Mendales Outline

Good Supplements Booth and Hamilton, Business basics for law students Fletchers Cycopledias of corporations Securities Regulation, Seligman and Loss

Agency
Agency is created by: a. Actual authority i. Agent has actual authority to act on principals behalf if principals words or conduct would lead a reasonable person in the agents position to believe that the principal wishes the agent so act. ii. If an agent has actual authority, and acts within the scope of that authority, the principal is bound. iii. May be express or implied (implied/inferred from words used, customs, and relations of parties R3rd2.02) iv. Common type of implied actual authority is incidental authority authority to do incidental acts that are reasonably necessary to accomplish or usually accompanies an actually authorized transaction. v. BOUND: even if third person did not know agent had AA, even if thought agent was principal 1. Principal set acts into motion, stood to profit from them 2. Agent would be liable and could seek indemnification from principal anyway. vi. Literal interpretation of principals manifestations does NOT always govern. vii. Agent may act in a way knowingly at variance with principals original instruction, if (R3rd2.02 cmt b) 1. Circumstances have changed since the initial instructions 2. Were the principal to reconsider the matter, different instructions would have been given 3. It is impracticable to communicate with the principal for further clarification before action needs to be taken b. Apparent authority i. Agent has apparent authority to act in a given way on principals behalf in relation to a third person, if manifestations of the principal to 3rd person (or manifestations by the agent to 3rd person that the principal authorized the agent to employ) would lead a reasonable person in 3rd persons position to believe that the principal had authorized agent to so act. ii. If an agent has apparent authority and act within the scope of that authority, principal is bound. iii. Power of position is created by appointing someone to a position which carries with it generally recognized duties, ordinarily entrusted to one occupying such a position, regardless of unknown limitations. 1. If a principal puts an agent into, or knowingly permits him to occupy, a position in which according to the ordinary habits of persons in the locality, trade or profession, it is usual for such an agent to have a particular kind of authority, anyone dealing with him is justified in inferring that he has such authority in the absence of reason to know otherwise. R2nd49 cmt c. c. Agency by Estoppel

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i.

A person who has not made a manifestation that an actor has authority as an agent and who is not otherwise liable as a party to a transaction purportedly done by the actor on that persons account is liable to a third party who is induced to make a detrimental change in position because the transcription is believed to be on the persons account, if: 1. The person intentionally or carelessly caused such belief, or 2. Having notice of such a belief and that it might induce others to change their positions, the person did not take reasonable steps to notify them of the facts. ii. So close to apparent authority, can be subsumed in it. d. Inherent authority i. Agent may bind a principal in certain cases even when the agent had neither actual nor apparent authority. ii. A disclosed or partially disclosed principal is liable for an act done on his behalf by a general agent, even if the principal had forbidden the agent to do the act, if 1. The act usually accompanies or is incidental to transactions the agent is authorized to conduct, AND 2. The third person reasonably believes the agent is authorized to do the act. iii. A general agent for an undisclosed principal authorized to conduct transactions subjects his principal to liability for acts done on his account, if usual or necessary in such transactions, although forbidden by the principal to do them. iv. Major rationale is based on an analogy to doctrine of respondeat superior in torts. v. Alternative rationale is based upon principals reasonable expectations. e. Ratification i. Even if agent has neither actual, apparent, nor inherent authority, the principal will be bound to the 3rd person if the agent purported to act on the principals behalf, and the principal, with knowledge of the material facts, either: 1. Affirms the agents conduct by manifesting an intention to treat the agents conduct as authorized, or a. Sometimes known as express ratification. 2. Engages in conduct that is justifiable only if he has such an intention. Ex. principal accepts benefits of the agents action. a. Sometimes known as implied ratification. ii. Rat. need not be comm. to the 3rd person to be effective, but must be objectively manifested. R3rd4.01 cmt d. 1. BUT, must occur before either the 3rd person has withdrawn, or there has been a material change in circum. that would make it inequitable to bind 3rd party unless the 3rd party so chooses. R3rd4.05. f. Acquiescence i. If the agent performs a series of acts of similar nature, the failure of the principal to object to them is an indication that he consents to the performance of similar acts in the future under similar conditions. R2nd43. ii. Acquiescence gives rise to actual authority iii. To 3rd persons that know of the acquiescence, it gives rise to apparent authority.

g. Termination of Agents Authority

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i.

Principal can terminate authority at any time, even if doing so violates contract, even if it had been agreed that the agents authority was irrevocable. (EXCEPT: agency (or power) coupled with an interest)

3rd Persons Liability TO Principal:

General rule: if an agent and a 3rd person enter a contract, and agents principal is liable to the 3rd person under the contract, then the 3rd person is liable to the principal. R2nd292, R3rd6.01-6.03 MAJOR EXCEPTION: 3rd person NOT liable to undisclosed principal if agent or principal knew that 3rd person would not have dealt with principal if he had known principals identity. R2nd292 cmt c.

Agents Liability TO 3rd Person: If agent has entered into contract with 3rd person on behalf of principal, whether agent will be liable to the 3rd person turns in the first instance on whether the principal is bound under the contract. Where principal is BOUND: (actual, apparent, or inherent authority) 1. Disclosed Principal 3d party knows both principal & agent a. if principal had actual, apparent, or inherent authority, or because principal ratified the act, general rule is that agent is not bound to the 3rd person. R2nd320, R3rd6.01. 2. Undisclosed Principal 3d party doesnt know its dealing with agent a. if agent purported to act on his own behalf, general rule is that both agent and principal are bound. R2nd322, R3rd6.03. i. Majority rule if 3rd person, after learning of Ps identity, obtains judgment against P, agent is discharged from liability, even if judgment is unsatisfied. Undisclosed principal is discharged if 3rd person gets judgment against agent. ii. Minority rule neither agent nor principal is discharged by judgment against the other, but only by satisfaction of the judgment. Adopted in R3rd6.09. BETTER RULE 3. Partially Disclosed Principal 3d party knows of agency but doesnt know know identity of principal. a. general rule is that the agent as well as the principal is bound to the third person. R2nd321, R3rd6.02. Where principal is NOT BOUND: (NO actual, apparent, or inherent authority) General Rule: agent is liable to third person. Theory: agent makes implied warranty of authority to the 3rd person. Few authorities have held that agent can be liable on the contract itself. Both R2nd and R3rd adopt implied warranty theory, BUT provide for expectation damages (as if contract theory)

Liability of Agent TO Principal:

If agent takes action he has no actual authority to perform, but P is nevertheless bound because the agent had apparent authority, the agent is liable to the P for any resulting damages to the principal. R2nd383, 3rd8.09.

Liability of Principal to Agent If agent acts within actual authority, principal is under duty to indemnify agent for payments the agent made that were authorized or made necessary in executing the principals affairs. INCLUDING: 1. Authorized payments made by the agent on the principals behalf 2. Payments made by the agent to a 3rd person under contracts on which agent was authorized to make himself liable (where agent acts on behalf of partially or fully undisclosed principal) 3. Payments of damages to third parties that the agent incurs because of an authorized act that constituted a breach of contract for which the agent was liable to the 3rd person

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4. Expenses in defending actions brought against the agent by 3rd persons because of the agents authorized conduct. R2nd438-440, R3rd8.14. Agents Duty of Loyalty Tarnowski v. Resop Agent misrepresented coin operated machine business profits, P bought, and lost money. It makes no difference that the principal rescinds the transaction and gets him money back, or even that he makes a profit. The agent has a duty of loyalty to the principal, and the principal can recover any unauthorized profits made by the agent on the transaction. RAgency407(2). If the agent violates the duty of loyalty, the principal is entitled to receive the value of what he put into the transaction plus any damages caused as a result of the transaction. RAgency401(1). (including attorneys fees) Wrongdoer is responsible for all the reasonable foreseeable injurious consequences of his tortious act. Reading v. Attorney-General seargent in Royal Army Medical Corps during WWII, helped sell whisky and brandy for money. Wore uniform, used military status to move alcohol. The Crown took all the money back. Financial Statements Assets = Liabilities + Owners Equity Assets things of value owned by business. Liabilities claims on assets by creditors of the entity. Owners Equity difference b/t A and L, represents stake of entitys owners on companys assets, called proprietorship. Balance Sheet restatement of accounting equation in chart form with assets on left and sources of assets (liability and equity) on right side. Shows financial condition of the company. Income Statement indicates what has happened to the accounting entity over some period of time. Revenue income derived from sale of goods or services. Expenses costs associated with producing revenue. Losses costs that do not result in producing revenue.

Partnership
Hilco Prop. Services, Inc. v. US conduct of parties and circumstances surrounding their relationship and transactions control the factual question of whether a partnership existed in cases where the parties have not documented their intentions in a written agreement. It is immaterial that the parties do not call their relationship, or believe it to be, a partnership, especially where the rights of third parties are concerned. Martin v. Peyton DFs loaned securities to KNK firm as collateral for bank loan, but it was stated that DFs were not partners, but could look at all books, veto decisions, or accept resignation of partners, etc. Creditors sought to call DFs partners, to make liable for partnership debts. Court said NO partnership. Sharing of profit is considered as an element of a partnership, but not all profit-sharing arrangements cause those participating to be partners; nor is the language saying that no partnership is intended conclusive. The entire agreement will be looked at in making this determination. All of the features are consistent with a loan agreement, no partnership has been formed.

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Lupien v. Malsbenden Lupien contracted with Cragin to build a Bradley car, paid deposit and checked on progress several times. Dealt with Malsbenden every time b/c Cragin was gone, Malsbenden told Lupien to sign over his truck, and gave him rental car. Lupein never got Bradley, sued Malsbenden who claimed to only be a creditor to Cragin. A finding that the relationship between two persons constitutes a partnership may be based upon evidence of an agreement, either express or implied, to place their money, effects, labor, and skill, or some or all of them, in lawful commerce or business with the understanding that a community of profits will be shared. Agreement amounted to a partnership as a matter of law, shared profits, shared operations, shared control. Formation of Partnership Formalities corporations, limited partnerships, limited liability partnerships, and limited liability companies can be organized only if certain formalities are complied with and a filing is made with the state. BUT, general partnerships can be organized with no formalities and no filing. Legal Nature of Partnership UPA Aggregate theory: as soon as partner leaves, partnership will be dissolved. P-ship is sum of persons who comprise Aggregate Theory partners jointly and severally liable for the obligations of the partnership. And for federal income tax purposes, the income or losses of the partnership are attributed to the individual partners; the partnership itself does not pay any taxes (although it does file an information return). RUPA P-ship is viewed as an entity. Ps unanimously agree not to dissolve the partnership when a partner decides to leave. Entity Theory for other purposes a partnership is treated as a separate entity from its individual partners. 1. Capacity to sue or be sued jurisdictions vary as to whether a partnership can be sued and/or sue in its own name. Ex. If a fed. question is involved, partnership can sue or be sued in its own name. 2. Ownership of property a partnership can own and convey titles to real or personal property in its own name, without all of the partners joining in they conveyance. RUPA unlike the UPA, RUPA expressly states that a partnership is an entity, thus simplifying many partnership rules such as those on property ownership and litigation. (RUPA 201)

The Ongoing Operation of Partnerships VOTING IN PARTNERSHIP All partners have equal rights in management (even if sharing of profits is unequal). UPA18(c) Summers v. Dooley S & D operated trash collection partnership, both worked in business and paid a substitute when he couldnt work. S asked D to hire a third person and D refused, S did it anyway with his own funds, D objected. S sued for reimbursement from partnership funds. S lost, cant make binding decision over partners objections. Where equal partners exist, then differences on business matters must be decided by a majority of the partners. Under the UPA, the rule that differences among partners as to ordinary partnership matters are decided by a majority is subject to any agreement between them. UPA18(h). Often times there are agreements to vest management in senior/managing partners, but doesnt have to be an express agreement, can be implied from conduct. Under UPA18(h), differences can be decided by majority vote, but no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners.

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Under RUPA401(j), differences can be decided by a majority vote, and any act outside the ordinary course of business of the partnership and an amendment to the partnership agreement both require consent of all of the partners. Changes in the way the partnership is conducted, not just changes in the way in which it has been explicitly agreed that the partnership will be conducted, may constitute amendments to the partnership agreement. Participation UPA18(e) all partners have equal rights in the management and conduct of the partnership business. Absent contrary agreement, every partner must be consulted in partnership decisions. Even if a majority could have voted it in anyway, not consulting minority would violate this. RUPA401(f) each partner has the right to participate in management. Comment notes that UPA18(e) requires all partners be consulted. Contribution and Indemnification Partner has right to be indemnified by the partnership. (partnership liability) Partnership has a right to require contribution from one or more partners. (partner liability) Indemnification if one partner pays off a partnership debt in full, he is entitled to indemnification from the partnership and contribution from the partners. Partner that pays debt becomes creditor to partnership. UPA18, RUPA401 Contribution contribution may be required when capital is needed such as to pay off a partnership creditor. Distributions, Remuneration, and Capital Contributions Each partner, in the absence of agreement, shares profits and losses equally. UPA18(a). Authority of a Partner RNR Investments Ltd Partnership v. Peoples First Community Bank RNR was limited partnership in FL, with agreement specifically saying general partner could not take on partnership debt without consent of limited partner, but general partner did this, and RNR defaulted, then when bank tried to foreclose, RNR claimed bank failed to properly investigate and realize GP didnt have proper authority. Bank won, GP had apparent authority to enter into loan. The determination of whether a partner is acting with authority to bind the partnership is a two-step analysis. The first issue is whether the partner is carrying on the partnership business in the usual way or the business is of the kind typically carried on by the partnership. Here the general partner was clearly carrying on Ds business in the usual way. The second issue is whether the other party knew or had notice that the partner lacked authority to bind the partnership. D argues that P had constructive knowledge of the restrictions on the general partners authority and was obligated to inquire about the general partners authority. We do not agree. P could rely on the general partners apparent authority unless it had actual knowledge or notice of the restrictions on that authority. There is no allegation that P had knowledge or notice of the restrictions on Ds general partner. Northmon Investment Co. v. Milford Plaza Associates partners disputed whether partner had authority to lease real property that was the partnerships only asset for a 99-year term. NO authority to bind as such. A partners authority to bind the partnership to transactions that are in the ordinary course of the partnerships business does not affect the right of partners to prevent transactions between a partner and a third party. The partners right to interfere with this or any other contract involving the partnership is absolute as well as privileged, excusable, and justified. Authority of Partners

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UPA basic rule governing partners actual authority Each partner is an agent of the partnership for the purpose of its business. UPA basic rule governing apparent authority Partner has authority to bind the partnership by any act for apparently carrying on in the usual way the business of the partnership of which he is a member. Controversy over whether this means carrying on as the partners firm does or as firms in the same locality and business customarily do. RUPA301(1) Partnership is bound by an act of the partner for apparently carrying on in the usual way (i) the partnership business or (ii) business of the kind carried on by the partnership. Under UPA9(1), partnership was not bound by unauthorized actions of partner if 3rd party had knowledge of partners lack of authority. Under UPA9(1) 3rd party had knowledge when actual knowledge or knowledge of such other facts as in circumstances show bad faith, creating some kind of implied notice, exact parameters of which are ill defined. Under RUPA, 3rd party will not be placed on inquiry notice, must have actual knowledge or receipt of notification of partners lack of authority. Imputed Knowledge - Under UPA12 knowledge or notice to any one partner of matters pertaining to the regular partnership business is imputer to the partnership, and is binding on all partners. Conveyance of Real Property UPA9(1) any partner has authority to convey real property in ordinary course of business RUPA302 has elaborate rules concerning when transfer of partnership property is binding.

Liability for Partnership Obligations

Liability on Contracts Partners are jointly, but NOT severally liable on partnership debts and contracts. UPA15(b) Creditor may not proceed against any one party, partner can force joinder of all partners as necessary parties within rules of compulsory joinder. If creditor obtains judgment for less than amount sought, satisfaction of judgment is a bar to any further action against other partners or against the firm. A creditor can always proceed against the partnership as an entity by filing suit against the partnership in the firm name, without the necessity of joining all the partners. If so, any judgment obtained binds only the partnership assets (together with the individual assets of each partner actually served with a summons). In most states, release of one partner operates to release all partners, since their liability is joint. Remedies partnership assets are subject to attachment and execution only upon partnership debts. Thus, an attachment or exclusion against partnership assets is void if the claim at issue is the debt of an individual partner. A partners right in specific partnership property is not subject to attachment. UPA25(2) Creditors remedy against individual partner debt is to obtain charging order against debtor-partners interest. UPA28. Buyer of this interest has right to compel dissolution if the term of the partnership has expired or if the partnership is an at will partnership. Alternatively, creditor may put individual partner into bankruptcy, which will result in dissolution of partnership under UPA31(5). Liability in Tort

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Partners are jointly and severally liable for torts and breaches of trust injuring third parties. UPA15(a). Action may be brought against any single partner without joining the others. Any judgment against one partner is not res judicata against the other partners in subsequent suits against them. Partnership relationship doesnt establish requisite privity to invoke res judicata since the liability is several. Partners are deemed to assume liability for any tortious act committed by a co-partner. But, where tort involves showing malice, must be shown that each partner sought to be held liable had such intent. Under RUPA partnership can sue and be sued in its own name RUPA 305 A partnership is liable for loss caused by a partners conduct in the ordinary course of business of partnership or with authority of the P-ship in both contract and tort. RUPA 306(a) Partners are liable jointly and severally for all obligations of the P-ship unless otherwise agreed; except I. A person admitted into an existing P-ship is not personally liable for any P-ship obligations incurred before the persons admission; AND II. An obligation incurred while a limited liability P-ship is solely the obligation of the P-ship a. Once the P-ship assets are exhausted, each partner becomes individually liable for the debt. RUPA 307 (a) specifically provides that a P-ship may both sue and be sued in its own name. (remember the entity status vs. the aggregate status of UPA) Partnership Interests and Partnership Property Rapoport v. 55 Perry Co. two families entered into partnership, one wanted to assign partnership rights to kids, but other partners objected, saying this required consent of all partners, court AGREED that must have consent of ALL partners. Partnership law provides that unless the partnership agreement states otherwise, no person can become a member of a partnership without the consent of all of the partners. Furthermore, an assignee of an interest in a partnership is not entitled to interfere in the business but is merely entitled to receive the profits to which the assigning partners would otherwise be entitled. All property originally brought into the partnership or subsequently acquired, by purchase or otherwise, for the partnership is partnership property. UPA8(1) Proof of Intent if theres no clear intention expressed as to whether its partnership property, courts consider facts related to the acquisition and ownership of the asset in question. Factors include: 1. How title to property is held; 2. whether partnership funds were used in the purchase of the property; 3. whether partnership funds have been used to improve the property; 4. how central the property is to the partnerships purposes; 5. how frequent and extensive the partnership use is of the property; 6. whether the property is accounted for on the financial records of the partnership. Individual Interests in Partnership Property rights of an individual partner in the partnership property are: UPA24 1. Her rights in specific partnership property 2. Her interest in the partnership 3. Her right to participate in the management of the partnership 1. Rights in specific partnership property Under UPA, each partner is tenant-in-partnership with her copartners as to each asset of the partnership. UPA25(1). Incidents of this tenancy are as follows: a. Each partner has an equal right to possession for partnership purposes b. The right to possession is not assignable, except when done by all of the partners individually or by the partnership as an entity c. The right is not subject to attachment or execution except on a claim against the partnership (the entity theory) d. The right is not community property, hence it is not subject to family allowances, dower, etc e. On the death of a partner, the right vests in the surviving partners (or in the executor or administrator of the last surviving partner). Hence, partnership property is NOT part of the estate of the deceased

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partner, but vests in the surviving partner, who is under duty to account to deceaseds partners estate for the value of the decedents interest in the partnership. 2. Partners Interest in the Partnership partners interest in the partnership is her share of the profits and surplus, which is personal property. UPA26. a. A partners interest is personal property, even where the firm owns real property. Thus the partners rights to any individual property held by the partnership are equitable (partnership holds the title), and this equitable interest is converted into a personal property interest. This can be important in inheritance situations where real property is given to one heir and personal to another heir. b. Assignments 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 an assignment will NOT dissolve the partnership. UPA27(1) i. Assignee has no right to participate in mgmt, BUT is liable for all partnership obligations. c. Creditors Rights creditor of an individual partner may not attach partnership assets. He must get a judgment against the partner and then proceed against the partners interest. RUPA, which confers entity status on partnerships, drops the elaborate tenancy-in-partnership apparatus of the UPA. RUPA203 provides that property acquired by a partnership is property of the partnership and not the partners individually. RUPA204 then sets out a series of rules and presumptions concerning whether any given property is partnership property or the separate property of a partner. These provisions are supplemented by 501 which provides that a partner is not a co-owner of partnership property and has no interest in partnership property which can be transferred, either voluntarily or involuntarily. Purpose of 501 is to explicitly abolish the UPA concept of tenancy in partnership. Assignment of Interest a partner who has assigned her partnership interest remains a partner; however, RUPA601(4)(ii) explicitly permits the non-assigning partners to expel the assignor from the partnership, and the UPA31(c) permits the non-assigning partners to dissolve the partnership as of right, even if the partnership is not at will. Creditors remedy against individual partner debt is to obtain charging order against debtor-partners interest. UPA28. Buyer of this interest has right to compel dissolution if the term of the partnership has expired or if the partnership is an at will partnership. Alternatively, creditor may put individual partner into bankruptcy, which will result in dissolution of partnership under UPA31(5). RUPA504 continues UPA28 largely unchanged, does add some details that are consistent with case law under 28. Like UPA, RUPA801(a) provides that a transferee of a partners transferable interest is entitled to judicial dissolution on the partnership (i) at any time in a partnership at will, and (ii) after the expiration of the partnerships term or the completion of the undertaking in a partnership for a particular undertaking. Priorities of Creditors Rights UPA40(h) provides that partnership creditors have priority over separate creditors as to partnership assets and separate creditors have priority over partnership creditors as to the individual assets of partners. See also UPA 36(4) dual priorities or jingle rule. Widely criticized on the grounds that it kept partnership creditors from getting full benefit of personal liability in individual partners. Bankruptcy Reform Act of 1978, in a partnership bankruptcy, the partnership creditors have priority over separate creditors as to partnership assets and once partnership assets are exhausted, if partnership creditors remain unsatisfied, they are put on parity with separate creditors in dividing up individual partner assets. RUPA drops the dual priorities rule of the UPA to reflect the abolition of the jingle rule in the Bankruptcy Code.

Partners Duty of Loyalty

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Meinhard v. Salmon Gerry leased a hotel to Salmon for 20 years, S was obligated to spend $200K in improvements. S entered into joint venture with Meinhard for M to pay of the money needed to alter and manage the property, receiving 40% of the net profits for 5 years and 50% thereafter. S had sole power to manage property, Ss interest in lease from Gerry was never assigned to M. Gerry owned a substantial amount of adjoining property and near the end of the lease term, tried to put together a deal to level all property and put up one large building. Failing that, Gerry approached S and they entered into a lease on all of the ground (renewable for up to 80 years), eventually calling for the destruction of the hotel and the building of a new, larger building. M found out about the new lease and demanded that it be held in trust as an asset of their joint venture. M was entitled to half interest in new lease and must assume responsibility for half the obligations. Joint venture partners have the highest obligation of loyalty to their partners. This includes an obligation not to usurp opportunities that are incidents of the joint-venture. The duty is even higher of a managing co-adventurer. There was a close nexus between the JV and the opportunity that was brought to the manager of the JV, since the opportunity was essentially an extension and enlargement of the subject matter of the existing venture. Latta v. Kilbourn it is well settled that one partner cannot, directly or indirectly use partnership assets for his own benefit, cannot carry on business of the partnership for his private advantage Partners Suit against another Partner Under UPA22, partner can sue for an accounting when: 1. Partner is wrongfully excluded from the business (22(a)) 2. If the right is granted under the partnership agreement (22(b)) 3. For appropriation of an unauthorized benefit in violation of 21 (22(c)) 4. Whenever other circumstances render it just and reasonable (22(d)) UPA13 says partner can sue any person, not being a partner in the partnership SO, courts have limited remedies to suits for dissolution or an accounting. Under RUPA305, phrase not being a partner in the partnership is dropped, to permit a partner to sue the partnership on tort or other theory during term of partnership, rather than being limited to accounting/dissolution.

Dissolution By Rightful Election

Dissolution of partnership does not immediately terminate the partnership. The partnership continues until all of its affairs are wound up. UPA30. Dissolution, under UPA31, is by express will of any partner. Causes of Dissolution unless otherwise provided in partnership agreement, the following may result in dissolution: 1. Expiration of partnership term a. Fixed term even where partnership lasts for 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 owed) b. Extension of term partners can extend the partnership by creating a partnership at will on the same terms. 2. Choice of Partner any partner can terminate the partnership at will (since partnership is a personal relationship which no one can be forced to continue). However, where the partnership is for a term or even where it is a partnership at will, if dissolution is motivated by bad faith, it may be a breach of the agreement. a. At will dissolution Girard Bank v. Haley court said that partners letter to other partners stating that partnership was terminated effectively dissolved the partnership because it was at will and

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partner expressed desire to dissolve. Court said didnt violate agreement because it didnt provide for a specific term or a specific undertaking. 3. Assignment assignment of a partners interest is not an automatic dissolution; nor is the levy of a creditors charging order against a partners interest. But, assignee or creditor can get a dissolution decree on expiration of the partnership term of at any time in a partnership at will. UPA30-32. 4. Death of Partner on death of partner, surviving partners are entitled to possession of the partnership assets and are charged with winding up the partnership affairs without delay. UPA37. Surviving partners are also charged with accounting to the estate of the deceased partner for the value of the decedents interest. a. DONT HAVE TO LIQUIDATE UPON DEATH SEE CASE BELOW Creel v. Lilly creel began business selling NASCAR memorabilia, desired to expand and entered into partnership agreement with Lilly and Altizer (DFs), forming Joes Racing partnership. For initial investment, DFs each paid $6666 in capital contributions, and Creel contributed inventory and supplies valued at $15K. Pursuant to agreement, DFs also paid Creel $3333 for the use and rights to the business known as Joes Racing Collectibles. Several months later, Creel dies, according to UPA partnership was automatically dissolved, and because agreement didnt call for continuation and Creels estate didnt consent to continuation, partners had to wind up business. Instead, they continued it under a different name, and were using original partnerships assets. Court said didnt have to liquidate, could just buy decedents share. Historically, the UPA was interpreted to permit decedents estate to compel liquidation of partnerships assets. To avoid this harsh result, many courts have adopted alternatives, and RUPA expressly permits continuation of partnership and purchase of decedents share. 5. Withdrawal or admission of a partner most partnership agreements provide that admitting or losing a partner will not result in dissolution. New partners may become parties to the preexisting agreement by signing it at the time of admission to the partnership. UPA13(7). When an old partner leaves, there are usually provisions for continuing the partnership and buying out the partner that is leaving. 6. Illegality dissolution results from any event making it unlawful for the partnership to continue its business. 7. 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. UPA31(4),(5) 8. Dissolution by Court Decree a court, in its discretion, may in certain circumstances, dissolve the partnership. These circumstances include insanity of a partner, incapacity, improper conduct, inevitable loss, and/or wherever it is equitable. UPA40 Stets out rules for distributions of assets after a partnership is dissolved. UPA40 states that partners must contribute the amount necessary to satisfy liabilities as provided under 18(a). Section 18(a) states that each partner shall contribute toward the losses sustained by the partnership, according to his share in the profits. Schymanski v. Conventz - Ps agreed to build fishing lodge, 50/50 basis. S put in large cash contribution and Cs put more non-cash contributions. Issue: Should Cs personal services be treated as a non-capital contribution? Holding: When C drafted agreements that they would substitute cash for labor contributions, these documents implied a modification of the P-ship agreement. Standard: In the absence of an agreement otherwise, a P contributing only personal services is ordinarily not entitled to any share of P-ship capital pursuant to dissolution. But where personal services may qualify as capital contributions where an express implied agreement b/t party exists. Get contribution for services. RUPA401(h) continues rule of UPA18 that if youre a service partner, that doesnt go to your capital, and you have to contribute to capital losses. It justifies this stance by saying that parties should know this and contract around it if they so choose. (this is really further justification for why this rule is wrong) Distribution of Assets

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1. Partnership debts partnership debts must be paid first. 2. Capital accounts then amounts are applied to pay the partners their capital accounts (capital contributions plus accumulated earnings and less accumulated losses) 3. Current earnings if anything leftover, partners receive their agreed share of current partnership earnings UPA40. 4. Distributions in kind where there are no partnership debts, or where the debts can be handled from the cash account,
partnership assets may not be sold, but they may be distributed in kind to the partners.

5. Partnership losses where liabilities exceed assets, the partners must contribute their agreed shares to make up the
difference. UPA18(a).

Rights of the Partners 1. No violation of agreement if the dissolution does not violate the agreement, the partnership assets are distributed as set forth above, and no partner has any cause of action against any other partner. 2. Dissolution violates agreement if dissolution does violate the partnership agreement, then innocent partners have rights in addition to those listed above. a. Right to damages innocent partners have right to damages against offending partner UPA38(2) b. Right to continue business innocent partners have right to continue the business by purchasing the offending
partners interest in the partnership. UPA38(2)(b) provision for posting bond and beginning court proceedings. Alternatively, innocent partners may dissolve and wind up business, paying offender his share, less damages.

Effects of Dissolution Liability of partners for existing partnership debts remains until they are discharged. New partnership remains liable for old debts Where there has been a dissolution due to health, withdrawal, or admission of a new partner, and the partnership business is continued, the new partnership remains liable for all of the debts of the previous partnership. UPA41.
Retiring Partners liability for debt incurred by partners continuing the business Dissolution ends the power of a partner to bind the partnership except to the extent necessary to wind up its affairs. UPA33. BUT, if 3rd party doesnt know of dissolution, contracts entered into with a partner bind the partnership. A retiring partner must make sure that prescribed procedures are followed to terminate any possible liability for partnership obligations. UPA provides that notice of withdrawal or dissolution may be published in a newspaper of general circulation. UPA35(1). Partnership at Will (partner can end at any time, not required to continue because its profitable) Page v. Page P and DF are partners in linen supply business. P supplied essentials to business and as a result, partnership owed him $47K. P was also managing partner. Each partner contributed $43K in capital. There was NO written agreement. For 8 years, business lost money, then starting making money when Vandenberg Air Force base opened near the town. P sued to dissolve business. D claimed (i) that there was an agreement to continue the business until all debt was paid back, and (ii) that P is terminating the business to take advantage of the opportunity himself. Court said, NO, this is partnership AT WILL, its over. Some cases do hold that the partnership shall continue for a term necessary to repay debt, but only if there is evidence showing this intention. If P is acting in bad faith seeking dissolution, he may be in violation of fiduciary duty as partner. Leff v. Gunter it is no less a violation of the trust imposed between partners to permit the exploitation of that partnership information and opportunity to the prejudice of ones former associates by the simple expedient of withdrawal from the partnership. Rosenfeld, Meyer & Susman v. Cohen page 91 of book, along the same lines.

Dissolution by Judicial Decree & Wrongful Dissolution

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Drashner v. Sorensen P and DFs bought real estate and insurance business for $7.5K, with DFs advancing the money. P claimed agreement was to provide him with enough money out of partnership fund to live on, then profits were to be split. P depended on the business for a living, DFs did not. After DFs disagreed with Ps claim, P allegedly neglected the business, got drunk often, was arrested for reckless driving, and made it impossible to operate the partnership. P sued to dissolve the partnership and wind up its affairs and DFs sued for the same thing. Court found for DFs, finding that P made it impossible to run the business, that DFs could continue it on their own, and that the value should be determined without including anything for goodwill, and that DFs should pay P for the value of his interest. When P neglected business, it made it reasonably impracticable to carry on as partners. UPA38(2).
State law allowed court, as penalty for wrongdoing causing dissolution, to refuse to consider goodwill in valuing business. Wrongful dissolution can result in: 1. Damages 2. A valuation of the interest of the wrongfully dissolving partner without taking into account goodwill 3. Continuing the partnership business without the dissolving partner.

Expulsion of a partner (page 99) Without good cause ordinarily a wrongful violation of the partnership agreement, and wrongfully expelled partner has right to compel dissolution and liquidation. UPA31(1)(d), 31(1)(d), 38(1).
UPA31(1) - Bona fide under partnership agreement (with good cause) and if the expelled partner is discharged from all partnership liabilities, either by payment or agreementhe shall receive in cash only the net amount due him from the partnership. Under this section, agreement may lawfully provide that partner can be expelled without cause by designated vote of remaining partners. Good faith, regardless of motivation, as long as the expulsion does not cause a wrongful withholding of money or property legally due the expelled partner at the time he is expelled. Lawlis v. Kightlinger & Gray Levy v. Nassau Queens Medical Group expulsion in bad faith may be actionable, but must be more than policy disagreements. Must show that partnership acted out of desire to gain a business or property advantage for the remaining partners. Crutcher v. Smith page 102, along same lines. Dissolution under RUPA Events of dissociation RUPA602(a) continues rule of UPA that every partner has right to withdraw at any time, by express will, right or wrong. RUPA602(c) provides that a partner who wrongfully dissociates is liable to the partnership and to the other partners for damages caused by the dissociation. Further, if partner wrongfully dissociates, partnership can carry on without him. Rightful Dissociation under RUPA An event of dissociation is rightful, unless specified as wrongful under 602(b). Major types of wrongful dissociations are: 1. A dissociation that is in breach of an express provision of the partnership agreement 2. A withdrawal of a partner by the partners express will before the expiration of the partnership term or the completion of an undertaking for which the partnership was formed 3. A partner has engaged in wrongful conduct that adversely and materially affected the partnership business 4. A partner has willfully or persistently committed a material breach of the partnership agreement or of a duty of care, loyalty, good faith, and fair dealing owed to the partnership or other partners under 404. Comment to 602 states: a partner has the power to dissociate at any time by expressing a will to withdraw, even in contravention of the partnership agreement. The phrase rightfully or wrongfully reflects the distinction between a partners power to withdraw in contravention of the partnership agreement and a partners right to do so. May give rise to damages under 602(c). Consequences of Dissociation under RUPA Driven by functional considerations rather than by the nature of a partnership. Does not provide that every termination of a persons status as a partnerevery dissociationcauses dissolution. Instead, the key issue is whether dissociation has occurred, and what are the consequences of the kind of dissociation that occurred.

Mendales Outline Under UPA, a partnership might end, but the partnership business can be carried on through another partnership, maybe where leaving partners are bought out. Under RUPA, however, dissociation of one partner does not necessarily cause dissolution at all. Under RUPA, dissociation, rather than necessarily causing dissolution, leads to two possibilities: 1. Winding up under Article 8 (801) a. Requires notice of partners express will to withdraw in a partnership at will, expiration of partnerships term in a partnership for a term, and an uncured event that makes it unlawful for all or substantially all of the partnerships business to be continued. b. Wind-up required after one of these events, all other dissociations result in Article 7 buyout 2. Mandatory Buyout under Article 7 a. If, upon dissociation of partner, winding up is not required under 801, then RUPA 701 requires a mandatory buyout of the dissociated partners interest by the partnership. b. However, if dissociation was wrongfully caused by the dissociated partner, 701(c) provides that the buyout price under 701(b) is the be reduced by damages for the wrongful dissociation. c. Under 701(h), partner who wrongfully dissociates before the expiration of a definite term, or the completion of a particular undertaking, is not entitled to payment of any portion of the buyout price until the expiration of the term or completion of the undertaking, unless the partner establishes to the satisfaction of the court that earlier payment will not cause undue hardship to the business of the partnership. d. Under 701(b), buyout price of a dissociated partners interest is theamount that would have been distributable to the dissociating partner if, on the date of dissociation, the assets of the partnershipwere sold at a price equal to the greater of the liquidation value or value based on a sale of entire business as a going concern, without the dissociated partner, and the partnership wound up as of that date.

Limited Liability Companies and Limited Liability Partnerships Limited Partnership

Revised Uniform Limited Partnership Act (RULPA), amended 1985 Uniform Limited Partnership Act, adopted in 2001 (only adopted in 4 states at time of book writing) Limited Partnership formed by two or more persons and having as its members one or more general partners and one or more limited partners. RULPA101.
RULPA201 in order to form a limited partnership a certificate of limited partnership must be filed in the office of the secretary of state. It MUST state the name of the limited partnership, the name and business address of each general partner, the latest date upon which the limited partnership is to dissolve, and the name and address of the agent for service of process. (like 102, 201 of 2001 act) 1. General partner assumes management responsibilities and full personal liability for debts of partnership. 2. Limited partner makes a contribution of cash, other property, or services rendered to the partnership and obtains an interest in the partnership in return, but is not active in the management and has limited liability for partnership debts. 3. A person bay be BOTH a general and limited partner in the same partnership at the same time. In such a case, the partner has, in respect to her contribution as a limited partner, all the rights that she would have had if she were not also a general partner. Limited partnership may carry on any business that a partnership could carry on. Limited Liability general partner is personally liable for all obligations of the partnership, but limited partner has no personal liability for partnership debts, and her maximum loss is the amount of her investment in the limited partnership. Exception when a limited partner takes part in the management and control of the business, she becomes liable as a general partner. RULPA303(b). SEE CASE BELOW:

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Gateway Potato Sales v. G.B Investment Co. Gateway(P) sued Sunworth Packing Limited Partnership to recover payment for seed potatoes that P had supplied the partnership for use in its potato farming business. P sued the limited partnership and Sunworth Corporation (a general partner) and GB Investment Co. (DF, limited partner). P cited an Arizona statute that stated a limited partner may become liable for the obligations of the limited partnership under certain circumstances in which the limited partner has taken part in the control of the business. Ps owner testified that he was contacted by the president of Sunworth Corp, where president assured Ps owner that despite past bankruptcy, he was in partnership with a large financial institution that was providing his financing and was actively involved in the operation of the business. P was under impression that president of Sunworth was doing business with general partnership formed by Sunworth and DF (GB Inv. Co.), but never took steops to verify this information. Court held for P, limited partner CAN be held liable. If limited partners participation in the control of the business is not substantially the same as the exercise of the powers of a general partner, he is liable only to persons who transact business with the limited partnership with actual knowledge of his participation and control. In re USACafes, LP Litigation Holders of limited partnership units (Ps) brought suit against partnership, the corporate general partner, and its directors, and Metsa Acquisition Corp.(DFs) Metsa purchased substantially all of the assets of the partnership. Ps argue that the sale was at an unfair low price in favor of Metsa in exchange for substantial side payments to the directors of the general partner. Ps win, directors have fiduciary duty to the partnership. Under general principles of fiduciary duty, one who controls property of another may not, without implied or express agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner. Thus, at a minimum, there is a duty not to use control over the partnerships property to advantage the corporate director at the expense of the partnership, as is alleged here. Formation of Limited Partnership Partners must file a certificate with the secretary of state setting forth name of partnership, name and address of agent for service of process, name and address of each general partner, and latest date upon which partnership is to dissolve. RULPA201. Dissolution of Limited Partnership A LP may be dissolved by: 1. Occurrence of the time stated in the certificate of limited partnership 2. Occurrence of the time or event specified in the partnership agreement 3. Withdrawal of a general partner (unless there is at least one other general partner and the partnership agreement permits the partnership to continue or within 90 days all partners agree in writing and a new general partner is appointed) 4. Written consent of all partners 5. Entry of a decree of judicial dissolution Corporate General Partners A corporation may be a general partner in a limited partnership. A director or officer of a corporate general partner will not be held liable for a limited partnerships debts simply because he participates in the partnerships business in his capacity as director or officer of the general partner. However, he may be held liable if the corporate directors and officers fail to maintain their corporate identity in their dealings with the partnership, if there is an intermingling of corporate and partnership assets, or if the corporation is inadequately capitalized. Fiduciary Obligations

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Gotham Partners, LP v. Hallwood Realty Partners, LP A general partner owes the traditional fiduciary duties of loyalty and care to the limited partnership and its partners, although the law permits modification of these duties in the partnership agreement. The trial court was correct in finding that the general partner was subject, by contract, to a fairness standard akin to the common law one applicable to self-dealing transactions by fiduciaries. Following Gotham case, Delaware amended its relevant statutes to make clear that partnerships, limited partnerships, and limited liability companies may, by agreement, eliminate, expand, or restrict fiduciary and other duties, but may not eliminate the implied contractual covenant of good faith and fair dealing.

Limited Liability Company

Created under statutes that combine elements of corporation and partnership law. As in corporations, the owners of an LLC have limited liability. As in partnerships, LLCs have great freedom in structuring their internal government. LLCs are generally taxed like partnerships. Like a corporation, and LLC is an entity, so it can hold property, sue and be sued in its name. Member-Managed LLCs managed by members Manager-Managed LLCs managed by manager who may or may not be a member Formation of an LLC Formed by filing articles of organization in a designated state office (usually Secretary of State) All statutes allow LLCs to be formed by one person. Articles must include name of the LLC, address of principal place of business or registered office in the state, and the name and address of its agent for service of process. Many statutes also require the articles to (i) state the purpose of the LLC, (ii) if the LLC is to be membermanaged, the names of its initial members or manager-managed, the names of its initial managers, and (iii) the duration of the LLC or the latest date on which it is to dissolve. Operating Agreement Most LLCs articles of organization are sketchy. Operating agreement is the crucial foundational instrument. Provides for the governance of the LLC, capitalization, admission and withdrawal of members, and distributions. Management Most LLC statutes provide default rule: LLC is to be managed by its members. A few LLC statutes provide that as a default rule, that an LLC is to be managed by managers, who may but need not be members, unless otherwise agreed. Default rule concerning management can only be varied by a provision in the LLCs articles of organization, but many statutes provide that the default rule can be altered in the operating agreement. Voting Rights within an LLC Most statutes default rule is that members vote per capita one vote per member. Minority of statutes default rule is members vote pro rata by financial interest. (unless otherwise agreed) Normally majority vote is all thats needed in per capita or pro rata, but some statutes require unanimous votes for certain designated actions, such as amending articles or operating agreement. Agency Powers

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Member-Managed LLC Apparent authority of member is comparable to that of a partner. Remaining members can confer or withdrawal right upon another member to engage in specified act that is in the ordinary course. LLC may be liable for actions of member with apparent authority, but member with apparent authority may be held to indemnify for wrongful actions. Manager-Managed LLC Typically only managers have apparent authority to bind the firm. Members have no authority, just as shareholders in a corporation wouldnt. Most statutes provide that a manager in a manager-managed LLC has the same authority as a member in a member-managed firm. Delaware Statute Unless otherwise provided in a LLC agreement, each member and manager has the authority to bind the LLC. Unusual because (i) it gives members wide apparent authority even in manager-managed LLCs, and (ii) it allows the apparent authority of both managers and members to be limited by the operating agreement, which is not a public document. Inspection of Books and Records Most statutes provide that members are entitled to access the LLCs books and records. Many include a provision that the inspection must be for a proper purpose. Fiduciary Duties Courts usually borrow heavily from partnership case-law in terms of fiduciary duties in an LLC, because duties are largely unspecified in LLC statutes. But LLC statutes do specify elements of duty of care, and some provide that a manager will be liable only for gross negligence, bad faith, recklessness, or equivalent conduct. Distributions Most LLC statutes hold that, in absence of an agreement, distributions should be made pro rata according to the members contributions, similar to corporate law. (different from partnership, where default rule is per capita) Liability Piercing the Veil Most courts apply the concept of piercing the veil to LLCs under similar conditions in which the concept applies to corporations. Kaycee Land & Livestock v. Flahive court recognized that the same policy reasons for finding the directors and officers of a corporation liable for certain actions or omissions applies to LLCs. Because an LLCs operation are much more flexible than a corporations; however, the factors relevant to a determination as to whether to pierce an LLCs veil vary from the corporate context and will have to be developed over time. Solar Cells, Inc. v. True North Partners, LLC parties formed solar company with one party providing unique product and other providing capital. Product wasnt marketable, and True North had to make another loan to the LLC, under which his interest could be converted to class A shares. D converted to class A shares and then with majority control sought to merge the LLC with another LLC that was wholly-owned by D. Court held for P, granted injunction. In addition to the issue of fair dealing, there is also the issue of fair price. The merger is based on a valuation of First Solar that is less than one-third of the value of the company as calculated only five months earlier. There is a reasonable probability that the latest valuation of the company was not entirely fair. Finally, to show irreparable harm, the injury must be one for which money damages will not be an adequate remedy. If the proposed merger occurs, P will lose the right to appoint managers of the managing board.

Limited Liability Partnership

Pages 511-514 in casebook

Mendales Outline

LLPs differ from general partnerships in that, generally speaking, a partner in an LLP is only personally liable for partnership obligations that arise out of his own activities. State statutes vary on the extent of liability. Variant on LLP is the limited liability limited partnership, LLLP, in which the liability of the general partners in a limited partnership is limited.

The Corporate Form

Corporation is preferred business form for business to be publicly held. Preference result from five central attributes of the corporate form: 1. Limited Liability shareholders are not personally liable for corporations obligations. And managers are not liable either. As long as managers act on corporations behalf and within their authority, treated as agents, not principals, for liability purposes. 2. Free Transferability of Ownership Interests - ownership interests (shares of stock) are freely transferrable. 3. Continuity of Existence legal existence is perpetual, unless shorter term is stated in certificate of incorporation. As a result, corporation is relatively secure against early termination. 4. Centralized Management normally managed by BOD, shareholder has no right to participate in mgmt. 5. Entity Status corporation is a legal person or legal entity, and can exercise power and have rights in its own name. Can hold property, and sue and be sued. Privately held Enterprises - Might be a close corporation, general partnership, LLP, LP, or LLC. Selecting a State of Incorporation generally, entity has right to incorporate in its State of choice, regardless of the extent of contacts with the state. Corporation is governed by laws of the state in which it is incorporated. Close Corporations typically incorporate in the state in which they have their principal place of business in order to avoid being taxed in more than one state. Publicly held corporations usually do business in a number of states, have more financial freedom to incorporate in the state of their choosing. Many choose Delaware, which imposes more lenient laws on corporations than many other states. Organizing a Corporation Requirements for Formation: The Articles of Incorporation Corporation is a legal entity that comes into existence by compliance with the statutory requirements of the state where it is incorporated. Incorporation begins by filing articles of incorporation. 1. Mandatory Provisions of the Articles of Incorporation a. Corporate Name b. Corporate Purpose state laws usually say corp. can be formed for any lawful purpose. Normally just state type of activities engaged in by corporation. c. Specific Business normally must also state specific business in which corp. will engage. Most states didnt allow professionals to incorporate, but most do now. d. Location of principal office and corporations agent for service of process. e. Number of Directors normally a minimum number is required. Original directors must be named. f. Capital Structure types of shares (voting/non-voting, common/preferred); par or no par value for each share, the number of shares authorized of each class. If theres more than one class, must be a statement of the preferences, privileges, and restrictions of each class. NOTE: Some states require corporation to begin with a certain amount of capital. 2. Optional Provisions in the Articles of Incorporation

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a. Preemptive Rights existing shareholders may have right to subscribe to any additional shares offered. b. Power of assessment BOD may assess additional amounts to be paid by shareholders. c. Other provisions any other provision regulating the corporation that is not against state law. 3. Execution original directors (called incorporators) must sign and acknowledge the articles of incorporation. 4. Filing articles must be filed with secretary of state. Some states provide that a copy of the articles must also be filed in other locations (county of principal office, etc.). 5. Corporate Existence most state laws provide that a corporations existence begins when the articles are stamped as filed in the secretary of states office. Completion of Corporate Organization 1. The Organizational Meeting as soon as articles are filed, corp. must hold an organizational meeting of the new BOD to complete all steps necessary to its organizational structure so that the corp. may begin to operate. 2. Matters to be decided a. Resignation of incorporators and election of directors often the incorporators just file the articles, and will elect first directors and resign at the end of the first meeting. b. Election of Officers c. Adoption of Bylaws bylaws state duties of officers, specify meetings to be held by directors and shareholders, state where corporate records are kept, regulate issuing shares, and cover many other matters regulating conduct of corporation. Bylaws can contain any provision not contrary to provisions of articles. Directors or shareholders may amend bylaws. d. Authorization to issue shares and other matters adoption of corporate seal, authorization to open bank account, authorization to do business in other states, leases of property, and authorization to issue first shares of stock. 3. Operating Outside the State of Incorporation states usually require foreign corporations, if they do business in the state, to pay a fee, register, and name an agent for service of process in the state. Penalties for failure to do so include criminal penalties on corporate officers and personal liability for corporate debts. 4. Authorized and Issued Stock a. Authorization whatever shares are issued by the corporation must come from authorized shares. Shares are authorized in the articles of incorporation. i. Classes and characteristics of the shares classes of stock must be stated, as well as whether shares will be par or non-par, number of shares authorized of each class, and other relevant characteristic of the shares (voting rights, etc.). ii. Increased Authorization the number of shares that are authorized by the corporation may only be increased with a shareholder vote of approval. b. Issuance of Shares once shares are authorized, they may be issued. i. Board Approval shares may be issued by the corp. in the discretion of the BOD, but some transactions in which shares may be issued (merger), shareholders must approve. ii. Outstanding Shares once shares have been issued, referred to as outstanding shares. Number of outstanding shares reduces number of shares that are authorized but unissued. 5. Preemptive Rights a. A preemptive right is the right of a shareholder to subscribe to a pro rate or proportionate share of any new issuance of shares that might operate to decrease her percentage of ownership in the corp. Thus, if there are 10 common stockholders with 10 shares each out of 100, if 1000 new shares are issued, each is entitled to subscribe to an additional 100 shares. b. Common law at common law, shareholders were deemed to have an inherent right to preempt new stock offerings. i. Generally, such rights were recognized only when shares were to be issued for cash. (corp. could issue shares for property or services without preemptive rights attaching)

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ii. Such rights generally attached only to common stock, although some states held that such rights also attached to preferred stock. iii. Also, majority view was that preemptive rights attached only to issues of newly authorized stock. Thus if corp. issued 10,000 of its 100,000 authorized common shares, then later issued another 10,000, preemptive rights would not attach to the second issue. BUT, if corp first issued all 100,000 shares, then later authorized and issued another 10,000, preemptive rights would apply to the 10,000 shares issued. c. Regulation by Statute preemptive rights today are generally governed by statute. i. Some states provide that there are no preemptive rights unless such rights are provided for in the articles. ii. Some states indicate that there are preemptive rights unless they are expressly denied in the articles. 6. Problem with Preemptive Rights such rights limit the financing opportunities of the corporation. Thus, today, preemptive rights usually appear only in the close corporation situation. a. Remedies several alternative remedies available to protect a shareholders preemptive rights i. Damages calculated on the basis of difference between the offering price of the new shares and the cost of acquiring the shares in the market. ii. Equitable remedies if shares are not available in the market, then shareholder with preemptive rights may sue for specific performance (to compel corp. to issue more shares necessary for shareholder to retain her proportionate interest). If the shares have not yet been issued, the shareholder may get an injunction against issuance of the shares in violation of her preemptive rights. 7. Basic Modes of Corporate Finance a. Corporations typically use equity financing (common stock) rather than debt, since the risk that the corporation cannot pay interest on the debt is substantial. b. BUT, in the close corporation, there are many reasons why shareholder-partners may want to issue debt securities (deductibility for tax purposes of interest paid). c. Private financing most corporations are started with capital raised from a few parties, rather than from stock that is offered to the public. d. Common Stock; debt (trade debt, bank debt, bonds and debentures, notes); preferred stock; convertibles, classified stock, derivatives; 8. Subscriptions for shares a subscription agreement between a corporation or a corporation to be formed and a subscriber, where the corporation agrees to create and issue shares and the subscriber agrees to pay for them. a. State law may regulate shareholder subscriptions. (require them to be in writing, etc.) b. Preincorporation Subscription Agreements several theories as to when the subscriber becomes liable on the subscription agreement. i. Continuing Offer theory the preincorporation subscription is a continuing offer to a proposed corporation and a timely withdrawal or revocation by the subscriber (prior to actual formation of the corporation and acceptance by the newly formed corporation) will defeat any liability under the agreement. ii. Agreement is among the subscribers when there is a group of subscribers, they have made promises to each other and there exists a contract among the members of the group to become shareholders when the corporation is formed; thus the subscriptions are binding and irrevocable from the date of subscription. iii. Statutory solutions statutes in many states say that subscriptions are irrevocable for some specified period of time (usually six months), giving those forming the corporation sufficient time in most cases to incorporate and formally accept the subscriptions.

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c. Other devices to prevent withdrawal when state law provides for revocation until acceptance, other devices have been used to prevent revocation, such as by having all the subscribers give an irrevocable power of attorney to a trustee who can subscribe for the shares for stated period of time.

Preincorporation Transactions by Promoters

In the course of forming the corporation, promoters often contract for products or services on behalf of the corporation (not yet formed). Promoter Liability Promoter contracts in the name of and solely on behalf of the corporation to be, promoter cannot be held liable if corporation doesnt form. If promoter contracts in his own name, then he may be held liable and may enforce the contract. Tricky when corporations name and promoters name appear. In this case, courts attempt to determine parties intent, and various factors enter into the determination of this intent. Corporate Liability If corporation ratifies or accepts the contract after incorporation, the corporation may be held liable on the preincorporation promoter contract (and may enforce the contract). Ratification may be express or implied form adoptive conduct of the corporation. 1. Quasi-contractual recovery if the corporation repudiates the contract, it is still liable for the value of anything that it makes use of (in quasi-contract). 2. Adoption by implication the general rule is that ratification is retroactive and adoption is not. For a corporation to adopt a contract, it must have knowledge of the terms of the contract. (but who must know of this to impute this knowledge to the corporation?) Most jurisdictions recognize that adoption may be by implication. Also, adoption is not generally held to be a novation (although some argue it should be); thus, the promoter is not relieved of personal liability by the adoption.

Consequences of Defective Incorporation

Introduction once there has been an attempt to incorporate, the first issue is whether or not a corporation has actually been formed, and if not, what the consequences are. Any number of the formal requirements for incorporation may have been omitted or improperly performed. Or steps necessary to complete the companys internal organization (adoption of bylaws, etc.) may not have been completed. Whats the effect? This normally arises when an outside party (such as a creditor) wants to disregard the corporate shield against liability and hold one or more of the shareholders personally liable for corporate debts. 1. De Jure Corporation a corporation that has complied strictly with all of the mandatory provisions for incorporation cannot be attacked by any party (even the state). What is mandatory and what is directory is a matter of judicial construction of the states incorporating laws. a. NOTE: Substantial compliance is okay too, if noncompliance is insubstantial. b. Some courts say it must be strict compliance with all mandatory rules, but if not with directory rules, thats okay. 2. De Facto Corporation there is a body of common law indicating that, even if a corporation has not complied with all of the mandatory requirements to obtain de jure status, it may have complied sufficiently to be given corporate status vis--vis third parties (although not against the state). a. Requirements for De-Facto Status i. Good faith attempt to comply with the provisions of the incorporation law. ii. Good faith actual use or conduct of business as though a corporation existed. b. Examples

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A corporation fails to put a seal on articles, as required by law; the incorporator gives incorrect address in articles, etc. ii. NOTE: If corporation has de facto status, all parties must treat it as a corporation, except the state may bring a quo warranto action to declare the corporation invalid. c. Elimination of Issue by Statute NOTE that a number of states have eliminated the de jure or de facto question altogether. Legislation has indicated that if the corporations articles have been stamped as filed with the secretary of state, they will be conclusively presumed to form a valid corporation, except in actions brought by the state. d. NOTE: p121 of book, McChesney says Three requirements for de facto status: i. Statute in existence by which incorporation was legally possible ii. A colorable attempt to comply with the statute iii. Some actual use or exercise of corporate privileges. 3. Corporation by Estoppel when corporation is not given de jure or de facto status, its existence can be attacked by any third party. But, there are situations where courts will hold that the attacking party is estopped to treat the entity as other than a corporation. 4. Other Situations if an entity cannot be treated as de jure or de facto or a corporation by estoppel, modern courts will hold only those shareholders who actively participate in management personally liable.

i.

Classical Ultra Vires Doctrine (p.122-125)

Any act that is beyond the purposes or powers (express or implied) of a corporation is an ultra vires act. Such acts may arise because the corporation acts outside the powers granted in its articles or beyond the powers granted by the state corporation law. Consequences of an Ultra Vires act State may bring quo warranto action to cancel the corporations charter or to oust the corporation from operating illegally, or an equity action for an injunction. Or a shareholder may bring an injunctive action against the corporation to prevent the corporation from acting outside its authority, or an action against the officers and/or directors for having authorized the corporations actions. Specific Instances of Ultra Vires acts 1. Torts generally, ultra vires is no defense to a tort action brought against a corporation for the act of one of its employees acting within the acope of his employment. 2. Criminal acts similar to the rule for torts. 3. Contracts in some situations, common law permitted claim of ultra vires to corporate contracts (e.g., where contract was purely executory). But the claim was not favored since it threatened the security of commercial transactions. Now most states have passed statutes that severely limit the claim of ultra vires acts. a. Ex. Ultra Vires may generally not be claimed once the contract is executed on both sides or is executed only on one side. The basis for so holding may be estoppel. b. UV contracts may be generally ratified by the unanimous vote of shareholders, which validates the contract. And where theres benefit to the corporation, ratification by a majority of shareholders is sufficient. However, corporation (or shareholders in derivative suit) may sue the directors for damages on the basis that they undertook an unauthorized action. c. The state may ALWAYS raise the issue. 4. Illegal Acts illegal acts are not merely ultra vires; the corporation may always be held liable for such acts. 5. State statutes most states have passed statutes limiting application of the ultra vires doctrine. Goodman v. Ladd Estate Co. Liles held all common shares of Westover Tower, Inc, and only common shares could vote. Dr. Wheatley borrowed $10K from the bank, and Ladd indorsed the note to the bank and Westover and Liles both

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guaranteed Ladd against loss from indorsing Wheatley note. Wheatley defaulted, Ladd paid bank. Mr. and Mrs. Goodman come along and buy all the stock of Westover and then sued Westover and Liles to collect on the guarantee. Court enforced the guarantee. There is nothing inequitable in enforcing an ultra vires guarantee. The fact that Ps agent erred in advising them that the guarantee was unenforceable does not make enforcing the guarantee inequitable. By state law, an ultra vires agreement is enforceable. To accept Ps argument that enforcing ultra vires agreements is inequitable would emasculate the statute.

Objective and Conduct of the Corporation

Both business and legal theory agree that a corporation must have a purpose or a goal. They tend to disagree about what this purpose should be. Business Theory tends to deal in terms of strategy when it comes to corporate purpose. Strategy is the determination of long-term goals and objectives of the company and the adoption of courses of action and the allocation of resources necessary to carry out the basic goals. Strategy Includes: 1. Selection of target markets, definition of basic products, determination of distribution systems. 2. Matching corporate resources and capabilities with necessary resources and capabilities for possible market alternatives, once alternatives have been selected, planning nec. resources and allocation. 3. Selection of alternatives in terms of managements personal preferences and values. 4. Selection of alternatives according to perceived obligations by management to segments of society other than the stockholders. Legal Theory asks what purposes are within those bounds set by the articles and the statutory law under which the corporation was formed. In effect, articles are contract between state and the incorporators. 1. Originally, the issue was whether a corp. had exceeded powers granted under a state-given charter. 2. More recently, with general incorporation laws, issue is whether corporation has remained within the purposes set by the incorporators and the state law. 3. Closely related to the issue of proper purposes is the issue of proper powers. State law often sets forth the acts that a corporation may legally perform. These acts should be in aid of a proper corporate purpose. 4. If the corp. engages in an improper purpose or uses an improper power, it is said to be ultra vires. Distinction between Purposes and Powers Purpose end or objective and usually is a statement of the kind of business that corp. will engage in. Power kinds of acts that a corporation may engage in in pursuit of corporate purposes.

Powers of a Corporation
Express powers corporation has express power to perform any act authorized by the general corporation laws of the state and by the articles of incorporation. General powers most states have statutory provisions allowing corporations to sue and be sued; own property; make gifts to charity; borrow money; acquire stock in other companies; redeem or purchase corporate stock, etc. Limitations most states also have express limitations on corporate powers. Ex: transfer of substantially all of a corporations assets normally requires the approval of a majority of voting power of shareholders. Implied Powers in most states, corporations also have implied power to do whatever is reasonably necessary for the purpose of promoting their express purposes and in aid of their express powers, unless such acts are expressly prohibited by common or statutory law. The trend is to construe broadly what is reasonably necessary. 1. There may still be some limits on what the corporation can do. Ex: some states limit right of corp. to enter into partnerships, since partner may bind corporate partner (removing management

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responsibility from the corporations board). Shareholders may give these powers in the articles of incorporation, however. 2. Some states have continued common law prohibition on corporations practicing a profession. Objective of the Corporation Maximizing profits typically run for the financial benefit of its shareholders. Interests other than maximizing profits: Charitable Contributions SEE CASE BELOW A.P. Smtih Manufacturing Co. v. Barlow Corporation, formed in 1986, gave a $1500 gift to Princeton University, and it was challenged by a shareholder. President and other execs testified it was a sound investment, created favorable environment for the company, and the public had reasonable expectations of such socially oriented contributions by corporations. Court said it was NOT ultra vires, was within implied powers of corporation. Control of economic wealth has passed to corporations. Common law has, therefore, begun to recognize the doctrine that such donations tend reasonably to promote corp. objectives; therefore its an implied corp. power. No wrongdoing by officers, concerning contributions to personal benefit. Social Responsibility of Corporations Some argue corporations should only focus on producing best products and maximizing profits. Others argue that corporations should focus on that, but also social welfare and overall positive influence. NOTE: Dodge v. Ford Motor Co. Ford wanted to reinvest in company to hire more people. Court shot it down.

Corporate Structure
Traditionally, shareholders owned and controlled a corporation, but now large portions of publicly held shares are owned by institutional investors, who take an active part in the control of a corporation or delegate decision-making powers to fiduciaries, such as banks. Two reasons why dispersion of shareholdings present a severe collective-action problem: 1. Shareholder owns tiny amount of corporation, and will be rationally apathetic. 2. Typically with such widespread ownership, voting is by proxy, controlled by management. Most institutional investors are: private pension plans, public pension plans, banks, investment companies, insurance companies, or foundations. (pages 155-156) Allocation of legal powers between management and shareholders SEE CASE BELOW Charlestown Boot & Shoe Co. v. Dunsmore Charlestown sued two of its directors for losses allegedly caused by not taking action with respect to liquidating assets, and by not insuring buildings that burned down. Shareholders had appointed Osgood to liquidate the company and DFs refused to work with him. Court held for directors. State law appoints directors to be in charge of managing the corporation. Unless articles, bylaws, or state law states otherwise, directors are responsible for management and officers work under their direction. Shareholders action in appointing Osgood was outside of the legal structure of management. There is no statute, as a matter of law, that requires directors to insure company buildings. Removal of Directors Shareholders can remove directors with cause, but cant remove directors without cause unless permitted by statute or, in some states, provided by the certificate of incorporation or the bylaws of the corporation. On the other hand, the board cant remove a director with or without cause unless given authority to do so under a statute. Some statutes also allow courts to remove directors for specified reasons.

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Management Decisions made Based on Improper Purpose Schnell v. Chris-Craft Industries, Inc Management of Chris-Craft attempted to advance the corporations annual stockholders meeting from Jan. 11 1972 to Dec. 8 1971. Dissident stockholders petitioned for injunctive relief, contending that meeting had been moved up solely to thwart them from gathering support for a proxy contest. DF contends its complied strictly with Delaware corporation law in advancing the date. Court held for shareholders. Ps filed intention to wage proxy contest with SEC and put company on notice. DFs obstructed Ps legitimate efforts to exercise rights to undertake proxy contest by refusing to produce a list of stockholders and by attempting to advance meeting date. Sole purpose was to thwart proxy contest, such conduct is improper and will not be permitted regardless of compliance with applicable rules. Original meeting date was reinstated. Board acting in Good Faith may still breach Fiduciary Duty Blasius Industries, Inc. v. Atlas Corp. Blasius acquired 9.1% of Atlas stock, then filed 13D statement with SEC indicating it intended to encourage the board to restructure and possibly seek control through representation on the board. Atlas had been restructuring, selling off divisions, and concentrating on goods production. Atlas mgmt. met with Blasius and heard their proposal that Atlas raise capital by borrowing and selling off assets and then distribute money to shareholders, with Atlas emerging as smaller, more highly leveraged company. Atlas mgmt. rejected the proposal. Blasius then deliverd a resolution to amend bylaws to expand board from 7 to 15 and vote in 8 Blasius directors. Atlas mgmt. reacted immediately to fend off what it thought was a takeover attempt; board held a telephone meeting; board was increased to nine members; and two new directors were elected to staggered terms. Now Blasius sues to set aside boards action as breach of fiduciary duty. Court finds for Blasius. Even though Atlas board acted on its view of the corps interest and not selfishly, the boards action constituted an offense to the relationship among corporate directors and shareholders that has traditionally been protected by courts of equity. The board may take certain steps that have the effect of defeating a threatened change in corporate control, when those steps are taken in good faith pursuit of a corporate interest and are reasonable in relation to a threat to legitimate corporate interests posed by the change in control. BUT, this rule may not apply when the action taken by board is designed for primary purpose of interfering with effectiveness of shareholder vote. After all, board members are agents, in effect, of shareholders. Actions taken to obviate a shareholder vote are not per se illegal, but the board bears a heavy burden to demonstrate a compelling justification for such an action. Here, board was not faced with coercive action of a majority shareholder against a minority. Conduct of directors of corporation is judged by the easier standard of business judgment, but its been said that actions that interfere with shareholder voting rights should be reviewed under the stricter compelling justification standard. Under Unocal Corp. v. Mesa Petrolium, court said in order for board to take defensive action against a takeover, it must satisfy an enhanced business judgment rule or intermediate standard of review (b/t business judgment & duty of loyalty) 1. Board must first show it had grounds for believing that the tender offer presented a danger to corporate policy and effectiveness. Done by showing good faith and reasonable investigation. 2. Board must then satisfy a proportionality test, the defensive action must be reasonable in relation to the threat posed. (pages 177-178)

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When Compelling Justification Must be Shown International Brotherhood of Teamsters v. Fleming Companies, Inc. - The International Brotherhood of Teamsters (P) owned 65 shares of the Fleming (D) stock. As an anti-takeover mechanism, Ds board of directors implemented a shareholders rights plan, also known as a poison pill. Such plans give boards of directors authority to adopt discriminatory shareholder rights, making a takeover difficult and assisting incumbent management in maintaining control of a company. P was critical of the plan and mounted an effort to change it. P proposed an amendment to the companys bylaws that would require any such rights plan implemented by the board to be put to the shareholders for a vote. D refused to include the resolution in the proxy statement. P brought an action to get a vote on the proxy. The court found for P, and D appealed. The appellate court certified the following question of law to the state supreme court Generally, the role of shareholders is indirect. A corporation may create and issue rights and options. However, it does not automatically translate that the board of directors of that corporation has in itself the same authority. A shareholder rights plan is essentially a variety of a stock option plan. There is authority supporting shareholder ratification of stock option plans. There is nothing in Ds certificate that speaks to the boards authority or shareholder constraints regarding shareholder rights plans. Furthermore, there is no shareholder rights plan endorsement statute in this state. MM Companies, Inc. v. Liquid Auto, Inc. BOD of Liquid voted to expand from 5 to 7 members for defensive purpose of preventing shareholders from effectively voting in an upcoming election for successor directors. Wanted to prevent MM, who was seeking to ultimately acquire the company, from gaining 2 of 5 directorships. MM sought injunctive relief against Liquid and its directors on ground that it violated principles from Blasius and Unocal cases. Court found for MM. Within a corporation, stockholders have the power to vote on specific matters, including election of corporations directors, while directors have the power to manage the corporate enterprise. Maintaining proper balance in this allocation of power depends upon the stockholders having unimpeded rights to vote for directors. There is a presumption that a corporations directors act on an informed basis, in good faith, and in honest belief that their actions are in the corporations best interests. (business judgment rule). Court will not substitute its judgment for the boards unless the presumption is rebutted. Blasius held that where board has acted for primary purpose of impeding stockholders right to vote, board bears burden of demonstrating a compelling justification for its actions. Unocal held that when the action taken was a defensive measure taken in response to some threat to corporate policy and effectiveness which touches upon issues of control, Unocal standard of reasonableness and proportionality applies as well. SO, compelling justification standard of Blasius must be applied within reasonableness and proportionality standard of Unocal. NOTE: WE DID NOT DO THIS CASE IN CLASS, NOT ON THE SYLLABUS.

The Legal Structure of Management

Modern companies mostly have management functions held by a CEO, not the board, because of constraints on boards to manage companies: time constraints, information constraints, composition constraints. Because of this shift, boards function more as monitoring boards, rather than managing boards. Their function is now usually to evaluate, fix compensation of, and replace senior executives. Because of this, must be functionally able to do so and must be independent of senior management in company. Where CEO is the chairman of the board, theres often a lead director of the board. (p.199) Corporate Law consists of: 1. State statutory law enables corporations to be organized, provides corporations with endowments, facilitates corporate transaction. 2. State judge-made law sets level of care require of officers and directors, regulates traditional conflicts of interest, give content to remedial structures to protect shareholder rights and resolve shareholder claims.

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3. Federal law regulates traditional conflicts directly, through rules on insider trading, and regulates positional conflicts of interest indirectly, through rules that govern proxy voting and by regulating information flow. 4. Private ordering (soft law) regulate position conflicts directly, by requiring independent board and committees to monitor the corporations executives. Ex. of soft law is the NYSE rules. The Business Concept: people in business think of management in terms of a general manager responsible for direction of the corporation. Management function involves: planning, organizing, directing, and controlling. The Legal Concept: most state corporation laws place ultimate responsibility for management of corporation with the BOD. Not entirely clear what this means. There are boundaries: shareholders are ultimate owners and have specific management responsibilities while manage cannot mean what a businessperson thinks it means, since directors dont normally have time to be involved in routine, detailed, day-to-day management functions. Hence, shareholders elect directors, directors appoint officers, and directors are responsible for management in the sense that they are really the overall supervisory body to pass on or review major decisions. Inside versus Outside Directors Outside directors are those who are not otherwise employed by the corporation (as employees). Inside directors are normally also company officers.

Formalities Required for Action by the Board

Appointment of Directors 1. The First Board members of the first board of directors are the incorporators. They hold office until the first meeting of shareholders or until they resign and new directors are elected. 2. Number of Directors normally, articles and bylaws indicate how many directors there shall be. Some state laws require a minimum number. Delaware permits a board of only one. If the articles permit it, the number may be changed by amendment of bylaws. 3. Acceptance directors must accept and consent to act as directors. 4. Qualification some states require that directors own stock in the corporation. Election of unqualified persons is voidable, but their acts while directors are effective. 5. Vacancies normally, remaining board members may fill vacancies on the board. Term as Directors 1. Period of Appointment most state laws indicate that directors are elected for a one-year term. Articles or bylaws may specify a different period. Some states provide for longer periods. 2. Resignation directors may resign at any time. Formal Aspect of Board Action (p207 -210) In order to be valid, board must act as a board by resolution or vote at properly called meetings at which there is a quorum present. Statutes indicate how meetings are to be called, notice requirements, and number necessary for quorum and for resolutions to pass. Despite these formal requirements, some opinions hold that if a majority of the directors knew of the transaction at the time it occurred, or knew about it afterward and took no action to disaffirm the unauthorized action by the corporate officers, the action will be held to be ratified, since it has been acquiesced in by the corporation. Also, some opinions hold that, even if directors didnt know of the transaction, such knowledge is chargeable to the corporation if the corporation accepted the benefits thereof and if the directors reasonably should have known of the transaction. NOTE: this same problem of required action (and acquiescence) by directors of corporate agents actions occurs when corporate law requires formal action by shareholders and the directors do not get this shareholder approval.

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Authority of Corporate Officers (p211-215)

It is assumed by corporation law that directors will delegate certain responsibilities to executive employees and maintain an overall supervisory role. But, modern trend is for more responsibility and authority to gravitate to executive officers. Corporation law usually indicates, by statute, the top-level officers of the corporation (president, VP, secretary, treasurer). Normally something is also said about the duties of these officers, and there may be other levels of managers, down to the blue collar worker. Tenure of Officers bound by a duty of loyalty and obedience to the corporation, which, in theory renders officers liable to the corporation in damages for breach of this duty. Normally, however, infractions of this duty are handled by reprimand, transfer, demotion, or dismissal. In essence, officers hold their positions at the discretion of the board. Executives and Their External Representation of the Corporation Types of Authority normally authority of officer comes from BOD or bylaws, thus officers act in an agency role. 1. Authority R2ndAgency authority is the power of the agent to affect the legal relations of the principal by acts done in accordance with the principals manifestations of consent to him. 2. Actual Authority a. Express actual authority given in bylaws, articles, corporation laws and by BOD resolutions. b. Implied actual authority that is necessarily and reasonably implied from express authority. i. Such authority can arise from a course of acquiescence in the conduct or acts of officers. ii. Schoonejongen v. Curtiss Wright Corp. implied actual authority may be found through evidence as to the manner in which business has operated in the past, MORE(p215) 3. Apparent Authority created by some action of the corporation that creates the impression in the mind of a 3rd party that the agent has the authority that she does not. NOTE: implied authority arising from acquiescence in the conduct of the officers is closely related to, if not identical with, apparent authority. a. If an agent acts outside her actual authority, the 3rd party dealing with agent may be able to hold the corporation liable on this basis. Corporation may also have an action against the agent. b. Pages 211-215 in Texbook detail apparent authority for each officer (P, VP, Treas., Sec., etc.) 4. Inherent Authority authority by virtue of the position of responsibility. Ex. president often deemed to have authority to make day-to-day decisions and run corporation on day-to-day basis. 5. Unauthorized acts RATIFICATION acts by corporate officers that would otherwise be invalid, are made valid by ratification or adoption by the board or the shareholders, or by estoppel. Liability for Torts or Crimes Corporation is responsible for the torts and crimes committed by corporate officers in course of and within the scope of employment.

Formalities Required for Shareholder Action

Law regards shareholders as owners of the corporation, the object of managements fiduciary duty, and ultimate source of corporate power. Rights of Shareholders in Management role of directors in management is circumscribed by certain rights given to shareholders. Indirect Power shareholders have no direct power over management of corporation. So, for example, resolutions by shareholders on matters within the board are void, unless ratified by the board. Shareholders have indirect power since their ownership allows them to remove and replace directors. Election of directors requires only plurality vote, NOT majority. Some decisions say transactions entered into by all shareholders are valid even without director approval.

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Close Corporations in situation where directors and shareholders are really same people (close corp.), many states have passed statutes that treat the few shareholders as partners. So, often agreements by shareholders are binding on the corporation, and other acts done by shareholders are effective as if done by the BOD. Some statutes even do away with the board entirely, leaving management of the corporation to the shareholders. Shareholder Approval of Major Changes Issues Concerning Shareholders: 1. When must shareholder approval of corporate transactions be secured? 2. When might directors ask for such approval as a matter of policy, even though not required by statute? 3. When may shareholders initiate corporate action? Major Changes state corporation law provides that certain major corporate transactions require shareholder approval. Normally, transactions listed in statute that require shareholder approval are: 1. Election and Removal of Directors - shareholders elect and may remove with cause the directors (some states allow without cause). Vacancies are filled by remaining directors. 2. Bylaws bylaws are adopted by directors in the organizational meeting. Typically may be changed by directors, but shareholders normally have the ultimate authority to amend bylaws. 3. Organic Changes power to make organic changes, by merging or consolidating corporation, selling entire corporations assets, reducing the capital, etc, resides with the shareholders. 4. Amendments to charter shareholders must approve amendments to the corporate charter. 5. Other matters state law differs in granting to shareholders the approval power of many diverse subjects. 6. Initiation state law also differs in naming the matters where, and the procedures by which, shareholders may initiate corporate action. (such as calling shareholder meetings, etc.) Right to Vote Shareholders vote annually to elect directors and on important corporate issues. In effect, have indirect control over management. If corporation is small, and number of shareholders relatively small, this control is meaningful. But in large corporations, this control may be illusory, since management really controls what happens and manipulates far-removed and disinterested shareholders according to its wishes. Who may vote? Right to vote is held by shareholders of record who hold shares with voting rights. Right to vote follows legal title. There must always be one class of shares with voting rights. If theres more than one class with voting rights, one must have restrictions. BUT, some states allow nonvoting common stock to be issued. Only shareholders of record may vote, that is, management sets a date when all those holding shares with voting rights on that date will be able to vote at a future date. (or can give proxy to someone else to vote their shares) Allocations of Voting Power right to vote may be allocated to others not owning the shares. Proxies shareholder may give proxy to another to vote the shares. Proxies normally are revocable. Voting trust another device to assure control of the corporation to some interested party. This device is often used because proxies are revocable. Shareholders transfer legal title to their shares to a trustee and receive a voting trust certificate. Trustee then has right to vote the shares for the life of the trust. Normally trusts are irrevocable by shareholders, regardless of whether consideration was given to shareholder for putting his shares in trust. But normally, most states limit duration of such trusts.

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An action for specific performance is available to compel the trust to perform according to terms. Shareholders receive all of the other normal benefits of being shareholders, such as dividends. Pooling Agreements shareholders exchange promises to vote their shares in some specific way, or as some part of the group shall direct. In the absence of fraud or illegal motives, such agreements are specifically enforceable. Fiduciaries shares of stock may be held by a trustee, custodian, guardian, or other fiduciary. Joint Ownership shares may be held by two or more persons joint tenants, partners, etc. Pledges shares may be pledged as security for a debt (and voting rights transferred). Brokers brokers may hold stock in their names (street names) as agents for clients. Other Limitations on Voting Power of Shareholders Shareholders cannot make agreements relative to their voting power that will interfere unduly with the interests of minority shareholders or disrupt the normal operations of the corporate system. Majority Approval normally matters requiring shareholder approval need only a majority vote. However, often those controlling the corporation at its formation attempt to provide, in articles and/or bylaws, that a greater percentage is required, which helps those with smaller percentage of the voting power to prevent change in the company. Most courts have held that shareholder agreements that require unanimous consent are invalid. But many that require less than unanimous approval but more than a majority have been approved. Shareholder Agreements for Action as Directors Most courts hold that shareholders cannot make agreements as to how they will vote as directors. Directors must be free to act independently in their roles as directors in order to faithfully execute their fiduciary duties to the corporation. Of course, shareholders can agree how they will vote as shareholders to elect directors. Shareholders Meeting Shareholders can only act at a meeting, duly called, with notice (or with notice appropriately waived), where a quorum (normally, majority of voting shares) is present, and by resolution passed by the required percentage vote. Some states permit action based on unanimous written consent or consent of some specified percentage of shareholders without actually being at a meeting. Bylaws normally require an annual meeting and permit special meetings to be called by officers or shareholders holding a specified percentage of the voting shares. Cumulative Voting Straight voting on most matters shareholders have one vote per share, with majority winning. Cumulative voting for electing directors ensures that minority shareholders have representation on the board. Cumulative voting works like this: each voting share is given one vote for each director to be elected. So, if there were 5 directors to be elected and you had 10 shares, you would get 50 votes. Then these votes can be cast for any one director or split up in any fashion. The formula is x=((y*n)/(1+N)) = 1 where n is number of directors desired to elect, and N is total number of directors, and x is number of shares needed to elect a given number of directors. Right to Cumulative Voting In many states its mandatory. Some states the right is given in state constitution, and in others merely statutory. Ways to Avoid Cumulative Voting

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Classification of Directors the fewer directors elected, larger percentage of outstanding shares needed to elect one. So, one way to avoid effect of cumulative voting is to stagger elections. Some states prohibit this. Reduce the size of the board, for same reason as above, to whatever state minimum is. Limited Liability Corporation as Separate Entity from Shareholders Since its a separate legal entity, corporation normally incurs debts and obligations in its own name, not responsibility of owners (shareholders). At same time, corp. is not responsible for debts/obligations of owners. EXCEPTIONS: Piercing the Corporate Veil, shareholders liable as individuals despite corporate existence. When can Veil be Peirced? 1. Fraud or Injustice where maintenance of corporation as separate entity results in fraud or injustice to outside parties, such as creditors. 2. Disregard of Corporate Requirements where shareholders dont maintain corporation as separate entity and use for personal purposes (records not maintained, required meetings not held, money transferred and commingled). If shareholders disregard corporate form, then entity is really alter-ego of individuals and decisions are being made for their benefit, not entitys. Most likely to occur with a close corporation. a. Alter Ego theory and subsidiary corporations SEE CASE BELOW Fletcher v. Atex, Inc. Two computer users filed suit against Atex and parent company Kodak for repetitive stress injuries resulting from use of keyboards manufactured by Atex. Atex participated in Kodaks cash management system, and Kodak exercised control over Atexs major expenditures, stock sales, and asset sales. Some overlap between members of the board of the companies, and Atexs promotional literature bore the Kodak logo. Based on this, Ps argued Atex is merely the alter-ego of Kodak, and veil should be pierced. Court found for Atex, said NOT alter-ego. To prevail on an alter-ego theory, P must show that the two corporations operated as a single economic entity. Some factors to consider are whether the subsidiary corporation was adequately capitalized and solvent, whether corporate formalities (such as regular directors meetings and recordkeeping requirements) were observed, and whether dominant shareholder siphoned corporate funds. Atex followed all corporate formalities. Cash management participation and parent company oversight are common, not unusual, and not indicative of an alter-ego status. While no showing of fraud is necessary to prove alter-ego, Ps must show some evidence of unfairness in upholding a legal distinction between the two companies. Undercapitalization major issue to consider and prime reason for piercing veil is when subsidiary is undercapitalized considering liabilities, debts, and risks it reasonably could be expected to incur. SEE CASE BELOW: Liability Insurance as Evidence of Undercapitalizion Walkovsky v. Carlton Walkovsky was injured in an accident with a cab, sued driver of cab, the corporation that owned the cab, and Carlton who owned the corporation and nine others, each having two cabs with the minimum $10K in liability insurance coverage required by state law. Complaint alleged corporation operated as a single entity and constituted fraud on the public. Court dismissed, but with leave for P to amend complaint. Courts will pierce the corporate veil when necessary to prevent fraud or to achieve equity. There is nothing wrong with a corporation being a part of a larger corporate enterprise. The issue is whether the business is really carried on in a corporate form but by and for another entity or person with a disregard of the corporate formalities. Must allege its carried on for personal, rather than business reasons. On the minimum insurance issue, thousands of cabs and companies that own cabs have done this, if the minimum is too low, the legislature needs to fix this.

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Active Participation by the Attorney-Shareholder Minton v. Cavaney Cavaney was attorney for Seminole CO. and helped form a company that leased a public swimming pool. Mintons daughter drowned in the pool and Minton got a $10K judgment against Seminole, which the company could not pay. Minton sued Cavaneys estate. Cavaney was a director and officer and was entitled to one of three founding shares of its stock, which were never issued. Cavaney argued that he was an officer/director merely as an accommodation to the company, and never actively participated in management, and thus should not be held personally liable if the veil is pierced. Court said Seminole never had any assets and never functioned as a corporation, P wins. Cavaney was a director and by state law is responsible for the management of the company. He also participated in other important aspects. It makes no difference that his activity was engaged in as an accommodation, he was an active shareholder. Thus if veil is pierced, he may be held personally liable. Where company is undercapitalized with regard to business risks it engages in, D can be personally held liable for the corporations obligations. NOTE: Corporate formalities were also disregarded here, remand to decide whether to pierce veil. Requirement of Fairness veil may also be pierced in any other situation where it is only fair that the corporate form be disregarded. Contract Liabilty major difference between tort and contract cases is that in contract cases the plaintiff has an opportunity in advance to investigate the financial resources of the corporation and has then chosen to do business with it. Thus, in contract cases, the intention of the parties and knowledge of the risks is assumed in entering into a contract are factors to be assessed in making a determination as to whether the veil should be pierced. The Two-Prong test for Piercing the Veil Sea-Land Services, Inc. v. Pepper Source (Sea Land I) Sea Land was an ocean carrier that shipped peppers on behalf of Pepper Source, and after PS refused to pay its freight bill, SL sued. District court found for SL, but SL couldnt get any recovery because PS had dissolved. P then brought action against PSs sole shareholder, Marchese, individually, and against other business entities Marchese owns. SLs plan was to pierce Marcheses other corporations. Court found for SL. Corporate veil may be pierced if two requirements are met: 1. There must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist; and 2. Circumstances must be such that adherence to the fiction of separate corporate existence could sanction a fraud or promote injustice. In determining whether a corporation is so controlled by an individual or another corporation that the court would be justified in disregarding their separate entities, Illinois courts look at following factors: 1. Failure to comply with corporate formalities or keep sufficient business records 2. A commingling of corporate assets 3. Undercapitalization 4. One corporations treatment of another corporations assets as its own Here, Marcheses corporations used same phones, same office, he borrowed money from them, and they borrowed money from eachother. Cleary first part of test is met to pierce veil. For second part to be satisfied, must be more than just that a creditor wont get paid, must be unjust enrichment or promotion of injustice by not piercing. Peircing the Veil to Prevent Injustice

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Sea-Land Services, Inc v. Pepper Source (Sea Land II) PS and Marchese appeal from trial court judgment where corporate veil was pierced and SL was awarded damages. PS and M argue that second prong of test wasnt satisfied. Court found for SL. Second prong of test is met if the PL proves that a failure to pierce would promote injustice. One way to meet the second test is to show that a party would be unjustly enriched if allowed to hide behind corporate veil. Equitable Subordination of Shareholder Claims (p252-253) An alternative to piercing the veil in contract situations where the corporation has become insolvent and shareholders are also debtors of the corporation is to subordinate the shareholders debts to the claims of the other creditors. The effect is to give priority to non-shareholders, who will be paid first, even where their claims are unsecured and those of shareholders are secured. This is must less drastic than piercing the veil and holding shareholders personally liable, and is usually used in the event of liquidation or reorganization of the corporation pursuant to receivership or bankruptcy proceedings under the Federal Bankruptcy Act. This is known as the deep rock doctrine b/c of Deep Rock Oil Co. Subordination of claims is an equitable remedy, therefore, its awarded when theres been bad faith by the shareholdercreditor toward other corporate creditors, or mismanagement of the corporation that adversely affects the corporations ability to pay debts owed to other creditors. Its also been applied where theres undercapitalization. The rationale behind this is that debts owed by the corporation to the shareholders should be treated as if they were invested capital, which, of course, is always subordinate to debts and obligations of the firm. NOTE: issue is not whether debt exists or whether shareholder should be ordered to pay debt, but rather whether fairness dictates that the non-shareholder creditors should have priority of payment of corporations debt in insolvency. Benjamin v. Diamond 3 things must be satisfied before equitable subordination can be exercised: (p255) 1. The claimant (who may be an owner, director, or officer of the bankrupt corporation), must have engaged in some type of inequitable conduct 2. The misconduct must have resulted in injury to the creditors of the bankrupt or conferred and unfair advantage on the claimant 3. Equitable subordination of the claim must not be inconsistent with the provisions of the Bankruptcy Act.

Shareholder Informational Rights and Proxy Voting

Saito v. McKesson HBOC, Inc. McKesson entered into a stock-for-stock merger agreement with HBOC. Few days later, Saito purchased McKesson stock. Merger was consummated 4 months later, and company was renamed McKesson HBOC, while HBOC continued as a wholly-owned subsidiary of the new company. Soon after, MHBOC announced a series of financial restatements, attributed to HBOC accounting irregularities that reduced MHBOCs revenues. In course of litigation, Saito demanded documents relating to the merger. Trial court said Saito had proper purpose to inspect books and recordsto discover any wrongdoing in connection with the mergerbut that his purpose extended only to wrongdoing after the date Saito had acquired shares of McKesson stock. Court said Saito did not have proper purpose to inspect documents relating to potential claims against third-party advisors who counseled the boards of directors in connection with the merger. Court said Saito was not entitled to HBOC documents, because he was not HBOC shareholder prior to merger, and stated no basis to disregard separate existence of the wholly-owned subsidiary. Court found for Saito, on all documents. Under Delaware law, stockholder may investigate matters reasonably related to his interest as a stockholder, including possible corporate wrongdoing. Where a meritorious claim is based upon corporate wrongdoing, the stockholder should be given enough information to effectively address the problem. Scope of his investigation is limited to those books and records that are necessary to accomplish the stated, proper purpose.

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By statute, stockholders that bring derivate suits must allege that they were shareholders at the time of the relevant transaction. This does not also control a shareholders inspection rights. Activities that occurred before the stock was purchased are reasonably related to the shareholders purpose. If shareholder requests documents for an improper purpose, they may still be granted if its secondary to a proper purpose. As long as theres a proper purpose, presumption is to allow inspection. Blanket exclusion of third party documents is improper. Stockholders of parent corporation are not entitled to inspect subsidiarys books absent a showing of fraud or basis to disregard separate entity status, but this rule does not apply to relevant documents that HBOC gave McKesson before the merger, or to a parent company after the merger. All proper and within scope. Shareholder Informational Rights Under Federal Law and Stock Exchange Rules (pp270-275) Securities Exchange Act of 1934 Purpose is to protect interstate commerce and the national credit, and to insure the maintenance of fair and honest securities trading markets. Act requires that certain securities be registered with the SEC, and once registered a company is subject to continued reporting under the Act and to regulation of many of its other activities. 1. Corporations are Required to Register their Securities companies whose securities are traded on a national securities exchange, or companies who have assets of $5 million or more and a class of equity security held by 500 or more persons, must register such equity securities with the SEC, SEA12. 2. Information Required - 12 requires that the registering company supply information similar to an S-1 registration statement under the 1933 act. 3. Exemptions numerous exemptions from the 1934 act, ex securities registered under 8 of the Investment Company Act of 1940 are exempted. 4. SEC Exemptive Power Additionally, the SEC has the power to exempt securities from registration if such exemption is in the public interest and does not endanger investors. SEA 12(h). 5. Reports required of companies that have offered their securities to the public every issuer of a security that was registered in the past year under the 1933 Act must also file periodic reports with the SEC (similar to those required of registered companies under 12 of the 1934 Act) (SEA 15(d)) Additional Registrations Required Under the 1934 Act 1. Registration of national securities exchanges 1934 Act defines a national securities exchange in 3(a)(1) and requires that the exchanges register with the SEC, unless exempt. 1934 act regulations functions of stock exchange members. 2. Registration of broker-dealers 1934 act also provides for registration with the SEC of all brokers and dealers who transact a securities business in interstate commerce. (SEA 15(a)(1)). a. Standards of Conduct 1934 Act authorizes SEC to adopt and enforce rules for broker-dealers with respect to training, qualifications, financial responsibility, etc. (SEA 15(b)(8)) OR broker-dealers can belong to a national securities association registered under 15A of the act. b. National Association of Securities Dealers NASD has registered under 15A of the 1934 Act and is very influential in regulating broker-dealers who are not members of a national securities exchange. c. Regulation by the SEC alternatively, broker-dealers may choose to be regulated by the SEC, and not belong to and be regulated by the NASD. 3. Registration of information processors securities information processors are required to register with the SEC, and make period reports. (SEA 11A(b)) 4. Registration of Clearing Agencies transfer agents, clearing houses, and others involved in the mechanical completion of securities trades are required to register and make periodic reports. (SEA 17A) Additional Reporting Requirements Under the Act

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1. Reports by 5% owners of registered securities 1934 Act requires that the purchaser of 5% or more of a class of equity securities registered under the Act must file certain information with the SEC, the issuer of the securities, and the exchange (if the securities are traded on a national exchange) concerning itself, the source of the funds used to purchase the securities, any plans it may have to acquire more, and plans it may have to attempt to change the issuers business or corporate structure. This is aimed at regulating tender offers, where company A makes offer to buy shares of company B by approaching company Bs shareholders directly. (SEA 13(d)) 2. Reports by officers, directors, and 10% security holders officers and directors of the issuer, and 10% owners of a class of security registered under 12, must file a report with the SEC of their holdings and a monthly update of any changes therein. (SEA 16(a)). 3. Reports by national securities exchanges and securities associations national securities exchanges and securities associations are required to file reports concerning changes in their rules. (SEA 6, 15) Margin Requirements Board of governors of Federal Reserve is granted power over margin requirements (loans to purchase securities and broker-dealer borrowings from regulated banks). (SEA 7,8) Market Manipulation SEC has power to control certain practices designed to manipulate securities market prices. (SEA 9, 10) Regulation of Practices Relating to Stock Ownership 1934 Act also regulates the following matters related to stock ownership: 1. Proxy solicitation act governs the manner in which voting proxies are solicited from the shareholders of companies having securities registered under 12 of the Act. (SEA 14) 2. Tender offers - 13 and 14 govern the practices used in making a tender offer. Role of the SEC in Administering the 1934 Act 1. Powers of Commission Act grants power to SEC for administration of 1934 Act. SEC has investigatory and study powers (SEA 19, 21, 22), rulemaking power (23), enforcement power (15, 19), and injunctive power (21). 2. Liability Provisions several important liability provisions of the Act. a. Some expressly provide for damages. 18 for making false or misleading statement. b. Others do not expressly provide for private damage actions, but in many instances private right of action has been implied by the courts. 10(b) and Rule 10b-5. The Role of the Courts 1. Jurisdiction District Courts of the US have exclusive original jurisdiction over actions for violations of the 1934 Act or its regulations and over actions brought to enforce duties or liabilities thereunder. (SEA 27) 2. Judicial review appeal from district court decisions is first to the circuit court, then by cert to US Supreme Court. Appeal from decisions of the SEC is also to the circuit courts. SEC decisions must be based on a record, and its decision on factual issues is conclusive if based on substantial evidence.

The Proxy Rules

Power of Attorney proxy is power of attorney to vote shares owned by someone else. At common law, were illegal, but statutes permit them today. Power to revoke In General proxy establishes agency relationship, generally revocable at any time (such as by grant of a subsequent proxy, or by shareholder personally attending meeting and voting) Irrevocable proxies proxy that is expressly made irrevocable and is coupled with an interest is irrevocable

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1. Coupled with an interest means that theres some consideration received by shareholder for grant of the proxy. Ex shareholder borrows money, pledges stock, grants lender proxy to vote shares. 2. Even where made irrevocable, statutes normally limit duration for which a proxy may be given. Proxy Control Under SEA of 1934 Act regulates wide variety of transactions involving securities market, two specific requirements of act: 1. Registration and Reporting requirements 12 and Rule 12g-1 of Act require a company to register its securities with the SEC and thereafter to file reports on the companys financial condition, if the companys securities are (i) traded on a regulated securities exchange, or (ii) traded over-the-counter and the company has assets of at least $5,000,000 and 500 or more shareholders of a class of equity securities. Companies that have so are called registered companies. 2. Proxy Solicitation - 14 regulates solicitation of proxy votes from shareholders of companies reg. under 12. Proxy Solicitation Rules 14 of the Act provides: its unlawful to solicit proxy or consent or authorization in respect to any security registered under 12 in contravention of such rules and regulations as the SEC may prescribe as necessary or appropriate. Rules Adopted by the SEC under authority of 14 of the Act, SEC has adopted rules for regulation of proxy solicitation of registered securities, designed to accomplish three objectives: 1. Full disclosure those soliciting proxies or attempting to prevent others from doing so must give full disclosure of all material information to the shareholders being solicited. (SEA Rule 14a-3 to a-6) 2. Fraud resort to the use of fraud in the solicitation is made unlawful. (SEA Rule 14a-9) 3. Shareholder solicitation shareholders may also solicit proxies from other shareholders, and management must include in its proxy statement proposals made by shareholders. (SEA Rule 14a-8) Remedies for Violation 1. Appropriate Remedies if proxy rules violated, courts fashion appropriate remedy, fairness of transaction taken into account in type of remedy granted. 2. Actions by the SEC SEC can bring actions seeking administrative remedies, such as injunction preventing solicitation of proxies, or preventing the voting of shares obtained through improper proxy solicitation. 3. Private Actions courts have held that private cause of action is implied under 14. 4. Materiality it need not be shown that the violation caused the outcome of the voting on the matter. All that need be shown is that such statements were material and could have had a propensity to affect the voting. 5. Relief Granted as stated above, court will fashion what is appropriate remedy, damages, rescission, etc. Solicitation Rule 14a-1 defines solicitation as communication to security holder under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy. Example: Company A agreed to merge with B, but C makes a counterproposal. A places newspaper ads directed to Bs shareholders, suggesting that theyd be better off merging with A. Where this occurred three months prior to the proxy solicitation, no solicitation was involved. Brown v. Chicago, Rock Island & Pacific Railroad Co. Private Actions Under the Proxy Rules False and misleading statements in the proxy statement Rule 14a-9 prohibits materially false or misleading statements or omissions in a proxy statement. PL must only show negligence 1. Requirement of a fact misrepresentation must be of a fact. Historically, SEC held that only past information and records was fact, not projections or speculations, but this is changing, and SEC encourages disclosure of financial projections.

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2. Materiality misrepresentations must be of a material fact. 3. Causation plaintiff must also prove that the misrepresentation or omission of material fact was the cause of the loss. 4. Standard of Culpability theres some confusion in the case law as to the relevant standard of culpability that must be shown. Some say negligence, others say scienter must be shown. (See p64 of supplement) 5. Remedies court will fashion whatever relief is appropriate to remedy a violation of proxy rules. a. Damages in some instances, damages may be awarded (for loss in value of shares due to violations) b. Other Remedies court may provide such remedies as required to make effective the purpose of the Act, remedies are not limited to prospective relief. JI Case Co v. Borak S.Ct. rescinded merger 6. Qualitative Statements in proxy Materials see Virginia Bankshares case below: Virginia Bankshares, Inv v. Sandberg in 1986, First Am. Bankshares, Inc, bank holding company, began freeze-out merger under Virginia law in which First Am. Bank of Virginia was merged into Virginia Bankshares, Inc., wholly-owned subsidiary of FABI. FABI got investment banker to give report that $42 per share was a fair price. Virginia law required that the merger be submitted to a vote at a shareholders meeting, preceded by a statement of information given to shareholders. FABI instead solicited proxies for voting at the annual shareholders meeting. Most minority shareholders approved the deal, but Sandberg did not, and sued for damages on basis that 14(a) and Rule 14a-9 were violated by material misrepresentations in the proxy materials. Supreme Court found for Sandberg. If a director makes a statement in proxy materials of his reasons for doing something and it is shown that the director did not really have these reasons or hold these beliefs, these statements can be material. These matters can usually be documented from corporate records. But in addition to showing an opinion or belief that was not in fact held, P must also show that the statement said or implied something false or misleading about the subject matter. Too hypothetical that proxy solicitation caused the action when vote wasnt even needed to do it. There have been cases where proxy solicitation has been a link in the process of preventing a class of shareholders from resorting to a state remedy otherwise available. Minority ratification of merger overcomes any problem of conflicts of interest.

Mills v. Electric Auto-Lite Co. - Shareholders (Ps) of the Electric Auto-Lite Company (D) brought suit to stop voting on a proposed merger of D with Mergenthaler Linotype Company and American Manufacturing Company. Ps alleged the roxy statement sent out by Ds management to solicit votes in favor of the merger was misleading. Mergenthaler owned over 50% of the outstanding shares of D and had been in control of D for two years. Furthermore, American manufacturing owned about one-third of Mergenthaler. The proxy statement failed to reveal that all 11 of Ds directors, who were recommending the merger, were nominees of Mergenthaler. The lower court found as a matter of law that this was a material omission and after a hearing determined that a causal relationship had been shown. Ds appealed. The district court agreed that the proxy statement was materially deficient but reversed on the issue of causation. The court held that if D could show that the merger would have received sufficient votes even if the proxy statement had not been misleading, Ps would not be entitled to relief. The Supreme Court granted certiorari. Court said CAN have PRIVATE ACTION. Use of a solicitation that is materially misleading is a violation of law. When a misstatement is shown to be material, that in itself shows that the defect might have been considered important by a reasonable shareholder in deciding how to vote. The requirement is only that the defect has a significant propensity to affect the voting process. There is no need to prove that the defect actually had a decisive effect on the voting Court v. Ash court said in determining whether private remedy is implicit in a statute not expressly providing one, several factors are relevant: 1. Is plaintiff one of a class for whose especial benefit the statute was enacted, that is, does statute create federal right in favor of plaintiff?

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2. Is there any indication of legislative intent, explicit or implicit, either to create such a remedy or deny one? 3. Is it consistent with the underlying purposes of the legislative scheme to imply such a remedy for the PL? 4. Is cause of action one traditionally relegated to state law, in an area basically the concern of the States, so that it would be inappropriate to confer a cause of action based solely on federal law? Shareholder Proposals As an alternative to independent proxy solicitations, a shareholder may serve notice on management of his intention to propose action at the shareholders meeting. The shareholder may only propose such action if (i) he would be entitled to vote at the meeting, and (ii) he is a shareholder at the time the proposal is submitted. Inclusion in Managements Proxy Statement If the shareholders notice of proposed action conforms to the proxy rules, management must include the proposal in its own proxy statement and make provisions in its proxy form for an indication of shareholder preference with respect to the proposalat no expense to the proposing shareholder. (SEA Rule 14a-8) If management opposes the proposal, shareholder may also include a 200-word statement in support of proposal, which management must also send out with its own proxy statement if the proposal conforms to proxy rules. Managements Omission of Shareholder Proposals If management opposes the shareholder proposal, it must file the proposal and the reasons for opposing it with the SEC. The SEC will review the proposal and give an indication of whether it agrees or disagrees with management. Management may properly omit shareholder proposals in the following situations under SEA Rule 14a-8(c): 1. Proposal not a proper subject if the shareholders proposal is not a proper subject for action by the shareholders, it may be omitted from managements proxy solicitation. State law of issuers domicile is used for purposes of determining what is a proper subject. 2. Proposal relates to ordinary business operations management may also omit proposals that relate to the ordinary business operations of the issuer. a. This prohibits shareholder intervention in the minute matters of daily operations. b. Example: selection by management of a corporate law is an ordinary business matter. c. In 1976 amendments to Rule 14a-8, SEC indicated ordinary business operations provision would be interpreted somewhat more flexibly than it had been in the past. Specifically, policy, economic, or other implications inherent in the act, are usually excluded. (p.67 supp.) 3. Proposals relating to economic and technical factors SEE CASE BELOW Roosevelt v. EI Du Pont de Nemours & Co. Roosevelt, shareholder in Du Pont, sued Du Pont to prevent from omitting her shareholder proposal from DPs proxy materials prepared for 1992 annual meeting. Rs proposals sought to expedite process of phasing out use of CFCs and halons and present shareholders with information regarding DPs efforts to find environmentally sound substitutes for CFCs and halons and the marketing plans for those substitutes. DP objected, claiming it was ordinary business operations stuff, under Rule 14a-8(c)(7). Court finds for DP. Ordinary Business Operations are business decisions that are mundane and do not involve considerations of significant business policies. Issues of timing may be significant policy issues when large time differences are at stake, but Rs proposal only seeks to move up the timeline one year. Economic and technical factors that are considered, when selecting a reasonable time frame must be dealt with within the business daily operations and are not meant to be open for shareholder participation and debate. 4. Proposal submitted for non-corporate purpose - if it clearly appears that the shareholder has submitted the proposal primarily for noncorporate purposes, management may properly omit it. SEA Rule 14a-8(c). Following areas are deemed by proxy rules to be noncorporate purposes: a. Personal claims personal claims or grievances against issuer. SEA Rule 14a-8(c)(4)

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b. Matters outside issuers control matters not within the control of issuer. Rule 14s-8(c)(6) c. Matters not related to business matters not significantly rel. to business. Rule 14a-8(c)(5) i. Amendments Rule 14a-8(c)(5) used to include language to the effect that proposals promoting general economic, political, religious, or other social causes not significantly related, now those words are gone, but intent is the same. See p69 supp. d. Election of Directors Rule 14a-8 does not apply to proposals by shareholders for election of officers. e. Proposal previously submitted rules also permit management to turn down a shareholder proposal if it has been previously submitted and it failed to get a substantial number of votes. (ex. if it didnt get more than 3% support last time, cant be resubmitted) f. Burden of Proof management has burden of proof to show that shareholder proposal is not proper for any of the above reasons. 5. Proxy Contests typically results from fight between management and other shareholders for control of the company. Most often insurgent shareholders will have acquired a substantial position in the company and either (i) want to control the company through the election of a majority of the directors, or (ii) will have proposed a merger or tendered the shares of the company, and management seeks to avoid a loss of control by a proxy fight, fighting off tender offer, or merging with a 3rd comp. a. In first situation (proxy fight), management will solicit shareholders for proxies to elect their slate of directors, and the insurgents will solicit shareholders for proxies to elect their slate of directors. b. In second situation (defensive merger), insurgents will attempt to get the shareholders to approve the tender offer, while management will solicit proxies from the shareholders to approve the defensive merger into a third company. Proxy Contest Expenses Expenses can be substantial, who can be reimbursed for these expenses? 1. Successful Management if management is successful in a proxy contest, it can recover its expenses from the corporation. Limitation is that expenses must have been incurred in good faith for the benefit of the corporation. 2. Unsuccessful Management SEE CASE BELOW Rosenfeld v. Fairchild Engine & Airplane Corp. Rosenfeld, shareholder, brought derivative suit to get return of money that the corporation reimbursed to the old management (for unsuccessful proxy contest) and to the new management. The majority of shareholders ratified the reimbursement payments. Proxy contest centered around compensation paid to one director (who was also CEO). Resenfeld LOST. In a contest over policy, as compared to a purely personal power contest, directors have the right to make reasonable and proper expenditures, subject to the scrutiny of the courts when duly challenged, for the purpose of persuading shareholders of the correctness of their position and soliciting their support for policies, which the directors believe, in good faith, are in the best interests of the corporation. There is no obligation on the corporation to reimburse the successful outside contestants, but the shareholders may vote to reimburse such contestants for the reasonable bona fide expenses incurred by them.

Close Corporations
Corporations are generally of three types: publicly held, private corporations (not publicly traded, but more than a small number of shareholders, and close corporations (subset of private corporations, only small number of shareholders and often characterized by owner-management and restrictions on the transferability of ownership interests).

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Partnership Law Norms 1. Internal governance UPA and RUPA govern where partners arrangements fail to cover, but allow owners to contract for different rules. 1. Absent contrary agreement, all partners have equal rights in management and conduct of business. 2. Absent contrary agreement, differences among partners are determined by a majority of partners, but matters outside scope of partnership business require unanimous consent. 2. Authority any partner has power to bind partnership on matters in ordinary course of business, even if by internal arrangements, partner lacks actual authority, unless third party knows partner is lacking actual authority. 3. Distributive Shares absent contrary agreement, partnership profits are per capita, and no partner gets a salary. Transferability 4. Term partnerships normally created for a term, usually short, and dissolution is easy. If not for specified term, any partner can cause dissolution at any time. If for specified time, dissolution is at end of the term or for other special reason. 5. Fiduciary Duties all partners have fiduciary duty to eachother. 6. Liability partners in GP are individually liable for partnerships obligations. Corporation Law Norms (mostly for publicly held corporations, mostly different for close corporations) 1. Internal Governance traditional corporate statutes are mandatory. 2. Authority shareholders have no apparent authority to bind the corporation, cant participate in mgmt. 3. Distributive shares corporate distributions are not shared per capita, but in proportion to stock ownership. 4. Transferability shares of stock, and shareholder status they carry, are freely transferable. 5. Term corporations are normally created for a perpetual term, dissolution is relatively difficult. 6. Fiduciary Duties traditional view is that shareholders dont have fiduciary duty to eachother, but this has changed in material respects. 7. Liability shareholders not individually liable for corporations obligations. Control Problems Formal roles assigned by law to manages of corporation may not be relevant. Formalities of notices, meetings, quorums, etc may not be as relevant, little possibility of injury to outsiders because of deviation from formal corporate requirements. Minority shareholders usually want more control in a close corporation, so voting requirements are usually set at higher percentages (often unanimous). Alternatively, may be types of voting agreements to give those in management (but without stock) a greater voice and more control. (such as by putting shares in voting trust). Often agreements between corporation and one or more founding members who are not in day-to-day management, for service or supplies, from founder and his other business. These create conflicts, but are often very reason for founding. Provisions for Transfer Public companies try to make their stock marketable, whereas close corporations try to control the transfer of stock, so that the nature of the partnership is preserved. Therefore, theres normally restrictions on transfersbuy-out arrangements in the case of death or other contingencies. Provisions for Resolution of Disputes Since there are normally provisions for higher percentages for voting and often buy-out arrangements for stock, disputes can often arise and paralyze the decision-making. Therefore, provisions for resolving disputes must be developed, such as arbitration proceedings. Other Problems Piercing the corporate veil, promoters, stock issuance, etc.

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Donahue v. Rodd Electrotype, Co. Donahue, minority stockholder in Rodd, sued Rodd, its directors, and Harry Rodd, former director and officer who had been the companys controlling shareholder. When Rodd retired, he sold some of his stock to the corporation at $800 per share. Donahue and her husband offered their shares to the corporation on the same terms, but the corporation said it couldnt afford to pay that much, but did make offers to buy them at prices ranging from $40 to $200 per share. Donahue brought suit to rescind Rodds sale to corporation and to compel him to repay the purchase price. Court said DFs breached their fiduciary duty. Court can either require rescind the sale and require Rodd to repay the funds, or offer the same deal to Donahue. Shareholders in a close corporation are much like members of a partnership, therefore, they have a strict duty of good faith to the minority shareholders. Not honesty alone, but the punctilio of an honor the most sensitive is the standard of behavior. Any lesser standard would put minority stockholders at the mercy of the controlling shareholders. Controlling stockholders of a close corporation who cause the corporation to purchase its own shares must act with the utmost good faith and loyalty to the other stockholders. If corporation is buying shares from a member of the controlling group, each shareholder must be given an opportunity to sell a ratable number of shares to the corporation at the same price.

Special Voting Arrangements at the Shareholder Level

Voting Agreements shareholders exchange promises to vote their shares in some specific way, or as some party of the group shall direct. In absence of fraud or illegal motive, such agreements are generally held to be specifically enforceable. Pooling Agreements Ringling Brothers-Barnum & Bailey Combined Shows v. Ringling Ringling owned 315 shares of the Ringling Brothers corporation, Haley owned 315 shares, and North owned 370. Ringling and Haley entered into agreement for 10 years that theyd act jointly in exercising voting rights, and if they couldnt agree, an arbitrator would make the decision. One year, at a shareholder meeting, they disagreed on how to vote, and Haley voted her shares rather than following the arbitrator, then Ringling sued for specific performance of the contract. Court found for Ringling. D argues that the agreement unlawfully separates voting power from ownership of shares by allowing arbitrator to decide the conflict. Various forms of pooling agreements have been held valid, and have been distinguished from voting trusts. Power to vote the shares was in no way transferred to the arbitrator, parties didnt agree that either could vote the shares of the other, or that the arbitrator could, rather, parties promised to vote their own shares in accordance with arbitrators decision. Agreement is valid contract with sufficient consideration. Issues with Pooling Arrangements two major issues are (i) whether such agreements are void as against public policy and (ii) if they are valid, how and against whom will they be enforced? Pooling agreements have been upheld where shareholders get together and create a majority shareholder interest in voting to elect a certain slate of directors. Even where cumulative voting has existed. BUT, whenever anything smacks of fraud, such agreements may be overturned. Courts are split on the Ringling Bros situation, some have held that voting power cant be split from shares, other have specifically enforced the agreements. Time period of agreements is important too, since voting trust statutes normally limit duration. (such as 10 years) Statutes of Delaware were later amended to prohibit voting agreements of longer than 10 years, and irrevocable proxies were recognized as valid if there was the requisite interest (interest in stock or in the corporation is sufficient). Thus, by statute, Delaware avoided the line-drawing problem in Ringling.

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NOTE: Some courts are hesitant to specifically enforce such pooling agreements, even though damages are an inadequate remedy. Since courts are sometimes reluctant, parties can expressly or impliedly substitute a self-executing remedy, such as giving each other proxies. NOTE: TO make proxy irrevocable, give proxy to someone who has in interest in the shares to which the proxy relates (where proxy-holder is a pledge of the shares, or has agreed to purchase the shares). Voting Trusts Developed to meet the limitations and problems associated with proxies and shareholder pooling agreements. The purpose of the trust is to assure control of the corporation to some interested party. It is often employed with public companies as well as with close corporations. Shareholders transfer legal title to shares to a trustee and receive a voting trust certificate. Trustee has the right to vote the shares for the life of the trust. Normally, trusts are irrevocable by the shareholder regardless of whether there was consideration given by the shareholder. But normally, most states limit the permissible duration of such trusts. Some states provide for revocation by a vote of a specified percentage of the shares, subject to the trust. Classification of Shares and Other Control Devices Nonvoting Shares and Classes of Shares Some states permit corporations to issue classes of stock with limited voting rights. Or corporation may issue classes of nonvoting stock. Either of these arrangements allows management to raise capital without losing control. Holding Companies Holding company may be formed for several purposes. 1. May be an investment company (buying few shares of many corporations). 2. May be like a voting trust (holders of shares in A transfer them to company B, and the party to control A gets voting stock of B; other parties get nonvoting stock) 3. Holding company may own operating companies as its subsidiaries.

Agreements Controlling Matters within The Boards Discretion

Shareholder Agreements for Actions ad Directors Most courts hold that shareholders cannot make agreements as to how they will vote as directors. Directors must be free to act independently in their roles of directors in order to faithfully execute their fiduciary duty to the corporation (part of which is to protect shareholder interests, including minority shareholders). Of course, shareholders can agree as to how they will vote as shareholders to elect directors, then directors may act as they choose. Directors Agreements with Directors For the same reason, directors may not agree with other board members in advance, as to how they will vote. Shareholder Agreements where there are Minority Shareholders McQuade v. Stoneham corporation had 2500 outstanding shares, Stoneham had 1306, McQuade had 70, and McGraw had 70. They agreed to use their best efforts to elect themselves directors and officers, to take salaries, and to perpetuate themselves in office (and further to not amend articles, bylaws etc. as long as any of the three owned stock). Stoneham appointed the other four directors, three years later, at directors meeting, Stoneham and McGraw refused to vote,

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allowing the other four directors to outvote McQuade in removing him as an officer. Then at later shareholders meeting, McQuade was removed as director (he had personal differences with Stoneham). McQaude sued for specific performance of the shareholder agreement. Shareholders may not agree to control the directors in the exercise of their independent judgment. They may combine to elect directors, but they must let the directors manage the business, which includes the election of officers. NOTE: We OMMITTED this case in class, did NOT do this one. Galler v. Galler - Emma Gallers deceased husband and her husbands brother and his wife owned 95% of the corporations stock, with the other 5% owned by an employee, which was repurchased after this suit began. P and DF signed shareholder agreement that provided that the 4 would vote for themselves as the corporations four directors; than an annual dividend of $50,000 would be paid as long as the corporations accumulated earned surplus was $500,000 or more; and that, upon the death of either brother, the corporation would give the widow a salary continuation contract for a five-year period. Galler demanded performance, and DFs refused, so Galler sued for an accounting and specific performance. Court found for Galler. Courts have allowed close corporations to deviate from corporate norms in order to give business effect to the intentions of the parties. If substantially all of the shareholders agree, its okay. Agreement didnt injure creditors, other shareholders, or the public. Duration of agreement was until the death of P, which wasnt too long. The purpose of the agreement (maintenance of widow) was proper. The provision for the dividend is valid since a base surplus is required to be maintained. State Close Corporation Statutes Trend toward recognizing the close corporation as a separate situation continues in the judicial opinions. More and more states are passing close corporation statutes as well.

Supermajority Voting and Quorum Requirements at the Shareholder and Board Levels
Normally the articles and bylaws provide that meetings of directors and shareholders may be called and action may be taken at them when a majority of directors and shareholders are present. Normally (except where state law requires a higher percentage for major corporate actions, such as selling corporate assets, etc.) matters are passed by a majority vote of those present. This section considers such agreements where a higher percentage than majority is required. Usually the intention of such rules is to operate the corporation more like a partnership, giving each shareholder the right to veto corporate action. Relationship to Shareholder Agreements Affecting Director Actions Very close to previous section because many voting changes are effectuated by shareholder agreements. Amending supermajority provisions: Sutton v. Sutton Shareholders of 70% of shares of Bag Bazaar, Ltd. Petitioned the court for declaratory judgment stating that an amendment to the corporations certificate of incorporation was valid and to compel the director of the corporation, Sutton, to sign and deliver a certificate of amendment to Ps for filing. Sutton refused, arguing that the certificate of incorporation required unanimous approval, and since this amendment was only supported by 70% of the shareholders, it was invalid. Bag Bazaars certificate of incorporation states that unanimous vote is required for the transaction of any business *** including amendment to the certificate of incorporation. Court found for DF.

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Section 616(b) states that supermajority provisions in a certificate of incorporation may be amended by a twothirds vote unless the certificate of incorporation specifically provides otherwise. Ps contend that despite the unanimity provision in the corporations certificate, a two-thirds vote is sufficient uder 616(b) unless the certificate explicitly states that unanimous consent is required to amend the supermajority provision. D contends that the specifically was only added to clarify that if more than two-thirds vote is required, the certificate should state exactly what percentage is needed, and therefore this certificate is valid, since it states that a unanimous vote is required. The certificate here is unambiguous, it requires a unanimous vote.

Fiduciary Obligations of Shareholders in Close Corporations

Rosenthal v. Rosenthal four specific fiduciary duties owed by business associates in a close corporation to each other: 1. To act with that degree of diligence, case and skill which ordinarily prudent persons would exercise under similar circumstances in like positions 2. To discharge the duties affecting their relationship in good faith with a view to furthering the interests of one another as to the matters within the scope of the relationship. 3. To disclose and not withhold from one another relevant information affecting the status and affairs of the relationship. 4. To not use their position, influence, or knowledge respecting the affairs and organization that are subject to the relationship to gain any special privilege or advantage over the other persons involved in the relationship. Partners in partnership have a fiduciary duty to each other, and similarly, there is an implied-in-law fiduciary duty of shareholders to each other in a close corporation. Wilkes v. Springside Nursery Home, Inc Wilkes had an option to purchase a building and a lot where a hospital had once been located. Riche, Quinn, and Pipkin joined with Wilkes in forming a close corporation to run a nursing home on the property. Each invested equal amounts of cash and purchased equal numbers of shares. It was understood that each would be a director and receive money from the corporation in equal amounts as long as each actively assumed his share of the burdens in operating the business. Pipkin sold his shares to Conner, now deceased. Quinn wanted to buy part of the corporate property. Wilkes convinced the other shareholder-directors to sell the property at a higher price than Quinn had anticipated paying. Form this point, the relationship between Quinn and Wilkes deteriorated. Quinn and other shareholders voted to put themselves on salary from the corporation, but did not give Wilkes a salary. Later, they voted Wilkes out of his office and his directorship. Wilkes brought action for declaratory judgment against the other shareholders for breach of incorporation agreement and breach of fiduciary duty. Court found for P. The rule in the state is that shareholders in a close corporation have the same duty toward each other that partners have; that is, the utmost good faith and loyalty. If several shareholders combine to freeze out another shareholder by removing him from all decision-making roles and denying him a return on his investment, they have breached their fiduciary duty to them. Untempered application of the strict good faith standard would hamper the ability of the controlling group to manage the corporation for the good of all concerned, but the rights of this group must be balanced against its duty to minority shareholders. Therefore, when the control group can show a legitimate business purpose for its actions, no breach will be found. Unreasonable Exercise of Veto Power

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Smith v. Atlantic Properties, Inc Atlantic was a corporation organized to buy and manage real estate. Smith, Zimble, Burk, and Wolfson invested equal sums and were the only stockholders. The bylaws provided that corporate decisions must be approved by 80% of the stock eligible to vote, effectively giving one stockholder veto power. Atlantic profited for 16 years, but only paid dividends in two years because of Wolfsons refusal to declare dividends. He wanted the earnings spent on repairs and improvements to its properties. But, only most basic repairs were made, and Wolfson didnt schedule or have a plan for repairs. Because of failure to declare adequate dividends, IRS levied penalties against Atlantic, as PLs had warned Wolfson would happen. Court found for PLs. The 80% provision is a reasonable means of protecting minority shareholders, but sometimes its exercise may violate the fiduciary duty stockholders in a close corporation owe each other. In determining this issue, the court must weigh the business interest each side presents as a reason for its actions. Terminating Employment in Close Corporations Merola v. Exergen Corp. P worked part-time for Exergen Corporation while maintain a full-time job elsewhere. Pompei, Exergens founder, president, and majority stockholder, offered P full-time employment if he quit his other job. Pompei indicated that if he worked full-time, invested in the companys stock, hed have the opportunity to become a major shareholder. P worked full-time for Exergen and purchased stock until his employment was terminated. P then filed suit against Exergen and Pompei alleging that Exergen was a close corporation and that Pompei, as the majority stockholder, breached his fiduciary duty to P as a minority stockholder by terminating his employment without cause. Court found for Pompei. Employees may be terminated at will, with or without cause. However, termination of a minority shareholders employment in a closely held corporation may present a situation where the majority has breached its fiduciary duty. (from Donahue case) Minority shareholders generally depend on their salaries as the principal return on their investment since the earnings of a close corporation are distributed in major part in salaries and benefits. While P invested in Ds stock with reasonable expectation of continued employment, investment wasnt tied to employment and no other employees had guarantees of employment simply because they purchased stock. Also, no evidence that all profits were distributed in the form of a salary. P clearly got a strong return on his investment, despite not being paid a salary, and no evidence that Ps termination was for the financial gain of D or against any public policy.

Valuation
Appraisal where is applies, appraisal remedy allows a dissenting shareholder in a merger or sale of the corporations assets to get the value of his shares in cash (rather than accept the consideration otherwise received as part of the major corporate change). Procedures to get the appraisal right, a specific set of steps must be followed: ie., voting aginst the transaction, requesting appraisal, etc. If required procedures arent followed, the right is typically lost. Price Paid price paid is set in the appraisal, various procedures for appraisal are set by state law. Other Remedies states vary as to other remedies, but in most states, once a shareholder has selected appraisal, other remedies are not permitted. The Delaware Block Method some courts value a corporation using this method, wherein the court first determined the market value of the corporations stock, the value of the corporations net assets, and the earnings value of the corporation. Then the court assigns a weight to each of these values, depending on considerations such as the comparative reliability of each factor in a particular case. Finally, court totals the values, as adjusted by their relative weights. In Piemonte v. New Boston Garden Corp court said that where stock of a corporation is only thinly traded, a court may determine the value of the stock based on actual sales already made rather than reconstructing a market

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value based on analyzing the sales of similar companies. Similarly, the court held that the judge acted within his discretion when he determined the earnings per share value by looking at the specific prospects of the corporation rather than the multipliers of other corporations. This method is falling out of favor. Other Methods (p. 409 411) (Le Beau v. MG Bancorporation, Inc.) 1. Comparative Company Approach 2. Discounted Cash Flow Approach 3. Comparative Acquisition Approach

Restrictions on the Transferability of Shares, and Mandatory-Sale Provisions (p421-424)

Normally, shareholders of a close corporation wish to keep it this way; thus, they desire to prevent the transfer of shares without approval of the transferee. Restriction on the transfer of shares is normally accomplished in one of three ways: 1. By provision in the articles 2. By provision in the bylaws 3. By private agreement among the shareholders General Rules 1. Restraints on Alienation normally restraints on alienation of shares are permitted if a. Person taking the stock is aware (has notice ) of the restraint b. The restraint is not unreasonable (not total, may still sell stock somewhere near true value) 2. Forms of Restraint a. Absolute Prohibition absolute prohibition of sale without the approval of shareholders, BOD, etc. b. Right of First Refusal give other shareholders a right to buy the stock before it can be sold to an outside party. c. Option option given to specified parties to buy the stock on certain specified events. 3. Notice - In order to retain restriction, safest to put it on the share certificate, ensuring that transferee has notice of the restriction. 4. The Price price of transfer may be set in several ways: a. By mutual agreement b. By appraisal of market value, etc. c. By reference to book value d. Look to p.423-424 for more. Foreclosure Sale F.B.I. Farms, Inc. v Moore three couples formed corporation and transferred land and machinery to the corporation in exchange for common stock. In 1977, BOD adopted restrictions on transfer of shares that stated: (i) the corporations stock couldnt be transferred/assigned/exchanged/divided unless or until approved by the directors, (ii) if any stock was offered for sale/assigned/transferred, corporation would have first right of refusal at no more than book value, (iii) if corporation wasnt interested and could not economically offer to purchase the stock, any stockholder of record would have next opportunity to purchase at a price not exceeding book value, and (iv) if neither corporation, nor stockholders were interested, the stock could be sold to any blood member of the family at a price not to exceed book value. Linda and Moores marriage dissolved, Linda got shares, Moore got money judgment secured by lien against her shares, after FBI came out of bankruptcy, Moore got writ of execution, sheriffs sale went forward, and P bought all of Lindas shares for $290,450.67. Moore then sued FBI and directors for cancelling the shares

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Most jurisdictions allow corporations to impose restrictions on the transfer of shares, and these restrictions are treated as contracts either between shareholders or between shareholders and the corporation, and should be read to further the manifest intention of the parties. Because they restrict alienation, their terms must not be expanded beyond their plain and ordinary meaning. Closely held corporations (like FBI) have a legitimate interest in keeping as they envision at incorporation and such restrictions are a valid way to achieve this, thus, transfer in violation of a valid restriction is voidable at the insistence of the corporation. A party is not bound by share restrictions absent notice of the restrictions. Indiana law requires that share restrictions be reasonable, and one is reasonable if it is designed to serve a legitimate purpose of the party imposing the restraint and the restraint is not an absolute restriction on the recipients right of alienability. In determining reasonableness, court considers the corporations size, degree of restraint upon alienation, and the probability that the restriction will promote the best interests of the corporation. Under basic contract law, reasonableness of a term of a contract is evaluated at the time of its adoption. Blood member restriction is enforceable as protecting a viable interest in maintaining FBIs ownership and operation in the hands of the family. Transfer restrictions cannot preclude transfer in a foreclosure sale and thereby leave creditors without recourse. Rule of Construction the rule of construction relating to restraints is that they are construed narrowly so as to give maximum scope to the ability of the shareholder to transfer shares. Buy Back Provisions Gallagher v. Lambert Gallagher was a mortgage broker for Eastdil Realty and in 1976, became president and CEO of Eastdil Advisor, Inc, wholly-owned subsidiary of Eastil Realty. At all times Gallagher was an employee at will, and bought stock in Eastil Realty pursuant to a stock purchase agreement containing a mandatory buy back provision, which provided that if an employee voluntarily resigns or his employment is terminated before January 31, 1985, the employee must return the shares at book value. Following January 31, 1985, the price at which the shares would be bought back would be determined through a formula keyed to the companys earnings. Gallaghers employment was terminated on January 10, 1985, and while he didnt contest the termination, he demanded that he receive for his shares an amount based on the post Jan. 31st formula. Eastdil refused, and Gallagher brought suit. Court found for Eastdil, Gallagher LOST. Buy back provision was designed so that all parties would be aware of their rights so as to avoid costly litigation on the fair value issue. Gallagher agreed to the provision, helped to write the provision, and reviewed it with his attorneys. DISSENT: He was fired 21 days before the date, and the book value was around $89K, while under the new formula the value would have been around $3 million. Seems like improper motive in firing.

Duty of Care and Duty to Act in Good Faith

Francis v. United Jersey Bank Pritchard and Baird commingled their own funds with those of clients. Made unreasonable loans to shareholders, to themselves really. Directors are under a statutory duty to act in good faith ad ordinarily prudent persons would under similar circumstances in like positions. This standard is a relative concept, depending on the kind of corporation, the directors corporate role, and the particular circumstances.

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Generally, a director should have a basic knowledge of the corporations business and knowledge about its ongoing activities, which require general monitoring of its affairs and policies. Has responsibility to attend board meetings and regularly review financial statements. If theres illegal conduct, has duty to object, and possibly either take reasonable means to prevent such conduct or resign. In cases involving nonfeasance, the causation issue requires determining what reasonable steps a director could have taken and whether those steps would have prevented the loss. The failure to act must be a substantial factor in producing the harm. Causation is best decided on a case-by-case basis. In re Emerging Communications, Inc Shareholders Litigation Specialized expertise of Muoio, had duty to advise board against the low price, violated this duty. Note on Causation 1. If the violation of the duty of care consists of an omission by a director, would the loss have occurred even if the director had not omitted his duty? a. PL must also show that losses would not have occurred if director performed duty correctly. 2. If the whole board, or a substantial majority of the directors, violates the duty of care, can an individual director be excused on the ground that the result would have been the same even if she had acted differently? a. An inattentive director will not be liable for a corporate loss if full attentiveness by all the directors would not have saved the situation, because in that situation there wont be cause-in-fact. Barnes v. Andrews (p. 529) Divergence of standard of conduct and standard of review in corporations context. (duty of care is leading example)(p539) Directors Duty of Care Officers Duty of Care Business Judgment Rule four requirements that, if met, a special standard of review is applicable to claims that are based on the quality of the decision. 1-4, p540 of textbook. Why such a divergence of standard of review? Fairness and Policy p542 Hindsight Bias Smith v. Van Gorkom Shareholders of Trans Union sued to rescind merger into new company, wholly owned subsidiary of Marmon Group, controlled by Pritzker. TU was profitable, multi-million dollar leasing company that was not able to use all of its tax credits it generated. Van Gorkom (TU chairman) asked Romans (financial officer) to do a study on possibility of a leveraged buyout by management, Romans said company could pay $50 per share, but not $60. Van Gorkom rejected this type of buyout (conflict of interest) but indicated hed take $55/share for his own stock. On his own, VG approached Pritzker (takeover specialist) and began negotiating sale of TU. He suggested $55/share with a five-year payout method without consulting board or management. TU had three days to consider the offer, which included selling a million shared to Pritzker at market price, so even if TU found someone that would pay a better price, Pritzker would profit; for 90 days TU could receive but not solicit competing offers. At meeting later TU investment banker was not invited, no copies of proposal were given, senior management rejected the offer, and Romans said the price was too low. Van Gorkom presented the deal in 20 minutes, saying the price was fair.

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Outside lawyer told the board they might be sued if they didnt accept the offer and that they didnt need an outside fairness opinion as a matter of law. Discussion lasted two hours, and deal was made. Within 10 days, management of TU was up in arms. Pritzker and Van Gorkom agreed to some amendments, which the board approved, other offers were made at $60 per share, but the first was discouraged and shot down by Van Gorkom, the second asked for more time and Pritzker wouldnt give it. Business judgment rule presumes that directors act on an informed basis, in good faith, and in an honest belief that their actions are for the good of the company. PLs must rebut this presumption. There is no fraud here or bad faith. The issue is whether directors informed themselves properly. All reasonably material information must be looked at prior to a decision. This is a duty of care, directors are liable if they were grossly negligent in failing to inform themselves. Directors were grossly negligent with regard to first meeting where deal was accepted. Outside opinion is not always necessary, but here there wasnt even an opinion given by inside management. Shareholder vote accepting the offer doesnt clear the DFs because shareholders werent adequately informed. Application of Federal Securities Laws In addition to the business judgment rule, federal securities laws, in particular situations, may place duties on the directors of the corporation. Under Federal proxy rules, the directors and the officers of the corporation have a fiduciary duty to see that disclosures made in a proxy statement are not false. The standard of care that directors must use may require that directors use due diligence in seeing that proxy statements are accurate. Whether this requires that directors make an investigation to determine the accuracy of the proxy statement has never been determined by a court. Some decisions have found that there can only be liability under federal securities laws where there is scienter (knowing intentional fraud).