CH.

9 INTRODUCTION TO CONTRACTS
I.
The Nature of Contracts allow us to enter into agreements with confidence to call on law and not rely merely on good faith of
other party to make sure agreements are honored.
A. Definition they let us create a type of private law the terms of the agreements made- that governs our relations with
others; facilitate planning in society
1. Contract= A legally enforceable promise or set of promises (not all promises are legally enforceable); party
injured by contract breach can call on courts 4 other party to honor contract
2. **Unless the law specifically requires a certain kind of contract to be in writing, an oral contract that
can be proven is as legally enforceable as a written one**
3. Freedom of contract = idea that contracts should be enforced because theyre the products of the free wills of
their creators, who should, within broad limits, be free to determine the extent of their obligations.
4. Assumption of risk when enter into contract; if voluntarily entered into, contract is enforceable; equal bargaining
power usually assumed.
B. Basic Elements - standardized form contracts = pre-printed by one party and presented to the other party for signing;
drafter has most bargaining power; terms are nonnegotiable
1. Offer, must be a voluntary agreement
2. Acceptance
3. Consideration (bargained-for exchange to support each partys promise)
4. Contract must be between parties who have capacity to contract, and the objective & performance of the
contract must be legal.
5. Negotiation - > Agreement? (offer and acceptance), Y/N - > Voluntary?, Y/N - > Consideration?, Y/N (If no, theres
no contract) - > Capacity?, Y/N - > Legality? Y/N - > Contract
II.
Basic Concepts and Types
A. Bilateral and unilateral contracts
1. Bilateral
a. Both parties exchange promises and the contract is formed as soon as the promises are exchanged
b. Most contracts are bilateral
2. Unilateral
a. Only one party makes a promise that is conditioned on the other partys performance (Contract is not
formed until the party completes performance)
b. I.e., reward, prize, contest
B. Valid, unenforceable, voidable, and void contracts
1. Valid contract: meets all of the legal requirements for a binding contract and are therefore enforceable in court
2. Unenforceable contract: meets the basic legal requirements for a contract but may not be enforceable due to
some other legal rule (ex: valid contract whose enforcement is barred by the applicable statute of limitations)
3. Voidable contract: contract in which one or more parties have the legal right to cancel their obligations (I.e.,
fraudulent contracts or contracts under duress); injured party has the right to cancel the contract if he chooses; if
injured party does not cancel the contract, then it is enforceable.
4. Void contract: an agreement that creates no legal obligations and for which no remedy will be given, such as a
contract to commit a crime
C. Express and implied contracts
1. Express contracts: agreements arising from the words of the parties at the time of the contract; parties state
the terms of their contract orally or in writing at time contract is formed
2. Implied contracts: agreements arising out of the surrounding facts and circumstances or conduct of the parties;
based on mutual agreement due to conduct
D. Executed and executory contracts
1. Executed contract: all the parties have fully performed their duties under the agreement
2. Executory contract: all of the parties have not fully performed their duties
III.
Sources of Law Governing Contracts
A. Article 2 of the Uniform Commercial Code (UCC) purpose is to create a uniform set of rules to govern commercial
transactions conducted across state lines.
1. Uniform law adopted by all states (except Louisiana); revisions of the UCC do not become law unless and until
adopted by legislatures.
2. Applies only to contracts for the sale of goods (tangible, movable, personal property such as bicycles)
B. Common law
1. Court-made law that is always evolving
2. Applies to all contracts other than the sale of goods (sale of real estate or intangibles such as stocks/bonds, which
are not goods); Article doesnt apply to service contracts
3. I.e., while the UCC applies to the sale of goods, common law applies to
a. The sale of real estate
b. Services (housekeeping, babysitting, etc.)
c. Intangibles
C. Hybrid contracts (for both goods and services): will be governed by the body of law applicable to the element (goods or
services) that predominates the contract; Is the major purpose or thrust of the afreement the rendering of a service, or is it
the sale of goods, with any services inolved being merely incidental to that sale?
D. Code concepts good faith dealing and unconscionability have enjoyed wide application in cases outside the scope of Article
2.
E. Code more concerned with rewarding ppls legit expectations than with technical rules, and thus more flexible than
common law contracts.More likely to find parties had a contract vs. common law contract court.
F. Gives less weight to technical requirements such as consideration.
THERES MORE
IV.
Noncontract Obligations: legally unenforceable agreements that a court will enforce anyway as a matter of fairness (law
enforces an obligation to pay for certain losses/benefits even in the absence of mutual greement and exchange of value); give
a person who cannot establish the existence of a contract a chance to obtain compensation
A. Quasi-Contract (unjust enrichment or contract implied in law) occurs when 1 party confers a benefit on
another who knowingly accepts it and retains it under circumstances that make it unjust to do so w/o paying
for it.
1. One person may have provided goods or services to another who benefited from them but has no contractual
obligation to pay because no facts exists to show a promise to pay
2. A court will find unjust enrichment and imply a contract as a matter of law if
a. At the plaintiffs expense
b. The defendant received a benefit
c. Under circumstances that would make it unjust for the defendant to retain the benefit without paying
d. Thus benefited party pays the reasonable value of the benefits received.
B. Promissory Estoppel (1 person may rely on a prmse made by another even though the promise and surrounding
cirumstances are not sufficicent to justify the conclusion that a contract has been created); to allow the promisor to argue
no contract was created would sometimes work an injustice on the person who relied on the promise (the promisee).
1. A promise
2. That the promisor should foresee is likely to induce reliance
3. Reliance on the promise by the promissee
4. Injustice as a result of the reliance, and thus promissry estoppel protects reliance.
5. Elements of a promissory estoppel claim: 1) a clear and unambigious promise in terms; 2) reliance by the party to
whom promise is made; 3) reliance myst be both reasonable and foreseeable; 4)the party asserting the claim
must be injured by his reliance.
CH. 10 THE AGREEMENT: OFFER (MUTUAL AGREEMENT LIES AT THE HEART OF CONTRACT LAW 1ST THING COURTS LOOK FOR)
I.
Offer: manifestation of intent to be bound to a contract
II.
Requirements for an offer
A. Intent to contract:
1. Judged by an objective standard words, actions, and circumstances signify the offerors intent
2. A secret intent not to be bound is irrelevant
B. Definiteness of terms
1. Common law
a. Contract must be reasonably certain as to its terms and requirements
b. Ambiguous terms can be made certain by the subsequent actions or declarations of the parties
2. UCC
a. Less strict than the common law
b. Courts will find a contract if the parties intended to make a contract and their agreement is complete
enough to allow the court to reach a fair settlement of their dispute
c. If a term is left open, the gap can be filled by inserting a presumption found in the UCCs gap filling
rules
d. Gap fillers are provided for terms such as
i.
Price
ii.
Quantity
iii.
Delivery; and
iv.
Time for payment
C. Communication to offeree: absence of communication indicates that the offeror is unsure about entering into a binding
agreement
III.
Special Offer Problem Areas
A. Advertisements
1. Generally not considered to be an offer
2. Treated as being invitations for a customer to make an offer
3. EXCEPTION: ads will be considered an offer that a customer can accept if they are highly specific about
a. The number of items available; and
b. Who can accept
B. Rewards
1. Generally treated as offers for unilateral contracts
2. Offeree must know of reward in order to accept (I.e., if Ron returns a dog that he found to the owner and later
discovers an award is available, he is not deemed to have accepted the offer)
C. Auctions: Generally treated as invitations to offer unless the auction is advertised as being without reserve
D. Bids
1. Generally treated as invitations to offer
2. However, an ad for the bid stating that the contract will be rewarded to the lowest bidder = an offer that is
accepted by the lowest bidder
E. Terms included in an offer
1. Traditionally courts held that offerees were bound by all the terms in the offer
2. Today, in the case of lengthy form contracts, courts look to
a. Whether the offeree actually read the term in question; or
b. Whether a reasonable person should have been aware of it
IV.
Termination of Offers
A. Express terms: an offeror, as the master of the offer, has the power to determine when the offer will cease to be valid
B. Lapse of time
1. Offers that do not state a specific time for acceptance are valid for a reasonable time
2. To determine the reasonable length, courts consider
a. Fluctuation in value (rapid v. relatively stable)
b. Context of the parties negotiations
i.
Face to face (time for acceptance does not extend past the end of the conversation)
ii.
Mail or telegram (time includes normal time for communicating the offer and a prompt
response by the offeree)
C. Revocation
1. An offer may revoked anytime prior to acceptance and is effective when received
2. UNLESS it is

a.
b.

An option: offeror promises to hold the offer open and receives consideration for that promise
A firm offer
i.
Merchant offeror
ii.
Makes written offer
iii.
Promises that the offer will be held open (limited to 3 months)
c. An offer for a unilateral contract: power to revoke is suspended for the amount of time reasonably
necessary for the offeree to complete performance
d. Subject to promissory estoppel: in some cases, prevents offeror from revoking an offer when the offeree
relies on the offer being kept open
D. Rejection
1. An offeree may reject the offer by
a. Indicating he is unwilling to accept it
b. Making a counteroffer (an offer to the original offeror with terms materially different from the first offer)
2. Once offerees reject an offer, they cannot later accept it
3. Rejections are effective upon receipt
E. Death or insanity of offeror or offeree: automatically terminates the offer without notice
F.
Destruction of the subject matter: the offer is terminated if, prior to acceptance, the subject matter of a proposed contract
is destroyed without the knowledge or fault of either party (I.e., lakeside cottage burns down after owner offers to sell it)
G. Intervening illegality: an offer terminates if the performance proposed by the contract becomes illegal prior to acceptance
CH. 11 THE AGREEMENT: ACCEPTANCE
I.
Definition of Acceptance
A. An offerees manifestation of assent to the terms of an offer
B. 3 requirements
1. Intent to enter into the contract
a. Judged by an objective standard
b. Outward manifestations, such as words and body language, rather than subjective intent
c. Specht v. Netscape Communications Corp.
i.
Click-wrap contracts have generally been found to be enforceable by courts
ii.
Browse-wrap contracts, however, fail to require a users indication of asset to form a
contract
2. Acceptance of the terms proposed by the offeror
a. Common law
i.
Acceptance must be the mirror image of the offer
ii.
If the acceptance includes additional or different terms, then a counteroffer results and the
original offer is rejected
b. UCC
i.
Does not require a mirror image acceptance
ii.
2-207 deems a definite and timely expression of acceptance to create a contract, even if it
includes terms that are different from or additional to those stated in the offer
iii.
If the parties are both merchants, additional terms become part of the contract, unless
a) The offer expressly limits acceptance to its own terms
b) The new terms would materially alter the offer; or
c) The offer gives notice of objection to the new terms within a reasonable time after
receiving acceptance
3. Communication of acceptance to the offeror
a. In a bilateral contract, the offeree must make the promise requested by the offeror
b. In a unilateral contract, the offeree must fully perform the requested act
c. Manner of communication
i.
The offeror may specify the exact time, place and manner in which acceptance may be
received
ii.
If the offeror merely suggests the manner of acceptance or is silent, however, the offeree
may accept within a reasonable time by any reasonable means of communication
II.
When is Acceptance Communicated?
A. Instantaneous forms of communication: when parties deal face to face, via telephone, or other instantaneous modes of
communication, acceptance is effective as soon as the offeree expresses it by words such as I accept (as long as the
offer is still valid)
B. Noninstantaneous forms of communication
1. Mailbox rule
a. Properly addressed and dispatched acceptances are effective when they are sent
b. Even if they are never received by the offeror
c. An acceptance is properly dispatched if complies with the manner of communication authorized by the
offeree either
i.
Expressly; or
ii.
Impliedly
d. An acceptance mailed prior to revocation that does not reach the offeror until after revocation is valid
2. Both common law and the UCC follow the mailbox rule
C. Stipulated means of communication: if the offer stipulates a means of acceptance, an acceptance by any other means will
not create a contract
III.
Special Acceptance Problem Areas
A. Acceptance of unilateral contracts
1. The offeree must perform the request act to accept
2. However, once the offeree starts to perform, courts will likely prevent the offeror from revoking for the time
reasonably necessary to complete performance
B. Acceptance of bilateral contracts
1. Generally, the offeree must make the promise requested by the offeror to accept
2. Acceptance can also be implied by action that indicates agreement
C. Silence as acceptance
1. Generally silence is not considered acceptance
2. Silence may operate as acceptance if
3. Prior dealings indicate use of silence
4. The offeree indicates silence will be acceptance (If I have responded in a week, I accept.)
5. Offeree accepts offerors performance, knowing a return performance is expected
D. Acceptance when a writing is anticipated: if parties have concluded negotiations and reached agreement on all essential
aspects, most courts will find a contract even without a formal writing
E. Acceptance by shipment
1. May be accepted by either a prompt promise to ship or shipment itself
2. **Note: sellers can avoid breaching the contract if they include a note explaining the reason for the
nonconforming goods, known as an accommodation**
Type of goods
Result
Nonconforming goods
Acceptance followed by breach
Conforming goods
Acceptance
CH. 1 3 THE AGREEMENT: ACCEPTANCE
I.
Effect of Doctrines Discussed in This Chapter
A. Absence of real consent creates a voidable contract
B. The person whose consent was not real has the power to rescind (cancel) the contract
II.
Applicable Doctrines That Create Voidable Contracts
A. Misrepresentation
1. Elements
a. Untrue assertion (includes concealment or nondisclosure)
b. Relating to material fact (must be past or existing fact rather than opinion, promise, or prediction about
future fact)
c. Actual reliance (causal connection between assertion and decision to enter the contract)
d. Justifiable (reasonable) reliance
2. Remedy: rescission (cancellation)
B. Fraud
1. Elements
a. Untrue assertion of fact or equivalent (note that the fact does not have to be material)
b. Scienter (made with knowledge of falsity) and intent to deceive
c. Actual reliance
d. Justifiable reliance
e. Economic loss (in a tort action for damages)
2. Remedy: rescission + tort action for damages
C. Mistake
1. Mutual (both parties have erroneous assumptions about the same fact)
a. Mistake about basic assumption
b. Caused imbalance so severe that it is unfair
c. Person adversely affected by the mistake does not bear the risk (I.e., in State of Alaska v. Carpenter, the
buyer bore the risk of mistake due to disclaimers in the land sale contract)
2. Unilateral (only one party mistaken not usually an excuse)
a. Same as mutual mistake
b. Plus, nonmistaken party must have known of or caused the mistake; or
c. Unconscionable to enforce the contract (consequences severe enough to make enforcement
unreasonably hard or oppressive
D. Duress
1. Coercion
2. Elements
a. Contract induced by an improper threat
b. Victim had no reasonable alternative but to enter the contract
E. Undue influence
1. Unfair persuasion of susceptible individual
2. Elements
a. Relationship of trust and confidence or dominance (I.e., attorney, psychiatrist, family member, etc.)
b. Unfair persuasion (in Goldman v. Bequai, the court found that Mrs. Goldman was unfairly persuaded due
to her age, lack of business experience, mental condition, and long friendship and reliance on her
attorney, making her susceptible to manipulation)
CH. 15 ILLEGALITY
I.
Meaning of Illegality
A. Agreements are illegal either because
1. The legislature has declared that particular type of contract to be unenforceable or void; or
2. The agreement violates a public policy that has been developed by courts or manifested in other sources of law
B. Courts consider the importance of the public policy involved and the extent to which the enforcement of the agreement
would interfere with that policy
1. Public policy = ideas about promoting public welfare
2. Straub v. B.M.T.: a contract that relieves a father of his obligation to support his child violates public policy
(contradicts the promotion of the public welfare)
II.
3 Main Categories of Illegal Agreements
A. Agreements in violation of statutes
1. Declared illegal by statutes; or
a. State legislatures sometimes enact statutes that expressly declare certain types of agreements to be
void or voidable

b.

Examples
i.
Surrogate birth contracts: declared void by an Indiana statute (note that they are not
necessarily void in all states)
ii.
Usury: federal law and most state law sets limits on the amount of interest that can be
charged for a loan or forebearance
iii.
Wagering statutes: all states either completely bar or regulate wagering or gambling
2. Violate public policy of a statute
a. Agreements to commit crimes: contracts requiring the violation of a criminal statute are illegal
b. Agreements promoting violations of statutes: if a person is aware of another persons illegal purpose of
entering into the contract and actively helps to accomplish the purpose, an otherwise legal agreement
(such as the sale of goods), will be illegal
c. Licensing laws: if a person without a license enters into an agreement, the enforceability depends on the
type of law requiring the license
i.
Regulatory laws (protect the public against certain behavior): an agreement by someone
without a license is unenforceable
ii.
Revenue-raising (purpose is to collect $ rather than protect the public): agreement by
someone without a license will generally be enforced
B. Agreements that may be in violation of public policy articulated by courts
1. Agreements in restraint of competition
a. If the sole purpose of an agreement is to restrain competition, it violates public policy and is illegal
b. If the restriction is part of an otherwise legal contract, it may be upheld Courts look to whether:
i.
The clause serves a legitimate business purpose
ii.
The restriction on competition is reasonable in time, geographic area, and scope; and
iii.
The clause does not impose undue hardship
c. Some states prohibit non-competition clauses in employment contracts unless the employer can show
i.
It entrusted the employee with trade secrets or confidential information; or
ii.
Its goodwill with near permanent customers is threatened
d. Also courts bar such clauses that restrict employees from engaging in an occupation that involves
relatively simple, repetitive tasks (I.e., salespersons, barbers, and auto trim repair persons)
2. Exculpatory clauses
a. Exculpatory clauses relieve one party of civil liability for injury to another party
b. General rules: courts will not uphold clauses if they
i.
Protect a party from liability for any wrongdoing greater than negligence
ii.
Exclude tort liability on the party of a party who owes a duty to the public (I.e., an airline)
iii.
Relieve statutorily imposed obligations that benefit one party to the contract (such as
workers compensation and landlord-tenant laws)
iv.
Are unconscionable, a contract of adhesion, or are the product of abuse of superior
bargaining power (courts focusing on whether the party with inferior bargaining power gave
knowing consent); in Leon v. Family Fitness Center, the court looked factors such as
a) Font size
b) Heading that serves as an alert
c) Bold lettering
d) Title of the document
e) Clarity
3. Affecting family relationships
a. Because the family is a valued institution, agreements that tend to interfere with family relationships will
be considered illegal
b. Examples
i.
Agreements to divorce a spouse
ii.
Agreements not to marry
C. Unconscionable agreements and contracts of adhesion
1. Unconscionability (oppressively unfair terms)
a. Both the UCC and the Restatement 2d recognize unconscionability as a reason to refuse to enforce
contracts
b. If a court finds terms unconscionable, it can
i.
Refuse to enforce the entire agreement
ii.
Refuse to enforce just the unconscionable provision; or
iii.
Limit the application of the unconscionable clause
c. Types
i.
Procedural: unfairness in the bargaining process (I.e., fine print, buried or hidden terms,
legalistic language, etc.)
ii.
Substantive: unreasonably one-sided terms or unjustifiably harsh terms
2. Contracts of adhesion
a. Adhesion contract = usually form contracts that require a party with inferior bargaining power to take or
leave the terms
b. Can take 2 different forms
i.
Contain terms that are harsh or oppressive; or
ii.
Contain terms to which the adhering party could not be expected to have known he or she
was agreeing
iii.
Ramirez v. Circuit City Stores, Inc.: adhesion contracts that allow the stronger party to seek
redress through the courts while requiring the weaker party to undergo arbitration and that
preclude class actions are unconscionable and unenforceable
III.
Effect of Illegality
A. Generally courts refuse to give any remedy to either party of an illegal agreement
B. EXCEPTIONS (when courts will provide a remedy even though the agreement is illegal)
1. Excusable ignorance of facts or legislation (but person claiming damages will not recover for anything he or she
does after learning of the illegality)
2. A party did not share equally in the wrong (less guilty parties) are entitled to receive what they have parted with
under the agreement
3. Rescission before performance of the illegal act (can recover any consideration provided)
4. Divisible contracts (if part of an agreement is legal and part is illegal, court will enforce the legal part only if it is
possible to separate it from the illegal part)
CH. 40 LLC, LLP, AND LLLP
I.
Limited Liability Companies
A. Uniform Limited Liability Company Act of 1996 (ULLCA)
1. Default rules that govern an LLC when there is no contrary agreement by its owners
2. Treats LLCs and their owners like RUPA treats LLPs and their partners
B. Tax Treatment
1. May elect to be taxed like a partnership or corporation
2. Most elect to be taxed like a partnership
a. LLC pays no federal tax
b. Owners report income and losses on their individual returns
3. Passive investors may use their shares of losses to offset only income from other passive investments
C. Formation
1. Must file articles of organization with the secretary of state
a. Must include
i.
Name of LLC, including words limited liability company, limited company, LLC or
L.L.C.
ii.
Duration
iii.
Name and address of registered agent
b. Must state whether
i.
Member-managed; or
ii.
Mangager-managed, including names of initial managers
c. Must indicate if LLC has a term; if not, it is deemed at will
2. Owners
a. Called members
b. May include an individual, partnership, corporation, or another LLC
3. Once formed
a. May sue and be sued
b. Can buy, hold and sell property
c. Can make contracts and incur liabilities
D. Foreign LLCs
1. Created in one state (domestic state) but conducts business in another (foreign state)
2. Foreign states may require that the LLC obtain a certificate of authority
3. Foreign certificate of authority must
a. Be filed with the secretary of state
b. Include
i.
Name and address
ii.
Agent for service of process
iii.
Payment of a fee
4. If a LLC fails to obtain a certificate of authority in foreign state,
a. Contracts are still valid
b. Members retain limited liability
c. May be required to pay back fees and fines
d. Disabled from using the foreign states courts until properly files certificate of authority
e. Appoints foreign states secretary of state as agent for service
E. Members Rights and Liabilities
1. Limited Liability
a. No individual liability on LLC contracts unless signed in personal capacity
b. Liability usually limited to members capital contributions
c. Must make capital contributions to the LLC as agreed
2. Management Rights
a. Member-managed
i.
Share equal rights in management
ii.
Each member is an agent with implied authority
iii.
Members also have apparent authority
b. Manager-managed
i.
Managers elected and removed by majority vote
ii.
Each manager shares equal rights in management as an agent
iii.
Managers have implied authority and apparent authority
iv.
Most matters may be conducted by individual managing members or managers or by a
majority of managing members or managers
v.
Matters requiring consent of all members include
a) Amending of the operating agreement
b) Admission of new members
c) Redemption of a members interest
d) Sale of substantially all of the LLCs assets
vi.
LLC is not ordinarily liable for wrongful acts of non-managing members
vii.
Non-managing members owe no fiduciary duties
c. Duties: each member in a member-managed LLC and each manager in a manager-managed LLC are
fiduciaries
d. Managing member or manager

II.

i.
Must account for LLC property and funds
ii.
Not compete with LLC
iii.
Exercise duty of care
e. All members owe a duty of good faith and fair dealing
3. Distributions: share profits and other distributions equally
4. Ownership Interests
a. Personal property of the member
b. Limited ability to sell or transfer
i.
May transfer right to receive distributions, but
ii.
Transferee does not become LLC member
a) No right to manage
b) Only a limited right to information
c) May obtain judicial dissolution if LLC is at will or term has expired
c. Creditors do not own the distribution interest until foreclosure and purchase
F.
Members Dissociation and LLC Dissolution
1. Member Dissociations
a. Power to dissociate by withdrawing from LLC at any time
b. Dissociation is caused by
i.
Death
ii.
Having a guardian appointed
iii.
Being adjudged legally incompetent
iv.
Being a debtor in bankruptcy
v.
Transferring all distributional interest
vi.
Being expelled by other members
c. Wrongful dissociations breach the operating agreement
i.
Withdrawing before LLC term has expired
ii.
Being a debtor in bankruptcy
iii.
Being expelled by court
d. Wrongfully dissociating member is liable for damages
e. Right to manage terminates
f.
May still have apparent authority unless notice given to third parties
i.
Personal notice to creditors
ii.
Filing a Statement of dissociation with the secretary of state
g. No right to force the LLC to dissolve and liquidate assets
i.
Remaining members must pay value of distributional interest
ii.
Must purchase interest at fair value within 120 days of members dissociation if at will
iii.
If term LLC, must pay the value of interest within 120 days after the end of term
2. Dissolution
a. Ordinarily must be wound up after dissolution
b. Few events automatically cause dissolution
i.
Event making it unlawful for the LLC business to continue
ii.
Judicial dissolution at the request of a member or transferee because
a) LLC cannot practicably carry on its business
b) Is being managed illegally or oppressively; or
c) Failed to purchase a dissociated members interest on date required
iii.
Administrative dissolution by secretary of state
c. Any member who has not wrongfully dissociated may wind up
i.
LLC is bound by the reasonable acts of members during winding up
ii.
May be liable for actions that continue the business and are inconsistent with winding up
unless notice is given to third parties in a reasonable manner
a) Email, letter or phone call
b) Filing a Notice of Dissociation, effective 90 days later
d. Proceeds are distributed
i.
First to creditors, including members who are creditors
ii.
Then members contributions are returned
iii.
Any remaining proceeds are distributed in equal shares
e. Ordinarily creditors have no recourse if LLCs assets are insufficient, unless members have not paid all of
the capital promised to LLC
3. Effect of Operating Agreement
a. ULLCA gives members much flexibility to arrange affairs in the way they want
b. In Re Garrison-Ashburn, LC
i.
Member dissociated from LLC by filing a petition in bankruptcy
ii.
Dissociated member was divested of all rights to participate in management or operation of
the company
Limited Partnerships and Limited Liability Limited Partnerships
A. Uniform Limited Partnership Act of 2001 (ULPA)
1. Will soon be the dominant limited partnership law in the U.S.
2. 11 states have adopted it
3. Applies to both LPs and LLLPs
B. Use of LPs and LLLPs
1. Primarily used for tax shelter ventures
2. General partners receive a greater tax shelter advantage
a. Losses can offset income from any other sources, while
b. Limited partners can only use losses to offset income from other passive investments
3. LPs are also used by family businesses because of limited right to dissociate
C. Creation
1. Certificate of limited partnership must be executed and submitted to secretary of state
a. Must be signed by all general partners
b. Must include
i.
Its address
ii.
Registered agent for service of process
iii.
General partners names and addresses
iv.
Whether it is an LP or LLLP
2. ULPA provides for the continuing life of a LP or LLLP
3. Any person may be a general partner
a. Natural person
b. Partnership
c. LLC
d. Trust
e. Estate
f.
Association
g. Corporation
D. Defective Compliance with LP Statute
1. ULPA requires substantial compliance or LP does not exist
2. No substantial compliance usually if
a. Failure to file a certificate of limited partnership
b. Filing of a defective certificate
i.
Misstate name of LP
ii.
Erroneously identify business form
3. Limited partners
a. If designated as a general partner, but individual believes he or she is a limited partner, may be liable
unless
i.
Good faith belief; and
ii.
Upon discovering he or she is not a limited partner,
a) Causes a proper certificate of limited partnership to be filed; or
b) Withdraws from future equity participation in the firm by a filing a certificate declaring
such withdrawal
b. Remains liable to third parties who believe in good faith that he or she is a general partner
c. ULPA has no provision to protect general partners who erroneously believe an LLLP has been formed
E. Foreign Limited Partnerships
1. Domestic in state where organized
2. Foreign in all other states
3. Laws of domestic state apply to internal affairs
4. Must file an application for a certificate of authority with the secretary of state of the foreign state to transact
business there, and include
a. Name and address of LP
b. Names and addresses of general partners
c. Name and address of agent for service of process
5. An unregistered foreign LP
a. May not use foreign states courts to sue
b. Contracts still valid
F.
Rights and Liabilities of LPs and LLLPs
1. Capital Contributions
a. Partners obligated to contribute as promised
b. Obligation may be enforced by LP or any of its creditors
2. Profits and losses shared based on value of each partners capital contribution unless written agreement
3. Voting Rights
a. Actions that must be approved by all partners
i.
Amendment of limited partnership agreement
ii.
Amendment of limited partnership certificate
iii.
Sale or transfer of substantially all of the LPs assets outside the ordinary course of business
b. Limited partners have no right to vote on any matter as a class
c. No new partner may be admitted unless each partner has consented
4. Derivative Actions
a. Usually the general partners hold the power to sue on behalf of the LP
b. Exceptions
i.
If a limited partner asks the general partners to sue someone who has harmed the LP and
they refuse, the limited partner may bring a derivative suit
ii.
Also may bring suit if shows that asking the general partners will be a futile effort
c. Recovery goes to the LP
5. Partners Transferable Interest
a. Personal property of each partner in a LP
b. Buyer or transferee (or creditor with a charging order) is entitled only to receive the partners share of
distributions
6. Power and Right to Withdraw
a. Power to withdraw from LP at any time
b. ULPA gives no right to withdraw, absent a contrary provision in LP agreement
7. Other Rights of General Partners
a. Same right to manage and same agency powers as in ordinary partnership
b. No right to compensation beyond share of the profits
8. Other Liabilities of General Partners
a. Liability

i.
ii.

CH. 41
I.
II.

III.

IV.

V.

In LP: unlimited liability to creditors

In LLLP: liability is limited to capital contributions
a) Exception: may not escape liability for torts the general partner, himself, commits in
the course of business
b) Protected from other torts, such as torts of other general partners
b. Fiduciary Duties
i.
Must account for LP property
ii.
Not compete against the partnership
iii.
Not self-deal with partnership
iv.
Duty of care
9. Other Rights of Limited Partners
a. Right to be informed about partnership affairs
b. General partners must provide financial information and tax returns to limited partners on demand
c. May inspect and copy a list of the partners, information concerning contributions by partners, the
certificate of LP, tax returns, and partnership agreements
10. Other Liabilities of Limited Partners
a. Liability
i.
No further liability once contributed all of promised capital
ii.
ULPA eliminates liability of limited partners who participate in control of the business
b. Duties
i.
No limited partner owes fiduciary duties (unless an agent)
ii.
Owe a duty to act in good faith and fair dealing
G. Partners Dissociations and LP Dissolution
1. Partners Dissociations
a. Limited Partners
i.
Occurs upon
a) Death
b) Withdrawal
c) Expulsion from partnership
1) By partners: must be unanimous
a. Transferred all of transferable interest
b. Suffered a charging order
c. Illegal to conduct business with limited partner
2) By court
a. Engaged in wrongful conduct negatively affecting business
b. Willfully and persistently breached partnership agreement or duty of
good faith and fair dealing
ii.
Retain right to receive distributions and liquidation value
b. General Partners
i.
Occurs upon
a) Death
b) Withdrawal
c) Expulsion
d) Mental or physical inability to care for self
e) Unable to perform as a general partner (determined by court)
f) Debtor in bankruptcy
g) Assigns assets to creditors
h) Custodian appointed over property
i) By a vote of all other partners or by court, the same as a limited partner
ii.
Ends right to manage
iii.
Released from fiduciary duties (except duty of confidentiality)
iv.
May retain apparent authority unless notice given
a) Email or phone calls
b) Filing of Notice of Dissociation
v.
Liable on obligations incurred during partnership unless creditors release
vi.
Not liable on obligations incurred after dissociation if
a) Proper notice to third parties
b) More that two years has elapsed since dissociation
c) In LLLP, no need for dissociated general partners to be released from liability
c. Effect of LP Agreement
i.
Can eliminate a limited partners right to withdraw
ii.
Cannot eliminate a general partners right to withdraw
H. LP Dissolutions
1. Does not dissolve and wind up merely because a partner dissociates
2. Dissolved and wound up only if
a. All general partners and limited partners owning a majority of the claims to the distributions vote for
dissolution
b. If a general partner dissociates and partners owning a majority of the claims to partners distributions so
vote
c. If last general partner or limited partner dissociates and is not replaced within 90 days
d. A court dissolves the LP because it is not reasonably practical to carry on the business
3. Administrative dissolution by the secretary of state is possible if
a. LP fails to pay fees and taxes due
b. Fails to deliver annual report
4. Winding up follows automatically after dissolution
a. General partners have the power to wind up
b. Unless dissociated
5. If no remaining general partner to wind up, limited partners may appoint one
6. Assets distributed
a. First to creditors
b. Remainder paid to partners in proportions as shared distributions
7. If insufficient assets to pay creditors
a. Persons who were general partners when obligation occurred must contribute cash in the same
proportions that they shared distributions when obligation incurred
HISTORY AND NATURE OF CORPORATIONS
History: modern corporation law emerged in the last 150 years
Classifications
A. For Profit
1. Includes most business corporations
2. Issue stock to shareholders who invest in the corporation with the expectation of profiting in the form of
a. Dividends
b. Increased market value of shares
3. Usually incorporated under the general incorporation law of a state
4. Can be
a. Publicly held
i.
Shares available to public investors
ii.
Tend to be managed by professional managers
b. Close corporations
i.
Shares not available to the general public
ii.
Very few shareholders
iii.
Controlling shareholders are generally the managers
iv.
Usually subject to the same rules as publicly held corporations, but many states allow
greater freedom in operation of internal affairs
v.
S corporations: treated like a partnership for federal income tax purposes
a) Shareholders report earnings and losses on individual returns
b) Eliminates double taxation
c) Must have
1) Only one class of shares; and
2) 100 or fewer shareholders
B. Not for Profit
1. Do not issue stock
2. Do not expect to make a profit
3. Have members instead of shareholders
4. No surplus revenue is distributed to members
5. Generally do not pay income tax
C. Government-owned
1. Perform governmental and business functions
2. Seek corporate status to free themselves from government operating procedures
Regulation of For-Profit Corporations
A. State Incorporation Statutes
1. Set out the basic rules for the relationship between the corporation, its shareholders, and its managers
2. Model Business Corporation Act (MBCA)
a. Basis of corporation law in most states
b. Not followed by Delaware, New York, California and other major commercial and industrial states
3. Statutory Close Corporation Supplement to the Model Business Corporation Act: ABAs solution to special
problems of close corporations
B. State Common Law of Corporations
1. Most corporation law is based on statutes
2. There is a substantial body of common law of corporations, including the law of piercing the corporate veil
Regulation of Nonprofit Corporations
A. Regulated primarily by the states
B. Created by complying with a nonprofit incorporation statute
C. Must deliver articles of incorporation to the secretary of state
D. Existence begins when the secretary of state files the articles
E. Most states have statutes based on the Model Nonprofit Corporation Act (MCNA)
F.
Law applied is substantially similar to for-profit corporation law
Regulation of Foreign and Alien Corporations
A. Domestic v. Foreign Corporations
1. A corporation is domestic in the state that has granted its charter
2. A corporation is foreign in all other states in which it conducts business
3. A corporation domiciled in one country is alien in all other countries in which it conducts business
B. Due Process Clause
1. Requires sufficient contacts with a state before it can exercise jurisdiction over a foreign corporation
2. International Shoe case: elements required for jurisdiction (authority to hear a case)
a. Certain minimum contacts with the state; and
b. Does not offend traditional notions of fair play and substantial justice
C. Commerce Clause
1. States have no power to exclude or discriminate against foreign corporations engaged solely in interstate
commerce
2. However, may require a foreign corporation doing interstate or intrastate business in the state to comply with
laws if they do not unduly burden interstate commerce
3. Three elements:

a. The law serves a legitimate state interest

b. Least burdensome means of promoting the interest; and
c. Interest outweighs burden on interstate commerce
D. Subjecting Foreign Corporations to Suit
1. Traditional notions of fair play and substantial justice
a. A court determines by weighing the contacts within the state against the inconvenience to the
corporation of defending suit in a foreign state
b. Burden must be reasonable in relation to the benefit
2. Even an isolated event may be sufficient to create jurisdiction
3. Long-arm statutes
a. Passed by most states to permit their courts to exercise jurisdiction under International Shoe
b. Specify several kinds of activities that make a corporation subject to suit within the state, such as
i.
Commission of a tort
ii.
Making of a contract
iii.
Ownership of property
4. Jet Wine & Spirits, Inc. v. Bacardi & Co., Ltd.:
a. Assumption of contract within New Hampshire between parties was sufficient to confer jurisdiction
b. Voluntary assumption of obligation under the contract was sufficient to show company purposefully
availed itself of the privilege of doing business within the state
E. Taxation
1. Must not violate Due Process or Commerce Clauses
a. Serve a legitimate state interest; and
b. Be reasonable in relation to foreign corporations contacts
2. Corporations property located within a foreign state is subject to property taxes
3. Greater contacts are needed for state income and sales taxes
a. Tax is applied to an activity with a substantial connection to the taxing state;
b. Tax is fairly apportioned;
c. Tax does not discriminate against interstate commerce; and
d. Tax is fairly related to services provided by the state
F.
Qualifying to Do Business
1. States are permitted to require that a foreign corporation qualify to conduct intrastate business within the state
2. Activities that do not require qualification include
a. Soliciting, by mail or through employees, orders that require acceptance outside of the state
b. Selling through independent contractors
c. Owning real or personal property
d. Conducting an isolated transaction that is completed within 30 days and is not in the course of repeated
transactions of a like nature
3. Activities that do require qualification include
a. Maintaining an office to conduct intrastate business
b. Selling personal property not in interstate commerce
c. Entering into contracts relating to local businesses or sales
d. Owning or using real estate for general corporate purposes
e. Maintaining a stock of goods within a state from which to fill orders
4. To qualify, the foreign corporation must
a. Apply for a certificate of authority
b. Pay an application fee
c. Maintain a registered office and a registered agent within the state
d. File an annual report with the secretary of state; and
e. Pay an annual fee
5. Corporations who do not qualify and are required to do so
a. Are subject to a fine
b. Cannot use the states courts to bring a lawsuit
6. Gosch v. B & D Shrimp,Inc.: corporation was required to qualify when it conducted a transaction that could not be
completed within 30 days
G. Regulation of a Corporations Internal Affairs
1. Usually exercised only by the state of incorporation
2. Psuedo-foreign corporations
a. Conduct most business in a state other than the state of incorporation
b. A few states subject pseudo-foreign corporations to extensive regulation
VI.
Regulation of Foreign Nonprofit Corporations: MNCA and other laws impose the same requirements and penalties on nonprofit
corporations as are imposed on for-profit corporations
VII.
Piercing the Corporate Veil
A. Shareholders, although generally subject to limited liability, may lose that status if two requirements are met
1. Domination of a corporation by its shareholders
a. Domination: shareholders cause a corporation to act to its detriment for their own personal benefit
b. Makes the corporation the alter ego or instrumentality of the shareholders
2. For an improper purpose
a. Defrauding creditors
i.
Inadequate or thin capitalization
ii.
Looting: transfer of assets to shareholders for less than fair market value
b. Circumventing a statute; or
c. Evading an existing obligation
B. Hildreth v. Tidewater Equipment Co.: no basis to pierce the corporate veil when no allegation or finding of fraud.
CH. 42 ORGANIZATION AND FINANCIAL STRUCTURE OF CORPORATIONS
I.
Promoters and Preincorporation Transactions
A. Promoter
1. Incorporates a business
2. Organizes its initial management
3. Raises its initial capital
B. Corporations Liability on Preincorporation Contracts
1. No liability on contracts made by a promoter prior to incorporation
a. Not automatically liable after becoming a corporation
b. Must adopt promoters preincorporation contract in order to become liable
i.
Must accept the contract with knowledge of all its material facts
ii.
May be express or implied
C. Promoters Liability on Preincorporation Contracts
1. Jointly and severally liable with copromoters, including the torts committed prior to incorporation
2. Liability exists even if the promoters name is not on the contract
3. Novation must occur to remove liability
a. Corporation and third party agree to release the promoter from liability; and
b. To substitute the corporation for the promoter as the party liable on the contract
c. Can be express or implied agreement
D. Obtaining a Binding Preincorporation Contract
1. In order for the third party to be liable, the promoter must be liable
2. Once the corporation adopts the contract, both the corporation and third party are liable and cannot rescind
without consent
3. Automatic novation clause: wording in a contract to indicate the promoters liability ceases upon adoption by the
corporation
E. Preincorporation Share Subscriptions
1. A prospective shareholder offers to buy a specific number of shares at a stated price
2. Ensure that the corporation will have enough capital
3. MBCA does not allow the prospective shareholder to revoke for a 6-month period
4. Promoters have no liability in the absence of fraud or other wrongdoing, but they have a duty to make a good
faith effort to bring the corporation into existence
F.
Relation of Promoter and Prospective Corporation
1. Promoter is not an agent
2. Promoter does owe fiduciary duties: full disclosure and honesty
a. Cannot divert money from prospective shareholders to pay own expenses
b. Cannot divert a business opportunity from the corporation and give to him or herself
c. May not purchase shares at a price lower than that paid by public shareholders
d. May not profit personally via secret transactions
G. Liability of Corporation to Promoter
1. Generally, no compensation for promotional services or expenses is required
2. MBCA permits shares to be issued for a promoters preincorporation services
II.
Incorporation
A. Steps in Incorporation
1. Preparation of articles of incorporation
a. Basic governing documents of a corporation
b. Contain many of the rights and responsibilities of the corporation, management and shareholders
2. Signing and authenticating the articles
a. Signed by incorporators
b. No special liability attaches to incorporators
3. Filing the articles
a. Must be delivered to the office of the secretary of state
b. Fee must be paid
4. Receipt of a copy of the articles with Filed stamp and fee receipt
a. Existence of corporation begins when the articles are filed by the secretary of state
b. Shareholders must approve most changes in the articles as the articles are a contract between
shareholders and the corporation
5. Holding an organizational meeting to adopt bylaws, elect officers, and transact other business
a. First formal meeting of the directors
b. Defines the powers, rights and responsibilities of the parties more precisely
c. MBCA authorizes incorporators or initial directors to adopt the preliminary bylaws
d. Board of directors has the power to repeal and amend the bylaws unless articles state otherwise
e. As the ultimate owners of the corporation, the shareholders always retain power to amend the bylaws as
well
6. Filing Annual Report
B. Close Corporation Elections
1. Most statutes require a corporation make an election to be treated like a close corporation
2. Statutory Close Corporation Supplement to the MBCA allows a corporation with less than 50 shareholders to elect
to be a close corporation
3. No penalty for a failure to make election
4. Courts may apply common law rules applicable to close corporations even in the absence of statutory election
III.
Defective Attempts to Incorporate
A. Failure to comply with all the conditions for incorporation may result in the following consequences
1. Managers and purported shareholders become personally liable for obligations
2. A party to a contract with the defectively formed corporation may refuse to perform
3. Defectively formed corporation may escape liability on the contract due to its nonexistence
B. 3 Classifications of Defectively Formed Corporations
1. De Jure Corporation
a. Formed when promoters substantially comply with each of the mandatory conditions for incorporation
b. Treated like a corporation for all purposes

c. Can only be attacked in a quo warranto proceeding: state asserts noncompliance with a condition
subsequent to incorporation, like failure to file an annual report
De Facto Corporation
a. Formed when incorporators fail in a material respect to comply with all of the mandatory provisions of
the incorporation statute, yet comply with most
b. 3 requirements
i.
Valid statute exists under which the corporation could be organized
ii.
Promoters make an honest attempt to organize under statute
iii.
Promoters or managers exercise corporate powers
c. Treated as a corporation with respect to
i.
An attack by a third party
ii.
An attempt by the business itself to deny that it is a corporation
d. State may attack in a quo warranto proceeding
3. Corporation by Estoppel
a. Court will not deny the existence of a corporation when
i.
People hold themselves out as representing a corporation; or
ii.
Believe themselves to be dealing with a corporation
b. Each contract must be considered individually to determine if either party is prevented from denying the
corporations existence
C. Liability for Defective Incorporation
1. Persons are generally deemed to be partners with unlimited liability for contracts and torts of the business
2. Most courts only impose contractual liability on those who are
a. Actively engaged in the management of the business; or
b. Responsible for the defects in organization
3. Tort liability is generally imposed on everyone, managers and purported shareholders alike
D. Modern Approaches to the Defective Incorporation Problem
1. MBCA states that the filing of the articles is conclusive proof of a corporations existence, except in proceeding
brought by the state
2. Courts have then found the opposite: failure to obtain a filing of the articles is conclusive proof of nonexistence
3. Liability for those purporting to act an behalf of a corporation with knowledge of its nonexistence is joint and
several
4. MBCA releases shareholders and others from liability who
a. Take no part in the management of the defectively formed corporation; or
b. Mistakenly believe that the corporation is in existence
5. Christmas Lumber Co., Inc. v. Valiga: court held parties liable as partners when appellant did not establish lack of
knowledge that a corporation was not yet formed
Incorporation of Nonprofit Corporations
A. Incorporated in substantially the same manner as for-profit corporations
B. Unlike a for-profit corporation, must state it is either a public benefit corporation, a mutual benefit corporation or a
religious corporation
C. Normally members and managers are shielded from personal liability, but those acting for a nonexistent corporation will
have the same liabilities as for-profit nonexistent corporations
Financing For-Profit Corporations
A. Equity Securities
1. Commonly called stock or shares
2. Creates an ownership relationship: stockholders or shareholders are owners of the corporation
3. Types
a. Common Shares
i.
Often occupy a position inferior to that of other classes
ii.
Shareholders have the exclusive right to elect the directors, who manage the corporation
iii.
Have an exclusive claim to the corporate earnings and assets that exceed the claims of
creditors and other shareholders
b. Preferred Shares
i.
Have preferences over other classes of shares
ii.
Shareholders are customarily given liquidation and dividend preferences over common
shareholders
iii.
MBCA: preferences must be set out in the articles of incorporation
a) Liquidated preferences: a stated dollar amount that must be distributed
b) Dividend preferences: can be cumulative or noncumulative
c) Participating preferred shares: have priority up to a stated amount or percentage of the
dividends to be paid
d) Mandatory dividend: generally held to be illegal
e) Redemption: allows a corporation to repurchase shares at its option, despite
shareholders unwillingness
iv.
May be convertible into another class of shares
v.
Have voting rights, unless articles state differently
B. Authorized, Issued, and Outstanding Shares
1. Authorized: shares that a corporation is permitted to issue pursuant to its articles of incorporation
2. Issued: shares that have been sold to shareholders
3. Outstanding: shares currently held by shareholders
4. Cancelled Shares: repurchased shares no longer in existence; cannot be reissued
5. Shares Restored to Unissued Status
6. Treasury Shares:
a. Repurchased shares that are neither cancelled nor restored to unissued status
b. MBCA has abolished the concept
C. Options, Warrants, and Rights
1. Options: MBCA allows the board of directors to issue options for the purchase of a corporations shares
2. Warrants: options evidenced by certificates
3. Rights: short-term, generally transferable, certificated options
4. Preemptive right: requires a corporation to offer each existing shareholder the opportunity to buy newly issued
shares in the same proportion as shareholders current ownership
D. Debt Securities
1. Debentures
a. Long-term
b. Unsecured
c. Typically have a term of 10 to 30 years
d. Usually have indentures: contract that states the rights of debenture holders
2. Bonds
a. Long-term
b. Secured by collateral
c. Usually have indentures
3. Notes
a. Shorter duration than other debt securities
b. May be secured or unsecured
c. Seldom have terms exceeding 5 years
d. Often convertible into other securities, such as common shares
Consideration for Shares
A. Quality of Consideration
1. Statutes require legal consideration to have real value
2. MBCA permits share to be issued in return for tangible or intangible property or benefit, including
a. Cash
b. Promissory notes
c. Services
d. Contracts for services
e. Securities
3. MBCA allows corporations to issue shares to their promoters in consideration for the promoters preincorporation
services
B. Quantity of Consideration
1. Par value: arbitrary dollar amount assigned to shares by articles of incorporation
a. Does not reflect the fair market value
b. Minimum amount of consideration for which the shares may be issued
c. Discount shares
i.
Issued for less than par value
ii.
Board of directors is liable to corporation for issuance
2. Fair value: shares are often worth more than their par value
a. Boards judgment as to the amount of consideration received for shares is conclusive when it
i.
Acts in good faith
ii.
Exercises the care of ordinarily prudent directors; and
iii.
Acts in the best interests of the corporation
b. Boards valuation of consideration is also conclusive when it
i.
Acts in good faith
ii.
Exercises the care of ordinarily prudent directors; and
iii.
Acts in the best interests of the corporation
c. Watered shares
i.
Board impermissibly overvalues the consideration for shares
ii.
Both board and shareholders are liable to the corporation
d. Fully paid and nonassessable: shareholder has paid proper amount of consideration
3. Accounting for Consideration Received
a. Stated capital account: the number of shares outstanding multiplied by the par value of each share
b. Capital surplus: excess or surplus consideration received when shares are sold for more than par value
c. MBCA has eliminated the terms stated capital and capital surplus
4. Resales of Shares
a. Board may sell treasury sales for less than par value, if it sells them for an amount equal to their fair
value
b. A shareholder may buy shares from another shareholder for less than par value or fair value and no
liability results
Share Subscriptions
A. A prospective shareholder promises to buy a specific number of shares at a stated price
B. Subscriber is a shareholder, even if the shares have not been issued
C. MBCA: subscriptions do not have to be in writing to be enforceable
D. Postincoporation subscriptions bind the corporation and subscriber
E. When the Board demands payment from subscribers, it must demand from all subscribers of a class of shares or none of
them: no discrimination
Issuance of Shares
A. Uniform Commercial Code (UCC) Article 8
1. Regulates the issuance of securities
2. Permits a corporation to only issue the number of shares authorized by its articles
3. Overissued shares are void
a. Two remedies for someone entitled to overissued shares
i.
Corporation must obtain identical shares and deliver them to the person; or
ii.
Corporation must reimburse the person for the value paid for the shares plus interest
b. Directors may incur liability, including criminal
2.

IV.

V.

VI.

VII.

VIII.

IX.

CH. 43
I.

II.

III.
IV.

V.

B. Share certificate: evidence that a person has been issued shares, owns the shares, and is a shareholder
C. MBCA: does not require a corporation to issue share certificates; a written statement with the information required in the
certificate suffices
Transfer of Shares
A. Transfer occurs through
1. Either
a. Indorsement of share certificate on it back by its registered owner; and
b. The delivery of the certificate to another person
2. Or (street certificate)
a. Delivery of share certificate
b. Without indorsement
B. UCC requires corporation to register the transfer of any registered shares if properly indorsed
C. Bona fide purchaser:
1. Buys shares in good faith
2. With no notice of any adverse claim against the shares
D. Corporation must register the transfer to a bona fide purchaser unless overissuance would result
E. Restrictions
1. Historically, shareholders are free to sell shares to whomever they want whenever they want
2. In close corporations, free transferability threatens the balance of power among shareholders
3. Modern corporation statutes permit most transfer restrictions, especially for close corporations
4. Types of Restrictions
a. Right of first refusal: grants the corporation or other shareholders the right to match the offer that a
selling shareholder receives
b. Option agreement: grants the corporation or other shareholders an option to buy the selling
shareholders shares at a price to be determined by agreement
c. Buy-and-sell agreement: requires a shareholder to sell his shares to the corporation or to other
shareholders at the price stated in the agreement
d. Consent restraint: requires a selling shareholder to obtain the consent of the corporation or other
shareholders before he or she may sell
e. Provision disqualifying purchasers: excludes unwanted persons from the corporation
5. Legality
a. MBCA: authorizes for any reasonable purpose, judged in light of the character and needs of the
corporation
b. Consent restraints and provisions disqualifying purchases are permissible if they are not manifestly
unreasonable
c. Per se reasonable
i.
Any consent restraint that maintains a corporations status when the status is dependent on
the number or identity of shareholders
ii.
Any restriction that preserves registration exemptions under the Securities Act of 1933 and
state securities laws
6. Enforceability
a. Restriction must be contained in the articles of incorporation, bylaws, an agreement among
shareholders, or an agreement between the corporation and shareholders; and
b. Shareholder must agree to restriction or purchase the shares with notice
c. Stufft v. Stufft: since no agreements to sell the stock were reached, the transfer restriction was not
initiated
MANAGEMENT OF CORPORATIONS
Corporate Objectives
A. Traditional: to enhance corporate profits and shareholder gain
B. Modern: most states have enacted corporate constituency statutes
1. Allow or require directors to consider the interests of constituencies other than shareholders
2. Direct the board to act in the best interests of the corporation, not just the shareholders, and to maximize profits
over the long term
Corporate Powers
A. Incorporation statute
1. Primary source of powers
2. Includes
a. Making gifts for charitable and educational purposes
b. Lending money to corporate officers and directors
c. Purchasing and disposing of corporations shares
3. Also may limit powers
B. MBCA: a corporation has the power to do anything that an individual may do
C. Purpose Clauses in Articles of Incorporation
1. Usually phrased in broad terms
2. Generally state that the corporation may engage in any lawful business
3. MBCA: inclusion of a purpose clause is optional
D. Ultra Vires Doctrine
1. Any act not permitted by the corporation statute or by the articles of incorporation is void due to lack of capacity
2. Today, the doctrine has little importance
a. Most corporations have broad purpose clause
b. MBCA and most other statutes do not allow a corporation or other party to an agreement to avoid an
obligation due to ultra vires action by the corporation
3. MBCA: permits ultra vires to be asserted by only three types of persons
a. Shareholder seeking to enjoin an ultra vires action
b. Corporation suing management for damages caused by exceeding the corporations powers; and
c. The states attorney general
Powers of Nonprofit Corporations
A. MNCA: grants nonprofit corporations the power to engage in any lawful activity and to do anything an individual may do
B. Usually, powers are limited by a purpose clause in the corporations articles
C. MNCA adopts same rules for ultra vires as MBCA
The Board of Directors
A. Traditionally had the authority and duty to manage
B. MBCA: permits a corporation to be managed under the direction of the board
C. Board Authority Under Corporation Statutes
1. Has authority to do almost everything within the corporations powers
2. Includes
a. General power to manage or direct the corporation in the ordinary course of its business
b. Power to issue shares of stock and to set price of shares
c. May repurchase share, declare dividends, adopt and amend by laws, elect and remove officers, and fill
vacancies on the board
3. Important changes require board initiative AND shareholder approval
a. Amendment of articles of incorporation
b. Merger of the corporation
c. Sale of all or substantially all assets
d. Voluntary dissolution
D. Committees of the Board
1. Have fewer members than the board has
2. Can more efficiently handle management decisions and exercise powers
3. Only directors may serve
4. MBCA: powers that must be exercised by entire board and not committees include a. Declaring dividends
b. Filling vacancies on the board or committees
c. Adopting and amending bylaws
d. Approving issuances of shares
e. Approving repurchasing of shares
5. Types
a. Executive committee
i.
Generally given the authority to act for the board on most matters when not in session
ii.
Usually consists of insider directors (corporation officers) and one or two outside directors
b. Audit committees: directly responsible for the appointment, compensation, and oversight of independent
public accountants
c. Nominating committees: choose managements slate of directors to be submitted to shareholders at
annual election
d. Compensation committees
i.
Review and approve the salaries, bonuses, stock options, and other benefits of high level
executives
ii.
May set compensation of their members
e. Shareholder litigation committee
i.
Consists of disinterested directors
ii.
Determines whether a corporation should sue someone who has allegedly harmed the
corporation
iii.
Formed when a shareholder asks the board to cause to corporation to sue directors for
mismanagement
E. Powers, Rights, and Liabilities of Directors as Individuals
1. Not agents of the corporation automatically
2. May manage only when they act as a board, unless granted agency powers
3. Have the right to inspect corporate books and records, containing information essential to performance of duties
4. Generally no personal liability for corporations contracts and torts
F.
Election
1. Generally any individual may serve as director
2. Corporation must have the number of directors required by state law
3. MBCA: requires a minimum of one director
4. Elected at the annual shareholder meeting
a. Straight voting: one vote per share
b. Class voting: certain shareholder classes have the right to elect a specified number of directors
c. Cumulative voting: number of shares X number of directors
5. MBCA: directors can have staggered terms
6. Proxy Solicitation Process
a. Shareholders not in attendance may appoint someone else to vote their shares for them
b. Signature of a proxy form designates who may vote the shares
7. Vacancies: MBCA permits the directors to fill by majority vote
8. Removal of Directors: modern statutes permit shareholders to remove directors with or without cause
G. Directors Meetings
1. A quorum (usually a majority) of the directors must be present in order to act
2. Each has one vote
Officers of the Corporation
A. Board is authorized to appoint the officers
B. MBCA:
1. Only requires an officer performing the duties normally granted to a corporate secretary
2. One person may hold several offices
C. Are agents of the corporation with
1. Express authority: based on bylaws or board of directors

2.
3.
4.

VI.
VII.

VIII.

IX.

X.

Implied authority: actions that are reasonably necessary to accomplish express duties
Apparent authority
Inherent authority
a. President: traditionally has no powers to bind the corporation; presides over meetings
b. Vice president: no authority to bind the corporation unless assigned to a specified department requiring
specific functions
c. Secretary: keeps minutes, maintains records, retains custody of corporate seal and certifies records
d. Treasurer: keeps corporate funds
D. Like other agents, normally have no liability on contracts on behalf of the principal
E. Directors may remove at any time with or without cause
Managing Close Corporations
A. May be managed by shareholders rather than a board of directors
B. May impose supermajority voting for board actions and restrict managerial discretion
Managing Nonprofit Corporations
A. Must have at least three directors
B. Any person may serve
C. Directors typically elected by members
D. Directors serve for one year, unless bylaws state differently
E. Directors may be elected through straight or cumulative voting and class voting
F.
Directors may be removed at any time with or without cause
G. Directors typically receive no compensation
H. Not required to have officers except for a corporate secretary
Directors and Officers Duties to the Corporation
A. Duty to Act within Authority
B. Duty of Care
1. Judged by the standard of the ordinarily prudent person in the same circumstances
2. Test
a. Reasonable investigation
b. Honestly believe that decision is in the best interests of the corporation
3. Business Judgment Rule
a. Absent bad faith, fraud, or breach of fiduciary duty, the judgment of board is conclusive
b. Courts will not substitute their business judgment for that of the corporations managers
c. Three requirements
i.
Informed decision through reasonable investigation
ii.
No conflicts of interest
iii.
Rational basis
C. Board Opposition to Acquisition of Control of a Corporation
1. Often, outsiders, known as raiders, will attempt to acquire control of a corporation
2. They will make a tender offer (offer to buy shares above market price) for the shares of a corporation (the target)
in the hopes of acquiring a majority of the shares
3. Defenses
a. Types
i.
Greenmail: repurchase of share from the raider at a considerable profit to the raider in
exchange for the signing of a standstill agreement
ii.
White Knight: friendly tender offeror preferred over the raider
iii.
Pac-Man: target makes a tender offer for the shares of the raiders corporation
iv.
Golden Parachutes: large severance payments to top level executives when there is a
change in control of the corporation
v.
Scorched Earth Tactics: public attacks on raider and management
vi.
Long-Range Acquisition Strategy: allows board to oppose a hostile takeover
vii.
Lock-Up Option: White Knight buys a highly valuable asset of the target at a low price if
raider succeeds
viii.
Friendly Shareholders: people who are unlikely to sell shares to someone who they see as
hostile to the continuation of business
ix.
Poison Pill: issuance of a new class of preferred shares to common shareholders with rights
to purchase share at less than fair market value
b. Unocal test
i.
Board has reasonable grounds to believe that a danger to corporate policy and
effectiveness was posed by takeover attempt
ii.
Act primarily to protect the corporation and shareholders from danger
iii.
Defense tactic was reasonable in relation to the threat
a) Paramount Communications, Inc. v. Time, Inc.: a board may oppose a hostile takeover if
it had a preexisting, deliberately conceived plan justifying its opposition
D. Duties of Loyalty
1. No self-dealing (conflicts of interest)
a. Transactions where the director has an interest of his or her own, not in accord with the corporations,
may be voided or rescinded
b. MBCA: transaction will not be voided on the grounds of conflict of interest if
i.
Approved by a majority of informed, disinterested directors;
ii.
Approved by a majority of the shares held by informed, disinterested shareholders; OR
iii.
Fair to the corporation
a) Intrinsic fairness standard: reasonable persons in an arms-length bargain would have
bound the corporation
b) Burden of proof initially on the director unless transaction approved by disinterested
shareholders or directors
c) Generally unanimous approval by informed shareholders conclusively releases
interested party from liability
2. No usurping a corporate opportunity: Guth v. Loft, Inc.
a. Must have a relation or connection to existing or prospective corporate activity
b. Corporation must be financially able to take advantage of opportunity
c. Can exploit opportunity rejected by corporation
3. No oppression of minority shareholders
a. One group of shareholders is isolated for favorable treatment to the detriment of another group
b. Transaction must be intrinsically fair
c. Examples
i.
Freeze Out: merging a corporation and the minority shareholders receive cash or other
securities in lieu of shares
a) Most states apply the total fairness test
1) Fair dealing
2) Fair price
b) Some apply a business purpose test: Coggins v. New England Patriots Football Club,
Inc.
c) Others place no restriction if the shareholders have a right of appraisal
ii.
Going Private
4. No insider trading
a. Impermissible to use non-public information to own benefit
b. Judicial trend to require disclosure of confidential information before buying or selling securities
Corporate and Management Liability for Torts and Crimes
A. Liability of the Corporation
1. Doctrine of respondeat superior applies for torts
2. Likely to impose criminal liability when the criminal act is requested, authorized or performed by
a. The board of directors;
b. An officer;
c. Another person having responsibility for formulating company policy; or
d. A high level administrator having supervisory powers over subject matter of offense committed within
scope of employment
B. Directors and Officers Liability
1. Always liable for own torts and crimes
2. Usually not liable for torts of corporation employees unless authorize or participate in the tort
3. Will have criminal liability if request, authorize, conspire, or aid and abet in the employees commission of a crime
Insurance and Indemnification
A. Mandatory Indemnification: a director is entitled to mandatory indemnification of reasonable litigation expenses if sued
and wins completely
B. Permissible Indemnification: a director who loses a suit may be indemnified if
1. Acted in good faith;
2. Reasonably believed acts were in the best interests of the corporation; and
3. No reasonable cause to believe conduct was unlawful (only need for indemnification of criminal fine)
C. Insurance
1. MBCA does not limit ability of a corporation to purchase
2. But liability for misconduct such as self-dealing, usurpation, and securities fraud is not insurable