BUSINESS ORGANIZATIONS OUTLINE

CHAPTER 1: Agency:

Restatement (Third) Agency 1.01 A Fiduciary relationship that results from:

(1) the manifestation of consent by one person ( a “principal) to another (an “agent”) (2) that the agent shall act on principals behalf and(3) subject to the principals control, (4) and the principal manifests assent or otherwise consents to the acts of the agent

I. To have agency there must be an agreement, but it does not necessarily have to be in writing/ or a contract between the parties.

II. Agency may arise even if the parties did not call it an “agency” and did not intend the legal consequences of the relation to follow.

III. Agency may be proven by circumstantial evidence that shows a course of dealings between the parties; when proven by circumstantial evidence the principal must be shown to have consented to the agency since one cannot be the agent of another except by consent.

IV. Agent acts on the principal’s behalf and subject to the principal’s control.

For Agency to Exist: 1) Both must consent to agency; 2) Agent must act on behalf of Principal; and 3) Principal must exercise control over Agent. 4) The agent consents to or assents to the control

SECTION 1: Who is an Agent?

Gorton v. Doty: (1937) (pg. 1)

Doty loaned her car to Garst (football coach) to transport members of the team to the game. While driving Garst had an accident and died, and Gorton (player/passenger in car) was also injured in the accident. Gorton’s father sued Doty (teacher and owner of the car), arguing that Garst was Doty’s agent while transporting the team in Doty’s car because she had said, “Don’t let any of the kids drive the car.”

o Issue : Whether the relationship of principal and agent exists when a person undertakes to transact some business or manage some affair for another by authority and on account of the latter?

o Rule : The relationship of principal and agent exists when one undertakes to transact some business or manage some affair for another by authority and on account of the latter.

Notes : The court reasoned that she consented that Garst should act for her and on her behalf is clear from her act in volunteering the car upon the express condition that only Garst should drive it, and that Garst consented to act for Doty by his act of driving the car.

a. Furthermore, the car’s ownership alone establishes a prima facie case against the owner for the reason that the presumption arises that the driver is the agent of the owner.

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b. It is not essential that there is a contract or that there is compensation for the Principal-Agent relationship to exist.

Four Elements of Agency : 1. Manifestation of Agent’s intent to act2. On the principal’s behalf3. Subject to the principal’s control4. And the Principal manifests assent or otherwise consents to the act

Gay Jensen Farms Co. (Warren) v. Cargill, Inc . : (pg. 7)

Cargill loaned millions of dollars to Warren and also, eventually, took over the day-to-day operations of Warren.

o Issue : Whether a creditor who assumes control of his debtor’s business becomes liable as principal for the acts of the debtor?

o Rule : A creditor who assumes control (de facto) of his debtor’s business may be held liable as principal for the acts of the debtor in connection with the business.

SECTION 2: Liability of a Principal to Third Parties in Contract:

MillStreetChurch of Christ v. Hogan: (pg. 14)

(Implied Authority case) Church hired Bill to paint the building. In the past, the Church had allowed Bill to hire his brother Sam to assist. Bill hired his brother to help and Sam’s ladder broke and he broke his leg. Sam filed a Worker’s Comp claim.

o Issue: Does a person possess implied authority as an agent to hire another worker where such implied authority is necessary to implement the agent’s express authority?

o Rule: A person possesses implied authority as an agent to hire another worker where such implied authority is necessary to implement the agent’s express authority.

Notes : Bill had the implied authority to hire Sam for several reasons: 1) In the past, the church had allowed Bill to hire Sam to assist in projects; 2) Bill needed assistance to do the job—the interior of the church simply could not be painted by one person; 3) Sam believed Bill had the power to hire him, as had been done in the past; and 4) The church treasurer had even paid Sam for the half hour of work he had done prior to the accident.

Three types of Agency:Authority is authority. Any type of authority will do.

1. Actual Authority:ReS 2.01 (pg. 18)-An agent acts with actual authority when at the time of taking action that has legal consequences for the principal, the agent reasonably believes, in accordance with the principal’s manifestations to the agent, that the principal wishes the agent so to act.

a. Express Authority:expressly granted in writing or orally—depends on the “reasonable belief” of the Agent.

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b. Implied Authority:Authority the Agent reasonably believes he has as a result of the principal’s conduct based on: P’s conduct, custom or usage

Authority to: 1) Do what is necessary to get the job done, or 2) To act in a way the agent believes the principal wants him to act based on agent’s reasonable interpretation of principal’s objectives

Both express & implied are actual authority Both kinds of Actual Authority depend on communication between P and A, however, “communication” is

liberally construed. “Express” Authority depends on solid communication. (Express is narrow). “Implied” Authority can result from things that are typical, customary, usual, or proper—and can be based

on “a wink and a nod.” o Customs vary depending on time and location. (Implied is broad).

2. Apparent Authority: ReS 2.03 (pg. 19) – Is the power held by an agent or other actor to affect a principal’s legal relations with third parties when a Third Party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principals manifestations.

The authority the agent possesses on behalf of the principal upon a reasonable belief by a third party. “Apparent” occurs when Principal communicates directly with the Third Party—this is often unclear. This is different from agency by estoppel, Agency by estoppel is where the P did not take reasonable steps

to protect the third party and the third party experiences a detriment in reliance on the apparent authority. The P has no rights against the third party

o I.e., A police officer at your door, wearing a uniform is “Apparent Authority” b/c the uniform is the “Apparent,” the people he represents are the Principal, and the Police Officer is the Agent. This is the “Principal” communicating (via the uniform) with the Third Party.

3. Inherent Agency Power:(Allot of courts do not follow this rule) The power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent.

You see this when you have an undisclosed principal.

Dweck v. Nasser (pg. 16)

(Apparent Authority Case) Dweck is the Principal and the Third Party. He is suing Nasser for acting as the Principal to the Agent, Shibboleth. Shibboleth was not the attorney of record for Nasser (it was kurt Heymna), but by his words and actions he reasonably led Dweck’s attorney, Wachtel, to believe that they had an agreement.

o Issue : Whether Shibboleth, who was not the attorney of record for Nasser, had the authority, as the Agent of Nasser, to agree to the Settlement?

o Rule : Based on Implied Authority : Even though Shibboleth was not Nasser’s attorney of record

(Hymen was), Nasser directed Shibboleth the settle the action and permitted him to speak “in his name.” Moreover, he told Shibboleth that he would execute any agreements that Shibboleth and Hymen presented to him. Given this behavior, and the long-standing close business relationship with Nasser, it was certainly reasonable for Shibboleth to assume he

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was authorized to settle the agreement—implied authority is based on the reasonable belief of the agent.

Based on Apparent Authority : A principal (Nasser) is bound by an Agent’s (Shibboleth’s) Apparent Authority which he knowingly permits the Agent to assume of which he holds the agent out as possessing—apparent authority is based on the reasonable belief the Principal allows the Agent to convince the Third Party that the Agent has to negotiate on the Principal’s behalf.

Three-Seventy Leasing corporation v. Ampex (pg. 23)

(Apparent Authority Case): Kay’s (a salesman) accepted on behalf of the company the right to sell memory cores to Kay. There was reasonable belief by Kay that there was apparent authority. In light of the communications and since nothing was said otherwise, Joyce could expect reasonably expect Kay to speak for the company.

o Issue: Was Kay an agent and capable to execute the deal?Was it an offer or a solicitation?o Rule: Apparent authority of an agent is sufficient to bind the principal

Questions (pg. 26):

1. To protect itself the company could have used a form contract or communicate better to potential customers that only certain people have authority.

2. Joyce could have determined who had the ability to sign and who had authority to bind the company.3. No the company had the ultimate responsibility

Watteau v. Fenwick: pg. 26

(Inherent Agency Power case) Fenwick (bar owner) authorized Humble as a purchasing agent, but only for specific items not cigars. Humble exceeded this authority when he bought cigars.

o Issue : Whether when one holds out another as an agent, can that agent bind the principal on matters related to such agency even if he was not authorized for that particular type of transaction?

o Rule : YES. When one holds out another as an agent, that agent can bind the principal on matters normally related to that agency, even if the agent was not authorized for a particular type of transaction.

The only recourse the principal would have is subrogation and go after the agent

Inherent Agency Power is a term used in the restatement of this subject to indicate the power of an agent which is derived not from authority, apparent authority or estoppel, nut solely from the agency relation and exists from the protection of persons harmed by or dealing with a servant or other servants.

Ratification: ReS 4.01 (pg. 21) When the Principal acknowledges the authority of the agent

o I.e., West Coast delivers the car to the principal who takes the keys and says, “Thank you.” This is ratification.

There is always a Principal, Agent, and Third Party. - If P talks to A, it is Actual Authority.

If P talks to Third Party then it is Apparent Authority. - This gets more difficult when P uses A to talk to a Third Party.

Types of Ratification:

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Expressed – Agent says what they did, action ratified Silence or Inaction Implied – you imply by accepting benefits Initiating a Lawsuit

Restatement 3d of Agency 4.05

Botticello v. Stefanovicz (pg. 31)

(Ratification) – This case is an appeal from the TC ruling about the sale of real property when only an undivided half interest was owned. No title search was requested from his attorney so one was not done. The D never said he was acting as the agent for his wife “Mary”. And the D refused to honor their lease sale. Reversed TC holding and dismisses against Mary & remanded for new trial against Walter.

o Issue: Can there be specific performance? No. The P has the burden of proving agency. Just because the wife let him handle some business does not make him her agent. There was no ratification.

o Rule: Agency must be proven on the fair preponderance of the evidence. Marital status cannot in and of itself prove the agency relationship, nor does the fact that they owned the property together.

Estoppel - this is Different from apparent authority, in that the P did not take steps to protect the third party and the third party experiences a detriment on relying on the P’s apparent authority.

The P has no rights against the third party, under apparent agency they would.

The liability of a principal to third parties for the acts of an agent many be shown by proof disclosing:1. Express or real authority which has been definitely granted2. Implied authority, this is, to do all that is proper, customarily incidental and reasonable appropriate

to the exercise of the authority granted3. And apparent authority, such as where the principal by words, conduct, or other indicative

manifestations has “held out” the person to be his agent

Hoddeson v. Koos Bros. (pg. 35)

(Estoppel) – Hoddeson wanted to buy furniture from D. She got a gift from her mom and went shopping at D’s store and paid in cash but got no receipt. Some of the items were on back order. After waiting for delivery, the D could not confirm her payment. P could not identify the salesman and the one they thought was him was on vacation at the time of sale. The purported salesman was a con artist. Reversed and remanded for new trial.

o Issue: Does the evidence that there was a purported salesman substantiate the existence of apparent authority and liability by the principal? YES.

o Rule: The proprietor has a duty to exercise reasonable care to protect a customer from a loss coming out of the false appearance of apparent authority.

Agents Liability on the Contract

Respondent Superior ReS 2.04 –An employer is subject to liability for torts committed by employees while acting within the scope of their employment.

Atlantic salmon v. A/S Curran (pg. 38)

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P Appeals lower courts verdict... D presented himself as treasurer and mkt. director for a company that did not exist (seafood). A dissolved company Marketing and Design was doing business as Boston seafood exchange with D set up as the president. D never told P of the existence of Marketing Design which was in not a viable entity. Reversed and remanded in favor of P.

o Issue: Does the fact that an undisclosed principal relieve the agent of liability? o Rule: NO. It is the duty of the agent if he wants to avoid personal liability to disclose not only that

he is acting in a representative capacity, but also identify the principal. A lot of times when companies are doing business with a corp they required a personal

guarantee from the owner – “I the owner will be responsible if the debts can’t be paid”

Partially Disclosed Principal When the agent reveals there is a principal, but does not reveal the identity of the principal the agent

becomes liable.

SECTION 3: Liability of a Principal in to third party in Tort:

ISSUE IN THESE CASES IS WHETHER THE RELATIONSHIP IS “PRINCIPAL-AGENT” OR “EMPLOYER-INDEPENDENT CONTRACTOR.”

Principal will be liable for torts of an agent committed within the scope

ReS 3rd 7.07

According to the Restatement: A master-servant relationship is one in which the servant has agreed to work and also to be subject

to the master’s control. o No control over how the work is done

An independent contractor, on the other hand, agrees to work, but is not under the principal’s control insofar as the manner in which the job is accomplished.

o In general, liability will not be imputed on the principal for the tortuous conduct of an

independent contractor. o Under “Apparent Agency,” the mere appearance that a master-servant relationship exists

may subject the principal to liability. o The amount of Control over how the work is done is how you determine if there is an

independent contractor

Humble Oil and Refining Company v. Martin: (pg. 43)

Appeal that Affirmed the trial ct. A gas station owned by Humble and operated/contracted by Schneider had a car on its lot that rolled away and hit Martin and his two children before any gas station employee touched it. Martin sued both Love (owner of the car) and Humble Oil.

o Issue: Whether a party may be liable for a contractor’s torts if he exercises substantial control over the contractor’s operations?

o Rule:YES. A party may be liable for the contractor’s torts if he exercises substantial control over the contractor’s operations.

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Notes: A party is not normally liable for the torts of contractors, but when that party so substantially controls the manner of the contractor’s operations, the contractor relationship breaks down and a master-servant relationship is formed.

In this case, Schneider was obligated to perform any duty Humble Oil imposed; Humble Oil paid some of Schneider’s operating expenses, and also controlled the station’s hours. Evidence showed that Humble Oil mandated much of the day-to-day operations of the station, certainly enough to justify a master-servant relationship.

Hoover v. Sun Oil Company : (pg. 45)

Summary Judgment for D. Similar fact pattern as above, but there is less control of the Sun Oil Company over the operator of the gas station (Barone). The franchisee maintained control of the inventory and operations; therefore there was no Master-Servant (Employee) relationship.

o The test here is to determine whether the franchisor (Sun) retained the right to control the details of the daily operations of the franchisee (Barone).

o The court found that while Sun had some control, Barone retained full control of his operations, including what inventory to stock.

o Rule : The court did find a Principal-Agent relationship, but did not find a master-servant relationship.The court found that an independent contractor does not have enough control for liability for tort to flow from the Independent Contractor to the Principal.

Murphy v. Holiday Inns, Inc.(p.48)

Summary- Lady staying at a holiday slips and falls from moisture from an AC unit. Lady sues Holiday Inn. The hotel is franchised by the Betsy-Len Motor Hotel Corp. The Agreement to franchise claimed the Holiday Inn was not an agent. Disclaimers may not be solid if acting in a way contrary to the disclaimer. Court looked and several factors of control that holiday in may have had and the fact that holiday inn was not part of the day to day control as seen in the maintenance which would have had the opportunity to keep this incident from happening.

Franchise Take away rules:1. Whole lot of control puts the franchisor at risk of liability.2. Less control, less unified product, less risk of liability. 3. Standards to follow will probably not be enough to create liability to the franchisor.4. Must be the “right to exercise control” mainly to the physical conduct. Employee acting within the scope of

employment

Miller v. McDonalds’ (p. 54)

Franchisee (and not McDonald’s) had the control of the instrumentality that caused the harm. McDonalds may have been seen to have this control as it was stemming from food handling which was one

of the points of control. Case was to review whether or not summary judgment was granted incorrectly and whether this should have

been a question for the Jury. Summary- Customer bit into sapphire eating big mac. Issues- Did M rep to customers that the restaurant was acting as its agents? Apparent agent.

o Actual agency- due to the amount of control that M had over the franchisor.o Apparent agency- 3rd party understood the operator of the McDonalds was an agent of McDonalds.o Apparent Agency Rule- One who represents that another is his servant or other agent and thereby

causes a third person justifiably to rely upon the care of such apparent agent.

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o Apparent Authority-power perceived by a third party in a supposed agent where there third party relies on the actions of the agent through his apparent authority.

ii. Once you establish that Agency exists (see above) the next question to ask is in what manner/how much control does the Principal have over the Agent?

If the control is minimal then the Agent is probably an Independent Contractor, therefore liability for tort will not flow from Principal to Independent Contractor.

a. But if there is more control you might have a Master-Servant (Employee) relationship; in this case liability for tort will flow to the Principal.

One more point : an Independent Contractor is subjected to only a little bit of control by the principal, but if there is too minimal an amount of control then the person in question is not even an agent.

Ira S. Bushey & Sons, Inc. v. United States: (pg. 59)

(Scope of Employment Case) Drunken Coast guard returned to his ship while it was in dry-dock. Before he went onboard he turned some wheels on the dry-dock, which caused part of the floating dry-dock to sink, causing damage.

Issue : Whether conduct of an employee may be within the scope of employment even if the specific act does not serve the employer’s interests?

Rule : Conduct of an employee may be within the scope of employment even if the specific act does not serve the employer’s interests.

o Servants use of force is within the scope of employment if it expected by the master. Like a bouncer or police officer.

o § 231 of ReS. – an act may be within the scope of employment although consciously criminal or tortuous.

o Notes : This case is the high-water mark for Scope of Employment Issues, where liability falls to a Principal for anything an Employee does that is Foreseeable. This case changed the law; previously liability was based on whether the Agent’s actions were motivated by a purpose to serve the master; the new law loosened the requirement to impose liability on the Principal if the conduct arose out of and in the course of employment.

This amounts to Strict Liability for employers as long as a connection of time and space can be made with the employment

Manning v. Grimsley (p.64)

Plaintiff complained that he as a spectator at a professional baseball game was injured by a ball thrown by a pitcher, sought in a battery court and in a negligence count to recover damages from the pitcher and his employer. The district judge directed a verdict for the defendants on the battery count and a jury returned a verdict for the defendants on the negligence count. The plaintiff appeals from the judgment on the battery count.

Issue: Did the district court correctly enter a directed verdict for defendants on the battery count? Holding: NO Reasoning: The jury could have reasonable inferred that Grimsley intended (1) to throw the ball in the

direction of the hecklers, (2) to cause them imminent apprehension of being hit, and (3) to respond to conduct presently affecting his ability to warm up and, if the opportunity came, to play in the game.

o “Where a plaintiff seeks to recover damages from an employer for injuries resulting from an employee’s assault … what must be shown is that the employee’s assault was in response to the plaintiff’s conduct which was presently interfering with the employee’s ability to perform his duties successfully.

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***Look to see if the desire of the employee was to serve the purpose of the employer.

Arguello v. Conoco, Inc. : (pg. 66)

Class-Action law suit was brought against Conoco stores, where several AA and Hispanic patrons had been subjected to racial discrimination while purchasing gas and other services. Incidents took place at two different types of stores: 1) Independently-owned Conoco branded stores, and 2) Conoco-owned stores whose clerks were employees.

Issue : Whether a plaintiff must demonstrate an agency relationship between the defendant and a third-party to impose liability under civil rights legislation for the discriminatory actions of a third party?

Rule : Plaintiff must demonstrate agency between Defendant and Third Party to impose liability under Civil Rights legislation for the discriminatory actions of a Third Party.

o Notes : The Conoco-branded stores in this case were independently owned, but had a PMA (Petroleum Marketing Agreement) which allowed them to market and sell Conoco brand gasoline and supplies in their stores, although Conoco did not control daily operations or personnel decisions. PMA’s stated each store was an independent business and not agents or partners, so no agency existed. However, some of the stores in the Complaint were not independently-owned, but were still owned and operated by Conoco. The employees of these stores were acting within the scope of their employment b/c they were performing authorized duties for Conoco, such as making sales and using the intercoms.

Majestic Realty Association, Inc. v. Toti Contracting Co.: (pg. 71)

(Shows that sometimes a Principal can be held liable for the actions of an Independent Contractor.) Plaintiff sought compensation from defendants for damage to Majestic’s building and to Bohen’s goods.

Issue : Whether a person who engages a contractor, who conducts independent business using its own employees, is liable for negligence of the contractor when the contractor performs inherently dangerous work?

Rule : A principal is liable for the work of a contractor if the contractor is hired to do inherently dangerous work (ultra hazardous / nuisance per se).

o Notes : Inherently dangerous work is work that must be done with special skill and care, and which involves grave risk to persons or property if done negligently.

o Liability is absolute for work that is “ultra-hazardous,” but this work was not in that category.

Exceptions where a Principal can be liable for the actions of an Independent Contractor (Typically they are not liable unless):

1. Landowner maintains control of the contractor actions.2. Where the Principal engages an incompetent Independent Contractor3. Where the activity contracted is a Inherently dangerous activity(ultra hazardous / nuisance per se)

SECTION 4: The Fiduciary Duty of an Agent (pg. 76): The purpose of these is punishment and deterrence. The remedy is to give up (disgorge) ill gained profits

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Reading v. Regem : (pg. 76) (Loyalty)

Reading was in the British military and while employed used his uniform to allow ride with trucks from one end of Cairo to the other to pass them through military inspection points.

Issue : Whether an Agent who takes advantage of the agency to make a profit dishonestly is accountable to the Principal for the wrongfully obtained proceeds?

Rule: An Agent who takes advantage of the agency to make a profit dishonestly is accountable to the Principal for the wrongfully obtained proceeds.

o he remedy is to give up (disgorge) ill gained profits Notes : It does not matter if the Principal has NOT lost any profits nor suffered any damages,

nor does it matter that the Principal could not have done the act himself. If the servant has unjustly enriched himself by virtue of his service w/out the master’s

sanction, such servant ought not to be allowed to keep the money. It should belong to the master b/c the servant obtained it solely by reason of the position the servant occupied as a servant of the master.

Town & Country H & H Service, Inc. v. Newbery: (pg. 83)

On appeal. Newbery worked for a house-cleaning company, which he left with other employees to start his own company. He took the old company’s list of clients to build up his own business.

Rule : Former employees may not use confidential customer lists belonging to their former employer to solicit new customers.

CHAPTER 2: Partnership:

Who is a Partner?: Control is critical, share in profits and losses, all partners are liable to each other and owe each other fiduciary duties, partnership isn’t taxed.

Actual partnership (main elements)- 1. Share profits and losses2. Control

Partnership by Estoppel(main elements)-1. Representation2. Reliance

Fenwick v. Unemployment Compensation Commission : (PG. 87): Partners Compared with Employees

Fenwick hired Chesire as a cashier and receptionist for his beauty salon. She requested a raise and Fenwick agreed to give her a raise if the income of the shop warranted it. An agreement was drawn up by a local attorney stating that Chesire and Fenwich associated themselves as a “partnership” for the operation of the shop; however, Chesire made no capital investment, had no control over management, and was not liable for any losses. It said she would get a year-end bonus of 20% if the business warranted it and that the partnership could be terminated by either party upon 10 days’ notice. The relationship was terminated and the UCC sought to determine whether Chesire was an employee or partner for the purpose of assessing liability under an unemployment compensation statute.

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o Issue : Is a partnership an association of two or more persons to carry on as co-owners a business for profit?

o Rule : A partnership is an association of two or more persons to carry on as co-owners a business for profit.

Notes : Although the agreement was termed “Partnership,” the essential element of co-ownership was missing. The agreement was merely one in which Fenwick agreed to share profits with Chesire. Chesire got nothing from the agreement other than the possibility of a bonus and she risked nothing from it. In this case their partnership was determined to be a compensation agreement.

Factors that exist in a Partnership: 1. The intent of the parties as evidenced through the language of any written agreements, 2. the right to share in profits, 3. the obligation to share in losses,4. Control of property and management of the business, 5. The rights of the parties on dissolution.

i. A written partnership agreement will not necessarily create a partnership and lack of a written partnership agreement will not necessarily preclude the finding of a partnership.

Martin v. Peyton: (pg. 92) : Partnership Compared with Lenders

A company, KN and K, were having financial troubles and Peyton loaned them $500K. This money wasn’t enough and KN and K suggested that Peyton and his associates (Perkins and Freeman) should become partners. They refused, but drew up an agreement where they would loan $2.5 million and would get 40% of KN and K’s future profits until the loan was repaid, and an option to join KN and K, if desired. Peyton and his associates were designated “Trustees” and kept advised of important matters with KN and K. Martin (a separate creditor of KN and K) filed suit against Peyton and his Associates, claiming their investments made them partners and therefore liable for KN and K’s debts.

o Issue: Whether the absence of an explicit partnership agreement precludes the creation of a partnership?

o Rule:No. The absence of a partnership agreement does not preclude the creation of a partnership. Notes: In the absence of an explicit partnership agreement, in order to have a “partnership”

the existence of an intention to form an association to carry on as co-owners a business for profit must be proven. The agreements in this case do not show the parties intended to be partners. The documents were merely a loan of securities with provisions to insure their collateral.

Southex Exhibitions v. RIBA (pg. 97): Partnership Versus Contract

An appeal of the DC ruling that no partnership exits. The Ct. of appeals affirms, saying there is no partnership under Rhode Island law. The existence of a partnership must be determined based on the totality of the circumstances test. There is an agreement between RIBA and SEM to host the shows at the civic center. Southex bought SEM and wanted to renegotiate the deal for management of the shows. RIBA expresses dissatisfaction with Southex’s performance and entered into a contract with another management company, which is the reason for the suit.

o They were trying to get access to the partnership assets.

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o Court used the clear error for determining if the DC was correct, they determined that there was no clear error in the DC’s ruling.

o Rule: The existence of a partnership must be determined based on the totality of the circumstances test. (UPA 1914 §24 & §25)

o In this case there was: Only slight control by RIBA, most control was with SEM SEM bore the risk of loss solely No corporate property The way they conducted business and were referred to did not say partnership

Questions to ask to see if there is a partnership:1. Who was entitled to the profits?2. Who bore the risk of loss?3. Who had control?4. What was the duration of the relationship?

Young v. Jones (pg. 101): Partnership by Estoppel

On the basis of the unqualified audit letter from the Bahamian PWC, the P’s deposited cash in the S.C. bank. The financial statement was falsified. PWC-US and PWC-Bahamas deny operating as a partnership. P seeks partnership by estoppel based on the marketing literature of PWC. However, there is no evidence that the deposits were made because of the marketing material, and that the US subsidiary had anything to do with the audit letter.

o Partnership in fact – mutual consent No mutual consent in this case

o Rule: Two things you have to show for partnership by estoppel (UPA 1914 §16) Representation Reliance

Notes: Certified Public Accounts – most import role they play is auditing financial statements

o Make sure info is accurateo Presented in accordance with accounting standardso After everything is correct they issue an “audit opinion”

So they are saying PWH-US didn’t do the audit letter and there is no connection

SECTION 3: Partnership Property:

Putnam v. Shoaf (pg. 132)

P owned a stake in the gin company and wanted to sell it to get out from under the debt. If the P would pay a little cash the D would assume the personal liable. For all of the debts. P gave the property over by way of a quit claim deed, and the D took over and fired the old bookkeeper. The old bookkeeper was embezzling. The banks were sued that honored the checks and P was suing for her (50% = 34,000) stake in those funds before she sold her ownership interest out. P then died. Since she had a partnership interest and conveyed it, she was not entitled to any part of the bank refund since she sold her interest.

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o Rule: Once a partner has sold their entire interest in a partnership, they are no longer able to claim a right in back unpaid profit.

o Distinguish between the Partnership Assets and Interest*** Uniform Partnership Act, her partnership property rights consisted of her

Right in specific partnership property Interest in the partnership Right to participate in management

Uniform Partnership Act 1997 sec 502 – only transferable

SECTION 5: The Rights of Partners in Management:

National Biscuit Co. v. Stroud : (pg 140) Stroud and Freeman entered a general partnership to sell groceries. Both had equal rights to manage the

business. Stroud told the bread company he would not be liable for any more bread orders, but Freeman requested more bread from the company. On the day of the last delivery, Stroud and Freeman dissolved their partnership. The assets were liquidated and most of the money went to Stroud to pay liabilities. The bread company eventually sued Stroud to recover the cost of the bread that had been requested by Freeman when the partnership still existed. Stroud argued that his notice to the bread company that he would not be liable for any more deliveries relieved him of any obligation to pay.

o Issue: Whether a partner may escape liability for debts incurred by a co-partner merely by advising the creditor, in advance, that he will not be responsible for those debts?

o Rule:No.The acts of a partner, if performed on behalf of the partnership and within the scope of its business, are binding upon all co-partners. According to UPA, all partners are equally liable for all obligations of the partnership.– Unless they have no authority and the person they are dealing with knows they have no authority

Notes: If a Majority of partners disapprove of the transaction before it was entered into, then they may escape liability.

But in this case Freeman and Stroud were equal partners, so neither had a veto power. All acts performed within the scope of the business are binding on both partners, AND even

an act outside the scope of the business may bind a co-partner if ratified by that partner. Partner is an agent of the partnership and is authorized to conduct business on behalf of the

partnership Uniform Partnership Act 1914

Section 9(1)

Things you might want to add in a Partnership agreement:1. Authority to purchase up to a certain limit2. Indemnification3. In the agreement define who does what4. for either a LP, LLC etc (formalities)5. buy out formula6. Events that can cause dissolution7. Rules for transition out8. How to bring in new partners

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Summers v. Dooley (pg .143) P entered into a partnership with D to run a trash collection business. The agreement stated that when one is

unable to work he hires a replacement at his own expense. P eventually decided to hire the worker full time but the D would not pay for any of the expense. Eventually this lack of payment resulted in the lawsuit which P only got parties relief on and appealed.

“Manifestly Unjust” Uniform Partnership Act: sec.18

o Issue: By his behavior the non-consenting partner ratified the act of hiring the third person as he took profits earned by him

o Rule:The D did continually voice his objections; therefore it is unjust to penalize the one partner for the benefit of the other.

Day v. Sidley & Austin: (pg. 144)

Day was a senior partner in a law firm and got a percentage of the firm’s profits; he was also privileged to vote on certain matters, as written in his partnership agreement, but he was not a member of the firm’s executive committee which managed daily operations. When the exec committee began talking about a merger all the partners agreed to it, including Day. Day chose not to attend any of the other meetings that took place concerning the merger. Day resigned 3 months after the merger, claiming changes after the merger had made working there intolerable. Mainly he did not like the fact his status of the Washington office was removed and this is why he claimed fraud and breach of fiduciary duty. The court said he could not substantiate those claims.

o Issue: Do partners have a fiduciary duty to make a full and fair disclosure to other partners of all info that may be valuable to the partnership?

o Rule:Yes.Partners have a fiduciary duty to make a full disclosure to other partners all info that may be of value to the partnership.

Notes:HOWEVER, NO court has recognized a fiduciary duty to disclose the kind of information handled by the executive committee involving the merger, the concealment of which does not produce any profit for the offending partners.

SECTION 2: The Fiduciary Duties of a Partner:

Meinhard v. Salmon: (pg. 105) (Disclosure is the lynchpin to the duty of loyalty.)

Salmon entered a joint venture with Meinhard to lease a hotel in NY for 20 years. Meinhard provided most of the money and Salmon managed the property, and both partners were responsible for any losses. As the old lease nears its end, the owner approached Salmon with an offer for a new lease. The new lease was for 20 years with a possibility to expand to 80. The new lease was signed between the owner and Salmon’s realty company. Salmon did not tell Meinhard of the negotiation of the new lease until the deal had been completed and therefore deprived him of an opportunity to take advantage of wit; Meinhard sued, and it is now on appeal and Meinhard won. He was due 49% and the D 51%.

o Issue: Whether joint adventurers owe to one another the highest fiduciary duty of loyalty while the enterprise is ongoing?

o Rule:Yes.Joint Adventurers owe to one another the highest fiduciary duty of loyalty while the enterprise is ongoing. (UPA 1914 §404)

Notes: Salmon kept to himself, in secrecy and silence, an opportunity that should have belonged to the joint venture.

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The new lease was an enlargement of the old lease; Salmon’s conduct excluded Meinhard from any chance to compete or enjoy the opportunity that had come to Salmon by virtue of the venture entered into by BOTH Salmon and Meinhard.

o How do we define “partnership opportunity?”

Sandvick v. LaCrosse Supplement 5-11

Meehan v. Shaughnessy: (pg. 117)

(Case is probably wrong—lawyers can leave a partnership with their clients, but probably not given the facts in this case.) Meehan and Boyle were partners in a law firm and decided to terminate their relationship with their law firm and start their own firm. Rumors circulated they were leaving as early as July, and they weren’t planning to leave until December. They denied leaving on several occasions, but admitted their plans in November. Law firm asked Boyle to ID which cases he wanted to take with him. Boyle didn’t respond for two weeks, during which time he already got permission from his clients to take their cases with him. After leaving the firm, Meehan and Boyle commenced an action to receive amounts they claimed were owed them under the partnership agreement. The law firm counter-claimed that Meehan and Boyle had violated their fiduciary duty to the firm, breached the partnership agreement, and tortuously interfered with their advantageous business and contractual relationships by engaging in improper conduct in withdrawing cases, clients, and law firm personnel. DC found for P’s and on appeal it was reversed in favor of D’s.

o Issue: Does a partner have an obligation to render on demand true and full information of all things affecting the partnership to any partner?

o Rule:Yes.A partner has an obligation to provide true and full information of all things affecting the partnership to any partner.

Notes: Although fiduciaries may plan to compete, they may not otherwise violate their fiduciary duties.

Meehan and Boyle did nothing wrong in preparing to leave, except they did breach their fiduciary duties by unfairly acquiring the consent from clients to remove cases from the law firm, while they were asked by other partners Is it true you are leaving? Meehan should have acknowledged they were leaving. This case was a breach.

Lawlis v. Kightlinger & Gray (pg. 125)

DC found for D and P appeals. Lawlis (P) worked with a firm (D) until he became partner. He developed an alcohol problem and sought treatment, then told the firm. The firm drafted a “program outline” which outlined the conditions he would need to meet in order to continue his relationship with the partnership. It said no second chance and he signed. He fell off the wagon and the firm gave him a second chance. The firm put in place an addendum where the partners can vote to lower partnership units. His kept getting lowered, and since he had not been drinking he wanted them increased. The firm decided to oust him with a vote even though he had not had a drink in approx. 2.5 yrs. He tried to say he got rid of him against the fiduciary duties, but the appeals court affirmed

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SECTION 6: Partnership Dissolution:

Dissolution (as defined in UPA (1914) § 29): the dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business. On dissolution the partnership is not terminated, but continues until the winding up of partnership affairs is completed.

Owen v. Cohen: (pg. 150)

This case is about selling the assets to settle the partnerships affairs. P&D had a partnership to operate a bowling alley. They started to have issues with each other. The court took control and it was decided that the D had done acts inconsistent with it and that it needed to be dissolved. The D argued that the problems were not big enough to dissolve the partnership and that the loan could not be paid back since it was supposed to be paid out of profits. The court denied both arguments.This was a partnership for an implied term.

o Rule: The court ruled under UPA 32(1) (d) that the partner was willfully not doing things consistent with the partnership and ordered dissolution.

The legal effect of a dissolution is that the partnership does not legally exist

Collins v. Lewis: (pg. 153)

Appellants who own 50% of the L-C Cafeteria sought receivership of the business and dissolution of the partnership and foreclosure of a mortgage on the appellees partnership interest. The appellees sought breach of contract. At the Trial the trial court denied the relief sought by the appellants. Both leased a downstairs part for opening a cafeteria for 30 yrs. Entered into a partnership agreement which is not complete and is only ascertainable based on the oral agreements. Lewis had an agreement to pay Collins and Collins assured him the bank note secured in his name would stay open. Collins tries to claim default by Lewis on not paying the bank note, but the agreement to pay Collins is the only thing that matters here, not the ability to pay the bank, which Lewis did.

o Rule: You can’t just dissolve a partnership for term because you unreasonably think your partner has not met his end of the deal.

The jury could find that the partner did meet his end of the bargain.

Page v. Page (pg. 158)

On appeal P wins a reversal. Partners (brothers) are in an oral partnership agreement to operate a linen business. The partnership’s biggest creditor is a corp. owned by the P. The Partnership operated for a loss but was improving, however the P wanted to terminate the partnership. There was no understanding as to the duration or term of the partnership, and the D could not provide facts to support that it was. This is a partnership at will.

o Rule: A partnership at will is not bound to stay in the partnership; however he must act in good faith and not freeze someone out and take all of the benefits.

Prentiss v. Sheffel (pg. 161)

An appeal where 2 of 3 partners at will (P’s) running a shopping center are seeking dissolution of the partnership. They claim that the one partner did not provide his proportionate share of the operating losses.

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D says he was wrongly excluded from the partnership. The TC says there is partnership at will and a receiver would sell the shopping center. The D did not want the P’s to be able to bid on it. They did and won, and the D appeals. The appeals Ct. affirms and says the D was withheld from management, but there was no indication that it was done with the wrongful purpose of obtaining the partnership assets. The D had the same right s to bid on the sale

o Rule : there is no rule against a partner bidding on the sale of the partnership assets.

Pav-Saver Corp. v. Vasso Corp.: (pg. 164)

Dale and PSC had the patent for concrete paving machines. Dale and PSC formed a partnership with Meersman and Vasso, in order to manufacture and sell paving machines. The partnership was to be permanent and not to dissolve w/out mutual assent. Dale and PSC began dissolving the partnership w/out Meersman/Vasso’s assent. When Meersman heard this he moved into an office at PSC and physically ousted Dale, and assumed daily operations of PSC. PSC then filed suit for a court-ordered dissolution of the partnership, return of its patent, and an accounting.

o Issue : Whether, when a wrongful dissolution occurs, partners who have not wrongfully caused the dissolution have the right to continue the business in the same name and to receive damages for breach of the agreement?

o Rule : Yes, when a wrongful dissolution occurs, partners who have not wrongfully caused the dissolution have the right to continue the business in the same name and to receive damages for breach of the agreement.

Notes : Wrongful termination invokes the provisions of the UPA. If a partner, after a wrongful termination, elects to continue the business, he has the right to possess the ownership property, but must compensate the withdrawing partner, minus any damages caused by the wrongful withdrawal.

However in this case it was a permanent partnership which did not allow for details of the dissolution, in the event of one or a buy-out clause. Moral of the story the partnership agreement was not specific enough.

Kovacik v. Reed: (pg. 170)

Kovacik asked Reed to be his superintendant on several remodeling jobs. Kovacik said he had $10k to invest and that if Reed would superintend and estimate the jobs, he would share the jobs with him 50/50. They did not discuss losses. The oral joint venture lost money and Kovacik demanded Reed contribute; when Reed refused he filed suit.

o Issue : Whether, in a joint venture where one party contributes money and the other labor, is either liable to the other for contribution for any losses sustained?

o Rule : No . In a joint venture in which one party contributes funds and the other labor, neither party is liable to the other for contribution for any loss sustained.

Notes : The general rule is that in the absence of an agreement to the contrary the law presumes partners and joint ventures intended to participate equally in profits and losses of the common enterprise, each sharing possible losses in the same proportion as he would in the profits.

HOWEVER, this presumption applies only in cases in which each party had contributed capital or was to receive compensation paid to them before computation of the losses or profits.

The rationale is that in the event of a loss, each party would lose his investment, one money and the other labor.

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Buyout or buy-sell agreements (pg. 173) these are agreements that allow a partner to end his relationship with the other partners and receive a cash payment or series of payments or some assets from the firm in return for his interest in the firm.Some of the things you would want to think about:

Trigger events Obligation to buy versus option Price Method of payment

G&S Investments v. Belman(pg. 174)

On appeal. Limited Partnership that owned a condo complex. This suit is related to the misconduct and death of a general partner (Nordale). There are 2 issues: 1. whether the surviving general partner is entitled to continue the partnership after the other partner’s death? 2. How the value of the dead partners interest is to be computed. P is a limited partnership. The dead partner was a coke head and disruptive. The p filed suit to dissolve the partnership, and while pending the general partner died and the P wanted to continue the partnership and assume the dead partners interest. Appellant says the filling of the complaint is dissolution and want liquidation for more proceeds to the estate. Appellees say the filing of the complaint did not dissolve, but gave the court the power to dissolve. They next argued over the buyout agreement on the capital account (and what exactly that was) and how it should be valued FMV or cost. It was determined cost.

Section 7: Limited Partnerships

Holzman v. De Escamilla (p. 179)

Defendants were partners raising crops on farmland in Sand Diego. The business named de Escamilla as a general partner and the other two defendants, James Russell and H.W. Andrews, were listed as limited partners. However, when decisions were made regarding what to plant, the limited partners chose the crops. The limited partners were able to draw on the business accounts while de Escamilla was required to get one of their signatures on any checks on the accounts. The limited partners checked in on the business twice a week. The business went bankrupt, and Plaintiff was appointed as trustee.

o Issue: The issue is whether Russell and Andrews should be held liable as general partners in the bankrupt business.

o Rule: A limited partner will be held liable as a general partner if the limited partner acts to take part in the control of the business

Big Issue – The Liability of limited partners; when do they cross the line and become general partners?

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CHAPTER 3 – THE NATURE OF THE CORPORATION

Critical Attributes of a Corporation Legal “person”

o For all purposes is separate – can sue, be sued, separate tax payer Limited Liability

o Allows all share holders protection from liability Separation of Ownership and Control

o Shareholders Have the ownership of the corporation

o Board of Directors Have the control of the corporation – elected by shareholders

o Officers/Management Appointed by Board of Directors – serve at the will of the board

Liquidityo The share of a Corporation are liquid, they are transferable.

Flexible Capital Structure through issuance of securities Bonds

o Debt – loan money to the corporation Stocks

o Equity – investments in the corporationo Common Stock

Has no preferenceso Prefered Stock

Stock that has some preference; ex. preference on dividend rights, liquidation, voting rights Some relevant Terms:

o Authorized Shares The number of shares authorized by corporations charters

o Outstanding Shares Sold shares

o Authorized but Uninssued Shares Authorized but not sold

Forming the Corporation Where do we incorporate?

o Delaware because they have very friendly corporation laws 95% of public companies are incorporated here

o Wouldn’t incorporate in Delaware – if you’re a local company and would only operate in one state it might not make sense

Articles of Incorporationo This is how one incorporates

Draft Corporate By-Laws Organizational Meeting

o Name Directorso Adopt By-Lawso Appoint Officerso Authorize Sale of stock to Initial Shareholders and Issue Stock

II.

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Limited Liability: (Question in these cases is, “The company is out of money, so who can we sue?”)

Walkovsky v. Carlton: (pg. 189) (Enterprise liability case)

Walkovsky was run down by a taxi owned by Seon Cab Corp. In his complaint, Walkovsky alleged Seon was one of ten cab corps of which Carlton was a shareholder, and each company had only two cabs registered in its name. Complaint said each company carried only the minimum auto liability insurance of $10k required by state law. It also alleged these corps were operated by a single entity. Walkovsky claimed this structure was an “unlawful attempt to defraud members of the general public.”

o Issue : Whether Walkovsky’s complaint stated a sufficient cause of action to recover against each cab company.

o Rule : No.The law does permit incorporation of a business to limit liability; however, this privilege can be abused. Courts will disregard the corporate form (“Pierce the Corp Veil”) to prevent fraud or achieve equity.

Notes : In this case, the corporate form may not be “pierced” simply because the assets of the corporation, together with liability insurance, are insufficient to assure recovery. The company had the min amount of required insurance; if the amount is insufficient the remedy lies with the legislature, not the courts.

It is very important to note that the Seon Corps saved themselves by following formalities and kept good records. There was no evidence of commingling of funds, so the veil could not be pierced.

Three Possible Legal Doctrines (Theories) P could invoke:

1) Enterprise Liability —this is a horizontal “pierce” of the corporate veil, where you go after other corporations with the same owners

2) Respondent Superior (Agency) —Cab is an agent of Carlton3) Disregard of the Corp Entity (“Piercing the Corp Veil” —means ignoring the corporate rules of limitation

on liability)—this is vertical

Sea-Land Services, Inc. v. Pepper Sauce: (pg. 194)

Sea-Land shipped peppers for Pepper Sauce, but then could not collect b/c Pepper Sauce (PS) had dissolved. PS also had no assets; unable to recover, Sea-Land filed another suit seeking to pierce the veil and hold Merchese, sole shareholder of PS and other corps, personally liable. Issue : Whether the corp veil will be pierced where there is unity of interest and ownership between the

corporation and an individual and where adherence to the fiction of a separate corp existence would sanction a fraud or promote injustice?

Rule : Yes , the corp veil will be pierced where there is a unity of interest and ownership between a corp and an individual and where adherence to the fiction of a separate corp existence would sanction a fraud or promote injustice.

o Notes : Corp formalities had not been maintained and funds and assets had been commingled with abandon—different corp assets were moved and borrowed w/out regard for their source (First prong of the test satisfied). But on remand the court said SL had to show the kind of injustice necessary to evoke the court’s power to prevent injustice—b/c an unsatisfied judgment by itself is not enough to show that injustice would be promoted.

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**Piercing the Veil 2 prong test:1. Unity of interest : When there is an entity such that the separate personalities of the corporation and

the individual no longer exist, and2. acknowledgement of the separate corps would sanction fraud or promote injustice

i. This may not be required in a tort case

Reverse piercing – This is when a P tries to pierce the corporate veil of one of D’s corporations to get to the assets of another one of their corporations.

**General factors to determine if piercing the veil is appropriate:1) Failure to maintain adequate corporate records2) Commingling of funds or assets3) Undercapitalization4) One corp treating the assets of another as its own

To avoid veil piercing owners of corporation should abide by the formalities, meaning to have meetings and votes and separate bank accounts, etc.

R.C. Archbishop of San Francisco v. Sheffield: (pg. 200) (Attempt to claim a subsidiary is liable for another subsidiary)

While in Switzerland, Sheffield entered an agreement to buy a St. Bernard dog, on installment payments, from a Roman Catholic monastery. The monastery breached and Sheffield sued The Archbishop of S.F., The Pope, The Vatican, the Catholic order in question, and Father Cretton, with whom he had made the agreement. Complaint alleged there was a “unity of interests” and ownership between all of the defendants, also that the Archbishop and others are a “mere conduit” for the Pope and Vatican, and that all the Defendants were “alter egos” of each other.

o Issue : (1) Whether where a parent corporation controls several subsidiaries, the corporate veil of one subsidiary may be pierced to satisfy the liability of another; and (2) Whether the “Alter Ego” theory may be applied where the unsatisfied creditor-plaintiff will merely not be able to collect if the corporate veil is not pierced?

o Rule : (1) No.Where a parent corporation controls several subsidiaries, the corporate veil of one subsidiary may not be pierced to satisfy the liability of another. (2) No.The “Alter Ego” theory may not be applied where the unsatisfied creditor-plaintiff will merely not be able to collect if the corporate veil is not pierced.

Notes : (1) The Archbishop of S.F. may be an “Alter Ego” of the Pope, but the Archbishop is not an “Alter Ego” of another subsidiary of the Pope (the Swiss monastery). The Arch of S.F. had no dealings with the Swiss monastery, thus negating any possibility that the Arch so controlled and dominated the Swiss so as to be liable for it under the “Alter Ego” doctrine. There is no Respondent Superior between subagents.

(2) A requirement to pierce the corp veil is that failure to pierce would lead to an inequitable result. It is not sufficient to say that Sheffield should collect from the Arch of S.F. just because to sue in Switzerland or Italy would be prohibitive.

Alter Ego : When a corporation uses another corporation to its advantage; when a corporation is determined to be using another as an “alter ego,” the courts may use it as grounds to find “Enterprise Liability” or “Respondent Superior” for the purpose of “Piercing the Corporate Veil.”

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In Re Silicone Gel Breast Implants Products Liability Litigation: (pg. 204) (Piercing is allowed w/out fraud in tort cases to satisfy justice, and to satisfy a judgment.)

Plaintiffs from many states claimed they had been injured by breast implants produced by MEC, which was a subsidiary owned by Bristol-Meyers. P’s wanted to pierce the veil, even though Bristol had not manufactured the product.

o Issue : Whether, in a corporate control claim seeking to pierce the veil, may veil-piercing ever be resolved by summary judgment?

o Rule : Yes , summary judgment for veil-piercing could be proper if the evidence presented could lead to but one result.

Notes : Summary judgment was denied here b/c a jury could find that MEC was the alter-ego of Bristol. When a corp is the alter ego of another, the corp structure may be denied in the interest of justice.

A showing of fraud, injustice, or inequity in a Contract case may not be required in a Tort case.

Also, veil-piercing is often allowed when it is sought to satisfy a judgment.

Factors to consider in determining alter ego in order to pierce the corp veil:

1) Parent and subsidiary have common directors or officers2) They have common business departments3) They file consolidated financial statements and tax returns4) The Parent finances the Subsidiary5) The Parent causes the incorporation of the Subsidiary6) The Subsidiary operates with grossly inadequate capital7) Parent pays salaries and expenses of subsidiary8) Subsidiary only receives business brought to it by Parent9) Parent uses the Sub’s property as its own10) The daily operations of the two corps are not kept separate11) Sub does not observe the basic corp formalities, such as keeping separate books and records and holding

shareholder and board meetings

SECTION 4: The Role & Purpose of the Corporation

A.P. Smith Mfg. Co. v. Barlow : (pg. 264)

Corporation wanted to give $1,500 to Princeton University, but the shareholders sued. The shareholders argued the law did not apply to them b/c they had been incorporated before the laws were enacted. Shareholders argued the corp’s charter (1) did not expressly authorize the power to give to charities, and (2) the New Jersey statute legalizing charitable giving by corps did not apply b/c the corp was in existence before the NJ statute was passed.

o Issue: Whether state legislation adopted in the public interest can be constitutionally implied to preexisting corporations under the reserved powers?

o Rule: Yes, state legislation adopted in the public interest can be constitutionally applied to the preexisting corporations under the reserved powers.

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Notes: 50 years prior to the incorporation of A.P. Smith, the NJ Legislature provided that every corp charter would be subject to the discretion of the legislature (“Reserved Power”).

NJ courts repeatedly showed decided that where justified by the advancement of Public Interest, the reserved power may be invoked to sustain later charter alterations even thought the affect contractual rights between the corporation and its stockholders.

The court was clearly swayed by the philanthropic concerns and devoted much of the opinion to discussing the economic and social importance of corp contributions, especially to universities.

Dodge v. Ford Motor Co. : (pg. 270)

In 1916, despite profits of almost $174 million, Ford announced no future dividend would be paid. The Dodge brothers offered to sell their $35 million in shares to Ford, who rejected the offer. The Dodge’s filed suit attacking the dividend policy and Ford’s plan to expand manufacturing.

o Issue: Whether the primary purpose of a corporation is to provide profits for shareholders?o Rule: Yes, a corp’s primary purpose is to provide profits for shareholders.

Notes:The power of the corp’s directors is to be employed to provide profits to shareholders.

The real reason for this ruling was that the court realized Ford was motivated not just by a desire to expand Ford’s manufacturing, but also by a desire to avoid funding the Dodge’s venture (is this fraud, illegality, or conflict of interest, as discussed in the next case?)

Shlensky v. Wrigley : (pg. 275)

Shlensky (minority shareholder) sued Wrigley b/c they refused to put lights on Wrigley field, which would have allowed for night games and increased revenues.

o Issue: Whether a shareholder’s derivative suit (suit by a third party on behalf of the corporation) can be based on conduct by the directors that does not border on fraud, illegality, or conflict of interest?

o Rule:A shareholder’s derivative suit can only be based on conduct by the directors which borders on fraud, illegality, or conflict of interest.

Notes: Shlensky was trying to force a business judgment on the Board of directors of the Cubs, but there was no showing of fraud, illegality, or conflict of interest.

There were valid reasons for not wanting night games on the part of Wrigley, notwithstanding his personal feelings about the game; Wrigley believed lights would have a detrimental effect on the neighborhood.

There was also no showing that night games would significantly increase revenues.

Other Corporation Stuff:

Sources of power for a corp are:o Anything a corp says it can doo Anything state law allows

What can shareholders do?o Vote on the Board of Directorso Vote to dissolve the Corpo Vote on mergers and acquisitions (decide to buy other corps)o Vote on whether to be acquired b another corp

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o Vote on decisions that are big and rare What do shareholders get for their money?

o Control (as listed above)o The ability to make more money—get percentage of ownership

Ownership: ability to make cap gains when they sell stock What does the Board do?

o Appoint Officerso Decide to issue dividendso Decide other rare, big, important decisionso Appoint Committees—Specialists

Accounting Committee to conduct audits in accord w/ Fed law Compensation Committee Nominating Committee

Officers:o Chosen by the boardo Employees of the Corp, which makes them all agents of the Corpo Fiduciary duty to shareholders and Corp

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CHAPTER 5: The Duties of Officers, Directors, and Other Insiders

Business Judgment Rule: Doctrine relieving corporate directors and/or officers from liability for decisions honestly made in the corp’s best interests. There must be allegation of fraud, illegality, or conflict of interest to bring a Cause of Action

Reasons for the BJR:

1) Wide berth to make decisions2) Courts are incompetent? No, this is not true; courts rule on complicated things all the time3) We don’t want shareholders second-guessing the business decisions of Officers4) Prompts risk-taking b/c there is little fear of retaliatory litigation

a. BJR promotes a lot of successes and also ends in a lot of failures

2 fiduciary duties owed by directors that are prerequisites to application of the BJR1. Duty of Care

a. How?i. Gather material information reasonably avail. and deliberate

2. Duty of Loyaltya. How?

i. Avoid conflicts of interest (self dealing) fraud, illegality, bad faith

Rule: Directors have carte blanche authority to make dumb mistakes, but can’t act selfishly or with grossly negligence or egregious conduct.

Things to do if you have a lot of cash on hand1) Distribute a dividend2) Grow the Business3) Repurchase the Companies Stock4) Sell the Company

A. SECTION 1: The Duty of Care:

Kamin v. American Express Co. : (pg. 310)

Am Ex acquired almost 2 million shares of common stock of DLJ at a cost of almost $30 million; it was later worth only $4 million. Am Ex made a decision to declare a special dividend and distribute a dividend “in kind” (meaning not of cash) by giving away the $4 million of DLJ stock, but Kamin charged this decision was negligent b/c it negated a possible tax savings of $8 million. Kamin sought, in derivative action, a declaration that the dividend was a waste of corp assets and sought damages.

o ISSUE : Whether the courts should interfere with a board of directors’ good faith business judgment as to whether or not to declare a dividend or make a distribution?

o RULE : NO. Whether or not a dividend will be paid is exclusively a matter of business judgment on the part of the board. Courts will not interfere as long as the decision is made in good faith. There would have to be fraud, illegality, or conflict of interest.

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NOTES : The Business Judgment Rule applies here also (see above). It is not enough to charge that the board made an imprudent business decision or that some other action would have been more advantageous. Such a charge cannot give rise to a cause of action.

This rule is used to provide a wide-birth for the board so that it can effectively and efficiently pursue the corp’s best interests rather than being constantly influenced by the need to practice “defensive management” or to prevent being held liable.

II. Delaware General Corp Law : i. § 141: Board of directors; powers; number, qualifications, terms and quorum; committees;

classes of directors; nonprofit corporations; reliance upon books; action without meeting; removal

ii. § 142: Officers; titles, duties, selection, term; failure to elect; vacanciesiii. § 143: Loans to employees and officers; guaranty of obligations of employees and officersiv. § 144: Interested directors; quorumv. § 145: Indemnification of officers, directors, employees and agents; insurance

Smith v.Van Gorkom : (pg. 314) (Cases will probably never be decided like this again)

Van Gorkom, CEO of Trans Union, approached a corporate takeover specialist to stage a leveraged buyout of Trans Union at $55/share. Van Gorkom only consulted the company’s controller, Peterson, but no other members of the board were consulted. On 9/18 Pritzker (the corp takeover specialist) demanded Trans Union respond to his offer in 3 days; Van Gorkom called a special meeting of the board the next day; the board approved the agreement based on Van Gorkom’s 20 minute presentation. W/out reviewing its contents, Van Gorkom executed the merger agreement on 9/22. Smith and other stockholders filed a class action law suit against Trans Union and the board. However, on 2/10 the shareholders voted to approve the takeover.

o ISSUE : Whether a director or officer of a corp is shielded by the business judgment rule when he relies on the representations of other directors or officers?

o RULE :The Business Judgment Rules shields directors or officers of a corporation from liability only if, in reaching a business decision, the directors or officers acted on an informed basis, availing themselves of all material information reasonably available.

o The court concluded that the board’s failure to inform itself before recommending a merger to the stockholders constituted a breach of fiduciary duty of care and rebutted the presumptive protection of the business judgment rule.

NOTES : A director or officer may not passively rely on information provided by other directors or officers, outside advisors, or authorized committees. The director may only rely on credible information provided by competent individuals, after taking reasonable measures to substantiate it. The BJR presumes the officers are making sound decisions and this presumption must be rebutted, but under BJR there is no protection for officers who have made “unintelligent or unadvised decisions.” The concept of gross negligence is the proper standard to determine if the business judgment reached by a board of directors was an informed one. § 102(b)(7) was created b/c of and after this case.

III. Four Concepts for Van Gorkom i. Options for the use of Trans Union’s cash :

LBO:

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a. Van Gorkom chose this option b/c he was close to retirement and wanted to cash-in.

b. If you issue all the shares at one time then you can charge a premium for the control you are giving over to the buyer.

c. This option is faster, which means there will be less time for the board to deliberate

d. A buyer right now means there is certainty right now. Even if they could have gotten more money later they might not have been able to find a buyer

Issue a Dividend Purchase another company Buy back outstanding shares which decreases the amount of shareholders

(probably), so the money goes from the company to the shareholders. This is similar to issuing a dividend.

a. Issuing a Dividend is the exact same thing, economically, as buying back shares.

ii. Worth of the Company is based on : (Ways to value) Future Income Comparing the company to other companies Value of assets—this is difficult b/c difficult to assess and these assessments are

usually the lowest possible valuation. This is a way to find the bottom value of the company

P/E is way to value if you know the whole value and then can divide by the number of outstanding shares

iii. LBO : Buying a house is like an LBO; typically put 20% down, which makes this a 20/80 or 4x LBO. Like an LBO b/c you put some amount of money down and then borrow the rest. Sometimes people with lots of money still engage in LBOs. Why is this?

LBO vs. Non-LBO : leverage greatly magnifies your amount of returns. The interest rate will be a large factor in determining amount of return.

Steps of LBO : The point is that this process takes a long time and is a lot of work. Also, the seller cares who the buyer is b/c when they pick a buyer they are also turning down a bunch of other Bids.

a. Look at Public Infob. Someone places a bid (there is an evaluation of the Bid)c. If Bid is accepted, there is an appraisal (the appraisal must take place after

the Bid b/c the seller won’t let you appraise w/out placing a Bid b/c the result of their appraisal will be pubic information. The appraisal is for one reason: trying to find reasons to lower your Bid. Next question is who fixes the problems; do you lower the price and fix it yourself or keep the same price and tell them to fix it.)

d. After all this there is the mortgage contingency, which says “If you can’t get the funding by a certain date, the deal is off.” You have to find financing w/in a certain amount of time and it must be at some interest rate.

e. Next the buyer has to shop for the financing (this involves providing lots of information)

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f. Closing: they hand over the deed and you hand over a checkiv. Rules for Veil Piercing

BJR: If you don’t like the way the company is being run you can’t just sue the board as a shareholder. The BJR is the legal mechanism by which the shareholders get kept in their place, and their power gets limited. Needs illegality, fraud, self-interest/self-dealing.

Van Gorkom: tells us in the absence of illegality, fraud, or self-interest, no informed business decision will be overturned. Directors will be personally liable for their carelessness.

a. This caused applicable insurance rates to increase 600% b. Also, the point of this case is that the court got it really really wrong

i. The court said there was not enough Care used by the Board, but the court was wrong

c. What businesses have learned since Van Gorkom is that they need to do a lot of paper work here to show they have been meeting the Duty of Care—this is to cover the requisite formalities

Francis v. United Jersey Bank : (pg. 328) (BJR only applies to business judgments—in this case Ms. Pritchard didn’t make ANY judgments. Not having BJR in place opens you up to negligence complaints.)

Lillian Pritchard inherited a reinsurance brokerage from her husband and her sons illegally withdrew over $12 million from the company for personal needs. Mrs. Pritchard was completely ignorant of the fundamentals of the business and paid no attention to the affairs of the corp. Company goes BR and is sued by the Trustee—claim is to cover the misappropriated amount

Issue : Whether individual liability of a corp’s directors to its clients requires a duty, breach, and proximate cause.

Rule : BJR only applies if there were decisions actually made—she made no decisions. o Duty to act in good faitho Duty to be informed on the business

Liability of a corp’s directors to its clients requires a demonstration that: 1) a duty existed, 2) the directors breached that duty, 3) The breach was a proximate cause of the client’s losses.

Notes : If she had at least resigned she would have signaled to the shareholders that there was something wrong with the company. This is a departure from the general BJR that a director is immune from liability and is not an insurer of the corp’s success. Directors normally do not owe a duty of care to third parties unless the corp is insolvent. The nature of the reinsurance business distinguishes it from most other commercial activities in that reinsurance brokers are encumbered by fiduciary duties owed to third parties. In other corps, a director’s duty normally does not extend beyond the shareholders to third parties. Reinsurance companies’ and some banks’ Directors have a fiduciary duty to both the corp and its stockholders. This requires basis understanding of the corp’s business and a duty to keep informed of its activities.

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CHAPTER 4 – THE LIMITED LIABILITY COMPANY

Water, Waste & Land, Inc. d/b/a Westec v. Lanham

Clark contacted Plaintiff to have Plaintiff perform some engineering work. Although a written agreement never emerged, both sides made an oral agreement regarding the work eventually performed by Plaintiff. During the negotiations, Defendants never notified Plaintiff that they were acting as agents on behalf of their LLC, Preferred Income Investors (P.I.I.). The only reference to P.I.I. available to Plaintiff was the initials “P.I.I.” on Defendants’ business cards. When Plaintiff tried to collect for the work performed, Defendants could not pay. Clark and Lanham asserted that they were not liable because Colorado’s statutes regarding LLC’s provided constructive notice to third parties by the act of incorporation. Defendants further argued that the Plaintiff should have inquired into the LLC status, and the business card sufficed to give some warning as to the possible existence of an LLC. Although the county court found for Plaintiff, the district court overturned, agreeing with Defendant’s reasoning.

o Issue: The issue is whether state statutes providing constructive notice of LLC’s to third parties were intended to cover agency law claims wherein the agents never fully disclosed the principle to the outside party

o Rule: State statutes providing constructive notice to third parties when an LLC has been incorporated do not extend to agency law.

Elf Atochem North America, Inc. v. Jaffari

In 1996, Appellant contracted with Appellee to form an LLC incorporated in Delaware that would produce more environmentally-friendly maskants for the aerospace and aviation industries. Appellant produces solvent-based maskants which have been classified as hazardous. Appellant provided much-needed financial backing for Appellee’s operation, while Appellee retained 70% of the profits from the newly formed LLC. The LLC agreement called for all disputes to be settled through arbitration in San Francisco. Appellant brought this action in 1998 in a Delaware court against Appellee for breach of contract, breach of fiduciary duty and tortuous interference. Appellant argued that since LLC was formed prior to the formation of the LLC agreement, and because the LLC never signed the agreement then the agreement and its arbitration provision are not effective over this dispute. Appellant also argued that the claims were derivative instead of direct, and that the Delaware Court of Chancery has special jurisdiction

o Issue: The first issue is whether an LLC agreement not executed by the LLS itself is valid. The second issue is whether the arbitration and choice of forum provisions are valid.

o Rule: The Delaware LLC statutes give great deference to the freedom of LLC members to contract, providing the terms do not overstep any of the mandatory statutory provisions

Kaycee Land and Livestock v. Flahive

Plaintiff wants to use general corporate veil-piercing principles to hold Defendant personally liable for damages that the LLC could be held responsible for. Defendant argued that although the legislature passed a statute for piercing the corporate veil as pertaining to corporations, they have been silent on LLC’s, and therefore there is no express intention to allow for the remedy

o Issue:The issue is whether corporate veil-piercing principles can be applied to a limited liability company.

o Rule:For the purposes of piercing the corporate veil, there is no law or policy that would require treating limited liability companies (LLC’s) different from corporations.

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McConnell v. Hunt Sports Enterprises

Several community leaders in Columbus Ohio including McConnell were contacted by the city mayor based on their involvement in professional sports to examine the possibility of applying for an NHL hockey franchise for Columbus.

McConnell's colleagues approached Hunt Sports Enterprises as a potential investor. McConnell and Hunt formed Columbus Hockey Limited. A limited liability company whose general

character was to invest in and operate a franchise in the NHL. Following an application for the franchise filed by CHL on behalf of the City of Columbus difficulty arose

when a planned tax to finance the construction of a required appropriate arena failed to pass approval. When hunt refused to accept an alternative lease proposal that would permit the required construction

McConnell offered to lease the arena in hunt's place. The offer was accepted and the NHL required that an ownership group be identified pursuant to its granting

of a franchise. McConnell signed the required documents in an individual capacity in the place intended for CHL's participation as franchise owner thus identifying him as majority owner

o Rule of law A member of an LLC does not breach fiduciary duty to the company by directly

competing against it where the operating agreement expressly permits competition

New Horizons Supply Cooperative v. Haack

New Horizons sold fuel to Haack through the use of a credit card taken out by her She signed the credit card agreement with no designation indicating whether her signature was given

individually or in a representative capacity on behalf of Kickapoo Valley Freight LLC of which she was a member/manager

Payments stopped so negotiations began to take place between the partieso Rule of law

A member or manager of an LLC is not personally liable for the debt, obligation, or liability of the company only if member or manager follows statutory prescribed formailities of LLC incorporation, dissolution, and creditor notice

Fisk Ventures, LLC v. Segal

B. SECTION 2: THE DUTY OF LOYALTY

Duty of Loyalty:

These will fall into two categories:(1) Corporate Opportunities or (2) Interested Insider Transactions

Loyalty questions are always trying to figure out if the transaction in question is “fair.”

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IV. Interested Insider Transactions: They cause the corporation to go into some transaction that will benefit an insider.

I.e., Salary negotiations—if a board is going to decide a CEO’s salary and the CEO is on the board we might have an Interested Insider Transactions.

ii. Direct Interested Insider Transactions : I.e., Salary negotiationsiii. Indirect Interested Insider Transactions : I.e., Stock options or suspiciously beneficial

loans (interest free loans) or, for example, if company A buys stuff from company B at an outrageously high price and we later find out a board member is on the board of both companies

V. Corporate Opportunities : VI. Duty of Loyalty. Duty of Loyalty cases will involve the “self-dealing” factor of BJR. Once you’ve made

the case that self-dealing is present the BJR no longer applies.

Bayer v. Beran: (pg. 336) (BJR only applies if loyalty to the corp is not violated)

The Celanese Corp had an advertising campaign prior to 1942. After 1942 the FTC said all Celanese products had to be labeled as “rayon.” B/c they believed their products were better than “rayon” The Celanese Corp commenced a radio advertising campaign costing $1 million/year. The decision was made based on studies by the in-house advertising dept., and the employment of a radio consultant and an advertising agency. The wife of the president of The Celanese was selected to perform in the radio program. The board was charged with negligence in its selection of the radio program and self-interest in initiating the program.

o Issue : Whether the courts may question decisions of business management made by a corporation’s board of directors.

o Rule : No. “As long as a contract is fair it is valid, even if disinterested directors have not yet approved it.” (Pg 341 of book) Policies of business management are left solely to the Board of Directors and may not be questioned absent a showing of fraud, improper motive, or self-interest, even if the decision is later judged to be unwise or unprofitable.

a. Notes : However, the BJR only applies to personal liability for negligence if directors have not violated their duty of loyalty to the corporation .

b. When directors have personal transactions with the corporation, the transactions are vigorously scrutinized—and are voided if there is unfair advantage.

c. Although the radio advertising expenditure was not agreed to by resolution of the entire board, it is not to be considered ultra vires (“beyond the power”) of the board b/c the members authorized it individually.

Structural Bias Theory : Says there is no such thing as an independent board member; after a certain amount of time, all board members have some level of bias (new, cynical view of boards).

Benihana of Tokyo, Inc. v. Benihana, Inc. : (pg. 341)

Benihana needed to renovate so they hired Morgan Joseph to come up with a plan to raise capital. Abdo was on the board at Benihana, but he was also on the board at BFC. BFC offered to provide the capital based on the plan Joseph had arranged to raise money for renovations. Abdo made the presentation to the Benihana board on behalf of BFC. However, at that time the board was not specifically informed that Abdo was the

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person at BFC who was actually doing the negotiations with Benihana. Upon agreement, Abdo sent a memo to Joseph, Schwartz (CEO of Benihana), and Dornbush (counsel for Benihana) listing the terms of the agreement. He did not send this memo to all the members of the board. The trial court found the board was NOT informed that abdo had negotiated the deal on behalf of BFC. A few weeks later, Schwartz sent a letter to the board saying it should abandon the transaction and seek other funding based on the directors’ conflicts, the dilutive effects of the deal, and questionable illegality—this was on behalf of Aoki (WHY DID AOKI REALLY WANT TO DO THIS??)

o Issue: Whether Abdo breached his duty of loyalty when he used Benihana’s confidential information against Benihana?

o Rule :

Begins the Second Type of Loyalty Claims:

Broz v. Cellular Information Systems, Inc.: (pg. 347) (Gives factors to determine whether what happened was fair—if not fair, then it was disloyal.)

Broz owned RFBC and also served on the board of CIS. RFBC owned MI-4 cellular area and Mackinac Corp owned MI-2 cellular area, both in rural parts of Michigan. Mackinac contacted Broz to see if he wanted to buy MI-2. CIS had just come out of BR and had divested of several cellular licenses AND Broz even told CIS’s CEO that he might buy MI-2. The CEO of CIS did not object. At the same time, Pri-Cell was trying to buy CIS. Pri-Cell was also trying to buy MI-2; they submitted an offer that would stand unless someone offered $500K more than Pri-Cell’s offer. Broz offered $500k over Pri-Cell’s offer and bought MI-2. Nine days later Pri-Cell acquired CIS and CIS brought suit against Broz for breaching his fiduciary duty to CIS by usurping a corporate opportunity that belonged to CIS, and that Broz should have “formally submitted to CIS’s board.”

o Issue : Whether the Corporate Opportunity Doctrine is implicated only in cases where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity?

o Rule : Yes, the Corporate Opportunity Doctrine is implicated only in cases where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corp and the self-interest of the director as actualized by the exploitation of the opportunity.

a. Notes : Broz was within his rights b/c: i. the opportunity became known to him in his individual, and not

corporate, capacity, ii. the opportunity was more closely related to the business of RFBC

than CIS, iii. CIS did not have the financial capacity, and iv. CIS was aware of Broz’s potentially conflicting duties to RFBC and

did not object to his actions on RFBC’s behalf.

Corporate Opportunity Doctrine: The corporate opportunity doctrine is the legal principle providing that directors, officers, and controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation.

The corporate opportunity doctrine is one application of the fiduciary duty of loyalty The corporate opportunity doctrine only applies if the opportunity was not disclosed to the

corporation. When the corporate opportunity doctrine applies, the corporation is entitled to all profits earned by

the fiduciary from the transaction.

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If the opportunity was disclosed to the board of directors and the board declined to take the opportunity for the corporation, the fiduciary may take the opportunity for him- or herself.

How is an Interested Insider Transaction different from the Corporate Opportunity Doctrine?

a. In a Interested Insider Transactions a Corp Officer is making money, whereas in a Corp Opportunity some Officer or Corporation is spending money

*** 4 Factor Corporate Opportunity Test: 1. Is the corporation financially able to exploit?2. Is the opportunity within the corporation’s line of business?3. Does the corporation have an interest or expectancy in the

opportunity?4. Is the opportunity within the official or individual capacity?

What are Broz’ options if he wants to buy MI-2?a. He can get formal ratification from the board of CIS, orb. He can quit his position on the board at CIS

In re eBay, Inc. v. Shareholders Litigation : (pg. 352)

Goldman Sachs “rewarded” lots of eBay directors and officers by allocating to them thousands of IPO shares, managed by Goldman Sachs, at the initial offering price. Shareholders of eBay filed a derivative suit against those eBay directors and officers on the grounds that such conduct usurped a corporate opportunity that belonged to eBay, which regularly invested in marketable securities, and constituted a breach of fiduciary duty of loyalty.

o Issue : Whether corp officers usurp a corp business opportunity when they accept IPO allocations at the initial offering price instead of having those allocations offered to the corp? Whether Goldman Sachs aided and abetted a breach of fiduciary duty when it made these allocations while knowing the corp’s officers owed a fiduciary duty to the corp?

o Rule : (1) Yes and (2) Yes. c. Notes : The concern of the shareholder in this case is that if some bank

comes along later that could do the job of Goldman Sachs at a better deal, the Officers of eBay will be persuaded by opportunity of kickbacks—therefore they might not be getting the shareholders the best deal

d. Spinning : Allocation of shares of lucrative IPOs of stock to favored clients.

Sinclair Oil Corp. v. Levien : (pg. 357) (When to apply the BJR vs. when to apply the Intrinsic Fairness Test.)

Appeal by Sinclair from an order for an accounting in a derivative action brought by Levien (minority shareholder) to account for damages sustained by Sinven (wholly owned subsidiary of Sinclair—located in Venezuela) for breach of fiduciary duty, overpayment of dividends, and denial of industrial development. It is not disputed that Sinven was a wholly owned subsidiary and that the Board was nominated by Sinclair and that Sinclair owed Sinven a fiduciary duty. Trial court found that b/c of the fiduciary duty, the BJR did not apply. Instead the court said the “Intrinsic Fairness” test should be applied. Sinclair argues the court should apply the BJR.

o Three claims:

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e. Too much dividend payment (like the Ford case). This doesn’t hold up b/c the money paid out went in equal proportion to the Plaintiff and to the Defendants. Sinclair had 97% and Levien had 3%, but at what percentage does this become a problem? At what percentage of ownership does a shareholder start to have to deal with lawsuits of this nature?

f. Foregone Business Opportunityg. Breach of Contract—Sinclair was found liable here b/c the other subsidiary

that had a contract with Sinven breached its contract. o Issue : Should the Intrinsic Fairness Test be applied to business transactions where a fiduciary duty

exists but is NOT accompanied by self-dealing?o Rule : No, the Intrinsic Fairness Test does not apply where a fiduciary duty exists between a parent

and subsidiary in the absence of self-dealing.h. Notes : Intrinsic Fairness Test did not apply here because there was not self-

dealing. The dividend payments in question went to Sinclair, but they also went, in equal proportion, to the minority shareholders of Sinven.

i. HOWEVER, wrt the allegation that Sinclair did engage in self-dealing when it forced Sinven to contract with Sinclair’s wholly owned subsidiary Sinclair International Oil, and then failed to abide by the terms of that contract, the Intrinsic Fairness Test did apply. AND b/c Sinclair could not show (under the Intrinsic Fairness Test) that its action under the contract were intrinsically fair to Sinven’s minority shareholders, Sinclair was required to account for damages under that claim.

Intrinsic Fairness Test: Involves both a high degree of fairness and a shift of the burden of proof to the Defendant who must show, subject to careful judicial scrutiny, that its transactions with the Plaintiff (Sinven in this case) were objectively fair.

***When to apply the Intrinsic Fairness Test: Only when the fiduciary duty is accompanied by self-dealing There must be self dealing. Self dealing is the situation when the parent is on both

sides of a transaction with a subsidiary. It shifts the burden and puts the burden on the majority shareholder to show that the

transaction with the subsidiary was objectively fair. If there is NO self dealing then the court relies on the business judgment rule

Zahn v. Transamerica Corporation : (pg. 361)

Axton-Fisher had three kinds of stock: preferred, class A, and class B. The charter said that upon liquidation a set amount was to go to the preferred stockholders with the remainder of the assets to be distributed to the A and B stockholders. Class A holders were to receive twice the amount per share as the B holders, but the charter also said the A stock could be redeemed by the board by paying $60/share plus unpaid dividends. Over time, Transamerica bought 80% of the class B stock and 2/3rds of the overall voting stock—they had also appointed the Board by electing a majority of the Board members. Between 1942 and 1943 that tobacco assets of Axton-Fisher went from $6 million to $20 million. B/c of this, the Transamerica controlled Board of Axton-Fisher redeemed the class A stock and then sold the assets of the corporation, thereby liquidating it and benefitting Transamerica who owned most of the remaining non-preferred stock.

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o Issue : A suit can be maintained by a minority shareholder against a majority shareholder where the majority uses his vote for personal benefit at the expense of the minority.

o Rule : There are two bases for such a suit: 1) A dominant shareholder has the same fiduciary duties as a director, and

when he benefits from the dealings in the corporation he has the burden of proving good faith in the transaction and also fairness to minority interests;

2) Also, when a director votes for the benefit of an outside interest, rather than for the benefit of the shareholders as a whole, there has been a breach of duty.

j. Notes : This case shows that a majority shareholder owes a fiduciary duty to the minority, even though he is only acting as a shareholder.

Fliegler v. Lawrence: (pg. 367)

Lawrence, President of Agau, acquired certain properties under a lease-option for $60,000. Lawrence agreed to transfer the properties to Agau, but after talking to Agau’s Board it was determined that Agau’s legal and financial position would not allow the acquisition and development at that time. Agau’s directors decided to transfer the properties to USAC, a closely held corporation formed for this purpose and a majority of whose stock was owned by Agau directors, so the capital could be raised through the sale of stock, without risk to Agau. Agau was also granted the option to purchase USAC if the properties later became commercially available. In 1970, upon vote of the shareholders, Agau exercised to option to acquire USAC. Agau was to deliver 800,000 shares of its restricted investment stock for all authorized and issued shares of USAC. The Board voted to do this and a majority of shareholders approved. Shareholders brought a derivative suit on behalf of Agau to recover the 800,000 shares and for an accounting, claiming the officers and directors wrongfully usurped a corp opportunity and profited from it.

o Issue : Whether ratification of an interested transaction by a majority of fully-informed shareholders shifts the burden of proof to the objecting shareholder (P) to demonstrate that the terms of the transaction are so unequal as to amount to a gift or a waste of corporate assets?

o Rule : Yes, ratification by a majority of the disinterested shareholders does shift the burden to the objecting shareholder (P) to show the terms of the transaction are so unequal as to amount to a gift or a waste of corporate assets.

k. You can still prevail without ratification, but it is still possible, you just have the burden to prove it is intrinsically fair.

l. Notes : Generally, the rule is the burden of proof involving an interested director or officer is on that director/officer to prove the transaction was intrinsically fair.

In re Wheelabrator Technologies, Inc. Shareholders Litigation : (pg. 370)

Waste Management bought 22% of WTI. Two years later Waste and WTI negotiated a merger in which: 1) Waste would acquire another 33% of WTI stock, and 2) WTI shareholders would receive .574 WTI shares and .469 Waste shares for each WTI share they held. WTI has a Board meeting w/ presentations where all speakers declared the transaction was “Fair”; all board members voted in favor and later majority if WTI shareholders approved the agreement.

o Issue : Does fully informed, good faith shareholder ratification serve to extinguish a duty of loyalty claim?

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o Rule : No . A fully informed, good faith ratification does not extinguish a duty of loyalty claim, but it serves to make the BJR the applicable review standard with the burden of proof resting on the Plaintiff stockholder.

Disclosure Claim : DE law says the Board has a fiduciary duty to disclose all material facts to the shareholders. The P’s only argument was that the Board meeting to “carefully consider” the merger was “only 3 hours” and therefore not long enough for them to have fulfilled their duty to “carefully consider” the merger, therefore breaching their fiduciary duty.

a. The court dismissed this notion, saying the basis of a short meeting was not enough to assume the Board had not come to an informed decision. The court noted that Board members of the two companies had been working together for two years.

Fiduciary Duty Claim : Since the disclosure claim was rejected by the court, the court has decided the merger was approved by a fully informed vote of a majority of WTI’s disinterested stockholders.

The Duty of Care Claim : Since the court said the shareholders’ vote was fully informed, the duty of care was met by the Board—they had ratification.

*** The Duty of Loyalty Claim: Two kinds of claims:

1) “Interested” transactions between a corporation and its directors. i. These transactions are not voidable if approved in good faith by a

majority of disinterested stockholders. ii. The good faith approval invokes the “Business Judgment Rule” and

limits judicial review to issues of gift or waste w/ the burden of proof on the attacking party

1. When there is an interested director transaction with majority ratification of the fully informed disinterested shareholders the “Business Judgment Rule” is used, with the burden of proof shifting to the Plaintiffs.

2) Cases involving transactions between the corporation and its “controlling shareholder”.

i. These usually involve parent-subsidiary mergers conditioned upon receiving a majority of the minority stockholder approval.

ii. The standard of review here is usually “Entire Fairness”, with the burden of proving the merger was unfair falls on the Plaintiff.

1. When there is a controlling shareholder involved in a merger the court uses the “Entire Fairness” doctrine to review the merger, with the burden of proof shifting to the Defendant

When there has been ratification, what happens next depends on whether the D is a Director or a controlling shareholder. If you have a circumstance where there is alleged disloyalty from a controlling shareholder, even if you have ratification on

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the part of shareholders, the burden shifts back to the P to show the transaction fails the Entire Fairness Test.

a. How do you Prove “Unfairness”? See Broz and Sinclair. See § 144 of DE General Corp Law on Page 118 in Supplement.

ii. Roadmap for Fiduciary Duty of Loyalty : Identify the act

a. Interested Insider Transactions – ID the act and the Defendantb. Corporate opportunity – ID the act and the Defendant

Apply BJR. The burden is on the Plaintiff to show fraud, illegality, or self-dealing (or Carelessness or Non-feasance)

Ratification—ask whether the act in question was ratifieda. To prove this there is a shift in burden to the Defendant (the following

applies to the Defendant’s burden of proof):i. § 144(a)(1): Board Ratification

ii. § 144(a)(2): Shareholder Ratification1. If you get either (a)(1) or (a)(2) ratification, then you are

once again concerned with either the Interested Insider Transactions or Corporate opportunity act.

a. If the act in question is a Duty of Care case and it is shown to be ratified by the Def, then case is over

b. If the act in question is a Duty of Loyalty case and it is shown to be ratified by the Def, and the Def is a Director or Officer then the Plaintiff is out of luck. The burden gets shifted back to the Plaintiff to try to prove Waste or something like that—this is functionally a loss b/c they won’t prove Waste (probably). If the Def is a Controlling Shareholder w/ ratification, the burden goes back to the Plaintiff who then has to prove the act was “Unfair”

iii. § 144(a)(3): No Ratification § 144(a)(3): If no Ratification then all that is left is an analysis of “Fairness” which

must be shown by the Defendant. a. Use the Broz Factors to determine if it is “Fair” for Corporate opportunity

actsb. Use the Beyer case to determine if it is “Fair” for Interested Insider

Transactions acts

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C. OBLIGATION OF GOOD FAITH

III. Obligation of Good Faith:I. Obligation of Good Faith: These cases trace the “triad” of care, loyalty, and good faith. They show the

obligation of good faith in two key areas: executive compensation and oversight.

In re The Walt Disney Co. Derivative Litigation : (pg. 376)

Eisner hired Ovitz as President of Disney. He was fired a year later b/c the relationship was not working out. Upon being fired Ovitz got about $130 million, in accordance w/ his contract. This was a derivative suit alleging breach of the duty of care of a fiduciary on the part of 1) Eisner and the Board and 2) Ovitz. This was also an action for breach of fiduciary duty for Waste. This was very costly for Disney to fight, but ultimately the BJR was used and Disney, the Board, Eisner, and Ovitz all got off.

o Issue: o Rule:The law presumes that in making a business decision the directors of a corp acted on an

informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. That presumption can be rebutted if the Plaintiff shows that the directors breached their fiduciary 1) duty of care or 2) of loyalty 3) of acting in bad faith. If that is shown, the burden then shifts to the director defendants to demonstrate that the challenged act or transaction was entirely fair to the corporation and its shareholders.

Bad Faith Continuum:a. The most culpable kind of Bad Faith is “Subjective Bad Faith.” This is

fiduciary conduct motivated by an actual intent to do harm. This is “Disloyal.” Examples:

i. A Fid intentionally acts with the purpose other than that of advancing he best interests of the corporation

ii. The Fid acts with the intent to violate applicable lawb. The middle ground of Bad Faith is “Intentional dereliction of duty.

Conscious disregard for one’s responsibilities”—this is Recklessness. This middle-ground is also “Disloyal.”

c. At the other end of the continuum of Bad Faith is Gross Negligence, which is the breach of the duty of care, but is not “Disloyal.” It is defined, in part, as “A failure to inform one’s self of available material facts.” Without more than this, Gross Negligence CANNOT be considered Bad Faith.

Notes: The plaintiffs also alleged that Ovitz breached his duty as an officer and director to the corporation by maximizing his own interest in his employment and termination negotiations at the expense of the corporation. The defendant directors and Ovitz moved to dismiss these claims. In declining to dismiss the plaintiffs’ claims, the court concluded that the allegations supported claims for breach of fiduciary duty against the directors because they failed to make any good faith attempt to fulfill their fiduciary obligations in the hiring and termination of Ovitz. The Disney case is important for two reasons. First, it offers guidance to corporate managers and executives regarding the boundaries of acceptable corporate behavior in the context of hiring and terminating executive employees. Specifically, at a minimum, directors must carefully consider the proposed compensation packages of

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officers and executives before approving them. Depending upon the circumstances, in the hiring of top executives, directors should strongly consider: (1) retaining a compensation consultant; (2) reviewing in advance of approval all agreements pertinent to the hiring, the estimated costs of the compensation package that they are approving, and the compensation of similarly situated executives at other firms; and (3) engaging in meaningful and critical discussion regarding the proposed terms of the hiring (and retaining a written record of such discussion). Officers too, cannot engage in conduct that unfairly benefits them at the company’s expense. Thus, in negotiating their personal employment matters, they must do so in a fair and impartial manner. The case is also important, because it may serve as a warning to corporate decision-makers that Delaware courts, and possibly other states’ courts, may not permit them to hide behind the business judgment rule for failing to act in good faith in carrying out their duties.

Jones v. Harris Associates, L.P. : (pg. 392)

P’s sued, complaining the fees for the mutual fund in question were too high; they argued the mutual funds advisors were being paid too much b/c the determination of the fees was based on “market prices.” The court disagreed, saying the percentages paid to advisors were reasonable if tied to market rates b/c investors would sell the mutual fund and buy a different one if the fees were too high. This is just a case that articulates the argument in favor of the market, as opposed to regulation. This case also makes the point that the market is the best tool to determine reasonable fees and that “reasonableness” imposed by courts and judges would not be better.

Notes on “Oversight” pg. 395:

Directors are not expected to know all details of a company, but should have basic knowledge of how the business works, keep informed of the business’s activities, engage in general monitoring of corporate affairs, attend board meetings regularly, and routinely review financial statements.

Directors must attempt in good faith to ensure that a corporate information and reporting system is in place and is adequate. Failure to do this might render a director liable for losses caused by non-compliance with applicable legal standards.

“Caremark Claim”: only a “sustained or systematic failure” of the board to exercise oversight—such as a complete failure to assure a reasonable information and reporting system exists—will establish the lack of good faith necessary to have liability.

Stone v. Ritter : (pg. 396)

The lawsuit alleged that the directors of AmSouth had breached their duty to act in good faith because, while AmSouth maintained a program to monitor Bank Secrecy Act compliance, the program was not adequate to prevent the violations giving rise to the fines and civil penalties. The Chancery Court dismissed the complaint on the basis that, under Caremark, directors can only be liable in situations involving a sustained or systematic failure of the board to exercise oversight, and the Court found that the complaint did not establish the requisite lack of good faith on which to base liability. Prior to Caremark, the duty of corporate directors in instances of corporate wrongdoing was defined by the rule announced in Graham v. Allis-

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Chapter 6: Problems of Control:

Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling

Plaintiff and Haley each owned 315 out of 1000 shares of Defendant company, Ringling Brothers-Barnum & Bailey Combined Shows, with the remaining 370 shares owned by another defendant, John Ringling North. The company’s board was comprised of seven members, and if each shareholder voted independently the most likely outcome would be for each shareholder electing two board members with North selecting the extra member. However, in 1941 Plaintiff and Healey contracted to pool their votes, wherein each selected two members and then used their remaining votes to select a fifth member of their choosing. The contract called for an arbitrator, Karl Loos, to resolve any disputes. The contract was terminated a year later with the parties still bound by the arbitrator provision that called for Loos to help decide how to vote. In 1946, Haley could not attend the meeting and sent her husband in her place, and instead of following Loos’ advice he chose to move for adjournment. Plaintiff and Defendant voted their shares, and Plaintiff brought this action to force Healey to vote according to Loos’ decision. Healey argued that the agreement between her and Plaintiff was invalid as it took the voting power away from the shareholders and gave it to a third party (Loos).

o Issue: The issue is whether the agreement between Healey and Plaintiff to pool their votes was valid.o Rule: Shareholders can agree to pool their votes and have a third party intercede when there is any

disagreement as to how to vote

II. Publicly held corp vs. Privately held vs. Widely held vs. Closely Held:i. Private is close to Closely held. Public is close to Widely held.

But you could be Widely held (by lots of people) but NOT be Publicly traded. a. You might want to do this to avoid the regulation that comes along with

being publicly traded. A lot of subsidiaries of Public corps are these Private and Closely held corps.

McQuade v. Stoneham:

McQuade (P) and McGraw (D) each bought 70 shares of stock in the NY Giants baseball team from Stoneham (D) in exchange for an agreement an agreement to preserve themselves as directors and officers of the company. The agreement also prohibited the amendment of salaries, shares, or bylaws of the corp except the unanimous consent of McQuade, McGraw, and Stoneham. McQuade was made Treasurer of the corp, but later the Board of 7 men voted him out of office, with McGraw and Stoneham abstaining, and in contravention of their agreement.

Issue: Whether a shareholder agreement that precludes a Board of Directors from changing officers, salaries, or retaining individuals in office is void and illegal?

Rule: Yes, a shareholder agreement is illegal if it prohibits the Board from changing Officers, salaries, or policies or retaining individuals in office, absent express contractual consent of the parties.

o Notes: McQuade, McGraw, and Stoneham entered into an agreement to make sure all three of them stayed in office. After McQuade was pushed out and the law suit ensued, the D’s argued that any contract that compels a director to vote to keep a particular person in office and at a stated salary is illegal. P argues the opposite; an agreement amount directors to continue a man as an officer of a corp is not to be broken as long as the officer remains loyal to the corp. The court said that Directors may not by agreements entered as stockholders abrogate their independent judgment. There is nothing wrong with a majority (or minority) uniting to make their powers felt, but this power to

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unite is limited to the election of directors and is not extended to contracts whereby limitations are placed on the power of directors to manage the business of the corporation by the selection of agents at defined salaries. Basically the Court said that the contract in question (to keep McQuade in power) was not legal. Also, the job of the court in this case is not to protect McQuade from the possibly immoral decision of Stoneham and McGraw to push him out of the company. The job of the Court is to protect the shareholders’ investment. The courts do not enforce “mere moral obligations.”

Clark v. Dodge

Defendant companies, Bell & Company, Inc. and Hollings-Smith Company, Inc., were co-owned by Plaintiff (25% of shares) and Defendant (the remaining 75% of shares). The companies manufactured medicine, the formulae that were known only by Plaintiff. Plaintiff entered into an agreement with Defendant wherein Plaintiff agreed to disclose the formulae to the son of Defendant in return for a promise that Defendant would keep Plaintiff as a director and would be entitled to 25% of all net income providing that Plaintiff was competent in his position. Afterwards, Defendant did not vote Plaintiff in as director, stopped delivering 25% of the income to Plaintiff. Plaintiff sought reinstatement and money owed from the stopping of payments and money wasted by Defendant. Defendant countered, citing McQuade v. Stoneham (263 N. Y. 323), that the agreement was invalid because it required Defendant as a shareholder to usurp the directors’ judgment.

o Issue: The issue is whether the agreement between Plaintiff and Defendant was invalid as an over-reaching agreement between shareholders to control powers of the directors.

o Rule: An agreement between shareholders, wherein the shareholders entering the agreement are the only shareholders of the company, is valid even if the agreement contemplates controlling management decisions

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