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Outline, Bus Org, Moll, Spring 09

1. INTRODUCTION a. Closely Held Business Org i. Closely held corp common law definition: 1) Small number of stockholders (less than 30 is common) 2) Substantial SH participation in the mgmt of the business 3) No market for corp's shares ii. Numerically far more closely held than publicly held companies iii. Lack of a market poses very different issues 1) Makes owners much more vulnerable to majority abuse (lack of an exit) 2) Owners have far different expectations (e.g., involvement in mgmt) b. Types of Biz Orgs i. Sole Proprietorship ii. General Partnership iii. Corporation iv. LLP v. LLC

2. GENERALLY a. Def.: Principles that govern relationships between agents, their principals, and third parties i. B/n agent and principal ii. B/n agents and third persons with whom the agent deals, or purports to deal, on the principal's behalf iii. B/n principals and third persons when an agent deals, or purports to deal, with a third person on the principal's behalf iv. Most common example = employer/employee b. Agent i. A person who by mutual assent acts on behalf of a principal AND is subject to that principal's control 1) General: authorized to conduct a series of transactions involving continuity of service 2) Special: only authorized to conduct a single transaction, or a series of transactions not involving continuity of service c. Principal i. The person for whom the agent acts 1) Disclosed P: T has notice that A is acting on behalf of a principal, and T also knows P's identity 2) Partially disclosed P: T has notice that A is acting for a principal, but T does not know P's specific identity 3) Undisclosed P: When A purports to be acting on A's own behalf, and T has no notice that A is acting for P (perfectly legal, unless T asks and you lie) (see Morris) d. Formation i. Arises when P manifests assent to another person (A) that A shall act on P's behalf and subject to P's control, and A manifests assent or otherwise consents to act as such ii. Although agency relationship is consensual, whether an agency relationship has been created does NOT turn on whether the parties intended to create such a relationship (R3Agency 1.01) e. Morris Oil v. Rainbow Oilfield Trucking (handout, 2) i. P-Morris, claims that Rainbow = agent of D-Dawn when Rainbow incurred indebtedness with Morris (already got default judg against Rainbow, but no assets) ii. Rainbow and Dawn (both oilfield trucking companies) executed K where Rainbow would use Dawn's certificate of public convenience (allowing operations in a particular area) and Dawn
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iii. iv. v. vi. vii.

Dawn's certificate of public convenience (allowing operations in a particular area) and Dawn would get a cut 1) Dawn reserved right to "full and complete control" over Rainbow's operations 2) Rainbow paid operating expenses, under "direct control and supervision" of Dawn 3) Dawn would bill and collect money for Rainbow's services 4) Agreement recited that Rainbow was not to become an agent of Dawn and was not empowered to incur any debt on Dawn's behalf "other than in the ordinary course of business relative to" the mgmt agreement 5) Rainbow would assume defense, compromise, or payment of any claims After Rainbow defaulted on debts to Morris, Rainbow rep directed then to Dawn for pymt Dawn had established escrow acct to settle Rainbow debts, but didn't pay Morris from fund Court finds Rainbow was an agent of Dawn's when debts incurred, so Dawn = liable 1) This = actual (maybe even inherent?) authority and an undisclosed agency Liability incurred by A for an undisclosed P where actions are usual or necessary in such transactions, even where P has forbidden to incur such debts Even assuming arguendo that Dawn was not liable for debts initially, court finds ratification where Dawn kept the receipts due to Rainbow for its operations

3. TYPES OF AUTHORITY a. Actual Authority i. If P's words or conduct would lead a reasonable person in A's position to believe that P had authorized A to act 1) Express: when P orally or in writing conveys authority to A a) E.g., "Go buy a computer from Best Buy, and spend less than $500" b) If P leaves a note on A's desk directing her to buy stock, A has actual authority even if P meant to leave the note for someone else 2) Implied: from words that P uses, from custom and usage, or from relationship b/n the parties (i.e., done this before) a) E.g., The instruction "Go sell my car" authorizes A to take/give possession, etc. b) This is also called incidental authority, where authority extends to incidental actions that are reasonably necessary to accomplish an expressly authorized transaction, or that usually accompany a transaction of that type 3) Limited by terms (e.g., P writes letter to A authorizing him to sell Blackacre, but only after consultation with P A has no authority to sell Blackacre w/o consultation) ii. R3A 2.02 is more generous with this concept and allows actual authority for deviations from instructions if it's consistent with purposes behind the instructions 1) Even if A's actions are within a literal interpretation of P's instructions, may not be reasonable if goes against P's intent as actually known by A 2) Correspondingly, A can act with actual authority in a way that is knowingly at variance with P's original instructions if A believes that a) Circumstances have changed since initial instructions; b) Were P to reconsider, different instructions would have been given; AND c) It is impracticable to communicate with P for further clarification before actions needs to be taken iii. Acquiescence: P fails to object to A performing a series of unauthorized acts 1) Failing to object rather than engaging in affirmative conduct (which = ratification) 2) Is it reasonable for A to believe that P's repeated ratification has created actual authority? 3) SO this is a way of establishing actual authority OR, if T relied on the acquiescence, apparent authority b. Apparent Authority i. If P's words or conduct would lead a reasonable person in the third party's position to believe that P had authorized A to act 1) E.g., P writes letter to A directing him to sell Blackacre; A shows letter to T, a prospective purchaser, and sells Blackacre to T A has actual authority to sell
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prospective purchaser, and sells Blackacre to T A has actual authority to sell Blackacre and, as to T, apparent authority ii. Can also have apparent authority even when there is no actual authority 1) Can come into play when P revokes actual authority after T is aware of the initial grant of actual authority (e.g., in above ex., P revokes authority b/f A sells Blackacre to T) iii. Power of Position: When P puts A in a position (or knowingly allows A to occupy that position) in which according to ordinary habits of persons in that locality, trade or profession, it is usual for such an agent to have a particular type of authority, T is justified in inferring that A has such authority 1) E.g., Appointing A to the position of treasurer, others could reasonably rely on A's ability to write checks for business c. Agency by Estoppel i. When a person who is not otherwise liable as a party to a transaction is nonetheless liable to T who is induced to make a detrimental change in position because of reliance on the appearance of authority if 1) The person intentionally or carelessly caused the belief OR 2) Having notice of such a belief and that it might induce others to change their positions, the person did not take reasonable steps to notify T of the facts ii. This will rarely, if ever, come up because the concept is subsumed by apparent authority 1) One example that may not fall into apparent authority is if P revokes actual authority, A continues anyway, someone notifies P of A's actions, and P refuses to stop A from acting (i.e., omission by P rather than commission) d. Inherent Authority i. When a reasonable person in P's position know that there was a significant likelihood that A would deviate from the instructions? 1) So this would cover situations where there is no actual or apparent authority 2) This is really more of a loss allocation rule rather than a true type of authority ii. R3A does not recognize it as a separate type of authority, but instead broadly defines actual authority to encompass many of the actions formerly included within inherent e. Ratification i. P can be bound by A's actions if P, with full knowledge of the transaction, acts as if he had authorized it (requires affirmative action of some kind, not merely failure to object) 1) Express: P manifests an intention to treat A's conduct as authorized 2) Implied: P engages in conduct justifiable only if P intends to treat A's conduct as authorized ii. Repeated ratification can create actual authority over time iii. Ratification need not be communicated to T to be effective, although it must be objectively manifested 1) But to be effective, ratification must occur before either (1) T has withdrawn or (2) there has been a material change in circumstances that would make it inequitable to bind T unless T chooses to be bound iv. See Morris: P kept proceeds from operations of A that gave rise to indebtedness 4. FIDUCIARY DUTIES a. In an agency relationship, A = fiduciary of P i. R2A 387: "Unless otherwise agreed, an agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected with his agency" ii. R3A 8.01: "An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the agency relationship" b. Fiduciary duty is the highest that the law can impose, where fiduciary must look out SOLELY for the interests of the party to whom he owes a duty (i.e., A's interest aren't even supposed to be considered AT ALL) c. Any profits made in the course of the agency relationship belongs to P i. Can contract out of this, but can never keep profits made by breach of fid duty ii. Upon breach, A liable for all damages, direct and consequential
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ii. Upon breach, A liable for all damages, direct and consequential 1) Wholly irrelevant if P actually profited from A's actions 2) Also irrelevant if P has been made whole by a third party 3) Bright line rule necessary to remove all incentive to screw over P iii. R2A 388: "Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal" iv. R3A 8.02: "An agent has a duty not to acquire a material benefit from a third party in connection with transactions conducted or other actions taken on behalf of the principal or otherwise through the agent's use of the agent's position" d. Tarnowski v. Resop (handout, 19) i. P hires A to scope out a good business deal for jukeboxes ii. A lies and tells P he did the research, when in fact he merely relayed the potential seller's misrepresentations as to the profitability of the business AND took a bribe for recommending them to P iii. Even though P recovered K price from sellers in another suit, A still has to (1) give secret commission to P and (2) pay P's attys fees from bringing first suit e. Reading v. Atty Gen [England] (handout, 23) i. P wore Royal Army Medical Corps uniform when driving a truck of smuggled goods through Cairo for a third party, British gov't seized profits made from trips and P sued for recovery ii. Funds were properly seized because it was only through P's position in the military that enabled him to receive those funds in the first place (wouldn't even matter if P didn't wear the uniform, still in capacity of agent) 5. LIABILITY NOTE: Can alter these liabilities through K provisions a. P liable to T i. If any one of the five types of authority exists, P is liable to T ii. See Morris iii. (Respondeat superior for torts) iv. Why? P set transaction in motion and stood to gain from it AND, generally, T could sue A, so this promotes judicial economy by cutting out indemnification suit b/n A & P and letting T sue P directly b. T liable to P i. Generally T is liable to P whenever P would be liable to T (i.e., when one of the five types of authority exists) ii. Exception for Undisclosed Ps: no liability if either A or P knows that T would never deal w/ P if P's identity was disclosed c. A liable to T (depends on status of P) i. Undisclosed P A is liable 1) Majority rule: Judgment against either A or P discharges the other, even if full pymt 2) Minority rule: Joint and several, only discharged upon full pymt ii. Partially disclosed P A is liable iii. Disclosed P A is not liable (ONLY IF one of the five types of authority exist such that P is also bound to T) iv. Where P is not bound A is liable (i.e., A off the hook only if P is on the hook) 1) Liability on the K theory: recover expectation damages 2) Implied warranty theory: recover reliance damages (R2A 329, R3A 6.10 adopts this theory, but still provides for calculations that afford expectation damages) d. A liable to P i. When A has no actual authority but nonetheless binds P A is liable ii. All the case law involves apparent authority, so technically it's an open Q whether A would be liable under other 4 types, but probably would be e. P liable to A i. When A has actual authority P is liable for all reasonable expenses A incurred when carrying out that authority (includes the K price + costs/damages from defend suit from T)
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carrying out that authority (includes the K price + costs/damages from defend suit from T) f. Policy Rationales i. Ability of enterprise to spread the risk from losses ii. Proper allocation of resources is promoted by requiring enterprise to internalize cost of risk iii. P is in the position to control A's conduct iv. Societal decision that losses should fall on those more able to bear them 6. AGENCY COSTS a. Costs that P would not have to incur if P could be sure that A would always act in P's interest i. Monitoring expenditures ii. Bonding expenditures (insurance, e.g., for torts committed by A) iii. Residual loss b. Ways to combat agency costs and aligning interests i. Stock options, commissions, etc. (reward A for helping P) ii. Lawsuit for breach of fiduciary duty c. Example = executive compensation P (corporation) employs A (CEO) and so interests are not aligned when A wants more money than is good for P 7. TERMINATION i. P always retains the power to terminate agency relationship at any time, but does not have the right, so creates liability for breach of K ii. This is true even if K says A's authority was irrevocable

8. GENERALLY i. Def.: Business owned by a single individual, and is not case in a special legal form of organization i. Most common by number ii. Relationships generally governed by agency law ii. Advantage = easy to establish (simply begin to conduct business) 1) Can file an organic document with the state pursuant to an authorizing statute, but not necessary 2) In some jurisdictions, a proprietor using an assumed name for the biz must also file an "assumed name" or "fictitious name" certificate with the county clerk iii. Disadvantage = Unlimited personal liability for the obligations of that business 1) This is because there is NO separate entity status (i.e., the law does not view the sole prop as a separate business entity from its owner )


9. GENERALLY (119) a. Def.: An association of two or more persons to carry on, as co-owners, a business for profit i. UPA 6(1), RUPA 202(a) ii. Only reason to have one of these today = ignorant, lazy, mistake BUT foundational for other types of biz entities b. Sources of Law i. Uniform Partnership Act (promulgated by NCCUSL, 118) ruled from 19141992 until ii. Revised Uniform Partnership Act (now much more influential, but few cases to guide) c. Choice of Law i. If agreement is silent 1) Rest. 2nd Conflicts 294: court will apply law of the state with the most significant relationship to the p'ship and transaction at issue 2) RUPA 106(a): law of the state in which the p'ship has its chief executive office
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relationship to the p'ship and transaction at issue 2) RUPA 106(a): law of the state in which the p'ship has its chief executive office governs internal p'ship affairs, waivable by contract per 103 ii. Parties can include choice of law provision, which will only be invalidated if: 1) There is no substantial relationship b/n the state whose law is chosen and the parties or the transaction at issue, and there is no other reasonable basis for parties' choice 2) The state whose law would otherwise govern has a materially greater interest in the controversy and has a fundamental policy interest that would be contravened by application of the chosen state's law (Rest. 2nd Conflicts 187) d. Default Rules i. Every partner has a right to perform the p'ship biz and to participate in mgmt of the p'ship ii. Partners have equal voting power iii. Partners share equally in the profits and losses of the p'ship iv. P'ship is liable for Ks entered into by partners acting with actual or apparent authority, for torts committed by partners acting with authority or in the ordinary course of the p'ship biz 1) Partners are jointly and severally liable for these actions WITH unlimited personal liability for the obligations of the p'ship 2) RUPA 305(a), 306 3) The rule that partners are liable to 3rd parties for obligations of the p'ship cannot be varied by agreement v. It takes unanimous agreement to admit new partners vi. Partners owe fiduciary duties to each other vii. Every partner may dissolve an at-will partnership e. Types i. At will (default): no particular term of time or undertaking ii. Term: when a period of time lapses OR when an particular undertaking is completed 1) There must be some evidence that this was intended (see Page, 250) Joint Ventures: Some ppl try to make the argument that a joint venture is a p'ship for a particular purpose and thus is not subject to default p'ship rules but that is NOT TRUE (especially in RUPA jurisdictions, which explicitly states that there is no difference)
f. Advantages i. Structural flexibility partners can contractually arrange to run the biz as they see fit ii. Restricted transferability of ownership interests ability to control who you deal with (this could, obviously, also be a disadvantage depending on your goals) iii. Pass-through taxation 1) P'ship profits are not subject to double taxation (i.e., p'ships profits are taxed only at the partner level , rather than also taxed at the entity [p'ship] level) 2) If p'ship has losses rather than gains, partners may use the losses to offset/shield other income on their individual returns iv. Check-the-box regulations: If you are a non-corporate entity, you get to choose how you want to be taxed; if you don't check any box, you get taxed like a p'ship 1) While no one would really want to do this now, this may change if the tax rates for corporations change g. Disadvantages i. Unlimited personal liability ii. Easy exit of the general p'ship = rather unstable biz form in certain circumstances iii. Taxation and Distributions 1) Gov't treats individual partners as if they earned the profits of the p'ship even if the p'ship never distributes a dollar to partners 2) Unless you're in control of the p'ship, you can't force the p'ship to pay out cash distributions 3) This is an effective way for a majority partner to bring the pain on others 10. FORMATION a. The Test
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a. The Test i. When two or more persons carry on, as co-owners, a business for profit (this is THE TEST) ii. RUPA 202(a): "[T]he association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership" iii. Unnecessary to intend to form a p'ship or to join an existing p'ship as a partner 1) Both positive (can't contract to form a p'ship or state your intent to if meet elements) and negative (can't disclaim intent to form p'ship if you did) b. Factors From Schlumberger [Tex. S.C., 120], illustrative of the test but NOT THE TEST i. An agreement to share profits (a business for profit) 1) UPA 7(4)/RUPA 202(c)(3): this is "prima facie evidence"/"presumption" of a p'ship 2) But both make exceptions to this presumption if profits distributed a) As pymt of a debt b) Wages to an employee or rent to a landlord c) Annuity to surviving spouse or rep of deceased partner d) Interest on a loan e) Consideration for the sale of the goodwill of a biz or other property ii. An agreement to share losses (customary for an owner) iii. A mutual right of control or management of the enterprise (CO-ownership concept) 1) Starkest example of control would be the right to initiate transactions on behalf of the business (affirmative control) but also right to prevent transactions (negative control) iv. A community of interest in the venture 1) No one knows what this means, so courts generally ignore it NOTE: profit sharing and control are the most important, but it's totality of the circumstances on a case-by-case basis
c. Martin v. Peyton (120) i. 3 ppl (PPK) loan a p'ship $2.5 million to stay afloat, when Martin sues claiming that PPK = partners, PPK claims they are lenders 1) We don't know who Martin is, but he's someone who believes the p'ship owes him $ 2) Keep in mind SOR, lower court found no p'ship ii. They were asked to become partners and refused, but court acknowledges that this could be a "mere sham" to hide real relationship iii. An agreement to share profits? 1) Did share profits (which = prima facie, presumed) BUT amount of profits shared is capped (normal = unlimited) and profits were a means of repaying the loan 2) RUPA says getting profits as repayment of a debt negates the presumption of a p'ship (although this itself is not dispositive that a p'ship does NOT exist) iv. An agreement to share losses? 1) No evidence that PPK would share losses either v. A mutual right of control or management of the enterprise? 1) While PPK required that they be fully informed of and consulted before proceeding on many actions of the business and thus exerted some control, it is common for lenders to exert some control 2) PPK could also inspect the books and records of the business, which is normally associated with ownership, but lender could demand similar access in order to protect the investment 3) PPK had the right to veto any transaction they felt was too risky (negative control?), but court finds it to be a proper precaution 4) All employees tendered their resignation to the managing partner, who, in conjunction with PPK, decided whether to "accept" or "reject" the resignation at any time (i.e., they can fire anyone they want); this borders on affirmative control, but while the court finds this "unusual," it not enough to overcome other factors (**and
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while the court finds this "unusual," it not enough to overcome other factors (**and to reverse the lower court**) vi. A community of interest in the venture? 1) Everyone wanted it to succeed, but the term itself is too unclear vii. Could this have been avoided? remember PROFIT SHARING and CONTROL 1) Get rid of the profit sharing say the loan will be repaid at particular intervals, or some other way or eliminating profit sharing 2) Weaken control provisions, with the obvious downside that you lose control d. Lupien v. Malsbenden (123) i. P executed a K for a custom-built car with York Motor Mart, claiming that Malsbenden and Cragin were partners 1) Cragin skipped town after taking some of P's money, so P went after Malsbenden, who claimed he was merely a lender to Cragin's business, like Martin v. Peyton ii. Court rejects Malsbenden's claim that he was merely a lender 1) Lenders make loans, owners make investments a) "Loan" carried no interest b) "Loan" was made in the form of day-to-day purchases of supplies, wages, and other business needs c) "Loan" was repaid upon the sale of each car, not at fixed times 2) Control: Malsbenden also opened the business every morning, had the final say on ordering of parts, paid for parts and equipment, paid employee's salary, dealt with customers, and was still doing biz ("just disposing of property") at the time of litigation iii. Are the Martin and Lupin cases consistent? 1) Probably, they both focus heavily on control and the presence or absence of affirmative control 2) But maybe not, because the inquiry is so fact-intensive and the standard of review on appeal, it is likely that these cases will come out differently every time iv. Problem 3-1 (138) 1) It doesn't look like they share profits they bill separately for their services and there doesn't appear to be a common pool of capital, but you'd have to look closely at how clients are apportioned (do they make individual appts with a specific Dr or do they split walk-ins as the come through the door) 2) They don't seem to have control over one another and they have separate nurses 3) Probably not a p'ship, but look closely at profits e. Partnership by Estoppel i. If you represent that you are a partner or that your business is a p'ship, you are liable as if your business was a p'ship 1) Reps must be made by the purported partner or with her consent 2) UPA 16:Need reliance on private reps, but not on public (even though Baines said you did need reliance) 3) RUPA 308: Reliance is required, whether reps made publicly or privately 4) This is the only way of holding you liable as a partner other than satisfying RUPA 202 (which creates a p'ship in fact) ii. Public v. Private representation of partner status 1) Private: must prove that the purported partner consented to it 2) Public: only have to prove that purported partner consented to the representation, not to the particular party who relied, b/c you must expect that any number of ppl will hear it and rely upon it iii. Scenarios 1) Business is not a p'ship, but owners hold themselves out as partners (reliance on belief that the business was a p'ship rather than the partner status of the individual should suffice here) 2) A p'ship exists, but the person holding themselves out as a partner is not a partner (you would probably have to show that you relied on the partner status of the individual to show sufficient reliance)
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individual to show sufficient reliance) a) But this only kicks in if the p'ship itself cannot pay iv. Cheesecake Factory v. Baines (138) 1) While D was in fact a corporation, P sues claiming that it relied on representations of p'ship before extending credit for foodstuffs a) Kolk, a co-officer of corporation, has held himself out as a partner as did Baines 2) Court first found the representation to be public, so Baines' consent was irrelevant 3) P claims that, b/c reps = public, don't need to show reliance 4) Although two state supreme court cases found that reliance was NOT needed, court determined that reliance on the representation was necessary (and while it is necessary under RUPA, it's probably not under UPA, which governed) 5) Somehow (very attenuated) found the evidence was sufficient to find that P relied on the fact that biz was a p'ship AND that Baines himself was a partner a) P said that it would not have extended credit if it knew that D's business was not a p'ship NOT ENOUGH, must actually rely on the fact that the person you are seeking to hold liable was a partner, not just that you relied on the p'ship status of the business b) Statute does NOT speak to which type of reliance is needed f. Aggregate v. Entity Status i. Aggregate theory: A p'ship is seen only as an aggregate of its members and thus dissolution occurs and a new p'ship is formed whenever the makeup of the partners changes at all 1) While most business organizations are seen by the law as separate legal entity, the law has traditionally seen p'ships as an aggregate of its members and legally indistinct from its parts 2) UPA 29: "The dissolution of a p'ship is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on...of the business" 3) UPA 41(1): Creditors of a "dissolved p'ship" (defined as where membership changes without liquidation) are also creditors of the "p'ship so continuing business" a) Comment also says that any change in membership (i.e., leaves or joins) dissolves the old p'ship and creates a new p'ship ii. Entity theory: the modern trend is to see a p'ship as a separate legal entity 1) RUPA 201: "A p'ship is an entity distinct from its partners" 2) To avoid problem posed by Fairway (where there would still have been dissolution even under 801(1)), rely on 802(b), where partners can by unanimous consent agree to continue a p'ship that has been dissolved if winding up completed iii. Why does this matter? 1) Dissolution rules are completely different 2) Unless UPA jurisdiction has additional statute allowing a p'ship to sue in its own name, all of the partners must join as plaintiffs to enforce an obligation owed to the p'ship a) Flip side: Unless juris has statute allowing a p'ship to BE sued in its own name, a plaintiff seeking to enforce p'ship obligations must sue each partner 3) Another example: banks are oftentimes forbidden by statute from loaning $ to any director; if Bank loans money to partnership A+B+C and B is a bank director, the loan would probably be illegal under the aggregate theory but not under the entity theory iv. Fairway Development v. Title Insurance Co. (145) 1) Purchasers sues p'ship (development co.), claiming that there was an undiscovered easement on their land, P-p'ship looks to D-title insurance co. to cover losses 2) D claims that P is not insured b/c the membership of the p'ship has changed since the policy was issued 3) State adopted UPA, and, applying aggregate theory, court agrees w/ insurance co. and finds that plaintiffs were not technically insured b/c partnership membership changed (i.e., no standing to sue) 4) Could this have been avoided? a) YES, should have put into the policy that it covers successor p'ships in addition to current membership form AND that successor p'ships would have standing
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to current membership form AND that successor p'ships would have standing 11. MGMT and CONTROL a. Sources of Law i. UPA 18(e)/RUPA 401(f): Each partner has equal rights in the mgmt and conduct of the p'ship biz 1) So, even if you're in the minority, you have the right to be informed and involved in the p'ship biz (but remedy??) ii. UPA 18(h)/RUPA 401(j) say that changes in ordinary biz decisions must (it says "may" but it has been interpreted to be mandatory) be made by a majority of the partners 1) Acts in contravention of the p'ship agreement must be unanimous (same sections) iii. RUPA 303(a)(2): p'ship can file statement of p'ship authority, which can explicitly limit the authority of partners to engage in certain transactions on behalf of p'ship b. Default Rules i. One partner, one vote (irrelevant what % of profits or ownership shares) ii. Texas default rule = ordinary p'ship matters are decided by partners with a right to a majority of the PROFITS iii. This makes sense because capital investment generally corresponds with risk assumed, BUT you're really not assuming more risk in a general p'ship where you have unlimited personal liability (essentially investing all your personal assets, too LOOK FOR: What is the ordinary course of business for the p'ship and who is looking to change it? c. Summers v. Dooley (151) i. S & D are partners in a trash collection biz, S wants to hire a third employee but D does not agree; S hires someone anyway and sues D for half of the salary 1) Technically, S should have sued the p'ship under RUPA 401(b)(c), then come after D only if the p'ship cannot pay ii. Because ordinary biz decisions require a majority, in a two-person p'ship, each person has veto power iii. Remember: this is only a default rule, they could have made an p'ship agreement that stated otherwise iv. Potential arguments for S 1) Implied p'ship agreement (RUPA 101(7)) by conduct when D dropped out of the biz for a while BUT probably not b/c S consulted D before hiring the employee (would distinguish Parks) 2) Ratification? No, b/c he explicitly said that he didn't want to hire v. Policy: A bit unfair that D gets the benefit of the added employee and didn't have to pay BUT probably more important to discourage partner's unilateral decisionmaking d. Parks v. Riverside Ins. (15354) i. Partners may agree that, as among themselves, one or more of them shall have exclusive control over the mgmt of the p'ship business and that agreement for exclusive control may be implied by the conduct of the parties e. National Biscuit v. Stroud (154) i. One partner said stop selling us bread (and he wouldn't be responsible for further shipments), the other partner said keep selling us bread ii. P'ship defaulted and seller went after the partner that said to stop selling iii. Partner was found liable why? 1) Can be distinguished from Summers b/c buying bread consistently was the ordinary course of biz and stopping was actually the change that would require majority assent 12. FINANCIAL RIGHTS & OBLIGATIONS a. Capital Accounts i. In the absence of an agreement to the contrary, if the business were sold for cash, each partner would be entitled to receive an amount equal to his or her capital contribution, if available
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available 1) Profit shares: amount a partner has earned and reinvested in the firm 2) Draw: earnings or capital taken out of the firm (cash pymts) a) Even if p'ship is operating at a profit, partners are not automatically entitled to receive a cash pymt b) Default is that draw is determined by majority vote of partners c) Add profit amount to capital funds, then deduct amount of draw ii. Capital accts are not meant to correspond to values in the firm but are instead intended to reflect the relative claims of the partners to the assets of the p'ship 1) Keep track of relative claims where initial contributions and profit shares differ 2) Most important in the cases of w/d of a partner or liquidation of a p'ship iii. Remember default: equal sharing of profits and losses regardless of capital contrib 1) So if you didn't contribute any capital, business suffered a loss, then was sold you could be required to pitch in equal share of losses (though there is some authority relieving partner of this debt to the extent he contributed services without adequate compensation) iv. Upon sale of business 1) If sold for more than is contained in the capital accts, distribute as previously unrecorded profits 2) If sold for less, distribute as previously unrecorded losses v. Deduct depreciation of business from gross revenues at p'ship level and allocate according to profit share (default = equally) vi. Could keep books by adjusting capital accts annually, or could record separate set of accts b. Default Rules i. UPA 18(a)/RUPA 401(b): If no agreement about profit-sharing, default rule = each partner gets an equal share of profit and losses regardless of her capital investment 1) Capital Investments: A = 5% B = 5% C = 90% still share equal profits and losses if no agreement ii. If you have an agreement about profits but not losses, losses follow profits BUT if you have an agreement about losses but not profits, profits do NOT follow losses 1) If agree to split losses 40-60, still share profits 50-50 iii. UPA 18(f)/RUPA 401(h): A partner can't get remuneration for services performed for the p'ship, except for reasonable compensation for services rendered in winding up p'ship affairs iv. UPA 9/RUPA 301 agency 1) (1): a partner is an agent of the p'ship and binds the p'ship unless partner had no actual authority AND the third party knew the partner had no actual authority a) Worried about partner binding you? Tell the third party he has no authority 2) (2): a partner's act does NOT bind the p'ship if it is not for carrying on the p'ship business "in the usual way" and it not authorized by the other partners c. $ Upon Dissolution i. UPA 40/RUPA 807: When a p'ship is dissolved, who gets the $? 1) First, p'ship creditors 2) Second, if there is $ left over, you pay back the partners for their capital contributions 3) Finally, if there is still $ left over, you count it as profit and pay out 4) If you don't pay (1) and (2), you have a LOSS d. "Services Partner" i. If you contribute services to a p'ship but no money, common law says that the value of those services do NOT count as a capital contribution and services partner gets nothing on dissolution 1) BUT can have an express OR implied agreement to the contrary 2) Odd b/c other partner obviously values the services, or you wouldn't be a partner ii. However, must distinguish between non-cash capital contributions to p'ship (ok if agreed) and compensation or remuneration for a partner's personal services performed in the day to-day affairs of the p'ship (usually prohibited by statute, UPA 18(f))
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to-day affairs of the p'ship (usually prohibited by statute, UPA 18(f)) iii. This is especially awful when p'ship sells for a loss (see 3-3, pg. 171), so courts will often stretch to imply an agreement (Kessler) e. Schymanski v. Conventz (163) i. S & C form p'ship to construct and operate a fishing lodge in Alaska (oral agreement) ii. C claims that parties agreed that C would play a greater role in construction and mgmt and contribute services in lieu of further cash contributions 1) Trial court found that C contributed $70,000 (50K for architectural services and 20K for mgmt) iii. General rule that partner contributing personal services is NOT entitled to any share of p'ship capital pursuant to dissolution, but may qualify as capital contributions where an express or implied agreement exists iv. Remand to determine if non-cash capital contribution or prohibited remuneration f. Kessler v. Antinora (167) i. K-P provided capital investment for real estate project, and A -D was to provide services as general contractor 1) P'ship agreement stated that profits would be split 60(P)-40(D), but silent as to losses 2) House eventually sold for about $80K less than it cost to build ii. P sues D for half of the loss he took on the house (plus money for another "loan" to p'ship) iii. Court reverses finding of liability agreement silent as to how P's potential lost money would be repaid but also silent as to how D's lost labor would be repaid iv. Refuses to apply default rule of splitting profits and losses v. 2 ways to get to the same result: 1) "[W]here one party contributes money and the other services, in the event of a loss, each loses his own capital one in the form of money, the other in labor" 2) Parties "have implicitly agreed, by their conduct and contract, to share profits and that their contributions of money and sweat equity have been valued in an equal ratio. Thus, upon the loss of both some money and labor, the loss falls upon each proportionately without any legal recourse" 13. LIABILITY TO THIRD PARTIES a. Generally i. Under UPA, any 3rd party may collect the entirety of any p'ship obligation from any partner, may do so under RUPA if judgment against p'ship goes unsatisfied ii. Types of liability 1) Joint: one person can still be liable for 100% of the damages BUT you must sue ALL the partners 2) Joint and Several: can sue only one partner and collect the whole judgment (even if you own 1% of the p'ship, P can sue you for 100% of the damages) iii. RUPA 307: 1) (a): P'ship may sue and be sued in its own name (entity theory) 2) (b): An action may be brought against p'ship AND any or all partners in the same or separate actions if not inconsistent with 306 (see below) 3) (c)(d): Exhaustion Rule: Cannot collect judgment against the partner unless creditor has a separate judgment against the partner AND a) He has unsuccessfully tried to enforce the judgment against the p'ship ; i) So you have to go after the p'ship's assets first before you turn to the assets of the partner ii) NOTE: this is vicarious liability, so you can go after a partner directly when the partner was directly liable for the injury b) P'ship is in bankruptcy; c) Partner has waived exhaustion requirement by contract; d) Court waives exhaustion requirement; OR e) Partner is independently liable to the claimant iv. UPA 18(b)/RUPA 401(c): Indemnity
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iv. UPA 18(b)/RUPA 401(c): Indemnity 1) A partner is entitled to indemnification for payment of a p'ship obligation 2) E.g., This is how Summers would have recovered in Summers v. Dooley (151) v. UPA 18(a)/RUPA 401(b): Contribution 1) If the p'ship is unable to pay, partners must contribute according to their loss shares 2) Partners may also be required to contribute to satisfy creditors on dissolution (UPA 40(b)/RUPA 807(a) vi. UPA 4(3)/ RUPA 104(a): law of agency applies (but start with other sections) 1) See 182 for agency principles commonly applied for fraud and mismgmt of funds **A partner can demand indemnification from the p'ship; the p'ship may demand contribution from the partners if it is unable to pay** SO even though it seems to the outside world that all partners have unlimited personal liability for p'ship, in reality (**assuming all parties are solvent**) each partner is only liable for their loss share after claims for indemnification and contribution are satisfied a. Contract i. Has a partner bound the p'ship? Look first UPA 9/RUPA 301 (always go from specific to general, do NOT start with agency law) 1) Each partner is an agent of the p'ship for the purpose of the business (with all responsibilities of an agent, including owing a fiduciary duty) 2) An act of a partner for apparently carrying on in the ordinary course of p'ship business or business of the kind carried on by the p'ship binds the p'ship a) This will be fact-intensive (does this p'ship or similar p'ships normally do this type of thing in the ordinary course of biz?) (See Burns) b) Some courts have found the burden to be on party seeking to hold nonparticipating partner accountable (See Burns) 3) UNLESS you had no actual authority and the third party knew 4) If no apparent authority, may be actual authority procured by consent of majority of partners ii. What is the extent of liability? 1) UPA 15(b): jointly liable for p'ship contractual obligations (must sue all partners together in a single action), so easier to sue in tort 2) RUPA 306 a) (a): partners are jointly and severally liable for all p'ship obligations b) (b): partner joining existing p'ship is not liable for obligations incurred prior c) So easier in one respect b/c claimant can sue p'ship and partners BUT exhaustion rule = add'l hurdle iii. Burns v. Gonzalez (173) 1) Partner executed promissory note, purporting to act on his own behalf and on behalf of radio station p'ship, w/o other partner's knowledge 2) Had no actual authority to execute note, but contract claimant did not know, so issue is whether such an obligation can be considered an act "for apparently carrying on in the usual way the business of the p'ship" (UPA 9(1)) a) Look at how other firms engaged in the same business in the same locality conduct business and how this firm specifically conducted business in the past 3) Parties presented no evidence on this issue, but outcome depends on burden of proof, and court finds burden is on person seeking to hold non-participating partner accountable a) No evidence that this sort of credit extension was common (obj or subj) 4) B/c no evidence presented, court looks to agency law to fill in gaps (specific gen) b. Tort i. Is the p'ship liable? Look first UPA 13/RUPA 305
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i. Is the p'ship liable? Look first UPA 13/RUPA 305 1) P'ship responsible for tort committed by a partner acting in the ordinary course of business OR with authority of the p'ship 2) Similarly to K situation, main inquiry is whether action was in the ordinary course of business (is this the type of thing a partner would normally do?) ii. What is the extent of liability? 1) UPA 15(a): partner are jointly and severally liable (so can sue together or individually) for tort and breach of trust claims, easier to sue here than contract a) Remember must sue individual partner, not the p'ship, for p'ship obligations b/c aggregate theory 2) RUPA 306 a) (a): partners are jointly and severally liable for all p'ship obligations b) (b): partner joining existing p'ship is not liable for obligations incurred prior c) See above for exhaustion rule iii. Sheridan v. Desmond (178) 1) P-tenant seeks to hold D-landlord (who owned building as tenant in common with other D, who managed property) for tortious acts resulting in wrongful eviction a) Blocked fire exits, resulting in forced closure of P's club 2) Look at whether a) This is the kind of thing a partner would normally do b) Occurred substantially within authorized time and geographic limits of p'ship c) Was motivated at least in part by a desire to serve the p'ship's interests 3) Court holds that D is NOT liable for her partner's actions a) While eviction is within the normal course of a landlord, it is NOT normal to illegally, forcefully evict ppl (and generally act insane like this) b) Barriers blocking fire exits were not erected on D's property, but on adjacent (so not within geographic limits) c) Insuff showing that insanity was meant to further p'ship interest 4) Court also finds that D's grant of authority to manage business did not = authorized partner's tortious actions a) See 181 for list of actions included in general authority to manage business c. Enforcing Liability i. Thompson v. Wayne Smith Constr. (182) 1) WS procured a judgment against T's p'ship and attempted to collect a) S. Carolina: original suit for breach of K, judgment entered against each partner individually, Ct. of App. affirmed judgment against p'ship but vacated as against individual partners WS did NOT appeal b) Ohio: registered judgment in Ohio and recovered what remained of p'ship assets, then instituted new action and procured judgment against partners individually, Ohio S.C. eventually affirmed but limited each partner's liability to a pro rata share (i.e., each for 1/3 of judgment) c) Indiana: while on appeal to Ohio S.C., brought action against T individually and procured judgment against him (we're in the Ind. Ct. of App.) 2) S.C. court held that WS would have to prove contracts with each individual partner in his individual capacity in order to collect (entity theory) 3) T claims that court should apply full faith and credit and res judicata to S.C. judgment and hold that T liable individually 4) Exhaustion rule: p'ship creditor must try to satisfy judgment from p'ship property before reaching individual property (whereas individual creditor can attach at any time) a) Court reads S.C. decision as merely establishing WS as a p'ship creditor rather than an individual creditor, not that WS can never collect from partners individually (T concedes that p'ship assets are exhausted) 5) Also finds no basis for limiting liability to pro rata share (only difference b/n joint and J&S liability is who must be sued)
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J&S liability is who must be sued) 6) Full faith and credit requires only that S.C. decision be followed b/c went to the merits (existence and amount of liability), not Ohio b/c interp legal term (joint liability)

14. OWNERSHIP INTERESTS & TRANSFERABILITY a. Nature of Interest i. Is a p'ship interest a security under federal securities law? 1) If so, fraud in connection with its purchase or sale may be punished under anti-fraud provisions of fed securities law 2) Also, may not be sold to the public without going through detailed registration and disclosure process 3) SEC v. W.J. Howey (231) a) To determine if an interest constitutes a security under catchall phrase, show i) Investment contract (requires volitional investment decision on the part of the purchaser) ii) In a common enterprise (horizontal, or sometimes vertical, commonality) iii) With the expectation of profit solely (really predominantly) from the efforts of others 4) Third prong leads most courts to say p'ship interest is NOT a security because of a partner's right to participate in mgmt (legal or actual?), but see Williamson, 232, for occasion where p'ship interest may = security) b. P'ship Property i. Why determining if property belong to p'ship is important 1) Status determines how prop may be conveyed by p'ship or partners 2) If belongs to p'ship, proceeds go to p'ship 3) If belongs to p'ship, partners cannot separately convey tenancy 4) If belongs to p'ship, individual creditors cannot seize to satisfy judgment 5) Must be counted among assets sold to provide each partner with distributive share upon dissolution ii. UPA 8 How to tell if it's p'ship property 1) (1): p'ship property = "all prop originally brought into or subsequently acquired by purchase or otherwise, on acct of the p'ship" 2) (2): presumption that prop bought with p'ship funds is p'ship prop 3) (3): real estate may be acquired in the p'ship name iii. UPA 10 Partner's ability to transfer p'ship REAL property Distinguishes between legal and equitable title holder of equitable title may enforce right to have legal title transferred to holder of equity, but will lose to subseq BFP of legal title 1) (1): If title is in the name of the p'ship, any partner can transfer by title executed in the p'ship's name a) P'ship can recover the property unless partner had authority under 9(1) or if BFP for value had no knowledge of lack of authority 2) (2): When title is in p'ship name, conveyance executed by a partner in her own name transfers equitable title if partner had authority under 9(1) 3) (3): When title is in some but not all of partners' names and record doesn't disclose right of the p'ship, those partners in whose name the prop is held may transfer a) P'ship can recover the property unless partner had authority under 9(1) (in which case the conveyance passes equitable title, 10(4)) or if BFP for value had no knowledge of lack of authority 4) (5): When title is in the name of all partners, conveyance executed by all partners passes their rights in the prop iv. UPA 25 1) (1) made up an entirely new way of property ownership "tenants in p'ship" 2) But (2) strips the partner of all aspects of individual ownership (basically don't have any individual rights in your bundle) except for use for the p'ship
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any individual rights in your bundle) except for use for the p'ship a) Can't use p'ship prop for non-p'ship purposes b) Can't assign interest c) Interest is not subject to attachment or execution of a personal claim against a partner, nor to dower, curtesy, or allowance to widows, heirs, or next of kin d) Upon death, partner's interest is vested in surviving partners 3) This was necessary b/c, under aggregate theory, p'ship can't own property b/c it's not an entity, but it really just allows the p'ship to own property in a roundabout way v. RUPA 203 1) All property acquired by p'ship belongs to the p'ship, not the partners 2) Logically follows entity theory expressed in 201 vi. RUPA 204 How to tell if it's p'ship property 1) (a): It's p'ship property if acquired in the name of a) The p'ship; or b) One or more partners with an indication in the instrument transferring title of the person's capacity as a partner or of p'ship's existence w/o indicating name 2) (b): Prop is acquired in the name of the p'ship if transferred to a) The p'ship in its name; or b) One or more partners, in their capacities as partners, if name of p'ship is indicated in instrument transferring title 3) (c): prop acquired with p'ship assets is presumed to be p'ship property, even if not in the name of the p'ship or indicating in instrument transferring title 4) (d): prop not acquired with p'ship assets, in partner's name, without indication in instrument transferring title is presumed to be separate prop vii. RUPA 302 Partner's ability to transfer p'ship property, REAL and PERSONAL 1) Similar to UPA, except a) Doesn't distinguish between real and personal property b) Makes no provision for the passing of equitable title viii. RUPA 303(e) Statement of Authority 1) By allowing p'ship to file statement of p'ship authority in the office for recording transfers of real prop (constructive notice), provides a mechanism to protect p'ship from claims of apparent authority and allow recovery ix. RUPA 501 1) Each partner has no interest in p'ship property that can be transferred c. Transferring P'ship Interest i. The party purchasing financial rights is a transferee, not a partner ii. RUPA 101(9) Two Prongs of P'ship Interest 1) Financial Rights a) Right to distributions, if any b) Right to share of profits/losses 2) Mgmt Rights a) Right to participate in mgmt (receive info, etc.) b) Right to use p'ship property iii. UPA 27(1)/RUPA 503 1) (a): Two types of interests are divisible "in whole or in part" 2) (b): Transferrable Interests a) Right to distributions (pre-dissolution) b) Right to distributions (at dissolution) c) Right to petition for dissolution i) This does NOT include financial obligations of the p'ship, so transferor must retain liability here (even though 502 says profits/losses, this only means the distributions you are entitled to at dissolution) 3) The ONLY rights a partner can unilaterally transfer are FINANCIAL rights (we know this b/c neither 502 nor 503 says anything about needing consent to transfer financial rights)
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rights) iv. Transferring partner retains mgmt rights 1) So it's possible that you wind up with a partner that has full mgmt rights but no financial rights whatsoever 2) Although that may be grounds to disassociate that partner v. UPA 18(g)/RUPA 401(i): If you want to be admitted as a full partner with both financial and mgmt rights, you need the unanimous consent of all partners 1) This makes sense in light of the unlimited personal liability for p'ship obligations vi. Rapoport v. 55 Perry Co. (195) 1) Two families (Rapoports and Parneses) form p'ship, w/ each family getting 50% 2) Rapoports transfer 10% of their p'ship rights to their adult children a) Rs claim that the p'ship agreement altered the default rules (need unanimous consent to admit full partners) and allowed adult children to become full partners w/o consent b) Ps claim that the provision in question only allows transfer of financial rights to adult kids w/o consent 3) Ps interpretation actually makes the agreement more stringent than the default rule, where financial rights may ONLY be transferred to adult kids (whereas default rule would allow transfer of financial rights to anyone) 4) Court finds that, although you can change default rules by agreement, language of p'ship agreement indicates an intent to follow UPA, so kids can have financial rights but no mgmt rights (odd for MSJ) d. Rights of Partner's Creditors i. Generally, a creditor has the capacity to seize any property that a person has the right to assign ii. P'ship interest is personal property (see RUPA 502) but can't seize it like other personal property 1) This makes sense b/c allowing forced sale of p'ship interest would present the same problem of liability and mgmt rights iii. UPA 28/RUPA 504 1) (1), (a): Charging order = court order issued to a creditor that says any cash distributions that would otherwise go to the debtor-partner now goes to the creditor with the order (THIS IS THE ONLY REMEDY THAT A CREDITOR OF A PARTNER HAS) a) This creates a lien on the partner's transferable interest (financial rights) b) This does NOT include profits/losses ONLY distributions c) This only includes the first two parts of the financial interests, not the right to petition for dissolution UNLESS the creditor forecloses on the order THEN the holder becomes a transferee i) Once underlying obligation is paid off, charging order disappears ii) Before charging order, p'ship interest was seized like any other asset and resulted in massive disruption of p'ship business 2) (2), (b): Foreclosure If you have trouble collecting on a charging order (e.g., there may be no distributions made and order is rendered useless), you may try to sell it a) SO can foreclose on the charging order to recoup some of the loss b) BUT why on earth would anyone want to buy the charging order when the prior creditor didn't have any luck getting distributions ?? i) May just be desperately trying to recoup losses ii) If you buy at a foreclosure sale, you become a transferee SO you can demand dissolution under certain circumstances under RUPA 801(6) (dissolution forces distributions) 1. So you might want to buy it yourself so you're no longer a lienholder, but are instead a transferee iii) You also get the right to indefinitely collect distributions, rather than that right disappearing on repayment of the debt c) RUPA has no restrictions when a court can order foreclosure ("may order ... at
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right disappearing on repayment of the debt c) RUPA has no restrictions when a court can order foreclosure ("may order ... at any time"), so may occur even if it would severely disrupt p'ship business (but see Hellman for common law gloss) iv. Forced Dissolution 1) UPA 32(2)/RUPA 801(6): Foreclosing purchaser may cause judicial dissolution of the p'ship if the p'ship term has expired or, if p'ship at will, any time the charging order is obtained v. Bankruptcy 1) UPA 31(5): Judgment creditor can cause dissolution by putting debtor-partner into bankruptcy 2) RUPA 601(6)(i): debtor-partner's bankruptcy causes dissociation, not dissolution (both partner and p'ship in bankruptcy? See 19899) a) 801(1): other partners may choose to dissolve as a consequence b) 701(1): if other partners choose to continue, dissociated partner has right to be bought out vi. Hellman v. Anderson (199) 1) H-creditors have a settlement judgment against A-debtor/partner and sought to foreclose on A's partnership interest (80%) 2) Though H obtained a charging order, never got any funds b/c p'ship was not generating profits and was not expected to in the near future, H seeks foreclosure 3) A claimed that a court may not order foreclosure of p'ship interest unless nondebtor partners consent (relying on decision of equivalent court, i.e., not binding) 4) Court rejects statute (equivalent of UPA 28(2), which allows charging of interest "at any time before foreclosure") clearly authorizes judicial foreclosure and doesn't explicitly require consent of nondebtor partners 5) Common law gloss on statutory provisions regarding foreclosure, where a court may only order foreclosure if it would not unduly interfere with p'ship business (RUPA has no such restriction) 15. FIDUCIARY DUTIES a. Generally i. Fiduciary = Must subordinate your interests to the interests of another ii. Partner owes it to other partners as well as to the p'ship itself iii. Disclosure/Loyalty 1) Every partner has a duty to make full disclosure of all material facts relating to the p'ship biz when necessary to allow other partners to safeguard their rights 2) Can't steal a p'ship opportunity for yourself, even if you disclose it a) What is a p'ship opportunity? iv. What are the limits? 1) You are an owner and are allowed to be selfish, and so you don't have to completely subjugate your interests altogether 2) This is in contrast to an agent, where you have no rights at all to be selfish 3) So this isn't really a "true" fiduciary relationship where you have an ownership right and are on equal footing with other owners v. So why make this the default? 1) Perhaps a way of saving transaction costs most ppl would contract for fiduciary duties so law does it for you b. Sources of Law i. UPA 19 1) Must keep books and make them available to partners for inspecting and copying ii. UPA 20 Disclosure 1) "Partners shall render on demand true and full information of all things affecting the p'ship or any partner..." 2) Compare RUPA, where obligation is affirmative and other partners need not ask 3) But common law requires broader disclosure obligations (see Meinhard)
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3) But common law requires broader disclosure obligations (see Meinhard) iii. UPA 21 Loyalty 1) Must account to the p'ship for any benefit, and hold as trustee profits derived from, any transaction connected with the formation, conduct, or liquidation of the p'ship or from any use of p'ship property without the consent of other partners 2) By literal terms, prohibits self-dealing without consent of other partners but silent as to usurping p'ship opportunities (but common law violation, see Meinhard) 3) How far does consent go? See Singer, where it's possible that a p'ship agreement allowing competition among partners could be construed as generalized consent iv. RUPA 403 Disclosure 1) (b): informational: p'ship must provide partners access to books and records 2) (c): must provide certain information a) (1): EVEN if no one asks for it, must provide any info reasonably required for the proper exercise of a partner's rights and duties under the p'ship agreement or default rules b) (2): WHEN someone asks, must provide any other info concerning p'ship business or affairs unless unreasonable or improper 3) 103(b)(2) says you can restrict the right of access to books and records per a p'ship agreement 4) Is this even a fiduciary duty? 404 says loyalty and duty of care are the only fiduciary duties, then those are narrowly defined (can work it into duty of care) v. RUPA 404 1) Applies only to "conduct" and "winding up", NOT to formation 2) (a): The ONLY fiduciary duties owed to the p'ship are duty of care and loyalty 3) (b): Duty of loyalty limited to: (1) Account for and give any benefit, profit, or property in the conduct or winding up for p'ship business derived from use of p'ship property, including appropriation of p'ship opportunity (eliminated UPA's inclusion of formation phase) (2) Refrain from dealing with p'ship as or on behalf of a party have an interest adverse to the p'ship (3) Refrain from competing with the p'ship before dissolution Can restrict the scope (see 103(b)(3) below) 4) (c): Duty of care is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or knowing violation of the law a) Bane: no violation for negligent mismanagement, limited to gross 5) (d): contractual obligation (not a duty) to act engage in good faith and fair dealing (this is not a fiduciary duty but rather an implied covenant) 6) (e): no violation merely b/c conduct furthers the partner's own interest a) This can be read broadly or narrowly, recognizes that this is not a true fiduciary relationship, or partner would always subordinate to interests of the p'ship b) Can you contract with the p'ship on fair terms? (i.e., a fair conflict of interest transaction) i) Maybe this is meant to align p'ship law with corporate law (corporate selfdealing ok when actor can validate her conduct by proving transaction was fair to the p'ship)? ii) But we don't want our fiduciaries taking adverse positions to the p'ship; we're only ok if all consent under 103 SO maybe it's ok under corp law b/c it's essentially impossible to get unanimous consent from all shareholders c) 404(b)(2) says nothing about fairness, so it's conceivable that it's never ok d) Perhaps this provision is recognizing that this isn't a traditional fiduciary duty (and so can be selfish to some extent), and you just can't disproportionately harm the p'ship for your own benefit (can argue this is what "merely" means) i) Comment gives the example that a partner can vote against the opening
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i) Comment gives the example that a partner can vote against the opening of a shopping center that would compete with your shopping center ii) But this seems to be reading the word "unfair" into (b)(2), but this could really be read to modify that provision e) Enea: gives this provision a de minimis role where a partner simply need not account for a minor or incidental benefit w/ no harm to p'ship (but note that the actions by partners in this case would be wrong under any interpretation) f) Probably have to contract out of it per 103 7) (f): partner can lend money to and transact other business with the p'ship AND you will be treated like any other party (i.e., no fiduciary duties [???]) a) Read literally, this completely negates the entire rest of 404 b) The very few cases looking at this (see note 6, pg. 812), which have read it extremely narrowly to say that it only allows the lending of money and transactions RELATED to that loan (e.g., buying a security interest in the p'ship, take other collateral, buying at a foreclosure sale) c) "Subject to applicable law" includes laws like fraudulent transfer, etc.
***Because 404(e) and (f) are so confusing, it's likely that a court will read them very narrowly (and you won't be able to rely on them to CYA)***

vi. RUPA 103 You cannot eliminate fiduciary duties by contract (except in Delaware, 219) 1) (b)(3): While you can't eliminate duty of loyalty under 404(b), but you can define categories of activities that don't violate the duty of loyalty if a) (i) Exceptions are not "manifestly unreasonable" OR b) (ii) Partners can ratify the action after the fact as not being a violation c) So you can't eliminate the duty, but you can carve out parts of it i) If you've taken out all duties of 404(b), it's probably unreasonable, but it's unclear how far you can push it (e.g., eliminate most, but not all) ii) So maybe you can self-deal if it's fair? iii) Undercuts goal of certainty but preserves judicial discretion d) This is paternalistic, but necessary? (Delaware adopted RUPA but permits total elimination of partner fid duties) 2) (b)(4): cannot "unreasonably reduce" the duty of care 3) (b)(5): cannot "eliminate" duty of good faith and fair dealing, but can prescribe standards if not "manifestly unreasonable" 4) Does not address duty to make disclosures pursuant to 403(c), so these may be varied or eliminated by agreement 5) See Singer for extent to which partners can eliminate fid duties c. Issues i. Fiduciary duty is a nebulous concept, and thus it's unclear what duties are encompassed 1) So greater chance of winding up in litigation (easy suit to bring, not so much to win) 2) Can't fully contract around this either (as opposed to other default rules) 3) But you can't really define it b/c humans can always come up with new ways to screw each other (so the very vagueness of the rule is an added deterrent) ii. Though ill-defined, definite benefits 1) The narrowed the discretion afforded, the less likely you'll abuse it iii. There are legitimate reasons to get rid of fiduciary duties 1) Active monitoring of p'ship mgmt can replace the need for fid duty, and p'ship is unique that you have the legal right to participate in mgmt 2) Contracts may deal with these problems more effectively 3) Easy exit from p'ship already acts as a deterrent to screwing around d. Defenses i. Did you come to know of the opportunity b/c of your capacity as a partner? May or may not be relevant if you learned of it in another (e.g., personal) capacity ii. Financial incapacity (some jurisdictions allow)
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ii. Financial incapacity (some jurisdictions allow) 1) Even if p'ship is broke and couldn't pursue the opportunity anyway, that doesn't give rise to the assumption that the partner doesn't need to tell the p'ship 2) Policy: don't want to incentivize driving p'ship into dire straits iii. Refusal to deal (some jurisdictions allow) would allow the partner to claim that the third party would never have dealt with the other partners (risk = collusion) iv. Triple Five v. Simon (212): 1) P'ship's lack of financial ability to pursue an opportunity negates the p'ship claim to the opportunity 2) Refusal to deal is an equitable defense that a party can assert only if the refusal was unambiguously disclosed and not the result of some "nefarious actions" on the part of the partner e. Remedies i. UPA 1) 22(c): right to an accounting (an all-encompassing review of p'ship affairs and the partner's obligations to each other) a) Doesn't require dissolution, unlike CL predecessor b) Dunn v. Zimmerman (246) i) Construes UPA 21 as allowing an action for breach of fid duty as between partners ii) Party seeking an accting must provide suff evid of the "true condition of the affairs" of the p'ship to enable the court to make a definitive accting iii) Traditional rule = all legal claims b/n partners must be brought in an accting action (CL); Reform rule = abolish exclusivity of accting remedy (see Sertich, 249) iv) Middle ground = allows for separate action when "the basis of the suit does not involve a searching inquiry into the affairs of the p'ship" v) If accting shows breach of fid duty, may also impose punitives 2) 31: dissolution 3) Probably the only statutory remedies, b/c 13 states that partner's liability applies only to "any person, not being a partner in the p'ship" ii. RUPA 305(a) 1) Omits limiting language of 13, permits action against p'ship for mismanagement or other torts committed during the ordinary course of p'ship business iii. RUPA 405 1) (a): P'ship can sue the partners 2) (b): Partner can sue the p'ship or fellow partner for, inter alia, breach of fid duty 3) Also abolishes exclusivity of accting remedy f. Meinhard v. Salmon (205) LOYALTY/STEAL OPPORTUNITY i. M & S are partners, but p'ship agreement says that S is the sole managing partner (so changed default rule of control) for a hotel lease while M is the financier 1) Note that sharing of profits and losses would almost certainly render this arrangement a p'ship, even without M having any control ii. S is approached by descendant of lessor to extend lease and increase the area, M is excluded from the arrangement and sues iii. Every partner has a duty to make full disclosure of all material facts relating to the p'ship business when necessary to allow other partners to safeguard their rights 1) Court isn't mad b/c S took the opportunity, only that he didn't disclose its availability 2) Don't have to prove that M would have taken the offer, failure is suff to = breach iv. Remedy 1) Constructive trust on 49% of shares of the new venture, so that S may retain the mgmt control he would have had under an extension of p'ship agreement v. Dissent: opportunity didn't manifest until after expiration of the lease, which formed the basis of the p'ship, so not a "material fact relating to p'ship business," although majority says that it was sufficiently related to prior business to qualify
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says that it was sufficiently related to prior business to qualify vi. Problem no real guidance as to what would constitute a breach of fiduciary duty (It's a "punctilio of an honor the most sensitive, but what the hell is a punctilio? Definition of the duty is incredibly vague) vii. Could this have been avoided? 1) Put into p'ship agreement that the p'ship is only for a term or for the specific venture g. Singer v. Singer (215) LOYALTY/STEAL OPPORTUNITY i. P'ship was considering buying land and, while issue was tabled, two partners formed a separate p'ship and bought the land themselves ii. Would generally be an obvious breach, but there were specific provisions in the p'ship agreement allowing competition between partners, even to the detriment of the p'ship court finds no breach 1) P'ship agreement is "uniquely drafted to promote spirited, if not outright predatory competition between the partners" iii. Does UPA 21 apply? 1) Could argue that it's not "connected with" p'ship conduct, although it probably was because the p'ship considered it 2) Could also argue that p'ship agreement constitutes "consent" under 21 (though generalized rather than specific consent) h. Enea v. Superior Court (219) LOYALTY/CONFLICT OF INTEREST i. P'ship owns a building, two partners lease office space from building at below market value, other partners claim breach of fid duty ii. Classic conflict of interest p'ship will always want higher rents and lessee will always want lower rents 1) 404(b)(1): use of p'ship property (maybe) 2) 404(b)(2): an interest adverse (clearly) iii. What if they were leasing it at a fair rent? 1) I.e., Could 404(e) permit this transaction as long as it's fair? 2) Court rejects reliance on this section because BELOW market value, but unclear whether it's ok if it were AT market value 3) Gives this provision a de minimis role where a partner simply need not account for a minor or incidental benefit w/ no harm to p'ship i. Bane v. Ferguson (233) DUTY OF CARE i. Partner, retired from a law firm, collects pension, which per the contract will terminate if the firm dissolves without a successor ii. When firm dissolves b/c of merger gone wrong, P sues for negligent mismanagement iii. Court finds that: 1) No fiduciary duty is owed b/c P is no longer a partner 2) Even if they did owe him a duty, ordinary negligence is insufficient to prove up breach of the duty of care (P alleged mismgmt of firm, not of pension plan) 3) AND even if they were negligent, protected by business judgment rule (so even if P were still a partner, would still protect rational decision) iv. Pretty dumb to plead ordinary neg 16. DISSOLUTION a. Generally i. This does NOT necessarily lead to "winding up" of p'ship 1) Winding up: selling off p'ship assets, paying off creditors, distributing whatever money is left to partners/split losses 2) P'ship business can continue as usual if you don't wind up ii. Dissolution sales: Pg. 652, note 12 iii. Under UPA or RUPA, one partner seeking to end the p'ship by her express will is going to result in liquidation b. UPA Dissolution i. 29: Defined
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b. UPA Dissolution i. 29: Defined 1) When the makeup of the p'ship changes AT ALL (any partner ceases to be associated with the p'ship) 2) Reflect aggregate theory of p'ship ii. 31: Causes of Dissolution (1):"Rightful" dissolution under all parts of 31, it's ok a) Terminate by the express will of any partner when no definite term or particular undertaking specified (this is the default) b) Terminate at conclusion of definite term or particular undertaking specified in the p'ship agreement c) Prior to expiration of term/undertaking by unanimous consent of all partners who have neither assigned their interest nor had them subject to charging order d) By bona fide expulsion of any partner pursuant to p'ship agreement (Drashner) (2): "Wrongful" dissolution a) Termination by express will of any partner "in contravention of the agreement between the partners", where circumstances/statute don't permit dissolution b) You always have the POWER to dissolve, but you don't have the RIGHT to terminate a term p'ship before its conclusion c) B/c unlimited personal liability, you have to be able to get out (3): By any event which makes it unlawful to continue (e.g., lawyers losing licenses) (4): By death of any partner (5): By bankruptcy of any partner or the p'ship (6): By judicial decree under 32 iii. 3334: General Effect on Authority 1) For the P'ship: Dissolution terminates authority of partners to act for the p'ship except that a partner may bind p'ship when acting to wind up p'ship business 2) Among the partners: terminates authority upon a) Upon dissolution when dissolution occurs other than by act, bankruptcy, or death of partner b) Upon knowledge of dissolution when caused by act of a partner c) Upon knowledge or notice of dissolution when dissolution caused by death or bankruptcy of a partner 3) If partner acts without authority, co-partners do not need to contribute to any liability those actions may have caused iv. 35: Authority to Bind P'ship 1) Retains apparent authority to bind p'ship in transactions with 3rd parties if acts would have bound p'ship before dissolution UNLESS 3rd party has knowledge or notice (def. 3) of dissolution a) Actual or constructive (in publication in newspaper of general circulation in all places where p'ship did business) v. 37: For good cause, can ask the court to carry out winding up process ( Dreifuerst) vi. 38: Liquidation 1) If dissolution is not wrongful, must liquidate "unless otherwise agreed" by unanimous consent of all partners a) an contract around when liquidation will occur, but dissolution can't be prevented by agreement (construe as agreement to create new p'ship) 2) Must pay in cash unless otherwise agreed (Dreifuerst) vii. 40: Distribution of Proceeds 1) (b): Once p'ship assets are sold, proceeds are paid out in the following order a) Nonpartner creditors b) Partner creditors c) Partners receive a return of their capital contributions d) Partners receive any remaining profits according to profit shares 2) (d): If assets are insufficient to satisfy p'ship obligations, partners contribute according to their loss shares
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to their loss shares viii. 41: Succeeding P'ship 1) Successor p'ship succeeds to the liabilities of its predecessor 2) Remember, under 17, new partner is not personally liable for preexisting p'ship obligations ix. 42: Buying Out a Partner 1) When a partner departs and the remaining partner chooses to continue the business, the departing partner may choose between a) Adding interest to his pymt from the date of dissolution; or b) Taking his share of the p'ship profits between the date of dissolution and the date of pymt 2) But see 265 for cases where the minority partner's share is subjected to a minority or marketability discount c. RUPA Dissociation i. Partner dissociation may or may not cause dissolution ii. 601: Events Causing Dissociation 1) P'ship has notice of partner's express will to withdraw 2) An event agreed to in the p'ship agreement as causing dissociation occurs 3) Partner is expelled pursuant to p'ship agreement 4) Partner is expelled for misconduct by court order for 5) Engaging in wrongful conduct that materially and adversely affect the p'ship a) Committing a willful and persistent breach of the p'ship agr or 404 duty b) Engages in conduct related to p'ship biz that makes it reasonably impracticable to carry on the biz with him 6) Partner becomes debtor in bankruptcy 7) Partner dies 8) And OTHERS (see statute book pg. 34445) iii. 602 Wrongful Dissociation 1) Can dissociate at any time, whether rightfully or wrongfully 2) Dissociating is wrongful if a) It contravenes an express provision of the p'ship agr; or b) Before end of p'ship for a term or particular undertaking, you: i) Withdraw by express will ii) Partner is expelled for misconduct by court order (this would be Drashner) iii) Partner becomes debtor in bankruptcy iv) Partner that is not a natural person is expelled due to willful dissolution or termination iv. 703 Liability for P'ship Obligations 1) (a): Dissociation does not discharge his liability for p'ship obligations incurred prior to his dissociation 2) (b): A partner is liable for transactions with a 3P who (1) lacks notice of the partner's dissociation and (2) reasonably believes that the dissociated partner is still a partner a) Potential liability continues for 2 YEARS after dissociation b) No UPA counterpart to protect 3Ps who justifiably rely on dissociated partner's credit in dealing with the p'ship v. 704: To protect herself, a partner may file a statement of dissociation under , and nonpartners are deemed to have notice 90 days after filing vi. Whenever a partner dissociates, you can (1) buy out the partner and keep the business going OR (2) liquidate the p'ship 1) Note that, either way, you're getting your money out (compare other types of biz org) 2) Generally speaking, when you rightfully dissociate it will lead to dissolution and when you wrongfully dissociate it will lead to buying out d. RUPA Dissolution i. 103(b)(8): Continuation Agreements 1) Unless dissolution occurs pursuant to 801(4), (5), or (6), the partners may agree in
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1) Unless dissolution occurs pursuant to 801(4), (5), or (6), the partners may agree in the p'ship agreement that partner dissociation does NOT dissolve the p'ship 2) If this happens, p'ship simply continues in existence despite change in membership ii. 801 Events Causing Dissolution 1) (1): In an at-will p'ship is dissolved when a) Partner gives notice of express will to withdraw as a partner per 601(1) b) This does NOT apply to dissociation per 601(2)(10) 2) (2): In a p'ship for a term or a particular undertaking is dissolved when a) At the expiration of the term or completion of the undertaking b) By unanimous agreement of the partners c) Within 90 days of dissociation, by express will of at least 1/2 of remaining partners when a partner has wrongfully dissociated per 602(b) or become dissociated per 601(6)(10) 3) (3): An event specified in the p'ship agr as causing dissolution occurs 4) (4): An event making it illegal to carry on p'ship biz occurs (can be cured) 5) (5): Court orders dissolution because a) Economic purpose of p'ship is "likely to be unreasonable frustrated" b) Partner engages in conduct so it's not reasonable practicable to carry on c) Not reasonably practicable to carry on p'ship biz in conformity with agr 6) (6): Transferee of partner's interest seeks dissolution if court determines it's equitable to do so (depends if at will or term) iii. 802: Winding Up 1) Dissolved p'ship carries on only for the purpose of winding up 2) Partners can agree to abandon the winding up process and continue the business as if dissolution never occurred, but must be unanimous and include all rightfully dissociating partners iv. 804: Authority to Bind P'ship 1) P'ship is bound by a partner's act after dissolution only if a) The act is appropriate for winding up the business; or b) The act would have bound the p'ship before dissolution and the 3P does not have notice of the dissolution (see 102 for "notice" def) v. 805: Can file statement of dissolution, deemed to give notice to 3Ps 90 days after filing 1) Cuts off apparent authority of partners vi. 806: Liability to Co-partners 1) Partner liable to co-partners for liability incurred for acts (other than winding up) after he acquired knowledge of dissolution vii. 807: Settlement of Accts 1) Partner creditors stand on same footing as outside creditors, and, partner's acct winds up with a positive balance after applying profit and loss shares, pymt must be in cash, and partner must contribute if balance is negative a) Cash requirement is the same as UPA 38 (so Dreifuerst would have come out the same way under RUPA) e. Consequences Following Rightful Dissolution i. Page v. Page (250) 1) P'ship loses money for many year, when things start to improve, one partner (P) wants to terminate p'ship 2) Other partner (D) wants to continue biz, P goes to ct looking for DJ that p'ship = at will 3) Was the p'ship for a term or at will? a) Must determine what type b/c P would be "rightfully" dissolving an at will p'ship but "wrongfully" dissolving a term p'ship b) D claims that "term" was until they turned a profit i) Former p'ship agreement provided in writing that profits were to be retained until all obligations were paid (former was also for a 5-yr term and limited pship) c) AT WILL: Court rejects b/c turning a profit is the goal of all businesses, and
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c) AT WILL: Court rejects b/c turning a profit is the goal of all businesses, and there was no evidence of anything beyond that i) Can agree to continue until certain sum of money is earned, investments are recouped, or until dispose of property on good terms, but no evid here 4) Did P act in bad faith by pushing out D as p'ship was becoming profitable? a) MAYBE: It looks like P would have the opportunity to buy liquidated p'ship at a foreclosure sale (P owns a separate company that was a creditor of p'ship) and get whole biz for himself at below market value b) It is not bad faith to force dissolution of an at-will p'ship by your express will BUT it is bad faith to dissolve a p'ship for the purpose of gaining the benefits of business for yourself (b/c you owed a fid duty when you were plotting to chuck the other guy) c) There was no evidence before the court of this b/c it wasn't really pled, but looks like D would have the opportunity to make that claim later ii. Dreifuerst v. Dreifuerst (261) 1) Brothers operate two feed mills under an oral p'ship agreement 2) Brother (P) served other brother (D) with notice of dissolution AND winding up of the p'ship a) At-will p'ship, so dissolution by express notice = rightful 3) P petitions court for in-kind distribution (you get one mill and I get the other), but D wants to force the sale of p'ship assets 4) Court holds that, absent an agreement to the contrary or consent of all partners, a partner cannot force in-kind distribution and p'ship assets must be sold for cash a) UPA 38(1) says you should be paid "in cash" and p'ship property should be "applied" to discharge p'ship liabilities b) Finds that in-kind distributions, even with the Rinkefactors satisfied, is still not appropriate without a prior agreement 5) Court also finds that D can force a judicial sale, rather than an actual, of the assets where court determines the value of the assets and orders P to pay D cash equal to D's share 37 6) Problems with in-kind a) Court sets value of p'ship (when market should be able to set price), and here the court actually accepted P's valuation b) The sum may be worth greater than the parts (synergy) c) Doesn't account for good will 7) This is the MAJORITY: Once a rightful dissolution occurs and liquidation begins, you have to sell the assets for cash iii. Rinke v. Rinke (263) 1) Michigan Supreme Court allows in-kind distribution in certain situations, where a) There were no creditors to be paid from the proceeds b) Ordering a sale would be senseless since no one other than the partners would be interested in the assets of the business c) An in-kind distribution would be fair to all partners 2) MINORITY: Arguably in contravention of UPA 38(1), but mitigates arguably harsh results iv. Creel v. Lilly (264) 1) Court ordered a buyout of a deceased partner's estate, where the surviving partners have in good faith wound up the business and the deceased partner's estate is provided with an accting allowing for pymt of a proportionate share of the business 2) Forcing sale in these circumstances would be a "harsh and destructive measure" 3) MINORITY: Arguably in contravention of UPA 38(1) f. Consequences of Wrongful Dissolution i. UPA 38(2) 1) Three major penalties imposed
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iv. v.


1) Three major penalties imposed a) Partner in the wrong pays damages for breach of K b) Do not have to liquidate the business (get to keep biz going without you) c) Distributive share (less any damages), that does NOT include goodwill of p'ship 2) This only kicks in when dissolution is "in contravention of the p'ship agreement," but may also kick in by dissolution obtained by court order under 31(6) and 32(1)(d) if you imply an agreement not to do the things in those provisions a) BUT if read literally, you'd have to find an actual provision that was breached 3) This seems more likely under the causes of dissolution that implicate culpability (e.g., impracticable to carry on v. dying) RUPA 602(c) 1) If you've wrongfully dissociated under 602(b), you're liable for damages caused, calculated under 701 RUPA 701 1) (a): If dissociation does not result in dissolution, p'ship continues and dissociating partner's interest is bought out 2) Buyout price a) (b): value of dissociating partner's share on date of dissociation (calculated by value if p'ship were being dissolved and sold, liquidation or going concern value, whichever is higher), with interest calculated from date of dissociation to date of pymt b) (c): Less damages for breach if dissociation is wrongful and share of other p'ship obligations (whether or not presently due and owing) with interest c) Share DOES include goodwill of p'ship (i.e., eliminates goodwill penalty of UPA) and does not permit minority or marketability discount 3) (h): if p'ship for a term or particular undertaking, p'ship doesn't have to distribute buyout share until term expires or undertaking is complete unless a court find that earlier pymt will not cause undue hardship on the p'ship ***Don't have to carry on p'ship, can dissolve Drashner v. Sorenson (265) 1) P'ship buys an insurance and real estate biz (Ds put in the capital) a) P claims violation of UPA 32(1)(d) refusing to allow him to draw on p'ship funds sufficient to support him and his family (needs "some money to run on") b) D turns around and claims same violation P spent all day in the bar, was arrested and served jail time for reckless driving, demanded more money, and neglected his duties with the p'ship 2) Agreement was either oral or implied, but court finds term p'ship until capital investments recouped (compare Page where same claim was found to be meritless b/c P there presented no evidence) 3) Court finds P's conduct constituted a violation of the p'ship agreement a) Willful breach of p'ship agr by attempting to dissolve the p'ship in order to get more money than he was entitled under the agr AND insistent and continuing demands for more money made it impracticable to run the business b) Wrongful dissolution c) P's buyout share doesn't include good will 4) Would come out differently under RUPA: a) RUPA 602(b)(2)(ii): if court kicks you out, you've wrongfully dissociated, go to 701 to calculate P would get goodwill calculated into his buyout share Wood v. Apodaca (272) 1) P asks court to order dissolution per 801(5) when Ds failed to invest promised sum a) (i) for unreasonable frustration of economic purpose is probably the best bet, could argue (ii) or even (iii) b/c partner didn't even perform the basic initial obligations of the agreement 2) While court finds sufficient evid of unreasonable frustration or impracticability, this was a 12(b)(6), not on final merits
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was a 12(b)(6), not on final merits 3) Could have asked court to dissociate the Ds 4) Could have ordered specific performance of the p'ship agreement

17. GENERALLY a. Intro i. While LLCs are the most popular for new businesses, still far more corps in U.S. today ii. Many closely held corps really function like p'ships (but corp law designed with huge companies in mind) iii. Model Business Corporation Act (ABA) has been adopted in about 30 states, largely overlaps with Delaware (5% of the time, there will be a material difference) b. Characteristics of a Corporation (almost everything = exactly opposite of p'ship) i. Entity Status: A corp is a separate legal entity ii. Continuity of Existence (how hard is it to dissolve a biz form): Has perpetual existence unless it explicitly chooses to have a limited duration 1) Dissolution requires approval by the bd of directors and SHs 2) This = lack of an exit right iii. Centralized Mgmt: Ultimate decisionmaking power traditionally resides in Bd (i.e., owners dont run the biz) 1) Directors may or may not be SHs 2) Shareholders do not get to vote on ordinary biz matters of the corp (but can vote in fundamental transactions) iv. Limited Liability: SH's losses are limited to the value of her investment 1) If corp's assets are insufficient to satisfy obligations, creditors are out of luck 2) NOTE: this is limited vicarious liability, you still have direct liability (e.g., if you commit a tort, you're still responsible, even if in the course of corp business) 3) This is the chief reason investors select corp over p'ship v. Transferability of Ownership Interests: share are freely transferrable 1) Closely held corps frequently limit ability to admit new SHs vi. Tax Status: Double taxation, so you're taxed at the entity and dividend levels 1) Actually three times: corp pays income tax, SHs are taxed on dividends, SHs are taxed again with capital gains when they sells shares 2) Subchapter S corps can elect to be taxed like a p'ship (all small, closely held corps should absolutely do this, and failure to do this can = malpractice) a) Requirements: i) Have less than 100 SHs ii) No non-individual SHs (some exceptions) iii) No nonresident-alien SHs iv) Have only one class of stock b) Advantages: no double tax, SHs can use their pro rata share to offset income on individual return c) Disadvantages: SH must pay tax on pro rata share of corp's income EVEN IF corp doesn't pay out dividends (have to pay tax on money you can't reach) 18. FORMATION a. Place of Incorporation i. Internal Affairs Doctrine: The internal affairs of a corp are normally governed by law of the jurisdiction where a business is incorporated 1) But see Francis (415) (applying law of state where essentially all corp business took place) ii. A majority of Fortune 500 (and many many other) companies are incorp in Delaware 1) Law seeks to facilitate rather than regulate corp transactions 2) Vast body of corp case law (so more certainty) iii. Tax implications 1) Pay a franchise tax to your place of incorp
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1) Pay a franchise tax to your place of incorp 2) If you do biz outside place of incorp, taxed as a foreign corp and are taxed again 3) SO if you're a small biz, makes sense to incorp in the state where you will be doing the bulk of your business b. Mechanics of Incorporation i. First, file a "certificate of incorporation" with a state official, usually the Secretary of State 1) Some states call it "articles" of incorp or "charter" but all the same 2) DGCL 102(a): Required items a) Must use particular suffix (association, company, corp, inc, etc.) b) Name of registered agent and address c) Nature of business or purposes (sufficient to state that the purpose of the corp is to engage in any lawful acts, almost all certs use this general purpose clause) d) Total number of shares of stock the corp will issue (make it high) e) Name and mailing address of incorporators f) If powers of incorporators are to terminate upon the filing of the cert, names and mailing address of directors 3) DGCL 102(b): optional stuff you can include, but this rarely happens 4) Usually about one page 5) This gets publicly filed 6) DGCL 106: Corporation comes into existence upon the filing (Sec State receives and file stamps) ii. Second, call an organizational meeting 1) Elect bd of directors 2) Elect officers 3) Set up minute books, other formalities 4) Create bylaws, which dictate how the corp will be run and are typically a complete code of conduct for the corp a) Bylaws usually include (see 279) voting rules, number and methods of electing and removing directors, indemnification, etc. b) All internal, so not publicly filed c. Financing a Corp (279) i. Every biz org has ownership interests, giving you a claim to the biz, in corps it's called stock (analogous to a p'ship interest) 1) Preferred stock: have contractual rights that give them priority on (1) dividends and (2) upon liquidation a) Often convertible into common stock at some predetermined ratio b) Usually carry no voting rights unless some number of mandatory dividend pymts is missed c) Dividends may be: i) Mandatory (if financially and legally able to do so) or discretionary ii) Cumulative (if unable to declare mandatory dividend for a quarter or more, next dividend reflects those quarters as well) or noncumulative iii) Participating (get quarterly dividend and share in dividend given to common stock) or nonparticipating (all dividends accrue to common stock once preferred dividend is satisfied) 2) Common stock: "residual" or ultimate owner ii. Issuance of shares 1) Only statutory requirement = authorized number and terms appear in the certificate of incorp 2) So corp can place whatever labels, classes, etc. on shares, define terms how they wish 3) Usually only one class of stock in closely held iii. Subscription agreements: promoters may line up capital investments prior to formation by executing agreements where the party agrees to buy a corp's stock after formation 1) DGCL 165/MBCA 6.20(a): Irrevocable for six months from the time they are made iv. Can also raise capital by:
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1) DGCL 165/MBCA 6.20(a): Irrevocable for six months from the time they are made iv. Can also raise capital by: 1) Direct loans from banks, investors, etc. (if secured by corp assets, it's a bond, if unsecured, it's a debenture) a) Both sold in accordance with an indenture K between corp and indenture trustee (usually bank) that represents bondholders or debentureholders, describes the terms and provides for enforcement 2) Notes, similar to bonds and debentures, but typically mature over shorter period of time and may or may not be sold pursuant to an indenture 3) Unlike preferred SHs, debtholders have absolute right principal and interest pymts, so preferred stock usually has higher interest rate 4) Convertible securities 5) Rights or warrants to purchase underlying securities (e.g., option to buy certain number of shares at a particular price) d. Creditors i. Def.: Anyone to whom corp owns money, but no ownership interest ii. Who gets paid first? 1) Creditors 2) Preferred stock holders 3) Common stock holders e. Preemptive Rights i. Def.: Gives existing SHs the ability to subscribe proportionately to any new issuance of shares, enabling them to preserve proportionate stake in corp assets, earning, and voting ii. May restrict freedom of corp to arrange new financing or make acquisitions, so 1) DGCL 102(b)(3)/MBCA 6.30: no preemptive rights unless expressly granted in certificate of incorp iii. Even if no preemptive rights, corp still cannot issue new shares for illegitimate purpose of dilution 1) See, e.g., Katzowitz v. Sidler (282): Corp can't issue new share at bargain price in order to dilute power of minority SH or force him into investing additional funds f. Promoters' Contracts (rare) i. Promoter = someone who helps to found and organize a corp 1) Will often make Ks for the corp's benefit with the intention of causing the corp to adopt the Ks once formed (pre-incorporation Ks) 2) This leads to problems of whether the corp comes to be liable on those Ks (if eventually formed) and, if so, if the promoter remains liable ii. General rule: promoter = liable on a preincorp K 1) Viewed as an agent for a principal that doesn't exist 2) Someone has to be liable iii. Promoter is NOT liable only when (need ALL four of these) (1) Parties agree that only corp will be liable (3P will look only to the corp to satisfy obligation) (2) Corp must be formed 1) Compare Goodman (287) (promoter liable for K executed for corp in the process of formation) with Company Stores (288) (promoter not liable on similar facts because P intended to look only to the corp for satisfaction of obligation) (3) Corp must adopt K (formally/expressly or informally/impliedly) (4) Corp must agree to let promoter out (novation) 1) If K says explicitly that promoter isn't liable, then when corp adopts that K, the corp has essentially fulfilled this element iv. If steps (2) and (3) are met, corp = liable on preincorp Ks v. Illinois Controls v. Langham (283) 1) L has technological innovation, existing corp BI has money and connections, sign preincorp agreement to join forces 2) Corp ultimately fails and L sues BI 3) Implied covenants = BI promised to make best efforts to market L's product
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3) Implied covenants = BI promised to make best efforts to market L's product 4) Technically, newly formed corps do not have the capacity to ratify Ks made on its behalf before incorp b/c ratification presumes that you were able to enter into that K at the time it was made (which it obviously couldn't b/c it didn't exist) a) R2Agency 84(1), 86(1); R3Agency 4.04 5) So corp ADOPTS the K rather than RATIFYING a) Difference important b/c timing: i) Adoption: K becomes binding on corp from the moment of adoption ii) Ratification: K becomes binding as of K execution 6) Court finds that newly formed corp adopted the K where BI promised to use best efforts when the corp began accepting the benefits of the preincorp K (use of L's patents, old facilities, etc.) a) Didn't adopt a resolution explicitly adopting preincorp Ks, so it was implied 7) All four of the above elements to let out promoter were not met, so LIABLE a) Not clear that parties agreed that corp would be liable at all, let alone solely b) Even if they did have some agreement on (1), no indication of (4), that corp affirmatively agreed to let promoter off the hook
19. DEFECTIVE INCORPORATION If you defectively incorporate, one of these categories may alleviate consequences a. De Jure i. Results when there has been conformity with the mandatory conditions precedent established by statute, but available even if you make an insubstantial mistake 1) See, e.g., People v. Ford, allowing de jure status where incorporators failed to include corp seal in certificate ii. State AG cannot bring a quo warranto to dissolve you b. De Facto (291): i. When one has defectively incorporated AND 1) State law permits incorporation a) Almost never an issue due to the demise of "special incorp" statutes, but some states don't allow liquor stores to incorporate 2) Make a bona fide attempt to incorporate 3) Some actual use or exercise of corporate privileges ii. Law will treat you exactly the same as de jure (i.e., retain limited liability) EXCEPT that state AG can bring a quo warranto to dissolve you iii. Essentially enforcing the expectations of the parties b/c almost certainly knew they were contracting with a corp, but still exceptionally generous to person responsible for defective incorp (it's not hard to incorp...) iv. See Cantor below c. Corporation by Estoppel (291) i. Really encompasses three doctrines 1) Corp may not avoid a K based on defective incorp ("true" estoppel, where corp held itself out as a corp) 2) 3P may not avoid a K w/ a corp based on defective incorp (dealt with and expected the company to be a corp) 3) Allows SHs of a defective corp to retain limited liability when a third party understands his K to be with the purported corp (expected corp to be a corp, and you'd be getting more than your bargained for if you could go after SHs) ii. This only applies to contract liability 1) The third doctrine only makes sense for contracting parties that actually relied on the corp's status and solvency, but not so much for, tort victims that had no choice to deal with a corp and take precautions to mitigate risk of limited liability 2) SO, in tort cases, only the de facto corp doctrine can preserve SHs limited liability d. Sources of Law i. MBCA 2.03
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i. MBCA 2.03 1) State filing of articles is conclusive proof that a corp is property incorp a) SO really no need for de facto doctrine ii. MBCA 2.04 (wipes out all of the above) 1) "All persons purporting to act as or on behalf of a corp, knowing there was no incorp under this Act, are J&S liable for all liabilities created while so acting" a) Adds knowledge element (we don't know whether constructive knowledge would be sufficient) b) But even if you knew, still have to "purport to act" on behalf of corp, so this protects the passive investor with knowledge of defective incorp (i.e., may retain the third branch for uninvolved SHs) 2) So DON'T assume that a defective corp will be treated like a p'ship iii. DGCL 105 1) State filing = prima facie evidence that a corp is properly incorp a) SO the de facto doctrine is still operative here iv. DGCL 329 1) Accepts the first two branches of estoppel doctrine, but no mention of the third branch anywhere in the code 2) This seems to trace the Robertson court's approach, retain first and second but eliminate the third e. Cantor v. Sunshine Greenery (288) De Facto i. B mails in articles for incorp, about a week later signs a lease in the name of corp with himself listed as president 1) The next day, repudiates lease 2) The next day, Sec State actually files articles of incorp (15 days after mailed in, apparently mailed to right office with wrong name) ii. Lessor claims that B is personally liable on the lease b/c there was no corp in existence at the time the lease was signed iii. Court rejects, finds DE FACTO corp, so B is not personally liable 1) Made bona fide attempt to incorporate 2) Exercised corp privileges: Negotiated lease on behalf of corp, signed in corp's name for corp's benefit iv. Should have gotten a personal guarantee, especially w/ a new corp f. Robertson v. Levy (293) i. R wants to sue L as an individual when L's corp = insolvent 1) L submits articles of incorp to state 2) L enters into a lease on behalf of his corp 3) Articles are rejected by state 4) L gives note on behalf of corp for purchase of R's business 5) Articles of incorp accepted 6) L makes one pymt then defaults ii. State law, liable on your Ks if you acted under unauthorized assumption of corp power 1) This was decided under old Model Act, current = MBCA 2.04 2) Under 2.04, L probably not personally liable for lease (b/c no rejection yet) but execution of note happened after rejection (but did he get it?) iii. While both de facto and estoppel doctrines seem to fit, court rejects these defenses and essentially said that L should have known not to act as a corp until articles were accepted (this is easy, idiot) 1) Court reads the unauthorized assumption statute to wholly eliminate the de facto and estoppel doctrines 2) BUT same court later acknowledged that first and second branches are still good, SO probably only wiped out third branch of corp by estoppel doctrine 20. ULTRA VIRES DOCTRINE a. Generally
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a. Generally i. Def.: Outside the scope of the corp's purposes ii. DGCL 122: Statutory powers of corps 1) 17 of them, very broad a) (9): donations for public welfare or charity, science, or education i) Some courts have imposed a reasonableness requirement on the amount of a donation given corp's size and financial situation (Henderson, 307) b) (13): gives broad leeway to execute Ks 2) Probably still need a reasonable corp purpose 3) NOTE: Delaware, unlike some other jurisdictions, has never passed a law specifically allowing directors to consider the interests of non-SH constituencies (307) iii. DGCL 124: Who can challenge 1) No act of a corp can be challenged as ultra vires unless a) You're a stockholder seeking to enjoin the corp (not the other party) from engaging in an UV act (not for damages, gotta catch it early), and you only get it enjoined if it's necessary for equity i) Corp can't use a shareholder as an agent to enjoin it from a K it wanted to get out of anyway b) Corp itself can bring a direct or derivative (stockholder sues on behalf of corp when bd is the bad guy) suit against former or incumbent officer or director c) Atty Gen can bring suit 2) I.e., corp itself cannot bring it up as a defense to a K AND third parties cannot bring a UV claim either iv. MBCA 3.02: Statutory powers of corps 1) (13): charitable donations 2) (15): broad catchall allowing corp to engage in all legal activities that further the business of the corp b. Significance i. Largely a dead letter 1) Modern laws allow you to incorp for the purpose of doing anything that the law allows (general purposes statement), so nearly impossible to act beyond your purposes a) DGCL 103(a)(3) b) Can if illegal, but many other doctrines cover that 2) Many states have statutes empowering corps to do certain things that may otherwise be beyond their purposes (e.g., DGCL 122) 3) Additionally, many states limit the standing of those able to raise ultra vires doctrine ii. When it will come up 1) If corp has special purpose statement a) E.g., you're not sure you want it to have perpetual life, make corp for a particular project or for a span of time b) But even if special purpose, may still fall within broad statutory category (Goodman) 2) If there is no corp purpose (i.e., doesn't benefit the corp at all) (Dodge) iii. Once upon a time, it was also controversial for a corp to make charitable contribution 1) Ok today, but anonymous? The more attenuated we allow, it's ok c. Goodman v. Ladd Estate Co. (298) i. W, director and shareholder of Westover corp, takes personal loan w/ Ladd guarantee and Westover in turn agreeing to indemnify if Ladd forced to pay up on guarantee ii. Goodmans wind up buying all shares of Westover, and they try to get out of indemnification on grounds that the K was ultra vires 1) Parties stipulated that it was ultra vires, special purpose clause stated as engaging in real estate and mortgage insurance 2) But wouldn't necessarily be ultra vires under DGCL 122(13), which allows a corp to execute guaranty and suretyship Ks, if it was related to the corp's business (can stretch it)
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stretch it) iii. But do Goodmans have standing to challenge transaction as UV? 1) Tainted shares rule: can't challenge a UV contract when you bought shares from the person executing the UV transaction and you knew about it 2) Also, this is an equitable remedy, and Goodmans knew about it b/f they bought shares iv. Could sue former directors as a derivative claim under DGCL 124(2) d. Dodge v. Ford Motor Co. (301) i. Henry Ford wants to lower the price of the cars and to reinvest so that he can hire more people and share the wealth SO refuses to pay dividends and shareholders sue ii. The purpose of any corp is to maximize value for the SHs 1) Directors can determine proper MEANS to that end, but they can't change the END iii. So you can't do something that lessens that value for benefit of someone outside the SHs 1) But implied that building a hospital for employees would be for a corporate purpose, like a bonus and employees are critical to the success to corp... iv. He COULD have spun it to where they were dropping the price to increase demand and increasing manufacturing capacity to make more profit, he just didn't e. A.P. Smith (305): i. Upholds corp gift to university, disagrees w/ Dodge and says you don't need a corp purpose and you don't have to justify it as benefitting the shareholders 1) But you always get PR boost, so you can read the case as saying that there simply WAS a corp benefit in this case ii. Probably stands for the proposition that you need a corp benefit, but we're going to let that benefit be really, really attenuated f. Unocal and Revlon (30607): seem in conflict, but maybe we're just letting it get attenuated
21. MGMT & OPERATION a. Generally i. Owners (shareholders) actually have no mgmt role, they only (1) elect directors and (2) vote on a very limited number of issues (extraordinary transactions; e.g., amending the articles of incorp, mergers) ii. Board of directors statutorily empowered to supervise the day-to-day mgmt of corp 1) Usually an odd number so there is a majority 2) Almost certainly have a day job, usually meet once a month 3) Get a director fee (less than a salary, more than an honorarium) 4) Directors are NOT agents b/c they don't act subject to the shareholders control (Dunsmore) 5) Usually don't have the power to amend the bylaws without shareholder consent, but many articles will give this power (constrained by Blasius) 6) Minority directors have very little power, but it's good that you have access to info and may be able to get a jump on suing the corp iii. Board appoints officers, to whom they delegate the real responsibility of running the corp 1) These = C-level officers (CEO, CFO, CIO, etc.) 2) Bylaws usually specify what the various offices are empowered to do 3) Chairman of the board is oftentimes labeled an officer (??) iv. This is centralized mgmt (as opposed to decentralized mgmt of p'ship) 1) Model works very well for very large, publicly traded companies, where shareholders are essentially just capital investors and we leave mgmt to the professionals 2) Strict procedures seem silly for closely held corps, especially if only one or two shareholders/directors v. Proxy voting gives power to another to vote your shares, usually the mgmt 1) Need this for big companies, or you'd never have a quorum b. Removal of Directors i. Usually accomplished at annual meeting, but can SHs call a special mtg? 1) DGCL 211(c),(d): NO a) Unless otherwise provided for in certificate of incorp or bylaws special mtgs may
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1) DGCL 211(c),(d): NO a) Unless otherwise provided for in certificate of incorp or bylaws special mtgs may be called only at director's discretion 2) MBCA 7.02: YES a) In addition to provisions in cert or bylaws and at director's discretion, can also call a special mtg if 10% of all votes entitled to be cast on an issue demand a special mtg in writing (articles can fix lower or higher %, but not about 25%) ii. If SHs can't call a special mtg, any other recourse? 1) Consent Solicitation: If you can't call a mtg, you can get certain % to give their written consent for a given action and therefore be able to act outside the mtg setting a) Can use this to remove directors and also to increase size of the board b) DGCL 228(a): majority of all of voting shares (NOT shareholders) c) MBCA 7.04(a): need unanimity d) (Directors can also act without a mtg, but must be unanimous under both acts) 2) Can also amend the bylaws to add an additional director seat, BUT default rule is that the directors get to fill (DGCL 223(a)) also amend to say SHs can fill vacancy iii. Even if you can act outside a mtg, can you remove directors prior to term expiration? 1) DGCL 141(k): remove with or without cause by majority of all of voting shares EXCEPT a) (1) If directors are in classified or staggered terms per 141(d), only for cause b) (2) Can't remove a director elected by cumulative voting without cause if the votes cast against his removal would have been sufficient to elect that director in the first place i) Protects minority SHs, see below under cumulative voting section 2) MBCA 8.08: remove with or without cause EXCEPT a) (a) If articles of incorp require removal only for cause b) (b) If director elected by a particular SH group, only members of that group can remove c) (c) Can't remove a director elected by cumulative voting without cause if the votes cast against his removal would have been sufficient to elect that director in the first place; if straight voting, votes for removal must exceed votes against 3) MBCA 8.09: Can also be removed by the court if fraud, gross abuse of position, or intentional infliction of harm to the corp 4) What = "for cause"? Compare cases on pg. 311 5) Director threatened with removal for cause get minimal PDP (notice, hearing) 6) Unless statute allows a court to remove, cases are split as to whether a court has the power to remove a director for cause iv. No directors left to fill vacancies? 1) DGCL 223(a): directors fill vacancies as default 2) MBCA 8.10(a): SHs or directors can fill board vacancies as a default matter 3) Can also petition court for appt or amend the bylaws to state that SHs fill vacancies v. Can't do any of those things? 1) Sue for breach of fiduciary duty 2) Pass a non-binding resolution that sends a clear message c. Charlestown Boot & Shoe v. Dunsmore (308) i. SHs want to liquidate and appoint a guy that they tell the directors to work with, directors say no and SHs sue ii. Court says SHs can't control the board "The only limitation upon the judgment and discretion of the directors is such as the corporation by its by-laws and votes shall impose" 1) Directors are agents of the corp as to 3Ps, not the SHs iii. But you can boot out directors at the next meeting 1) If you don't want to wait for an annual meeting, can call a special mtg 2) BUT directors get to call special mtgs unless it's in your bylaws that it's something different (DGCL 211(d)) d. Blasius Indus. v. Atlas Corp. (312) i. 9.1% shareholder wants to force leveraged restructuring (take on a bunch of debt to pay out
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i. 9.1% shareholder wants to force leveraged restructuring (take on a bunch of debt to pay out dividend to s'holders, then sell off assets to pay off debts) ii. SH starts consent solicitation to amend bylaws to increase number of directors from 7 to 15 iii. While this was going on, board preemptively amends bylaws (power to do this in the articles) to increase number of board seats to 9 to secure majority iv. Courts says board can't do this it is illegal for directors to act for the primary purpose of thwarting the shareholder franchise (free will) 1) Shareholders have such few rights as it is, can't trample them e. Formalities Required for Board Action i. Basic proposition that directors cannot act outside formal board meeting 1) Corollaries: a) Independent approval by an single director is not effective board action b) Directors may not vote by proxy c) Formalities such as notice, quorum, and voting must be adhered to 2) Directors do NOT have agency authority ii. First, look at 1) What are the quorum rules? a) Legal minimum needed for an action to be valid b) Quorum also operates to protect minority shareholders 2) What are the voting rules? iii. Notice: see pg. 32021 1) MBCA 8.22: unless articles or bylaws otherwise provide, can hold meeting without C notice of date, time, place, or purpose of the meeting 2) DGCL iv. DGCL 141(b)/MBCA 8.24: Default Quorum and Voting rules 1) Quorum: need a majority of authorized directors (so even if there is a vacancy, still need a majority of potential seats) a) Can alter through bylaws and go less than a majority, but can't go less than 1/3 b) Can break a quorum by leaving 2) Voting: if you have a quorum, need a majority of total directors who are present a) Does not specifically allow you to go less than a majority, so it appears that you need a majority to vote successfully b) Bylaws can require supermajority 3) Used to need physical presence, but nowadays allows conference calls (hear and speak) v. DGCL 141(c)/MBCA 8.25 Delegation to Committee 1) Board can delegate most actions to a committee, which may be comprised of one or more directors a) (e): certain things you can't delegate vi. DGCL 141(f)/MBCA 8.21: Act By Written Consent 1) Directors can act without a mtg by written consent, but it MUST be unanimous (unlike SH action without a mtg in Delaware, where unanimity req) vii. DGCL 141(i)/MBCA 8.20(b): Remote Mtgs 1) Can meet remotely by any method where directors can all hear each other (phone) viii. MBCA 14.30(2): Deadlock can petition for judicial dissolution ix. Closely held? 1) If the whole board in a closely held corp agrees to do something in an informal manner, some cases have said that's ok (not formal mtg and not action outside mtg per 141(f)) 2) Some cases even say that unanimous consent of shareholders = sufficient b/c usually shareholders are the directors 3) Agency law may confer apparent authority, even if lack of proper board meeting prevents conferral of actual authority 4) But this is not always the case, you should always follow the formalities x. Gearing v. Kelly (322) NY
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x. Gearing v. Kelly (322) NY 1) Four directors, two appted by one family (G), two appted by the other (K) 2) Even number of directors can easily lead to deadlock, which is what happened here 3) G family rep resigned, K family (now 2 of 3) appts one of their own to fill the vacancy 4) G family knows of this plan, and they boycott the mtg to prevent a quorum, then brings an action to nullify the election 5) Court rejects unclean hands, now estopped from seeking equitable relief a) But quorum requirement is also used as a protective device (dissent) xi. But see Tomlinson (323) coming out the other way on similar facts, and that is Delaware, so Delaware allows directors to prevent the creation of a quorum by avoiding meeting, but watch for fiduciary duties f. Authority of Officers i. DGCL 142/MBCA 8.40: 1) Offices of corp are stated in bylaws or board resolution not inconsistent w/ bylaws 2) Officers are chosen in manner prescribed by bylaws 3) But almost always by board (means SHs can't direct the board to replace an officer) ii. Source of authority (in descending order of importance) 1) Express actual authority (1) bylaws (usually written in general terms, so may not be helpful) and (2) board resolution 2) Implied actual authority a) Ratification b) Acquiescence c) Power of position (e.g., treasurer gets to write checks) 3) Apparent authority iii. Vice President, Secretary, Treasurer see 332 iv. President 1) Lee v. Jenkins Bros. (324) a) Does president have authority to offer Lee a pension above and beyond plan offered to other employees? b) President of a corp has at least apparent authority to bind his company by acts arising in the usual and regular course of business but not for Ks of "extraordinary" nature i) Q = ordinary or extraordinary? ii) Probably did have authority (implied actual if created reasonable belief in president's mind or apparent if created belief in P's mind) b/c this could be construed as ordinary c) Court construes as ordinary b/c (1) future director or SH control is not impeded, (2) agreement itself was not unreasonable and benefitted the corp (3) pension Ks are often used as fringe benefit to recruit d) Apparent authority = Q of fact, remand to jury e) Should have i) Gotten a board resolution granting pension or ratifying offer ii) Ask secretary for copy of board resolution giving officer authority 2) NOTE: Some jurisdictions take an extremely restrictive view of the authority that a president has by virtue of her position (i.e., reject the ord/extra distinction) g. Formalities for Shareholder Action i. Only generally take action on annual election of directors and extraordinary events ii. DGCL 211(b)/MBCA 7.01(a): corp is required to hold an annual mtg of SH at which directors are elected iii. Just like for board action, look at 1) What are the quorum rules? 2) What are the voting rules? iv. DGCL 216/MBCA 7.25(a): Quorum 1) Need a majority of total number of voting shares in the corp (in person or by proxy) 2) DGCL: cert or bylaw can prescribe a lower or higher percentage, but not less than 1/3
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1) Need a majority of total number of voting shares in the corp (in person or by proxy) 2) DGCL: cert or bylaw can prescribe a lower or higher percentage, but not less than 1/3 3) MBCA: can prescribe greater than a majority (but not less?) v. Voting: for everything other than election of directors 1) DGCL 216(2): If there's a quorum, need majority of voting shares present at the mtg a) Abstentions are effectively a "no" vote 2) MBCA 7.25(c): if "yes" votes exceed the "no" votes a) Abstentions are ignored 3) So if 40,000 shares show up, in Del need 20,001 votes to pass but in Model juris, you can have less if there are abstentions vi. DGCL 222(b)/MBCA 7.05: Notice 1) At least 10 days and not more than 60 days before the mtg 2) Can waive defect (see 333) vii. Record date: date after which shares purchased do not have the right to vote at the mtg 1) DGCL 213(a): board establishes, at least 10 and not more than 60 day before mtg a) If board doesn't establish, it's the day before notice is given b) If notice isn't given, it's the day prior to the mtg 2) MBCA 7.07: unless otherwise in bylaws, board sets date not more than 70 days before the mtg 3) Typical for stock seller to grant purchaser a proxy to enable vote after record date viii. Consent solicitation (act without a mtg) 1) DGCL 228(a): need only a majority 2) MBCA 7.04(a): need unanimity h. Shareholder Voting (33445) i. Default = directors are elected by a plurality (top, e.g., 5 votegetters are elected) 1) DGCL 216(3)/MBCA 7.28(a) ii. Straight: every shareholder votes the entire number of shares that she owns for as many directors as there are seats up for election 1) E.g., 3 seats open; A = 600 shares B = 400; A votes 600 shares for D, 600 for E, 600 for F; B votes 400 for G, 400 for H, 400 for I; so D, E, and F are the new board members 2) So minority shareholder effectively has NO SAY iii. Cumulative: every shareholder has a number of votes equal to the number of shares she owns multiplied by the number of board seats up for election (allocate across candidates) 1) First, you have to determine how many votes you get a) Number of shares X total number of director seats up for election b) E.g., A = 600 B = 400; 3 seats up; A has 1800 B has 1200; A puts 900 on each of his top two candidates and B can put all 1200 on his top choice c) There is no way that A can distribute his votes in a way that would keep B from getting at least one person elected ROUND DOWN 1) You can calculate how many shares are needed to elect one director (X) a) X = Total # of shares voting X # of directors + 1 vote Total # of directors up for election + 1 2) You can also calculate the number of directors a shareholder has the power to elect at the same election a) N = # of shares owned by a shareholder (Total # of directors up for election + 1) Total # of shares voting 3) In most states, to elect by cumulative voting, you have to put it in your articles a) DGCL 214/MBCA 7.28(b) 4) In a very small number of states, cumulative voting is mandatory iv. Problems/Solutions with Cumulative 1) Removal a) Default = only need a majority of shareholders needed to remove a director, so as soon as the minority shareholder gets her guy elected, removed b) Solution = can't remove a director elected by cumulative voting without cause if the votes cast against his removal would have been sufficient to elect that
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the votes cast against his removal would have been sufficient to elect that director in the first place (DGCL 141(k)(2)) c) Go back up to formula (X = ) 2) Staggered/Classified Voting a) Staggered = only a certain subset of the board is up for election every year b) Classified = only a certain class of directors is up for election every year i) DGCL 141(d) allows this ii) Legitimate purpose = prevents hostile takeover b/c it's less desirable to take over a company where you can't get the whole bd in one swipe c) As the number of directors up for election decreases, the number of shares you need to elect one director increases d) Same effect if you simply decrease your board size e) Compare Wolfson (can't do it in a state where cum voting is required) and Bohannan (ok despite state con'l provision mandating cum voting if minority shareholders retain some representation) 336 i. Informational Rights i. Can't get info on demand like pship (even have to give certain info without being asked) ii. In publicly traded companies, securities law force dissemination of certain information, but if publicly traded, corp doesn't have to give you anything unless you ask 1) Some states modify this by statute and force disclosure, but rare iii. DGCL 220: Must have a "proper purpose" which is reasonably related to the person's interest as a shareholder to get access 1) Found to be proper = investigating mismgmt, attempting to values one's shares, ascertaining the corp's financial condition 2) Found to be improper = satisfying curiosity, giving info to a competitor, gathering ammo for a lawsuit against a corp that is not related to interest as a stockholder iv. DGCL 220(c): Depend on what you want books/records or stockholder list? 1) Books burden is on stockholder to prove proper purpose 2) Stockholder list burden is on corp to prove that stockholder's purpose is improper 3) Why the difference? a) Usually want list to communicate with other stockholders in connection w/ vote, usually removal or election of directors, unquestionably a proper purpose and so essential to corp governance v. DGCL 220(d)/MBCA 16.05: Directors have broader informational rights and can access books and records for any legitimate purpose (i.e., can't access to give info to a competitor) vi. But corporate law places NO LIMIT on ability to obtain books and records during discovery phase of litigation this is a good way to avoid the time and expense of proving a proper purpose 1) May need it to ensure lawsuit frivolous, but pleading standards are still low vii. Skouras v. Admiralty Enterprises (336) 1) P seeks books and records of family corp claiming he suspects mismgmt, corp says no b/c claims that P only wants to harass the family to force a buyout of P's stock 2) Investigating corp mismgmt is clearly a proper purpose BUT finds that there must be a clear indication of wrongdoing (court says established at trial, but you only need a credible basis for suspecting mismgmt, detailed allegations are probably sufficient) 3) Lot of evid that P may be harassing the corp to put pressure for buyout but there also is evid of some mismgmt, court takes position that so long as ONE purpose was proper, you can have other less laudable purposes as well (i.e., mixed motives are ok as long as one is proper) 4) But court won't let P look at books and records of subsidiaries a) P technically isn't a stockholder of the subsidiaries, only of parent b) Absent a showing of fraud or that a subsidiary is in fact the mere alter ego of the parent, a common central mgmt along is not a proper basis for disregarding corp separateness c) THIS IS WRONG TODAY DGCL 220(b)(2): you get access to subsidiaries
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corp separateness c) THIS IS WRONG TODAY DGCL 220(b)(2): you get access to subsidiaries 5) Rejects claim of laches no indication in statute that you have to act within a particular time 22. ALTERING DEFAULTS BY CONTRACT NOTE: Harder to contract around default rules in corp context than p'ship a. SH Voting Agreements i. Def.: K among two or more shareholders to vote a certain way 1) Not discoverable 2) Not self-enforcing but enforceable a) I.e., parties can vote in violation of the agreement and only remedy is damages in a suit for breach, unless you can get an injunction before the vote ii. DGCL 218/MBCA 7.31(a): To be enforceable, a SH voting agreement must be 1) In writing 2) Signed by the parties to be bound 3) SCOTUS has held that voting agreements need not fulfill reqs for voting trust (350) iii. Common law (350): vote buying (buying votes by giving the seller a purely personal benefit) is illegal per se 1) Some say only voidable and subject to review under entire fairness iv. Ringling Bros. v. Ringling (343) 1) 1000 Shares a) Ringling = 315 b) Haley = 315 c) North = 370 d) (By pooling their votes, R & H get to elect 5 of 7 seats rather than 4) 2) Ringling and Haley agree that they will always vote their shares the same way, with a dispute resolution mechanism where lawyer (Loos) = designated arbitrator that tells them how to vote if they can't agree 3) R & H can't decide on who they want as a director, agree to vote to adjourn, but H reneges when the mtg arrives and refuses to vote to adjourn also ignores Loos's command that they vote to adjourn 4) H also refused to vote how Loos told him to vote, and ppl get on the board that R did not want, R claims breach and sues for specific performance 5) Court finds for R 6) Remedy = orders the results changed to comport with Loos's instructions 7) Why was this stupid? a) Court could have specifically enforced the agreement or held H liable for damages for breach b) Remedy resulted in a vacancy in the 7th position on the board, with North having 50% control (3 of 6), when better way would have let R and H keep voting control 8) This could have been avoided by a voting trust b/c parties can't breach b. Voting Trust i. A voting trust involves conveying shares to a trustee, who becomes legal owner 1) Only giving away your right to vote, retain all other benefits of ownership (e.g., dividends) 2) Self-enforcing/executing: can't really be breached ii. Trust agreement dictates how the trustee will vote the shares and state that every other right of stock ownership remains with the stockholders iii. DGCL 218(a): To be enforceable, must be 1) In writing 2) Signed by the parties to be bound 3) Shares subject to the trust must be transferred to the trustee/s a) Corp cancels shares and reissues them in the trustee's name 4) Copy of the voting trust agreement must be filed and kept at the corp office and
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4) Copy of the voting trust agreement must be filed and kept at the corp office and available for public inspection (discoverable) a) No clear answer as to why trust agr have to be publicly filed and voting agr don't iv. Noncompliance with statutory requirements generally renders voting trust illegal 1) Compare Abercrombie (353) and Grynberg (354) where parties may or may not have inadvertently created a voting trust v. DGCL 218(a)/MBCA 7.30(a): Voting 1) If trust agreement is silent, stock is voted as majority of trustees direct 2) If trustees are equally divided, the vote of the stock is divided equally among trustees vi. Trustee may be sued for breach of K and of fid duty if he fails to vote in accordance with the trust agreement (though defeats the purpose of self-enforcing) vii. Default validity period 1) MBCA 7.30(b): voting trust expires in ten years unless it's extended 2) DGCL : No time limit c. Irrevocable Proxies i. DGCL 212(e)/MBCA 7.22(d): Convey proxy (only need signed authorization to the proxyholder), state that it is irrevocable and the proxy must be "coupled with an interest" 1) Proxy in exchange for cash pymt = likely unenforceable for public policy BUT if you lend a SH money and put a lien on shares as security, likely enforceable 2) So "coupled with an interest" must show little likelihood that power to vote will be abused by proxyholder 3) DGCL gives little guidance as to what = "coupled with an interest" but MBCA spells it out in a nonexclusive list (see 352) ii. Like all agency relationships, normally revocable at will iii. If proxy itself doesn't state, default until expiration 1) DGCL: 3 years 2) MBCA: 11 months iv. NOTE: this wouldn't have worked in Ringling because Loos didn't have an interest in the corp, but R and H could have granted each other IF one didn't follow Loos's instructions d. Classified Voting (355) i. Can create different classes of stock with different voting rights, serves to: 1) Provide non-voting related benefits, such affording a majority investor with majority stake and thus proportional right to dividends and distributions upon liquidation 2) Ensure control of the board 3) Prevent board deadlock e. Agreements to Control the Board i. SHs can make many different types of agr, but can't impermissibly try to control the Bd 1) Directors have fid duty to corp, so can't dictate actions through agr or they may be unable to fulfill that duty ii. Look for: 1) Directors' and officers' fiduciary duty 2) SHs overstepping their limited role 3) Potential injury to SHs 4) Potential injury to creditors (e.g., agr to pay out every dollar of profit in dividends) 5) Do the terms of the agr "sterilize" the Bd? (McQuade & Long Park OR Clark & Galler?) iii. Remember: statutory close corps can make agreements that sterilize the bd (see below) 1) In Texas you can make a SH agr to constrain the Bd iv. If you want a permanent board position, you can: 1) Make a SH agr to that effect (make it a voting trust to guarantee) 2) Require unanimity for removing an officer (supermajority req in the bylaws) v. McQuade v. Stoneham (356) NY 1) Three shareholders McQ, McG, S enter into a SH agreement that they will (1) vote for each other as directors and (2) vote for each other as officers 2) McQ and S have personal issues, (1) S and McG vote to remove McQ as an officer and (2) SHs vote him off the board at the next meeting
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2) (2) SHs vote him off the board at the next meeting 3) McQ sues for specific performance of the agreement, S and McG use illegality of K as a defense (usually a loser, but works here) 4) Ok for SH to agree to elect a particular person as a director (see Ringling), but not Ok to agree to appoint certain officers b/c impermissibly restrains the Bd a) Upside-down triangle SHs have no right to appoint officers, so this impermissibly restrains the discretion of the board, who has that right (can't constrain board, see Dunsmore) b) Agr to elect directors is fine b/c election of directors is a clear right of SHs 5) Court doesn't find any reason to believe that having McQ in the corp is definitely in the interest of the corp (so agr was in McQ's best interests but not necessarily in the best interests of the corp) 6) Advocates a per se rule against these types of agreements vi. Clark v. Dodge (359) NY 1) C and D execute SH agr that C will always (1) be a director and an officer as long as he remains "faithful, efficient, and competent" and (2) get 25% of net profits (as salary or dividend no difference then but different tax treatment today) 2) When D breaches and C sues, D claims the K is void under the per se rule of McQuade 3) Court limits McQuade to its facts and finds that such Ks restraining the Bd should only be void if there is a clear injury that is threatened or suffered a) No harm to SHs b) No harm to creditors c) But still have to read McQuade to mean that such Ks are only invalid when there are nonparty SHs or creditors that may be harmed to be consistent 4) Court also construes a reasonability req into the 25% of profits C only gets 25% of whatever is left after the directors had in good faith set aside what they deemed necessary for the running of the corp a) This was necessary b/c would otherwise impermissibly constrain Bd action and creditors would also be harmed vii. Galler v. Galler (362) Illinois 1) Similar to Clark, focus on potentiality of harm to SHs or creditors 2) Notable b/c court recognizes the desire of SHs in closely held corps to have greater control over mgmt, and cts should not limit closely held SHs' ability to constrain the Bd in this manner (or maybe SHs just won't invest) viii. Long Park v. Trenton-New Brunswick Theatres (362) NY 1) SHs of certain classes of stock were given "plenary" power to run theaters and the only way to replace managers is through arbitration 2) Court finds that this agr is void as far beyond the K in Clark totally "sterilized" the Bd by prohibiting them from having a say in the principal business of the corp 3) This seems like an about-face from Clark b/c no real showing that SHs or creditors would be harmed f. Supermajority Reqs i. Used to be viewed with hostility b/c of deadlock fears, now accepted as a way for minority owners to protect their rights, and most states allow even to the point of unanimity ii. DGCL 141(b) for quorum and 216 for voting, allows up to and including unanimity iii. MBCA 7.25 (a), (c) for quorum and 8.24 for voting also allow up to unanimity iv. Amendment problems 1) DGCL 109: Default rules for amending bylaws = majority, so you can get rid of supermajority provisions unless you explicitly state otherwise 2) MBCA 7.27/DGCL 242(b)(4): If in articles (not bylaws), can't amend supermajority provision unless you get the required supermajority percentage (need whatever percentage is required by the article provision you're trying to repeal) 3) MBCA 10.21(c): extends this to bylaws, so more protection than DGCL v. Frankino v. Gleason (363) 1) Bylaws = Art. IX requires a supermajority vote to amend Art. III, which governs, among
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v. Frankino v. Gleason (363) 1) Bylaws = Art. IX requires a supermajority vote to amend Art. III, which governs, among other things, board size 2) When P tries to pack the board, gets simple majority to repeal Art. IX, for which there was no supermajority vote protection 3) This is ok! g. Share Transfer Restrictions i. Traditional norm of corp law is the free transferability of ownership interests (as opposed to p'ship law, where transferability is severely restricted due to unlimited personal liability and right to participate in mgmt) ii. Conflict b/n contract law (upholding the manifestation of mutual assent of the contracting parties regardless of fairness) and property law (stock as personal property and prop law disfavors restraints on alienation) iii. K law generally wins (see Allen), unless wholly unreasonable (low bar) BUT property law comes back in where courts narrowly construe these agreements (so you can wiggle out of restraints where language isn't clear) 1) DGCL 202(d)/MBCA 6.27(c): Per se reasonable if designed to preserve a tax advantage or any other regulatory advantage 2) Substance v. form (many clever tricks to get around plain lang, see 4-7, 374) where you can convert restricted shares to unrestricted shares iv. General commitment to upholding stock transfer agreements reasonable b/c 1) Don't want parties running to court when deals go bad 2) Want corps to be able to plan for sale contingencies, especially in closely held 3) B/c closely held corps have many similar concerns as p'ship about allowing random ppl being able to own part of corp must be more than mere disparity in price (Allen) v. Types of Restraints (see 37172 for advantages and disadvantages) 1) First option a) Stated price: Buy back at a par value, purchase price, or negotiated price i) Seems unfair to SH, but this is the only way that a corp will know how much to set aside to buy back the shares and increases certainty (Allen) b) Book value: total SH equity on the balance sheet divided by total # of shares i) Often underestimates true value of business c) Capitalization of earnings d) Appraisal or arbitration 2) First refusal a) SH can negotiate a sale with any 3P at any price, but required to offer to corp first at the offer price i) Real threat of collusion where SH colludes with 3P to get high price b) Routinely upheld by courts c) Again, problems with valuation and purchaser will have to do significant legwork to determine the appropriate price only to have the corp usurp 3) Consent agreement a) Have to get corp's consent before any transfer b) Viewed with hostility because of fears it will be used arbitrarily and function as a complete restraint on alienation 4) Buy-sell agreement a) Corp or another SH has absolute right (or obligation) to purchase shares if stated circumstances occur (as opposed to above agreements where you only have to offer to corp if you intend to sell shares) b) Guaranteed liquidity but problems with fair price again 5) Prohibit transfers to designated persons a) DGCL 202(c)(5)/MBCA 6.27(d)(4): Allowed if not "manifestly unreasonable" vi. Allen v. Biltmore Tissue (367) FIRST OPTION at stated price 1) Corp bylaws w/ two pertinent provisions: a) If SH wants to sell stock at any time, option for corp to by back that stock at the ORIGINAL price (appreciation matter); and
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ORIGINAL price (appreciation matter); and b) If SH dies, option for corp to buy back that stock at the same orig price i) Death provision somewhat harsher b/c at least you have a choice whether to sell stock or not, but on death there is only one choice offer to corp 2) Kaplan, SH, dies and corp offers to buy back stock at 4x orig price, but estate still refuses to sell to corp 3) Option = valid b/c "primary purpose" was to enable corp to buy the shares, NOT to prevent the SH from selling them a) Finds not an unreasonable restraint b/c corp only has 90 days to take option and recognizes the need for closely held corps to control ownership rights 4) Court refuses to find such Ks invalid based solely on the fairness of the option price a) "To be invalid, more than mere disparity b/n option price and current value of the stock must be shown" b) This is the vast majority rule c) Look to other K mechanisms (fraud, unconscion, etc.) 5) Some mutuality of risk where stock price could easily have gone down 6) But practically they ARE absolute restraints on alienation, but policy that we don't want contracting parties running to court every time stock prices rise and the deal doesn't look so good anymore h. Statutory Close Corps i. Only about 5% of eligible corps actually go thru steps to become statutory close corps 1) Because of dubious status of common law (Galler/Clark or McQuade/Long Park?), it's far better to have a statute justifying your actions ii. Delaware (Subchapter 14) Close Corps: QUALIFY and ELECT 1) DGCL 342: to qualify as a close corp a) 30 or less SHs b) All stock must be subject to at least one stock transfer restriction c) Can't be a public market for your shares 2) DGCL 343 & 344: must actually elect to be a close corp (in articles for new corps, amended articles for existing corps) a) 2/3 SHs must approve to elect status as well as to terminate status 3) Why does this matter? a) DGCL 350: Trying to control the board through a SH agreement is OK if you're a statutory close corp ("sterilize" = ok) b) DGCL 351: Can get rid of the board altogether (act like p'ship where SHs run the corp) but note that SHs take on the duties of the board c) DGCL 355: Can agree to dissolve corp on certain occurrence iii. MBCA differences 1) No eligibility reqs for electing status in original articles of incorp 2) But you can have no more than 50 SHs 3) Requires all SHs to be parties to a written agreement restricting the Bd's power 4) SHs in ANY corp can vary corp norms by K (because statutory status used so infrequently), but you can achieve the same results in Delaware by different means (see Nixon) iv. Texas has similar qualification/election system, BUT ability to constrain the board thru SH agreements is actually in the general corp section so ANY type of corp can do this v. Zion v. Kurtz (376) NY 1) SH agreement that board essentially could not act without Z-minority SH's consent 2) SH agreement said that D would take steps to elect close corp status, but he never did, so qualified but didn't elect 3) Court imposes equitable remedy D is estopped from relying on the fact that he never elected because he was supposed to, so agreement valid for close corp ( 350, 351) when it would otherwise be invalid (no 3Ps hurt by enforcing agreement, see Clark v. Dodge) vi. Nixon v. Blackwell (382) Delaware
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Clark v. Dodge) vi. Nixon v. Blackwell (382) Delaware 1) Disagrees with Zion and says that you're relegated to the common law (Galler/Clark OR McQuade/Long Park) if you fail to comply with statute 23. LIMITED LIABILITY & PIERCING CORP VEIL a. Limited Liability, Generally i. Def.: The most you can lose is the amount of your investment ii. This only prevents status-based/vicarious liability, so you are always directly liable for wrongdoing that you commit, even in the course of corp business b. Benefits of Limited Liability i. Encourages investment ii. Makes the public market work by making shares worth the same to everyone without lim liab, there would be different share prices for everyone (same share of stock is worth more to a poor person, b/c less to lose, than to a wealthy person, who has a lot more to lose) iii. Discourages excessive monitoring of mgmt and resulting transaction costs (passive investor would be nonexistent) iv. Encourages diversification (can invest in many corps without worrying about liab in each) c. Drawbacks of Limited Liability i. Encourages mgmt engaging in excessively risky behavior ii. Encourages externalization of costs (when internalization of costs is preferable) and can therefore be characterized as inefficient when society/creditors/etc. bear the brunt 1) This can be mitigated with personal guarantees, but that won't help, e.g., tort victims d. Piercing the Corp Veil i. The only true exception to lim liab, only was to get to SH ii. Every jurisdiction has a different test for this, hard to know so rely on generalization iii. TEST: Are SHs respecting separate legal status of corp? Ct is likely to pierce the veil when the owners are not treating the corp like a separate legal entity, factors (usually) include following (5) factors 1) Inadequate capitalization (Do you have enough assets in the corp to cover your reasonably anticipated liabilities?) a) Most states, including Del, have NO legal minimum capital requirement b/c (1) hard to know where to set the limit and (2) you're deterring entrepreneurship b) Makes this factor controversial c) This ties in with the next factor, so we as a society are fine with folks starting a biz on a shoestring, but if you become well-capitalized and you start siphoning off funds, far less sympathy 2) Siphoning off assets (Are the SHs draining corp assets for any reason?) a) Normal way = pay yourself dividends i) Nothing inherently wrong with this, only may justify piercing when it leaves corp unable to pay its debts b) More direct = directly routing profits to yourself, justifies piercing c) Fraudulent transfer law (392) effectuates this i) But problem w/ this is that the remedy for fraudulent transfer is merely the invalidation of the transfer (not a real deterrent) ii) Also extremely hard to establish (much more fact intensive and specific where you must show required elements for each transaction) 3) Using corp assets for noncorp purposes (overlaps with 2) 4) Failure to follow corp formalities a) Note that most closely held corps do not follow corp formalities, but you should still advise the sole shareholders to do so anyway b) Though not always clear how this factor contributes to plaintiff's injury, following formalities generally = better records to support other factors c) Texas: failure to follow formalities is insufficient 5) Element of injustice/unfairness (Does equity require piercing?) e. Types of Piercing
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5) Element of injustice/unfairness (Does equity require piercing?) e. Types of Piercing i. Horizontal: going after separate corps that really act as one entity ii. Vertical: going after SH of a corp (I have a judgment against the corp, let me enforce it against the SH) iii. Reverse: going after corp of a liable SH (I have a judgment against the SH, let me enforce it against the corp) 1) Rare, but allowed more often in sole SH context iv. Even if you do pierce, not all SHs on the hook, only the ones who are active in the corp f. Parent-Subsidiary i. Court will generally refuse to pierce and hold a parent liable for the obligations of a subsidiary if the parent respected the separate identity and did not exercise undue domination and control over the subsidiary's action 1) See Fletcher v. Atex (401) ii. In other cases, can hold a parent liable for the obligations of a subsidiary over which the parent exercised actual control, a form of vicarious liability 1) See U.S. v. Bestfoods (402): holding a parent liable under CERCLA when it actually operated the polluting subsidiary g. Tort v. Contract i. Courts will be much less sympathetic to contract creditors because we assume that the creditor is well aware of the limited liability and have compensated for it in the biz dealings (higher interest rates, personal guarantees, etc.) ii. Texas: contract creditors can only pierce the corp veil if there is evidence of actual fraud (i.e., concealed the actual financial situation of the corp so that you were misled into relying) iii. But some suggest that, rather than drawing the line b/n tort and contract, we should draw the line b/n voluntary and involuntary creditors (will normally shake out the same, but some K creditors are in such an unequal bargaining position that they deserve another look) iv. Thompson found that corp veil was pierced more often in K cases than tort cases (405), but stats might be skewed v. Walkovsky v. Carlton (387) TORT 1) W gets run over by a taxi, run by a corp owned by C a) C formed 10 corps, 2 taxis in each, each with state minimum insurance b) W sues, trying to get to C b/c insurance minimum = insuff, claiming that C set up these corps to avoid liab 2) Goes after them horizontally (trying to get to the other 10 corps) and vertically (trying to get to C as the SH) 3) Court rejects: facts may support, but pleadings essentially allege a type of fraud, and court refuses to disregard corp formalism just b/c insurance = insuff (leg can increase the minimum if it's a policy issue) a) Acting all as one entity may support horizontal, but vertical? Need more facts (show that C used corp as personal piggy bank) 4) It may have been serious judicial overreaching if the court said that the state minimum insurance = insuff (defer to Leg?) vi. Minton v. Cavaney (392) TORT 1) Corp manages public swimming pool where P's daughter drowns; P obtained judgment against corp, but insolvent and P tries to go after D-director/secretary 2) Court agrees that piercing is warranted, though can't on another procedural issue a) Inadequate capitalization D didn't even dispute that there was no attempt to provide adequate capitalization (not even undercapitalized, but NO capital) i) See Nilsson (395): citing Minton for the proposition that inadequate capitalization alone is sufficient to pierce b) Failure to follow corp formalities i) No stock was ever issued c) Active participation in the conduct of corp affairs d) Rejects D's claim that he was only an "accommodation" director (figurehead),
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d) Rejects D's claim that he was only an "accommodation" director (figurehead), b/c that doesn't relieve D of the fiduciary duty that comes with directorship vii. PRES v. Michaelson Properties (396) CONTRACT 1) Injustice alone is insuff in VA, this is nearly impossible without rank fraud 2) Sanctity of K, P could have asked for a personal guarantee and failed to 3) Classic K creditor has far more info than tort claimants (involuntary creditor) and, to an extent, has assumed the risk of contracting with a corp rather than an individual 24. FIDUCIARY DUTIES, GENERALLY a. Generally i. Most lawsuits are against directors, although officers also owe fid duty ii. Internal Affairs Doctrine: The internal affairs of a corp are normally governed by law of the jurisdiction where a business is incorporated 1) But see Francis (415) (applying law of state where essentially all corp business took place) b. Standing i. Duty is to the CORP, not to an individual SH 1) Under traditional doctrine, only corp may file a direct lawsuit against the corp, but a SH can file a derivative action on behalf of the corp 2) But when corp is insolvent, many states have laws saying that a corp may owe a fid duty to creditors as well ii. Also may have a fid duty to others when you hold P's money in trust (e.g., banks, see also Francis) c. Types, Generally i. Duty of care: duty to exercise reasonable care in mgmt and operation of the corp 1) Oversight: you must use reasonable care in monitoring the affairs of the corp (asleep at the switch) 2) Decisionmaking: you must act carefully when making business decisions that will affect the corp's welfare ii. Duty of loyalty: duty to put corp's interests ahead of your own iii. Duty of disclosure: not an independent fid duty (within care and loyalty) but must be independently complied with nonetheless (480) iv. Knowingly engaging in illegal conduct is technically distinct but also considered a breach of fid duty (see, e.g., Miller v. AT&T (438) where corp decided after careful thought that engaging in illegal conduct was in the best interest of the corp) 25. FIDUCIARY DUTIES DUTY OF CARE/OVERSIGHT ***BJR does not apply in the oversight context unless inaction somehow purposeful*** a. Standard of Care i. MBCA 8.30: Standard of Conduct 1) (a)(1) Must act in good faith AND: a) (a)(2) Subjective: "in a manner the director reasonably believes to be in the best interests of the corporation" b) (b) Objective: "shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances" 2) Rejects "reasonably prudent person" language b/c didn't want to imply that biz ppl should be risk-averse, but essentially the same 3) If you have a special skill set (e.g., lawyer), you'll be held to the standard of a reasonably prudent person with that skill set (will customize on the high end, but won't let folks go below the low end even if they have little experience) 4) (e), (f): Can rely on "information, opinions, reports or statements" prepared by certain people (listed) ii. Some courts impose a higher duty of care on an "inside" director 1) Inside: actually employed by the corp (usually an officer) 2) Outside: does not hold an employment position with the corp
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1) Inside: actually employed by the corp (usually an officer) 2) Outside: does not hold an employment position with the corp 3) See Bates (428) (holding D, president of bank and member of the Bd, liable for bookkeeper theft when outside Bd members escaped liability) iii. Large corp with many employees doesn't absolve of responsibility, but rather imposes responsibility to institute system of info-gathering (Caremark, 429) b. Breach/Standard of Liability i. MBCA 8.31: Not liable for failure to act unless P 1) (a)(2)(iv) Shows "a sustained failure of the director to devote attention to ongoing oversight of the business and affairs of the corporation, or a failure to devote timely attention, by making (or causing to be made) appropriate inquiry, when particular facts and circumstances of significant concern" materialize that would alert a reasonably attentive director to the need therefore c. Causation i. MBCA 8.31(b)(1): proximate causation req ii. Must show that actions that harmed the corp would not have occurred if D had been properly exercising oversight iii. Harder with negligent omission than with commission, must determine the reasonable steps D should have taken and whether that course of action would have averted the loss d. Francis v. United Jersey Bank (415) i. D (estate) was a director (majority SH that inherited her husband's shares and directorship at his death) at a reinsurance brokerage company ii. D's kids (also directors) siphon off money from the company under the guise of "SH loans," drove the company into bankruptcy and trustee of BR estate sues D for breach of fid duty of care for failing to stop kids from stealing iii. Choice of law = NJ, even though incorp in NY 1) Internal affairs doctrine: choice of law rule stating that disputes that arise "w/in the triangle" of directors, officers, and SHs, or b/n those parties and the corp dispute governed by company's state of incorp 2) BUT court finds (and parties agree) that NJ law should trump instead because the only real connection with NY was incorp and all significant transactions = in NJ iv. Standard of care: directors must discharge their duties in good faith and act as ordinarily prudent persons would act under similar circumstances in like positions 1) Should acquire as least a rudimentary understanding of the biz of the corp, and become familiar with the fundamentals of the biz in which the corp is engaged 2) Under a continuing obligation to keep informed about the activities of the corp 3) Attend board meetings regularly, will depend on nature of corp 4) Not required to audit books, but should maintain familiarity with the financial status of the corp by regular review of financial statements a) But generally immune if reasonably relied on opinion of counsel or accountant, which were represented as correct but weren't 5) If review of financial statements reveals or indicates possibility of misconduct, gives rise to a duty to inquire further 6) If discover illegal course of action, may have to object and resign, seek assistance of counsel, and even take reasonable means to prevent this illegal conduct (threaten or even bring suit) 7) "A director is not an ornament, but an essential component of corp governance" v. Breach: obviously a breach, D did NOTHING to prevent the illegal conduct 1) Even a "cursory reading of the financial statements" would have revealed misapprop vi. Causation: had D paid any attn and objected, most ppl would stop engaging in illegal activity once detected (should have threatened to sue if objection work) 1) Must infer causation in cases of negligent omission, assume threat of suit would have stopped kids because their actions were so blatantly illegal 2) Voting against course of action and recording dissent in minutes, maybe resigning would normally absolve D of liability (see examples, 424), but nature of reinsurance business (where corp owes fid duties to 3P clients as well as to SHs) raises duty
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business (where corp owes fid duties to 3P clients as well as to SHs) raises duty 3) But wouldn't D have been outvoted on the board if she did try to stop it? Not realistic b/c this isn't the type of thing you vote on vii. D = personally liable for breach of duty of care e. Barnes v. Andrews (426) i. D here also paid little attn to the activities of the corp, bankrupt in large part due to expenses associated with production delays (no illegal conduct) ii. Breached duty of care, but NO causation P put on no evidence showing that the production delays would not have occurred had D paid more attn 26. FIDUCIARY DUTIES DUTY OF CARE/DECISIONMAKING a. Ways to Evaluate i. Process: how did we get here? ii. Substantive Outcome: what result? b. Business Judgment Rule i. Absent egregious circumstances, courts will uphold the substantive business decision of directors and officers if it can be attributed to a rational business purpose ii. Will uphold decision IF it was made: (need all) 1) In good faith (duty of care claim) a) Subjective, encompasses in knowing engagement in illegal conduct b) "Honesty of purpose and a genuine care for the fiduciary's constituents" (Walt Disney, 436), may require malevolent intent beyond gross neg c) See, e.g., Miller v. AT&T (438) where corp decided after careful thought that engaging in illegal conduct was in the best interest of the corp d) No one really knows what this is (either a redundancy or a catch-all) 2) With reasonable decisionmaking process (duty of care-process claim) a) Delaware standard = gross negligence, but may be regular neg elsewhere 3) With no COI (duty of loyalty claim) iii. These factors are "inputs" and, if the inputs are ok, then we won't look at the output iv. This is akin to a standard of review and, if these three factors are satisfied, it will be upheld as long as it's rational (NOT reasonable), an extremely low standard 1) Need only be attributed to a rational business purpose (court can assume, don't even have to prove the purpose was your basis for making the decision) 2) Not rational? Cannot be coherently explained (e.g., corporate waste) **Negating an element does NOT mean you win, then you go to fairness** i. MBCA 8.31(a)(2) 1) (i) Good faith: Which the director 2) (ii) Reasonable decisionmaking process: As to which the director did not reasonably believe to be in the best interests of the corporation OR as to which the director was not informed to an extent she reasonably believed appropriate in the circumstances 3) (iii) COI: A lack of objectivity due to the directors familial, financial or business relationship with, or a lack of independence due to the directors domination or control by, another person having a material interest in the challenged conduct a) (A) relationship could reasonably he expected to have affected the director's judgment in a way adverse to the corp b) (B) director has the chance to explain why she thought it was best for the corp ii. DGCL 141 1) (a) BJR stems from principle here that the "business and affairs" of every Del corp "shall be managed by or under the direction of a board of directors" 2) (e) You're "fully protected" if you rely in good faith "upon the records of the corp and upon such information, opinions, reports or statements" of corp employees or others if you reasonably believe it's "within such other person's professional or expert competence" iii. DGCL 102(b)(7): passed in response to Van Gorkum 1) Corp can put in articles a provision that eliminates the possibility of personal,
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1) Corp can put in articles a provision that eliminates the possibility of personal, monetary liability for breach of duty of care, but can't eliminate liability for: a) Breach of duty of loyalty (but no where else in the statute imposes this duty?) b) Bad faith acts or omissions or intentional misconduct/knowing violation of law c) COI transactions where director received improper personal benefit iv. Rationales: 1) Hindsight bias (hard to separate bad result from bad decision) 2) We want businesses to take risks, etc. 3) Incentive to serve as a director (liability in most cases would far outweigh any benefit gained from serving as director) 4) Judges are not experts in business (but proves too much, judges aren't experts in most things that they rule on) 5) Market will constrain bad decisions, so courts don't need to (bad decisions will harm the corp and the bad decisionmakers will be ousted or corp taken over) BUT this doesn't work with closely held where SHs can't sell stock freely If three factors of biz judg rule are NOT shown, revert to a. Entire Fairness Standard i. Was the substantive outcome FAIR to the corp? 1) Fair dealing: when the transaction was timed, how it was initiated, structured, negotiated, disclosed to directors, & how approvals of directors & SHs were obtained 2) Fair price: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of the transaction ii. This is a much higher level of scrutiny, so whether BJR applies or not is usually outcome determinative iii. We'll get to this standard most often in COI transactions (see duty of loyalty below), but also if you negate good faith or reasonable DM process (though Van Gorkum court skipped this because violation of duty of disclosure = automatically not fair) b. Litigation Strategy i. Don't state your claim as attacking the result (decision was bad), b/c BJR will require you to show irrationality ii. Rather, attack a prerequisite of the BJR, which may get you to entire fairness 1) E.g., Attack decisionmaking process as a duty of care claim 2) Claim conflict of interest as a duty of loyalty claim c. Remedy i. Personal liability of Ds, J&S among all found in violation ii. Van Gorkum: damages to the extent that true value of shares exceeded purchase price iii. Rescissory damages: what would P's shares have been worth if the challenged action had not occurred? But difficult to calculate as buyer inevitably alters course of corp business d. Effect on Substance Claims i. BJR generally precludes liability only for an bad outcome, must show irrationality (this is essentially impossible) ii. Shlensky v. Wrigley (430) Ill. 1) At the time, the Cubs were the only team in the league without lights of the field and so can't play night games 2) SH brings derivative lawsuit on behalf of corp, claiming decision = stupid 3) Court doesn't care unless biz decision was result of fraud, illegality, or conflict of interest (stupidity is insuff) e. Effect on Process Claims i. Biz judg may not protect you from a faulty process ii. If you're in Delaware attacking decisionmaking process of BJR, standard = gross negligence iii. NOTE: duty of care claim as to process (decisionmaking prong) can be eliminated if SHs approve after disclosure of all facts germane to transaction at issue iv. Smith v. Van Gorkum (443) Del. 1) VG = CEO of Trans Union (TU), a corp in trouble b/c it has a lot of tax credits that it
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iv. Smith v. Van Gorkum (443) Del. 1) VG = CEO of Trans Union (TU), a corp in trouble b/c it has a lot of tax credits that it can't use, so it's been going around acquiring small businesses to increase its taxable income and considering other, better, long-term options 2) VG approaches Pritzker (takeover specialist) about a leveraged buyout, VG offers $55/share, which he got from CFO's study of the price that could be supported in a leveraged buyout a) Leveraged buyout in the form of a cash-out merger: TU will merge into New T, which, as the surviving corp, will assume all assets and liabilities of TU; must come up with consideration b/c shares of TU will no longer exist (sometimes this is stock in new corp, but here the "cash-out" part says that SHs will just get cash) b) New T intends to use cash flow to pay off debt taken out to purchase TU (this is the leveraged buyout part) 3) Court finds board breached fid duty to SH b/c (1) failure to inform themselves of all info reasonably available to them and relevant to their decision to recommend the merger and (2) failure to disclose all material info such as a reasonable SH would consider important in deciding whether to approve offer a) Standard = gross negligence, even though "reasonable" decisionmaking process implies ordinary negligence (unclear if other juris follow) 4) Court finds ample evidence of (1) i) Everyone just accepted the reps made by VG and didn't ask any questions as to how he reached numbers or terms ii) No one even read the merger K or the amendments, which differed significantly from the representations made as to their content (don't need to read word for word, but must know general contents) iii) Made in serious haste (2-hour Board meeting) and tight deadline (48-hrs) for approving, where no evidence of emergency 1. But corp had been discussing this issue for years? Court seems to assume that it was not a conscious decision that it was worth it iv) Can't rely on premium over market price, evidence that the stock was undervalued in the market (so premium didn't look so good?) 1. But court did NOT say that $55 was a bad price, court admits it doesn't know if it was good or bad, the point is that the board didn't know either v) Reject claim that reliance on reps of CEO, CFO, and corp counsel gave them protection of 141(e) b/c 1. Reliance on VG wasn't reasonable when there were red flags and no further inquiry was made 2. Opinion of counsel that corp would get sued if they didn't take merger is insuff (corps can get sued for anything) a) Court REJECTS Ds claims that certain actions saved them i) Directors collective experience (directors were exceptionally qualified) is NOT sufficient to save an uninformed process (this is dissent) 1. Though this could alleviate other concerns such as haste (i.e., we can make these decisions faster and w/ less info than others) ii) Premium over market price is not sufficient b/c no valuation 5) As to (2), duty of care process claim (decisionmaking prong) can be eliminated if SHs approve after disclosure of all facts germane to transaction at issue, but court rejects a) Failed to disclose lack of valuation info b) Board's reference to "substantial" premium was misleading 6) BJR can't apply here b/c P attacked prereq decisionmaking process and successfully rebuts BJR a) If P had attacked fairness of share price, would have been different 7) WHY gross neg? May not have been if court had believed that the decision was actually a conscious one in response to particulars of situation rather than a rubber
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actually a conscious one in response to particulars of situation rather than a rubber stamp a) Engage in a deliberative process GIVEN THE CONTEXT (i.e., there might be other situations where this quantity and quality of deliberation would = suff) 8) Damages a) What was a fair price for a cash out merger? b) PERSONAL, joint and several liability b/c breach of fid duty c) Pritzker wound up paying $13 million to cover d) This was weird that the court jumped straight to damages (if you rebut a prong of BJR, should have gone to fairness analysis) e) BUT court later explained that violation of duty of disclosure in addition to duty of care meant that decision automatically could not withstand entire fairness v. What suggestions result from this? 1) Ask more questions of insiders proposing deal (would have discovered lack of reasonable basis for decision, where the price here wasn't even the product of negotiation, if they had) 2) Read the contract you're signing, especially when other party drafted 3) Need to show that decision was not made in haste, especially in the absence of dire circumstances or emergency, made in a deliberative manner 4) Preserve contextually relevant info on which you based decision (this could be a valuation, but not necessary if you have other info) vi. Cede & Co. (460) Del. 1) Finding of gross negligence = prima facie evidence of liability, even without a full showing of proximate causation, shifting burden to Ds to demonstrate fairness 2) But with no/insuff evidence of causation, may have damages problem 27. FIDUCIARY DUTIES DUTY OF LOYALTY a. Generally i. Requires the fiduciary (directors and officers) to put the corporation's interests ahead of her personal interests 1) When your fid is contracting with the corp, supposed to be thinking about the interest of the corp, concern is that fid is instead thinking about personal interests 2) Do NOT use terms "self dealing" or "standing on both sides of the transaction" b. Who = interested? i. Important for coverage (who must disclose) and for quorum purposes ii. Delaware law doesn't give any indication of definition 1) Case law in states with similar statutes (Shapiro, 481) indicates that you're interested if you have a "material financial interest" or substantial enough to affect your judgment OR if there is a "close" family member that is a party 2) But see Brehm (Del., 435): No BJR if directors are interested or "lack independence relative to the decision" 3) Plain language only covers situations when directors are parties or have a financial interest but not, e.g., when other party is related iii. MBCA 8.60 1) (1): COI transaction = a) Director is a party b) Director had knowledge and material financial interest c) Director knew that a related person was a party or had a material fin int 2) (4): Material financial interest: interest that would reasonably be expected to impair the objectivity of a D's judgment c. (2) Most Common Scenarios i. Conflict of interest: When Os or Ds enter into Ks or other transactions with the corp, including Ks for compensation or other remuneration 1) Standard: if you sufficiently allege a conflict of interest, this rebuts BJR b/c negates essential element entire fairness
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essential element entire fairness 2) BOP: Once conflict is shown, prima facie evidence of violation and burden shifts back to interested party to show fairness of transaction 3) COI transactions used to be per se illegal under common law, but evolved into rule of fairness in recognition that these can be beneficial to corp (so not per se illegal anymore, but stink enough to take away protection of BJR) a) WTF: Essentially, fairness is required to validate a COI transaction, which is exactly the state of the common law before statute was passed!! 4) Today, all jurisdictions have some sort of "interested director" statutes ii. Corporate opportunity: when Os or Ds take potential corp opportunities for themselves 1) This aspect is really three: usurping a corp opp, using corp prop for personal purposes, and competing with the corp (see 505) 2) What is a corp opportunity? a) "Line of business" test (Delaware): looks at whether the opportunity was so closely associated with the existing business activities as to bring the transaction within that class of cases where the acquisition of the property would throw the corp officer purchasing it into competition with his company (see Guth, 493) b) "Fairness" test (Mass.): fact-intensive inquiry where court looks to application of ethical standards of what is fair and equitable c) "Interest or expectancy" test: opportunity is open to the fiduciary unless (1) corp has an interest already existing in the opp (K or prop) d) ALI test (Maine, NE Harbor): Any opportunity to engage in a business activity of which D became aware i) Either (1) in connection with performance of functions of corp O/D or under circumstances where reasonable to think offeror expects opportunity to be offered to corp; or (2) through use or corp info or property, if reasonably think would be of interest to corp; OR ii) And knows is closely related to a business in which the corp is engaged or expects to engage 3) If it's a corp opp, what do you have to do? a) NE Harbor (484): If it IS a corporate opportunity, officer or director MUST disclose is to corp before taking it, it's illegal if you don't (bright line rule) i) If defective disclosure, can defend as fair to the corp, but can't claim fairness if you failed to disclose at all b) Delaware: even if it is a corp opp, don't have to disclose it to the board if you can (as a defense in a suit) prove that corp was incapable of taking the opp d. Entire Fairness i. Burden is always on the interested party ii. Technically, don't have to meet both, more of a totality approach (but need both in reality), ARGUE ALL 1) Fair dealing: when the transaction was timed, how it was initiated, structured, negotiated, disclosed to directors, & how approvals of directors & SHs were obtained 2) Fair price: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of the transaction iii. This is Delaware, in other jurisdictions, fair price might suffice even if no fair dealing iv. See also MBCA 8.60(6): "Fair to the corp" means fairness in terms of transaction and comparable to what would have been paid in an arms-length transation e. DGCL 144 i. (a)(1), (2): To establish director or SH approval, must show 1) Material facts related to interested party's dealing with the corp and the transaction are fully disclosed or actually known to the disinterested directors/SHs a) Requires disclosure of material facts of the conflict itself AND as to the transaction itself (compare Iowa in Cookies, where D need only disclose the facts relating to the conflict) b) So only defenses to nondisclosure = (1) not material (2) actually known
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b) So only defenses to nondisclosure = (1) not material (2) actually known 2) Good faith authorization/ratification by a) Majority of disinterested directors, even if they're less than a quorum (just one seems ok) (no "deliberate" req like MBCA, but "good faith"); OR b) By "vote of the SHs" i) Disinterested? Doesn't say, but Marciano footnote says "disinterested SHs", 477 n.3, and explicitly imposed additional requirement by Del. S.C. in Fliegler, BUT other states?? 3) Effect of compliance with (a)(1) or (2): (1) revert back to protection of BJR and (2) burden shifts back to P to show "issues of gift or waste" (ex. of irrational) a) Cures the stink can still attack other two prongs of BJR, but COI b) Compare with Cookies, where still have to show fairness even after compliance ii. (a)(3): Can also show entire fairness, only look at fairness at the time of authorization, approval, or ratification (so that obviously must have occurred) ***REMEMBER: This vote only blesses the conflict, STILL must have a second vote (with regular quorum) of the WHOLE board to authorize a transaction (COULD have one vote, but must comply with (a)(1) requirements)*** f. MBCA 8.60(1): COI transaction = i. (i): Director is a party ii. (ii): At the relevant time, D had "knowledge and a material financial interest known to D" iii. (iii): At the relevant time, D knew that a "related person" was a party or had a material financial interest iv. (4) defines "material financial interest" and (5) defines "related person" g. MBCA 8.61(b): No liability for COI transaction if i. (1): Director ratification per 8.62; ii. (2): SH ratification per 8.63; OR iii. (3): Adjudged fair to the corp, even in the absence of ratification 1) Compare DGCL 144(a)(3) which implies that ratification must have also occurred h. MBCA 8.62: Director's Action (734) i. (a): Affirmative vote of majority (no fewer than 2) qualified (defined at 1.43) and fully informed directors AND 1) Directors must have "deliberated" and voted outside presence of and w/o participation by the conflicted directors 2) If committee, all members must be qualified and either (1) committee composed of all qualified board members or (2) members appointed by affirmative vote of majority of qualified board members ii. (b): Doesn't require full disclosure if such disclosure would violate a legal duty, a duty of confidentiality, or professional ethics rule, as long as certain info is provided iii. (c): Majority of qualified board member constitutes a quorum iv. Effect of compliance w/ (a): presumed valid (no fairness review or reversion to BJR like Del) 1) Also here i. MBCA 8.63: SH's Action i. (a): Approval by majority of the votes cast by "holders of all qualified shares" 1) Requires notice to SHs describing action to be taken 2) Provision to corp of info related to conflicted shares and 3) Disclosure of required info to SHs, if no actual knowledge ii. Conflicted party must notify, b/f SH vote, of all shares known to be conflicted iii. (e) Court may validate SH vote if such vote would be otherwise invalid for conflicted director's failure to supply this info AND failure to provide did not affect vote result j. TBCA 2.35-1: "An otherwise valid contract or transaction . . . shall be valid notwithstanding" i. Compare Del 144: "No contract or transaction . . . shall be void or voidable solely for this reason" ii. On its face, it looks like transaction is valid UNLESS there's some other problem, but effect is
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ii. On its face, it looks like transaction is valid UNLESS there's some other problem, but effect is the same as DGCL b/c still must show "otherwise valid" k. Remedy i. Conflict of interest 1) Usually rescission of K 2) If rescission not an option, damages for difference between K price and fair price ii. Corporate opportunity 1) Usually to turn the opportunity over to the corp and hold fiduciary liable for any profits made (imposition of a constructive trust in corp's favor) iii. Problem with restitution-based remedies = no deterrent b/c fiduciary simply has to relinquish whatever was gained, so court have imposed some add'l sanctions: 1) Punitive damages 2) Order fid to repay any salary received from corp during time of breach of duty 3) Order fid to pay corp's atty fees and other expenses incurred l. Cookies v. Lakes Warehouse (465) Iowa i. Herrig-D = director/majority SH in Cookies and also owned Lakes (warehouses) and Speed (auto parts) ii. Minority SHsP bring a derivative lawsuit, claim D has several COIs and should be voided 1) Warehousing fees (Lakes): Board accepted proposal to compensate D at the "going rate" for use of his storage facilities (claims building and staffing own facilities would have been more expensive) 2) Exclusive distribution agreement (Lakes), but extension was identical to prior extension 3) Royalty K (D): Approved royalty fee to D for taco sauce recipe invention (similar to plan approved for BBQ sauce inventor with a slightly higher sales percentage) 4) Compensation (D): Jan. 1983 approved $1000/month consulting fee in lieu of salary, Aug. 1983 add'l increase in D's compensation, amended distributorship K to allow D an add'l 2% of gross sales iii. BJR doesn't apply here b/c conflict of interest element negates iv. Court found that D met burden to establish fairness of transaction b/c 1) Even P's EW admitted that D was probably underpaid considering the services he provided, and court finds that benefit to corp as demonstrated by financial success 2) Even if services could have been obtained elsewhere at lower cost, fees not automatically unreasonable or exorbitant (court seemed to shift burden back to P here, where D should have been forced to show fairness) 3) Sales and profits would not have been the same with other vendors b/c D was "driving force" behind corp's success 4) Dissent: looked only at the financial success of the corp, rather than whether the value was actually fair v. Compliance with one of two options in the statute (director or SH approval) would merely preclude the court from rendering the transaction void or voidable outright solely on the basis of the conflict 1) GLOSS: Even if ratified by Bd or SHs, D still has the add'l burden to show fairness 2) But why go through one or two is you still have to prove fairness?? vi. Statute is similar to DGCL 144, other problems with Iowa law: 1) Don't have to disclose material facts about transaction itself, only about the conflict specifically ( 144 says must disclose conflict "material facts as to the contract or transaction") 2) Unclear whether you need a majority of disinterested directors, unanimous, etc.? Just says "without counting the votes" of interested directors (authority to act Q) 3) Unclear whether interested directors can vote shares if they have them 4) Don't use "ratify" in SH context but does use it with directors, on purpose? m. Marciano v. Nakash (474) i. P-M and D-N enter into a joint venture and form and clothing corp ii. P claim COI where D
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ii. P claim COI where D 1) Advancing personal funds to Gasoline (it doesn't even look like this transaction was authorized) 2) Arranging for U.F. Factors (also owned by D) to assume personal loans and becomes Gasoline's lender 3) Approving terms of loan such as interest rate and personal guarantees iii. Curative steps of 144(a) (ratification) not available b/c 1) Deadlock of board (whose directors were also only SHs) prevented ratification 2) SH control by interested directors precluded independent review iv. So lost BJR and N has burden to show entire fairness. YES, it's fair (not many facts here but deferential SOR for TC finding of fairness) 1) Can still win under entire fairness 2) Loan terms compared favorably with terms available from unrelated lenders 3) Need for external financing clearly demonstrated (only way they kept afloat) 4) Loans made w/ bona fide intention of keeping Gasoline in business (good faith) 5) Though failure to bring it to the board at all doesn't seem like fair dealing? n. Executive Compensation i. Often arises as: 1) SH direct or derivative action 2) SH oppression claim (where termination = exclusion from profits because this is usually the way that closely held corps distribute profits (de facto divided)) 3) IRS enforcement action: disallow deduction of unreasonable compensation ii. How to challenge in direct or derivative suit? Remember, BJR in your face 1) COI (duty of loyalty claim) if executive is also a director a) Stock options (classic COI) go to 144-ish law b) Most stock option cases proceed under conventional waste analysis but, if no SH ratification, may go to Delaware 2-part test (51314) 2) Reasonable DM process (duty of care-process claim) 3) Irrational (duty of care-substance claim) CORP WASTE a. Waste = an exchange that is so one-sided that no business person of ordinary, sound judgment could conclude that the corp has received adequate consideration b. SHs can't ratify corp waste except by unanimous vote iii. Wilderman v. Wilderman (507) 1) P sues D (ex-husband), claiming his compensation as CEO of their corp was unreasonable 2) So no BJR b/c COI (D = director) fairness 3) Court considered: a. What other similarly situated executives earn (D presented no evid) b. Ability of the executive (court was skeptical) c. Whether IRS has allowed corp to deduct full amount paid (no) d. Whether salary bears reasonable relation to success of corp (D's salary tripled when corp's earnings less than doubled) e. Amount previously received as salary (huge increase "by his own fiat") f. Whether increase was tied to increase in value of services rendered (court was skeptical) g. Amount of salaries compared to other salaries paid by same corp (P made less than 10% of D's) 4) NOT fair to corp, finds salary should be between amount set by P's EW and amount IRS allowed D to deduct iv. Why most litigation involves closely held corps 1) Directors at closely held are more likely to approve their own compensation 2) Less careful about observing formalities necessary for compliance w/ duty of care 3) SHs of closely held are more likely to be involved in the business and be aware of the actions of the board
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actions of the board 4) Compensation tends to be a much larger percentage of the profits 5) Closely held set your own pay conflict of interest no BJR protection court applies entire fairness test burden on Bd to prove fairness o. Duties of Controlling SHs i. Absent a contractual obligation, a SH normally has no duty to the corp or to other SHs, but can owe duty in certain circumstances, mainly: 1) COI transactions a. DGCL 144 doesn't apply here b/c COI doesn't involve O or D b. But courts have found duty of disclosure 2) Sales of the controlling interest ii. Not really a "fiduciary" duty, because focus is on fairness rather than selflessness iii. What is a controlling SH? 1) Investor or group of investors with the power to direct corp affairs 2) Not necessarily majority SH, but inquiry will focus on SH's ability to control the conduct of the corp 3) Generally need some evidence of concerted action iv. Why impose this duty? Because other fiduciaries (Os, Ds, etc.) owe the duty due to their level of control over the conduct of the corp v. Sinclair Oil v. Levien (515) Del. 1) Sinclair = parent (owned 97% of stock) in Sinven, needed $ so caused Sinven to pay out dividends; minority SHs sue claiming that dividend policy caused Sinven to be unable to pursue business opportunities 2) Parent-subsidiary relationship controls the transaction and fixes the terms 3) Parent owes a fiduciary duty to subsidiary in COI transactions, where parent causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority SHs of the subsidiary 4) BJR or was this a COI transaction and thus entire fairness? a. BJR! b. Dividends paid to minority SHs as well as to Sinclair, so benefit was not obtained to the exclusion of or detriment to the minority SHs c. Ps claim usurp corp opp but pointed to no opportunities that Sinven specifically could or should have been offered, so BJR says this is ok too 5) No violation, not irrational/waste BUT there were other Ks between the two companies that Sinclair caused Sinven not to perform violation under entire fairness because this is a clear COI transaction (didn't have to K with Sinven, but did) vi. Citron v. DuPont (520) 1) May be different with parent-subsidiary merger 2) Entire fairness, even when subsidiary was represented in negotiations by committee of disinterested, independent directors and was ratified by informed vote of disinterested minority SHs p. Exculpation Statutes i. Because of the fear of personal liability of Os and Ds (see Van Gorkum), more than 35 states have passed laws aimed at limiting the exposure of Ds (sometimes Os) to personal liability for money damages ii. Charter Option Laws: authorizes adoption of a provision eliminating or limiting the personal liability of a director to the corp or SHs for monetary damages for breach of fid duty of care 1) Common exceptions (see 539), which can be read expansively by courts 2) Does not apply to suits by 3Ps 3) About 30 states, this is DGCL 102(b)(7) iii. Self-Executing Laws: direct alteration of the standard of liability necessary to recover money damages, requiring willful misconduct or recklessness 1) Many apply to suits by 3Ps 2) Only a handful of states, very restrictive iv. Cap on Money Damages: limits damages that may be assessed against Os or Ds to greater of
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iv. Cap on Money Damages: limits damages that may be assessed against Os or Ds to greater of $100,000 or the amount of cash compensation received by O or D during 12 months prior to violation BUT permits SHs to reduce or eliminate (but not increase) limit in bylaws or charter q. Indemnification & Insurance i. Fine line with indemnification where it's good to protect Ds that went a bit too far, but allowing it too often would totally defeat the purpose of fiduciary duties ii. DGCL 145(g)/MBCA 8.57: allows corps to buy insurance policies on behalf of a person even when the corp would be prohibited from directly indemnifying that person, includes: 1) Reimbursement to corp for costs of indemnifying 2) Covers Os and Ds directly for sums that are not able to be indemnified iii. Common exclusions (see 559) 28. DISSENSION & SH OPPRESSION a. Dissension & Dissolution i. Dissension mainly arises in two situations: deadlock and oppression ii. Court typically has the power to order dissolution upon establishment of either iii. Dissolution usually involves: termination of corp's existence, sale of the business (as a going concern or asset by asset), repayment of debt to creditors, pro rata distribution of any remaining assets to SHs iv. Types of dissolution: 1) Voluntary: not ordered or compelled by a court or a state 2) Involuntary: ordered or compelled by a court or a state 3) Administrative: for noncompliance with certain reqs of the state (e.g., failure to pay taxes or fees) a. MBCA 14.20: Sec State empowered to bring dissolution proceedings b. DGCL 510: dissolution is automatic b. Deadlock i. Wollman v. Littman (561) 1) Ps and Ds each have 50% stakes in corp and control equal halves of the Bd 2) Ps claim that separate proceeding against them (i.e., Ds are suing the Ps in a different suit) is evidence of deadlock requiring dissolution 3) "Irreconcilable differences even among an evenly divided board of directors do not in all cases mandate dissolution" 4) No dissolution here a. Evidence that Ps and Ds control different parts of the corp and could function independently of one another b. If dissolved, it would essentially afford victory to Ps in other lawsuit in which they are Ds 5) Appts receiver to oversee orderly functioning of regular course of business c. Oppression, Generally i. Def: majority uses control to deny participatory and/or financial rights in the venture 1) Freeze out: majority uses control to deny participatory and/or financial rights in corp a. Terminating employment b. Refusal to declare dividend c. Removal from Bd d. Siphoning off corp earning thru high compensation to majority SH e. Usually a combination 2) Destroying S-corp status (where avoid entity level taxation), see Chesterton (595) ii. Most close corp owners expect employment and mgmt as part of return on investment AND most pay out profits as salaries rather than dividends (b/c salaries are a tax deductible business expense and dividends are not) 1) So stripping employment may eviscerate return on investment 2) Many oppression statutes exclude public corps from bringing action (though not all) iii. Why can't traditional corp law handle freeze out problem? 1) Fiduciary duties run to the corp (need to show injury to corp, not just SH)
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1) Fiduciary duties run to the corp (need to show injury to corp, not just SH) 2) SH doesn't have standing to bring individual suit 3) Even if overcome BJR and get to fairness, still ask only if it's fair to the corp, not to SH iv. Traditional employment law isn't much of a help b/c of at-will doctrine v. Some jurisdictions allow a 50% SH to bring suit under oppression statutes b/c focus is on power (meant to prevent abuse exercise of control) 1) E.g., via SH agreements, collusion, officers out of control (need board to reign in), etc. 2) Hollis (and others, see 607) d. State Approaches to Freeze Out i. Protection thru K 1) SH agreements 2) Supermajority reqs 3) Buy-sell provisions, etc. ii. In the absence of a contract, jurisdictions respond in two ways to freeze out problems 1) Special rules: Some juris adopt specific doctrines to protect minority SHs a. Fiduciary duty approach (Mass., Donahue, Wilkes) i) Focus on actions of the majority (legitimate business purpose) b. Dissolution for oppression statutes (NY, Kemp) i) Focus on the effects on the minority (reasonable expectations) ii) MBCA 14.30, .34 (see below) iii) Majority of 38 states that have these statutes use Kemp reas exp test c. Most cases will come out the same, but conceivable that they could differ when majority action taken through no misconduct or incompetence of minority SH 2) No special rules: Other jurisdictions refuse to adopt special common law doctrines to deal with this, and SHs must rely on traditional legal principles a. This is Delaware (Nixon ) b. Have to rely on traditional corp law protection (but de facto dividend claim is the only way you will probably succ/eed here b/c BJR and other fid duty imped) c. But Ragazzo says that Delaware might be open to special rules (628), Nixon wasn't a freeze out case iii. Not mutually exclusive with traditional corp fid law, can still bring all those claims e. Remedy i. Dissolution (see above) 1) MBCA 14.30 2) Traditionally the only remedy ii. Buyout at fair value 1) MBCA 14.34 2) This is far more common today as a less harsh alternative 3) Some commentators advocate mandatory buyout at the will of minority SH (safeguards for corp stability: installation pymts, holding period, limited waiver) a. Problems (648) iii. Appointment of a custodian or provisional director (see Wollman, 561) iv. Cancel/alter provision of articles, bylaws, or resolution v. Dissolution at a later date, if parties can't come to an agreement vi. Enjoining or requiring certain activities, rescind a particular act vii. Order constructive dividend of amount above reasonable compensation viii. Ordering cancelling or issuing of stock to achieve equal balance of ownership ix. Compensatory and/or punitive damages x. Some states allows courts to impose any equitable relief it deems appropriate f. Interplay with Other Doctrines i. Business Judgment Rule doesn't come into play here b/c 1) No standing b/c fid duty only runs to corp and must show injury to corp 2) Even if did have standing, indirect COI b/c one SH benefitting from other SH's harm 3) But more than that, BJR doesn't really even apply in this context b/c displaced by the Wilkes standard (see cases 587)
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Wilkes standard (see cases 587) a. Under Wilkes, must PROVE legitimate business purpose, not attribute to rational purpose like BJR and have opportunity to rebut even still (see Smith) ii. Employment at Will Doctrine 1) An employee without K for a fixed term can be fired for any reason or no reason at all 2) Interplay with Donahue duty if P can't make the connection between employment and capacity as a SH (Merola), revert to emp't at will doctrine 3) Only exceptions: a. Breach of express or implied promise, including reps made in emp'e handbook b. Discharge in violation of public policy c. Breach of implied covenant of good faith and fair dealing (classic = denying the fruits of the contract to a party that has fully performed her own obligations) 4) See Gallagher below g. The Fiduciary Duty Approach i. Must connect your injury to your position as a SH ii. Donahue v. Rodd Electrotype (565) Mass 1) Established fiduciary duties (utmost good faith and loyaltly) between SHs of all closely held corps (just like p'ship), rather than, in traditional corp law, running to corp only a. Not limited to majority or controlling SHs (n. 17) but also to minority b. Most states do not have explicit law saying that it runs both ways (only majority minority) 2) Rodd = majority SH (president/director), Donahue = minority SH (operations, mgmt) a. Rodd's kids and other Bd appointees buy out his stock without telling Donahue's kids (who inherited his stock), they demand same buyout price and corp refuses b/c it's not in a financial position to do so 3) If close corp is repurchasing stock from a member of controlling group, must also offer minority SH equal opportunity to sell same amount of stock at the same price a. Ability to sell transforms illiquid asset into a liquid asset, both should be able to have this benefit b. Does this only apply in the stock repurchase context? Some language in opinion seems like it is, but other language seems broader (concurrence refuses to join in implication that the rule applies beyond this context, implying there is) c. Majority of states generally reject equal opportunity rule 4) But was Donahue (who was never involved in mgmt) really in the same position as Harry Rodd? There wasn't really a nexus b/n stock and employment interest iii. Problems with Donahue decision: 1) Relies heavily on p'ship analogy to import fiduciary duties a. How are close corps like p'ships? i) Often active participation in mgmt of business (though in p'ship you have an actual legal right to do so) ii) Relatively small number of owners iii) Usually restraints on transferability of stock (though this is NOT the default in corps while it IS the default in p'ships) b. How are they different? i) Ease or difficulty of dissolution ii) Limited liability c. While there are similarities, is this justified? i) Even p'ships don't have unlimited buyout rights and you can't assume all close corp SHs want p'ship law to govern (how much are we importing) ii) Concerns that underpin p'ship law (unlimited personal liability) are absent in corp law, and limited liability is why most ppl opt for that structure iii) But close corp SHs often have most of their assets tied up in the corp, so common ground is ability of one owner to harm another owner 2) Equal opportunity rules may be untenable a. Corp may not have enough money to buy out everyone every single time it
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a. Corp may not have enough money to buy out everyone every single time it wants to buy some shares (won't buy anyone out, bad for corp?) b. Does this extend beyond stock repurchase context? To raises, promotions, any other benefit? What are the limits? Aren't there legit reasons to treat ppl unequally at times? iv. Wilkes v. Springside Nursing Home (580) Mass 1) W, R, Q, P start nursing home business with understanding that each would be a director and actively participate in mgmt, and that each would take salary from corp in equal amounts 2) Eventually, bad blood leads to W being shut out and employment terminated, offered far less that fair value for W's shares (classic freeze out) 3) Court automatically treats others as a controlling group (evid of concerted action?) 4) While Donahue holding that SHs owe a fid duty of utmost good faith and loyalty, equal opportunity doctrine went by the wayside 5) ***NEW standard*** a. Initial burden on P to show breach of Donahue duty of utmost good faith and loyalty i) Injury must be incurred in P's capacity as a SH (i.e., if injury relates to loss of emp't, must tie to expectations or capacity as a SH) ii) If it's a traditional SH right like receiving dividends, that's the end; but if it's a nontraditional right like employment, have to show connection with SH capacity b. Burden shifts to defendant Can the D-controlling group demonstrate a legitimate business purpose for its action? i) Later articulated that it must be a legit biz purpose for corp, not for D-SH c. Burden then shifts back to P to show that the same legitimate objective could have been achieved through an alternative course less harmful to P's interest i) Important limitation: court must weigh legit biz purpose against "practicability" of a less harmful alternative (i.e., corp's interest are still considered) 6) Under this standard, court finds breach of fid duty but focuses on several factors a. Action was in disregard of long-standing policy of the SHs that each would be a director and that employment with the corp would go hand in hand with stock ownership (W met this burden b/c testimony of implied agreement) i) Denial of certain traditional SH rights would immediately give rise to breach (access to books and records, voting, dividends) but stock ownership, as a per se matter, doesn't give you an automatic right to directorship, employment, and other nontraditional SH rights ii) Critically important: b/c Donahue duty only protects you as a SH, you must show that you were injured as a SH, so this explains the required nexus between stock ownership and employment interest b. Corp never declared a dividend (this is strong circumstantial evid that employment and stock ownership go hand in hand) c. W was also an founding SH of the corp (no case explains the significance of this, but they always note whether P was or wasn't, probably just bolsters claim that investment was tied to empt expectations) d. No legitimate business purpose whatsoever pure spite h. Applying the Donahue/Wilkes Fid Duty Approach i. Merola v. Exergen Corp. (588) Mass 1) P was enticed to work for D's company with understanding that he would have opportunity to become a major stockholder and for continued emp't 2) Started as a part time employee and bought some stock, later became full time and continued to buy more and more stock when options offered later fired 3) Court rejects a. ROI: When fired, corp bought P's shares back at more than he paid (didn't
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a. ROI: When fired, corp bought P's shares back at more than he paid (didn't completely deny P a return on his investment) b. Loss of emp't doesn't work b/c capacity as an employee (nontraditional SH right) c. Doesn't go "hand in hand" with capacity as SH when no link here when P didn't even acquire any stock until after he started working d. No "general policy regarding stock ownership and employment" e. Corp didn't distribute all profit in the form of salaries (can still get ROI) 4) P didn't meet his initial burden to show breach of Donahue duty b/c he couldn't tie emp't to capacity as a SH emp't at will governs (when your job is just a job) 5) This may be the only case where a minority SH was NOT able to establish a connection ii. Smith v. Atlantic Prop. (592) Mass 1) Four SHs (each with equal shares) form corp, bylaws contain provision that every board resolution of corp requires 80% of voting shares to approve (so every SH has veto power) a. SH have an agreement that constrains the discretion of the board (McQuade, Galler, Long Park 35962) assuming it's not a statutory close corp, have to check juris to see if this is ok 2) W, through veto power, prevents payment of dividends for many years, claiming that the profits should be reinvested for repairs to corp property but this constant blocking results in IRS tax penalties for unreasonable accumulation of corp earnings a. Probably could have brought this as a traditional derivative action b/c penalties hurt corp, but Ps bring oppression claim instead (is this ok? SH injury isn't really distinct from corp injury here) 3) Court finds that W owes a Donahue duty runs from controlling to minority, but also from minority to controlling if minority has sufficient control a. While court didn't explicitly state that W = "controlling", FN 5 emphasis says that Wilkes stands for proposition that all minority SHs don't owe the duty, only the ones that are "controlling" 4) Court rejects W's asserted legitimate business purpose he had no plan to implement repairs that he claimed were necessary to retain profits (court thinks he's just lying) a. This is a good example of how legit biz purpose is different from BJR b/c court won't attribute a purpose but rather W has to produce evid supporting claim i. Applying the Dissolution for Oppression Approach i. Reasonable expectation doctrine will produce substantially the same result as Donahue duty of utmost good faith and loyalty ii. MBCA 14.30(2)(ii): can judicially dissolve upon a showing by a SH that "directors or those in control of the corp [are acting] in a manner that is illegal, oppressive, or fraudulent" 1) 14.34 allows buy out at a fair price iii. What = oppressive? 1) Most of the 38 states with dissolution for oppression statutes adopt Kemp reasonable expectation test 2) "Burdensome, harsh, and wrongful conduct" (BEST for the plaintiff, see 604) 3) Fiduciary duty concept of Donahue (but this is rare) 4) Kemp reasonable expectation test 5) Some combination of these definitions (this includes Texas, which has an oppression statute on the books but also imposes fiduciary duties on controlling SHs in certain factual circumstances) iv. Factors for reasonable expectations 1) Are all SHs employees? 2) Is P a founding SH? 3) What were the other SHs' expectations? 4) Did P quit other job to join corp (i.e., depend on corp for employment)? 5) De facto dividends (7 factors of reasonable compensation, 603) a) But rebut with unclean hands if P was part of implementing program?
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a) But rebut with unclean hands if P was part of implementing program? b) But basic corp law says you have to distribute equally to equal classes of shares 6) If termination, why? Incompetence/misconduct? v. At what point in time is a SH's reasonable expectations assessed? 1) Kemp: reas exp "in committing their capital to the particular enterprise ... [that were] central to the petitioner's decision to join the venture" a. Not only does this limit the timeframe, but it also excludes those who did not explicitly invest capital (gift, inheritance) b. But, at a minimum, you have traditional/general expectations if given stock (but argue no expectations as a defense atty anyway) 2) Meiselman (N.C.): look at entire course of relationship at the inception, as altered over time, and as developed as the participants engage in a course of dealing in conducting the affairs of the corp a. This seems like the better approach if you have an explicit or implicit understanding, why does it matter when that occurred? vi. In re Kemp & Beatley (596) NY 1) Ps, after leaving company (one resigned, one fired), claimed that refusal to pay out dividends rendered their stock "virtually worthless" when can't get ROI after method of distributing corp profits changes a. Before, corp practice to distribute corp profits either as dividends or bonuses b. After, distribute based on "services rendered" so none to Ps b/c work there 2) NY law allows dissolution for oppressive conduct (statute book, 88081) a. Unlike Model (which just says "a" SH), plaintiffs must have at least 20% of shares to have standing to bring action on basis of oppressive conduct b. But "oppressive" isn't defined in the statute, so court has to figure it out 3) Oppressive conduct = conduct that substantially defeats the reasonable expectations held by minority SHs, objectively viewed, in committing capital to the particular enterprise (central to decision to join the venture) a. If it's a traditional SH right (general reasonable expectation), that's the end; but if it's a nontraditional right (specific reasonable expectation), have to show connection with SH capacity b. More specific way of articulating "hand in hand" required connection, where P has to show ownership would accompany nontraditional SH rights "a job, a share of corp earnings, a place in corp mgmt, or some other form of security" 4) Ps' reasonable expectation: If and when dividends are paid, they will be made on the basis of share ownership as they have been in the past (this is traditional SH right/ general reasonable expectation) a. To show that paying out distributions as extra compensation is oppressive, have EW show range of reasonable compensation for labor and that compensation exceeded that everything in excess = dividends (de facto dividends) b. Ps could have won under traditional corp law (it's just theft) c. Hard to make a claim that you have a reasonable expectation of declaration of dividends without more BUT The longer its been without paying a dividend, the better claim you have, but a court will not set clear time limits b/c inquiry is fact-intensive 5) Dissolution with the opportunity for a buyout is the proper remedy: only real way of getting your capital out of the company, but stops short of killing the corp j. No Special Rules Approach i. Nixon v. Blackwell (617) Delaware 1) Class A shares (voting) and Class B shares (nonvoting) 2) Corp had ESOP, which allows employees to own stock in a corp and cash out stock when they retire or are terminated (affording the coveted liquidity in close corp) 3) Corp also purchased keyman insurance plans, the proceeds of which buys back executives' shares upon their death (essentially paying the estate taxes of estate) 4) Ps (Class B SHs) sue as breach of fid duty, claiming implementation of system that
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4) Ps (Class B SHs) sue as breach of fid duty, claiming implementation of system that unfairly affords liquidity to some SHs to the exclusion of others 5) Entire fairness BJR doesn't apply b/c directors are also employees and thus benefit from both programs (COI transaction) 6) Court REJECTS a. Transactions fair to corp, even if not to SHs (traditional corp fid law, without benefit of special oppression rules, say duty is only owed to corp) b. Being treated fairly does not mean that you have to treat different classes of SHs that are not similarly situated equally c. This was part of the founder's design that different classes of SH would NOT be treated the same (since inceptionimportantit wasn't changed to screw P) d. Corp had also offered to buy back stock several times, so some liquidity offered (but at a decent price?) 7) Rationales for rejecting the special rules approach a. Can use all other traditional corp law rules, which supply sufficient safeguards b. K rationale: many ways to protect yourself through contract (e.g., SH agreements, employment Ks, etc.) i) SH makes a business judgment to buy into minority position in close corp ii) But this won't often work b/c 1. Can't foresee all possible ways that majority can oppress 2. Act of negotiating for this may harm relationship 3. Overtrust, think family dynamic will work it out 4. Lack of sophistication 5. Expense (i.e., atty fees) of getting advice 6. If you got your shares by gift or inheritance, no opportunity to K c. There are existing statutory protections for close corps, but this corp doesn't fall within that statutory definition i) Del 34156: Enables SHs of close corps to contract for greater protection from oppression, but it doesn't create a fid duty between SHs or prohibit oppression 1. E.g., 355: Can force dissolution or eliminate the board, but must contract for this on the front end and put it in the articles ii) But this only facilitates your ability to contract for protection, it doesn't provide a safety net iii) AND very, very few companies elect to take advantage of statutory close corp provisions (lack of case law, availability of other bus orgs, common law ways to achieve the same ends) ii. Applying Nixon's facts to other approaches 1) Would have been different under Donahue b/c it would require equal opportunity for stock repurchase (but could you argue that not similarly situated?) 2) May have been different under Wilkes because, even if it's fair to the corp than it's probably a legit bus purpose, there was probably a less harmful alternative 3) Would probably not be different under Kemp b/c it's hard to argue that you have a traditional SH right to liquidity or a reasonable expectation that you would be treated like a different class of SH or like employees (shares were also a gift) k. Modification by K i. You can modify fiduciary duties through SH agreements and other Ks ii. BUT you have to show that the K 1) Gallagher v. Lambert (629) NY a. P was a longtime employee (at will) with D, upon purchase of stock signed agreement that the corp could buy back stock at book value if P resigned or was terminated before a specific date i) Why have this? Certainty to parties, "golden handcuffs" keeping valuable employees, keeps stock in hands of employees, or just to rip ppl off b. 4 yrs later, fired 21 days before specified date, P sues claiming that he was fired solely
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b. 4 yrs later, fired 21 days before specified date, P sues claiming that he was fired solely b/c the corp didn't want to pay the higher price c. This is NY, so reasonable expectations test, where P claims that he reas expected that the corp would not fire him solely to steal value of stock i) P is NOT challenging termination (b/c he knows he can't tie it to stock ownership), but only treatment as SH d. Court rejects simple matter of contract where P got what he bargained for (can modify and define fid duty by K) and has no rights as an at will employee i) But even if this is a pure K case (which the court says it is), why is there no implied covenant of good faith and fair dealing? Following K to the letter may not constitute a breach, but that depends on whether you think the K allowed opportunistic termination (and on MSJ...?) ii) Could also argue ambiguity where parties understand K to mean that this situation was allowable iii) If K didn't cover this, we revert to fid duty law e. Odd in light of Kemp, another NY case, but even Kemp recognized ability to modify these duties by K 2) But see Jordan v. Duff & Phelps (635): an "avowedly opportunistic discharge is a breach of contract, although the employment is at will" and so corp had duty to disclose upcoming merger and corresponding increase in the value of P's stock and Jensen v. Christensen & Lee (637): different results under the same facts as Gallagher 3) Evangelista v. Holland (636) a. Court upholds stock repurchase agreement although value when bought b. "Questions of good faith and loyalty do not arise when all the stockholders in advance enter into an agreement for the purchase of stock of a withdrawing or deceased stockholder."

29. GENERALLY a. Defined 1) Partnership comprised of at least one general partner (unlimited personal liability) and one limited partner (no liability for debts of the venture beyond loss of investment) a. There is a TX case saying you can't piece the veil of an LP because of the availability of a general partner, but there doesn't seem to be any doctrinal basis for this b. Basic Features 1) You must file something with the state (certificate, usually) 2) Significant contractual freedom (structural flexibility to alter almost all default rules) 3) Pass-through taxation a. Publicly traded LPs do not get pass-thru, but there is an exception (766) 4) Mostly treated as securities, which means interests can't be sold to the public without going thru detailed registration and disclosure process (and fraud goes under sec laws) c. Why still relevant 1) Relatively long history of use of LPs = comfort level 2) Same history created a body of common law precedent that makes LPs more predictable 3) Legal framework for LLPs and LLCs stem from this 4) Still popular in certain areas (real estate, venture capital, oil & gas) d. Sources of Law 1) ULPA (1916) 2) RUPLA (1976) 3) RULPA (1985): Most states operate under this scheme 4) ULPA (2001): About 10 states have adopted 30. LINKAGE a. Generally 1) A jurisdiction's general p'ship law would apply to a limited p'ship when that issue was not
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1) A jurisdiction's general p'ship law would apply to a limited p'ship when that issue was not covered by the limited p'ship statute (silent) 2) RULPA 1105: In any case not provided for in this Act, the provisions of the Partnership Act (or whatever the current general p'ship statute is) govern a. I.e., don't go to the P'ship Act if the LP Act covers the issue 3) Why? a. Avoids chaos when the LP Act doesn't speak to an issue b. De-Linkage 1) ULPA specifically "de-links" itself from general p'ship law and operates as a stand-alone, comprehensive LP act 2) Why? (Prefatory Note addresses) a. More convenient, providing a single, self-contained source of statutory authority for issues pertaining to LPs b. Eliminate confusion as to which issues were solely subject to the LP act and which required reference (i.e., linkage) to the general p'ship act c. Rationalizes future case law by ending the automatic link between the cases concerning partners in a general p'ship and issues pertaining to general partners in LPs 31. FORMATION a. Creation 1) RULPA 201: LP forms when certificate is filed b. General Requirements 1) Must file a certificate of LP with sec state (or equivalent) in proper jurisdiction a. Certificate really operates to give notice to third parties, while p'ship agreement really governs the duties and obligations of the partners b. File in other states as well if you plan to do business there 2) Partners are sually required to make a contribution, but defined broadly 3) RULPA 201: Reqs 1) Name of LP i) Can't abbreviate names generally (RULPA 102(1)) but almost all states have amended to allow this (needed initially to give notice to 3Ps, no longer needed) ii) Be careful!!! 303(d): LP who knowingly allows her name to be used in the name of the LP is liable to creditors if they don't have actual knowledge that she's not a GP 2) Address of registered office and name and address of registered agent 3) Names of general partners and addresses a) Do NOT have to name limited partners b) Makes sense b/c you only really to know identity and solvency of general partners 4) Latest date on which LP will dissolve 4) Signature of ALL general partners 1) RULPA 204 5) Can include a purpose, but you don't have to 6) RULPA 201(b): substantial compliance provision (ok to mess up registration a little) c. P'ship Agr 1) Not required to have a p'ship agr 2) RULPA 204/ULPA 102(13: can be written or oral d. Conversion 1) RULPA doesn't address whether a business can convert to an LP, so go to RUPA 90204 2) ULPA 1102 allows conversion and also allows LPs to convert to another form
32. CONTROL RULE a. Generally 1) Traditional Rule: Limited partners can lose their limited liability if they participate in the control of the business
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control of the business 2) Reform as progressively more protective of LPs 3) REMEMBER: This does not apply to situations of direct liability Sources of Law 1) ULPA (1916) 7: LP is liable if "he takes part in control of the business" a. Holzman 2) RUPLA (1976) 303: Two ways that a LP can be liable a. Participation and control substantially the same as a general partner? If no b. Still can be liable if 3P has actual knowledge of participation and control c. Gateway Potato 3) RULPA 303: Only liable to a 3P that transacts business with the p'ship and the 3P reasonably believes, based on the LP's conduct, that the LP is a GP a. (b): safe harbor provision that protects certain actions (not exclusive) i) This includes a provision where you can state actions in pship agreements that do not constitute control (b)(6)(ix) b. "Transacts business" indicates that tort victims will not be able to reach LP here (unless tort was committed in the course of business, e.g., misrep) 4) ULPA 303: Eliminates control rule altogether a. Obligation in contract, tort, or otherwise, is not the obligation of a limited partner, even if the limited partner participates in the management and control of the limited partnership. Policy i. Advantages 1) Protects the GP (I'm ok with personal liability as long as I'm calling the shots) 2) Helps to ensure that only those with a strong incentive to be careful are managing ii. Disadvantages 1) Less collaboration and expert input from LPs 2) Disincentive to invest in these p'ships 3) Discourages monitoring of GPs for fear it will be construed as control 4) Although it's been around for a while, very outcome uncertain ( clear case law) Entity General Partners i. You will ALWAYS be an entity because it protects you from liability ii. Problems 1) May be minimally capitalized 2) Limited liability entity defeats the purpose of having a GP that would bear the risk (complete evasion of control rule) 3) Relatively easy to control transfer of managerial authority to 3Ps 4) Less incentive to be careful if you're a minimally capitalized GP 5) Corp assets can be siphoned without the consent of the LPs iii. Historically, the extent of liability was an issue when GP = corporation or other limited liability entity and LP = officers or directors of that corp (see Delaney, 791) iv. No longer an issue today 1) It's established in RULPA 303(b)(1) that simply acting as an officer of a general entity does not expose you to personal liability 2) RULPA 101(5), (7), (11): Definition of GP = "person"; Definition of person = includes other bus orgs (except for LLCs, which will probably be read into the statute by the courts), so statutorily allowed Remaining Options (after the demise of the control rule) i. Estoppel ii. Fraud iii. Veil-piercing 1) Texas says you can't pierce the veil of a limited partner because the doctrine is only properly applied when no one would otherwise by liable (Pinebrook Props., 789), but many other states say you can (Georgia, statutory comment; Virginia, C.F. Trust) 2) But you can always seek to pierce the veil of a corporate general partner
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many other states say you can (Georgia, statutory comment; Virginia, C.F. Trust) 2) But you can always seek to pierce the veil of a corporate general partner f. Holzman v. De Escamilla (779) ULPA (1916) 1) Hacienda Farms is an LP with de Escamilla as the GP and Russell and Andrews as the LPs 2) LP goes into bankruptcy and bankruptcy trustee tries to reach LPs 3) Evid of control a. Determined what crops to plant and actually overruled GP on some occasions b. Asked GP to resign as mgr and selected his successor c. GP had no power to withdraw money without the signature of a LP 4) Clear cut case of control LPs are liable g. Gateway Potato v. G.B. Inv. (781) RUPLA (1976) 1) Gateway = LP; GP = Sunworth Corp; and LP = G.B. Investment 2) P wary of selling potatoes to Gateway, assured by head of Sunworth that collaboration with G.B. assuring financial solvency 3) When Gateway defaults, P goes after everyone but Gateway and Sunworth are insolvent 4) Evid of control (per affidavit from head of Sunworth) a. G.B. folks come to office at least 23 times per week and make affirmative changes in the way the business is run b. G.B. obtained line of credit c. Can initiate transactions on their own as well as require prior approval for other transactions d. Approved all expenditures and G.B. folks had to sign all checks e. More See FN 1 pg. 782 5) Would be slam dunk under ULPA (1916), but harder under RULPA (1976), so have to show that GP acts substantially the same as LP or actual knowledge of control 6) Participation and control substantially the same as a general partner? OR Still can be liable if 3P has actual knowledge of participation and control a. P claims that head of Sunworth told him about the control, but court finds that direct contact between LPs and 3P is necessary to show actual knowledge (although there doesn't seem to be any basis in the statute for this at all) b. No SJ for G.B. on substantially the same, though, so remand to determine h. Gonzalez v. Chalpin (793) 1) Excel = LP; GP = Tribute (corp) and LP = Chalplin (prez, sole SH, director of Tribute) 2) Before NY had adopted safe harbor provision similar to RULPA 303(b) 3) While can't be held liable solely b/c you're officer of a GP, that also doesn't protect you 4) Burden shifting a. Once P meets threshold burden of proving that a LP took an active part in effectuating the LP's interests, LP who assumed dual capacity must then prove that the relevant actions were performed solely in the capacity of officer of the GP 5) LP = personally liable a. No evidence that Chalpin ever "asserted his identity and authority as a corporate officer when conducting *the LP's+ affairs with *the creditor+" b. Chalpin signed checks in his own name to P and without indicating that he was signing in a representative capacity 6) LPs who participate in the control of an entity general partner should seek to ensure that 3Ps are aware of the capacity in which the LPs are acting


33. GENERALLY a. Definition 1) A general p'ship where the liability of the general partners is limited (everyone's a GP, unlike LPs and LLLPs) 2) This is NOT an LP, it operates under UPA, RUPA, etc. (i.e., no linkage problems) a. This is a statutory p'ship (unlike an LP), RUPA 101(5) 3) But are general p'ship rules suitable for LLP setting? a. Need the right to participate in mgmt if your liability is limited?
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a. Need the right to participate in mgmt if your liability is limited? b. Why should the default be equal profit and loss shares when you may be practicing in a less risky area of the firm? c. Why limit ability to admit new partners to unanimous vote? b. Versus LPs 1) You won't lose limited liability for exercising control over the business 2) General partners have limited liability 3) But supervisory liability (see Texas) may actually broaden scope of potential exposure, unless you argue that supervision falls under control test 4) Certainly less protection than corps b/c supervisory and knowledge/notice (see Texas) 5) Created to shield partners from the malpractice claims or those arising from negligence or misconduct in which they were not involved 6) This is the vast majority of law firms
34. FORMATION a. Requirements 1) Start with forming a p'ship "two or more persons carrying on a business for profit" PLUS 2) Document (certificate, registration, etc.) filed with the state a. Firm's name, address, statement of business or purpose 3) Some states have registration and annual fees 4) Some states have insurance/segregated funds requirement a. Failure to comply = lose limited liability to the extent that insurance or segregated funds should have provided b. Even if no specific statute, may be subject to similar reqs under licensing, etc. 5) 3.08(b): LLP (unlike GP but like a LP) MUST be registered with Sec State 6) 3.08(d): must carry insurance of at least $100k to protect against tort obligations OR have $100k of funds set aside to pay b. Disclosure 1) Need to disclose that fact that you're an LLP, but extent isn't clear 2) When a client asks, ethics rules say you have to explain it fully and clearly 3) Most states don't require notification of change to LLP from another form (NY requires publication but minority)

35. LIMITED LIABILITY a. Generally 1) RUPA 1001(d): begins as soon as registration statement is filed 2) But effect on existing Ks is not clear may be the same as for liabilities of new partners, based on creditor expectations as to who would be liable 3) Failure to comply fully with statute = lose limited liability (unlike LPs, where you can usually substantially comply) (see Apcar, 855) 4) Most LLP statutes don't include restrictions on distributions that leave the firm undercapitalized a. Can attempt to pierce the veil or fraudulent transfer law b. Sources of Law 1) TX Limited Liability Partnership Act, generally a. No personal liability for K obligations of the LLP b. For tort, no personal liability except for 3 situations 2) Tex. Rev. Civ. Stat. art. 6132b, 3.08 (supp. 1174) (based on RUPA) a. (a)(1): A partner in an LLP is not liable for p'ship obligations incurred while registered b. (a)(2): not personally liable "for debts and obligations of the partnership arising from errors, omissions, negligence, incompetence, or malfeasance" of a partner "not working under the supervision or direction of the first partner" except for 3 situations: i) Direct liability (duh) ii) You're personally liable for obligations incurred by someone under your supervision or direction (does NOT say "direct", but court may impose a
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supervision or direction (does NOT say "direct", but court may impose a directness gloss) i) Unclear the extent of this (not many cases, so partner in a different office may be liable) ii) Some argue that negligent supervision would already be covered under negligence, the supervision refers to non-negligent supervision, but this seems harsh iii) Disincentivizes supervision not good iii) If you had notice or knowledge of acts of other partners and you failed to take reasonable steps to stop it c. (a)(3)(B): doesn't affect "the liability of a partner, if any, imposed by law or contract independently of the partner's status as a partner" so shielded from vicarious liability for malpractice-related claims sounding in contract as well (addition) i) So only protects the partners from malpractice-related liability ***None of this matters if the entity is able to pay*** a. (d)(1): $100K segregated funds requirement 3) RUPA 306(c): not personally liable for tort or K obligations of the LLP solely for reason of being a partner c. Megadyne Info v. Rosner (857) 1) P wants to sue the gov't and hires D-law firm, who totally botch it and file a claim after the SOL on the state tort claims act had run, P tries to reach LLP attys for intentional misrep 2) Because can't get them for vicarious liability, have to show direct involvement in handling the case 3) GIMF on evidence that attys discussed the possibility that P would have a malpractice claim against another law firm for making the same time-barred claim d. Kus v. Irving (862) 1) P dealt with D-atty who, she claims, filed suit after receiving a settlement to collect a higher contingency fee, and she also tries to reach other two attys at LLP firm 2) Insuff evid that, as required under state law, D was under others' "direct supervision and control" a. Affidavits stating no personal knowledge of P's case or any supervision/control b. Under p'ship agr, D retains all fees for his activities and does not share with others (shared no benefit) c. P produced no affidavits or other evid to support her claim, except that attys admitted knowledge of the alleged tort and didn't fix it (but knowledge after the fact = insuff) 36. MGMT & OPERATIONS a. Voting 1) Depends on statute, either unanimous, majority, or majority in interest 2) RUPA 1001(b): approval by the vote necessary to amend the p'ship agr is needed


37. GENERALLY a. Defined 1) It's an LP at least one general partner and at least one general partner, but the general partner has limited liability as in an LLP (must comply with LP reqs) a. In most jurisdictions, LP gets same protection, meaning that conduct that would cause liability under the control rule would not produce liability in an LLLP unless a partner in an LLP would be liable for the same conduct i) Effect = elimination of control rule in LLLPs ii) ULPA clarifies that full status-based liability shield applies to LPs and GPs iii) Strangely, in some states, LPs subject to control rule and therefore doesn't get to participate in mgmt but GP does, despite limited liability (providing GPs with greater protection than LPs) b. In TX, GP only liable for own conduct, supervisory liability, knowledge/notice liability
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b. In TX, GP only liable for own conduct, supervisory liability, knowledge/notice liability 2) There are not a lot of LLLPs b/c the LLP allows all of the partners to participate in control with the same basic protections 38. FORMATION & LIABILITY a. Requirements 1) Have to comply with LP filing and formation reqs 2) If an LP want to convert to an LLLP, must comply with registration and segregated funds, etc 3) TX: Must use words "limited p'ship" or "ltd." + LLP or equivalent after name b. Tex. Rev. Civ. Stat. art. 6132a-1, 2.14 (supp. 1178) 1) (c): If a limited partnership is a registered LLP, section 3.08(a) applies to its general partners and to any of its limited partners who, under other provisions of this act, are liable for the debts or obligations of the limited partnership. c. Problem 6-2, p. 868 1) Does the limited partner face personal liability for misconduct of employee under supervision? 2) Normal limited partnership -- is supervision enough to constitute control? Probably not. 3) In an LLLP? 1) If otherwise would be liable (if failed control test), you now get the LLP protection overlaid. a) if supervision is not control, no liability b) assuming that supervision is an act of control, now LLP applies and liable for your own torts, and those working under your supervision and control, and know/notice c) Back to the earlier inquiry if supervision means negligent supervision, or all supervision, encompassing non-negligent supervision 2) Still, under TX statute, better off than under LP statute 3) Q -- is there a tort duty if you negligently supervise someone in TX?


39. GENERALLY a. Characteristics 1) Mainly: 1) Full shield limited liability (regardless of control) 2) Pass through taxation (like a p'ship) 3) MASSIVE contractual freedom 2) Same benefits as S-corp without less stringent reqs 3) Have to make contribution, but defined broadly 4) Most states allow single member LLCs now b. Sources of Law i. DLLCA and ULLCA (8 states) ii. But 48 states and D.C. had passed there own LLC laws by the time the uniform laws came out, so extreme variations in state law here c. Taxation i. IRS used to operate under Kintner regulations to determine whether LLCs should be taxes like p'ships or corps 1) Taxed like a corp if you showed at least three of four: continuity of life, centralized mgmt, limited liability, and free transferability of ownership interests ii. In 1988 IRS abandoned its test, now it's check the box regulation -- pick if you want corporate or pass-through taxation (default is pass-through partnership type taxation) iii. Still some holdovers in older LLC statutes that restrict aspects to conform with Kintner d. Why Not an LLC? i. If you want to go public, corp is still probably best because of uncertainty in LLC law ii. Some tax laws give favorable treatment to corp to corp merger iii. Was a franchise tax for LLCs in TX until a few years ago, but no more
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iii. Was a franchise tax for LLCs in TX until a few years ago, but no more iv. You can always start as an LLC and convert to a corp later BUT to convert requires a huge overhaul of p'ship agreement, so many law firms haven't v. At the end of the day, the LLC is the only smart option for a closely held corp 1) You can do almost ANYTHING you can do with another business entity (can even make the equivalent of limited partners)
40. FORMATION a. Time of Creation i. At the time of filing (so that's when you get lim liab) ii. DLLCA 18-201(b): LLC created if "substantial compliance" with reqs iii. ULLCA 201: filing is "conclusive proof" that reqs are met iv. NO amendment/withdrawal protection for members who mistakenly but in good faith believe that an LLC has been formed (compare RULPA 304 and ULPA 306) v. Can be a member (with lim liab) before execution of op agr, effective date relates back to certificate of formation filing date b. Registration i. Have to register certificate of formation with Sec State ii. DLLCA 18-201: Name (can't use Ltd), address of registered office and name and address of registered agent for service of process, any other matters 1) (4): probably not an exclusive list of words you can use, but don't push it and be misleading iii. ULLCA 203, (supp. 1213) 1) Requires a lot more information 2) Term company or not? 3) Member or manager managed? c. Operating Agreement i. Most statutes don't require, but INSANE to not have one b/c sometimes no default ii. DLLCA 18-101(7): Defined as written OR oral agreement "among the members" (implies unanimous) iii. Uncertain whether an op agr can be enforced among members of an improperly formed LLC (see 875 for policy arguments) iv. If articles and op agr conflict, NY and CA say articles trumps, but ULLCA says it depends (op agr controls internally and articles control as to 3Ps who rely) d. Entity Status i. Separate legal entity, so can exercise powers in its own name (bring or defend a lawsuit, own property, etc.) ii. DLLCA 18-201(b)/ULLCA 201: LLC is a separate legal entity e. Conversion i. DLLCA 18-214/ULLCA 90203 41. ROLE OF K a. Generally 1) Elf Atochem v. Jaffari (877) 1) Malek LLC formed with two members -- Elf Corp., and Malek Corp. a) Jaffari is president of Malek Corp and manager of the LLC a. Operating agreement contains mandatory arbitration clause and forum selection clause (says any litigation arising needs to be heard in CA court) b. Elf brings derivative suit against Jaffari in Delaware, claiming that D breached fiduciary duty owed to LLC, claiming that the LLC is not bound to op agr b/c it was not a signatory to the operating agreement (i.e., only if suing personally would it bind) a) DLLCA established Delaware chancery court as default if parties don't K for it c. Court rejects a) Op agr doesn't distinguish b/n types of claims, simply says "any claim" must be brought in CA
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brought in CA b) Distribution agreement doesn't contain forum selection clause, but court finds it subsumed within the op agr c) The members are the real parties in interest, the LLC is simply their joint business vehicle d. Is this a resurrection of the UPA aggregate concept of partnership in the LLC world? a) Yes court seems to be saying that the LLC is an aggregate b) The court's language is a little troublesome if you extrapolate from this point c) Here, probably just saying that it's silly to argue this when ALL the members signed e. Easier way to reach conclusion without implying aggregate entity? a) Agreement includes FSC for ANY action brought by member (admittedly, its a derivative claim, but it is any claim brought by a member), a member filed it (even on behalf of LLC) and therefore, the K governs b) Would have been a better way to handle it 2) But see Bubbles & Bleach v. Becker (885): LLC derivative suit not governed by binding arbitration clause in op agr because "none of the members signed in a way that purports to bind [the LLC]" a. More consistent with entity theory b. What You Can and Can't K Around 1) DLLCA 18-1101(b): it is the policy of this chapter to give the maximum effect to the principle of freedom of contract and to the enforceability of LLC agreements a. Legislature to courts: don't mess with these 2) DLLCA 18-1101(c): to the extent that member or manager has duties (including fiduciary duties), duties may be "expanded or restricted or eliminated" by provisions in the op agr, but cannot eliminate the implied contractual covenant of good faith and fair dealing 3) DLLCA 18-1101(e): able to eliminate liability for breach of (fiduciary) duties a. This allows members to sue for injunctive relief but not monetary relief (assuming that you keep the duty but eliminate liability) b. So equitable relief fair game, but no money damages 42. MGMT & OPERATIONS a. General Governance 1) Member-managed: members themselves have default mgmt power a. May be preferable because it's difficult to cash out (if it's publicly traded, it's taxed like a corp, so rare) b. Default: DLLCA 18-402/ULLCA 101(11), (12), 203(a)(6) 2) Manager-managed: managers, who may or may not be members, have default mgmt power a. May be preferable when you have a huge amount of members, if you have managers with special skills, to limit agency authority, don't need as much control because limited liability b. This is the default in Texas, but vast minority 3) This is only default, not only can you change jurisdiction's default, but you can split a. E.g., manager-mgmt for ordinary decisions, member-mgmt for extraordinary decisions b. Agency authority i. Member-mgmt a. Members possess p'ship-like agency authority to bind the LLC ii. Manager-mgmt a. Managers possess p'ship-like agency authority to bind the LLC b. Members are NOT agents simply be virtue of the fact that they are members (can try other common law agency theories) c. ULLCA 301: d. But see DLLCA 18-402: Unless otherwise provided, each member AND manager has agency authority to bind the LLC (this seems to apply to even manager-mgmt, but no case law)
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case law) iii. This is why some jurisdictions require mgmt structure to be listed in certificate of formation, and those that don't put 3Ps in a real bind where they don't know whether a member has authority to enter transactions c. Voting 1) Per capita: one member one vote a. About half the states b. This may be preferable when all contributions to the business are relatively equal c. Default rule in p'ships, and this makes sense because J&S liability for all obligations regardless of initial investment (account for personal assets) d. ULLCA 404: per capita based on "majority of the members" i) (c): Except that certain actions require unanimity (extraordinary) i) Amending op agr, authorization or ratification of transaction that violates duty of loyalty, amending articles of org, compromise of an obligation to make a contribution, 7 more... 2) Pro rata: based on ownership interest (calculated by financial or other contributions) to firm a. About half the states b. This may be preferable when contributions are vastly unequal c. Default rules in corps, and this makes sense because someone that owns one share shouldn't be able to hold up corp business when no personal assets are on the line d. DLLCA 18-402: pro rata based on profit allocation (see financial rights to determine profit allocation where op agr is silent) i) This does NOT distinguish between ordinary and extraordinary decisions, so probably applies to both (this seems odd, argue for a judicial gloss) 3) Ordinary decisions are usually majority vote 4) Extraordinary decisions usually require a supermajority a. E.g., amending the op agr 5) In mgr-mgmt LLCs, ordinary decisions usually made by majority (by number), though extraordinary may require a specified number 6) Some statutes allow for classification similar to corp classified shares d. Manager Election/Removal i. ULLCA 404(b)(3): majority of members get to elect OR remove in the absence of op agr provision (so if you say unanimity is required to elect, but silent as to removal, you probably only need a majority to remove) ii. DLLCA 18-402: If you choose to be manager-mgmt, must provide for appt and removal of managers in the op agr (doesn't give any guidance if you don't) e. Formalities 1) LLC statute typically fail to include provisions that address governance formalities a. Bad on the one hand because, if the operating agreement doesn't address this, you have no law to apply b. Good on the other hand because this is often onerous and unnecessary in closely held businesses AND may make it more difficult to pierce the veil when formalities aren't required by statute 2) DLLCA 18-404(d): managers can act outside a formal meeting, without notice and without unanimity, if you have the affirmative vote of the number of mgrs required for action at a formal meeting (but see Castiel, can be breach of fid duty) 3) DLLCA 18-305/ULLCA 408: members' defined right to inspect records
43. FINANCIAL RIGHTS & OBLIGATIONS a. Profit & Loss Allocation i. Default rules tend to provide either a partnership-like equal allocation or corp/LP-like pro rata allocation based on contributions to the firm ii. Many op agrs provide that profits and losses will be allocated according to an agreed "sharing ratio" which is usually based on a member's financial contribution (but service providing members may not)
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providing members may not) iii. DLLCA 18-503: based on op agr, and, if silent, based on "agreed value ... of the contributions make by each member" iv. ULLCA 405: Distributions must be made in "equal shares" (doesn't say profits, but comment assumes that this includes profits) v. Preemptive rights: this is a situation where there is a "cash call" and you have to cough up contributions or be diluted, this can vastly change the mgmt right, especially in a DLLCA jurisdiction, where voting rights are pro rata b. Distributions i. No unilateral right under either act ii. DLLCA 18-601: You get a distribution when the op agr says you get one (no rights without an agr, but remember this can be oral) iii. ULLCA 404(c)(6): Can get a distribution upon the unanimous consent of all members c. Creditor's Rights i. DLLCA 18-502/ULLCA 402(b): A member may be liable to a creditor for unpaid contribution to a firm even if the other members have decided to waive the obligation ii. DLLCA 18-607/ULLCA 40607: Members may have liability for receiving distributions that render the LLC insolvent 44. REGULATORY ISSUES a. Nature of the LLC i. Because LLC takes characteristics from both p'ships and corps, it may be necessary to determine which org it is MORE like in order to determine applicability of pre -LLC laws ii. Options: a. Leg revises each statute to add "LLC" where appropriate i) Massively time-consuming b. Leg makes "quick fix" by including a statutory provision indicating that the word "corporation" and/or "partnership" shall always include an LLC i) Problem: some statutes don't make sense applied to LLC ii) Some states say include LLC "unless context otherwise requires", but that just looks like c. Leave it to courts to make these decisions in individual, statute-by-statute basis iii. Whenever you're trying to figure out whether a corporate or p'ship principle should be applied to an LLC, look at policy behind principle and purposes of LLC iv. Issue with securities (i.e., is LLC interest a security?), see 902 b. The Test i. Look at the statutory language (textual) ii. Look at the purpose behind the statute (policy) c. Exchange Point v. SEC (901): holding that an LLC did not have standing under Right to Financial Privacy law because (1) not covered by plain language ("individual or p'ship of less than 5 ppl") and (2) purpose of law is to protect rights of individuals and small biz, and privacy expectations for companies with lim liab is weak d. Meyer v. OK Alcoholic Bev. (898) i. OK state constitution limits who can get s liquor license a. 4: "Not more than one ... license shall be issued to any person or general or limited p'ship" b. 10: Can't get a license if you're a "corporation, business trust, or secret p'ship" ii. State LLC act also says that LLCs can engage in any business except banking and insurance iii. P argues that it doesn't explicitly prohibit an LLC from getting a license and Act implies that it's ok iv. Court rejects: a. Policy behind con'l limitation is to ensure that someone is personally or criminally liable for liquor license violations, and limited liability feature of LLCs thwarts that goal b. If LLCs were allowed under P's theory, they wouldn't be subject to the limitations (also in the constitution) imposed on p'ships and individuals (e.g., no prior felonies)
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in the constitution) imposed on p'ships and individuals (e.g., no prior felonies) c. Even if Act allowed this (court doesn't think it does), can't override the constitution
Maybe we don't even get to policy rationale of individual liability if the constitution says it's ok, but only if it's silent? But anyway... i. What if LP with individual general partner? a. Probably fine, LPs explicitly allowed in constitution and sufficient liability (policy) ii. What if LP with corporate general partner? a. Fine under the constitution because it doesn't distinguish when allowing LPs b. But less acceptable under policy rationale because it's debatable whether a corp general partner can have "personal" liability and may have minimal assets iii. What if it were an LLP? a. Fine under the constitution because it's a general p'ship b. But unacceptable under policy because limited liability

45. LIMITED LIABILITY a. Scope of Liability i. DLLCA 18-303/ULLCA 303(a): no member or manager of an LLC is liable for the obligations of the LLC, in tort or contract, solely because of their status as a member or mgr a. This is protection from status-based liability (i.e., vicarious liability) b. (b): Can make yourself individually liable for LLC's obligations in op agr (never ever) ii. Most states impose liability on those who act knowingly on behalf of an unformed LLC iii. Pepsi-Cola v. Handy (910) a. Pepsi bought some land from an LLC, alleged that the LLC fraudulently concealed the fact that the land contained wetlands b. Court finds it highly relevant that the members committed the alleged fraud before the LLC was formed BUT that's ridiculous because you're always directly liable for your own torts c. No brainer directly liable AND statute only protects you if you're being sued SOLELY because you're a member (status-based liability) b. Piercing the Veil i. While LLC defendants have asserted that piercing the veil is not a valid doctrine in the LLC context, there doesn't seem to be any doctrinal difference between the limited liability of corps and LLCs on this issue a. All cases that look at this allow piercing for LLCs b. Some LLC statutes explicitly state that piercing the veil doctrine applies to LLCs ii. BUT should we undergo the same analysis for LLCs as we do for corps? a. Wouldn't make sense look at whether formalities were followed (even odd then), because there usually are no statutory formalities requirements for LLCs and some statutes that address this issue state clearly that failure to follow formalities is not a factor to consider iii. Kaycee Land & Livestock v. Flahive (922) a. Certified Qs to state supreme court asking whether piercing the veil is appropriate in the LLC context b. YES! But factors considered in the analysis won't necessarily be the same (but won't articulate because few facts given) iv. Litchfield v. Howell (927) a. Allowed a reverse piercing claim against an LLC, so P can reach LLC's assets to satisfy personal judgment against members 46. FIDUCIARY DUTIES a. Generally i. In contrast to many corp statutes, but many states' LLC statutes address the concept of fid duty and state that it runs to the LLC and, occasionally, to other members ii. Some statutes impose what seems like ordinary negligence, others are grossly negligent
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ii. Some statutes impose what seems like ordinary negligence, others are grossly negligent iii. BJR appears to apply b/ why not? iv. Some statutes explicitly allow derivative suits (some require majority vote of disinterested members or mgrs to authorize), others have implied the right v. Duty of Loyalty 1) Many statutes, like p'ships, say duty of loyalty requires consent of managers or members for a COI transaction, either majority or unanimous 2) Others, like corps, say COI can be validated through a disinterested member or mgr vote or though a showing of fairness 3) Probably generally encompasses same duty of loyalty claims discussed (corp opp, etc) b. Sources of Law i. ULLCA 103: Cannot eliminate the fiduciary duty of loyalty or the duty of good faith and fair dealing 1) BUT you can define actions that do not violate the duty of loyalty or good faith if not manifestly unreasonable 2) AND you cannot "unreasonably reduce" the duty of care 3) (b)(2): Can put in op agr what actions members may do to ratify COI transactions 4) This looks a lot like RUPA i) But should you also be able to argue entire fairness like you can with corps? RUPA doesn't give you a clear out under fairness either, so are we leaning toward p'ship or corp law here? ii. ULLCA 409: Fiduciary Duties 1) (a): only duties are duty of loyalty and care 2) (b)(2): duty of loyalty prohibits COI transactions 3) (c): if member-mgmt, duty is to refrain from "engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law" 4) (e): it's ok to further your own interests in the process 5) (h): if mgr-mgmt, member who is not a mgr owes no duties solely b/c she's a member iii. ULLCA 409: Duty to disclose 1) Without demand, must furnish any info reasonably required for a member to exercise her rights 2) On demand, info about firm's affairs unless unreasonable or improper under circum 3) Can't unreasonably restrict this duty ( 103(b(1)) but not technically a fid duty iv. DLLCA 181101(c)(d): Can limit or eliminate fiduciary duties BUT you cannot eliminate the implied covenant of good faith and fair dealing in contract 1) Good faith probably only comes in where you have border line cases v. DLLCA 18406: protects mgrs and members for good faith reliance on reports, etc. (but must be good for the LLC, see Flippo 935) 1) This is ALL that the DLLCA says about fid duties c. VGS v. Castiel (928) i. LLC Holdings (Castiel) Ellipso (Castiel) Sahagen Satellite (Sahagen) Castiel's two companies together own 75% of LLC, Sahagen's owns 25% ii. Members: Castiel, Sahagen, Quinn (appointed by Castiel) iii. Provision in op agr says that managers may be immediately removed by a majority vote, essentially giving Castiel total control over the LLC iv. Sahagen and Quinn collude to oust Castiel from power by meeting without Castiel and voting for a merger that gives Sahagen majority control a. DLLCA 18-404(d): managers can act outside a formal meeting, without notice and without unanimity, if you have the affirmative vote of the number of mgrs required for action at a formal meeting v. Castiel sues for breach of fid duty vi. Op agr apparently didn't cover what percentage of approval was needed for mgr voting (i.e., majority or unanimity), and this is Delaware so there is no default rule
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majority or unanimity), and this is Delaware so there is no default rule vii. Because of 18-404, court finds that Sahagen and Quinn did not violate anything in the act or the op agr BUT finds breach of fid duty because even though technically valid, the circumstances show that both men knew that Castiel would have immediately replaced Quinn if he knew what they were up to a. This firmly established that (1) fid duties do in fact exist in the LLC context and (2) it runs to both the LLC and to the other mgrs (? court probably meant to the other members ?) b. No crazy that the court established fid duty here b/c it's always been a CL concept viii. Does this square with broad principle of Nixon v. Blackwell (you could have protected yourself and you didn't so you're out of luck)? Del comes to the rescue of a majority member when it wouldn't rescue a minority SH d. McConnell v. Hunt Sports (937) i. Member of LLC formed for purpose of investing in and operating professional hockey franchise, who had created separate corporation which competed with company and obtained expansion franchise, brought declaratory judgment action along with second member against company and its other members ii. Held: (1) operating agreement expressly allowed plaintiffs to compete with company in seeking franchise; (2) plaintiffs were properly granted leave to amend complaint; (3) plaintiffs could properly seek declaratory judgment that they had not violated any fiduciary duties; (4) no fiduciary duties were breached during competition for franchise; (5) company was properly dissolved after plaintiffs obtained expansion franchise and company's reason for existence was eliminated e. Anderson v. Wilder (944) Tenn. i. Applies controlling SH oppression doctrine that a majority SH owes a fid duty to a minority SH to LLC, even though op agr allowed expulsion of a member with or without cause and buyout occurred according to agr terms 47. OWNERSHIP INTERESTS & TRANSFERABILITY a. Generally i. Ownership interest allows member to: a. Right to receive distributions and share in profits and losses (financial rights) AND b. Right to participate in mgmt and control of the business (mgmt rights) ii. Cannot transfer mgmt rights, but can transfer financial rights iii. Default rule is unanimous consent is needed to transfer b. Sources of Law i. ssss c. Creditor's Rights i. Most LLC statutes provide a charging order remedy that creditors can use against a member's interest

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Have to file certificate

Have to file certificate

Have to file certificate

Have to file certificate

The association of two Have to incorporate De jure, de facto, by or more persons to carry on as co-owners a estoppel business for profit

Continuity of Unless for a term or Existence undertaking, at will

Perpetual existence unless it explicitly chooses limited duration (no exit right)
Centralized mgmt (directors officers SH) Member-managed Mgr-managed (centralized)

Mgmt & Operation

Partners have equal right of mgmt

Financial Rights & Obligations Entity Status UPA: not separate Separate legal entity RUPA: separate entity Liability Unlimited personal liability Limited liability (limited to value of investment), unless direct liability or piercing
Owed to corp, not SHs Transfer financial but not mgmt rights Split on if security

Separate legal Separate legal entity entity GP: unlimited personal liab LP: limited liability (but control rule) GPs shielded from malpracrelated tort (maybe K) liab GP: shielded like LLP LP: limited liab (control rule in some juris)

Separate legal entity

Fiduciary Duties Ownership Interest & Transfers

Owed to p'ship and to other partners

Transfer financial rights Not freely but not mgmt rights transferable in closely Generally = Generally security security held (oppression)

Structural Flexibility Tax Conseq. Pass-through tax Double tax unless Scorp Pass-through Pass-through tax tax Pass-through tax

Greatest flexibility here can K for ~anything Default = Pass-thru Check box for corp tax

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Panel 3/26
Thursday, March 26, 2009 12:46 PM

Problem 4-10, pg. 463

Sell immediately if you are the sole owner of the car and need not consult with anyone else If you had a fiduciary duty, you would be required to investigate further and make reasonable inquiries N&Q, pg. 472 1. Conflicts of interest a. Warehousing fees (Lakes): Board accepted proposal to compensate D at the "going rate" for use of his storage facilities (claims building and staffing own facilities would have been more expensive) b. Exclusive distribution agreement (Lakes), but extension was identical to prior extension c. Royalty K (D): Approved royalty fee to D for taco sauce recipe invention (similar to plan approved for BBQ sauce inventor with a slightly higher sales percentage) d. Compensation (D): Jan. 1983 approved $1000/month consulting fee in lieu of salary, Aug. 1983 add'l increase in D's compensation, amended distributorship K to allow D an add'l 2% of gross sales Falls within Iowa statute b/c D had a financial interest in companies that were receiving contracts and compensation Ks were a K with a director (D) 2. Concerns that the corp is being disadvantaged as a result of the conflicted transactions
3. Standard: First, P must show the presence of a conflict of interest. Once such a showing is made, the burden shifts back to the director to show that the transaction was fair and reasonable to the corp

4. Must show that fully informed, disinterested Ds or SHs authorize the transaction (in board auth, don't count votes of interested Ds). Some edited out, but looks largely similar to 144 5. Transactions all appeared to be approved by the board, but four of the five directors were placed on the board by D and may not have been sufficiently disinterested to give approval 6. It does not appear that D ever sought SH approval. D was the majority SH in the corp, but could have sought approval from the rest of the disinterested SHs 7. Compliance with any of the three options in the statute would merely preclude the court from rendering the transaction void or voidable outright solely on the basis of the conflict. The director would then have the add'l burden to show that he acted in good faith, honesty, and fairness. Though didn't address noncompliance, assume that if no D/SH approval AND no fairness, transaction = void or voidable 8. Court found that D met burden to establish fairness of transaction b/c a. Benefit to corp as demonstrated by financial success b. Even if services could have been obtained elsewhere at lower cost, fees not automatically unreasonable or exorbitant c. Sales and profits would not have been the same with other vendors b/c D was "driving force" behind corp's success Seems faulty not clear, e.g., that D wouldn't have driven the corp to success using another warehouse, but argument could fly for compensation agreements N&Q, pg. 478

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N&Q, pg. 478

Del 144 on pg. 444 9. Conflicts of Interest a. Advancing personal funds to Gasoline b. Arranging for U.F. Factors (also owned by N) to assume personal loans and becomes Gasoline's lender c. Approving terms of loan such as interest rate and personal guarantees Seem to fall within 144(a) b/c transaction b/n corp (Gasoline) and one or more officers or directors AND b/c N had a financial interest in U.F. Factors

10. Curative steps where approval by fully informed, disinterested directors or shareholders were not available b/c deadlock of board (whose directors were also the only SHs) prevented ratification and b/c SH control by interested directors precluded independent review Q: 144(a)(1) says need only "affirmative votes of a majority of disinterested directors", so would transaction be ratified if majority of Marciano votes were in favor? N prevails even without curative steps of 144 b/c court finds that 144 is not the sole available method for validating an interested transaction two-tiered analysis where a court looks to application of 144 as well as to the intrinsic fairness test 11. To establish director or SH approval under 144(a)(1), (2), must show a. Material facts related to interested party's dealing with the corp are fully disclosed or actually known to the disinterested directors/SHs b. Good faith authorization by (1) majority of disinterested directors or (2) by "vote of the SHs" 12. Effect of compliance = the K is not automatically void or voidable; Effect of noncompliance = look to the intrinsic fairness test as alternate means of validation (or in conjunction as in Marciano) 13. 144(a)(2) does NOT appear to require a majority vote of disinterested shares, but judicially imposed additional requirement by Del. S.C. in Fliegler 14. N meet burden of intrinsic fairness? Yes, according to courts. Not many facts here but deferential standard of review for TC finding of fairness a. Loan terms compared favorably with terms available from unrelated lenders b. Need for external financing had been clearly demonstrated (only way they kept afloat) c. Loans made with bona fide intention of keeping Gasoline in business (good faith)
15. 16. MBCA 8.62 Director's Action (pg. 734) a. Affirmative vote of majority (no fewer than 2) qualified (disinterested?) and fully informed directors AND i. Directors must have "deliberated" and voted outside presence of and w/o participation by the conflicted directors ii. If committee, all members must be qualified and either (1) committee composed of all qualified board members or (2) members appointed by affirmative vote of majority of qualified board members b. Doesn't require full disclosure if such disclosure would violate a legal duty, a duty of confidentiality, or professional ethics rule, as long as certain info is provided (see (b)) c. Majority of qualified board member constitutes a quorum MBCA 8.63 SH's Action a. Approval by majority of the votes cast by holders of qualified shares i. Requires notice to SHs describing action to be taken ii. Provision to corp of info related to conflicted shares and iii. Disclosure of required info to SHs, if no actual knowledge
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iii. Disclosure of required info to SHs, if no actual knowledge b. Conflicted party must notify, b/f SH vote, of all shares known to be conflicted i. (e) Court may validate SH vote if such vote would be otherwise invalid for conflicted director's failure to supply this info AND failure to provide did not affect vote result 17. Effect of compliance w/ MBCA 8.61(b)(1), (2) = transaction "may not be the subject of equitable relief or give rise to an award of damages or other sanctions against director or corp" on those grounds a. Comments: "Immune from attack" on the ground of conflict of interest if comply with 8.62, 8.63, or adjudged fair (no mention of at the time of ratification like 144) BUT not immune from another defect Effect of noncompliance = "court may take such remedial action as it considers appropriate under the applicable law of jurisdiction" 18. Del 144: "No contract or transaction . . . shall be void or voidable solely for this reason" Tex 2.35-1: "An otherwise valid contract or transaction . . . shall be valid notwithstanding" a. Difference? Probably nothing, because Del's you would still need to show otherwise valid? b. Same fairness language, so doesn't seem any clearer...

PROBLEM 4-11 (pg. 483) 19. If Acme Corp purchases a parcel of land, how would the following transactions fare under 144 and 8.60, .61? a. Seller = cousin of Acme director i. 144: Doesn't fall within plain language of preamble 1) But court could look to whether the relationship with his cousin would reasonably be expected to exert influence on the director's judgment ii. 8.60, .61: cousin is not within plain language of 8.60(5), unless cousin was living in the same house as the director, and comment says this list comprises the "exclusive universe" of section 1(iii), so transaction ok unless afoul of 1(i) or (ii) b. CEO of seller corp Beta = daughter of Acme director i. 144:Doesn't fall within plain language of preamble, 1) But court could look to whether the relationship would reasonably be expected to exert influence on the director's judgment ii. 8.60, .61: daughter is a "related person" within (5) but must also show that she "was a party or had a material financial interest" c. Acme director is an employee of seller corp Beta i. 144: only if director was a director or officer of Beta, other types of employees don't fall within plain language ii. 8.60, .61: this falls within the "related persons" category of (5)(vi), and so inquiry (per comment, pg. 729) must be whether this relationship is likely to influence the director to act in the interest of Beta rather than Acme d. Acme director owns 10% interest in seller corp Beta i. 144: this falls within the plain language, and director has "a financial interest" in Beta ii. 8.60, .61: inquiry would be whether this stake constitute a sufficiently material financial interest that would reasonably be expected to impair the director's judgment N&Q, pg. 511 20. Can't apply biz judg rule b/c D set his own pay (conflict of interest), court therefore applied entire fairness doctrine
21. Court considered: a. What other similarly situated executives earn (D presented no evid) b. Ability of the executive (court was skeptical)
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b. Ability of the executive (court was skeptical) c. Whether IRS has allowed corp to deduct full amount paid (no) d. Whether salary bears reasonable relation to success of corp (D's salary tripled when corp's earnings less than doubled) e. Amount previously received as salary (huge increase "by his own fiat") f. Whether increase was tied to increase in value of services rendered (court was skeptical) g. Amount of salaries compared to other salaries paid by same corp (P made less than 10% of D's) 22. It seems that executive compensation, when executive is also a member of the board, would fall within 144 as a contract between the corp and a director 23. Why most litigation involves closely held corps a. Directors at closely held are more likely to approve their own compensation b. Less careful about observing formalities necessary for compliance w/ duty of care c. SHs of closely held are more likely to be involved in the business and be aware of the actions of the board d. Compensation tends to be a much larger percentage of the profits e. Closely held set your own pay conflict of interest no biz judg rule protection court applies entire fairness test burden on board to prove fairness

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Qs for Prof
Friday, April 03, 2009 11:48 AM

(713) 743-2172 office number 1. To form a sole proprietorship, may a person simply begin operations or must she file an organic document with the state pursuant to an authorizing statute?
2. When attempting to prove partnership by estoppel, when is consent necessary? In my notes, I wrote that a plaintiff need only consent to the representations when made in public, but I'm not entirely sure what that means. In a similar vein, I'm not entirely sure how to tell the difference between a "public" and "private" representation. Does it solely depend on the setting? a. To a single person or group of persons, versus in an ad, in the p'ship name, to a bank, employees, etc. (repeated private becoming public?) 3. When determining the financial rights of partners upon dissolution, how do you tell the difference between non-cash capital contributions to partnership (which seems allowable if there is an express or implied agreement) and compensation or remuneration for a partner's personal services performed in the day-to-day affairs of the partnership (usually prohibited by statute)? a. Non-cash contribution you would not get paid, if you do it right, I'll have an agreement as to the value of your contribution b. Difference here is evidence of intent of the parties, but almost certainly contribution when no compensation in the meantime 4. Under UPA, are there any restrictions on when a court may order foreclosure sale of a debtor-partner's charged interest? The Hellman (199) court placed a common law gloss where such a sale may be ordered only where it would not unduly interfere with the partnership business, but otherwise it appears there are no inherent restrictions (and thus operates like RUPA). a. Not in either statute, so purely a judicial gloss 5. In Meinhard v. Salmon, as a remedy for the breach of fiduciary duty committed by Salmon in failing to disclose the existence of a partnership opportunity, the court imposed a constructive trust on (it seems) 49% of the shares in the new venture. Is this the most common type of remedy for such violations, and will courts often account for the partners' prior business relationship (as here, where the court gave Meinhard only 49% so that Salmon could retain managing partner status)? a. Constructive trust is a common remedy, even on stock of a new venture, but you would look at evidence and not wholesale import prior relationship __________________________________________________________________ 6. Significance of DGCL 106? On pg. 297 as affecting de facto or corp by estoppel doctrines __________________________________________________________________ 7. In Delaney (791), assuming some additional facts, could the creditors have attempted to impose liability on the limited partners under a theory of apparent authority of an undisclosed or partially disclosed principal? Or perhaps on a partnership by estoppel theory (e.g., Baines v. Cheesecake)?

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Practice Qs
Friday, April 03, 2009 8:56 PM

33, pg. 171

35, 182 417, 608 53, 791

73, 888

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