business organizations outline kyser 2006 (alw)

8/2/2019 Business Organizations Outline Kyser 2006 (ALW)

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BUSINESS ORGANIZATIONS

FINAL EXAM

SPRING 2006NICHOLAS KYSER

AMINIE WOOLWORTH


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Who is an Agent?

Restatement (Second) of Agency 1-3, 14K, 14O, 144, 194, 219, 220

Gorton v. Doty (page 1) - Permission to drive ones vehicle creates an agency relationship.

Agency is the fiduciary relationship which results from the manifestation of consent by one person

to another that the other shall act on his behalf and subject to his control, and consent by the otherso to act. (Restatement of Agency 1)

Agency indicates the relation which exists where one person acts for another.Three principle forms:

(1) Relation of principal and agent

(2) Relation of master and servant

(3) Relation of employer or proprietor and independent contractor

Not essential that there be a contract between the principal and the agent OR the agent promise toact as such NOR essential that the agent receive compensation.

*Could have avoided liability by (1) using a contract to rebut the presumption by declaring the absence ofan agency relationship (2) charging the person using the car a fee (3) buying some insurance.

A. Gay Jenson Farms Co. v. Cargill, Inc. (page 7) -A creditor who assumes control of its debtorsbusiness operations may become (is) liable as a principle for the debtors debts (acts) in connection with

the business(Restatement of Agency 14O CONTROL)(14KCompares Agent with Supplier)

To create agency relationship: (need all three) Person alleging agency has the burden of proof:

o Principal must consent to relationship;o Agency must act on behalf of principal;o Principal must exercise control of the agent.

To create an agency there must be an agreement, not necessarily a contract between the parties.o Agreement may result in creation of agency relationship although parties did not call it an

agency and did not intend legal consequences of relationship.

o Can be proven by circumstantial evidence which shows dealing between the two parties:principal must be shown to have consented to the agency since one cannot be the agent of

another except by consent of the latter.

Liability of Principal to Third Parties in ContractRestatement (Second) of Agency 7, 8, 8A, 26, 27, 33-35

Authority -Mill Street Church of Christ v. Hogan (page 14) - Continuous past authorized acts

sufficiently confer implied authority on an agent. Specific conduct by the principle in the past permitting

the agent to exercise similar powers is crucial. 3rd

party belief in authority to hire is irrelevant.

Implied authority is actual authority that the principal intended the agent to possess and includes

such powers as are practically necessary to carry out the delegated duties.

Apparent authority is not actual authority but is the authority the agent is held out by the principal

as possession. It is the matter of appearances on which third parties come to rely.


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Apparent Authority -Lind v. Schenley Industries, Inc. (page 16) - Sales manager has apparentauthority to offer pay increases when charged with transferring information among executives.

Apparent authority need not be authority actually given to an agent as long as the principals

manifestations lead 3rd

parties to reasonably believe that the agent possesses authority to act on the

principals behalf.

*To avoid Schenleys problem, specifically tell or detail in the employment contract the authority of

supervisors and managers. To avoid Linds problem ask to see an employment contract or talk to the

president.

Three-Seventy Leasing Corp v. Ampex Corp. (page 22) -Absent contrary knowledge, a salesperson hasapparent authority to bind his principal to sell its products. Absent knowledge of such a limitation by 3

rd

parties, that limitation will not bar a claim of apparent authority.

An agent has sufficient apparent authority to bind the principal when the principals acts would

lead a reasonably prudent person to believe the agent had the authority he purports to exercise. Absent knowledge on the part of 3rd parties to the contrary, an agent has the apparent authority to

do those things which are usual and proper to the conduct of the business which he is employed.

*Ampex could have protected itself by stating the restriction of authority in the written contract or made a

communication that the contract was not binding unless entered into by a specific person in the

corporation.

Implied Authority - Watteau v. Fenwick (page 25) - When a principal is undisclosed to third parties,the actions taken by an agent in furtherance of the principals usual and ordinary business binds the

principal notwithstanding limitations, as between the principle and the agent, put upon that authority.

.

Why have Doctrine of Inherent Agency Power (Restatement of Agency 8A). Otherwise, inevery case of an undisclosed principal, or at least in every case where the fact of there being a

principal was undisclosed, the secret limitation of authority would prevail and defeat the action ofthe person dealing with the agent and then discovering that he was an agent and had a principal.

Kidd v. Thomas A. Edison, Inc. (page 28) A principle cannot claim that he is not bound by his agent if

the agent makes minor deviations from his delegated authority given the industry customs.

The scope of any authority must be measured not alone by the words in which it is created, but bythe whole setting in which those words are used, including the customary powers of such agents.

Nogales Services Center v. Atlantic Richfield Co. (page 31) -An agent with actual authority to extendvarious discounts has inherent authority to offer specific discounts.

Inherent authority exists in three types of situations:(1) Agent does something similar to what he is authorized to do.

(2) Agent acts purely for his own purposes in entering into transaction if it would be authorized

under a proper motive.

(3) Agent is authorized to dispose of goods and departs from the authorized method.


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Partnerships What is a Partnership and who are the Partners?

UPA 1914 2, 3, 6-8

Fenwick v. Unemployment Compensation Commission (page 92) - A partnership is not formed by

merely agreeing to share business profits because although sharing of profits is prima facie evidence of

partnership no such interference shall be drawn if such profits were received in payment as wages of an

employee (UPA 7(4)).

A partnership is an association of 2 or more persons to carry on as co-owners of a business forprofit. Partnership formation: no papers need to be filed no written or oral agreements needed.

Since a partnership can be created absent any written formalities totality-of-the-circumstances

Elements to determine whether a partnership exists:

(1) Intention of the parties;

(2) Right to share profits;

(3) Obligation to share in losses;

(4) Ownership and control of the partnership property and business;

(5) Community of power in administration, and the reservation in the agreement of the exclusive

control of the management in the business;(6) Conduct of parties toward third persons;

(7) Rights of the parties on dissolution.

Martin v. Peyton (page 97) A loan agreement that allows for sharing of profits as repayment does notestablish a partnership absent intent.

A partnership is created by an express or implied contract between two persons with the intentionto form a partnership.

If denied may be proven by:(1) Production of some written instrument;

(2) By testimony as to some conversation; or

(3) By circumstantial evidence.

Southex Exhibitions, Inc. v. Rhode Island Builders Association, Inc. (page 102) - Two promotersmutual sharing of profits and intellectual property does not establish a partnership because although

Sharing profits is prima facie evidence of a partnership it can be rebutted by evidence sufficiently

demonstrating that the parties did not intend to create a partnership.

UPA 7(4) has five instances in which profit sharing does not create a presumption ofpartnership formation.

Young v. Jones (page 107) - Price Waterhouse-US is not a partner by estoppel with Price Waterhouse-

Bahamas - partners cannot raise an estoppel argument because it only exists as a 3rd

party claim.

A person who represents himself, or permits another to represent him, as a partner in an existing

partnership or with others not actual partners, is liable to any person to whom such a representation is

made who has, in reliance on the representation, given credit to the actual or apparent partnership.

Partnership by estoppel third party reliance (UPA 16)


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Partnerships The Fiduciary Obligations and Duties of Partners

Restatement (Second) of Agency 13, 379-396

UPA 9, 18, 20, 21

Fiduciary Obligation of Agents

Reading v. Regem (page 81) (A sergeant must surrender illegal bribes received because of hisemployment position). When an agent uses [principals] controlled assets, facilities, or is enriched by the

position occupied the gain goes to the principal.

If a person has unjustly enriched himself by virtue of his service without his masters sanction, thelaw says that he ought not to be allowed to keep the money, but it shall be given to his master,

because he got it solely by reason of the position which he occupied as a servant of his master.

General Automotive Manufacturing Co. v. Singer (page 84) - Defendant is liable to his employer forprofits derived from an undisclosed competing business.

An agent owes his principal the fiduciary duty of good faith and loyalty not to act adversely to

his principles business interests in the furtherance of his own. Failing to disclose all facts relating to orders and receiving secret profits violates fiduciary duty

to act solely for benefit of principal.

Fiduciary Obligations of Partners

Meinhard v. Salmon (page 111) - Breached his duty of loyalty to the other joint adventurer because hisconduct excluded his co-adventurer from any chance to compete, from any chance to enjoy the

opportunity for benefit that had come to him alone by virtue of his agency.

Might have been good enough not to put Meinhard before himself but only the partnership.

*To avoid the problem: concrete time limits, expiration date of lease, exclusion of other ventures,covenant not to compete, dual agreements for matters, stipulations about renewals.

Bane v. Ferguson (page 117) - The fiduciary duties owed by one partner to another terminates when the

partnership is dissolved.

A partner is a fiduciary of his partners, but not of his former partners, for the withdrawal of apartner terminates the partnership as to him.

Meehan v. Shaughnessy (page 119) - One-sided solicitations to a partnerships clients breach the duty ofgood faith and fair dealing.

Although fiduciaries may plan to compete with the entity to which they owe alliance, providedthat in the course of such arrangements they do not act in violation of their fiduciary duties.

Lawlis v. Kightlinger & Gray (page 127) - When a partner is involuntarily expelled from a business, his

expulsion must be in good faith for a dissolution to occur without violating the partnership agreement.

Not only can you withdraw from a partnership at ANY time, a partner can be expelled at ANYtime, unless the partnership agreement says otherwise (you can limit both withdrawal and

expulsion by an agreement).


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Partnerships Rights of Partners in Management

Right of each partner to participate in the operation of the business in some way will be animplicit term of the partnership agreement (UPA 18).

National Biscuit Company v. Stroud (page 142) - Every partner is an agent of the partnership for the

purpose of its business, and every partners acts for apparently carrying on in the usual way thepartnerships business binds the partnership, unless the acting partner has in fact no authority to act for

the partnership and the person with whom he is dealing knows that he has no such authority.

*Apparent authority would bind the partnership even if the partnership was severed if they held the ex-partner out as having the power to bind (without notice to the 3rd party).

Summers v. Dooley (page 144)- A partner is not liable for expenses incurred by another partners

unilateral decision to hire an additional employee.

Absent a contrary agreement, each partner possesses equal rights to manage the partnershipsaffairs, and no partner is responsible for expenses incurred without majority approval. (UPA

18(e))

Day v. Sidley & Austin (page 146) - Managing partners need not disclose management decisions to

partners with no right to control business operations.

Fiduciary duty as explained by this Court is narrower that inMeinhard: Managing partners haveno fiduciary duty to disclose changes in the partnerships internal structure if the changes do not

effect (1) profit accountability (2) partnership asset usage or (3) commitment not to compete.

Partnerships Dissolution and Winding UpUPA 29-32, 37, 38

Owen v. Cohen (page 154) - Mutual disharmony and disrespect are basis for a judicial dissolution of apartnership.

Courts may order dissolution of a partnership if the partners disagreements are to such an

extent that all confidence and cooperation between the parties has been destroyedOR if a

partners misbehavior materially hinders the proper conduct of the partnerships business. Trifling, minor differences and grievances which involve no permanent mischief will not

authorize a court to decree dissolution of a partnership.

One partner cannot constantly minimize and deprecate the importance of the other withoutundermining the basic status upon which a successful partnership rests.

Causes for judicial dissolution of partnership (UPA 32)

Dissolution termination of a partnership v. Winding up selling off the assets after thepartnership terminates.

*Plaintiff probably filed a lawsuit seeking dissolution rather than simply giving notice because he was

afraid that under 31(2)(d) he would be found to have wrongfully dissolved the partnership and wouldhave to pay damages.

Collins v. Lewis (page 157) - A partner may not obtain a judicial dissolution of the partnership if his owninterference causes the partnership to be unprofitable.


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Page v. Page (page 162) - Absent bad faith or a breach of fiduciary duty, apartnership may be dissolvedby the express will of any partner if the partnership agreement specifies no definite term or particular

undertaking.

A partner may not dissolve a partnership to gain the benefits of the business for himself, unlesshe fully compensates his co-partner for his share of the prospective business opportunity.

Prentiss v. Sheffel (page 165) - Former partners may purchase the partnership assets; upon dissolution

of a partnership, a former partner may bid on the partnership assets at a judicial sale.

Pav-Saver Corp. v. Vasso Corp. (page 171) (UPA 38) Upon a wrongful dissolution of a partnership inviolation of the partnership agreement, each partner who has not wrongfully dissolved the partnership is

entitled to damages for breach of contract and may continue the partnership business for the term

required under the partnership agreement . . . bond payment or payment to dissolved party.

Partnership agreement is a contract, and even though a partner may have the power to dissolve,he does not necessarily have the right to do so.

Rights and duties of partners in relation to partnership are governed by UPAPartnerships Dissolution and Winding UP Continued

UPA 18(a), 40

Kovacik v. Reed (page 177) - If one partner or joint adventurer contributes the money capital and the

other contributes the skill and labor necessary for the venture, neither party is entitled to contribution

from the other because they agreed that the money and labor were equal in forming the partnership.

General rule: in the absence of an agreement to the contrary the law presumes that partners intended to

participate equally in profits and losses irrespective of any inequity in the amounts contributed.

Buyout Agreements (page 180)- Need to put one in place to set forth basis for one to buyout another.

An agreement that allows a partner to end his relationship with the other partners and receive acash payment, or series of payments, or some assets of the firm, in return for his interest in thefirm. See approaches listed in textbook p. 180.

G&S Investments v. Belman (page 181) - The court must honor a partnership agreements termproviding for the buyout of a partner upon death.

Under (UPA 32), a court may dissolve a partnership when a partner becomes incapable of performingunder the partnership agreement, when a partners conduct tends to affect the business prejudicially, or

when a partner willfully breaches the partnership agreements terms.

Because partnerships result from contract, the rights and liabilities of the partners amongthemselves are subject to such agreements as they may make.

Partnership buyout agreements are valid and binding although the purchase price agreed upon isless or more than the actual value of the interest at the time of death.

Jewel v. Boxer (page 185) - In the absence of a partnership agreement, the UPA requires that attorneysfees received on cases in progress upon dissolution of a law partnership are to be shared by the former

partners according to their right to fees in the former partnership, regardless of which former partner

provides legal services in the case after the dissolution.


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Absent a contrary agreement, any income generated through the winding up of unfinished business is

allocated to the former partners according to their respective interests in the partnership.

Meehan v. Shaughnessy (page 190) - Wrongfully retained profits are placed in a constructive trust for

the partnerships benefit.

Every partner must account to the partnership and hold as trustee for the partnership any profitshe derives, without the other partners consent, from any transaction connected with thepartnerships formation, conduct or liquidation.

UPA gives a partner the power to dissolve a partnership at any time. (textbook p. 193). What leaving partner gets see textbook p. 192.

Tax Considerations Affecting Choice of Legal Entity

I. Choice of Organizational FormA. Key Considerations

1. Liability of Owners2. Management and Control of Owners3. Transferability of Ownership4. Continuity of Life5. Entity Status6. Taxation7. Formation and Organization

B. Tax Considerations1. A Corporation is treated as a separate entity for tax purposes

a) When there are losses or gains, corporation retains the reporting requirements on itsown tax return.

2. Partnership (P), Limited Partnership (LP), Limited Liability Partnership (LLP), LimitedLiability Company (LLC) - all make an election as to whether they wish to be taxed as a

corporation or as a partnership for the next 5 year period.

a) Default for failure to elect is partnershipb) A partnership passes on losses and gains to the individual partners for recognition on

their individual tax returns.

c) Partnerships may therefore act as tax shelters to offset personal income if thepartnership is expecting losses

3. S-Corporation (S-Corp.) - treated like a partnership as far as passing on losses toshareholders.

a) Must be less than 30 shareholders who are individuals, trusts, or estates (not othercorporations)

b) Must only have one economic class of stock, but can have many voting classes.4. Double-Taxing - if a corporation makes money, it is taxed on its income. If the

corporation then declares a dividend, the dividends are taxable to the individual

shareholders as income.

a) Corporations try to hide dividends as excessive salaries because salaries are deductibleto the corporation as a current expense.

b) Corporations try to avoid distributions by selling debt instead of selling equitybecause the interest on the debt is deductible as a current expense.


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Key

Consideration

Partnership

Page 414

Limited

Partnership

Page 414

Corporation

Limited

Liability

Partnership

Page 141

Limited

Liability

Company

Page 408

Owners

Liability

Personally

liable

General partner

personally

liable

No personal

liability

No personal

liability

Members

have limited

liability

Management

& Control

Partnerscontrol

General partnercontrols

Board ofDirectors control

Generalpartner

controls

Members/manager

controls

Continuity

Dissolves if

partner

leaves

Dissolves if

partner leaves

Yes.

Buyout

agreements.

Dissolves if

partner leaves

Members

may

withdraw

Entity or

Aggregation

Aggregation Aggregation Entity Aggregation Entity

Taxation

Passed on to

partners

Passed on to

Partners

Taxed to

Corporation

Passed on to

partners

Taxed to

LLC

Formation Informal File certificate

File Articles of

Incorporation &

Bylaws

File

Application File Articles

Limited Partnerships

RULPA was assigned

Holzman v. De Escamilla (page 196) - Control over limited partnerships crop selection and banktransactions establishes limited partners as general partners.

(RULPA 303(a)) A limited partner is not liable for the obligations of a limited partnership unless the

limited partner is also a general partner or, in addition to the exercise of his rights and powers as a limitedpartner, he takes part in the control of the business. . .

Frigidaire Sales Corporation v. Union Properties, Inc. (Page 229)Limited partners do not incurgeneral liability for the limited partnerships obligations simply because they are officers, directors, or

shareholders of the corporate general partner.

Corporations Formation (Promoters and the Corporate Entity)

MBCA 2.03-2.06

See textbook p. 199-201 for detailed information of agent, promoter, fiduciary obligations, etc.

Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. (page 201) - Lack of formal corporate statusdoes not excuse nonperformance.

A defendant may not introduce as a defense to a breach of contract that a plaintiff corporation lacked the

capacity to contract because it was not incorporated at the time it executed the contract, unless the failure

to incorporate actually harmed the defendant.

*Theories of planning: (1) contract is merely an offer to x (2) promoter is personally responsible if the

corporation is never formed, but if formed no liability (3) promoter promises to use best efforts to form


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corporation, promoter not liable if no corporation (maybe if best efforts not used) (4) strict application of

agency law, no capacity because there was no principle.

Corporations Limited Liability

MBCA 6.22

Walkovsky v. Carlton (page 206) The law permits the incorporation of business for its proprietors toescape personal liability, but a court may disregard the corporate form, piece the corporate veil, to

prevent fraud or achieve equity.

In determining whether liability should be extended to reach assets beyond those belonging to thecorporation guided by the general rules of agency - whenever anyone uses control of the corporation

to further his own rather than the corporations business, he will be liable for the corporations acts

upon the principle ofrespondeat superior applicable even where the agent is a natural person.

*Pierce the veil (1) corporation is a fragment of a larger corporation larger corporate entity responsible

(2) corporation is a dummy for individual stockholders liable if conducting bus. in individual capacity

See textbook p. 211 for separate legal doctrines of liability:(1) Enterprise liability

(2) Respondeat superior

(3) Piercing corporate veil

(4) Principal/agent

Sea-Land Services, Inc. v. Pepper Source (page 211) - Inability to satisfy a judgment alone is insufficientto pierce the corporate veil.

In order to pierce the corporation veil and impose individual liability, a creditor must show (1) that there

was such a unity of interest between the individual and the corporate entity that separate identities no

longer existed, and (2) acknowledging false separate entities would sanction a fraud or promote injustice.

When to pierce the corporate veil:

(1) Failure to maintain adequate corporate records or to comply with corporate formalities,

(2) Commingling of funds or assets;

(3) Undercapitalization (see textbook p. 231) and

(4) One corporation treating the assets of another corporation as its own.

Corporations Powers and Duties of Directors, Business Judgment Rule IMCBA 7.30-7.32, 8.01-8.04

DGCL 141 (p. 97 Statute book) (Delaware)

A.P. Smith Mfg. Co. v. Barlow (page 270) - A corporation need not have specific authority to make valid

charitable contributions (absence of statutory provision)

Charitable contributions must be reasonable use of discretion (fair). Charitable contributions limited to 10% of taxable income IRC 170(b)(2)

Dodge v. Ford Motor Co. (page 276) - Shareholders have no rights to dividends, that decision is one held

by the Board of Directors, however a for-profit corporation must pay dividends absent a justifiable

business reason.


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Although a corporations directors have discretion in the means they choose to make productsand earn a profit, the directors may not reduce profits or withhold dividends from thecorporations shareholders in order to benefit the public.

Corporations are organized and carried on primarily for the profit of the stockholders,maximizing profits for shareholders is the foremost important duty of the Board of Directors.

Shlensky v. Wrigley (page 281) - Officers and directors decisions are protected by the businessjudgment rule.

Business Judgment Rule courts will not step in and interfere with honest business judgment of thedirectors unless there is a showing of fraud, illegality or conflict of interest.

Corporations Control in Closely Held Corporations, Business Judgment Rule I

MCBA 7.30-7.32, 8.01-8.04

DGCL 141 (p. 97 Statute book) (Delaware)DGCL 122 (p. 94 Statute book) (Delaware)

Ringling Bros. Barnum & Bailey Combined Shows v. Ringling (page 606) - Stockholders may make

binding agreements on how to vote their stock; A shareholder may agree with another shareholder tovote his stock in a particular way.

McQuade v. Stoneham (page. 613) - A shareholder agreement may not control a board of directorsexercise of judgment (here to elect officers and fix their salaries)

Shareholder power to unite is limited to the election of directors and is not extended to contractswhereby limitations are placed on the power of the directors to manage the business of the

corporation by the selection of agents as defined salaries.

Clark v. Dodge (page 618) - Where the directors are the sole stockholders, there seems to be no objectionto enforcing an agreement among them to vote for certain people as officers.

Agreements by which the shareholders simply commit to electing themselves, or their representatives, as

directors, are generally considered unobjectionable, courts have more difficulty with shareholder

agreements requiring the appointment of particular individuals as officers or employees of the corporation

Voting Trust shareholders who wish to act in concert turn their shares over to a trustee. The trustee

then votes all the shares, in accordance with instructions in the document establishing the trust.

Galler v. Galler (page 624) - Shareholder agreements that relate to the management of a closecorporation will be upheld, even if the agreements violate corporate norms.

BJR II

Duties of Officers, Directors, and Other Insiders (Obligations of Control Duty of Care)MBCA 8.30-8.31

Kamin v. American Express Co. (page 316 - Classic BJR case) - A corporations directors are not liablemerely because a better course of action existed.

A complaint alleging that some course of action other than that taken by the board would have

been more advantageous does not give rise to a cause of action for damages.


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Smith v. Van Gorkom (page 320) - The BJR presumes that, when making business decisions, directorsact on an informed basis, in good faith and in the companys best interests.

Under BJR - no protection for directors who have made an unintelligent or unadvised judgment:

Directors must have informed themselves prior to making a business decision of all materialinformation reasonably available to them.

If BJR is rebutted, burden shifts to defendant directors to prove to trier of fact the entire fairness of

the transaction to the shareholder plaintiff.

Duty of Care

Duty of Loyalty

Brehm v. Eisner (page 339) - The waste-test is very stringent; In order to constitute waste, an exchange

must be so one-sided that no person of a reasonable mind would have entered into it.

Francis v. United Jersey Bank (page 349) - Directors must diligently discharge their duties.

Directors are under continuing obligation to keep informed about the activities of the corporation. Directorial management does not require a detailed inspection of day-to-day activities, but rather

a general monitoring of corporate affairs and policies.

Shareholder Derivative ActionsMBCA 7.42-7.46

Cohen v. Beneficial Industrial Loan Corp. (page 232) - (A court may require a plaintiff to post a bond in

a derivative suit.) A federal court with diversity jurisdiction must apply a state statute providing security

for costs if the state court would require security in similar circumstances.

Eisenberg v. Flying Tiger Line, Inc. (page 236) - An action to reverse corporate actions that deprived

shareholders of a voice in operations is not derivative.

Claims of injury to stockholder or for deprivation of rights aredirect actions.

Grimes v. Donald (page 241) - A stockholder generally must demand the board bring an action before hebrings a derivative suit.

A shareholder need not make a demand that a companys board institute a lawsuit before bringing a

derivative suit on behalf of the corporation on a showing the demand would be futile, and if a demand is

made and rejected, a shareholder may still proceed by establishing that the boards refusal was wrongful.

Due care, waste, excessive compensation claims arederivative actions.

Zapata Corp. v. Maldonado (page 261) two step process to determine if the claim is meritorious.

(1) The Court should inquire into the independence and good faith of the committee and the bases

supporting its conclusions. The corporation should have the burden of proving independence, good faithand reasonable investigation.

(2) The court should determine, applying its own independent business judgment whether the motion

should be granted.


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Corporations Duty of Loyalty

DGCL 144

MBCA 21 8.31(A)(2)(III), (b)

Directors and Managers

Bayer v. Bayer (page 368) - BJR can only be advanced if the duty of loyalty has been up.

When personal transactions of directors with their corporations are made OR when transactions are made

that may cause a conflict of interest between self-interest and fiduciary obligation: if there is any evidence

of oppression, unfairness or undue advantage the transactions may be voided burden on the Directors toprove the good faith of the transaction AND to show the fairness from the standpoint of the corporation.

Lewis v. S.L. & E, Inc. (page 373) - Directors may not engage in self-dealing. A transaction in which a

director has an interest, other than as the corporations director, is automatically suspect and

subject to further review.

B. Corporate Opportunities

Broz v. Cellular Information Systems, Inc. (page 377) - Directors must put a corporations interestsbefore their own.

Under the doctrine of corporate opportunity, a corporate fiduciary must place the corporations interests

before his own interests in appropriate circumstances, but a corporate fiduciary does not breach his

fiduciary duty by not considering the interests of another corporation proposing to acquire the corporation

in deciding to make a corporate purchase.

Presenting the opportunity to the board creates a kind of safe-harbor for the director(Meinhard)

C. Dominant Shareholders

Sinclair Oil Corp. v. Levien (page 385) - If, in a transaction involving a parent company and itssubsidiary, the parent company controls the transaction and fixes the terms, the transaction must meet the

intrinsic fairness test.

Self-dealing occurs when parent, by virtue of its domination of the subsidiary, causes the subsidiary

to act in such a way that the parent receives something from the subsidiary to the exclusion of, and

detriment to, the minority stockholders of the subsidiary.

Zahn v. Transamerica Corp. (page 389) - If a stockholder who is also a director is voting as a director,he represents all stockholders in the capacity of a trustee and cannot use the directors position for his

personal benefit to the stockholders detriment.

Majority has right to control, but when it does; it occupies a fiduciary relation toward minority, asmuch so as the corporation itself or its officers and directors.

D. Ratification

Fliegler v. Lawrence (page 395) - Interested shareholders cannot ratify their own transactions with theircorporation. A majority of disinterested shareholders must ratify corporate transactions with an

interested director.


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In re Wheelabrator Technologies, Inc. v. Shareholders Litigation (page 398) - Stockholders must befully informed when they ratify an interested transaction.

An interested transaction between a corporation and its directors is not voidable if it is approvedin good faith by a majority of fully informed, disinterested stockholders.

In parent-subsidiary merger, standard of review is ordinarily entire fairness, with the directorshaving burden of proving that merger was entirely fair. (page 400).

Introduction to Federal Securities Laws

Securities Act of 1933 2(a)(1), 4, 5, 11(a)

Securities Exchange Act of 1934 12-14, 16

See textbook p. 403-404 for definitions and goals of the Act of 1933 and the Act of 1934.

Great Lakes Chemical Corp. v. Monsanto Co. (page 405) - An interest in a limited liability company is

not a security unless the management is directly involved.

Interests in a limited liability company are not securities if they lack thefive common features ofstock: (1) the rights to receive dividends contingent upon an appointment of profits; (2) negotiability; (3)the ability to be pledged or hypothecated; (4) voting rights in proportion to the number of shares owned;

and (5) the ability to appreciate in value.

Three requirementsfor establishing an investment contract are: (1) an investment of money; (2) in a

common enterprise; and (3) with profits to come solely from the efforts of others. Flexible Principle

See horizontal commonality and vertical commonality tests textbook p. 413SEC 5 imposes three basic rules: (1) a security may not be offered for sale through the mails or by

use of other means of interstate commerce unless a registration statement has been filed with the SEC; (2)

securities may not be sold until the registration statement has become effective; and (3) the prospectus (a

disclosure document) must be delivered to the purchaser before a sale.

Doran v. Petroleum Management Corp. (page 417) - The status of private offerings rests on the offereesknowledge, the # of offerees, not the number of purchasers, is relevant to the number of persons involved.

In determining whether an offer to participate in a limited partnership was a private offer, the court must

consider (1) number of offerees and their relationship to each other and to the issuer, (2) number of units

offered, (3) offerings size, and (4) manner of the offering.

Note on Integrated disclosure and exchange act disclosures see textbook page 441

Fundamental purpose of securities acts was to substitute a philosophy of full disclosure for the philosophy

of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.

Securities Act ~ requires disclosures with respect to particular transactions, such as new issues of stocks

or bonds to the public.

Exchange Act ~ imposes a system of periodic disclosures on certain companies-most importantly,

obligation to file annual and quarterly reports. (Companies must report major event immediately).


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Oh Brave New World: Enron, Anderson, Sarbanes-Oxley, Etc.

Disclosure and Fairness

Escott v. BarChris Construction Corp. (page 426) - If false statements are made in a registration

statement or omitted facts that should have been included are material, the registration statement is

misleading.

Material - those matters as to which an average prudent investor ought reasonably to be informedbefore purchasing the security registered.

Ethics Across the Curriculum ABA Task force report on Corporate Responsibility

Follow your own instincts and do whatever you can do to do the right thing.

Sarbanes-Oxley Act of 2002 (considered to be the most significant change to federal securities laws).

Among the major provisions of the act are: criminal and civilpenalties for securities violations, auditor

independence / certification of internal audit work by external auditors and increased disclosure

regarding executive compensation, insider trading and financial statements.

Rule 10b-5

34 Act 10(b) (p. 240 statute book)

SEC Rule 10b-5 (p. 256 statute book) (textbook p. 443)

Basic Inc. v. Levinson (page 444) - An omitted fact is material if there is a substantial likelihood that theaverage, reasonable shareholder would have considered it important knowledge to have before deciding

how to vote.

West v. Prudential Securities, Inc. (page 457) - Fraud-on-the-market does not apply to non-publicstatements.

The fraud-on-the-market doctrine and its presumption of reliance on misstatements do not apply in asecurities fraud class action against a securities brokerage firm alleging that a stockbroker had falsely told

several clients that a particular corporation was certain to be acquired at a premium in the near future.

Pommer v. Medtest Corp. (page 462) - Statements are material if a substantial likelihood exists that thewhole of the information, as considered by a reasonable investor, would have been significantly altered if

the omitted fact had been disclosed.

See measurement of damages textbook p. 465Note on judicial limitations on actions under Rule 10b-5 textbook p. 466Liability for issuance of a false or misleading statement required proof of a state of mind referred to as

scienter. Scienter person making the false statement made it with intent to deceive, manipulate, or

defraud.

Santa Fe Industries, Inc. v. Green (page 466) - A parent may merge itself with its subsidiary in somecases.

Under the short-form merger statute, a parent company could merge with its subsidiary if the parent owns

at least 90 percent of the subsidiarys stock and the parent companys Board approves the action.


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Insider Trading: Rule 10b-5 and other means of regulation

34 Act 20A, 21A

SEC Rules 10b5-1, 10b5-2

Goodwin v. Agassiz (page 477) - Directors direct stock sales or purchases must be fair.

A directors knowledge of the corporations condition requires that he engage in fair dealing whendirectly buying or selling the corporations stock.

Where a director personally seeks a stockholder for the purpose of buying his shares withoutmaking disclosure of material facts within his particular knowledge and not within reach of the

stockholder, the transaction will be closely scrutinized and relief may be granted in appropriateinstances. (Textbook p 479).

Securities and Exchange Commission v. Texas Gulf Sulphur Co. (page 480) - Insiders may not use

business information for their personal trading.

A person who is trading a corporations securities for his own benefit and who has access toinformation intended to be available for business use only, may not take advantage of the

information, knowing it is not available to those with whom he is dealing.

Private action for SEC 34 Act violation, plaintiff must prove(1) made a material misrepresentation/omission in connection with the purchase/sale security;

(2) Reliance;

(3) Scienter; and

(4) Causation.

Dirks v. Securities & Exchange Commission (page 493) - Tippees do not automatically have a duty to

disclose merely because he knowingly received the information.

2 elements to establish Rule 10b-5 violation: (1) the existence of a relationship affording access to inside

information intended to be available only for a corporate purpose; and (2) the unfairness of allowing a

corporate insider to take advantage of that information by trading without disclosure (Page 495). An insider will BE liable under Rule 10b-5 for insider trading ONLY where he fails to disclose

material nonpublic information before trading on it and thus makes secret profits.

NO DUTY to disclose where person who traded on inside information was not the corporationsagent, was not a fiduciary, or was not a person in whom sellers (of the securities) had placed their

trust and confidence (Page 495).

DUTY arises from existence of a fiduciary relationship.Intentional disclose issuer must simultaneously disclose that information in a manner designed to

convey it to the general public (Page 501).

Unintentional disclosure where corporate officer let something slip, issuer must make public

disclosure promptly after a senior officer learns of the disclosure (Page 501).

United States v. OHagan (page 501) - Attorney breaches his duty of loyalty if he uses nonpublicinformation to trade securities.

An attorney who, based on inside information he acquired as an attorney representing an offeror,purchased stock in a target corporation before the corporation was purchased in a tender offer is

guilty of securities fraud in violation of Rule 10b-5 under the misappropriation theory.


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Shareholder Voting Control

MCBA 1.40(22), 6.02, 7.01-7.05, 7.08, 7.28, 7.30-7.32

Stroh v. Blackhawk Holding Corp. (page 592) - Shares may represent a proprietary interest even if they

do not entitle the holder to dividends or other property.

Rights of earnings and rights to assets economic rights may be removed and eliminated fromthe other attributes of a share of stock.

The only way to have different economic rights and voting rights is through different classes ofstocks.

State of Wisconsin Investment Board v. Peerless Systems Corp. (page 597) - A court will not uphold aboards action, under the BJR, that interferes with a shareholders vote, absent a compelling justification.

Oppression of Minority Shareholders, etc.

Wilkes v. Springside Nursing Home, Inc. (page 638) - A close corporations shareholders need alegitimate business purpose to terminate another shareholders employment.

Majority shareholders acting to freeze out a minority shareholder by terminating his employmentwithout a valid business purpose have breached their duty to act as fiduciaries.

Ingle v. Glamore Motor Sales, Inc. (page 645) - Share ownership is not a guarantee of continuedemployment absent an agreement providing lifetime employment.

If a shareholders agreement provides for the right to repurchase shares upon the termination of a

shareholders employment with the issuing company, the employment is treated as employment at will

and the shareholder has no claim for damages upon termination

There is no implied obligation of good faith and fair dealing in an employment at will.

Sugarman v. Sugarman (page 651) - A majority shareholders action is evaluated against his fiduciaryduties and may be viewed as a freeze-out.

If a controlling shareholder uses corporate assets for his own personal benefit, an offer topurchase minority shareholders stock at an inadequate price will be viewed as part of a plan to

freeze-out the minority shareholders.

Shareholders in a close corporation owe one another a fiduciary duty of utmost good faith andloyalty. (textbook p. 653).

Smith v. Atlantic Properties, Inc. (page 655) - A minority shareholder may act in a manner that breacheshis fiduciary duty to the other shareholders.

A minority shareholder may abuse his position by using measures designed to safeguard hisposition in a manner that fails to take into consideration his duty to act in the utmost good faith

and loyalty toward the company and his fellow shareholders.

Deadlocks, etc. (Control, duration, and statutory dissolution)

MBCA 14.30-14.34

Alaska Plastics, Inc. v. Coppock (page 673) - A shareholder may not require a company to purchase itsstock for fair value if the company has not done so for others unless there is a breach of fiduciary duty.


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Shareholder of a closed corporation four avenues to have the corporation buy his/her shares at fair

market value (1) provision in the articles of incorporation or by-laws that provide for the purchase

of shares, contingent upon the occurrence of some event (2) petition the court for involuntary

dissolution (3) demand statutory right of appraisal merger (4) equitable remedy for breach of

fiduciary duty.

Pedro v. Pedro (page 682) - A shareholder may obtain value for shares in excess of that provided in avalid stock redemption agreement.

A shareholder-employee of a closely held corporation, who was fired by other shareholders in abreach of fiduciary duty, is entitled to damages equal to the total of the difference between hisstocks fair value and any lesser amount required by a stock retirement agreement, in addition to

the damages arising from his loss of life-time employment.

Factors court must consider determining intent of employment: (1) written and oral negotiationsof the parties, (2) the parties situation, (3) type of employment, and (4) particular circumstances

of the case.

Stuparich V. Harbor Furniture Mfg., Inc. (page 688) - Minority owners are not granted judicial

dissolution without evidence of preferential treatment of majority shareholders.

A court will not order dissolution of a close corporation if the plaintiffs fail to show thedissolution was reasonably necessary to protect their rights.

Dissolution is a drastic relief of involuntary dissolution.Transfers of Control

Frandsen v. Jensen-Sundquist Agency, Inc. (page 695) - Mergers do not trigger the right-of-first refusal(are interpreted narrowly) upon sale provided in a shareholder agreement (take-me-along provision).

A minority shareholders right of first refusal that is triggered by the majority shareholders saleof their stock does not apply to a transaction in which an acquiring entity purchases thecorporations principal asset, after which the corporation is liquidated.

Zetlin v. Hanson Holdings, Inc. (page 700) - Shareholders may receive a premium on the sale of their

shares for the control represented by their shares.

In the absence of an allegation that a shareholder is looting corporate assets or has committed fraud or

other acts of bad faith, a shareholder may obtain a premium price for the sale of a controlling block of

shares.

Perlman v. Feldmann (page 703) - A control premium must be shared among all stockholders if it

represents the transfer of a corporate asset.

A shareholder with a controlling interest who transfers his shares is accountable to the minority

shareholders for the amount in excess of the market price if the premium is attributable to the sale of a

corporate asset.

As a director and dominate stockholder, Feldmann stood in a fiduciary relationship to thecorporation and minority stockholders as beneficiaries thereof.

Essex Universal Corporation v. Yates (page 707) - A contract to sell a controlling interest in acorporation may include control of the corporations board.


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If the transfer of shares is sufficient to constitute the transfer of a controlling interest, a seller may

lawfully agree to assist the buyer in installing a favorable board of directors.

It is illegal to sell corporate office or management control by itself (accompanied by no stock orinsufficient stock to carry voting control).

Rationale for rule: persons enjoying management control hold it on behalf of the corporationsstockholders, and therefore, may not regard it as their own property to dispose of as they wish.

Mergers and Acquisitions

MCBA 11.01 11.07

De Facto Merger Doctrine (page 716)Statutory merger is a combination accomplished by using a procedure prescribed in the state

corporations laws.

Under a statutory merger the terms of merger are spelled out in a document called mergeragreement. Drafted by the parties, which prescribes, among other things, treatment of the

shareholders of each corporation.

Farris v. Glen Alden Corporation (page 718) - If a contemplated transactions result is the same as a

merger, the transaction is a de facto merger, and the target corporations shareholders have the right todissent and receive fair value for their shares.

To determine nature of corporate transaction court refers to (1) all agreement provisions, (2)consequences of the transaction, (3) purposes of the provisions of the corporation law said to be

applicable.

Hariton v. Arco Electronics, Inc. (page 725) - Corporations may legally effect a merger using the

statutory provisions applicable to an asset sale.

A reorganization plan that requires one corporation to sell its assets to a second corporation inexchange for stock in the second corporation and that calls for the first corporation to liquidate

and distribute the second corporations shares to its stockholders constitutes a permissible defacto merger.

True sale of assets stockholder of the seller retains right to elect whether the selling companyshall continue as a holding company.

Weinberger v. UOP, Inc. (page 727) - Shareholders approval of a merger is void if inadequate

information was disclosed to the minority shareholders.

Minority shareholders in a cash-out merger are entitled to damages based on their shares fairvalue, as determined by taking into account all relevant factors (including damages based on

rescission), if the mergers approval was obtained on less than full disclosure and the mergers

terms were unfair.

First plaintiff has burden of attacking the merger to demonstrate some basis for invoking fairnessobligation. (textbook p. 728)

Then, burden of proof is on majority shareholder to show by preponderance of the evidence thatthe transaction is fair. (textbook p. 728).

Issue of disclosure to minority shareholders, majority shareholders had a duty to disclosure allgermane information in their possession. Germane information such as a reasonableshareholder would consider important in deciding whether to sell or retain stock. (textbook p.

733).

Thiscase rejected BJR in cases of Mergers and Acquisitions and imposed fairness test. Fairness test = concept of fair dealing and fair price.


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Totality of circumstances test (1) purpose of merger, (2) accuracy and adequacy of disclosure inconnection with the merger, (3) fairness of the price.

Coggins v. New England Patriots Football Club, Inc. (page 739) - Frozen-out minority shareholders are

entitled to damages if there is no valid corporate objective for a merger.

If a company cannot show that a freeze-out merger served a valid corporate objective beyondadvancing the majority shareholders personal interests, the minority shareholders who werefrozen-out by the merger are entitled to relief.

Defendants bear burden of proving 1st) merger was for a legitimate business purpose, and 2nd)considering totality of circumstances, it was fair to the minority. (textbook 743).

Rescission damages based on present value (stockholders would have if merger were rescinded).Rabkin v. Philip A. Hunt Chemical Corp. (page 746) - Majority shareholders owe a fiduciary duty thatgoes beyond refraining from illegal activity.

Majority shareholders owe a fiduciary duty to minority shareholders and may not unfairlymanipulate the timing of a merger to avoid paying the minority shareholders the price agreed

upon as part of an earlier transaction.

Cash-out merger MUST be free of fraud or misrepresentation (Page 749). No SAFE HARBOR in Delaware. When directors of Delaware Corporation are on both sides of

a transaction, they are required to demonstrate their utmost good faith and the most scrupulous

inherent fairness of the bargain (Page 751).

Rauch v. RCA Corporation (page 752)

Takeovers and Takeover Defenses

Cheff v. Mathes (page 763) - A board may stop shareholders efforts to change the companys character. If the actions of the board were motivated by a sincere belief that the buying out of the protesting

stockholder was necessary to maintain what the board believed to be proper business practices,

the board will not be held liable for such decision, even though hindsight indicates the decisionwas not the wisest course.

If board has acted solely or primarily because of the desire to perpetuate them in office, the use ofcorporate funds for such purposes is improper.

Inherent danger in purchase of shares with corporate funds to remove threat to corporate policywhen a threat to control is involved. The directors are of necessity confronted with a conflict of

interest, and an objective decision is difficult. BURDEN is on DIRECTORS to justify such a

purchase as one primarily in corporate interest.

o Burden satisfied by showing reasonable grounds to believe a danger to corporate policyand effectiveness existed. Directors must show good faith, reasonable investigation.

Two-tier, front loaded, cash tender offer

Terribly coercive maneuver shareholders are offered a price if they sell up front (front end)become fearful that if they dont sell and merger goes through, their shares will be worth less

because they merged into the new company with less value per share (back end).

Unocal Corporation v. Mesa Petroleum Co. (page 775) - A self-tender offer may disallow a take-overbidders participation.

A board may use corporate funds to purchase its own shares to remove a threat to corporatepolicy and may deny the protesting shareholder the right to participate in the self-tender offer

provided the actions are motivated by a genuine concern for the company and its shareholders


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and provided that the proposed defensive measures are not out of balance with the threats

significance.

Boards power to act derives from its fundamental duty and obligation to protect the corporateenterprise, which includes stockholders, from harm reasonably perceived, irrespective of its

source. (textbook p. 779).

Standards by which director action is measured is BJR (applicable to takeover). BJR assumes inmaking a business decision the directors of a corporation acted on (1) an informed basis, (2) ingood faith, and (3) in the honest belief that the action taken was in the best interests of the

company. (textbook p. 780).

Note on SEC Reaction and Poison Pills textbook p. 784 Poison pill creates financial instrument that acquirer will have to swallow if it attempts to acquire

corporation. Pill destroys acquirer by creating significant financial liability.

See textbook p. 785 for flip-in and flip-out

Junk bonds are debt obligations of a corporation that are usually subordinate to other debts (theyare comparable to a 2

ndor 3

rdmortgage on personal residence). They bear relatively high level or

risk and high interest rate. See textbook p. 785-786 for two benefits to shareholder of junk bonds.

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. (page 786) - The board of an acquired companymust maximize the companys value for the benefit of its shareholders.

Delaware law permits agreements to forestall or prohibit hostile forces from acquiring acompany, but the methods may not breach a directors fiduciary duty, so that once the sale

appears inevitable, the board must work to maximize the companys value to ensure the highest

possible price.

See textbook p. 786-787 forlock-out option (right to purchase certain assets); no-shop provision(agreement not to shop around).

See textbook p. 789 forgolden parachute (take away director conflict) See textbook p. 791 forpoison pill (a plan by which shareholders receive the right to be bought

out by the corporation at a substantial premium on the occurrence of a stated triggering event).

Paramount Communications Inc. v. QVC Network, Inc. (page 806) - In a corporate sale, a board mustoptimize the price for its shareholders and treat competing bidders equally.

A board selling its corporation has a duty to obtain the best value for its shareholders and cannotgive preference to one of the competing bidders.

Jordan v. Duff and Phelps, Inc. (page 660)

Limited Liability Companies

LLC can have one member or any number of members do not have to have an agreement detailing

management responsibilities but Michigan has a statute outlining the operating agreement.

Buy-out Agreements for Small Businesses

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