I. GeneralA. What kind of Business is this?

1. Sole Proprietorship (SP) - “a biz in which one person owns all the assets, owes all the liabilities, and operates in his or her personal capacity.”

a) Pros - Most common – simplest structure; best if choosing to work along; easy to form, offers complete managerial control – YOU make all the decisions; Biz earnings only taxed once (no double taxation)b) Cons – owner is PERSONALLY LIABLE for ALL financial obligations of biz; places own assets at risk; no liability protection; difficult to raise $; must depend on own financing sources (loans, home equity, etc.); Banks reluctant to make biz loans to SP’s

(1) E.g. D sells comic books to T (which is an SP), Cam in middle as an agent dealing w/3rd party on behalf of D

2. Partnership – “voluntary association of 2 or more person’s who jointly own & carry on a biz for profit. Agree to share in profits & losses of biz”

a) General Partnerships (GP) – partners manage the co. & assume responsibility for the P’s debts & other obligations; Pros: (1) Good for 2 or more parties who want to be actively involved AND (2) Easier to formb) Limited Partnership (LP) – serve as INVESTORS ONLY; CON - NO CONTROL over the co., but PRO: they’re not subject to the same liabilities as GP’sc) PROS: (1) Shared liability; (2) “Pass through tax” – losses are “passed through” to report on individual income tax returns d) CONs: (1) TRUST ISSUES: One person can make decisions w/o consulting other partner, binding on P’ship; (2) each p personally liable for financial obligs of the biz (like SP); (3) More expensive to establish b/c requires more extensive legal & acct’ing services

(1) NOTE: Probly Not best choice for a new biz b/c of (1) all the required filings & (2) admin complexities, UNLESS you expect to have MANY PASSIVE INVESTORS

3. Corporation – “an entity (usu. A biz) having authority under law to act as a single person distinct from the shareholders who own & it & having rights to issue stock & exist indefinitely…”

a) PROS - (1) No individual liability – limited liability (you’re only liable for the amt of your investment in the co., e.g. buy starbucks for $2, & it goes out of biz, all you lose is $2); (2) Ability to raise $ by selling stocks, (3) Duration: Corp’s continue INDEFINITELY – even if shareholders die, sell shares, or become disabled

(1) NOTE: Subchapter corporation (SCorp) avoids double taxation by allowing income or losses to be passed through on individual tax returns, similar to a partnership

b) CONS - (1) Double taxation – taxes on the profits (a) Dividend to owners gets taxed too (2) Expensive to create corp [admin filings etc.]

4. Hybrids – Popular b/c they give you limited liability AND less costly: LLC’s, LP’s, etc.

B. Key Terms 1. Debt – “a specific sum of money due by agreement or otherwise”2. Creditor – one to whom a debt is owed3. Equity - typically used in this class as some ownership interest in an entity, property, esp. in a biz; e.g. value in house,

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4. Shareholder – same as “equity owners”/ “stockholders” one who owns or holds a share or shares in a co.5. Owner – one who has the right to possess, use, and convey something6. Residual owner – one who will reap the marginal dollar of the firm’s gain or suffer the marginal dollar of its losses

a) E.g. – Home + mortgage, HV (worth/value) = 200K, Mtg (creditor), owe 100K, subtract, to get 100K, and you are residual owner; but if you owe more than its worth, then you are the lowest entity to get anything

II. Agency Relationship: BA 1‐13 Rest. 2d §§ 1, 3; Rest. 3d §§ 1.01‐1.03A. Agency Structure: Three parties- P, A, Third PartyB. Is there a P, an A, and a 3rd party?C. Did P manifest assent for A to act on P's behalf/in P's control? Did A manifest assent or otherwise consent to act?

1. RULE: Restatement (Third) § 1.01: (1) a P (2) manifests assent to (3) an A (3) that the A shall act on the P's behalf and (4) subject to the P's control, and (5) the A manifests assent or otherwise consents so to act.

a) P's assent = unexpressed reservations or limitations harbored by the P do not restrict the P's expression of consent to the A.

(1) So, if A is otherwise on notice of the meaning the P ascribes to a particular expression, that meaning is operative as between P and A. (2) A P's manifestation of assent to an agency relationship may be informal, implicit, and nonspecific

b) "manifests assent or otherwise consents so to act," = not necessary that A manifest assent to the P.

2. Did P & A call it "Agency"? Doesn't matter. Only agency if elements of § 1.01 are present. § 1.023. Was assent &/or intent manifested? § 1.03-- written or spoken words or other conduct.

a) conduct (1) by a person (2) observable by others (3)which expresses meaning (broader than communication)b) State of mind may not be relevant if it is not manifested.

4. Who is an A? RULE: a party who agrees to act on behalf of a 2d party & subject to their control. Gorton v. Doty. [H.S. Coach borrows car]

a) HARNER: agency has: fact intensive determination, emphasis on control, & least cost avoider

5. Who is a P? RULE: agency relationship can be established w/o a K being formed or w/o the parties intending to be bound by the legal obligations of that relationship. Jensen v. Cargill. CONTROL.

a) HARNER: (1) advising Cargill in the future?

(a) Set up a separate affiliate for financing, and be sure to respect the differences between your 2 mechanisms. Franchise—assume liability, but have more control.(b) If there's a default on a line of credit you extended, shut down the loan, collect what you can, and mitigate your risk.

6. Common Issues: a) Does agency relationship exist Between P & A?b) What consequences follow to P from interaction between A & T?

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III. Agency Rel’t -- IS THERE A K BETWEEN A & T? Liability of Ps to third parties in K

A. WHAT KIND OF AUTHORITY IS THERE? 1. Did P tell A to do something? RULE for ACUTAL AUTHORITY: [(PA)]: when, at time of taking action that has legal consequences for the P, the A reasonably believes, in accordance with the P's manifestations to the A, that the P wishes the A so to act. §2.01

a) Was it Express? Actual express- P tells A to do X; A does X; P is boundb) Was it Implied? Actual Implied- If, in order to do X, A must take some other steps, P is bound.

(1) Implied authority is actual authority that is proven circumstantially to indicate that the P intended to delegate powers to the A that are necessary for carrying out the A’s duties, and one major circumstantial factor is prior work performed by A for P. Mill Street Church v. Hogan

(i) Two things to consider w/ implied authority: (a) past or present conduct of the P that the P wishes him to act a certain way(b) The nature or task of the job §2.02 Scope of Actual Authority

2. Did P's actions cause T to think A had authority? RULE for Apparent Authority [PT]: (1) 3rd party reasonably believes, (2) that A or other actor has authority to act on behalf of the P, b/c (3) that belief is traceable P's manifestations.

a) P's manifestation does not have to be a direct statement. Dweck v. Nasser [T thought P's atty could act]b) Absent knowledge on the part of T to the contrary, an A has the apparent authority to do those things which are usual and proper to the conduct of the business which he is employed to conduct." Three-Seventy Leasing [A's dealing w/ T was enough to bind P despite lack of P's signature].

3. Was P undisclosed? RULE for Liability of Undisclosed P: § 2.06a) (1) An undisclosed P is can be liable to a T who is justifiably induced to make a detrimental change in position by an A acting on the P's behalf and without actual authority, if the P, having notice of the A's conduct and that it might induce others to change their positions, did not take reasonable steps to notify them of the facts. b) (2) An undisclosed P may not rely on instructions given an A that qualify or reduce the A's authority to less than the authority a third party would reasonably believe the A to have under the same circumstances if the P had been disclosed.

(1) Can't use a "I didn't know b/c I thought he'd rely on my instructions" defense). Watteau

B. WAS K RATIFIED? I.e. Did P give after-the-fact acceptance?1. RULE: § 4.01 Ratification Defined [meant to address the after-the-fact acceptance by a P]

a) (1) Ratification is the affirmance of a prior act done by another, whereby the act is given effect as if done by an A acting with actual authority.b) (2) A person ratifies an act by

(1) (a)[Express affirmation] manifesting assent that the act shall affect the P's legal relations, OR

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(2) (b) [Implied Affirmation] Conduct that justifies a reasonable assumption that the person so consents.

(a) accepting benefits at a time when it's still possible to decline the benefits(b) silence or inaction when affirmative action expected (c) by filing a lawsuit to enforce the K

c) (3) Ratification does not occur unless(1) (a) A acted or purported to act like an agent. § 4.03 (Boticello),(2) (b) ratifier has capacity § 4.04 (3) (c) ratification is timely. § 4.05 (no circumstances occurred that would have an adverse effect on the rights of T), and(4) (d) ratification encompasses the act in its entirety § 4.07 (self-explanatory).

d) HARNER: Ratification's two basic requirements: (1) A valid affirmation by P, (2) to which the law will give effect.e) SUB RULE: § 4.02 Effect of Ratification

(a) (1) Subject to the exceptions stated in subsection (2), ratification retroactively creates the effects of actual authority.(b) (2) Ratification is not effective:

(i) (a) in favor of a person who causes it by misrepresentation or other conduct that would make a contract voidable;(ii) (b) in favor of an A against a P when the P ratifies to avoid a loss; or(iii) (c) to diminish the rights or other interests of persons, not parties to the transaction, that were acquired in the subject matter prior to the ratification.

(2) Notes: Questions to ask in a ratification case: (a) (1) what types of acts constitute an affirmation by the P?(b) (2) what effect should we give to that affirmation?

f) Sub-Rule: 4.06 Sufficient Knowledge: Not bound by ratification made without knowledge of material facts when the person is not aware of such lack of knowledge

C. RULE: ESTOPPEL: Rest. 3d § 2.05 Estoppel to Deny Existence of Agency Relationship: A person who has not made a manifestation that an actor has authority as an A and who is not otherwise liable as a party to a transaction purportedly done by the actor on that person's account is subject to liability to a T who justifiably is induced to make a detrimental change in position because the transaction is believed to be on the person's account, if:

1. (1) the person intentionally or carelessly caused such belief, or2. (2) having notice of such belief and that it might induce others to change their positions, the person did not take reasonable steps to notify them of the facts.3. HARNER: Elements:

a) P creates, through intentional or negligent words, acts or omissions, appearance of authorityb) T reasonably and in good faith relies on appearance of authorityc) T changes her position in reliance on appearance of authority

(1) HARNER: Bottom line on estoppel- we're not quite as broad as Koos bros might suggest.2.05 focuses on intentionally or carelessly caused such belief or has notice of the issue. Estoppel is similar to apparent authority, but the difference is that in apparent authority we have a P-A relationship.

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4. A's Liability on the K: Atlantic Salmon A/S v. Currana) §6.01 Disclosed P-DP is the party to the K with T, not A, unless A & T agree otherwiseb) §6.02 Unidentified P- P & A are both parties to K w/ T unless A & T agree otherwise c) §6.03 Undisclosed P- P is a party unless excluded, A & T are parties tood) §6.04 P Does not Exist or lacks capacity- a person who makes a K with a T, purportedly as an A on behalf of a P, becomes a party to the K if the purported A knows or has reason to know that the purported P does not exist or lacks capacity to be a party to a K. Atlantic Salmon v. Curran

IV. Liability of P to Third Parties in TortA. RULE: Rest. 3d § 7.03 P's Liability - In General

1. (1) P is subject to direct liability to a 3rd party harmed by A's conduct when [no need for e/e or IC distinction]

a) (a) as stated in § 7.04, A's conduct is within the scope of his actual authority OR ratified by P, AND

(1) (i) A's conduct is tortious, OR(2) (ii) A's conduct, if that of the P, would subject the P to tort liability; OR

b) (b) P is negligent in selecting, supervising, or otherwise controlling A [§ 7.05]; ORc) (c) the P delegates performance of a duty to use care to protect other persons or their property to an A who fails to perform the duty [§ 7.06].

2. (2) A P is subject to vicarious liability to a T harmed by an A's conduct whena) (a) as stated in § 7.07, the A is an employee who commits a tort while acting within the scope of employment [is it an e/e or i/c relationship [now ic nonemployee A v. i/c nonA service provider]; ORb) (b) as stated in § 7.08, the A commits a tort when acting with apparent authority in dealing with a T on, or purportedly on, behalf of the P.

B. Sub-rule: RS 3rd §7.07 Definition of employee: “[A]n employee is an A whose P controls or has the right to control the manner and means of the A's performance of work”C. Sub-rule: RS 3rd § 7.08 Vicarious Liability: P is subject to vicarious liability for a tort committed by an A in dealing or communicating with a T on or purportedly on behalf of P when actions taken by A w/apparent authority constitute the tort or enable A to conceal its commission.” [E.g. Fraud, Defamation, etc.]D. Sequential Analysis of Tort Liability: Is there and Agency relationship between P & A Is P subject to direct liability? Is P subject to vicarious liability? Is A P's employee or nonemployee A?E. Determining Employee/Nonemployee A/NonA Service provider

1. Service Station Cases:a) Humble OilEmployer [Oil Co]/Employee [Station Operator]/Subordinate [Station worker/tortfeasor]b) Sun OilP [Oil Co.]/ [IC] [Station Operator]/Subordinate [Station worker/tortfeasor]c) Bottom Line--these two were close calls, but the focus is on control and level of risk. The more control, the more likely to be found liable.

2. A K doesn't matter: A K saying the parties are not P-A (or master-servant) does not matter if the P (in this case franchiser) regulates the A with such control as within the definition of agency--the agency relationship arises even though the parties expressly deny it." Murphy v. Holiday Inns

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F. Tort Liability and Apparent Agency-- P liable for acts of an apparent A if P held A out as such and T relied. Miller v. McDonald's

V. Agents as Fiduciaries1. RULE: Rest. 3d §§ 8.01- General Fiduciary Principle: An A has a fiduciary duty to act loyally for the P's benefit in all matters connected with the agency relationship.2. § 8.02- Material Benefit Arising Out of Position: An A has a duty not to acquire a material benefit from a T in connection with transactions conducted or other actions taken on behalf of the P or otherwise through the A's use of the A's position.

a) Any profit A earns while violating duty of loyalty to P belongs to P (when he earns the $ solely through his position). Reading v. Regem

3. § 8.03 Acting As Or On Behalf Of An Adverse Party: An A has a duty not to deal with the P as or on behalf of an adverse party in a transaction connected with the agency relationship.

An employee will be held to his or her contractual duty of loyalty and their fiduciary duty would forbid them from engaging in activities that are competitive with their employer. General Automotive v. Singer

4. § 8.05 Use Of P's Property; Use Of Confidential Information: An A has a duty

(1) (1) not to use property of the P for the A's own purposes or those of a third party; AND(2) (2) not to use/communicate confidential info of P for A's own purposes or those of a 3rd party. Town & Country House & Home Service v. Newberry

5. § 8.08 Duties Of Care, Competence, And Diligence: Subject to any agreement with the P, an A has a duty to the P to act with the care, competence, and diligence normally exercised by As in similar circumstances. (A's special knowledge/skills will be factored in).

[END OF AGENCY]

VI. PartnershipsA. General:

1. Definition of Partnership: a voluntary association of 2+ persons to carry on as co-owners a business for profit. (same in UPA (1914), UPA (1997))2. Difference from Corporations: Partnerships (1) are not taxed, gains and losses taxed at partner level, (2) typically have a limited life, (3) unlimited liability, (4) interests nontransferable3. Partnership as Entity: A partnership is an entity distinct from its partners. (UPA (1997) §201(a))4. Partnership Property: Property acquired by a partnership is property of the partnership & not of the individual partners. UPA (1997) § 203

B. RULE: Who is a partner? UPA (1997) § 202(c) (3) A person who receives a share of the profits of a business is presumed to

be a partner in the business, unless the profits were received in payment:o (i) Of a debt by installments or otherwise;o (ii) For services as an independent contractor or of wages or other

compensation to an employee. [Fenwick. written "partnership" agreement at salon];

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o (iii) Of rent;o (iv) Of an annuity or other retirement or health benefit to a beneficiary,

representative, or designee of a deceased or retired partner;o (v) Of interest or other charge on a loan, even if the amount of

payment varies with the profits of the business . . . [Martin v. Peyton]; OR

o (vi) For the sale of the goodwill of a business or other property by installments or otherwise

Sub-rules: o Is a written agreement necessary to create a partnership? No. Fenwick

(dicta).o Is the existence of a written agreement determinative? No. Fenwick.

Fenwick Court looked at multiple factors: (1) intention of the parties, (2) right to share in profits, (3) obligation to share in losses, (4) ownership & control of the partnership property and business, (5) community of power in administration (right to invest, or make other management decisions), (6) language in the agreement (not just word "partner[ship]" but also what the rest says about the rights/duties of each), (7) conduct of the parties toward third persons, (8) rights of the parties on dissolution. In Southex, court also looked at (9) duration (fixed, but renewable).

EXAM TIP: If a question has a written agreement saying "Partnership" second guess it!

o Partnership by estoppel: creates a liability to third parties who rely upon representations that a partnership exists. PriceWaterhouse. In order to establish a partnership by estoppel, four elements must

be proven: (1) express or implied "holding out," (2) made by one sought

to be charged as a partner, (3) reasonable good faith reliance, & (4) detrimental reliance

C. Is there a dispute between P(s) & 3rd Party as to whether a P acted w/ Authority? RUPA §301:

1. Each partner is an A of the partnership for the purpose of its business. 2. An act of a partner (including the execution of an instrument in the partnership name) binds the partnership if it's apparently for carrying on in:

a) the ordinary course the partnership business, ORb) business of the kind carried on by the partnership

(1) UNLESS: (1) P had no authority to act in the particular matter, AND (2) 3rd Party knew or had received a notification that the partner lacked authority. Nat'l Biscuit v. Stroud.[NOTE: Slight Difference in 1914--"Unless 3rd Party "had knowledge"]

D. Is there a dispute between Ps as to whether a P acted w/ Authority? RUPA (1997) § 401

. . . (f) Each partner has equal rights in the management and conduct of the partnership business

. . . (j) A difference arising as to a matter in the ordinary course of biz of a partnership may be decided by a majority. An act outside the ordinary course of biz of a partnership OR an amendment to the P agreement may be undertaken only w/ consent of all partners. Summers v. Dooley.

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(1) Is there a limit on P's Authority? A partner's authority/equal rights in partnership can be limited by a partnership agreement to certain extents. E.g. authority to make amendments or other decisions outside the ordinary course of business can be made with less than unanimity if the partnership agreement specifies the use of a committee, etc. Sidley & Austin v. Day.

2. RULES: Disclosure a) UPA (1914) § 20: Partners shall render on demand true and full info of all things affecting the partnership to any partner or [his rep.].b) UPA (1997) § 403(c): Each partner and the partnership shall furnish to a partner (or his rep):

(1) w/o demand, any info about the partnership's biz/affairs reasonably required for the proper exercise of the partner's rights and duties under the P agreement or this [Act]; AND(2) on demand, any other info concerning the partnership's biz/affairs, UNLESS the demand/info demanded is unreasonable/improper under the circumstances.

E. RULES: The Partnership Interest1. UPA (1997) § 401(i): a person may become a P only w/ consent of all partners2. UPA (1997) § 501, a P is not a co-owner of partnership property and has no interest in partnership property which can be transferred, either voluntarily or involuntarily.3. UPA (1997) § 502, P's Transferrable Interest: P's only transferrable interest is the P's share of the profits/losses his rights to receive distributions. The interest is personal property. Putnam v. Shoaf

a) Important caveat, In General, an assignment or sale of a partnership "interest" does not make the assignee a partner (see UPA (1997) 503(a)(3).

4. UPA (1997) § 503(a)(2) codifies CL that transfer of an interest does not effect a dissolution of the partnership.

a) A partner who has transferred his interest remains a partner.F. What is Partnership Property? RULES

1. UPA (1997) § 204 codified the CL, laying out 3 rules [Notice these are not in same order in statute]:

o (1) Any asset acquired in the name of the partnership is partnership property if:

A transfer directly to the partnership in its own name a transfer to one or more partners acting in their capacity as partners

and the name of the partnership appears on the transfer 204(a)(1), (b)

o (2) If the partnership is not named, property acquired by one or more partners is partnership property if the document transferring title indicates the buyer was acting in his capacity as a partner. § 204(a)(2)

o (3) Property purchased w/ partnership funds is presumed to be partnership property. §204(c)

Related Rule: UPA (1997) §404(b)(1): P is trustee of partnership property [see duty of loyalty].

G. Financing the Partnership: problem of add'l capital is often highlighted in partnership context b/c there are limited sources for add'l capital and no ability to sell new interests, absent consent.

1. Capital account: a running balance reflecting each partner's ownership equity. UPA (1997) § 401(a)

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H. RULES: Partnership Profits1. UPA (1997) § 401(b) [paraphrased]: profits and are divided equally among Ps & losses follow.

this provision that can be varied by agreement, §103(a).I. Partnerships: Fiduciary Duties--Duty of Care and Duty of Loyalty UPA (1997) §404

(a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections (b) and (c).

(b) A partner's duty of loyalty to the partnership and the other partners is limited to the following:o (1)to account to the partnership and hold as trustee for it any property,

profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;

o (2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and

o (3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.

A partner has a duty to disclose partnership opportunities to allow other partners equal opportunity to take advantage of it. Meinhard v. Salmon

related Rule: UPA (1997) § 103(b): the partnership agreement may not (3) eliminate the duty of loyalty under 404(b) . . . but (i) the agreement may identify specific types or categories of

activities that do not violate the duty of loyalty, if not manifestly unreasonable.

(ii) all of the partners or a number or percentage specified in the partnership agreement may authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyaltyo Ratification acceptable where interested party votes for

merger, b/c "manifestly unreasonable" language from subsection (i) is not in subsection (ii). Perretta v. Prometheus

(c) A partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.o NOTE: More than negligence.

(d) A partner shall discharge the duties to the partnership and the other partners under this [Act] or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing.o A partner can act in his own best interests when planning to leave the

partnership but is still subject to his duty of good faith, and can't lie to the other partners about leaving or use the partnerships resources to start his other company. Meehan v. Shaughnessy

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o No cause expulsion provision in a partnership agreement is okay, and Partners expelling another partner act in good faith, regardless of motivation, when they do not withhold money or property legally due the expelled partner. Lawlis (drunk lawyer expelled after other partners tried to see him through his addiction).

. . .[left out other sections, not important?]J. Is the Partnership Liable?

1. §305(a): A partnership is liable for loss/injury caused to a person, for a penalty incurred, as a result of wrongful act or omission, or other actionable conduct, of a P acting in the ordinary course of biz of the partnership OR w/ authority of the partnership2. §305(b): If, in the course of the partnership's biz OR while acting w/ authority of the partnership, a P receives or causes the partnership to receive $ or property of a 3rd party, and it is misapplied by a P, the partnership is liable for the loss.3. Is the partner liable?

a) §306: (a) Ps are all jointly and severally liable for all obligations unless changed by agreement, (b) a P entered the partnership after the obligation was incurred, or (c) [not on test?].

K. Ending a Partnership: Dissolution or Disassociation1. Dissolution:

a) UPA (1914) § 29: dissolution 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 businessb) § 31: Dissolution is caused:

(1) without violation of the agreement:(a) by the termination of term or occurrence of event specified in the agreement,(b) by the express will of any partner when no term or even specified,(c) by the express will of all partners who have not assigned their interests or lost them to debts, before or after term or event specified in agreement(d) by expulsion of a partner in accordance with such expulsion provisions in agreement

(2) In contravention of the agreement, where no other section of UPA (1914) calls for dissolution, by the express will of any partner at any time;(3) By any event which makes it unlawful for the business of the partnership to be carried on or for the members to carry it on in partnership(4) By the death of a partner(5) by the bankruptcy of any partner or the partnership(6) By decree of the court

c) §32 Dissolution by Decree of Court:(1) on application by or for a partner the court shall decree a dissolution whenever . . .

(a) (c) a partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business(b) (d) a partner willfully or persistently commits a breach of the partnership agreement, or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him, . . .

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(c) (f) other circumstances render a dissolution equitable. P's refusal to do his share of the work, talking about pressuring

another P out of the biz & taking $ beyond agreed amounts is enough. Owen v. Cohen.

Mere bad blood between Ps is not enough. Collins v. Lewis. Power to dissolve subject to fiduciary duties. Page v. Page

d) Dissolution's effect on partnership:(1) After dissolution, the partnership must be wound up, absent agreement among the Ps to carry on the biz.(2) Assuming that the business will not be continued, the winding up process generally contemplates that the firm’s assets will be distributed to the Ps.(3) Authority of Ps to act on behalf of partnership terminated except in connection with winding up of partnership business. UPA (1914) § 33; UPA (1997) § 804.

e) continuation per Agreement: Effect on Partnership(1) Technically creates a new partnership(2) creditors of former partnership automatically become creditors of new partnership. UPA (1914) § 41(4)(3) Must consider the rights of the departing partner

f) Term Partnerships:(1) explicit term:

(a) durations specified in partnership agreement(b) specific purpose/object specified in partnership agreement

(2) Implicit term(a) In Owen, the court found an implied term where one partner loaned $7000 into the partnership to be repaid out of the prospective profits as soon as it could reasonably be paid.(b) In Page, the court held that a $43K distribution by each partner did not constitute an implied term to expire when obligations were paid, instead it was at will, b/c there was no evidence of an intent to end when the obligations were paid.

(3) How do you know if you have an at will or term partnership?(a) explicit term or implied term established by reliable evidence of one or more specific undertakings to be accomplished prior to end of business relationship. UPA (1914) § 31; UPA (1997) § 602.

(i) If at will, a partner can leave at any time. Usually w/o damages unless bad faith conduct.

(a) thus, can't form a partnership to benefit from essentially inside information than exit the partnership to the detriment of copartners.

(ii) If term, generally can't leave w/o penalty, but can always leave with penalty

(a) Liable for damages: UPA (1914) § 38; UPA (1997) §§ 602, 701(i) May include anticipated damages flowing from future business operations.

(iii) If you leave (at will or term) liability to creditors?(iv) Yes for existing obligations §36, 703

(a) Generally no liability for future obligations, BUT, if for term and wrongful departure, damage calculations may consider future obligations of business.

2. After Dissolution:11

a) acquisition of assets/Business by some partners(1) Partners can buy business after it is dissolved (in good faith) Prentiss v. Sheffel.(2) Continuation following wrongful dissolution:

UPA (1914) §38(2): When dissolution is caused in contravention of the partnership agreement the rights of the partners shall be as follows:

o (a) Each partner who has not caused dissolution wrongfully shall have, …

II. The right, as against each partner who has caused the dissolution wrongfully, to damages for breach of the agreement.

o (b) The partners who have not caused the dissolution wrongfully, may continue for the agreed term if they secure bond or pay out the P who left, minus liabilities & damages for leaving

o (c) A partner who has caused the dissolution wrongfully shall have: …

II. If the business is continued the right to his interest as mentioned above, but in ascertaining the value of the partner's interest the value of the good-will of the business shall not be considered. Pav-Saver v. Vasso

Note: § 701 is different. No reduction for value of goodwill

§ 40(b): subject to contrary agreement, upon dissolution partnership assets should be distributed as follows: “(I) Those owing to creditors other than partners, (II) Those owing to partners other than for capital and profits, (III) Those owing to partners in respect of capital, and (IV) Those owing to partners in respect of profits.”

§ 40(d): "partners shall contribute, as provided by [§18(a)] the amount necessary to satisfy the liabilities [set forth in § 40(b)]. . . ."

Kovacik Rule: Upon loss of the money the party who contributed it is not entitled to recover any part of it from the party who contributed only services. Kovacik v. Reed.

o EXCEPTIONS: Courts do not apply the Kovacik rule where (1) the service partner was compensated for his work, or (2) the service partner made a capital contribution, even if it was nominal

UPA (1997) §401 Comments: the default (profit/loss) rules apply where one or more of the partners contribute no capital, althought there is case law to the contrary [citing Kovacik].

[END OF PARTNERSHIP]

VII. THE CORPORATION AND LIMITED LIABILITYA. General

1. Definition: Corporation: An entity (usually a business) having authority under law to act as a single person distinct from the SHs who own it and having rights to issue stock and exist indefinitely.2. Critical Attributes:

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a) Legal Personality, Limited Liability Separation of ownership & control MBCA § 8.01(b): Bd of Dirs exercises powers & manages, liquidity secondary trading markets (NYSE, etc.)b) Flexible capital structure can issue/package securities in many ways.

3. FIDUCIARY DUTIES--(When Solvent) FLOW FROM BD OF DIRS TO OWNERS4. Process of Incorporation: draft & file AoI:5. Post-Incorporation: Draft Bylaws (MBCA §2.06), Have organiz meeting (MBCA §2.05)-, Issue Stock6. Liability for Pre-Incorporation Activity:

a) Corporation by Estoppel: treat firm as though it were a corp if the person dealing w/the firm (1) thought it was a corp all along, AND (2) would earn a windfall if now allowed to argue that the firm was not a corp. Camcraft.b) Liability of Promoter: A promoter is liable for the acts of the to-be corporation until released from liability by both the corporation and the third party.

7. Why incorporate? Pros: limited liability; cons: more formalities and rules, and double taxation.

a) Pros for SHs: avoid personal liability, minimize monitoring costs, downplay "free rider" issue

8. Limited Liability & Piercing the Corporate Veil ("PCV")a) Limited Liability: MBCA § 6.22(b): “Unless otherwise provided in the AoI, an SH of a corp is not personally liable for the acts or debts of the corp except that he may become personally liable by reason of his own acts or conduct”b) PCV Rule: Two requirements:

(1) unity of interest and ownership "alter ego":(a) Factors: Commingling of funds, Undercapitalization, treating assets of corp as those of the pvt person or other corp, or Disregard for corporate formalities.

(2) adherence to limited liability would sanction a fraud or promote justice.(a) in the absence of proof of fraud, proving injustice requires more than proof that some creditors will go unpaid. . Sea Land

(i) examples of injustice: unjust enrichment, intentional scheme to put assets into a liability-free corp & heap liability on an asset-free corp, parent corp causes a sub's liability and the sub's limited assets allow them to escape the liability.

(3) Sub-rule: Piercing corporate veil can be effectuated against a person (SH) or larger corp (if the corp that harmed you was one of several small corps controlled by a bigger corp--enterprise liability). Walkovszky v. Carlton (multiple taxi companies) (4) Sub-rules for parent-subsidiary Alter Egos:

(a) use a totality of circumstances test to determine if sub is alter ego of parent:

(i) (1) common Dirs/Offs, (2) common biz departments, (3) file consolidated financial statements and tax returns, (4) Parent finances the sub, (5) Parent caused the incorporation of the sub, (6) Sub operates w/ grossly inadequate capital, (7) Parent pays the salaries/other expenses of the sub, (8) Sub receives no biz except from the parent, (9) Parent uses the sub's property as its own, (10) Daily operations of the 2 corps are not kept separate, (11) Sub doesn't observe the basic corp formalities. In Re Breast Implants

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(a) However, parents are expected—indeed required—to exert some control over their subsidiaries. Limited liability is the exception, not the rule.

(b) "No respondeat superior among subs." R.C. Archbishop of San Fran (c) HARNER: some jurisdictions relax the 2nd element of PCV, particularly w/parent-subs.

(5) Ways to protect against PCV:(a) Can't PCV to officers of corp that acts as GP for an LP even where some of the limited Ps are the officers in the corp, thus limiting their liability and allowing them to control the partnership at the same time. Fridgidaire case.(b) Advice to person starting corp and wanting to avoid PCV:

(i) Avoid personal liability: respect the corp formalities & take out the min insurance(ii) Avoiding enterprise liability (more difficult): Need separate books and bank accounts for each corp, plus careful accounting for supplies, borrowing of prop, etc

9. Types of limited liability entities: Limited Partnerships: GPs still carry personal liability, but Lim Ps generally do not

a) Lim Ps can be held liable as GPs if they exercise significant control of the biz. Holzman

(1) Exception: Revised Uniform LP Act: Lim P only liable to those 3rd parties who reasonably believe . . . that the limited partner is a GP.”

10. Types of limited liability entities: LLCs (Limited Liability Companies): Hybrid: tax advantages of partnership w/limited liability of corp.

a) Capital: Mems contribute one or more forms of capital. ULLCA § 401.b) Is Mem liable? only for loss of capital contrib, not personal assets, except under Agency law if LLC status undisclosed. Westec v. Lanham.c) LLC Created? file Articles of Organization in designated state. ULLCA §202(a), choose name (include "LLC), office for service of process, draft operating agreement.d) Member's Rights: may include:

(1) financial interest, i.e. right to distributions and liquidation participation, AND/OR

(a) can be assignedbut assignee gets other rights if admitted as member by consent of all other members or by provision of the operating agreement. (like partnership rules). ULLCA §§ 501-03.

(2) management rights.(3) Profit and Loss Sharing: absent contrary agreement, most statutes allocate based on value of mems' contributions

(a) Under ULLCA §405(a), distributions must be made in equal shares(4) Withdrawal: mem may WD and demand payment of his interest by giving adequate notice (see statute or LLC's operating agreement)(5) Management Rights:

(a) Member-managed (default rule): Absent contrary agreement, each member has equal rights in the management of the LLC, ULLCA § 401(a)(1)

(i) most matters decided by majority vote, (a)(2)(ii) Significant matters require unanimous consent § (c)

(b) Manager-managed LLC option § 404(b): 14

(i) can be structured as Bd of Dirs, CEO, or both(a) manager(s) can make all decisions other than those in 404(c) w/o member vote(b) manager(s) added or removed by majority vote of members.

(ii) must be specified in Art of Org.(6) Dissociation v. Dissolution:

(a) Dissociation: withdrawal or expulsion of a member. ULLCA § 601

(i) Like RUPA, not UPA. LLC can buy-out dissociated members' interests.

(b) Dissolution(i) winding up of LLC triggered ULLCA § 801.(ii) Events of dissolution by law:

(a) event specified in operating agreement, vote of members (as specified in operating agreement), OR if unlawful to carry on the business

(iii) Events of Dissolution by court order:(a) economic purpose frustrated, OR misconduct by members

e) RULE for Freedom of K in LLC Agreements: LLC's power to K in agreement will not be circumvented by courts unless it expressly violates a statute. Elf v. Jaffarif) RULES for Piercing the LLC:

(1) PCV can be used in LLC Context: There is no law or policy saying PCV should be different for LLCs than Corps. Kaycee case. (even though no statute expressly calls for PCV w/ LLCs)

(a) "A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager." ULLCA § 303(a)

(2) PCV Requires More Than Minor Transgressions: The failure of an LLC to observe the usual company formalities or requirements relating to the exercise of its powers or management of its biz is not a ground for imposing personal liability on the members or managers for liabilities of the company. ULLCA § 303(b)

g) Fiduciary Duties:(1) Manager-managed: managers have duty of care & loyalty (usually mems have no duty to LLC/other mems)(2) Member-managed: all members have a duty of care and loyalty.(3) Fiduciary obligation absent agreement to the contrary: ULLCA § 409(b)

(b)(1): “to account to the LLC ... for ... any property, profit, or benefit ... derived from a use by the member of the LLC’s property, incl. the appropriation of an opportunity”(b)(3): “to refrain from competing w/ LLC in the conduct of its biz before dissolution (a) Sub-rule: members of an LLC can agree to limit the scope of the fiduciary duty they owe to the LLCUCCLA 103(b): operating agreement may not: (2) eliminate duty of loyalty, but may call for procedures to determine what does/doesn't violate it; (3) unreasonably reduce duty of care; OR (4) eliminate obligation of good faith and fair dealing, but may determine how that obligation is measured as long as they

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are not manifestly unreasonable. McConnell v. Hunt [AoOrg provision said mem could compete w/LLC][NOTE: Very Very Similar To Corp Fiduciary Duties]

VIII. Fiduciary Duties in the Corporate Context- GeneralA. General: MBCA § 8.01 all corp powers, management and ownership are vested in the bd of dirs.

1. Corp Directors owe two primary fiduciary dutiesa) Duty of Careb) Duty of Loyalty (DoL)

(1) good faith is a subpart of DoL in DE (Stone v. Ritter), but is a separate duty in some courts.

2. Who are the beneficiaries of the dirs' fiduciary duties?a) If SolventPrimarily SHsDirs' duty to MAXIMIZE SH VALUEb) If Insolvent primarily creditorsc) If in "Zone of Insolvency"Depends

3. Dirs Must: maintain fairness to employees & competitiveness in the marketplace4. Agency Principle: DIRS ARE As OF THE CORP, WHICH IS A P

IX. Fiduciary Duties in the Corporate Context- Duty of Care (DoC): A. MBCA § 8.30(a) Standard of Conduct [Aspirational]: “Dirs shall act: (1) in good faith, & (2) in a manner the Dir reasonably believes to be in the best interests of the corp.”

1. Must exercise the degree of skill, diligence and care of a reasonably prudent businessperson

(1) (similar to negligence, but different b/c it's a reasonably prudent "business person" and tempered by the BJR.)

b) Sub-rule for Withholding Dividends: A court won't interfere in Dirs' business decisions re dividends unless it would = fraud or breach of good faith. Dodge v. Ford & Kamin v. Amexc) BJR: “[A] presumption that in making a business decision, the Dirs of a corp acted on an informed basis, in good faith & in the honest belief that the act taken was in the best interests of the corp.”

(1) P has no right to sue, unless BJR is rebutted. Wrigley.(2) How Can P rebut BJR? Fraud/Conflcit (go to DoL) OR if decision is Illegal, Egregious, Uniformed, Wasteful, OR there was a Failure to Decide (or failure to monitor)

(a) When is it uninformed? Dirs must gather/review all materials "reasonably available" Van Gorkom. HARNER: PROCESS & DISCLOSURE.

(i) If Decision was not well-informed, & Ds can't show entire fairness, Corp is liable, but Dirs probably aren't (in DE): DGCL § 102(b)(7): AoI can include provision that Dirs are not liable for breaches UNLESS DoL, or Bad Faith (DoC violations not gonna cut it!)

(b) DoC & No Decision/Ignorance of Dir: BJR protects decisions (to act/not act) but not a complete failure to make any decision. Dir has a duty to understand basics of the biz ignorance is no excuse. Francis (c) DoC & Caremark Duty to Monitor: (1) sustained/systemic failure to exercise oversight, OR a failure to implement an oversight system. Caremark.(d) If P "Knocks Down" BJR Wall: D must prove "entire fairness" of the transaction.

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(i) Factors: timing, initiation, negotiation, and structure of the transaction, the disclosure to and approval by the board & the SHs.

(3) Reconciling DoC and BJR: DoC tells Dirs "don't be negligent," and BJR insulates Dirs from negligence liability—liable only for fraud or self-dealing or gross negligence.(4) BJR Overview:

(a) Is there evidence of fraud? If yesBJR Rebutted; If noContinue(b) Is there evidence of Conflict of Interest? If YesRebutted; If Nocontinue(c) Is there Illegality, Egregious decision, uninformed decision, waste, no decision? If No, BJR Applies, Court abstains; If Yes BJR RebuttedDid D violate DoC? If Yes, calculate damages (Van Gorkom); If No, D wins.

d) MBCA § 8.31 Standards of Liability [§ 8.30 is what we want Dirs to do, 8.31 determines whether they're liable in court]: Basically codifies the BJR and says that Dirs only personally liable if plaintiff knocks the BJR wall down through one of the methods mentioned above AND there is no 102(b)(7)-type provision (or MBCA §2.02(b)(4) which is very similar to 102(b)(7)) precluding liability.

(1) Thus, if there is a 102(b)(7)-like provision, Dir's won't be personally liable for DoC violations.

I. Fiduciary Duties in the Corporate Context- Duty of Loyalty A. Is there a DoL? - A person’s duty not to engage in self-dealing or otherwise use his or her position to further personal interests rather than those of the beneficiary.”

1. Self-Dealing - dealing in a way that benefits oneself instead of another who is owed a fiduciary duty

B. Is there a Conflict of Interest (CoI)? 1. If so, it Rebuts BJR & Shifts Burden of Proof to D to Prove entire fairness or Ratification. Bayer v. Beran [CoI didn't exist just b/c Dir's wife was involved--D showed entire fairness]

a) NOTE: Proof of Entire Fairness extinguishes ANY DoL or DoC Claim]2. Are we in DE & Was there Ratification? DGCL § 144 [Shifts Burden Back to P to show waste]

Questions: Was there a quorum? Was there Disint Dir/SH ratification? Was it otherwise fair?a) [A deal between a Corp & one of its own Dirs/Offs (or a biz they own/manage) will not be void/voidable just b/c [i] that conflict exists, [ii] the conflicted Dir/Off was present/participated in the deal meeting, OR [iii] the conflicted Dir/Off's vote was counted in the deal, if:

(1) [All material facts were disclosed and a majority of disinterested Dirs (majority of total, not just present) voted to authorize the deal in good faith, even though the disinterested Dirs be less than a quorum; or(2) all material facts were disclosed to the (vote-capable) SHs & they vote in good faith to approve; or [NOTE: Ratification illegitimate if a majority of SHs are interested parties. Fleigler](3) The deal is fair as to the corp as of the time it is authorized, approved or ratified, by the Bd of Dirs, a committee or the SHs.

used to ratify when: (1) no requisite majority of disinterested Dirs/SHs, or (2)there's defective disclosure of material facts.

what is a "fair transaction"? W/i the range of terms that parties bargaining at armslength might reach.

b) (b) conflicted Dirs may be counted toward a quorum.17

(1) Quorom = majority of total Dirs, unless AoI or bylaws require more NOTE: Judicial review is not precluded by ratification, just less reasons for

a deal to be void or voidable. NOTE: Failure to ratify does not mean a failure to authorize (DGCL § 141),

just that the authorized transaction will be voidable and thus more subject to litigation later .

C. Was there a Corporate Opportunity? Corporate Opportunity Doctrine (COD):

1. Objective: to deter appropriations of new business prospects "belonging to" the corp2. Targets: Dirs/Offs & Dominant SHs who take dominant role in managing the corp3. RULE: The Broz Test: A CO exists where:

a) Corp is financially able to take the opportunityb) Opportunity is in the corp's line of business (fundamental knowledge, practical experience and ability to pursue).

Investing was "a line of business" of eBay, even though not their main purpose b/c they

invested a lot. In re eBay. But not in line of business of Martha Stewartc) Corporation has an interest (firm has a legal right) or expectancy (would come to the corp in the ordinary course of things [harder to prove than an interest]) in the opportunity

In Broz, no interest or expectancy where corp was getting out of that biz, had sold of similar franchises, & key players told Broz it was ok.

Is corp (1) in need of (2) seeking OR (3) even remotely interested in the opp? Martha Stewart

d) Embracing the opp would create a CoI between the Dirs & the Corp IPO shares created conflict b/c they were basically a kickback from

Goldman Sachs to the Dirs for bringing their business to Goldman. In re eBay.

Courts may allow Dirs/Offs to buy/sell stock in their corp at will as long as in good faith. Martha Stewart.

Note: This is a totality of the circumstances test. Don't need all 4, but prob more than 1.4. Sub-Rule for COD Disclosure/Rejection: A Dir/Off can legally appropriate a Crop Opp if he discloses the Opp to the Bd of Dirs and they properly reject the Opp.5. COD Roadmap Questions: Is the prospect a Corp Opp? If no, no breach, If yes Did Fiduciary Disclose? If no, D is in breach if he appropriates, If YesDid Corp Properly Reject? If no, D is in breach if he appropriates, If yes, no breach if D appropriates.

D. Duty of Loyalty for SHs1. SHs acting as SHs owe one another no fiduciary duties, BUT Controlling SHs owe duties to the minority

a) 2 types of controlling SHs: (1) 50.1%+ of stock, OR (2) <50.1% but dominates through actual control

2. Corp as SH: DGCL §123: A corp can own some or all of the shares in another corp

a) if "some" is >50% = Parent & majority-controlled subsidiary (minority-owned if less than 50%)

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(1) other stock owners are minority SHsb) if "all" = Parent & wholly-owned subsidiaryc) Is there a Deal Between Parent & Sub? Test for Domination:

(1) If self-dealing by Parent: BoP on Parent to show intrinsic ("entire") fairness.(2) If no self-dealing: BJR is used, & P has burden to show gross overreaching. Sinclair Oil.

(a) NOTE: Look for self-dealing separately in each transaction if there are more than one.

(3) Sub-Rule: If nonenforcement of K had been approved by a majority of the disinterested directors and then also by a majority of the disinterested SHs (aka a majority of the minority")? Shifts BoP to P to show deal was unfair. Wheelabrator.

d) Sub-rules for SHs Domination: Majority SHs (indivs or Corps) owe a fiduciary duty to the minority just like directors when they control corp decisions. Zahn v. Transamerica.

E. Duty of Loyalty--Good Faith1. Failure to Act in Good Faith- where the fiduciary (1) intentionally chooses not to advance the best interests of the corp, (2) intentionally violates the law, OR (3) intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties (including (1) utterly failing to implement any reporting or information system or controls, OR (2) having implemented a system or controls, consciously failing to monitor or oversee its operation thus disabling themselves from being informed of risks or problems requiring their attention). Disney, Stone, Caremark.

a) Lack of good faith is more than gross negligence (DoC) it is a subset of DoL. b) Good faith is the other route to DoL when there's no apparent Conflict of Interest.c) HARNER: Take away from Disney: we want corps to use best practices, but deviation from those will not result in liability unless there is other evidence of breach of duty of loyalty.

2. Advisor Fees: fees okay unless they bear no reasonable relationship to the services rendered.

II. Derivative Litigation: Overview and Demand RequirementA. Derivative v. Direct: Tooley Test:

1. Who suffered the alleged harm: the corp or the suing stockholders, individually?

a) dilution of voting rights constitutes direct injury to SH, thus direct suit. Eisenberg.

2. Who would receive the (direct) benefit of any recovery/remedy, the corp or the SHs, individually?

a) Is injury: directly corp, not SH? b) If injury is to the corp: SH can't sue directly, but can sue derivatively. c) Complainant must be a SH. Creditors remedy is PCV.

3. If Direct Draft Complaint; If DerivativeDoes My Client Meet Requirements

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a) Was My Client a SH: (1) at time of wrongdoing (MBCA 7.41), + (2) when suit began (MBCA 7.42), + (3) through final judgment (some states), + (4) is he fair representative (MBCA 7.42)?

4. Is it State or Fed Case? Erie Issue:a) Federal law governs procedural issues/State law governs substantive issues. Cohen.

(1) so if state claim in Fed court for diversity, state law requiring payment for suit is valid b/c it is substantive (i.e. creates new liability for P--to pay cost of suit) not procedural?

b) Is your client a Dir/Off of Corp & Scared of Derivative Suits for things other than DoL/Fraud? Legal Advice:c) Many directors can be indemnified. DGCL § 145d) Can get D&O Insurance

5. Demand Requirements: Demand Required Unless Excused, Excused when Futile

a) What's the Requirement? Complaint shall allege the efforts P made to obtain the action desired from the Corp/Dirs/[if necessary]SHs, and the reasons for P's failure to obtain the action or for not making the effort. FRCP 23.1/Del. RCP 23.1b) FUTILITY NOTE: go for Futile 1st, b/c it'll get waived if , & can make demand afterward if it fails!

(1) Futility Standards: P can claim futility if:(a) DE Standard (Grimes): Reasonable doubt as to: (1) majority of Bd has material financial/ familial interest, (2) majority of Bd is incapable of being indep b/c of reason like domination/control, OR (3) the underlying transaction is not the product of a valid exercise of biz judgment.(b) NY Standard (Marx): (1) Majority of Dirs interested, (2) Dirs failed to inform themselves, OR (3) challenged transaction could not have been product of sound biz judgment

(1) Primary differences between NY and DE: NY has no reasonable doubt requirement, P just has to plead 1 of the 3 w/ particularity, AND #2 differs in each test.

(c) Some States: Universal Demand Requirement(2) Did P Make Demand? letter from SH to Bd. of Dirs asking to bring suit for alleged CoA:(3) Minimum Requirements: (1) ID the alleged wrongdoers, (2) describe factual basis of the wrongful acts and harm caused to the corp, AND (3) request remedial relief.

(a) Must be sufficiently specific to inform Bd of the nature of the CoA & allow them to evaluate its merits.

(4) If P can succeed on futility and made demand Bd can sue or refuse to sueIf Bd refuses to sue, P can argue wrongful refusalIf court finds no wrongful refusal, stop: no suit; BUT If court finds wrongful refusal, P can sue!

B. Derivative Litigation: SLCs [For Bd to Regain Control When Demand Excused]

1. Three Standards of Review for Refusing Demand via SLC:a) NY Standard (Auerbach): Show that your SLC is (1) disinterested/independent, & (2) has a process, AND YOU WILL BE ABLE TO REFUSE DEMAND

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(1) Auerbach Court: SLC members were disinterested b/c they were added to the Bd after the challenged transactions, & SLC took substantial steps (process) b4 dismissing derivative suit.

b) DE Standard (Zapata) TWO-STEP Test: (1) Court should inquire into (a) the independence and good faith of the SLC, AND (b) the bases supporting the SLC's recommendations[(a)+(b) essentially = Auerbach Test], AND (2) Court may go on to apply its own biz judgment as to whether the case is to be dismissed.

(1) Under step 2: Court may decide that public policy calls for suit to go forward even if Corp's SLC seemed to satisfy criteria in step 1.(2) The Corp has BoP to show: independence, good faith, and reasonable investigation.

c) DE Rule for Independence: whether a Dir is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind. That is, … focus on impartiality and objectivity.” Oracle. [too many collegial/other connections between SLC & Ds = not independent]

(1) Sub-rule: Oracle standard only applies where demand was already excused. Martha Stewart

III. Securities: A. General:

1. Key Statutes: '33 Act (offering/sale of new securities) & '34 Act (secondary market activity)2. Universe of Corp Governance:

a) Fed Law: Disclosure & Some Procedures (proxy contest & tender offers)b) State Law: Most Other Issues—Fiduciary Duties, Voting Rights, Limited Liability, Dissolution

B. Is the thing in question a Security? Security = "Any note, stock . . . bond, debenture, . . . investment contract . . . or, in general, any interest or instrument commonly known as a 'security.'"

1. Sometimes, the thing is a per se security, e.g. a stock, BUT, other times it's not that clear, so

a) If it's something like an investment K or scheme, use the Howey Test to see if it's a security:

(1) a K, transaction or scheme whereby a person invests money, (2) in a common enterprise,

(a) Horizontal commonality: Did SHs of a corp pool their interests? looks to the relationship betwn the individ. investor & the other investors who put $ into the scheme(b) Vertical Commonality: Were the investor and promoter of the scheme in a common enterprise? looks to the relationship betwn the investor & the promoter of the scheme.

(3) AND is led to expect profits (4) solely [or substantially (added by courts)] from the efforts of the promoter or a 3rd party” [i.e. is the investor passive]

(a) Is the investment for an interest in an LLC? Investors in LLCs tend to be active [i.e. w/ control], thus don't need protection of the securities statutes. Robinson v. Glynn.

(1) As to investments in GPs, Circuit Split:21

(i) 3rd Cir: Bright line rule--not securities b/c partners have legal right to control, (ii) 5th Cir: Balancing Test--A security may be present if (1) GP agreement limits his control, (2) he's too inexperienced/unknowledgeable to know his legal rights, OR (3) he's dependent on some unique entrepreneurial/managerial ability of the promoter.

C. Purposes of Securities Laws: Disclosure & Fraud Prevention:1. IS THERE DISCLOSURE? KEY QUESTION FOR ALL SECURITIES PROBLEMS

a) '33 Act--Was there Disclosure in the registration statement?b) '34 Act--Was there disclosure in transactions?

D. Are we dealing w/ intial sales of the Security? '33 Act Issues: 1. Pre-registriation-- No selling Post-regiatration but Pre-Approval by SEC-- offers ok, but no sales; SEC reviews Reg Statement Registration Effective-- sales allowed, must deliver prospectus 2. Registration Exemptions: 2 Types: (1) entire security. (2) particular transactions of a security

a) Transactional Exemption: Private Offering Exemption--4 Factor Test: (1) the # of offerees & their relationship to each other & the issuer, (2) the # of units offered, (3) the size of the offering, (4) the manner of the offering.

(1) key to the test: Disclosure! Under element (1), were offerees given, or had access to, all relevant info that would have been in the reg. statement if it was a public offering? Doran

3. Fraud in the Registration Statement:a) '33 Act § 11(a) if there is a material misrepresentation/omission in the reg statement, the corp is liable (buyer never has to read it). Directors and experts involved in creating the reg statement can be sued as indiv Ds. b) 11(b) Issuer (Corp) is liable for fraud in the reg statement, but indivs are not liable if:

(3)(A) Non-expert: had a reasonable belief, after a reasonable investigation, that there was not material falsity/omission(B) Expert who drafted part of the reg statement in question: (i) had a reasonable belief, after a reasonable investigation, that there was no material falsity/omission, OR (ii) such reg statement did not fairly represent the expert portion he created(C) Expert who did not draft part in question: (i) had no reasonable gound/belief that there was any material falsity/omission, or (ii) that the part of the reg statement was not a fair/accurate version of that created by the other expert. BarChris.

**The Keys are: materiality (avg prudent investor think it important?), reasonable investigation (as to 11(b)(A)&(B)) & reasonable belief (as to 11(A)-(C))

D. Rule 10b-5: Cause of Action for Securities Fraud (Private Right is implied via SCOTUS cases)

1. Statutory Language of the Rule (paraphrased): unlawful for "any person" [to]:

a) employ any device, scheme, or artifice to defraud,

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a) falsely state/omit a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, orb) engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

2. HARNER'S VERSION OF THE ELEMENTS:a) a material misstatement or omission, [fraud; device, scheme or artifice to defraud]

(1) materiality depends on the signicance the reasonable investor would place on the withheld/misrepresented information.

(a) Basic Test: assess (1) the probability that the event will occur(indicia of interest at highest levels of the corp) and (2) the anticipated magnitude of the event(size of the two corp entities and of the potential premiums over market value).

b) made with scienter (Intent to defraud/Reckless disregard of falsity of statement)c) in connection with the purchase or sale of securities,d) on which the plaintiff relied, and

(1) omission cases: reliance is presumed;(2) misrepresentation cases: we presume under fraud-on-the-market-theory (presumption that investor relied on the integrity of the market price--so investor need not have seen misrepresentation). Basic. [Basic is the federal law, but some states (e.g. DE & CA) have rejected]

e) that caused the plaintiff's injury(1) Must prove 2 types of causation:

(a) transaction causation: but for the fraud, P would not have invested (or sold, etc.)

(i) closely related to reliance; where reliance is presumed, court will also presume transaction causation

(b) loss causation: the fraud caused the loss(i) what do you have to prove? That there would have been a differential if the info in question was added/corrected.(ii) not presumed. How do you prove? (iii) A fraudulent statement needs to be made publicly for holders to claim loss. West v. Prudential Securities.

f) NOTES:g) manipulation/deception requirement: breach of a fiduciary duty alone is a state law issue not for federal law. Sante Fe Indus.

(1) manipulation are practices that artificially affect market activity for the purposes of misleading investors.

h) Standing requirement: must be a holder of a security (doesn't have to be a stock), and must be trading during the time of the alleged misrepresentations.

XII. Insider Trading-- [Violation of 10b- SEC jurisdiction, pvt suits are rare.]A. Who is an insider?

1. Was he an employee of the issuer whose shares are being traded? One who has a fiduciary duty, i.e. an employee, has duty to disclose/abstain insider info.2. Was he a nonemployee tipee? a tipee assumes a tipper's fiduciary duty, & must disclose/abstain if:

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a) the tipper breached a fiduciary duty by disclosing to the tipee for the purpose of a benefit, direct or indirect, from his disclosure, AND

(1) Direct/Indirect benefits = $ gain, enhanced reputation that will = future $, OR gifts

b) the tipee knows or has reason to know of the breach of duty. Dirks.3. Was he a misappropriator? A fiduciary's undisclosed use of information belonging to his P [the source of his insider info], without disclosure of such use to the P, for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5. O'Hagan [O'Hagan was a lawyer who traded on insider info of his frim's client]

a) misappropriates under 10b5-2 if: (1) agrees to maintain confidence, OR (2) recipient should know/has reason to expect that info is given in confidence b/c there's a history/pattern/practice of confidential info exchanged between he and the sharer, OR (3) the info is from a spouse/parent/child/sibling, unless recipient shows history/pattern/practice of no expectation of confidentiality.

b) Important Notes: (1) Misappropriation can occur without involving an insider as the source or the illegal trader(2) Permission from the P is a defense to misappropriation

4. Was he like O'Hagan But with Permission? O'Hagan was also guilty of insider trading under Rule 14e-3: Prohibits insider trading during a tender offer and thus supplements Rule 10b-5.

(1) Once substantial steps towards a tender offer taken, Rule 14e-3(a) prohibits anyone, except the bidder, who possesses material, nonpublic information about the offer from trading in the target’s securities

(a) Rule 14e-3(d) prohibits anyone connected with the tender offer from tipping material, nonpublic information about it.(b) NOTE: 14e-3 is not premised on breach of a fiduciary duty, but O'Hagan court upheld it any way.

B. Was information material? (see Basic test above) & Did Insider Disclose or abstain?

1. RULE: when insider has material nonpublic information he must either (1) disclose before trading, OR (2) abstain from trading until the info has been disclosed.

a) NOTE: the choice to disclose/not disclose insider info is a business judgment of the directors, so it's not likely to be problematic unless they trade on it before disclosing.

2. Dirs of companies owe fiduciary duties to the corp, but are not trustees for the SHs. It's not illegal for an insider to buy stock in an open market (e.g. thru a broker) before speculative information is revealed publicly. Goodwin v. Agassiz.3. Evolution of state common law

a) "Majority" Rule [not a majority any more, but people still call it that]: Officers and directors may trade with SHs w/o disclosing material information.b) Fed Law uses State "Minority" Rule: insiders have a duty of full disclosure of material information whenever they purchase shares from SHs.c) Special Circumstances Rule: Duty to disclose where there were special circumstances (e.g. purchaser's identity not revealed.

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XIII. Proxy Access and contestsA. General: "Proxy" has two meanings: (1) the SH's voting A; (2) the written instrument by which the SH designates that voting A.B. Proxy Fights: insurgent group solicits proxies to vote their rep onto the Bd (and incumbent off the Bd)

1. Is There a Proxy Contest? RULE for Proxy Fight Expenditures: In a policy contest (not just a personal power struggle) Dirs may make reasonable and proper expenditures to solicit proxies. Rosenfeld

a) Sub-rule for reimbursement [After proxy fight]:(1) Incumbents: can be reimbursed for fight-related expenses, win or lose(2) Insurgents: can be reimbursed for fight-related expenses only if they win

C. Is There a SH Proposal? RULE 14a-8 (SEC Rule promulgated under '34 Act § 14): Allows qualifying SHs to put a proposal before their fellow SHs & have proxies solicited in favor of them in the corp’s proxy statement (Expense thus borne by the corp).

1. Can Board Exclude the proposal?a) Is the Proposal Economic-related? Rule 14a-8(i)(5): If the proposal relates to operations which account for less than 5% of the corp’s total assets at the end of its most recent fiscal year, AND for less than 5% of its net earnings/gross sales for its most recent fiscal year, AND is not otherwise significantly related to the company’s business. "significantly related" is not limited to economic significance. Lovenheim v. Iroquois [less than 5% & 5% okay if otherwise significant]b) Is the Proposal Election-related? Rule 14a-8(i)(8): precludes proposals relating to an election for membership on the corp’s Bd of Dirs (SHs precluded from nominating Dirs) AFSCME v. AIG, Inc.

2. Potential Responses by Bd of Dirs to Proposal, other than exclusion:a) (1) Incl. w/opposing statement, (2) Negotiate with proponent (wide range of compromises), (3) Adopt proposal as submitted

3. Notes on Proxy Access and Contests on SH Proposals: Proxy fights are difficult b/c challengers need $, effort, disclosure, etc. BUT, SH proposals can be an alternative way to at least influence the corp's decisions (as long as it goes to policy and not elections).

XIV. SH Voting RightsA. General

1. Straight v. Cumulative [how SHs can use their votes]: a) Straight: I can vote up to each of my [n # of] shares, but no more, for each Dir candidate.b) Cumulative: I have 8 votes, can use them any way I want: more power for SH than straight

2. Plurality v. Majority [how Dirs are elected by the votes]a) Plurality: Whoever gets the most votes are electedb) Majority: Need to have 51% of outstanding share votes (can be applied to each Dir candidate)

B. Stockholder's Rights:1. economic: (1) receive dividends, (2) residual claim on assets liquidation2. voting rights: (1) elect directors, (2) approve some extraordinary matters3. Packaging:

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a) need at least 1 class of stock w/unlimited voting rights & at least 1 class w/ the residual claim on assets (the 2 may be the same class, but need not be). MBCA § 6.01(b)

(1) nonvoting stock & other variants on one-share-one-vote are authorized. MBCA § 6.01(c)

(a) MBCA is very liberal, some states are more restrictive.b) Corps can break up voting stock and economic stock, or limit the amount of votes the voting stock retains, to maintain power over the corporation. Stroh

C. Closely-held Corps: (1) stock in a few hands (or a few families), & (2) shares are rarely (if ever) dealt

1. General: no secondary market for shares, governed by state statutes.2. Solutions to deadlock:

a) voting trust: SHs agree to transfer all shares to a trustee, who becomes nominal record owner

(1) The trustee votes the shares in accordance w/ the the trust agreement, if any, & is responsible for distributing any dividends to the beneficial owners(2) trust document must be filed with the state. DGCL § 218

b) SH agreements:(1) agreements relating to election of Bd of Dirs (aka vote pooling agreements)

(a) Courts may hold that SHs are bound by their agreements, but are reluctant to tell people how to vote their shares. Ringling.

(2) agreements relating to limitation on the Bd of Dirs' discretion(a) Are there minority SHs other than the parties to the agreement? RULE: when there are minority SHs other than those who are parties to the agreement, agreements limiting the independent business judgment of directors are void for public policy. McQuade v. Stoneham

(i) agreeing to vote for each other as directors is okay (like a vote pooling agreement), but agreeing on policy decisions and business judgments (officer salaries, etc) not okay.

(b) Are the parties to the agreement the only SHs? RULE: Where there are no minority SHs, the McQuade rule is unnecessary (freedom of K).

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