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Business Organizations Outline Michaelmas 2011

1. Sole Proprietorship a. simplest form of business organization b. Maximum one owner c. No legal distinction between owner and business d. Liability issues - Personally liable for all debts and obligations e. Tax issues business doesnt pay taxes Owner will have to report the income on her personal tax return and pay taxes on it

2. Partnership a. An association of two or more persons to carry on as co-owners b. Doesnt have to be in a form of a contract can be an understanding c. Partnership is considered a separate entity from the owners Liability - Partner a / b and the( ab) partnership (a legally recognized separate entity) Partners are personally liable to the debts and obligations of the partnership o Ex: Partnership liable for $1 million dollar in damages. Partnership only has $10k, the partners are still jointly and severally liable for the debts of the partnership and the plaintiff can still go after the partners for the full damages

Tax benefit - $10,000 profit for the year a/b partnership doesnt have to pay taxes only files an informational return since a/b partnership doesnt pay taxes, then the partners pay the taxes so partner a and partner b will report $5,000 a piece and pay the taxes on it

Flow thru tax treatment the partnership doesnt pay the taxes, but their income or loss flows thru the partners.

d. Partners generally share the profits of the business and the risks of financial loss Except when profits are received as Debt service Wages Rent Or annuity

e. Neither sharing gross returns nor giving capital to an enterprise, independently is sufficient to create a partnership.

3. LLP partnership a. Liability issues - not personally and severally liable for the debts and obligations of the partnership if a partner commits a tort only the committing partner is liable for any damages

b. has flow through taxation

4. Limited partnership a. Need to file a certificate of limited partnership with the state b. You need one i. General partner makes most of the business decisions and is liable for the debts and liabilities of the LP and ii. One limited partner who is a passive investor has no liability for the LPs debts or liabilities 1. Doesnt make any decisions regarding the corporation

2. Except if you take over the role of the general partner then you may be held liable. c. flow through taxation 5. LLC a. Hybrid between a corporation and a partnership b. Articles of organization needs to be filed with secretary of state c. Limited liability for owners (members) - not personally and severally responsible for the LLCs debt like a corporation d. Flow through tax treatment like a partnership e. Structures i. Member managed LLC all the owner get to make decisions, including ordinary course decision ii. Manager managed LLC one or more managers (who may or not be members) make all the ordinary course decisions f. May be subject to veil piercing 6. Corporations a. Entities that make up a corporation Shareholders owners of the corporation, however, dont control the corporation mainly elect the board of directors to run the corporation. Shareholders own an equity interest in the corporation. Liability issues - shareholders not personally and severally liable for corporate debt and obligations. At the worst, their stock becomes worthless if they company cant pay its debt or obligations.

Taxes c corporation- double layer of taxations o - $10,000 profit will have to pay taxes on the income Shareholders also will pay taxes on dividends, once disbursed.

Taxes s corporation taxes like a partnership whatever income the corporation makes, it doesnt file 3

taxes on it the income is passed through to the shareholders, who report their income and pay taxes on it. Maximum 100 shareholders, US citizens or resident aliens as shareholders and incorporated in the U.S. Board of directors make the decisions that control the organization Delegates decision making authority to officers of the organizations

Sources of business law


1. State law a. Internal affairs doctrine the rules for how a business entity is governed, and how to resolve disputes between the businesss owners and its managers, are found in the law where the business is incorporated or organized, not where it is physically located. i. Can incorporate under any state law 1. Governance issues (internal issues) are dealt using the law of the state of incorporation 2. Tort or negligence issues the state where the tort / negligent action occurred applies 2. Federal law 3. Stock exchange rules

Financial Statements
1. GAAP (Generally accepted accounting principles) o Rules governing how numbers are to be reported in financial statements 1. Balance sheet snapshot of the assets, liabilities and the owners equity (difference between assets and liabilities) Assets = the liabilities + owners equity (need to balance out) o $100k assets = $60k liabilities + $40k owners equity

Real estate documented as the lowest value of the property, regardless of its appreciation 4

2. Income statement measures a period of times (month, quarters) Revenue - expenses = income

3. Cash flow statement to determine for the same period of time covered by the income statement, how much cash the business generated or used. Net income - $30k (+ $2k depreciation of machine $10k/5 yrs =$2k/year) 10k (expense paid for machine)

Agency Law (R 3rd)

1. Principal (p) a. Person (or legally recognized entity) on whose behalf a work is being done i. Disclosed ii. Undisclosed or iii. Unidentified 2. Agent (A) a. Person who performs the task

3. Third party (TP) a. Person with whom the agent deals with on behalf of the principal

Agency is the fiduciary relation that arises when a principal manifests assent to an agent - that the agent shall act on the principals behalf and subject to the principals control, and the agent manifests assents or otherwise consents so to act

Principals liability to 3rd party

1. Actual authority a. Express actual authority - principal makes a manifestation (words or other conduct) which the agent has to become aware of and as a result of that, the agent reasonably believes the agent is authorized to do something b. Implied actual authority - The agent has actual authority to take action designated or implied in the principals manifestation to the agent and acts necessary or incidental to achieving the principals objective

2. Apparent authority a. Principal makes a manifestation 3rd party becomes aware of the manifestation - and as a result the 3rd party reasonably believes the agent has the authority to do something i. Power v. right to do something - in power the agent has the power to bind, but may not always have the right to as to the right to do something the agent has the actual authority as instructed by the principal to bind the principal

3. Estoppel (estopped from denying liability if ...) a. Purported principal has not made a manifestation that an actor has authority as an agent and not otherwise liable as a party to the transaction by the actor on the purported principals account, is subject to liability to a 3rd party, who justifiably is induced to make a detrimental change in position, if i. The principal intentionally or carelessly caused such belief or ii. Having notice of such belief and that it might induce others to change their positions, the principal did not take reasonable steps to notify them of the facts 4. Ratification a. Is the affirmance of a prior act done by another, whereby the act is given effect as if done by an agent acting with actual authority? 6

[authority that is given after the contract has been made ] Need to know all the terms; either ratifies the whole or nothing.

3rd Party liability to principals a. General rule yes if there is a contract b. Exception i. Undisclosed party ii. 3rd party would not have dealt w/ the principal iii. Principal or agent knows or has reason to know that the 3rd party would not deal with the principal iv. The agent makes a misrepresentation to the 3rd party about an existence of an agency relationship

Agents liability to the 3rd party if the principal doesnt perform?

1. Disclosed principal 3rd party knows there is a principal and who they are R 601 agent is not liable 2. Undisclosed principal 3rd party doesnt know there is a principal R 603 agent liable 3. Unidentified principal 3rd party knows there is a principal but dont know who it is R 602 agent liable unless otherwise agreed

Tort Liability

1. Master / employer or servant or employee relationship a. An agent is liable for his tortuous conduct, regardless whether the principal is liable through vicarious liability. 2. Scope of employment 7

a. Can determine whether the principal is liable through vicarious liability.

Partnership

What is a partnership? 1. Partnership is an association of two or more persons to carry on as co-owners a business for profit, formed under 202, predecessor law, or comparable law of another jurisdiction.

What are the effects of being an entity (legal person)? 1. Own property / Be a plaintiff or defendant / Sign contracts and hire employers 2. Flow through tax liability 3. No need to file any papers with the state to become a partnership

Gross Return v. Profits 2. Gross returns = revenue (just concerned about revenue) and if you share revenue, no presumption of partnership 3. Profits = income (concerned about expenses and profit) if you share profits, its presumed you are a partner

Sources of Partnership Law 1. Partnership agreement first place you should look at if there is a dispute about a partnership RUPA 103 (a) 8

a. Partnership agreement not required but highly recommended under RUPA 101(7) if you dont have a partnership agreement, RUPA steps in with the default rules. i. RUPA 103(b) prohibits a clause in the partnership agreement 1. That restricts a partners access to look at books and records 2. That eliminates duty of care or loyalty 3. That eliminate the obligation of good faith and fair dealing 4. That restrict rights of 3rd parties 5. That eliminates the power of a partner to disassociate 2. RUPA 3. Case Law

Approaching a partnership law issue: (p.80)

When analyzing a partnership law issue, you should first ask whether the partnership agreement addresses the issue. If not, find the applicable RUPA rule. If the agreement does address the issue, ask whether the partnership agreement violates RUPA 103b. If not, apply the rule from the partnership agreement. If so find the applicable rule in RUPA.

Decision making in a partnership 1. RUPA 401 each partner has equal rights in management and conduct of the partnership business - one partner vote 2. RUPA 401(j) o o on ordinary course of business majority vote on outside ordinary course of business (outside issues) unanimous vote admitting new partner unanimous vote 9

RUPA 404 1. Duty of care basically states do a good job o Refrain from grossly negligence ,reckless conduct, intentional misconduct or a knowing violation of the law Ordinary negligence is not a breach of duty of care

2. Duty of loyalty avoid a conflict of interest dont do anything that furthers your interest over your partners o o Dont steal Refrain from dealing with the partnership in the conduct of winding of a business as or on behalf of a party having an interest adverse to the partnership Refrain from competing with the partnership

Partnership Liability issues

1. RUPA 301 a. Partner has agency authority to bind the partnership in the ordinary course of business b. Partner doing outside the ordinary course of business can only bind the partnership if he has actual authority 2. RUPA 305 - partnership is liable for the wrongful act or omission or other actionable conduct of a partner acting in the ordinary course of business of the partnership or with the authority of partnership 3. RUPA 306 all partners are jointly and severally liable for all obligations of the partnership unless otherwise agreed by the claimant or provided by law. a. A newly admitted partner is not liable for any partnership obligation that was incurred prior to his becoming a partner

b. An obligation of a partnership incurred while the partnership is a LLP, whether arising in contract, tort, or otherwise is solely the obligation of the partnership. 10

4. RUPA 307 a. A partnership may sue and be sued in the name of the partnership b. An action may be brought against the partnership and to the extent not inconsistent with 306, any or all of the partners in the same action or in separate actions. c. A judgment against a partnership is not a judgment against a partner, unless the partner is also named as a defendant d. If you have a judgment against a particular partner in order to recover from the partners asset you must have one of the 5 options. (p.22) i. Exhaustion rule partnership doesnt have enough asset to recover from, or ii. Partner is liable for some other reason besides merely being a partner, or iii. Court order granting creditor to levy execution against partners asset, or iv. Partner has agreed the creditor need not exhaust partnership assets, or

Financial Issues

1. RUPA 401b- Partners are not paid for their services as a partner, unless it is during a winding up of a partnership. a. Each partner is entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportion to the partners share of the profits b. Partnership account a form of book keeping not actually what you own 2. RUPA 401a partnership account balance will go up when a. You make a contribution 11

b. You receive a share of partnership profits i. Allocated equally absent a partnership agreement 3. RUPA 401b partnership account balance will go down when a. You receive a distribution b. You receive your share of the partnership loss i. Allocated equally absent a partnership agreement

Partner Disassociation - when a person in no longer a partner of a partnership

1. RUPA 601 events causing a partners disassociation a. Notice of withdrawal b. An event in partnership agreement causing partners disassociation c. Expulsion based on the unanimous vote of the other partners d. Expulsion by judicial determination e. Death of the partner 1. Disassociation is rightful if at the end of a specific undertaking a. Get share of profits after all creditors are paid 2. Disassociation is wrongful if prior to the end of a specific undertaking or term. a. Do a hypothetical dissolution - still get share of profits, but reduced by the amount of damages and not until the completion of undertaking, unless they can show no hardship 2. RUPA 702 - if you disassociate without a resulting dissolution of the partnership you may still bind the partnership for up to 2 years 3. RUPA 703 you may still be liable to 3rd parties for up to 2 years if certain conditions are met 12

4. RUPA 704 to reduce liability, one may whittle the 2 year period by filing a letter of disassociation and after 90 days the whole world would have constructive notice that he isnt the partner

Partnership Dissolution

1. RUPA 801 events causing dissolution and winding up of partnership business a. At will partnership partnership is dissolved or must be wound down if a partner quits and gives notice to the partnership unless it meets the exceptions under 601 (2)-(10) b. Partnership for definite term or undertaking within 90 days after a partners disassociation by death or otherwise under 601(6) (10) or 602 (b) , the express will of at least of the remaining partners to wind up the partnership business i. If after 90 days then unanimous vote

2. Partnership accounts and balances after dissolution a. First zero out the partnership accounts Amount to be distributed = total account balances after settlement. b. Left over are profits - Partners Alpha, Beta and Omega have decided to dissolve and wind up ABC partnership. After fully paying all creditors, the partnership has $21k ofc. Shortfall is aAs of the date of dissolution, Alphas account = $8k, cash left over. loss Beta = $3k and Omega =$1k. - How will the $21,000 be distributed? - Same facts, now partnership only had $6k after paying its creditors. How will the $6k be distributed

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Corporations
1. A separate legal entity 2. Existence depends on the filing of the article of incorporation with the state a. To include i. Unique name ii. The purpose of the corporation iii. The number of shares which are authorized for each class of stock iv. The name and address of the agents for service of process 3. If there is a conflict between article of incorporations and bylaws, a.o.i. wins 4. Members of the corporation are a. Shareholders elect board of directors b. Directors make business decisions for the corporation but i. Cant bind the corporations to 3rd parties as they are not agents c. Officers and other employees directors appoint and delegate authority to and as agents may bind corporations to 3rd parties d. Promoters person who acts on behalf of a corporation that has yet to be formed i. General rule subject to personal liability to the contract 2.04 ii. Exception if you put in the contract that the promoter is not liable 1. If there is ambiguity in the contract as to whether promoter is liable, the courts will find in favor of finding the promoter liable 2. To get out of liability have a novation which requires all parties to agree 14

a. Promoter doesnt get off the hook, when the corporation adopts the contract e. Incorporators person who files the article of incorporation f. Subsidiaries (and parents) parent owns the subsidiary corporation i. If a parent owns all of the stocks of the subsidiary corporation, then its a wholly owned subsidiary, otherwise it is not g. 3rd parties Shares 1. Authorized shares a number of shares a company can issue 2. Outstanding shares shares that have already been issued 3. Issuing shares a company can issue more shares than it initially started out a. By amending the articles of incorporation b. Getting board approval c. Possible shareholder approval 6.21 (f) 4. If you have a purpose clause in your article of incorporation and a director of that corporation decides to open a business other than what it is currently operating, then the subsequent business is ultra vires (corporation lacks or lacked the power to act) 3.04 a. A shareholder may then enjoin the corporation What is common stock? 1. What rights do common shareholders have? a. b. c. d. e. Common stock shareholder can vote for the board of directors Get one vote per share (voting rights) Have the right to get dividends (economic rights) To freely transfer your shares through sale Residual owner if the company is dissolved

2. What rights dont you have? a. Dont have the right to have the company buy back your stock b. Dont have the right to have a job What is preferred stock? 1. No universal definition any description of the preferred stock will be in the articles of incorporation (1) liquidation preference and or (2) dividend preference What is a dividend? 1. Dividends are payments that the corporation makes with respect to its stock. a. In a sense the corp. is giving away its money to the shareholders 15

2. What a. b. c.

are the limitations on issuing dividends? MBCA 6.40 (c)(1)(2) MBCA 8.83 Liquidation limitations i. First creditors get paid ii. Then preferred stock members iii. Then common stock holders if there is money left over

3. MBCA 6.40(c) has two tests: a. The insolvency test can issue dividends and leave the corporation insolvent and b. The balance sheet test - After paying the dividend, the corporations assets must be at least equal to: i. Its total liabilities, PLUS ii. The amount that would be needed to pay the preferential rights upon dissolution of shares that have rights superior to the shares that are receiving the dividend

Shareholder liability 1. General rule no shareholder liability a. Exceptions i. When the bank has the person requesting the loan personally guarantee the loan. ii. When you pierce the corporate veil MBCA 6.22(b) 1. Dewitt Truck Bros. v. W. Ray Flemming Fruit Co. p. 181 2. Plaintiff has to establish the element for veil piercing 3. Veil piercing can also happen in a parent / subsidiary company 4. Veil Piercing Test a. Concentration of owners veil piercing only happens when there is a concentration of ownership in an individual. b. Not having an adequately capitalized company i. Enough capital to have that business to meet its reasonably foreseeable obligations and whatever minimum insurance is required for the business. c. Not observing corporate formalities i. Having board or shareholder meetings, failure to take minutes, elect officers, and adopt bylaws. ii. Showing of a separation between the sole shareholder and the corporation to allow him the privileges of limited liability of a corporation 16

iii. Not paying dividends when paying a salary to the dominant stockholder d. Manifestly unjust - look for any fraudulent conduct or unjust enrichment issues Enterprise Liability 1. Enterprise liability - When you have a company under common control 2. Walkovsky v. Carlton if you have a series of taxi corporations owned by the same person and one of the taxis of corporation 1 injures a plaintiff; can the plaintiff sue the owner and his other corporations under veil piercing, if corporation 1 has no assets? a. Court said yes because it was not ten separate companies. All the companies are doing the same business, share the same garage and dispatcheretc. 3. What advice would you give a parent corp. that has several subsidiaries to avoid veil piercing and enterprise liability? a. Have the subsidiary companies provide different services b. Hold subsidiary companies have their own directors and officers c. Financial matters i. Hold each subsidiary accountable for its debts ii. Have separate bank accounts iii. Have good insurance d. Observe corporate formalities Corporate Decisions 1. Board of directors generally handle the important decisions of the corporation 2. Action by the board of directors (resolutions) are done through a. Regular meeting i. dont need notice since they are in the bylaws b. Special Meeting i. Notice to all directors ii. Have to have a 2 day minimum notice (date, time and place) 1. Not required to say purpose but is a good idea iii. Or get a waiver of 2 day notice c. Generally most board decisions, when a quorum is present are made by the affirmative votes of the majority of directors present or d. Unanimous written consent resolution How shareholders vote 1. Shareholder meetings a. Annual and b. special shareholder meetings 2. Notice requirements 17

3.

4.

5.

6.

a. Date, time and place b. For a special meeting, you must include a description of the purpose i. No fewer than 10 days and no more than 60 days c. Shareholder entitled to vote are those who own shares on the record date Quorum a. Need majority of shares to be present b. Can be done by proxy i. Written or electronic document allowing the holder to vote on a persons behalf 1. Specific instructions on how to vote may be assigned or 2. At the discretion of proxy holder 3. Proxy is revocable, unless otherwise agreed Record date a. Can be no more than 70 days before the meeting b. Record date cant be too close to the meeting date because you need to give enough time to mail notice to the shareholders Shareholders elect directors a. Annually at annual meeting b. Non- staggered all director positions are for 1 year and up for reelection every year i. Can be disruptive to the corporation when you have new directors each year they can take the corporations into different paths every year c. Straight (plurality ) voting who ever gets the most vote Shareholders also vote on a. Mergers or dissolutions and amendments to the AOI and bylaws

Counting shareholder votes


Cumulative voting 1. Only applies for electing or removing a directors 2. Only applies if article of incorporation says we use cumulative voting a. N X S / D + 1 = X b. IF YOU GET A WHOLE NUMBER + 1 c. IF YOU GET A FRACTION, ROUND UP TO THE NEXT WHOLE NUMBER d. X THE ABSOLUTE NUMBER OF SHARES YOU NEED TO ELECT N NUMBER OF DIRECTORS. i. S # of shares that will be voted at the meeting and D = total directors that will be elected to the board 3 Squash Corp = 1000 shares and BOD = 4 a. How many shares to elect 1 director i. 1x1000/4+1 = 201 b. How many shares to elect 2 directors i. 2x1000/4+1 = 401 3. Numbers of votes you have is the total numbers of shares you have multiplied by the amount 4. Reason behind cumulative voting was to give minority shareholders a greater opportunity to elect a director to a corporations board. In a traditional voting structure, the majority shareholders will otherwise elect all the directors. 18

5. Plurality voting straight voting 6. Voting on other things more yes votes than no votes Voting agreements 1. MBCA 7.31 are legal and enforceable in a court of law a. Enforceable through specific performance Director Duties M.B.C.A. 8.30 1. Duty of care director when discharging duties shall act in a. Good faith and b. In a manner the director reasonably believes to be in the best interest of the corporation i. Such as relying on reports and opinions of experts 2. Duty of loyalty is implicated when director is involved in a situation in which there is a conflict of interest, which results in the creation of a personal benefit for the director a. Director taking actions to enrich himself over the corporation

Schlensky v. Wrigly 1. Unless a plaintiff can overcome the business judgment rule, their suit will fail 2. Business judgment rule - the judgment of the directors of corporations enjoy the benefit of presumption that it was formed in good faith, acting in an informed basis and designed to promote the best interests of the corporation they serve. a. Effects i. The decision stands ii. The BJR can be overcome by showing 1. fraud, illegality or a conflict of interest 2. Gross negligence by not being informed of all reasonable information when making a judgment 3. Irrational decision making beyond the realm of reason iii. MUST ALSO SHOW CAUSATION BY SHOWING A BREACH OF A D.O.C. OR A D.O.L. iv. If there is no decision, then the BJR doesnt apply, because there has not be a judgment by a director. 3. Further, M.B.C.A. -2.02(4) can also be approved by the shareholders to further shield the directors from suit. a. Often approved by the shareholders, because directors will not join the board if they can be sued for every decision they make. Control premium 19

1. when an offer more than the market price of one share is made 2. so you can get the shareholders to agree to the sale of the corporations

Duty of Loyalty
Interested Director Transactions M.B.C.A 8.60 1. DCIT Directors conflicting interest transactions a. Where a director engages in a transaction with a corporation, where he or a relative or a related entity has a material financial interest in the transaction and then exercises his influence to the detriment of the corporation. i. Concern is that director may reap benefits from a sale to the organization or when buying from the organization. 2. Three questions to assessing a DCIT question a. Is the transaction a DCIT? b. If so, how do you sanitize it? i. Get approval from qualified disinterested directors ii. Get approval from qualified disinterested shareholders iii. Show the transaction at the time was fair to the company 1. Fair fair dealing and fair price 2. Burden of proof the interested directors c. Whats the effect of the sanitization? i. To challenge a share holder approval of a DCIT 1. Show that there was waste Qualified director 1. M.B.C.A 1.43(a)(i) for purposes of 8.62 a qualified director is anybody who does not have a material interest in the outcome of the proceedings, or a material relationship with a person who has an interest

Usurping a corporate opportunity


What is a corporate opportunity? 1. What body of law to apply. a. Delaware law b. American Law Institute 2. Factors to consider whether a director can take a corporate opportunity? (Delaware Law) a. Did the corporation have the financial ability to pursue the financial opportunity? b. Is the opportunity in the corporations line of business? c. Does the corporation have an interest or expectancy in the opportunity? i. Interest something the corp. has a pre-existing contractual right 20

d. e. f. g.

ii. Expectancy something which a corp. had a reasonable expectancy the opportunity would be offered to it, given the other contractual dealings of the corporation. Was the opportunity essential to the corporation? i. Something the corp. needs to stay in business, such as raw materials. By taking the opportunity for his own, is the corporate fiduciary placed in a conflict with the corporation? Did the corporate fiduciary wrongfully use corporate resources in pursing the opportunity? Was the opportunity presented to the director in his individual or corporate capacity?

3. If so, did the insider sanitize it or can he show fairness? (Delaware Law) a. Offer it to the board with full disclosure and the fact that you are interested in the opportunity and b. the disinterested directors rejected it on behalf of the company, then you have a defense 4. ALI model for usurping a corporate opportunity? Only have to meet one of the three to meet the test (ALI) a. Any opportunity to engage in a business activity of which a director or senior executive became aware, either i. In connection with the with the performance of his function as a senior executive or director, which reasonably leads a him to believe it was a corporate opportunity ii. Through the use of corporate information or property, if the resulting opportunity is one that the director or senior executive should reasonably believe would be of interest to the corporation. (corporate resource test) iii. Any opportunity to engage in a business activity of which a senior executive became aware and knows is closely related to a business in which the corp. is engaged or expects to engage. (line of business test) 5. Defenses to taking a corporate opportunity (ALI) a. Offer it to the corporation b. The corporate opportunity is rejected by the corporation and either i. The rejection of the opportunity is fair to the corporation ii. The opportunity is rejected in advance, following such disclosure by disinterested directors, iii. The rejection is authorized in advance or ratified, following such disclosure, by disinterested shareholders and the rejection is not equivalent to a waste of corporate assets Can directors compete with their corporation? 21

1. Directors or senior executive may not advance their pecuniary interests by engaging in competition with the corporation unless either: a. Any reasonably foreseeable harm to the corp. by such competition is outweighed by the benefit that the corp. May reasonably be expected to derive from allowing the competition to take place, or there is reasonably foreseeable harm to the corporation from such competition. b. The competition is authorized in advance or ratified, following disclosure concerning the conflict of interest and the competition, by disinterested directors, or in the case of a senior executive who is not a director, is authorized in advance by a disinterested superior, in a manner that satisfies the standards of the business judgment rule; or c. The competition is authorized in advance or ratified, following such disclosure, by disinterested shareholders, and the shareholders action is not equivalent to a waste of corporate of assets. 1. Directors and senior executives are not agents so Restatement 3rd of Agency doesnt apply.

Non-competes
1. Non-competes have to be reasonable in restrictions for a court to issue an injunction: a. The bigger the scope b. The bigger the durations i. The less likely the court will find the non-compete is reasonable! c. If the court finds it is unreasonable, consider having in place prior a savings clause, which states if the court finds it is unreasonable as it is written, then we can modify the scope and duration to the extent that is reasonable.

Derivative Lawsuits
Derivative lawsuit v. direct lawsuit 1. Proper analysis for distinguishing between a direct and derivative lawsuit. a. Who suffered the alleged harm? i. Did the individual shareholder (direct lawsuit) or 1. Only applies if the individual only suffered the harm and not the corp. ii. The corporation suffer the harm (derivative lawsuit) b. Who would receive the benefit of the recovery or the other remedy? i. If the recovery goes to the individual (direct lawsuit) ii. If the recovery goes to the corporation (derivative lawsuit)

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Definitions of direct and derivative lawsuit 1. Derivative a suit by a shareholder on behalf of the corporation alleging harm to the corporation, where the reward of the suit returns to the corporation. 2. Direct a suit by a shareholder alleging am individual harm whereby the recovery will go to the shareholder

Standing requirements for a derivative lawsuit (have to meet both and maintain throughout the lawsuit) 1. Was the plaintiff a shareholder at the time of the of the act or omission complained off or become a shareholder through transfer by operation of law, from one who was a shareholder at the time 2. Must fairly and adequately represent the interests of the corporation in enforcing the rights of the corporation

The Demand Requirement (gives the comp. one last opportunity to sue the person or corp. that harmed it). 1. MBC a. No shareholder may commence a derivative proceeding until i. A written demand has been made upon the corp. to take suitable action; and ii. 90 days have expired from the date the demand was made unless the shareholder has been notified that the demand has been rejected by the corp. or unless irreparable injury to the corporation would result by waiting for the expiration of the 90 days 2. Delaware a. For demand to be excused plaintiff must allege particularized facts which allege that i. The majority of the directors are interested and not independent, or ii. The challenged transaction was otherwise the product of a valid exercise of business judgment 3. NY 23

a. Demand is excused if complainant alleges with particularity that i. The majority of the board of directors is interested in the challenged transaction, or ii. The board of directors did not fully inform themselves about the challenged transactions to the extent reasonably appropriate under the circumstances, or iii. The challenged transaction was so egregious on its face that it could not have been the product of a sound business judgment of the directors If the corporation rejects your demand, you can still file your derivative suit: 1. Allege in your complaint the majority of the directors were not qualified (disinterested) at the time the rejection was made, or 2. Allege that the board did not make a good faith decision based on a reasonable inquiry Dismissal 1. A derivative proceeding shall be dismissed by the court on motion by the special litigation committee (made up of new directors or disinterested directors) a. If they acted in good faith and b. Conducted a reasonable inquiry i. Under Zapata (Delaware) the court can use their business judgment rule and decide it is in the best interest to not dismiss, even if the corp. acted in good faith and made a reasonable inquiry. 2. If plaintiff wants to settle the case with the defendant, the court has to approve the settlement. a. Public policy reason the courts dont want the corporation to bribe the plaintiff and in the process deprive the shareholders of getting a fair settlement. b. Res judicata once a derivative law suit is filed and settled, you cant sue again

3. On termination of the suit a. Court can order the corporation to pay the plaintiffs reasonable expense, including atty. Fees if they find the proceedings resulted in a substantial benefit to the corporation b. Court can order the plaintiff to pay the corporations reasonable expenses, including atty. Fees, if they find the proceeding was commenced without reasonable cause or for an improper purpose

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Closely Held Corporation


1. A close corporation is typified by a. A small number of shareholders (10 or fewer) b. No ready market for the corporate stock c. Substantial overlap between shareholders and management - majority stockholder participation in management, direction and operations of the corporation 2. If you are a minority shareholder, what can you do to protect yourself? a. Have a shareholder voting agreement to make sure you are always elected to the board b. Use a sections 7.32 agreement i. Place it in the article of incorporation or the bylaws ii. Has to be approved by every shareholder iii. Have it in a written agreement which is known to everybody and signed by every shareholder 3. Rights of a minority shareholder in a closely held corporation where there is a dispute and a. You can do a fiduciary duty analysis (MA), or i. All shareholders owe a fiduciary duty to each other b. Under M.B.C.A 14.30 Involuntary dissolution of the corporation for oppression i. You can get a court ordered dissolution of company which can be prevented by buyout of the plaintiffs shares by a certain date at FMV. 4. Fiduciary duty analysis a. Equal opportunity rule (case law) if a member of the controlling group has his stock redeemed by the company, then the same should be offered to the minority shareholder at the same price. Doesnt apply to a wider variety of claims so they came up with the following test: b. Wilkes test i. Ask the defendant for a legitimate business person for what they did? If the corporation is able to show legitimate business person ii. Then we ask the plaintiff to show an alternative to what defendant could have done that was less harmful to the plaintiffs interest. 1. If they both provide a legitimate answer, then the judge would have to decide which alternative provided by the plaintiff would have accomplished the legitimate business purpose. 25

2. Generally, the courts would order a court ordered buy out of the plaintiffs stock at fair market value 5. Oppression Analysis a. Plaintiff will have to show the directors are acting in a manner that is illegal, fraudulent or oppressive. i. Reasonable expectations test of oppression 1. Reasonable expectations are being substantially defeated by defendant 2. The expectations were objectively reasonable 3. Defendant should or should have know of your expectations 4. The expectations were central to plaintiffs decision to become a shareholder Rule for closely held corporation plan ahead people dont plan ahead because they are starting the corporation with family and friends and dont think it could turn sour and they do not want to spend the monies to hire an attorney to look out for their interests. Duties of Controlling Shareholders 1. Applies only to publicly held corporations 2. Controlling shareholders can be a. Majority shareholders or b. Shareholders that can exert domination through the control of corporate conduct 3. Some courts say majority shareholders do owe fiduciary duties (Sinclair Oil) a. Test to use can either be a business judgment rule i. Defendant will generally win because it is hard to overcome the BJR b. Or intrinsic fairness i. Plaintiff will probably win, because the defendant would have the burden to establishing intrinsic fairness have to show fair dealing and fair price How does the court evaluate a claim of self dealing by a parent company over its subsidiary? 1. If there is self dealing the test the court will use is the intrinsic fairness test? a. When one benefits in its dealings in exclusion of the other party i. In this case the smaller party will win. 2. If there is not self dealing, the court will use the business judgment rule a. In this case, usually the corporation will win

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Business Acquisitions
Upon a merger, the target company shareholder may get cash, shares or a combination of cash and shares Tender offer when acquiring company makes an offer of money for shares Asset Sales 1. Do not need shareholder approval for sale of assets (no matter how large the sale) in the regular course of business 12.01 (1) 2. Do need shareholder approval if following the sale; the corporation would be without a significant continuing business activity. 12.02. a. However if after the sale, the company retains a significant business activity that represented 25% of either total assets at the end of the last fiscal year and it either generated 25% of pre-tax income or 25% of revenue then you dont need shareholder approval Successor Liabilities 1. If you are a buyer and want to avoid successor liabilities a. Pay cash b. Pay an adequate amount of cash (fair price) i. Because creditors will think the company is dissolving and selling its assets for cash to pay them off Hallmark of a de-facto merger include: 1. Continuity of ownership 2. Cessation of ordinary business and dissolution of the acquired corporation as soon as possible 3. Assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation 4. Continuity of management, personnel, physical location, assets and general business operation

Dissolving a corporation
Steps to a voluntary dissolution of a corporation 1. Need board of directors to approve 2. Shareholder need to approve a. Need to have proper notice b. Was there a quorum 27

c. And if so, was there more yes than no votes Voluntary dissolution of a corporation 14.06 & 14.07 1. Creditor gets paid first a. 14.06 applies to known creditors i. Needs to be submitted within 120 days if not claim is barred ii. If you submit a claim and we reject it, you have 90 days to sue us and if you fail to do so, then your claim is barred b. 14.07 applies to unknown creditors i. Take out an advertisement in a local paper (once), within the general county of business, inviting those individuals with monies owed to contact the company to satisfy their debt within 3 yrs, or their claims will be barred ii. In the advertisement you need to include 1. Contact person and address where they can be contacted 2. Then shareholders get whatever profits are remaining. 3. If a claim is not barred and the corporations still had assets that was paid to the shareholders, then 14.07d(2) a. The creditor can go to court and file a claim against the shareholders to get monies back from shareholders, which it should not have gotten in the first place. Generally shareholders are not liable for corporate debts, but here the plaintiff is arguing they are going after what the shareholders should not have gotten in the 1st place. i. Each shareholder is liable for its proportionate amount in the claim ii. There is an overall cap the most they would have to return is the amount they received when the company dissolved and iii. If you want more than that you will have to argue veil piercing

Mergers
Forward triangular merger 1. target company merges into the subsidiary it created Reverse triangular merger 2. the subsidiary of the acquiring corporation merges into the target corporation and the target corporation survives 28

Mergers 1. All liabilities and assets of a target company get acquired by acquiring company. a. Make sure you do due diligence so you dont get surprised with all the liabilities that target company may have before you acquire it. b. Target shareholders stock cease to exist after the merger i. In exchange for cash, stocks or other considerations ii. Merger agreement will tell you what will happen to the target company stocks c. File a certificate of merger with the state i. To alert state that target company will not exist following merger d. Generally both board of directors and shareholders of the target and acquiring company will need to approve merger. i. See exceptions below Merger approvals are they required? 1. Generally all 4 parties (acquiring board of directors and shareholders and the same of the target company )to the merger must agree to the merger a. 11.04g approval of the acquiring company shareholders is not required if i. The corporation will survive the merger (target comp. will always have to approve) ii. Except for amendments provided by section 10.05, its article of incorporation will not change iii. Each shareholder (of the acquiring comp.) with outstanding stock before the date of the merger will hold the same number of shares with the same preferences, limitationetc iv. The issuance (in the merger of new shares)other than for cash and which does not result in an increase of 20% of outstanding stocks (6.21f)

Shareholder remedies 1. Sue board for breaching the duty of care 2. Vote no on the merger 3. Assert dissenter right a. Acquiring company doesnt 29

b. Target company does but the dissenter rights may be taken away under 13.02(b)(1) 4. Sue board (on controlling shareholder) for a breach of the duty of loyalty Dissenters right Allows the plaintiff to have the court (a neutral party) determine the fair value of the share 1. MBCA 13.02 (a): Gives dissenters rights if you are a privately held corporation (b)(1): May take them away if you are a publicly traded company (b)(3): May restore them if you get Neither cash Or other publicly traded stocks

Hostile Takeovers
Only applies to publicly traded companies Tender offer 1. An invitation to shareholders deposit potential shares with the offeror and if certain conditions are met, the offeror will close and will offer you the price tendered. If not, the offeror will return the shares a. Needs to be open for 20 business days (4 weeks) b. Highest price you offer to anybody has to be offered to everyone c. Shareholders have withdrawal rights until closing d. Usually 30% - 40% over market price e. If you buy over 5% of the shares of a publicly traded company you have to file a schedule 13d, within 10 days f. Have to document your intent as to the shares of the company you are purchasing g. If more shares are tendered than you asked for, then you can purchase on a pro rata basis 2. If you do a tender offer, make sure you get a majority of the shares 3. Clean house and get rid of the board of directors who did not want to do the merger 4. Proceed with the merger

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Securities
What is a security? 1. Security is defined in section 2 of the Securities Act a. Stocks, bonds, notes, options i. Look to see if the instrument has the presence of the following features 1. Right to receive dividends 2. Negotiability 3. Ability to appreciate in value 4. Voting rights b. Investment contracts (Howey Test) i. Investment of money ii. Expectation of profits iii. Common enterprise iv. Solely from the effort of others 1. Not through the effort of the investors If you want to offer or sell stocks you can: 1. Either register it (and in doing so, it becomes publicly traded in other words, one class of the companys stock is publicly traded) with the SEC or 2. Find one of the exemptions a. Section 4(2) you dont have to register a securities if it involves a transaction that is not a public offering i. USSC ruled that it only applies to those people that dont need the protections of the Securities Act ii. Every single offeree and purchaser needs to be able fend for themselves and generally wealthy iii. If you offer to even one person who cant fend for themselves, then you cant use Sec 4(2) 1. The purpose of the Securities Act was to better inform the public through the use of company prospectus before investing their monies. 2. The Securities Act applies to any person who is offering a security b. Regulation D 31

i. Rule 504 if you raise below $1million in a 12 month period in a sale of securities 1. can sell to an unlimited amount of people 2. dont have to show they are wealthy or educated ii. Rule 505 if you raise below $5 million in a 12 month period in a sale of securities 1. can sell only to 35 non-accredited investors a. under Rule 501 i. husband / wife count as one ii. can sell to an unlimited amount of accredited investors (must have a $1 million net worth or $200k for last 2 yrs. and expect to make the same the next year or $350k for a couple). iii. Rule 506 there is no limit in the amount of money you can raise 1. Can sell only to 35 non-accredited purchasers a. Same Rule 501 b. Every purchaser who is a non accredited investor has to be sophisticated c. Sec 3(a)(11) Intra State exemption when a corporation did a securities offer, which is offered and sold only to persons resident within one state, where the issuers of the security and the person resident doing the business or the corporation is incorporated in the state it is doing business i. No monies limit ii. No limit to persons offered and sold iii. Only have to show they are resident of that state if offered to a non-resident, cant used Sec 3(a)(11) Integration when the SEC views two offerings as a single offering using the elements below: 1. Single plan of finance 2. Same class of securities 3. At or about the same time a. Doesnt apply generally if you complete one transaction and wait 6 months 4. Selling for cash 5. Same purpose

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Insider Trading
How do you do it? 1. Trading on undisclosed good news 2. Trading on undisclosed bad news Common law insider trading I. II. As long as you dont seek out the client As long as the transactions occurred in a stock exchange a. Then there is no common law insider trading

Insider trading - 10b-5 creates liability for anyone who makes a misleading representation or omission that is connected to the purchase or sale of any security. When analyzing a 10b-5 situation, the following prerequisites must be satisfied I. Was there use a. of interstate commerce b. of facilities of a stock exchange c. Was there a use of the mail Somebody must be buying or selling a security The person doing the buying or selling was in possession of material (reasonable investor test: is this information a reasonable investor would consider important on whether to buy, hold or sell the security Non-public information a. If you have material information, you should i. Disclose the non-public information ii. Or abstain from trading using the material non-public information

II. III.

IV.

Insider trading theories 1. Rule 10b5 (Cady Roberts Duties) a. Classic insider trading subject has Cady Roberts duties if an insider who has confidential material non-public information from a company 33

(meant only for corporate purposes) and has a fiduciary duty not to use the information for personal gain and uses that information in the purchase and sale of stocks. i. A corporate insider must abstain from trading in the shares of the corp. unless he has first disclosed all material inside information to him.

2. Rule 10b5-1 (Dirks) a. Tipper someone who provides material nonpublic information to another i. Must owe a Cady Roberts duty to the company ii. Must breach your Cady Roberts duty when you pass along the information to someone else 1. Test did the tipper get a personal benefit from passing along the information? Yes if: a. There was there a quid pro quo relationship? b. There was a gift of information? b. Tippee i. Someone who receives material nonpublic information from a tipper. ii. Must have known that the tipper was breaching his Cady Roberts duties iii. And the tippee trades on the information or provides the information to others, receives a personal benefit for the tip and someone trades on that information iv. If you do not have a tipper then you dont have a tippee 3. Rule 10b5-2 a. Misappropriation when you buy or sell securities based on material non-public information from a source where you owe a duty of trust or confidence to the source of the information Misappropriation theory 1. If you secretly use non public material information, from a source to buy or sell any securities, to whom you owe a duty of trust and confidence to that source, then you are misappropriating Section 16(b) (only 1 mpc question) 1. Applies to only publicly traded company 2. Applies to: a. Officers b. Directors c. 10% shareholders 34

3. Two or more matched sales a. Within six months of each other b. Produce a profit (sale price is higher than purchase price) c. Profit must be handed over to the company a. If you dont, shareholder can file a derivative lawsuit to make you turn the profits over to the company Completely mechanical; no inside information required

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