlord here was treating the law firms as if it was an entity (meaning that it was always obligated aggregately); D says hes not liable here because he left before the K was effective and way before the firm breached it; the court says the K is effective the moment it is signed by all parties; court says not just contractual but also real
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property here based on your tenancy so your liability will be for the leasehold payments that are due for the period of time when your partnership was in possession of the lease; so it sort of limits the liability to the time that they are actually part of the partnership that is in possession of the lease; there was no discussion with the landlord to assign the lease and there was no landlord approval or consent to the assignment of the lease; court addresses this by saying their possession of the land/property Bohatch v. Butler &Binion (p. 114): Butler worked for particular partner at a law firm and later became partner herself; over time, she received internal reports, which led her to believe that partner had overreported his billable hours; she reported it to managing partner. After an incestuous and corrupt investigation, the firm found that the billing was reasonable. Client raised concerns about Bs work. B asked to leave. B filed suit for breach of partnership agreement and fiduciary duty. Held: that a law partnership had no tort duty not to expel one of its partners for reporting suspected over-billing by another partner, reasoning that the fiduciary duty that partners owe one another does not include a duty to remain partners or else answer in tort damages.

D. Limited Liability Partnerships (LLPs)


Structure is such that 2 types of partners are required: At least one general partner (with unlimited liability, who is actively involved in the management/operation of the biz), AND A limited partner who exercises no control Must be filed with the Secretary of State; some states also require advertisement/announcement that LLP will be forming/operating in the area and that a receipt that shows that notice was published for 6 weeks must be filed with he with secretary of state as well 2 Things can destroy the limited liability of a limited partner: failure to file (remedies are to hurry up and file or give notice of intent to withdraw from the partnership) exercising/participating in control over the biz by limited partner Revised Limited Partnership Act said that (and is the law in NJ) youre not liable as a general partner unless you participate in control of the biz in a way that is similar to the way a general partner would have; youre not liable unless 3rd party reasonably relied on the idea that you were a general partner; also there is a laundry list of activities that dont count as exercising/participating in the control of the biz

III. Nature of the Corporation:


The formation of business corporations is firmly in the hands of the states. Also, per the Internal Affairs Doctrine: the law of the incorporating state govern relations among directors, officers, and shareholders. Because a corporation is held to be a separate legal entity, the corp normally incurs debts and obligations in it sown name that are not the responsibility of its owners (shareholders). At the same time, the corporation is not responsible for the debts and obligations of its owners (again, the shareholders). For exceptions to this default position, see the section on piercing the corporate veil below.

A. Promoters
Premature Commencement of Business:
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Promoters: the term promoter is a person who, acting alone or in conjunction with one or more other persons, directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer. Promoters make the necessary arrangements prior to the start of the business, such as raising capital, negotiating employment contracts, securing a site or building, etc. Main functions of a promoter are to secure: o necessary capital, and o necessary assets and personnel The promoter owes a significant fiduciary duty to other participants in the venture and to the to-beformed corporation, he therefore may not pursue his own profit at the corporations ultimate expense. The corporation itself may bring suit against its promoters after it has come under the control of subsequent investors or other persons. Contractual problems are avoided if the corporation is formed first, so that the necessary steps may be carried out in the name of the corporation, thus avoiding chance of confusion between the corporation and the promoters individual liability. Promoters may be held personally liable for debts he contracts. For large ventures, this role has largely been filled by investment banks. Default Rule: Promoters retain contractual liability unless they disclaim it expressly. Contracts Executed in the name of the Promoter: If the promoter enters into a contract in his or her own name w/o referring to the corporation with the thought of subsequently assigning the contract to the corporation, personal liability clearly exists on the part of the promoter. The subsequent assignment of the contract to the corporation does not relieve the promoter of personal liability unless the creditor agrees to release the promoter (called a novation). Contracts Entered in the Name of the Corporation: If the promoter enters into a contract with a third person in the name of the corporation without disclosing that it is not in existence, the promoter is personally liable on the contract. If the corp is thereafter created and takes over the contract, the promoter has a chance of being relieved of liability but there is a substantial chance that a court will conclude that no novation was intended and the promoter remains personally liable. Contracts Referring to the Fact that the Corporation is not Yet Formed: If the contract entered into by the promoter on behalf of the corporation recites that the corporation has not yet been formed, the liability of the promoter depends on what the court finds to be the parties intent. If the corporation is never formed, or is formed but then immediately defaults, the promoter will probably be liable. If the corp is formed, and then shows its intent to take over the contract, then the court may find that both parties intended that the promoter be released from liability. Liability of Corporations for Promoters Contracts: The corporation is not automatically liable on obligations incurred by its promoters before it is formed. The reason usually cited is that the promoter cannot be the corporations agent since the corporation is not yet inexistence. However, if a corp takes the benefits of a contract made by its promoter, it will usually be concluded that is has assented to the burdens of the contract.
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The corporation becomes liable only when it adopts the contract. Adoption may be implied. Stanley J. How & Assoc., v. Boss (p. 236)Facts: Boss (D) signed a contract, on behalf of a corporation not yet formed, with How (P). Rule: A promoter will be liable on a contract he entered into on behalf of a corporation yet to be formed unless the other party agree to look to some other person or fund for payment McArthur v. Times Printing Co.: Rule: Formal adoption or acceptance of a contract by a corporation is not a requirement, but acceptance may be inferred from acts or acquiescence on the part of the corporation or its authorized agents.

B. The Corporate Form


Attributes of the corporate form: Legal personality with indefinite life. Limited liability for investors Free transferability of share interests Centralized management o Separation and Specialization of Ownership & Management Functions Legal separation among shareholders, directors, and officers Directors manage the corporation- they are responsible for determining basic corporate policies, appointing and monitoring the corporations officers, and determining dividend distribution RMBCA 8.01(b) BUT management power must be exercised collectively, and individual directors are not given general agency power to deal with outsiders. Compensated for services rendered but not entitled to share of the residual profits. Outside directors - not simultaneously employed as an officer of the corp. Inside directors - simultaneously employed as officers, so theyre intimately familiar w/ corps business, personnel, and markets. Deference to Directors Judgment and Power Business Judgment Rule- courts and regulators do not like to substitute their own judgment for that of the board of directors Shareholder agreements that are intended to sterilize director discretion o to be effective, must bind the shareholders in their roles as directors o may be invalidated for impermissibly encroaching on the directors duty to use independent judgment Shareholders own the corporation and are entitled to a certain percentage of the firms profits and net assets upon dissolution. They are the corporations risk bearers and residual claimants Authority- they may annually elect the corporations directors and approve fundamental changes in the corporations governing rules or structure, but their right to participate in daily management is very limited. Officers are responsible for the day-to-day operations of the firm newer codes allow the corporation to specify names and duties of its officers in its by-laws.
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An officers power and authority is subject to the dictates of the board of directors. Often, one person will be an officer, director, and shareholder Appointed by equity investors The Corporations Adaptability to Changed Circumstances o Hierarchical decision-making in executing corporate policy o Majority rule for significant decisions - Unlike partnership unanimity rule, the state corporation law norm is majority rule. o Exit rights from selling shares, which are liquid. No need to convert the firms assets into cash. o Withdrawal or Expulsion of Officers or Directors does not Dissolve the Corporation - officers serve at the pleasure of the directors, and directors serve at the pleasure of the shareholders

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Process of incorporating: 1. Choose a state of incorporation - choice of law issues, internal affairs of the corp are governed by this states corp laws. Most small local corps stick to their state, while big ventures that will probably go public go to DE (50%) or NY (5%). 2. Articles of incorporation (AOI) are filed (RMBCA 1.25) with the Secretary of State (or equivalent) by an incorporator (RMBCA 2.01), usually a lawyer; Articles must include per RMBCA 2.02(a): Name of Corporation Articles must state corporations complete name and include a reference to its corporate statues, e.g. Corporation, Incorporated, or Inc.; Sec of State will check the records to make sure that the name is still available o Different from other names in state Must be distinguishable upon the records (RMBCA 4.01), or in some states it must not be deceptively similar to another. The Number of shares that the corporation is authorized to issue Registered office and agent Articles must state the corporations address for service of process and for sending official notices. (RMBCA 2.02) o Registered agent Often, the Articles must also name a registered agent at the office on whom process can be served. (RMBCA 2.02, 5.01) o Changes Change is registered office must be filed with the Secretary of State. Capital structure of corporation Articles must specify the securities the corporation will have authority to issue. o Describe classes of authorized shares, no. of shares of each class, and privileges, rights, limitations, etc. associated with each class. (RMBCA 6.01) Purpose and powers of the corporation The Articles may (but need not) state corporations purposes and powers. Modern corporations can engage in any lawful business. (RMBCA 3.01, 3.02) o Ultra vires doctrine With decline of this, a purposes clause far less important. Capitalization no minimum required Number of shares that the corp is authorized to issue, not how many they actually plan to issue Clases of Shares/Stocks Names of Incorporators Names of Directors - (either elected by incorporators or simply just named in the certificate of incorporation) Signature of an officer (usually an incorporator) Limitation of liability of directors Opt-out provision re: pre-emptive rights of shareholders

o Opt-in: RMBCA 6.30 provides that no preemptive right exists unless provision for it is expressly made in the articles of incorporation. This protects 3rd parties because then everyones consciously agreeing to this. o Opt-out: protects shareholders, may be more fair b/c corporation has more access to information than the shareholders. Optional provisions Articles can contain a broad range of other provisions to customize the corporation MBCA 2.0(b) o Voting provisions Calling for greater-than-majority approval of certain corporate actions, such as mergers or charter amendments; o Membership requirements Example: Directors must be shareholders, or that shareholders in a professional corporation be members of a profession; or o Management provisions Requiring shareholders approve certain matters normally entrusted to the Board, such as executive compensation. Amendment: they can be amended at any time, but usually require that o the amendment be one that could have been adopted initially and o any class of shareholders who would be adversely affected by the amendment must approve the amendment by majority vote

3. By-laws once the corp has been formed by filing of the articles, it should then adopt bylaws, which govern the corporations internal affairs (procedural) Contents: may specify (1) date, time and place for the annual mtg of shareholders, (2) number of directors, (3) whether cumulative voting for directors will be allowed, (4) listing of the officers of the corporation together with a description of the duties of each, (5) what constitutes a quorum for a mtg of the directors Not usually filed with the Secretary of State and not matters of public record. Amendments: usually may be amended easily, usually provide that they may be amended either by the Bd or shareholders If they conflict with the articles, the articles control Incorporators: Role Purely mechanical: sign the articles and arrange for their filing. If the articles do not name directors, the incorporators select them at an organizational meeting. Fade away After incorporation, the incorporators fade away and have no more continuing interest in the corporation. Corporation as incorporator In some states, the incorporators must be natural persons, but the trend is that a corporation may act as an incorporator RMBCA 2.01, 1.40(16) Filing Process: Simple process, under the MBCA, the state officials must accept the Articles for filing if they meet minimum criteria RMBCA 1.25 Public documents Once the Articles are filed, they become public documents. o Confirming existence: Certificate of existence or certificate of incorporation from Secretary of State; Receipt returned by Secretary of State when Articles are filed; Copy of Articles with original acknowledgement stamp by Secretary of State Certified copy of the original articles obtained from Secretary of State for fee
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Problems with Filing - corp can go on despite the following: o late filing o failure to file articles o incomplete filing (info missing)

4. Incorporation: Unless delayed effective date is specified, the corporate existence begins when the AOI are filed RMBCA 2.03(a) 5. Organizational meeting - an actual meeting is not usually necessary, just a record of all the activities listed below. There are firms in the business of incorporating new businesses. They have standard fill in the blank articles that accomplish what the org meeting entails; Creates the working structure of the corporation, but follows a script devised by the corporate planner. Election of directors Unless initial directors named in Articles will remain in office Approving Bylaws Govern internal structure of corporation o Bylaws have assumed greater importance in corporate practice. o Must be consistent with the Articles and state law. RMBCA 2.06. o Not enforceable if they deviate too far from the traditional corporate model. Electing officers Adopting pre-incorporation promoters contracts - including lawyers fees for establishing corporation Designating a bank for deposit of corporate funds Authorizing issuance of shares Setting consideration for shares 5. Shareholders meeting - bylaws are officially voted on Defective Incorporation Doctrines: De Facto Corporation: a corporation arising from the good faith attempt to comply with the statutory requirements of establishing a corporation; cures formal defects in incorporation that prevent it from being a de facto corporation. So long as the following test was met, there is limited liability for the SH and promoters, just as there would have been were it a de jure corp. The usual test was fourfold: o There must be a statute under which incorporation was permitted, o There must have been a good faith or colorable attempt to comply with the statute, o The defect was unknown to the principals o There must have been actual user of the corporate privilege. At common law, this would be sufficient to shelter the would-be incorporator from personal liability. Today, most states have abolished the de facto doctrine and impose personal liability. De Jure Corporation: corporation that results from the incorporators full satisfaction of the statutory requirements of establishing a corporation. It is, for all intents and purposes a fully formed corporation. Corporations by Estoppel: creditor who deals with the business as a corporation, and who agrees to look to the corporations assets rather than the shareholders assets will be estopped from denying the corporations existence. This applies mostly to contract cases because some corp relationships must preexist. Thus, tort cases dont usually apply.

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Robertson v. Levy (p. 241): The corporation comes into existence only when the certificate has been issued. Before the certificate issues, there is no corporation de jure, de facto, or by estoppel-Under 139, if an individual or group of individuals assumes to act as a corporation before the certificate of incorporation has been issued, joint and several liability attaches. Rule: Officers and directors who attempt to act for a defectively formed corporation or prior to its formation are jointly and severally liable for those acts. Cranson v. International Business Machines Corp. (p. 245): An officer of a defectively incorporated association was not subjected to personal liability. Rule: Two doctrines have been used by the courts to clothe an officer of a defectively incorporated association with the corporate attribute of limited liability: 1) the Doctrine of De Facto Corporations, where there is evidence showing (a) the existence of law authorizing incorporation, (b) an effort in good faith to incorporate under that existing law, and (c) actual exercise of corporate powers and 2) The doctrine of estoppel where the person seeking to hold the officer personally liable has contracted or otherwise dealt with the association as a corporation. Limited Liability: Corporations have limited liability. Shareholders can only lose the amount they invested. Rationales for limited liability: o Decreased need to monitor managers. o Reduces the costs of monitoring other shareholders. o By promoting free transfer of shares, gives managers incentives to act efficiently. o Makes it possible for market prices to impound additions information about the value of firms. o Allows more efficient diversification. o Allows investors to finance a business without risking other assets Benefits and Drawbacks of Limited Liability o Very important to contractual relations because It allows investors to limit their risk according to the amount invested It makes value of shares predictable (no hidden liabilities beyond the amount invested) and thus easily traded (very important for publicly held corps) Lenders have the security that liability will be limited to the assets of the corp and conversely it makes clear which assets will be available to satisfy the loan o Problematic in torts because The victim of the tort is an involuntary creditor that could not have taken protective measures (ie requiring extra collateral for a loan) Undercapitalized corps may act recklessly (cab example) knowing their liability is limited Closely held corps are usually more vulnerable to have other assets reached in case of a tort (where as its not common in airlines, railroad and other major publicly traded corps) o On balance, despite theses tort disadvantages, the contractual advantages prevail because without limited liability it would be much more difficult to raise capital The Corporate Entity and Limited Liability: Actual Authority Internal Action o Express actual authority Arises when the board, acting by the requisite majority at a proper meeting, expressly approves the actions of a corporate agent. Unless the corps constitutive documents limit the boards authority, the board-approved action binds the corporation. Note: Most corporate transactions are not specifically approved by the board. o Implied actual authority 2 Ways to Infer this Authority
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Officers authority Consider penumbra of express actual authority delegated to the officer (i.e. corporate president) Analogous situations Look to the Boards reaction to other similar actions by corporate agents as an indication that the action was already impliedly approved. o Retroactive ratification Even when an officers actions are not binding against the corporation when made, the Board can create express actual authority. Implied ratification Boards knowledge or acquiescence in an officers novel course of conduct may evidence implied ratification. Respondeat Superior Corporate Liability for Employee Torts o Where an employee is acting within the scope of his employment, the corporation is bound even if the action was not actually or apparently authorized. The Formation of the Closely Held Corporation - -

Where to Incorporate - Deciding where to incorporate depends on A cost analysis of the relative costs of incorporation, and Consideration of the advantages and disadvantages of the states under consideration. o If the corporation is closely held and its business is to be conducted largely or entirely w/in a single state, local incorporation is almost always preferred. How to Incorporate - The modern trend is to limit the articles of incorporation to provisions that are required by law to appear in that public document while all other substantive provision are placed in documents that are not filed of public record. -Formal requirements for filing of documents are set out in RMBCA, Chapter 1 The Decline of the Doctrine of Ultra Vires (p. 223) -Ultra Vires: An act undertaken by a corporation that is beyond the scope of its authority pursuant to law or its Articles of Incorporation. The doctrine of Ultra Vires is declining in importance and should not be applied to purposes clauses of articles of incorporation. Common Law Roots In the 19th century, state legislatures chartered American corporations for narrow purposes with limited powers. The doctrine was fashioned by the courts to invalidate corporate transactions beyond the powers stated by the charter. Modern Ultra Virus Doctrine Modern corporation statutes eliminate vestiges of inherent corporate incapacity. Neither the corporation nor any party doing business with the corporation can avoid its contractual commitments by claiming the corporation lacked capacity. RMBCA 3.04(a) o 3 Exclusive Means of Enforcing a Corporate Limitation under the RMBCA: Shareholder suit Which enjoins the corporation from entering into or continuing an unauthorized transaction. RMBCA 3.04(b)(1) Corporate suit against directors & officers Corporation on its own or by another on its behalf can sue directors and officers (current or former) for taking unauthorized action. The officers/directors can be enjoined or held liable for damages. RMBCA 3.04(b)(2) Suit by state attorney general State atty. gen. can seek judicial dissolution if the corporation has engaged in unauthorized transactions, under a state concession theory of the corporation. RMBCA 3.04(b)(3), 14.30 Corporate Powers, not Corporate Duties Do not confuse limitations on corporate power with corporate duties (i.e. corporations duty not to engage in illegal conduct and managements fiduciary duties) Charitable contributions? Courts have accepted that corporations have implicit powers to make charitable gifts that in the long run may benefit the corporation.
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o Most state statutes specifically permit corporations to make charitable donations. See RMBCA 3.02(13) & (15) o Gifts cannot be for unreasonable amounts and must be for a proper purpose. 711 Kings Hwy. Corp. v. F.I.M.s Marine Repair Serv., Inc. (p. 224): Facts: 711 (P) leased premises to FIM (D) to use as a movie theatre, but then sought to declare the lease invalid on the ground that the intended use was outside the scope of business activities allowed in the charter. Rule: No act of a corporation and no transfer of property to or by a corporation shall be held invalid by reason that the corporation was without capacity or power to do such act except in an action brought by a shareholder. Dodge v. Ford Motor Co. (p. 386): Facts: As a matter of corporate law, "corporations exist only to maximize returns to their shareholders." Mr. Ford had decided that the Ford Motor Company should drastically reduce its dividend payout to shareholders and instead invest in an expansion plan that would reduce car prices for consumers and create employment. The court criticized Ford "for forgetting that, 'a business corporation is organized and carried on primarily for the profit of the stockholders.'" Rule: that Henry Ford owed a duty to the shareholders of the Ford Motor Company to operate his business for profitable purposes as opposed to charitable purposes.

Differences Between Closely Held Corporations and Public Corporations: more intimate enterprises no market exists for the shares of close corporations o most shareholders expect to eventually sell their shares back to the corporation, to other shareholders, or pass them to their children Minority shareholders are more vulnerable because majority rules and theres no public market for their shares o Majority opportunism stems from majority rule, separation of function, lack of guaranteed employment and dividend rights for shareholders, and denial of unilateral dissolution rights to minority shareholders. o The norms that both ensure the firms adaptability and protect the firm from minority opportunism create the risk of majority opportunism Benefits of the Close Corporation: limited liability favorable tax treatment via a Subchapter S election governance rules via ex ante contract and ex post judicial rules Contracting as a Device to Limit the Majoritys Discretion: As to Director Decisions o Evolution of the Rule McQuade v. Stoneham (p. 418): Rules: 1) An agreement among shareholders that attempts to divest the directors of their power to discharge an unfaithful employee of the corporation is illegal as against public policy; and 2) Stockholders may not, by agreement among themselves, control the directors in exercise of the judgment vested in them by virtue of their office to elect officers and fix salaries.
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Clark v. Dodge (p. 422): Rules: 1) Where the directors are the sole stockholders, there seems to be no objection to enforcing an agreement to vote for certain people as officers; and 2) Limitation to faithful, efficient, and competent officers. Rationale: 1) Since unanimous agreement, no third party (minority) shareholder is harmed; and 2) not complete divestment of director power, since they may still dismiss for cause. Director level agreements valid so long as they are unanimous Shareholder Agreements (Close Corporations): Delaware G.C.L. 341-356 basically, any corporation with not more than 30 shareholders can come under these supplementary rules by simply indicating in its Articles of Incorporation that it is electing a close corporation. o 350 specifically sanctions sterilizing shareholders agreements. o 354 strengthens shareholders ability to avoid majority rule by directors by permitting agreements that attempt to treat the close corporation as a partnership Zion v. Kurtz (p.432): Facts: Zion and Kurtz were the only shareholders. Zion and Kurtz entered into a shareholders agreement providing that the corporation would not engage in any business or activities without Zions consent. Despite this agreement, Kurtz caused the corporation to act without Zions consent. Rule: 1) May limit directors power in the Articles of Incorporation; 2) under GCL 350, shareholders of close corporation may limit directors in shareholder agreements, but must register as close corporation first; and 3) However, since Kurtz agreed to do what is necessary to make Agreement enforceable he is estopped to rely upon the absence of those amendments (registration) from the corporate charter. Rationale: 1) Not against public policy, as evidenced by statutes allowing such action; and 2) since unanimous among shareholders, no intervening third parties harmed. Dissent: 1) Statutory mechanisms there to provide notice, and cannot be ignored; 2) permitting deviations from the statutory norms for corporations should only be under controlled conditions; and 3) must protect potential shareholders and potential creditors. REJECTED IN DELAWARE: Nixon v. Blackwell (p. 438) Delaware will not follow Zion v. Kurtz (create certainty and provide precedent in Court of Chancery) Disregard of the Corporate Entity aka Piercing the Corporate Veil - (3rd way that personal liability can be attached to individuals) Piercing the Corporate Veil: The corporate law concept piercing (lifting) the corporate veil describes a legal decision where an officer, director, or shareholder of a corporation is held liable for the debts of the corporation despite the general principle that those persons are immune from suits in contract or tort that otherwise would only hold the corporation liable. Corporations exist in part to shield their shareholders from personal liability for the debts of a corporation. Prior to the invention of the limited liability corporation in the 17th century, any partner in a general partnership could be held responsible for all the debts of the corporation. As the capital needed to finance the largest projects grew, and along with it the necessity of raising money, investors were reluctant to invest because of the risk involved in essentially guaranteeing the entire debt of the business entity. Generally, the plaintiff has to prove that the corporation was set up to perpetrate a fraud, or at least show that the incorporation was merely a formality and that the corporation never held proper shareholder meetings to distribute profits as dividends. This is quite often the case when a corporation facing legal liability transfers its assets and business to another corporation with the same management and shareholders. It also happens with single person corporations that are managed in a haphazard manner. As such, the veil can be pierced in both civil cases and where regulatory proceedings are
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taken against a shell corporation. Generally, courts are hesitant to pierce the corporate veil, except in situations where outright fraud seems likely. Almost always doen to closely held corps with few shareholders. Factors for Court to Consider: not all of these factors need to be met in order for the court to pierce the corporate veil. Further, some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable. Closely Held v. Publicly Held: strictly for closely held corporations Voluntary v. Involuntary Creditor: less willing when voluntary contract creditor, b/c of forseeability, contractual protections, access to information, etc. usually applies to involuntary creditors such as tort claimants Enterprise Liability/Instrumentality: treats corporations under common ownership as one pool of assets if: o they are essentially part of a single business and o separate incorporation merely isolates risk Failure to Observe Corporate Formalities: unusual for corporations to follow these formalities so this only produces a weak inference Commingling of Assets and Affairs: Almost certain liability using corporate assets for personal affairs Under-Capitalization and Purposeful Insolvency: under-capitalization, without more, is not enough, measured from time of formation Alter Ego: goes to show dominance (must be substantial dominance) ; factors considered include o Common directors/officers between P & S o Common business departments between P & S o P & S file consolidated financial statements and tax returns o P finances the S o P caused the incorporation of S o S operates with grossly inadequate capital o P pays salaries and other expenses of S o S receives no business except that given to it by P o P uses the Ss property as its own o Daily operations of P & S are not kept separate o S does not observe basic corporate formalities, such as keeping separate books and records and holding shareholder/board meetings. Deception, Misrepresentation Vertical Piercing: where specific shareholder(s) are held personally liable for specific corporate acts/obligations; if they are natural people; or to shareholders that are another corporation, in which case it is a parent-sub relationship Individual shareholders -If the corporations shares are held by individuals, the following are factors that the court looks to in deciding whether the veil should be pierced: Tort v. contract: Courts are more likely to pierce the veil in a tort case where the creditor is involuntary, than in a contract case, where the creditor is voluntary Fraud: veil piercing is more likely where there has been grievous fraud or wrongdoing by the shareholders

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Inadequate capitalization: veil piercing is most likely if the corporation is inadequately capitalized, though most courts do not make inadequate capitalization alone enough for veil piercing (zero capital or siphoning) Failure to observe corporate formalities: shareholder meetings, keeping books, etc.

If a parent/subsidiary situation exists, the test is modified to: the D shareholder dominated and controlled the corporation, so that corporation had no mind of its own the parents conduct in using the subsidiary was unjust, fraudulent, or wrongful toward the plaintiff, and Actions or conduct were the proximate cause of the loss or injury Bartle v. Home Owners Coop. (p. 254) Westerlea was a wholly owned subsidiary of Home Owners Coop. Appellate court agreed with the trial court that the corporate veil of Westerlea should not be pierced. The law permits the incorporation of a business for the very purpose of escaping personal liability. There is no requirement that a corporation make a profit. Strong dissent: the business was run in such a way that it was impossible to make a profit. The objective of Westerlea was to benefit stockholders of Home Owners Coop. RULE: Where there has been neither fraud, misrepresentation, nor illegality, the doctrine of piercing the corporate veil will not be invoked to hold a corporation liable for the debts of a wholly owned subsidiary. (Deception/Misrepresentation) DeWitt Truck Brokers v. W. Ray Flemming Fruit Co. (p. 256) A corporation is an entity, separate and distinct from its officers and stockholders, and that its debts are not the individual indebtedness of its stockholders. This power to pierce the corporate veil is to be exercised reluctantly and cautiously and the burden of establishing a basis for the disregard of the corporate fiction rests on the party asserting such claim. Factors to look at in piercing: under-capitalization, failure to observe corporate formalities, nonpayment of dividends, insolvency of the debtor corporation at the time, siphoning of funds of the corporation by the dominant stockholder, non-functioning of other officers or directors, absence of corporate records, the fact that the corporation is merely a facade for the operations of the dominant stockholder. RULE: The conclusion to disregard the corporate entity may not rest on a single factor, but must involve a number of such factors; in addition, it must present an element of injustice or fundamental unfairness. Baatz v. Arrow Bar (p. 263) Parties injured by a drunk sued the bar that served him. Factors that indicate injustices and inequitable consequences and allow a court to pierce a corporate veil are: 1) fraudulent representation by corporation directors, 2) undercapitalization, 3) failure too bserve corporate formalities, 4) absence of corporate records, 5) payment by the corporation of individual obligations, 6) use of the corporation to promote fraud, injustice or illegalities. (Alter Ego) Radaszewski v. Telecom Corp (p. 268)-The doctrine of limited liability is intended precisely to protect a parent corporation whose subsidiary goes broke. We think the doctrine would largely be destroyed if a parent corporation could be held liable simply on the basis of errors in business judgment. Under Missouri law, a P must show 1) complete domination of finances, policy and business practices, 2)that control must be used to commit fraud or wrong, 3) the aforesaid control and breach of duty must be the proximate cause of the injury or unjust loss complained of. (Under-capitalization) Fletcher v. Atex, Inc. (p. 272) Facts: Fletcher (P) brought suit against Atex (D) and Eastman Kodak (D), its parent company, to recover for injuries incurred from the utilization of computer keyboards procured by Atex. Rule: Under applicable state law, the court may pierce the corporate veil of a company and hold its shareholders personally liable only in cases involving fraud, or where the company is a mere instrumentality or alter ego of its parent company. (Instrumentality)
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The Piercing Doctrine in Federal/State Relations: Roccograndi v. Unemployment Comp. Bd. of Review (p. 297):Facts: Three shareholders in a family corporation appealed a ruling saying that they couldnt basically lay themselves off from their own company to collect unemployment checks because they were really self-employed and had the power to work or not work. Issue: Can the corporate entity be ignored for the purposes of determining whether the claimants are statutory employees or if they are self-employed? Rule: The corporate entity may be ignored in determining whether the claimants are just self-employed people whose business wasnt going so good at the time. Analysis: Not much! It seems pretty tricky to vote on who will get laid off each time there isnt enough work to go around. This court sees right through it. Conclusion: The administrative rulings against the claimants are affirmed. United States v. Bestfoods (p. 337) bedrock principle is that here is an equally fundamental principal of corporate law, applicable to the parent-subsidiary relationship as well as generally, that the corporate veil may be pierce and the shareholder held liable for the corporations conduct when, inter alia, the corporate form would otherwise be misused to accomplish certain wrongful purposes, most notably fraud, on the shareholders behalf. Horizontal Piercing: to move between brother and sister companies Reverse Piercing: where the corporation is held liable for specific individual shareholder acts/obligations Sweeney v. Kane (p. 298): corp. set up to shield estate money awarded to the wife; court has no problem piercing here since whole corp. was set up to shield funds from creditors/was an instrumentality and to refrain from piercing would result in an injustice; Piercing the corporate veil is an equitable concept that allows a creditor to disregard a corporation and hold its controlling shareholders personally liable for the corporate debt. Reverse-piercing flows in the opposite direction and makes the corporation liable for the debt of the shareholders. Pepper v. Litton (p. 303): Facts: Litton was the sole shareholder of Dixie Splint Coal Company. Pepper sued the company for royalties he was due on a lease. Before this case came up, Litton made the company confess a judgment, pay him claims for back salary, and then declare bankruptcy. The district court disallowed Littons claim, but the Court of Appeals reversed, saying that the previous judgment was res judicata. Issue: Did the bankruptcy court have the power to disallow Littons judgment against the company of which he was the sole shareholder? Rule: Bankruptcy courts sit in equity and can set aside deals that dont have the hallmarks of an arms-length bargain. Analysis: Basically, the Court says that you cant hide behind a one-man corporation to avoid being liable to creditors. Conclusion: The Supreme Court reverses the Court of Appeals and reinstates the decision of the district court. Successor Liability: Nissen Corp v. Miller (p. 307): Facts: The plaintiff bought a treadmill from American Tredex. Soon after that purchase, Nissen bought the company, but excluded assuming any tort liability. Five years later, the plaintiff was injured while using the treadmill. A year or so after that, American Tredex was officially dissolved. Almost a year after that, the plaintiff sued American Tredex and Nissen. Nissen won summary judgment, but the plaintiff appealed. The Court of Special Appeals reversed the trial court, and Nissen appealed to the Court of Appeals of Maryland. Issue: Should the court adopt the general rule of nonliability of successor corporations with the four traditional exceptions, or should it add an exception for continuity of enterprise? Rule: NEW RULE, in Maryland! The general rule is adopted with the four traditional exceptions (listed on p. 308 of the casebook) but not the continuity of enterprise exception.
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Analysis: The petitioners and respondents put forth some different juicy policy arguments. If only I had more time to brief them! Conclusion: Nissen is found to be not liable as a corporate successor.

C. Financial Matters and the Corporation


Basic Concepts of Valuation: 1. Time value of money a. How much more valuable a payment or sum of money is today, rather than later, depends on the value of the use you have for it, or on the value you can get by finding someone who needs that dollar for something valuable. b. Present value The value today of money to be paid at some future point. c. Investors want to invest in positive net present value projects Where the amount invested is less than the present value of the amount received in return. 2. Risk and return a. Expected return Weighted average of the value of the investment. It is the sum of what the returns would be if an investment succeeded, multiplied by the probability of success, plus what the returns would be if the investment failed, multiplied by the probability of failure. b. Risk premium Additional amount that risk-averse investors demand for accepting higherrisk investments in the capital markets. Compensates for the unpleasantness of volatile returns to the risk-averse investors who dominate market prices. 3. Systematic risk and diversification a. You want a diverse portfolio to minimize risk. 4. Capital market efficiency a. Efficient capital markets hypothesis Prices of securities reflect well-informed estimates, based on all available information, of the discounted value of the expected future payouts of corporate stocks and bonds. Market prices aggregate the best estimates of the best-informed traders about the underlying present value of corporate assets net of payment to creditors, taxes, etc. b. A & K say that prices in an informed market should be regarded as prima facie evidence of the true value of traded shares. Authorized shares: number of shares that a corp is actually authorized to issue Issued Shares: number of shares that a corp has actually issued Treasury Shares: stock issued by a corp, but is then re-acquired and either cancelled or held. 1. Debt and Equity Capital Capital may be obtained from a variety of different sources: borrowing funds capital contributions from owners capital contributions from outside investors retaining earnings of the business rather than distributing them. Raising capital may be with funds that are in the form of equity capital or debt. Debt usually must be repaid at some time, usually with interest. Equity capital is composed of contributions by the original entrepreneurs in the firm, capital contributed by other investors usually in exchange for ownership interests in the business, and
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retained earnings of the enterprise. The Securities Act of 1933 imposes substantial disclosure requirements on the public sale of securities Forms of Equity and Debt Its a range of risk, return, certainty and distribution of income. Debt - a security interest Equity - a beneficial in the corp ownership interest in the corp descrip. an advance of capital funds a residual right to potential in exchange for fixed and dividend (no set schedule) compulsory interest that may vary with corps payments according to a success. schedule. exampl bonds, loans and accounts common and preferred stock e receivable of a trade creditor risk/ less risky b/c it gets priority/ riskier b/c gets whats leftover return stable b/c returns are fixed varies with corp success control no voting rights but can force voting rights (except pref. bnktcy if corp default stock) and fid. duty claim fiduciar Managers do NOT owe lender Managers have a fiduciary y duty a fiduciary duty b/c lenders obligation towards SH, have protective covenants, particularly voting SH info, and deal at arms length because they otherwise lack protection. insiders Corp insiders are not Corp insiders can be SH. responsible for the debt tax interest payment is a tax dividends are taxed deduction for corp (single separately to the SH (double tax) tax) 2. Types of Equity Securities Shares generally Shares are the units into which the proprietary interests in a corporation are divided All shares within a single class must have the same rights. If a corporation issues only one class of shares, they may be referred to as common shares, capital shares, or simply shares or stock. RMBCA 6.01(b) sets forth two fundamental rights of shareholders: o (1) right to vote for the election of directors and other matters, and o (2) they are entitled to the net assets of the corporation when distributions are made. Common and Preferred Shares: Common shares: (junior equity interests) o Are a class or classes of share that have the fundamental rights of voting and receive the net assets o But get paid last when in comes to dividends and liquidation payouts o Holders of common shares have non-financial rights too: right to sue, right to inspect books, right to financial info./accounting Preferred shares: (senior equity interests)
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o If the corp only has enough money to pay these guys, they are the only and first ones to get paid; same goes for liquidation payouts o Are typically classes of share with preferential but limited rights, usually non-voting because their interests are already protected o Holders of preferred shares are entitled to a specified distribution before anything can be paid on common shares. o Non-participating: fixed amount of dividends only o Participating: fixed amount of dividends plus some residual amount Special Rights of Publicly Traded Preferred Shares: Cumulative Dividend Rights - dividend that grows from year to year when not paid. Unlike interest on a debt, dividends on preferred shares may be paid only from funds that are legally available for making distributions. Voting - Preferred shares are usually nonvoting shares. Liquidation Preferences - Preferred shares usually also have a liquidation preference. Redemption Rights - Preferred shares may be made redeemable at the option of the corporation. A right to redeem shares means that the corporation has the power to buy back the redeemable shares at any time at the fixed price, and the shareholder has no choice but to accept that price. Conversion Rights - Preferred shares may be made convertible at the option of the holder into common shares at a fixed ratio. Protective Provisions - Preferred shares may also have certain financial safeguards, such a sinking fund provisions, which require the corporation to set aside a certain amount each year to redeem a specified portion of the preferred stock issue. Participating Preferred - These shares are entitled to the specified dividend and, after the common shares receive a specified amount, they share with the common in additional distributions on some predetermined basis.4. Classes of Common Shares RMBCA 6.01 - authorizes the creation of classes of common shares by appropriate provision in the articles of incorporation; such classes may vary in terms of management, financial or voting rights. Dividends: are distributions from current or retained earnings; payments to shareholders out of capital are called distributions.

3. Issuance of Shares (Subscriptions, Par Value and Watered Stock)


Watered Shares: are par value shares issued for property that has been overvalued and is not worth the aggregate par value of the issued shares. Par Value: (or stated value) of shares is a nominal value assigned to each share. At one time par value represented the selling or issuing price of shares, but in modern corporate practice, par value has little or no significance. o Share Subscriptions and Agreements to Purchase Securities Historically, the traditional method of raising capital for a new corporation was by public subscriptions pursuant to which persons agreed to purchase a specified number of shares contingent upon a specified amount of capital being raised. Modern practice is to use simple contractual agreements to purchase securities rather than a formal subscription agreement. o Authorization and Issuance of Common Shares Under the RMBCA The price must be the same if shareholders are to be equally treated.

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The number of authorized shares must be at least equal the number the corporation plans to issue o Par Value and Stated Capital In 22 states, the articles of incorporation must stat the par value of the shares of each class. The remaining states, like the RMBCA, have eliminated or made optional the concept of par value, and the current trend is toward the elimination of this concept as an historical anomaly Eligible and Ineligible Consideration for Shares: MBCA (1969) 19 shares issued for a promissory note are prohibited Hanewald v. Bryans Inc. (p. 327)-It is the shareholders initial capital investments which protects their personal assets from further liability in the corporate enterprise. Notion of limited liability. Facts: After Bryans Inc. (D) went out of business without paying off a promissory note or the lease on his store, Hanewald (P) filed suit against the corporation and the Bryan (D) family members, to whom the corporate stock had been issued, seeking to hold them personally liable. Rule: A shareholder is liable to corporate creditors to the extent his stock has not been paid for. A corporation that issues its stock as a gratuity commits fraud upon creditors who deal with it on the faith of its capital stock. The Bryans had a statutory duty to pay for the stock issued to them by Bryans Inc. Par Value in Modern Practice: To avoid watered stock liability, the issuance price for shares of stock with par value must always be equal to or greater than par value. Under current practice, par value serves only a minor function and is in no way an indication of the price at which the shares are issued. Today the practice most often followed is to use nominal par value, that is one cent, ten cents, or one dollar per share when the shares are issued for several dollars or more per share. RMBCA 2.02(b)(2)(iv): optional par value provisions maybe of use to corps which are to be qualified in foreign jurisdictions in that franchise or other taxes are computed upon the basis of par value; optional par value may also be given effect essentially as a matter of contract between parties Par value relates only to the initial issuance of shares, and has no application whatever to subsequent transactions in the shares themselves, which may be bought or sold at any mutually acceptable price. Ted Fiflis, Homer Kripke, Accounting for Business Lawyers (p. 335): this provides creditors little protection so, rather than rely upon statutory protection against shareholder distributions, they rely on security interests, careful monitoring of their receivables, full disclosure, etc. Earned Surplus: the tax base from which to calculate the major portion of a corps franchise tax; earned surplus is the corps reportable federal net income, less certain foreign-source income, plus officer and director compensation 4. Debt Financing

RMBCA 6.25 Issuance of Certificates From an economic standpoint, debt financing is considerably more important and frequent than equity financing. Bonds and debentures are evidence of long term indebtedness that are usually referred to a debt securities; both involve unconditional promises to pay a stated sum in the future and to make payments of interest periodically until then; payable to the bearer anyone in possession of the piece of paper could obtain payment on the debt; the owner kept debt securities in a lock box to protect it against theft

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Bonds: secured by a lien or mortgage on corporate property; but bonds is used indiscriminately to describe both bonds and debentures Registered Bond: a bond that has been registered in the name of a specific individual and from which the coupons have been removed; interest is paid directly to the registered owner by check; all new bonds are issued today in registered form in order to minimize tax evasion; still, these are freely transferable Junk Bonds: simply below investment-grade debt instruments; aka Zero coupon bonds or zeroes; they pay no interest at all; they sell at a substantial discount from face value and upon maturity the holder receive the face value. o Debentures: unsecured corporate obligations It is usually advantageous to engage to some extent in debt financing. The notion that the best business is a debt-free business, while sounding attractive, is not consistent with either the minimization of income taxes or with the maximization of profits.
o

Distributions: Two primary ways that corps commonly distribute their assets or earnings to its shareholders a. Paying dividends b. Repurchasing some of its shares from shareholders (Buy-out) Dividends a cash payment made by a corp to its common shareholders pro rata a. Decision whether to pay dividends is always affected by tax status b. Cannot pay out dividends if a corp. cant pay its creditors. c. How much discretion does the Board have in paying out dividends? i. Compelling a Corp to Pay Dividends If an adequate corp surplus is available for the purpose, directors may not withhold dividends in bad faith, but the mere existence of an adequate surplus is not alone sufficient for the court require issuance of a dividend. ii. Gottfried v. Gottfried (Sup. Ct. of NY, 1947) RULE: if an adequate corporate surplus is available for the purpose, directors may not withhold the declaration of dividends in bad faith. Courts cannot compel absent bad faith. (A) Factors for the ct. to infer bad faith: intense hostility of the compelling faction against the minority; exclusion of the minority from employment by he corp.; high salaries or bonuses or corporate loans made to the officers in control; the fact that majority may be subject to high personal income taxes if substantial dividends are paid; existence of desire of majority to acquire the minority. [if none are motivating cause, then no bad faith] Are the directors acting out of concern for personal rather than corporate interests? (B) Ct. finds that Bd. may be unduly conservative but no bad faith and will not substitute the judgment of the Bd. There may a good reason-remember double taxes. iii. Dodge v. Ford Motor Co. (Sup. Ct of Michigan, 1919) Decisions to issue dividends must be made with shareholders benefits in mind, not the general publics. (An unusual circumstance that ct. intervened, Ford should have tempered his reasons to withhold dividends for a valid business interest; or have social good in the charter.) The Concept of Leverage: The amount of a corps debt magnifies the fluctuations above/below the expected income. This magnifying effect of debt in the capital structure is referred to as leverage. The higher the debt (in relation to equity) the greater the percentage of return on the investment if the corp meets or exceeds its expected income, but if income falls below whats expected then the greater the diminution of the return and maybe increased risk of default. Leverage is favorable to the borrower when the borrower is able to earn more on the borrowed capital than the cost of the borrowing.
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Debt financing is attractive during periods of high inflation because the loans will ultimately be repaid with inflated dollars. Loan competition and high interest rates may offset this though

Tax Treatment of Debt: Interest payments on debt are deductible by the borrower whereas dividend payments on equity securities are not. There are tax advantages of loans by individual shareholders to C Corporations. Debt as a Planning Device: Obre v. Alban Tractor Co. (p. 342): the court treated Ps preferred stock as an equity investment rather than debt Public Offerings: A public offering is the sale of securities by an issuer or a person controlling the issuer to members of the public. Normally registration of a public offering under the Securities Act of 1933 is required, though in some instances exemptions from registration may be available. 5. Preemptive Rights, Dilution, & Re-capitalizations

Preemptive rights give an existing shareholder the opportunity to purchase or subscribe for a proportionate part of a new issue of share before it is offered to other persons. A preemptive right protects shareholders from dilution of value and control when new shares are issued. In modern practice, preemptive rights are often limited or denied by provisions in the governing corporate documents. Makes it easier for the people who are managing it and goes towards the increasing separation between management control and the economic interests within the corp.; moved from being opt out to being opt in - - in other words, you only have preemptive rights if you choose to have them from the outset; would make sense to opt in if youre dealing with a closely held corp. (the site of the most vicious battles for control); probably should put preemptive rights in the charter document/Articles of Incorporation o Created by common law, entitle stockholder to retain proportional ownership despite the issuance of new stocks. Finally, he has the right to vote for directors and upon all propositions subject by law to the control of the stockholders, and this is his supreme right and main protection. P. 370 of the case book o Equity dilution: when per share price is unfair: if new shares are issued at a price above value of existing shares, there is no dilution. When issued below existing value, then equity dilution. If issued with no voting rights, no vote dilution. Issuing stock at book value is an example of e. dilution. o Vote dilution involves control: Stocks sold at fair price. o Stokes: Proposition to double capital of the company by bringing in a new control group; P had 4% interest diminished to 2%. o In a public corporation: you dont want preemptive rights b/c they are a nuisance. o Since ~ 1930: stats have authorized a denial of preemptive rights. Older, p. rights exist unless you opt out, i.e. there will be no preemptive rights. Newer, you must opt in per RMBCA 6.30, set of default provisions. people with face value preferred plain vanilla nonvoting dont need preemptive rights, b/c they cant have equity or vote dilution.

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Does no provide for nonvoting common stock or preferred shares with voting rights. If you have either you have a conflict betw vote dilution and equity dilution. You cant grant p. rights to one without incurring problems with the other. For Rights Granted: see RMBCA 6.30(b) (1)-(2) For Rights not Granted: see RMBCA 6.30(b) (3) (6)

Stokes v. Continental Trust Co. of City of New York (p. 368) Facts: Stokes (P), a shareholder of Continental Trust (D), demanded that they sell him an equivalent number of newly issued shares of stock to the proportion he now holds. Rule: A corporation must allow a shareholder to purchase newly issued stock at the fixed price to allow him to keep his proportionate share of the stock; power of individual stockholder to vote according to his shares cannot be interrupted or prevented. Katzowitz v. Sidler (p. 372) Facts: Two of three directors of a close corporation voted an additional issuance of stock which they opted to purchase and which the third director refused. When the corporate assets were sold, the proceeds were distributed in proportion to the stock owned, and the third director sought to have this distribution set aside. Rule: Where new shares are offered in a close corporation, existing shareholders who do not want to or are able to purchase their share of the issuance are not estopped from bringing an action based on a fraudulent dilution of their interest where the price for the shares is inadequate. preemptive rights - 3rd guy had them but didnt use them here; logical outcome would be tough!; but court is offended by the disparity between the book value and sell price of the stock and the actions of the two guys so, it decides to use a different standard - they saw a freeze-out 6. Distributions by a Closely Held Corp RMBCA 6.40: Board authorizes distributions RMBCA 6.40(b): promissory notes, real estate, redemption Dividends- a distribution of earnings to SH declared by the Board. The proportion of a companys profit that it pays to its shareholders, usually declared as a dividend per share (DPS). In the UK the dividend is normally paid in two parts; an interim dividend payment and a final dividend once the final results are known. Dividends can only be distributed from earnings NOT Legal Capital Dividends come from tangible returns (folding money) that can also be spent on reinvestment in the corp. RMBCA 6.40 - corps cannot give to SH what they dont have; cant make corp insolvent. There must be enough assets to cover liability and outstanding debt before dividends can be distributed. Most states will hold Directors personally liable for paying the corp back if illegal distributions of dividends (DE 174). The Efficient Market Hypothesis: stock prices automatically reflect all relevant info o Strong version: market price reflects all public and private info: speculators can profit only through luck o Semi-strong version: market price reflects all public information affecting share value; assumes arbitrageurs are clearing the market to its efficient price at all times. However, room is left for inefficiency when the arbitrageurs themselves try to cash in on the common persons misguided speculation o Weak version: market prices reflect only historical info about a firm

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Gottfried v. Gottfried (p. 382): Facts: Minority stockholders (P) sought to compel the board of directors (D) to declare dividends on the common stock, alleging that such dividends had not been paid upon consideration other than the best welfare of the corporation or its stockholders. Rule: If an adequate corporate surplus is available for the purpose, directors may not withhold a declaration of dividends in bad faith. Dodge v. Ford Motor Co. (p. 428): Facts: Ostensibly to lower the price of its autos and increase jobs, the Ford Motor Co. (D) decided to discontinue the payment of dividends. Rule: Ordinarily, the directors of a corporation alone have the power to declare a dividend, but the courts will intervene to require that a dividend be paid if it is discovered that the refusal of the directors to do so is based in fraud or an intention to conduct the affairs of the corporation not for the shareholders. Wilderman v. Wilderman (p. 390) Facts: Joseph Wilderman (D), as president of a family-owned business, paid himself large sums w/o the approval of his wife, Eleanor (P), who was the companys only other director, officer and shareholder. Rule: In the absence of a specific authorization by the companys board of directors, a corporate executive may receive only compensation that is reasonably commensurate with his functions and duties. Donahue v. Rodd Electrotype Co. (p. 396) Facts: Donahue (P), a minority stockholder in a close corporation, sought to rescind a corporate purchase of shares of the controlling shareholder. Rule: A controlling stockholder (or group) in a close corporation who causes the corporation to purchase his stock breaches his fiduciary duty to the minority stockholders if he does not cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of shares to the corporation at an identical price.(Flatly rejected in Delaware where the entire fairness test is applied); reason court sees closely held corps as being like partnerships because the a) majority of shareholders also participate in management, direction, and operations of the corp.; b) they can refuse to pay dividends; c) they can force payment of high rent; d) can force corp to sell its shares at an inadequate price, etc. (see p. 400); boils down to vulnerability of the minority shareholders a) small number of shareholders; b) not a ready market for corporate stock; and 3) the substantial majority of the shareholders participate in the management, direction, and operations of the corporation Equity Insolvency Test Older statutes prohibited payments of dividends if the corporation was, or as a result of the payment would be, insolvent in the equity sense. This test is retained, appearing in RMBCA 6.40(c)(1) In determining whether the equity insolvency test has been met, certain judgments or assumptions as to the future course of the corporations business are customarily justified Equity (or equity interest) in general refers to the extent of an ownership interest in a venture. In this context, ownership interest refers to the economic concept that an owners equity in a business is equal to that business assets minus its liabilities and amounts allocable to senior securities. Equity financing is raising money by the sale of common or preferred shares. Insolvency may be either equity insolvency or insolvency in the bankruptcy sense. Equity insolvency means the business is unable to pay its debts as they mature while bankruptcy insolvency means the aggregate liabilities of the business exceeds its assets. Balance Sheet Test RMBCA 6.40(c)(2) requires that, after giving effect to any distribution, the corporations assets equal or exceed its liabilities plus the dissolution preferences of senior equity securities. Pure Insolvency Test Liability is imposed on directors if the distribution renders the corporation insolvent. (applied in Mass)
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Dividends and distributions: There are lies, damn lies, and statistics. Assets consist of cash, marketable securities, land, accounts receivable, inventories. None of these numbers are hard and fast. o Cash can include varying currencies at varying rates o Marketable securities fluctuate enormously o Land is difficult to evaluate o Machinery: cost less depreciation. o A/R: depends on credit worthiness of customers. o Inventory: how sellable is it? Liabilities: accounts payable (bank loans, warranty claims, etc.) o How does the Board make a decision so as not to breach duty of care? Traditional: Look to availability of earned surplus Is the corp. solvent, i.e. able to pay obligations as they come due? Current model act: 6.40(c): solvency plus balance sheet test. o 8.33: liability for unlawful distribution To avoid liability, a director must make sure his dissent is recorded in the minutes. A director held liable is entitled to contribution from each director who could be held liable, and from each shareholder who accepted the distribution knowing that it was made in violation. Layer of federal law: if a company goes into bankruptcy, distributions may be set aside by the bankruptcy trustee, either as a matter of state or federal law

C. Shareholder Derivative Actions


Introduction: Competing Tenets: o Corporate fiduciaries owe their duties to corporation, not to individual shareholders; o Board of Directors manage the corporations business, which includes authorizing lawsuits in the corporate name. Structure of Derivative Suits 2 in 1: Shareholder (1) sues the corporation in equity (2) to bring an action to enforce corporate rights Federal securities class action suits: SEC rules are supreme; 10b; gave rise to huge group of securities lawyers; the court decided to try to reign this in language started to appear in decisions re: strike suits (suits alleging securities fraud where the case if pretty damn week but out of embarrassment or whatever, the D/corp. would likely just settle); now you cant bring a federal securities suit if you dont own stock; doesnt have to do with a purchase and a sale but holding on to stock; congress then came back and said you can only sue in federal court if your claim is re: securities law; but when they wrote the legislation, they carved out certain exceptions: (anti-trust suits you get treble damages) Recovery Any recovery in derivative litigation generally runs to the corporation the shareholder P shares in the recovery only directly. Damages are for the full amount of harm to the entire corp so the corp collects and all SH benefit equally. Whereas individual suits recover the SHs precise share (which is probably too small to be worth the expense of litigation). Plus if the derivative suit is successful, the corp pays SHs legal expenses.

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o Plaintiffs Expenses In derivative litigation, the corporation pays the successful Ps litigation expenses, including attorneys fees if the proceeding has resulted in a substantial benefit to the corp RMBCA 7.46(1) Many states require the P to post a high bond to cover the Ds legal expense if the action is unsuccessful. Lawyers have gotten around the bond requirement by posing it as a representative action (direct suit) instead of a derivative action. o Defendants Expenses the P can be order to pay the Ds litigation expenses, including attorneys fees if the proceeding was commenced or maintained without reasonable cause or for an improper purpose per RMBCA 7.46(2) o Opponents Expenses parties can be ordered to pay their opponents expenses, including attorneys fees, incurred because of the filing of a pleading, motion, or other paper which was not well grounded in fact, submitted in bad faith, or was interposed for an improper purpose such as to harass or cause unnecessary delay or needless increase in the cost of litigation RMBCA 7.46(3) Calculation Attorney fees in derivative litigation generally have been calculated using either a percentage of recovery (usually 15-35%) or a lodestar method (fees based on number of hours spent multiplied by prevailing market fee rate). Derivative Suit Plaintiff Self-Appointed Representative o Courts and statutes impose on the derivative suit Ps a duty to be a faithful representative of the corporations and the other shareholders interests Res Judicata Preclusion of Corporate Re-litigation Corporation cannot bring a subsequent suit based on the claims raised in the derivative suit. Conversely, shareholders cannot bring derivative suits where the corporation is already pursuing its own suit or settlement. Derivative v. Direct v. Class Action Suits o Direct Suits Those in which shareholders seek to enforce rights arising from their share ownership: Enjoin ultra vires action; Compel payment of dividends declared but not distributed; To challenge fraud on shareholders in connection with their voting, sale, or purchase of securities; To challenge corporate restrictions on share transferability; To require the holding of a shareholders meeting; To compel inspection of shareholders lists, or corporate books and records; To challenge the denial or dilution of voting rights, such as when substantially all the corporations assets are sold without shareholder approval; To compel dissolution of the corporation. o Claims with Direct & Derivative Attributes Some courts characterize suits to compel payment of dividends as derivative; Look at the facts, (i.e. wrongful refusal by management to provide a shareholders list to a shareholder for a proxy fight may violate the shareholders right to inspection and mgmts fiduciary duty to the corp.) Eisenberg v. Flying Tiger Line, Inc.: A shareholder challenged a corporate reorganization in which shareholders of an operating company became, after a merger, shareholders of a holding company. The corporation sought to require the P to post security for expenses, a derivative suit requirement. Held: The action was direct because the reorganization deprived the shareholder of any voice in the affairs of their previously existing operating company. o Class actions Direct Suits Brought by Representative

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When a shareholder sues in his own capacity, as well as on behalf of other similarly situated shareholders, the suit is not derivative but class action. Some of the suits enforcing fiduciary duties are class action, e.g. Weinberger, Van Gorkom. Some procedural rules applicable to class actions also apply to derivative suits. 1. All dont (i.e. demand requirement is not applicable in class actions) Procedural barriers to derivative suits Cohen v. Beneficial Industrial Loan Corp. (KRB: 24145) New Jersey statute that conditions a stockholders action cannot be disregarded by the federal courts as a procedural under Erie v. Tompkins.

2 Major Patterns in All States: Demand Requirement - SH must first demand that the corp assert a claim to protect itself (before bringing a derivative action) when the underlying claim is against some person not related to the corp or when the interests of the corp insiders are not immediately implicated. Done to ensure that the shareholder derivative suit is not used illegitimately to usurp directors management power, shareholders are required to make a demand on directors as a precondition to filing a derivative suit. The demand must explain the claim(s), which he wishes investigated and remedied. o Failure to demand is grounds for dismissal. DE wrinkle: If P makes a demand, its presumed to be required thereby shielding the corp decision with the Business Judgment Rule. So Ps dont make demands in DE. o NJ requires demand via court rules 4:32-5 o Steps: SH demands corp to bring its own action against the wrong doer (usually an insider). If the corp agrees, either it or the SH on its behalf will bring the action. The corp may also take corrective actions or settle. If the corp disagrees, then it must be determined whether the rejection was wrongful and suit should go forward o RMBCA 7.42 Demand Excused - Demand is not required when actions of self-interest by insiders are involved or when corp officers being accused are not shielded by the Business Judgment Rule. o Steps: P goes straight to court and explains why she didnt make a demand Court decides if demand is excused/suit should go forward Board of Directors determine whether demand is required or futile o If required, directors decision not to go forward with litigation will be reviewed under the business judgment rule. making demand on the board concedes its disinterestedness if demand is made, business judgment rule standards apply o If futile, may get intrinsic fairness standard however, defendants avoid this result by appointing a special litigation committee to consider the value of the litigation to the corporation, usually resulting in a recommendation for termination of suit. The question then focuses on the level of judicial review- more intrusive than under business judgment rule RMBCA 7.44 Dismissal of Derivative Suits See Aronson Below for Test for Futility The Role of Special Committees:
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What are they? Special Litigation Committees (SLCs) are appointed by the board and consist of disinterested and often recently appointed directors to decide whether a shareholders derivative suit should go forward. The committee consists of directors who did not participate in the challenged transaction and could not be named Ds. NY: Business Judgment Review Courts held that an SLCs recommendation to dismiss litigation was like any other corporate business decision. Unless the P could show the committees member were themselves interested or had not acted on an informed basis, the committees recommendations were entitled to full judicial deference under the Business Judgment Rule o Auerbach v. Bennett: Disposition of the case turns on the proper application of the business judgment doctrine, in particular to the decision of a specially appointed committee of disinterested directors acting on behalf of the board to terminate a shareholders derivative action.... [T]he determination of the special litigation committee forecloses further judicial inquiry into this case. DE: Heightened Scrutiny (demand-excuse cases) When demand on the board is excused as futile, the courts listen to the SLC but regard any recommendation to dismiss with great suspicion. ONLY GET TO ZAPATA IF DETERMINED THAT DEMAND IS FUTILE / DEMAND EXCUSED o Zapata Corp. v. Maldonado (p. 724) In demand-excuse cases, 2-Part Test for whether an SLCs recommendation to dismiss would be followed: Procedural inquiry Committee members must carry the burden of showing the committee members independence from the Ds, their good faith, reasonable investigation, and the legal and factual bases for the conclusions. Any genuine issue of material fact suit proceeds. Substantive inquiry Even if the procedural inquiry passes, the trial judge may apply his own independent business judgment as to whether the suit should be dismissed.

Aronson v. Lewis (p.733): Facts: Fink owns 47% of companys outstanding shares. Fink had an employment agreement with Prudential which provided that upon retirement he was to become a consultant to that company for ten years. Claim of over compensation to Fink as waste of corporate assets and Fink too old to render services. Claim that since Fink controls the board, dominates the directors. Holding: The plaintiff has failed to allege facts with particularity indicating that the directors were tainted by interest, lacked independence, or took action contrary to companys best interests in order to create a reasonable doubt as to the applicability of the business judgment rule. Only in the presence of such reasonable doubt may a demand be deemed futile. a. The demand requirement exists to 1. insure that a stockholder exhausts his intra-corporate remedies 2. provide a safeguard against strike suits b. Business Judgment can be claimed only by 1. disinterested directors whose conduct otherwise meets the tests of business judgment a. no appearance on both sides of the transaction b. no self-dealing 2. directors informed of all material information reasonably available to them. c. In determining demand futility, the court must decide whether, under the particularized facts alleged, a reasonable doubt is created that: 1. the directors are disinterested and independent (for reasonable doubt in order to escape business judgment rule), and

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2. the challenged transaction was otherwise the product of a valid exercise of a business judgment (court must explore the substantive nature of the transaction and the boards ratification of it (gift or waste)) Cuker v. Mikalauskas (p. 743): Facts: PECO Energy Companys board of directors (D) sought to quash tow derivative actions initiated by its minority shareholders. Rule: Under PA law, application of the business judgment rule permits a corporations board of directors to terminate a derivative suit initiated by the companys minority shareholders

IV. Management and Control of Corporations


Shareholders: Shareholders own the corporation and elect the directors. i. Powers of shareholders (1) Election and removal of the members of the board of directors. (2) Approval of fundamental changes to the corp (3) Approve or disapprove of changes to the articles or bylaws which may consequently influence the allocation of power as among themselves, the directors, and the officers (4) Some transactions by officers or directors are void or voidable unless ratified by a vote of the shareholders ii. Limitations do not have power to conduct business directly on behalf of the corp and therefore cant bind the corp by their actions iii. Shareholder resolutions can seek to influence the board by exercising their right to adopt shareholder resolutions that recommend particular actions to the board Directors: run and manage the corporation i. Two main duties (A) Appointment of officers, who are the day-to-day managers (B) Setting of major corp policy (C) provide advice at regular meetings and discipline to management ii. Election of Board Members (A) Always elected by the shareholders (B) Term usually last one year and the entire Bd stands for re-election at the annual mtg of shareholders (C) Vote to elect directors must satisfy the same basic procedural requirements as a stockholder vote to take any other action incl. giving proper notice of the time and place to all shareholders and needing a quorum present (more than 50% of the shares must be present either in person or via a valid proxy) (D) Staggered terms Bd may be divided into three classes, where one class is elected for a one-year term, another for a two-year term and a third for a three-year term; reduces the effect of cumulative voting iii. Number of directors some statutes require at least three, but many states have gotten rid of minimum requirements (incl Del), allowing a bd to consist of less than three so long as it is equal to the number of shareholders; the number is usually fixed in the articles or in the bylaws, but may merely set a minimum or maximum iv. Filling of vacancies most statutes allow them to be filled either by the shareholders or by the board, unless the articles provide otherwise v. Removal most statutes allow this to be done by either a shareholder vote or by court order vi. Power of directors (A) Shareholders cant give them orders to take a particular action
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(B) Supervises the day-to-day activities of the officers (C) Main function today is to set the policies of the corp and to authorize the making of important contracts (D) Authority of Directors: RMBCA 8.01, 8.21 Mickshaw v. Coca Cola Bottling Co. (PA, 1950) (holding that director's statement binding upon corporation although he had no actual authority; the board's silence was a sufficient ratification). An act of a single director will be binding upon a corporation if it subsequently ratified or acquiesced to by a majority of the directors. In re Drive In Development Corp. (p. 512) holding that Secretary of a corporation had actual authority to bind the corporation for a loan guaranty, although he misrepresented the fact that the resolution was never approved Officers: appointed by the directors and manage the company. i. RMBCA 8.01, 8.41generally officers carry out the policy and decisions of the board on a day to day basis ii. Agent of the corporation. An officer can bind his company by acts arising in the usual and regular course of business but not for contracts of an extraordinary nature. iii. Black v. Harrison Home Co. (CA, 1909) holding that the President had no actual or apparent authority to bind the corporation iv. Lee v. Jenkins Bros. (p. 514) holding that president acted within the scope of his authority in offering a pension to a prospective manager, because the activity arose out of the normal course of business and was not of extraordinary nature v. Ratification if a person with actual authority to enter into the transaction learns of the transaction and either expressly affirms it or even fails to disavow it, the court may find that the corp is bound; usually the court will consider whether the corp retained benefits, whether a third party relied to their detriment, and whether the ratifier had full knowledge of the contract vi. Bullet-proof means of confirming authority if a third party wants to be certain that the corp officer hes dealing with really has the authority to bind the corp to the proposed transaction, he should require the person purporting to act for the corp to deliver, prior to the closing of the transaction, a certified copy of a resolution by the Bd authorizing the transaction in question or directing the named officer to enter into the transaction on behalf of the corp

A. Traditional Roles for Shareholder and Directors Shareholders: (citizens) ultimate power (votes) but not immediate power to affect day-to-day activities. Board of Directors: (town council/parliament) as a body it has long-term, large-scale policy and principles decision-making authority, but no power to act individually. Essentially, any action that has a substantial effect on the distribution of risk/return on SH. (Names CEO, controls compensations and reviews financial reports.); authority of directors RMBCA 8.01, 8.21 Chairman of the Board: Board usually has a one (who may also be the President) and the following subcommittees: Executive Comm - inside officers (has lost importance because its redundant)
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Compensation Comm - meant to align interests of officers with SH, usually made up of outsiders Audit Comm - put together corps financial statements for investors (most important for publicly traded corps), includes both insider and outsiders (now more of the latter)

Officers: (executive/Mayor) the day-to-day executive power (i.e. hire/fire employees). Carry out the policy decisions made by board. Cant make certain decisions w/o board approval. They are answerable to the SHs, but can refuse a SHs request. How officers can/cant bind corp: ordinary vs extraordinary standard The standard can be viewed as a matrix: x-the effect on long-term capital structure (which could require Board approval) y-reasonableness of expectations (understood through the normal course of dealings). 1. President/CEO/Vice-President that orders food despite boards prohibition bind the corp to pay the restaurant (though they may have to personally pay corp back later) because it is reasonable for restaurant owner to believe President has this authority, though technically he may not. 2. President/CEO/Vice-President seeking multi-million $ loan for pet project w/o board approval does not bind corp because it would be unreasonable for a bank to make such a loan w/o board approval. Banks are sophisticated enough to know better. 3. Vice President Replaces the president when needed. VPs can only bind the corporation to matters within their respective areas. 4. Secretary Normally does not bind the corporation. 5. Treasurer Normally does not bind the corporation but keeps the books, receives/makes payments. Lee v Jenkins (p. 514) - Yardley, the Pres of Jenkins, was able to recruit Lee from his old job by offering to extend his current pension plan. By the time Lee planned to collect 30yrs later he was denied the pension. Judge Medina describes how to draw the line between ordinary vs extraordinary actions by an officer that bind the corp concluding that officers have the authority to award pension plans to employees binding on the corp, but not to offer lifetime employment. This was the former. Note: long-term employment Ks can have a major effect on the financial structure, yet they dont appear on the balance sheets as debt, but rather as some fuzzy form of operating leverage. This should strengthen the case for requiring Board approval of such Ks. 6. Shareholder Actions: Auer v. Dressel (p. 438) Shareholders could properly make a non-binding recommendation that the corporations former president be reinstated, even though the recommendation had no binding effect on the board. Structural Variation for Closely Held Corps: Small corps are sometimes allowed a variation similar to a direct democracy. No board, just SH meetings. SH effectively replace the board in making big decisions and can serve as officers, etc. This only works for very small corps. DE 341-356 limits this option to non-publicly traded corps of <30 SHs. However, this variation is not used as much now that LLCs can accomplish the same. In NJ: Remove Directors Article 6-6 (which says: shareholders can remove directors with cause and they can remove directors without cause unless otherwise barred from doing so in the articles of incorporation - - NJ gives a lot of power to shareholders

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Amend the by-laws Article 2-9 (which says that bylaws can be amended by the directors but that can always be undone by the shareholders afterwards; if the shareholders are amending it can be in the articles of incorporation that the directors cannot come after and change; Replace the exiting directors (aka fill the vacancies) - Article 6-5 (which says the shareholders would want to have a provision put into the articles of incorporation to say that they get to fill future vacancies otherwise, that power will rest with the directors) B. Meetings/Valid Votes Voting Rights Consist mainly of right to elect directors, but also include: 1. Charter amendment after BOD approves 2. Mergers after BOD approves 3. Dissolution after BOD approves 4. Selling off assets As entity changes, SH get to vote (19th century view). SH known as rationally apathetic. Ex: not reading merger proposal accompanied by proxy statement. Why? 1. Not an expert, so wont find reason to disapprove the merger 2. Wall Street rulesimpler to just sell shares 3. Not enough shares to make a difference 4. Respect for experts 5. Let someone else do the workfree riding on the bigger investors Not rational for institutional investors to be apathetic: have bigger block of shares w/more to lose, easier access to good info, easier time of coordination among themselves. Basic Voting Rules 1. Valid call - There must be a valid call by a person having the authority to call; the statutes distinguish between annual meetings versus other meetings scheduled by the charter or regulations (special meetings). In general, the people in charge of a company will give notice of general or annual meetings. 2. SH must meet at a regularly scheduled annual meeting. RMBCA 7.01 3. Special meetings for particular purposes. RMBCA 7.02 4. Record dateonly SH of record by a certain date can vote (set by bylaws or BOD) RMBCA 7.07 Shareholder of Record/Record Owner: the person in whose name shares are registered, may or may not be the beneficial owner; generally speaking, the corp can treat the record owner as the owner of the shares for purposes of voting, the payment of dividends or distributions, and determining to whom the shares have been transferred; these are usually brokerage firms; Cede & Company is the largest Beneficial Owner: the person who is the actual owners of the shares; can compel the record owner to execute a proxy appointment in their name so that they may vote how they want; also has the power to compel the record owner to turn over any distributions made by the corp and ultimately to re-register the shares in the name of the beneficial owner when requested to do so 5. SH action at a meeting requires a quorum, majority unless charter says o/wise RMBCA 7.25(a) 6. Cannot break quorum by walking out RMBCA 7.25 7. To get a matter approved concerning election of directors, a plurality is needed. RMBCA 7.28(a) 8. If matter is dissolution, change in charter rules, the positives must exceed the negatives. RMBCA 7.25(c) 9. Proxy votingSH can authorize someone else to exercise their voting rights (usually mgmt.) RMBCA 7.22 Regulated by federal law. 10. Vote by written consent instead of meeting must be unanimous. RMBCA 7.04

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Annual Meeting Date usually set forth in bylaws RMBCA 7.01 If corp wants to change date, must make sure date is set w/in 6 mos. after end of fiscal year or 15 mos. after last annual meeting. RMBCA 7.03(a) Special Meeting Note a special meeting can be called by the BOD (or whoever authorized to under A of I or bylaws) OR by SH of at least 10% of votes to be cast Corp can raise or lower the 10% mark (but cant go higher than 25%) Notice of Annual Meeting - RMBCA 7.05 BOD must give notice of meeting no fewer than 10, no more than 60 days before the mtg date Notice of a special mtg requires description of why mtg being called Record date may be set in bylaws to determine who gets notice RMBCA 7.07 Record date cant be more than 70 days before the mtg If mtg adjourned more than 120 days after original mtg date, new record date must be set

Notice of Special Meeting If SH makes demand for special mtg, notice must be given of mtg w/in 30 days of receipt of demand RMBCA 7.02/7.03 All in all BOD cant schedule mtg later than 90 days after the demand is made. RMBCA 7.03/7.05 (notice given w/in 30 days of demand but cant be given more than 60 days in advance of mtg). Action w/o a Meeting SH can take action by written unanimous consent w/o a mtg. RMBCA 7.04 BOD has ability to manipulate the record date w/receipt of consents here RMBCA 7.04(b) Record date is when SH signs first consent. BOD can change this record date under RMBCA 7.07(a), just has to be w/in 70 days. Ex: could set 100 days after last consent. Could invoke Schnellmaneuvering w/in statutory limits but designed to entrench the BOD Election of Directors A quorum is needed under RMBCA 7.25(a) Proceeds by plurality voting RMBCA 7.28(a). Ex: 5 directors to be elected from a slate of 10. Winners are the 5 w/the most votes. Staggered terms of directors: ensures BOD will always have some directors w/experience. Also makes takeover less likely b/c wont be able to put all people on BOD at once. Two methods of plurality voting: straight and cumulative. Note: Cant have a proxy for a meeting of the board of directors.

C. Shareholder Voting Control/Agreements

The person in whose name shares are registered is called the record holder and may or may not be the person who is the actual owner of the shares, usually referred to as the beneficial owner. See above more detailed description.

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Cumulative Voting - method of voting that allows substantial minority shareholders to obtain representation on the board of directors. When voting cumulatively, a shareholder may multiply the number of shares he owns by the number of director positions to be filled at that election, and cast that number of votes for any one candidate or spread that number among two or more candidates. these votes can be spread amongst as many candidates as the shareholder desires. A way to make sure that minority shareholders have some representation on the board.] Formula: To elect X number of directors, a shareholder must have more than SX / (D+1) + 1 shares, where S equals the number of shares voting and D equals the total number of directors to be elected. (Adding 1 at the end assures the number of shares you will need for a proper outcome. Good for a proxy fight; voting directors. Much harder in publicly traded setting, because we dont know how many people will cast votes, etc.; Works better in a closely held corporation. Positive: What is the use of cumulative voting when you only get one director on the board. 1) having a voice to influence 2) get more information 3) may change dynamic of meeting b/c somebody is watching Negative: 1) factionalizing board of directors, which is not necessarily in the best interests of shareholders as a group Cumulative voting power falls as the number of directors to be elected decreases. RMBCA 7.28: mandates that shareholder give notice if he plans to cumulate his votes. Virtually all states permit cumulative voting and some mandate it. Straight Voting - (or non-cumulative voting) limits the number of votes a shareholder may cast for a single candidate to the number of shares he owns; 1 share equals one vote (with 3 directors, and 100 shares, you get 300 votes) However, you can only allocate votes for a particular candidate the amount of shares that you have. (i.e. may not give all 300 votes to one particular candidate. Therefore, the shareholders with the most shares will always win.

Galler v. Galler (p. 423): Shareholder agreements are enforceable even if they deviate from state corporation law practice; especially: 1) in closely held corps; 2) in order to give business effect to the intentions of the parties; 3) so long as it does not injure creditors, other shareholders, or the public Salgo v. Matthews (p. 445) Facts: A corporate election inspector (D) appointed by Salgo (D) refused to accept several proxies, which, if accepted, would have enabled Matthews (P) to win his proxy fight against Salgo (D). Rule: Shares of stock may be voted only by an authorized representative of the party designated in the corporate records as legal owner of the shares. Ringling Bros. Barnum and Bailey Combined Shows v. Ringling (p. 456) Facts: Ringling (P) and Haley (D) entered into a stock pooling agreement by which they agreed to always vote their shares together, but when Haley refused to agree on a vote for director or vote as directed by the arbitrator, who was provided for in the agreement, Ringling sought to enforce the arbitrators decision. Rule: A group of shareholders may lawfully contract with each other to vote in such a way as they determine. Lehrman v. Cohen (p. 476) Facts: Dispute between rival factions, Lehrman (P) and Cohen (D) over issuance of class AD stock and its voting power. Rule: The creation of a new class of voting stock does not divest and separate the voting rights, which remain vested in the stockholders who created it, for the other attributes of the ownership of that stock. Voting trust - An agreement establishing a trust, whereby shareholders transfer their title to share to a trustee who is authorized to exercise their voting powers. Voting trust v. pooling agreement: RMBCA 7.30 7.32
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Voting trust: an actual trust in the sense that you surrender your stock, its placed in the trust, the trustee votes the stocks and the stockholder gets certificates and they are the ones who get the money/the trust only gives the power to vote, nothing else/voting trusts can only be set up for a maximum of 10 years Pooling agreement: you vote your own shares but per an arrangement; the holder of the certificate can bring suit; to have standing you have to have stock, and have had stock at the time the event occurred; if you bring a suit and lose, you have to pay the other partys reasonable attorneys fees/court costs; usually you have to put up a bond at the start unless you own 5% of the stock and the market value of your stock is worth at least $25,000

Buy-Sell Agreements: parties contractually determine what happens to the corp stock after a triggering event in the hopes of avoiding shareholder disputes and can also solve owners estate planning problems Possible triggers: o An owner or shareholder becomes disabled o Married owners or shareholders divorce o A minority owner is fired o An owner faces personal bankruptcy o An owner is convicted of a crime or involved in a scandal To determine the buy-sell value o Objective Formula: an agreed upon and objective formula is used but this may not take into account subjective factors such as good will o Independent Appraisal: fair market value per an outside appraiser: questions arise as to who the appraiser should be o Agreement by the Parties: all involved sit down periodically and agree to a value using the above to methods and/or others Two types of Buy-Sell Agreements: o Cross-purchase agreements: each shareholder agrees to personally purchase his proportionate share of the stock of the other shareholders in the event of their death and each would bind their estate to do the same in the event of their death o Stock-redemption agreements: the corp becomes a party to the agreement as well as the shareholders; the corp would agree to redeem or purchase the shares of the first shareholder to die, and each of the 2 shareholders would bind his estate to do the same upon their death; upon the death of the first shareholder, the corp buys his shares using corp funds. D. Electing and Removing Directors Default Rule o Shareholders may remove directors without cause by a simple majority vote at a meeting specially called for that purpose. o All directors stand for election annually, unless it is a staggered or classified board. Staggered Board Rules of staggered board 41(d) must be provided for in articles of incorporation, bylaws, or amendment of bylaws adopted by the shareholders. (Directors not able to amend bylaws to make such changes to avoid entrenchment.) Rationality of Staggered Board Anti-takeover mechanism. It takes at least two-years to gain control over the board.
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Stability having experienced members on the board at all times Autonomy since elected for three years less likely to be swayed by management Shareholder Value staggered boards reduce returns by 8 to 10% to shareholders, because it takes away control form shareholders, making the stock less desirable Now movement by institutional shareholders to de-classify boards If staggered board created in bylaws, then may amend the bylaws If in articles of incorporation, then directors may block amendment May make a predatory proposal for suggesting that they make an amendment Hostile takeovers allow shareholders to replace poorly performing directors, with better performing directors Removal of Directors Removal of Directors o The default rule of modern codes generally grants shareholders the right to remove directors with or without cause by simple majority vote. o Del. G.C.L 141(k): can remove any or all directors without cause, except that: If the directors are divided into classes with staggered terms, their must be cause for removal. If theres cumulative voting, and less than the entire board is to be removed, director X cant be removed without cause if the votes cast against X would be sufficient to elect X (in a cumulative-vote election of the entire board or of the class of directors that includes X). Roven v. Cotter (Del. Chanc. 1988) HELD: Shareholders may amend a certificate of incorporation, thereby eliminating a bylaw establishing a classified board of directors, so that the stockholders can then remove a director without cause o Staggered Board w/ Cumulative Voting Since staggered board may only be removed with cause, and director with significant amount of shares may vote himself back in through cumulative voting, best strategy for removal is: Declassify board in the bylaws (may require amendment to articles) Remove cumulative voting in the bylaws o Replacement of Directors; filling newly created positions Most codes allow replacement directors to be selected by either the shareholders or the directors. See Delaware G.C.L. 223 Securing a special meeting o Delaware G.C.L. 211(d) does not give shareholders any statutory right to call a meeting. But by-laws may allow one or more shareholders to do so. o If not empowered to call a special meeting, shareholders must wait until the next annual meeting to remove directors, or remove or replace directors via written consent in states that permit this on a less than unanimous basis

Removal for Cause Requires service of specific charges, adequate notice, and full opportunity of meeting the accusation. Show of cause requires notice and opportunity to respond; DPC Campbell v. Loews, Inc. (Del.Ct.Chan. 1957) Holding: The stockholders have the right between annual meetings to elect directors to fill newly created directorships. Under Delaware law, the
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shareholders have the power to remove a director for cause. A planned scheme of harassment constitutes a legal basis for removing a director. stockholders have the power to remove a director for cause in order to prevent the damage of an offending director; stockholders may remove a director for cause even where there is a provision for cumulative voting. A charge that the directors desired to take control over the corporation is not cause for removal. Nor is a charge of lack of cooperation E. Deadlocks/Control in Closely Held Corporations Deadlocks in closely held corporations arise when you have two shareholders or factions and an even number of directors. One or more factions of shareholders is then able to block corporate action when they disagree with some aspect of corporate policy. Usually arise: o in the election of a director o at the level of the board of directors if there is an even number of directors and no single faction of shareholders has power to elect a majority of the board. Deadlocks may be avoided by careful planning (i.e. initial distribution of shares is allocated to more than two parties) Two types o Shareholders usually involving 50/50 factions w/ equal voting power (cumulative voting may help resolve); if shareholders are deadlocked, the corp may continue to operate under the guidance of the Bd in office when the deadlock arose

o Directors usually involves Bd w/ an even amt of members (can be prevented w/ heightened majority or quorum requirements) Gearing v. Kelly (p. 492) Facts: When Mrs. Meacham (P) refused to attend a directors meeting, the Kellys (D) elected Hemphill, and the Meacham-Gearing faction objected. Rule: where one shareholder intentionally or deliberately fails to attend a meeting for the purpose of preventing a quorum, the court will not set aside the results of the election that occurred at the meeting; courts reasoning based on notions of equity and fact that even if the shareholder had been present, the same result would have occurred In Re Random & Neidorff, Inc. (p. 495) Facts: Random (P) and his sister Neidorff (D) were the sole shareholders in a music publishing corporation. Due to a mutual dislike and distrust, they were deadlocked as to the election of directors and the declaration of dividends Rule: Where corporate dissolution is authorized by statute in the case of deadlock or other specified circumstances, the existence of the specified circumstances does not mandate the dissolution. The court will exercise its discretion, taking into account benefits to the shareholders as well as injury to the public. Here the court considered: (1) no stalemate or impasse; (2) corp is flourishing; and (3) theres no grievance recognizable by the court F. Modern Remedies for Oppression, Dissension, or Deadlock Dissention: Dissention in a closely held corporation refers to personal quarrels or disputes among shareholders that may make business relations unpleasant and interfere with the successful operation of the business. Dissention may occur w/o constituting oppression or causing a deadlock or adversely affecting the corporations business. Oppression:
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in a close corporation involves conduct by controlling shareholders that deprive a minority shareholder of legitimate expectations concerning roles in the corporation, including participation in management and earnings; abusive tactics by majority shareholders that limit or exclude minority shareholders. has been described as an expansive term that is used to cover a multitude of situations dealing with improper conduct, including significant misconduct by those in control of the corp & waste of assets; courts try to narrow its definition does not carry an essential inference of imminent disaster; it can contemplate a continued course of conduct; does not carry an essential inference of illegal behavior or mismanagement, some course have association oppression with violations of the fiduciary duty of good faith and fair dealing as imposed in Donahue v. Rodd Electrotype (p. 44 Above) may include non pro-rata (proportional) distributions of corporate assets. Freeze-out: Majority shareholders in a company using their power to deprive one or more minority shareholders of their role in governing the company. This is done to force the minority shareholders to sell their stock at a reduced price and exit the company. Squeeze-out: a transaction that involves the issuance of additional shares by the corporation on a non-proportionate basis that dilutes the interest of minority shareholders.

In order to prove oppression (and therefore be granted a right to dissolution), must show o From Wiedys Case in NY (p. 502 CB) o The majoritys conduct substantially defeats o Your reasonable expectations, when objectively viewed, were both o Reasonable under the circumstances AND o Were central to your decision to decide to invest in the corp/join the venture You = a minority shareholder is the most common violation for which a buy-out was found to be an appropriate remedy in many jurisdictions.

Remedies only available if shareholder has voting rights per RMBCA 6.30(b)(4),(5) Judicial Dissolution: Involuntary dissolution comes in sub-flavors at common law: a court can enter an order of dissolution when it finds (1) fraud, (2) oppression (in a close corporation), or (3) deadlock (by statute). Heres an important legal point: all dissolution orders by courts are on the equity side of the docket (as opposed to the law side). RMBCA 14.30(2) model statute granting discretionary judicial dissolution to the court; contains specific grounds for dissolution (i) Director deadlock irreparable harm to the corp. required to be present or threatened (ii) Oppression harm required (iii) Shareholder deadlock no harm required (iv) Waste harm required

Other Remedies:
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Allowing dissolution by less than a majority written into bylaws or Articles of Incorporation as a shareholder agreement, but make sure that subsequent purchasers or creditors have notice (legend) Buy-Out Agreements (2 types) provides effective exit strategies o In the event of an unreasonable agreement, one solution is for one shareholder to buyout the other at fair value per the courts determination o Courts have turned to this remedy (court-ordered buyouts) where it is unfavorable to dissolve a deadlocked company. o The court may mandate a buyout of the interest of a minority shareholder at a judicially determined price. o If the majority shareholder is unwilling to purchase the interest, the court may then order involuntary dissolution. o RMBCA 14.34 outlines a buyout remedy in deadlock or oppression cases. It is less flexible than remedies devised by the courts. It is triggered only if a suit is brought for involuntary dissolution. Cross-purchase agreement between shareholders that they will buy the other's shares. Stock-redemption agreement where corporation buys the shares using corporate funds May be judicially imposed as an equitable remedy within the courts discretion, especially where the court finds that the D is using oppressive conduct towards P - court prefers ordering a buy-out rather dissolution, especially where the corp is solvent No state gives a minority shareholder an automatic right to be bought-out Davis v. Sheerin (p. 500): Here we have despicable conduct on the part of the majority shareholder. The majority shareholder claims that the minority shareholder isnt a shareholder at all! The minority shareholder brings an action for oppression. Since what the majority shareholder was doing was arguably oppressive, the minority shareholder claims that the court should enter an order forcing the majority shareholder to buy the minority shareholders shares at market value without a minority discount. The problem was that until five years before, Texas had a statute authorizing this remedy. The statute was modeled after Michigan and California. The Texas legislature had since repealed the statute. The court held that as a court of equity they have inherent jurisdiction under judge-made law to enter the buy-out order. Davis v. Sheerin. 1. Does SH have a preemptive right to purchase additional shares under statute or A/I? RMBCA 6.30(a) a. RMBCA 6.30(a) says no, unless A/I so provide. b. If not, see #5, below. c. If so, is SH exempt from PE rights provision anyway? RMBCA, if it applies, has default exceptions in RMBCA 6.30(b)(3)(i)&(ii) = compensation exception. (iv) shares not for $. 2. Did SH waive PE right? RMBCA 6.30(b)(2) allows. May waive if not timely raised. Stokes says SHs offer that was too low isn't a waiver. 3. Remedy? Specific performance or expectation damages? 4. Does SH have a right not to purchase addt'l shares w/o facing dilution? Katzowitz v. Sidler says in a CHC, majority SHs must show a good business reason to sell additional shares cheaply. If no good reason, i.e., a freeze-out tactic, then SH has right not to buy, and not to face dilution.

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5. Even if SH has no PE right via statute, still has a Katzowitz (no freeze-out) right, supra #4. 6. If ALL SHs exercise PE rights, no dilution, & additional cap. needed raised from present SHs. 7. If BOD acts in bad faith unfair to minority SHs, may be limited by a general fiduciary duty. Appointment of Provisional Director helps guide the corp through crisis towards stabilization o In evaluating candidates for provisional director, the court may consider: degree and quality of past involvement in the corporation, an understanding of the corporations history and current situation, experience and abilities, degree of impartiality o NJ requires impartiality - - one of the 11 jurisdictions that require that the provisional director of a co. be impartial/not related to anyone else involved

Abreu v. Unica Indus. Sales, Inc. (p. 507): Alternative Remedies to Dissolution; Facts: After Abreau (P) filed a shareholders derivative action for a usurping of a corporate opportunity by one of the directors of Ebro Foods, Inc., the court removed one of Ebros directors and appointed a provisional director to stabilize the two hostile factions. Rule: As an alternative to judicial dissolution of a corporation, the court may retain jurisdiction and, in its discretion, appoint a provisional director. Shareholder Derivative Action: Action asserted by a shareholder in order to enforce a cause of action on behalf of the Corporation; the test is: a) it has to be someone who will do whats in the best interest of the company, b) behave per corporate norms/by the book, c) must be a deadlock otherwise not exigent enough to warrant a provisional vote and the decision will have to be made by the board of directors Arbitration o Mandatory arbitration may be used as a device to resolve internal corporate disputes and deadlocks. o Requires either a current willingness or a pre-existing agreement to submit to arbitration. o Advantages of arbitration include speed, cheapness, informality (compared to court), and the prospect of the decision being made by a person knowledgeable of business, permits the corporation to continue. o Disadvantages are that in close-corporations, many disputes are personal and arbitration is impossible. Rarely applied is a duty on the majority shareholders to their minority shareholders, which if breached for example by oppressive conduct, the court will order that the majority pay damages to the minority rather than order dissolution or a buy-out (not followed in Delaware)

G. Action by Directors and Officers & Controlling Interests RMBCA 8.40, 8.41, 8.42: says little purpose in statutorily requiring that there be certain officers and statutory requirements for each as it may sometimes create problems of implied or apparent authority or confusion with non-statutory offices the crop desires to create; possible source of this info would be the corps bylaws o Proposed Model Bylaws to be used with the RMBCA:

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President: principal executive officer of the corporation, and subject to the control of the board of directors, shall in general supervise and control all of the business affairs of the corporation. Secretary: keeps minutes of proceedings, sees that all notices are duly given in accordance of the bylaws, acts as custodian of corporate records, authenticates records of the corporation Treasurer: has charge and custody of all funds and securities of the corporation, receives and gives receipts for monies due. See RMBCA 8.21 Action without Meeting: designed to prevent informal board practices

In the Matter of Drive-in Corp. (p. 512): P, Inc. owned 100% of S, Inc. P, Inc. is borrowing money from a bank. P, Inc. happens to be in pretty bad shape itself, while the subsidiary, S, happens to be in good financial shape. The bank wants what is known as an upstream written guaranty by S, Inc. of Ss liability to the bank. The corporate secretary for S, Inc. fills out a certificate and delivers it to the bank stating that Ss board of directors has duly met and has unanimously approved the S guaranty. Based on that, Ss president has signed the guaranty on behalf of S, Inc. Later, there is a bankruptcy and the bank files its claim both against P, Inc. and S, Inc. There are two touchy issues: (1) It just so happened that the board of directors of S, Inc. didnt actually meet, and an upstream guaranty is so unusual that only the board of directors could approve it. S, Inc. says Sorry, the board didnt meet, despite what the corporate secretary did. Without a board meeting, were not liable on the guaranty! On the agency issue, the court holds that there is apparent authority. The notes indicate some contrary authority. In the later case, a reasonable person would have been put on notice if the secretary was lying. (2) There also were the fraudulent conveyance statutes. Here, the attorney for S did not properly raise the issue in the bankruptcy court. In a big 1990s Third Circuit case, upstream guaranties were said not to be per se fraudulent. Black v. Harrison Home Co.: Facts: Black (P) purchased property which the Harrison Home Co. (D) had, through its president, agreed to sell. A company resolution required joint action by the president and secretary whenever property was to be sold. Rule: The president of a corporation has no authority to execute contracts on behalf of the company in the absence of a bylaw or a resolution of the board of directors permitting him to do so. Common Law rule regulating authority of management to execute contracts or commit property, in the absence of some approval of the board, is very, very strict. Lee v. Jenkins Bros. (p. 514) Facts: Lee (P) sought to enforce a promise made by Jenkins (D) president in 1920, when Lee (P) was hired, that Jenkins would pay Lee a $1500 pension at age 60, regardless of what happens. Rule: A president has authority only to bind his company by acts arising in the usual and regular course of business but not for contract of an extraordinary nature. Controlling Interests: Perlman v. Feldmann (p. 528) Facts: Feldmann (D), a director and dominant stockholder of Newport Steel, sold, along with others, the controlling interest of that steel manufacturer, to steel users, along with the right to control distribution. Rule: A corporate director who is also a dominant shareholder stands, in both situation, in a fiduciary relationship to both the corporation and the minority stockholders if selling controlling interest in the corporation, its accountable to it (and the minority shareholders) to the extent that the sales price represents payment for the right to control.

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V. The Duties of Officer, Directors, and Other Insiders


A. The Duty of Care/Obligations of Control Duty of Care: Officers and Directors owe a duty to the corporation to exercise reasonable care in performing their duties with respect to the corps affairs. They have a fiduciary relationship to the company, and are bound by all those rules of conscientious fairness, morality, and honesty. A director should be influenced by no consideration other than the welfare of the corporation. High level officers are held to be substantially the same duties as directors, but the lower down the officer ranks as you go, the less of a duty the officer owes. Shlensky v. Wrigley (p. 676) Courts cannot interfere with the management of corporations and second-guess the decisions of the directors unless it is clear that they are guilty of fraud or misappropriation of the corp. funds, or refusing to declare a dividend when corp. has a surplus of net profits which it can w/out detriment to the business. Business Judgment Rule: Doctrine limiting the liability of a director in the good faith pursuit of his duties (usually everyday decisions)RMBCA 8.03 - director or officer who makes a business judgment in good faith fulfills the duty under this if he: o is not self-interested in the decision (self-dealing) o is informed w/ respect to the subject of the bus. judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances; and o Director is entitled to rely on information provided by competent corp officers, legal counsel or accts o Director will only lose the protection of the JR if he was grossly negligent. o rationally believes that the business judgment is in the best interests of the corporation. Burden is on the challenger of the conduct. BJR is a presumption that in making a business decision, the directors of a corp acted on an informed basis, in good faith, and in the honest belief that the action taken was the in the best interest of the corp see Smith Smith v. Van Gorkom (p. 685): this decision epitomizes the outer limits of the business judgment rule. Ct. found that directors did not reach an informed business judgment in voting to sell the corp. for $55/share. o Directors decided based on Van Gorkoms proposal; Chelbergs representations; Romans oral statement; Brennans legal advice; and knowledge of market hx of stock. (took 2 hours) o All 10 directors are collectively held liable even though the stock price didnt turn out to be substantially different. o MBCA allows directors to rely on lawyers, but Van Gorkom had just hired him the day beforenot reasonable to rely on him. o Some of the 10 were outside directors who probably didnt have anything to do with the decision, s as a litigation strategy sued them all b/c knew Ct. wouldnt hold outside directors solely, ct. asked them if they had a special defense but they didnt figure it out. o Significance in that they suggest that the process is exceptionally important in obtaining benefits of the BJR o DE adopted a statute that effectively changes this a bit, now Business Judgment rule is used as a defense, conduct must be so unreasonable that it is not worthy of the shield from personal liability BJR employs an Objective standard of the ordinarily prudent person." Duty of Care standard is a procedural one that asks if the procedure by which the business decision is reached complies with the duty imposed focuses on the process as opposed to the decision itself
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Why court is reluctant to find that directors breached duty of care financial liabilities would be huge and would discourage qualified people from wanting to serve on Bds; directors may become overly cautious and pass up good business opportunities because theyll fear being held liable Most often shareholders will file as a derivative suit on behalf of the corp Requires that shareholder have been a shareholder at the time of the complained of act or omission If the P is successful, the negligent director will have to pay damages to the corp Applies equally to directors and officers, but must consider the greater access to info that officers likely have Causation is also a required element

Litwin v. Allen (p. 670): Facts: Stockholders (P) brought a derivative action against Trust Co. (D), its subsidiary, Guaranty Trust (D), and J.P. Morgan (D) for a loss resulting out of a bond transaction. Rule: A director is not liable for loss or damage other than what was proximately caused by his own acts or omissions in breach of his duty. A director owes to his corporation a loyalty that is undivided and an allegiance un-influenced by no consideration other than the welfare of the company Smith v. Van Gorkom (p. 681): Facts: The trial court held that because Van Gorkom (D) and the other Trans Union directors had three opportunities to reject the merger proposal, they acted with due deliberation and their conduct fell within the business judgment rule. Rule: Directors are bound to exercise good faith informed judgment in making decisions on behalf of the corporation. Business Judgment Rule: Doctrine relieving corporate directors and/or officers from liability for decisions honestly and rationally made in the corporations best interest. Del. Gen. Corp. Law In re Caremark Intern. Inc. (p. 701): Where a director in fact exercises a good faith effort to be informed and to exercise appropriate judgment, he or she should be deemed to satisfy fully the duty of attention. Absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists Gall v. Exxon Corp. (p. 720): Facts: At trial of Galls (P) shareholder derivative suit against Exxon (D), claiming illegal bribes by the corporation, Exxon moved for summary judgment, claiming that it was in the corporations sound business judgment and to refuse to sue on Galls complaint. Rule: The decision of corporate directors, whether or not to assert a cause of action held by the corporation, rests within the sound business judgment of management B. Duty of Loyalty/Conflict of Interest Duty of Loyalty and Conflicts of Interests: Shareholder Derivative suit: A suit that is brought on behalf of the corporation by shareholders on the grounds that he board has made a decision detrimental to the corporation. o All damages, if awarded, go to the corporation. o Only those who were shareholders at the time the action occurred or decision was made can bring a suit. Commencing a derivative suit: o DEMAND-REQUIRED-RMBCA 7.42 -No shareholder may commence a derivative proceeding until: A written demand has been made upon the corp. to take a suitable action; and 90 days have expired from the date the demand was made unless the shareholder has earlier been notified that the demand has been rejected by the corp. or unless irreparable injury to the corp. would result by waiting 90 days.
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If a committee, composed of independent and disinterested directors, conducted a proper review of the matters before it, considered a variety of factors and reached, in good faith, a business judgment that the action was not in the best interest of the corporationaction must be dismissed. [based on independence, good faith and reasonable judgment] This dismissal by the committee is reviewed by the court by the BUSINESS JUDGMENT RULE. A demand, when required and not wrongfully refused terminates a stockholders legal ability to initiate a derivative action. o DEMAND-EXCUSED RULE: [Very seldom excused after Aronson] A shareholder need not make a demand when it is apparent that a demand would be futile Where facts are alleged w/ particularity which create a reasonable doubt that the directors action was entitled to the protections of the business judgment rule. Two-part test (Aronson): Are the directors independent (a directors decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences) and disinterested? and Does the challenged transaction represent sound business judgment. (officers under an influence that sterilizes their discretion and renders them too partial to conduct the litigation). If shareholder has not made a demand on the corporation, at the pre-trial phase, independent committee may file a pre-trial motion to dismiss or summary judgment motion (presumably under the same good faith, independent and reasonable judgment when deciding whether to dismiss a demand) Court reviews this motion by a 2-part test: (Zapata) Independence and good faith of the committee and the bases supporting its conclusions. Limited discovery may be ordered to facilitate such inquiries. Corp. possesses the burden of proving independence, good faith and reasonable judgment rather than a presumption of it. If the court determines that either the committee is not independent or has not shown reasonable bases for its conclusions or not satisfied w/ good faith, ct. should dismiss the motion and give the P their day in court. Ct. applies its own independent business judgment to determine if motion should be granted. This means that committee could establish good faith, independence, etc. and still have its motion denied. Used when ct. finds it not proper to terminate a stockholder grievance deserving of further consideration. PA and some other states do not follow this process, they sat demand is universal and always required, see Cuker v. Mikalauskas (p. 743)more predictable, puts people on notice, business judgment is the only review std, encourages them to remedy absent litigation. 1. Self Dealing Self-Dealing Transactions: Kinds of transaction were concerned with (3 conditions) o Where a key player and the corp are on opposite sides; o Where the key player has helped influence the corps decision to enter the transaction;
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o Where the key players financial interests are at least potentially in conflict with the financial interests of the corp In Sinclair Oil Corp. v. Levien, the court defined self-dealing as when the parent, by virtue of domination over its sub, caused the sub to act in such a way that parent receives something from the sub, to the exclusion of and to the detriment to the minority shareholders of the sub. Intrinsic Fairness Test is applied when it is shown that the transaction in question is a self-dealing one (no presumption of good faith); Marciano v. Nakash (DE, 1987) (holding that transaction was self-dealing but the transaction was fully fair to the corporation). RMBCA 8.62-directors action is effective if transaction received the affirmative vote of the majority of those directors or on a committee of the vote who voted on the transaction after required disclosure o Section 144 (Del.) exceptions. A self-dealing transaction will not be void if: Knowledge of and approval by majority of the disinterested directors; Knowledge of and approval by shareholders; Fair to the corporation at the time authorized, approved or ratified. Weinberger v. UOP, Inc. (DE, 1983) (introducing the no valid business purpose rule) Del does not accept this view but it has been applied in a few jurisdictions Marciano v. Nakash (p. 759): Facts: A loan to Gasoline, Ltd. by certain board members was validated as a fair transaction. Rule: A transaction by a corporation with its insiders will be valid if intrinsically fair Heller v. Boylan (p. 764): Facts: Heller (P) and six other stockholders in American Tobacco Company claimed that the bonuses paid top executive officers bore no relation to the services for which they were given. Rule: If a bonus payment has no relation to the value of services for which it is given, it is in reality a gift in part, and the majority stockholders have no power to give away corporate property against the protest of the minority Brehm v. Eisner (p. 769): compare this to the Smith v. Van Gorkum case: shareholders say: 1) they werent fully informed per the Van Gorkum standard (the process was inappropriate) and 2) there was also a violation of their duty of care b/c they could have terminated this guy for cause and paid nothing but instead offered him the no fault package; court says there are those cases when its so egregious on its face that board approval cannot meet the business judgment standard; so, the court concludes that there is a lack of egregiousness in the decision to give the compensation package Sinclair Oil Corp. v. Levien (p. 777): Facts: A minority stockholder in Sinven, Levien (P) accused Sinclair (D), the parent company, of using Sinven assets to finance its operations. Rule: Where a parent company controls all transactions of a subsidiary, receiving a benefit at the expense of the subsidiarys minority stockholders, the intrinsic fairness test will be applied, placing the burden on the parent company to prove the transactions were based on reasonable business objectives. Weinberger v. UOP, Inc. (p. 783): Rule: When seeking to secure minority shareholder approval for a proposed cash-out merger, the corporations involved must comply with the fairness test, which has two basic interrelated aspects: o fair dealings - which imposes a duty on the corporations to completely disclose to the shareholders all information germane to the merger, and
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o fair price - which require that the price being offered for the outstanding stock be equivalent to a price determined by an appraisal where all relevant non-speculative factors were considered. 2. Corporate Opportunity The Corporate Opportunity Doctrinea fiduciary concept that limits the power of officers, directors, and employees to take personal advantage of opportunities that belong to the corporation; is decided/considered by the court on a case-by-case basis and apply a fairness test (should the opportunity, in all fairness, have belonged to the corp); It is an opportunity that a fiduciary to a corporation has to take advantage of information acquired by virtue of his or her position for the individuals benefit. In order to plead corporate usurpation, the P must show, among other things, that the company had the financial means to take advantage of the alleged opportunity Corps may renounce an opportunity voluntarily in order to enable an officer, director, or shareholder to take advantage of it per Delaware GCL 122(17) Northeast Harbor Golf Club, Inc. v. Harris (p. 797) Rule: Prior to availing herself of an opportunity property belonging to the corporation, an officer or director must first fully disclose the opportunity to the corporation, and allow the board of directors the opportunity to reject it by a majority vote of the disinterested directors 3. Duties to Corporate Constituencies Other than Common Shareholders Preferred shareholders: Delaware courts have also recognized fiduciary duties running to preferred shareholders on questions such as whether the proceeds of a merger were being fairly divided between preferred and common shareholders. Holders of Convertible Securities: Where convertible securities are called for redemption, holders have the option of converting into common shares or to be redeemed. The corporation has a duty to provide holders with accurate information about the desirability of each alternative. Creditors: As a general rule, directors do not owe fiduciary duties to creditorswhether they be shortterm trade creditors, long-term bondholders, or holders of debt securities convertible into common shares

C. Disclosure and Fairness Duties of Controlling Shareholders: Few, if any statutes, impose a general fiduciary duty on the controlling shareholder towards the noncontrolling shareholders, but case law has done so in the closely-held corporate context less likely in public corp Donahue v. Rodd Electrotype Co. (p. 396) (holding that in a closely held corporation, controlling stockholders are held to a higher standard of good faith and inherent fairness). Rule: in close corporations only, controlling shareholders owe a fiduciary duty to minority shareholders when involving self-dealing transactions (similar to the duty directors owe to the corp) and must accord her an equal opportunity to sell shares to the corp. Zetlin v. Hanson Holdings, Inc.: not closely-heldcontrolling interest [absent looting of corp.
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assets, conversion of a corp. opportunity, fraud or other acts of bad faith] are free to be sold and purchased at premium price. VI. Social Responsibility Chapter (p. 539 CB) In the early days, corporate charters were granted by the govt on the theory that the corp would contribute to the public interest as well as make money for shareholders only. In the 1930s, a debate began about the responsibility of corps; this debate is still going on (with inconclusive results). Some argue that a crops objective should be to produce the best possible goods and services, that no other legal standard is enforceable, and that any other standard allows an unhealthy divorce between management (making suck decisions) and ownership. Others argue that corps have a social responsibility and that they must balance the interests of the shareholders, employees, customers, and the public at large. Property Conception of the Corporation: corp is seen as the private property of its stockholder-owners; its purpose is to advance the purposes of these owners (predominantly to increase their wealth) and the function of the directors as agents of the owners, is faithfully to advance the financial interests of the owners. Social Entity Conception of the Corporation: sees the corp as a social institution with a public purpose; it comes into being and continues as a legal entity only with govtal concurrent; promoted by the states interest in promoting the general welfare; the board of directors duties extend beyond assuring investors a fair return,, to include a duty of loyalty, in some sense to all those interested in or affected by the corp; the corp itself is capable of bearing legal and moral obligations. This is the majority approach today.

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