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Business AssociationsProfessor BradfordFall 2016

Exam Answer Outline

The following answer outlines are not intended to be model answers, nor are they intended to include every issue students discussed. They merely attempt to identify the major issues in each question and some of the problems or questions arising under each issue. They should provide a pretty good idea of the kinds of things I was looking for. In some cases, the result is unclear; the position taken by the answer outline is not necessarily the only justifiable conclusion.

I graded each question separately. Those grades appear on your printed exam. To determine your overall average, each question was then weighted in accordance with the time allocated to that question. The following distribution will give you some idea how you did in comparison to the rest of the class:

Question 1: Range 4-9; Average = 7.17Question 2: Range 3-9; Average = 6.52Question 3: Range 2-8; Average = 6.61Question 4: Range 0-9; Average = 6.52Question 5: Range 0-8; Average = 4.13Question 6: Range 4-9; Average = 7.96Question 7: Range 2-8; Average = 5.96Question 8: Range 2-9; Average = 5.78Question 9: Range 6-9; Average = 7.43

Question 10: Range 0-9; Average = 5.65Question 11: Range 2-8; Average = 5.43

Total (of unadjusted exam scores, not final grades): Range 4.10-7.48; Average = 5.95

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All of these grades are on the usual law school scale, with 9 being an A+ and 0 being an F.

If you have any questions about the exam or your performance on the exam, feel free to contact me to talk about it.

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Question 1

Sadie has been removed.

If, as here, a director is elected by a voting group of shareholders, only the shareholders in that group get to vote on removal. MBCA § 8.08(b). Sadie is elected only by the Class A shareholders, so we can ignore the voting by the Class B shares. They’re not entitled to vote.

The vote required to remove a director depends on whether or not cumulative voting is authorized. Unless otherwise provided in the articles, cumulative voting is not authorized. MBCA § 7.28(b). Since the questions indicates there is nothing relevant in the articles, then cumulative voting is not authorized.

Where cumulative voting is not authorized, the director is removed if more votes are cast in favor of removal than are cast against removal. MBCA § 8.08(c). More Class A votes were cast in favor of removal than against (73-27). Therefore, Sadie has been removed.

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Question 2

The board appears to have done a reasonable job informing itself about the value of the Gambler’s Den. They hired an expert appraiser, who produced a valuation study. They also solicited bids publicly and tried to get Clinton to increase her bid.

They also evaluated the Trump contact, or at least relied on the attorney to do so.

The biggest problem is that they never valued the hotel they are trading their property for, the Suave. To know whether the trade is a good deal, they have to know not only the value of their own hotel but also the value of the property they’re trading it for. Unless they know the Suave’s value, they can’t possibly know whether this is a better deal than the Clinton cash offer.

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Question 3

The answer to the question depends on whether the machine is partnership property or is the property of the individual partner, Betty.

If the property is Betty’s personal property, then Carla may not (yet) levy against that property. A judgment against the partnership cannot be satisfied from a partner’s individual assets unless there is also a judgment against that partner. RUPA § 307(c). Betty would be personally liable for the claim, RUPA § 306, so it would be easy to get a judgment against her, but Carla has not yet done that.

If the property is partnership property, then Betty could levy execution on it. RUPA § 204 sets forth the rules for determining whether property is partnership property. It is partnership property if it is acquired in the name of the partnership, RUPA § 204(a)(1), which is further defined in § 204(b).

The machine was not acquired by the partnership in its name. RUPA § 204(b)(1). And the name of the partnership is not indicated in the instrument transferring title; only Betty’s name appears. Therefore, § 204(b)(2) does not apply.

It is also partnership property if it is acquired in the name of a particular partner, as this was, if there’s something in the instrument transferring title that indicates the person’s capacity as a partner or the existence of the partnership, but not the partnership name. RUPA § 204(a)(2). This was acquired in Betty’s name, but there is nothing that indicates Betty is a partner or that there is a partnership. The address alone doesn’t indicate the existence of a partnership or that Betty is a partner; it could be any address.

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There’s a presumption in § 204(c) that property is partnership property if it is purchased with partnership assets, but that doesn’t appear to be the case either. Betty used her personal credit card, and there’s nothing in the question that indicates she was ever reimbursed for this expense. If she was reimbursed, then she essentially sold the machine to the partnership and it would become partnership property.

Thus, this machine falls within the residual subsection (d), which applies when none of the foregoing indicia of partnership property are present. The presumption is that it is Betty’s separate property, even though, as here, it’s used for partnership purposes. That’s only a presumption, but there don’t appear to be any facts in the question to overcome that presumption. The partners discussed the machine and agreed that it would help the business, but nothing in that discussion indicates it was to be partnership property.

Therefore, it is presumed to be Betty’s individual property and Carla cannot levy on it until she gets a judgment against Betty.

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Question 4

The internal affairs rule is a choice of law rule. Each state has its own corporate law; the internal affairs rules tells us which state’s corporate law applies to a particular corporation.

To create a corporation, one files articles of incorporation with the secretary of state; this is known as incorporation. You may file those articles in any state you choose, whether or not the business has any other connection to that state or plans to do business in that state.

The internal affairs rule says that the law of the state of incorporation applies to internal corporate affairs. The internal affairs rule essentially allows you to choose the corporate law that applies to your corporation by incorporating in that state.

The rule only applies to questions of internal corporate affairs: how the corporation is operated; the rights of shareholders, officers, and directors; the relationship between those various participants in the corporation; and, even though it may not seem internal, the limited liability of the shareholders to people who deal with the corporation.

The internal affairs rule does not affect other legal questions, such as those that arise under contract law or tort law (except for shareholder liability). It also does not affect employment law with respect to the corporation’s employees, although those might seem like internal corporate affairs.

The internal affairs rule also does not constrain where a lawsuit involving internal corporate affairs may be brought. But, whatever, the forum, the forum court will apply the

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law of the state of incorporation to questions of internal corporate affairs.

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Question 5

Demand is not excused. The court should dismiss Paula’s derivative action because her complaint has neither pled that she made a demand on the board nor adequately alleged that demand is excused.

The Standard

Under Delaware law, demand is excused if the plaintiff’s complaint alleges with particularity sufficient facts to create a reasonable doubt that:

1. a majority of the directors are interested or lack independence; or2. the challenged transaction was not the product of a valid exercise of business judgment.

Aronson v. Lewis. Demand is not excused merely because all of the directors are named as defendants. Id. Paula’s statement to that effect is incorrect.

Directors Who Are Interested or Lack Independence

1. Directors Who Are Interested

Carlos clearly is an interested director. The decision was about his own salary, so he clearly had a personal interest. None of the other directors were interested in the decision.

2. Directors Who Lack Independence

A director lacks independence if he is so closely related to or controlled by the interested director that he is unable to make an independent decision.

Molly lacks independence. She is Carlos’ subordinate and could be fired by him. Because of that, her judgment is likely to be unduly affected by Carlos’ conflict of interest.

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A majority of the board must be interested or lack independence. Since there are five directors, it’s not enough that Carlos and Molly are tainted. Paula must adequately allege that at least one other director lacks independence.

Paula alleges (¶ 11) that Allie, Bob and Danielle are controlled by Carlos, but that conclusory allegation is insufficient to excuse demand. Paula must allege particularized facts establishing such control.

The other three directors are close friends of Carlos; they attend his parties and play golf with him. But social ties like this do not establish control. If they did, directors would almost never be independent. These types of friendship should be expected among directors who serve on a board of directors for a long period of time. Similarly, the directors’ fees the three receive cannot be enough to establish a lack of independence, or no director would ever be independent. Paula also alleged that Carlos nominated all of them to serve on the board, but his role in their selection doesn’t show that he controls their decision-making.

Paul has not shown that a majority of the board was interested or lacked independence, so Paula has not satisfied the first prong of the Aronson test.

Not Otherwise the Product of a Valid Business Judgment

Demand would still be excused if Paula established a reasonable doubt that the decision was otherwise a valid business judgment. This could be either because the directors failed to inform themselves or because the transaction was a violation of substantive due care.

1. Failure to Inform

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Paula has alleged nothing about how much the directors informed themselves before making the decision, except to note certain information that they were aware of. Since the burden is on her, she clearly hasn’t sufficiently alleged a failure to inform.

2. Substantive Due Care

Demand would also be excused if Paula has created a reasonable doubt that the decision was a violation of substantive due care. Directors are protected by the business judgment rule and violate the substantive duty of care only when the decision is a no-win transaction or corporate waste—where there is no plausible claim of corporate benefit.

Paula has alleged several facts that would indicate that Carlos was probably overpaid. However, the question of Carlos’ value to the company is a business judgment. It’s not enough to show that some experts think he isn’t worth as much as he’s paid or that his salary has increased disproportionately to the company’s performance. Paula must allege facts showing that there is no plausible case that Carlos is worth that much to the company. Since this a matter of business judgment, she probably hasn’t done that. It’s plausible that Carlos might be worth that much, even if some experts don’t think so. The performance of the company might have been even worse without him.

Therefore, Paula probably hasn’t sufficiently alleged facts showing a violation of substantive due care. She failed to satisfy the second prong of the Aronson test.

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Question 6

A. If the limited partnership agreement does not provide in writing how profits are to be allocated, they are allocated on the basis of the value of the contributions made by each partner. RULPA § 503. The partnership agreement is silent on this point, so the default rule applies. George contributed $50,000 and the total contributions were valued at $100,000 ($50,000 + $30,000 + $20,000). Therefore, George would be entitled to 50,000/100,000, or 50% of the profits. Allie would be entitled to 30,000/100,000, or 30% of the profits. Bob would be entitled to 20,000/100,000, or 20% of the profits.

This assumes that none of their capital contributions have been returned. If some of the contributions have been returned to one of the partners, then his or her allocation would be based on the net amounts remaining. See RULPA § 503.

B. The rule for general partnerships under RUPA is different. Absent something in the agreement, each partner is entitled to an equal share of the partnership profits. RUPA § 401(b). Therefore, if this were a general partnership, George, Allie, and Bob would each be entitled to 1/3 of the profits.

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Question 7

In order for an insider trader to be liable under Rule 10b-5, there must be a breach of fiduciary duty. Chiarella.

Bob is not a classical insider, as in TGS. He does not owe Omega, the company from whom the information came and whose stock he traded, a fiduciary duty.

Bob could be liable as a tippee under the Dirks standard. His wife, Anne, is a temporary insider within the meaning of Dirks fn. 14. As an accountant, she owes a duty of confidentiality to her client, Omega. Thus, Bob would be liable if Anne’s disclosure was in breach of her fiduciary duty and if Bob knew or should have known of that breach. Dirks.

For there to be a breach of duty within the meaning of Dirks, Anne must have given the information to Bob for personal gain. She clearly didn’t receive anything from Bob in return for the information, but Dirks says that a gift to a friend or relative can also constitute personal gain. However, Anne tried to prevent Bob from using the information; that hardly seems consistent with a gift.

One could argue that, given her knowledge about Bob’s past abuse of confidences, she expected him to misuse the information, she really did intend to give a gift to Bob. That’s a stretch and, even if that argument succeeds, Bob would be liable only if he knew or should have known that. In sum, liability as a tippee under Dirks is unlikely.

Bob would also be liable if his use of the information breached a duty of confidentiality he owed to the source of the information, Anne. A contractual agreement to keep something confidential would suffice to create such a duty. Rule 10b5-2(b)(1). But Bob never agreed to confidentiality when Anne asked him; he was silent. The duty would also

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be met if Bob and Anne had a history or pattern of sharing confidences such that Anne would expect confidentiality in these circumstances. Rule 10b5-2(b)(2). The problem is that their history is exactly the opposite; Bob never keeps things confidential, so Anne would have no expectation of confidentiality.

Finally, there is a duty of confidentiality whenever someone obtains confidential information from his spouse. Rule 10b5-2(b)(3). That applies here. However, Bob can rebut that presumptive duty by showing that he “neither knew nor reasonably should have known” that Anne “expected that . . . [he] . . . would keep the information confidential, because of the parties’ history, pattern or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain . . . confidentiality.”

It’s not clear how that exception would apply here. Bob can probably establish that Anne did not expect him to keep the information confidential because of past history (he always blabs) and the lack of an agreement (he never agreed to keep it confidential). Thus, if the exception is read literally, he has met the rebuttal case. But Anne expressly told him to keep the information confidential, so he knew she expected him to keep it confidential in spite of past history and the lack of an agreement.

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Question 8

The stock sale will have three effects on Omni’s balance sheet. First, the asset Cash will increase by $200,000 to reflect the cash received by Omni. As a result of this change, Omni’s total assets would be $835,000. Second, the Common Stock account will increase by the par value of the stock, 1,000 x $1 = $1,000. Del. § 154. Its Common Stock account after the sale is thus $4,000 + $1,000 = $5,000. Third, the Additional Paid-In Capital Account will increase by the remaining purchase price of the stock, $199,000.

Under Del. law, a corporation may pay dividends out of its surplus. Del. § 170(a)(1). “Surplus” is defined as the excess of the company’s net assets over capital. Del. § 154. “Net assets” are defined as the excess of total assets over total liabilities. Del. § 154.

After the stock sale, Omni’s net assets are $835,000 -$200,000 = $635,000. Its surplus is this amount less its capital, which Del. § 154 defines as the stated capital—the par value of the stock. The stated capital is $5,000 after accounting for the stock sale. Thus, Omni’s surplus is $635,000 - $5,000 = $630,000.]

Omni may lawfully pay dividends totaling $630,000.

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Question 9

Arnie has dissociated from the LLC. A member is dissociated when the LLC has notice of his express will to withdraw. RULLCA § 602(1). The LLC had such notice when Arnie said, “I quit. I’m no longer going to be a member...”

Arnie’s dissociation does not result in a dissolution of the LLC. None of the events specified in § 701 has occurred. There’s nothing in the agreement, RULLCA § 701(1), and all of the members have not consented, RULLCA § 701(2). None of the other things listed in § 701 have happened.

Arnie’s dissociation is wrongful under RULLCA § 601(b)(2)(A). His dissociation occurred before the termination of the LLC (since there has been no dissolution) and he withdrew by express will. Because of that, he’s liable to the LLC and to the other members for any damages caused by his dissociation.

Arnie’s right to participate in the management of the LLC is terminated. RULLCA § 603(a)(1). He’s no longer a member but he does continue to hold a financial interest in the LLC. § 603(a)(3). He has the same financial rights as a transferee: he is entitled to receive the same distributions to which he was entitled when he was a member. RULLCA § 502(b).

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Question 10

The contract is binding on KT Productions unless Warner was aware of the dispute between Kanye and Taylor.

Kanye had no actual authority to sign the contract. Differences as to matters arising in the ordinary course of business of the partnership are decided by a majority of the partners. RUPA § 401(j). In this case that would require agreement by both Kanye and Taylor. Because of the disagreement between the two partners, there was never a majority vote either to grant Kanye agency authority to sign the contract or to approve the contract.

However, an act of a partner that is “apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership” binds the partnership unless the partner had no authority and the third party knew that the partner had no authority. RUPA § 301(1). The distribution contract with Warner is clearly within the ordinary course of KT Productions’ business, which is creating and distributing music albums. Kanye had no authority to enter into the contract, but there is no indication in the facts that Warner was aware that Kanye was exceeding his authority. Therefore, the contract is binding on the partnership.

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Question 11

The plaintiffs are seeking to pierce the corporate veil and make Bristol responsible for the liability of its subsidiary, MEC, arising out of the sale of silicone breast implants to the plaintiffs. I have determined that the corporate veil should not be pierced.

Shareholders are not ordinarily personally liable for the debts and obligations of the corporation whose shares they own. Corporations that are shareholders are treated the same as individuals under that general rule; corporations are not liable for the liabilities of their subsidiaries. The legislature has made that choice, so the plaintiff has the burden of showing why a court should override that legislative choice and pierce the corporate veil. The plaintiff has not met that burden here.

Undercapitalization

MEC was not undercapitalized. Its net assets had a value of over $57.5 million, as shown by the subsequent sale of those assets. In addition, it had a liability insurance policy for $2 billion. Although its products might have had significant risk, it’s hard to see how any reasonable person would have thought more than $2 billion was needed.

Corporate Formalities; Failure to Fully Separate the Two Companies

The plaintiffs’ argument for piercing turns primarily on a failure to fully separate Bristol and MEC as corporations—the use of common business departments; the use of consolidated financial statements and tax returns; common directors; the financial interrelationship between the two firms. But, many of those failures to follow formalities

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didn’t negatively affect the plaintiffs in any way. Some of them actually benefitted the plaintiffs by leaving MEC with more money.

For example, MEC’s use of Bristol’s legal, auditing, and communications departments saved MEC money. If MEC had paid for its own legal, auditing, and communications departments, there would now be less money in MEC to pay the plaintiffs. The same can be said about the loans that Bristol provided MEC to allow MEC TO acquire other companies; absent evidence that Bristol charged MEC above-market rates, this actually benefitted MEC.

The presence of Bristol officers on MEC’s board is hardly surprising, given that Bristol owned 100% of MEC’s stock. The special voting rights granted to one of those directors is unusual, but since two of MEC’s directors were Bristol officers, it’s hard to see that this had any effect. Plaintiffs have also shown that some MEC board members were unaware they were directors. All we can conclude from that is that MEC’s board did not meet as it should have. That’s a failure to follow a corporate formality, but it’s hard to see how anything would have been different if the board had met regularly. It’s also not surprising that MEC consulted Bristol regarding capital appropriations. In any other setting, such shareholder participation would be applauded, not made the basis for liability. In any event, the plaintiffs have not shown that any request by MEC for capital was refused.

One of the things the plaintiffs point to—the consolidated tax returns and financial statements, are actually required by tax law and accounting rules, respectively. If that’s a ground for piercing in this situation, it’s a ground for piercing in every parent-sub relationship. It does not distinguish parent-sub relationships that should be pierced from those that should not.

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The only fact the plaintiffs have pointed to that might have negatively affected their ability to recover is that Bristol paid no interest on the funds it held for MEC. That probably should give rise to a claim against Bristol to recover that interest, but the small amount lost hardly justifies making Bristol liable for a potential billion-dollar liability. The extreme punishment plaintiffs are asking this court to impose on Bristol for failure to follow all of the requisite corporate formalities bears no relation to the harm, if any, the failure to follow those formalities has caused.

Bristol’s Name on MEC Advertising

Finally, the plaintiffs point to the fact that Bristol allowed its name to be used on MEC’s breast implant advertisements, packaging, and product inserts. If Bristol falsely claimed in those materials that it, rather than MEC, was the manufacturer, the plaintiffs could probably make out a claim for fraud. In that case, it would be unnecessary to pierce the corporate veil. If Bristol merely indicated that MEC was a company it controlled, it’s unclear why that should justify piercing. Bristol has not agreed to guarantee the liability, merely made a truthful statement about its relationship to MEC.

Moreover, the plaintiffs, or their doctors on their behalf, voluntarily chose to do business with MEC. They were free to check out MEC’s financial status and do business with another company if they were dissatisfied with the assets MEC had available to cover the liability risk. They did not. They might argue that such action was not feasible and that the plaintiffs should not be bound by a choice made by their doctors. But, if that is the case, plaintiffs also cannot show any reliance on Bristol’s name on MEC’s advertising.

In sum, none of the fact proven by the plaintiffs provide sufficient justification to override the legislative decision

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not to make Bristol liable for MEC’s obligations. Therefore, this court refuses to pierce MEC’s corporate veil.