Fall 2008 A. Mutual Corporations Outline

I. Introduction* The 5 Questions One Must Be Able to Answer:1. What is the business structure?2. How does one form the business structure?3. Who owns the business?4. How does the business make money?5. How does one get out of a business?

* What is the purpose of a business? o To make a profit ($$$) o To create value for the business’s owners o Note: Businesses also serve hidden public functions by facilitating certain human needs. * What is Milton Friedman’s View? o He describes businesses as “special purpose entities” whose sole purpose is to make $ on behalf of the owners. o Managers are agents of the owners of the business, and as agents their primary responsibility is to the owners of the business. * What is the structure of Not-For-Profits? o They are associations, not businesses* Entity Theory of the Firm: A corporation is a separate legal person with individual rights.

How does a Lawyer determine what form a business should take (what are the considerations)?:* Ease of Forming: How easy/difficult is it to get started as this type of entity?* Liability: Lawyers seek to reduce the risk of an owner’s liability when one is going to invest in a business.

o Personal Liability: If you can be held personally liable, then your personal assets can be reached and not just your business’s assets. o Limited Liability: As investor, you will only be liable for your investment in the business, and not your personal assets. o 2 Types of Liability can occur in Business Law?

-Tort: injury to person/property-Contract: damages that occurred from the breach of an agreement, economic liability.

* Taxes: when forming a business structure, one wants to make tax liability for the owner as little as possible. o Pass Through Taxation: The owners of the business will pay tax on the profits/losses of the business on their personal income tax returns.

o Double Taxation: The business entity, itself, pays taxes and then the owners must also pay taxes on distributions of earnings (dividends) that the business issues to its owners.* Management/Control: What type of power does the owner want in the business or who do they want to delegate that power to?

o Centralized Management or Triangular Model: The owners delegate power to the managers who then run the entity. The managers make day-to-day decisions and are agents of the entity.

o Decentralized Management: All of the business owners are the actual managers of the entity.* Transferability/Exit: How easy/difficult is it for me to sell or exit from this form of business?

AP Smith Mfg. Co. v. BarlowCB6: The Corporation’s BOD donated $1500 to Princeton University. The shareholders of the corporation sued because the articles of incorporation did not provide for donations and that this money was given to a school when it could have been paid to them in the form of dividends.Issue: Was the donation intra vires (within the scope of their authority) or ultra vires?H/R: The donation by the BOD was in the scope of the Board’s authority.Rsg.: The Court stated that the power to donate was an “implied authority”. Specifically, the state codified a common law principle that allowed for such donations to be made (this law was passed after this corporation was formed). The Court stated that the BOD acted properly because they were acting in a morally and socially responsible way, which could benefit the corporation (public benefit yields good advertising and increases the company’s marketability, improving the work force by donating to education) and only donated a modest amount. Court also states that

corporations were originally formed with a public purpose and that they may continue to act with a public purpose, even though anyone can form a corporation today. Since individual wealth is now moving into the hands of corporations, the corporations have an implied power to meet the social obligations that individuals used to meet.

Pet projects (charities)? If one gave to a pet charity, they would be acting on their own behalf, rather than truly acting with the interests of the corporation in mind, so this might be barred, according to Milton Friedman.

What is a Rule you can take away from this case? Management has broad discretion to act within the corporation’s interests even if some shareholders disagree with the action. So as long as a donation has some business purpose and is not given to a pet charity, a donation will be allowed.

II. The Sole Proprietorship & its Funding; Agency; & Franchise Law*Managers as Agents to the Corporation: Managers are agents of the corporation, which is a separate legal entity; they are not agents of the owners, in the eyes of the law.

The Sole Proprietorship: * Defined: Default business structure for business with one owner* State: One has to file nothing with the state to form this type of business.* Owner: The owner is the sole proprietor* Profits/Losses & Taxes: The owner bears the profits/losses of the business and pays the taxes on the profits (if any) on his/her personal income tax return.* Creditors: They sue the sole proprietor (not the business)* Liability: There is personal liability; no limited liability. The owner is responsible for the torts and contracts of her employees. This poses a big risk to someone who operates a business this way because all of their personal assets are exposed.

Agency Theory:* Restatement of the Law (Second) Agency: §§ 1, 2, 7, 8, 8A, 26, 27,34, 35, 82, 140, 219, 220, 228, 229, 320, 383, 385, 400, 401, and 402.

o Note: 140 & 320 not in your statute book.

§ 140: Liability Based on Agency Principals: The liability of the principal to a third person upon a transaction conducted by an agent, or the transfer of his interests by an agent, may be based upon the fact that:(a) the agent was authorized;(b) the agent was apparently authorized; or(c) the agent had a power arising from the agency relation and not dependent upon authority or apparent authority.

§ 320: Principal Disclosed: Unless otherwise agreed, a person making or purporting to make a contract with another as agent for a disclosed principal does not become a party to the contract.

§ 393: Competition as to Subject Matter of Agency: Unless otherwise agreed, an agent is subject to a duty not to compete with the principal concerning the subject matter of his agency.

* 3 Central Requirements to have an Agency Relationship: See §1o Fiduciary Relationship: The agent owes duties to the principal (a “trust” relationship” such as the duties of care,

loyalty, and to obey reasonable instructions).o Manifestation of consent: words or conduct from the principal to the agent delegate some type of authority to the

agento Consent of Agent to Do it: Agent can accept to act on behalf of the principal in words/conduct as well.o Example: American Airlines: The principal (AA) is liable to 3rd parties (customers) for actions of the agent

(travel agent of AA) who acts (books tickets).* Contractual Capacity: the ability to enter into a contract

o Who doesn’t have contractual capacity? Minors, incompetents, and organizations [people in organizations have capacity to bind the org.]

o Do Agents have contractual capacity? They do not have to have it.* Torts in the P/A relationship:

o Ps, who are masters, are liable for their As, servants, torts if the servant is acting within the scope of his employment (even if P did nothing wrong).

o How do we know if something is within the scope of employment? We look to §§ 228 & 229.o Can the Master be held liable for the torts of their servants if the Servant acted outside of the scope of his/her

employment?-YES, see § 219(2), if the

# (a)Master intended for the conduct or the consequences or# (b) the master was negligent or reckless or# (c) the conduct violated a non-delegable duty of the master or

# (d) the servant is purported to act or to speak on behalf of the principal and there was reliance upon apparent authority, or he was aided in accomplishing the tort by the existence of the agency relation.

* 5 Ways to Establish Authority of P-A Relationship:o Actual Express Authority: P tells A to do (or not do) something or P uses conduct to tell A to do (or not do)

something. The communication is between P and A.-See §§ 7, 26, 34, and 35

-Example: P leaves $ on the table and A asks if they should go buy milk. P nods head at A. What authority does A have?

# A has actual express authority to buy milk.o Actual Implied Authority: A must take steps that are “reasonably necessary” or that A “reasonably believes” are

necessary to get the job done for the P. These acts are incidental to completing the P’s goal. [may be implied from custom, what A reasonably believes, from acquiescence, or can be implied from an emergency]. The P must be specific and clear if they don’t want something to be implied from their instructions to A.

-See §§ 7, 26,34 and 35Ex: Professor Mutua asks her secretary Dawn to make arrangements for the conference in Cincinnati. What is

Dawn’s actual implied authority?Dawn, an agent to Prof. Mutua, has actual implied authority to make plane, hotel, and car reservations b/c all of

these activities are “reasonably necessary” to get the job done for the principal, Professor Mutua.o Apparent Authority: P manifests (informs) to a 3rd party in some manner that A has authority to do something.

The communication is between P and a 3rd party. (Note: Past relationships allows 3rd parties to infer that an A has apparent authority to do something). All that matters is what the 3rd party “reasonably believes” to be the power of the A and that the 3rd party relied upon that reasonable belief in its dealings with the A.

-See §§ 8 & 27Ex: Mary, who works for Lettuce Co., walks into Moe’s with the owner and CEO. Mary says that I am here to

sell you lettuce and Bob says nothing to the owner of Moe’s. Mary sells lettuce to Moe’s. Did Mary have the authority to enter into this contract?

Yes, Mary had apparent authority to sell lettuce to a 3rd party (Moe’s) because P said nothing an evidenced to Moe’s that Mary had such authority to engage in this transaction.

Ex: Raquel Welch works for Guliard. Raquel always brings in music equipment to get fixed at Music Mania and Guliard always pays the bill on time. Raquel is fired and then brings in a guitar to get restrung. Is Guliard responsible to Music Mania for the repair costs?

-Yes, Guliard is responsible because Raquel had the apparent authority to bring in equipment to be fixed and the principal did nothing to communicate to the 3rd party (Music Mania) that Raquel’s authority to get things fixed no longer existed.

o Inherent Authority: The authority of A to act is part of the “nature of the relationship” between P and A. There might be an undisclosed relationship here that gives A the authority or there might be an undisclosed principal when the agent exceeds its authority, but it seems part of A’s job.

See §8A Ex: The Hayes Case, see below.

o Ratification: although their was no prior relationship between P and A that allowed A to act in a certain way, A acts in a way, and then P approves A’s action, means that P has ratified and has taken responsibility for what A has done. P forms the P/A relationship by allowing A’s actions to continue.

See §82

Ex: Benny Jets buy tickets for George Jetson, his boss, to go to Space World Conference, which focuses on how to improve one’s space business. The tickets come in the mail and George goes to the conference. George tells Benny to pay for the tickets out of his own money. Benny says no because he says that George went to the conference anyway. Who has to pay for the tickets?

- George Jetson must pay for the tickets because he “ratified” the actions of his agent by going to the conference even though George never approved Benny’s purchase of the tickets. If George didn’t want to pay for such tickets, then he should not have gone to the concert.

* Problems Page 46o (1) Propp hires Agee as cook, and tells her that part of her job will be to order food for the restaurant. Agee orders

grits and the other essential ingredients for Southern-style burritos from Tee Pee Distributing Co. Agee orders food from TP and TP delivers the food to Bubba’s Burritos. Is Propp legally obligated to pay for the food? Is Agee legally obligated to pay for the food.

-Yes, A is an agent of P pursuant to §1. P is legally obligated to pay for the food ordered by A because P gave A either actual express or actual implied authority to do so because P told A that ordering food is specifically part of A’s job and that is what A did. Agee is not liable to pay for the food because under §320 of the Restatement, the agent is not a party to the contract when there is a disclosed principal here like Propp.

o (2) After several months of various bad experiences with Agee’s food orders, Propp instructs Agee to reduce food purchases from TP from their present levels of 2200/month to no more than 1000/month. Notwithstanding this clear indication, Agee orders 2200 of new food from TP. What result?

- P is obligated to pay TP because of A’s apparent authority to do so. Apparent authority occurs when P manifests to a 3rd party that A has the power to do something. Here, P never communicated to TP that A no longer had such authority to make larger orders. §27 allows for P to be held liable to TP because TP “reasonably interpreted” that P consented to A making such large orders. A is not legally obligated to pay the 2200 under the contract because A is not a party to the contract under §320. However, A can be held liable to Propp because A owes P a fiduciary duty under §1. The fiduciary duty breached by A here is the duty to obey, which is described in §385 and states that “an agent is subject to a duty to obey all reasonable directions” and since it is reasonable for P to tell A how much food to order and A ordered a different amount, it is reasonable to conclude that a breached the duty to obey. §401 makes A liable “for loss caused to the principal by any breach of duty.” In this case, the breach was the duty to obey, so A may be held liable to P for a loss.

o (3) Agee (cook) calls the Tuscaloosa News and tells the advertising director that she is running Bubba’s Burritos for Propp (which is not true). She then places a series of full-page ads for BB with the newspaper. What result?

- Agee had no actual express or implied authority to use the company’s resources in this manner. Agee also had no apparent authority to do this because P never communicated to the News that A would have authority to place ads. So, Agee will most likely be held liable because an Agent has a “duty to act only as authorized” under §383 where “an agent is subject to a duty to the principal not to act in the principal’s affairs except in accordance with the principal’s manifestation of consent” and breached this duty by placing the ads. A will be held liable under §401 for the “loss caused to the principal by any breach of duty.”

* Master/Servant Relationship, aka, Employee/Employer Relationshipo Master is liable for the TORTs of their servants (a heightened liability) if the tort was committed within the scope

of employment. (respondent superiorà P can be liable even though P was not personally negligent).-Whereas, a P is not typically liable for the torts of an agent, the P will be held liable for the torts of its agents in

the master/servant context. All Ps are typically liable for contracts that A forms, regardless if master/servant or P/A more generally.

o Master, Servant & Independent Contractor: See § 2-Master: is a principal that is an employer-Servant: is an agent that is employed by a mater.-Independent Contractor: “is a person who contracts with another to do something for him but who is not

controlled by the other nor subject to the other’s right to control with respect to his physical conduct in performance of the undertaking.” He may or may not be an agent.

o Note: One can turn an independent contractor into an agent, but not a servant.

* Problems Page 49

o (1) Propp hires Servantes to work as a waiter in BB. What is going on here and who is what using the terminology studied thus far?

-S is a servant here pursuant to §2, which thus makes S an agent as well. P is the principal and master in this situation. The main difference between the regular P/A relationship and the M/S relationship is that a master has more control over the day to day actions of his servants and therefore his held liable for his servant’s torts, whereas a more general principal will not always be held liable for his agent’s torts.

-All agents are NOT servant. However, all servants are agent.- All employees are servants. What is the difference between P and Master liability?-The master has more day to day control over the servant and is liable in both contract and tort, whereas the

principal is only liable in contract for the actions of its agent.o (2) Is the CEO of GM a servant? Is the pilot of Flight 222 a servant of AA? Are you liable if your accountant

accidentally burns someone with cigar ash while doing your taxes?-The CEO of GM is a servant (an employee like all others).- The pilot is a servant as well.- The accountant is an independent contractor here because he is “not controlled by the other nor subject to the

other’s right to control with respect to his physical conduct in performance of the undertaking.” §2(3). And since the accountant is an independent contractor, I would not be liable for my accountant’s torts even though he was working on my taxes.

o (3) Servantes negligently spills coffee on a customer. Is Propp liable in tort to the customer? What if Propp specifically told Servantes, both orally and in writing, that his job description does not include spilling liquid on customers? Is Servantes also liable in tort to the customer?

- Yes, P is liable for the torts of his A here because P and A are involved in a master/servant relationship, pursuant to the definitions of master and servant in §2 where a master is an employer and a servant is an employee. Under §219, a “master is subject to liability for torts of his servants committed while acting in the scope of employment.” Servantes was acting within the scope of his employment because serving drinks at a restaurant is “of the kind [of work] he is employed to perform,” occurred within the restaurant, and was done to make the master money pursuant to §228(1), which defines generally what “conduct of servant is within the scope of employment.” 228(1)(d) is not needed because force was intentionally used. §229(2) gives factors that can be used to determine if something is within the scope of employment. Even though P gave those specific instructions, P will still be liable under §229 because A was acting within the scope of his employment because of many factors listed in §229(2) such as (a), (b), (f), (g), and (h). Additionally, Servantes can be held liable for the tort to the customer, but the customer goes after P because P has the money.

o (4) While driving to work, Servantes negligently injures a pedestrian. Is P liable in tort to the pedestrian? Is Servantes liable in tort to the pedestrian?

- P is not liable because Servantes’ driving to work is not “within the scope of his employment.” Under §§ 228 & 229, the action by Servantes occurred outside of the “authorized time and space limits.” Driving to work is generally considered outside the scope of employment. Servantes can be held liable for this tort because he is the tortfeasor.

o (5) P hires A to work as a cook. When A overhears Customer Cully criticizing her cooking, she hit Cully over the head with a skillet. Is A liable in tort to the customer? Is P liable in tort to the customer? Is Servantes liable in tort to the customer?

-We will likely NOT hold P liable for A’s intentional use of force tort here because A’s use of force was “unexpectable by the master.” Had A’s use of force been “not unexpectable by the master,” then P could potentially be held liable for such a tort under §228(1)(d). Agee will be held liable for this tort as a tortfeasor. Of course, Servantes is not liable for his co-workers tort.

Hayes v. National Service Industries:CB50 Hayes hired Rogers (an attorney) to represent her in a discrimination action. Rogers reached a settlement with National’s attorneys but Hayes did not like it. National filed this suit to enforce the settlement.H/R: An attorney is an agent who may bind the principal, his client, because the attorney has apparent authority to settle cases. Hayes has to live with the settlement.Rsg.: Attorney/Client Relationship: An attorney’s actual authority is determined by a representation agreement between the client and attorney and any instructions given by the client, and that authority is plenary (full and complete authority) unless 1) it is limited by the client AND 2) that limitation is communicated to opposing parties. So, an

attorney has an apparent authority to settle cases unless, the client communicates to the 3rd party that the attorney may not take such action.

*Questions on Page 52: Actual authority is created through words/conduct to the agent, whereas apparent authority involves a manifestation from the principal to a third party that A has authority to do something to bind P. National was able to assume that Rogers could settle the case for Hayes because of the existing relationship between Hayes and Rogers. Hayes did not limit the duties of Rogers by communicating to the 3rd party that Hayes does not have the authority to settle. Even if Hayes communicated to Rogers not to settle, Rogers still had apparent authority to settle the case and the settlement would be binding unless Hayes communicated to the Third Party that Rogers cannot do this. Hayes may still sue Rogers for breach of contract if Rogers actual authority did not include the ability to settle cases. In this case Rogers might have had actual authority to settle because of actual implied authority or inherent authority.

Can an agent create his own authority to bind a principal? No, the agent binds the principal because the principal created the apparent authority that the agent could act in some way. What the agent says or thinks is irrelevant; all that matters is whether the 3rd party reasonably believes that A had such authority based on P’s words or conduct communicated by the P to the A.

Franchise Law* Franchise: an independently owned and operated store.* Franchisor: one who gives someone permission to replicate their business model for some type of fee (fixed amount or % of profits).

o What does the franchisor want? Control.o Ex. of a Franchisor: McDonalds, Subway, etc.

* What does the consumer expect when they enter a franchise?o Consistency AND Reputation

* Franchisee: the person who owns/operates the independent store, who wants to sell the consistency/reputation of the franchisor, so that they themselves as owner can generate a profit.* Main Theme: Should franchisors be held vicariously liable for the torts of his/her franchisees? We ask this question because the consumer thinks that the franchisee has apparent authority to act on behalf of the franchisor.* What is the trick about franchise cases and determining whether the franchisor will be held liable for the torts of franchisee?

o They are virtually all fact specific in determining whether vicarious liability should be imposed or not for the tort of a franchisee.* Franchisors & Contract Liability: No liability for the franchisor because the franchisee will enter into contracts with their own independent business’s name.

Miller v. McDonald’s Corporation:CB55 3k Restaurants owns a McDonalds franchise. A customer found a sapphire ring in her Big Mac and sues the McDonalds Corporations instead of 3k for this tort.Issue: Should McDonalds be held liable for 3Ks tort?H/R: Yes, because McDonalds “exercised sufficient control” over the day-to-day operations of 3Ks restaurants by imposing uniformity (layout, management training, advertising, trademarks, food handling, and suppliers), which makes them vicariously liable for 3Ks negligence. This was evidenced by the fact that McDonalds set the daily hours of operations and continually made surprise site visits at the restaurant to insure that it was being operated pursuant to McDonald’s standards. All of these facts together, make it pretty clear that McDonalds exercised sufficient control over the operations to be held liable for the tort of its franchisee.

Could 3k have been found liable? Yes, 3K could have been held liable under general agency principles, but McDonalds has the deep pockets and that is who the customer goes after.

The Court noted that the agreement between 3k and McDonalds provided that 3k was not an agent of McDonalds. Did these words matter? No, these words do not matter to the court because of the amount of control McDonalds exercised over 3k. The words were not determinative, because the conduct of McDonalds corporation manifested apparent authority to the customer and thus created an agency relationship, that subjected McDonalds corporation to vicarious liability for the torts of its franchisee, at least in this situation.

How does one fund a Business?* Equity: investment, where you get a stake in the business by having some ownership in it. There is no right of repayment for invested capital.* Debt: this is a loan. The creditor has the right to be repaid principal + interest. The business has a legal obligation to repay a loan and will get paid before any equity investors if the business tanks.* Risks: debt vs. equity? Debt can force you into bankruptcy because one must be able to meet their debt service, which are mandatory payments that could make a business insolvent quickly. Equity can all be lost by the investor if the business tanks, which is a pretty big risk.

o Debt: Risky for the business and not the individualo Equity: Risky for the indiv., not for the business

In Re Estate of Fenimore:CB74 Brother and Sister sign an agreement where S agrees to loan money to her B so he can start a business, but the agreement also states that B & S will share in the profits. The creditors of the business then came after B. S then says that she is entitled to the money that B has first because she had an outstanding loan with her B. The creditors disagree and say that B and S were operating a partnership and that S did not make a loan.Issue: whether debt or equity? Does a partnership exist?UPA §4: “The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business…”H/R: B and S were engaged in a partnership because they agreed to share the profits. So, S will be last in line to get money back since she is deemed an equity investor.

Bottom Line: You can form a partnership with someone even if you do not intend to.How could S have avoided UPA §4? S could avoid it by arguing under §4(a) or (d) that the money she gave her

brother was debt by saying that the profits were received in payment “as a debt by installments” or “as interest on a loan.” The Court just chose not to go there.

How would this come out under RUPA §202: The Court would still consider it a partnership because the business was being carried on for profit, “whether or not the persons intend to form a partnership.”

What were the effects of treating this as equity, opposed to debt? Now, the creditors can go after her personal assets as a partner and she will be the last person to be paid back if there was money left over after liquidation.

III. General Partnership Law* What is a partnership?

o The Basic Elements:-Default: It is the default business structure when 2 or more people own and operate a business together. No

lawyer necessary. It is cheap to form.- UPA & RUPA govern as default rules for partnership law.-Profits/Losses: they share them equally, unless otherwise agreed upon.-Management/Control: they share the control (management) equally, unless otherwise agreed upon.-RUPA §401(f): “Each partner has equal rights in the management and conduct of the partnership business”-RUPA §401(i): “A partner may become a partner only with the consent of all the partners.”-RUPA §401(j): Majority of the partners can make a decision that is done in the “ordinary course of a business

of a partnership,” however “an act outside the ordinary course of business of a partnership and an amendment to the partnership agreement may be undertaken only with the consent of all the partners.”

-All of the provisions of 401 can be altered by the partnership agreement.-Partnerships Own Property?: the partnership can own property and it is not owned by the individual partners. -RUPA §203: Partnership Property: “Property acquired by a partnership is property of the partnership and not of

the partners individually.”-RUPA §204: When Property is Partnership Property: spells out what is partnership property and what is

separate property.-Residual Category: §204 – presumptions of who own property: transfer of title, transfer into name, assets used

to purchase, -Flow Through Taxation: pass through entity where the owners pay taxes on the profits/losses on their personal

income tax returns.-Liability of Partners:

-RUPA §306: Except as in (b) and (c), “all partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law.” Essentially, there is unlimited liability for the partners who are part of a partnership.

-The partnership (the entity, itself) and/or the partners can be held liable to potential creditors.-In many cases, a Plaintiff collects the judgment from the partnership’s assets, itself before going after the

individuals.*You can only get individual assets of one partner if that partner is specifically liable and the partnership has no

assets left for you to get.Transferability: is rather difficultFiduciary Duties: Care, Loyalty, and Fair Dealing between the partners and the partnership.Ends: at the death of all of the partners unless otherwise agreed upon.

o RUPA §201(a): “A partnership is an entity distinct from its partners.”o Defined:

UPA §6: A partnership is an association of two or more persons to carry on as co-owners of a business for profit. [does not consider the partnership a distinct entity]

RUPA §202: “…the association of 2 or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.” [does consider it a distinct entity]

o Partnership Agreement: While UPA and RUPA govern partnership law by providing default rules, UPA and RUPA both allow partnerships to have a partnership agreement among the partners that spells out each partners’ functions within the partnership. The partnership agreement basically becomes the law of the business. However, there are certain non-waiveable provisions in a partnership agreement.

RUPA §103(b): lists 10 non-waivable features of partnership law.-Ex: 103(b)(10): the agreement cannot “restrict the rights of 3rd parties,”

o What governs a partnership besides the partnership agreement?UPA, RUPA and other statutesCase LawAgency Principles (Ex: Statement of Partnership Authority in RUPA §303).

* Problems/Questionso Pg. 83

(2) Can a Business be both a partnership and corporation? -No, it cannot be a partnership and a corporation because of RUPA §202(b), which states that once you file as one then, you can’t be the other.

(3) Can a corporation be considered a partner in a partnership?-Yes, because a corporation is considered a person under RUPA §101(10).

o Pg. 85(1) To operate BB as a partnership, do P, A, and C need a written partnership agreement?-No they do not need one, but a lawyer should advise them to have one because of the potential conflicts that

could develop later on. But if they don’t have one, UPA and RUPA will govern their affairs.(2) Do P, A, and C need a lawyer? Do they need more than one?-No, they don’t need a lawyer. But, if they do get one, then they probably each need their own so that each can

be given unbiased advise and negotiate for his/her individual interests.o Pg. 87

(1) P, A, and C decide to operate BB as a partnership. How can the partnership acquire property?-The partnership may acquire property pursuant to RUPA §204.(2) Did the cooking equipment P used in the restaurant before the formation of the partnership automatically

become partnership property?-No, the cooking equipment is separate property under RUPA §204(d). The partner must transfer the property

under §204(b)(2), if he wants to, in an official manner in order for the equipment to belong to the partnership and not himself anymore.

(3) Are the cash and credit card receipts from the partnership operation of BB partnership property?-Yes, because the cash and receipts were earned in the name of the partnership, pursuant to §204(a)(1).(4) After formation of BB partnership, suppose BB acquires new tables and chairs. Are these partnership

property?

-Yes, assuming BB purchased the furniture in the name of the partnership or one or more of the partners indicated in the title transfer that they were purchasing this in their capacity as a partner even though it doesn’t state the partnership’s name, pursuant to §204(a). It can also be partnership property, if it was “purchased with partnership assets,” pursuant to §204(c).

(5) After formation of the partnership suppose BB uses funds provided by Capel to buy Blackacre. Is Blackacre partnership property? What if the seller deeds Blackacre to Capel?

-Yes, Blackacre is assumed to be partnership property as long as Capel had already contributed those funds to the partnership, pursuant to §204(c), which states that “property is presumed to be partnership property if purchased with partnership assets.” Even if the seller just deeded blackacre to Capel, it would still be partnership property under §204(c) because it was purchased as a partner with partnership funds, in his capacity as such, even though it was deeded to his name.

o Pg. 89(1) BB is a partnership. A, P and C are the partners. A and C want the partnership to lease a building from

Roberts. P disagrees. P comes to you with the question of whether the partnership can lease the building even though he is opposed. Assume no partnership agreement concerning this issue. What result?

-Absent an agreement, under 401(j) a majority of partners can make a decision that is in the ordinary course of business. Since 2/3 agree here to lease the property, the partnership can lease it if the leasing of a building is construed in the ordinary course of business. However, since leasing a building might fall outside the ordinary course, P’s approval might be needed if leasing is deemed to be outside of the ordinary course. When something is outside of the ordinary course, “consent of all of the partners” is needed under 401(j).

(2) Same basic set up, however, the partnership agreement provides that “Capel shall serve as managing partner, and, as such shall have the authority to lease property on behalf of the partnership without consulting any other partner.” Capel without consulting A or P, rents a building for the partnership from Roberts for 10,000/year for 10 years. Is the partnership legally obligated to pay Roberts?

-Yes, the partnership is legally obligated to pay Roberts because Capel had apparent authority to make such a lease. The partnership agreement is irrelevant to a 3rd party. This statement in the partnership agreement is valid because §401 is a section that can be addressed in a different way in the partnership agreement.

(3) Same facts as Q2 except Capel is not the managing partner. Instead, the partnership agreement provides “No partner may, without the express consent of the other partners, lease property on behalf of the partnership.” Notwithstanding this provision, C, without consulting A or P, rents the building for the partnership from R. Is the partnership legally obligated to pay the lease?

-Yes, the partnership will be legally bound to pay the lease unless the partnership communicated to Roberts that C could not enter into such an agreement, pursuant to the requirements of §301(1) & (2).

(4): Same facts as Q3, but now A and P want to know if they can take legal action against C?-§405 (Note: does not appear in statute book): Actions by Partnership and Partners:

(a) A partnership may maintain an action against a partner for a breach of the partnership agreement, or for the violation of a duty to the partnership, causing harm to the partnership.

(b) A partner may maintain an action against the partnership or another partner for legal or equitable relief, with or without an accounting as to partnership business, to: (1) enforce the partner's rights under the partnership agreement;(2) enforce the partner's rights under this [Act], including:(i) the partner's rights under Sections 401, 403, or 404;(ii) the partner's right on dissociation to have the partner's interest in the partnership purchased pursuant to Section 701 or enforce any other right under [Article] 6 or 7; or (iii) the partner's right to compel a dissolution and winding up of the partnership business under Section 801 or enforce any other right under [Article] 8; or(3) enforce the rights and otherwise protect the interests of the partner, including rights and interests arising independently of the partnership relationship.

(c) The accrual of, and any time limitation on, a right of action for a remedy under this section is governed by other law. A right to an accounting upon a dissolution and winding up does not revive a claim barred by law.

-P and A can sue C under §405(a) for the breach of the partnership agreement. P and A can sue C under §405(b)(1).

Meinhard v. Salmon:CB90 S entered into a 20-year agreement with M, where S managed the property. In the 19th year of the deal, S was approached by G to do a redevelopment and did not tell M. Only after the 20th year, did M find out that S entered into this redevelopment plan.Issue: w/ coadventure=pship & req. fid. duty?H/R: (Cardozo) The plan for redevelopment came to S, in S’s capacity as manager of the original transaction between M and S. And since it came to S, in this capacity, S had at a minimum a duty to disclose to M about the opportunity, which stemmed from the original agreement. Rsg.: Co-adventurers & Duties: M and S were joint-venturers or co-adventurers, which is akin to a partnership. In such a relationship, one has a duty to disclose opportunities that exist for the benefit of the enterprise and not take those opportunities for one-self. The opportunity existed for the entity and not S, personally. S acted in secrecy, when this opportunity came to S because of the position that M put S in and therefore the opportunity belonged to the partnership enterprise and not S personally. In this case, this opportunity had to come to S first because S was the manager, which required him to tell M of this opportunity that existed for their enterprise.

Bottom Line of the Case: Fiduciary Duties attach when the opportunity arises out of the pship.Dissent: Andrews says this is not a general partnership and that this opportunity was for a separate and distinct deal.

* Fiduciary Duties of Partnerso RUPA §404(a): The only fiduciary duties a partner owes to the partnership and other partners are the duty of

loyalty and duty of care as described in (b) and (c).(b): The Duty of Loyalty:

Account to the partnership profits and lossesDon’t deal with someone who has an adverse interest to the partnershipCan’t compete with the partnership

(c): The Duty of Care:act “skillfully” - due diligence, investigation, research“…is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct,

or a knowing violation of law.”(d): Obligation of Good Faith and Fair Dealing: Good faith and fair dealing should be done in one’s conduct(e): “A partner does not violate a duty or obligation under this [Act] or the partnership agreement merely

because the partner’s conduct furthers the partner’s own interest.”o How does §103(b) apply to the fiduciary duties of care and loyalty:

(b)(3): Duty of loyalty cannot be eliminated, but the partnership agreement may identify and name specific types of activities that do not violate the duty of loyalty, “if not manifestly unreasonable” or the agreement allows the partners to authorize a certain transaction that would otherwise violate the duty of loyalty.

(b)(4): The partnership agreement may not “unreasonably reduce the duty of care” and may not eliminate it.(b)(5): The partnership agreement may not eliminate good faith and fair dealing, but it may identify standards to

determine what is good faith and fair dealing as long as those standards are not manifestly unreasonable.o The Duty of Care is not as specific as the duty of loyalty, so what might the duty of care entail?

Due Diligence, Thoughtfulness, Skill, Gathering of Information, Acting on Informationo What happens when one of the fiduciary duties are breached?

§405 of RUPA will apply, see above.o RUPA §§ 305, 306, and 307: All deal with who can be sued, who can sue, who can recover, and where the

recovery may come from. All are very important sections.o Problems Page 100: A, C, and E are partners in the ACE partnership. In the course of her work for the

partnership, A, through her negligence, injures P.(1.1) Could P sue and recover from ACE?-Yes, because the entire partnership was sued under §305(a) where the negligence of one of the partners was

done in the ordinary course of business. All partners would be held jointly and severally liable under §306(a). A partnership can be sued in the name of a partnership under §307(a).

(1.2) Instead could P sue and recover from A?-Yes, P can sue A directly because one can always sue the tortfeasor directly.(1.3) Instead, could P sue and recover from E?-Yes, P can sue E for A’s negligence because partners are jointly and severally liable for tort actions under

§306(a) of RUPA. However, recovery from E’s personal assets would be difficult. Under §307(d), it would be difficult

for P to recover from E’s personal assets because E would have been had to have been found personally liable, which is unlikely since A’s negligence caused the injury to P. §307 has mixed interpretations. Some interpret that E could be held personally liable since he can be found joint and severally liable under 306. Others interpret “personally liable” in 307 as meaning be able to recover just from the tortfeasor and one of the five factors to get at an individual tortfeasor. But, Mutua states that §307(d) has typically interpreted “personally liable” as against the actual tortfeasor.

(2) Suppose P sues ACE and obtains a judgment against the partnership. How can P enforce her judgment?-§307(c) applies here because “a judgment against a partnership is not by itself a judgment against a partner,” so

P can only recover from the partnership’s assets unless a judgment was maintained against one of the partners.-In the lawsuit you would name the partners, everyone individually.(3) Suppose P sues both ACE and A in a single suit and obtains a judgment against both. From whose assets can

she collect?-Under §307(d) AND one of the factors. In this case P must go after the assets of the partnership first under (d)

(1) before P may go after A’s personal assets.-One can try to argue that P can go after both at the same time, but the intent of §307 forces a judgment creditor

to go after the partnership’s assets before any personal liability is awarded from an individual partner tortfeasor.-Partnership assets will pay for this case regardless because the Partnership will indemnify the partner. The only

way that partnership assets will not pay is if A is sued individually and the partnership is not sued or if the partnership is broke.

(4) P sues both ACE and E and obtains judgment against both.-E is not personally liable.-307(d)(1)

* How does a partnership grow?o Get $ from existing owners

Legal Problems: want to establish guidelines for contributions, time lines, etc....in the partnership agreement. Want specificity.

What happens if you say no? If there is nothing specified, if all the other partners contribute. Your partnership interest may shrink if you don’t contribute with the other partners.

May want to specify that if one partner fails to contribute, all the other partners contributions are considered as loans, so they are paid off first...because loans are paid before equity.

Percentage of ownership then will not change.This could pose a problem if all the partners except you are able to contribute capital because they will

increase their equity stake while you must take a loan from the partnership to make the capital contribution, and thus lose control.

Want to specify form the contribution can take.RUPA §404(f): A partner can lend money or do business with the partnership and will get paid back this

money like other creditors if the partnership dissolves.o Loans

Usually require a guarantee from all the partners and the partnership must be credit worthy to get one.Risk/Return.

o Add new owners/investorsCan dilute shares and control is given upRUPA §401(i): consent of ALL partners is needed for a new partner to come in under.New members are not liable for old obligations under 306(b).401(j): amendments to the partnership agreement require the consent of all the partners.

o Retain Earnings and invest them in the partnershipJust need a majority of partners to distribute earnings or retain them in the business because this is an action in

the ordinary course of business under 401(j).o Problems (p104).

(1) 401(j) – all members to a partnership agreement have to agree to change the agreement. Only a majority is required for decisions in the usual course of business. New partner cannot be admitted without agreement of all partners.

(2) New partners are not liable on obligations incurred before the partner joined the business.* How do people make money from a partnership? 1) Salary, 2) Profits, 3) Sell Interest in Business.

o Salary

Under 401(h), a partner is not entitled to payment for services performed for the partnership, except for reasonable compensation in winding up the partnership. Essentially, you can’t get paid a salary for running the business as a partner, but a partner can be made an employee (sign employment agreement) entitled to a salary, which is a way to get around 401(h) by putting such language in the partnership agreement. One can waive 401(h) because it is not listed in 103(b) and 103(a) allows partners to construct their agreements as long as they comply with the applicable laws.

Amending the partnership agreement to give each other salaries would require consent of all the parties since this action would be outside the ordinary course of business, pursuant to 401(j), unless of course the partnership agreement requires some lesser % for the approval of amendments.

Sweat Equity: when one gets equal ownership for their work, but doesn’t contribute money. This person will probably want some salary as a partner, so the agreement must be amended to allow for this salary.

o Problems Page 107: Partnership Salary(1) 401(h), Partners cannot receive a salary from the partnership unless it is specified in the agreement.(2) Partners can be prevented from increasing their salaries specified in the partnership agreement when one

partner refuses to amend the partnership agreement. You need all partners to agree to amend the agreement. To avoid this problem the partners may not want to specify the exact amount of salary.

(3) A partner cannot compel the partnership to employ him, because all partners have to agree to amend the partnership agreement. However, deciding to hire someone is within the ordinary course of business so as long as the majority of partners agree they can hire someone.

o Profits401(b): Each partner is entitled to an EQUAL share of profits and losses, unless otherwise agreed upon in the

partnership agreement.If you are contributing more capital, you might want more profits, this has to be written into the partnership

agreement.401(j): only a majority vote is needed to make a distribution of profits

o Sale of Ownership Interest Back to the PartnershipThis is difficult because…-You have to find a buyer,-You have to gain the necessary approval from the existing partners,-You have to deal with the issue of inherited obligations, AND-RUPA § 502: The only transferable interest in the partnership is “the partner’s share of P/L and the right of the

partner to receive distributions” And RUPA §501: A partner cannot transfer his interest in partnership property, voluntarily or involuntarily.

o Problems Pg. 108(1) BB has no agreement as to profit allocations. BB is a partnership. C invests 1,000,000. P invests 20,000. A

does not make a contribution of capital, but works for the partnership and draws a salary. A, P, and C are the only partners. The partnership makes a profit of 99,000 in 2007. How will these profits be shared?

-Each partner will get an equal share, pursuant to §401(b) of RUPA, which requires an equal share of partnership profits.

(2) If the partnership agreement provided that C would get 2/3 of profits and that A and P get 1/6 each. How much would each get under 1?

-Each would get their proportional share of the 99k, pursuant to their agreement.(3) What if C thinks that the 99k should be distributed as profits, but A and P think that it should be retained and

used for advertising. What will happen to the 99k for 2007?-A and P will win because distributions are considered to occur in the ordinary course of business under 401(j)

and thus they constitute a majority of the partners and can force the $ to be used for advertising rather than C getting his proportional share in 2007.

(4) What if A and P want to distribute earnings in a bad year?Normal business decision, a majority can decide.

They may do so because you can have a profit in a bad year and still distribute that money as long as you can cover your debts even though you really probably had no profit.

The book tells you to reference §807(a), which basically just states that creditors must be paid before the partners can in the winding up of a partnership, which seems to suggest that partners should behave in the same manner when running the business. Usually the banks require the partnership to meet its debt obligations before any distributions could be made in a given year.

o Problems Pg. 109(1) Partnership interest purchased from a partner entitles the purchaser to profits, etc...does not entitle purchaser

to decision making power.(2) Partnership interest purchased from the partnership entitles the purchaser to participate in partnership

decision.* What is the difference between adding a partner and selling one’s partnership interest?

o When a partner is added, they are a new partner and get the ability to control, make decisions, and share in the P/L.

o A partner is permitted to sell their financial interest in a partnership (their ability to receive P/L), but not one’s ability to control the organization, under §503(a)(3).

However, if the partnership itself were to sell an interest, then a new partner is brought in and they can have a say in the management as well as share in the P/L.

o Buy-Sell Agreement: allows other partners or the partnership to buy back your interest in the company.Even if there is no buy-sell agreement, the partner may compel the partnership to purchase his interest by

withdrawing from the partnership.* Partnership Endgames

o What can happen to a partnership if a partner dies or withdraws from the partnership?-The remaining partners can buy the departing partner’s interest and continue the business OR-Dissolution, with winding up and termination.

o Withdrawal: a partner may withdraw from a partnership at any time under both UPA and RUPA.UPA: If there is withdrawal, then there is an automatic dissolution-A change in the partnership arrangement where a partner is no longer a partner brings about a dissolution, see

UPA 29, 31.What happens if a partner dies under UPA? -The death will result in dissolution, which will lead to winding up and termination of the partnership. [This is

because UPA views the partnership in the aggregate and not as a separate entity]. (Essentially, the partnership dies with the dead partner)

RUPA: If there is withdrawal, there may or may not be dissolution, which will depend on whether the withdrawal was rightful or wrongful.

What happens if a partner dies under RUPA? -The death is a disassociation event, which can either lead to.... one of the following…

Dissolution, Winding Up, and Termination OR: §601 Can disassociate; §602 Wrongful disassociation; 801. Events causing Continuation because of a Buy-Out under §701.

Big Difference: In RUPA, there is disassociation, whereas in UPA there is not.-UPA: Dissolution, Winding Up, and Termination-RUPA: Disassociation, Dissolution, Winding Up, Termination

o UPA versus RUPA for the End of the BusinessUPA:-§29: Dissolution: “The dissolution of a partnership is the change in the relation of the partners caused by any

partner ceasing to be associated in the carrying on as distinguished from the winding up of the business.”-§31: Causes of Dissolution: (1) Without violation of the partnership agreement when: (a) the definite term ends

or a specified event occurs (b) express will of any partner when there is no definite term, (c), (d), and (2), (3), (4) death, (5), (6) by court order.

-Under UPA, once there is dissolution, the partnership must wind up and terminate.RUPA:-§601: Events Causing Partner’s Disassociation: This section lists the many events that could cause a partner’s

disassociation from a partnership, including:(1): “the partnership’s having notice of the partner’s express will to withdraw as a partner or on a later date

specified by the partner” (Other Listed Events: death, expulsion, etc. are all listed in 601.)* Note: Disassociation events lead to dissolution or a mandatory buyout.

-§602: Partner’s Power to Dissociate; Wrongful Disassociation:(a): “A partner has the power to disassociate at any time, rightfully or wrongfully, by express will pursuant

to §601.”(b): Spells out what is wrongful disassociation(c): If wrongful disassociation, withdrawn partner is liable to other partner’s for damages stemming from

wrongful disassociation.-§603: Effect of Partner’s Disassociation-§701: Purchases of a Disassociated Partner’s interest:

(a): “If a partner is disassociated from a partnership without resulting in dissolution and winding up of the partnership business under 801, the partnership shall cause the disassociated partner’s interest in the partnership to be purchased for a buyout price”

(b): Determines the buyout price.-§801: Events Causing Dissolution and Winding Up:

(1) If the partnership is at will, and the partner withdraws, then the partnership MUST dissolve and be wound up. But, if the partner withdraws for any reason listed in 601(2)-(10), then there is no automatic dissolution upon the occurrence of the disassociation.

(2) If the partnership is for a definite term OR particular undertaking,o If after the death of a partner or under 601(6)-(10) reasons or by wrongful disassociation under 602(b),

half of the partners don’t say in 90 days that they want to continue the partnership, it dissolves. Check the statutory interpretation of this, OR

o If all the partners say they want to wind up, then the partnership will dissolve ORo If the term ends, then the partnership will dissolve.(3) An event in the partnership agreement can trigger the partnership to dissolve(4) Something illegal can cause it to dissolve(5) & (6) Judicial determination can cause it to dissolve

-§802: Partnership Continues After Dissolution: Once dissolution is determined under §801, then the partnership stays in operation to be wound up and terminate.

-Summary of 801/802: A partner who disassociates from an at will partnership, does so by withdrawal, which causes the partnership to dissolve. A disassociation by death causes a mandatory buyout.

-§803/§804: Winding Up ProvisionsWhat happens during WINDING UP?o Sell off partnership propertyo Pay off partnership debt and creditors first.o Each partner’s account, under 401(a), must be settled and pay cash if there are any losses.o Partnership is legally obligated to pay partner balance in partnership account at the winding up.o When winding up is complete, the entity no longer exists.o Partners must contribute money towards losses equal to the amount which they would have been entitled

to of the profits.o Freeze Out: When the holders of the majority interest of a partnership force a minority owner or owners to sell or

otherwise give up his/her interest.o Problems Page 112:

(1) BB is a partnership. A, C, and P are the partners. The partnership agreement has no provision with respect to withdrawal/disassociation. The agreement does say that the partnership is to have a 10-year term.

?Can P withdraw from the partnership in the 3rd year?-Yes, P can withdraw in the 3rd year under 602(a) because “a partner has the power to disassociate at any time,

rightfully or wrongfully” and P gave notice of his express will to withdraw as a partner pursuant to §601(1) by saying he wants to withdraw. This disassociation would not have been wrongful if it followed another wrongful disassociation or death of a partner.

?Will such withdrawal be wrongful?-The withdrawal was wrongful under §602(b)(2) because this partnership was for a definite term and the partner

left by “express will” under 602(b)(2)(i).?Will P be paid for his partnership interest?-701(b): Determines the buyout price.

-701(c): Damages for wrongful disassociation under 602(b) and all other liabilities that the partner might owe the partnership are subtracted from the buyout price.

-701(h): P will not be paid his buyout price until the expiration of the term of the partnership because he wrongfully disassociated from the partnership. P could get paid then and there if he can prove to the court that paying him would not cause an “undue hardship to the business of the partnership.”

-602(c): states that the partner is liable for damages caused by one’s wrongful disassociation.o Problems Page 124:

(1) P, A, and C are partners in BB. The partnership agreement contains no provision relating to dissolution or to the duration of the partnership. C withdraws. Can P and A continue to operate BB?

-Under 801(1), P and A cannot continue to run the partnership if C were to withdraw because C chose to withdraw at will under 601(1) and become disassociated from the partnership. This disassociation event, in an at will partnership, leads to automatic dissolution, which means that the partnership must be wound up and terminate under Article 8. However, since C has not wrongfully disassociated under 602(b), C can agree with P and A to allow them to continue to run the partnership, but only if C’s consent is given under 802(b). Had C’s disassociation been wrongful, the partnership must dissolve at that point in time and such an option to continue the partnership would not be available.

-Look at 701 and 702.(2) Same as Q1 above, but what if C wants the p-ship to dissolve but P and A want to continue to operate the p-

ship?-If C wants this at will p-ship to dissolve, then he can compel the dissolution and winding up of the p-ship under

802(b) because his consent is necessary for the p-ship to be continued to operate.-(3) Same facts as Q1 except that C dies, and her widower, Mr. C, wants the p-ship to dissolve. Again, A and P

do not want the p-ship to dissolve. What result?-This is a p-ship at will where C has died and disassociated from the p-ship pursuant to 601(7)(i). A

disassociation by death is not considered a wrongful disassociation under 602(b). Because this is a 601(2)-(10) event of disassociation under 801(1), the p-ship does not automatically dissolve and become wound up even though Mr. C wants it to be wound up. So, under §701(a), a mandatory buyout occurs where the p-ship purchases the disassociated partner’s interest from the estate because C was disassociated “from a p-ship without resulting in a dissolution and winding up of the p-ship business under 801,” for a price determined by 701(b).

(4): Drs. A, B, C, and D are in a p-ship. The p-ship agreement has a 10-year term. In year 3, Dr. A withdraws. Can B, C, and D continue the p-ship?

-Dr. A’s withdrawal in year 3 results in Dr. A being disassociated from the p-ship under 601(1) because it was A’s express will to withdraw as a partner. Dr. A’s withdrawal will be considered “wrongful” under 602(b)(2) because the p-ship was for a definite term of 10 years and A withdrew before that date occurred in year 3. Dr. A falls into none of the exceptions under 602(b)(2) so his withdrawal is wrongful. Be it as it may, the p-ship does not have to automatically dissolve if under 801(2) in a p-ship for a definite term, half of the partners who remain agree to continue the p-ship within 90 days, or they can all agree not to continue it and wind it up, or the term hasn’t ended. Here since A hasn’t died, the other 75% of the partners (B, C, and D) do not have to dissolve the p-ship and wind it up and A will not be paid until the end of the term under 701(h) unless he can prove to the court that payment would not cause undue hardship to the p-ship.

(5): Does your answer change to Q4 if B wants to dissolve the p-ship?-The answer doesn’t change because under 801(2)(i) “at least half” (C and D) want the p-ship to remain, so the

p-ship doesn’t have to dissolve and wind up because B didn’t withdraw under a 601(6)-(10) event.*Rule for Term-P-ships:-Term Agreement + Early withdrawal under 601(6)-(10) = Dissolution only if half of the partners agree to wind

up under 801(2).-Term Agreement + Early withdrawal NOT under 601(6)-(10)= Dissolution will only occur if ALL the partners

agree.o Problems Page 127

(1) At the start of BB p-ship, C invests 250k, P deeds land to the p-ship worth 150k, and A contributes 2k of cookware and agrees to work for the p-ship as a manager. They agree to share profits from the p-ship equally. What do their accounts look like to start?

-C$250k; P$150k; A$2kDo they need to agree as to p-ship accounts?

-Yes, the amount of each partner’s loss from their investment in the p-ship is determined from the p-ship account, a bookkeeping device which keeps track of how much has been put into the p-ship and how much has been taken out. RUPA 401(a), 807(a)-(b).

Can you represent all three of them?-Don’t think so, you have to represent your clients interest which may conflict with the others partners interests.(2) Suppose that, at the dissolution of BB, the p-ship has cash and property worth 200k after paying all of its

creditors. C earlier received distributions of 150k, P received 142k, and A received nothing. How should the 200k be distributed?

-C = 250k – 150k = 100k-P = 150k – 142k = 8k-A = 2k – 0k = 2k-So, how do you deal with the 200k? The money owed to the partners is determined by adding up the balances

in their p-ship accounts, where 110k is owed to the various partners. After that 110k is paid, 90k will be distributed equally among the partners so each person will receive…

C = 100k + 30k =130kP = 8k + 30k = 38kA = 2k + 30k = 32k

(3) Same facts as 2, but now the p-ship only has 20k left over after paying creditors.-C = 100k, still owed to him-P = 8k, still owed to him-A = 2k still owed to him-The p-ship would have needed to collect 110k for there to have been a profit paid out to the partners, instead

there is a loss now that must be shared equally.-There is a total account balance of 110k. 20k – 110k = total loss of 90k. That 90k loss must now be shared

equally among all 3 partners. So, each partner must bear a 30k loss from their accounts.C = 100k – 30k = 70k is owed to CP = 8k – 30k = -22k, P must pay to the p-ship.A = 2k – 30k = -28k, A must pay to the p-shipSo, the money that A and P must pay, which is 50k combined with the 20k left over, would make C get 70k

back, so C still bears an equal loss of 30k from his original investment of 100k.

Creel v. Lilly:CB113 Partner dies and his estate wants the assets to be liquidated.H/R: Court applies RUPA, even though MD has not officially adopted it yet. The Court said a forced sale upon the death of a partner under UPA’s terms was not necessary in this case b/c termination clause manifested intent of pners not to dissolve business.

The court said that business provided an accurate accounting and that BV was an appropriate value for the business to pay a proportionate share to the estate because it was only in operation for 9 months and no goodwill had accrued. Liquidation was entirely unnecessary here.

Kovacik v. Reed:CB128 Kovacik gave money to a venture and Reed provided the labor. They orally agreed to share the profits, but said nothing about the losses. Kovacik then later determined that the venture was unprofitable and asked Reed to contribute towards an 8k loss. Trial Court concluded that they agreed to share equally all their joint venture profits and losses. General Rule, in the absence of an agreement to the contrary the law presumes that partners and joint adventures intended to participate equally in the profits and losses of the common enterprise.Issue: Did a p-ship exist between Kovacik and Reed?H: Court held that there was no p-ship and Reed was not required to share in the losses here. In this situation, each will lose their money or services only.R: When one partner or joint adventurer contributes the money capital as against the other’s skill and labor, neither party is liable to the other for contribution for any loss sustained. (Losses from money contributed cannot be recovered from the partner who only contributes services, is what this court held).

The partner who contributed services did suffer a loss because he did not get anything for his time. He was not being compensated in the form of a salary, they agreed only to share profits.Note: If the Court applied RUPA 401(b), the partners would both have had to share equally in the profits AND the losses, so Reed would have probably had to pay for some of the losses, since he was able to share in any profits 50-50.

Bohatch v. Butler & Binion:CB132 Law Firm Partner, in good faith, complains of over-billing being done by another partner. She brings suit and then is expelled from the p-ship.R: A firm does not owe a fiduciary duty not to expel a partner after she accuses another partner of misconduct.H: The law firm acted properly in expelling her because that is what the p-ship agreement called for, however, the firm did breach the contract by not giving her monthly draws. There is no dissolution because the agreement calls for expulsion of a partner. The implication of the court only allowing her to bring an action in contract and not tort prevents her from being able to recover mental anguish and punitive damages.

What if this case was decided under RUPA? There would be no dissolution either Page v. Page: 2 partners own a p-ship. One of the partners solely owns a corporation that does business with their p-ship that is holding a demand note against the p-ship. The p-ship was just not profitable, so the partner (who owned the corporation) wanted to terminate the p-ship. The other partner (the defendant) did not want this to happen.H: The partner (who owns the corporation and the plaintiff) can end this at will p-ship at any time to get a pay out as long as he is acting in good faith.R: An at-will p-ship may be dissolved by the express will of any partner; however the desire to end the p-ship must be made in good faith. If the partner seeks to dissolve the p-ship in bad faith by seeking to dissolve the p-ship for his own benefit, then there is a freeze out. A freeze out is a wrongful disassociation where the wronged partner can hold the other partner(s) liable for this freeze out.

o Questions (p143)(1). Plaintiff wanted declaratory judgment that p-ship was p-ship at will so if he chose to leave the p-ship it

would cause dissolution. RUPA 801(1).

IV. Corporation LawCategory P-ship CorporationFormation informal formation,

you can just start it like under UPA and RUPA default rules

Formalities require you to register with the state to start one (Articles of Incorporation, by laws, BoD, minutes, elections, and filings)

Limited Liability

No, but one can form an LLP or buy insurance to prevent against liability

Yes, but creditors may still seek guarantees from the owners and there is PCV

Free Transfer-ability

No, but can agree to allow it or have a continuation agreement

Yes, but can restrict it if appropriate and you would need an agreement to restrict

Continuity At will unless agree to a term

Indefinite, but can limit the life of a corporation in the AIC. Need an exit agreement to continue a corporation effectively

Centralized Management

No, each partner is an agent, but can use executive committee and limit authority by agreement and notice

Yes, but may want to modify to avoid a freeze out

Cost Zero, but should hire a lawyer to

Need a lawyer and you have to pay filing

write up a p-ship agreement

fees to get it set up

Default Rules

Extensive More Extensive

Client Perception

Hard to understand, need to use entity concepts and has low prestige

Easier to understand, but can mislead clients about their responsibilities. They view corporations as prestigious, though.

Flexibility Great Not quite as great and awkward in some circumstances

Tax Pay on one's own income taxes so the partner can use the losses, if any, to offset any other income

Double taxation: the entity pays taxes and the owners pay taxes on the dividends (distributions of earnings). Plus, only the entity itself can use the losses.

* Before we have an analysis of corporate law, let’s say a word on some other business entities…o LLP: p-ship with some limited liability, that requires a filing with the stateo LLC: hybrid between p-ship/corporation; very flexible (in some states less flexible), provides limited liability, can

achieve p-ship taxation.o LP: limited partners have limited liability because they are not involved in day-to-day control of the company. It

is taxed as a p-ship. A corporation can be the general partner, so no individuals will be personally liable.o S Corporation: a corporation that elects to be taxed like a p-ship (single taxes paid on personal income taxes), but

limits the # of SHs, types of SHs, and capital structure.* Basic Elements of a Corporation:

o Separate legal entity formed under the laws of a given stateo Limited Liability, which means SH are only liable for their original investment and not the debts of the

corporationo Separation between the managers and the ownership (usually)o Perpetual Life for Corporations (unless otherwise stated)o Free Transferability of ownership for public corporations, whereas close-corporations have trouble selling ones

interest because there is no readily available market for such interests.* What are the sources of corporate law?

o State Statuteso AIC, Bylaws, other agreementso Case Lawo Federal Law

* The Model Business Code (MBC) provides some guidance on various issues in forming a corporation…o §2.01: Incorporators:

One or more persons may incorporate and file the papers with the Secretary of Stateo §2.02: Articles of Incorporation (AIC):

(a): Must include…Corporate Name# of Authorized Shares to IssueStreet Address of the registered office and registered agentName and Address of each incorporator

(b): May include… provides a list of 5 thingso §2.06: Bylaws:

(a): The incorporators shall adopt initial bylaws for the corporation(b): They may talk about the management of the business and the regulation of its affairs as long as they are not

inconsistent with the articles of incorporation.

* DCL provides some guidance on forming a corporation as well…o DCL §102: Contents of the AIC

* What is the process for forming a corporation more generally?o Articles of Incorporation (AIC):

Get a form for your stateCheck to see if the corporate name you want to use is distinctDetermine the appropriate number of shares you want to issueFile the document with the secretary of state so your corporate existence can come into being.

o By Laws: rules that the corporation has for internal governance that are not filed with the stateGet a form and see what bylaws you want to use for your type of business and industry. Once you get it add and

remove bylaws that apply to your business and make sure they are not inconsistent with applicable state law.o Organizational Meeting: This occurs after the articles of incorporation are filed.

Elect the BODAdopt the bylaws.Appoint OfficersIssue Stock

o Problems Pg. 1541. How do you decide what goes in the articles of incorporation and what goes in the bylaws? What are the

differences between articles of incorporation and bylaws?-MBCA 2.02 says what must be contained in AIC, and what may be contained.-Bylaws may contain any provision for managing the business and regulating the affairs of the corporation that

is not inconsistent with the articles of incorporation. MBCA 2.06(b). They are a completely internal document.-Articles of incorporation bring the corporation into existence with the appropriate state agency.-Articles of incorporation determine the number and type of shares a corporation may issue, see MBCA 6.01,-Articles of incorporation set the par value.-AIC determines the votes each shareholder is entitled to, see MBCA 7.21(a).2. If the articles and bylaws conflict, which wins?-The articles win.

* What is a promoter? What are some of the issues with promoting?o A promoter is someone that is acting on behalf of the corporation that is not yet formed.o A promoter can be held liable for any agreements made prior to the corporation actually being formed under

§2.04 of the MBC.o Secret Profit: The promoter might sell property to the corporation and has a duty to disclose to the corporation

any profit she is making on the transaction with the corporation. If she fails to disclose the profit, then the corporation can recover that profit. There will be no secret profit, if the promoter just tells the corporation this is how much I will be making on these transactions.

Promoter Buys Property While Promoting: Price Paid by the Corporation – What the promoter paid is the profit that needs to be disclosed.

Promoter Owned the Property Prior to Promoting: Price Paid by the Corporation – FMV of the property is the profit that needs to be disclosed. The price the promoter paid for that property is irrelevant.

o Novation: you want the corporation to adopt the contracts that promoter might have made while the corporation was being organized so the obligations of the promoter become the obligations of the corporation.

o Problems Pg 1551.1. MBCA 2.04, All persons purporting to act as or on behalf of a corporation, knowing there was no

incorporation under this Act, are jointly and severally liable for al liabilities created while so acting.-L&L can enforce the lease against Propp.-Actual Implied Authority to enter into the lease creates liability, or Inherent Authority, there is a relationship

between Bubba’s and Propp which allows Propp to act in a certain capacity, Bubba’s then has the option of adopting the lease.

1.2. Enforceable against Propp, there is no corporation yet formed to impose liability upon for this contract.1.3. No basis for L&L to enforce the lease against Agee or Capel.2. What is the liability of the corporation if it is formed? Once the articles of incorporation are filed is the

corporation liable on the lease with L&L?

-No, the corporation did not exist when the lease was entered, and has not yet adopted it. Inherent authority principles.

3. If the AIC are filed can L&L enforce the lease against Propp individually?-Yes

* Share Terms Defined Below:o Note: Issuing shares is governed by MBC 6.03; other §’s of Article 6 of the MBC deal with this as wello Issued Shares: The shares that the corporation has sold.o Authorized Shares: The total # of shares the corporation may issue that is listed in the articles of incorporation.o Outstanding Shares: The total # of shares actually issued, but not reacquired by the corporationo Preferred Stock: a class of stock that is given some preferential treatment in the AIC. (dividend rights, liquidation

rights, or redemption rights).o Common Stock: a class of stock with no preferenceso Par Value: minimum amount the issuing company can charge by law for a share of stock.

Not as important, most time it is listed as pennies, some states do not even require a minimum value.o Stated Capital: minimum amount can be the total par value collected during an issuance and cannot be distributed

as dividends. This exists to protect creditors.o Capital Surplus: funds received in excess of par value during an issuance and can be distributed as dividends.o Shareholder’s Equity: Stated Capital + Capital Surplus

* Problems: Page 162:o (1) Can a corporation issue stock in exchange for land? How about a promise of future services to the

corporation? How about a promissory note? How about for goodwill? How about for a release of a claim against the corporation?

-Delaware Corporation Law (DCL) §153: Shares must be issued for consideration = to at least the par value for par value stock and for no par value stock share must be issued for a price determined by the BoD or SHs, if allowed in the AIC.

-See also DCL §152:-In applying the DCL, the shares could be issued for any consideration since they are without par value.

Although Mutua posits that it may not be issued for goodwill. Check this…-MBC §6.21: (b): Shares may be issued for any tangible or intangible property, including cash, promissory

notes, services performed, contracts for services to be done, or other securities. AND (c): The BoD must determine whether the consideration is adequate for the number of shares purchased.

-In applying the MBC, the shares could be issued for any consideration determined by the BOD, but Mutua posits that goodwill cannot be used. Check this…

o (2) The AIC of C Inc., a DE corporation, provide that Class A stock shall have a $2 par value. Can C Inc. issue 2000 shares of Class A stock to S for $1/share?

-DCL §154: Determination of amount of capital: capital, surplus, and net assets defined.-Stated Capital: the aggregate PAR value of all the issued shares and cannot be distributed to owners as

dividends. It serves as a cushion for creditors incase the business has trouble.-Capital Surplus (or Additional Paid in Capital): the aggregate value received in excess of par value. It may be

distributed as dividends to owners.-In applying DCL §153(a), shares of stock with par value must be issued at least at par value, so C Corporation

cannot issue the shares for $1/share. They must issue it at least at $2 because that is the par value.o (3) and (4): Same facts Q2. Can C Inc. issue 3000 shares of Class A stock for S for 5/share? How will the

issuance be allocated to capital surplus and stated capital?-Yes, the Corporation can issue stock for more than par value under DCL §153(a) because there is only a

minimum price and no maximum price. Under DCL §154, 6k (3k*2) will go into the stated capital account and 9k (3k*3) will go into the capital surplus account. Only the capital surplus may be issued as dividends.

o (5): Can S sell her $5 par C Inc. Class A stock to T for $3?-Yes, only the corporation must sell the stock during its initial issuance for at least par value. Any subsequent

stockholder like S can sell it for any amount, even below par value because the DCL and MBC only apply to when a corporation issues stock.* Corporate Liability: The general rule is that the shareholder is not liable for what the corporation does or doesn’t do. SHs can only stand to lose their initial investment. The corporation, as an entity, can be sued and held liable though.

o MBC 6.22(b): Only liable for the consideration one has to pay to purchase the shares. (Only liable for one’s initial investment)

o DCL 162: If the SH does not pay the appropriate consideration for a share, then they can be held liable for that amount only. But, SHs are only liable for their initial investment

o Look to the Corporation for its liabilities.* Piercing the Corporate Veil (PCV): This is a judicially created exception to limited liability for shareholders of a corporation. It allows a plaintiff to sue a dominant owner of a corporation when the corporation has no assets for the plaintiff to get. NOTE: Almost all the cases involve a single shareholder.

o What factors/conditions will lead a Court to PCV and thus allow the plaintiff to go after the personal assets of a shareholder of a corporation?

-Must be a dominant owner-Fraud is not necessary to prove (However, fraud alone can lead to PCV, but it is a separate legal action)-2 Major Factors will drive the Court to PCV?

1) The corporation is not conducting corporate formalities, the owner is not respecting the corporate form, not treating it as a separate entity, almost treating it as a sole proprietorship. (at a minimum the corporation must maintain separate bank accounts from the actual shareholder and conduct some meetings/have minutes of the BoD or SHs) AND

2)Something unfair or there is some inequity or unfairness here that is preventing a plaintiff from recovering. (Note PCV will allow some injustice.)

-Undercapitalization (usually only matters for when the corporation is first set up)-Unity of Interest

o Contract versus TortContract: Much harder to PCV in contract cases because people know who they are getting into business and

can research the person.Tort: PCV is much more likely because people cannot control who they are injured by.

DeWitt Truck v. Fleming Fruit:CB170 Fleming (Corporation) sold fruit and DeWitt trucks transported it. Corporation owed DeWitt $. Corporation’s principal SH, orally promised that he would pay for the transportation of fruit if the corporation did not; however, this promise was not enforceable because of the Statute of Frauds. The principal SH did not pay the debts of the corporation so DeWitt sought to PCV?H/R: PCV occurred here because Fleming was essentially a one man corporation, where the dominant stockholder owned 90% of the stock and corporate formalities were not followed to protect him from personal liability.Rsg.: Factors that allowed for the PCV in this case:

-Disregard of Corporate Formalities-No separate bank accounts, separate assets-No formal meetings of the BOD-SHs were not participating in their capacity as owners-Did not pay dividends, while the corporation paid the dominant owner salaries.-Complete unfairness here; he was perpetuating a fraud on the community-Undercapitalization (usually not a factor in PCV cases, Courts only care about undercapitalization when the

business first starts)-No working capital here and instead Fleming withdrew money as profit for himself only (in the form of a salary)-He never distributed any of the monies to the other 10% owners-Company has no assets, no capital, creditors will get nothing if Corporation goes Bankrupt. Capital serves as a

cushion to creditors and others who may be injured. Want Corporations to operate with capital, with that cushion.-Concerned about undercapitalization at the beginning of the Corporations life. You are perpetuating a fraud,

endangering the public, trying to make money at someone else’s expense...business must have capital to operate, especially at the beginning.

-The corporation was linked to Fleming’s exclusive existence and was said to terminate when he died.-The oral promise to pay influenced the decision even though it was unenforceable under the SOF.

*How can you avoid PCV?-Maintain separate bank accounts and-Have formal meetings.-Do these both, then you can avoid the PCV.

In re Silicone Breast Implants:CB178 Bristol established a subsidiary called MEC (Medical Engineering Corporation), a separate corporation. Bristol controlled almost every aspect of MEC and was MEC’s sole shareholder. Plaintiffs sue Bristol because of the MEC implants that caused injury to the plaintiffs.Issue: Can Bristol, as sole SH of MEC, be held liable even though MEC is a corporation?H/R: YES because “when a corporation is so controlled as to be the ALTER EGO or mere instrumentality of its stockholder, the corporate form may be disregarded in the interests of justice.” The courts will not allow a legal fiction (like a subsidiary that is entirely controlled by its parent) to abuse the community at large.Rsg.: Court talks about a number of corporate formalities that have not been observed.

Close Corporation: a corporation with relatively few SHs, the stock of which is not publicly traded. MBC 7.2* Who gets to make the decisions for the corporation?

o SHs own the corporation, who elect a BOD, who then in turn appoint the Officer is an Agent....run the corporation’s day-to-day operations.

o What do SHs vote on/do?Vote on the election and removal of the DirectorsVote on the fundamental corporate changes:

MergersDissolutionSale of all or substantially all the corporate assets ANDAmendments to the AIC

Note: Their votes react to the decision of the BoDThey have a right to inspect corporate records (The 2 statutes below deal with it in a slightly different way)

See MBC 16.02: the records inspected must match the purpose for why the SH has requested those records.See DCL 220: A SH may only request records for a “proper purpose,” which means “a purpose reasonably

related to such person’s interest as a stockholder.” [This is more restrictive than MBC]o What does the BOD do?

See MBC 8.01MBC 7.32(a)(1): The SH can enter into an agreement and eliminate the BoD or restrict its discretion.More generally…-Select officers AND-Set broad policy for the corporation AND-Oversight responsibilities over the officers from their broad range of expertise-They are NOT AGENTS

o What do the officers do?They are agents to the corporation.MBC §8.4 & 8.41

* VOTING BY SHAREHOLDERS:* There are 2 Ways SHs can vote for directors, what are they and how do they work?

o Straight: Vote for each seat individually based on the amount of shares you have. Under this system, if you have a majority of the shares, you can elect every director by yourself.

o Cumulative: an at-large election, where all the directors are elected simultaneously (at once).Total Number of Votes Per/SH = (# of shares owned)*(# of Director Seats to Be Filled). This total # of votes

can be divided up in anyway, so the minority SH can use all of them and try to control the election of at least one of the directors.

Formula for the Minority SH to Elect One Director = [(Number of Directors the SH wants to elect*Total number of shares voting)/ (Total number of directors to be chosen at the election + 1)] + 1

Cumulative Voting is really only good if there is basic equality among the SHs, otherwise it favors the minority SH.

o The Statutes: Both say that SHs elect directors at annual meetings (with some caveats on when the elections may take place)

DCL 211(b)MBC 8.03(c)

* How do you remove a director?

o NY BCL 706: Director can ONLY be removed for cause. Director can be removed without cause if the Certificate of Incorporation allows it.

o DCL 141(k): “Any director or the entire BoD may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors,” There are exceptions…

o MBC 8.08: SHs may remove directors with or without cause, unless the AIC say that the director can only be removed with cause.* Of Record…

o Record Owner: the person who has the right to vote at a SH meetingo Record Date: cut off period determines, which record owners will receive notice of and a vote at a meeting.o MBC 7.05 and 7.20(a) and 7.07(a)/(b)o DCL 212, 213(a) (note 213 is not in the statute book)

* Voting (Shareholder) Agreements: SHs can generally enter agreements with one another to vote in a certain way.o DCL § 218: SH agreements are allowed, but doesn’t say that they are specifically enforceable Need to get the

section number for this.o MBC § 7.31 & 7.32: SH agreements are explicitly enforced.

* Proxies: An authorization to vote someone else’s shares because they cannot attend the SH meeting where the vote will take place. They are revocable, unless they say otherwise. But a lot of state statutes make even irrevocable proxies, revocable.

o Proxies may be solicited from those who might not vote...by those who have an interest in voting.o SEC Rule 14a-9: False or Misleading Statements or Omission: Essentially, prohibits false or misleading

statements in a proxy or notice of meeting.Basic Requirement to Invoke this Rule: “false or misleading with respect to any material fact, or which omits to

state any material fact” under the circumstances, which makes the proxy of someone false or misleading.* Shareholder Proposals: an idea that is put forth by a SH that needs to be voted on at a SH meeting, and thus must be attached to all proxies.* What are some other ways a shareholder can protect his interests other than a voting agreement?

-Employment Contracts-Buy-Out Agreements

* Need to know Shareholder Inspection Rights (p242) – right to inspect the books of an entity in which they have an ownership share.

o Requires written notice and a proper purpose.o Look at what is appropriate considering interest as a shareholder.o Problems Page 197

* (6) What decisions do you think the McDonald’s BoD actual makes? Consider the following…o Personnel decisions such as who should be President of the Corporation and who should be interns?

-The BoD will choose the President since he is an officer. However, officers will be left to choose interns of a corporation.

o Operational decisions like closing all McDonald’s outlets to observe the Sabbath and whether to close this one store in the University of Alabama?

-The BoD will probably make the decision to close “all stores” since this is a broad policy decision for the corporation. However, officers will likely be able to decide to close any one particular store.

o Acquisitions like whether to acquire the makers of dentures or whether to acquire Bubba’s Burritos?-The BoD can decide to buy a new business, but the SHs will have to approve this purchase because this a large

scale decision that is changing the nature of McDonalds. However, the BoD does not have to decide to purchase one little store like BB; the officers can make this decision.

o Problems Page 198(1) You receive a letter from the Vice President of Legal Affairs at McDonalds offering you a position as a staff

attorney; does that letter obligate McDonald’s to hire you? How about if the letter was signed by S, a staff attorney?-This question requires more information, but the VP of Legal Affairs is probably an officer who has inherent

authority to hire you, so McDonalds will probably be bound. However, the letter from the staff attorney will probably not bind the corporation because he has less power.

(2) Who should sign for a loan of the corporation: the majority stockholder, a director, or an officer?-The Corporation’s officer signs for the loan because he is the authorized agent of the corporation who can

make such a decision. However, the bank might require a loan guarantee from the majority stockholder.

McQuade v. Stoneham:CB199 In this company a few shareholders serve as the directors and officers. The shareholders enter into an agreement where they agreed that the 3 of them would be officers and that they would use their “best endeavors” to continue themselves as directors of the corporation. McQuade, a party to the agreement, was voted off the board, and then later fired as treasurer. McQuade sues for breach of the shareholder agreement. What result?H/R: SHs can make agreements like an agreement to elect directors, but cannot make agreements that limit the discretion/role of the BoD. The BoD’s sole purpose is to further the interests of the corporation and not make any decisions that are in the interest of a particular SH. McQuade is not reinstated as treasurer because it was not in the interest of the corporation. McQuade is not awarded any damages because there was no injury to the corporation as a result of his removal.

Stockholders may combine to elect directors....the power to unite is limited to the election of directors and is not extended to contracts whereby limitations are placed on the directors to manage the business. (p202)

The Court says this contract is void because it is overstepping what the BoD is allowed to do...SH’s are not allowed to control the BoD in this way.

Shareholders cannot limit the discretion of the BoD, but see MBC § 732...in closely held corporations. VERY IMPORTANT: NY state statutes overrule this case and SHs are allowed to limit the discretion of the BOD. This case has limited applications. The shareholders must have control of all shares, not allowed to move them without specific agreement. Must be put in the Cert of Corporation if you are going to so limit the board, or place this information on the shares....if you don’t a shareholder can ask for a refund.

What if the contract was between the corporation and McQuade, not McQuade and the other SHs (directors)? This would then have been a simple breach of contract case like an employer/employee situation.Villar v. Kernan: CB205 V (49%) and K (51%) enter into an oral agreement as the sole shareholders of their corporation that they would never pay salaries. The manager S received 2% ownership (1% from each of them). S and K team up and have the board pay K 2k/week as a consultant. V sues because taking profits out of the company to pay K a salary takes profits away from V that he should get also. H/R: Oral agreement was not in writing, so K gets to keep the $ and V loses out on $.Rsg.: The SH’s agreement, had it not been oral, that limits the discretion of the BoD, would have been legal.... disclosed on the Cert of Incorp and on the Stock Cert.

Although the BoD manages, the shareholders retain some control, they are responsible for the election of the BoD...also responsible for amendments to cert of incorp, merger with other corp...this is a reactive voice to the actions of the BoD who need shareholders approval for these matters. Shareholders primary action is election and removal of dir.’s

o Problems Pg. 2131. What about cumulative voting?-For three people, cumulative voting is probably the best so two people do not control the whole election.

Cumulative voting allows that one person to control the vote of at least one position.3.1. Assume there are 9 directors to be elected to the BoD of Bubbas and the Corp has 1000 outstanding shares.

Cumulative voting in effect. There are three shareholders. You are one of them and want to elect Epstein.N = # of dir.’s the SH’s wants to electS = Total # of shares votingD = total # of dir.’s to be chosen at the election[(N x S)/(D + 1)] + 1[1 x 1000 / 9 + 1] + 1; [1000/10] + 1; = 101

You need 101 votes to secure the election of one dir.

Ringling v. Ringling:CB257 Edith owned 315 shares, Aubrey owned 315 shares, and Jon North owned 370 shares. In the 1940s, Edith and Aubrey enter into a SH’s agreement to elect 5/7 directors and if they cannot agree that arbitration will be held and that a lawyer would pick the directors. Later, they could only agree on 4/5 directors they sought to place on the BoD, however Aubrey did not follow arbitration.Issue: Was this SH voting agreement valid?H/R: Yes, because SH are free to enter into an agreement to vote their shares in a particular way. But the Court did not specifically enforce the agreement.

Note: When it comes to SH’s agreements, they are enforceable and can be specifically enforced. Courts are reluctant to specifically enforce where personal services are involved. Courts are more inclined to enforce the terms of the agreement under the Model Business Code.

McQuade versus Ringling: McQuade held that a voting agreement was contrary to public policy and void, whereas Ringling allows the agreements. But remember, McQuade was overruled, so NY is probably now more in lines with DE on the subject of voting agreements.

Clark v. Dodge: C owned 25% and D owned 75%. D promised to vote for C in return for a secret formula, so that C can have a seat on the Board. D later removes C from the BoD.H/R: This SH agreement was specifically enforceable and D should not have violated.

Virginia Bankshares v. Sandberg:CB221 Virginia owned 85% of the stock in a Bank. Virginia wanted the bank to merge and sent out a proxy statement that told the other 15% that the merger would achieve a “high value” for their shares.Issue: Was this a violation of SEC Rule 14a-9?H: No. “High Value” was a misrepresentation, but the misrepresentation wasn’t material, so no violation of 14a-9, because the minority SHs had no power to swing the vote the other way.R: A fact is materially misleading/false if there is a “substantial likelihood” that a reasonable SH would consider it important in deciding how to vote.

Kortum v. Webasto Sunroofs:CB242 Plaintiff wants to inspect corporate books as SH and Director of the corporation.R: Directors: have unfettered access to the books, whereas, Shareholders have the burden to prove that his purpose for inspecting the books is proper. Directors who have the duty to manage the corporation have the right to inspect all books.H: P can inspect since he is a director, but P was also able to inspect because determining the value of one’s share is always a proper purpose.

* Duty of Care & Loyalty and Business Judgment Rule What are the Responsibilities of a Corporations Decision-makers and to Whom are they Responsible?

Fiduciary Duties of Directors: duty of care & loyalty* Business Judgment Rule (BJR): Courts will not second guess the business judgment of directors as long as the decision was made in good faith, absent a conflict of interest, (independent) and some due diligence (process) was undertaken. Courts will not interfere with a business decision unless there is GROSS NEGLIGENCE.

o Essentially, the BJR will apply if both the duty of care and/or duty of loyalty are met by the directors.

* What are the duties of care the directors owe?o Pay attention to the business, sense of what is going on, try to correct problems, gather information...o You have an obligation to the business...you have to monitor what is going on.o Ethics.o Good faith decision making...you do not have to be right, but you need to make an informed decision. Making an

informed decision, right or wrong, you have exercised diligence, which fulfills your duty of care.o As long as diligence is exercised, you cannot place blame, because business is inherently a risk. You do not want

to discourage all risk because that is how the business will grow. You may not know that a decision was wrong until you can look back.

o You should not be penalized for not knowing if you used your best judgment.o If you do those things, the Court will not second guess your business decision.

* What do some of the statutes say on the subject of directors and duties of care/loyalty?o MBC is § 8.3: Standards of Conduct for Directors: “Each member of the BOD, … shall act (1) in good faith, and

(2) in a manner the director reasonably believes to be in the best interests of the corporation.” See also MBC 8.31o The duties can be limited, but not eliminated, in the AIC by inserting limited liability provisions on behalf of the

directors. See MBC 2.02(b)(4) or (5) and DCL 102(b)(7)* Why have the BJR? (from Joy v. North)

o SH voluntarily enter a business and asses the risk to determine entryo Courts are bad at adjudicating business decisions

o Courts are reluctant to enter into after-the-fact litigation to evaluate business decisionso More risks will yield higher profits, so directors are actually encouraged to take risks.

* When will the BJR not apply? (from Joy v. North)o Decision lacked a business purpose ORo Decision is tainted by a conflict of interest ORo Decision is so egregious as to amount to a no-win decision ORo Damage that results from an obvious and prolonged failure to exercise oversight or supervision.o Standard is Gross Negligence: because every decision that turns out to be wrong could be considered negligent,

so applying this higher standard emphasizes that the Ct. will not punish a mistake, only an egregious error that amounts to gross negligence.* The Duty of Care:

o Standard of review is gross negligence, if no gross negligence then BJR will apply.o In a general sense, what are some things that need to be done for there to be a valid duty of care exercised by the

BOD?:Staying informed and gathering information, particularly in regards to the BOD decision making function,

and/orPromoting the creation of value for the owners, and/orMonitoring/Oversight of the management of the business, and/or: Asking questions, and/or; Attending meetings, and/or; Laziness that causes a loss, and/orNot being grossly negligent in one’s responsibilities as directorSee MBC 8.30, 8.31 for a more specific listing of standards of conduct and standards of liability in these types

of cases.o What can the AIC do to the duty of care?

MBC § 2.02(b)(4): AIC can limit the amount of damages that the director might have to pay for an action or inaction.

DCL § 102(b)(7)(ii): AIC cannot limit/eliminate the amount for breaches of the duty of care that involves intentional misconduct or bad faith acts.

o What must you ask to analyze whether there was a breach?If the BoD goes through the necessary PROCESSES (due diligence) in making its decision, then the BJR will

apply and their decision will not be criticized by the court.If the BoD does not go through the necessary processes (due diligence, asking questions) = breach duty of care,

then the BJR does not apply, and the court must analyze the SUBSTANCE of the decision.o In order to prevail on the merits in a breach of a fiduciary duty case, what must you show in addition to a breach

and which party has the Burden of Proof?MBC: The Plaintiff has the BoP of showing that the Defendant’s breach CAUSED a loss to the company or

himself (if a direct suit). [Barnes uses this approach]DCL: The BoP is on the plaintiff to show a breach of the duty, but then the BoP shifts to the D to show that his

action or inaction DID NOT CAUSE the LOSS. [Rejects Barnes]* The Duty of Loyalty:

o Generally, what does the duty of loyalty entail:Not Competing against the Corporation, and/orPlacing the corporation’s financial interest ahead of your own individual interest, and/orNot taking a corporate interest (opportunity) for yourself personally (not putting your director/officer interest

ahead of the company), and/orDisclosing material information to the board, and/orNo self-dealing (cannot be on both sides of the transaction)

o What statutes apply to this type of duty?MBC:

§ 8.31(a)(2): deals with interested director transactions that could cause a breach of the duty of loyalty§ 8.60: defines director’s conflicting interest transaction

DCL:

§ 144: Interested directors, officers, etc. (Being on both sides of the trx doesn’t automatically void it, certain procedures must be followed)

ALI § 5.05: Strict Requirement of Full disclosure prior to a director/officer taking advantage of a corporate opportunity is the central feature of this test. The opportunity must be offered to the corporation and rejected by the corporation, in order for the interested director/officer to take the opportunity for oneself, personally.*Seizure of Corporate Opportunities: 2 Tests:

*ALI (5.05) Test:First step: Is there a corporate opportunity?-Something is a corporate opportunity if:

The director/officer becomes aware of this business opportunity in their capacity as officer/director OR through the use of corporate information or property OR it is a business opportunity that is closely related to the business in which the corporation engages in.

Second Step: If it is a corporate opportunity, the director CANNOT take it for herself UNLESS…(1) She discloses it, AND(2) Offers it to corporation, AND(3) Corporation rejects it, AND Either one of the following with regards to the rejection:

The rejection is fair to the corporation, ORThe rejection has been approved by a majority of disinterested directors, ORThe rejection has been approved by a majority of disinterested shareholders.

*Delaware (Guth) Test: The Line of Business Test: This provides factors for whether the director/officer has taken an opportunity (No one factor can control the outcome, all must be considered):

Was the corporation able to financially undertake the opportunity?Is the opportunity in a closely related business, where the opportunity would put the acquiring party in

competition with his corporation?Does it provide practical advantage to the corporation and is it something the corporation has an interest in OR

a reasonable expectancy in?Would it bring the director/officer in conflict with the corporation?

Compare and Contrast the Two Tests:Finances: matter in the DE test because if the corporation can pay then, the director should not take the

opportunity; ALI doesn’t care about the finances of the corporation.Position: DE doesn’t really mention whether one’s position matters; ALI says one’s position probably does

matter.Disclosure: Under DE disclosure is not required, one can refrain from discloses and not violate the duty,

whereas under ALI, disclosure is a key element.* Self-Dealing (interested director transactions): What do the Courts apply?:

DCL § 144: Self-Dealing transactions are NOT VOID (they are ok) as long as there is:(1) disclosure and it is approved by the majority of disinterested directors OR(2) disclosure and it is approved by the majority of disinterested shareholders OR(3) the transaction was FAIR to the corporation at the time it was entered into.-How a Court determines #3—Fairness: Self-Dealing in and of itself is enough to rebut the BJR, which then

causes the Court to look to the SUBSTANCE of the deal under an Entire Fairness review if there was no prior approval by the Board or SHs:

(1) Was there fair dealing? (the timing of the transaction, how it was negotiated, how is was approved by directors and stockholders, essentially was everything on the up and up) AND

(2) Was there fair price?Note: If both these are answered yes, then the self-dealing would be considered fair and then there would be

no breach of the duty of loyalty.-How a Court determines #1 & #2—When there is Disclosure: Self-Dealing, in and of itself, is still enough to

rebut the BJR, but the Court will only look to the PROCESS to determine whether the deal was fair and not actually the substance of it.

-What is the BoP in self-dealing cases?The P must show that there is self-dealing (a conflict of interest), and once self-dealing is shown, the D can

rebut the breach of the duty of loyalty by proving that the deal was in good faith, honest, and fair.

o What is the difference between interested director transactions like self-dealing and seizing a corporate business opportunity?

-In interested director transactions, the director has an interest on the other side of the transaction and no business is lost for the corporation, whereas in seizing a corporate opportunity the director actually takes the opportunity for himself (personally) rather than letting the corporation have it, which causes the corporation to lose the business altogether.* Summary on BoP in Fiduciary Duty Cases

o Duty of Care:DCL: The P has the BoP to show a breach of the duty of care and then the burden shifts to the defendant to

show that the (in)action did NOT cause the loss.MBC: The P has the BoP to show that there was a breach of the duty of care and that the breach of the duty of

care caused a loss for the plaintiff.o Duty of Loyalty:

MBC 8.31, 8.60, DCL 144, and ALI 5.05: P must show that there is some conflict of interest (self-dealing, seizing of a corporate opportunity), then the burden shifts to the Defendant to show that the deal was fair. When accused of self-dealing, the D must show that he acted in good faith, honestly, and fairly.

* The Duty of Care: Breach of Duty by Board Action Shlensky v. Wrigley:CB269 P was a minority owner in the Cubs. P wanted lights built to make the team more profitable, but D (the majority owner) said no because he felt that baseball should only be played during the day.H/R: The BJR applies here, so the derivative suit brought by P loses. The Court will not interfere in the economic decision of the BoD if there is no fraud, illegality, and conflict of interest. There must be GROSS NEGLIGENCE for the Court to interfere.

Joy v. North:CB274 Bank made loans to Katz that went bad. SH brings derivative action because the Bank kept making loans to Katz after some had already gone bad.H/R: BJR is not invoked here because the directors “who willingly allow others to make major decisions affecting the future of the corporation wholly without supervision or oversight may not defend on their lack of knowledge, for that ignorance itself is a breach of fiduciary duty.”

Ignorance may be evidence of what is going on.

Smith v. Van Gorkom:CB281 Van Gorkom (CEO and director) gives a 20 minute presentation to his fellow BoD members about a merger. He and one other director negotiated the entire deal. The BoD approved the merger immediately following the presentation. The SHs brought a derivative suit because they did not think it was a fair priceR: A business judgment is informed if the directors have informed themselves prior to making a decision of all the material information reasonably available. If one is grossly negligent in making a decision (by being uninformed), this is a breach of the duty of care.H: The BOD was grossly negligent (standard is gross negligence) because it was entirely uninformed and did not do the necessary due diligence to approve such a deal, which means they breached their duty of care. They were uninformed because they did not know the purpose of the meeting, didn’t review any written documents, and Van Gorkom didn’t even read the documents (just simply presented on them).

How do the BJR and the duty of care come into play together? Since there was a breach of the duty of care, the BJR will not apply. The Court must assess the business decision and analyze its substance.

When there is not a breach of the duty of care, the BJR will apply because the court will give deference to the business judgment of the actor/actors.

In the absence of care, the BJR does NOT apply...Dissent – says that this decision was made by people who know what they are doing and are experienced in business, no matter if there was documentation of what they considered or not, the Court should give deference to them and apply the BJR.

* Breach of Duty by Board InactionBarnes v. Andrews:CB289 Dir. was sued because he wasn’t really monitoring the company much. Funds of the corporation were being depleted because of excessive salaries.Issue: Does D’s inaction make him liable for a breach of the duty of care?

H/R: D’s inaction only makes one liable for a breach of the duty of care if it can be shown that D’s inaction caused a LOSS to the company. It is unclear here whether D’s inaction caused a loss.Rsg.: Directors vested with the responsibility to manage, and if they fail to know what is going on then it is easily argued that he was grossly negligent and breached the duty of care, HOWEVER, his gross negligence must be the cause of the loss to the company.Note: Under Model Business Code, the burden of proof falls on the plaintiff to prove that the defendant’s breach caused the loss.

In Delaware: If plaintiff proves a breach, the burden then shifts to the defendant to prove that his actions were not the cause of the loss.

*Duty of Care and Duty of LoyaltyIn Re Caremark:CB296 Directors didn’t monitor closely the employees who caused losses to the corporation by violating Medicare/Medicaid rules. SHs bring derivative suit alleging directors violated a duty of care by failing to actively monitor the employees.H/R: The BOD must have SOME monitoring system (or system of oversight) in place to act in good faith and not breach their duties of care. Caremark had a system and therefore did not breach the duty of care.

McCall v. Scott:CB303 P alleges that the BoD inaction (failure to investigate), with regards to the employees, who were perpetuating a fraud on Medicaid, violated the duty of care. There is a waiver in the Cert of Incorp that says BoD are not personally liable for breach of duty, recklessness, as long as it was in good faith.H: Intentional Misconduct is not necessary for there to be a breach of the duty of care; all that needs to be shown is that particularized facts show a substantial likelihood that the director’s actions (inactions) were reckless, which caused a breach. Rsg.: Here, the directors (because of their prior experience) should have known that they were encouraging their managers to do fraudulent practices.

Intentional versus Reckless Breaches of the duty: Intentional breaches of the duty will cause directors to have to pay for damages, but something less than intentional (between recklessness and intentional) might still cause the directors to pay, although not necessarily.

-In Delaware, you have a liability waiver, and it does not require that a director act intentionally to harm the corporation...it may be something less than intentional....see below:“A director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director; provided, however, that the foregoing shall not eliminate or limit the liability of a director (1) for any breach of the director’s duty of loyalty to the Corporation or its stockholders, (2) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (3) under Section 714 of the General Corporation Law of Delaware, or (4) for any transaction from which the director derived an improper personal benefit.

-Intentional conduct – director cannot be reimbursed for personal loss. Ct is saying that it need not be intentional to fall within the statute, only reckless.

[Note: Summary – Business Judgment Rule – Ct will not second guess GOOD FAITH business judgment of directors. Even if director fails to exercise duty of care, plaintiff must still show that loss was caused by director failure, standard is gross negligence. Business Judgment Rule does not apply when there is a breach of duty.

* – Directors must act within the best interest of the corporation:Directors avoid conflicts of financial interest with the Corporation.Directors avoid competition with the Corporation.Directors avoid taking opportunities that belong to the Corporation.See MBC § 8.31(2)

Jones Co. v. Frank Burke, Jr.:CB311 The officers of Jones Co. left an advertising agency to start their own and took employees and clients with them. Jones Co. sues them for breach of duty of loyalty.H: Officers are agents of the corporation and have a duty not to compete with the corporation, which caused these officers to thus be found to have breached the duty of loyalty. Their actions destroyed Jones Co.Notes:- Directors are not agents of the corporation.

- BOD manages the corporation....appoint officers to implement BOD policies.-Directors have a duty of loyalty and care, same as agents.

may want less stringency with duty of loyalty on your board, you need to allow members to sit on other boards and also you want to attract members with expertise, expertise they have gained from sitting on other boards and being involved in businesses, so you allow them more flexibility.

What would have happened if this case involved directors? Directors are not agents to the corporation, so one would have to check the bylaws to see if they could compete in this manner. Also, the state corporation law will matter in determining whether the duty of loyalty was limited, but not eliminated for the directors.

NE Harbor Golf Club v. Harris:CB317 President of Golf Club purchased 2 surrounding pieces of property, but did not disclose this to the BoD until after she paid for it. The first piece of property she learned about in her capacity as President; the second piece she learned about when playing golf. 10 years after purchase, she begins to develop the property and a new BoD sues her for a breach of the duty of loyalty. What result?- Harris is taking for herself something that belongs to the entity and would not have been available to her absent her position.-Opportunity present to the corp, and she takes it for herself.H: The Court rejects the Delaware (Guth—line of business) test and remands the case to be decided under the ALI test if there was a breach of the duty by purchasing/developing the land. [Under Guth, there would be no corporate opportunity because NE was unable to undertake it financially, but the ALI test largely eliminates the financial component in determining whether something is a corporate opportunity or not].

Broz v. Cellular Information Systems:CB326 Defendant was director of CIS and a director of RFBC a competing Co. He did not tell the CIS about an opportunity that came up from his position RFBC. Issue: Is the director liable to CIS for a breach of the duty of loyalty?H: This director was not held liable because the court applied the Guth (DE-line of business test). Under this test, CIS was not financially able to take the opportunity, although the opportunity was in the same line of business, and the CIS board knew he sat on both. The director did not disclose it, but disclosure is not required under Guth. Considering the weight of the factors, the director was not liable here.Notes: Would this case come out differently under ALI? Hard to determine because the corporate opportunity came to his attention as a director in the other corporation, but it was in the same line of business, so the Court would have to make a determination whether there was actually a corporate opportunity for CIS, which is difficult to do.

HMG v. Gray:CB333 Gray was 1 of 5 directors of HMG. He negotiated the sale of real estate from HMG to NAF, which Gray had an interest in. Another director also knew about Gray’s interest in the other company, but both of them did not disclose this interest. Issue: Did Gray and the other director breach their duty of loyalty?H: Yes, they both breached it because they violated their duty of fairness. It was self-dealing under DCL §144, which requires one to disclose their interest and seek Board approval when one is on both sides of a transaction. The deal wasn’t fair even under the “fairness standard of review” that does not require disclosure because Gray did not act solely and zealously on behalf of HMG to get the best deal possible. If the Board knew about Gray’s self-dealing, they would have made someone else the negotiator, pushed for a higher price, or walked away from the deal.

Note: This is a quintessential self-dealing case.

Cookies Food Products v. Lakes Warehouse:CB341 D owned Lakes and eventually became the majority SH of Cookies, where he stacked the BoD of Cookies to give him higher salaries and made Cookies enter into contracts with other companies that D owned. All the directors and SHs knew of D’s interests.Issue: Was there a breach of the duty of loyalty in this self-dealing case?H: There was no breach because the Iowa court applied DCL §144, essentially. The court said that there was full disclosure; that the deal was fair and honest.Note: Where there is a conflict and the self dealing has been disclosed, or where there is no conflict of interest, plaintiff has the burden of proof and the deal is subject to the BJR. However, in a situation where there is a conflict that has not been approved by the BoD, the defendants have the burden of showing the transaction was fair, BJR does not apply and the Total Fairness Test applies....must show (1) fair dealing(process), and (2) fair price(substance).

o Who Sues and Who Recovers?Derivative Suit: derived from the fact that the corporation has a right to bring suit on behalf of itself when the

corporation is harmed. SH(s) step into the shoes of the corporation and sues on behalf of the corporation, where the corporation (itself) will recover if victorious, not the SHs. Harm is to the corporation, SH’s vindicate the corporations right by standing in its shoes.

o When do these typically occur?Directors or officers breach duty of care or duty of loyalty. Derivative in these cases because the duty is owed to

the corporation.The BOD (or individual directors) has (have) done something wrong and doesn’t sue itselfUnder this type of suit, the SH can sue the directors on behalf of the corporation.Usually happens when there has been a breach of the duty of loyalty.However, the decision to bring suit is within the BoD’s control as they control the corporation. But the BoD

may not act to protect the corporation’s rights or the BoD might refuse to have the corporation bring suit.o How does this affect the BJR? If the concept of a derivative suit allows shareholders to second guess management

decisions.Shareholders will demand that BoD institute a suit on co.’s behalf, BoD then decides if it makes sense to go

after a third party or review a decision that we made.The demand gives the BoD a chance to act.MBC says that you must make a demand, then for 90 days you cannot do anything, unless the corporation has

refused within 90 days, then you can bring the suit. Or, if you think that there will be irreparable harm, then you can bring the suit within that 90 days. Otherwise, you have to wait for a response within that 90 day period, once it is up, then you can sue.

o Ex.s: Wasting of Corporate assets or Directors have not acted with the best interests of the corporation in mind or there is self-dealing.

Sometimes occurs, when the majority SH has done something wrong.o Why are courts reluctant to allow derivative suits? Because the BJR prevents the Court from second

guessing mngt decisions and this type of suit allows SHs to do exactly that. The Courts are thus very particular in allowing only certain types of derivative suits.

Strike Suits: Minority SH sees something wrong and wants to recover $, but the $ winds up going to the corporation and the lawyers, so the Court doesn’t want to allow any minor SH to bring such a suit that could force the D into paying some money just to get the action resolves.

o Why allow derivative suits then?Justice ReasonsIf the Corporation wins $ from some other entity, the Earnings/Share go up

Lawyers have a direct interest in pursuing these cases ($$$$)o What are the PROCEDURAL requirements of Derivative Suits?

1) The corporation must be joined as plaintiff (the real defendant is the directors or other party that harmed the corporation)

2) The plaintiff must own stock:At the time the transaction took place ORWhen the suit is about to start.

3) The plaintiff must make a demand (req. in NY)Demand: P must state the claim in writing to the corporation and demand that the BoD bring a suit on behalf

of the corporation. o What 2 things can happen here?

BoD accepts and brings the suit itself ORBoD rejects - you could stop or you can continue.

4) The plaintiff must make a security pledge (required in NY and about 10 or 11 other states) to prevent frivolous suits.

This insures that the corporation’s legal bills will be paid and is why SHs prefer direct suits because they don’t have to post a bond to bring one.

o What do some statutes say about the procedural requirements?If the BoD is somehow tainted, some states will excuse the Demand

MBC §7.42: requires universal demand in writing and gives 90 days for the board to reject it. If the demand is rejected you have to argue that the BoD was wrong.

NY-Claim must be stated with PARTICULARITY why the demand would be futile-The demand requirement is EXCUSED if it is FUTILE (useless). (ex. Board Members breached their duty

of care)o When Futile?

Majority of Board is tainted: If 5/5, 4/5, and even 3/5 of a BoD breach a duty, the demand will be futile because the majority of the board is still tainted. 2 or less directors, the demand would not be futile. OR

Board didn’t take the time to inform themselves to a reasonably necessary degree about the transactions ORBoD’s decision on its face could not have been the product of sound business judgment.

o Must post bond in NYo DCL?o There is reasonable doubt as to the director’s disinterest and independence

If you show this then BJR does not apply, the suit can proceed and the court can analyze the BoD’s procedure and substance of the transaction.

o Special Note on DCL: DE courts view a demand as an admission that the directors were disinterested, so never make a demand in DE, if you want to bring a derivative suit. So, in DE we just try to show that the board is tainted to bring the derivative suit forward.* Direct Suits: SH is directly injured and wants to vindicate his/her own personal interest/claim. (The SH is seeking to vindicate his/her personal claim out of her ownership of stock).

o SH does not have to post a bond.o SH wins the money/injunction if he wins.o Can be brought as a class action

* Class Action Suit: SHs can bring these when the various SHs are similarly situated and all claiming the same types of injury(ies) arising out of ownership of the stock of a particular corporation.* Questions Page 359:

o (5) Are the following direct or derivative suits?(5.1) Roberts sues the directors of BB because they failed to permit him to inspect corporate books/records?-This is a direct suit because the BoD is harming him directly as a SH by preventing him from exercising his

right as a SH to inspect the corporate books.(5.2) The AIC of BB provide that the corporation will “operate restaurants featuring burritos and related food

and beverage products.” Shepard learns that the directors plan to enter a contract with Chad & Associates to go into the voting machine business. He sues to enjoin the corporation for engaging in this ultra vires activity?

-This is a derivative suit because the activity is outside the corporate authority defined by the certificate of incorporation, so it harms the corporation itself.

(5.3) Roberts sues the directors of BB for wasting corporate assets by paying themselves huge bonuses?-This is a derivative suit because it is a classic corporate waste situation, where the waste harms the corp.’s

assets, which harms the corporation’s ability to operate effectively. (Also, breach of duty of loyalty.)(5.4) Shepard sues the directors of BB for usurping corporate opportunities?-Derivative suit because a breach of the duty of loyalty. The duty of loyalty is owed to the corporation itself, not

SHs individually, so that is why this is a derivative suit.(5.5) Epstein sues the directors of BB for failing to exercise due care because they purchased supplies at a price

much higher than could have been negotiated?-Derivative suit because this is a breach of a duty that the directors owed to the corporation, so the corporation

was in fact the party harmed and should be the party that recovers.(5.6) Roberts is the minority SH in BB, which is a close corporation. He sues the controlling SHs, alleging that

they have breached the fiduciary duties by oppressing him by hiring themselves and paying themselves cash for stock, but not offering the same things to him, as minority holder?

-Direct suit because the controlling SHs were harming him directly as a minority shareholder, where the injury stemmed from his ownership of stock. There was no injury to the corporation.

o Hypothetical: The Corporation insures a certain dividend, but has not paid it. 70 SHs want to bring suit, what type should they bring?

-They should bring a direct suit because the injury flows from the SHs ownership of stock.

-BOD decision to issue dividends, Ct will be inclined to recognize BJR.o Hypothetical: ICE Corp. issues stock without honoring Bambi’s preemptive rights. What type of suit?

-Direct, because Bambi was injured by an interest that stemmed from her ownership as SH.* Indemnification of Directors and the MBC

o MBC §8.52: Must indemnify a director who is wholly successful in litigation, which he was brought in because he was a director

o MBC §8.51: May indemnify a director who has acted in good faith and that believed the action was in favor of the corporation.

o MBC §8.51(d): CANNOT indemnify the director if found liable and he received a financial benefit to which he was not entitled. * Insurance of Directors:

o MBC §8.57: Company may purchase insurance on behalf of an officer/director…against liability asserted against or incurred by him in that capacity or arising from one’s status as a director/officer, whether or not the corporation would have power to indemnify or advance expenses to him against the same liability…

Eisenberg v. FTL, Inc.:CB353 Eisenberg was SH in one company that ran an airline that merged with another company, which caused him to now be a SH in a holding company. He didn’t want to influence the holding company, but wanted to influence the airline instead.Issue: Can Eisenberg bring a direct or derivative suit?H: Eisenberg should be allowed to bring a direct suit because the merger affected the value of his shares, which stems from his interest as a SH. Direct suit allows SH to vindicate his rights as a SH.Note: - NY, you do not have to post money as security when bringing a direct suit, however, you must when bringing a derivative suit.

Why wasn’t this a nuisance suit? Because he wasn’t seeking money, instead he was just seeking justice in how he was wronged.

Why is this case criticized? This was a nuisance suit because as a minority SH, he had no power to stop the merger.How could this be framed as a derivative suit? The Ps could have said that the duty not to merge the corporation

was only owed to the corporation, which only derivatively affects SHs. You would have to argue that the corporation was harmed in a way which derivatively affects the SHs.

* Demand on DirectorsWritten notice to corp. to take action....universal demand in some states.In NY, demand can be waived and you can institute suit without demand, you must make allegations with

particularity...lay out how the board is tainted, what the taint is, and why you believe this is so.

Marx v. Akers:CB368 P was a SH in IMB. P brought a derivative action against the IBM BoD without making a demand. P claimed that the BoD engaged in corporate waste by paying 3 executives (inside directors) and 15 outside directors excessive compensation.Issue: Was the demand required? Would a demand have been futile?H: No, it was not required for the outside directors since they were tainted, but it was required for the 3 inside directors because the majority of the board would not be concerned (interested) with the minorities’ compensation.

* Derivative Action: Review.Remedy sought is for wrong done to the corporationPrimary cause of action belongs to the corporationRecovery must ensure to the benefit of the corporationStockholder brings the action, in behalf of others similarly situated, to vindicate the corporate rights and a judgment

on the merits is a binding adjudication of these rightsDemand: The plaintiff must set forth with particularity the efforts of the plaintiff to secure the initiation of such

action by the board or the reasons for not making such effort...demand is required unless such demand is futile.Three purposes for demand:1) Relieve courts from deciding matters of internal corporate governance by providing corporate directors with

opportunities to correct alleged abuses

2) Provide corporate boards with reasonable protection from harassment by litigation on matters clearly within the discretion of directors

3) Discourage strike suits commenced by shareholders for personal gain rather than for the benefit of the corporation.

- The demand is generally designed to weed out unnecessary or illegitimate shareholder derivative suits.- Have to negotiate the play between the BJR.

Auerbach v. Bennett:CB 383 (NY Case) P made demand in a derivative action and the corporation set up a special litigation committee (SLC), which rejected the demand. The SLC comprised of 3 people who were not involved in the transaction. Only 4 of 15 directors were said to have breached a duty, they were involved in self dealing. P argued that the whole board was compromised because they were all sitting when the transaction took place.H: This was a properly formed SLC, which preserved the BoD’s independence in determining whether to accept or reject the demand. Rsg.: One cannot say a whole Board is tainted simply because they all sat when the wrongdoing occurred. Only if the BoD’s procedure for setting up the SLC was flawed, would the court look to the substance of P’s claim.

Court says that the BJR is extended to the decisions of the special committee, the Court can look into the procedure for setting up the SLC, but if the procedure is sound, if the investigation was done in good faith, then the BJR applies to the decisions of the SLC. If then the SLC decides that the suit should be dismissed, it is then dismissed.

Zapata Corp. v. Maldonado:CB389 P brought derivative action against 10 directors alleging breach of duty. P didn’t make a demand because he thought it would be futile. A few years later, 4 of the defendant directors were no longer BoD members, two new directors were appointed. A SLC was comprised of only the two new members. SLC dismissed the action. Issue: Can the SLC dismiss a derivative action? When does the Corporation have the power to dismiss a suit instituted properly and legally on its behalf.H: SLC cannot dismiss the action on its own; the Court must be involved. The Court, then, must balance the rights of the BOD to manage its affairs and a SH to bring suit and determine whether the business acted properly (process and substance).Rsg.: If the instituted suit is dismissed by the board, the suit will stand as dismissed and the decision upheld unless it is wrongful.

-Plaintiff can ask the Court to review the decision.BJR will apply to committee decisions if the investigation, methods, processes are made independently....but, even

if these circumstances are met the Court will still look into the substance of the decision if the suit is rejected. The Court will substitute its own business judgment. They are trying not to divest BoD authority but do not want to just dismiss a suit.

In the absence of a conflict of interest, the SLC is independent, the Court will look to see if there has been a reasonable investigation and an informed decision. When is the SLC decision wrongful? When there is an inadequate process. In this case the Court will look at the substantive decision.

If the Court concludes that the SLC made the correct decision, then that is the end. If the Court determines that the decision of the SLC was wrongful, the Court will allow the SH to continue suit.

*Who really pays?o Indemnity.... MBCA § 8.51, 8.55o Three Categories:

1) Corp must indemnify directors, § 8.52, who are wholly successful in litigation2) May indemnify, § 8.51, where party acted in good faith and reasonably believed that action was in favor of

corp.(3) Will not indemnity, § 8.51(d)(2), where the party is adjudged liable on the basis that he or she received a

financial benefit to which she was not entitled.o Insurance

Covers negligence NOT intentional tort*Salaries, Dividends, and 10b-5.

o How do Corporations Grow?Borrow money

Retained EarningsIssue More Stock:Sell interest in Corp....but then you decrease everyone else’s interest.

Avoid this? Preemptive rights – before shares offered to anyone else, they are offered to current SH’s so that they can maintain their percentage of ownership.* How do businesses grow?

o Borrow MoneyIssues:

Need a lender?Covenants could be tough?Repayment? (Guarantees)Default?

o Issue More Stocko Preemptive Rights: Existing SHs (generally in closely held companies) have a right of first refusal to maintain

their current % upon a new issuance by the CORPORATION, so their interest is not diluted. [You can have preemptive rights from state statutes, articles of incorporation, or the purpose of an issuance. General Rule: In half of the states if the AIC are silent, then it is presumed that preemptive rights exist; the other half do not presume preemptive rights if AIC are silent.

The SHs pay market value.They can waive their preemptive rights, but then they lose themThe option to purchase exists for one yearSee MBC §6.30

Bylecki v. Vivadelli:CB415 D-majority SH (90%) of close corporation eliminated SH preemptive rights, and reduced P’s ownership from 10% to 1% when it issued new stock just to himself. P sues for breach of duty. Direct suit, SH trying to enforce rights directly.H: D cannot issue shares of stock in this self-dealing way. When you issue stock to gain control, not to raise capital, there is a good indication that a fiduciary duty has been breached.Rsg.: What duties do SHs owe each other in Close corporations like this one? Trust, Confidence, and loyalty to one another. There is no market to readily sell one’s stock, so the controlling SHs cannot simply freeze out the minority one like this D tried to do here. Since this is the case, a minority SH is able to sue a controlling SH directly and does not have to bring a derivative suit since the controlling member would try to crush it anyway by rejecting a demand. [Close Corporations require SHs to owe fiduciary duties to each other just like partner SH owe duties to one another in the p-ship business form]

What is this case really about? This case is not really about preemptive rights, it is about fiduciary duties between SHs in Close Corporations.

What is special about close corporations and fiduciary duties? A close corporation is like a codified p-ship that allows limited liability for SHs.

Since it is like a p-ship, we insure that SHs protect each other by making them have to adhere to their fiduciary duties to one another.

- Underlying idea: Courts want to see these people who have invested get a return on their investment.

o Use Retained Earnings (should earnings be reinvested or distributed as dividends)o Going Public: very expensive because of the huge transactional costs. Why?

Is SEC Act of 1933 going to apply?Who is going to be the underwriter?Etc, etc, it is just an overly expensive proposition, so it is really only suited for certain types of companies.

o Venture Capital: substantial equity investment in a non-public company without taking active control, where the firm (banks, pension funds) is looking for a high ROR. Entrepreneurs usually seek venture capital when they are unable to raise capital elsewhere.

Retained earnings are usually the most favorable, but with startup companies they have not produced any earnings to retain.

Debt financing is usually preferred over equity because investors demand a higher rate of return than lenders.Why would someone take on VC investors?

Because there are no other options (no loans or R/E available)Only about 1/3 of VC endeavors are successfulThey are highly risky.

How are the VCs protected?Usually get a significant voice in the firmLiquidation preferenceàGet $ when the assets are liquidatedRight to require additional stock at a predetermined priceVoting/Veto RightsExit Opportunities: Redemption rights to sell the stock back to the company

* Securities Law/Sales and Purchases of Stock: How does a Corporation Issue Stock?o Sale of Public Shares

Register with the SEC? Very expensive, too expensive for corps that require venture capital usually.What do you have to disclose?

o What is the difference between the corporation and the SH selling securities?Businesses grow by issuing securities, where they get to keep the money raised.SHs make money by reselling those securities to other people. The individual makes money from this

transaction and not the corporation.o Why do corporations have to register with the SEC to sell securities?

To make information available to the public about that sale and require full disclosure so that an investor can know if they are making a good investment.

To protect against fraudTo protect investorsTo protect the publicTo balance the playing fieldTo have accurate pricing of corporations because a publicly traded company’s price is supposed to reflect all

available information about a corporation.To protect the market itself (The market is a price setting mechanism itself and most people do not have access

to all the information about businesses to what to invest in, so the registration allows the public to trust the corporation’s price)

To provide access to the market for unsophisticated investorsHow are investment bankers involved in the sale of securities?They take the shares of the stock of the corporation and market and sell them to the public under a promise of

best efforts or firm commitment:o Two Investment Bank IPO options:

Best Efforts: Investment Bank agrees to sell the org’s shares with best efforts.Firm Commitment: I-Bank buys all the corp’s shares and agrees to sell them all to the public.

o What is a secondary market and how does it work?A secondary market involves the resale of securities by the SH.The corporation is not involved and does not receive any of the money from the resale.The SH relies on an informed, stable market so the investor can determine when he should buy or sell.

o Why do corporations care about the resale on Wall St then?Selling Price makes them look good to current and future investorsWhen they do want to raise money in the future by a new issuance, this allows them to issue new shares at a

higher price and thus raise more capital than they could before.Selling price allows the corporation to borrow in the future in debt, bonds, promissory notes, etc.

* Common Law Fraud and Misrepresentation and Rule 10b-5 Constraints on Stock Issuanceo No issuance of stock is exempt from the common law of fraud and misrepresentation...a person who buys stock

from a corporation as a result of that corporations false or misleading statement can either invoke the contract law of misrepresentation to avoid her contract to buy the stock or invoke the tort law of fraud or deceit to recover damages from the corporation.

o No issuance of stock is exempt from Rule 10b-5, the securities antifraud rule developed by the SEC.* Why Rule 10-b-5 for the purchase/sale of securities?

o Anti-fraud provisiono Federal provision – always applies to the sale or purchase of shares of stock

o Makes unlawful to make a misstatement of material fact or omit a material fact in the purchase/sale of securities. There has to be an intent to do this though (scienter).

o Covers both public/private sales to protect people from getting ripped off by lies.*7 elements of a 10-b-5 CAUSE OF ACTION?

o 1) Misstatements or Omissionso 2) Materialityo 3) Scienter: requisite knowledge of the illegal act.o 4) In connection with sale or purchase of securities (registered or unregistered)o 5) Using Instrumentality of Interstate Commerce (federal)o 6) Reliance upon the misstatements/omissionso 7) Reliance on the misstatements or omission is the proximate cause of the injury/loss/damage

* What remedy exists besides 10-b-5 for purchase/sale of securities?o Common Law Fraud: protects affirmative acts;o An omission of a material fact does NOT allow a common law fraud suit.

* 10-b-5: What is so important about it?o See Basic v. LevinsonCB498, it is the quintessential case on the subject and provides guidance on different

theories that can be used to argue on the exam in a variety of situations. It is EXTREMELY IMPORTANT to know all aspects of this case.* What is Bespeaks Caution?

o Cautionary language, if sufficiently cautionary, renders the alleged omission or misrepresentation immaterial as a matter of law.

o Problems on Page 4401) Agee, C and P are the only SHs in BB. Each owns 1,000 shares. Roberts is considering buying 1000 shares

from BB for 100k. Agee, the CEO of BB, tells Roberts that BB has never received a Health Department rating lower than “VG”. In reliance on that representation, Roberts buys 1,000 shares from BB. Roberts later learns that BB had received 7 Health Department ratings of “UB”. What can Roberts do?

-Roberts’ value of his shares is much less than he thought it would be because of this lie (a lie signals scienter), it was in connection with the purchase of securities, IC provision was met, reliance occurred, and it caused some type of injury. He can bring a 10-b-5 claim then. Roberts can also sue for misrepresentation to avoid the contract or fraud or deceit to recover damages because this was a lie.

2) Same facts as 1 except BB had not received a Health Department rating lower than “A”. However, the day before Agee told Roberts that BB had never received a poor rating, the Health Department inspected BB and told Agee that there were major problems and that it was almost certain that the company would receive the lowest rating (an F). While Agee tells Roberts about the history, he does not mention his conversation with the Health Department. After Roberts purchases the stock, the bad rating of F was released and Roberts learns of Agee’s conversation with the Health department. What can Roberts do?

-Roberts can bring a 10-b-5 suit because the elements are met.-He will be unable to bring a common law fraud suit because common law fraud requires an affirmative act, and

not speaking (an omission) is usually not construed as an affirmative act, which would warrant fraud.3) Same facts as 2, except Agee does not say anything about Health Department ratings.-Roberts can use 10-b-5, because there is a duty to disclose.-No common law suit, just as #3.4) Common law fraud. 10-b-5 applies to transactions between individuals. Transactions in connection with the

purchase and sale of securities triggers 10-b-5 duty.* Debt versus Equity:

o Debt: less risky, but allows the owners to have a lower RoR; interest payments are deductible; companies pay a lower price for debt than equity

o Equity: instant cash, but forces the current owners to lose some of their ownership %; provides a higher RoR for the SHs.* How do owners make money?

o Salaries, Dividends, Selling Ownership Interest: o Dividends

What are they? Distributions to SH from Retained Earnings or current earnings.Who decides to issue? The BoD

-MBC: says you cannot pay a dividend (also called a distribution) if the corporation is insolvent or the payment will make the corporation insolvent. Distributions, in violation of this may impose liability upon the directors.

-NY and DCL: dividends are not only issued from earnings, but can only come from capital surplus, not stated capital.

o Close v Public: They are much more prevalent in public corporations.Close corporation investor usually looks to salary for the principal return on investment, usually except

employment and a substantial role in management.o Types:

P/S: get paid dividends first, but not necessarily the most.P/S Participating: the stock gets paid dividends first, but then gets paid again if there is money left over after

common are also paid.P/S Cumulative: carry over from year to year. All accrued cumulative dividends that were not paid in any year

must go to P/S holders before c/s get any dividends.o Salaries

Who decides the salaries?-BOD determines compensation for the top level executives-In close corporations, shareholders expect employment and a meaningful role in management because they

don’t expect to get dividends.What is the objective of setting salaries by the BOD, especially in close corporations?-To make them as high as possible because they are deductible, whereas dividend payments to SHs would not

be deductible. So, since most managers of closely-held corporations are also SHs, this allows SHs to avoid taxes on their earnings if salaries are set high.

o Sale of one’s sharesVery difficult to do in a close corporation.

* What are the main characteristics of a close-corporation?o Small # of SHso No readily available market for the corp’s stocko Substantial SH participation management of the corporation.

* How do Courts help out a minority SH in a close corporation?o They impose fiduciary duties between SHs, where the majority cannot freeze out the minority SH’s interest.o They do this because there is no market for the stocko The fiduciary duties extend to the issuance of shares, so when there is a wrongful issuance (or buyback) the courts

will help out the minority SH

Hollis v. Hill:CB447 There were 2 corporations, FFUSA and FFUI. Hollis and Hill each owned 50% of both. Hill was a director of FFUSA and served as its president and operated the Houston office. Hollis was a director of FFUSA and served as its vice president and operated the Florida office. Hill wasn’t happy with Hollis and thought Hollis was being paid too much so he proposed to buy Hollis’ interest in FFUSA in exchange for a ten year consultant agreement. Hollis rejected. Hill then took FFUSA and placed it into a sole proprietorship and stopped sending financial reports to Hollis. Hill refused to let Hollis look at the books then Hollis asserted his right as shareholder to do so. Hollis and Hill then agreed that Hill would acquire Hollis’ interest in FFUI, draw a salary from FFUSA and that Hollis would also draw a salary from FFUSA. Under this agreement both retained 50% ownership of FFUSA. A few months after this agreement Hill informed Hollis that he was reducing Hollis’ salary to 0. Hollis then sued Hill for his actions alleging oppression. Hill then terminated Hollis as VP but Hollis continued as secretary, board member, and 50% holder of FFUSA.

Texas law applies internal affairs doctrine, which says apply the law of the state of incorporation: NV.Issue: Did Hill breach any duties to Hollis?H: Yes, Hill breached the fiduciary duties because the court analyzed this under a p-ship-type analysis, rather than straight corporation analysis.Rsg: The Court did so because only two shareholders existed, there were no shareholder meetings, no election of directors, or adherence to bylaws.

The Court concluded that Hill violated his fiduciary duty because he prevented the other SH from getting a return on his investment by taking away his salary.

In addition, although a 50/50 relationship, Hill oppressed Hollis because he was the one who controlled the assets, despite the corporate form. There was no legitimate business reason for Hill to deprive Hollis of his rights.

Takeaway: Controlling of the assets by one SH to the detriment of another will allow p-ship fiduciary duties to be owed between the SHs of closely held corporations, even if they own an equal number of shares.

In this case, Hill controlled the assets, so he was controlling, even though both Hollis and Hill were 50% owners.If this were a large corporation many of these acts would be shielded by the BJR. However, in a closely held

corporation the Court will protect the minority’s interest as shareholder because of the expectations of shareholders in closely held corporations are different from those in public corporations.

The defendant has the opportunity to argue that the actions were done with a legitimate business purpose. The burden shifts back to the plaintiff to show that the defendant could have gone about things in a different way.

Employment by this type of shareholder is often the only return on investment and the principal source of income.Therefore, The majority/minority relationship in a closely held corporation is akin to a p-ship, so fiduciary duties

must be owed to one another as SHs just like partners owe fiduciary duties to one another.Remedy, the Court found Hill liable for breach of his fiduciary duty and ordered a buy-out of Hollis’ shares.....the

date of which is the date suit was filed.How could Hollis have protected himself? With an employment contract.

Exacto v. Commissioner:CB464 Exacto was accused of hiding dividends as salary by the IRS because salaries were deductible as an ordinary and necessary business expense from the corporation’s taxable income.H/R: Posner held the salary was just right because the CEO was adding value to the Company. Salaries can be high for top officers if they are creating value for the owners. He said that the IRS’s 7-factor test was just wrong.Notes: What would the IRS need to argue to win? That the CEO was not creating the value and that it was really others who were running the corporation or they could have said that the increasing value of the company was not a result of the CEO, but because of other factors.

Giannotti v. Hamway:CB470 Min. SH brought action for corp. waste because of excessive salaries. The directors set their own salaries here and were not disinterested.Issue: Was there a breach of the duty of loyalty here?H/R: Yes, self-dealing when one sets their own salaries, so no BJR, and the BoP shifts from the P to the D, to prove that the salaries were not excessive.Rsg.: Courts rarely second-guess salaries, unless there is self-dealing.

Courts will not second-guess compensation with an independent board in a large company, there must be self dealing, usually found with a closed corp.H: Yes, there was a breach here because the directors had no experience, spent little time involved in the business, and they had 5 men doing a job that one could have done. The business made much less than other similarly situated businesses because they took these salaries that diminished profits.Note: Summary Point - So what happens when there is self-dealing in legal actions? The BoP is on the P to show self-dealing, once self-dealing is alleged the BJR will not apply and the Court can look to the substance of the transaction and determine if it was fair using the entire fairness standard. Burden shifts to D to show that the dealing was fair.

o DividendsCorporations issue stock of different class, MBC § 6.01.Who makes the decision to issue dividends: The BoD.Problems arise in small corps when there are few people expecting different things.MBC § 6.01 – different types of stock. Authorized in the AIC. Different types must be listed in the AIC.Identical shares have same rights but there may be differences between classes.Can be paid from:

As long as Corp is not insolventDistribution of dividends will not make Corp insolventDE, and NY, dividends taken from surplus earnings, NOT stated capital.

Zidell v. Zidell:CB483 This involved 4 closely related and closely held corporation that have 3 SHs, who were largely getting a return from salaries. The companies regularly retained earnings. Arnold owns 3/8 (minority SH) quits his job and then the company raised the salaries. But since he quit, he could no longer get paid. He is now suing for a lack of dividends.

H: Having no dividends was not unreasonable in this situation because it was the companies’ common practice not to pay dividends. They operated the business in good faith and had valid reasons for doing what they did (largely, they were workers)Rsg.: Defendants had a legit business reason for their actions, therefore, burden shifts back to the plaintiffs to show bad faith in determining the amount of corporate dividends....to show that defendants reasons were just a pre-text.

How are directors held liable? Directors have a duty to the corporation itself and serve at the pleasure of the corporation, they are therefore collaterally (secondarily) liable to SHs for breaches of good faith, duty of loyalty, and duty of care.

Who has the BoP in dividend cases? The P has the BoP in actions where they allege a problem with the dividend and must show that the directors acted in bad faith in setting them (or choosing not to issue them at all).

The decision to distribute dividends belongs to the board and will be upheld if the decision reflects good faith and a legitimate business purpose. Concern that the majority shareholder gets a return on his investment.

Sinclair Oil Corporation v. Levien:CB489 Sinclair, parent company of Sinven, owned 90% of Sinven’s stock and controlled its BoD. Levien owned 3% of Sinven’s stock. Sinclair made Sinven pay out a lot of dividends, which Levien claims should have been retained as earnings. Levien claims that this amounts to self-dealing as well.Issue: Was there a breach of duty by Sinclair, as parent and controlling SH?H: The BJR applies here because there was no self-dealing, according to the Court. Rsg.:There was no self dealing because the minority shareholder received its proportionate share of the dividends. If the minority was excluded, then there would have been self dealing and the BJR would not apply, thus invoking the entire fairness test. However, there were valid reasons for the dividends to be paid and everyone, including Levien, and Levien benefited from the distributions and such a decision was left to the control of the BoD.

What would have happened if there was self dealing? The Court would not apply the BJR and determine whether the transaction was fair (an entire fairness standard).

In a parent/subsidiary relationship, this is the analysis. This is a corporation, so the duties are owed to the corporation, not the shareholders (except in a close corporation), so this is a derivative suit by the minority shareholder for improper distribution of dividends and maybe corporate waste.

Basic v. Levinson (US S. Crt.): CB498 Basic made 3 statements that no merger negotiations were going on. Suddenly, they announce a merger. Some relied on the public statements and sold their shares. They lost money by selling their shares when they relied on Basic’s misstatements because once the merger was announced the stock price of Basic skyrocketed.

Those who sold the shares brought suit, because 10-b-5 allows a private cause of action. The are alleging that they were injured by selling Basic shares at artificially depressed prices in a market affected by petitioners misleading statements and in reliance thereon.Rsg.: What is the standard for determining MATERIALITY about mergers (and other speculative events) then? It is a balancing test that seeks to balance the probability that a stated event might occur with the anticipated magnitude of the event in light of the totality of the company activity. Thus, materiality depends on the significance the reasonable investor would place on the omitted/misrepresented information.

Why should merger negotiations be kept secret then? If the merger negotiations are announced, the price of the shares might go up too high, which could prevent the merger from happening because the purchaser might no longer be able to afford the shares. Conversely, if the merger doesn’t happen for this reason, the SHs would lose money by not having their shares go up because of the merger.

Have to balance the statements being announced too early as speculative, and too late as being material omissions. Merger context – balance the probability and the magnitude of the event happening.

What is FRAUD on the MARKET THEORY: In an efficient market (open and developed securities market) the company’s stock price should reflect all available material information, but if there are misleading statements then the price will not be accurate and purchasers are defrauded even though they don’t rely directly on the misstatements. When alleging fraud on the market, one can bring a 10-b-5 suit.

So what is a plaintiff to do when he alleges a fraud on the market? It can get a P started in litigation, but then the Defendant can rebut the presumption of reliance on the misstatement and prove that the plaintiff did not actually rely on the market when making his purchase/sale decision and is therefore unable to bring a 10-b-5 suit if the D can rebut the presumption of reliance.

Example: How could D show that P did not rely on the market setting the price? D can show that P sold the stock for other reasons and therefore there was no fraud on the market. The fraud on the market theory would be properly rebutted. D could also say that the price reflected the misinformation and rebut the fraud on the market theory as well. D could also say that P sold his stock then because he needed the money was or was under political pressure to do so, which would all rebut reliance as well and thus bar a 10-b-5 claim.Issue: Were the misstatements material?H: The court says that these misstatements were material in this context because there was a really strong probability that this merger would happen. All 3 statements were made in the course of one year and the merger agreement was just suddenly given to SHs to vote. The final statement was made one month before the announcement, which signals how material the misstatement was. Also, the fact that public trading was extremely high because of rumors of negotiations leads one to believe that the merger was of great magnitude.

EP Medsystems v. Echocath:CB508 (another good discussion of 10-b-5) EP invested 1.4 million in Echo because Echo’s CEO made oral statements to EP that certain important contracts were imminent. EP signed contracts when investing the money that specified some of the risks that they were taking. Echo never got the important contracts. What did the court do when EP sued?Rsg.: Materiality – a misrepresentation or omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to act. There must be a substantial likelihood that the disclosure of the omitted fact or misrepresentation would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.

However, there is a safe harbor for forward-looking written or oral statements. (Bespeaks caution)There was no safe harbor in this case because defendants said contracts were imminent.

Note: Fraud on the market theory does not apply here as shares are not being traded on the open market.H: This is a 10-b-5 action, where Echo tried to argue bespeaks by saying that the written contacts specified sufficient cautionary language. The Court ignores that and says that EP relied on the material oral statement, which had no cautionary language, and not the written contracts that had cautionary language, which a jury could reasonably find caused EP to lose substantial money under 10-b-5 elements.

EP relied on the statements, but for the statements EP would have never invested in this manner.Notes: What is different about this case from the typical securities case? In the typical securities case, someone relies on public information and then they suffer a loss because of reliance. In this case, they claim that the purchase itself was the loss, rather than future activity, which typically causes a loss to someone in the regular securities case.

This is almost like a venture capital situation.

Malone v. Brincat:CB523 This company restated its earnings for 3 prior years, which caused the company’s stock price to go down 2 billion dollars. The SHs lost money because they thought the company was in strong financial position.Issue: What type of case is this and what did the court decide? H:This is not a 10-b-5 case because there was no purchase/sale of securities involved here. No sale or purchase in connection with, then no 10b5 cause of action.Rsg.: The Court said the SHs need to bring a derivative action here because the injury was caused by the BoD breaching its duty of loyalty and care to the corporation, which caused a loss to the corporation. Directors don’t owe duties to SHs.

Why did this court say there should be a duty to disclose by the BoD?(1) The BoD has a duty to disclose accurate information to the public; (2) they are under a duty to disclose when

they ask SHs to vote on a BoD decision or ask SH’s to take action there is a duty of good faith. Therefore, in a case like this one where SHs aren’t asked to do something, the BoD still has a duty to disclose all material information to the SHs that is accurate and if they disclose inaccurate information, then BoD has breached its duties and injured the corporation.

Shareholders acting on material information that is not accurate have a claim against the source of that inaccurate information.

-State of DE doe not recognize fraud on the market theory.

Dupuy v. Dupuy:CB532 One brother induces another brother to sell him his shares of their company over the phone. They were both in the same state (intrastate). The brother who sold wants to bring a 10-b-5 action.

Issue: Does an intrastate phone call satisfy the jurisdictional hook requirement of interstate commerce for the brother to bring a 10-b-5 action?H: Yes it does because the intrastate phone call was an instrumentality of interstate commerce. “Interstate” commerce will not be narrowly construed...any instrumentality of interstate commerce, such as a phone, will qualify.Note: SEC policy in creating 10b5: to substitute a philosophy of full disclosure for the philosophy of caveat emptor and this to achieve a high standard of ethics in the securities industry.

o Questions Page 5351)2) Freer misrepresents facts about the value of his stock in BB to Shepherd in a face to face meeting. As a result

of those misrepresentations, Shepherd agrees to buy Freer’s stock. He pays for it with a check. Freer endorses the stock certificates to Shepherd. Clearly, Shepherd could sue Freer for common law fraud, but how about 10b-5?

-Shepherd probably can sue with a 10b-5 action because the check is likely to be considered an instrumentality of interstate commerce under Dupuy. The misrepresentation was face to face, but the actual check that consummated the transaction traveled through interstate commerce, so thus a 10-b5 claim may be brought.

3) Agee, who is a director of BB, misrepresents facts about the Future Value of BB stock in a face to face meeting with Epstein. In reliance on those misrepresentations, Epstein goes to an online brokerage service and purchases stock in Bubba’s through a national exchange. The stock craters in value. Can Epstein sue Agee under 10b-5?

-Yes, 10b-5 captures this as well because national exchanges are definitely part of interstate commerce.o 10-b-5 as to Insider Information/Trading: information by officers, directors, and other insiders who have not yet

disclosed information to the public yet, but is traded on by those with the inside information.o Does 10b5 cover insider trading?

Not really. 10b5 talks about material information that would correct statements already made, so that might allow you to bring a 10b-5 action, but it is unlikely.

o Is the duty to disclose imposed upon someone who accidentally overhears information?No, it is typically not imposed on the accidental over-hearer.See Chiarella, below!

o What is the classical insider trading case? When an insider trades on information of stock in his/her own corporation and has, thus taken advantage of his/her company by virtue of one’s position.

Goodwin v. Agassiz:CB536 P had sold his stock of a company. The President of the company became aware of the fact that their geologist had a theory that certain materials might be found in MI and told 2 Directors, who purchased the company’s stock on a national exchange, relying on this information, while the company was securing this land. The Company did not disclose this information to the public so P is upset that the Ds had better information than him when they went to go purchase their shares. P says he would have never sold had he known.H: The Ds had a right to purchase the stock because the President was just speculating at the nebulous stage and is not required to disclose his hopes and future aspirations to the world about what he plans to do with the company. This trade was also done on an impersonal exchange, which seems to suggest that no one misrepresented or omitted anything to P to get him involved in selling his stock.Rsg. Directors do not owe a duty to SH’s; directors owe a duty to the Corporation. Duty owed in law to the corporation.

If insider information is false and it is disclosed before finding out it is false, the company and the public is hurt. The public is hurt by people with insider information trading.

What does this case really stand for? In special circumstance cases, directors will have a duty to disclose non-public information. But in a case like this, where there is no face to face contact, then the Courts of MA will not impose upon the company a duty to disclose.

When a director is trading with a shareholder, the director has to deal fairly...when there is a face to face situation, there is a duty to disclose.

When directors trade on an impersonal stock exchange, there is no duty to disclose to a SH information that is at best speculative.

o Questions Page 541

(5.1) Agee is director of BB and in that capacity has learned that BB may well be taken over by McDonalds. The public does not know this. Roberts owns 50 shares of BB and thinks the company is doing poorly. At a SH meeting, he complains to Agee and says “I wish I had never bought this stock.” Agee then offers to purchase Roberts’s stock. Roberts sell, after which the announcement of McDonald’s takeover is made. Could Roberts sue Agee?

-Agee has a duty to disclose to Roberts in this case because of the special circumstances that exist under Goodwin. Here the special circumstances, are the fact that they had a face-to-face meeting to discuss Roberts’s situation, so Agee should have been compelled to tell Roberts, once Roberts inquired about the stock.

(5.2) Agee is a director and in that capacity learns something that he believes will cause the stock price to plummet. The public does not know this. Epstein is not a BB SH, but thinks the company is interesting. Epstein plays golf with Agee and asks Agee if he would sell him some of his BB stock. Agee says nothing except OK. After Epstein buys and the stock craters, would the Goodwin court permit suit by Epstein against Agee.

-Agee does not have a fiduciary duty to disclose, so Goodwin probably does not force her to do so. But if Epstein, was already a SH, then he would be able to sue Agee under Goodwin because of the nature of the face to face transaction.

-How would this come out under 10b-5?Might be able to make an argument under 10b-5 because this allows you to go after the purchase/sale of

securities.

* Legal Duties Applied to Selling StockSEC v. Texas Gulf Sulfur:CB542) TGS was investigating land and found some minerals. Some directors purchased the land for TGS and then they purchased the stock at a low price in the company based on this inside information. Once the news came out about the land, the price went up a lot.Rsg: The only objective against insider trading is that access to material information be enjoyed equally; this objective requires nothing more than disclosing basic facts so that outsiders may draw upon their own evaluative expertise in reaching their own investment decisions with knowledge equal to that of the insiders.{what about the theory that the opportunity belongs to the corporation – the idea is that the information is for the benefit of the corporation, not for the directors or the employees, the same way a director cannot take an opportunity that belongs to the corporation, that belongs to the shareholders}H: This was a violation of 10b-5. Court doesn’t buy the directors’ argument that they couldn’t disclose for fear that the price of the land would go up because the directors could have just sat on the information and not traded on it. Corporate purposes may be served by not disclosing material facts, but if you don’t disclose it then you must not trade on it. If you want to trade, then you have to disclose.R: If the information is material or will have a material effect on the price, directors must either abstain from trading or disclose.Rsg.: Why? If insiders have non-public material information, then the insiders must disclose or refrain from trading on the company’s securities or else face 10b-5 violations.Notes: How would this case come out under common law fraud? The plaintiffs would lose because omissions are not covered under common law fraud. One must present an affirmative act to prevail on a common law fraud case.

How would this case come out under Goodwin? No cause of action because it was done on an impersonal exchange. So, P’s would lose again.

They only prevail on 10b5.Is Rule 10b5 or Common Law Fraud broader on inside trading? 10b5 is much more broader.

Chiarella v. US:CB551 A man who worked at a publisher found out about a potential takeover, so he went out and bought stock in the target corporation. SEC went after the man under 10b5.H: The man was not an insider who found out about material-nonpublic information. In order for him to have had to disclose this information, he would have had a duty to speak and since he was not an insider, he had no such duty, which makes him not liable for 10b5 violations.- The man was under no duty to disclose, not a director.Dissent: Argues that there should be an absolute duty to disclose all information when trading or refrain from trading if you get inside information.

Dirks v. SEC:CB560 Dirks is a financial analyst who finds out about fraud in a company. He tells people about it, but nobody believes him, so he advises his customers to sell.

H: Tipper has to have breached a fid. duty for there to be liability for the tippee. The tippee inherits the duties to disclose or abstain of insiders ONLY if the information was inappropriately (breach of duty) given to the tippee by the tipper and if the tippee had reason to know (or knew) that the tipper had breached a duty. Also the tipper had to have had personal gain from the disclosure; here there was only a motivation of exposure of the fraud, so there can be no liability against the tipper. (This case is really turns on the absence of scienter.)Notes: Important Points on Tippers/Tippees: (1) The tippees violation of 10b-5 depends on the tipper’s violation of a fiduciary duty. If the tipper breached no duty, then there can be no 10b5 claim, (2) Breach occurs only if tipper gets personal gain, and (3) Lawyers and accountants constitute temporary insiders.

US v. O’Hagan:CB571 O’Hagan was a partner in a law firm and learned of a deal that he did not work on in the law firm and traded on one of the companies. O’Hagan made 4 million on the trades.Rsg. Misappropriation Theory: A person commits fraud in connection with securities trading and violates 10b5 when he misappropriates confidential information from a company for personal trading purposes, in breach of a duty owed to the source of the information (akin to usurping corporate opportunity).H: In applying the misappropriation theory, O’Hagan had a duty of loyalty to the law firm, which thus in turn has a duty to its clients not to reveal confidential information. O’Hagan misappropriated the information he had and thus violated 10b-5.

Key Takeaway: If given information, in confidence (as a lawyer, accountant, etc.) and then you trade on it for your own personal gain, then you have violated 10b5.

What is Rule 16b and How does it work?o This is an SEC rule that tries to capture insider trading, by imposing strict liability on short-swing transactions

and does not care about scienter (intent).o The Elements:

1) 16b is implicated when…owners or directors are trading no matter how many shares are involved ora person with more than 10% ownership (10%+SH) before the initial transaction.

2) The corporation can recover any profits on the transaction if one buys and sells a security (or sells and buys) within 6 months.

3) Only applies to Registered Securities under the 1934 Act (does that just mean public stocks?) o What is a Control Premium?

The control premium is the amount extra one can charge for their stock (above the regular share price) because they have the ability to control the corporation and people are willing to pay extra for that ability to control it. (No court has ever said it is improper to sell stock at a control premium)

The only things the Courts are concerned about when one sells their control is corporate looting:The Courts don’t want the buyer, who now has control, looting the corporation’s assets to the detriment of

minority SHs who still own the corporation, so this imposes a duty on the seller to investigate the buyer.o Buy-Sell Agreement: A contract that allows the corporation or the majority SH to buy back the shares of a

shareholder upon a specified event (death, retirement, etc.) at a specified price.Why have Buy-Sell Agreements?-Because it provides a market for one’s stock in a close corporation and thus allows one to exit from the

corporation.What are some of the issues that need to be addressed with regards to the buy-sell agreement?-What type of contract it is-How the business is valued-And how the repurchase will be funded

Reliance Electric v. Emerson Electric:CB579 Emerson buys 13% of a company in an effort to take it over. Suddenly, Reliance purchased some, so Emerson sold off his shares in two separate sales to avoid 16b implications (He sold 3+% and then 9+%). Is Reliance entitled to 16-b damages?H: Reliance is entitled to 16b profits because Emerson owned more than 10%, but it only applied to the first sale of 3+%, which then brought him under the 16b provision.Note: Emerson should have argued that he wasn’t a 10% owner at the time of the purchase so that 16b didn’t apply to when he sold the stock.

* Common Law Duty of Selling ShareholderDeBaun v. 1st W Bank:CB586 Bank had controlling shares in a corporation and there were 2 minority SHs. The bank sold the shares to a shady character named Mattilson. Mattilson looted the company and ended it as a going concern, by leaving it with no assets and 200k in debt. A bank officer knew of Mattilson’s troubled past, yet they sold him the shares anyway. When trouble started after the sale, the bank was aware of it, but did nothing.R: The controlling SH has a duty to exercise good faith and fairness to the minority SH by properly investigating who they are going to sell the control stock to. H: The bank breached this duty by not investigating Mattilson and by allowing him to continue to loot the company.Note: Was this a derivative or direct suit? It was a derivative for damage against the Corp, but the Court might have allowed a direct suit for damages to the individual shareholders, but the damage to the Corp was much greater than the individual damage to the shares.

Perlman v. Feldman:CB595 Perlman controlling SH, Pres. and Chair of BoD – sold shares for premium.Issue: whether Perlman had a duty to minority SHs? Whether sale was a misappropriation of corporate property?H: Duty to min. SH’s in sale of control exists here. This is a misappropriation of corporate property.R: Fiduciary has the burden to prove that the sale is fair. Plaintiff need only prove possibility of corporate gain.

* To Whom Can A Shareholder Sell Her Shares?Donahue v. Rodd Electric Company:CB608 The Rodd Company is a close corporation where the family owns the majority of the shares. The eldest retires and sells back his interest to the company at a specified price. A minority SH wanted to do the same, but the company denied her the ability to sell back her shares, they did not have enough money. She sues. H: Remedy in this case was that the Corporation had to buy her shares or rescind the purchase of the majority shareholders shares.R: Equal Access Rule: In a close corporation, if one SH is going to be allowed to sell back one’s shares at a specified price, then all should be allowed to in a proportionate amount because the close corporation is akin to a p-ship and cannot discriminate as to whose stock gets repurchased.Rsg.: What type of duty does the controlling shareholder owe to the minority ones? The controlling SH owes a heightened duty to the minority SH.

Fiduciary duty requires that if the majority shareholder has the opportunity to sell stock back to the Corp then the minority should also have that option, unless you can show a legitimate business reason for treating shareholders differently. See Zindel.

Jordan v. Duff & Phelps Inc:CB628 J was an employee of this close corporation, who quit and wanted to sell his shares back pursuant to a buy-sell agreement. After he sold them back, he learned that the company had merged, and that his shares would have been worth a lot more had he waited.Issue: Under 10b-5, was there a failure to disclose material information to J by the corporation?H: Possibly, it was for a jury to decide. Essentially D and P should have not omitted the fact regarding the merger negotiations even though they fell through and the company wound up reorganizing, which increased its overall value. Rsg.: A reasonable investor would want to know about the on going negotiations, which would have increased the value of the company substantially. The only thing that is key, here, then is the timing because once Jordan left, he would have to sell his shares anyway so the jury must decide whether he would have relied on the disclosure.Notes: Key Takeaway: Essentially, the question you must ask is, then: Was the information material to the timing of his resignation? (If jury says no, then he can not recover).

Berreman v. West Publishing Company:CB636 Berreman was employee and SH of West, which was private company. He left and sold his shares. After the sale, West was bought and Berreman could have made a lot more money if he waited. It was found out that West was talking with some people about going public.Issue: Should West have disclosed these talks to Berreman when he was selling his stock back to the company?H: No, these discussions about going public were far too speculative for the company to be required to disclose this to B, so West did not breach any fiduciary duty of fair dealing and care.

*Shareholder’s Voting, Mergers & Sales, Hostile Takeovers, Defensive Measures:

o What options do SH have when they disagree with the BOD?-In the context of public corporation, you could sell your shares-Close corporation:-You may have an action if there is harm,-You can try to negotiate with the corporation to sell your shares back to the corporation.-If there is fundamental change, you might have other options

o On what things can a SH vote on? Things that are FUNDAMENTAL Amendment of the Articles of IncorporationDissolutionMergerSale of Substantially All or All of the Corporation’s assets-Remember: one does not need to get SH approval for purchase of assets, though, unless it brings about a

fundamental corporate change.o What must happen? 5 steps

MBC: you need a quorum (51%) of shares present, number of shareholders does not matter, then you need a majority vote of the quorum of shares.

o Who Votes? o Dissolution: When can corporations be dissolved?

Voluntarily: The BOD, along with SH approval, can decide to dissolve the corporation and wind up.Involuntary: When the corporation breaks a statute the Court can order it dissolved-Maybe when shareholders bring a suit for shareholder oppression or some illegality

-Creditor can move to have a corporation dissolved in Court-Administrative Dissolution: Corporation can be dissolved by the Secretary of State because it did not pay its

feeso What is a MERGER and What are the issues involved?

Terms:Surviving corp – the Corporation which the other Corporation is merged into....one survives and one

disappears. (Surviving corp – assumes the liabilities of the disappearing corporation.)Merger: is a fundamental corporate change, where 2 or more companies agree to be a new one or one

merges into another company, etc.Issue 1: Voting:

MBC § 11.04: requires SHs to have to vote when the entity is going to disappear or fundamental change. The MBC says in (g) that SH of the surviving corporation do not need to vote on the merger. Obviously, if both disappear, then both must vote on the plan of merger.

Quorom: you need a majority of the shares present, who are entitled to vote and then a majority of those present (if there is a quorum) to approve the merger.

What was the old rule under the MBC?You needed 50+% of shares entitled to vote, to pass a merger, irrespective of how many people show up at

the meeting.What does NY require? 2/3 of all SH entitled to vote must approve a merger if corporation formed before 1998.

For corporations formed after 1998, it is just a majority of shares entitled to vote.DCL § 251(c): In a lot of situations, DE requires that both the disappearing and acquiring company SHs should

vote on the plan of merger.DCL § 252(f): Lists situations in which, the surviving corporation would not have to vote (very strict

requirements).*Some states require both corporations to vote; in that case the surviving corporation will create a wholly

owned subsidiary, and the board of the surviving corporation will vote for the wholly owned subsidiary.Issue 2: Shareholder appraisal: If a SH VOTES NO on a merger and they follow the appropriate procedures of a

state, then they can be allowed to sell their shares back to the corporation for FMV pursuant to appraisal rights laws. If you don’t think you are getting a fair price, then you can sue and have the Court settle the dispute.

Note: SH appraisal is generally not allowed for shares traded on a national exchange. Appraisal rights are typically only offered to those who are holding shares in close corporations. (Makes sense in a closed corporation because there is no market for the shares)

What is the basis for the rights? At common law, one SH was allowed to veto a merger (because you needed unanimous consent of the owners), so today the appraisal rights now allow the SH to have an exit when there was a proposed merger.

MBC § 13.02: Right of Appraisal: provides when you can get appraisal rights.Other sections in Article 13 also deal with appraisal rights and the procedures that must be followed. DCL § 262: Appraisal Rights: Provides the procedures for one to follow to perfect his/her appraisal rights.§ Issue 3: Types of Mergers

Stock for Stock: stock in your old corporation gives you the new stock in the merged corporationCash Out (or Freeze Out Merger): The disappearing corporation’s interest is purchased by the acquiring

corporation, so the disappearing corporation shareholders are bought out and they disappear forever.What if the SH does not want to take cash but wants to maintain the shares? -Vote against, buy more stock to obtain a controlling share then vote against or solicit proxies, or ask for an

appraisal, or buy shares of the merged corporation, or bring a derivative suit for damage to the corporationWhat if it is a closed corporation? -Appraisal and get fair value, allege the merger agreement is problematic and breaches a duty of some sort.

ISSUES: 1. Vote (who votes); 2. Who Votes?; 3. Liability; 4. SH Appraisal rights; 5. Cash Merger. HMO-W v. SSM Health:CB652 Appraisal Rights Case: Minority SHs (Nills and SSM) of HMO wanted to compel the corporation to buy his shares after they voted no on a merger. HMO had one price initially and then reduced it because they said the first valuation was wrong. HMO also wanted to impose a minority discount on the price of shares. SSM sues.H: A minority discount should NOT apply because it unfairly penalized the dissenting SHs. Fair dealing should be considered by the court in the context of appraisal and this company was not acting with fair dealing, although it is not problematic that they reduced the valuation after reexamining the initial number. The minority discount was the problem here.

*Cash out MergersWeinberger v. UOP:CB664 Signal thinks UOP is a good investment and buys out 50.5% of it, but wants the remaining shares. Signal puts in the majority of the BoD at UOP, which hires Lehman Brothers to determine a price. Lehman’s gives a lower price. Some board members knew that this was a lower price than Signal was originally willing to pay. Signal abstained from voting and the rest of the BoD approved the price except the Board was on both sides of the transaction as representatives of Signal and as representatives of UOP. Was there a breach of fid. duty here?H: Yes, there was a breach here because of the self-dealing (breach of loyalty). Rsg.: Whenever there is self-dealing one must disclose their interest on the transaction and if they don’t disclose then they must show that the deal was fair. DE requires entire fairness (which is both fair dealing and fair price, whereas other jurisdictions apply the legitimate business purpose test). If Signal had set up an independent committee, the process would have been fair and the price would have been fair and there would be no breach. In the merger context, if you have a committee, the burden will shift back to the plaintiff to prove that the deal wasn’t fair.

DE Entire Fairness Test: P has the BoP to show that there is a conflict of interest. Once, P shows that, the burden shifts to the D to prove fair price and fair dealing.

Business Purpose Rule: MA rejects the fact that the directors have to prove a legitimate business purpose and that the entire fairness test is adequate for a minority shareholder.

Coggins v. NE Patriots:CB676 Sullivan owns all the voting shares of the Patiots, but wants to acquire the public, non-voting shares. Sullivan is sued by a minority SH who says the public ownership of the corporation is being destroyed. BJR not applied because the Court does not like to see a “freeze out” of minority shareholders, also, this is a cash out merger which may be worthy of more scrutiny.Issue: What standard did the Court apply when reviewing this deal?H: This Massachusetts Court applies an entire fairness standard AND says that Sullivan had no legitimate business purpose for the merger, other than for the minority shareholders to assume his personal debt.Note: DE law consistently rejects the legitimate purpose being needed for a merger to exist, whereas MA requires a legitimate business purpose for a merger, in addition to the entire fairness standard.

MA Business Purpose Test: P must show that the merger (freeze out) had no legitimate business purpose, then the BoP shifts to the D to show that the business purpose was legitimate and that there was entire fairness (both fair dealing and fair price).

o Sale of Substantially All The Corporation’s Assets: MBC §12.01, 12.02: provides when SH approval is required and when it is not required for sale, lease, etc. of

assets.DCL §271: Majority of shares entitled to vote must approve the sale after the board approves it.o Who Votes: So, only SHs of the selling corporation have to approve the sale of the assets. (The buying

corporations SHs do not have to vote)o What happens with liabilities?

At common law, the acquiring corp. in the sale of assets context does not inherit the target company’s liabilities. The rationale is that the selling corporation has now received cash to pay off all of its debts.

Conversely, in mergers, the acquiring company assumes all of the disappearing corporation’s liabilities.o Where one corporation sells/transfers all of ones assets to another corporation, the buyer is NOT LIABLE for any

debts/liabilities of the seller unless:The buyer agrees to assume liabilities, orThe transaction amounts to a merger, not a sale, orThe purchasing corporation is merely a continuation of the selling corporation, orThe transaction is entered into fraudulently to escape debts.

o So, once again the key determining factor is what it is: a sale or merger, and the way you look at this is if there was adequate consideration paid.

Adequate Cash Consideration = sale of assets = no liabilityInadequate Cash Consideration = merger = liability assumed

Franklin v. USX Corp:CB686 WPS sold assets to Con Cal and Con Cal also assumed the liabilities of WPS. Con Cal then sold the assets to Con Del, and Con Del did not assume any liabilities. US Steal merged with Con Del, which became USX. Now, a P is suing USX for injuries caused by WPS having asbestos many years ago. Issue: Can USX be held liable?H: No, because the sale between Con Cal and Con Del was not a merger, but simply a sale of all assets because adequate consideration was paid in that transaction, where Con Del assumed none of Con Cal’s liabilities (which would have included any of WPS’ liabilities). But since this is a sale of assets and no liabilities were assumed and there was adequate consideration, one cannot recover from this successor corporation.Rsg.: Key Takeaway: Only in the merger context would you have successor liability. Otherwise, there is no successor liability in the sale of assets because adequate consideration had been paid. If no adequate consideration, then might be deemed a merger and thus make one as successor liable.

o Hostile Takeovers (T/O): What is it?This occurs when the BoD has no involvement in the transaction and:Purchaser buys the corporation directly from individual SHs (slowly, but surely) ORPurchaser makes a tender offer, which is a public offer of cash and those SHs who accept it first, get dibs at this

guaranteed cash.o Why are these done?

The bidder wants to side-step the BoD and get a controlling interest in the company, who probably wants to fire the existing board once they gain the power.

o What should the BoD do once it learns of the attempt of a hostile T/O?Begin talking to the bidder ORTake permissible defensive measures

o Why are the Courts concerned about T/O?Because they fear that Directors will take defensive measures just to protect their jobs rather than what is in the

best interest of the corporation.Courts look at these actions taken by the BoD with heightened scrutiny in the T/O context

If the BoD breached no duties, then the BJR will apply. If there is a conflict because of the BoD’s actions, then the Court will ask serious questions. But in the hostile T/O context, there is always an inherent conflict, so it is pretty much easy to escape the BJR and try to get a better deal.

o Fiduciary Duties of the Board in a Merger/TO Contexts: BoD owes the corporation fiduciary duties. In a merger context, the BoD makes a recommendation to SHs to vote up or down, whereas in the T/O context no such recommendation is made. The BoD is not negotiating the deal, so they fear losing their jobs, which creates an inherent conflict of interest, so enhanced scrutiny is always applied to Board actions in the T/O context. So, you analyze the duty of loyalty then!

o Unocal, Revlon, Time, all represent developing law.Unocal only applies to determining the T/O context, whereas Revlon applies heightened scrutiny to determine

the validity of defensive measures.

Unocal v Mesa Corp:CB697 Unocal was the target of Mesa. Mesa already owned 13%. Mesa made a tender offer of cash and then for whatever was left over: junk bonds for the controlling interest in UNOCAL. This tender offer by offering a threat of junk bonds forced SHs of Unocal to act quickly and sell their shares to Mesa. BoD of Unocal takes a defensive measure by offering all the SHs debt in the company (except Mesa) at a significantly higher price.Issue: Were the defensive measures taken by Unocal’s BoD appropriate?H: Yes, they were appropriate because the BoD wanted to insure a fair price for their SHs and to protect the corporation’s enterprise purpose, which Mesa sought to change. Mesa’s offer was inadequate and the directors had a DUTY TO OPPOSE the THREAT here. Here, there reaction was reasonably related to the threat posed because of the BJR.Rule of Unocal: Defensive Measures by a BoD are ok in the hostile takeover context if: 3 part test:

1) The BoD was acting independently, AND2) The BoD has a reasonable grounds for believing that a danger (threat) to corporate POLICY and

EFFECTIVENESS exists because of who the hostile takeover is, ANDCourt will look to the process the BoD used to come to the conclusion that there was a danger...did they

research anything, set up a committee, what else? BJR.3) That the defensive measure that was employed was reasonable in relation to the threat posed.

Notes: What happened after UNOCAL? The SEC overruled a portion of it by saying that issuer tender offers need to be made to all SHs, so the BoD of Unocal could not have excluded Mesa when it took its defensive measure since Mesa already owned some of Unocal.

* Bidding WarsRevlon v. MacAndrews Inc.:CB707 PP made an offer to acquire Revlon for cash. Revlon consults I-Bank, who says the price is inadequate, so Revlon’s BoD offered a better deal to its SHs. Some SHs take the Revlon BoD deal (the senior subordinated notes with restrictive covenants). After Revlon’s offer to SHs, Frostman talks with Revlon and Frostman wants to do an LBO for Revlon. PP increases its bid and then Frostman increases its bid. Frostman said it would withdraw the offer if not accepted and then require a no shop clause, break up fee, and lock up fee to buy other parts of Revlon in the final bid. The BoD of Relvon accepted Frostmans bid and waived the covenants in the notes issued to its shareholders. Revlon took 2 defensive measures in this case, so analyze them.Issue 1: Was the defensive measure by Revlon’s BoD to make its own offer appropriate?H 1: Yes, because Revlon’s BoD met the UNOCAL standard of acting independently, they reasonably believed that the price was inadequate by investigating the price with an I-Bank and that the defensive measure was reasonable in relation to an inadequate price.Issue 2: What about Revlon’s 2nd action of accepting Frostman’s bid with all those provisions?H: The BoD’s duty shifted to the SHs at this point because the sale was imminent. It was clear that there was a bidding war going on and their actions of accepting the bid of Frontsman did not maximize SH’s value. Relvon breached its duty to the SHs by accepting such a bid in the middle of a bidding war. The BoD had a duty to get the best price possible.Rule:Key Takeaway: When it becomes apparent that the “break up” of the company is inevitable, the duty of the board shifts from preserving the corporate entity to the maximizing value for the benefit of SHs.

Paramount Comm. V. Time Inc:CB717 BoD of Time wants to get into the entertainment industry, while maintaining its culture. They approached Warner about this in 1983 and both companies were said to be equals, but Time wanted to

maintain control, so they created a subsidiary that could merge with Warner, where Time would be at the top. Paramount learned of these talks and then started talking with Time and makes a bid, but Time determines Paramount’s bid is low. Time, then changes strategy and seeks to buy 51% of Warner, which wont require SH approval since it is just a purchase of assets. Both the SH of Time and Paramount, the entity, sue Time.

Time never put itself up for sale as happened in Revlon (there has to be a change in control, see Paramount v. QVC), it felt that it would be better off structuring a deal with Warner for the long term, it was not under a duty to maximize short term benefit for the shareholder. Unocal test did apply because of the defensive measures.Issue: Was Time’s rejection of Paramount’s bid and restructuring of the deal appropriate?H: Yes, the BoD reasonably investigated Paramount, the investigation was in good faith, and the response was reasonable to the threat of hurting the corporation’s culture and Time’s ability to expand. Paramount was trying to control Time, where Warner wasn’t trying to, so this was a valid threat and Time could decide to purchase Warner to achieve the same goal of expansion. (The first deal being structured as a merger, was a merger, which requires approval, but Time was free to change strategy and the BJR prevents the Court from questioning the substance of their process, which seemed to be fair)

Paramount v. QVC:CB732 Viacom and QVC are bidding for Paramount. Paramount would be selling its control if it let Viacom buy it because Mr. Redstone controls all of Viacom (essentially). Paramount and Viacom’s tentative deal included no shop, cancellation fees, and a put option to prevent Paramount from entertaining other bids. But, then QVC came along and makes a hostile bid, yet Paramount’s BoD ignore it and accept Viacom’s bid.Issue: Did Paramount’s BoD violate any duties in rejecting QVC?H: Since this was going to be a sale of control under Unocal, Paramount had to search for the best available price, so once QVC started bidding the BoD had a duty to get the best price and Paramount should have negotiated with Viacom to get a better deal. The BoD had a duty to improve the deal and they did not. The SHs would have been made a minority owner in the Viacom deal, but in the QVC deal, the SHs would have received a premium.Notes: How does this differ from Time Warner Case? Here there was a bidding war, whereas in Time there was none. Here there was no long range planning like there was done in Time Warner. Here the control of the board was at stake, which raises Revlon issues, whereas Time pushed it into the defensive measure context of Unocal. QVC was strictly about profit maximizing, whereas Time was about strategic planning.

CTS Corp v. Dynamics:CB754 The Indiana law achieved the same purpose as the Williams Act by placing the investor on equal footing with the t/o bidder, by allowing the SH to vote on the merger.

Williams Act: Federal Law that preempts state law that is inconsistent with it and requires: (1) offeror/bidder to file a statement disclosing information about the offer AND (2) it gives the SHs a window of time to accept or reject the offer.

Amanda Acquisition Corp v. Universal Foods:CB762 WI has an anti-takeover law.H: Anti-takeover laws are allowed because it just forces corporations to incorporate elsewhere. Such a statute does not necessarily make it inconsistent with federal law.

V. The Limited P-ship & Limited Liability Company*The Limited P-ship Basic Elements:

o LP is a separate legal entity that requires a filing with the state.o Partners share in profits equal to their amount of contribution or as determined by the limited p-ship agreement. o Must have at least one General Partner and Limited Partnero Limited Partners are not personally liable to third parties but the General Partner is liable.o GP manages the p-ship and exercises day to day control; o LP does not manage or control the p-ship (only shares in profits and votes on only certain key issues). GP is liable

like under UPA and RUPA.o Limited Partner has limited liability because they don’t have control. They can only lose their investment in the p-

ship.o Only the p-ship as an entity and maybe the GP are liable for the debts and contributionso Limited Partner is not liable for p-ship debts unless they exercised control on which the creditor relied on and

reasonably believed.

o GP has fiduciary duties to the p-shipo Limited Partners owe no fiduciary duty, they are similar to the shareholders of a corporation.o GP can withdraw at will, however, the Limited Partner must provide 6 months notice (usually because they are

providing the capital) so the GP can find a new limited partner.o You can only sell distribution rights with a LP.o Limited P-ship, for a Limited Partner, is merely a security interest.o A person or a Corporation can be a General Partnero Has been overtaken by the LLC and LLP

*The Limited Liability Company: o Combines Corporation and P-ship – increased flexibility with emphasis on freedom of contracto Requires filing with appropriate state agency. (If you want limited liability you have to declare it; sole

proprietorship and p-ship are the only ones that do not require filing because there is unlimited liability).o There should be an operating agreement.o Many States & Uniform LLC Act require that in your filing you declare whether this is a Member Managed LLC

or a Manager Managed LLC.o Member Managed LLC – all members, like a p-ship, have some management responsibility, but they have limited

liability. o Manager Managed LLC – more centralized management that looks like a corporation, therefore, only a small

amount of people run the company.o The ISSUE is who can bind the entity.

Member Managed – everyone is managing and everyone can bind the corporation with a third party.Manager Managed – only the managers can bind the corporation with a third party.

o Management responsibility is dictated by how much money you put in.o Member Managed LLC partners have fiduciary duties to one another; analyzed the same way as p-ship, except

everyone has limited liability.o Manager Managed LLC the managing partners have fiduciary duties to the members and the LLC as a whole.