Business Organizations

Agency 
In General (Defining Relationship)

 Three principal forms of agency:

1. Principal and Agent
2. Master and Servant
3. Employer and Independent Contractor

 TEST for the “Principal-Agent Relationship”:

1. Mutual Consent (manifestation by the principal that the agent will act for the principal)
i. Just look for existence of an agreement on both sides
ii. Doesn’t require an explicit agreement (e.g. a contract)
iii. Parties do not have to intend that they be held to the legal consequences of the
principal-agent relationship
2. [Primarily] “On Behalf” of the Principal (acceptance by the agent)
i. This element also considers whether the principal derives a benefit from the
agent’s conduct
3. Control by the Principal
i. Focus here is not the “end result” of the activity, but rather how the agent
accomplishes the task
ii. Look at whether the principal has certain aspects of control over the actions of
the agent (can involve an intense factual analysis)
 Subagency – when an agent makes an agreement with yet another agent in order to assist in
the activity
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Gorton v. Doty (1937) – D (female teacher) lends car for football team transportation but
requests that the Coach be the driver. Was there a principal-agent relationship between the
teacher and the driver?
a. There is an automatic presumption that the driver of the car is an agent if the owner loans it
to him
b. Question of “Giving permission” (loan) v. “Giving instructions” (agency)
c. Why doesn’t the court consider another agency between the driver and the school?
i. B/c we generally want to find one clear relationship (but see subagency above)
d. Compensation does not have to present in order for there to be a relationship
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A. Gay Jensen Farms v. Cargill (1981) – Farmers (P) suing Warren and Cargill b/c Warren did
not pay debts it owed to farmers, and it looks like Cargill was a principal here.
a. "Agency is the fiduciary relationship that results from the manifestation of consent by one
person to another that the other shall act on his behalf and subject to his control, and
consent by the other so to act"

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 b. The relationship may be proved by circumstantial evidence
c. The 3 element TEST:
1. Consent to Agency – Cargill made recommendations to Warren, which may be seen
as consent (circumstantial coming into play)
a. But Warren didn’t actually implement the recommendations
2. Acting (Primarily) on Behalf – Warren was producing grain for Cargill
3. Control over the Agent – Cargill obviously interfered with operations to some degree
d. This was not just a buyer-seller relationship b/c a supplier must first have an independent
business
a. Here, Cargill actually financed Warren’s operations
e. Open-Account Financing – Warren could draw money as needed, and sales would go
automatically to Cargill
f. It looks like Cargill increased its management over operations to compensate for its lack of
security in Warren
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Liability to Third Parties

I. We first must have Manifestations of the Principal:

1. Direct reference by the agent to a third party re the principal
2. Past practice of the principle
3. Power of position (job title can suffice)
II. After looking at manifestations, we look to see Whether the Third Party was Justified in
Relying on the Manifestations
 Ideally, we want the principal to work directly w/ the third party, but agency theory has
allowed flex here
 As a General Rule, we will hold the principal liable in situations where conduct by the agent
results in a bogus K (principals should police their agents)
 Types of Authority:
a. Express Actual Authority – principal actually told the agent that s/he had the
authority in issue
b. Implied Actual Authority – authority that is circumstantially proven by showing
that the principal wanted the agent to have power over those activities practicably
necessary to accomplish the task
i. Look to whether the agent was justified in believing s/he had the
authority based on the past (or present) conduct of the principal and
the nature of the job
c. Apparent Authority – When the principal acts in such a manner (can be
allowance) that the third party is led to believe the agent has authority that s/he
may or may not actually have
d. Inherent Authority – when it looks to the third party like it is working directly
with the principal, but in reality, that person is an agent working for an
undisclosed principal, acts of the agent done on the principal’s account will be
inherently authorized if within the normal course of those type of operations

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a. Mill Street Church of Christ v. Hogan (1990) – Hogan wants workman’s comp b/c he got
hurt after his brother asked him to help paint the Church that had told the brother to get
another guy to help him. Church supplied the tools and supplies for the job.
b. The Church may have said to get someone different, but they didn’t say he had to get a
different guy
c. The person alleging the existence of agency and the resulting authority has the burden of
proving that there was such an agency
d. Here, based on past practice of hiring his brother, and no express instruction otherwise by
the Church, the brother was reasonable in assuming authority
i. Past Conduct – Brother had been allowed to hire Sam for previous work
ii. Necessary to Implement Implied Actual Authority – Brother had to hire someone to
finish the job
iii. Agent Reasonably Believed – Past practice created the belief that brother had the
authority (this creates apparent authority too)
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Dweck v. Nasser (2008) – CEO of business is fired by the chairman and a dispute over
compensation ensues. Agreement is reached via chairman’s apparent agent, but that person is not
the chairman’s attorney of record, and chairman disputes the agreement.
a. The Court finds that there was authority here for the attorney via actual, implied, and
apparent authority
i. Express Actual Authority: chairman told the agent to “do what he wants” with
the agreement
ii. Implied Actual Authority: agent had settled many cases for chairman over the
course of 20 years
iii. Apparent Authority: Chairman knew that agent was working w/ his attorney
of record on the agreement, so the agent thought he had the authority
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Three-Seventy Leasing Corp. v. Amex Corp. (1976) – Joyce, the only employee of 370 Corp.,
signs agreement with Kays, who was directed by Mueller (Kays’ supervisor) to negotiate an
agreement. Now Mueller says Kays didn’t actually have the authority to enter into the
agreement.
a. This case involves apparent authority
i. Ampex’s actions formed the basis for Joyce to believe that Kays had the
authority to enter into this agreement
ii. Absent knowledge by the 3rd party to the contrary, an agent has the
apparent authority to do those things which are usual and proper to the
conduct of the business which he is employed to conduct
iii. Kays was a salesperson, and job title can be considered a manifestation of
the principal
b. NOTE: since the corporation is the real principal here, Mueller was an agent of the corp.
who had both actual and apparent authority
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Watteau v. Fenwick (1892) – Humble sells alehouse to firm, which allows Humble to appear as
the owner of the bar, but instructs him not to enter into Ks for things like cigars.
a. There is not actual authority here, b/c Humble was told not to K for these things
1. But there is inherent authority
b. The firm here is an undisclosed principal
1. If there is an undisclosed principal and it looks like the agent would be authorized
to do what s/he did, then the principal will be held liable
c. ELEMENTS:
1. Undisclosed principal (the firm/ investors)
2. That principal hires a manager to manage the business
3. Manager enters into transactions that are normal in such business (even if they are
forbidden by the principal)
d. Difference between Rest. 2d and 3d on this issue
1. 2d says the same thing as this case (the majority view)
2. 3d narrows inherent authority, requiring that the principal (1) knows of the
agent’s conduct, and (2) doesn’t take steps to prevent it
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Ratification

 Ratification is like saying “My agent didn’t really have the authority to enter into this
agreement, but I’m glad s/he did anyway”
 ELEMENTS of Ratification:
1. An act done or professedly done on the principal’s account
2. An act of affirmance (this can be express or implied)
3. Intent to ratify (objective intent)
4. Full knowledge of all material circumstances
 LIMITS
1. Principal can’t just ratify an agreement after the deal has become much more lucrative (a
new K has to be drawn up at that point)
2. Principal can’t ratify after the 3rd party walks away from the agreement (3rd party can do
so anytime before the principal ratifies)
3. Principal can’t have a line item veto
4. Principal can’t just wait forever to ratify (has to be in a reasonable amount of time)
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Boticello v. Stefanovicz (1979) – Couple buy farm as tenants in common and look to lease the
farm to the P, but wife says she won’t agree to less than 85k, and it gets leased at that price. P
doesn’t know that the wife has any interest, and he gets pissed when the couple won’t follow
through w/ purchase rights.
a. The knowledge that P was living on the farm was not enough to be an affirmance b/c the
husband was free to lease his undivided share
b. Just b/c someone has received benefits does not mean that s/he has ratified
i. In order for there to be ratification, the wife would have to actually be aware
that the conduct was done on her account
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Ercanbrack v. Crandall-Walker Motor Co. (?) – P buys a truck from the D car lot through a
salesman that wasn’t authorized to enter into the agreement. D refuses to deliver the truck as
agreed upon.
a. The P argues that the D ratified the sale, so we have to look at the 4 elements:
i. Act done on Principal’s Account – the salesman was acting on the account
ii. Act of affirmance – if the seller doesn’t know about the sale, how can it
affirm?
1. Silence can’t be affirmance when there is no knowledge
2. But can’t saying the car would be in constitute affirmance?
iii. Intent – w/ out knowledge there’s no intent
iv. Full knowledge – court finds no knowledge whatsoever

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Estoppel

 Estoppel occurs when a principal fails to take reasonable precautions to ensure that third
parties are not defrauded
 ELEMENTS of Estoppel:
1. A negligent act or omission that allows an imposter to create an appearance of authority
that allows the consumer to be defrauded
2. The third party must reasonably believe that the imposter has the authority to act for the
principal
3. Based on that belief, the third party relies on the imposter’s representations to his/her
detriment
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Hoddeson v. Koos Bros. (1957) – Lady buys furniture from guy she thinks is a salesman but
never gets the goods and has no receipt to prove she bought the stuff.
a. In order for there to be apparent authority, there must be a manifestation by the principal,
such that the principal holds out the person as an agent (but here, the D didn’t even know
this guy was doing what he was doing)
b. The D should have taken necessary precautions to ensure that its customers were not
defrauded (thus comes the estoppel)
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Agent’s Liability on the K

 Partially-Disclosed Principal Rule – when an agent tells the third party that there is a
principal but does not say who that principal is, the agent is liable on the K
 Defacto Corporation Doctrine – when an “agent” says s/he is working on behalf of an org
that doesn’t exist, that person will be liable unless he tried to establish the corp. in good faith
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Atlantic Salmon A/S v. Curran (1992) – Curran dissolves former corp. and then files papers to
have “Seafood Exchange” act in place of that dissolved corp. These papers do not actually form
a new corp. and Curran is sued by seafood sellers after he fails to pay them.
a. The court uses the “partially-disclosed principal” doctrine, but Schwartz thinks this is
more of a “de facto corp.” situation (b/c there actually was a principal disclosed, but it
wasn’t real)
b. It looks like the agent here was not exactly acting in total good faith
c. If an agent wishes to contract on behalf of a principal, the agent must disclose that
principal if s/he wishes to not be liable on the K
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Tort Liability of Principals (Master-Servant)

 Under Respondeat Ssuperior, a master-servant relationship exists where servant has agreed
to (1) work on behalf of the master, and (2) be subject to the master’s control or right to
control physical conduct of the servant
 Respondeat Superior – employer is liable for those acts of an employee performed w/ in the
scope of employment
 Traditional Grounds: principal should be liable in order to incentivize better conduct
I. Problem: aren’t there times when finding liability won’t change anything?
II. Least-Cost Avoider: party that would have been able to avoid the harm by changing
its behavior at the least cost
 Foreseeability Approach: whether it is foreseeable from the nature of the employment that a
certain harm could occur (Bushey)
I. A servant’s use of force against another is w/ in the scope of employment if use of
force may be expected by the master (e.g. a bouncer)
 Grimsley Approach: To recover damages from an employer for injuries resulting from an
employee's assault, it must be shown that the assault was in response to the Π's conduct
which was presently interfering with the employee's ability to perform his duties successfully
 Master-Servant takes the control aspect of agency and slides it to the more “control” end of
the scale
 NOTE: Servants are different than independent contractors
 3 Things to Look At:
1. Is there an agency?
2. Is there a master-servant relationship?
3. Did the tort arise out of the employment?
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Humble Oil & Refining Company v. Martin (1949) – P’s car rolls out of D’s gas station while
it’s being serviced, and D says it’s Schneider the operator that should be held liable b/c he’s an
“independent contractor.”
a. We look at the nature of the relationship between Schneider and the D (this is a factually
sensitive analysis)
i. Humble retained title
ii. Humble controlled the hours of the station
iii. Strict financial control and supervision

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 iv. Humble provided the equipment and paid for most operating costs
v. Lease was terminable at will of Humble
b. Thus, Humble is the master of Schneider
c. There’s subagency here (employee-Schneider-Humble) but it doesn’t matter b/c Humble
is on the ultimate hook anyway
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Hoover v. Sun Oil Co. (1965) – Back of P’s car catches fire while at gas station due to
negligence of employee. Sun says that owner Barone is on the hook b/c he is an independent
contractor.
a. Like Humble, we need to look at the factors for control here (both direct and indirect)
i. Control by Barone (direct)
1. Hours, employment, risk of loss/ profit
ii. (indirect)
2. He was sole proprietor, could sell non-Sun products, either party could
terminate lease
iii. Control by Sun (direct)
3. Gas from Sun and mostly Sun products
iv. (indirect)
4. Sun uniforms and Help
b. Court finds that these factors do not evidence enough control to constitute M/S
v. It’s not enough that the result is controlled by Sun; we need to see that
day-to-day operations are being controlled
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Murphy v. Holiday Inns (1975) – P sues Holiday Inn after she slips and falls on floor at a hotel
w/ their name. Holiday Inn says “don’t look at us…”
a. There was a clear franchise agreement here, but REMEMBER that it doesn’t matter
what the parties call the relationship, it’s what their conduct evidences
i. Even an agreement that neither party will be liable to the other may be
nixed if there is agency
b. Here, the agreement did not give Holiday Inns any real control over the operations of the
hotel, so there’s no agency
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Ira s. Bushey and Sons v. US (1968) – US ship was being overhauled at P’s dry dock, and when
a drunken sailor turned a wheel, the ship sank and damaged the dock. US says the sailor wasn’t
acting in his scope of employment.
a. This case involves the Foreseeability Approach
b. Although some conduct may be unforeseeable, the employer should expect that
employees may cause damage
c. The conduct of an employee may be w/ in the scope of employment even if the specific
act does not further the aims of the employer
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Manning v. Grimsely (1981) – Manning heckles Orioles baseball player and gets hit by a ball
thrown at him.
a. In order for the employer to be liable, P has to show that (1) there was conduct interfering
(or intended to interfere) w/ the employee’s performance, and (2) the employee’s assault
was in response and not retaliation to that interference
i. This forms the nexus between the assault and the employment
b. Here, the heckling could be seen as conduct interfering w/ the duties of the player, and
the player’s throw could be seen as “in response”
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Torts of Independent Contractors

 2 Types of Independent Contractors:

1. Agent: agrees to work on behalf of the principal, but not subject to control
2. Non-Agent: operates independently and enters into “arm’s length” transactions w/ others
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Majestic Realty v. Toti Contracting (1959) – Parking Authority is building parking lot and hires
Toti to demolish a building. Toti fucks it up and stuff crashes on Majestic’s building.
a. Ordinarily, a person who hires and independent contractor to do work is not liable for the
acts of the contractor
i. Exceptions
1. Person still retains control of the manner and means of performance
(agency) (here, we have a non-agent independent contractor)
2. Person hires an incompetent contractor
3. The activity is a nuisance per se (“inherently dangerous”)
b. Here, the court finds that demolition is inherently dangerous, so the Parking Authority
will be on the hook
c. We need for the contractor to be negligent in order for the contractee to be liable
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Parker – Domino has control over everything b/c they had a giant handbook that addressed
everything
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Billops v. Magnus – Apparent authority and apparent agency

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Anderson (?) – TK does clean up for the Marathon Oil Company and provides masks that don’t
protect adequately against lung disease. Employee Anderson sues both TK and Marathon.
a. Abnormally Dangerous (ultrahazardous) Activity – we don’t need to see negligence
here b/c the activity is so dangerous that we impose strict liability
i. Ultrahazardous activities can’t be made safe
a. The main difference between ultrahazardous and inherently dangerous
is that ultrahazardous can never be made reasonably safe (argue this)

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 ii.Even if no one does anything wrong, we place liability on the person
making money off the activity (also encourages person to insure against)
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Kleeman v. Rheingold (1993) – Law firm hires contractor to serve summons on a doctor that the
P is suing, but fucks it up. P wants the law firm to pay damages.
a. Non-delegable duties: duties so important that they shouldn’t be entrusted to anyone but
the principal (and if they are then the principal is held liable for fuck-ups)
i. 2 types
1. By statute – e.g. landlord must ensure habitability
2. Responsibility is so important to the community that transfer to
someone else isn’t permitted (hospital’s duty to care for patients)
ii. Lawyers server an important function in society and serving process is an
important aspect of that function

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Fiduciary Duties of Agents (Protect the Principal)

 3 different duties:
1. Duty to Obey – when agent defies the reasonable instructions of the principal
2. Duty of Care – agent has a duty to perform, with reasonable care, the instruction given by
the principal
3. Duty of Loyalty – agent may not put his/her own interests (or those of 3rd party) ahead of
the interests of the principal
a. Secret Profits (Regem, Singer) – agent is only permitted to earn compensation for
agency arising out of the assigned job
i. Elements
1. Agent’s position has to be the predominant reason for ability to make
money
2. Dishonesty
b. Conflict of Interests Transactions – e.g. real estate agent who wants to represent
buyer and seller
c. Grabbing and Leaving – what an agent can and cannot do when leaving a
principal and going somewhere else
 NOTE: since duties under agency are designed to protect the principal, the same duties do
not run in the other direction
II. But agency is used as a gap filler when other laws (e.g. employment law) don’t cover
it (principal can’t make agent do something that would damage his/her reputation)
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Reading v. Regem (1948) – Serviceman uses his uniform to smuggle goods for people while
stationed in Egypt. (secret profits case)
a. Duty of honesty and good faith has been violated here
i. The only reason that the serviceman could make this money was through
his uniform, which itself was a direct product of his employment

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 1. The uniform was the predominant reason that money was earned
a. NOTE: the secret profits do not have to come from the pockets of the principal
ii. The principal couldn’t have earned this money, so it’s getting a windfall
here
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General Automotive Manufacturing v. Singer (1963) – Machinist Singer takes job with P, and
the agreement says that he won’t do any work for anywhere else while employed there. Singer
outsources work that P’s shop can’t do and then pockets the difference, eventually setting up
brokering shop.
a. Secret Profits
a. Singer claims that P couldn’t have fulfilled the orders, but he should have told
them in order to make sure they didn’t want to expand
b. Agents have a fiduciary duty to exercise good faith and loyalty by not acting adversely to
the interests of the employer by serving any private interest
c. Conflict of Interest: even if the principal is not disfavored by the conflict, the agent is
obliged to be up front with it
d. Principal gets all of the profits that the agent is forced to disgorge (punishment policy)
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Town and Country v. Newberry (1958) – Employees of a cleaning service business leave and
form their own business using the list of customers that was generated by their former employer.
a. Grabbing and Leaving - Former employer can estopp the Ds from using the list b/c it
was created with time and money
i. There are times when you can use lists when you leave (e.g. lawyers that
brought the clients to the firm in the first place)
b. If the information (client names) can be gathered by some kind of public source, then
there’s no breach of duty
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Partnerships

In General

 Partnership – an association of 2 or more persons to carry on as co-owners a business for

profit
 It’s a type of Unincorporated Business Entity (UBE)
 Whereas agency involves a vertical relationship, partnerships call for a horizontal
arrangement
 Think of a restaurant owned by one cash person and one management person
 Where all persons have the ultimate power of ownership/ control (Schwartz doesn’t think
equating ownership w/ control is appropriate though)
 P’ships are controlled by 2 major statutes:
1. UPA (1914/ 40% of states)
2. RUPA (1997/ majority of states including CA)
 Q: What it means to be a partner?
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 A: you have a bundle of rights:
1. Management Rights – decision making/ bind to transactions/ use p’ship property
a. If there is a disagreement w/ re to “default matters,” then only a majority
vote is needed
i. But if there is an “extraordinary decision” (changing nature of
the p’ship, kicking a partner out, etc.) pending, a unanimous vote is
needed
b. Need unanimous consent from partners to transfer these
2. Economic Rights – right to share in profits and obligation to share in losses
a. Can transfer these rights w/ out the consent of partners
 NOTE: partners do not own the underlying property of the p’ship (that belongs to the p’ship
itself)
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Partnership Agreement Structure

1. Economics and Accounting

a. Initial contributions
b. Ongoing contribution obligations
i. Raising initial capital
c. Profit sharing (per capita, pro rata, etc.)
d. Loss sharing (service-only partner?)
2. Management
a. Committee?
b. CEO?
c. Voting procedures (per capita, pro rata?)
i. Can divide by issue (this issue will require 2/3, etc.)
d. Draws (partnership distributions of money)
i. Quarterly?
ii. 2/3 consent?
3. Compensation
a. CEO-type may involve a salary (or any other type of service partner)
4. Fiduciary Duties (these don't spring from K, they spring from the law)
5. Transfer of p'ship interests
a. When?
b. The effect
c. Buy/sell agreement (ROFO, ROFOR, etc.)
6. Liquidation
7. Term/ Purpose of the P'ship
8. Taxes
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Fenwick v. Unemployment Compensation Committee (1945) – In order to assuage a disgruntled

cashier, Fenwick puts in writing that a p’ship is formed, w/ the cashier getting 20% of profits
(after Fenwick gets his) and the cashier having no control over operations nor risk of loss.
a. “Good” FACTORS for determining whether a p’ship exists:

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 i. Intent of the parties (whether the persons intended to become partners)
a. Here, there was intent to hold onto the cashier but not really to form a
p’ship
i. 2 approaches:
1. Assume that parties intend p’ship (disfavored)
2. Ask whether parties intended a p’ship relationship
(“meeting of the minds”)
ii. Right to share in profits – wasn’t real profits split here b/c cashier would
only get money if Fenwick did first
iii. Obligation to share in losses – not present here
iv. Ownership/ control of the property and business – focuses on the sharing
of management (all the control was retained by Fenwick)
b. “Bad” FACTORS for determining whether p’ship exists:
v. Language of the agreement – language is not dispositive (intent more
important)
vi. Conduct towards third parties – we don’t really care whether 3rd parties
think the persons are partners or not
vii. Rights upon dissolution – not a big factor
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Martin v. Peyton (1927) – Peyton and 2 others loan money to firm so that the firm can borrow
money from banks (collateral). Agreement is made whereby the three lenders are “trustees” and
get 40% of profits, can inspect books, and are able to nix bad business ventures. When firm goes
under they want the three to be considered partners so they’ll be liable for debt.
a. The agreement simply allowed the three to safeguard the loan, not to become
partners (distinction here)
i. Although there may have been an ability to control here, it wasn’t exercised
frequently
a. Didn’t have control over “day-today” stuff (contrast w/ Cargill above)
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Southex v. Rhode Island Builders (2002) – RIBA enters agreement w/ Sherman, who later gets
bought out by Southex. The agreement creates profit sharing and some joint-control over the
home shows, but is not clearly a p’ship agreement.
a. Sharing of profits alone will not determine whether a p’ship exists (even if UPA does
say that profit sharing is prima facia evidence)
i. We still use the totality of the circumstances test
ii. Just putting in the term “partners” will not automatically make the thing a
p’ship
b. Factors under this agreement:
I. Intent – Doesn’t seem like Sherman had intended a p’ship
II. Management – Southex had the “lion’s share” of the management here
III. Profits – Yes, there was sharing
IV. Losses – RIBA had no risk of loss under the agreement
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Partnership by Estoppel

 ELEMENTS:
1. P must establish a representation (express or implied) that one person is the partner of
another (i.e. holding someone out as a partner)
2. The making of the representation by the person sought to be charged as a partner or
w/ his/ her consent
3. A reasonable reliance in good faith on that representation by a 3rd party
4. An adverse change in position to the 3rd party as a result of reliance on that
representation
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Young v. Jones (1992) – P invests money in a bank based on an audit letter from Price-
Waterhouse Bahamas and sues the US Price-Waterhouse when the bank goes belly-up and the P
loses a bunch of dough. Are PW-B and PW-US partners?
a. The brochure for PW Bahamas would be the instrument that would lead the P to
believe that they were partners
i. But the Court doesn’t think that the P here relied on that brochure in order
to make the decision to invest (meaning element 3 not present)
ii. Also, PW-US didn’t make these representations, and doesn’t appear to
have consented to them (we don’t have element 2 here either)
b. Although it could be argued that all the PWs were connected “in some way,”
there cannot be a reasonable belief that they were actually partners (there’s a
distinction here)
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Fiduciary Obligations of Partners

 Fiduciary duties under RUPA:

1. Duty of Loyalty: focuses on the p’ship, protecting against damage resulting from
indirect injury to other partners
i. Hold as trustee any profit, property, or benefit
ii. Refrain from acting adversely to p’ship
iii. Refrain from competing
2. Duty of Care – refrain from engaging in (1) grossly negligent (reckless) behavior, (2)
intentional misconduct, (3) knowing violation of the law
 NOTE: there is also a Duty of Good Faith, but that is not considered a fiduciary duty here
 directly protects partners from each other (e.g. partner expulsion)
 focuses on the person rather than the p’ship
 Like agents to principals, partners owe duties to one another
 All partners are “agents of the p’ship,” and we don’t want anyone taking advantage of the
p’ship
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Meinhard v. Salmon (1928) – Salmon and Meinhard are cash/ management partners in a hotel
lease. Before the lease is over, Salmon is approached to buy up the entire block, which he does
w/ out telling his partner. Meinhard wants a cut of this new action.
a. Coventurers owe the highest duty of loyalty to one another not to abscond with
an opportunity when that opportunity falls under the purpose of the p’ship
i. The opp must be disclosed to the partner(s)
ii. This doctrine resembles “secret profits” under agency
____________________________________________________________________________

Peretta v. Prometheus (2008) – 1 entity wishes to merge w/ another in order to be able to buy
out all of the limited partners. A vote for ratification is held, but interested parties (those that
would benefit from the merger) are counted towards the majority. The merger would not have
been ratified if these interested votes didn’t count.
a. Under CA law, a p’ship agreement may permit ratifications of violations of the
duty of loyalty by majority vote if they are not “manifestly unreasonable”
i. Here, the Court finds that a provision allowing interested partners to vote
in favor of a violation of the duty of loyalty would be unreasonable
b. Even though the interested parties’ votes were supposedly apportioned “neutrally”
(half yes and half no), this did not account for the votes that were not returned by
dis-interested voters
______________________________________________________________________________

Grabbing and Leaving

Meehan v. Shaugnessy (1989) – Partners and associates of Parker Coulter firm agree to set up
their own firm, and make plans to take certain clients w/ them.
a. By denying that they planned to leave the firm and by being secretive generally,
the leaving partners breached their fiduciary duty of loyalty by not allowing the
clients to choose whether to leave or stay (unfair advantage)
b. It is permissible to make logistical arrangements to set up a competing firm while
still working at the original firm
c. There wasn’t enough evidence to show that the leaving partners intentionally
didn’t resolve cases at Parker Coulter in order to resolve them at their new firm
______________________________________________________________________________

Expulsion

Lawlis v. Kightlinger & Gray (1990) – Attorney is member of firm that employs a “unit system,”
and develops substance abuse problems. His condition improves but when he asks for more units
the other partners decide to expel him.
a. The mere taking of files was not an expulsion before the vote
i. NOTE: courts interpret “expulsion” very technically
2. There was no bad faith expulsion here
i. NOTE: even if the partners just wanted more money, that’s OK under the
RULE: as long as the p’ship agreement doesn’t say otherwise, a partner

14
 can be expelled for any reason as long as it doesn’t deny him money/
property legally due to him/ her
1. Economic Predation Approach
3. NOTE: since partners are not considered employees, you could expel a partner
for being disabled
_____________________________________________________________________________

Bohatch – Lady partner becomes obsessed w/ her view that another partner is overcharging
client Pennzoil, and is eventually expelled from the p’ship.
a. Determining whether there is a breach of the duty of good faith requires a case-
by-case approach
i. 4 things may warrant expulsion
1. Resolve a fundamental schism
2. Purely business reasons
3. Protect the firm’s relationships
4. Whistle-blowing (this one is created by the court here)
______________________________________________________________________________

Partnership Property

Putnam v. Shoaf (1981) – Partner sells her interest in the p’ship to Shoaf, but then wants money
retrieved by the p’ship after a judgment against a former thieving employee is resolved.
a. Co-partners do not actually own any asset of the p’ship, they only own an
interest in the p’ship, which itself owns the assets
b. Possessory rights do not exist absent an interest in the p’ship
i. Here, the P had already transferred her interest
______________________________________________________________________________

Raising Additional Capital

 There are no default rules in the UPA or RUPA for raising additional capital, so the only
way for partners to avoid obstacles for raising capital down the road is to put provisions in
the p’ship agreement
 Pro Rata Dilution: more points offered at the initial price w/ the option for contributors to
buy up the remaining points left from the non-contributors
I. This decreases the worth of each point, but gives contributors a greater share of the
points (decreases the overall value of points for non-contributors)
II. To get the new value of each point, you divide the initial value of all points by the
new number of all points
 Penalty Dilution: involves offering more points at a reduced price
I. This approach greatly reduces the price of each point, but provides contributors with
more points and a higher value than non-contributors
II. This results in a “no-change” (since the increase in points will balance out the
reduced cost) in value for contributors and a decrease for non-contributors (since
they will have same number of shares but reduced value)

15
 Pro Rata Loans: requires partners to make a pro rata loan to the p’ship when asked to by the
managing partner
I. Loans could bear interest above the prime rate but partners would not get paid until
loan and interest is paid off
II. Difficult to say what the consequences of this provision would be for non-
contributors (maybe you could compensate the contributors 150% + interest to
provide incentive)
 What We Can Get Approach – managing partner offer shares to anyone at whatever price
can be sold
_____________________________________________________________________________

Rights of Partners in Management (Disagreements)

 UPA provides:
 “All partners have equal rights in the management and conduct of the partnership business”
(absent other agreement)
 “Any difference arising as to ordinary business matter connected with the partnership
business may be decided by a majority of the partners”
_____________________________________________________________________________

National Biscuit Company v. Stroud (1959) – 1 partner tells the other that he doesn’t want to
buy from Biscuit anymore, but other partner still does. At liquidation, disagreeing partner doesn’t
want to be liable b/c he said he didn’t want bread anymore.
a. Since this was a default decision (w/ in the scope of the p’ships’s general
business activities) it is not an extraordinary matter, but still requires a majority
vote
i. Since there are only 2 partners here, one partner’s disagreement cannot
constitute a majority
1. Illustrates the danger w/ having on 1 co-partner
b. NOTE: it was the guy who didn’t want to buy bread anymore that was trying to
change the status quo (see next case)
______________________________________________________________________________

Summers v. Dooley (1971) – 2-partner trash collection business where one partner decides to
hire a helper and pay him out of the p’ship against the other’s wishes. Resisting partner wants
reimbursement.
a. Resisting partner will be reimbursed here b/c there was not a majority vote
b. Where there is an even number of partners, the person wishing to change the
status quo has to attain the majority vote, and here that was impossible
______________________________________________________________________________

Day v. Sidley & Austin (1977) – Day agrees to merger with the executive committee but then the
committee decides to merge w/ Washington offices and a co-chairman is appointed w/ Day,
which he doesn’t like.
a. Even though the committee advised that no one would be worse off b/c of the
merger, Day isn’t made worse off b/c he has lost no legal rights here

16
 b. It wasn’t reasonable for Day to think that there wouldn’t be any changes made
after the merger
c. Schwartz thinks this case reveals that there is no rule re’ing the need for full
disclosure of all material facts in these circumstances (although RUPA has
something that looks like this)
______________________________________________________________________________

Dissolution of the Partnership

 Dissolution: occurs when the p’ship ceases to exist as a “going concern” and its only purpose
is to wrap things up and “shut the doors.”
 Process:
I. Trigger – what gets the dissolution ball rolling (2 possibilities)
a. Judicial Decree of Dissolution
b. Any Partner Expresses Wish for P’ship to Dissolve
i. UPA: leaving by itself constitutes a trigger (but you can agree
around this rule)
ii. RUPA: partner can just get cashed out and leave
(“disassociation”). Although leaving + expression of dissolution =
dissolution under RUPA.
II. “Winding Up”
a. Liquidation, which is turning the p’ship into a “pool of cash,” and then
paying off (1) outside creditors, (2) inside creditors, (3) then partners
(if anything is left over)
b. Cashing Out and Continuation – can cash one partner out and then
continue the p’ship under a new agreement (this is only possible if
there was an initial agreement among all partners that things could
continue after one person cashes out)
 Limited-Term P’ships: established only for a limited purpose/ time (may need some analysis
here)
1. Can cause dissolution if unanimous consent
2. If no unanimous consent:
i. Under UPA, this creates a Wrongful Dissolution: (1) leaving partner pays
damages, (2) leaving partner doesn’t get cashed out at “going concern
value,” and (3) liquidation is not forced
ii. Under RUPA, this creates a Wrongful Disassociation: leaving partner
pays damages, and (2) leaving partner is given whatever capital is in his/
her account (doesn’t create the penalty that UPA does)
______________________________________________________________________________

Owen v. Cohen (1941) – 2 partners form a bowling alley p’ship but don’t get along. 1 partner
says he’ll sell the other his interest or buy out the other guy. Partner claims that he’s the one
doing all the work, and the other partner is taking money w/ out permission. Trial court allows
dissolution and resisting partner doesn’t want leaving partner to get liquidation monies. The
reason this is important is b/c the leaving partner doesn’t want to be a wrongful dissolver if
it’s found that the p’ship is for a limited term (which the court finds it is).

17
 b. Court offers 2 ways to get a judicial decree under Common Law (Schwartz says
use the CL)
i. Parties can’t get along
ii. One party is behaving badly and materially hinders the p’ship
c. Under RUPA (more ambiguous)
i. One party behaving badly and injures the p’ship
ii. Other circumstances make dissolution equitable
d. Here, there was disagreement AND the other guy was behaving badly (e.g. taking
money)
i. NOTE: since it was the P who was the one acting badly, in equity, he
shouldn’t be allowed to prevent the D from getting liquidation money
(courts can use equity here)
______________________________________________________________________________

Collins v. Lewis (1955) – Collins puts up the money and Lewis is supposed to manage as 50/ 50
partners. Business does poorly and each partner blames the other. Collins moves for a judicial
decree of dissolution.
a. Court denies Collins a decree b/c it thinks that he was the one who was behaving
in a bad way (this is a judgment call based on the facts) and he shouldn’t be able
to benefit from a decree (he would benefit b/c he wouldn’t be getting punished as
a wrongful dissolver)
b. Schwartz sees 2 problems w/ how Collins went about this p’ship (LESSON)
i. He didn’t set a cap on the money to be supplied
ii. He didn’t secure enough security from Lewis
_____________________________________________________________________________

Page v. Page (1961) – 2 partners enter into p’ship for linen business that doesn’t do well, and the
one guy wants to dissolve the thing. D says that the p’ship was for a limited duration (rather than
“at will”) and the other guy should be considered a wrongful dissolver.
a. This case isn’t like Owen v. Cohen, where the partners agree that the p’ship would
only be for as long as it would take to repay the loan
i. There is no support in the evidence that the p’ship was for a limited term
here
b. Court does NOTE that if it could be shown that the partner with more resources
was just trying to “freeze out” the other partner in order to take over a profitable
business, then the dissolution would be wrongful (partner can’t wrongfully
exclude defendant from p’ship business opp)
___________________________________________________________________________

Prentis v. Shefel (1973) – 3-person “at will” p’ship and 2 of the partners want to dissolve and
continue the p’ship w/ out the other partner (dereliction of duties). Other partner doesn’t want the
others to be able to bid on the p’ship at auction b/c he says they wrongfully dissolved.
a. Even though the D was “frozen out” of management affairs, there is no evidence
to show that the exclusion was made towards wrongfully obtaining the p’ship for
the other partners (no breach of good faith)

18
 i. D also failed to show how he would be injured by sale to the Ps (actually,
their high bid helped get him more money for his share)
1. Also, the D could have bid just like the Ps did
______________________________________________________________________________

Pav-Saver Corp. v. Vasso Corp. (1986) – Pav and Vasso have p’ship agreement that says (1)
patents and specs will be returned to Pav at end of p’ship, and (2) p’ship is supposed to be
permanent, and a unilateral dissolution will be considered wrongful.
a. Although the agreement provided for the return of the patents, the fact that Pav
was a wrongful dissolver here controls, b/c we look to the statute (UPA) in this
scenario
i. Vasso can’t carry on the business w/ out the patents/ specs
ii. LESSON: don’t agree to a permanent p’ship whereby any termination is
wrongful
b. Dissent says that the clear intent of the parties should be honored here (in the K)
______________________________________________________________________________

Kovacik v. Reed (1957) – one partner puts in money and one puts in services. The p’ship loses
money, and the service partner does not think he should have to pay for any of the losses.
a. General Rule: where there is an agreement re the sharing of profits, the sharing of
losses will abide by that split as well
b. California (minority) Rule: where (1) there is a cash and a service partner, and (2)
the service partner doesn’t get paid any salary, then the service person will not
have to pay for any losses (b/c he is losing his services)
i. Otherwise, the service partner would have to pay through both services
and money
c. Both UPA and RUPA reject the rule the CA court comes up w/ here
______________________________________________________________________________

Buy-Out Agreements – the terms by which the p’ship cashes out the partner who either (1) wants
to leave, or (2) has to leave

 Options:
 Sell to a 3rd party (must have unanimous consent for this)
 Sell interest to current partners
 Leave – UPA – dissolution – liquidation (but risk of being wrongful dissolver)
 Leave – RUPA – dissolution – cash out (but risk of wrongful disassociation)
 LESSON: take care of these things w/ provisions before you sign the agreement
 Provisions to consider:
A. Trigger Events:
i. Death (Belman)
ii. Disability (Lawless)
iii. Will of any partner (wants to “get out”)
B. Who Buys?
i. P’ship Buys – P’ship itself buys out the leaving partner’s interest

19
 1. Problem: doesn’t contribute anything to the p’ship b/c the partner
just leaves w/ the money (life insurance possibility)
ii. Outside Party Buys – may be able to waive the unanimity need
iii. Remaining Partners Buy – the actual partners come up w/ the money to
buy out the partner and get the interest
C. Price – how much should people pay for the interest?
i. Book Value – often doesn’t reflect true fair market value
ii. Appraisal – neutral outside appraiser (but who picks the appraiser?)
iii. Formula – notoriously “off”
iv. Have partners set p’ship value every year (can be fallback provision in
case not agreement)
D. Procedure for offering to buy/ sell
i. Right of First Refusal (“matching right”) – allows remaining partners to
buy out departing partner at same price as an external offer
ii. Right of First Offer – Departing partner makes offer to remaining
partners, but if they don’t “bite,” then s/he can take offer (must be same
offer) to 3rd parties
1. If doesn’t happen w/ 3rd parties, then has to revise offer to partners
iii. Dynamite Provision (The “JJ”) - If partner wants to leave s/he can go to
other partners and say “here’s my price, I can buy you at that price or sell
at that price”
1. Tends to force a fair price from the departing partner, b/c has to
buy/ sell at same price (but not so if there isn’t equal footing)
iv. Drag-Along Right – majority and minority owners, and majority wants to
sell to 3rd party
1. Minority party is “dragged along” w/ the sale and cashed out
according to terms of the sale (forced)
v. Tag-Along Right – allows the minority owner to be cashed out at the same
terms that the majority owner was if there’s a sale (doesn’t force)
______________________________________________________________________________

G & S v. Belman (1984) – Limited p’ship between G&S and Nordale, and G&S files for decree
of dissolution b/c Nordale turns out to be a cokehead. Nordale dies before the decree goes
through, and G&S wants to apply self division provision (remaining partner can buy out if person
dies) but Nordale’s estate doesn’t like that.
a. The filing for a decree did not constitute a dissolution b/c it never went through
the process
______________________________________________________________________________

Bane – p only has fid duty to partners, not former parters

Jewel -

Limited Partnerships

20
 Whereas general partners (there may only be one) are personally liable for the debts of a LP,
the limited partners only stand to lose as much as they put in
 LPs are creatures of statute
 Often used as a means of raising capital for people who don’t want to take too much risk
 Being on the board of directors does not mean that a limited partner has taken control of the
LP
 OLD RULE: Limited partner transformed into general one if s/he takes control over
operations
 NEW RULE: limited partner only transformed if his/ her behavior led the general partner to
believe that s/he was acting as a general partner (tends to allow more control by the limited
partners)
 This new rule was likely a reaction to the development of LLCs, which allowed more control
w/ less liability (it’s a general movement in this direction)
 Voting – the default rule is that limited partners have no voting rights
 But the statutes allow for limited partners to have limited voting rights if the p’ship
agreement allows this
____________________________________________________________________________

Holzman v. De Escamilla (1948) – P’ship for farm that includes both general and limited
partners. Limited partners had ability to write checks as needed and could fire the general
partner, which they did. Liquidator wants to come after limited partners when the p’ship
dissolves.
a. Generally, limited partners are not liable for the debts of the p’ship
i. There is an EXCEPTION where the limited partners take part in actual
control of the p’ship
1. Here, the limited partners had control of the p’ship b/c (1) they
could empty out the p’ship account if they wished, and (2) they
could fire the general partner
ii. The general partner always has unlimited personal liability
_____________________________________________________________________________

Limited liability companies

In General

 Q: How do you form any corporate entity?

 A: you just “file a form” (this goes for p’ship, LLCs, and corporations)
 Taxation: this is one of the ways that LLCs and limited p’ships are different from
corporations
 LLCs aren’t taxed “double-time” like corporations are
o Corporations are taxed (1) at the corporate level, and then (2) on the dividends
sent to shareholders
 But limited p’ship and LLCs are only taxed at the personal level (not
corporate)

21
 Losses “pass through” – members can account for losses to the LLC on their individual tax
returns
 Management: Default Rule is that the members manage the LLC (this is akin to a p’ship
arrangement)
 But the members can change this setup and have a manager-managed LLC (this manager
doesn’t even have to be a member/ more similar to corporate scheme)
____________________________________________________________________________

Water, Waste & Land v. Lanham (1998) – 2 members of an LLC and one of the members gets
into relations w/ fast food chain. Gives the chain a card that has the name of the LLC but doesn’t
say it’s an LLC. Chain wants to come after LLC members for debts.
a. The Court here uses agency to get around the limitations of an LLC
i. Where there is a partially-disclosed principal, the agent may be held liable
on the contract made
1. Here, Clark was acting as an agent for the partially-disclosed
principal (the LLC)
b. The Court doesn not allow “constructive notice” of the LLC b/c that would invite
fraud down the road
______________________________________________________________________________

The Operating Agreement

Elf Atochem North America v. Jaffari (1999) – LLC enters agreement w/ individual to form
LLC for airplane maskants. The agreement has an arbitration selection provision and eventually
the LLC wants out of the agreement but doesn’t want to abide by provision.
a. Court notes that the whole point of having LLCs is that they provide needed
flexibility
i. The parties placed this provision in the K, and that will suffice to K
around the governing LLC rules in DE
b. The operating agreement will control if there are no mandatory statutory
provisions
______________________________________________________________________________

Piercing the LLC Veil

Kaycee Land v. Flahive (2002) – P contracts w/ an LLC that is comprised of one person to raise
livestock on the surface of the D’s land. P wants to sue D individually, claiming that he
contaminated the land. Can you use piercing the LLC veil argument?
a. Even though there is no explicit rule to pierce the LLC veil, the piercing of the corp.
veil arose out of common law needs, and there’s no reason why we shouldn’t be able
to pierce the LLC veil
b. The factors for piercing the LLC veil are similar to those for corporations, but do
differ
______________________________________________________________________________

22
Fiduciary Obligations

McConnell v. Hunt Sports Enterprises (1999) – LLC operating agreement provides that no
member shall be precluded from operating another business, even if it is in competition w/ the
LLC. P claims that D violated fiduciary duty to the LLC by entering into agreement for hockey
stadium that the LLC couldn’t get.
a. Although the Default Rule is that LLC members are bound by same duty
constraints as partners, here the members contracted around that reality (and that’s
OK)
i. The D didn’t do anything wrongful here (no secretive shenanigans or
tortuous interference)
1. D said he would only contract if the LLC couldn’t get it
_____________________________________________________________________________

Dissolution

New Horizons v. Haack - LLC dissolves but member does not properly dissolve the LLC as
required by statute. Gas company is owed debt from LLC that could have been paid first had the
lady properly dissolved.
a. Proper dissolution of an LLC is one statutory requirement that courts will not fudge
(they’re designed to make sure that creditors get paid first)
i. Here, the member didn’t properly dissolve and kept the money for herself,
so she is personally liable
ii. RULE: if you don’t properly dissolve, you can be held personally liable
for the debts of the LLC
_____________________________________________________________________________

Accounting

In General

 Accounting is an imperfect mechanism for determining how well a corp. is doing

o Governed by “Generally Accepted Accounting Principles” (Federal Securities
Laws require these to be used by public companies, but if private company uses it
to keep track for itself, it has to provide to SHs too)
 Itself created by the “Financial Accounting Standards Board”
 Federal Securities Laws require 4 things each year:
1. Balance Sheet (aka "statement of financial position")
2. Income Statement (aka "statement of operations/ earnings")
3. Statement of Retained Earnings (aka "statement of changes in shareholders'
equity")
4. Statement of Cash Flows (non-accrual-based accounting)
 Fiscal-Year: some 12-month period that doesn’t align w/ the normal calendar year (usually
b/c certain times of the year are slower for accounting/ e.g. September)
 Important GAAP Principles:

23
 I. Reliability/ Objectivity Principle
a. We focus on what is real and tangible
II. Cost Principle
b. Assets recorded on a company’s books are recorded at their historical value
(meaning the price that was actually paid for things), not at their fair market
value (we don’t want to keep adjusting)
i. The only way you could reflect this change is to sell it at the increased
price (and this would reflect the fair market value)
ii. Notice that a gift must be valued at fair market (b/c we don’t know
what it sold for)
iii. There’s an exception for market securities (market-to-market
transactions)
III. Consistent/ Comparable Financial Statements
c. We want to be able to look at statements through time and across different
companies
IV. Revenue Recognition Principle – companies should account for earnings and
payments, whether or not they’ve been received or paid out yet (accrual-based
accounting)
d. EXAMPLE: if company X pays something quarterly, then numbers will be off
during those months where payment is due, b/c it’s actually being spread out over
3 months
_____________________________________________________________________________

I. Balance Sheet – (Equation): assets are on one side, and liabilities and owner's equity are on
the other side
a. Assets: the "resources of the company" (expected to be of benefit to the company in
the future)
i. 2 categories:
1. Current Assets: resources of the company that can be used immediately or
w/ in 1 year (inventory would be included in this category)
A. Accounts Receivable: the corp. has sold inventory but not yet
collected the inventory (but expect to do so w/ in the next several
months)
2. Long-Term Assets - assets that will not be used immediately or in the near
future
B. “P,P,E”: property, plants, and equipment
b. Liabilities and Owner's Equity: "claims to those resources"
ii. Claims broken down into 2 categories:
1. Liabilities - (debts of the corp./ money that the corp. owes to creditors/ aka
"outsider’s claims")
A. Current Liabilities: debts that are payable w/ in one year (e.g.
accounts payable)
B. Long-Term Liabilities: debts of the company that have a longer
term than 1 year (e.g. a mortgage)
1. Current Maturities – the portion of long-term liabilities
that are currently due (e.g. payment on a mortgage)

24
 2. Owner's Equity (aka “capital” or “shareholder's equity”) - the owner's
claims on the resources of the company ("insider's claims")
1. Assets (-) Liabilities = Owner's Equity (represents who takes
the "hit" when things go bad and who gets the benefits when
things go well)
2. Owners want the liabilities to be low and the assets to be high
3. Paid in Capital: the capital that has been contributed to the
company by its shareholders (reflects what the owners of the
business have paid)
c. Retained Earnings (aka "earnings surplus") – the leftover money that is not given to
the SHs in dividends
i. If the only way you can get the balance sheet to balance is to have retained
earnings be negative, that would be referred to as accumulated deficit
1. 3 things comprise Retained Earnings:
a. Revenues: increase in retained earnings that happen b/c
the company is actually working
b. Expenses
1. Net income = the revenue (-) expenses
c. Dividends: given to SHs
i. Revenues (-) Expenses (-) Dividends = Retained Earnings (net
income (-) dividends = Retained Earnings)
 Depreciation – assets are expected to decrease in value: this can be accounted for by an
annual standard decrease in value (or other formulas)

II. Income Statement – tracks what happened during the year

 Net Earnings = Total Revenues and Gains (-) Total Expenses and Losses
 Earnings Multiple (PE Ratio) = Market Price (/) Earnings Per Share
 Represents the difference that investors are willing to pay for one stock over another, based
on belief that it will do well in the future
 For example, if a company is currently trading at $43 a share and earnings over the last 12
months were $1.95 per share, the PE ratio for the stock would be 22.05 ($43/$1.95)
 Stock Options – when one party gives another party the right to buy a stock at a specified
time, w/ in a certain period of time (like when employers offer to employees)
 Strike Price
 Expiration Date
 The theories behind giving stock options have been eroded somewhat (working harder, etc.)
 RULE: companies that use stock options to pay employees must expense those options, since
they are something of value

III. Statement of Retained Earnings = amount of retained earnings at beginning of year (+) net
earnings from income statement (-) dividends
 Shows how much money is being kept in the business for future business

IV. Statement of Cash Flows – ignores the traditional accounting principles such as accrual-
based accounting (it’s a different approach to give investors a more complete picture)
 Breaks cash flow into 3 categories:

25
 1. Operating Activities: cash earned from actual operations
2. Investing Activities: cash the company spent/ earned from investments that year
3. Financing Activities – the cash the company gains/ loses through things like (1) issuing
stock, (2) getting loans, (3) dividends, (4) paying debt
_____________________________________________________________________________

Finance

In General

 Q: What do you buy when you buy stock?

 A: the company’s future income streams
 The price of the stock is the value of the future income streams (the dividends)

Determining a “Good Investment”:

I. Dividend-Discount Model: dividend (/) discount rate (-) growth rate

a. Discount Rate: a complex notion that represents the return that an investor demands on an
investment (if 0.10, then wants a 10% return)
II. Opportunity Cost: investor is giving up the opp to do something else by doing this thing
b. We want to choose the income stream that gives the most return
i. 2 Categories:
1. Risk-Free Rate of Return: return you would get from a no-risk savings
bond (90-day treasury)
2. Risk Premium: what you want in excess of the risk-free rate of return
A. Determining the Risk:
A. Volatility – measured by the standard deviation (the higher
the standard deviation, the higher the discount rate)
i. More volatility = more demanded return
B. Growth Rate: how much an investor would expect the
dividends to grow
Theories of Modern Finance

I. Capital Asset Pricing Model (CAPM): used to determine a “theoretically appropriate”

required rate of return of an asset, if that asset is to be added to an already well-diversified
portfolio, given that asset's non-diversifiable risk
a. Based on several assumptions:
i. Investors are “Risk Averse” – investors choose the less risky investment
ii. Investors are “Rational” – when actually confronted w/ 2 investments,
investors will choose the less risky one
b. The conclusion that results from these two assumptions is that investors will diversify in
order to minimize risk
iii. Since a higher risk equals a higher discount rate (the return the investor
wants), then a non-diversified investor will want to pay a lower price for the
stock

26
 1. But a diversified investor will be willing to pay a higher price, which will
“push out” the non-diversified investors
2. This means that the only risk the market will compensate you for is the
lower risk that is associated will building a diversified portfolio
c. Alpha: the risk associated with one, non-diversified stock (CAPM doesn’t use this since
all investors will diversify)
d. Beta: represents non-diversifiable risk (“macro-economic activity”)
iv. The difference between one stock and the whole market (you can’t diversify
this away)
v. If a stock moves exactly the same as the market, it has a “beta of 1”
3. More risky = bigger beta (and converse)
II. Efficient Market Hypothesis – the prices reflected in the stock market are efficient, which
means they’re correct
a. Investors are rational
b. Mistakes cancel out
c. Sophisticated traders will step in to correct deviations in the market
d. This theory ends up showing that you can’t beat the market (w/ day-trading, etc.)
i. Its tenants are actually kind of shaky
___________________________________________________________________________

Corporations

In General

 Certificate of Incorporation: essential doc needed to form a corp. (only needs to contain the
basics like directors’ names, etc.)
 Bylaws: set out the basics of the corp.’s governance
 Structure:
 Shareholders at the bottom, who elect the…
 Board of Directors
o Responsibilities:
 Set policy
 Appoint officers
 Monitor the officers
 Officers
o Carry-out policies set by the board
o Run “day-to-day business”

The Entities

I. Officers: Bylaws will normally set out (1) CEO, (2) VP, (3) Secretary, (4) Treasurer
II. The Board (consisting of directors):
a. Serve for a specified period of time
b. May be a staggered board
c. Must have good cause (breach of duty) to oust a director
i. Directors can appoint new director in this case (unlike usual SH appointment)
27
 ii. OR there can be alternative schemes (special SH meeting, etc.)
d. It’s the Board as a whole that has the authority (not individuals)
1. To have valid action, there must be (1) quorum, and (2) majority (sometimes
committee or unanimous written consent is cool)
III. Shareholders – have only ”blunt” tools of control
a. Vote for the Board of Directors
- “Straight Voting”: one slot, one vote
- “Cumulative Voting”: share equals 3 votes and can distribute votes
- Quarum then majority
- Usually by proxy
Purpose

 Corporate law creates a fictional being, and we can say what powers that being has
 2 Mechanisms that restrain a corp.'s power to do whatever it wants:
1. The Law: there used to be laws re what a corp. can/ cannot do, but now there are really
no restrictions (except the restrictions that would be on anyone)
2. Certificate of Incorporation: many states require that the certificate include a purpose for
the corp.
a. Thus, anything outside that purpose would be ultra vires
i. But states now allow people to say that the purpose is "anything legal"
 Ultra-Vires Doctrine:
- Not terribly important, but gets tossed around sometimes (cause it sounds cool)
 Is giving to charity ultra vires? (maybe corp's shouldn't be giving away your money)
 Courts don't like this arguments, prob b/c corps donate so much money
 Can't donate to orgs that directly benefit a board member, etc.

Criticism of the Traditional Corporation Hierarchy

 Paradigm breaks down when there is a Closed Corporation (where the same person may act
as a SH, director, and manager at the same time) structure
 Also, in large corporations, we just have a huge mass of people of shareholders
 Functionally, CEO often picks who s/he wants on the board, and then the shareholders just
rubberstamp that decision
 So the structure gets inverted, since it’s the shareholders who are supposed to be
deciding directors
 Idea that SH's actually pick directors becomes a fiction
 "Shareholder Apathy" - SH's just don't care enough to pay close attention to what's going on
 The cost of paying attention is really high (lotta stuff to read, etc.); benefits are pretty
low
 There are counter-incentives to put together a competitive slate to run against the incumbent
board
1. It's expensive, since the corp. will fund the current board (though you do get
reimbursed if your board wins)
2. Benefits are low, since you have to share all the good that you bring w/
everyone else

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  If you're not happy w/ the way things are run, why not just sell your stock?
 There may be conflicts of interest on the board
 If the board is chosen by the managers, why would they look out more for the interests
of the SHs?
 2 board member categories:
1. Inside Directors: the CEO (vice pres., etc.) may also be on the board (so they
would have to police themselves)
2. Outside Directors: not also employed by the corp. as officers
i. But once they're on the board, they kind of are employed by the corp. (it's a
lucrative position that demands very little)
ii. Why would you stand up against the directors who picked you for this
cushy gig?
iii. Often, attorneys serve on the board of directors (so they do work for the
corp., but aren't technically employed)
iv. Often, these people don't even really know what's going on in the company
("informational disadvantage")
1. And the info they do get comes from the officers
 The potential result of all this is that management looks out for themselves
 Results:
1. High executive compensation
2. Shirking: managers may not work so hard
3. Entrenchment (just looking to protect themselves)
i. Mergers are often seen as tools for entrenchment (SHs shouldn't really
desire mergers, b/c it doesn't matter if one firm is diversified if they're whole
portfolio is diversified)
 Agency Costs - whenever you delegate authority to someone else, there are costs involved
 SHs get the short end of this stick
 Checks on Management:
1. Role of institutional investors: people who have so much money that they actually
will take an active role as SHs (activist shareholders); aka "people who actually care"
2. Role of the stock market:
1. Market-based compensation:
2. Market for corporate control: if management does a bad job, they'll end up
getting kicked out by a take-over guy (eg Karl Ichan)
3. Breaches of fiduciary duty: if they aren't looking out for SHs, the
managers will get sued
i. But this is weak, b/c it's expensive to sue, and the advantage is in
the managers' court
_____________________________________________________________________________

Derivative Suits

 RULE: if you're going to be a SH that sues for breach of fiduciary duty, then you have to have
actually been there when the bad deed took place
 Demand on Directors: if SH wants to sue for breach of duty, then s/he has to ask the board of
directors to do it first

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 - B/c the Cause of Action belongs to the Corp. itself
- EXCEPTION: SHs don't need to make the demand when the demand would be futile
1. it would be futile when you're suing the majority of the Board of directors (b/c
they won't want to sue themselves)
A. To get around people taking advantage of this exception, SHs must specify
why they are suing each director (must be "particularity")
* must be more than a blanket statement (must be colorable)
 Certain breach of fiduciary claims are characterized as Direct rather than derivative
a. the reason is that the injury is direct on the SHs rather than an injury on the corp. (which
is indirectly felt on the SHs):
1. SHs claiming that a board action is diluting their voting rights (Eisenberg v. Flying
Tiger, where there was an injury to the SH's voting rights)
2. Cash-Out transactions: Smith v. Van-Gorkem - where the SHs claimed that they
were not getting enough money as a result of the Corp's decision
_____________________________________________________________________________

Organization and Voting Rights (including Proxy Fights)

Levin v. Metro-Goldwyn-Mayer (1967) – 2 groups compete over the Board, and the incumbent
directors use the corp.’s money to win the proxy war. P SHs say they shouldn’t have to pay for
this fight.
a. Court doesn’t think (1) the cost involved here nor (2) the method of disclosure to be
unfair or illegal
b. Proxy fights are regulated by 14(a)
i. Starting the process doesn’t count as solicitation
ii. Must furnish proxy statement to SHs
c. NOTE: proxy fights have fallen out of favor for simple economic reasons – if you
lose, then you bear the entire cost of fighting the war, and if you win, then you get
reimbursed, but you only get a small stake of any improvement you create
______________________________________________________________________________

Pillsbury v. Honeywell (1971) – Honeywell wants Pillsbury to stop making bombs for Vietnam,
buys up 100 shares to start proxy war. Pillsbury resists when Honeywell wants the corp.’s
business records.
a. Generally, a SH may request corp. records
i. BUT, s/he must have a valid economic purpose
1. Here, Pillsbury didn’t care about the economic aspect (just the bombs)
b. Perhaps Pillsbury could have gotten around this problem by saying that making
bombs would adversely affect the corp.
c. Burden Shift: (1) Corp. has to show no valid purpose, then (2) SH has to show valid
economic purpose
_____________________________________________________________________________

Piercing the Corporate Veil

 Generally, SHs have no personal liability for the debts of the corp.

30
 But SH may be liable if P “pierces the corp. veil”
 Only happens w/ smaller, closely-held corps
 Could arise out of (1) Tort Claims, or (2) K claims
 Requirements (for the “Alter-Ego Theory”)
1. Unity of Interest and Ownership – the corp. and the person are not separate
a. 4 Factors
i. Failure to comply w/ corp. formalities (or keep records)
ii. Commingling of corp. assets – what’s yours is mine
iii. Undercapitalization – doesn’t have funds to go forward
iv. One corp’s treatment of another corp’s assets as its own
2. Not piercing would allow the D to further fraud or injustice
 Requires 2 things (in different wording than above):
a. Problematic conduct that takes money out of the corp. (unit of interest)
b. Taken w/ knowledge and intention to deprive claimants of payment (fraud or injustice)
_________________________________________________________________________

Walkovsky v. Carlton (1966) – P injured in cab accident and he wants to sue D, who ran 9
different cab corps, personally. Each cab corp. carried only the minimum insurance.
a. Court won’t allow P to pierce the veil here b/c there’s not a “disregard of the corp.
form” (the D wasn’t using the corp. as his own personal business/ individual capacity)
i. It looks like the individual corps were just subsidiaries of the larger corp.
b. If there isn’t enough insurance to go around then that’s the legislature’s problem
______________________________________________________________________________

Sea-Land Services v. Pepper Source (1991) – P tries to collect for breach of K but D’s corp. has
already dissolved and has no money left to pay creditors. P wants to come after D personally.
a. Court allows the P to come after the D personally
i. There was no distinction between the D and the corp. here
1. Used same office and phone
2. Used same bank account
3. Borrowed money from corp. for personal expenses
ii. Finding otherwise would also promote injustice b/c the D used the resources
of creditors while ensuring that there wouldn’t be enough money left over to
pay them
____________________________________________________________________________

Fiduciary Duty of Care (including Business Judgment Rule)

 Everyone except for SHs owe a fiduciary duty to the corp.

- BUT majority SHs do owe a duty
 Failure to Monitor: (Francis v. United Jersey Bank) Lady made director but doesn’t know
what she’s doing
- Breached her duty of care
- Liable b/c she was “asleep at the switch” while her sons robbed the company
- She has a duty to (1) get herself up to reasonable speed, and (2) monitor the corp.

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 NOTE: directors may rely on the reports of their officers under DE 141(e) (you don’t have to
dig around yourself)
- BUT directors cannot blindly follow officers
 Business Judgment Rule – discretion of making a business judgment should be reserved for
the board
- Tort review standard - Presumption of OK decision can be rebutted by P if breach of
(1) care, (2) loyalty, (3) good faith
 Then burden goes to D to show “entire fairness” (comes from Disney)
 General notion that we should pay deference to the Board when they make decisions
o But what is the scope of that deference?
 3 standards used for getting around the Business Judgment Rule:
1. Cases that say it is a different way of saying there is a negligence standard
(Litwin v. Allen – the business judgment rule means that director are liable
for negligence in the performance of their duties. Not being insurers,
directors are not liable for errors of judgment or for mistakes while acting
with reasonable skill and prudence)
2. Cases that say there will be no review of the business decision as long as
there has been no breach of the duty of loyalty – Kamin – Amex
distributes shares of subsidiary in such a way that corp. loses out on tax
break/ no violation of business duty here, b/c there was no fraud or
dishonesty/ mere bad decisions won’t suffice
3. Gross negligence: decisions only reviewed for gross (not normal)
negligence
- DE uses this standard (Arenson v. Lewis – gross negligent standard)
 DE 102(b)(7) allows the Certificate of Incorporation to include provision that limits/ prevents
personal liability of directors (not officers) for a violation of the duty of care (but violation of
duty of loyalty or good faith still fair game)
 This doesn’t preclude injunction (just monetary damages)
_____________________________________________________________________________

Smith v. Van Gorkem (1985) – Van Gorkem is Transunion CEO and explores leveraged buyout
to get more taxable income. He presents to the board, which approves the buyout in only 20
minutes. Ps say the board violated the business judgment rule.
a. Ps have to rebut presumption that the judgment was an informed one (have to get
around the business judgment rule)
i. RULE: you can rely on officers but you can’t blindly follow them (DE 141(e))
b. The board breached its duty of care to the SHs, b/c they were grossly negligent in
informing themselves
i. They did not inform themselves w/ re to all of the reasonably available info
ii. The board did not disclose all material info that a reasonable SH would want to
know
c. Ds here should have done a valuation study (outside bank determines value of shares)
d. NOTE: there was a caveat added after this case that even if the process for the decision
was bad, if the actual decision turns out to be a good one, then there is no violation (“no
harm, no foul”)
e. Factors to be consider from Cede (for “entire fairness”):

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 i. Timing
ii. Initiation
iii. Negotiation
iv. Structure of transaction
v. Disclosure to directors
vi. Disclosure to SHs
_____________________________________________________________________________

Fiduciary Duty of Loyalty

 2 Categories:
I. Conflict of Interest Transactions – when a director or officer is on both sides of a transaction
(e.g. the corp. buys a director’s car)
a. Commonly Addressed by Statute (DE 144): allows conflict of interest transaction to
escape automatic voidability:
i. No K or transaction between a corp. and one of its directors or officers, OR
between a corp. and another corp. where a director or officer has a material
(material is subjective to the person) financial interest shall be voidable if:
1. Material facts re (1) the director’s or officer’s interest, AND (2) the K
or transaction are disclosed AND a majority of the disinterested
directors approve the K or transaction in “good faith” (doesn’t even
have to be a quorum), OR
A. Good Faith is undefined (but bad faith seems to require that no
reasonable person would approve)
2. The material facts of the K or transaction is disclosed to (or known to)
the (disinterested) SHs entitled to vote on the matter and the SHs
approve the matter in good faith, OR
B. We don’t know how many SHs needed to approve
3. The K or transaction is fair to the corp. at the time it is authorized,
approved, or ratified by Board, SHs, or committee
A. This has been interpreted as needing only fairness to pass
muster
II. Corporate Opportunity Doctrine – when officers or directors take business opps that belong
to the corp. (see below for more)
______________________________________________________________________________

Benihana of Tokyo v. Benihana (2006) – Benihana sees problems with the control of the
majority of the common stock by BOT owner’s wife AND needs money for improvements. It
issues preferred stock that gets bought up by a company that one of the directors “sits” for. P
says (1) material info not disclosed, and (2) this was aimed at vote dilution.
a. Corporate action may not be taken for the sole purpose of entrenchment
i. P says that the stock was issued just to dilute his wife’s interest
ii. But here, the primary purpose was to get more money (is the test primary
or sole purpose?)
b. Even though the director didn’t disclose that he was negotiation on behalf of the
buyer, this fact was understood based on the circumstances

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 c. Preferred Stock (main distinctions) – you can “do what you want” w/ preferred
stock (the stock here was “convertible” to common stock)
i. Liquidation Preference: puts you “first in line”
ii. Dividend Preference: you can obligate the corp. to disburse some
dividends to you
d. NOTE: Disinterested Distinction – it’s not enough to just show that you don’t
have a direct financial interest on the other side
______________________________________________________________________________

Corporate Opportunity Doctrine

 What to look at:

1. How did the officer/ director learn about the opportunity?
a. Learned about the opp in his/ her individual capacity (e.g. at a friend's wedding)
i. Officer
1. Can take the opp unless the corp has an interest or expectancy in it
(opps where the corp has a tentative claim already or the corp is
already negotiating for it.)
2. The opp is essential to the company's business (when the corp needs
the opp to continue its operation)
ii. Outside Director (Director that is not also an officer)
1. Outside directors can take the opp in this circumstance (b/c the
director isn't tied to the corp in the same was that an officer is)
b. Presented w/the opp b/c of that person's role w/ the company (someone came to
you w/ the idea b/c they knew you were involved w/ the corp)
i. Officers and directors cannot take the opp if it is w/ in the corp's line of
business
1. Line of business: an activity to which the corp has fundamental
knowledge, practical experience and the ability to pursue (pretty much
when it relates to what the corp. does)
c. Corp. actually sends the officer/ director out searching for it
i. Always belongs to the corp.
 Two defenses to the corp. opp. doctrine:
1. Corporate rejection: director claims that the corp rejection the opp after it was offered
already (this would open up the opp to the off/ dir)
a. Unless the interested party is actually part of the vote to reject (then the court will
have to find that the rejection was fair)
2. Financial inability: when the corp. didn't have the money to take advantage of the opp
(this is no defense in some jdxs)
a. Irving Trust (2nd Cir.) said this was not a defense
b. Delaware allows this as a defense
______________________________________________________________________________

In re eBay v. Shareholders (2004) – eBay directors are offered IPOs (Initial public offering)
from Goldman Sachs b/c of the business relationship that the 2 have (Goldman wants to attract
more business). SHs say that accepting this would be a breach of the fiduciary duty of loyalty.

34
 a. IPOs should have went to the corp. rather than the directors
i. RULE: corp. officials cannot take opps if those opps are w/ in the line
of business
1. Here, eBay was investing heavily in the stock market
2. There is an analogy to the secret profits doctrine under agency
(soldier smuggling case)
b. Bribing corp. official is known as “spinning”
c. Remedy: court usually forces a constructive trust and makes the officials disgorge the
benefits
______________________________________________________________________________

Ratification – Not a complete defense; SH must be disinterested and well-informed in order to

properly ratify (DE 144 – the third possibility)

Fliegler v. Lawrence (1976) – Director of Agua buys some property and offers them to Agua,
and board member set up another corp. to hold the properties, until they finally exercise option to
buy them. There was a vote by SHs here, but did that constitute ratification.
a. Even though 144 says that SHs can ratify, here there was only 1/3 of the disinterested
SHs that voted (and that ain’t enough)
i. It was the directors themselves that were holding most of the shares here
b. When this is the case, the interested SHs (directors in this case) must show the fairness
of the transaction
i. Here it was fair
c. Gottlieb Rule (doesn’t apply here): where there has been a SH ratification of the
transaction, even if less than unanimous, “the entire atmosphere is freshened” (unless
there is a “gross waste” inherent in the transaction
______________________________________________________________________________

Obligation of Good Faith (including Care-Mark Duty)

In re Walt Disney Derivative Litigation (2006) – Disney hires Ovitz for a load of money, he
fucks up and gets golden severance. SHs are angry and claim that (1) Ovitz breached duty of
care, (2) Committee shouldn’t have been used, (3) Committee breached duty of care, and (4)
violation of duty of good faith.
a. Ovitz wasn’t a fiduciary yet, so he owed no duty
b. Committee is fine as procedural tool
c. Duty of care not breached b/c there was no gross negligence (determining pay is at the
“heart” of the business judgment rule)
a. Doesn’t have to be “best practices” (if they circulated a memo everything would
have been cool)
d. Good Faith not breached – Good Faith violation can be (1) gross negligence (more than
under duty of care?), (2) intentional dereliction of duty, or (3) intentional harm
a. *You have bad faith when you have an intentional dereliction of duty, which can
also be described as a conscience disregard of ones duties.
e. Whether Eisner could fire Ovits by himself – court looks at the governing docs of corp.
and they are a little ambiguous but it seems to give power to hire and fore to the board

35
 but the bylaws give Eisner the power over the directors to fire. This seems to imply that
Eisner in fact did have this power based on his past practice of firing.
f. Breached duty of care when they decided they could not fire Ovitz for cause - court says
this fails because you would have to see if the counsel and Eisner’s conduct was
negligent and the court says it was not. It looks right and it seems like no one could get a
long with Ovitz and it must be deferred to their judgment of firing him.
g. Corporate waste claim – sh argue that this payout was corporate waste. Court says that
they cannot challenge the payment because that was contracted. They would have to
challenge the actual contract. There still isn’t enough to establish corporate waste.
h. At the end of the day the courts say that this payout was rational.
_____________________________________________________________________________

Stone v. Ritter (2006) – AmSouth is fined 50 mil. For not filing “suspicious activity reports.”
SHs sue in derivative, claiming that the failure to file was a violation of the Care-Mark Duty.
a. Care- Mark Duty: directors must make sure that there is an information and
recording system in place ("internal controls")
1. Exists w/ the duty of good faith (failure to set up system is an intentional
dereliction) -court says the duty of good faith is a sub-category of the
duty of loyalty.
b. 2 ways to find violation of Care-Mark Standard:
1. Sustained or systemic failure of oversight by Board
2. System set-up but then conscious disregard
c. Court here finds that a sufficient system was set up, but the employees just
weren’t filling out the forms (no violation)
__________________________________________________________________________

Indemnification and Insurance

1. 2 Types of Claims:
1. 3rd party claims
2. Fiduciary Duty claims
- These claims lead to expenses (attorney's fees, court costs, and the actual
liability)
 When is Indemnification Mandatory?
o Defendant wins on the merits or otherwise (corp must reimburse the person for
attorney's fees and court costs under S145(c) of DE Code)
o Wolfson - D entered into plea bargain and the Feds agree to drop 4 of the 9 counts
 Wants indemnification b/c he "partially won"
 The court awarded partial indemnity (cited the statutory language "to the
extent")
 Permissive Indemnification: where the D loses or settles (S145(a), which applies to
third party claims)
o 145(a) says that all expenses may be reimbursed (including the actual judgment)
 Limitations: can only indemnify if:
 Action taken was in good faith

36
  Action taken was based on the officer's reasonable belief that the
conduct was not opposed to the corp's interests
 If crime? Can still indemnify if the officer had no cause to believe
that the action was unlawful
o 145(b): when D settles fiduciary claim - all the D can get back are the attorney's
fees and court costs (not the judgment) – subject to same limitations as above and that
they have the same reasonable belief that what they were doing was in the best
interest of the corp.
 If you settle: board can indemnify as long as (1) good faith, and (2)
reasonable belief that not opposed to corp.
 If you lose: you get nothing (unless the court thinks awarding something
would be "fair and reasonable")
o If D loses then they get nothing. Unless the court thinks that such indemnification
would be fair and reasonable.
 Waltuch – Corp. doesn't want to indemnify the D, and says that he didn’t act in good
faith; Waltuch points to a part of the incorporation agreement that says directors will be
indemnified as long as they are not found liable; Court says that such a clause cannot
overcome the limits of S145, and that the Corp shouldn't indemnify the guy
o The Court did say that a corp could transform permissive indemnity into
mandatory indemnity (that's what S145(f) is about apparently)
 This would be in the incorporation docs, and so the decision wouldn't be
in the hands of the directors
______________________________________________________________________________

Insurance

 Director and Officer insurance (it's very expensive)

o 2 Components:
1. Corp insures itself against indemnifying its directors
2. Officers and directors are themselves covered against things that they cannot be
indemnified against
 Are there limits to what officers and directors can be insured against?
o No, there are no limits in DE law to the insurance a corp. can provide to Dir/Offs
(doesn't matter if they could have indemnified them)
o But insurance law does have limitations - can't insure someone against what would be
considered wrongful conduct
o You cannot be insured against duty of loyalty breaches (but you can be insured
against duty of care claims [like malpractice insurance])
__________________________________________________________________________ 

Securities Fraud

 Securities Fraud (10(b)(5)) SEA '34:        

- Action available: civil suit, criminal claims, private plaintiffs

37
 - Companies it applies to: doesn't just apply to public companies (it applies to anyone who
issues securities)
- can even be a closed Corp.
 ELEMENTS (SEC only needs to show 1-5, but private Ps need to show 6-9 also):
1. The fraud must involve interstate commerce or facility of national securities exchange
2. Fraud has to be in connection w/purchase or sale of security
- fraud in connectION w/ face-to-face transactions
- market transactions (even a statement "to the market" is in connection with a sale of
security)
3. False or misleading statement or omission
- Gets tricky when we deal w/ omissions: (Basic v. Levinson - silence absent a duty to
disclose is not a violation of 10b5)
- Duty to disclose when a failure to disclose would render a contemporaneous
statement misleading (you can't tell "half-truths")
- Corps also have a "duty to correct" (e.g. if it didn't realize that what they said
before was incorrect)
- When there is a "duty to update" (courts are split on this one) - statement used to be
correct but is now incorrect b/c of later developments
- majority of courts say that there is no duty to update (other courts reject this,
but only in the circumstance where the officials have made a forward looking
statement that is unqualified by an appropriate cautionary statement
4. Statement must be material - if there is a substantial likelihood that a reasonable
investor would find the statement important given totality of information available
- Contingent events?: Can a Corp. lie about whether that event is happening or not?
- in order to determine whether statement in connection w/ contingent event is
material, you have to look at the magnitude of the event and consider that in
light of the probability of its occurrence
- soft information (2 types): are these really material?
1. Puffery - when someone says "things are looking good," etc. (law says that
this stuff is immaterial, b/c reasonable investors would assume this doesn't
mean anything)
2. Forward-Looking Statements (like puffery but alot more detailed) - Corp
actually talks about the Corp in more substantive terms (e.g. "we anticipate 10%
growth rate next year")
- there are required cautionary statements here (there must be specific
cautionary statements particular to the statement at issue)
- Note that the forward looking statement must still be material under 10b5
5. State of Mind - must show Scienter (a mental state embracing intent to deceive
manipulate or defraud)
- if SHs can show intent to deceive, than this element will be met
- also met by high level of recklessness (must be pretty extreme: either knew or had
to know the falsity)
- mere negligence will not suffice (must be more than failure to investigate)
- private plaintiffs have a higher pleading standard for the scienter standard (need to
plead w/ particularity the facts giving rise to a strong inference that there was the
required state of mind)

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        6. Private Ps must show that they have standing:
- only those who bought or sold securities (but SHs may say that they didn't sell or didn't buy
b/c of the lie [but courts reject this claim])       
- must lay framework for a strong inference that there was the requisite state of mind. (intent
or that the defendant knew that they were saying something wrong) 
 
7. Transaction Causation: must show that it was the lie that caused you to buy or sell (this
element has been "severely diluted")
- face-to-face: you actually do need to show reliance here (although some courts say
that you just need to testify that you relied)
- ommission: you don't need to show reliance (it would be impossible for someone to
say that they relied on something that wasn't said)
- market transactions (exec makes statement that affects the market price) - no
reliance needed (it is presumed)
- "fraud on the market theory": all public statements that are made impact the
market price (so even if you never read the press release, you're still affected by
the statement b/c it affects the price)
8. Loss Causation – the amount between the actual value and what you actually paid for it
is your loss. You must show that the loss is there because of the lie, not for some other
reason.
- aider and abettors liability – people who didn’t actually do the lying but who knew about it.
This would be accountants and lawyers usually. The rule is that the SEC but not private
plaintiffs can sue those who knowingly or recklessly facilitate in some manner another person’s
10(b)(5) violation
____________________________________________________________________________

Goldman

 SEC makes two claims in its investigation

1. Claims against Goldman
2. ACA put the portfolio together w/ out mentioning Paulson, who helped put together the
portfolio would be betting against the portfolio
 Can SEC fulfill the reqs of 10b5?
1. JDX: yes, b/c there were instruments of interstate commerce
2. Connection w/ purchase/ sale of security?
i. Yes
3. False/ misleading statement?
i. There is an argument by Goldman that it was clear from Paulson's actions that he
would be betting against the Abacus portfolio (this is in connection w/ Paulson)
ii. Re IKB: it does look like Goldman would have a duty to disclose
1. But Goldman says that custom did not require any further disclosure
4. Materiality: would Paulson's role in the transaction be material to the people who
would be investing?
i. It's the role that's important, not the person filling that role (it's not the "who," it's
the role)

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 ii. Seems like Goldman makes pretty strong arguments about why there wasn't
materiality
5. Scienter:
i. Goldman's arguments:
1. ACA was a long-time business partner, so why would Goldman deceive
ACA for this one-time transaction
2. Also, IKB was a long-time customer, so why would Goldman deceive IKB
this one time
3. Goldman also says that they have a duty to keep client trades confidential,
so they couldn't have disclosed Paulson's role anyway
 The SEC case here (on the whole) doesn't seem that strong
o NOTE: if this were a personal plaintiff, the case would be even harder to bring
 SEC receives a large settlement from this case, w/ a lot of money going to the US treasury
o It's arguable that this case was more about political symbolism rather than the merits of
the case
_____________________________________________________________________________

Insider Trading - accrues to those who trade or tip on the basis of material non-public
information

ELEMENTS:
1. JDX
2. Trade or a Tip
3. That tip or trade must be "on the basis of" - aware of the information
4. Material - reasonable investor would consider important
5. Info in non-public - info that is not "generally available"
6. Scienter
7. Breach of fiduciary duty: 2 theories of how breach can occur:
1. Classical theory - you breach the duty when you transact with someone they owe
a fiduciary duty to w/ out telling them the non-public info
i. This theory captures "traditional insiders" (e.g. officers and directors of
the corp., etc.)
1. This captures traditional insiders who trade in stock of their own
corporation (b/c if you buy stock, then you're buying it from a SH, and
you owe a SH to that person; and if you sell stock, then you're selling it to
a prospective SH, so there's a duty there too)
ii. Temporary insider: lawyers, accountants, and consultants
2. Misappropriation Theory - applies even though an insider is not trading in their
own stock
i. The idea is that when you're trading in stock of another company, you're
still using your position at your company for a personal gain (thus you're
breaching a duty to your own company)
1. NOTE: this is similar to the "secret profits" doctrine
ii. Person owes fiduciary duty to anyone (whether it be a company or an
employer) who shares information w/ that person in confidence (so the duty is
to not use that info to his/ her personal gain)

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 iii. This theory has been applied to traditional insiders who trade in stock to
other companies
iv. Also applies to temporary insiders who trade in stock of other corporations
v. According the SEC, it should apply to anyone
_________________________________________________________________________ 

Tipping

 To get someone for insider trading for tipping, you have to find that the tipper gave the
tip for personal gain
o NOTE: even if the tipper is giving the tip as a gift w/ the expectation that the
receiver will use the tip for personal gain, the tipper will be liable
 The "Tippee" (receiver) will be liable when (1) the Tipper would be liable, and (2) s/he
knows (or is reckless) that the tipper was breaching a fiduciary duty when disclosing the
information
 
 Insider trading cases brought by private Ps are pretty rare
o It's usually the SEC that brings these cases (SEC can (1) require disgorgement,
and (2) levy fines up to 3x the profits)
______________________________________________________________________________

Martha Stewart

 IMClone company awaiting approval from the FDA about whether drug would be approved
o People were dropping shares b/c they knew the FDA was not going to approve the
product
o Waxsol is one of these people who executes the trade through their broker, who then
shares the info w/ Martha Stewart
 Stewart decides to drop the shares as well, saving $46g
 The elements (for Brokanovich):
1. JDX: yes
2. Trade/ tip: looks like it
3. Aware? Broker was aware of the info
4. Material: seems like most people would think this was important
5. Nonpublic: it seems that the broker knew the info was non-public (that's why he was
sharing it)
i. No one else knew that the Waxsols were trading
6. Scienter: yes, that's why he was sharing it
7. Breach of fid. Duty? - the broker doesn't fall under the traditional theory of breach (b/c
he's not trading in the stock of his own company)
i. But there may be a breach under the misappropriation theory (owes a duty to
anyone who entrusts them w/ confidential information, not to use that info for
personal gain)
ii. There could be two ways that Brachonovich could have breached: (1) to Waxsol,
and to (2) Merrill Lynch

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 1. But what if Merril didn't really have an expectation that its information would
be kept confidential
2. It's also "weird" to think of the info as property of Merrill Lynch
iii. The personal gain does not have to be actual money in return (it can be personal or
intangible)
 The Tippee's liability is derivative
 What about for Martha Stewart?
o She would have to know that Brochonovich was breaching his duty to Merrill
 This isn't clear here
____________________________________________________________________________ 

Speaker Nonsense

 Securities Act of 1933

o Boils down to the action of selling, and the actors of issuers and sellers
o Focuses on the burdens that are on the sellers of securities
o 2 types of sellers (we can also look at these as primary and secondary transactions):
1. Issuers of securities: this would be the corporations who issue stocks
2. Non-issuers of securities: between the party's who buy the stock from the issuers
a. It's rare to ever meet the other non-issuer
 
 33' Act puts big burdens on issuers, as opposed to non-issuers
o There are often registration requirements put on corps before they issue stock to buyers
 Then there are also potential exemption claims that corps can used to escape these
requirements (but the burden for proving these exemptions is substantial)
 Securities Act of 1934
o Very well organized as compared to the 33' Act
o Deals with the trading markets in 2 parts:
 The markets -
 The participants in those markets - what kind of burden we put on participants in
the trading markets
o Continuous Disclosure System:
 Integrated the registration requirements of the 33' Act into the new market
restrictions
 Composed of (1) Regulation S-K and (2) Regulation S-X
o Established the Financial Industry Regulatory Authority
o Established the Securities Exchange Commission (SEC)

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