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BUSINESS ASSOCIATIONS I. AGENCY 1. Summary a. First, did an agency relationship exist? b.

If so, did the agent have authority (actual, apparent or inherent)? A. Does an Agency Relationship Exist? 1. Agency: The principal is responsible for the acts of his agent. Gorton a. Two-Step Test for Agency: Agency is the fiduciary relation which results from i. the manifestation of consent by one person (the principal) to another (the agent) that the other shall a) act on his behalf and b) subject to his control, AND 1. Manifestation: doesnt have to be written or oral (nor aware that relationship constitutes an agency). Can be inferred from conduct. But the manifestation by or attributable to the principal must somehow reach the agent. a. Agreement, but no K necessary: In order to create an agency there must be an agreement, but not necessarily a K between the parties. The relationship of the parties does not depend upon what the parties themselves call it, but rather in law what it actually is. ii. consent by the other to so act. Gorton (Look at circumstantial evidence to determine if these two steps have been met.) 1. Objective standard for determining consent: The courts use an objective standard for determining consent: Has the principal done or said something that the agent reasonably interpreted as consent that the agent would act for the principal? Has the agent done or said something that, reasonably interpreted, indicated agreement to act? 2. Compensation: It is not essential to the relationship of principal and agent that either receive compensation. Gorton. c. Burden: Where a party seeks to impose liability upon an alleged principal on a K made by an alleged agent, the party must assume the obligation of proving the agency relationship. It is not the burden of the alleged principal to disprove it. 2. Creditor/ Debtor relationship v. Principal/Agent relationship: The point at which a creditor becomes a principal is that at which he assumes a de facto control over the conduct of his debtor, whatever the terms of the formal K with his debtor may be. Factors must be viewed in light of all the circumstances. Cargill. B. Liability of Principal to Third Parties in Contract 1. Summary: To hold principal liable on contract, plaintiff (third party) must prove a. agency relationship existed AND b. what kind (or kinds) of authority agent possessed i. Hierarchy of authority: An agent can have the power to bind a principal through: 1. actual authority (express or implied); 2. apparent authority; 3. inherent authority; 4. estoppel; AND/OR 5. ratification. 2. Authority: Authority is the power of the agent to affect the legal relations of the principal by acts done in accordance with the principals manifestations of consent to him. RS 7. a. Do the legal consequences of an agents acts depend on the type of authority the agent possessed? No. Authority is authority. If the agent was authorized (under any of the forms), then the principal is bound. 3. Three Types of Authority: EXAM: All of these categories overlap. A lot of times you will find more than one.

a. Actual authority: Actual authority is authority that the principal, expressly or implicitly, gave the agent. i. Elements: 1. an objective manifestation by the principal; a. Express actual authority: look at agreement b. Implied actual authority: Implied actual authority is the act of putting agent in such a position leads agent to reasonably believe he has authority i. Incidental: agent has authority to use all means reasonably necessary to carry out result mandated by principle ii. Custom: if it is customary in trade/community for this type of agent to have certain powers, then the agent has it iii. Pattern of conduct: if P knows A has engaged in pattern of behavior and P fails to object to continuance of it, then A has authority to continue it 2. followed by the agents reasonable interpretation of that manifestation; 3. which leads the agent to believe that it is authorized to act for the principal. RS 26. b. Apparent Authority: An agent has apparent authority sufficient to bind the principal when the principal acts in such a manner as would lead a reasonably prudent person to suppose that the agent had the authority he purports to exercise. Lind; Ampex; RS 8. (Apparent authority can co-exist with actual authority.) i. Elements: Creation of apparent authority involves: 1. an objective manifestation from one party (apparent principal), a. Objective manifestation: i. direct communication by P to T ii. inaction by principal iii. *placing agent in position with customary powers (implied apparent authority). iv. principal authorizes agent to state he is authorized v. course of conduct b. Issue: What were principals manifestations? This will factor into whether it was reasonable for third partys belief was reasonable. 2. which somehow reaches a third party, AND 3. which causes the third party to reasonably believe that another party (apparent agent) is indeed authorized to act for the first party (i.e., for the apparent principal). RS 27 ii. Implied apparent authority: the act of putting agent in such a position that leads third party to reasonably believe agent has authority c. Inherent Authority: Inherent agency power is the power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent. Restatement 8A. i. Elements: Under the doctrine of inherent agency power: 1. if a general agent, a. General agent: If a principal authorizes an agent to conduct a series of transactions involving a continuity of service, the law calls the agent a general agent. RS 8A, cmt a. (Example: copy clerk has inherent authority to order supplies of paper.) b. Specific agent: If a principal authorizes the agent only to conduct a single transaction, or to conduct a series of transactions that do not involve continuity of service, then the law calls the agent a special agent. 2. acting in the interests of the principal,

3. does an act usual or necessary with regard to the authorized transactions, AND 4. the third party reasonably believed the agent had authority, 5. then the act binds the principal regardless of whether the agent had actual authority and even if the principal has expressly forbidden the act. RS 161; RS 8A. ii. When used: Two classic situations in which inherent authority has been found 1. Undisclosed principals a. RS 194: An undisclosed principal is liable for acts of an agent done on his account, if usual or necessary for such transactions, although forbidden by the principal. b. RS 195: An undisclosed principal who entrusts an agent with the management of his business is subject to liability to third persons with whom the agent enters into transactions usual in such business and on the principals account, although contrary to the directions of the principal. 2. Agent exceeds authority 4. Estoppel: In estoppel cases, the principal will say, I dont know who the person was who entered into a K with you. a. Elements: Elements of estoppel: i. acts or omissions by the principal, either intentional or negligent, which create an appearance of authority in the purported agent; ii. the third party reasonably and in good faith acts in reliance on such appearance of authority; AND iii. the third party changed her position in reliance upon the appearance of authority. RS 8B; Hoddeson. 5. Ratification: Ratification is the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account. RS 82. a. Elements: Ratification requires: i. valid affirmation by P, express or implied; AND 1. Implied Affirmation by Principal: a. *The principal accepts the benefits of the K at a time when it is possible to decline b. Silence/inaction c. P must know/have reason to know all material facts d. All or nothing cannot ratify part of contract 2. Ratification requires acceptance of the results of the act with an intent to ratify, and with full knowledge of all the material circumstances. RS 62. ii. principal must know or have reason to know of all material facts. RS 62. b. **Innocent third party: Law will deny legal effect to ratification where necessary to protect the rights of innocent third party. It will be the third partys option to elect to be bound by contract. Innocent third party occurs when material change in circumstances between time of contract and ratification c. When used: Ratification will only occur where Agent acts without authority (of any kind) and there are no grounds for estoppel, but Principal will only be bound if P ratifies the contract 6. Agents liability on the K: In order to avoid liability on a K, the agent must disclose to the third-party 1)that he is acting in a representative capacity and the 2)identity of his principal. Curran. a. Undisclosed or partially disclosed principal: In cases of a partially disclosed or undisclosed principal, the agent is treated as a party to the contract unless the agent and third party have agreed otherwise. The third party must elect which party he will get a judgment against (cannot get a judgment against both parties and cannot later sue the other one). RS 226. b. Disclosed Principal: Generally an agent has no liability on the contract where he discloses the principal, unless:

i. there is a clear intent of all parties that agent be bound (Restatement 323); OR ii. the agent made the contract without authority and principal refuses to ratify. In this case, the agent is liable, but not the principal. (She SAID: This is the one Ill test on exam.) C. Liability of Principal to Third Parties in Tort 1. Sequential analysis of tort liability a. Is there an agency relationship between P and A? b. Is the Agent Ps servant or independent contractor? c. If servant, was conduct within scope of employment? 2. Respondeat superior (setting up rules): Under the doctrine of respondeat superior, a master (employer) is liable for the torts of its servants (employees) committed while acting within the scope of their employment. On the other hand, the general rule is that a principal is not liable for the torts of independent contractors (IC). RS 250. 3. Servant vs. Independent Contractor: The main factor in determining whether a person is a servant or an IC is control. Factors: Control, duration, risk of loss, and return. a. Servant (aka employee): A master-servant relationship exists where the servant has agreed 1)to work on behalf of the master and 2)to be subject to the masters control or right to control the physical conduct of the servant. RS 2. b. Independent Contractor (aka franchisee): An IC is a person who agrees to carry out some task but is not subject to the principals control in doing so. RS3. c. Factors: i. the agreed extent of control which the employer may exercise over details of the work; ii. whether the person employed is engaged in an occupation or business distinct from that of the employer; iii. whether the work is usually done under the employers direction, or by a specialist without supervision; iv. whether the employer supplies the tools and place of work; v. the length of time for which the person is employed; vi. the method of payment (whether by time or by completed job); AND vii. the degree of skill required by the person employed. RS 220 4. Liability for Torts of Servants: (Respondeat superior rule.) A master is liable for torts of a servant only if they are within the scope of employment. a. Scope of employment factors: RS 229 lists the following facts in determining whether a servants conduct is within the scope of employment: i. the similarity in quality of the act done to the act authorized; ii. it occurs substantially within the authorized time and space limits; iii. it is actuated, at least in part, by a purpose to serve the master; AND iv. forseeability of the act. See Bushey. b. Unauthorized conduct: Unauthorized conduct can be within the scope of employment if it was foreseeable and meets the other factors. 5. Liability for Torts of Independent Contractors: A person who engages a contractor is not liable for the negligent acts of the contractor in performance of the contract unless: a. the principal retains control over the aspect of the work in which the tort occurs; b. he engages an incompetent contractor; OR c. the activity contracted for constitutes a nuisance per se; Majestic OR i. Nuisance per se: A nuisance per se is an activity which is inherently dangerous, meaning an activity which can be carried on safely only by the exercise of special skill and care, and which involves grave risk of danger to persons or property if negligently done. Majestic. 1. Inherently dangerous vs. ultra-hazardous: As opposed to inherently dangerous activities, those which are ultra-hazardous 1) necessarily involves a serious risk of harm to the person, land or chattels of others which cannot be eliminated by the exercise of the utmost care, and 2)is not a matter of common usage. (The

distinction is important b/c liability is absolute where the work is ultra-hazardous.) ii. Example: Demolishing a building is a nuisance per se. Thus, owner was liable for the torts of the demolisher in carrying out the demolition. Majestic. d. it is a nondelegable duty. i. Nondelegable duty: A nondelegable duty is a duty so important to the community that the principal should not be allowed to farm it out to another (example: transporting nuclear waste). Nondelegable duties most commonly involve statutory duties. D. Fiduciary Obligations of Agents 1. Agents Duties to Principal: Every agent is deemed a fiduciary i.e., he owes his principal the obligation of faithful service. RS 15. a. Duty of loyalty: As a fiduciary, the agent or employee owes a duty to be loyal to his principal on all matters connected with the agency. RS 17. i. Competing with employer: The agent is under a duty not to compete himself, or to act for persons who are in competition with his principal, unless he has the consent of the principal. RS 18;. 1. After termination: After termination of his employment, the agent can compete with the employer, unless he has agreed otherwise and the agreement is valid. However, a former agent cannot use or disclose trade secrets or other confidential information obtained during his employment. Newberry. a. Example: Employee quits, then forms a cleaning service similar to Employer. He takes Employers customer list with him. Court: breach. ii. Acting adversely to employers interest: An employee has a fiduciary duty to his employer to exercise good faith and loyalty so that he does not act adversely to the interests of the employer by serving or acquiring any private interest of his own. Singer. 1. Example: Employee sold car parts for Employer. On the side, without Employers knowledge, Employee referred customers to other manufacturers for a fee. Court held: breach of fiduciary duty to Employer. iii. Secret profits, advantages, benefits: Anything which an agent obtains by virtue of his employment belongs to his principal. T/f, the retention of any benefit or profit which he derives through or from his employment, without his employers consent, is a breach of fiduciary duty. Reading. 1. Example: Military officer gets paid to transport civilians. Court held that Officer was able to do this only by virtue of his being an Officer. Thus, he privately profited off of his position of employment and had to give the money to the Army. b. Duty to inform: The fiduciary obligation requires an agent to notify his principal of all matters which come to his knowledge affecting the subject of the agency. RS 16. c. Duty to act within authority: An agent has a duty to act only as authorized. An agent who violates this duty is liable to the principal for any resulting damage. d. Duty to follow instructions: If the principle tells Agent something, he must obey it. II. PARTNERSHIPS **Note: If not specified, it UPA refers to the 1914 version. A. Has a Partnership Been Formed? 1. Partnership: A partnership is an association of two or more persons to carry on as co-owners a business for profit. Fenwick; UPA 6(1). a. Elements: The essential characteristics of a partnership are: i. an unincorporated business, intended to make profit;

ii. which has two or more participants, who may be either individuals or entities; iii. each of whom brings something to the table, such as efforts, ideas, money, property, or some combination; iv. each of whom co-owns the business; v. each of whom has a right to co-manage the business; AND vi. each of whom shares in the profits of the business. Martin. 1. Right to profit sharing prerequisite: (It is not necessary that the business actually have profits, and profit sharing is not irrefutable evidence of partner status, but the right to share whatever profits exist is a necessary precondition to being a partner.) 2. Receiving profits presumption: Under UPA 7(4), a person who receives a share of the profits of a business is prima facie evidence that he is a partner, unless the profits were received in payment: a. of a debt by installments or otherwise; b. as wages of an employee; OR c. as interest on a loan. b. Liability: Generally, partners are jointly and severally liable for everything chargeable to the partnership. Young; UPA 15. (For dissolution, see 40.) 2. Partnership by Estoppel: a. General rule: As a general rule, persons who are not partners as to each other are not partners as to third persons. Young. b. Partnership by Estoppel, UPA 16: However, under UPA 16 (partnership estoppel), if: i. a person represents itself, or consents to others representing it, as a partner in an enterprise, AND ii. a third party reasonably relies on that representation in good faith and enters into a transaction with the supposed partnership, THEN iii. the person is liable to the third party on the transaction. Young. B. Partnership Property 1. Partners interest in partnership property: Under UPS 24, the property rights of a partner are: a. the rights in specific partnership property; Under UPA 25(1), a partner is a tenant in partnership with co-partners as to each of the partnership. The incidents of this tenancy are as follows: i. each partner has an equal right to possession for partnership purposes; ii. *the right to possession is not assignable, except together with that of the other partners; 1. Creditors cant get it: A creditor of an individual partner cant get to the partnership property. Only a creditor of the partnership can. iii. the right is not community property and hence is not subject to family allowances, dower, etc.; AND iv. upon the death of a partner, the right vests in the surviving partners (or in the executor or administrator of the last surviving partner.) b. an (economic) interest in the partnership; AND A partners interest in the partnership consists of a right to share in the profits of the partnership and the right to receive, when the partnership ends, the value of any property contributed to the partnership. UPA 26. i. Assignability: A partners interest is assignable unless there is an agreement to the contrary. Such an assignment will not itself dissolve the partnership. The assignee does not become a partner and he is not entitled to interfere with management of the partnership or to exercise any rights with respect to its affairs. UPA 27(1). ii. Undivided interest: The partners interest is an undivided interest, as co-tenant in all partnership property. That interest is the partners pro rata share of the net value or deficit of the partnership.

c. the right to participate in the management of the partnership (see Section C). i. Cant assign: Cant assign rights to participate in management. The assignee of a partners economic interest is not entitled to any rights in the management of the partnership. (Must have unanimous consent to add a partner). 2. Creditors Access to Firm (Partnership) and Personal (Partner) Assets a. Creditor of partnership: A creditor of the partnership may attach the personal assets of a partner. UPA 15. b. Personal creditor of individual partner: A personal creditor of a partner has no right to execute or attach partnership assets or property. UPA 25(2)(c). But the creditor may get the partners interest (share of firm profits) by getting a charging order. UPA 26 & 28. c. Priority of creditors: Creditors of the partnership and the individual partners are going after both firm and personal assets at the same time. Who has priority? i. UPA 40(h): personal creditors have priority on personal assets and firm creditors have priority on partnership assets. US Bankruptcy Code 723: Creditors of partnership have priority vis--vis partnership assets and share ratably with personal creditors vis--vis personal assets (i.e., pro rata based on the size of the claims). UPA (1997) defers to federal approach. 3. Sharing profits and losses a. Profits: Absent a contrary agreement, each partner receives an equal share of the profits. UPA 18(a). b. Losses: Absent a contrary agreement, partners share losses in the same percentage as they share profits. UPA 18(a). i. Partner who provides only labor: 1. UPA 18(a): UPA 18(a) applies regardless of whether a partner only provides labor (service partner). If the partnership loses money, the service partner will receive nothing from the partnership (since there are no profits to share) and in addition, must pay the partner who contributed capital so as to share losses with that partner (since UPA 18(a) provides for loss sharing). 2. Kovacik rule: Some courts have held that a service partner shares losses only if he has expressly agreed to do so. Kovacik. Policy: The rationale is that where one party contributes money and the other services, in the event of a loss each loses his own capital the one his money and the other his labor. Kovacik. a. Limiting Kovacik: Courts do no apply the Kovacik rule where: i. the service partner was compensated for work; OR ii. the service partner made a capital contribution, even if that contribution was nominal. 4. Partners right to indemnity: The partnership must indemnify every partner in respect of payments made and personal liabilities reasonably incurred by him in the ordinary and proper conduct of its business, or for the preservation of its business or property. UPA 18(b). C. Rights of Partners in Management 1. Unanimous or Majority Consent? Any difference arising as to ordinary matters connected with the partnership may be decided by a majority of the partners; but no act in contravention of any agreement btwn the partners may be done rightfully without the consent of all the partners. UPA 18(h). a. Majority consent ordinary matters of the partnership: Subject to any agreement between them, any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners. UPA 18(e) & (f). (Issue: is it ordinary?) i. Even number of partners: If there are only two partners, or if there is an even number and they are split in half, there can be no majority vote

that will be effective to deprive either partner of authority to act for the partnership. Stroud. ii. Dealing with third-parties: Where there is no majority, if one partner goes to a third person to buy an article for the partnership, the other partner cannot prevent it by writing to the third person not to sell to him. What is true in regard to buying is true in regard to selling. What either partner does with a third person is binding on the partnership. Stroud. b. Unanimous consent: The following require consent by all partners: i. Matter outside ordinary business: If the dispute is about a matter that is outside the partnerships ordinary business, then must have unanimous consent. ii. Changing partnership agreement: In order to change the partnership agreement, there must be unanimous consent from all the partners. Stroud; Day. iii. Adding member to partnership: No person can become a member of a partnership without the consent of all the partners. UPA 18(g). iv. Substantial change to partnerships business: Substantial changes to the nature of the partnerships business are likely to require unanimous consent. So too are decisions to increase substantially the size of the business, where that increase requires a significant increase in the liability exposure of each partner. v. Particular matters requiring unanimous approval: Under UPA 9(3), unless a partnership agreement provides otherwise, the following actions require unanimous approval: 1. assigning the partnerships property in trust to creditors or in return for the assignees promise to pay the partnerships debts; 2. disposing of the good will of the business; 3. doing any other act which would make it impossible to carry on the partnerships ordinary business; 4. confessing a judgment against the partnership; 5. submitting a claim by or against the partnership to arbitration. 2. Management rights: a. List of rights: Generally, each partner has the following management rights: i. the right to know what is going on in the partnership; ii. the right to be involved in conducting the business; iii. the right to commit the partnership to third parties; 1. Binding the partnership to third party, UPA (1997) 301(1): An act of a partner in the ordinary course of business binds the partnership, unless a. the partner had no authority to act for the partnership in the particular matter AND b. the person with whom the partner was dealing knew or had received a notification that the partner lacked authority. iv. the right to participate in decision making; AND v. the right to veto certain decisions. b. Agreement that restricts management rights: Partners may agree to limit management rights through a partnership agreement, but: i. no agreement can remove totally the fiduciary obligations that partners owe each (can only waive certain fiduciary duties and define others); ii. the more fundamental the restriction, the more judicial scrutiny; AND 1. Test: A restriction is most likely to be upheld if it: a. has some important justification; b. is not overbroad; AND c. does not leave the partners who lack access vulnerable to oppression. iii. cant restrict the nondelegable right to consent to fundamental changes in the partnership agreement. D. The Fiduciary Obligations of Partners

1. Two duties: The only fiduciary duties a partner owes to the partnership and other partners are the duty of loyalty and the duty of care. UPA (1997) 404. a. Duty of loyalty: Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership. UPA 21(1) i. Without consent: In particular, without the consent of fellow partners, a partner is prohibited from: 1. competing with the partnership; 2. taking business opportunities from which the partnership might have benefited or that the partnership might have needed; 3. using partnership property for personal gain; 4. engaging in conflict-of-interest transactions. ii. Partnership agreement (With consent): A partnership agreement may not . . . (3) eliminate the duty of loyalty but: (i) the partnership agreement may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable. UPA(1997) 404(b)(1). b. Duty of care: A partners duty of care to the partnership and partners is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or knowing violation of the law. UPA (1997) 404. 2. Duty to Former Partners: Generally, a partner owes no fiduciary duty to a former partner, for the withdrawal of a partner terminates the partnership as to him. a. Grabbing and Leaving: Partners owe each other a fiduciary duty of the utmost good faith and loyalty. As a fiduciary, a partner must consider his partners welfare, and refrain from acting purely for private gain. Meehan. i. Competing with partnership: Fiduciaries may plan to compete with the entity to which they owe allegiance, provided that in the course of such arrangements they do not otherwise act in violation of their fiduciary duties. Meehan. 1. Example: Lawyer A is going to leave firm B. A cant secretly send letters to Bs clients asking permission to remove their cases with him. A has to wait until he tells B he is leaving in order to give B sufficient opportunity to contact the clients as well. Must be equal playing field. Meehan. ii. Duty to Disclose Information to Partners: A partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner. Meehan. E. The Right to Dissolve 1. 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. UPA 29. a. Winding up: When a partnership dissolves, it does not immediately disappear. It lingers to wind up its affairs. 2. Causes of dissolution: Unless otherwise provided by agreement of the parties, the following acts or events will cause a dissolution of the partnership: a. expiration of partnership term: If the partnership agreement provides that the partnership is to last for a specific period of time, or until a certain project is accomplished, the expiration of the period or accomplishment dissolves the partnership. UPA 31(1)(a). i. Note: Even where the partnership is for a fixed term, either partner can effectively terminate the relationship prior to the expiration of the partnership term (see below). b. express choice of partner: Any partner can effect a dissolution of the partnership at any time by expressing his will to dissolve the relationship. However, though partners always have the power to dissolve, they do not always the right to do so (i.e., can be a wrongful dissolution). i. Partnership at will no violation of agreement: If the partnership is at will (i.e., no definite term), the partners election to dissolve is not in

violation of the agreement unless the partner has acted in bad faith in which case it would be treated as a wrongful dissolution. UPA 31(1)(b). ii. Partnership for fixed term violation of agreement: Where the partnership is for a fixed term, dissolving the partnership prior to the expiration thereof is a violation of the agreement. A partner still has the power (albeit not the right) to dissolve in this situation, but he may be liable for any losses caused by the dissolution (see below). 1. At Will or Fixed Term? Was there a definite term or undertaking specified? If not, its a partnership at will. Can look at implied agreements as well as express agreements. A term can be implied as well as express (i.e., partnership until a loan is repaid.) c. expulsion of partner: The expulsion of a member will cause a dissolution. If the expulsion is bona fide and pursuant to a power reserved in the partnership agreement, there is no violation of the agreement and the expelling partners are not liable for any losses caused thereby. UPA 31(1)(d). i. Expulsion subject to good faith: The right to expel by agreement or statute is subject to duty of good faith and fair dealing. If the power to involuntarily expel partners granted by a partnership agreement is exercised in bad faith or for a predatory purpose, the partnership agreement is violated, giving rise to an action for damages the affected partner has suffered as a result of his expulsion. Lawlis. d. withdrawal or admission of a partner: The withdrawal of a partner, or the admission of a new partner, results in a dissolution of the partnership unless the partnership agreement otherwise provides. UPA 31(7). e. death or bankruptcy: In the absence of an agreement to the contrary, the partnership is dissolved upon the death or bankruptcy of any partner. UPA 31(4), (5). f. decree of court: UPA 32 authorizes the court to dissolve a partnership when: i. a partner becomes in any other way incapable of performing his part of the partnership contract; ii. a partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business; OR iii. a partner willfully or persistently commits a breach of the partnership agreement, or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him. 3. Rights of Partners in Dissolution: a. Where dissolution does not violate partnership agreement: Where the cause of dissolution is not a violation of the partnership agreement, no partner has a claim against any other partner for any loss sustained in the dissolution. Each partner has the right to have the partnership assets applied to the discharge of its liabilities, and the balance distributed to the partners in accordance with their respective interests. UPA 38(1). i. Death of partner: A death of a partner does not violate the partnership agreement, but it does cause dissolution. ii. Continuing partnership: In order to continue the partnership, there must have been a prior agreement. b. Where dissolution violates partnership agreement: Where the dissolution is caused by an act in violation of the partnership agreement, the other partners have certain rights: i. right to damages: If the dissolution is a violation of the agreement, the partner is liable for any damages sustained by the innocent parties as a result thereof (i.e., loss of profits due to interruption of business). UPA 38(2). ii. right to purchase business: The innocent partners also have the right to continue the partnership business in the firm name, provided they pay the partner causing the dissolution the value of her interest in the partnership (less any damages recoverable). UPA 38(2).


iii. right to wind up partnership affairs: If the innocent partners decide not to purchase the wrongdoers interest, they have the right to wind up the partnership affairs and arrange for distribution of assets. UPA 37. 4. Effects of Dissolution: a. Liability for existing partnership debts: A dissolution in no way affects each partners liability for the partnership debts. The partners joint liability remains until the debts are discharged. b. Liability of partners continuing business: Where, after a dissolution, there is a change in the composition of the partnership and the business continues, the new partnership remains liable for all debts of the previous partnership. The creditors of the first or dissolved partnership are also creditors of the partnership continuing the business. UPA 41. c. Authority of partners to act: The authority of partners to act on behalf of the partnership are terminated except in connection with winding up of partnership business. UPA 33. d. Auction: After dissolution of the partnership, a partner may be able to insist on an auction of the partnership property, and can bid for the property themselves, using their interest in the partnership as partial payment. Prentiss. 5. Settling accounts: Assets that belong to the partnership are marshaled and liquidated. a. Order of payment: From those assets: i. outside creditors are paid off; ii. inside creditors (i.e., partners who have made loans or leased property) are paid off; iii. partners are repaid their investment capital; AND 1. See sharing losses, above. 2. Formula: the value of any property they have contributed to the partnership, plus any profits previously allocated to the partners and left in the business, less any returns of capital previously made. iv. any remaining funds are divided, as profit, according to each partners ordinary profit percentages. UPA 40(b). 1. See sharing profits, above. b. Insufficient funds: If the partnership has insufficient funds to pay its creditors and repay capital contributions, then the partners must pay into the partnership according to their respective obligations to share losses (see above). UPA 40(a). F. Limited Partnerships 1. Definition: A limited partnership is a partnership formed by two or more persons, having as its members one or more general partners and one or more limited partners. a. General partner: The general partner is a partner who assumes the management responsibilities of the partnership, and full personal liability for the debts of the partnership. The general partner is personally liable for all obligation of the partnership. i. Corporation: A corporation can be a general partner. b. Limited partner: The limited partner is a partner who makes a contribution of cash or other property to the partnership and obtains an interest in the partnership in return but who is not active in management, and whose liability for partnership debts is limited. A limited partner has no personal liability for partnership debts, and her maximum loss is the amount of her investment in the limited partnership. i. Limited partner as manager: However, where a limited partner takes part in the management and control of the business, she becomes liable as a general partner. RULPA 303(a). Issue: did the limited partner take control of the business or participate in its management? c. Dual status: A person may be both a general partner and a limited partner in the same partnership at the same time. III. THE NATURE OF THE CORPORATION


A. Pre-Incorporation Transactions by Promoters 1. Promoter: A promoter is someone who purports to act as an agent of the business prior to its incorporation. a. Promoters fiduciary obligation: During the pre-incorporation period, the promoter has a fiduciary obligation to the to-be-formed corporation. He t/f may not pursue his own profit at the corporations expense. (He must give any profit to the corporation.) RS of Agency 388. 2. Liability on a pre-incorporation contract: a. Promoters liability: A promoter is liable on the pre-incorporation contract, even if the corporation adopts it or the corporation is never formed unless the other party agrees to release promoter from liability. MCBA 2.04 b. Corporations liability: If the corporation did not exist at the time the promoter signed a contract on its behalf, the corporation will not become liable unless it adopts the contract, either expressly or implicitly (i.e., accepts its benefits). i. Defective incorporation: Where the incorporation is defective, there are two ways to hold a corporation liable to a pre-incorporation contract: 1. de facto corporation: Treat firm as a corporation if the organizers a. in good faith tried to incorporate b. had a legal right to do so AND c. acted as a corporation. 2. corporation by estoppel: Under the doctrine of corporation by estoppel, a creditor who deals with a business as a corporation, and who agrees to look to the corporations assets rather than the shareholders assets will be estopped from denying the corporations existence. (Prevents creditor from earning a windfall if he now argued that the firm was not a corporation.) B. The Corporate Identity and Limited Liability 1. Separation of ownership and control a. Board of directors: All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed by or under the direction of, its board of directors. MBCA 8.01(b). b. Shareholders entitled to vote on: i. Election of directors (MBCA 8.03-.04) ii. Any amendments to the articles of incorporation and generally the bylaws (MBCA 10.03, 10.20) iii. Fundamental transactions (such as mergers; MBCA 11.04) iv. Miscellaneous things, such as approval of independent auditors 2. General rule Limited liability: Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct. MBCA 6.22(b) a. not personally liable: Shareholders losses limited to the amount the shareholder has invested in the firmthe amount paid by the shareholder to purchase his stock b. for the acts or debts of the corporation: A corollary of the corporations status as a separate legal person: It is the corporation that incurs the debt or commits the tort, and it is the corporation which must bear the responsibility for its actions. c. except that he may become personally liable by reason of his own acts or conduct: Includes piercing the corporate veil 3. Piercing the corporate veil: There are two theories by which a plaintiff can pierce the corporate veil. (The distinction is whose assets youre going after. Enterprise liability: youre going after another corporation in the group. The parent corp. doesnt treat the subsidiary as a separate corp. Alter ego liability: trying to get the shareholders assets.) a. Enterprise liability: Under the enterprise liability theory, there is such a high degree of interest between two entities that 1) their separate existences have de facto ceased and 2) treating the two entities as separate would sanction fraud or


promote injustice. Under enterprise liability, the corporation is treated as an agent and the corporate veil is pierced to reach the principal, but only the enterprise is held financially responsible (not the shareholders). Carlton. i. Proof of enterprise liability: To recover under the enterprise theory, the plaintiff must show that the corporations were all run as one company, i.e., that the shareholder did not respect the separate identities of the corporations (use of bank accounts, maintenance of separate books/ records, assignment of driver, ordering of supplies, etc.). Carlton. b. Alter Ego: When a corporation is so controlled as to be the alter ego of its stockholder, the corporate form may be disregarded in the interests of justice (and can go after the stockholder). Silicon Breasts. Two prongs: i. Control prong: (Balance the factors that suggest piercing veil vs. not piercing.) Four factors for determining whether a controlling corporation is so controlled by another to justify disregarding their separate identities: 1. the failure to maintain adequate corporate records or to comply with corporate formalities; 2. the commingling of funds or assets; 3. undercapitalization; AND 4. one corporation treating the assets of another corporation as its own. Sea-Land ii. Injustice prong: Under the injustice prong, courts look at whether circumstances are such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice. SeaLand. 1. Promote injustice: Courts that properly have pierced the corporate veils to avoid promoting injustice have found that, unless it dos so, some additional wrong beyond a creditors inability to collect would result. Examples of additional wrongs: a party would be unjustly enriched, a parent corporation used corporate facades to avoid its responsibilities to creditors, etc. Sea-Land. 4. Entities kept separate: When the shareholders of a corporation, who are also the corporations officers and directors, conscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or manifest injustice is perpetrated upon third persons who deal with the corporation, the corporations separate entity should be respected. Frigidaire. C. The Role and Purposes of the Corporations 1. Purpose of a corporation: A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. Ford. a. Limits on For the Profits of the Shareholders: law compliance, charitable giving, etc. 2. Donations by corporation: A corporation may voluntarily make donations in the reasonable belief that they will aid the public welfare and advance the interests of the corporation, but a donation may not be unreasonable or to a pet charity of the corporate directors in furtherance of personal rather than corporate ends. Barlow.

IV. DUTIES OF OFFICERS, DIRECTORS, AND OTHER INSIDERS A. Shareholder Derivative Actions 1. Summary: The plaintiff sues the individual directors/ officers he is accusing of wrongdoing. a. Derivative or direct? i. Direct: Plaintiff (shareholder) can sue ii. Derivative


1. Is demand futile? a. Yes: Demand is excused. Plaintiff sues. Special Litigation Committee issue. b. No: Demand is required 2. Was demand made? a. Yes: Was demand refused? i. Yes: 1. Foreclosed from arguing that demand was futile. 2. Wrongful refusal? a. No: stop no suit b. Yes: Plaintiff sues. ii. No: Board of Directors sues (i.e., they accept demand and agree to sue.) b. No: Usually stay of action while make demand. (i.e., court usually lets the plaintiff shareholder argue that demand was futile. Then, if court holds that demand was not futile, it will usually stay the proceedings and allow the shareholder to make demand and amend his pleadings.) 2. Derivative or Direct Suit?: Test: If the gravamen of the complaint is injury to the corporation, the suit is derivative, but if the injury is one to the plaintiff as a stockholder and to him individually and not to the corporation, the suit is direct. Eisenberg. Policy: Directors owe a duty to the corporation (not to the shareholders). A corporation is a separate legal entity. Shareholders are just residual claimants. a. Derivative: A derivative suit is one brought by a shareholder on the corporations behalf. All of the recovery goes to the corporation. The cause of action belongs to the corporation as an entity and arises out of an injury done to the corporation as an entity. i. Examples: Most cases brought against insiders for breach of the fiduciary duties of care or loyalty are derivative. Examples: 1)**suits against board member for failure to use due care; 2)**suits against an officer for self-dealing; 3)suits to recover excessive compensation paid to an officer; and 4)suits to reacquire a corporate opportunity usurped by an officer. b. Direct Suit: A direct suit is one brought by a shareholder in his own name. The cause of action belongs to the shareholder in his individual capacity and arises from an injury directly to the shareholder. i. Examples: 1)an action to enforce the holders voting rights; 2)an action to compel the payment of dividends; 3)a suit to prevent oppression of minority shareholders; and 4)a suit to compel inspection of the companys books and records. c. Consequence of distinction: Usually, plaintiff will want his action to proceed as a direct rather than derivative suit. If the suit is direct, P gets the following benefits: 1)the procedural requirements are much simpler (doesnt have to own stock at time of wrong); 2)no demand requirement; and 3)can keep all or part of recovery. i. Security-for-expenses statutes: Some states have statutes by which P must post a bond to guarantee repayment of the corporations expenses in the event that Ps claim turns out to be without merit. Cohen. 3. Derivative suit requirements: a. Pre-requisites for a Derivative Suit: There are three pre-requisites that P must generally meet for a derivative suit: i. he must have been a shareholder at the time the acts complained of occurred, MBCA 7.41(1); 1. Continuing wrong: An important exception is for continuing wrongs P can sue to challenge a wrong that began before he bought his shares, but that continued after his purchase. ii. he must still be a shareholder at the time of the suit, MBCA 7.42; iii. he must be a fair and adequate representative of the corporations interests, MBCA 7.41(2); AND


iv. he must make a demand (unless excused) upon the board, requesting that the board attempt to obtain redress for the corporation. b. Demand Requirement: To satisfy the demand requirement, the stockholder filing a derivative suit must allege either that i. the board rejected his pre-suit demand and the rejection was wrongful OR 1. BJR Presumption if rejected: If a demand is made and rejected, the board is entitled to the presumption of the BJR unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is entitled to the benefit of the presumption. Grimes. a. For example, that 1)the board participated in the alleged wrong; or 2)the directors who voted to reject the suit were dominated by the primary wrongdoer. 2. Wrongful rejection: If P proves that rejection was wrongful, he may bring the underlying action with the same standing which the stockholder would have had if demand had been excused as futile. Grimes. 3. Cant argue demand is excused once demand asserted: A shareholder who makes a demand can no longer argue that demand is excused. Grimes. ii. that demand is excused. Demand is excused where it would be futile. Is demand futile? 1. Delaware approach: Under the Delaware approach, the demand requirement is futile and thus excused if: a. a majority of the board has a material financial or familial interest in the challenged transaction; b. a majority of the board lacks independence (domination and control by wrongdoers); OR c. the challenged transaction was not the product of a valid exercise of business judgment. Grimes. 2. New York approach: In New York, the demand requirement is futile and thus excused if: a. a majority of directors are self-interested in the transaction; OR b. the directors failed to inform themselves to a degree reasonably appropriate (due care); OR c. the challenged transaction was so egregious that it could not have been the product of the sound business judgment of the directors. Marx. c. Special Committees: A corporation may respond to Ps demand by appointing a special committee of directors to study whether the suit should be pursued. i. NY law: In NY, it is difficult for P to overcome the special committees recommendation that the suit be terminated. The ultimate (substantive decision) is covered by the BJR. But judicial inquiry is permitted with respect to the procedures of the committee, in particular whether the committee had disinterested independence and whether the investigation was adequate. *P has the burden of proof. Bennet. ii. Del. Law (better for shareholder): Del. courts have a two-step standard for reviewing committee decisions and allow more wiggle room than NY. 1. Step 1: Under Step 1, the corp. has the burden of proof and court inquires into the independence and good faith of the committee, as well as the bases supporting the committees recommendations. 2. Step 2: Under Step 2, the court may apply its own business judgment as to whether the case is to be dismissed and will look at the corps compelling interest and matters of law & public policy. B. The Duty of Care and the Business Judgment Rule


1. Duty of Care: The law imposes on each director a duty of care with respect to the corporations business. MBCA 8.30(a). The basic standard is that the director or officer must behave as a reasonably prudent person (RPP) would behave in similar circumstances. Courts usually apply a gross negligence standard. a. Reliance on experts and committees: Officers are generally entitled to rely on experts, or reports prepared by insiders, and on action taken by a committee of the board. But all such reliance is allowed only if it is reasonable under the circumstances. Eisner. b. Passive negligence: A director will not be liable merely for failing to detect wrongdoing by officers, but if the director is on notice of facts suggesting wrongdoing, he cannot close his eyes to these facts. Francis. Also, in large corporations, it may constitute a violation of due care for the directors not to put in place monitoring mechanisms to detect wrongdoing. i. Failing to monitor individual employees: Absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the companys behalf. Caremark. (The board is required only to authorize the most significant corporate acts or transactions: mergers, changes in capital structure, fundamental changes in business, etc.) 1. Breach of duty of care for failing to control employees: In order to show that directors breached their duty of care by failing adequately to control their employees, plaintiffs (i.e., shareholders) must show either: a. that the directors knew or should have known that violations of law were occurring and, in either event, b. that the directors took no steps in a good faith effort to prevent or remedy that situation and c. that such failure proximately resulted in the losses complained of. Caremark. 2. Business Judgment Rule: The business judgment rule (BJR) presumes that directors and officers do not breach their duty of care. Unless this presumption is rebutted, courts will not second guess business decisions. Thus, the BJR 1)shields directors from personal liability and 2)insulates board decisions from judicial review. a. Policy: Judges are not business experts. Ford. b. Requirements: The BJR provides that a substantively unwise decision by an officer will not by itself constitute a lack of due care, as long as there is: i. no self-dealing/ no conflict of interest (duty of loyalty see below); The officer will not qualify for the protection of the BJR if he has an interest in the transaction. This gives the plaintiff a breach of duty of loyalty claim. ii. informed decision; AND The decision must have been an informed one, meaning the officer must have gathered at least a reasonable amount of information about the decision before he makes it (usually a gross negligence standard). Van Gorkom. iii. rational decision. Finally, the officer must have rationally believed that his business judgment was in the corporations interest. The decision does not have to be substantively reasonable, but must be at least rational (low burden of proof). c. Rebutting presumption: The BJR may be rebutted if there is: i. fraud: If there is fraud, BJR is rebutted and plaintiff can bring federal/state fraud claims against the corporate officer. ii. corporate waste (irrational decision): Corporate waste is a transaction that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration. If there is corporate waste, then BJR is rebutted. iii. illegality: If the act taken or approved by the officer is a violation of a criminal statute, the defendant will lose the benefit of the BJR.


iv. no decision OR: If there is no business decision, then the BJR does not protect the officer. v. an egregious decision. d. Result: i. BJR applies: If BJR applies, then court abstains from reviewing the decision by the board. ii. BJR does not apply: If BJR is rebutted, then the court asks whether the defendant violated the duty of care. If no, then the defendant wins. If yes, then damages are calculated per Van Gorkom. 1. Damages: If an officer violates the duty of care, and the corporation subsequently loses money, the officer will be personally liable to pay money damages to the corporation. Separately, if the board of directors has approved a transaction without using due care (and the transaction has not yet been consummated), the court may grant an injunction against the transaction. Van Gorkom. C. Duty of Loyalty 1. Duty of Loyalty for Directors and Managers: Officers/ directors of a corporation have a duty of loyalty to the corp and the BJR yields to the rule of undivided loyalty. Bayer. a. Self-dealing: A self-dealing transaction is one in which three conditions are met: i. an officer/director/ controlling shareholder and the corp are on opposite sides of a transaction; ii. the officer/director/controlling shareholder helped influence the corporations decision to enter the transaction; AND iii. the officer/director/controlling shareholders personal financial interests are at least potentially in conflict with the financial interests of the corporation. Bayer. b. Avoiding invalidation of self-dealing: Per Fliegler and 144(a), there are three different ways that a proponent of a self-dealing transaction can avoid invalidation: i. by showing approval by a majority of disinterested directors, after full disclosure of a)the material facts about the conflict and b) the material facts about the transaction; (must have both sets of disclosures.) 1. Disinterested director: A director will be interested if either: 1)he or an immediate member of his family has a financial interest in the transaction; OR 2)he or a family member has a relationship with the other party to the transaction that would reasonably be expected to affect his judgment about the transaction. 2. No immunization of unfairness: The fact that a majority of disinterested directors (acting after full disclosure) have approved the transaction does not necessarily immunize it from attack if the unfairness is very great. But it does shift the burden to the person attacking the transaction, and it will only be struck down if the unfairness is so great as to constitute fraud or waste. ii. by showing ratification by a majority of disinterested shareholders, after full disclosure of a)the material facts about the conflict and b)the material facts about the transaction; OR iii. by showing that the transaction was fair to the corporation as of the time it was authorized, approved, or ratified by the board of directors. c. Burden of proof: i. No conflict of interest: Absent a conflict of interest, plaintiff has burden of proof (and likely will lose because of business judgment rule) ii. Unratified conflict of interest: Given an unratified conflict of interest, directors have burden of proving that challenged transaction was fair and reasonable.


iii. Ratified conflict of interest: If transaction with conflict of interest is ratified (by disinterested shareholders or directors), then plaintiff has burden of proof and must overcome business judgment rule. d. Remedies for violation: If there has been a violation of the rule against selfdealing, there are two possible remedies: i. rescission: Normally, the court will rescind (void) the transaction, where this is possible. ii. damages: If the transaction cannot be rescinded, the court will allow restitutionary damages and the wrongful officer will have to pay back to the corporation any benefit he received beyond what was fair. 2. Corporate Opportunities: Under the corporate opportunity doctrine, a director may not usurp for himself a business opportunity that is found to belong to the corporation. a. Effect: If the officer/director has taken a corporate opportunity, the taking is per se wrongful to the corporation, and the corp may recover i. damages equal to the loss it has suffered OR ii. the profits it would have made had it been give the chance to pursue the opportunity. b. Corporate Opportunity? Two tests: There are two tests that are used to determine whether an opportunity is a corporate opportunity. i. Delaware law: Under Delaware law, a corporate opportunity exists where: 1. the corp is financially able to take the opportunity; 2. the opportunity is in corporation's line of business; 3. the corp has an interest or reasonable expectancy in the opportunity; AND 4. embracing the opportunity would create a conflict between directors self-interest and that of the corporation. Broz. a. Unclear points: It is unclear under Del. Law whether these are factors or elements. ii. ALI 5.05: Bifurcates the inquiry: 1)Was the opportunity in question a corporate opportunity as defined by 5.05(b)? 2)If so, was the corporate opportunity properly rejected by the appropriate corporate actor per 5.05(a)? 1. Corporate opportunity?: Under ALI 5.05(b), a corporate opportunity is one that: a. a director or senior executive becomes aware of in his corporate capacity; b. a director or senior executive should know the outside party is offering to the corporation; c. a director who became aware of it through the use of corporate information, should know is an opportunity in which the corporation would be interested; OR d. the senior executive knows is closely related to the corporations current or expected business. 2. Properly rejected?: Under ALI 5.05(a), a manager may take a corporate opportunity only if: a. the manager offered it to the corporation and disclosed his conflicting interest AND b. the board or shareholders rejected it. 3. Duties of Controlling Shareholders: A controlling shareholder, whether an individual or a parent corporation, is one that has sufficient voting shares to determine the outcome of a shareholder vote. a. Parent-subsidiary dealings: i. Dealings with wholly owned subsidiaries: When a subsidiary is wholly owned and there are no minority shareholders, the parent has virtually unfettered discretion to do with the subsidiary corporation as it pleases. ii. Dealings with partially owned subsidiaries: Parent-subsidiary dealings in the ordinary course of business are subject to fairness review


only if the minority shows the parent has preferred itself at the minoritys expense. Levien. 1. Preference=fairness standard: If the minority can show this, the courts presume the parent dominates the subsidiarys board and places the burden on the parent to prove the transaction was intrinsically fair to the subsidiary. The burden is on the parent unless approved by disinterested directors. Levien. 2. No preference=BJR: But if there is no preference, the transaction is subject to the BJR, and the minority must prove that the dealings lacked any business purpose or that their approval was grossly uninformed. b. Shareholder voting as a director: Shareholders acting as shareholders owe one another no fiduciary duties. However, when a shareholder votes as a director, he has a fiduciary duty to the shareholders. Zahn. i. Directors and personal profit: Directors may not declare or withhold declaration of dividends for the purpose of personal profit or take any corporate action for such a purpose. Zahn. D. Indemnification and Insurance 1. Indemnification: a. Mandatory: Under most statutes, in two situation the corporation is required to indemnify an officer or director: i. when the officer/director is completely wholly successful in defending himself against the charge, Waltuch; AND 1. Successful: Success means an escape from an adverse judgment or other detriment. Waltuch. ii. when the corporation has previously bound itself by charter, law, or contract to indemnify, Del 145(f). 1. Subject to good faith: However, a director may seek indemnification of his unreimbursed litigation expenses from a corporation only if he acted in good faith and in a manner reasonably believed to be in the best interest of the corporation, (regardless of the wording in the corporations articles of incorporation). Waltuch. b. Permissive: In a range of circumstances, the corporation may, but need not, indemnify the director of officer. i. Third party suits: In suits brought by a third party, the corp is permitted to indemnify the officer if he 1)acted in good faith; 2)was pursuing what he reasonably believed to be the best interests of the corporation; AND 3)had no reason to believe that his conduct was unlawful. ii. Derivative suit: For a derivative suit, the corp may not indemnify the officer for a judgment on behalf of the corp or for a settlement payment. But indemnification for litigation expenses is allowed, if D is not found liable on the underlying claim. 1. Subject to good faith: see Waltuch above. iii. Fines and penalties: D may be indemnified for a fine or penalty he has to pay, unless: 1)he knew or had reason to believe that his conduct was unlawful; OR 2) the deterrent function of the statute would be frustrated. 2. Insurance: A corporation has the power to purchase insurance on behalf of any director, officer, employee, or agent against any liability asserted against him and incurred by him in any such capacity, whether or not the corporation would have the power to indemnify him against such liability typically. Watluch.

V. TRADING IN SECURITIES A. Disclosure and Fairness 1. Definition of a Security: The Securities Act of 1933 (SA) regulates securities. The term security means any note, stock, investment contract, or any instrument commonly known as a security. SA 2(a)(1).


a. Stock?: If an instrument is a stock, there is no further inquiry and the investment K test is not applied. Monsanto. i. Factors: Courts look at 5 factors in determining if an instrument is stock: 1. the right to receive dividends contingent upon an apportionment of profits; 2. negotiability; 3. the ability to be pledged or hypothecated; 4. voting rights in proportion to the number of shared owed; AND 5. the ability to appreciate in value. Monsanto. b. Investment K?: Under the Howey test, an investment contract must meet 4 elements: i. a contract, transaction or scheme whereby a person invests money, 1. Investment of money? Anything constituting legal consideration for purposes of contract law should satisfy the first prong of the Howey test. ii. in a common enterprise, 1. Common enterprise? Two types of commonality: a. Horizontal: Horizontal commonality looks to the relationship between the individual investor and the other investors who put money into the scheme. Requires a pooling of interests (e.g., shareholders of a corporation). i. Horizontal commonality satisfies common enterprise requirement b. Vertical: Vertical commonality looks to the relationship between the investor and the promoter of the scheme (fortunes of investor linked with those of the promoter). Requires that the investor and the promoter be involved in a common enterprise, but no pooling of interests by multiple investors. i. Circuit split as to whether vertical commonality also suffices iii. and is led to expect profits iv. solely from the efforts of the promoter or a third party. 1. Solely from the efforts of others? The critical inquiry is whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure of success of the enterprise. Monsanto. (Virtually no court takes the word solely seriously.) 2. The Registration Process: a. General rule, 5: 5 of the Act imposes three basic rules: i. a security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed with the SEC; ii. securities may not be sold until the registration statement has become effective; AND iii. the prospectus (a disclosure document) must be delivered to the purchaser before a sale. b. Two types of exemptions: Registration is not required for the following: i. Exempt securities: In general, an exempt security need never be registered, either when initially sold by the issuer or in any subsequent transaction. ii. Exempt transactions: Exempt transactions, in contrast, are one-time exemptions. 1. Example: If A sells a non-exempt security to B in an exempt transaction, B is not automatically free to resell that security. B must either register it or utilize another exempt transaction. 3. Securities Act Civil Liabilities:


a. Failure to register security, SA 12(a)(1): SA 12(a)(1) imposes strict liability on anyone who sells a security that should have been registered but was not. (Liability is imposed even for an honest and in fact non-negligent mistake.) i. Remedy: Under 12(a)(1) the main remedy is rescission: the buyer can recover the consideration paid, plus interest, less income received on the security. b. Misrepresentation in initial public offering: i. Misrepresentation in registration statement, SA 11: SA 11 imposes liability for any material errors or omissions in a registration statement. A misrepresentation is material if it is information which an average prudent investor ought reasonably to be informed of before purchasing the security registered. BarChris 1. Who may sue: A 11 suit may be brought by anyone who buys the stock covered by the registration statement. a. Reliance: P does not have to show that he relied on the registration statement to make out a prima facie case. (However, D can raise the affirmative defense of showing that P knew of the untruth 2. Who may be sued: Under 11, the following parties may be liable: a. everyone who signed the registration statement (which includes at least the issuer and the principal officers); i. No defenses. ii. Liability for signing: The liability of a director who signs a registration statement does not depend upon whether or not he read it or, if he did, whether or not he understood what he was reading. BarChris. b. everyone who is a director at the time the registration statement was filed; i. Due diligence (DD) defense c. every expert who consent to being named as having prepared part of the registration statement; AND i. DD defense d. every underwriter. i. DD defense 3. Due Diligence Defense, 11(b): The issuers liability is absolute; even if the misrepresentation was inadvertent and in fact nonnegligent, the issuer is strictly liable. But all other potentially liable parties may raise the due diligence defense, which is an affirmative defense to 11(a). a. Non-experts: i. Non-expertised portions: As to non-expertised portions, non-experts must show that, after reasonable investigation, they had reasonable grounds to believe and did believe that the statements were true. 11(b)(3)(A) ii. Expertised portions: As to expertised portions, non-experts must show that they had no reason to believe and did not believe that the statements were misleading. 11(b)(3)(C) b. Experts: i. Non-expertised portions: Not liable for misstatements in non-expertised portions. 11(a)(4) ii. Expertised portions: As to expertised portions, experts must show that, after reasonable investigation, they had reasonable grounds to believe and did believe that the statements were true. 11(b)(3)(B).


c. Reasonable investigation: A reasonable investigation is the level of care that a prudent person would exercise if his own money were at stake. 11(c) 4. Damages: Damages are the difference between original price of security and its present price. Defendant may reduce those damages by showing that part of the damages resulted from other causes and not from the misstatements. 11(e) ii. Misrepresentation in prospectus or oral communication SA 12(a) (2): SA 12(a)(2) imposes liability for misrepresentations, but unlike 11, it is not limited to misrepresentations made in the registration statement. 1. Prima facie case: Ps prima facie case has six elements: a. the sale of a security; b. through instruments of interstate commerce or the mails; c. by means of a prospectus or oral communication; d. containing an untrue statement or omission of a material fact; e. by a defendant who offered or sold the security; AND f. which defendant knew or should have known of the of the untrue statement. 2. Reliance not an element: Reliance is not an element. 3. Due diligence defense: The standard is a negligence standard, so due diligence is a potential defense. 4. Subsequent re-sale of security, Rule 10b-5: i.e., listed on stock exchange. a. Text of 10b-5: It is unlawful for any person, directly or indirectly, in connection with the purchase or sale of any security: i. (a) to employ any device to defraud, ii. (b) to make any untrue statement of a material fact or to omit a material fact necessary, OR iii. (c) to engage in any act which operates or would operate as a fraud upon any person. 10b-5. b. Does 10b-5 apply? The following elements must be met for 10b-5 to apply: i. security; ii. jurisdictional nexus; Use of an instrumentality of interstate commerce, the mails, or a national securities exchange. (Only a problem if face-toface sale.) iii. transactional nexus; P must have been a purchaser or seller of the companys stock during the time of non-disclosure. iv. material misrepresentation or omission; 1. Material misrepresentation: Information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding whether to buy, sell, or hold stock. Northway; Texas Gulf. 2. Statement not true when made: Just as a statement true when made does not become fraudulent b/c things unexpectedly go wrong, so a statement materially false when made does not become acceptable b/c it happens to come true. Pommer. v. reliance; There are two general ways of showing reliance: 1. Traditional reliance: Traditionally reliance is satisfied if: a. affirmative misrepresentation; OR Plaintiff must show he relied on it. b. failure to disclose/omission. Rebuttable presumption that plaintiff relied. Basic 2. Fraud on the market theory: Under the fraud-on-the-market doctrine, because most publicly available information is reflected in market price, an investors reliance on any public material misrepresentations may be presumed for purposes of a Rule 10b-5 action. West. a. Is the information public? Where the information disseminated by the corporation is not public, the fraud on the market doctrine does not apply. West.


b. Rebutting presumption: The D may rebut the fraud on the market presumption by showing: i. market not deceived; ii. corrective statements; AND iii. specific plaintiffs would have traded anyway vi. causation; AND 1. Proximate cause: P must show that the fraud caused the damages vii. scienter. 1. Test: To satisfy the scienter requirement, negligence is not enough. There must be: a. intent to deceive, manipulate or defraud; OR b. reckless disregard of falsity of statement. Ernst. c. Damages under 10(b): Damages under 10(b), in contrast to 11 and 12, usually are the difference btwn the purchase price of the stock and its value on the date of the transaction if the full truth were known. Pommer. This is sometimes known as loss causation: the plaintiff must establish that the misstatement caused him to incur the loss of which he complains; it is not enough to establish that the misrepresentation caused him to buy or sell the securities. Pommer. B. Insider Trading, 10b-5 1. Insider trading: Insider trading refers to the buying or selling of stock in a publicly traded company based on material, non-public information about that company. It is a violation of 10b-5. The policy behind 10b-5 is to encourage full disclosure and prevent fraud. Texas Gulf. 2. Step one: Requirements: a. security b. jurisdictional nexus c. transactional nexus d. material, non-public information i. Material: see above ii. Non-public: Non-public is interpreted broadly: even if a fact has been disclosed to a few reporters, it is still non-public (and trading is not allowed) until the investors as a whole have learned of it. Texas Gulf. e. reliance: If the case involves silent insider trading, the requirements of reliance and causation are not very important so you can ignore them. f. causation g. scienter. 3. Step two: Theories of liability: Mere trading while in possession of material nonpublic information is not by itself enough to make D liable under 10b-5: there must have been a breach of a fiduciary duty. D will not be liable unless he was 1)an insider, 2)a tippee OR 3) a misappropriator. a. Insider: A person is an insider only if he has some sort of fiduciary relationship with the issuer that requires him to keep the non-public information confidential. (The fiduciary duty is to the shareholders.) i. Who is an insider? 1. Employee: An insider is one who obtains information by virtue of his employment with the company whose stock he trades in. Texas Gulf. One can be an insider even if one is a low-level employee, i.e., a secretary. 2. Constructive insider: A person who is given confidential information by the issuer so that he can perform services for the issuer is a constructive insider. (Thus an investment banker, accountant, lawyer, or consultant will be a constructive insider and thus may not trade, or tip others to trade.) a. Elements: A person becomes constructive insider when they i. obtain material nonpublic information from the issuer with


ii. an expectation on the part of the corporation that the outsider will keep the disclosed information confidential AND iii. the relationship at least implies such a duty. Dirks. 3. Educated guess/ prediction: However, an insider is not obligated to confer upon outside investors the benefit of his superior financial or other expert analysis by disclosing his educated guesses or prediction. Texas Gulf. ii. Disclose or Abstain?: The insider must either: 1. disclose the information to the investing public, OR a. Effective disclosure: Insiders must wait until the information is effectively disclosed in a manner sufficient to insure its availability to the investing public. 2. abstain from trading in or recommending the securities concerned while such inside information remains undisclosed. Texas Gulf. a. Information must be material: An insiders duty to abstain from dealing in his companys securities arises only in those situations where the information is material. Texas Gulf. b. Tippee: (The tipper does not change. Its always the first insider: if the tipper doesnt breach a duty, then tippee is not liable.) i. Elements: A person is a tippee only if: 1. he receives information given to him in breach of the insiders fiduciary responsibility; a. Did the insider have a fiduciary duty? Did he breach it by disclosing the information? b. Mere fact of tip is not a breach of fiduciary duty 2. he knows that (or should know that ) the breach has occurred; AND 3. the insider/tipper has received some benefit, directly or indirectly, from the disclosure (or intended to make a pecuniary gift to the tippee). Dirks. c. Misappropriator: A misappropriator is one who takes information from anyone (especially from a person who is not the issuer) in violation of an express or implied duty of confidentiality. OHagan. i. Rule: Under the misappropriation theory of liability, 1. a fiduciarys undisclosed use of information belonging to his principal, 2. without disclosure of such use to the principal, a. How do you avoid liability under misappropriation theory? Disclose the information. Duty is to the person who gave the insider the information. No duty to shareholder. The potential flaw is that the insider can tell the source hes going to act on the information, the source tells him not to, but he acts anyway. 3. for personal gain 4. constitutes fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5. ii. Fiduciary duties, Rule 10b5-2: Rule 10b5-2 provides a non-exclusive list of three situations in which a person has a duty of trust or confidence for purposes of the misappropriation theory: 1. whenever person agrees to maintain info in confidence; 2. whenever person communicating info and person to whom it is communicated have a history of sharing confidences, such that recipient of info knows or reasonably should know that person communicating info expects recipient to maintain confidentiality; OR


3. whenever info is obtained from spouse, parent, child or sibling, unless recipient shows that history, pattern or practice indicates no expectation of confidentiality. iii. Unannounced tender offers, 14e-3: Rule 14e-3 prohibits trading on non-public information about a tender offer, even if the information comes from the acquirer rather than the target, and even if the information is not obtained in violation of any fiduciary duty. 1. Limited scope: 14e-3s scope is very limited: a. limited to information regarding tender offers; b. limited to offering person, issuer of securities sought by tender offer (target), and both of their officers/directors/partners/employees; AND c. not triggered until offeror has taken substantial steps towards making the offer d. Strangers: A stranger with no relationship to the source of material, non-public information whether from an insider or an outsider has no 10b-5 duty to disclose or abstain. Chiarella. Strangers who overhear the information or develop it on their own have no 10b-5 duties. 4. Not violations: a. Acquired by chance: Thus if an outsider acquires information totally by chance, without anyone violating any fiduciary obligation of confidentiality, the outsider may trade with impunity. i. Example: The outsider randomly overhears inside information in a restaurant without any fiduciary violation by the speaker or by the outsider. b. Acquired by diligence: Similarly, if an outsider acquires non-public information through his own diligence, he may trade upon it. Texas Gulf. 5. Remedies for insider trading: The SEC can seek a court order that enjoins the insider trader or tipee from further insider trading and that compels the disgorgement of any trading profits. Texas Gulf. C. Short-Swing Profits 1. Flow chart: a. 16(b) Applies to i. Registered companies (traded on national exchange) ii. Equity securities (only stocks & convertible debt) iii. Insiders only officers, directors, or 10% shareholders 1. Officer or director at the time of purchase OR sale a. Head person: dont care if they own 10%. 2. Shareholder must hold 10% at time of purchase AND sale a. Transaction crossing 10% threshold is not matchable b. Look second before trade to determine if 10% SH c. Find out at which transactions they are 10% shareholder. Cross off the ones they are not a 10% owner. iv. Sale and purchase within 6 months (regardless of order) b. Profit disgorged to the company under 16(b) i. Courts interpret 16(b) to maximize gains company recovers 1. Start by matching highest sale and lowest buy (there is no concern for being chronological but make sure you match all of the shares) 2. Make sure the buy/sale combination produced a profit 3. Make sure you track the number of shares a. If you bought 500 shares and sold 1000, can only match 500 of the 1000 to the 500 shares. Must match the remaining 500 with other shares. 2. 16(b): Under 16(b) of the SA, officers and beneficial owners must pay to the corporation any profits they make from the purchase and sale of the firms stock within 6 months.


a. Public companies: 16(b) applies only to the insiders of companies which have a class of stock registered with the SEC under 12. b. Who is covered: i. Officer: Two groups of people are officers under 16(b): 1. anyone with the title President, Vice President, Secretary, Treasurer, Principal Financial Officer, or Comptroller: 2. anyone (regardless of title) who performs functions that correspond to the functions typically performed by named persons in other corporation. ii. Beneficial owner: A person is a beneficial owner covered by 16(b) if he is directly or indirectly the owner of more than 10% of any class of the company c. Who may sue/ recovery: Suit may be brought by the corporation or by any shareholder. But any recovery goes into the corporate treasury. d. When status is required: 16(b) applies regardless of order (sale then purchase, or vice versa). But sale and purchase must be within 6 months of each other i. Officer at purchase or sale: If D is an officer at the time of either his sale or his purchase of stock, 16(b) applies to him even though he does not have the status at the other end of the trade. 1. Purchase before becoming an officer: But if D purchased the stock before becoming an officer, dont count it. (B/c she couldnt have had any inside information at the time.) ii. Beneficial owner at purchase and sale: A beneficial owner is caught by the 10% owner prong only if he has the more than 10% at both ends of the swing. 1. Purchase that puts one over: The purchase that puts a person over 10% does not count for 16(b) purposes. 2. Sale that puts one below 10%: In the case of a sale that puts a person below 10% ownership, measure the insider status before the sale. e. Is it a sale or purchase? In interpreting the terms purchase and sale, courts have asked whether the particular type of transaction is one that gives rise to speculative abuse. Kern. i. Merger/ Involuntary exchange: Although an exchange of stock pursuant to a merger may possibly result in 16(b) liability, where the exchange is involuntary, coupled with the absence of the possibility of speculative abuse of inside information, 16(b) should not apply. Kern. ii. Scarlett said: I will not test you on Kern. f. Damages: To calculate damages, the court matches the lowest priced purchases and the highest priced sales. VI: PROBLEMS OF CONTROL A. Shareholders Informational Rights and the Proxy System 1. The Regulatory Scheme: Section 14(a) of the 1934 Act prohibits people from soliciting proxies in violation of SEC rules. a. Solicitation: Courts construe the concept of solicitation broadly. b. Proxy statement: The rules (14a-3, 14a-4, 14a-5, and 14a-11) require people who solicit proxies to furnish each shareholder with a proxy statement before soliciting the proxy. In it, they must disclose information that may be relevant to the decision the shareholder must make. i. Filing: Must file the proxy statement with the SEC. 2. Proxy contest: A proxy contest is a competition btwn management and a group of outside insurgents to obtain shareholder votes on a proposal. Proxy fights are subject to both the 1934 Securities Exchange Act (14(a)) and to state corporate statutes. a. List access: There is nothing in the federal proxy rules requiring the corporation to give the shareholder list. However, under 14a-7, insurgents can force management to choose between: i. mailing the insurgents materials and charge insurgent for the cost OR 1. Management will usually mail instead of giving up the list.


ii. giving the insurgents the list so that the insurgents can mail the shareholders. b. Costs: i. Managements (incumbents) expenses: Management can use corporate funds to pay for expenses they incur in conducting their proxy solicitation as long as: 1. the amounts are reasonable AND a. Reasonable expense?: Are the following reasonable expenses: Disclosure statements to shareholders? Telephone solicitations? In person visits to major shareholders? Wine and dine them? Private jet to bring them to company HQ? 2. the proxy contests involve policy, not merely a personal power struggle. Rosenfeld. a. If elements not met: If these two elements are not met, courts will disallow the expenses. Rosenfeld. ii. Insurgents: 1. Majority of insurgents elected: Where a majority of insurgents are elected to the board, a majority of shareholders must approve reimbursement of the insurgents expenses and expenses must be reasonable. Rosenfeld. 2. Majority of incumbents elected: The insurgents have no right to reimbursement unless the board (or majority of shareholders) approves. Further, the incumbents must be successful, its a contest involving policy, and the expenses reasonable. Rosenfeld. 3. Shareholder Proposals: Generally, if any shareholder notifies the issuer of his intention to present a proposal for action at a forthcoming meeting with sufficient notice (120 days b/f the date on which proxy materials were mailed previous year), the issuer shall set forth the proposal in its proxy statement (and thus issuer bears the expense). Rule 14a-8. a. Exceptions: However, an issuer may omit a proposal from its proxy statement if it is: i. not a proper subject ii. illegal or violates proxy rules iii. *personal benefit or personal grievance iv. **for election purposes v. repeat proposals vi. the proposal relates to operations which account for less than 5% of the issuers total assets or net earnings and gross sales AND vii. is not otherwise significantly related to the issuers business. Rule 14a-8(i) (5). 1. Significantly related: The meaning of significantly related is not limited to economic significance. Lovenheim. a. Example: Shareholder wants a proposal about foi gras in the proxy statement. Foi gras makes up less than 5% of corporations business, but court held: due to the ethical and social implications of Ps proposal and the fact that it implicates significant levels of sale, it is significantly related. 4. Shareholder Inspection Rights: a. Shareholder list to discuss tender offer: A shareholder desiring to discuss relevant aspects of a tender offer should be granted access to the shareholder list unless: i. it is sought for a purpose contrary to the corporation OR ii. its stockholders and the manner of communication selected should be within the judgment of the shareholder. Crane. b. Corporate records: Under Delaware law, any shareholder has the right to inspect corporate records, including a list of its stockholders if it is for a proper purpose. Honeywell.


i. Proper purpose: A proper purpose is one reasonably related to such persons interest as a stockholder. It is one germane to a shareholders economic interest. If you have some moral purpose, this will disqualify you, even if you have an economic purpose. Honeywell. 1. Proper Purposes: a. Investigate alleged corporate mismanagement b. Collect information relevant to valuation of shares c. Communicate with fellow shareholders in connection with proxy contest 2. Improper Purposes a. Discover proprietary business information for the benefit of a competitor b. Secure prospects for personal business c. Institute strike suits d. Unrelated personal goal e. Social/ political goals: Example: Guy hears Honeywell produces arms for Vietnam war. He disagrees with war and buys stock just so he can inspect Honeywells records and send information to stockholders to get them to stop the production of munitions. Court held: Guy had no economic purpose and thus purpose was not proper.

B. Shareholder Voting Control 1. Classified stock and weighted voting: The use of different classes and weighting of voting is generally valid. Stroh. a. Explanation: Stock rights include economic rights and voting rights. The economic rights may be removed from the share of stock, but the voting rights cannot. However, the corporation can weight the votes. Stroh. b. Example: Company issued Class A stock and Class B stock. Its articles of incorporation states that none of the shares of Class B stock were entitled to dividends. Court held: this was okay. Stroh. i. Example: A corporations articles of incorporation provided that each shareholder shall be entitled to one vote for every share of common stock he owns not exceeding fifty shares, and one vote for every twenty shares more than fifty owned by him. Court held: this was okay. Baker. 2. Class notes: a. Stock rights: i. Economic rights 1. Receive dividends when declared by the Board 2. Residual claim upon liquidation of corporation ii. Voting rights 1. Elect directors 2. Approve extraordinary matters (e.g., mergers) b. Special Voting Rules i. Default rule - Election by plurality: Straight voting for each open director seat. Top vote getters are elected even if fail to get a majority of votes. ii. Cumulative voting: Must be in articles of incorporation. Optional system for electing directors permitted by statute. Shareholders may cumulate their shares in voting for directors (see Ringling fn 1). 1. Cumulative voting formula: Number of shares necessary to elect desired number of directors = (Number of directors a shareholder desires to elect * Total number of shares authorized to vote) / (Total number of directors to be elected + 1) + 1 2. Cumulative voting: Cumulative voting is a mechanism by which: a. the minority gets to elect some directors;


b. directors are elected all at once; c. each shareholder gets number of votes = (# of board vacancies) x (# of shares owned) AND d. may cast all votes for one (or more) director(s) 3. Cumulative Voting Formula Applied to Ringling a. Number of shares necessary to elect desired number of directors = (5 [Directors Desired] * 1000 [shares outstanding]) / (7 [directors being elected] + 1) + 1 = 626 shares to elect 5 directors. b. Ringling and Haley each owned 315 (630 total). iii. Voting by groups: Potentially available when multiple classes of stock. E.g., Class A elects 3 directors and Class B elects 4 directors C. Control in Closely Held Corporations 1. Closely held corporation: A close corporation is one with the following traits: a. a small number of stockholders; b. lack of any ready market for the corporations stock; AND c. substantial participation by the majority stockholders in the management, direction and operations of the corporation. 2. Shareholder agreements: a. Vote pooling agreements (election of directors): A shareholder voting agreement is an agreement in which two or more shareholders agree to vote together as a unit on certain or all matters. i. Validity: In general, vote pooling agreements are valid: a group of shareholders may lawfully contract with each other to vote in the future in such way as they, or a majority of their group, from time to time determine. Ringling. Legal consideration for the promises of each party is supplied by the mutual promises of the other party. Ringling. ii. Enforcement: There are two ways that a voting agreement may be enforced: 1. by proxy; AND The agreement may require each signatory to give a third person an irrevocable proxy to vote the signers share in accordance with the agreement. Usually this irrevocable proxy arrangement will be enforced. 2. by specific performance: Most courts will grant specific performance of the terms of the voting agreement. iii. Not a close corporation: Even if a corporation does not qualify as a close corporation, a vote pooling agreement may still be valid. Ramos. b. Agreements restricting the boards discretion: Shareholder agreements constraining director discretion require certain persons to serve as officers; specify compensation and dividend policy; and require shareholder approval of board action. i. Validity: Generally, a contract is void so far as it precludes the board of directors from changing officers, salaries, or policies or retaining individuals in office, except by consent of the contracting parties. McQuade (J. Pound). This is because such an agreement deprives the directors of one of their most important functions. ii. Exceptions: However, most courts will uphold even a shareholder agreement that substantially curtails the boards discretion if the agreement: 1. does not injure any nonparty shareholders or creditors, Clark; AND a. Directors are sole stockholders: Where the directors are the sole stockholders, an agreement among them to vote for certain people as officers is valid. Clark. b. Unanimity not required if: Unanimity not required (i.e., not all shareholders have to sign agreement) if: i. the corporation is closely-held ii. the minority shareholder does not object iii. the terms are reasonable


1. So this goes a little farther than Clark. Even if there are minority shareholders, agreement may be valid if the three elements are met 2. does not violate any express statutory provision. c. Vote trusts: Another device that can be used for control is the voting trust. With a voting trust, shareholders who wish to act in concert turn their shares over to a trustee. The trustee then votes all the shares, in accordance with instructions in the document establishing the trust. The shareholders become beneficial owners they receive a voting trust certificate representing their beneficial interest, and get dividends and sale proceeds. But they no longer have voting power. i. Validity: Most states enforce voting trusts, if they conform with statutory requirements. Usually, these requirements include the following: 1. maximum term; (i.e., no longer than ten years); 2. disclosure; AND (usually the trusts terms must be publicly disclosed) 3. writing (the trust must be in writing, and must be implemented by a formal transfer of the shares on the transfer records of the corporation. 3. Remedies for breach of agreement: a. Arbitration clause: Reasonable provisions for cases of failure of the group to reach a determination b/c of an even division in their ranks is unobjectionable. Ringling. b. Specific performance: Specific performance, (if included in the K), is a valid remedy. Ramos. D. Abuse of Control in Close Corporations (freeze out) 1. Fiduciary duties: Stockholders in a close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. That standard of duty is the utmost good faith and loyalty. Such stockholders may not act out of avarice, expediency, or self-interest in derogation of their duty of loyalty to other stockholders and to the corporation. Donahue. a. Freeze-out: Abuse by Majority Two views: In a close corporation, majority stockholders have the opportunity to oppress, disadvantage, or freeze out minority stockholders. Wilkes. There are two approaches to determine if the majority will be liable. i. Fiduciary duty: Majority must have some legitimate business purpose. If so, burden shifts to minority to show purpose could have been achieved through alternative less harmful to minoritys interest. If so, court must balance the legitimate business purpose against the practicability of proposed alternative. Wilkes ii. Delaware no fiduciary duties: Delaware law rejects special close corporation fiduciary duties. Controlling shareholders subject only to Sinclair Oil standard (BJR) under Delaware law. Nixon. b. Abuse by Minority: The minority may also breach their fiduciary duties. i. Example: Minority stockholder would not agree to release dividends. Court held: He recklessly ran serious and unjustified risks of precisely the penalty taxes eventually assessed, risks which were inconsistent with any reasonable interpretation of a duty of utmost good faith and loyalty. E. Control, Duration, and Statutory Dissolution 1. Shareholder remedies: There are four ways shareholder can get corporation to buy his shares at their fair value, per Alaska Plastics: a. provision in articles of incorporation; First, there may be a provision in the articles of incorporation or bylaws that provides for the purchase of shares by the corporation, contingent upon the occurrence of some event, such as the death of a shareholder or transfer of shares. b. **petition court for involuntary dissolution; Second, the shareholder may petition the court for involuntary dissolution of the corporation (i.e., liquidate the corporation). See Grounds for involuntary dissolution, below.


c. change in corporate structure; OR Third, upon some significant change in corporate structure, such as a merger, the shareholder may demand a statutory right of appraisal. i. When available: The remedy is available: 1. upon the merger or consolidation with another corporation, OR 2. upon a sale of substantially all of the corporations assets. d. breach of fiduciary duty (see above). Finally, in some circumstances, a purchase may be justified as an equitable remedy upon a finding of a breach of a fiduciary duty btwn directors and shareholders and the corporation or other shareholders. 2. Grounds for involuntary dissolution: a. director deadlock; Three conditions must be met for dissolution due to director deadlock: i. the directors must be evenly divided and therefore unable to make corporate decisions; ii. the shareholders must be unable to resolve the deadlock; AND iii. the deadlock must threaten irreparable injury to the corporation or prevent the business of the corporation from being conducted to the advantage of the shareholders. b. shareholder deadlock; Two conditions must be met for dissolution due to shareholder deadlock: i. the shareholders must be evenly divided; AND ii. because of their division the shareholders must be unable to elect a board of directors for two years running. c. illegality, fraud, or oppression by majority; i. Oppression is conduct that substantially defeats a minority shareholders reasonable expectations. It must be more than mere disappointment the reasons for participating must have been defeated. 1. Reasonable expectations: Reasonable expectations are expectations that were: a. reasonable under the circumstances; b. known (or should have been known) to the majority; AND c. central to the petitioners decision to join the venture. d. waste or misapplication of corporate funds by majority, Alaska Plastics; OR e. dissolution is reasonably necessary for the protection of the rights and interests of the complaining shareholder, Meiselman; Stuparich. i. Rights and interests: Rights and interests include reasonable expectation, which include expectations that the minority shareholder will participate in the management of the business or be employed by the company, but limited to expectations embodied in understandings, express or implied, among the participants. Meiselman. F. Transfer of Control 1. Premium stock: The premium is the added amount that an investor is willing to pay for the privilege of directly influencing the corporations affairs. Rule: A controlling shareholder may sell her stock at a premium without being obligated to share the premium with minority shareholders, absent: a. looting; b. conversion of corporate opportunity; AND c. fraud or bad faith. Zetlin. 2. Right of first refusal in articles of incorporation: Where a stockholder agreement gives minority shareholder a right of first refusal to buy shares, this right does not include the right to refuse a merger because a merger is different than a sale of shares. In a merger, the acquired firm disappears as a legal entity. The shares disappear, but not by sale, for in a merger the shares of the acquired firm are not bought, they are extinguished. Frandsen. 3. Immediate transfer of management: It is legal to give and receive payment for the immediate transfer of management control to one who has achieved majority share


control but would not otherwise be able to convert that share control into operating control for some time. a. Selling management control by itself: It is illegal to sell management control by itself (that is, accompanied by no stock or insufficient stock to carry voting control). E. Mergers and Acquisitions 1. For exam: You need to know shareholder voting and appraisal rights for these changes in corporate form transactions (mergers, assets sales, etc). a. When its a change in form, shareholders must approve it. Theyll have shareholder approval rights. Very basic just know what would trigger you to do an analysis of something else we did. 2. Shareholder Voting and Appraisal in Standard Merger a. Approval rights: i. Both companies boards AND ii. both companies shareholders have approval rights. b. Appraisal rights: i. Available to shareholders of both corporations ii. Appraisal rights give dissenting shareholders the right to demand that the corporation buy their shares at a judicially determined fair market value iii. Prospect that significant number of shareholders exercise them will threaten the acquisition 3. Shareholder Voting and Appraisal in Asset Sale a. Approval rights: i. Selling corporation: Delaware 271 requires approval of a sale of substantially all the corporations assets by the board and shareholders of the selling corporation. Approval must be by a majority of the outstanding shares. ii. Purchasing corporation: Delaware does not require that the shareholders of the purchasing corporation approve the sale. Only the board of the purchasing corporation need approve the sale. b. Appraisal rights: Nobody gets appraisal rights under Delaware law in an asset sale. Some states give appraisal rights to the shareholders of the selling corporation. 4. Tender Offers: A tender offer is simply a public offer usually made to all shareholders of the target corporation in which the buyer offers to purchase target company shares. You offer to buy any and all shares tendered VII: THE LIMITED LIABILITY COMPANY A. LLC 1. Formation: a. Notice that company is an LLC: Where an LLCs agent fails to disclose that it is an LLC, common law rules of agency apply and an agent to a partially disclosed principal (i.e., the existence of a principal is known but his identity is not) is personally liable to the contract, as is the LLC. Westec. (Basically, an LLC must give notice that it is an LLC.) i. Example: Agent of LLC gives his business card to party. Business card says, P.I.I. but doesnt say what it stands for or indicates that it is an LLC. Held: Agent is personally liable for the contract. 2. The Operating Agreement: An LLC, even if it does not itself execute the LLC Operating Agreement defining its governance and operation, is nevertheless bound by the Agreement. Only where the Agreement is inconsistent with mandatory statutory provisions will the members agreement be invalidated. The policy is to give the maximum effect to the principle of freedom of contract and to the enforceability of LLC agreements. Tom Thumb. 3. Piercing the LLC Veil: The same principles for piercing the corporate veil apply to piercing the LLC veil. (i.e., If the members and officers of an LLC fail to treat it as a separate entity, they should not enjoy immunity from individual liability for the LLCs acts that cause damage to third parties.). Tom Thumb. Two views:


a. Minnesota law: Minnesota law requires the application of corporate law standard to pierce the veil of an LLC, which is: Courts will pierce the corporate veil if i. an entity ignores corporate formalities and acts as the alter ego or instrumentality of a shareholder AND ii. the liability limitations of the corporate form results in injustice or is fundamentally unfair. Tom Thumb. b. ULLCA 303(b): The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company. 4. Fiduciary Obligation: A limited liability company, like a partnership, involves a fiduciary relationship. Normally, the presence of such a relationship would preclude direct competition between members of the company. McConnell. a. Effect of operating agreement: However, an operating agreement of an LLC may limit or define the scope of the fiduciary duties imposed upon its members. Hence, where there is an operating agreement that by its very terms allows members to compete with the business of the company, members may compete without breaching a fiduciary duty. McConnell. b. Fiduciary obligation absent agreement to the contrary: ULLCA 409(b) i. (b)(1): to account to the company ... for ... any property, profit, or benefit ... derived from a use by the member of the companys property, including the appropriation of a companys opportunity ii. (b)(3): to refrain from competing with the company in the conduct of the companys business before the dissolution of the company c. Taking a company opportunity (absent agreement): Apply Delaware corporation standard: A company opportunity is taken, and the duty of loyalty violated if: i. corporation (i.e., company) is financially able to take the opportunity; ii. opportunity is in the corporation's line of business, iii. corporation has an interest or expectancy in the opportunity, AND 1. Interest and Expectancy a. Interest: Something to which firm has a better right b. Expectancy: Something which, in the ordinary course of things, would come to the corporation 2. Probably an expectancy LLC formed to look for franchise iv. embracing the opportunity would create a conflict between directors selfinterest and that of the corporation 5. Dissolution: A dissolved LLC may dispose of known claims against it by filing articles of dissolution, and then providing written notice to its known creditors containing information regarding the filing of claims. Haack. a. Dissociation v. Dissolution i. Dissociation: Dissociation is the withdrawal or expulsion of a member (ULLCA 601). Unlike UPA, dissociation does not necessarily lead to dissolution. ii. Dissolution: Dissolution is when the winding up of the LLC is triggered. (ULLCA 801) b. Dissociation Without Dissolution i. Dissociated members interest must be purchased by the LLC (ULLCA 701). Judicial appraisal proceeding available (ULLCA 702) ii. Members right to participate in LLCs business terminates (ULLCA 603(b) (1)). Exception for participation in post-dissolution winding up process (ULLCA 603(b)(2)) c. Events of Dissolution ULLCA 601 i. By operation of law: 1. Upon notice of members express will to withdraw 2. Upon the happening of any event specified in operating agreement 3. Vote of members pursuant to operating agreement 4. Death, incapacity, bankruptcy, etc. ii. Upon court order:


1. Economic purpose frustrated 2. Misconduct by members d. Consequences of Dissolution Absent Contrary Agreement i. business dissolved per 802(a); OR 1. Business must be wound up 2. Any member who did not wrongfully dissolve may participate in winding up ii. business continued per 802(b) 1. Requires unanimous consent 2. Makes clear that disassociated member entitled to vote 3. Purchase of disassociated partners interest (701)