Spring 2019 Business Association: Corporation Law Prof.

Lee

Is X an Agent?

An agent is any person who is authorized to act on behalf of another, known as the principal. An agency
relationship is a consensual relationship between a principal and an agent. An agency relationship is
created when 1) the principal “manifests assent” to have the agent act on the principal’s behalf and
under the principal’s control, and 2) the agent “manifests assent or otherwise consents” so to act.

Did X have actual authority, either express or implied, to bind Principal to X’s K with 3rd party?

Actual authority is created by a manifestation from the principal to the agent that the principal consents
to the agent taking actions on principal’s behalf. In determining the actual authority of an agent, one
would evaluate the communications from principal to agent. An agent’s actual authority can include both
express and implied kinds. Express actual authority of an agent to act on a principal’s behalf may be
conveyed orally or in writing. Implied actual authority is the power to do those things necessary to fulfill
the agency.

Did X have apparent authority to bind Principal to X’s K with 3rd party?

Apparent authority arises when a third party reasonably believes that an agent has authority to act in a
specific way on behalf of the principal, and that belief can be traced to the principal’s manifestations to
the third party. An agent cannot create apparent authority for herself.

Does X have a fiduciary duty to the Principal?

An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the
agency relationship. An employee may breach the duty of loyalty owed to an employer in three
situations: (1) when an employee competes with an employer, (2) when the employee misappropriates
an employer’s profits, property, or business opportunities, and (3) when the employee breaches an
employer’s confidences.

Does Y have a fiduciary duty to the Agent?

(1) Good faith and fair dealing; performance of contractual obligations; indemnification under
certain circumstances. (i.e. expense account)

Inward v. Outward looking

Inward: Fiduciary duties as to the agency-principal relationship – liabilities thereof

Outward: Authority of the agent act on principal’s behalf with 3rd party – liabilities thereof

Partnership

A general partnership is an association of two more persons as co-owners of a business for profit.

Partnership Creation

There is no requirement that the parties subjectively intend to form a partnership, only that they intend
to run a business as co-owners or form an agreement to share profits.

Joining a Partnership
Spring 2019 Business Association: Corporation Law Prof. Lee

No one can become a partner without the unanimous consent of all other partners.

Partner

Each partner is an agent for the partnership. An agent has the power to bind a principal to a contract if
the agent had actual authority, expressed or implied, or apparent authority to enter into the contract.

Liability

A partnership is liable for loss or injury caused to a person by a partner acting in the ordinary course of
business or with authority of the partnership.

Once a partnership is created, partners are personally liable for all debts and obligations of the
partnership and are also entitled to equal sharing of the profits.

When there is no explicit agreement as to losses, losses are divided equally between the partners,
without regard to the amount each partner contributed to the venture as long as each of the partners
contributed capital to the enterprise.

When a partner only contributed labor and the other only capital, the partner contributing only labor
takes a loss in the form of lost labor.

In a partnership, all partners must consent to actions falling outside of the partnership’s ordinary course
of business, proven by circumstances/agreement, while matters within the normal course of business
may be decided by a majority of partners.

Actual Authority:

 A majority of partners is necessary to approve an act that is in the ordinary course of the firm’s
business, while a unanimous vote is necessary for actions that are not in the ordinary course of
business.

Apparent Authority:

 It appeared to the third party that the partner had the authority to act on behalf of the
partnership in engaging in the ordinary course of the partnership’s business, and the third party
had no actual or constructive notice that the party lack actual authority.

Fiduciary Duties

(RUPA)

A partner owes a duty of loyalty to the partnership that includes not placing the partnership at a
competitive disadvantage. A partner may breach the duty of loyalty by sharing confidential information.

A partner owes a duty of care to the partnership, for the breach of which is shown by gross negligence,
recklessness, intentional misconduct or knowing violation of the law.

(UPA): A partner owes a duty of loyalty to the partnership that provides only that partners must not steal
from the partnership

Dissolution
Spring 2019 Business Association: Corporation Law Prof. Lee

A partnership may be dissolved by any partner if the partnerships is formed for an indefinite term or for
no particular undertaking.

If the partners formed the partnership for a particular purpose or for a particular time period, then one
partner does not have the right to terminate the partnership until the term has run or the goal has been
achieved.

Partnership Accounting

A capital account tracks each partner’s ownership against the partnership, which is calculate by looking
at:

(1) Contributions made by each partner;

(2) Each partner’s share of profits/losses from partnership operations
(3) Any withdrawal of funds from the partnership
(4) Each partner’s gains or looses upon sale of the partnership or its assets.

Partners are entitled to a repayment of any capital contributions/advances made to the partnership.

The partnership must reimburse a partner for payments made and indemnify a partner for liabilities
incurred in the ordinary course of business.

Paying Liabilities

Assets of the partnership are used to pay liabilities in the following order:

(1) Amount owed to creditors, who are not partners;

(2) Amount owed to partners other than for capital and profits
(3) Amounts owing to partners for repayment of capital; and
(4) Amounts owing to partners for any remaining profits.

If partnership assets are insufficient to cover these liabilities, partners must contribute to the payment of
those liabilities.

Corporate Formation

Closely Held: (MBCA)

A corporation created when the articles of incorporation (charter) are filed with the Secretary of State
and includes the mandatory provisions:

(1) Business name with “Inc.”

(2) Address of registered office and agent
(3) # of shares issued, types, preferences, limitations or restrictions on particular classes of stock,
and par value of each if different classes.
(4) Name/Address of incorporators

After incorporated, a meeting must be held to adopt bylaws, appoint officers, and carrying on another
other business.

Public Held: (DGCL)

Spring 2019 Business Association: Corporation Law Prof. Lee

A corporation is created when a certificate of incorporation (charter) is filed with the Secretary of State
and includes the mandatory provisions:

(1) Business name with “association” “corp”

(2) Address of registered office and agent.
(3) # of stocks issued, types, preferences, limitations or restrictions on particular class of stock and
par value if different classes.
(4) Name/Address of the Incorporators
(5) Business Purpose “Corporation may be formed for any lawful reason”
(6) Name/Addresses of persons who are to serve as directors until first annual meaning.

After incorporated, a meeting must be held to adopt bylaws, elect directors, and carrying on another
other business.

How to amend the Articles? – public document -

Amendment is proposed by board, approved by shareholders, and filed with state.

Bylaws – private document -

Bylaws are internal rules regulation enacted by the corporation to governs its acts and relations to its
shareholders, directors, and officers.

How to amend the Bylaws?

The power to amend bylaws is at the sole discretion of the shareholders.

Management of a Corporation – Power Struggle –

Directors – DGCL -

The directors manage or supervise the operations of the corporation; this includes: hiring, firing,
advising and making decisions in the ordinary course of business (quorum that constitutes majority
required)

Under DGCL, having a board is required, under a staggered board director may only be removed for
cause, unless otherwise stipulated in charter.

Under MBCA, board can be removed via shareholder agreement, with or without cause unless otherwise
stipulated in charter, or by a judicial proceeding for fraudulent conduct or gross abuse of authority.

Inside Directors

Employed as corporate officers as well as board members.

Outside Directors

They just serve as board members.

Officers

If appointed, the top executive officers exercise control over the corporation’s day to day matters.
Spring 2019 Business Association: Corporation Law Prof. Lee

Shareholders

The shareholders own the corporation and have the power to:

 Elect/remove directors via the annual director elections

 Vote on:
o Amending the Charter/Bylaws
o Approving a merger
o Ratifying conflict of interest transactions
o Sale of assets not in the ordinary course of business.

How do Shareholder’s Vote? - A quorum constituting majority required unless otherwise provided -

 In Person or by proxy – giving authorization to 3rd party to vote shares (retain legal title)
 Via a voting pool agreement (to protect the minority shareholder interest)
o Shareholders vote together as a single block
 Via voting trust – gives authorization, and legal title, to 3rd party to vote shares (retain financial
rights)
o Trustee is subject to a duty of good faith

What Impacts Voting Power?

Classified Shares – Shareholder Hierarchy – Preferred/Common/Class C

Policy

Allocate control among various classes of shareholders by:

(1) Providing a class:

a. Veto power
b. No voting power (only financial rights)
c. Voting power only on certain transactions; OR

Preemptive Rights – Must opt in – (common in MBCA)

Preemptive rights provide shareholders with the right of first refusal in deciding whether they will
subscribe to their proportionate percentage of stock during a subsequent issuance of stock. Generally,
the corporation must opt in for minority shareholders to have preemptive rights.

Cumulative Voting – Must opt in Charter -

Method of counting shareholder votes where each shareholder in director elections are entitled to vote
the product of their share’s times the number of director’s to be elected; and casting their votes in favor
of single director (as opposed to straight voting where the votes are allocated among candidates).

Policy

Increase minority shareholder influence on the board.

Supermajority (Quorum) Requirements - % required to pass/elect –

Policy
Spring 2019 Business Association: Corporation Law Prof. Lee

Ensure giving minority shareholders voice in corporate affairs.

Under DGCL

Must be provided for in charter/bylaws.

If in charter – can be amended/repealed only by supermajority.

If in bylaws – can be amended/repealed by simple majority; unless otherwise specified.

Under MBCA

Must be provided for in charter – can be amended/repealed only by supermajority.

Deadlock – Business Comes to a Standstill -

Occurs when shareholder or director vote is evenly divided. Leads to dissolution; unless:

 Use provisional directors; buyout; arbitration; mediation; judicial intervention

Capital Structure

Equity Claims

They are the corporation’s capital stock, and the individual units of capital stock are called shares.

Debt Claims

Corporations borrow money and incur indebtedness by issuing bonds (loan), and these debt claims have
tax advantages over equity claims. Redemption allows corporation to buy back the debt securities
created by the bonds.

Paying the Shareholder – Residual Assets –

Dividends – 2-fold tax -

Dividends are a payment from a corporation to its shareholders calculated on a per share basis.

Share Repurchasing – Transfer Restrictions -

Occurs when a corporation repurchases its own stock, pays money to shareholders, and retires shares.

How is the distribution Calculated? – Limitations on Distributions -

DGCL

(1) There is a solvency restriction on distributions, which means that the corporation cannot
distribute money if it would result in insolvency, inability to pay debts as they are due. (Solvency
Test)
(2) Distributions can be made out of the surplus, which is calculated by determining all capital in
excess of the aggregate par value, generally set at a penny to maximize surplus, of the issued
shares plus any amounts the board has elected to add to its capital amount. (Impairment of
Capital Test)

MBCA
Spring 2019 Business Association: Corporation Law Prof. Lee

(1) A corporation can make distribution only out of there surplus, and the surplus can be calculated
in any reasonable manner, as long as they acted in good faith. (Technical Insolvency Test)

Policy Behind Limitations

To protect debtholders, including creditors, when a business fails – to ensure they get paid.

Capital Impairment

Where distributions are made in excess of the surplus.

Limited Liability

Generally, individuals who are part of or invest (shareholders) in corporations have limited liability.

Policy

Under the DGCL

Removes the risk of unlimited liability, allows for the free transfer of shares in the public markets
(diversification), reduces the monitoring cost of managers/shareholders.

Under the MBCA

Advantages are present because investors do not invest to diversity because they are employed by the
corporation, and the shareholders/managers are often the same people

Effects

(1) Increases cost of corporate debts, while decreasing the cost of corporate equity – because it
increases the business risk for voluntary/involuntary creditors. (lenders/tort victims)
(2) Incentive to engage in riskier behavior, moral hazard, since they don’t have to bear the total
cost.

Exception to Limited Liability – Piercing the Corporate Veil –

Courts can impose more liability to shareholders beyond the amount of their investments. (MBCA)

Analytical Framework:

(1) Whether liability may attach to the shareholder directly by reason of the shareholder’s own
actions?
(2) If no personal liability,
a. Were corporate formalities observed?
i. i.e. lack of separate corporate/personal: records, property, or bank accounts
b. If not, most courts require a showing of injustice or unfairness showing that the
wrongdoing is connected to the harm.
i. i.e. third party confused about whether dealing with corporation/person
ii. i.e. shareholder has treated funds as own. – comingling of funds -

Transferring Shares
Spring 2019 Business Association: Corporation Law Prof. Lee

Under the DGCL

Generally, shares of stocks are freely transferable.

Under MBCA

Generally, transferring stocks is ill-advised, as shareholders want to: - encourages transfer restrictions -

(1) Retain power to select future associates – to main collegial work environment –
(2) Prevent competitors from buying shares.
(3) Prevent one shareholder from gaining absolute control.

Transfer Restrictions

Are within the charter, bylaw, a separate agreement among shareholders, or between shareholders and
the corporation that restrict a shareholder’s freedom to sell his or her shares.

Transfer Restrictions are valid only if:

(1) The restriction complies with formal requirements related to the adoption of the restriction and
must be clearly noted on the share certificates.
(2) The restriction must be for a proper purpose – reasonableness standard –

Types of Transfer Restrictions

 Buy/Sell Agreement: only shareholders/corporation can buy the share. – reasonable

 An option: corporation/shareholders given option of first refusal to purchase shares either at
specified price or price offered by third party purchaser. – reasonable
 Prior approval or consent requirement: approval by shareholders/corporation - reasonable
 Prohibition: prohibited from transferring to certain persons - unreasonable

Liabilities/Claims against Directors – agents –

Directors are fiduciaries to the shareholders and corporation. Under the shareholder primacy norm
doctrine, the shareholders are the primary beneficiaries of the duty of care.

Breach of the Duty of Care – Most Jurisdictions have Exculpation Clauses for this Duty -

The duty of care is primarily a procedural duty, that is a duty to make lawful decisions in a well informed
and careful manner. Under the business judgment rule, a court will not second guess the decisions made
by corporate directors, unless there actions were grossly negligent, in that they did not inform
themselves of all material information reasonably available to them. Generally, courts will not second
guess the actions by directors because it encourages directors to serve by limiting their exposure to
liability.

Policy

Judges have no expertise and it encourages directors to avoid making decisions.

Breach of the Duty of Loyalty – Pick your flavor to Satisfy –

How to Prove:
Spring 2019 Business Association: Corporation Law Prof. Lee

The duty of loyalty requires that directors serve the interests of the corporation over their self-interests.
The duty of loyalty is breached if a director has a conflict of interest and has engaged in self-dealing.
Additionally, part of the duty of loyalty includes the duty to provide oversight, that is to have a have a
proper reporting and compliance system in place to ensure that directors are informed about was
happening within the corporation. The duty of loyalty is breached when there is an intentional
dereliction of one’s duty or a conscious disregard for their responsibilities.

 The duty of loyalty is breached if a director had a conflict of interest and engaged in self-dealing.
 Duty of Oversight: (EE engaged in illegal activities several times and they paid settlements)
 Duty of Good Faith: (not to compete; usurp corporate opportunities without giving them
opportunity)
 Duty not to act in a Self-Interested Manner (case- company selling property to director’s kin)

Corporate Waste

To prove a claim of corporate waste, the exchange must be so one sided that no person of sound
business judgment would have made the decision.