my ba outline copy 2

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BUSINESS ASSOCIATIONS I. AGENCY LAW A. GENERALLY i. Questions to ask: 1. Does an agency relationship exist between P & A? 2. What consequences follow P from interaction between A & T? B. DEFINITION OF AGENCY i. Typically involves three parties: 1. Principal 2. Agent 3. Third party the person with whom the agent is doing business on behalf of the principal ii. Definition of Agency 1. Restatement 2nd §1(1 ) Agency is the fiduciary relation which results from: a. A manifestation of consent by one person (the principal) to another (the agent) that the other shall: i. Act on the principal’s behalf and ii. Subject to the principal’s control b. And the agent consents to so act 2. Restatement 3rd §1.01 (use on exam) Agency is the fiduciary relationship that arises when: a. One person (a principal) manifests assent to another person (an agent) that the agent shall i. act on the principal’s behalf and ii. subject to the principal’s control, and b. the agent manifests assent or otherwise consents to so act. iii. Types of Agents (Rest. 2nd §3) 1. General Agent an agent authorized to conduct a series of transactions involving a continuity of service. 2. Special Agent an agent authorized to conduct a single transaction or a series of transactions not involving continuity of service. C. CREATING THE AGENCY RELATIONSHIP i. Has there been an agreement? 1. Rest. 3rd §1.02 whether the parties label their relationship as agency or not, it is not controlling (doesn’t really matter).

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Page 1: My BA Outline Copy 2

BUSINESS ASSOCIATIONS

I. AGENCY LAW A. GENERALLY

i. Questions to ask:1. Does an agency relationship exist between P & A?2. What consequences follow P from interaction between A & T?

B. DEFINITION OF AGENCYi. Typically involves three parties:

1. Principal2. Agent3. Third party the person with whom the agent is doing business on behalf of the

principalii. Definition of Agency

1. Restatement 2nd §1(1 ) Agency is the fiduciary relation which results from:a. A manifestation of consent by one person (the principal) to another (the agent)

that the other shall:i. Act on the principal’s behalf and

ii. Subject to the principal’s controlb. And the agent consents to so act

2. Restatement 3rd §1.01 (use on exam) Agency is the fiduciary relationship that arises when:

a. One person (a principal) manifests assent to another person (an agent) that the agent shall

i. act on the principal’s behalf andii. subject to the principal’s control, and

b. the agent manifests assent or otherwise consents to so act.iii. Types of Agents (Rest. 2nd §3)

1. General Agent an agent authorized to conduct a series of transactions involving a continuity of service.

2. Special Agent an agent authorized to conduct a single transaction or a series of transactions not involving continuity of service.

C. CREATING THE AGENCY RELATIONSHIPi. Has there been an agreement?

1. Rest. 3rd §1.02 whether the parties label their relationship as agency or not, it is not controlling (doesn’t really matter).

2. Rest. 3rd §1.03 “a person manifests assent or intention through written or spoken words or other conduct. (use circumstantial evidence, based on what the parties did and said to determine whether there was agency relationship).

3. Gorton v. Doty teacher lent her car to football coach so that he could transport the team to an away game. Coach gets into a car accident and one of the players gets injured. The player’s father sues the teacher, arguing that the coach was her agent, driving the car on her behalf. There was no exchange of money between teacher and coach.

a. Holding : the teacher was liable for the coach’s actions because he was acting as her agent. By telling the coach he had to drive the car himself, she was

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exercising her muscle as a principal, and the coach assented by driving the car (following her instructions).

b. “the principal is responsible for the acts of the agent… to the same extent as though [the principal] had been [acting herself driving the automobile herself]”

c. “where one undertakes to transact business or manage some affair for another by authority and on account of the latter, the relationship of principal and agent arises.”

d. “it is not essential to the existence of authority that there be a contract between principal and agent or that the agent promise to act as such.”

e. The fact that the teacher owned the car and that the coach was driving it established a prima facie case against the teacher the presumption arose that the coach was the agent of the teacher.

f. Dissent :i. Agency involves more than mere passive permission. It involves request,

instruction or command. ii. It would seem to be that one who borrows a car for his own use is a

gratuitous bailee and not agent of the owner. iii. The purpose for creating the relationship matters. Who benefits? Why

was the relationship/arrangement created? In this case, the teacher lent her car to the coach so that he could transport his football team, to the away game. He was the one that benefited from the arrangement, not the teacher.

iv. Although, it doesn’t necessarily entail that the principal benefit, but it matters why the relationship was formed.

g. Take away : The question of whether there is an agency relationship is fact intensive. The “on behalf of” element, especially.

4. A. Gay Jenson Farmers Co. v. Cargill, Inc. a. The agency relationship results from an agreement between the parties and

there doesn’t necessarily have to be a contract between the parties. b. Doesn’t matter what they say: an agreement may result in the creation of an

agency relationship although the parties did not call it an agency and did not intend the legal consequences of the relation to follow.

c. May be proved by circumstantial evidence: can show a course of dealing between the two parties (that the agent acted on the principal’s behalf and upon the principal’s direction and control). However, when the agency relationship is proven through circumstantial evidence, the principal must be shown to have consented to the agency.

ii. “A creditor who assumes control of his debtors business may become liable as principal for the acts of the debtor in connection with the business.” Cargill, Inc. citing Restatement 2nd §14O.

1. it is really rare for a court to find that a creditor is a principal (comments to rest 2nd)2. A security holder who merely exercises a veto power over the business acts of his

debtor by preventing purchase or sales above specified amounts do not thereby become a principal. However, if he takes over the management of the debtor’s business either in person or through an agent, and directs what contracts may or may not be made, he becomes a principal, liable as a principal for the obligations incurred

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thereafter in the normal court of business by the debtor who has now become his general agent.

3. The point at which the creditor becomes a principal is that at which he assumes de facto control over the conduct of his debtor.

4. Factors should not be considered in isolation, but, rather, they must be viewed in light of all of the circumstances surrounding Cargill’s aggressive financing of Warren.

5. How would we advise Cargill to prevent liability in the future? a. They could have subsumed Warren as a subsidiary of Cargill.b. They could have hired a third-party financial advisor to Warren. This removes

Cargill from direct contact – the more remote you can make the control over the alleged agent, the stronger your argument before the court.

c. Enforce your rights as a creditor and force Warren to default. This is the most conservative decision

iii. “Martial status cannot in and of itself prove the agency relationship. Nor does the fact that the defendants owned the land jointly make on the agent for the other.” Botticello v. Stefanovicz.

D. LIABILITY OF PRINICPAL TO THIRD PARTIESi. Generally

1. Who is the least cost avoider? The principal, usually… 2. Unless the principal puts limitations on the agent, the principal will likely be liable for

anything the agent does on your behalf.3. Agency is not a COA. It is a means by which you have prove that someone is liable.

Agency is used to prove that a principal is liable to a third party for the breach of contract, negligence, etc., of the agent. Usually to get to the principal’s big pockets.

4. PAT Triangle

a. Line (3) - did the principal manifest in some way that the purported agent had the authority to act on the principal’s behalf? (Dweck).

ii. Contract Liability 1. Rest. 2nd §144 a principal is subject to liability upon contracts made by an agent

acting within his authority if made in proper form and with the understanding that the principal is a party.

a. Rest. 2d §26, Creation of Authority “authority to do an act can be created by written or spoken words or other conduct of the principal which, reasonably interpreted, causes the agent to believe that the principal desires him so to act

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on the principal’s account.” the principal tells the agent to conduct some business for the principal.

2. Types of Agent Authoritya. Actual (either express or implied) cite Rest. 2d §26 or Rest. 3rd §2.01

i. Express: Explicit direction from the principal to the agent, and the agent follows the direction. Express understanding between the two parties that the agent is authorized to conduct a transaction on behalf of the principal.

1. Ex: P tells A to do X; A does X P is bound to that contractii. Implied: P tells A to achieve an objective. All the details of how to

accomplish the principal’s objectives are not expressed but are necessary to accomplish the objectives.

1. Ex: If, in order to do X, A must take other steps, A has implied authority to take those other steps and P is bound (and liable).

2. Summary Questions:a. Did the agent reasonably believe that she had the

authority to conduct the transaction? (Based on present or past conduct – course of dealing – from the principal?)

b. Is such a transaction customary for the agent’s role? OR Is such a transaction necessary to achieve a greater objective that was required by the principal?

c. If so, agent probably had the implied authority to act.

d. However, if the principal provided limited express authority (Anne, please hire someone to cut the grass), then this also limits implied authority (Anne would not be impliedly authorized to hire a janitor based on orders to cut grass).

3. “Implied authority is actual authority circumstantially proven which the principal actually intended the agent to possess and includes such powers as are practically necessary to carry out the duties actually delegated.” Hogan

4. “whether implied authority exists, it is important to focus on the agent’s understanding of his authority. It must be determined whether he agent reasonably believes because of present or past conduct of the principal that the principal wishes him to act in a certain way or to have certain authority.” Hogan

5. Factors: (1) certain additional steps are required to achieve objective ordered by principal, (2) the agent reasonably believed he had the authority to act based on present or past conduct from the principal.

6. Also consider, is the action from the agent customary for that role? Ex: a building manager hiring a janitor to keep building clean, even though the principal did not explicitly order the building manager to keep building clean.

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7. Authority toa. Do what is necessary, usual, and proper to accomplish

or perform an agent’s express responsibilitiesb. To act in a manner in which an agent believes the

principal wishes the agent to act based on the agent’s reasonable interpretation of the principal’s manifestation in light of the principal’s objectives and other facts known to the agent. Dweck.

iii. (note: focuses on the P-A relationship)b. Apparent : P holds A out as her agent, A takes unauthorized step that is

customary to agent’s role, then P is bound/liable. i. (note: focuses on the P-T relationship)

ii. Questions:1. Did the third party believe that the agent was the principal’s

agent with the authority to act on principal’s behalf? (Could be based on past conduct)

2. Is such a transaction customary for the agent’s role? 3. If so, the agent probably had apparent authority?

iii. Rest. 2d distinguished between apparent agency and apparent authority.

1. §8. Apparent Authority “Apparent authority is the power to affect the legal relations of another person by transactions with third persons, professedly as agent for the other, arising from and in accordance with the other’s manifestations to such third persons.

iv. Rest. 3rd §2.03 – “Apparent authority is the power held by an agent or other actor to affect a principal’s legal relations with third parties when a third party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal’s manifestations.” Reasonableness of reliance is critical.

v. “Apparent authority… is not actual authority but is the authority the agent is held out by the principal as possessing. It is a matter of appearances on which third parties come to rely.” Hogan

vi. Requires a manifestation from the principal to the third party that the agent had authority. But this communication does not need to be direct between P and T. The principal in some circumstances may tell A to tell T that A has authority.

vii. “Further, absent knowledge on the part of third parties to the contrary, an agent has the apparent authority to do those things which are usual and proper to the conduct of the business which he is employed to conduct.” 370 Leasing.

viii. Even if the agent’s power was limited by the principal, if the third party does not know about this limitation, then the limitation will not bar a claim of apparent authority. 370 Leasing (Joyce, the buyer, reasonably relied on the salesperson closing the deal – typically, sales persons have the authority to close deals, even though in this case, he didn’t).

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c. Inherent : (not recognized by Rest. 3rd)i. §8A. Inherent Agency Power: “Inherent agency power is a term used in

the restatement of this subject to indicate the power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent.”

ii. This is a very broad concept that rest. 3rd refused to accept. Instead, in created a rule directly targeted at cases like Watteau (undisclosed principals).

d. Undisclosed i. Rest. 2d §186 “an undisclosed principal is bound by contracts and

conveyances made on his account by an agent acting within his authority, except that the principal is not bound by a contract which is under seal or which is negotiable, or upon a contract which excludes him.”

ii. Rest. 2d §194. Acts of General Agents: “A general agent for an undisclosed principal authorized to conduct transactions subjects his principal to liability for acts done on his account, if usual or necessary in such transactions, although forbidden by the principal to do them.”

iii. Rest. 3d §2.06. Liability of an Undisclosed Principal1. An undisclosed principal is subject to liability to a third party

who is justifiably induced to make a detrimental change in position by an agent acting on the principal’s behalf and without actual authority if the principal, having notice of the agent’s conduct and that it might induce others to change their positions, did not take reasonable steps to notify them of the facts.

2. An undisclosed principal may not rely on instructions given an agent that qualify or reduce the agent’s authority to less than the authority a third party would reasonably believe the agent to have under the same circumstances if the principal had been disclosed.

iv. Rest. 3d In other words For an undisclosed principal to be liable, the undisclosed principal:

1. Has given the agent express instructions to not do something, has expressly limited the agent’s authority

2. Has to know the agent is not following those directions, acting outside given authority, and

a. even if the principal claims that the she didn’t know the agent was acting outside of her given authority, this defense will not stand if the agent’s conduct was customary in the industry.

3. Does nothing to notify the parties that reasonably relied on the agent.

v. Watteau

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1. The court found the undisclosed principal liable for the cigars and Bovril the agent purchased for the bar, even though the defendants claimed that they didn’t know the manager was buying these things.

2. The court reasoned that buying cigars and Bovril was customary for bar owners/managers. Hubble had been buying cigars and Bovril from the Ps for years.

vi. Under Rest. 3d, Watteau may have been decided the same way because Rest. 3d is narrower than the common law and Rest 2d, because it requires that the principal have notice (???).

vii. Rationale: Concept of cheapest cost avoider:1. We have social loss here – a busted contract. How do we avoid

such losses in the future? a. Find the actor who can achieve the greatest reduction

of accident costs with the lowest expenditure of precaution costs

i. We seek to minimize total social costs (including admin costs)

b. Place liability on that individual. 2. Then apparent authority If the principal gives express

instructions to the agent, then the principal has the duty to supervise the agent and make sure the instructions are being followed. If the third party reasonably believed that the agent had more authority, then the P can’t use those instructions to avoid liability.

3. Part of comment c. The doctrine allocates to the principal the risk that the agent will deviate from the principal's instructions while doing acts that are consistent with the apparent position the agent occupies, which are acts that third parties would anticipate an agent in such a position would have authority to do and may well be acts that are foreseeable to the principal. Such acts are especially likely to be foreseeable when they are consistent with the agent's position although they contravene the principal's instructions.

iii. Liability by Ratification or Estoppel1. Generally

a. Comes into play when you can’t show the other three types of authority (actual, apparent, undisclosed).

b. Purpose : to prevent an unjust result. Notions of equality and equitably remedies. Meant to impose liability on the principal when it would be unjust to do otherwise.

2. Ratification : Occurs when an agent exceeds its authority granted to it by the principal, but the principal does not repudiate the transaction, but instead accepts it. Ratification requires acceptance of the results of the act with an intent to ratify, and with full knowledge of the material circumstances.” Botticello.

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a. May be proved when the principal receives benefits of an agreement and fails to repudiate it.

b. However, the principal must have full knowledge of the material circumstances in order to ratify.

c. The principal must have the opportunity to either accept or reject. Ex: if the grass is already cut, the principal didn’t have the opportunity to correct the mixup (that the agent did not have the authority to hire landscapers).

d. Implied ratification : occurs when the principal learns that the agent acted beyond scope of authority but remains silent or fails to act.

e. The principal may not ratify an act by the agent after there is a material change in circumstances that makes it inequitable to bind the third party (ex: an agent sold a house w/o authority, then house burns down, principal ratifies).

f. See Rest . 3d §401-4.033. Estoppel Rest. 3d §2.05

a. Elements:i. P creates, through intentional or negligent words, acts or omissions,

appearance of authorityii. T reasonably and in good faith relies on appearance of authority that

“the appearances being of such a character as to lead a person of ordinary prudence and circumspection to believe that the imposter was in truth the proprietor’s agent.” Koos Bros.

iii. T changes her position in reliance on appearance of authority.b. Koos Bros.

i. There needs to be (1) detrimental reliance, but also (2) detrimental change in position.

ii. The court found that the store had a duty to monitor its floor, supervise its EEs, to prevent situations like this one.

iii. The principal should be estopped from denying liability. “in such circumstances the law will not permit the proprietor to defensively to avail himself of the imposter’s lack of authority and thus escape liability for the consequential loss thereby sustained by the customer.”

iv. An Agent’s Liability on the Contract – Atlantic Salmon and Rest. 3d §6.01-6.041. §6.01 – Agent acting for a disclosed principal When an agent acting with actual or

apparent authority makes a contract on behalf of a disclosed principal,a. the principal and the third party are parties to the contract; andb. the agent is not a party to the contract unless the agent and third party agree

otherwise2. §6.02 – Agent Acting for Unidentified Principal When an agent acting with actual or

apparent authority makes a contract on behalf of an unidentified principal,a. the principal and the third party are parties to the contract; andb. the agent is a party to the contract unless the agent and the third party agree

otherwise.3. §6.03 – Agent for Undisclosed Principal When an agent acting with actual authority

makes a contract on behalf of an undisclosed principal, a. unless excluded by the contract, the principal is a party to the contract;b. the agent and the third party are parties to the contract; and

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c. the principal, if a party to the contract, and the third party have the same rights, liabilities, and defenses against each other as if the principal made the contract personally.

4. §6.04 – Inexistent Principal, or Principal Lacks Capacity to Contract Unless the third party agrees otherwise, a person who makes a contract with a third party purportedly as an agent on behalf of a principal becomes a party to the contract if the purported agent knows or has reason to know that the purported principal does not exist or lacks capacity to be a party to a contract. (Atlantic Salmon in a nutshell).

a. Comment c. add in5. Atlantic Salmon

a. Holding : Found agent liable for debts incurred in contract with P because the agent was not being truthful in identifying the principal.

b. “The duty rests upon the agent, if he would avoid personal liability, to disclose his agency, and not upon others to discover it. It is not, therefore, enough that the other party has the means of ascertaining the name of the principal; the agent must either bring him to actual knowledge or, what is the same thing, that which to a reasonable man is equivalent to knowledge or the agent is bound.”

v. Liability in Tort1. Servant Versus Independent Contractor

a. Vicarious liability/respondeat superior liability of master for actions of servants (liability of ERs for actions of EEs).

i. A master (ER) is liable for the torts of its servants (EEs). A master-servant relationship exists when the servants agreed to (1) work on behalf of the master and (2) to be subject to the master’s control or right to control the physical conduct of the servant (that is, the manner in which the job is performed, as opposed to the result alone).

ii. At first, ERs used to be liable for any an all damage caused by the EEs. Over time, the courts have limited that to apply only to actions done by EE in his capacity as an agent.

iii. Rest. 3rd §2.04 an ER is subject to liability for torts committed by EEs while acting within the scope of their employment.

b. Definition of EE by §7.07 An EE is an agent whose principal controls or has the right to control the manner and means of the agent’s performance of work (as in the manner in which the job is performed, as opposed to the result alone).

c. §7.03 – Principal’s Liability – In General i. A principal is subject to direct liability to a third party harmed by an

agent’s conduct when1. The agent acts with actual authority or the principal ratifies the

agent’s conduct, anda. The agent’s conduct is tortious, orb. The agent’s conduct, if that of the principal, would

subject the principal to tort liability, or2. The principal is negligent in selecting, supervising, ot otherwise

controlling the agent, or

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3. The principal delegates performance of a duty to use care to protect other persons or their property to an agent who fails to perform the futy

ii. A principal is subject to vicarious liability to a third party harmed by an agent’s conduct when:

1. The agent is an employee who commits a tort while acting within the scope of employment

2. The agent commits a tort when acting with apparent authority in dealing with a third party on or purportedly on behalf of the principal.

iii. don’t try to pigeon hole these arguments, can be bothd. §7.04 – Agent Acts with Actual Authority a principal is subject to liability to a

third party harmed by an agent’s conduct when the agent’s conduct is within the scope of the agent’s actual authority or ratified by the principal; and

i. the agent’s conduct is tortious, orii. the agent’s conduct, if that of the principal, would subject the principal

to tort liability. iii. typically involves the ER-EE relationship, but may involve other agency

relationships where the Pr’s conduct is at faultiv. direct liability when the P orders the A to do something tortious (gives

actual authority) and that act harms a third party. e. §7.05 – Principal’s Negligence in Conducting Activity Through Agents;

Principal’s Special Relationship With Another Personi. A principal who conducts an activity through an agent is subject to

liability for harm to a third party caused by the agent’s conduct if the harm was caused by the principal’s negligence in selecting, retaining, supervising, or otherwise controlling the agent. (which is pretty much everything?)

ii. When a principal has a special relationship with another person, the principal owes that person a duty of reasonable care with regard to risks arising out of the relationship, including the risk that agents of the principal will harm the person with whom the principal has such a special relationship.

f. §7.08 – Agent Acts with Apparent Authorityi. A principal is subject to vicarious liability for a tort committed by an

agent in dealing or communicating with a third party on or purportedly on behalf of the principal when actions taken by the agent with apparent authority constitute the tort or enable the agent to conceal its commission.

ii. Comment a1. This rule applies to (1) agents, whether or not they are EEs, and

(2) agents who are EEs whose tortious conduct is not within the scope of employment.

2. This rule applies to torts in which an agent appears to deal or communicate on behalf of a principal and the agent’s

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appearance of authority enables the agent to commit a tort or conceal its commission.

g. Independent contractorsi. Agent-type independent contractor – a person who has agreed to act on

behalf of another, the principal, but is not subject to the principal’s control over how the result is accomplished (that is, over the “physical conduct” of the task).

1. will be liable?ii. Non-agent independent contractor – a person who operates

independently and simply enters into arm’s length transactions with others.

iii. the real distinction is between servants/agents and non-agent independent contractors.

h. Sequential Analysis of Tort Liabilityi. Is there an agency relationship between P and A?

1. (if there is, on what sort of authority was the A acting on? ii. Is the P subject to direct liability?

iii. Is the P subject to vicarious liability? 1. (is A P’s EE or non-EE agent?)

i. When will a principal be liable? (When the independent contractor is agency-type). Agency-type when:

i. The difference is that one has subtle control over the contractor and the other has more direct, heavy-handed control.

ii. Controls day to day operations : Gasoline Station Cases the difference was that Humble Oil controlled the day-to-day operations of the gas station

1. hours of operation2. the duration of the contract (it was terminable at Humble’s

will), how it compensated the operator).3. Business expenditures4. Customer rates5. Share of the profits 6. Power to hire and fire7. Determine EE wages or working conditions8. Set standards for EE skills and productivity9. Supervise EE work routine10. Discipline EEs11. Exactly which products the agent may sell (McDonalds)

iii. The independent contractor is agent-type when the principal maintains a “strict system of financial control and supervision … with little or no business discretion reposed in [the agent].” Humble Oil. (except that the agent had control over the hiring and firing, payment and supervision of a few station employees.

iv. Maintained title over Humble products until delivery to consumer. Only allowed to sell Humble products?

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v. Supervision by the principal ex: weekly visits by sales rep to take merchandise orders, inspect restrooms, communicate customer complaints, make various suggestions to improve sales and discuss any problems that the agent may be having. (Sun Oil)

vi. Submit reports if the agent has to submit some sort of financial reports to the principal

vii. Subsidizing (Sun Oil) rebate on gasoline so that agent could keep competitive prices.

viii. Principal takes hit from losses or benefits from profits no relationship if the agent assumes the overall risk of profit or loss in the business operation.

ix. Continuous subjection to the will of the principal, Rest. 2nd §1, comment (b), from Murphy v. Holiday Inns, Inc.

x. Power over daily maintenancexi. Building standards follow franchisor’s specific blueprints and

specifications for the equipment and layout of restaurant, including adopting reasonable changes that the franchisor made. And cannot make changes to basic design without franchisor approval. McDonalds.

j. Just because a contract between two parties contains a disclaimer clause – “this is not an agency relationship” – doesn’t matter. There must be an agreement for an agency relationship to exist. However, the court will look at the terms of the contract and the parties’ behavior to determine whether there is an agency relationship. “The critical test is the nature and extent of the control agreed upon.” Murphy .

k. Franchising – Murphy v. Holiday Innsi. Franchising is not an agency relationship. The franchisor provides the

brand identification and supplies on a continuing basis, while the franchisee, an independent businessman or woman,

ii. Whether a franchise arrangement creates an agency relationship depends on the contract and whether the franchisor regulates the activities of the franchisee to such an extent that it vests the franchisor with control within the definition of agency.

iii. Holding: there was no agency relationship.1. Achieving a system-wide standardization of business entity,

(control over the architectural style of the building, the furnishings and equipment), uniformity of commercial service not sufficient to indicate agency relationship.

iv. “If, in practical effect, the franchise agreement goes beyond the stage of setting standards, and allocates to the franchisor the right to exercise control over the daily operations of the franchise, an agency relationship exists.”

v. The test: right to control. It does not matter whether the putative principal actually exercises control, what is important is that it has the right to do so. Miller v. McDonalds.

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l. Rest. 3rd Does the franchisor have control over the instrumentality that caused the harm? If so, then there is an agency relationship and the principal is liable.

i. Vandermark v. McDonald’s Corp. McDonalds was not liable when an EE was assaulted during a robbery of a McDonald’s store because the franchisor did not control the security measures employed by the franchisee

ii. Hong Wu v. Dunkin Donuts, Inc. Dunkin Donuts was not liable when an EE was raped and assaulted during the night shift because the franchisor, Dunkin Donuts, did not mandate specific security equipment or otherwise controlled the steps taken by its franchisees in general to protect EEs.

iii. “The issue turns narrowly upon the defendant’s level of control over the alleged ‘instrumentality’ that caused the harm.”

2. Tort Liability and Apparent Agency a. Apparent Agency: “Apparent agency is essentially agency by estoppel. Its

existence depends upon such conduct by the principal as would preclude the principal from denying another’s agency.”

b. Apparent Authority: “The liability of the principal is determined in any particular case by what authority the third person, exercising reasonable care and prudence, was justified in believing that the principal had by his acts under the circumstances conferred upon his agent.”

c. Rest. 3rd considers these two essentially the same thing. §2.03: Apparent authority is the power held by an agent or other actor to affect a principal’s legal relations with third parties when a third party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal’s manifestations.”

d. Miller v. McDonald McDonalds, as the franchisor, was the principal, and thus liable for the torts of 3K, the franchisee.

i. There was an actual agency relationship because McDonalds controlled the day-to-day operations of the restaurant.

ii. Also, there was apparent agency:1. The P went to the restaurant under the assumption that

McDonalds controlled and managed it. 2. Nothing disclosed to her that any entity other than McDonalds

was involved in its operation. (there was a small sign at the front counter than identified the franchisees, but this was not sufficient).

3. The P justifiably relied on McDonald’s holding this franchise out as its agent, that she could expect the same quality of service and food at this location. (This came in part from her experiences at other restaurants – McDonald’s insistence on uniformity).

iii. “One who represents that another is his servant or other agent and thereby causes a third person justifiably to rely upon the care or skill of such apparent agent is subject to liability to the third person for harm

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caused by the lack of care or skill of the one appearing to be a servant or other agent as if he were such.”

iv. “A jury could find that it was defendant’s very insistence on uniformity of appearance and standards, designed to cause the public to think of every McDonald’s franchised or unfranchised as part of the same system, that makes it difficult or impossible for P to tell whether her previous experiences were at restaurants that defendants owned or franchised.”

v. Lesson : Need to provide notice to the public that the franchisor does not control the day-to-day operations of the franchisee.

1. Best Western Example: “independently owned and operated hotels.”

2. But this sort of disclaimer does not save you from actual authority. If the contract is too detailed, controls everything, then a court may still find agency.

3. Real world: change the language of the contract “suggest” a certain uniform, “suggest” certain best practices instead of a manual. But then you always run the risk that there will be rogue franchisees ruining the franchisor’s reputation.

E. AGENT’S FIDUCIARY DUTIESi. Key Terms

1. Duty: “A legal obligation that is owed or due to another and that needs to be satisfied; an obligation for which somebody else has a corresponding right.”

2. Fiduciary: “A person who is required to act for the benefit of another person on all matters within the scope of their relationship.”

3. Fiduciary Duty: “A duty of utmost good faith, trust, confidence, and candor owed by a fiduciary… to the beneficiary; a duty to act with the highest degree of honesty and loyalty toward another person and in the best interests of the other person.”

ii. These duties are also often regulated by contract. If they are not, the restatements (and the common law) govern.

iii. Duty of Loyalty: Overview1. Agent has a duty to act loyally for the principal benefit and not for the agent’s benefit.

a. Rest. 3d §8.01 – General Fiduciary Principal – “An agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected with the agency relationship.”

b. “Under his fiduciary duty to [the principal] [the agent] was bound to the exercise of the utmost good faith and loyalty so that he did not act adversely to the interests of [the principal] by serving or acquiring any private interest of his own.” General Automotive.

c. The agent has a duty to act solely for the benefit of the principal. General Automotive.

2. Agent has a duty not to seek his own material benefit using the assets and position given to it by the principal.

a. §8.02 – Material Benefit Arising Out of Position – “An agent has a duty not to acquire a material benefit from a third party in connection with transactions conducted or other actions taken on behalf of the principal or otherwise through the agent’s use of the agent’s position.”

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b. Reading v. Regem i. If the main reason why the agent got the job in the first place what his

position as the principal’s agent, then the agent is accountable for the money earned to the principal.

ii. It is a breach of the duty of loyalty to use the office, supplied, tools, in order to work that the principal has given the agent, for things that to do not benefit the principal.

iii. If the assets the agent enjoys and the position which he occupies are the real cause for his obtaining the money are distinct from merely affording the opportunity for getting it, that is to say, if they play the predominant part in his obtaining the money, then he is accountable for it to his master.

1. if the assets and position given to the agent by the principal plays a predominant part in the agent obtaining these money-making opportunities, then it is a breach, and the agent owes this money to the principal.

3. §8.03 – Acting as or on Behalf of an Adverse Partya. An agent has a duty not to deal with the principal as or on behalf of an adverse

party in a transaction connected with the agency relationship.4. Agent has a duty not to compete with the principal while still under the agency

relationship. a. §8.04 – Competition

i. Throughout the duration of an agency relationship, an agent has a duty to refrain from competing with the principal and from taking action on behalf of or otherwise assisting the principal’s competitors. During that time, an agent may take action, not otherwise wrongful, to prepare for competition following termination of the agency relationship.

b. If the agent is considering competing with the principal, or at least taking some opportunity that belongs to the principal for his own personal gain, the agent must disclose these facts to the principal. General Automotive.

i. If the agent does not disclose and takes the business opportunity for himself, that is a breach of duty.

ii. If the agent does disclose, it is up to the principal to decide whether to consent. If the agent gets informed consent to take the opportunity, then the agent may take it and there is no breach.

c. if the agent terminates the relationship in order to compete with the principal, the former-agent cannot use the principal’s confidential information to use in the agent’s own business to compete against them. Town and Country

i. the principal had put a lot of time and effort to develop the list of customers and the special prices to be set. “this represented an accumulated body of experience of considerable value.” “these customers were screened by [the principal] at considerable effort and expense.”

ii. There has to be equal footing in the solicitation of clients. The client needs to have the right to choose between the principal’s business and the former-agent’s new business.

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5. Agent has a duty to not use the principal’s property or confidential information for the agent’s own material benefit or to benefit a third party.

a. §8.05 Use of Principal’s Property; Use of Confidential Informationi. An agent has a duty

1. Not to use property of the principal for the agent’s own purpose of those of a third party; and

2. Not to use or communicate confidential information of the principal for the agent’s own purpose or those of a third party.

b. Comment b. termination of an agency relationship does not end the agent’s duties to the principal…

i. In general c. Questions to Ask:

i. What is the material benefit?ii. Who benefits?

iii. Who should have gotten it? Did the agent get that benefit predominantly because of his relationship with the principal?

6. §8.06 Principal’s Consent (my own words)a. A principal may consent to an agent doing something that would otherwise

constitute a breach under §§8.01-8.05, and would then not constitute a breach of duty of loyalty, provided that:

i. The agent acts in good faith,ii. The agent discloses are material facts the agent knows, has reason to

know, or should know would reasonably affect the principal’s judgment, unless the principal manifests that such facts are already known to him/her or the principal does not wish to know the facts.

iii. The agent otherwise deals fairly with the principal, andiv. The principal’s consent concerns either a specific act or transaction that

could reasonably be expected to occur in the ordinary course of the agency relationship

b. An agent who acts for more than one principal in a single transaction has a dutyi. To deal in good faith with each principal

ii. To disclose to each principal1. the fact that the agent is acting on behalf of the other

principal(s)2. all other facts the agent knows, has reason to know, or should

know would reasonably affect the principal’s judgment3. otherwise deal fairly with each principal

C.iv. Duty of Performance : Overview

1. Agent has a duty to comply with terms of a contract. a. §8.07 – Duty Created by Contract – An agent has a duty to act in accordance

with the express and implied terms of any contract between the agent and the principal.

2. §8.08 – Duties of Care, Competence, and Diligence

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a. Subject to any agreement with the principal, an agent has a duty to the principal to act with care, competence, and diligence normally exercised by agents in similar circumstances.

b. Special skills or knowledge possessed by an agent are circumstances to be taken into account in determining whether the agent acted with due care and diligence.

c. If an agent claims to possess special skills or knowledge, the agent has a duty to the principal to act with care, competence, and diligence normally exercised by agents with such skills or knowledge.

3. §8.09 – Duty to Act Only Within the Scope of Actual Authority and to Comply with Principal’s Lawful Instructions

a. An agent has a duty to take action only within the scope of the agent’s actual authority.

b. An agent has a duty to comply with all lawful instructions received from the principal and person designated by the principal concerning the agent’s actions on behalf of the principal

4. §8.10 – Duty of Good Conducta. An agent has a duty within the scope of the agency relationship, to act

reasonably and to refrain from conduct that is likely to damage the principal’s enterprise

5. §8.11 – Duty to Provide Informationa. An agent has a duty to use reasonable effort to provide the principal with facts

that the agent knows, has reason to know, or should know wheni. Subject to any manifestation by the principal, the agent knows or has

reason to know that the principal would wish to have the facts or the facts are material to the agent’s duties to the principal; and

ii. The facts can be provided to the principal without violating a superior duty owed by the agent to another person.

6. §8.12 – Duties Regarding Principal’s Property – Segregation, Record-Keeping, and Accounting

a. An agent has a duty, subject to any agreement with the principal,i. not to deal with the principal's property so that it appears to be the

agent's property;ii. not to mingle the principal's property with anyone else's; and

iii. to keep and render accounts to the principal of money or other property received or paid out on the principal's account.

v. Duties of P to A – Duty of Loyalty 1. §8.13 – Duty Created By Contract

a. A principal has a duty to act in accordance with the express and implied terms of any contract between the principal and the agent.

2. §8.14 – Duty to Indemnifya. A principal has a duty to indemnify an agent

i. Un accordance with the terms of any contract between them; andii. Unless otherwise agreed,

1. When the agent makes a paymenta. Within the scope of the agent’s actual authority, or

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b. That is beneficial to the principal, unless the agent acts officiously in making the payment, or

2. When the agent suffers a loss that fairly should be borne by the principal in light of their relationship.

3. §8.15 – Principal’s Duty to Deal Fairly and in Good Faitha. A principal has a duty to deal with the agent fairly and in good faith, including a

duty to provide the agent with information about risks of physical harm or pecuniary loss that the principal knows, has reason to know, or should know are present in the agent’s work but unknown to the agent.

f. AGENCY SUMMARYi. For a P-A relationship to exist, there needs to be:

1. Consent by the P to have A act on his behalf2. Consent by the P to have A act subject to his control3. Consent by A to so act.

ii. P is liable on contract if:1. Actual (express or implied) authority2. Apparent authority3. Undisclosed principal

OR4. Ratification5. Estoppel

iii. A is liable on contract if:1. Disclosed principal and expressly stated in the agreement2. Partially disclosed or undisclosed principal.

iv. P is liable in tort if:1. Direct liability2. Employer-Employee (control) and within the scope of employment3. Nonemployee Agent (or employee outside scope of employment) and apparent

authority.v. A has fiduciary duties to P

1. Primary duty is duty of loyalty2. Basically, A (like all fiduciaries) must act honestly (includes disclosure), in good faith and

without conflict (i.e. loyalty).3. A’s duty of performance includes duty to act with care, competence and diligence

II. General Partnerships Unincorporated and Unlimited Liabilitya. Generally

i. What is a Partnership? 1. UPA 1914 §6(1) “A partner is an association of two or more persons to carry on as co-

owners of a business for profit.”2. UPA 1997 §101(6) same

ii. Characteristics1. Not taxed; gains and losses taxed at the partner level as income tax.2. Typically, limited life. (though you could have a 99-year partnership)3. Unlimited liability (partners are jointly and severally liable for all partnership debt)4. Ownership interests nontransferable.

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a. Can’t force a new partner onto the old partner. Can’t substitute yourself as partner without the other partner’s consent

b. Don’t allow unilateral decisions on substitution.c. This can be contracted around, but this is the default rule.d. We are more protective of partnerships – this is an intimate business

relationship. (If you don’t like the way a corp is being run, you can just sell your stock and go, not so for partnerships).

iii. Who is a partner?1. UPA 1913 §7

a. Joint tenancy, tenancy in common, tenancy by the entireties, joint property, common property, or part ownership does not of itself establish a partnership

b. The sharing of gross returns does not of itself establish a partnership, whether or not persons sharing them have a joint or common right or interest in any property from which the returns are derived.

i. Gross returns are everything that comes in the door. Profits are calculated after all the costs have been subtracted.

c. Sharing profits presents a prima facie case of partnership that may be rebutted by (the elements in UPA 1997 §202(c)).

i. This means that if the P presents a prima facie case, the burden then shifts to the D (the person challenging the existence of the partnership) to prove that there wasn’t one.

ii. Other courts (those that look at UPA 1913) consider shared profits as just another factor (a very strong factor) that is used to determine whether there is a partnership.

1. Southex: Whether a partnership was created depends on the totality-of-the-circumstances.

2. And the presumption of a partnership, created by an agreement to share in the profits, may be rebutted by other factors than those listed in the UPA. Southex

2. UPA 1997 §202(c) A person who receives a share of the profits of a business is presumed to be a partner in the business, unless the profits were received in payment:

a. Of a debt by installments or otherwise;b. For services as an independent k-or or of wages or other compensation to an EEc. Of rentd. Of an annuity or other retirement or health benefit to a beneficiary

representative or designee of a deceased or retirede. Of interest or other charge on a loan…f. For the sale of the goodwill of a business or other property by installments or

otherwise3. Factors that indicate an intent to form a partnership (under UPA 1913?) Fenwick

a. The intent of the parties.i. A contract is evidential but not conclusive.

ii. In Fenwick, the intent of the parties, as evidenced by the contract, was would provide a possibility of increase of compensation to Mrs. Cheshire and at the same time protect Fenwick from being obliged to pay such increased unless the business warranted it. This profit-sharing scheme

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created a prima-facie case of partnership. But it does not mean we decisively have a partnership.

iii. Indicative of intent to operate as a partnership entering into contracts or doing business with third parties under the name of the putative contract. Not doing business in the name of a partnership indicates the contrary intent no partnership. Southex.

iv. Labels the parties assign to their intended legal relationship is probative partnership formation, but is not necessarily dispositive as a matter of law. Southex Found no partnership even though the parties used the word “partners” in the contract.

b. Right to share in the profitsc. Obligation to share in the losses

i. “State law normally presumes that partners share equally or at least proportionately in partnership losses.” Southex Exhibitions.

d. Ownership and control of the partnership property and business. (Co-ownership).

i. How could an atty draft a partnership agreement between Fenwick and Cheshire that would grant her some power, to make the partnership consistent with UPA, yet keep most of the power himself?

1. Give her control over “day-to-day affairs of the salon.”a. Schedulingb. Ensuring customer satisfactionc. Book-keepingd. While leaving money issues, which is what Fenwick

cared about, with Fenwick.2. Subtle ways of putting checks voting shares. He takes 80% of

profits, so his voting share always trumps. Enact majority vote for the things he cared most about.

ii. The court would probably still analyze whether she had any control, but at least it looks better than the current contract.

e. Community of power in administration (look at the language of a contract, if there is one).

f. Contribution of property by each partner for the partnership and an understanding that the property will be co-owned by the partners. Mutual intent to convert property into partnership property. Southex.

g. Rights of the parties on dissolutioni. If the “partner” can just leave like an EE can just quit – that indicates

merely an ER-EE relationship, not a partnership. Fenwick.ii. Usually a partner will have a right to some capital/payment, whatever $

the partner put into the business. (??)h. Duration

i. If two persons/business entities go into business by contract, and the contract is for fixed renewable terms – that seems more like an arms-length contract business relationship and not a partnership. Southex Exhibitions.

ii. Partnership contracts will usually be for indefinite duration?

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4. Partners Compared with Lenders – Martin v. Paytona. Lenders may share in some of the profits as re-payment of the loan and

maintain some control over the business to ensure the business will survive long enough for the lender to be repaid.

b. Seems like as long as the policies of the lender are designed to ensure repayment, there is no partnership. To ensure performance of the agreement.

i. In Payton, the trustees could not initiate a transaction for the partners and they could not bind the firm by any action of their own.

c. Although, if the control is too much, the lender may be considered a partner. Depends on the extent of control.

5. Partnership by Estoppela. In order to establish partnership by estoppel, four elements must be proven:

i. P must establish a representation, either express or implied, that one person is the partner of another, i.e., that there was a holding out of a partnership

ii. The making of the representation was made by the person sought to be charged as a partner or with his consent

iii. A reasonable reliance in good faith by the third party upon the representation

1. There has to be actual proof of reliance. In Young v. Jones, the court found that the P did not rely on PW-US’s representation of a partnership with PW-Bahamas because there was no evidence that the P saw a brochure holding out all PW offices as partners – there was no evidence that the partnership was represented directly to the P and the P actually relied on this representation. ?

iv. A change in position, with consequent injury, by the third person in reliance on the representation.

b. Main difference between partnership and partnership by estoppel:i. A partnership requires proof of consensual agreement to share profit

and controlii. Partnership by estoppel requires a representation by the D and reliance

by the P. this is used when the P cannot prove a partnership in fact. b. How do you govern a partnership?

i. Partner’s authority 1. Differences in UPA 1914 and 1997

a. §9 every partner is an agent of the partnership for the purpose of its business. The partner can bind the partnership “for apparently carrying on in the usual way the business of the partnership of which he is a member,” unless the partner had no authority to act and the third party knew this fact.

i. If the partner does something that doesn’t seem consistent with carrying on the business of the partnership, it’s not binding on the other partners unless they all agree/consent to the action. (does this include ratification?)

ii. There needs to be consent from all of the partners to do the following:

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1. Assign partnership property in trust for creditors or to pay partnership debts

2. Dispose of the “good will” of the business3. Do anything that would make it impossible to carry on the

business4. Confess a judgment5. Submit a claim or liability on behalf of the partnership to

arbitration or reference. b. §301(1) similar language, except: “for apparently carrying on in the ordinary

course of the partnership business or business of the kind carried on by the partnership.”

i. Much of a difference at all? 2. Partner’s Rights and Duties (§18 (1914) and §401 (1997)):

a. Each partner shall be repaid his contributions and share equally in the profits (after all debts and liabilities, including those to partners, are satisfied). Each partner also has a duty to contribute to the losses, according to his share in the profits.

b. If the partner reasonably spends personal money for the partnership business (“ordinary and proper conduct of its business”), the partnership agrees to pay him or her back.

c. If a partner makes a loan to the partnership, the partnership should pay the partner back with interest.

d. Same as (c), reallye. All partners have equal rights in the management and conduct of the business. f. No partner is entitled to get paid or get a salary from the partnership. They get a

share of the profits.g. No one new may join the partnership unless all the partners agree.h. Majority rules for decision-making. However, if the partners want to change

something in their agreement, all partners must consent.i. National Biscuit

1. The unilateral act of one partner, without the consent of the other, bound the two-person partnership. One of the partners bought bread from the P when the other partner did not agree.

2. The court found that the acts of one partner, which were in the ordinary matter of business (buying bread for a grocery store), were binding on the partnership, even though there was no majority agreement. “All partners are jointly and severally liable for the acts and obligations of the partnership.”

a. ordinary course = “the normal routine in managing a trade or business”

3. And it didn’t matter that Stroud advised the P that he would not personally be liable for the additional bread sold to the other partner – because Stroud, as co-partner, could not restrict the power and authority of Freeman (the other partner) to buy bread for the partnership.

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4. “The partnership being a going concern, activities within the scope of the business should not be limited, save by the expressed will of the majority deciding a disputed question; half of the members are not a majority.”

ii. Summer v. Dooley 1. The unilateral decision by one partner to hire another EE to

work for the business was not binding on the partnership, because a majority did not decide to hire the new EE.

2. “Business differences bust be decided by a majority of the partners provided no other agreement between the partners speaks to the issues.”

iii. The difference? 1. As between the partners and some third party, National Biscuit

applies.2. As between the partners and the partnership (question of

whether one partner should be reimbursed for paying the EE out of pocket), Summers controls.

iv. Planning how do we resolve a deadlock?i. these are the default rules – which means they may be superseded by an

agreement between the partners. When there is no rule in the agreement, these default rules come into play.

i. Day v. Sidley Austin illustrates extent to which courts allow partnership agreements to derogate from statute

1. Here, there was an executive committee of partners that managed the affairs of the partnership. Executive committee has complete authority to decide questions of firm policy – which is contrary to subsection (e).

2. It also had a provision for majority approval for matters requiring unanimity per statute (merger).

j. Duty to Disclose:i. UPA 1914 §20 “Partners shall render on demand true and full

information of all things affecting the partnership to any partner or the legal representative of any deceased partner or partner under legal disability.”

ii. UPA 1997 §403(c) “Each partner and the partnership shall furnish to a partner, and to the legal representative of a deceased partner or partner under legal disability:

1. Without demand, any information concerning the partnership’s business and affairs reasonably required for the proper exercise of the partner’s rights and duties under the partnership agreement or this Act; and

2. On demand, any other information concerning the partnership’s business and affairs, except to the extent the demand or the information demanded is unreasonable or otherwise improper under the circumstances.”

ii. Rights to Partnership Property and Profits

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1. Ownership of Partnership Propertya. UPA 1914 §25(2): “A partner is co-owner with his partners of specific

partnership property holding as a tenant in partnership.”b. UPA 1997 §501: “A partner is not a co-owner of partnership property and has

no interest in partnership property which can be transferred, either voluntarily or involuntarily.”

c. UPA 1997 §203: “Property acquired by a partnership is property of the partnership and not of the partners individually.”

2. Assigning Property Interests to a third partya. Differences in UPA

i. UPA 1997 §502: “The only transferable interest of a partner in a partnership is the partner’s share of profits and losses of the partnership and the partner’s rights to receive distributions. The interest is personal property.”

ii. UPA 19141. §26: basically same as §5022. §27: A conveyance by a partner of his interest in the partnership

does not itself dissolve the partnership. It also doesn’t give the assignee the right to interfere in the partnership affairs. The assignee is only entitled to the profits to which the assignee partner would otherwise be entitled.

3. UPA 1997 §503 – basically the same as §27. b. Putnam v. Shoaf

i. I’m taking it to mean that partnership property cannot be conveyed alone – that it comes with a conveyance of the partner’s interest in the partnership.

ii. “a co-partner owns no personal specific interest in any specific property or asset of the partnership. The partnership owns the property or the asset… the Partner’s interest is an undivided interest, as co-tenant in all partnership property… That interest is the partner’s pro rata share of the net value or deficit of the partnership.”

iii. Caveat! In general, an assignment or sale of a partnership “interest” does not make the assignee a partner. (UPA 1914 §27).

iv. Bottom line: once you’ve sold your rights and the other partners have consented to someone else being in your stead, then you no longer have any rights. Once you’re out, you’re out.

c. When Property is Partnership Property (UPA 1997 §204) – Three Rulesi. Any asset acquired in the name of the partnership is partnership

property1. A transfer directly to the partnership in its own name2. A transfer to one or more partners acting in their capacity as

partners and he name of the partnership appears on the transfer document

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

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iii. Property purchased with partnership funds is presumed to be partnership property.

iv. (What this means: property acquired in the name of one or more partners, without an indication that the partners were acting in their capacity as partners AND without the use of partnership funds, is presumed to be separate property, even if it is used for partnership purposes.)

v. [Related: UPA (1997 §404(b)(1)]: “A partner’s duty of loyalty to the partnership and the other partners incudes to account to the partnership and hold as trustee for it any property, profit, or benefit… derived from a use of the partner of partnership property, including the appropriation of a partnership opportunity.”

3. Financing the Partnershipa. Partnerships can be very hard to finance. Extra capital often comes from the

partners themselves. Sometimes partners will get financing in their personal capacities, then they lend it to the partnership. Usually, the assets of the individual are on the line for the loan.

b. Partnership Capitali. Capital = the total assets of a business, especially those that help

generate a profit.ii. Capital account = a running balance reflecting each partner’s ownership

equity (UPA 1997 §401(a)iii. Management of Account

1. Allocation of profits increases capital account2. Allocation of losses decreases capital account3. Taking a “draw” (distribution) decreases capital account.

iv. Partnership Profits1. Profits are divided equally (pro rata). UPA 1997 §401(b) even

if one partner contributes more initial capital than the other – profits always 50/50, though this can be changed by contract.

2. If the contract is silent on losses, these are divided like profits are divided. If profits divided 50/50, then losses are divided 50/50. If profits, by contract, are 90-10, then losses are 90-10.

3. How losses will be divided can also be changed by contract. Contract wins out, unless it is one of the long list of stuff in UPA (1997) §103.

iii. Fiduciary Duties 1. Generally

a. UPA (1997) §404 – General Standards of Partner Conducti. The only fiduciary duties a partner owes to the partnership and other

partner(s) is (1) a duty of loyalty and (2) a duty of care.ii. A partner’s duty of loyalty is limited to the following:

1. To account to the partnership any property, profit, or benefit derived by the partner in the conduct (or winding down) of the business – this also includes not taking partnership opportunities

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2. To refrain acting in a way that is adverse to the partnership; and3. To refrain from competing with the partnership before

dissolution.iii. A partner’s duty of care:

1. Limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or knowing violation of the law.

2. Notice a partner does not breach his duty of care by behaving with ordinary negligence.

iv. Partners have an obligation of good faith and fair dealing. v. Merely behaving in a manner that furthers a partner’s own interests is

not a breach.vi. If a partner lends money to the partnership, the rights and obligations of

the partner are the same as a lender who is not a partner.vii. These duties also apply to a person winding down the business as the

personal or legal representative of the last surviving partner.b. Meinhard v. Salmon

i. Salmon breached his duty of loyalty because he used his position in the partnership for his own benefit without giving his partner a chance to benefit as well. He didn’t tell him what his new plans were.

ii. Salmon had a duty to disclose to Meinhard the offer given to him by Gerry to renew the lease and take over the adjacent lots to the Hotel Bristol, because “only through disclosure could opportunity be equalized.”

iii. If partners can withhold new information – such as the discovery of a new business opportunity – from each other, then each has an incentive to drive the other out so as to take full advantage of the information.

iv. Disclosure is more efficient 2. Opting out of Fiduciary Duties

a. §103 – Effect of Partnership Agreement – (b) The partnership agreement may identify specific types of categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable. AND, the partnership agreement needs to identify specific types or categories of activities that do not violate the duty of loyalty.

b. Self-Interested Transactions Perretta v. Prometheusi. Approval of the merger received a majority of all the partnership votes,

including those that did not vote at all and including the votes of interested partners.

ii. P agreement placed no limitation on the ability of interested partners to participate in ratifying its own self-interested transactions. However, the court finds this “manifestly unreasonable.” Even though the interested partners attempted to have a “neutral vote” by putting in only as many votes in favor in proportion with the unaffiliated votes in favor. ?

iii. “Not all self-interested transactions violate the duty of loyalty. The question is not whether the interested partner is benefited, but whether the partnership or the other partners are harmed. Partnership is a

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fiduciary relationship, and the partners may not take advantages for themselves at the expense of the partnership.”

iv. Disinterested partners may ratify the actions of an interested partner – as long as there has been full and complete disclosure of all the material facts.

v. If the interested partners cannot show proper ratification by disinterested partners, the burden is on the interested partners to show the transaction was done in good faith and fairness.

vi. It is manifestly unreasonable for a P agreement to allow interested partners to vote in ratification of their own self-dealing transactions. Courts will look at such cases with “particular skepticism.” “allowing an interested partner to participate in a ratification election subverts the very purpose of ratification itself…”

3. Grabbing and Leaving – Meehan v. Shaughnessya. Duty of Good Faith UPA (1997) §404(d) “A partner shall discharge the

duties to the partnership and the other partners under this Act or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing.” Does “discharge” mean that this duty applies when the partner is getting ready to leave?

b. “Fiduciaries may plan to compete with the entity to which they owe allegiance, provided that the course of such arrangements they do not otherwise act in violation of their fiduciary duties.”

i. a partner may make logistical arrangements in preparation of leaving – like preparing lists of clients, obtaining financing, finding a physical location for the new firm, etc.

ii. However, they departing partner may not directly compete with the partnership during this time, like taking new clients for himself.

c. It is a breach of the duty of loyalty to unfairly acquire clients and referring attorneys consent to withdraw from former firm. In this case, they way they took the clients was unfair because:

i. By keeping their preparation secret for so long, they took an unfair advantage in the race to get clients.

1. important to the court that they actively lied to the former partners.

2. “A partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner.” UPA 1914 §20.

ii. Meehan delayed in providing the former partners the list of clients he was planning on taking.

iii. Meeting secretly with clients to persuade them to come to new firm, before the partners had even announced their departure.

iv. The content of the letters they sent to clients was unfairly prejudicial to former firm. A departing attorney may send letters to the clients with whom he has an active lawyer-client relationship (has open and pending matters with the client), as long as the attorney:

1. Gives notice to the client that he is planning or leaving the form

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2. The notice does not urge the client to sever the relationship with former firm

3. The letter does not recommend the client to follow the departing attorney to new firm

4. The letter makes it clear that the client has the right to decide who will complete or continue the matters

5. The notice is brief and dignified doesn’t attack the former firm with disparaging remarks

6. basically, letter allows the former firm to have an equal chance at competing for the client’s matters.

4. Expulsion – Lawlis a. Court held that a no-cause expulsion provision in a partnership agreement,

which was freely negotiated and entered into, was OK.b. “When a partner is involuntarily expelled from a business, his expulsion must

have been “bona fide” or in “good faith” for a dissolution to occur without violation of the partnership agreement.” an expulsion must be in accordance with PA and must have been done in good faith. (there is an implied duty of good faith when expelling a partner).

c. “if the power to involuntarily expel partners granted by a partnership agreement is exercised in bad faith or for a predatory purpose, the partnership agreement is violated, giving rise to an action for damages the affected partner has suffered as a result of his expulsion.” the duty of good faith is implied in the PA.

i. what constitutes good faith or bad faith? “the expelling partners act in ‘good faith’ regardless of motivation if that act does not cause a wrongful withholding of money or property legally due the expelled partner at the time he is expelled.”

c. How do you end a partnership?i. Key Terms

1. Dissolutiona. “the termination of a previously existing partnership upon the occurrence of an

event specified in the partnership agreement, or as specified by law.”b. UPA (1914) §29: “change in the relationship of the partners caused by any

partner ceasing to be associated in the carrying on as distinguished from the winding up of the business.”

2. Disassociation – “to remove from association.”3. Winding up – the process of shutting down partnership post-dissolution. “On dissolution

the partnership is not terminated, but continued until the winding up of partnership affairs is completed.” UPA 1914 §30

ii. Dissolution under UPA 1914 1. Causes of Dissolution - §31

a. When the partnership agreement has not been violated:i. By termination of a definite term or particular undertaking specified in

the agreementii. By the express will of any partner when no definite term or particular

undertaking is specific in PA

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iii. By the expulsion of any partner from the business in accordance with PA1. Prentiss v. Sheffel the “freezing out” of the third partner from

the management of the business caused the dissolution of the partnership.

2. A “freeze out” is not a wrongful dissolution as long as it is done without bad faith (to take from the partner something or money he was entitled to – usually revolves around money).

b. Pretty much at the express will of any partner at any time – whether it is in contravention of the PA or any of the UPA articles [of course, a partner may leave at any time, what changes is the consequences that flow from leaving]

c. When it becomes unlawful for the business of the partnership to be carried ond. By the death of any partnere. By the bankruptcy of any partnerf. By a decree of court under §32.

2. Dissolution by Decree of Court - §32a. On application by or for a partner, the court shall decree a dissolution when:

i. A partner is declared a lunatic or is shown to be of unsound mindii. A partner becomes in any way incapable of performing his part

iii. A partner is found guilty of a crime that affects the carrying on of the business

iv. When a partner willfully or persistently breaches the PA or otherwise behaves in such a way that it is not reasonably practical to carry on the business in partnership with him.

1. Minor differences and grievances that involve no permanent mischief will not authorize a court to decree a dissolution of partnership. Owen v. Cohen

2. Mere bad blood between the parties is not enough to justify a judicial dissolution. Collins v. Lewis

a. Each partner has the power to dissolve the partnership, but not the right to do so if one partner leaves in breach of the PA, the partner prob wouldn’t get Pship interests back b/c liable for damages.

3. Problems don’t have to be big ones – constant petty disagreements and mistreatment of one partner to another can have the same effect. Owen v. Cohen

4. In these sorts of situations, the well-behaving party sues, and may sue after withdrawing from the Pship in order for the court to find that he didn’t breach, and thus avoid consequences of wrongful dissolution (§38(c))

v. The business can only be carried on at a lossvi. Whenever the court finds a dissolution is fair (equitable).

b. On the application of the purchaser of a partner’s interest…. I don’t think this was covered in class

3. General Effect of Dissolution on Authority of Partner - §33a. Dissolution terminates all authority of any partner to act for the partnership –

except so far as a partner’s authority is necessary to wind up the partnership.

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4. Right of Partner to Contribution from Co-Partners After Dissolution - §34a. When the dissolution is caused by the act, death or bankruptcy of a partner,

each partner is liable to his co-partners for his share of any liability of the partnership, unless

i. When incurring the liability, the partner acting for the partnership has knowledge of the dissolution (other partners are not responsible for the debts incurred by a partner after dissolution (or had knowledge of the death/bankruptcy) if the partner incurring the debt knew about the dissolution)

5. Power of Partner to Bind Partnership to Third Persons After Dissolution - §35a. After dissolution a partner can bind the partnership:

i. By any act appropriate for winding upii. By any transaction which would have bound the partnership before

dissolution if the third party1. Had extended credit to the Pship prior to dissolution and had no

knowledge or notice of the dissolution or2. Though had not extended credit, had nevertheless known of the

Pship before dissolution and had no knowledge or notice (including whether the dissolution was announced in a newspaper of general distribution) of it.

b. Blah blah, don’t think important6. Effect of dissolution on partner’s existing liability - §36

a. The dissolution of the Pship itself does not itself discharge the existing liability of any partner

b. Unless the partners and creditors come to an agreement to that effect (as long as creditor has knowledge of dissolution)

c. The individual property of a deceased partner shall be liable for all obligations of the partnership incurred while he was a partner but subject to the prior payment of his separate debts

7. Right to Wind Up §37 partners who have not wrongfully dissolved the Pship have the right to wind up the Pship affairs

8. Rights of Partners to Application of Pship Property §38a. When the dissolution is caused in any way, except in the contravention of the

PA, each partner gets his share of the Pship assets, which includes property. If the dissolution is caused by the expulsion of a partner, bona fide under PA, the expelled partner shall receive in cash only the net amount due him from Pship.

b. When the dissolution is caused by a violation of the PA:i. The partners who did not cause dissolution shall have:

1. All the rights in paragraph 1 [for outline, a.] and 2. The right to sue the breaching partner for damages

ii. The partners who did not cause the dissolution wrongfully have the right to continue operating the Pship in the same name, either by themselves or jointly with others, and for this reason, may maintain Pship property.

1. However, they have to pay the departing partner the value of his interest in the Pship, less any damages recoverable.

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2. Should also indemnify him against all present and future Pship liabilities.

iii. The partner who wrongfully caused the dissolution shall have:1. Rights outlined in paragraph 1 [a.], minus any damages2. If the business is continued, the departing partner has a right to

a payout of his share in the business, minus any damagesa. Shall be released of all existing and future liabilities.

9. Rights Where Partnership is Dissolved for Fraud or Misrepresentation §39 (see rulebook)

10. Rules for Distribution §40a. The assets of the Pship are:

i. Pship propertyii. The contributions of the partners necessary for the payment of all the

liabilitiesb. Liabilities shall be paid in this order:

i. Creditors other than partnersii. Creditors who are partners for debts other than for capital and profits

iii. Then creditor partnersc. Assets will be applied to satisfy these liabilitiesd. The partners shall contribute the amount necessary to satisfy all liabilities. If one

or more of the partners are insolvent or for some reason refuse or cannot pay liabilities, creditors can seek payment from other partners.

e. Creditors have the right to sue solvent partners for remaining liabilitiesf. Partners who paid in excess of their share have the right to sue other partners

who did not pay their share of the liabilities.g. Pship creditors have priority over Pship property and separate creditors on

individual property, except to other secured creditors.h. When a partner or his estate becomes bankrupt, claims on his separate

property shall rank in the following order:i. Those owing to separate creditors

ii. Those owing to partnership creditorsiii. Those owing to partners by way of contribution (who put more than their

share)11. Liability of Persons Continuing the Business in Certain Cases - §41

a. When the partnership is continued, the creditors of the first or dissolved Pship are also creditors of the Pship so continuing the business

b. (7) when a third person becomes a partner in the Pship continuing the business, the creditors of the dissolved Pship shall be satisfied out of the Pship property only

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iii. Dissociation Under UPA 1997 1. Events Causing the Partner’s Dissociation - §601

a. The partner expresses a will to dissociate (takes effect when the departing partner decides)

b. An event agreed upon in PA that causes a partner’s dissociationc. A partner’s expulsion pursuant to PAd. A partner’s expulsion by the unanimous vote of the partners if:

i. It is unlawful to carry on the Pship with that partnerii. See others…

e. By judicial determination (when one partner sues):i. The partner engaged in wrongful conduct that adversely and materially

affected the Pship businessii. The partner willfully or persistently committed a material breach of the

Pship agreement or a duty owed to the Pshipiii. The partner engaged in conduct relating to the Pship business that makes

it not reasonably practicable to carry on the business with that partner.f. When the partner

i. Becomes bankruptii. Executes an assignment for the benefit of creditors (??)

iii. Seeks or consents to the appointment of a trustee, receiving, or liquidator for partner’s property, or

iv. Fails, within 90 days, to object to such an appointmentg. In the case of

i. The partner’s deathii. The appointment of a guardian for partner or

iii. The partner is deemed incapable of performing dutiesh. More…

2. Partner’s Power to Dissociate; Wrongful Dissociation - §602a. A partner has the power to dissociate at any time, rightfully or wrongfully, by

express will pursuant to §601(1)b. A partner’s dissociation is wrongful when:

i. It is in breach of an express provision in the PA, or ii. (when the Pship is for an definite term or particular undertaking) before

the expiration of the term of the completion of the undertaking:1. the partner withdraws by express will2. the partner is expelled by judicial determination3. the partner is dissociated by becoming a debtor in bankruptcy4. when the partner is not an individual, trust or estate, the

partner is expelled or otherwise dissociated b/c it willfully dissolved or terminated.

c. A partner who wrongfully dissociates is liable to the Pship and other partners for damages caused by dissociation

3. Effect of Partner’s Dissociation - §603a. Sections that apply

i. If the partner’s dissociation results in dissolution and winding up of the business, then Article 8 applies

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ii. If the business is continued despite the partner’s dissociation, then Article 7 applies.

b. Upon the partner’s dissociation:i. His right to participate in the management of the Pship are terminated

ii. His duty of loyalty under §404(b)(3)to the Pship is terminated, and iii. His duty of loyalty under §404(b)(1) and (2) and his duty of care under

§404(c) continues only with regard to matters arising and events occurring before the partner’s dissociation, unless the partner participates in winding up the Pship’s business pursuant to §803.

4. When the business is continued without dissociated partner

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a. Purchase of Dissociated Partner’s Interest - §701i. If the remaining partners choose to continue the business of the Pship,

the dissociated partner’s interests in the Pship shall be purchased for a buyout price determined pursuant to subsection b.

ii. The buyout price is the amount that would have been distributable upon dissociation and the assets of the Pship were sold. Interest must be paid from the date of dissociation and the date of payment.

iii. Buyout price is offset by any damages awarded to the Pship and/or partners for wrongful dissociation

iv. Pship must indemnify the dissociated partner whose interests are being bought out against all Pship liabilities, whether incurred before or after dissociation

v. More.. b. Dissociated Partner’s Liability to Other Persons - §703

i. A dissociated partner is not otherwise liable for Pship obligations incurred after dissociation except as provided in subsection b.

ii. A partner may be liable after dissociation if the partner enters into a transaction with third party

1. That reasonably believed the dissociated partner was then a partner

2. Did not have notice of the partner’s dissociation3. And is not deemed to have knowledge under §303(e) or notice

§7-4(c).iii. By an agreement, the dissociated partner may be released from liability

5. When dissociation causes dissolution wind up a. Events Causing Dissolution and Winding Up of Pship Business - §801

i. In a Pship for a definite term or particular undertaking1. Within 90 days after a partner’s dissociation by death or

otherwise, the express will of at least half of the remaining partners to wind up the Pship

2. The express will of all of the partners to wind up the Pship business, or

3. The expiration of the term or the completion of the undertakingii. An event agreed to in the PA results in the winding up of the Pship

businessiii. An event makes it unlawful for all or substantially all of the business of

the Pship to continue – this illegality may be cured within 90 days after notice

iv. On application by a partner, by judicial determination:1. The economic purpose of the Pship is likely to be frustrated2. The partner has behaved in such a way that continuing the

Pship business would not be reasonably practicable with that partner or

3. It is not otherwise reasonably practicable to continue business in accordance with PA or

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v. On application by a transferee of the partner’s interests, a judicial determination that is it equitable to wind up Pship business

1. After the expiration of the term of completion of undertaking2. At any time, …. ?

b. Partnership Continued After Dissolution - §802c. Right to Wind Up Partnership Business - §803d. Partner’s Power to Bind Partnership After Dissolution - §804

iv. Summary: 1. Dissolution v. Going out of Business

a. Dissolution is not the same as going out of business: a dissolution is simple the change in relationship of the partners caused by any partner ceasing to be associated in the carrying on of the firm’s business. UPA 1914 §29.

b. Winding up: the process of shutting down post-dissolution.2. Term of the Partnership

a. Important to know the term of the partnership, in order to determine when the Pship has been wrongfully dissolved.

b. Explicit term Pship: i. Duration specified in partnership agreement

ii. Specific purpose/object specified in PAiii. It wrongful dissolution if a partner leaves before the end of the term or

before the specific purpose or objective is completed. c. Implicit term:

i. Compare Owen with Page. ii. Owen: the court finds that the Pship was for a term – that Owen lent the

Pship money, and the Pship would operate the bowling ally until Owen could recuperate his investment.

iii. Page: the court rejected the P’s argument that the Pship was for a term – that they had put money into the Pship and that the Pship would continue until that money is recuperated/profit is made. But the court does not find this to mean there was an implied term, b/c people enter into Pships and other business for the purpose of making a profit.

d. Pship at willi. “a partnership at will may be dissolved by the express will of any partner,

this power, like any other held by a fiduciary, must be exercised in good faith.” Page

ii. It is not wrongful dissolution if a partner express a will to leave, unless the PA puts some limitations on how a partner may leave.

iii. Bad faith? 1. “A partner may not by use of adverse pressure ‘freeze out’ a

co=partner and appropriate the business for his own use. A partner may not dissolve a partnership to gain the benefits of the business for himself, unless he fully compensates his co-partner for his share of the prospective business opportunity.” Page

2. if he does, the dissolution is wrongful and the remaining partner would be liable for damages

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3. Dissolution and Winding Up Under UPA 1914a. There is a dissolution under §§29, 31, or 32

i. Partners may continue business as per agreement, or ii. Partners (the good actors, non-wronging partners) may continue

business following a wrongful dissolution (§38), or 1. The partners continuing the business may possess partnership

property this includes any property that is vital to the continuation of the business, even if by the PA, that property was to be returned to the wronging party upon dissolution. Pav-Saver.

2. Pav-Saver dissent provisions of the contract should prevail over the statute (UPA). Because the PA required the return of the patents to Vasso, then Pav-Saver should not get to keep them, even if they are continuing the business of the Pship

3. Real life lesson: the contract needs to make clear that it will be overriding statutes, with language like, “In light of section __ of the UPA,” or “the only rights of the parties will be __” The court took the silence in the k and inserted the default rules.

4. When paying out departing partner, the courts will not consider the value of the business’s “good will.” In Pav-Saver, the value of the patents was excluded from the payout as “good will.”

b. If there is no agreement as to how to continue business in this situation, or the dissolution was not wrongful, the Pship enters a winding up period:

i. Liabilities are collected from assets of the Pship, including Pship property and the interests of the partners. (§38 & §40)

1. If there are still liabilities to be satisfied, the creditors may go after partner’s separate assets and property.

ii. Pship assets are usually sold in judicial sale. At this point, former partners may bid for the assets, and thus, continue to run the Pship. Prentiss v. Sheffel. Former partners are not prohibited from bidding at a judicial sale.

1. However, bad actors (the one that wrongfully departed) is not allowed to bid at judicial sale and continue the business. Prentiss.

4. Disassociation and Dissolution under UPA 1997a. There is a dissolution under §601

i. Partners may choose to continue the business, per article 71. Purchase of dissociated partner’s interests (§701)2. Dissociated partner not automatically released (§703)

ii. Partners may choose to dissolve the Pship (or it happens by contract or judicial determination) as per article 8

1. Events of dissolution §8012. Business must be wound up

5. Effect of Dissolution on Pship

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a. After dissolution, the Pship must be wound up, absent agreement among the partners to carry on the business

i. Assuming t hat the business will not be continued, the winding up process generally contemplates that the firm’s assets will be distributed to the partners

b. Authority of partners to act on behalf of the partnership terminated except in connection with winding up of partnership business. UPA (1914) §33; UPA (1997) §804

6. Continuation per Agreement: Effect on Pshipa. Technically creates a new partnershipb. Creditors of former partnership automatically become creditors of new

partnership. UPA (1914) §41c. Must consider rights of departing partner.

7. Consequences of Dissolution a. If Pship at will

i. Can a partner leave? Yes, at any time for any reasonii. Damages for leaving? General rule: no, but damages may flow from

bad faith conduct. b. If Pship for a term

i. Can a partner leave? 1. General rule: no, but…2. Always have power to leave with penalty

ii. Damages for leaving?1. Yes, UPA (1914) §38; UPA (1997) §§602, 7012. May include anticipated damages flowing from future business

operationsc. If partner leaves, liability to creditors?

i. Yes, for existing obligations – UPA 1914 §36; UPA 1997 §703ii. General rule = no liability for future obligations, but…

iii. If for term and wrongful departure, damages calculation may consider future obligations of business.

8. Sharing Lossesa. General rule: absent an agreement to the contrary, the law presumes that

partners intent to participate equally in the profits and the losses of the common enterprise, irrespective of any inequality in the amounts each contributed to the capital employed in the venture, with the losses being shared by them in the same proportion as the share the profits.

b. Kovacik v. Reed i. this general rule does not apply in situations where one partner

contributes all the money and the other partner contributes only with labor. One loses his own capital, the other loses his labor (doesn’t get paid).

ii. “Upon loss of the money the party who contributed it is not entitled to recover any part of it from the party who contributed only services”

c. Courts (following the 1914 UPA?) do not apply the Kovacik rules where:i. The service partner (Reed) was compensated for his work

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ii. The service partner (Reed) made a capital contribution, even if that contribution was nominal.

d. UPA 1997 expressly rejects Kovacik partners must share in the losses. i. Comments to UPA (1997) §401: “The default rules [of UPA §401] apply,

as does UPA §18(a), where one or more of the partners contribute no capital, although there is case law to the contrary [citing, inter alia, Kovacik].”

e. Bargain forcing defaults i. Impose a penalty on at least one of the parties if they fail to bargain out

the default rule.ii. Why? give at least the party subject to the penalty an incentive to

negotiate a contractual alternative to the penalty default. iii. However, you have to know about the default rule first. If you’re not a

sophisticated party (like Reed likely was), then you are at a disadvantage. Kovacik probably had all the know-how and the money to hire an attorney.

v. Buyout Agreements1. Definition : an agreement that allows a partner to end her or his relationship with the

other partners and receive a cash payment, or series of payments, or some assets of the firm, in return for her or his interests in the firm.

III. LLCs, LPs, LLPs Unincorporated and Limited Liability a. Limited Liability Entities - Generally

i. LPs (Limited Partnerships)1. Constituted by general partners (manage the business) and limited partners (merely

investors)2. General partners still carry personal liability, but limited partners generally do not.

ii. LLPs (Limited Liability Partnerships)1. General partner with limited liability limited liability for all partners2. Everyone is a general partner – they each filed a certificate that says the general

partners are not liable for certain debts, torts, other conduct, of other general partners (so that you are not liable for the malpractice of your lawyer partner, doctor partner).

3. Typically restricted to tort claims and certain types of professional firmsiii. LLLPs (Limited Liability Limited Partnerships) relatively new, affords limited liability protection

to both general partners and limited partners1. The difference is management rights this is the same as the LLP, but here, not

everyone has equal management rights (not everyone is a general partner). This one involves limited partners.

2. Does not protect the firm from partners suing partners.iv. LLCs (Limited Liability Companies)

1. Hybrid of corporation and partnershipsa. Tax advantages of partnershipsb. Limited liability of corporationsc. None of the restrictions applicable to S corporations

2. Probably the most flexible

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3. Can do business by contract the partners manage the extent of their relationship by contract. It is meant to give sophisticated business people the opportunity to bargain for every aspect of running the business and the business relationship.

4. Sometimes publically ownedv. S Corporations corporations that elects to be taxed like a partnership; limits on number and

types of shareholders and capital structures. They are treated like a C corp for governance.b. Limited Partnerships

i. “A limited partner shall not become liable as a general partner, unless, in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business.”

ii. Revised Uniform LP Act However, if the limited partner takes control of the business and is not also a general partner, the limited partner is liable only to persons who transact business with the limited partnership and who reasonably believe… that the limited partner is a general partner.”

c. Limited Liability Companyi. Generally

1. Funding:a. Members typically contribute capitalb. Contribution may be cash, property, services rendered, a promissory note, or

other obligation to contribute cash, property, or to perform services. i. Some states don’t require anything you don’t have to contribute

capital to become member of the LLCc. These are negotiated business entities, so you may contract terms for financingd. A lot of LLCs are started to be public selling units of the LLCs. Share

distribution between the unit holders2. Liability members stand to lose capital contributions, but their personal assets are

not subject to attachment3. Tax consequences

a. Income passes through membersb. LLC does not pay taxesc. These days, the members can check a box and decide how they want to be

taxed, like a partnership or like a corp. 4. Formation

a. File articles of organization in the designated State office. Can’t just shake hands and agree to do business – like for partnerships.

i. Required and optional contents set forth in ULLCA §203. ii. Filing fees and minimum franchise tax

b. Other formation tasksi. Draft operating agreement – the basic contract governing the affairs of a

limited liability company and stating the various rights and duties of the member

ii. Choose and register name: LLC statutes generally require the name of the LLC to include the words limited liability company, the abbreviation LLC, or similar phrases

iii. Designate office and agent for service of process5. Members’ interests

a. Financial interest a right to distributions and liquidation participation

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i. Profit and loss sharing1. Absent contrary agreement, most statutes allocate profits and

losses on the basis of the value of member contributions can contract this term, negotiation and bargain.

2. Compare with partnership law’s equal division of profits. ULLCA §405(a) uses partnership-like equal shares rule

ii. Withdrawal 1. Member may withdraw and demand oayment of his/her

interests upon giving notice specified in the statute or the LLCs operating agreement.

2. Usually negotiated in the contractb. Management rights

i. Absent contrary agreement, each member has equal rights in the management of the LLC

1. Most matters decided by majority vote, ULLCA §404(a)(2)2. Significant matters require unanimous consent, ULLCA §404(c)

ii. Manager-managed LLC option available (as opposed to member-managed). ULLCA §404(b)

1. Can be structured as a “board of directors,” a CEO, or botha. Each member gets to choose managers. b. Whether you can/when you can remove these depends

on the operating agreement. 2. Must be specified in articles of organization.

c. Assignment of LLC Interesti. Unless otherwise provided in the LLC’s operating agreement, a member

may assign his financial interest in the LLC1. An assignee of a financial interest in an LLC may acquire other

rights only by being admitted as a member of the company if all the remaining members consent or the operating agreement so provides. See ULLCA § 501-50

ii. Analogous to partnership rules 6. Dissociation v. Dissolution

a. Same as partnership under UPA (1997)b. Events of dissolution:

i. By operation of law:1. Upon the happening of any event specified in the LLC operating

agreement2. Vote of members (as specified in operating agreement)3. It becomes unlawful to carry on the business

ii. Upon court order1. Economic purpose frustrated2. Misconduct by members

7. It is possible to be a one-person LLC. Doesn’t raise any issues in most states. (unlike partnerships).

ii. Required to Provide Notice to the Public Water, Waste & Land1. When there is some confusion with the business entity, the default goes back to the

basics, agency law. 2. By having the letters LLC after your company name, then that is enough notice. Should

let all your business partners know that they can only collect from business assets. Need to provide notice to the public that you are an LLC, and having the letters LLC next to your name is enough.

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3. In Waste, Water & Land, the agents of LLC were personally liable for unpaid bills of the LLC because the Ps were not provided notice that Clark, the agent, was acting on behalf of an LLC. The Ps relied on this representation.

4. Court used partially disclosed/undisclosed agency rule to find the agent was liable for debt.

iii. The Operating Agreement Jaffari 1. It is the policy of the LLC acts to give the maximum effect to the principal of freedom of

contract and to the enforceability of limited liability company agreements. a. In general, only where the agreement is inconsistent with mandatory

statutory provisions will the members’ agreement be invalidated. These statutory provisions are likely to be those intended to protect third parties.

2. LLC parties may contract to avoid the applicability of most sections of the LLC statutes, unless they are mandatory provisions. LLC Agreement trumps.

iv. LLC Veil Piercing1. Kaycee Land and Livestock v. Flahive

a. The factors that apply to corporations may not be applicable in the LLC context b/c in most LLCs, the managers and the owners are one and the same (unlike in corporations, where management and ownership are separated).

b. This is one of those areas of uncertainty – still a lot of debate. c. The court found that the statute was silent on the issue of LLC veil piercing. If

the statute is silent, this means the common law prevails. (without specific language that indicates the statute intends to override the common law). it is presumed that no change in the common law was intended unless the language employed clearly indicates such an intention

d. Court held that LLC veil piercing should be treated in the same way that corporate veil piercing is if the members and officers of an LLC fail to treat it as a separate entity they should not enjoy immunity from individual liability for the LLC’s acts that cause damage to third parties.

2. ULLCS §303(b) “the failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.”

a. Exception: Fraud is the only grounds to pierce the LLC veil.3. ULLCS §103(b)(2) managers may eliminate the duty of loyalty in specific actions

unless it is manifestly unreasonable. v. Fiduciary Duties

1. Generallya. Manager-managed LLCs

i. Managers = duty of care and loyaltyii. Members = no duties to LLC or its members by reason of being members

b. Member-managed LLCsi. All members of a member-managed LLC have a duty of care and loyalty.

(because they are the managers!)c. Some states, Delaware and Nevada, allow members to contract around fiduciary

duties – except for the duty of good faith and fair dealing (these always mandatory?)

2. Members may contract away certain duties – McConnell v. Hunt Sports Enterprisesa. In this case, OpA allowed members to compete with the LLC – allowed members

to own an interest in any other business venture, even those that compete with this LLC, even in the same industry and business.

i. Even though the default rule is that LLC members are prohibited from competing with the LLC or from taking the company’s opportunities. ULLCA §409(b)

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b. Holding: the operating agreement of a limited liability company may limit or define the scope of the fiduciary duties imposed upon its members,

i. An agreement may not waive the entire duty of loyalty, but it may specify certain actions that will not violate the duty of loyalty, as long as they are not manifestly unreasonable. ELLCA §103(b)(2).

ii. Duty of good faith remains the members were allowed to compete, but one member could not secretly induce or otherwise purposefully cause a prospective business client to go with new firm. That would be bad faith.

1. “a person, without privilege to do so, induces or otherwise purposefully causes a third person not to enter into or continue a business relationship with another…”

2. need to be allowed to compete fairlyIV. INCORPORATED AND LIMITED LIABILITY

a. Corporations Generally i. Corporation – “an entity (usually a business) having authority under law to act as a single person

distinct from the shareholders who own it and having rights to issue stock and exist indefinitely.”

ii. Universe of Corporations1. Public

a. Characterized by a public secondary market in which shares of the company are listed for trade. E.g. NYSE or NASDAQ

b. E.g., IBM or Microsoft2. Closely held

a. Characterized by an absence of a secondary market for its stock (the corporation chooses not to sell it’s stock publically)

b. Often, but not always, a relatively small number of shareholders who actively participate in the firm’s management

c. May display many characteristics of partnerships3. For profit corporations4. Professional corporations

a. Physicians, dentists, lawyer, accountantsb. Increasingly use LLPs or LLCs

5. Non-profit corporationsa. None of the surplus revenue (profit) may be distributed to shareholders

(members)b. Often have members rather than shareholdersc. Ex: charities, churches, fraternal organizations

6. Quasi-governmental and governmental corporationsa. E.g., Fannie Mae and Freddie Macb. Universities, hospitals, etc.

iii. Critical attributes:1. Legal personality

a. the corporation is an entity with separate legal existence from its ownersb. Legal fiction but a useful one.c. It is a separate tax-payerd. There are requirements for formal creation under state law

2. Limited liability

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a. MBCA §6.22(b): “Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct.”

3. Separation of ownership and controla. MBCA §8.01(b): “all corporate powers shall be exercised by or under the

authority of, and the business and affairs of the corporation managed by or under the direction of, its board of directors…”

i. Board of directors is in charge of the management of the company. This is where fiduciary duties come in: board of directors have fiduciary duties to the owners (shareholders) (to responsibly manage the business and make a profit).

b. Rule of thumb: i. Boards ACT

ii. Shareholders REACT (by voting, selling, suing)c. Shareholders entitled to vote on:

i. Election of directors (MBCA §§8.03-8.04)ii. Any amendments to the articles of incorporation and, generally speaking,

by-laws (MBCA §§10.03, 10.20)iii. Fundamental transactions (e.g., mergers, MBCA §11.04)iv. Odds and ends, such as approval of independent auditorsv. Through Dodd Frank Act: now shareholders have the right to review the

compensation packages of the directors. But this is nonbinding This is an attempt to give shareholders more of a say and prevent the abuses seen before the Great Recession.

d. Rights of Shareholdersi. Vote on limited range of issues

ii. Receive payment of dividends when and as declared by boardiii. Inspect corporate books and recordsiv. Receive distribution upon terminationv. Purchase proportionate share of a new issuance or corporate stock to

maintain current ownership percentage (Preemptive Right)vi. File derivative suit to redress wrong suffered by the corporation

(damages recovered belong to corporation). 4. Liquidity

a. Ability to gain capital by selling stock to the public in secondary markets5. Flexible capital structure

a. The permanent and long-term contingent claims on the corporation’s assets and future earnings issued pursuant to formal contractual instruments called securities.

b. Many ways to package such claims: e.g., stocks and bondsiv. The incorporation process

1. Draft articles of incorporationa. Contents:

i. Mandatory terms (MBCA §2.02(a))ii. Optional terms (MBCA §2.02(b))

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2. File articles with Secretary of State – one or more persons are the incorporator MBCA §2.01 you have to have some sort of designation in your name that indicates you are a corporation (like Inc.)

3. Post-incorporation:a. Draft bylaws (MBCA §2.06)b. Organizational meeting (MBCA §2.05)

i. Name of directors, if necessary1. Don’t want it to be too big (9 is a popular number)2. Usually want it to be an odd number – tie breaker

ii. Adopt bylawsiii. Appoint officers – most states require at least 2

c. Issue stockb. Liability for Pre-Incorporation Activity

i. Generally:1. Promoter: someone who purports to act as an agent of the business prior to its

incorporation2. Legal Issues:

a. Once the articles are filed, does the corporation become a party to the contract?

b. Once the articles are filed, is the promoter liable if the corporation breaches the contract?

c. If the articles are not filed, is the promoter liable on the contract?d. If the articles are not filed or are defectively filed, can the defectively formed

entity (or individuals) enforce the contract?ii. Southern-Gulf Marine Co. No 9, Inc. v. Camcraft, Inc.

1. P entered into a contract with D before the it was incorporated, through its promoter. The contract recognized that the corporation was to be formed in Texas. However, the corporation was incorporated in the Cayman Islands. (Two wrinkles: (1) corporation seeks to enforce a contract that was made on its behalf before it was incorporated and (2) there is a defective incorporation because the contract called for incorporation in Texas).

2. D fails to follow through with the contract.3. Court held that Camcraft is estopped from denying SGM’s corporate status. Hence, P

(SGM), may sue to enforce the contract. 4. Rule : A third party who dealt with the firm as though it were a corporation and relied on

the firm, not the individual defendant, for performance is estopped. iii. Corporation by estoppel

1. Estoppel: treat firm as though it were a corporation if the person dealing with the firm:a. Thought it was a corporation all alongb. Would earn a windfall if now allowed to argue that the form was not a

corporation. (Camcraft should not be allowed to take a windfall from the much higher prices in the market now)

iv. MBCA §2.04 all persons acting on behalf of the to-be corporation are personally liable for pre-incorporation transactions. Default rule, which may be contracted around.

c. Limited Liability

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i. MBCA §6.22(b): “Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct.”

ii. This is the protection provided to corporations by the state. It is a trade-off the corporation pays taxes in the state, the corporation agrees to be governed by the laws of that state, and the state, in turn, provides this special protection from liability.

iii. Why do shareholders want limited liability?1. Avoid personal liability (losing the house, college fund to creditors for business debt)2. Minimizes monitoring costs

a. Helps investors make wise economic decisions about how to allocate their resources

b. Knowing what you have to lose through limited liability – helps make better investment decisions (know that all you have to lose it what capital you put in).

3. Downplay the “free rider” issuea. Free rider = someone who reaps the benefits but doesn’t contribute anything.

This is always a concern with investors. (??)b. Policy argument: limited liability avoids the free-rider problem. Some people

would have to make sure the corporation was run well, have to be very vigilant, while others will be passive investors.

4. In exchange, corporations are burdened by regulationsd. Piercing the Corporate Veil

i. Courts will pierce the corporate veil, whenever necessary:1. “to prevent fraud or to achieve equity” 2. “whenever anyone uses control of the corporation to further his own rather than the

corporation’s business, he will be liable for the corporation’s acts upon the principle of respondeat superior…” Operate the corporation in the shareholder’s individual capacity.

a. A corporation has to act through its agents (directors, officers), since it is not a natural person.

b. So, for an officer or director to be personally liable (pierce corporate veil), the P will have to prove that the director/officer was acting in their personal capacities and not in their corporate capacities. Need to prove that the officer was using the corporation as its alter ego. This is very difficult to prove.

c. Evidence in favor of control prong (that officer was controlling corporation as its alter ego)

i. Commingling fundsii. Undercapitalization

iii. Disregard for corporate formalities1. Failure to hold shareholder meetings2. Failure to hold board meetings3. Failure to keep minutes of said meetings4. Failure to keep separate books5. Failure to issue stock6. Failure to appoint board7. Failure to adopt charter or by-laws

3. This liability extends not only to the corporation’s commercial dealings… but to its negligent acts as well. (Walkovsky)

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ii. Walkovsky the controlling shareholder of the cab companies was not liable to the P because there was no evidence that he was acting on his own personal behalf, he was not using the corporations for his personal purposes, comingling his personal funds with that of the corporation.

iii. Van Dorn Test: (as articulated in Sea-Land v. Pepper Source) 1. “A corporate entity will be disregarded and the veil of limited liability pierced when two

requirements are met:a. there must be such unity of interest and ownership that the separate

personalities of the corporation and the individual [or other corporation] no longer exist; and

i. Factors to determine whether a corporation is so controlled b y another to justify disregarding their separate identities:

1. Failure to maintain adequate corporate records or to comply with corporate formalities

2. The commingling of funds or assets3. Undercapitalization4. One corporation treating the assets of another corporation as

its own5. Holding out by one entity that it is liable for the debts of the

other Sheffield. 6. Use of the same officers and EEs. Sheffield.7. Use of one as a mere shell or conduit for the affairs of the other.

Sheffield.b. circumstances must be such that adherence to the fiction of separate corporate

existence would sanction a fraud or promote an injustice. (Sea-Land)i. Just getting stiffed is not enough to constitute an injustice (that would

eviscerate limited liability!). There needs to be something more – some fraud or illegality. The court has to prove something more, like unjust enrichment.

ii. “an injustice” “some elements of unfairness, something akin to fraud or deception or the existence of a compelling public interest must be present in order to disregard the corporate fiction.”

iv. Reverse Veil Piercing 1. After piercing the veil to get to the controlling shareholder(s), then the controlling

shareholder’s other corporations are also on the hook for the debt. 2. Can use when controlling shareholder comingles his own personal assets with the other

corporations.3. Don’t necessarily have to prove that the corporations were run as a single entity, that

there was comingling of funds between the corporations.4. “With both PCV (piercing corporate veil) and reverse piercing, general approach is to

avoid an over-rigid preoccupation with questions of structure… and apply the pre-existing and overarching principal that liability is imposed to reach an equitable result.”

v. Enterprise Liability 1. When the shareholder doesn’t necessarily commingle funds, but the corporations do,

and are run as a single entity.

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vi. Parent/Subsidiary Control : when will the parent company be liable for the liabilities of the subsidiary?

1. The totality of the circumstances must be evaluated in determining whether a subsidiary may be found to be the alter ego or mere instrumentality of the parent corporation. Needs to be a showing of substantial domination.

a. Factors listed in p. 208 In re Silicone Gel Breast Implants Products Liability2. Delaware: there does not need to be a showing of fraud if a subsidiary is found to be the

mere instrumentality or alter ego of its sole stockholder3. Injustice in Silicone Breast Implants Bristol permitted its name to appear in breast

implant commercials, packages, product inserts, to improve sales and give the product additional credibility. They should not be allowed to dodge liability when it induced customers in believing that Bristol vouched for this product.

vii. Piercing the Veil of a Limited Partnership Frigidaire Sales Corporation 1. Holding: Limited partners do not incur general liability for the limited partnership’s

obligations simply because they are officers, directors, or shareholders of the corporate general partner.

2. This holding was justified because the P was never led to believe that the LPs were acting in any capacity other than their corporate capacities. They never acted in any direct, personal capacity.

3. “When the shareholders of a corporation, who are also the corporation’s officers and directors, conscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or manifest injustice is perpetrated upon third persons who deal with the corporation, the corporation’s separate entity should be respected.”

viii. Planning Avoid PCV and enterprise liability?1. Avoid personal liability? respect corporate formalities2. Avoid enterprise liability

a. Need separate books and bank accounts for each corporation, plus careful accounting for supplies, for borrowing drivers, etc.

b. Need separate boards of directors and officers. c. Also need to make sure that officers respect corporate formalities!d. May be more cost-efficient to have one corporation, after all. (one board of

directors, one account, etc.) Balance this with risk of liabilitye. FIDUCIARY DUTIES

i. Generally1. MBCA §8.01 “All corporate powers shall be exercised by or under the authority of the

board of directors of the corporation, and the business and affairs of the corporation shall be managed by or under the direction, and subject to the oversight, of its board of directors…”

2. With this power and control comes fiduciary duties to the owners of the corporation. These are:

a. Duty of Loyaltyb. Duty of Carec. Some courts also impose a third duty – duty of good faith – Delaware Supreme

Court recently opined that good faith not a separate duty, but part of duty of loyalty. See Stone v. Ritter

3. These duties are owed to:

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a. Primarily shareholders, if the corporation is solvent b. Primarily creditors, if the corporation is insolventc. Depends if the corporation is nearly insolvent

i. Because insolvency is fungible thing – courts have created this zone of insolvency. In Delaware, until you are absolutely and unquestionably insolvent, you still owe your duty to shareholders. Other states say that when you are in that zone of insolvency, you owe a fiduciary duty to the “corporate enterprise,” to everyone! Shareholders and creditors.

d. In bankruptcy, you owe a duty to the bankruptcy estate4. Objective of director’s duties = MAXIMIZE SHAREHOLDER VALUE

a. This also includes:i. Fairness to EEs

ii. Most, at least equally important, = maintain competitiveness in the market

b. “A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the director are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes.” Dodge v. Ford Motor Co.

i. directors have discretion on how to run the business – how to maximize profits – but that discretion does not extend to alter the purpose of the business. Ford was not allowed to withhold dividends from the shareholders in order to pay EEs, but he was allowed to spend more money on a new plant

5. DGCL §102(b)(7) the articles of incorporation may eliminate or limit the personal liability of directors of the corporation or its stockholders for monetary damages for breach of fiduciary duty, but in CANNOT:

a. Eliminate the duty of loyaltyb. Eliminate liability for acts or omissions not in good faithc. Liability for intentional misconductd. Liability for any transaction where the director derived improper personal

benefite. Can’t retroactively apply to prior breaches

ii. Duty of Care (Business Judgment Rule)1. Dodge v. Ford Motor Co. – Rule of Law re Dividends

a. Courts will generally leave dividends to the discretion of the directorsb. But will intervene if refusal to pay amounts to “such an abuse of discretion as

would constitute a fraud, or breach of… good faith.” c. The court held that Ford had to pay out dividends, because the Ford Motor Co

was not an “eleemosynary” institution. the main purpose of the corporation is to provide profits to its investors, the shareholders.

2. MBCA §8.30(a ): “Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation.”

a. This is very similar to the duty of care for agency and partnerships.

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b. Very similar to the negligence standard: directors must exercise that degree of skill, diligence and care that a reasonably prudent person would exercise in similar circumstances. However, this ordinary negligence standard is modified in two ways:

i. Reasonably prudent “business person”ii. Also tempered by the business judgment rule (BJR).

iii. When these two are combined, you rarely get a duty of care violation for directors. Only get it when there has been shocking actions by directors. Very difficult to get liability for breach of duty of care.

3. The Business Judgment Rule a. “A presumption that in making a business decision, the directors of a

corporation acted on an informed basis, in good faith and in honest belief that the action taken was in the best interests of the company.” Aronson v. Lewis

i. A person seeking to rebut this presumption needs to show gross negligence, illegal conduct, conflict of interest, or other intentional wrongdoing

ii. Policy: trying to get bad actors, not the ones making innocent, yet stupid, business decisions.

iii. Good faith is an element of the duty of care.b. “The directors are chosen to pass upon such questions and their judgment

unless shown to be tainted with fraud is accepted as final. The judgment of the directors of corporation enjoys the benefit of a presumption that it was formed in good faith and was designed to promote the best interest of the corporation they serve.” Wrigley

i. in the absence of a showing of fraud, illegality or self-dealing by the directors, their decision is final and not subject to review by the courts.

ii. The court will not speculate about the reasons behind the director’s decision, even if it seems off-hand like it hurts the business. (Refusign to put lights on Wrigley field to have night games at home).

c. The burden is on the P to provide evidence that indicates the director’s decision was made in bad faith (some fraud, illegality, self-dealing, grossly negligent). Then the burden is on the D to prove the decision was made in good faith/honest business decision.

d. Reconciling the DoC and the BJRi. The duty of care tells directors don’t be negligent

ii. Then the BJR insulates negligence liability – liability only for fraud or self-dealing or gross negligence.

e. MBCA §8.31 – Standards of Liability for Directorsi. A director shall not be liable for any decision to take or not to take

action, unless the party asserting liability establishes that:1. The director does not have a defense in

a. The articles of incorporationb. In §8.61c. In §8.70

2. The challenged conduct consisted or was the result of:a. Action not in good faith

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b. A decision:i. Which the director did not reasonably believe

was in the best interest of the corporationii. Was taken without the director being informed

to the extent reasonably believed appropriate under the circumstances

iii. Made with lack of objectivity (director’s familial, financial, or business relationship) or lack of independence (another person with material interests controlled)

iv. A sustained failure of the director to devote attention to ongoing oversight of the business and affairs of the corporation

v. Receipt of financial benefit to which the director was not entitled or any other breach of the director’s duties to deal fairly with the corporation and its shareholders that is actionable under applicable law.

f. BJR in Kamin v. AMEXi. Courts will not interfere unless

1. the directors’ powers have been illegally or unconscientiously executed or

2. it be made to appear that the acts were fraudulent or collusive, and

3. are destructive of the rights of stockholders. ii. Mere errors of judgment are not sufficient as grounds for equity

interference – the powers entrusted to directors in mainly discretionary.iii. The distribution of dividends is firmly within the matter of business

judgment. 1. Courts will not interfere with dividend decisions unless it first

made to appear that the directors have acted or are about to act in bad faith and for a dishonest purpose. (self-dealing).

2. Up to directors, and minority stockholders are not in a position to question this right (in court), so long as the directors are acting in good faith.

iv. A complaint that alleges merely that some other course of action other than the one pursued would have been more advantageous gives rise to no cognizable cause of action thus, the stockholders do not have standing to challenge the directors’ decision in court.

v. “The directors’ room rather than the courtroom is the appropriate forum for thrashing out purely business questions which will have an impact on profits, market prices, competitive situations, or tax advantages.”

vi. The wall put up by the BJR will become softer if P can show a prima facie case of conflict of interest, fraud, bad faith, gross negligence then the court will look a little more closely at the facts of the case instead of dismissing it outright.

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g. Van Gorkom BJR in the Context of the Obligation to be Informedi. When making business decisions, directors have an obligation to inform

themselves of all material information that is reasonably available to them.

ii. The BJR presumes that directors make business decisions on an informed basis, in good faith, and in the honest belief that the action taken was in the best interest of the company. This can be rebutted by the Ps by indicating that the decision was uninformed.

iii. There is no protection for directors who have made an unintelligent or unadvised judgment. Uninformed decisions = gross negligence.

iv. Why did court find decision was uninformed? 1. The directors had no prior notice of the purpose of the meeting

(to vote on a merger by Marmon (Pritzker) until they got there. They had no time to review documents before hand. They had no idea that Van Gorkom was working out this deal with Pritzker until the meeting

2. The diretors did not take time to do own research or read materials they relied solely on Van Gorkom’s 20-minute presentation on the terms of the agreement (which Van Gorkom never read)

3. Only a two-hour meeting.4. Directors are fully protected in relying on good faith reports

made by other officers. (DGCL §141(e)) However, these were not considered “reports” here because:

a. Van Gorkom’s oral presentation because it lacked substance – Van Gorkom was uninformed as to the essential provisions of the document he was talking about.

b. Roman’s brief oral statement was irrelevant to the issues before the Board because it was not a valuation study (the Board did not make a valuation study).

c. best practices: get report from an objective reputable investment organization – they would do due diligence in valuating the company.

5. The Board lacked sound valuation information they depended on their knowledge of the history of the stock price alone the Board accepted, without scrutiny, Van Gorkom’s $55 per share valuation.

v. The Agreement did not allow TransUnion to shop around – it limited its ability considerably.

vi. Bottom line: 1. There needs to be process! (we hope that process will equate to

substance and informed decisions). a. There needs to be some sort of process to value the

company. Part of a director’s fiduciary duty is to make sure you get the highest and best price for shares.

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b. Need to make sure other officers and directors are fully informed before they vote.

c. Process usually = a parade of experts presenting their opinion on the terms of the merger.

2. Decisions must be well-informed decisions to be protected under the BJR. This requires directors to gather and review all materials “reasonably available” to them prior to making a decision.

3. Also have duty to inform the shareholders (primarily arises in the merger context). When the board is not fully informed in deciding to go to forward and presenting it to the shareholders, then the information provided to the shareholders is also incomplete.

vii. What happens when presumption is rebutted? (Ps provided evidence that indicates the board does not deserve BJR) Burden on the D to prove the transaction was made in “entire fairness” to the corporation.

1. Factors to consider in “entire fairness”a. The timing b. Initiationc. Negotiationd. Structure of the transactione. Disclosure and approval by the directorsf. Disclosure to and approval by the shareholders

h. BJR and Failures to Acti. BJR protects decisions

1. Both a decision to act and a decision not to act2. However, the BJR does not protect a complete failure to make

a decision. Francis v. United Jersey Bank ii. As a general rule : a director should acquire at least a rudimentary

understanding of the business of the corporation. Because directors are bound to exercise ordinary care, they cannot set up a defense of lack of knowledge needed to exercise the requisite degree of care.

iii. The BJR will not protect a director when she completely fails to do anything about a problem. It will protect if she tries and fails, but not if she does nothing.

i. Public Policy for protecting directors so much? Personal liability can be a real deterrent for directors to want to serve on boards. Usually the corporations are going into business for large sums, billions of dollars, and if the corporation was sued, those billions would be on the directors (for billions of dollars).

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iii. Duty of Loyalty 1. Generally:

a. Duty of Loyalty: “A person’s duty not to engage in self-dealing or otherwise use his or her position to further personal interests rather than those of the beneficiary.”

b. Self-Dealing = “Participation in a transaction that benefits oneself instead of another who is owed a fiduciary duty.”

c. Directors attacked for having allegedly violated the duty of loyalty are not protected from attacks by the BJR. Alleged violations of the duty of loyalty not protected by the BJR.

i. “the business judgment rule, however, yields to the rule of undivided loyalty.” Bayer v. Beran

1. purpose: to avoid the possibility of fraud and avoid the temptation of self-interest.

ii. “Dealings of a director with the corporation for which he is the fiduciary are therefore viewed with jealousy by the courts.

iii. Standard of review: most scrupulous care. iv. “if there is any evidence of improvidence or oppression, any indication of

unfairness or undue advantage, the transaction will be voided.” Bayer 2. Caremark and the Duty to Monitor (not in the book)

a. In general, liability for failure to monitor if “a sustained or systematic failure to exercise oversight” or “an utter failure to attempt to ensure a reporting and information system.” In re Caremark Int’l

b. Test: to show liability, the P has to show tha:i. The failure was systematic and continuous, and

ii. There was an “utter failure” to monitorc. This duty to monitor is lumped into the duty of loyaltyd. Martha Stewart

i. Ps claimed that the board of directors of the Martha Stewart Omnimedia had a duty to monitor Stewart’s personal trading.

ii. Court: it is unreasonable to impose a duty upon the Board to monitor Stewart’s personal affairs because such a requirement is neither legitimate nor feasible.

iii. There is no duty to monitor the personal activities of corp executives.3. Standard of Review: rigorous scrutiny4. Burden of Proof: on the director to prove the good faith and inherent fairness to the

corporation.a. Entire Fairness:

i. Fair price? What did the corp pay and what did they get in exchange? ii. Dealings? Was there bias in the dealings?

b. When the D meets the burden to prove good faith and inherent fairness, it is then on the P to show corporate waste

i. Corporate waste : the management of the corporation wasted the company’s assets to the detriment of the shareholders. Very hard to prove.

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ii. THE TEST: The transaction or the expenditure in question is so one sided that no reasonable business person could conceive that it benefits the corporation.

1. any reasonable business person2. any benefits

c. Outcome : If the P cannot show that the contract was unfair and a majority of the directors ratified the contract, then the D wins. In Bayer, the court decided that because the contract was fair, it was valid even though disinterested directors did not formally ratify it.

5. Conflicts of Interests Voting by Interested and Disinterested Directors a. DGCL §144 – Interested Directors, Quorum

i. No contract or transaction between the corporation and another entity, in which one or more directors has a financial interest is void solely for that reason, as long as:

1. The material facts of the directors’ interests are disclosed or known to the disinterested directors and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum, or

2. The material facts of the directors’ interests are disclosed and shareholders vote to approve the contract or transaction, or

3. If none of these are achieved: the director must prove that the contract or transaction was fair to the corporation at the time it was authorized, approved, or ratified

ii. The votes of common or interested directors may be counted in determining the presence of a quorum.

1. Although best practices is to have the interested director recuse himself from voting.

b. What is a quorum? i. DGCL §141(b): “…A majority of the total number of directors shall

constitute a quorum for the transaction of business unless the certificate of incorporation or the bylaws require a greater number.”

ii. a majority of the total number of directors need to be present in order for the board to vote and approve a transaction.

iii. “The vote of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors unless the certificate of incorporation or the bylaws shall require a vote of greater number.”

c. Impracticality of getting all board members present – directors allowed to vote by conference call, but they still need to be informed before voting DCGL §141(i).

d. Summary :i. §141(b) how the company acts – is it authorized? Only votes where

are quorum is present is authorized by the boardii. §144(a) how corp protects itself from attack that there was a conflict

of interest, and for that reason, the transaction should be void. (by ratification of disinterested directors)

6. Taking Corporate Opportunity (Corporate Opportunity Doctrine) a. Generally

i. Objective: to deter applications of new business prospects “belonging to” the corporation

ii. Targets:1. Officers and directors of a corporation

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2. Dominant shareholders who take active role in managing firmiii. “A corporate fiduciary agree to place the interest of the corporation

before his or her own in appropriate circumstances.” Broz Cellullar. b. A corporate opportunity exists where: (Broz Cellullar)

i. Corporation is financially able to take the opportunityii. Opportunity is in the corporation’s line of business

1. Ebay Casea. eBay Shareholders Litigation the line of business isn’t

always clear-cut. b. The court found that investment was in eBay’s line of

business (even though the main function of the corporation is to run an online auction website), because eBay had more that $550 million invested in equity and debt securities.

c. When eBay directors took an IPO for themselves instead of giving to the eBay, they were found to be in breach of the duty of loyalty.

d. Court brought in agency – agents is under a duty to account for profits obtained personally in connection with transactions related to his or her company. No doubt that eBay executives got the IPO because of their position as executives, Goldman Sachs gave them the IPOs to keep them doing all of their investments with Goldman.

2. In Beam ex rel. v. Martha Stewart court found that they did not take a corporate opportunity

a. Line of business = an activity as to which the corporation has fundamental knowledge, practical experience and ability to pursue

b. A company’s line of business is one that is intended to be profitable. (the issuance of stock here, as not in the line of business)

iii. Corporation has an interest or reasonably expectancy in the opportunity

1. Interest: something to which the firm has a legal right2. Expectancy: takes something which, in the ordinary course of

things, would come to the corporation3. In Broz, the corp didn’t have an interest or expectancy in the

opportunity because they were getting out of that business, had sold off several similar franchises, and key players of the corp told Bro to go ahead.

4. Martha Stewart if there is some time between that property and the nature of the corporate business

5. Most courts assume that executives are knowledgeable about the corporation’s future plans. Pleading ignorance is usually not a defense.

iv. Embracing the opportunity would create a conflict between director’s self-interest and that of the corporation.

1. Delaware law recognizes a policy of allowing directors of corporations to buy and sell shares of that corporation at will so long as they act in good faith.

v. no single factor is dispositive. Instead, the Court must balance all the fators as they apply to a particular case. Martha Stewart

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vi. if the opportunity was disclosed to the board and the board approves the taking of the opportunity, then the burden is on the P to show corporate waste.

c. Disclosure: Presenting the opportunity to the board of the corporation creates a “safe harbor” for the director wishing to take the opportunity. Although, it is not a necessary prerequisite.

7. Controlling Shareholder a. Basic Principles:

i. Shareholders acting as shareholders owe one another no fiduciary duties. Shareholders are always allowed to act in their own self interests (buy and sell as they please).

ii. Controlling shareholders owe fiduciary duties to the minority – those shareholders that control the corporation must take the minority’s interests into consideration when making decisions.

1. What is a controlling shareholder?a. If you’re a majority holder -- 50.1% or more of stock.

b. If not a majority holder, can show “domination by [that] minority shareholder through actual control of corp conduct.” (full text of Sinclair?) Looking for the puppeteer.

b. Parent and Subsidiary Corporationsi. The Relationship

1. Corporations can own the stock of other companies. DGCL §1232. “Wholly owned subsidiary” the parent company owns all of

the shares of the subsidiary3. “Majority owned subsidiary” parent company owns a

majority of the stock of the subsidiary (at least 50.1%)4. Minority owned subsidiary” parent company owns less than

50% of the stock.

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ii. Test: is intrinsic fairness – used when the parent has received a benefit to the exclusion of the minority shareholder of the subsidiary and at the expense of the minority shareholders of the subsidiary.

1. the burden is on the D to show the transaction was fair to the subsidiary.

2. Used in situations of self-dealing – where the parent is on both sides of the transaction with the subsidiary (the parent is on one side and on the other as the majority shareholder of the subsidiary).

3. Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary.

iii. If there is no self-dealing , then the BJR is the standard to be applied . 1. In Sinclair Oil, the court found that the distribution of dividends

beyond the subsidiary’s profit was BJR b/c the minority stockholders also benefited from the dividends.

2. Also found that parent was not taking corp opportunities3. However, in contract between the parent and the subsidiary,

the court found self-dealing the parent was breaching on the contract by being late with payments, but because it dominated subsidiary, caused subsidiary not to seek breach of contract claims. Parent allowed subsidiary to take the losses instead of paying on time. Meanwhile, parent had more cash in the coffers.

iv. Difference between fiduciary duties of stockholders and directors: (Zahn v. Transamerica Corp)

1. When a majority stockholder votes as a stockholder, he may have the legal right to vote with a view towards his own benefit and to represent himself only.

2. But, when the parent company votes as a director he represents all the stockholders in the capacity of a trustee for them and cannot use his office as a director for his personal benefit at the expense of the stockholders.

3. a dominant or controlling shareholder or group of stockholders is also a fiduciary.

4. In this case, Transamerica, as the controlling stockholder, had a duty to watch out for the minority stockholder’s best interest. Instead, it caused the minority stockholder, Axton-Fisher, to call its stock at a lower price than it would have gotten had they waited until liquidation, in order to keep the excess profits for themselves.

5. Calls and Conversionsa. Court in Speed v. Transamerica Corp. “a disinterested

board of directors of Axton-Fisher would undoubtedly have exercised its power to call the Class A stock before liquidation, disclosing the intention to liquidate together with full information as to the appreciated value of Axton Fisher-s tobacco inventory.”

b. Disclosure was key. Transamerica should have disclosed to the minority stockholders that it was intending to

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liquidate Axton-Fisher. That way, the stockholders could have exercised their option to convert stock to Class A.

8. Ratification a. An insider transaction may be ratified by:

i. A majority of the disinterested directors (who are fully informed) voting in favor

ii. A majority of shareholders (who are fully informed) voting in favor. (DGCL §144(a)(1)-(2))

1. Under Fliegler a majority of the disinterested shareholders have to approve the transaction (it reads the word “disinterested” into the statute.

a. Reasoning: §144 was meant to codify the common law. Parties always have to be disinterested in order to achieve ratification.

b. This does not insulate the issue from judicial review. i. The Ds still have to prove that the disinterested directors were fully

informed about the material facts of the interested directors’ interests in the transaction

ii. That the decision was made in good faith. c. When an interested transaction is properly ratified by a majority of the

disinterested directors, this invokes the business judgment rule and the burden shifts to the P to demonstrate that the terms of the transaction were so unequal as to amount to a gift or waste of corporate assets.

i. Waste = no person of sound business judgment would say that the consideration received for the options was a fair exchange for the options granted.

d. When a transaction is ratified by a majority of the minority shareholders (in a controlling shareholder situation), the burden shifts to the P to show unfairness. Wheelabrator.

e. When interested party cannot prove ratification the burden is on the interested director to prove the contract or transaction was fair to the corporation as of the time it was authorized, approved, or ratified, by the board of directors, a committee or the shareholders. DGCL §144(a)(3).

i. Hallmarks of a fair transaction? 1. Within the range of terms that parties bargaining at arms-length

might reach. 2. E.g, Bayer

a. Nothing to show that some other soprano would have enhanced the program

b. No suggestion that the present program’s costs is disproportionate

c. Tennyson’s contract was on a standard form, negotiated through her professional agent

d. Her compensation was in conformity with that paid for comparable work

i. She received les than any other artist on the program

e. Although she appeared with greater regularity than any other, she received no undue prominence.

f. Subordinated to the ad of the company’s products. ii. Burden is on D to prove entire fairness.

9. Summary :a. There is a complaint, a director gets sued.

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b. Start with the BJR rule wall comes up that presumes the directors were acting (1) with care, (2) in good faith, (3) in the best interest of the company.

c. Ways the P can knock that wall down:i. Show self-dealing

1. The interested director moved forward with the transaction for his own benefit and not for the benefit of the corporation

2. Now the burden is on the D to prove that his breach of the duty of loyalty (seeking personal transaction) was somehow blessed or ratified (§144).

a. Have to show that directors or shareholders were fully informed.

b. Majority of those disinterested approved. c. If can’t prove ratification, then D has to prove that the

transaction was entirely fair to the corporation. (use Bayer).

3. If D is successful in either (1) proving ratification or (2) proving fairness, then the burden is on the P to show the transaction was a waste of corporate funds or unfair (depends on who is being sued).

a. If it is a director who is being sued, then the P has the burden of proving that the transaction was a waste of corporate funds.

b. If it is a controlling shareholder being sued, the burden is on the P to show that the transaction was unfair.

iv. Obligation of Good Faith (Separate Duty?)1. Generally

a. Most courts now recognize a duty of good faith as a separate duty, though it used to be under the duty of loyalty.

b. A shareholder P challenging a decision of the board of directors has the burden at the outset of rebutting the BJR. To rebut the BJR, a P assumes the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triad of their fiduciary duty – good faith, loyalty, or due care. If the P fails, the BJR attaches to protect the corporate officers and directors.

c. If the BJR presumption is rebutted, then the burden is on the Ds to prove the “entire fairness” of the transaction to the shareholder P.

i. The whole inquiry under §144 under “entire fairness” 2. Disney Shareholder Ligation

a. Shareholders sue Ovitz (new president), Eisner (former President of Disney that hired new one), and the board of directors

i. Grossly negligent in negotiating the contract to hire Ovitz and it was not performed in good faith.

ii. They never calculated how much the severance package would be. Never took the time to figure it out. Sloppy.

iii. The court acknowledges that this was not best practices but that the behavior was not so low as to violate the duty of care.

b. Court finds that the board was fully informedc. The decision to fire Ovitz without cause was protected by the BJR. d. Upshot:

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i. Conduct falling below best practices will not necessarily result in liability. ii. Identified three types of conduct that might constitute “bad faith,” but

unclear as to how that fits into duty of care and duty of loyaltyiii. Failure to act in good faith may be found where:

1. The fiduciary intentionally acts with purpose their than that of advancing the best interests of the company

2. Where the fiduciary acts with the intent to violate applicable positive law, or

3. Where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.

e. Corporate Waste Cause of Actioni. “To recover on a claim of corporate waste, the plaintiffs must shoulder

the burden of proving that the exchange was ‘so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.’”

ii. “A claim of waste will arise only in the rare, ‘unconscionable case where directors irrationally squander or give away corporate assets.’”

iii. Note: COA for waste very different from normal conception of “corporate waste” that comes into play in duty of loyalty.

1. This COA is under duty of care, which carries the protection of BJR.

3. Jones v. Harris (Fiduciary Duty of Investment Advisor)a. “An investment advisor of a registered investment company shall be deemed

to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company, or by the security holders thereof, to such investment adviser or any affiliated person of such investment adviser. “ Investment company Act, sec. 36(b)

i. Tries to create a fiduciary duty where the common law may not typically create one.

b. This case is no longer current. SCOTUS remanded the case back to the 7th Cir. To consider case under Gartenberg standard – adviser fee okay unless bears no reasonable relationship to the services rendered.

i. Let the market determine what is a reasonable feec. All we need to know: there is a fiduciary relationship here, which includes an

obligation for full disclosure and fees. 4. Stone v. Ritter (Oversight means good faith)

a. Allegations that AmSouth failed to file “suspicious activity reports.” Govt slapped $50 million in fines and penalties. Shareholders sue.

b. Ps argue:i. The directors should have known about the illegal conduct, and they

didn’t, so they should be liable. ii. They did have a monitoring system in place – a whole list of reports. P.

400 – 401. It wasn’t like AmSouth was ignoring or intentionally refusing to comply with federal law.

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iii. But this monitoring system did not work because they had bad egg EEs. EEs did not follow through – even the best-thought-out monitoring system and process, but if people don’t comply with the process, then the system doesn’t work.

iv. They should have known but they didn’tc. Caremark standard

i. Directors utterly failed to implement any reporting standards or information or controls.

ii. Having implemented any reporting or information systems or controls, monitor or oversee its operation thus disabling themselves from being informed of the risks.

d. Here, the AmSouth did have a monitoring system, but this system did not work because they had bad eggs (EEs) who did not follow through.

i. There were no red flags to alert the board. ii. When there are red flags, then the board needs to take action (under

Caremark). e. Holding: directors met Caremark standard. f. Duty of Oversight

i. Oversight = good faithii. In order to show bad faith, you must show tht the director intentionally

fails to act in the face of known duty, showing intentional disregard. The director got the red flags and did nothing about it. beach of duty of good faith.

g. Upshot i. “the obligation to act in good faith does not establish an independent

fiduciary duty that stands on the same footing as the duties of care and loyalty”

ii. “‘[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest.’”

f. DERIVATIVE LITIGATION i. Summary:

1. Steps to Filing a Derivativea. Harm to a Corporationb. No action by the board of directorsc. Eligible shareholders must file a demand on the board (MBCA §7.41 & 7.42)

i. Must be a shareholder at the time of the act or omissionii. Must be fairly & adequately represent the interests of the corporation

d. If the board accepts the demand:i. Corporation files suit against bad actors

e. If the board rejects demand or does not act for 90 days:i. Shareholders may file derivative suit (§7.42(2))

ii. Shareholder must meet additional pleading requirements (§7.42(d))iii. Corporation may appoint special litigation committee, which can move to

dismiss1. Must make required showing 2. Otherwise, derivative suit may proceed

2. Derivative Lawsuits

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a. Broughtii. Generally

1. Rights of Shareholdersa. Vote on limited range of issuesb. Receive payment of dividends when and as declared by boardc. Inspect corporate books and recordsd. Receive distribution upon terminatione. Purchase proportionate share of a new issuance or corporate stock to maintain

current ownership percentage. f. Can file a derivative suit to redress wrong suffered by the corporation (damages

belong to the corporation). Someone outside the company brings a suit on behalf of the company against bad actors inside the company. A shareholder is not an agent of the comp (remember we have a divide between owners and managers)

2. Direct v. Derivative Suitsa. Definition of Derivative Suit: “A suit by a beneficiary of a fiduciary to suit by a

beneficiary of a fiduciary to enforce a right belonging to the fiduciary; especially a suit asserted by a shareholder on the corporation’s behalf against a third party (usually a corporate officer) because of the corporation’s failure to take some action against the third party.”

b. Direct suitsi. Brought by the shareholder in his or her own name because the harm

affects the shareholder directly. 1. These are often brought as a class action. (Class actions are

typically a tip off that this is a direct suits). ii. The cause of action belongs to the shareholder in her individual capacity.

iii. Arises from an injury directly to the shareholder. iv. Make a huge difference because there is no requirement (1) to post a

bond (talked about in Cohen and Flying Tiger) or to (2) make a demand on the board (other cases in A16).

c. Derivative suitsi. Brought by a shareholder on corporation’s behalf.

ii. COA belongs to corporationiii. Arises out of an injury done to the corp as an entity

iii. The legal standard – How do you know whether it is derivative or direct? 1. Traditional Test:

a. Who suffered the most direct injury?i. If the corporation, suit is derivative.

1. Ex: director embezzles all corp funds and causes the stock price to plummet this is a derivative suit, although the shareholders suffer because the price went down. However, the shareholders suffered, in this case, because the corporation suffered. Their harm is derivative of the harm to the corp.

ii. If the shareholder suffered individually, then it is direct (Eisenberg)1. For ex: Eisenberg a dissolution in voting rights affected the

shareholders individually, not the corporation, and for that reason, this suit was direct.

2. Often takes the form of a class action

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b. To whom did the defendant’s duty run?i. If corporation, suit is derivative

1. Called into question by Eisenberg. How?2. Delaware Alternative – the Tooley Test

a. In Tooley, the Delaware Supreme Court adoted a two-pronged standard to be used in determining whether a stockholder’s claim is derivative or direct:

i. Who suffered the alleged harm, the corporation or the suing stockholders, individually?

ii. Who would receive the benefit of any recovery or other remedy, the corporation or the stockholders, individually?

iv. Plaintiff Qualifications – Shareholder Status1. MCBA §7.41 – limits standing to shareholders (derivative suits). For ex: creditors may

nor being a derivative suit. 2. MBCA §7.41(1) – Must be a shareholder at the time of the alleged wrongdoing

a. §7.42 by implication requires that must be a shareholder when suit commencedb. Many states say also must remain a shareholder through final judgment.

3. MBCA §7.41(2) – names P must be a fair and adequate representative of the corporation’s interests

v. Cohen v. Beneficial Industrial Loan Co. the Court finds that expenses statute for derivative suits is substantive b/c it creates a new liability, as well as a condition on standing. (which means the court will use the law of the state, not the federal rules of procedure).

vi. Public Policy Concerns (Derivative Suits)1. Derivative Suits allow shareholders to hold directors accountable. Shareholders are

often helpless, so its an important remedy2. May be used for abuse:

a. Strike suits nuisance suits brought for settlement valueb. Meritorious suits settled too easily, b/c lawyer usually has a huge incentive to

settle, bigger fees, less risk (litigation =risk)c. Its important to recognize that courts are allowing shareholders to override

managers – limiting the independence of managers3. Protection for directors and officers

a. Indemnification Statutes – at common law, corporate EEs were entitled to indemnification for expenses incurred on the job, including certain legal liabilities, but directors were not.

i. Today, all states have statutory provisions authorizing director indemnification to some degree. See DGCL §145.

b. Insurancei. Can purchase various types of D&O insurance policies.

ii. Can insure, even if cannot indemnify. iii. Typically very expensiveiv. Typically, does not cover gross negligence, fraud, self-dealing, etc.

vii. Demand Requirement 1. Role of the demand requirement Bascially, shareholders need to ask the directors to

sue themselves or a fellow director. If the board refuses, then shareholders can bring derivative suit. If they don’t demand the board to sue, then they must prove that demand was futile.

2. What is “the demand”?

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a. Typically a letter from shareholder to the board of directorsi. Have to be specific – tell the board you want it to sue for this specific

reason. ii. Must request that the board bring suit on the alleged cause of action

iii. Must be sufficiently specific as to apprise the board of the nature of the alleged cause of action and to evaluate its merits

iv. “At a minimum, a demand must identify the alleged wrongdoers, describe the factual basis of the wrongful acts and the harm caused to the corporation, and request remedial relief.” Allison v. Gen. Motors Corp., 604 F. Supp. 1106, 1117 (D. Del.), aff’d mem., 782 F.2d 1026 (3d Cir 1985).

b. Shareholders must make a “demand” on the board before filing, unless the demand is excused because it would have been futile.

i. How to show demand is futile”1. A majority of the directors are interested. 2. Finding grounds for futility is good for P, can go straight to court

making a demand on the board waives your ability to claim that the board was interested. By default, presenting a demand, means you acknowledge that the board was disinterested

3. Standards for demand futility?a. NY Standard (Marx v. Akers)

i. Majority of directors interested in the transaction (either from self-interest or a loss of independence b/c disinterested director controlled by a self-interested director); or

1. Interested = director will receive a direct financial benefit from the transaction which is different from the benefit to shareholders, generally.

2. Ex: directors vote to increase their salariesii. Directors failed to inform themselves to a degree reasonably necessary

about the transaction; oriii. the challenged transaction is so egregious on its face that it could not

have been the product of sound business judgment of the directors. b. Delaware Standard (Grimes)

i. There is reasonable doubt as to whether the board is capable of making independent decision to assert the claim if demand were made. The basis for excusal would normally be that:

1. Majority of board has a material financial or familial interest;2. Majority of the board lacks independence, for some other

reason, such as domination or control; or3. Challenged transaction not product of valid exercise of business

judgment. ii. Meaning of “reasonable doubt” the stockholder has a reasonable

belief that the board lacks independence or that the transaction was not protected by the BJR.

1. The shareholder can do this by using the “tools at hand” a. request to inspect books and records

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b. use public sources, including media and governmental agencies such as the SEC

c. Bottom line: P needs to show that there is some bias that prevents board from suing

d. These claims need to be made by the P with particularity. The P cannot just provide conclusory allegations, but must back up the allegations with some facts.

4. Wrongful refusala. When the P makes a demand on the board, the P can claim that the board

wrongfully refused to bring suit. b. The board of directors is entitled to the presumption of the BJR in deciding to

reject the demand, unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is entitled to the benefit of the presumption.

c. Showing wrongful refusal:i. P must show that there is reason to doubt that the board acted

independently or with due care in responding to the demand.5. Special Litigation Committees (SLC)

a. Generallyi. The board of directors may create an SLC and take the suit away from the

shareholders at any time it wants (Zapata)ii. The burden is on the corporation to prove independence, good faith, and

a reasonable investigation. b. Tensions between accountability and authority:

c. The task: Balancing

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d. The independent director: i. The SLC needs to be composed of independent directors.

ii. The “independent director” versus “director independence”1. Two different, but equally important corporate concepts2. Concepts can and do overlap.

iii. Sarbanes Definition of “Independence” for independent director1. “a director may not accept any direct or a director consulting,

advisory, or other compensatory fees from the company other than fees for service as a director or member of . . . committee” and

2. “a director may not be ‘affiliated’ with the company or any of its subsidiaries.”

e. Director independence in the SLC contexti. Are the directors free from conflict or material interest?

1. Did they on the board at the time of the alleged wrong?2. Did they get any benefits from the alleged wrong? 3. Did they have connections to the alleged wrongdoers?

ii. Delaware also worries about structural bias – since the old board is the one that chooses the SLC, there is an opportunity for bias – and so the court will look at the decisions of the SLC with more scrutiny. Oracle.

iii. Maryland follows Auerbach. iv. Aronson v. Lewis – the case we cite for the BJR (one of the earliest

recitations of the rule)1. Also involved a situation where you have a derivative lawsuit.

Chief wrongdoer owned 47% of the corporation’s stock and allegedly had personally selected each board member.

2. The supreme court held that this did not render the board per se incapable of exercising independent judgment.

3. Instead, plaintiffs must “demonstrate that through personal or other relationships thedirectors are beholden to the controlling person.”

f. Auerbach v. Bennett (NY)i. The BJR will not completely insulate the SLC’s conclusion not to litigate.

The court may evaluate the process that the SLC took to come to the conclusion not to litigate. If the SLC had a sufficient process, then the court will not take down BJR wall.

ii. In NY : for your SLC to be insulated from judicial reivew (BJ stands), you need to have two things:

1. Everyone on the board is independent and disinterested2. Have to have process to investigate

a. were these done in good faith? b. “courts may properly inquire as to the adequacy and

appropriateness of the committee’s investigative procedures and methodologies”

c. the SLC may have to show that they have pursued their chosen investigative methods in good faith.

d. What would raise questions of good faith?i. Investigation restricted in scope

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ii. Shallow in executioniii. So halfhearted as to constitute a pretext or

shame. Questions of good faith or conceivable fraud is never

shielded by the BJR3. otherwise, the decision by the SLC not to bring suit is

“squarely within the” BJR.g. Zapata v. Maldonado (DL)

i. Similar to Auerbach the board appointed to outside directors to head the SLC, which recommend dismissal.

ii. Two-step test for reviewing SLC recommendations:1. Step 1:

a. Inquiry into the independence and good faith of the committee

b. Inquire into the bases supporting the committee’s recommendations.

2. Step 2: Court may go on to apply its own business judgment as to whether the case is to be dismissed.

3. if SLC passes this test, P can try to being down the BJR wall by showing waste (waste?)

iii. This is a real deviation from what we currently know about Delaware. The court will use its own business judgment. Much criticism, but it is still good law.

1. The SLC has to be more detailed about how it came to the conclusion not to sue – the courts will review it for soundness – make sure the process was done thoroughly and in good faith

h. Oracle (Structural Bias)i. Rule : “At bottom the question of independence turns on whether a

director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind. That is, … focus on impartiality and objectivity.”

ii. Holding : Not independent. There were too many collegial and other connections between the SLC members and many of the defendants. Also, two of the defendants were potentially big-time donors to Stanford.

iii. Found structural bias there is cognitive bias in board-room decision making. Social and collegial ties between directors and how that affects decision-making.

iv. Later In Beam v. Martha Stewart1. Stage in litigation: determining whether or not demand was

futile2. Found, old test (Marx or Grimes) is still good when we’re

determining whether demand is excused. “to render a director unable to consider demand, a relationship must be of bias-producing nature. Allegations of mere personal friendship

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or a mere business relationship, standing alone, are insufficient to raise a reasonable doubt about a director’s independence.”

3. If the court has already decided that demand is excused, then the rule is Zapata/Oracle heightened standard for SLC: friendship leading to structural bias may be enough at this stage.

v. this case is cabined only into determining whether the SLC’s decision should stand – when directors in an SLC are biased.

viii. Summary: Litigation Tree

g. PUBLIC COMPANIESi. Securities Regulation

1. Generally:a. Key Statutes

i. Securities Act 1933 (“Securities Act”) regulates the offering and sale of new securities in primary markets (directly from corporation to investors).

Special Litigation Committee Analysis

=> P may sue to determine whether directors in committee were biased

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ii. Securities Act of 1934 (“Exchange Act”) regulates secondary trade – so sale of shares from one investor to another, not directly from the company to investors.

1. Also requires all the substantive disclosures by companies. that companies have to make public regular financial reports.

2. Created and enforced by the Securities and Exchange Commission (SEC)

b. What is a security? Securities act §2(a)(1)i. “any note, stock, bond, debenture, investment contract, or, in general,

any interest or instrument commonly known as “security.” that language is the one that creates litigation, provides fodder for creative lawyers.

ii. What is an Investment contract where we see a lot of litigation1. a contract, transaction or scheme whereby a person invests

money, 2. in a common enterprise and 3. is led to expect profits 4. solely (“or substantially”) from the efforts of the promoter or a

third party. 5. Now “sole or substantially” the USSC recognized that the

previous language was too restrictive. (SEC v. Howey, US 1946)iii. Investing in a common enterprise

1. Horizontal commonality relationship between an individual investor and the other investors who put money into the scheme. Requires pooling of interests.

a. (did this group of people get together and expect to put their resources together into this one common area? What was the expectation?)

b. E.g., shareholders of a corporation2. Vertical commonality relationship between investors and

promoter of the scheme. Requires that the investor and the promor of the scheme by involved in a common enterprise, but no pooling of interests by multiple investors.

a. What was the expectation? Why was the investor giving money? There is usually a business or charitable purpose.

c. Is a LLC or Partnership Membership Interest a Security? Robinson v. Glynni. Holding : interest in the LLC was not considered a security (an investment

contract) because P (Robinson) was an active and knowledgeable executive at the LLC, rather than a mere passive investor.

ii. Have to look at the economic realities of the case:1. Robinson became a partner at the LLC because he invested $10

million into the LLC. 2. However, he was not depending solely on the efforts of the

promoter or a third party, since he took an active role in the management of the company.

iii. Court left the door open to the possibility of an ownership interest in an LLC may be a security

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iv. Fact-intensive analysis do the Howey test to see if investment contract is a security.

v. General Application to Partnerships1. There is a circuit split: some courts have ruled that ownership in

a partnership is never a security, while others have left the door open.

2. Goodwin v. Elkins (3d Cir.): A bright line standard that says that because partners have a legal right to control the firm a general partnership interest is never a security

3. Williamson v. Tucker (5th Cir.): Look beyond the bare scope of partnership law and consider the economic realities. A security might be present if

a. (1) the partnership agreement deprives one or more partner of his legal control rights, essentially leaving him in the position of a limited partner;

b. (2) the investor is so inexperienced or unknowledgeable in business affairs as to be incapable of exercising his or her legal rights; or

c. (3) the investor is so dependent on some unique entrepreneurial or managerial ability of the promoter that the investor cannot exercise meaningful partnership powers

vi. Application to Limited Partnerships1. Limited partners have limited control rights, though RULPA

gives greater rights2. Some courts therefore adopt a per se rule that limited

partnership interests are securities. a. But limited partners can exercise considerable de facto

control. E.g., Holzman v. de Escamilla.2. Registration Process

a. Purpose of these laws:i. Full disclosure: make sure that investors have all the information they

need to make informed decisionsii. Prevention of fraud: agency cost problem re disclosure – how to make

credible bond? b. Disclosure Obligations:

c. Filing the Registration Statement:

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i. An error in the prospectus can cause you to be in violation – fraud. The prospectus is distributed to investors

ii. Can’t sell any stock until the registration statement is filed. Can’t talk to investors, advertising anything, only private negotiations with the underwriter.

iii. Then, once the filed, the company can start talking about offers, but sale is still not permitted.

iv. Can’t start selling until the SEC approves. And the SEC often send comments back, and the statement will go through 2, 3, or even 4 revision and amendments before the SEC will approve.

1. Section 5a prohibits sale. 2. Section 4 – exempted transactions

a. Certain securities: i. notes, loans from banks (would chill the market

if banks had to get approval from SEC every time they wanted to extend money to the market/individuals).

ii. Those not in public offeringb. Certain transactions:

3. Section 11 and 12 where all the liability falls expressly creates a private action remedy. Private citizens and investors can bring actions against you. Can sue every person that signed the registration statement, any director of the company, appraisers of the statement

a. Untrue statement of material fact. b. Calculation of damages – price it was sold at (minus) the

price it should have been sold at given the untrue statement or misrepresentation.

d. Exemption: private offering exemptione. Selling Securities under the Securities Act of 1933

f. Important Civil Liabilities i. 1933 Act §11

1. Fraud in the registration statement (a) if any part of the registration statement contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security may sue:

a. Every person who signed the registration statement

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b. Every person who was a director or partner in the issuer at the time of the filing

c. Every person who, with his consent, is named in the registration statement as being or about to become a director or partner

d. Every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him (experts), who has with his consent been made as having prepared or certified any part of the registration statement.

i. Experts are only liable for the expertised portion of the RS. BarChris

e. Every underwriter with respect to such security2. Exceptions in subsection (b):

a. With regards to any part not purported to be made by an expert, when that person had, after a reasonable investigation, reasonable grounds to believe and did believe, at the time the registration statement because effective, that the statements were true and that there was no omission of a material fact required or necessary to make the statement not misleading

b. For experts: i. Had, after reasonable investigation, reasonable

ground to belive and did believe, that the statements were true and that there was no omission of material fact…

ii. Such part of the registration statement did not fairly represent his statement as an expert or was not a fair copy of or extract from his report or valuation and

c.3. Other exceptions: (b) persons, other than the issuer, who can

prove:a. That before the effective date of the part of the

registration statement for which he was responsible, hei. Resigned, and

ii. He advised the commission and the issuer in writing that he had resigned and that he would not be responsible for such part of the registration

b. Such part of the registration statement became effective without his knowledge

4. Due diligence defense:a. For officers :

i. can’t argue that they are not financially literate enough to understand that there were

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misstatements in the RS. Court says that doesn’t matter. Part of the duty of care is to acquire the level of sophistication necessary to perform job well. Francis (drunk widow case).

ii. have to show that they did a reasonable investigation and had a reasonable belief. If you’re an officer or director that signed the registration statement, you have to show that you did a reasonable investigation of what is put forth in the registration statement, and you have to believe its true.

b. For experts: reasonable investigation, reasonable beliefc. Non-experts for expertised portions: reasonable belief

ii. 1933 Act §12(a)(1)1. Strict liability for illegal offers and sales2. Rescission remedy

iii. 1933 Act §12(a)(2)1. fraud in a prospectus or oral sales communication

iv. Implied private rights of action1. 1934 Act §10(b) and SEC Rule 10b-52. 1934 Act §14(a) and proxy rules

g. These do not apply to small private placements Securities Act §4 “the provisions of section 5 shall not apply to transactions by an issuer not involving any public offering…”

h. Private Placement Test:i. Factors:

1. Number of offerees and relationship to issuera. Small number (8 in Doren v. Petroleum Mgmt Co.)b. Relationship to issuer:

i. Offerees’ knowledge and sophisticationii. Oferees’ access to information

2. Number of units offered3. Size of the offering4. Manner of offering

3. Rule 10b-5

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a. Key Elements i. a material misstatement or omission

1. Material fact = if there is a substantial likelihood that a reasonable shareholder/investor would consider it important in deciding how to vote. Basic

2. Materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity. Basic

ii. made with scienter1. State of mind:

a. Mistatements were made with the intent to deceive, manipulate, or defraud.

b. Or with a reckless disregard of falsity of statement2. Required in private party litigation3. Required in SEC actions4. Hard to prove

iii. in connection with the purchase or sale of securitiesiv. one which the plaintiff relied, and

1. In omission cases, reliance is presumed. Affiliated Ute Citizens of Utah

2. “Fraud on the market theory”v. that caused the plaintiff’s injuries

b. Basic v. Livingstoni. Basic had been negotiating a merger for 2 years. Rumors circulated about

the deal, but the board consistently denied them. ii. Were Basic’s statements materially false?

1. Any merger discussions are material to shareholders to decide what to do with the stock of the company.

2. There is a spectrum when the talks are preliminary on one side of the spectrum, and when the deal is done, on the other. Somewhere in the middle, the facts become material.

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3. When to disclose material facts : materiality will depend at any given moment upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.

4. Factors that a merger is close at hand:a. Board resolutionsb. Instructions to investment bankersc. Actual negotiations between principals or

intermediariesiii. Is this a proper class action, when proof of reliance is an issue?

c. Reliance element - Fraud-on-the-market theoryi. Presumption that investor relied on integrity of market price – so

investor need not have seen the misrepresentation. Do not need to prove direct reliance when purchase made on the open market?

ii. the fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business.

iii. Therefore, misleading statements will defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.

iv. The causal connection between the D’s fraud and the P’s purchase of stock in such a case is no less significant in a case of direct reliance on a misrepresentations.

v. The Efficient Capital Markets Hypothesis (ECMH) In an efficient market, current prices always and fully reflect all relevant information about the commodities being traded

1. Semi-strong form: the price reflects all the publically available information on the market

2. Strongest form: that the price reflects all the information, publically and privately available – the market always knows.

a. the 7th Cir. explicitly rejects this form in West v. Prudential Securities, Inc. neither the identity of Hoffman’s customer not the volume of their trades would have conveyed information to the market in this fashion (b/c Hoffman was an investment advisor who was telling his private clients information – none of this was public).

3. This presumption can be rebutted when the investors knew or should have known the information.

vi. DE and CA have rejected this theory.vii. If the transaction occurs in a more personal environment, then the P

would have to show actual direct reliance.

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viii. How do we know if the market is efficient? Unger v. Amedisys.

d. Causation – Misrepresentations caused P’s injuriesi. Two Types of Causation (have to prove both)

1. Transaction causationa. Closely related to relianceb. But for the fraud, P would not have invested (or sold,

etc.)2. Loss causation

a. Akin to proximate causeb. Fraud caused a loss. E.g. market doesn’t believe the

misrepresentation, stock tanks due to market decline. ii. Presumption of Causation?

1. Where reliance is presumed, court will also assume transaction causation

a. Omissionb. Fraud on the market typically with affirmative

misrepresentations2. Loss causation is not presumed, Ps have to prove

a. “An inflated purchase price will not by itself constitute or proximately cause the relevant economic loss needed to allege and prove ‘loss causation.’” You have to show more. Have to show that the misrepresentation caused the stock price to rise, but you also have to show that but for that information not being there, the stock price would not have risen. The stock was priced, not artificially, and that information had been taken away or corrected, there would have been a differential.

b. For this, have to use experts. Isolate the price movement, which is difficult in a noisy market.

iii. Problems with Class Certification1. Because of that, we wanted some control over class action

litigation – so Congress passed the Private Securities Litigation Reform Act of 1995 – it doesn’t take away the right to sue as a

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class, but require heightened standards. The court will require more to show a prima facie case.

2. This is to deter frivolous class actions. 3. When causation is presumed – easier to sue as a class

e. Scienter Element Santa Fe Indus. i. P’s alleged that the parent company obtained a “fraudulent appraisal”

and gave them less than the company was worth after a short-term merger. They essentially claim a breach of duty of loyalty – that the parent company manipulated the appraisal to give minority stockholders less. (like Sinclair Oil) They wanted to benefit at the expense of the minority holders.

ii. Holding : Conduct only violates Rule 10b-5 if it is manipulative or deceptive within the meaning of the statute.

1. Manipulation = term of art that refers generally to practices, such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity. that is not what was going on in this case.

2. Types of manipulation :a. White wash = a wash sale occurs when you sell or trade

stock or securities at a loss and within 30 days before or after the sale, you:

i. Buy substantially identical stock or securitiesii. Acquire substantially identical stock or

securities in a fully taxable tradeiii. Acquire a contract or option to buy substantially

identical stock or securities. iv. these activities affect supply and demand of

the stick you are acquiring (inflates or decreases price).

3. Federalism argument : This federal statute does not cover actions for breaches of fiduciary duties. That is under the realm of state law. We delegate most corporate governance standards to the states.

f. Standing = need to have been a purchaser and seller of a corporation’s securities

i. Can also be a option-holder or a bond-holder, but have to be a buyer or seller of a security. Deutschman court held that a call option holder had standing to sue. An option is a security.

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ii. However, unless you hold stock before, during, and after, you do not have standing.

ii. Insider Trading1. Definition: illegal insider trading means a trade that violates breach of loyalty to the

corporation, because they are trading based on non-public information. It can be anyone who has a duty to disclose but trades on that confidential information anyways. May apply to lawyers, reporters at Wall Street Journal, printers, etc.

2. Insider Trading and Market Efficiency :a. Assumes that ECMH strong form is false (that the market knows everything –

wouldn’t be a reason for punishing insider trading otherwise).b. Assumes the market cannot adjust prices when there is material nonpublic

information3. Property Rights Analysis

a. The rationale for prohibiting insider trading is precisely the same as that for prohibiting patent infringement or theft of trade secrets

b. If we allow certain individuals to capitalize on unknown information, that will chill the market. It’s really an innovation argument that has won the day.

4. Where does insider trading come from? Rule 10b5-1a. “manipulative and deceptive devices” prohibited by Rule 10-b includes:

i. (1) the purchase or sale of a security on the basis of nonpublic information about that security of issuer,

ii. (2) in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively to the issuer of that security or the shareholders of that issuer

b. “on the basis of” = person making the purchase or sale was aware of the material nonpublic information hen the person made the purchase or sale.

5. Goodwin v. Agassiza. Holding: Defendants had no duty to disclose before trading, and therefore not

liable. No insider trading. i. There was no face-to-face transaction. The transaction was at arms-

length in the marketii. Information was highly speculative (materiality).

iii. the D did not have a fiduciary duty to the P. The duty ran to the corporation.

b. Evolution of State Common Law has moved away from this. 6. Majority Rule : There may be a duty to disclose when there are special circumstances

that are causing you to trade.7. Minority Rule : Insiders have a duty of full disclosure of material information whenever

they purchase shares from shareholders.8. Federal Rule : you either hold or disclose. Have to disclose material information before

selling. Now with electronic trading, you may only need to wait a few seconds. 9. Penalties

a. Relief in civil case brought by the SECi. Injunctions forbidding violator from being EEed in the securities

industry, being a director or officer for a public companyii. Disgorgement of profits

iii. Treble money sanctions under ITSA

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b. Criminal indictmentc. Private suits

10. Materiality and Texas Gulf Sulphura. General Test :

i. Whether there is a substantial likelihood that a reasonable investor would consider the omitted fact important in deciding whether to bur or sell securities.

ii. With respect to contingent facts: probability/magnitude balancing (Basic)b. Insider defendants

i. Legal rule: Where an insider has material nonpublic information the insider must either disclose such information before trading or abstain from trading until the information has been disclosed.

ii. Rationale : 1. “The Rule is based in policy on the justifiable expectation of the

securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information.”

2. “The essence of the Rule is that anyone who … has “access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone” may not take “advantage of such information knowing it is unavailable to those with whom he is dealing, ” i.e. the investing public

11. Tipping and Dirks v. SECa. Tipping involves an insider, but the insider herself is not doing the trading,

rather she is sharing the information with an outsider and that person using that information to buy or sell.

b. Holding : In general, the tippee’s liability is derivative of the tipper’s, “arising from his role as a participant after the fact in the insider’s breach of a fiduciary duty.”

c. A tippee therefore can be held liable only when:i. The tipper breached a fiduciary duty by disclosing information to the

tippee, andii. The tippee knows or has reason to know of the breach of duty.

d. Is the mere fact of the tip a sufficient breach? No.i. Looking at objective criteria, the courts must determine whether the

insider personally will benefit, directly or indirectly, from his disclosure. ii. Pecuniary gain; enhanced reputation that will translate into future

profits; or gifts.iii. Preserving the BJR?

e. Chiarella, p. 48212. Misappropriation O’Hagan

a. Held: The misappropriation theory is a valid basis on which to impose insider trading liability.

b. *** A fiduciary’s undisclosed use of information belonging to his principal, without disclosure of such use to the principal, for personal gain constitutes

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fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5.

c. Rule 10b5-2 provides a non-exclusive list of three situations in which a person has a duty of trust or confidence for the purpose of the misappropriation theory:

i. Whenever a person agrees to maintain info in confidenceii. Whenever the person communicating info and the person to whom it is

communicated have a history, pattern or practice of sharing confidences, such that the recipient of the info knows or reasonably should know that the person communicating info expects the recipient to maintain confidentiality; or

iii. Whenever the info is obtained from a spouse, parent, child, or sibling, unless recipient shows that history, pattern, or practice indicates no expectation of confidentiality.

d. Rule 14e-3 Prohibits insider trading during tender offer and thus supplements Rule 10b-5.

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

ii. Rule 18e-3(D) prohibits anyone connected with the tender offer from tipping material, nonpublic information about it

iii. Is not premised on breach of a fiduciary duty but O’Hagan upholds it anyways

h. Proxy Rules and Shareholder Proposals i. The Annual Meeting

1. DGCL §211(b)a. Incumbent board sets agendab. Incumbent board committee selects director candidates

2. Incumbent board sets record dates and prepares proxy and annual report3. Shareholder Voting

a. DGCL §216 – Decisions must be approved by the vote a majority of the shares present.

b. Certain matters require vote of majority of outstanding shares (e.g., mergers [DGCL §251] and amendments to certificate of incorporation [DGCL §242])

c. Directors voted by plurality [DGCL §216(3))]i. --> distinguished from cumulative voting. Cumulative voting allows

shareholders to take all of their votes and put them for one director. By putting them all on one person is going to help.

ii. Under plurality, the shareholder can put down number of votes for any director, may be more than one, that the shareholder wants to elect to the board.

ii. Securities Exchange Act §14(a) “It shall be unlawful for any person, by use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors to interest or for the protection of investors, to solicit … any proxy … in respect of any security … registered pursuant to Section 12 of this title

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iii. Levin v. MGM1. Who pays for proxy solicitation?

a. Proxy contests are time consuming and expensiveb. In general, insurgent only entitled reimbursement if they winc. But when should corporations pay for incumbents’ expenses?

2. Bottom line : it is really hard to unseat an incumbent group of directors. It is very expensive to have proxy fights.

3. Holding: a. No violation of proxy rules or regulations to pay outgoing board of directors.

Court found this to be a question of policy, not personnel.b. Disclosure, disclosure, disclosure the incoming disclosed all material facts

about reimbursing outgoing board. iv. Rosenfield management may look to the corporate treasury for the reasonable expenses of

soliciting proxies to defend its position in a bona fide policy contest. If directors are not allowed to freely answer challenges of outside groups and in good faith defend their actions.

v. Summary of Levin and Rosenfield :1. May reimburse for policy (which direction should the corporation take? This rests

heavily on BJR), but not personnel disputes (not for self-perseveration)2. May reimburse only reasonable and proper expenses3. May reimburse incumbents whether win or lose; and4. May reimburse insurgents only if they win and with shareholder ratification (fully

informed with full disclosure of expenses). vi. Rule 14a-8 – Shareholder Proposals

1. Allows qualifying shareholders to put a proposal before their fellow shareholdersa. And have proxies solicited in favor of them in the company’s proxy statementb. Expenses thus borne by the company

vii. Usual Response to Proposals1. Attempts to exclude on procedural or substantive grounds

a. Must have specific reason to exclude that is valid Rule 14a-8b. Grounds for excursion:

i. Economic1. Not otherwise significant2. Rule 14a-8(i)5): If the proposal relates to operations which

account for less than 5 percent of the company’s total assets at the than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business

3. Lovenheim v. Iroquois Brandsii. Elections

1. Rule 14a-8(i)(8) precludes proposals relating “to an election for membership on the company’s board of directors”

a. Construed to preclude shareholders from nominating director

2. AFSCME v. AIG, Inc2. Include with opposing statement

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3. Negotiate with proponenta. Wide range of possible compromises

4. Adopt proposal as submittedviii. Proxy Access

1. Big push after recession to allow more shareholder access to corporate matters. 2. Delaware enacted legislation effective August 2009 – can allow by amending bylaws to

allow shareholders more voting power. 3. SEC proposed a rule that allowed long-time shareholders more voting power – but a DC

CC vacated the rule, holding that it was arbitrary and capricious. i. Shareholder Voting Control

i. Voting for Directors1. Straight v. cumulative

a. Straight If there are four directors, the most I can vote for any directors are my number of shares, for each director. Majority shareholders dominate.

i. “Under straight voting each shareholder votes the number of shares he owns for as many candidates as may be elected.”

b. Cumulative I have eight votes to cast, and I can cast these votes any way I want. I can put them all in one director, or spread them out. It gives minority shareholders a little more power.

i. “Under cumulative voting, which is a procedure designed to give some control to minority shareholders, each shareholder gets a black of votes equal to the number of shares he owns multiplied by the number of directors to be elected.”

2. Plurality v. Majority a. Plurality whoever gets the most votes.b. Majority the candidate needs to get at least 51% of the vote.

i. Get more qualified candidates in the seats. ii. If only one candidate gets 51% of the vote, then that is the only person

appointed to the board and there are vacancies to fill. iii. Usually combined with straight voting. (would probably be much more

challenging under cumulative).ii. Common Stock as Bundle of Rights for Shareholders

1. (nice, because we have been focusing on directors the whole semester. But there aren’t a whole lot of rights that attach to the shareholder status).

2. Economic Rightsa. Receive dividends (distribution of profits) when and as declared by the board of

directors. b. Residual claim on assets in liquidation.

3. Voting Rightsa. Elect directors (though not as powerful as it seems, since the incumbent board

determines the slate of directors to be nominated)/ b. Approve some extraordinary matters. Like whether to decide to merge or

liquidate. 4. These rights can be determined by contract.

a. There is huge flexibility in the LLCb. There is much less flexibility in the structure and governance of the corporation.

There are state statutes that govern what you can do with your ownership interests. Whether you can parse them out into classes of stock, whether or not you can give more voting rights to one group over another is all determined by state law.

5. Packaging Rightsa. MBCA §6.01(b)

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i. At least one class with unlimited voting rightsii. At least one class with residual claim.

iii. May be the same – but need not be. b. MBCA §6.01(c) Authorizes nonvoting stock and other variants on one

shareholder vote. c. You can have a variety of combinations. The MBCA is incredibly flexible. d. The MBCA is very liberal, some states are more restrictive. Need to look at state

law. e. All these conditions must be set forth in the articles of incorporation. If you

wantto change the, have to amend the articles, which is more tedious. 6. Special Voting Rules

a. Election of directors by pluralityb. Cumulative votingc. Voting by groups

i. You can have series of common stock (Class A, B, C, preferred). ii. You can divide the election of directors by class (Class A elects 2

directors, Class B elects 2). d. Some boards do not get elected every year. Some boards are staggered boards,

only three of them are up for reelection every year. It’s really an anti-takeover device. If someone is trying to take over the company by buying a majority of the stock, then the person has to wait a few years before the majority stockholders can have control over the board. Most times, management has reason to be leery of who is buying up the majority of stock.

iii. Stroh v. Blackhawk Holding Corp. 1. a share could contain any of those three types of rights (economic, ownership, or

voting) and still be valid. 2. Current law?

V. Closely Held Corporations a. Close corporation typically defined as: “One in which the stock is held in a few hands, or in a few

families, and wherein it is not at all, or only rarely, dealt in by buying or selling.” Galler v. Galler. b. Characteristics:

i. Held in few handsii. No secondary market for shares

iii. Governed by state statute1. In most states, you can’t have more than 30 or 35 shareholders. 2. You have to agree to not become a public company, agree not to sell shares on the

secondary market3. In exchange, you get much more flexibility in governance. You don’t need to have a

board of directors, can eliminate annual meeting, can do a lot more with written consent instead of in-person meetings, etc.

4. Not every state has close corporation statute. c. Contrasting Close and Public Corporation Shareholders

i. Public corporation shareholders1. Usually have small % of shares as part of a diversified portfolio. 2. Interested in share price. 3. Aren’t really vested in the future of the corporation. If they’re dissatisfied, they sell.

ii. Close Corporation Shareholders1. Often undiversified2. There is a different dynamic, usually involves family and/or close friends. 3. Personality conflicts can lead to deadlock or oppression. 4. If you breach your fiduciary duties, the shareholders have a right to bring a derivative

suit, but very messy because the shareholders are often the directors themselves. The likelihood of an actual lawsuit being filed is low. Litigation is less frequent.

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d. Solution to Deadlocki. Voting Trusts

1. An agreement among shareholders under which all of the shares owned by the parties are transferred to a trustee, who becomes the nominal, record owner of the shares.

2. The trustee votes the shares in accordance with the provisions of the trust agreement, if any, and is responsible for distributing any dividends to the beneficial owners of the shares

3. DGCL §218 copy of trust document must be filed with corporation’s registered Delaware office

4. Under older Delaware statute, voting trust duration could not exceed 10 yearsii. Voting Pool Agreements : Enforcement Mechanisms

1. Ringling Bros a. Overview of Facts:

i. The arbitrator made a wise suggestion, but there was a problem with the arbitration agreement it was not self-executing. There was nothing in the agreement that was self-effectuating of what the arbitrator decided. It just said that the arbitrator’s decision was binding on the parties, but nothing stopped the parties from voting how they liked (like a provision that said the arbitrator shall vote for them, or something like that, those votes will automatically be cast).

ii. The court decides that the Haleys should be taken out all together, since they breached their agreement. So, the elected directors are Edith, Rob, Dunn, John, Woods, and Griffith.

b. Enforcement:i. Specific performance was not granted. Why?

ii. It would be unfair on North, he didn’t do anything wrong. iii. There are sort of contracts that the court are uncomfortable in enforcing,

because it would be involuntary service. Courts are very reluctant to enforce voting, ground that in the reluctant to enforce service contracts. Try to structure a remedy that will bring about a fair result, but also one that does not force someone to perform a service or vote in a particular manner.

c. Problems for Noos – valuable lessoni. Agreeing to serve as a mediator or arbitrator, particular ethical

obligationsii. Making sure you are thoughtful of conflict resolution. Make sure you

don’t cross the line beyond ethical obligationsiii. So its probably good that the court took him out of the equation.

2. McQuade v. Stoneham a. Holding : The agreement is void as against public policy.

i. Court really dissects the agreement – determines what realm are within shareholder spheres, and which are not.

ii. Directors must exercise their independent business judgment on behalf of all shareholders. An agreement that limits the decisions of directors in the future is void as against public policy.

iii. The Court saw that some other provisions as crossing into the management power sphere. To be effective, a board of directors needs to have flexibility in how they conduct management. These shareholders should be able to agree on how the directors will manage the corporation.

iv. If directors agree in advance to limit their judgment, then shareholders do not receive the benefit of their independence.

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v. General rule: shareholders do not owe duties to each other. So shareholders can unite

3. Clark v. Dodge a. The restrictive parts of the agreement were okay because all the shareholders

were a party to the agreement. Unlike McQuade. b. Also, they were both residual owners of the company and they managed it, so

they owed duties only to themselves. 1933 SECURITIES ACT

Section 11

a. Persons possessing cause of action; persons liable

In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdiction, sue-- 

1. every person who signed the registration statement; 

2. every person who was a director of (or person performing similar functions) or partner in the issuer at the time of the filing of the part of the registration statement with respect to which his liability is asserted; 

3. every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner; 

4. every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him; 

5. every underwriter with respect to such security.

If such person acquired the security after the issuer has made generally available to its security holders an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement, then the right of recovery under this subsection shall be conditioned on proof that such person acquired the security relying upon such untrue statement in the registration statement or relying upon the registration statement and not knowing of such omission, but such reliance may be established without proof of the reading of the registration statement by such person.

b. Persons exempt from liability upon proof of issues

Notwithstanding the provisions of subsection (a) of this section no person, other than the issuer, shall be liable as provided therein who shall sustain the burden of proof-- 

1. that before the effective date of the part of the registration statement with respect to which his liability is asserted (A) he had resigned from or had taken such steps as are permitted by law to resign from, or ceased or refused to act in, every office, capacity, or relationship in which he was described in the registration statement as acting or agreeing to act, and (B) he had advised the Commission and the issuer in writing that he had taken such action and that he would not be responsible for such part of the registration statement; or

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2. that if such part of the registration statement became effective without his knowledge, upon becoming aware of such fact he forthwith acted and advised the Commission, in accordance with paragraph (1) of this subsection, and, in addition, gave reasonable public notice that such part of the registration statement had become effective without his knowledge; or 

3. that (A) as regards any part of the registration statement not purporting to be made on the authority of an expert, and not purporting to be a copy of or extract from a report or valuation of an expert, and not purporting to be made on the authority of a public official document or statement, he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and (B) as regards any part of the registration statement purporting to be made upon his authority as an expert or purporting to be a copy of or extract from a report or valuation of himself as an expert,(i) he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or(ii) such part of the registration statement did not fairly represent his statement as an expert or was not a fair copy of or extract from his report or valuation as an expert; and (C) as regards any part of the registration statement purporting to be made on the authority of an expert (other than himself) or purporting to be a copy of or extract from a report or valuation of an expert (other than himself), he had no reasonable ground to believe and did not believe, at the time such part of the registration statement became effective, that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that such part of the registration statement did not fairly represent the statement of the expert or was not a fair copy of or extract from the report or valuation of the expert; and (D) as regards any part of the registration statement purporting to be a statement made by an official person or purporting to be a copy of or extract from a public official document, he had no reasonable ground to believe and did not believe, at the time such part of the registration statement became effective, that the statements therein were untrue, or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that such part of the registration statement did not fairly represent the statement made by the official person or was not a fair copy of or extract from the public official document.

c. Standard of reasonableness

In determining, for the purpose of paragraph (3) of subsection (b) of this section, what constitutes reasonable investigation and reasonable ground for belief, the standard of reasonableness shall be that required of a prudent man in the management of his own property.

d. Effective date of registration statement with regard to underwriters

If any person becomes an underwriter with respect to the security after the part of the registration statement with respect to which his liability is asserted has become effective, then for the purposes of paragraph (3) of subsection (b) of this section such part of the registration statement shall be considered as having become effective with respect to such person as of the time when he became an underwriter.

e. Measure of damages; undertaking for payment of costs

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The suit authorized under subsection (a) of this section may be to recover such damages as shall represent the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and (1) the value thereof as of the time such suit was brought, or (2) the price at which such security shall have been disposed of in the market before suit, or (3) the price at which such security shall have been disposed of after suit but before judgment if such damages shall be less than the damages representing the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and the value thereof as of the time such suit was brought: Provided, That if the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from such part of the registration statement, with respect to which his liability is asserted, not being true or omitting to state a material fact required to be stated therein or necessary to make the statements therein not misleading, such portion of or all such damages shall not be recoverable. In no event shall any underwriter (unless such underwriter shall have knowingly received from the issuer for acting as an underwriter some benefit, directly or indirectly, in which all other underwriters similarly situated did not share in proportion to their respective interests in the underwriting) be liable in any suit or as a consequence of suits authorized under subsection (a) of this section for damages in excess of the total price at which the securities underwritten by him and distributed to the public were offered to the public. In any suit under this or any other section of this title the court may, in its discretion, require an undertaking for the payment of the costs of such suit, including reasonable attorney's fees, and if judgment shall be rendered against a party litigant, upon the motion of the other party litigant, such costs may be assessed in favor of such party litigant (whether or not such undertaking has been required) if the court believes the suit or the defense to have been without merit, in an amount sufficient to reimburse him for the reasonable expenses incurred by him, in connection with such suit, such costs to be taxed in the manner usually provided for taxing of costs in the court in which the suit was heard.

f. Joint and several liability; liability of outside director

1. Except as provided in paragraph (2), all or any one or more of the persons specified in subsection (a) of this section shall be jointly and severally liable, and every person who becomes liable to make any payment under this section may recover contribution as in cases of contract from any person who, if sued separately, would have been liable to make the same payment, unless the person who has become liable was, and the other was not, guilty of fraudulent misrepresentation. 

2.

A. The liability of an outside director under subsection (e) shall be determined in accordance with section 21D(f) of the Securities Exchange Act of 1934.

B. For purposes of this paragraph, the term "outside director" shall have the meaning given such term by rule or regulation of the Commission.

g. Offering price to public as maximum amount recoverable

In no case shall the amount recoverable under this section exceed the price at which the security was offered to the public.