EXAM based on answers to the problemsClosed book/noteIL and Delaware follow RUPA (UPA 1997) they are default rules that apply to partnership unless the agreement says otherwiseBusiness OrganizationsHelvestonSpring 2014

I. Overviewa. Main Questions re: Lawi. When/why does the law recognize a business as a distinct entity?ii. What are the different legal forms for businesses?iii. How does the law influence the different structures/operations?iv. What rights/duties does the law impose on businesses/business owners?b. Main Questions re: Otheri. What are a business goals?1. Primary Goal: to maximize utility ($, personal satisfaction, helping others, etc.)a. Maximize utility for the ownersb. Why not max social utility? would make disincentive for creation of business2. Why does society care about businesses? a. Organize labor and capital efficientlyi. Produce goods and services that benefit societyb. Create uniformity in the market allows for complex commercial transactions to occur3. Limitation of liability, tax structureii. How do they obtain capital?iii. What are the different ways business/owners make money and how is it distributed?iv. What financial tools do businesses use to help them meet their goals?v. What do lawyers have to do with all this?c. Main Goals of Biz Orgsi. Maximize social utility by promoting the creation and operation of businesses (bc businesses benefit society)ii. Provide rules that will resolve disputes that arise w/in businesses and btw businesses and third parties in a societally-optimal mannerd. How does the law incentivize the creation of businesses?i. Protect owners from certain types of liabilityii. Define legal relationships to help individuals feel secure enough to interact w/ businessese. Conflictsi. Owners v. Agents/Management (A.P. Smith case, CEO v. Shareholders)ii. Owners v. Owners (Majority Owners v. Minority Owners)iii. Business v. Stakeholders a.k.a. any person or business that is influenced by the business (BP v. Gulf of Mexico residents, employees, etc.)

II. What Do Businesses Do?a. A.P. Smith Mfg. Co. v. Barlow (SC NJ 1953)i. Facts: President OBrien recommends to Board of Directors of AP Smith to give $1,500 to Princeton stockholders disagreed and said it the contribution wasnt authorized 1. Shareholders want declaratory judgment to declare the donation invalid and rescind ita. All the excess money of a corp belongs to the shareholders they dont want the Board of Dir to give away their $!ii. Court: Contribution was valid (intra vires)1. Historically, under common law, such contribution allowed if benefits the corp2. In 1930, a statute was passed (after incorporation, pre donation) that allowed any corp to provide philanthropic funds to institutionsa. Board of Directors/CEOs have wide discretion when managing the companyi. Want to be in a state where there is no liability for the charitable contributionsb. The state has the power to pass laws that modify every corps articles of incorp.c. This is in the favor of public policyb. Notesi. Who owns AP Smith? The shareholders. They are suing the company itself.ii. A business is a separate entityiii. Real persons are agents of the corporationiv. A business with more than one owner that is a corporation can distribute and use its funds in ways that are opposed by at least some ownersv. Ultra vires acts of a person/corp deemed outside the authorityvi. Intra vires acts of a person/corp deemed inside the authorityvii. Problem of Close Corporations1. A corp makes a transaction that a shareholder dislikes. If its a publicly traded company, a disgruntled shareholder can sell his sharesa. But if this isnt an option, what else is there? (not many options)b. Derivative action not generally an option for charitable donationsc. Get a place on the Board or get other stockholders to threaten the Board

III. ACCOUNTING Financial Statementsi. Income Statement computes the profit of a business for the period in question (usually 1 year)1. Profit before taxes = Revenue Costs2. What happens when you obtain an asset to be used for longer than 1 year? a. Charge the full cost to the term that asset was required ORb. Divide the cost across the # of terms the asset will be usedi. Depreciation when equipment gets less valuable each year, part of it is being used up3. Net Income = PBT Taxes4. Looking @ two most recent income statements Can find out what the company did, where it spent money, how it changes over time, etc.a. Cant see actual cash earned or spent depreciation ii. Cash Flow Statement measure of how much more or less cash a business has at the end of the year than it had at the beginning of that year1. Net income2. + Depreciation (spreads a one-time cash cost over a period of time distorts the picture of what the companys cash reserves were at a period in time)3. Amounts actually spent during that period (Investments)a. Investment money spent to purchase equipmenti. When business buy something to use for more than one year this is an investment and only depreciation appears on income statementii. If business buy something to use up in one year this is an expense and the total amount appears on the income statement4. Cannot tell how much $ the company has doesnt include starting or ending amount (but usually that is included on the CF statement)iii. Balance Sheet snapshot, sets forth the current book value of a company1. Categoriesa. Assets things that the company owns that has value (aka stuff, ie. accounts receivable, cash, land)b. Liabilities what the company owes (ie. accounts payable, wages owed to employees, debts)c. Equity what is left over after you subtract liabilities from assets2. Assets = Liabilities + Equity 3. Cash flow = profits from income statement + depreciation net change in balance sheet asset accounts other than cash + net change in liabilities and funds from new issues of stockiv. Why keep these statements?1. Auditors2. Manage funds efficiently3. Inform investorsv. Keep in mind:1. Problem: if a company takes out a loan thats more than equity2. Relying on book value alone is a bad idea because: a. You dont know the full value of whats depreciated, b. Some of the values might be off (they are estimated conservatively, not very precisely)c. No cash flow or profit numbersd. Need to know what the market is like3. Hypo a company makes $5K in net revenue per year. Should it be bought for $100K? $50K?a. Need to know the market will revenue go up or down?b. What else can you invest in? Opportunity costs what is riskier? Making an investment or fully buying the company?b. Accounting Fraudi. Main feature: false financial statements1. Off-balance-sheet moving liabilities off the balance sheetii. Sarbanes-Oxley Act attempts to clarify responsibilities of auditors, company management, boards/audit committees1. Section 404 company must evaluate its own internal controls and must do so w/ procedure that evaluate the design of those controls and test their operating effectivenessa. Auditors then audit managements assessment and opine on the state of internal controls of the company

IV. Legal Structures for BusinessesMain Questions-Who owns this business?-Who manages this business?-Who gets the profits?-Who is liable for business liabilities?-How are business proceeds taxed?i. Sole Proprietorship a person undertakes a business w/o any formalities associated with other forms of organization; the individual and the business are one and the same for tax and liability purposesii. Corporation a tax paying entity 1. Income is taxed twice: (1) corporation pays tax on income; (2) owners of corp pay tax on that part of corps earnings that is distributed to them as dividendsiii. General Partnership like a SP for tax/liability, earnings are distributed according to the partnership agreement, taxes paid only at the personal level on the partners share of that income1. Partners are jointly and severally liableiv. Limited Partnership like a SP for tax/liability1. General partner assumes the management responsibility and unlimited liability // the limited partner has little voice and is not individually liable for companys debts (acts like a shareholder)v. Limited Liability Company (LLC) developed to provide protection from liability of a corp and the protection from double taxation of a partnership1. Owners of LLC not individually liable for companys debts2. LLC is not a tax-paying entity income taxes only paid once by owners of LLC when part of the companys earnings is distributed to them

V. Sole Proprietorshipa. Sole Proprietorship a person undertakes a business w/o any formalities associated with other forms of organization; the individual and the business are one and the same for tax and liability purposesi. Only one owner he manages, makes profits, is liable, pays taxesb. Agency (RST 2d 1)i. P manifests consent to have A act on his behalf and under his control A consentsii. (1) Fiduciary relation + (2) manifestation of consent by one person (principal) to another (agent) that the other (agent) shall act on his (principals) behalf and subject to his (principals) control + (3) consent by the other (agent) to so act.1. Fiduciary duty to act with the highest degree of honesty/loyalty toward another person and in that persons best interest2. Examples of Agency employer/employee3. Concernsa. When is a business/owner liable for the actions of its agent/employee?i. Types of Liabilities1. Contractual2. Tortiousii. Why have liability?1. You will trust a company more knowing it is willing to take the blame for errors of the agent people wouldnt want to deal with agents if liability didnt trace back2. Dont want third-party to be undercompensated3. Dont want to hold the agent liable if they were a puppet4. Companies wont hire risky people; put employees in risky situations, etc. more cautiousc. Contractual Liabilityi. P will be liable for CLs created by A, when A had one of three things:1. Actual Authority2. Apparent Authority3. Inherent Agency Power

ii. Authority1. Actual Authority manifestations from P to A that A reasonably believes create authoritya. P simply tells A that A is empowered to act on Ps behalf in accomplishing some taski. P takes an action towards A and A reasonably believes he has authority through this action1. Example: John, please go buy me green shoes.a. John is the A, you are the Pb. Actual Express v. Actual Impliedi. Actual Implied A has the authority to do what is reasonably necessary to get the job done, even if P did not spell it out in detail, includes authority to do acts which are incidental to it, usually accompany it, or are reasonably necessary to accomplish it1. Example: John set up a dinner partya. John, A, has implied actual authority to call dinner guestsc. *Liability limited to actions within the scope of authority granted*2. Apparent Authority P does not really authorize A to act on his behalf / Apparent Authority is created by manifestations by P to a third party (TP)a. Manifestation must be (1) attributable to P (2) must get to TP (3) must lead TP reasonably to conclude that A is an agent for Pb. P has liability regardless of whether he actually authorized Ac. Example: I tell A, you dont have authority to buy cheeseburgers, but yesterday I told cheeseburger guy that A does have the authority. I will be liable if A goes and buys cheeseburgersi. P must be held to this contract so as not to blame TP for the secret convo btw P and Aii. P can avoid liability by not saying such things to TPs3. Inherent Agency Power power of A to bind P to deals with TPa. P has created an agency relationship with Ai. (ie. a chef in a restaurant has the authority to do XYZ, P is liable for chefs XYZ actions)ii. Protect the TP who doesnt know betterb. Subset of Apparent Authority e.g. 1) name a CEO, 2) TP knows a CEO, 3) CEO(A) does something4. PROBLEMS pg. 36a. Yes, Actual Authority (P told A that its part of her job to buy food)i. Propp is legally obligated to pay for the food. ii. Agee is his agent and is not obligated to pay for the food.1. Where a Principal is KNOWN then the Agent is not a party to Kb. Yes, Apparent Authority (A had bought food in the past from TP so TP thinks this is ok)i. Propp is legally obligated to pay for the food1. A is not a party to the K!ii. A is liable to P for violating fiduciary duty c. No authority at all.i. Cooks normally do not have this authority.1. A did not enter into a K not contractually liable2. A has tortious liability to newspaper for fraud/misrepii. Can an agent create his own authority? (ie. cook told newspaper she was the owner)1. NO, there is no Principal not fair to hold P liable to something it didnt do and had no idea ofd. Tort Liabilityi. Agency Relationships1. Master-Servant Relationship tort liabilitya. P has complete or near complete control over As actions R. 2d 220b. P only liable for actions taken by A that are within the scope of As employment2. Non-M/S someone hired to do a job, but not told specifically how to do it i.e. Independent Contractor, Auditor parts of the task cannot be controlled by the P no tort liability, only contractual, see aboveii. Respondeat Superior 1. Vicarious liability Ps liability is vicarious and does not depend on Ps being negligent, P must control the details of how a job is to be done, tort must be committed w/in the scope of employmenta. Frolic not w/in scope = No liability for Pb. Detour still w/in scope during the course of completing his duties = liability for B2. PROBLEMS pg. 39a. Servantes is a servantb. CEO of GM is a servant b/c the master is the Board of Dir Pilot is servant (although a bit more unclear b/c specialized training but the airline can tell them what to do Accountant not a servanti. If your accountant burns someone while doing your taxes, you are not liable b/c he is not your servant (you arent exercising control, you dont know how to do your taxes)c. P liable for S burning P specifically tells S that his job description doesnt include burning customers P is still liable, its still within the scope of employment, you cant cut stuff out to free yourself from liabilityi. S is liable for his own tort everyone always liable for own negligenced. S injures a pedestrian otw to work, is P liable?i. No, this is outside the scope, even if part of your job is to commuteii. S is liable for his own torte. P hires A as cook, but then A hits a customer on the head (S not liable)i. A is liable for her tortii. P is not liable for As tort b/c its outside the scope of employmentf. Can P eliminate need to hire attorney simply by purchasing insurance?i. No insurance doesnt solve problems like theseiii. Attorney-Client1. Hayes v. National Service Industries, Inc. (CtofApp 11th Cir 1999)a. Facts: Robin Hayes attorney entered a settlement agreement with APs lawyer on Hayes behalf. Hayes argued that she did not give her lawyer the authority to do sob. Court: Rogers (the lawyers) actions were validi. He was acting w/in the scope of his employmentii. He had apparent authority 1. Doesnt matter for contractual liability if Rogers told AP he had authority or not but it could be a breach of fiduciary duty2. Attorneys have apparent authority unless CL tells APs lawyer that he doesntiii. His authority is determined by the representation agreement btw client and the attorneyiv. If 3rd party knows that attorney does not have authority, the K isnt binding otherwise 3rd partys belief in authority must be reasonableiv. Franchises and Other Business Relationships1. Miller v. McDonalds Corp (Or.Ct.App 1997)a. Facts: P found a sapphire in her Big Mac and went directly to McDonalds Corp to sue. McD said that it did not own that restaurant but the franchise owner was 3K and P should sue himb. Court: McD was the proper partyi. Tigard McD was an agent of McD Corp bc McD had given 3K full instructions/details on how to run the franchise1. The more detailed the control the more it seems like a master/servant relationshipii. Is McD Corp liable for the tort of his franchisee?1. YESa. Court looks at the amount of control McD had over the franchisec. Agency by Estoppel / Apparent Agencyi. I know someone out there is acting as my agent even if theyre not. I do nothing to stop others from acting as my agent, so I can be held liable for their actionsd. **Most courts say that franchisee-franchisor relationships are not agency relationships! And NO MASTER/SERVANT relationships = just a contractual relationship cannot bind one anothere. How Sole Proprietorships Growi. Funding by the Owner1. Increase Personal Equity owner puts in $ himselfa. No obligation to pay back lowers risk2. Debt owner takes out a loana. Legally obligated to pay back, usually with interest increases risk to business (repayment) and ownership (loss of control)ii. Funding from Entities (other than owner)1. Equity funding investment business receives for selling part ownership in the business2. If sole-proprietorship uses, they are no longer a sole proprietorshipiii. Risks1. Ownership (loss of control equity)2. Risk to Lender/Third Party my not be repaid guaranteed amount (when lender) Equity lender has higher risk but also potential for higher return3. Risk to Business (repayment) Equity lower risk to business owner; Debt higher risk to business b/c established payment scheduleiv. As an owner, how can you make it safer for someone to lend to you?1. Secured Interest (collateral)2. Co-Signing3. Short term lending4. Give lender control in managerial decisions of the company (i.e. on the board)a. Problem: too much control makes the loan look like equity Bank profit tied to businesses profiti. Idea Does the person lending money seem like an owner?1. Control OR Financial stake tied to success of operationb. Other control options: loan covenants including promises that creditor makes to not do certain things5. Flexible Repayment Terms (i.e. 5% of net revenue will go towards repaying the loan)v. Sharing Profits w/a Lender1. In re Estate of Fenimore (Del 1999)a. Facts: Mrs. S gave her brother a bunch of money and he had creditors after him; Villabona = debt, ? if Mrs. S is debt or equityb. Court: this is a partnership, Mrs. S gets nothing, Villabona gets all inheritancei. Based on 7 of UPA ~ Partnerships = share in profits, unless an exception applies1. Agreement says agrees to divide the profits from each vehicle2. Called it an advance, not a loan more like an equity contribution ~ return was primarily tied to profitsii. UPA Priority: those who are not members of the partnership, their debts have to be paid off before the debts of the partnerc. Notesi. If you want this to just be a sole proprietorship, make sure the lender has no control over the company, is just giving a loan, etc.

VI. Partnerships-Who owns this business?-Who manages this business?-Who gets the profits?-Who is liable?-Taxes

a. What is a Partnership?i. A partnership is a business with more than one owner1. Sometimes a partnership is a separate entity2. Only partners pay tax on the business profitsii. RUPA 103 general rule = relations among/between partners are governed by the partnership agreement1. Partnership agreements act like Ks private agreements2. Dont need to be filed aka a default form of business structure unless the party takes action to become LLC or something else3. Partner fiduciary duties are mandatory as specified in RUPA/UPA4. If partners fail to agree RUPA provides other default rules [UPA 18]iii. Theories of Partnerships both are right, most use entity1. Entity the partnership is a legal entity of its own RUPA 201a. If a partner withdraws/dies, the partnership can continue2. Aggregate the partnership is the aggregate of its partnersa. If a partner withdraws/dies, the entire partnership is destroyedb. Partnership Agreementsi. Agreements not needed, but highly recommendedii. Lawyers not needed unless there are disputes between partnersiii. 103(a) partnership agreements can change any default rules except for those under 103(b)iv. KNOW THE CATEGORIES IN 103(b) Partnership agreement MAY NOT eliminate 1. 103(b)(3-5) Fiduciary Duties2. 103(b)(6-8) When A Partnership Is Ending3. 103(b)(8) cannot vary dissolution rights in 801(4)-(6)4. 103(b)(9) Vary the law applicable to a LLP under 106(b) Dont need 2 know5. 103(b)(10) Partnership agreements cannot restrict rights of third partiesv. Problems: Partnership Agreements p. 66-671. 3a-c = all valid2. 3.1 = probably, but not well drafted ambiguous, everyone or majority3. 3.2 = Would want unanimity for payments of net profits to partners because may need equity to remain in the business and be reinvested; but not for payments to creditors of the business b/c it would interfere with daily operation of businesses4. 3.3 = might indicate some difference, BUT, still ambiguous5. 3.5 = No, 103(b)(10) states the p-ship agreement may not limit the rights of 3d parties & everyone is liable for their own negligencec. Property Interestsi. UPA 8(1)/ RUPA 203 Property acquired by a partnership is property of the partnership and not of the partners individually1. Property can be transferred to partnership or a partner in p-ship capacity2. Partnership that entered the partnership but wasnt transferred is part of the p-ship ONLY IF it was bought with partnership assets3. If something is bought in the partnerships name or bought by C as partner of Company B then it is partnership propertyii. Why do we care?1. For tax reasons2. In case of litigation3. Control If the partnership owns it, they all have to decide on control4. In case of partnership dissolving need to know what needs to be divided and howiii. Problems: Partnership Property p.671. 1) see above; 2) N, presumption arises only if purchased w/p-ship assets; 3) Y, indicated by the name on the receipts; 4) Y, purchased by p-ship; 5) Capels money Blackacre titled to BB = p-ship property, Capels money Blackacre titled to Capel = non-partnership propertyd. Partnership Decision-Making aka Managementi. Default Rules1. RUPA 401(f) In the absence of an agreement to the contrary, matters arising in the ordinary course of the business may be decided by a majority of the partners2. RUPA 401(j) an extraordinary measure requires the unanimous consent of the partners for a grant of authority outside the ordinary course of business, unless the partnership agreement provides otherwisea. Extraordinary Amendments to the partnership agreement & matters outside the ordinary course of the partnership business b. Although the text of the UPA is silent regarding extraordinary matters, courts have generally required the consent of all partners for those matters. See, e.g., Paciaroni v. Crane, 408 A.2d 946 (Del. Ch. 1989); Thomas v. Marvin E. Jewell & Co., 232 Neb. 261, 440 N.W.2d 437 (1989); Duell v. Hancock, 83 A.D.2d 762, 443 N.Y.S.2d 490 (1981).ii. Conflicts1. UPA third party has to actually know that a person does not have authority to enter into such management decisions or else the partnership is bound2. RUPA third party only has to receive noticeiii. Problems: P-ship Decision-Making p. 68-691. As long as ordinary, can do without Ps consent2. Need Ps consent3. Yes, in partnership agreement and not unreasonable4. UPA 9(1) + 9(4), yes, the p-ship is bound unless the person had knowledge of a restriction on a partners authority; RUPA 301(1) provides that a person who has received a notification of a partners lack of authority is also bound. 5. UPA the term knowledge embodies the concept of bad faith knowledge arising from other known facts; RUPA only actual knowledgea. RUPA 102(d) can give a notification of a restriction on a partners authority to a person dealing with that partner; may be effective upon delivery, whether or not it actually comes to the other persons attentioni. To that extent, the risk of lack of authority is shifted to those dealing with partners.6. Yes, RUPA405(b) A partner may maintain an action against the partnership or another partner for legal or equitable relief, with or without an accounting as to partnership business, to: (1) enforce the partners rights under the partnership agreement; (2) enforce the partners rights under this [Act], including: (i) the partners rights under Sections 401, 403, or 404; (ii) the partners right on dissociation to have the partners interest in the partnership purchased pursuant to Section 701 or enforce any other right under [Article] 6 or 7; or (iii) the partners right to compel a dissolution and winding up of the partnership business under Section 801 or enforce any other right under [Article] 8; or (3) enforce the rights and otherwise protect the interests of the partner, including rights and interests arising independently of the partnership relationship.a. But RUPA remedy is Bullshitb. If there was contractual entitlement ORc. CL Tort Breach of Fiduciary Dutye. Fiduciary Dutiesi. Fiduciary duty to act with the highest degree of honesty/loyalty toward another person and in that persons best interest1. An agent has a fiduciary duty to the principal, not vice versa2. UPA does not list what fiduciary duties are owed these states have to rely on common law3. RUPA 404 a. 404(b) - Duty of loyaltyi. 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;ii. 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; and1. E.g. contracting with the p-ship where they benefit more than the p-shipiii. To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.iv. 103(b)(3) Partnership agreement may NOT eliminate the duty of loyalty under Section 404(b) or 603(b)(3), but:1. (i) the partnership agreement may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable; or2. (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 loyalty;b. 404(c) - Duty of carei. Refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law when acting on partnerships behalfii. 103(b)(4) Partnership Agreement may NOT unreasonably reduce the Duty of Care under 404(c) or 603(b)(3)1. 603(b)(3) the partners duty of loyalty under Section 404(b)(1) and (2) and duty of care under Section 404(c) continue only with regard to matters arising and events occurring before the partners dissociation, unless the partner participates in winding up the partnerships business pursuant to Section 803c. 404(d) Duty of good faith and fair dealing when engaging in partnership duties applies all the time!i. General contractual duties, not actually a fiduciary dutyii. 103(b)(5) Partnership Agreement may NOT eliminate the obligation of good faith and fair dealing under Section 404(d), but the partnership agreement may prescribe the standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonableii. Meinhard v. Salmon (NY 1928)1. Facts: Salmon entered a lease agreement with Gerry and another agreement with Meinhard to share some P+ would cover L equally; Salmon power to manage buildinga. Right before the Gerry lease was going to expire, Gerry told Salmon about a proposal to lease 5 properties and build one giant buildingb. Salmon agreed, but Meinhard was not informedc. Meinhard sued for an interest in the new building breach of fiduciary duty2. Court (Cardozo): In favor of Meinharda. New lease was an extension and enlargement o/t subject-matter of the old oneb. Joint adventurers (ie. partners) owe to one another the duty of loyalty (fiduciary duty) when opportunities arise during the course of the relationship related to the partnerships existing scope of operationsi. Opportunity was an incident of the existing enterprise S had a duty to disclose to M + he could have competed for job3. Dissent (Andrews): The new lease btw Gerry/Salmon was very different from the original; joint venture not a partnership limited object and design4. Notesa. Contrarian School of Economic Thought business people ought to be free to agree to the terms of their relationship, with minimal statutory impositionb. A joint venture is not a legal category. This was a partnership.iii. Policy1. Social/economic environment will benefit more (aka maximize utility) by having fiduciary duties to regulate certain behaviorsa. We want people to act properly but they will also have the freedom to contractiv. Questions: p. 751. Loyalty/Care to partnership and partners good faith and fair dealing in all (not FD)2. Loyalty/Care cant be eliminated, but can be limited, can ask for permission - end if disassociated. Otherwise, cant be eliminated. f. Liabilityi. Of Partnership1. 3rd party can sue partnership for: Ks entered by its agents & torts committed by its agents2. RUPA 405(b) a partner can sue the partnership to enforce her rights under RUPA or the partnership agreement (not permitted under UPA)ii. Of Partners1. RUPA 305-307 Partners are jointly and severally liable for all obligations of the partnership (tort and K)2. UPA 15 partners are jointly (but not severally) liable in K [must sue all partners]; BUT are jointly and severally liable in tort [can sue 1 or more partners]a. A partner is liable for torts of another partner even if the first partner had nothing to do with thisiii. Problems: Partnership and Partner Liability p.771. 1.1-Yes 305(a), 307(b)-p-ship directly sued; 1.2-Yes, everyone liable for own negligence; 1.3-Yes, J+S liable for obligations of partnership2. First go after p-ship assets, then A3. 1st ACE, then A for any deficiency 307(d)4. 1st ACE, then A (personally liable and judgment against p-ship)5. Yes, from the partnership may require contribution from the partners 401(c)6. Easier to get personal guarantees from all people than to have to go after partnershipiv. 307(c) A successful plaintiff cant collect her judgment from partners individual assets until exhausting partnership assetsv. 401(c) the partnership is liable for the individuals tort and the partnership has the obligation to indemnify all the partnersvi. LLP (Limited Liability Partnership) public filing of a doc that serves as notice that partners will not be personally liable for what the partnership does1. RUPA 306(b) A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the persons admission as a partner;2. RUPA 306(c) An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership a. A partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for such an obligation solely by reason of being or so acting as a partner. This subsection applies notwithstanding anything inconsistent in the partnership agreement that existed immediately before the vote required to become a limited liability partnership under Section 1001(b)g. How Does a Partnership Business Grow? Financingi. Existing Owners1. Partnership agreements contain provisions that state:a. The vote/events that trigger the obligation to contributeb. The amount of each partners contribution obligationc. The time in which to make the additional contributiond. The consequences of a failure to contribute2. UPA/RUPA do not have default rules3. Hypoa. What happens if 4/5 partners kick in additional capital and the last one doesnt do anything?i. Consider the 4/5 contributions to be loans so they will be repaidii. Rebalance the percentage of partnership shares/controlb. Vests a lot of power in the managing partnerii. Outside Lenders Consider risk/return and who the loan is guaranteed by1. Leverage the use of debt to finance a businessa. Any action that multiplies the potential gains/losses of a business increasing a business leverageb. Taking on debt will increase the leverage by using borrowed money to purchase more than it can afford via equity alone, the business increases potential return on investment if things go great, but risks putting itself in a worse position is things go south (due to debt payment obligations)iii. Additional Owners (ie. Investors)1. Want to establish the % age share that a given amount of equity would receive2. ROI = Potential Dividends/Total Investment in business [debt+equity]3. ROE(quity) = Potential Dividends/Equity Investment4. Legal Issuesa. RUPA 401(i) requires the consent of all existing partners unless the partnership agreement provides otherwisei. Or 401(j) an extraordinary act needs unanimity = amendmentb. RUPA 306(b) a new partner is not personally liable for partnership obligations incurred before his admission as a partneriv. Problems: New Partners p.811. No, must have unanimous decision to amend a partnership agreement, not in ordinary course of business so majority is insufficient2. Existing Lease No; Anticipated Construction Yes, if LLP not personally unless signh. Earnings from Business Operations: Profitsi. Making Money1. A business owner makes money by:a. Being paid a salary by that businessi. RUPA 401(h) a partner is not entitled to remuneration for services performed for partnership, except for reasonable compensation for services rendered in winding up the business of the partnership1. Most partnership agreements agree to change this ruleb. Distribution of all or part of the profits from that businessi. RUPA 401(b) each partner is entitled to an equal share of the partnership profits, if the agreement does not state otherwisec. Selling his interest in the businessi. RUPA 502 the only transferable interest of a partner in the partnership is the partners share of profits and losses of the partnership and the partners right to receive distributionii. Why cant you sell management authority?1. Partnerships as voluntary contributions and its not fair for someone to just switch out favors the aggregate theoryiii. If you sell your interest, you still RETAIN management authority1. And RETAIN liability for p-ship obligations2. And RETAIN fiduciary duties to partners and p-shipd. Reinvestment of partnership earnings - P.81 if nothing in agreement then majority wins if in the ordinary course of business (this includes determining what to do with earnings)2. Problems: Partnership Profits p.82-83a. 33k each of no provision in agreementb. Enforced b/c in agreement 66k, 16.5k Propp, 16.5 Ageec. Capel NOT entitled to payment 2/3 of distribution does not = 2/3 of voting powerd. Can compel a distribution BUT the partnership must pay off all debts before it can make a distribution cant force a distribution if the p-ship has negative value 807; could sell off stuff to make distribution (loyalty okay; care only violated it grossly negligent)i. Sale of Ownership Interest Back to the Partnershipi. Buy-Sell Agreements1. Sale of partnership interests (1) back to the partnership or (2) to other partnersa. Can be made via a (1) new K or can be a (2) clause in the partnership agreement itself2. Even w/o a buy-sell agreement, a partner has the power to compel the partnership to pay for her interest by withdrawing from the partnershipa. RUPA 602(a) any partner has the power to dissociate (withdraw) at any timei. Cannot alter this rule!!b. RUPA 602(b) If the withdrawal violates the partnership agreement, occurs before expiration of partnership term (does not have to be definite time can be as long as Obama president or #4 p.86), or satisfies any other circumstance in 602(b), it is wrongfuli. Consequences1. 602(c) Damages caused by dissociation2. 701(h) Partner will be paid out whenever the partnership is supposed to endii. A partner in a partnership at will, with neither a specified end date or specific undertaking to complete, can quit at any time without it being wrongfulc. 701(b) how much will he be paid? Distributional share under 807(b)i. Look at higher of:1. Liquidation value (selling assets individually) of partnership OR2. Selling the business as one entityd. UPA no right to withdrawal??ii. Creel v. Lilly (MD 1999)1. Facts: Creel owns Nascar memorabilia to expand the business, takes on 2 partners and then dies (leaves poorly executed partnership agreement)a. Creels wife wants them to sell the business (liquidate) and give her Mr. Creels shareb. Other partners disagree and offer to buy his share outi. List the book value of the business and apply Creels percentage2. Court: UPA governs (during phase-in period) but there is no forced sell; the agreement shows the intent to allow remaining partners for purchasea. UPA mandates forced sellb. RUPA no obligation to force sell, gives non-withdrawing partners the option of dissolving it liquidly or buying out the withdrawing partners share3. Selling the corp as a whole brings in more money than selling the assets separatelya. Problems: its a lot more likely to find buyers for assets than for an entire companyb. Look at Book Value vs. Market Value no finding of goodwill so they required payment of proportionate share of book valuec. If no agreement = dissociation b/c of death and buyout price of dissociated parties interest would be determined by the larger of the share of liquidated value or Sale valuej. Disputesi. Partnership v. outside Third Party1. Look to: relevant partnership statute, then agency principles (actual/apparent)ii. Partner v. Partner1. Look to: provisions of the partnership agreement, then provisions of relevant partnership statute, then agency principlesiii. Liability 7021. Of dissociated partner when partnership doesnt wind up after dissociation, w/in 2 years of dissociation, AND TP doesnt know (RUPA) or have notice (UPA)k. Partnership Endgamei. RUPA1. Lists certain times when you must liquidate and when you must continue on (buy-out)ii. Buy/Sell agreement built into partnership agreement the right of the partner to buy out or sell their interest1. Problems: everyone wants their own share, if the firm was going to continue theres a chance they wouldnt get their rightful share2. How to deal: say that the partner gets his percent share of book valuea. Problem: book value can significant diverge from actual valueb. How to deal: we will have an appraiser to come in and value all the assets, or come up with a formula that takes into account book value and other accountingi. If someone dies then you can use the valuation scheme to cash them outiii. Dissolution, Winding Up, Termination1. When a partner dies or withdraws, there are two choices:a. The remaining partners can purchase the departing partners interest and continue the partnership business orb. The partnership can dissolve, liquidate, and terminate2. Dissolutiona. Definition someone has withdrawn from the partnershipb. The partnership continues for the limited purpose of winding up the businessc. UPA the withdrawal of any partner will cause dissolutiond. RUPA uses Dissociation; doesnt automatically mean the partnership is dissolved Entity-theoryi. 601 A partner is dissociated from a partnership upon the occurrence of any of the following: 1. Express notice that partner wishes to withdraw in the future; 2. Event in p-ship agreement causes the partners dissociation; 3. Expulsion pursuant to p-ship agreement; 4. Expulsion by unanimous vote of other partners unlawful, transfer of substantial part of that partners interest has occurred, no right to continue for whatever reason; partnership where partner has been dissolved and its business is being wound up5. Expulsion by judicial determination upon application6. Bankruptcy or similar financial impairment7. Death or incapacity8. Distribution by a trust-partner of entire p-ship interest9. Termination of an entity partnerii. 801 A partnership is dissolved, and its business wound up 1. Partnership is at will w/notice of non-dissociated partners express will to withdrawa. Withdrawing partner can force liquidation2. Partnership for a definite term or particular undertakinga. Can not be forced to liquidate by a partner who withdraws prematurely in violation of the p-ship agmtb. If one of the partners dies or wrongfully dissociates before the end of the term, the partnership will be dissolved only if half of the remaining partners vote in favor of dissolution within 90 days after the dissociation3. Event agreed to in p-ship agreement4. Unlawful to continue5. On application by a partner, a judicial determination6. By judicial determination based on equity to transferee of a partners transferrable interesta. Rights of a transferee under this section cannot be varied in the partnership agreement 103(b)(8)iii. 802 A partnership (a) continues after dissolution only for the purpose of winding up its business, SUBJECT TO1. (b) Agreement of all partners (except wrongfully dissociating partner) to waive the right to have the partnerships business wound up and the p-ship terminateda. Resume carrying on business and liability after dissolution and before waiver remainsb. Rights of a third party under 804(1) or arising by conduct in reliance on the dissolution before knowledge of waiver may not be adversely affectediv. Death does not cause dissolution (but does cause dissociation RUPA)3. Winding Upa. 807(a) assets must be applied to discharge its obligations to creditors, including, to the extent permitted by law, partners who are creditors any surplus must be applied to pay in cash the net amount distributable to partners in accordance with their right to distributions under subsection (b)b. Comment 2 partner whose debt has been repaid by the partnership is personally liable, as a partner, for any outside debt remaining unsatisfied, unlike a limited partner or corporate shareholderi. Accordingly, the obligation to contribute sufficient funds to satisfy the claims of outside creditors may result in the equitable subordination of inside debt when partnership assets are insufficient to satisfy all obligations to non-partners1. 306 not personally liable for any p-ship obligation before becoming a partnerii. All debtors should be treated the sameiii. Required contributions are considered assets of the p-shipc. When completed, p-ship entity terminates4. RUPA Default Rules (401, 807) Unless partners agree to the contrarya. The partners share responsibility for losses from operation of partnership and partners losses from investment in partnership 401(b)b. The amount of each partners loss from her investment is determined from her partnership account 401(a), 807(a)-(b)c. When the partnership is dissolved, the partnership is legally obligated to pay each partner an amount measured by the balance in her partnership account 807(b) i. 401 The amount in each partners account will be =1. The value of investment (not including labor)2. Minus distributions to partner3. Plus an equal share of whatever remains after paying creditorsa. If there are ISF then loss divided equallyd. If a partner has a negative balance, he must contribute additional funds in the amount of the negative balance5. Kovacik v. Reed (Cali 1957)a. Facts: K told R (defendant) that K had an opportunity to do work for Sears and asked R to be his job superintendent. K invested $10K and promised R hed share the profits 50/50. K did not ask R to agree to share any loss and R didnt offer to do so. Rs only contribution was his own labori. K informed R that the venture was unprofitable and demanded contribution from Rb. PP: TC said that R agreed to share the profits/losses and owed of loss to Kc. Court: reversed, found for Ri. In the absence of an agreement to the contrary, the law presumes that partners/joint adventurers intend to participate equally in profits/losses1. Exception: when one partner contributes only money capital against only anothers skill, labor, then in the event of a loss, each party would lose his own capital (what he initially contributed, person cant receive a salary)ii. This case decided under UPA (split everything btw partners unless it falls within this exception)1. Under RUPA, labor doesnt count as contributiond. Partnership Accounti. Details what each partner put into the partnershipii. This is a default rule under RUPAiii. Do not need to agree to partnership accounts to have themiv. Expulsion1. If there is no partnership agreement, there are no rules for expulsion2. RUPA 601(3) expulsion does not require dissolution, but requires remaining parties to buy them out UPA has aggregate theory so it would have to dissolve3. Bohatch v. Butler & Binion (Tex 1998)a. Facts: Bohatch reported to firms managing partner that another partner was overbilling Pennzoil she was told to look for other employment, reduced her tentative distribution share to zero, and did not pay 4 months of monthly drawb. Issue: Is there an exception to this rule that a partnership has a duty not to expel a partner for reporting suspected overbilling by another partner?c. Court: No dutyi. Partners have a duty of loyalty and good faith, fairness, honesty, but there is no obligation to remain partners1. A partnership exists solely b/c the partners choose to place confidence/trust in one another2. There is no fiduciary duty that creates an exception to the at-will nature of partnerships for whistle blowingii. Policy: the threat of tort liability for expulsion would force partners to remain in untenable circumstances to their own detrimentiii. However, the firm did breach its K when it didnt pay monthly draw (but no fiduciary duty = no damages for mental anguish/punitive)v. Freeze Out1. Where holders of the majority interest force a minority owner to sell/give up her interest2. Page v. Page (Cali 1961)a. Facts: Partners entered an oral agreement where each partner contributed $43K. Even though the partnership ended up being profitable, Plaintiff wanted to terminate partnershipi. D said P acted in BF and that upon the dissolution, he will receive very little $ii. D said P used his superior financial position to push out D so P can acquire the whole business and receive 100% of the profits1. P has a $47K from his corp which funded the partnershipb. Court: D failed to prove P acted in BFi. P had the power to dissolve the partnership by express notice1. This is an at-will partnership, P could pull out at anytimeii. The dissolution is only wrongful if it was done in BF and violated Ps fiduciary dutiesc. How to avoid this:i. Require appraisal and then auction-based sale upon dissolution will help ensure that partner reqd to unwillingly dissolve gets the fair market value and assets arent poachedii. Set a term so its not at willvi. RUPA 103(b)(6)1. Can only modify a partners ability to withdraw/dissociate by requiring notice in writingl. Wrap-Upi. Sole Proprietorship v. Partnership1. Goalsa. Want to maximize social utility by promoting businessesi. Its not hard to create these structures and the rules provide definitionsb. Want to provide rules that will resolve disputes and promote efficiency and trusti. We have default rules to fall back upon2. Whats missing?a. Limited liability neither of these forums protect owners from the business liabilityi. Debts are paid from the owners

VII. Corporationsa. A corporation is a separate legal entity and its owners (shareholders/stockholders) are generally not personally liable for the corps debts, dictated by state lawi. Limited Liability: the most an owner risks is the amount she paid for stockii. Public (publicly traded stock, large) v. Close (not publicly traded stock, small)iii. Why entity theory?1. We need something to blame and be liable other than the owners, which you cant do if there isnt limited liabilityb. Sources of Corporate Lawi. State Statutes1. Model Business Corporation Act2. Delaware General Corporation Lawii. Articles of Incorporation, Bylaws, Agreements1. AoI: A corp. does not exists until AoI are property executed/filed with appropriate state agency (Secretary of State) MBCA 2.03a. Can be filed by a corp. or an individualb. Very basic infoi. MBCA 2.02(a): 1. Must set forth (1) Name, (2) # of Shares Authorized to Issue (3) Street Address and Registered Agent (4) Name/Address of Each Incorporator2. May set forth (1) names and addresses of the individuals who are to serve as initial directors; (2) provisions not inconsistent with the law: duration, shareholder liability/non-liability, procedures for dealing with self-dealing procedures, etcii. Delaware: 1. Name is more detailed, include inc, corp, ltd, etc to signify what type of higher corp structure, a. Cant include the word bank unless registeredb. Want to make sure that it is more transparent when you are dealing with a corporation2. Statement of Purpose (usually generic)3. More detail about stock4. Stock issuance requirement makes sense so potential stock buyers will know whats available and what their percentage of ownership will bec. Purposei. Give notice to the world - Know who will be responsible ii. Know if authorized to issue certain amounts of stockiii. Maintain efficiency/organizationd. Why not more information required?i. Want maximum flexibility2. Bylaws: Adoption of bylaws is not required but recommended, bylaws are a completely internal doc3. What if Bylaws and AoI conflict?a. Articles winb. Sometimes governance procedures are included in the articles instead of the bylaws . . . WHY? More difficult to change the AoIiii. Case Law interpret and apply provisions in corporate statutes and corporations articles and bylaws & act as gap-fillersiv. Federal Statutesc. Promoter = someone acting on behalf of a corporation that is not yet formed **not tested on**i. Corporation never formed . . . P knew it wasnt a corporation at the time1. P jointly and severally liable for anything he signs, whether signing on behalf of the entity OR if he signed his name individually MBCA 2.042. Mitigated liability If he tells TP there is no corporation yet3. Non-promoters can be liable if acting as a partnership (before incorporation); can also make an equitable argumentii. A corporation is liable on a lease once it takes an action to adopt it1. Why? Corporation didnt exist at the time, not fair to hold it liable for what the promoter did2. How does this happen?a. Ratification = the affirmance by a person of a prior act which did not bind him but which was done on his account (implied)b. Novation = an agreement that the corp. will replace the promoter on a lease (express)iii. Liability of Promoter post Incorporation1. Still liable via agency law2. How to get Promoter off the hook? a. Agree to Indemnify P for any contractual obligationsb. Novation all parties agreed. De Facto v. De Jurei. De facto in practice, but not actually legal (against the law)1. If everyone believes that a corporation exists, then courts will act as if it actually does exist and will isolate them from liabilitya. More and more states are abandoning this idea b/c its very easy to incorporateb. Based on good faith 2. MBCA 2.04 still personally liable if you take actions on behalf of a non-existent principal (even if in good-faith belief)a. Other parties to the non-existent corporation are j/s liable based on a general partnershipb. Not liablei. If belief filed Must be reasonable e.g. mailii. You think filed and TP knows it hasnt beenii. De jure in accordance with the law, a corp. actually formede. Issuing Stocki. MBCA/Delaware require corps to say how much stock they can sellii. Classes: Preferred, Common, and Par Value1. AoI usually specify how many of each2. Preferred stock = a class of stock to be treated more favorably than another class (common stock)a. Why issue preferred stock? i. Can sell it for a different value ii. Can use it to satisfy creditors3. A share of common stock confers a certain amount of ownership/rightsa. Amount of ownership depends on the # of stock actually issued and outstanding4. Common Stockholdersa. Receive dividendsb. Vote on Board of Directors (aka participate in management decisions_c. Are owners of the corporationd. % of assets received if corporation is sold5. Preferred Stockholdersa. No voting rightsb. Preference in dividends can give more dividends per sharec. Liquidation rights preference that you get paid x amount per share before common shareholders are paidd. Convertibility to common stocki. Preferred stock can be turned into common stock (2-4-1 or fee to convert)e. Redemption rights force the corp. to buy the stock from you call-ability6. Why use preferred stock? (a finance company would do something like this)a. Cant get debt & Dont want to leverage @ rates they can getb. Dont increase your fixed payment, debt-obligationsc. More security for preferred stock buyer than common stock still risky in the case of bankruptcyiii. Par value = the minimum price for which a corporation can issue its shares1. Only regulates the issuance pricea. Corp only gets $ from a stock when it issues it. 2. Purpose: capitalization (get $ into your corporation at the beginning as you are issuing your stock money goes into a stated capital account containing all par value $)a. Protect parties from under-capitalized incorporation money stays in the account as securityb. States wants to make sure corps arent running around committing torts and K breaches without paying damages3. Not all that relevant anymore used to be a requirement in all states only a few still have it **May still be on the bar**a. The shares would be priced so low, that the amount retained was uselessb. Assume market/reputational costs will protect tort claimants and that creditors will be smart enough to require security in contractingiv. Problems1. 1) Can issue stock in exchange for land, any tangible/intangible property or benefit; includes: a promise of future services, goodwill (come up w/amount), a release of a claim against the corporation; 2) No; 3) Yes; 4) $2 per share = $6k; 5) Yes, can sell for less than par value when a secondary sale maybe the market value is lower and this is all she can get for it tax write-offs for loss in value; 6) Yes, would want to make sure property is valued for at least as much as par value ~reasonable valuation~ or statement from BoD saying they value as much; 7) prob doesnt care, might get pissed if avg share was 100 and then later they were available at 50, but there is not necessarily a relationship between par and actual value ~generally just a floor for the initial sale; 8) if you buy for higher than par value you run the risk that more shares will be issued that dilute her ownership interest and depending on the price, it would effect the value of her shares v. Capital1. Stated capital = the aggregate par value of all issued shares of par value stocka. Cannot be distributed to shareholders2. Capital surplus = funds for issuance of stock in excess of para. May be distributed back to shareholders in dividendsf. State of Incorporationi. The laws of the state of incorporation become default rules that govern internal affairs1. Internal affairs = procedures for corporate actions and the rights/duties of directors, shareholders, and officers2. The companys internal affairs do not include rights of third partiesii. Foreign corporation = a corporation that does significant business in a state other than that in which it is incorporated1. Must also register in the state in which the business is being conducted2. Must also pay respective fees to those statesiii. What determines where a company will incorporate?1. Corporate statutes and Common Law contender for choice of law2. Taxes, corporation fees (initial and annual)3. Where it will primarily do business foreign/domestica. NOT REQUIRED TO HAVE A MINIMUM BUSINESS PRESENCE TO INCORPORATE IN A PARTICULAR STATEb. If you do business in other states, choice of law may dictate that the law of the other state apply e.g. Tort cases where the victim is a resident of that state4. ~50% of corporations are out of Delaware Why?a. Corporate governance issues will be adjudicated by courts in the state of incorporation & Delaware has a specialized judiciary for corporations have significant knowledge of the area, especially bankruptcyb. A lot of precedent has been developed b/c so many companies have incorporated there gives you some guidance when evaluating certain disputesc. Gives corporations maximum flexibility ** maybe not so much anymore **

VIII. How Does A Corporation Operate?a. Liability Default: shareholders are not personally liable for acts/debts of the corp beyond the amount of their investment in the corporationi. Why? Because we want them to provide services that we needii. Why should we be concerned? Think of the puppies. If they kill the puppies, then Compensatory & Societal Harm want to deter stupid shitb. Contractual Exception: third parties often refuse to extend credit to a corp w/ limited assets unless the shareholders agree to be personally responsible (personally guarantee payment)c. Judicial Exception Piercing the Corporate Veili. Dewitt Truck Brokers, Inc. v. W. Ray Flemming Fruit (1976)1. Facts: Flemming was corps principal shareholder, orally promised P that he would personally pay for the fruit transportation if corp did nota. Oral promise was not enforceable b/c surety ship requires SOFb. P asked court to pierce the corp veil and hold Flemming liable for his corps failure to pay2. Court: Flemming is personally liablea. Inadequacy of capital is the most common reason to pierce the CVi. Other factors: non-payments of dividends, if corporation is a faade for the operations of the dominant shareholderb. Flemming owned 90% of corp outstanding stock, he did not follow corporate formalities, the corp functioned for the financial advantage of Flemmingi. Courts want there to be a clear separation btw shareholders and the corporationd. How to Pierce the Corporate Veili. Fraud e.g. lying to induce people into K with the corporation ii. Instrumentality/Alter Ego Theory: if the corp and individual are the same thing, there is no reason to give the individual immunity for the corps actions1. Some jurisdictions say you must also have injustice to pierce the CV2. Much easier when there is a smaller or closely held corporationa. As a general rule, will not be able to pierce a publicly traded companyiii. Factors/Actions that may pierce the CV: individual determination1. Not protecting the interests of justice2. Undercapitalization no funds sufficient to pay out people in the ordinary course of business, this is a judgment sometimes there are legal standards, e.g. insurance cosa. Whether it should factor into the analysis is what type of claimant it isi. Should factor for tort claimants, BUT NOT contractual claimants (could have procured promises from corp)b. At what time do we care about undercapitalization?i. At the time of incorporation best explanation is that you want to make sure the owners have a stake in the game and if they invested a lot at the beginning then they would be expected to want it back3. Failure to follow corporate formalities e.g. absence of corporate recordsa. Confusing why we care, but the justification is never that cleari. Contract claimants we dont really care b/c they entered into the dealii. Tort claimants it wouldnt factor into their decision4. Non-payment of dividends (very rare) generally irrelevant, BUT consider siphoning5. Siphoning of funds difficult to differentiate between legitimate/illegitimate transactions; e.g. what is an exorbitant salary?6. Solvency of debtor corporation again, difficult to establish standards7. Non-functioning of other officers/directors8. Corporation is merely a facadee. Other Corporations as Shareholdersi. Subsidiary a corporation whose stock is owned by another corporationii. Parent Corporation the corp that owns a majority/all of another corps outstanding stock1. Not liable for Ks, torts, obligations of subsidiary corp unless there is a K or judicial exception a. Pierce corp veilb. Direct liability P participated in act of Subsidiaryc. S acting as Agent of P2. Corporation Trees (one company has shares in another company that has shares in another) Why do companies have subsidiaries?a. Isolate parts of a business for liability reasons*i. If there is a claim against one subsidiary, just close it down and the rest arent affectedb. Isolate parts of the business for credit/salei. Isolate revenue streams for repayment of credit and other debtsii. Simplify insurer/lenders analysis in determining loan transactionsc. Tax reasons / choosing state lawsd. Avoid regulationi. There are industry/sector specific requirements you dont want applied to all parts of your corporation so subsidiary only has to comply with those regulations ex. airline industryiii. In re Silicone Gel Breast Implants (Alabama 1995)1. Facts: Bristol is the sole shareholder of MEC. Bristol had extensive control over MEC (set wages, approved hiring, maintained $, controlled board)a. Bristol argued that it is not directly liable or liable under the piercing of the CV for MECs breast implantsb. MECs Assets 57 million demand note & Insurance policy w/2 billion limit2. Court: Bristol is liablea. MEC is so controlled as to be the alter ego or mere instrumentality of its stockholderb. It would be unjust to allow Bristol to avoid liability basically just a fairness justification for applying the alter ego theory. . . wouldnt happen if rich whities3. Class Notesa. Piercing the CV should be applied rarelyb. Principal/Agent Theory a court could find that a subsidiary is acting as an agent of the parent corp (principal)c. Only cases that have a high percentage chance of winning go to court and then only 40% of those are successful others are settledi. More successful in K than tort situations, BUT this is probably b/c of the settlement factoriv. Enterprise Liability corporations that (although technically separate) are commonly owned and engage in one enterprise should be treated as a single legal entity for purposes of liability1. When assets are shifted to try to insulate from liabilitya. P shift asset to GP (would create another veil problem and would be more difficult) or a separate subsidiaryi. One of Ps assets are the other subsidiary corporations so if they dont pay, you can go after those assets i.e. this doesnt protectii. Transfer to another random this is a fraudulent conveyance2. Only natural persons have limited liability if a business owns another business then the debt of the subsidiary is also the debt of the parent company3. Rejected in US, but forms of it exist in tax, bankruptcy, etc.4. Walkovszky v. Carlton (1966)a. All cabs are individual corps. Parent corp has a lot of $ and suit is brought against one of the subsidiaries. Plaintiff wants to pierce the veil. How can we protect the assets?i. Transfer assets to another subsidiaryii. Transfer assets to the parent of the parent (this is a fraudulent conveyance of equity)iii. You cant do anything really!f. Decisions for the Corporationi. Three Primary Groups1. Owners (shareholders) little control, a mere symbol of ownership2. Officersa. The only individuals who are agents of the corp bind and create liabilityb. Do the day-to-day work: manage company, implement macro-level decisions made by board3. Board of Directorsa. Make the corps most important decisions i. Business performance and plans, major risk that corp is or will be exposed to, performance of officers, compliance, hiring officers, e.g. Chik-fil-A being closed on Sundays, diversifying into new business, etc.b. BofD of a small corp has the same tasks as that of a big corpi. Most commonly the shareholders in a small corp, BUT not requiredii. May do lower level type decisions when smallii. McQuade v. Stoneham (1934)1. Facts: P and D (stockholders) directors had agreement to keep respective officer/director positions: Stoneham as president, McGraw as vice-president and Plaintiff as treasurer; P was not renewed as treasurer or director, not b/c of misconduct, but b/c he had conflicts with Da. Ps Argument - McQ: agreement that he entered with McGraw and Stoneham provided for each of them to use their best endeavors to keep each other in their respective positionsb. Ds Argument - S: agreement was invalid because it granted authority to shareholders for a decision that is normally left to the judgment of directors.2. Court: Found for D (the agreement is unenforceable)a. Can agree to be directors, BUTi. An agreement controlling how directors exercise their judgment is illegal constrains directors authority to make decisions as they see fit1. Directors have to act in business interestb. Voting agreements among directors are void and against public policyiii. Villar v. Kernan (Maine 1997) Shareholders Decisions instead of Directors Decisions1. Facts: V (49%) and K (51%) went into the pizza business agreeing to never get a salary. Eventually Stephan came in and owned 2% of the sharesa. K entered a consulting agreement with the business to get a salary with his 50% and Ss 2% V sues for breach of oral K2. Court: Maine law precludes an action for breach of an oral contract between two shareholders of a closely held corporation prohibiting their receipt of salaries from corporationa. The original agreement must have been in writing to be enforceablei. Such agreements are okay if: Must be in articles of incorp, or if its an amendment, must be agreed upon by all shareholders, and after the agreement is made anyone who acquires shares must have notice or actual knowledge of the agreementb. So, K was allowed to keep his salary3. If you are in a closely held corporation and you have minority share, you are kind of screwed. Only remedy would be to sue for breach of fiduciary duty if one of the owner/directors breached. Otherwise you cannot force someone to buy/sell sharesg. Shareholders Decisions About Directors and Cumulative Votingi. Duties1. Elect directors2. Remove directors3. Approve fundamental corporate changes4. Pass shareholder proposals **wont really talk aboutii. Voting (for director elections only, not fundamental changes) **State Law OR AoI Determine**1. Straight Votinga. A separate election for each seat on the boardb. Each shareholder gets to cast her number of shares in any way she wants for each of the separate electionsc. A shareholder owning a majority of the stock will be able to elect every director2. Cumulative Votinga. One at-large election in which shareholders cast voteb. Each shareholder gets to multiply the # of shares she owns times the number of directors to be electedc. Protects minority shareholders only get to pick just over the seats if majority shareholder as opposed to Straight where the majority SH would pick alld. Where allowed, cumulative voting limited to election and removal of directorse. If elected under cumulative voting, you wont be removed if you maintain that many supporters in a vote to potentially remove3. Delaware 141(k) removal with or without cause, BUT if a board has staggered terms you need causea. Staggered elections provide an opportunity to dilute minority SH4. MBCA 8.08 with or without causeiii. Fundamental Changes1. Fundamental corporate changes req. shareholder approvala. Electing board of dir and taking them out this is shareholder actionb. Fundamental Changes are shareholder reactions to decisions of the BoDi. Amendment of AoIii. Merger with another corporationiii. Dissolutioniv. Acquisitionv. Sale of all or substantially all of the assets of the corporationc. Only use straight votingd. Most states require majority some require supermajorityi. Usually default rule and can be changed by AoIiv. Where Shareholders Vote and Who Votes1. Annual Meeting meeting held annually, required where elections occura. Special meeting any other meeting of shareholdersi. By-laws or AoI say when special meetings will be held2. Record Owner a person who has the legal right to vote at an annual or special meeting of shareholders; owners dont necessarily get physical stock certificates nowa. Mutual fund: I give them $, they invest in stuff, I get returns, but I do not personally own any shares so the mutual fund gets to vote, I dont3. Record Date only record owners as of that date are entitled to notice of and a vote at the meeting Even if you sell your share after thisa. MBCA date between 70 and 10 daysb. Delaware date between 60 and 10 days4. Street Name Ownership an investor buys shares through a broker; the depository company, maintained by a group of brokerage firms, holds the certificate and is shown as the owner in the corps record; investor is shown as the owner in the brokerage firms records5. Proxy a person entitled to vote authorizes another person to vote for her; written form is the proxy that allows someone to be your proxya. A proxy that does not address revocability will be revocableb. A proxy is irrevocable only if it both (1) states that it is irrevocable and (2) is coupled with some interest in the stocki. Bank will take over voting rights in shares of a corporation to give someone a loanc. Can specify how you want someone to vote and they have to complyd. Default effective rules: Delaware 212(b) 3 years, MBCA 7.22 11 monthsv. Shareholder Proposals1. Can force shareholder votes on certain issuesa. Corporate Governanceb. Timing of Electionsc. Executive Compensation limit CEOs pay b/c paid too much d. Corporate Social Responsibility (CSR) Issues use no labor from China2. Not binding, they are more recommendations pretty ineffectivevi. Shareholders Inspection Rights1. Every state provides shareholders access to corporations books and records (some also have a CL right to inspect)2. Limits on what shareholders can have access to generally screened financial datavii. Shareholder Voting Agreements1. Typesa. Voting Pooling I enter a K with another shareholder and we all agree to vote the same way on all issuesb. Voting Trusts we create a trust, transfer all of our rights to the trust, and the trustee has the right to vote (one legal entity) more difficult to go rogue2. Ringling Bros-Barnum & Bailey v. Ringling (Delaware 1947)a. Facts: Mrs. Ringling (315) and Mrs. Haley (315) had an agreement where they would act jointly in exercising their voting rights. Mr. North was 3rd shareholder (370); If they failed to agree, the arbitrator (Karl Loos) would make a final decision.i. Stock pooling agreement each selected two members and then used their remaining votes to select a fifth member of their choosing1. Mr. Haley, the VP went to jail and North visited him changed allianceii. The two did not agree on the 5th director Ringling went to Loos who decided that they should vote for Mr. Dunn1. Mr. Haley (as Mrs. Haleys proxy) attempted to vote his wifes shares and Mr. North didnt agree to anything at all2. Haley said that the agreement is invalid b/c it vests power in a non-party (Loos)b. PP: Vice Chancellor said the agreement was valid and that the decision of the arbitrator was binding specific performancec. Court: Agreement is valid, will not invalidate electioni. Doesnt matter what the voters motives are because he has no legal duty to vote at allii. Arbitration provision okay as deadlock-breaking maneuver unless at least one of the parties entitled to cast at least half of the their combined votes is willing to that it be enforcediii. Mrs. Haleys votes should be rejected, but not Mr. Norths b/c he didnt sign onto the agreement 3 Ringling votes and 3 North votesd. MBCA and Delaware valid agreement; remedy would be specific performance (expressly provided for in MBCA)h. Responsibilities Of A Corporations Decisionmakers* And To Whom Are They Responsible?i. Fiduciary Duties 1. Duty of Care2. Duty of Loyalty3. Obligation to engage in good faith and fair dealingii. Who Owes Fiduciary Duties To Corporation?1. Shareholders do not have fiduciary duties to corp 2. Directors have fiduciary duties to corp through corporate law3. Officers have fiduciary duties to corp through agency law4. Liability arises when you analyze what hat the person was wearing when he made a decisioniii. Why do we have fiduciary duties?1. Want to make sure that directors arent doing anything to hurt the company/constrain their self-interested behavior, BUT Dont want to prevent directors from acting/taking risks or doing what they need to do in order to be successful but we want to reign2. If we didnt have them, no one would invest in companiesif you cant trust the people running the company there is no reason to investiv. Terms1. Inside Director: if a director is also an officer, employee, large shareholder of a corporationa. Generally dont like bias & conflict of interest2. Outside Director: if a director is not an officer, employee, large shareholder of a corporation but may have some financial relationship with corpa. Usually govt requires certain amt of outside directior3. Independent director: No financial relationship with the corp at all, except for whatever salary they get for sitting on the board (sitting fees)4. Why does it matter? If youre getting a lot of $ from the corp, you have a greater stake in the success of the corpa. Outside directors are not beholden to any other officers/directors, just have connections to shareholders They are more independent5. Derivative Suita. A shareholder who is upset by a board decision cannot sue on his own derivative suit where the corporation itself sues the boardi. Shareholder animates the corporate puppeti. DUTY OF CAREi. What is it?1. Act in the best interest of the company2. Exercise good business judgment and ordinary care and prudence when making decisions for the companyii. How to breach? Action or Inactioniii. Business judgment rule 1. It is not up to courts to resolve questions of business management unless there is fraud, illegality, or conflict of interest (Shlensky v. Wrigley)2. Standard is gross negligence to find director liability (Joy v. North)a. The higher the risk the more diligent they should be, BUT generally not required to look under every rock3. A director has duty to inform oneself of all material information reasonably available to him before making a business decision (Smith v. Van Gorkum)4. Does not protect directorsa. Where board decisions are tainted by a conflict of interestb. Rationality = decisions are completely wasteful (no way to benefit corporation)/decisions lack a business purposec. Result from obvious and prolonged failure to exercise oversight and supervisiond. Fraud/Illegality5. Justifications for:a. Courts want to leave discretion to the boardsb. If shareholders arent happy, they can just vote a director in or outc. Shareholders voluntarily undertake the risk of bad business judgmentd. After-the-fact litigation is an imperfect device to evaluate corp business decisionse. Potential profit often corresponds to potential riskj. Breaching of Duty of Care By Board Action1. Shlensky v. Wrigley (1968) a. Facts: P is a minority stockholder in D corp (Chicago National Legal Ball Club) that operates the Chi Cubs and Wrigley Field. Wrigley is the majority shareholder i. P brought a stockholders derivative suit against directors for negligence and mismanagement b/c they refused to install lights at Wrigley and schedule night games which = $ lossesii. P says that all other major league teams have mostly night games to maximize revenue/incomeiii. P says Wrigley refused to install lights bc of his personal opinions that baseball is a daytime sport and it will deteriorate the surrounding neighborhood and that Wrigley has dominated the rest of the directorsb. Court: Found for Wrigleyi. BJR It is not up to courts to resolve questions of business management unless there is fraud, illegality, or conflict of interestii. Courts want to leave discretion to the boards1. Directors do not need to follow the lead of other corps in the field failing to follow the crowd is not a dereliction of dutyiii. This was decided on a M2D the court is saying that as a matter of law, there was not a sufficient claim stated the court gives great deference to the business judgment rule BJR1. ** Should we allow Wrigley to care about the neighborhood when his job is to create a return for investors/owners? ** a. Ehhh. Courts dont take this viewiv. If we allow shareholders to sue directors whenever they make a decision, we destroy the respective roles.1. If shareholders arent happy, they can just vote a director in or out2. Joy v. North (1982)a. Facts: Shareholder brought suit against Citytrusts officers/directors for breach of duty of care (loans to developer) corps board appointed a special litigation committee (supposed to be looking out for shareholders best interest) that said the suit should be dismissed as to outside directorsb. PP: TC granted SJ for D corpc. Appellate Court: found SJ was improper, there was genuine issue of material fact to whether there was a breach of fiduciary dutyi. Need gross negligence for there to be liabilityii. Reasons for the Business Judgment Rule1. Shareholders voluntarily undertake the risk of bad business judgment2. After-the-fact litigation is an imperfect device to evaluate corp business decisions3. Potential profit often corresponds to potential riskiii. Derivative suits involve 2 actions 1. Action against corp for failing to bring a specified suit2. Action on behalf of corp for harm to it identical to one which the corp failed to bringiv. Committee Report1. Outside directors cant be liable bc they had no info about the Katz transactionsa. Lack of knowledge is not a defenseb. Ignorance itself is a breach of fid duty2. Corps CEO dominated the management and board 3. There is general potential liability bc the bank subjected the principal to risks of continuing extensions of substantial creditd. Does the BJR apply to officers who are just officers?i. In favor: lack of financial incentive to sue officersii. Technically doesnt apply to officers3. Smith v. Van Gorkum (1985) BJR/duty of care/corporate organizationa. Facts: Have more tax credits than liability want to buy another corporation in order to write off additional credits Van Gorkum didnt want to do iti. TransUnions CEO negotiated a deal to sell TU (cash out merger) to Prizker for $55/share (market share $38, he said $18) technically he cant sell shares he doesnt own, he was just drunk and made the deal1. Didnt tell the other directors until they attended a special meeting and were asked to approve the sale2. Leverage Buyout (LBO) Company 1 gets a loan and uses it to buy Company 2s shares with cashii. Van Gorkum only informs 2 directors in a 20 minute oral presentation both think it is a low price and that they can do betteriii. Directors approve merger, then shareholders, relying on directors decision, approves mergerb. Court: reversed TC finding for the Directors (based on BJR) and remanded for an evidentiary hearing to determining the fair value of the shares provided damages to extent value exceededi. Officers use statute as protection - Delaware 141(e) says directors can rely on reports to make their decision, but this court says that reports means physical written reports ii. New component of the duty of care and BJR: duty to inform oneself of all material information reasonably available to them before making decisions 1. The directors did not inform themselves and acted on blind reliance on Van Gorkums representations2. Not in good faithiii. Possible Breaches of Duty of Care Conflict of interest Rest dont apply1. Maybe if Van Gorkom has stock in the company, selling the stock will benefit him BUT he would want the highest share price; could rebut by saying he is old and just wants to cash out2. 5 inside, 5 outside directors some people think they may lose their job (that they get paid) = not substantial enough to create a conflictc. Dissent: stresses the experience of the directors directors of this caliber are not taken in on a fast shuffle, they were more than qualified to make on the spot business judgments and the BJR should protect themd. Notes/Broad Issuesi. Judiciary is looking for procedural shortcomings, not the actual decision itselfii. Roles when is judicial policing of roles appropriate? 1. Van Gorkom overstepped his role: attempting to force a merger by setting things up that essentially forced their hand (didnt ask for a time to determine price, put a time restriction on the decision and limitation on shopping around)2. Board did not act in its role by making an informed decision should be in the best decision of the business owners i.e. shareholders3. Shareholder also messed up they overwhelmingly approved it- could only complain that they didnt get enough information or the information they got was crappyiii. Satisfying Duty of Care When Pricing Something1. Hire expert (investment bank) to value for you or give price to see if fair2. Shop around see how much people would pay to buy the company3. Control Premium when you buy one share in a company with a bunch of other shares, you just get the financial benefit. But if you buy all the shares, you get the financial benefit and control over the company so youll have to pay more for those sharesa. Merger Price - $55b. Market Price - $18c. Would need to find out if $37 was a sufficient CP. Hard to do.4. Does not have to be exhaustive or go on forever must be reasonableiv. Ways a Board Can Protect Itself From Liability1. Confer with general counsel about what you should do2. Have a lot of process, have a long meeting with lots of docs and the courts will be reluctant to scrutinize it3. Studies/shopping around might do too much to be safe, but we have decided this is the better result4. Have a shareholders vote give a ton of accurate info and they vote to approve the merger, you can essentially claim that they ratified the merger couldnt go in VGv. Aftermath of Van Gorkum RAINCOAT PROVISIONS1. It became hard to get directors and officers insurance 2. Delaware 102(b)(7)a. Applies only directors, not officersi. Why? Officers can negotiate indemnity provision in their employment contractsb. Allows corps to eliminate or limit personal liability of a director from monetary damages for breaching a fiduciary duty so long as it doesnt attempt to eliminate:i. Breach of a duty of loyaltyii. Liability for acts not in good faith/constitute intentional misconductiii. Liability for a knowing violation of the lawiv. Liability for a director personally benefitting from transaction (improper benefit basically DoL)c. Can still bring a suit against directors for equitable reliefi. E.g. undoing the merger, just not damagesii. Why take monetary damages out?iii. Lots of P lawyers bringing meritless suits so they can settle them and get attorneys fees3. MBCA 2.02(b)(4)a. Same as Delaware statutek. Breach of Duty of Care by Board Inaction1. Barnes v. Andrews (1924) a. Facts: when P took over the company as receiver of Liberty Starters Corporation, he found it w/o funds and very little on the sale of its assetsi. D (former director)s only attention to affairs of the comp consisted of talks with the pres as they met occasionally golfing; went to 1 of 2 board meetings during tenurewas b. Court: D is guilty of misprision of office (violation of duty) but not liable to the corp b/c P (Barnes, the receiver of the corp) hadnt shown that had D performed his duty, the loss would have been avoidedi. Directors arent expected to interfere individually in the actual conduct of a companys affairs but they have an individual duty to keep themselves informed in some detail1. D made no effect to keep advised of the actual conduct of corp affairs2. Also, he was only one directorwould be better off trying to sue the whole boardii. Ascertainability of loss hard to determine actual amount of lossiii. Majority View: burden of proof on P to show causation1. Delaware: when P proves D breached duty = liability; burden of proof shifts to D to show there was no causal relationship btw breach and damages (affirmative defense)idea that the director has better access to information, judicially it is more efficient than requiring P to suec. MBCA 8.30(b) and 8.31(a)-(b)i. Ps must show that Ds breach proximately caused damages2. In re Caremark Intl Inc. Derivative Litigation (Delaware 1996)a. Caremark is a healthcare company (huge and employ a lot of people) Shareholders brought suit alleged directors violated their duty of care by failing to supervise conduct of Caremark employees Caremark was getting kickbacksi. Ps settlement express assurances that Caremark will have a more central, active supervisory system & attorneys fees paid by the corporation1. Derivative suit settlements (like class actions) require court approval2. Plaintiffs Attorneys brought the suit to rack up hours and get a settlementin the short term this screws over the shareholders (the company had to pay out all the claims & now they have to pay attorneys fees) might get some benefit in the long run if the monitoring system makes significant improvements but nothing good in the short termb. Court: Settlement in favor of Ps approvedi. Directors can be liable for (1) negligence or (2) losses arising from an unconsidered failure of the board to actii. Graham v. Allis-Chalmers Mtg Co.1. This court limits the holding of Graham: absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employeesiii. Breach of Duty of Care Analysis1. Can be liable for this breach by action (BJR) or inactiona. Ordinary business decisions by regular employees can create liability for the business, BUT that might not be evidence that the directors arent doing their job2. Only a sustained, systematic failure of board to exercise oversight will establish lack of good faith that is necessary to find liabilityiv. After Caremark Graham not sufficient, 1. Board has affirmative duty to have some type of monitoring system, but courts will be deferential to the Board as to whether the system was good or nota. This type of monitoring would likely be done by an external third party to come in occasionally and audit complianceb. Internal provisions in employee handbooks and instruction to employees on what the law is (mandatory training, etc), periodic compliance reports3. McCall v. Scott (2001) **Modern Rule in Action**a. Facts: P shareholders allege that Columbias senior management, w/ Board knowledge, devised schemes to fraudulently increase revenue/profits and provided incentives for employees to commit fraud. Delaware corporationb. PP: TC dismissed suit for failure to comply w/ requirements of shareholder derivative suit TC also said that Caremark can only be violated intentionallyc. Court: there is a substantial likelihood of liability for intentional/reckless breach of duty of carei. Overcoming the waiver of liability raincoat provision does not require intentional conduct somewhat less than intentionalii. If you have actions that manifest a lack of GF by directors, that can be enough for director liabilityiii. Court was influenced by the fact that the directors had experience4. What will a P allege in a complaint that asserts a directors neglect of duty? Negligence not enough; gross negligencenot w/raincoat; recklessDelaware (only requires not in good faith, intent not required) or intentionalMBCA5. Judge director on what knowledge they have & dont expect them to go out and get more knowledge; e.g. when people have a lot of particularized experience we expect them to use it6. Sarbanes-Oxley Act: wanted to increase the internal accountability of businesses through increased public disclosure of financial information, forcing the companies to have tougher policing mechanisms for themselves via audit committees & requires a certain number of outside directors to serve on boards and participate on the auditing committees 7. Structural Bias Theory Directors will help each other out to get what they want, even if they are independent with no stake in the company may still do things for an inside director for a favor later

l. DUTY OF LOYALTYi. 3 Types: Usurping Corp Opportunity, Directly Competing, Both sides of transactionii. Breaching Duty of Loyalty by Competing With the Corporation1. Jones Co., Inc. v. Frank Burke, Jr. (NY 1954)as a result of his behavior lapse, several of Duane Jones officers began a new competing agency while still employed with Jones and then quit after incorporating the new agencya. One of the directors told Jones of their intention to either buy him out or start a new company. Incorporated the new business while they were still directors and officers; then made offer to Jones putting a gun to his headb. Ultimately, the new agency took many of Jones former accountsc. Court found former officers violated their duty of loyaltyi. Actions benefitted themselves via destruction of Ps business2. Officers and Directors have fiduciary duties under corporate law and agency law liability would not changea. Can go beyond fiduciary law and go into K and employment law to prevent directors and officers from stealing clients anti-poaching clauseiii. Breaching Duty