Search for notes by fellow students, in your own course and all over the country.
Browse our notes for titles which look like what you need, you can preview any of the notes via a sample of the contents. After you're happy these are the notes you're after simply pop them into your shopping cart.
Title: Business Enterprise
Description: 2nd year law student at a top 50 law school. This is my Business Enterprise outline (69 pages - I received an A in the class). It is a quick and dirty overview of all of the important topics on the BAR exam. For example, it covers agency law, partnership, franchise agreements, sole proprietorships, the corporate structure, close corporations, shareholder rights + derivative suits, issuance of securities, etc.
Description: 2nd year law student at a top 50 law school. This is my Business Enterprise outline (69 pages - I received an A in the class). It is a quick and dirty overview of all of the important topics on the BAR exam. For example, it covers agency law, partnership, franchise agreements, sole proprietorships, the corporate structure, close corporations, shareholder rights + derivative suits, issuance of securities, etc.
Document Preview
Extracts from the notes are below, to see the PDF you'll receive please use the links above
THE CORPORATE FORM
Articles of incorporation:
To form a corporation, you file “articles of incorporation” (also known as a “charter”) with the Secretary of State of the
state of incorporation
...
The articles can usually be amended only by majority vote of shareholders,
followed by a new filing with the Secretary of State
...
Bylaws are usually not filed with the Secretary of State,
and are more easily amended than the articles of incorporation
...
The doctrine is of
much less significance today than formerly
Promoter liability: A person who arranges for formation of a corporation is called a “promoter
...
Generally, whether the promoter is liable for a pre-‐incorporation contract made in the corporation’s name
depends on the intent of the two parties (the promoter, and the other party who expects to deal with the
corporation once it’s formed
...
However, sometimes things go wrong, and the shareholders are held liable anyway
...
Piercing the veil: Most importantly, sometimes a court may “pierce the corporate veil” to hold shareholders liable,
if the corporation can’t or doesn’t honor claims against it
...
Where to incorporate: The individuals who want to form a corporation have several important initial decisions to
make
...
Usually this decision comes down to choosing between: (1) the state
where the corporation will have its principal place of business; and (2) Delaware, which has made a major industry
out of serving as the state of incorporation for companies whose principal place of business is elsewhere
a
...
What difference does it make where you incorporate? The main significance is that under the
“internal affairs” rule, it is the law of the state of incorporation that controls issues of internal
corporate governance
ii
...
b
...
The organizers of a closely-‐held corporation should normally choose to incorporate in the state in
which they have their principal place of business, rather than in, say, Delaware
ii
...
Mechanics of incorporating: The mechanics of creating a corporation vary from state to state
...
Articles of incorporation: In every state, those wishing to form a corporation must file a document with the
state official, usually the Secretary of State
...
” A filing fee must be paid with the document
b
...
The articles are then reviewed by the state officials (usually by a clerk in the Secretary of State’s
office)
...
The date of incorporation is usually made retroactive to the date of filing—MBCA § 1
...
The state usually shows that it has accepted the corporation merely by issuing a receipt for the filing
fee (though some states still issue a more formal “charter” or “certificate of incorporation”)
...
Incorporators: Since no corporation exists at the time the articles of incorporation are prepared and filed,
this document cannot be signed by the corporation’s “shareholders
...
” Most states today require only a single
incorporator, who need not reside in the state of incorporation and need not expect to have any connection
with the corporation once it comes into existence
...
g
...
Usually the incorporators perform no practical function once they have
signed the incorporation papers
d
...
In most states, these contents include”
i
...
The Secretary of State will check the records to see whether this
name is still available
ii
...
Traditionally, such a clause set forth fairly narrowly the purposes for
which the corporation was being formed
1
...
g
...
Today, the purposes clause is almost always as broad as possible, e
...
, “for general business
purposes” or “to engage in any lawful business
...
In fact, the MBCA §2
...
” § 3
...
Capitalization: The number of shares the corporation is authorized to issue—MBCA § 2
...
Even if the corporation does not plan to actually issue that many shares, it lists the number
that it is authorized to issue
...
3
...
A
corporation’s bylaws are rules governing the corporation’s internal affairs
a
...
56) will be allowed; (4) a listing of the officers of the corporation (e
...
, that
there shall be a president, a vice-‐president, a secretary and a treasurer), together with a description of the
duties of each; (5) what shall constitute a quorum for the meeting of directors, etc
...
Not filed: Bylaws are usually not filed with the Secretary of State and are not matters of public record
c
...
(The articles of incorporation, by contrast, are not in all
respects amendable by the board of directors alone
...
03(b); 10
...
Conflict: If the articles of incorporation conflict with the bylaws, the articles control
ULTRA VINES & CORPORATE POWERS
The doctrine of “ultra vires” was once extremely important, but is of little practical significance today
A
...
If a corporation purported to act beyond the scope of what it was authorized by statute
to do (or beyond the scope of its perhaps even more limited certificate of incorporation), the problem arose, What, if
anything, was the legal significance of these corporate actions? Such impermissible transactions were labeled “ultra
vires” (latin for “beyond the power”), and some cases held that the corporate action was totally void
a
...
Modern abolition: Modern American corporate statutes have largely eliminated the ultra vires doctrine
...
Broad powers clauses: First of all, as noted under most statutes unless the articles of incorporation expressly
limit the corporation’s powers, it will be deemed to have the power to engage in
PRE-‐INCORPORATION—PROMOTERS
A promoter is a person who takes initiative in founding and organizing a business or enterprise
...
A promoter
may act alone or with co-‐promoters
...
arranging for the necessary capital;
2
...
g
...
); and
3
...
When used in its corporation-‐law sense, the term “promoter” does not have any of the negative
connotations that surround the popular use of the term
b
...
We’re concerned with three questions:
i
...
Under what circumstances does the corporation, once it is formed, become liable based on the
promoter’s pre-‐incorporation transactions? and
iii
...
Liability of promoter: If the corporation has already been formed, and a promoter makes the contract in the
corporation’s name, there is normally no issue as to the promoter’s liability — the corporation is liable, and the
promoter is not
...
Depending on the circumstances, the promoter may or may not be personally liable if the
corporation is never formed, or if it is formed but does not perform the contract
...
Corporation not named: First, suppose the promoter makes the contract in his own name, without referring
to the not-‐yet-‐formed corporation
...
In fact, the promoter’s personal liability here is so clear that it
is rarely litigated
...
Contract in corporation’s name: Now, assume that the contract purports to be in the corporation’s name,
and that the contract does not on its face disclose the fact that the corporation has not been formed as of
the contract date
...
Promoter knows: If in this situation the promoter knows that the corporation has not yet been
formed, he will almost certainly be held personally liable if the corporation is never formed, or if it is
formed but does not take over and fulfill the contract
...
” Other decisions base this result on
a tort theory: the promoter, by concealing the fact that the corporation has not yet base this result
on a tort theory: the promoter, by concealing the fact that the corporation has not yet been formed,
is liable for misrepresentation
1
...
2
...
04 provides that “[a]ll persons purporting to act as or on behalf of a corporation,
knowing there was no incorporation under this Act, are jointly and severally liable for all
liabilities created while so acting
...
Later formation of corporation and adoption of contract: Suppose that after the contract has been
made in the name of the not-‐yet-‐existing corporation, the corporation is formed
...
Promoter unaware that corporation hasn’t been formed: Now suppose that the promoter honestly believes
that the corporation has been formed, but due to some technical defect of which he is unaware, the
corporation doesn’t really exist at the time he signs a contract on its behalf
...
This class of cases is discussed under the heading “defective
incorporation and its consequences”
d
...
For instance, the contract may recite that one of those parties is “ABC, Inc
...
” (Or, alternatively, the other party knows that the corporation has not
yet been formed but accepts a contract executed in the corporation’s name
...
Therefore, this
class of cases comes down to a question of interpreting the parties’ intent
...
Corporation never formed: If the corporation is never formed, the promoter is quite likely to be held
personally liable
...
Or, the court may reason that the promoter has made an implied promise to cause the
corporation to be formed, and has breached this promise
ii
...
If the corporation never takes any acts to adopt the contract or to begin
performance, the situation is really no different from that in which the corporation is never formed,
so the promoter will probably be personally liable
iii
...
Here, too,
the question is one of the intent of the parties
...
Tendency to bind promoter: The decision in any case is likely to turn on the facts, since it is
the parties’ intention that is being measured
...
(In other words, they tend to view the case as
falling within choice (3) above rather than (1) or (2)
...
Urging by other side to use corporate name: If the other party urges the promoter to
contract in the name of the corporation-‐to-‐be-‐formed, the court is more likely to find that
the other party intended to look only to the credit of the corporation once it was formed
and assented
e
...
In that case, under what circumstances does the corporation become liable under the contract?
i
...
If the
corporation does not take any action to manifest its assent to the contract, it is simply not bound
...
Adoption by corporation: If, on the other hand, the corporation after its formation does manifest its
assent to be bound by the contract previously signed in its name, this intent will be enforced: the
corporation will be liable just as if it had itself originally executed the contract
...
What constitutes adoption: adoption by the corporation may be either express or implied
2
...
Thus if the corporation passes a
resolution, “Resolved that a certain contract made on the corporation’s behalf by Promoter
with Landlord for the lease of premises is hereby ratified and adopted by the corporation as
if it had entered into such contract initially,” the corporation will obviously be bound
...
Implied: adoption may also be implied from the corporation’s acts, and even from its failure
to act
...
This might be the case, for instance, if the
promoter purports to hire an employee in the corporation’s name under a contract, and the
corporation permits the employee to begin work
4
...
Promoter’s fiduciary obligation to corporation and shareholders: The promoter may, once the corporation is
formed, have dealings with it
...
DEFECTIVE CORPORATION
1
...
Related problems arise when the promoter
has attempted to incorporate, but because of some technical defect the incorporation has not yet successfully
occurred
...
How defects can occur: occurs for a number of reasons
...
Or, perhaps the promoter relies on a lawyer to file,
and the promoter is unaware that the lawyer has not done the filing
...
Common law’s “de facto” doctrine: At common law, the “de facto corporation” doctrine was frequently used
to shield the “shareholders” from liability
...
g
...
That is, the entity was not a
true corporation insofar as the state itself was concerned, but it could take advantage of quasi-‐corporation
status vis-‐a-‐vis its creditors
...
Modern view: Today, the de facto doctrine is much less frequently used, because of statutory reforms
...
In return, most states
have statutes that expressly impose personal liability as the penalty for purporting to do business as a
corporation that is not in fact incorporated
i
...
04: “All
persons purporting to act as or on behalf of a corporation, knowing there was no incorporation
under this act, are jointly and severally liable for all liabilities created while so acting
...
Knowledge of defect: But MBCA § 2
...
Passive investors: Just as courts have tried to protect those who mistakenly but honestly believe
that incorporation has taken place, so they try to protect passive investors from personal liability,
even investors who put up money for the commencement of operations without an honest belief
that incorporation has taken place
1
...
If an active investor acts on behalf of the
corporation while knowing it hasn’t yet been formed, he’ll be personally liable
d
...
”
i
...
Once the creditor has done this, he is
said to be “estopped” from denying the corporation’s existence
ii
...
Thus the doctrine is most often used where the shareholder in good faith relies on some third party
(e
...
, a promoter or a lawyer) to handle the incorporation, and based on assurances from this third
person, falsely but honestly believes that a corporation has been formed
iii
...
Tort claimants: Because of the requirement that the estoppel doctrine applies only where the
plaintiff has dealt with the business as a corporation and agreed solely to look to the corporation’s
credit, the doctrine is essentially limited to contract cases, and is virtually never applied against tort
plaintiffs
...
g
...
Effect of Model Act: The MBCA does not explicitly either allow or prohibit the classical corporation-‐
by-‐estoppel doctrine
...
04 of the act exempts from personal liability those who act as a
corporation without knowledge that there has been no incorporation
...
04 leads to same result of non-‐liability without using estoppel doctrine
THE DUTY OF LOYALTY
Self-‐dealing transactions: In a transaction where the Key Player and the corporation are on opposite sides (e
...
, the Key
Player sells property to the corporation), the transaction may be voided by the court, and the Key Player required to pay
damages to the corporation, unless the conflict is disclosed in advance
1
...
Fairness or ratification: Alternatively, the Key Player will avoid self-‐dealing problems if either: (1) the transaction is
basically “fair” to the corporation; or (2) disinterested directors or shareholders ratify the transaction after the
fact, after receiving full disclosure about it
...
g
...
If he doesn’t, he may be required to surrender the opportunity to the
corporation after the fact, and/ or pay damages
Sale of control: The owner of a controlling block of stock is generally allowed to sell his shares for an above-‐market
“premium,” without sharing that premium with other shareholders
...
I
...
Key Players as trustees: It is sometimes said that directors, officers and controlling shareholders are in effect
“trustees” of the corporation, and have a fiduciary obligation to it
i
...
Many forms of conduct permissible in a workaday world for those acting at arm’s length, are
forbidden to those bound by fiduciary ties
iii
...
It is true
that these Key Players have varying duties to the corporation and its other shareholders that are
somewhat similar to the fiduciary duties that a trustee incurs
iv
...
For example, a trustee must behave in a prudent manner,
whereas the managers of a business enterprise are expected to take risks, sometimes big ones (and
often ones that would be inappropriate for a trustee)
v
...
Full-‐time employee: There is one situation in which fiduciary responsibilities will be quite strictly enforced in
corporate law: any full-‐time employee of the corporation (including an officer) is an agent of the corporation,
and is subject to all the fiduciary rules of agency, including a very strict ban on self-‐dealing
i
...
This difference is especially noticeable in the corporate opportunity
context — a business opportunity that a full-‐time employee learns about is much more likely to be
found to “belong” to the corporation, than is a business opportunity that an outside director or non-‐
employee major shareholder learns about
II
...
The key aspect of such transactions is that the Key Player (officer,
director or controlling shareholder) and the corporation are on opposite sides of the transaction
a
...
the Key Player and the corporation are on opposite sides;
ii
...
the Key Player’s personal financial interests are at least potentially in conflict with the financial
interests of the corporation, to such a degree that there is reason to doubt whether the Key Player is
necessarily motivated to act in the corporation’s best interests
...
Sale of property: For instance, the paradigmatic illustration of the self-‐dealing transaction is
the sale of property by a director to the corporation, or by the corporation to the director
...
If transaction with stockholder: Observe that the fact that the Key Player happens to be a shareholder in the
corporation does not remove this danger of unfairness to the corporation
...
This is true even if he is the majority shareholder
...
Modern rule in detail: Let us now consider in more detail the modern rule
...
Statement of rule: Most courts, acting by a combination of statutory interpretation and common-‐
law principles where the statute is silent, seem to divide self-‐dealing transactions into three
categories:
1
...
This is true whether or not the transaction
was ever approved by disinterested directors or ratified by the share-‐holders
2
...
This is true
even though the transaction has been approved by a majority of disinterested directors
(acting with full knowledge of the transaction they were approving) or ratified by the
shareholders
3
...
If a majority of disinterested and knowledgeable directors have
approved the transaction, the court will probably uphold it; the court will similarly uphold it
if it has been ratified by the shareholders
...
The
burden of proof is on the Key Player; he must show that the transaction was approved by
either: (1) a disinterested and knowledgeable majority of the board without participation by
the Key Player; or (2) a majority of the shareholders after full disclosure of the relevant facts
...
See generally, Nutshell, p
...
3
...
MBCA: The corporation statutes of 38 states have explicit provisions dealing with transactions
between the corporation and a Key Player
...
Probably the most important, and explicit, such statute is MBCA § § 8
...
63
...
2
...
Typical approach: Also, the general pattern of these MBCA provisions — that a self-‐
dealing transaction will be upheld if it is either approved by disinterested directors,
ratified by shareholders or found by a court to have been fair — is typical of the
approach of most states
...
§ § 8
...
63
d
...
61—That section imposes two major rules:
i
...
ii
...
62); or (2) a majority of the votes held by disinterested shareholders are cast in
a vote ratifying the action, after disclosure of the conflict (§ 8
...
”
1
...
60 is exclusive
...
Directors only: Second, Subchapter F covers only transactions between the corporation and
one of its directors
...
Thus transactions with non-‐director officers or shareholders under the MBCA are
left entirely to common-‐law principles (though the court is likely to approach these
in almost the same way as a transaction between the corporation and a director)
...
Disclosure after controversy: Third, the disclosure and approval can happen even after the
transaction has been challenged by a dissident shareholder or third party
...
See
Official Comment to MBCA § 8
...
e
...
[1] by showing that it was approved by a majority of disinterested directors, after full disclosure;
ii
...
[3] by showing that it was fair when made
f
...
However, this formulation
raises a number of questions:
i
...
Conflict: Often the fact that there is a conflict will be obvious to the disinterested directors
(e
...
, when the contract runs directly between the director and the corporation)
...
This will be
true, for instance, if the other party to the transaction is a corporation in which the Key
Person has a significant pecuniary interest
...
Example: XYZ Corp wants to buy an office building
...
D has a real estate broker offer the building to XYZ, and the board of XYZ
votes to acquire it
...
Even though all
material economic facts about the underlying transaction (e
...
, the condition and market value of the building)
have been disclosed to the other board members, approval by the board of the contract will not insulate the
transaction from attack, because D has not disclosed his financial interest in Realty Corp to the board
...
62 (requiring disclosure to the board, before approval, of details regarding the director’s conflict); §
8
...
b
...
Disclosure of transaction: Apart from disclosure of the facts that cause a conflict, the Key
Person must also disclose all facts about the underlying transaction that a reasonable
observer would consider “material
...
For instance, if the Key
Person knows of facts that are likely to make the proposed contract turn out to the
disadvantage of the corporation, he must disclose those facts, whereas a third party
negotiating at arm’s length with the corporation could remain silent
3
...
But courts are in
fact in disagreement about whether this is required
...
Ratification allowed: Some courts will uphold the transaction based on board
approval even if the disclosure does not come until after the transaction is entered
into, so long as the directors then “ratify” it (by formally stating that they have no
objection, or perhaps even by simply failing to raise an objection)
...
61( b)( 1) insulates the transaction against judicial review if “directors’ action
respecting the transaction was at any time taken in compliance with § 8
...
The phrase “at any time” is
intended to allow for post-‐transaction ratification
...
Contrary view: But other courts require the disclosure to occur before the
transaction, or at least make it tougher for transactions to be ratified after the fact
instead of approved beforehand
...
Who is a “disinterested” director: The approval must be by a majority of the “disinterested” directors
...
201 for what this means); and (ii) the director does not have a
“material relationship” with another director as to whom the transaction is a “director’s conflicting interest
transaction
...
43(a)(3)
...
EXECUTIVE COMPENSATION
a
...
When an executive is sufficiently senior that he can influence the corporation’s
decision on his compensation, we have a transaction that presents all the traditional dangers of self-‐dealing:
i
...
courts handle the question of executive compensation in much the same way they handle the more
general self-‐dealing problems we reviewed above: they look essentially to the “fairness” of the
transaction, and are influenced by the fact that there has been (or has not been) approval by
disinterested directors and/ or ratification by shareholders
b
...
There are three main issues:
i
...
(2) Must there be “consideration” for the compensation, and if so, what kind? and
iii
...
The self-‐dealing problem: There is a self-‐dealing problem whenever the compensation is fixed for either: (1)
a director; or (2) an executive who is sufficiently senior that he can influence the corporation’s decision about
how much he is to be paid
i
...
Thus according to most courts, an executive
or director compensation scheme is much more likely to be upheld if either: (1) a majority of the
disinterested directors have approved it, following disclosure of all material facts about it; or (2) the
shareholders have approved it, following such disclosure
1
...
In
the compensation context, the question, “Is the scheme ‘fair’ to the corporation?” becomes
transformed into the question, “Is the compensation ‘excessive’?”
2
...
3
...
Business judgment rule: The importance of approval by disinterested directors or shareholders is
shown by the fact that in many courts, the disinterested directors’ decision to approve a scheme will
be awarded the protection of the business judgment rule
1
...
Consideration: Courts insist that there be consideration for each element of a compensation plan
...
THE CORPORATE OPPORTUNITY DOCTRINE
a
...
We turn now to a different type of problem: the Key Player
appropriates to himself some business opportunity or property that is found to “belong” to the corporation
...
There are
three sub-‐problems:
i
...
[2] When may a Key Player make personal use of corporate assets (e
...
, by using the company plane
to fly on a personal vacation)? and
iii
...
Competition with the corporation: A director or senior executive may not compete with the corporation,
where this competition is likely to harm the corporation
1
...
With either of these methods,
the Key Player must first make full disclosure about the conflict of interest and the
competition that he proposes to engage in
2
...
Much more
commonly, they prepare, while still on the company’s payroll, to engage in later
competition
...
There are no hard and fixed rules for this situation, but in general courts tend
c
...
e
...
to hold that these activities constitute disloyalty if they occur while the director or executive
is still on the original corporation’s payroll
...
Assuming that the executive
has not signed any “non-‐compete” agreement, he is not barred from basic competition w/ former employer
i
...
Any of the following acts may be deemed to be a wrongful taking of trade secrets: (1) the systematic
solicitation of a large number of the former employer’s customers; (2) the solicitation of the former
employer’s employees to become employees of the new company; and (3) the use of the former
employer’s secret processes or other methods of doing business
ii
...
However, courts have become increasingly reluctant to enforce broad
non-‐competition agreements, because they do not wish to unduly constrict the executive’s ability to
earn a living
...
“Corporate assets,” consist not only of tangible goods but also intangibles like information
ii
...
Similarly, in the case of use of tangible corporate property, the transaction will not be
wrongful if Key Player pays fair value for any benefit he has received
The “corporate opportunity” doctrine: Suppose that a senior executive or director of a corporation learns of
an attractive business opportunity
...
May the executive or director pursue this
opportunity on his own, rather than turning it over to the corporation? The brief, but unhelpful, answer is
that the manager may not pursue the opportunity on his own, and must turn it over to the corporation, if the
opportunity is one that can be said to “belong” to the corporation
...
Effect of finding of “corporate opportunity”: If the manager is found to have taken for himself an
opportunity that “belongs” to the corporation (i
...
, to have usurped a “corporate opportunity”), the
rules are very strict: this taking is per se wrongful to the corporation, and the corporation may
recover damages equal to the loss it has suffered, or the profits it would have made had it been
given the chance to pursue the opportunity
...
” The Delaware courts use a multi-‐factor test, which has been influential in other courts
...
The multi-‐factor test: Under Delaware law, a business opportunity presented to a corporate officer
or director will count as a “corporate opportunity” if it meets the following requirements:
1
...
the opportunity; the opportunity is “within the corporation’s line of business”;
3
...
if the director or officer were to embrace the opportunity, he would thereby be placed in a
conflict with his duties to the corporation
a
...
Delaware courts seem to hold that the opportunity must merely satisfy
either the “line of business” or “interest or expectancy” test, not both
b
...
The Delaware courts (and the courts of other states following the general
Delaware approach) seem to take a fairly broad definition of line of business
...
Thus
a “functional relationship” between the type of activity the corporation already
engages in and the prospective activity may be enough, even though they are in
different industries
g
...
These factors are especially likely to be considered by a court that uses
“fairness” as a partial or sole standard:
i
...
The
case for regarding opportunity as corporate is obviously stronger in latter situation than in former
ii
...
Thus if President learns of the
opportunity while attending a meeting that relates solely to his company’s business, the case for
finding a corporate opportunity is stronger than where President learns of it while having drinks with
a social friend
iii
...
An illustration of the use of corporate resources would be where
President takes the company jet to scout out the opportunity
1
...
e
...
”
However, this by itself is unlikely to be a very important factor, especially if the time used is
not very substantial
iv
...
The
more important the opportunity is to the corporation’s well-‐being — i
...
, the worse financial injury
the corporation will suffer if it does not have the opportunity — the more likely the opportunity is to
be regarded as corporate
v
...
A full-‐time executive is commonly
understood to owe his entire efforts and loyalties to the corporation that employs him
...
Therefore, the outside director should be more free to take an opportunity for himself
...
Rejection by corporation: Even if an opportunity is a “corporate opportunity,” the Key Player is not
necessarily barred from pursuing it himself
...
i
...
Thus if
President purports to offer the corporation the chance to pursue the opportunity but understates
the potential benefits, or overstates the cost to the corporation, rejection by the disinterested
directors or disinterested shareholders will probably not be a defense
...
Parent-‐subsidiary problems: Suppose one corporation owns a controlling (but not 100%) interest in another
corporation
...
Does the corporate opportunity doctrine apply? In brief, the answer is
probably “yes” — if the opportunity relates much more closely to the subsidiary’s present or contemplated
business than to the parent’s, the parent probably violates its fiduciary obligation to the subsidiary and the
subsidiary’s minority shareholders by usurping it for itself
CLOSE CORPORATIONS
A close corporation has the following characteristics:
1
...
The lack of any real resale market for the corporation’s stock;
3
...
Shareholder voting agreements: Under a shareholder voting agreement, some or all shareholders agree to vote
together as a unit on specified matters
2
...
g
...
The shareholders
retain their economic interest in the business
3
...
A common pattern is for a particular group of minority holders to get its own class of stock, which is
guaranteed the right to elect one or more directors
4
...
g
...
g
...
The purpose is to give minority holders blocking power
5
...
g
...
Dissolution: If the holders are deadlocked, one way to undo the deadlock is for the court to order the corporation
“dissolved
...
1
...
”
a
...
Rodd—a close corporation is a corporation meeting these three requirements:
i
...
Lack of market: The lack of any ready market for the corporation’s stock; and
iii
...
2
...
It is sometimes said that a close corporation should be treated almost like a partnership
b
...
For instance, just as no person can become a member of a partnership without the consent of all partners,
shareholder agreements in close corporations often accomplish almost the same result by restricting transfer
of the corporation’s shares without consent of the other stockholders
...
Similarly, partners stand in a fiduciary relationship to each other; some courts now impose a corresponding
I
...
Arrangements at the shareholder level generally: We first examine a trio of arrangements that take place at the
shareholder (rather than director) level: (1) shareholder voting agreements; (2) voting trusts; and (3) classified
stock
...
Voting agreements: A “shareholder voting agreement” or “pooling agreement” is an agreement in which two or
more shareholders agree to vote together as a unit on certain or all matters
a
...
“agreement to agree”: Some voting agreements attempt to resolve in the
agreement itself exactly how the votes will be cast
...
Example 1: A and B, the only two shareholders of XYZ Corp
...
Example 2: A owns 60% of XYZ Corp
...
They sign a shareholders’ agreement in which each
promises that as to any matter on which a vote of shareholders is required (e
...
, a sale of substantially all the
company’s assets, a merger, a major acquisition, etc
...
This agreement does not specify how they will vote on such matters, since the issues are not even known at
the time of the agreement
...
Generally valid: Such shareholder agreements are today generally valid
...
31(a)
i
...
”
ii
...
A shareholder agreement that does restrict the authority of the board of directors
2
...
g
...
Time limits: Generally, voting agreements may remain in force for an indefinitely long period of time
...
g
...
d
...
The problem is that such agreements are not self-‐enforcing
...
There
are two solutions to this problem:
i
...
The proxy holder will then vote the shares as provided in the agreement, and no
judicial intervention is necessary
1
...
, agree that each will vote to elect the other to the
board
...
When it comes time for the election of directors, X, not A and B, will
cast the vote for directors, so neither A nor B will be able to thwart the agreement
a
...
A proxy is a form of agency — the shareholder is the principal, and the
one to whom he gives the proxy is his agent
...
This would make the use of supposedly irrevocable proxies in a
shareholder agreement valueless
...
Most courts today hold that where a shareholder has purchased stock
in a close corporation in reliance on the existence of a shareholder
agreement and the creation of proxies, a sufficient “interest” exists to
make the proxies truly irrevocable
iv
...
However, in some states there is still a risk that the “irrevocable” proxy
referred to in a shareholder agreement will be found to be in fact
revocable, and thus useless as an enforcement device
ii
...
That is, the court orders the breaching shareholder to cast
his vote as prescribed in the shareholders’ agreement
...
3
...
Mechanics: To create a voting trust, the shareholders who are part of the arrangement convey legal title
to their shares to one or more voting trustees, under the terms of a voting trust agreement
...
Usually they receive a
“voting trust certificate” representing their equitable interest
...
But they no longer have voting power — votes are
cast by the trustees in accordance with the instructions in the voting agreement
b
...
30
i
...
But today, nearly all states
have statutes authorizing voting trust arrangements
...
Most statutes impose these requirements:
1
...
Generally, the maximum term for such a trust is ten years
a
...
30(b)—ten-‐year limit, but at any time some or all parties may sign an
extension agreement, which may continue the trust as to them for up to ten
years from the signing of the extension)
2
...
MBCA § 7
...
Writing: all states require that the trust be in writing, and that the trust be implemented
by a formal transfer; MBCA § 7
...
Powers of trustees:
i
...
In general, they may exercise only those powers that are specifically spelled out in the trust, and
unless the trust expressly permits they may not vote in a way that damages the beneficial
owners that they represent
d
...
In
most states, an arrangement that is found by the court to be a voting trust will be held to be entirely
invalid if it fails to meet all the statutory requirements
...
MBCA loosens rule: à MBCA § 7
...
If the trust does not specify a term, or specifies a term longer than ten years, the trust
will be enforceable, but only for ten years
e
...
Another way in which the shareholders can re-‐allocate their voting power, and ensure minority
stockholders a bigger voice than they would otherwise have, is by the use of classified stock
ii
...
By this means, a minority stockholder may be given voting rights equal
to those of the majority even though he does not have equal financial rights
...
Generally valid: This use of different classes and weighting of votes is generally valid
...
Representation for minority: Observe that use of different classes furnishes an easy
way to insure that minority gets a disproportionate (perhaps even equal) # of directors
II
...
How problem arises: So far, we have looked only at shareholder agreements where the participants limit their
discretion as shareholders (e
...
, they agree to vote for a certain slate of directors)
...
A quite different and more severe problem is posed when
shareholders agree to restrict their discretion as directors
...
Rationale: The courts holding that director-‐fettering agreements are invalid seem generally to be worried
that such agreements will be unfair to minority stockholders who have not signed the agreement, and
possibly to the public (including creditors)
i
...
The New York case law: The leading line of cases limiting the enforceability of agreements that restrict the
board’s discretion has arisen in New York
...
McQuade: the majority shareholder (Stoneham) and two minority shareholders (McQuade and McGraw)
agreed that all would use their best efforts to keep one another in office as directors and officers at
specified salaries
...
Holding: shareholder agreement was invalid, and thus held for the defendants
...
The court reasoned that stockholders may not, by agreeing among themselves, place
“limitations … on the power of directors to manage the business of the corporation by the
selection of agents at defined salaries
...
Clark v
...
In Clark, P owned 25%, and D 75%, of two corporations
...
” D argued
that this agreement violated the McQuade rule, since it purported to restrict the discretion of the board
of directors
i
...
The court seemed to rely on two respects in which this agreement was different from the one
struck down in McQuade: (1) all shareholders had signed the agreement, and there was no sign
that anyone would be injured by the contract; and (2) the impairment of the board’s powers was
“negligible,” apparently since P could always be discharged for cause, and his one-‐fourth of
income could be calculated after the board determined in its discretion how much should be set
aside for the company’s operating needs
...
Also, it may be a requirement that all shareholders consent (or at the
very least that the person now attacking the agreement have previously consented to it)
3
...
Galler: Probably the leading non-‐New York case showing this modern liberal trend
b
...
5% of the
stock
...
Benjamin died, and Isadore
refused to carry out the agreement
i
...
The court required an agreement to satisfy three tests before it would be
enforced: (1) there must be no minority interest who is injured by it; (2) there must be no injury
to the public or to creditors; and (3) the agreement must not violate a clear statutory
prohibition
...
ii
...
Perhaps more importantly, the Illinois court in Galler stressed the importance of broad
and enforceable stockholder agreements in the close corporation context
2
...
He feels, understandably, that he is more than a mere investor and that his voice should
be heard concerning all corporate activity
4
...
”
c
...
So the modern, increasingly prevalent view seems to be that a shareholder agreement that
substantially curtails the discretion of the board of directors will nonetheless be upheld if it:
1
...
(2) does not injure creditors or the public; and
3
...
III
...
The stockholders of a close corporation will usually agree to limit the transferability of shares in the corporation
2
...
or the right to buy them by matching what the outside person is willing to pay (right of first refusal)
b
...
(e
...
, the stockholder’s death, retirement or termination of employment with the corporation)
3
...
Right of first refusal: Under a right of first refusal, a shareholder may not sell his shares to an outsider
without first offering the corporation or the other current shareholders (or both) a right to buy those
shares at the same price and terms as those at which the outsider is proposing to buy
...
Advantage: An advantage of the right of first refusal is that it gives the non-‐selling shareholders
a way to keep shares in the current “family”, yet apparently does not cost the selling
shareholder any funds—he is receiving same price and terms as the outsider was willing to give
...
Disadvantage: However, the existence of a right of first refusal in fact probably makes it more
difficult for the shareholder to find an outsider willing to buy his shares
...
Also, the first refusal device works only when the shares are
to be sold, not when they are to be transferred by gift or bequest
b
...
” This is similar to the right of first refusal,
except that the price is determined by the agreement creating the option
...
g
...
Advantage: An advantage of this method is that, unlike the right of first refusal, transferred by
gift or bequest
c
...
Disadvantage: powers, since they might be used to unreasonably restrict alienation, are likely
to be more closely scrutinized by the courts for “reasonableness” than the above two methods
d
...
A buy-‐back right, by contrast, is given to the corporation to enable it to buy back a
holder’s shares on the happening of certain events, whether the holder wants to sell or not
...
The corporation is not obliged to exercise its
buy-‐back right
e
...
Most often, the
corporation and the shareholders will make a buy-‐sell agreement under which the corporation must re-‐
purchase the shares upon the death of a shareholder/ employee
...
DISSOLUTION
1
...
30(a)(2), a shareholder may obtain dissolution only if he shows one of four things:
a
...
30(a)(2)(i)—that the directors are deadlocked in the management of the
corporation’s affairs, in a way that is causing injury to the corporation or its shareholders (
b
...
30(a)(2)(ii)—that the directors or those controlling the corporation have acted in a manner
that is “illegal, oppressive, or fraudulent” or
c
...
30(a)(2)(iii)—that the shareholders are deadlocked in voting power, and have
failed to elect successor directors “for a period that includes at least two consecutive annual meeting dates”
d
...
30(a)(2)(iv)—that the corporation’s assets are being “misapplied or wasted”
i
...
Observe that none of these four MBCA showings permits a shareholder to dissolve the
corporation merely because he thinks he would be better off cashing out his investment
2
...
Only in the “shareholder deadlock” situation is a finding of serious harm or abuse not
needed, and there the shareholder will have to show that at least two annual meetings have
occurred at which no successor directors could be elected
CORPORATE STRUCTURE
Straight vs
...
But there are two distinct methods by which
these shares can be voted, “straight” and “cumulative
...
Straight voting: In “straight” voting, no share may be voted more than once for any given candidate
2
...
This increases the power of minority shareholders, since a
shareholder may cumulate (i
...
, lump together) all his votes so as to be sure to elect a single director
Quorum: At both a shareholders’ meeting and a board of directors’ meeting, no action may be taken without a “quorum
...
Board meeting: At a board meeting, a quorum is usually a majority of the directors in office
2
...
They have two main sets of powers:
1
...
2
...
For
instance, the corporation cannot sell substantially all of its assets, or merge into another corporation, unless the
shareholders so vote
Directors: The board of directors manages the corporation, at the policy level
1
...
For example, the board elects the president
2
...
For instance, any non-‐trivial acquisition of another company’s
stock or assets would have to be approved by the board
3
...
)
Officers: Officers administer the day-‐to-‐day affairs of the corporation
...
1
...
a
...
Ratification: However, even if the officer acted completely without authority, later actions by other officers or by
the board may amount to a “ratification” of the act, binding the corporation
The statutory scheme may be summarized as follows:
1
...
(1) electing and removing directors, and (
b
...
g
...
Directors: The directors “manage” the corporation’s business
a
...
Officers: administer the day-‐to-‐day affairs of the corporation, under the supervision of the board
...
For very large or very small corporations, this statutory scheme does not reflect reality
2
...
At the other end of the spectrum, a very large publicly-‐held company is really run by its officers, and the board of
directors frequently serves as little more than a “rubber stamp” to approve decisions made by officers
...
SHAREHOLDERS POWER
1
...
Instead, they can influence the conduct of the business through a number of indirect method
3
...
Elect and remove directors: They have the power to elect and remove directors
i
...
Notice: MBCA § 7
...
Quorum: MBCA §7
...
That is, more than 50% of
the shares eligible to vote must be “present,” either in person or via valid proxy
a
...
Many of these require that
at least one-‐third of the shares be present as the minimum allowable quorum
i
...
MBCA §7
...
Articles of incorporation and bylaws: They can approve or disapprove of changes to the articles of
incorporation or bylaws and thereby influence the allocation of power as among themselves, the
directors, and the officers
i
...
Fundamental changes: They have the right to approve or disapprove of fundamental changes not in
the ordinary course of business, such as a merger, a sale of substantially all of the corporation’s
assets, or dissolution
i
...
[1] mergers;
2
...
[3] amendments of the articles of incorporation;
4
...
[5] dissolution of the corporation
a
...
This is sometimes referred to as the board of directors’ “gatekeeping”
function—MBCA § 11
...
Void or voidable transactions: Finally, some transactions by officers or board of directors are void or
voidable unless ratified by a vote of shareholders
...
See infra p
...
No power to bind corporation
a
...
They must operate through their control of the board
c
...
And this is true even of actions taken by a majority of shareholders, purportedly in the corporation’s
name — unless the action is somehow ratified by the board or by an officer with power to bind the
corporation to the kind of transaction in question, the action by the shareholders has no effect
II
...
Traditionally, state corporation statutes have provided that the board of directors shall “manage” the affairs
of the corporation; view the board not as agents of the stockholders, but as an independent institution with
responsibility for supervising the corporation’s affairs
a
...
It is the
board, not the shareholders, who formulate policy; shareholder control is limited to removing
directors or approving/disapproving certain major actions contemplated by the board (mergers)
b
...
01(b)
i
...
MODERN—MBCA says that “All corporate powers shall be exercised by or under the
authority of the board of directors of the corporation, and the business and affairs of the
corporation shall be managed by or under the direction, and subject to the oversight, of its
board of directors
...
Sets policy: board’s main function is to set the policies of the corporation, and to authorize
the making of important contracts
c
...
That is, the board may be divided into, say, three “classes” of directors, one
class elected for a one-‐year term, another for a two-‐year term, and the last for a three-‐year term
...
06
d
...
MBCA § 8
...
the director “engaged in fraudulent conduct with respect to the corporation or its
shareholders, grossly abused the position of director, or intentionally inflicted harm
on the corporation,” and
2
...
Quorum: The board of directors may act only if a quorum is present
a
...
This is
true even though there are vacancies on the board at the moment
i
...
At the
time of a particular directors’ meeting, there are two vacancies
...
Variable board: MBCA § 8
...
But if the articles set up a variable-‐size board, a quorum is generally set as a majority of the
directors in office at the start of the meeting
c
...
both DGCL § 141(b) and the MBCA § 8
...
Super-‐majority as quorum: §8
...
Conversely, statutes often permit articles/bylaws to establish quorum of more than majority
ii
...
For instance, the bylaws could be amended to provide that all three directors must be
present for a quorum; this way, a minority shareholder who controls one seat could actively
block corporate action by refusing to attend directors’ meetings
e
...
Thus even if a quorum is present at the start of a meeting, directors may, by leaving, remove
the quorum and thereby prevent further board action
...
(A different rule applies to shareholders’ meetings; at which all that counts is that a quorum
be present at the start of the meeting
3
...
5
...
f
...
There is one exception to this rule: In most states, the board may fill a vacancy even though
less than a quorum of directors is present
ii
...
What constitutes act of board: MBCA §8
...
board may take action only by vote of a majority of the directors present at the meeting
b
...
For instance, §8
...
For instance, a committee may authorize the corporation to take on long-‐term debt
or to make a large capital investment; it may set the price at which shares shall be issued (so long as the
whole board has approved the issuance); it may appoint or remove senior management, and fix the salary of
these executives
...
25
Formalities for board action: board of directors may take action only at a meeting, not by individual action of
the directors
...
Rationale: the decision-‐making process is likely to function better when the directors consult with
and react to one another
...
24(d)(2) and (3)
a
...
May be important for the director to register her dissent, because if she does not do so, she may be
personally liable for the board’s action even though she remained silent or orally voiced reservations
c
...
OFFICERS POWER
1
...
In practice, of course, the officers frequently have much greater power than
this implies, especially in large publicly-‐held corporations
2
...
Not automatically binding: an officer (even the president) will not automatically have authority to bind the
corporation to a transaction merely by virtue of his office
...
express actual authority
i
...
This explicit grant generally comes from either the corporation’s bylaws, or in the form of a
resolution adopted by the board of directors
...
implied actual authority: it is often described as “authority which is inherent in the office”
i
...
First, authority may be inherent in the particular post occupied by the officer,
measured by the common understandings of business people
2
...
e
...
Particular action of board:
1
...
EX: Thus even if vice presidents in the business world are generally not
permitted to sign contracts disposing of surplus plants, the fact that ABC’s
Corp’s board has allowed Vice President to do so in the past without objection,
or the fact that the board has known that Vice President was about to sign the
particular contract in question, would be enough to clothe Vice President with
implied actual authority to sign the present contract on behalf of ABC
c
...
Requirements: for third party to successfully invoke the apparent authority doctrine, he will
have to show that:
1
...
(2) the plaintiff was aware of those corporate indications and relied on them
ii
...
3P may be able to point to specific, affirmative conduct by the corporation that
indicates to the world that the officer has the authority in question
2
...
Most likely to happen where action is by company’s president, and action is
of a sort that presidents are usually permitted to take
b
...
for #1: if the board of directors is aware that Vice President has routinely
been signing large contracts to buy raw materials, and the board does not
object, a supplier who can show this past pattern of acquiescence (and who can
show he was aware of it at the time of his own contract) would probably
succeed in arguing that Vice President had apparent authority
iii
...
It is not sufficient that the agent himself represents to the third party that he has
authority to enter into the transaction
2
...
(2013-‐06-‐05)
...
Aspen Publishers
...
d
...
Suppose has neither actual nor apparent authority
...
Under this doctrine, if a person with actual authority to enter into the transaction learns of
the transaction and either expressly affirms it or even fails to disavow it, the court may find
that the corporation is bound
1
...
(1) the corporation has received benefits under the contract, which it has
not returned; or (2) third party has relied to his detriment on the existence
of the contract
b
...
Full knowledge by board: Of course, the plaintiff who is claiming ratification must
show that the ratifier had full knowledge of the contract
For instance, if the board knows that the president has signed a contract to acquire a company
from X, but does not know that the president is receiving a kickback from X or does not know that
the contract calls for the corporation to pay a very excessive price, a court would probably not find
that the board’s mere failure to object constituted ratification
SHAREHOLDERS INFORMATIONAL RIGHTS & PROXY SYSTEM
*how shareholders can get information about the corporation’s affairs, and how (at least for publicly-‐held corporations) the
system of “proxy voting” lets shareholders vote on the corporation’s affairs without having to physically attend shareholders’
meetings
Inspection of books and records: Shareholders are normally allowed by state law to inspect the corporation’s books and records,
if they are doing so for a “proper purpose
...
The ’34 Act requires the company
to “register” its stock, and to continuously supply the public with information about the company
Proxy rules: A “proxy” is a document in which the shareholder appoints someone (typically management) to cast his vote for one
or more specified actions
...
This is the means by which a shareholder can vote without physically attending the annual meeting
2
...
(This information is contained in a “proxy statement
...
Shareholders’ proposal: Under certain circumstances, a minority shareholder may require management to
include in management’s proxy statement the minority holder’s proposal for shareholder action
b
...
g
...
g
...
Proxy contest: A “proxy contest” is a competition between management and another faction — usually a group
of outside insurgents — to obtain shareholder votes
...
The SEC has elaborate rules
governing proxy contests, which have the effect of somewhat equalizing the outsiders’ chances
I
...
For a privately held company, the shareholders’ inspection rights described above are the principal way in which
the corporation’s shareholders can get financial information about the company
...
But once a corporation becomes
“publicly held,” the shareholder’s access to information about it improves dramatically; Under the federal
securities laws, the corporation is required to file a great deal of financial information with the Securities and
Exchange Commission (SEC), which then becomes available as a public record; also, under SEC rules the public
corporation is required to send certain types of financial information to the shareholder automatically
b
...
there is no official federal meaning to the concept of a “publicly held” company
ii
...
(i
...
, companies that are either exchange-‐listed or have 500 shareholders plus ten million in assets
...
Two types of public filings: two main statutes that impose filing requirements on publicly held corporations:
i
...
Principally regulates the initial offering of securities to the public
2
...
may issue shares to the public, it must file a “registration statement” with the SEC
3
...
Once a corporation issues its shares (and assuming that it does not make any additional issues),
the ’33 Act largely becomes irrelevant
ii
...
Requires registration of the shares of certain companies, and also requires the continuous
updating of information about companies whose shares are so registered
...
Listed stocks:
a
...
’34 Act, § 12(a)
b
...
g
...
), must be registered, no
matter how small the company or the issue of stock
3
...
Even companies whose shares are traded over the counter (i
...
, not on any formal stock
exchange) must be registered with the SEC if the company is above a certain size
b
...
(1) the company has assets in excess of ten million dollars; and
ii
...
d
...
This includes many of the stocks on the NASDAQ Automatic Quotations System, which in
many ways functions like stock exchange but not considered an exchange for purposes
of the 34 Act
4
...
In the case of
stock not listed on any exchange, it is the class of stock that must have more than 500 record
holders before registration will be required
a
...
has 300 record holders of its common stock and 300 record holders of its preferred stock
...
Termination: Once a class of shares has to be registered under the ’34 Act, even a reduction of
assets or reduction of record holders below the number that would have been required for initial
registration will not automatically be enough to remove the registration requirements
...
This means that even a publicly-‐held corporation with billions
of dollars of assets can terminate its SEC reporting requirements (and thereby “go private”) if it
can reduce the number of record holders of its stock to fewer than 300
d
...
Among the many kinds of filings that are required are: (1) an annual report each year on SEC form 10-‐
K; (2) a quarterly financial report every three months on SEC form 10-‐Q; and (3) a report of major
business developments (e
...
, changes in control, acquisition or disposition of significant assets,
resignations of directors, etc
...
II
...
Few shareholders have the time or inclination to physically attend the shareholders’ meeting and vote
their shares in person, whether for the election of directors, approval of a merger, or for some other
action requiring a shareholder vote
...
How can a majority of the shares be represented if few of the shareholders are present? à PROXY
c
...
How SEC regulation fits in: SEC a broad opportunity to regulate:
a
...
(2) the information that must be furnished to a shareholder when his proxy is solicited; and
c
...
The focus of this proxy regulatory system is on making sure that investors have adequate
information before they exercise their right to vote by filling out a proxy card
2
...
“unlawful for any person, by the use of the mails or by any means or instrumentality of interstate
commerce or of any facility of a national securities exchange … in contravention of such rules and
regulations as the [SEC] may prescribe … to solicit or to permit the use of his name to solicit any proxy
or consent or authorization in respect of any security … registered pursuant to section 12 of this
title
...
Registration pursuant to §12
i
...
Stock must be registered under § 12 if it is the case that either: (1) the stock is traded on a
national securities exchange; or (2) the company has at least ten million dollars of assets and
the class of stock in question is held by at least 500 record owners
iii
...
3
...
After taking into account these exemptions, here is what is covered by the SEC rules:
a
...
Solicitation by non-‐management: But if the solicitation is by non-‐management (e
...
, it is by an
insurgent faction trying to get its own slate of directors elected to the board), the solicitation is not
covered so long as the number of persons solicited is ten or fewer
i
...
What is a “proxy”
a
...
Under rule 14a-‐1(e), the term includes “every proxy, consent or authorization
...
Meaning of “solicitation”
a
...
Oral requests: An oral request for a proxy, even if no proxy card is sent to the person being
solicited;
ii
...
Advertisement: The “furnishing of a form of proxy or other communication to security holders
under circumstances reasonably calculated to result in the procurement, withholding, or
revocation of a proxy
...
Under this definition a newspaper advertisement
urging shareholders to give or deny one side a proxy would be a “solicitation
...
Example: A suit brought against an officer for engaging in self-‐dealing transactions with the corporation
...
Suits for breach of the duty of care and of the duty of loyalty are normally derivative
2
...
e
...
3
...
(For instance, it’s relatively easy for the board of directors to have the derivative suit
discontinued if they don’t think it has merit
...
If (as usually happens) board declines, court will often dismiss suit
1
...
g
...
Settlements: Because there’s a big risk that the plaintiff and the corporation will collude, any settlement of a derivative action
has to be approved by the court
Indemnification: The corporation may sometimes reimburse (indemnify) the director or officer for losses incurred relating to her
actions on the corporation’s behalf
...
Remedy for Fiduciary Breaches: wrongdoer will normally be an insider — a director, officer, or controlling
shareholder — and the wrongdoer’s fellow insiders will normally be reluctant to turn on one of their own
a
...
Suit against insider: The derivative suit may in theory be against anyone who has wronged the corporation,
whether that person is an insider or outsider
...
e
...
)
i
...
Breach of loyalty: Most significantly, claims can be brought against an insider who has caused the
corporation to enter into a self-‐dealing transaction with him (e
...
, a sale of corporate property at
below fair market value) or against an insider who has usurped a corporate opportunity
iii
...
For instance, if Corporation’s board of directors vote to acquire all of the stock of Small
Corp
...
PROS, FAVORING DETRIVATIVES: those who find a lot of value in derivative suits, and who therefore argue
for court rules that make it relatively easy to file and pursue such suits, make the following arguments:
i
...
The corporation itself (as represented by its incumbent board of directors) will
rarely take action against an insider
...
g
...
Only an action
brought by a shareholder whose investment has been made less valuable because of the wrongdoing
will directly redress the injury to the corporation
ii
...
Legal fees: The enforcement action is generally without direct cost (including attorneys’ fees) to the
corporation, since the plaintiff’s attorney will only receive fees if he is successful, and he will then
receive these fees only out of the recovery that is made on behalf of the corporation
d
...
Waste of corporation’s time: The mere prosecution of a derivative suit often wastes a lot of the time
and energy of the corporation’s senior executives, and any resulting benefit to the corporation is less
than the value of this time and energy
ii
...
Strike suits: Because of the large waste of senior management time when a suit continues through
trial, management will often be tempted to settle even suits that have little merit, in order to be rid
of them
...
e
...
In the end, only the plaintiff’s
lawyers, not the corporation, are enriched
e
...
Therefore, most states
attempt to allow meritorious suits to be filed and to proceed to trial, while at the same time attempting to
screen out suits without merit
...
The early termination of meritless derivative suits is the single most
important issue in connection with derivative suits, and is discussed extensively beginning infra, p
...
II
...
General distinction à Not all suits by shareholders are derivative — in some situations, a shareholder (or a
class of shareholders) may sue the corporation, or insiders, directly
...
How, then, can we
distinguish between an action that should be characterized as a derivative action and one that should be
characterized as a direct action?
i
...
if the injury is an injury to the corporation, the suit to redress it is a derivative action;
2
...
Illustrations of derivative action: Thus most cases brought against insiders for breach of the fiduciary duty of
care or loyalty are derivative
...
Due care: A suit against the board members for failing to use due care in overseeing the company’s
operations (e
...
, by grossly negligently approving a disastrous acquisition);
ii
...
g
...
Excessive compensation: A suit to recover excessive compensation paid by corporation to its officers;
iv
...
g
...
1
...
But the action is still a derivative, not direct
a
...
c
...
Voting: An action to enforce the holder’s voting rights, or to prevent some other shareholder from
improperly voting his shares;
ii
...
Anti-‐takeover defenses: An action to
prevent management from improperly using the corporate machinery to entrench itself (e
...
, a suit
to enjoin the corporation from enacting a “poison pill” which would prevent a takeover);
iii
...
Protection of minority shareholders: A suit to prevent oppression of, or fraud on, minority
shareholders, especially where the corporation is closely-‐held
d
...
Procedural requirements: If the action is derivative, the plaintiff must jump through a number of
procedural hoops merely to be able to proceed at all
...
1
...
For instance, most states hold that a
derivative action is equitable, and that there is therefore no right to a jury trial on it
...
Demand on board; termination: Second, P in a derivative suit is much more likely to lose control of
his action than where the action is direct
...
The court will often respect this termination recommendation, so that the plaintiff will
simply not be allowed to proceed
...
iii
...
Derivative—the recovery is always by the corporation, and the plaintiff benefits only to the
extent that his shares in the corporation (as well as the shares of everyone else) become
more valuable due to the corporation’s recovery
2
...
For instance, if P sues to
compel the payment of a dividend, this money will be paid directly to him if he succeeds
Requirements for Maintaining Derivative: generally: There are three main procedural requirements that, in most
states, a plaintiff must meet in order to maintain a derivative suit:
a
...
Nearly universal requirement: MBCA § 7
...
…”)
ii
...
(1) it discourages litigious people from bringing frivolous suits, since they can’t look around
for wrongdoing and then buy shares that will support standing; and
2
...
Criticism: on the grounds that it screens out meritorious suits as well as frivolous ones, and screens
out suits where there would be no unjust enrichment
b
...
I
...
continue to own the shares in the corporation not only at the time of suit, but right up until the
moment of judgment
...
Involuntary merger: Normally, this requirement does not have much bite — since even a one-‐share
holding by the plaintiff will suffice, compliance with the requirement is rarely difficult for the
plaintiff
...
Here, many courts ease the unfairness that
would result from mechanical application of the continuing ownership rule — they allow the
shareholders in the no-‐longer-‐existing corporation to bring a non-‐derivative suit against the
wrongdoers, or they allow the surviving corporation (or its shareholders) to bring suit
...
Demand on Board: P must make a WRITTEN demand (unless excused) upon the board of the corporation,
requesting that the board attempt to obtain redress for the injury the corporation has suffered
i
...
Only if the board refuses to
act may the plaintiff then commence suit
ii
...
For example, if essence of P’s claim of wrongdoing is that the entire board of
directors personally benefited in a pecuniary way from the transaction which they approved, most
courts would excuse the would-‐be plaintiff from demanding that the board in effect sue itself
iii
...
42(1) requires a demand on the board in all cases
...
42(2)
iv
...
In theory, the
shareholders would then vote on whether to maintain the derivative action, and if a majority voted
against the action, the plaintiff would not be permitted to proceed
More demand issues
d
...
How the committee works: Here is how this process works: As soon as P files his derivative suit or
makes a demand on the board, the board appoints a supposedly “independent committee” of
directors to investigate P’s allegations
1
...
If all directors are being sued, the board may even vote to enlarge itself by the
appointment of one or more additional new directors, who are then immediately appointed
as the committee
2
...
Dismissal recommended: In virtually all instances, the committee recommends that P’s suit
be dismissed
...
Often, however, the committee reasons that although the
allegations have merit, the burden to the corporation of pursuing the suit would outweigh
any possible recovery
ii
...
44(b)(2)
ISSUANCE OF SECURITIES
Par value: A corporation may choose to declare a “par value” for its shares before they are issued
...
Preemptive rights: Corporations sometimes opt to give shareholders “preemptive rights
...
1
...
For instance, if the corporation issues shares in return for services or property, other shareholders’ preemptive rights
don’t become triggered
Public offerings: issuance shares to “the public” (i
...
to large numbers of buyers simultaneously) tightly regulated by federal law
...
Exemptions: A large part of our treatment of public offerings consists of rules defining the borderline between offerings
that are “public” (and thus tightly federally-‐regulated) and those that are “private” (subject to less regulation)
...
For instance, offerings to fewer than 35 affluent people, and offerings aggregating less than $ 1 million, are generally
given an exemption
I
...
Subscription agreements: MBCA §6
...
Suppose that A, B, C, D, and E all want to form a new business that will operate as XYZ Corporation
...
One way the five would-‐be shareholders
could do this is by having XYZ enter into a separate subscription agreement with each of the prospective
investors
...
Once these agreements are signed, XYZ’s promoter can begin
arranging for workers, facilities, etc
...
Installment plan: Apart from this “reliance” objective, a second reason why promoters might want
to use subscription agreements is that some or all of the stockholders may want to pay for their
shares in installments
...
iii
...
If the corporation will be formed as part of a public offering, then the SEC’s public offering
procedures will be used instead of the subscription-‐agreement procedure
2
...
Law governing: Nonetheless, subscription agreements are sometimes used, so it’s worthwhile to
understand the general principles governing them
1
...
A key question is whether this agreement may be
revoked by the signing shareholder if he attempts to do so before the corporation is formed
a
...
20(a) Statute: subscription agreement is irrevocable for six months unless
it provides for a longer or shorter period; however, it may be revoked at any time if
all the subscribers agree to revocation
b
...
2
...
This means that
a subscriber is liable for the unpaid portion of his subscription price
...
Preemptive Rights
Aright sometimes given to a corporation’s existing shareholders that permits them to maintain their
percentage of ownership in the corporation, by enabling them to buy a portion of any newly-‐issued shares
i
...
Under a typical preemptive
rights scheme, Mousetrap would have been required to offer to Inventor 49% of any new issue of
shares
...
Example: Inventor has invented a marvelous new mousetrap, which is guaranteed to be a commercial success if only he can raise the funds to produce it
...
Together, they form Mousetrap Corporation, with Capitalist receiving 51% of the stock (in
return for advancing all of the capital) and Inventor 49% (in return for assigning to the corporation all of his rights to the invention
...
There are 1,000 shares outstanding, held 510 by Capitalist and 490 by Inventor
...
Capitalist wants to increase his percentage of ownership, and decrease not only Inventor’s percentage of the economic pie
but also Inventor’s participation in decision making
...
He causes the board to offer these shares to (and only to) Capitalist’s own personal holding
corporation, PHC, Inc
...
Now, Capitalist controls three quarters of the company, and Investor
has only one quarter
...
ii
...
“Opt out” provision: the corporation has preemptive rights unless it expressly specifies, in
the articles of incorporation, that it does not want such rights
2
...
30(a)
a
...
the corporation does not have preemptive rights unless it expressly elects, in the
articles of incorporation, to have such rights
...
§6
...
30(b) (including terms of waiver, exceptions for such items as shares issued for
property or satisfy stock options, & other procedural aspects)
iii
...
Thus the following kinds of share issuances are generally
not covered even if the corporation has preemptive rights
1
...
Here, the theory is that a diligent shareholder should understand at the time he
makes his initial purchase that the corporation may ultimately be selling to persons other
than himself the entire rest of the initially-‐authorized amount
a
...
MBCA § 6
...
When to use?
1
...
A preemptive rights scheme will cause substantial delays in financing —
before the corporation offers shares to the public, it must make a “rights offering” to each
existing shareholder, a complex procedure
...
Closely held corporations: But the reality is quite different in the context of the closely held
corporation
...
PUBLIC OFFERINGS
a
...
The Securities Act of 1933: Federal regulation of securities issuance is principally governed by the
Securities Act of 1933 (33 Act)
1
...
The ’33 Act is virtually limited to the
regulation of new issues of securities to the public
...
Thus the proxy
regulations (supra, p
...
262), and the requirement of periodic financial
disclosure (supra, p
...
So it may loosely be said that the ’33
Act regulates “new issues,” and the ’34 Act regulates “companies
...
Section 5 of the ’33 Act
1
...
In brief, § 5 makes it unlawful (subject to some
exemptions) to sell any security by use of the mails or other facilities of interstate
commerce, unless a registration statement is in effect for that security
...
Additionally, § 5 prohibits the sale of any security unless there is delivered to the buyer,
before or at the same time as the security, a “statutory prospectus,” which contains the
most important parts of the registration statement (this way, the investor does not have to
go to the SEC to read the registration statement
...
Disclosure
1
...
The SEC has no power to decide that a particular stock issue should be prohibited on the
grounds that it is too risky, overpriced, or otherwise inappropriate on the merits — so long
as full disclosure is made in the registration statement and prospectus, there is no security
too worthless to be offered to the public
iv
...
The ’33 Act does not apply only to “stocks,” as you might expect
...
WHAT IS A SECURITY?
i
...
” Section 2(1) gives a definition of the term that is vastly broader than you might expect —
the term is defined to include a list of items too long to reprint here, but one that includes any
“note,” “stock,” “bond,” “evidence of indebtedness,” “certificate of interest or participation in any
profit-‐sharing agreement,” “investment contract,” “certificate of deposit,” or any put, call, or other
option on any of the above
...
Stock: A share of stock will almost always be a security
...
”
a
...
Does the fact that the entire business is being sold,
rather than just a portion of it, prevent the stock sold from being a “security”? The
answer seems to be “no” — even the sale of all the stock of a business will be the
sale of a “security,” and must therefore comply with the ’33 Act
...
v
...
S
...
’”
2
...
” At one end of the
scale, we have, say, a “note” given by a small-‐business owner to a bank, in return for a loan;
this is clearly not a “security
...
” Other debt
instruments will fall closer to the dividing line
...
Bank loans: A note or other debt instrument that is issued to a single, or small
number, of banks will normally not be a security
...
“Investment contract”: The trickiest aspect of the definition of “security” involves whether a
given money-‐raising scheme involves the sale of an “investment contract” (listed in § 2(1) as
one of the types of “securities”)
...
” The key concept seems to be that if A pays B money as an
investment in a venture whose economic success will depend solely on the efforts of B or
third persons (and not at all on A’s own efforts), deal will be held to have involved a security
a
...
III
...
Importance of exemptions
i
...
But because of the exceptional breadth of the securities laws, many more
transactions will be held to be “public offerings” (and thus governed by the registration requirement)
than a non-‐lawyer might expect
ii
...
Therefore, we must examine this pattern of exemptions with great care
b
...
Section 5( a) provides that “unless a registration statement is in effect as to a security, it shall be unlawful for
any person, directly or indirectly — (1) to make use of any means or instruments of transportation or
communication in interstate commerce or of the mails to sell such security through the use or medium of any
prospectus or otherwise
...
i
...
Section 3 exempts
certain securities, and § 4 exempts certain transactions
...
But the general point remains: if something
constitutes a “sale” of a “security” (and the terms “sale” and “security” are very broadly defined; see,
e
...
, supra, p
...
1
...
(1) Persons other than issuers, underwriters and dealers
i
...
”
ii
...
iii
...
Boiling it all down, therefore, registration will generally be required only
where the transaction is being carried out by a person who is an “issuer” or
“underwriter
...
b
...
The second key exemption is given in § 4(2): “transactions by an issuer not
involving any public offering
...
So if an issuer can show that its sale of securities was “non-‐public” rather
than “public,” it need not comply with the registration requirements
c
...
Therefore, the SEC has created a “safe harbor” — if a transaction satisfies the requirement of SEC
Rule 506, it will be deemed “private” regardless of whether it would meet the requirements of cases
(like Ralston Purina) decided under the basic § 4( 2) statutory exemption
ii
...
(The other rules within Regulation D are discussed in our treatment of
small offerings) & imposes a somewhat mechanical test based on the number of purchasers
...
Gist: The gist of Rule 506 is that an issuer may sell an unlimited amount of securities to: (1)
any number of “accredited” investors; and (2) up to 35 non-‐accredited purchasers
a
...
The full definition is too intricate to reproduce here
...
In the case of an individual, he
is accredited if either: (1) his net worth is more than $ 1 million (not counting his
personal residence) (501(a)( 5)); or (2) he has had an income of more than $
200,000 in each of the two most recent years ($ 300,000 when his income is
combined with that of his spouse), and has
d
...
” It allows a higher dollar amount than
Rule 504, yet imposes less stringent requirements on who may invest than does Rule 506
...
Gist: Under 505, the issuer can sell up to $ 5 million of securities in any 12-‐month period (counting
sales not only under 505 but also those under 504)
...
Disclosure and advertising: If the issuer is selling to any non-‐accredited investors, it must make the
same disclosure to all investors as would be required under 506
...
550) that apply to Rule 506 offerings that are sold to non-‐accredited
investors apply equally to Rule 505 offerings
iii
...
Given that the number-‐of-‐investor limits, disclosure rules, and anti-‐advertising rules that
apply to 506 also apply to 505, and that 505 limits the offering to $ 5 million whereas 506
has no dollar limits, why would anyone ever use 505?
2
...
3
...
”
WHAT IS A CORPORATION?
1
...
Artificial entity: an independent entity, separate from the identity of its owners (“shareholders”)
...
For instance, it can enter into
contracts, own property, and sue or be sued
3
...
Limited liability: the corporate form allows for limited liability
...
In contrast, a person operating a sole proprietorship, or a group of individuals
operating a partnership, will normally be personally liable for the debts of the enterprise
b
...
Ownership interests in
the corporation are represented by shares, and shares can be readily sold
...
COMPARING TO PARTNERSHIP
1
...
Corporation: centralized management
i
...
The board of directors then appoints “officers” (i
...
, high-‐level executives)
iii
...
So if the investors desire to entrust management to non-‐shareholders, or to some but
not all shareholders — which will frequently be the case in a larger corporation — the centralized
management structure of the corporation is helpful
b
...
General partnership: all partners have an equal voice in managing the enterprise, unless they
otherwise agree
...
” For
instance, they may decide that the decision-‐making powers will be limited to one or a few of them
rather than all
1
...
Limited partnership: same as general partnership, except that the limited partners may not actively
participate in management without losing their limited liability
...
Continuity of existence: differ in ability to continue in existence when ownership changes
a
...
” In other words, the fact that ownership (i
...
, shares)
changes hands, whether by sale, inheritance, gift, etc
...
Partnership: The rules for a partnership are quite different
i
...
In fact, even the withdrawal of a
general partner will dissolve the partnership unless the partnership agreement otherwise provides
...
1
...
First, the partnership agreement
may provide that the withdrawal of a partner will not cause the partnership to dissolve
...
Limited: not dissolved by the withdrawal or death of a limited partner
Summary: If it is important to the owners that the business continue with a minimum of fuss even if one owner withdraws or
dies, then the corporate form is somewhat superior
...
In any event, through careful drafting of the partnership or shareholders’ agreement, a
corporation can be made to look like a partnership, or a partnership like a corporation, with respect to continuity of existence
...
Transferability of interest: how readily transferable an ownership interest is
a
...
Ownership is, of course,
embodied in shares of stock
...
This transferability is especially
important where: (1) the business wants to attract “venture capital,” i
...
, equity investments in a young or
start-‐up business; or (2) the business is large and is owned by many different people
b
...
Ordinarily, all
partners must consent to the admission of a new partner
...
A partner may “assign” his
partnership interest, but this does not make the transferee a partner; instead, the transferee merely obtains
limited economic rights
i
...
this limited transferability is not necessarily a disadvantage
2
...
Limited partners: Limited partners, similarly, may in a sense transfer their interests, but the transferee does
not really become a limited partner — he merely has certain economic rights
...
One buys and sells “limited partnership
interests” in such partnerships much as one would buy or sell stock in a corporation
Summary: If free transferability is important, the corporate form is clearly superior to the partnership form
...
Complexity of formation and operation: Especially where the business will at the beginning be small and thinly
capitalized, the degree of complexity and expense involved in forming and operating the business will be important
a
...
The would-‐be shareholders must file a
moderately complex document with the Secretary of State, and more importantly, must then comply with a
small blizzard of regulatory requirements applicable to corporations
...
Partnership: By contrast, a partnership (at least a general partnership) can be created and maintained with
somewhat less expense and fuss
...
There tend to be somewhat fewer regulatory requirements, and some states do not impose a
fee on the partnership for the mere privilege of existing
...
)
Summary: So if the enterprise will be a very modest one carried on by just a couple of people, ease and inexpensiveness of
creating the enterprise and operating it argue in favor of the partnership rather than corporate form
...
***Federal income tax: consequences of operating as a corporation rather than as a partnership are enormous
a
...
In other words, if the corporation has profits or losses, it files its own
tax return, and pays its own taxes independently of the tax position of the stockholders
i
...
The corporation pays a corporate income tax on its profits
2
...
Example: Suppose that ABC Corp
...
Simplifying in terms of tax rates, ABC will pay a
corporate-‐level tax (at 2002 rates) of 34%, or $ 340,000
...
Assuming that each shareholder has taxable
income of, say, $ 150,000 before these dividends and is married filing jointly,
the individual federal marginal tax rate on the total $ 660,000 dividends will
be 30% (or additional taxes of $ 198,000)
...
(But if the shareholders are corporations, the dividends they
receive will be taxed at a much lower rate, on account of special treatment
given to “inter-‐company dividends
...
Deduction of salaries
i
...
ii
...
iii
...
Reinvested profits: Also, keep in mind that the double taxation problem only arises
when the corporate profits are actually paid out
...
(There is a possibility that these accumulations might be taxed under a
separate provision of the Internal Revenue Code intended to discourage
unreasonably large accumulations, but this is usually not a problem
...
S-‐CORP: can be avoided if the corporation qualifies for status as a “Subchapter S corporation,” and
elects to be treated that way
iii
...
Partnership: unlike corporations, are not separately-‐taxable entities
i
...
True, the partnership files a tax return; but this tax return is merely an informational return, which
shows how much the partnership earned and how those earnings are distributed among the
partners
...
Avoids double taxation: This means that the partnership avoids the “double taxation”
problem that can occur in corporations
...
8, if ABC operated as a
partnership rather than a corporation, the total tax on the $ 1 million of pre-‐tax profits
would probably be about $ 300,000, all of which would be reported on the partners’
individual tax returns
2
...
Shelter: Partnerships offer significant opportunities for sheltering gains from other activities
(though these opportunities were much reduced by the Tax Reform Act of 1986)
...
Summary: the investors will probably prefer to be taxed as partners rather than as C corporation stockholders if the business has
(after payment of salaries) either losses or large profits
...
Conversely, the corporate form is probably better if, after payment of salaries, the corporation makes a modest
profit (say between $ 15,000 and $ 75,000)
...
Lastly, many of the benefits of
partnership taxation can be achieved by operating as an S corporation or as an LLC
...
(A limited
partnership may be an adequate alternative in this situation
...
Corporations superior
(1) simplicity and inexpensiveness of creation/operation are very important (enterprise is very small and not very profitable);
(2) where there are either losses or large profits, making the fact that the partnership is taxed only at the level of the
individual partners significant
*But remember that these tax advantages will often be largely attainable in corporate form, by operating as an S corporation
LIMITED LIABILITY COMPANY
**The fastest growing form of organization since the 1990s has been the limited liability company, or LLC
...
The LLC is neither a corporation nor a partnership, though it has
aspects of each
...
Advantages: Here are the principal advantages of an LLC over both a corporation and a partnership
a
...
Even in a limited partnership, there must be a general partner who has full personal
liability for partnership debts
i
...
The LLC suffers from none of these undesirable liability-‐related problems: no “member” (analogous
to a partner in a partnership or a stockholder in a corporation) can be liable for anything other than
the amount of his investment in the LLC, regardless of how involved that member is in the daily
operations of the business
iii
...
Taxed as partnership
i
...
Therefore, unlike the standard “C” corporation, the LLC can operate as a “pass-‐through” entity and
avoid double taxation
1
...
For instance, an LLC’s two members could agree that A (an individual in a high tax
bracket) would receive 99% of all operating losses, and that B (a low-‐tax-‐bracket
person) would receive 99% of all operating profits
b
...
This customized allocation cannot readily be done in an S corporation, where
allocations are essentially dictated by each parties’ percentage of stock ownership
c
...
Lastly, the LLC provides nearly total flexibility in how operations are to be conducted
ii
...
(i
...
, the people designated to run the company’s business operations
...
Similarly, the restrictions that exist by statute on a corporation’s right to dispose of its financial
resources — see, e
...
, the restrictions on dividends
2
...
Complexity in formation: LLCs are more complex to form — an LLC requires an “operating agreement” to
specify how it will work; and the very flexibility that the LLC form allows makes drafting an effective operating
agreement more challenging than, say, drafting the more-‐routine certificate of incorporation and bylaws for
a typical corporation
b
...
State taxes: In some states, state income or franchise taxes are applicable to LLCs just as they are to
corporations, but are not applicable to partnerships
...
3
...
The same is
theoretically true of corporations
...
Some statutes apply similar rules: Some state LLC statutes contain express provisions requiring that
whatever the jurisdiction’s rules are about when a corporate veil may be pierced, similar rules should apply
to the piercing of LLCs
...
Where statute is silent: Where the state statute governing LLCs is silent about veil-‐piercing, most courts have
held that, as matter of CL, rules similar to those governing veil-‐piercing in corporations should apply
i
...
Thus one court considering the matter endorsed the general idea that courts have
equitable power to pierce the veil of an LLC, but then cautioned that “the various factors which
would justify piercing an LLC veil would not be identical to the corporate situation for the obvious
reason that many of the organizational formalities applicable to corporations do not apply to LLCs
...
Classical ultra vires doctrine
a
...
If a corporation purported to act beyond the scope of what it was authorized by statute to do (or
beyond the scope of its perhaps even more limited certificate of incorporation), the problem arose
b
...
Use to invalidate contracts: Most importantly, ultra vires contracts were often said to be
unenforceable either against the corporation or by the corporation
2
...
Broad powers clauses: First of all, as noted (see supra, p
...
Therefore, the probability that the corporation will try to do something beyond the
scope of its charter is much reduced
b
...
MBCA § 3
...
”
1
...
See
MBCA § 3
...
But the ultra vires doctrine in its classical function — as a
defense asserted by the corporation in a suit brought by one who contracted with it,
or as a defense by the third party if suit on the contract was brought by the
corporation — is now abolished in virtually all jurisdictions
3
...
Most significantly, a shareholder may still sue to enjoin the corporation from acting beyond its powers
...
Charitable donations: Most shareholder-‐injunction cases have involved charitable donations which the
corporation has attempted to make
...
Implied power: Thus corporations have been held to have the implied power to make reasonable
charitable contributions
II
...
02(13) allows every corporation (unless its articles of
incorporation provide otherwise) to “make donations for the public welfare or for charitable,
scientific, or educational purposes
...
Reasonableness limitation: However, courts usually read statutory language like this
as authorizing only charitable donations that are reasonable in size and type
a
...
”
MBCA § 3
...
ARTICLES OF INCORPORATION
Mechanics of Incorporating
1
...
In every state, those wishing to form a corporation must file a document with the state official, usually the
Secretary of State
...
A filing fee must be paid with the document
2
...
MBCA § 1
...
The articles are then reviewed by the state officials (usually by a clerk in the Secretary of State’s office)
c
...
The date of incorporation is usually made retroactive to the date of filing
e
...
Incorporators:
a
...
” Therefore, the articles can be signed by any individual
or individuals, who are known as “incorporators
...
Most states today require only a single incorporator, who need not reside in the state of incorporation and
need not expect to have any connection with the corporation once it comes into existence
...
g
...
c
...
4
...
In
most states, these contents include:
a
...
b
...
i
...
g
...
Today, the purposes clause is almost always as broad as possible, e
...
, “for general business
purposes” or “to engage in any lawful business
...
MBCA eliminates the requirement of a purposes clause entirely—§ 2
...
and provides that every corporation “has the purpose of engaging in any lawful business
unless a more limited purpose is set forth in the articles of incorporation
...
01(a)
c
...
MBCA § 2
...
Even if the corporation does not plan to actually issue that many shares, it lists the number that it is
authorized to issue
iii
...
e
...
No “accommodation” directors: no such thing as an “accommodation” or “dummy” director
...
Egregious cases: However, liability for breach of the duty of due care is generally imposed only when the director or
officer behaves “recklessly” or with “gross negligence
...
Example: D, a director, fails to attend board meetings, fails to read financial reports, fails to obtain the advice of a
lawyer or accountant even though he is on notice that the corporation is being mismanaged — taken together,
these acts amount to recklessness, and thus justify holding D liable for losses suffered by the corporation that
could have been prevented by a director who exercised reasonable care
...
Objective standard: the director is held to the conduct that would be exercised by a “reasonable person” in the
director’s position
...
Special skills: On the other hand, if the director has special skills that go beyond what an ordinary director
would have, he must use those skills
...
, if he learns of facts that would make a person in that profession suspicious, must follow through and
investigate even though these facts would not make a non-‐professional suspicious
4
...
Directors are generally entitled to rely on experts, on reports prepared by insiders, and on action taken by a
committee of the board
...
Example: A director may rely on the financial statements prepared by the corporation’s accountants;
therefore, unless the director is on notice that the accountants are failing to uncover wrongdoing,
the director will not be liable for, say, embezzlement that is not reflected in the financial statements
5
...
Director on notice: if director is on notice of facts suggesting wrongdoing, he cannot close his eyes to facts
b
...
e
...
c
...
But such an “exculpatory” provision can’t block
liability for breach of the duty of loyalty, or for lack of “good faith
...
Will be liable for poor oversight only if:
1
...
[2] having implemented such a system or controls, the directors “consciously failed to
monitor or oversee [the system’s] operations, thus disabling themselves from being
informed of risks or problems requiring their attention
...
Knowledge of shortcoming required: To put it another way, directors who are
protected by an exculpatory provision are still liable for lack of “good faith,” but
failure to supervise won’t constitute lack of good faith unless the plaintiff shows
that the directors “knew that they were not discharging their fiduciary obligations
...
Gross negligence not enough: not enough for director-‐liability in Delaware
where there’s an exculpatory clause in the certificate of incorporation
6
...
For instance, if the loss would have happened anyway, even had the directors all behaved with due care,
there will be no liability in these courts
...
Joint and several: If a board member violates his duty of due care, at least some courts hold him
jointly and severally liable with all other directors who have violated that duty, so long as the board
collectively was a proximate cause of the loss
BUSINESS JUDGMENT RULE
FUNCTION: saves many actions from being held to be violations of the duty of due care
1
...
(1) the duty of due care imposes a fairly stern set of procedural requirements for directors’ actions;
b
...
the business judgment rule then supplies a much easier-‐to-‐satisfy standard with respect to the substance of
the business decision
2
...
However, there are three requirements (two of them procedural) which a decision by a director or officer
must meet before it will be upheld by application of the business judgment rule:
a
...
First, the director or officer will not qualify for the protection of the business judgment rule if he has
an “interest” in the transaction
...
Example: X, an officer of Corp, has Corp buy supplies at inflated prices from another
company of which X is secretly a major shareholder
...
(2) Informed decision:
i
...
That is, the director or officer must have gathered at least a reasonable amount of information about
the decision before he makes it
1
...
In other words, even if the director or officer is
somewhat (but not grossly) negligent in failing to gather all reasonably available
information, he will not lose the benefit of the rule
...
Example: The Ds, directors of a publicly held corporation, approve a sale of the company without
making any real attempt to learn the “intrinsic value” of the company, without having any written
documentation about the proposed deal, without learning that no true bargaining took place with
the buyer, and while spending only two hours on the decision even though there was no real
emergency or time pressure
...
[Smith v
...
(3) “Rational” belief:
i
...
Note that this belief does not have to be substantively “reasonable,” but
it must be at least “rational” (i
...
, not totally crazy)
ii
...
No review of substance of underlying decision: Because of this emphasis on the rationality
of the “belief,” not the rationality of the underlying decision, the court will generally focus
on the directors’ decision-‐making process, and will rarely consider the merits of the
underlying decision
...
Exceptions: Even where these three requirements for the business judgment rule are satisfied, there are one or two
situations where the court may find the rule inapplicable:
a
...
b
...
Personal liability: If the director or officer is found to have breached this duty of care, in a way that causes loss
to the corporation, he may be held liable for money damages, which are to be paid to the corporation
Business judgment rule: The court will not find an absence of due care merely because the officer/ director’s decision
turns out to have been an unwise one
The “business judgment rule” says that there’s no breach of the duty of care where 3 requirements are met:
1
...
he made himself adequately informed about the facts relevant to the decision; and
3
...
Damages vs
...
Separately, if the
board of directors has approved a transaction without using due care (and the transaction has not yet been
consummated), the court may grant an injunction against the transaction
2
...
(When this
happens, it’s usually because there is some taint of self-‐dealing, but not enough to cause the court to find a formal
violation of the duty of loyalty
...
Directors and officers: The same duty of care is imposed on both officers and directors
a
...
Since the officer normally has a better understanding of the corporation’s affairs
4
...
Emanuel, Steven L
...
Emanuel Law Outlines: Corporations, Seventh Edition (Kindle Locations 2822-‐2828)
...
Kindle Edition
...
The Law of Agency
a
...
An agent can bind his or her principal to a contract, subject that principal to tort liability, and, in some
circumstances, to criminal liability
ii
...
Fiduciary relationship §13, 14, 18; that arises when one person (a “principal”) manifests assent to
another person (the “agent”) that the agent shall act on the principal’s behalf and subject to the
principal’s control, and the agent manifests assent or otherwise consents so to act
a
...
conscious, contract (should be written, doesn’t have to be)
ii
...
A à consenting to acting on P’s behalf; must have legal capacity
iv
...
Objective standard: outward manifestations & reasonable person
1
...
Court looks to conduct, words, silence (implied; i
...
start task)
b
...
Must be a “continuous control of P”
ii
...
A can bind P, A should not be a risk-taker
1
...
A made whole [indemnified] from P for any losses
3
...
Agency v
...
Essentially, agency is consensual relationship in which one agrees to act for benefit of other
b
...
(1) Is there an agency relationship?
ii
...
The Agency Relationship is typically a contractual relationship
i
...
You do, however, need a consensual relationship
iii
...
Practically, trilateral relationship (P-A-3P)
v
...
Cannot compete with P—need to disclose key info that will effect decisions, obey P
iii
...
This is the most common principal-agent relationship
2
...
PACIFIC ELECTRIC RAILWAY
(1961)—Purchased precision grinding machine, Illinois
shipped to CA, notified arrived, machinery movers come
to remove it, before moving equipment see it is damaged
ISSUE:
Whether the Plaintiff complied with the
requirement of the bill of lading that in order to
recover for damages to freight, a claim in writing
must be filed with the carrier within 9 months
after delivery of the property
...
The fact that the freight bill was
annotated by Hileman, Pacific’s agent, is not fatal to
Thayer’s claim
...
Affirmed
...
Fiduciary: In general, a fiduciary owes to the person for whom he is a fiduciary (the “beneficiary”) certain duties
1
...
Relationship of trust & confidence; power to bind—agent needs to act to benefit P
3
...
A cannot delegate to another party without permission of P or benefactor
b
...
A cannot compete with P
i
...
e
...
)
v
...
General §3(1): agent authorized to conduct a series of transactions involving a continuity of service
2
...
e
...
Master / Servant
a
...
Servant §2(2)—agent employed by master to perform service in his affairs whose conduct is
controlled or is subject to control of master
4
...
May or may not be A à depends on facts (i
...
degree of character & control exercised over IC)
vi
...
Disclosed § 4(1)
a
...
A not part of lawsuit unless misconduct of A
c
...
3P entitled to [1] insist of rendering performance to A; and [2] escaping k entirely
i
...
Partially Disclosed § 4(2)
a
...
3P may bring in P and A into lawsuit; A depends on indemnification
c
...
Undisclosed § 4(3)
a
...
May be for privacy reasons, does not mean no relationship
c
...
3P dealing with agent as if sole party in interest
e
...
P has most risk, importance of K—could be based on prior transactions
ii
...
The Dual Agency Rule: an agent cannot act on behalf of the adverse party to a transaction connected with the
agency without the permission of the principal
1
...
NOTE: this is a general principal, and is not always the case
b
...
Need consent
2
...
GAY JENSON FARMS CO
...
CARGILL, INC
...
1981)
Warren operated grain elevator and purchased grain from farmers for
resale
...
Also contracted
into unrelated agreements that clearly established a principal-agent
relationship
...
Warren had
financial problems, Cargill reassured Ps they would make payments
...
Plaintiffs
brought suit against both, claiming Cargill was a principal of Warren
ISSUE:
4
...
5
...
Whether Cargill, by its course of dealing with Warren, became liable as
a principal on contracts made by Warren with plaintiffs
...
An agreement may result in the creation of an agency relationship
although the parties did not call it an agency and did not intend
the legal consequences of he relation to follow
...
A creditor who assumes control of his debtor’s business may
become liable as principal for the acts of the debtor in connection
with the business (Rst
...
Defacto Control: presumes liability, day-to-day operations
3
...
Cargill consented to be
a principal once Warren agreed to implement the
changes and policies that Cargill suggested
...
Cargill argued that
they never consented to the agency relationship, and
each of their actions could fall under a debtor-creditor
or a buyer-seller relationship
...
The court agrees that
many of the factors, when taken individually, could fall
into another category of a relationship
...
b
...
Two sources of an agent’s authority recognized by courts:
1
...
Authority arises from the manifestations of a consenting P to an A, that the A has power to deal
with others as a representative of P, and A believing actions will bind P—§ 7
b
...
Some task in which A connects the P with the 3Ps
d
...
Written document (K) between P and A, in corporate bylaws, or in a written power of attorney
i
...
If question à look primarily at P and their manifestations
f
...
Authority may be inferred from a prior course of conduct by the P
ii
...
§ 35 cmt
...
Ex
...
Incidental / Expressed Authority § 35
1
...
Implications based on custom or past dealings
h
...
Doctrine imposes enterprise liability, loss on enterprise that benefits relationship
ii
...
Notion of enterprise & custom [inherent = thus in relationship]
1
...
In practice, inherent authority is indistinguishable from apparent authority
3
...
3rd of Agency has abandoned the term “inherent” authority
iv
...
3P knows A is acting without authority; or
2
...
(2) Apparent Authority
a
...
Focuses on P à TP, need some type of manifestations from P to 3P
c
...
Must be able to point to some manifestation attributable to P, *relies to their detriment
ii
...
e
...
Based on the theory that the agent “appears” to have certain authority to bind the
principal even though the agent may not have the actual authority to do so
3
...
Applies even though claimant can show no manifestation
b
...
Courts have estopped a person to deny authority of another to act on such person’s behalf; to
prevent injustice by 3P making drastic moves (i
...
extending credit)
i
...
Look to what is knowledge in reliance of 3P? Did they change their position?
iii
...
Do not have to prove elements = “conduct in the circumstances indicated agency”
d
...
(1) he intentionally or carelessly caused such belief; or
ii
...
§ 8B(3) “change of position” = payment of money, expenditure of labor,
suffering a loss or subject to legal liability
4
...
Unforeseen situations, and it is impracticable for A to communicate with the P, he is authorized
to do what he reasonably believes to be necessary in order to prevent substantial loss to the P
with respect to the interests committed to his charge
i
...
Agency by Ratification
a
...
Accept act as yours/adopt it back to original act when were not A but retroactively clears it
i
...
Relates back to the time & place when/where P consents or acts—§ 100A
c
...
Allows a person to ratify the actions of another undertaken on behalf of the person
ii
...
REQUIREMENTS:
i
...
Agent purported to act at the time acted § 85
iii
...
*Cannot ratify undisclosed P/As, must know who is acting for P; knowledge
of all facts in original action
2
...
“material”—knowledge essential to an intelligent election § 91
iv
...
If formalities originally required, affirmance the same § 93(2)
vi
...
Affirmance of Act
i
...
Obj
...
Conduct that justifies made a choice
f
...
Can preclude ratification if (1) give notice of withdrawal (2) before P affirms; OR
ii
...
[1] An Agent’s Express Authority: construed strictly
KING v
...
and Mrs
...
They resided there until they began having
marital problems and Mrs
...
Eventually, Mr
...
Bankerd moved back in
...
The rule of strict construction
cannot override the general and
cardinal rule that the court
departed, he executed a power of attorney to Arthur V
...
In 1975, King
sent Bankerd an updated power of attorney
...
Bankerd as a gift, and Mrs
...
Bankerd filed suit against King alleging breach of
trust and breach of fiduciary duty
ISSUE:
Whether a power of attorney authorizing the agent to “convey,
grant, bargain, and/or sell” the principal’s property authorizes the
agent to make a gratuitous transfer of that property
RULES:
1
...
Powers of attorney have fiduciary duties (loyalty & care)
b
...
” strictly construed against drafter
determine the intention of the
parties
...
An agent holding a broad power of
attorney lacks the power to make a gift of
the principal’s property unless that power
(1) is expressly conferred, (2) arises as a
necessary implication from the conferred
powers, or (3) is clearly intended by the
parties, as evidenced by the surrounding
facts and circumstances
HOLDING:
There is no genuine dispute as to any material
fact
...
The court did not err in
granting Bankerd’s motion for summary
judgment
...
[2] An Agent’s Apparent Authority
1
...
The mere relationship between the agent and principal or the title conferred upon the agent by the
principal is sufficient to constitute a representation of some authority
a
...
If a third party knows or has reason to know that the agent’s authority is set forth in a written
instrument, the party is under a duty to inspect that instrument
c
...
EXCEPTION:
1
...
When an agent misrepresents authority, and the 3P is unable to prevail on the issue of apparent authority,
the agent will be liable to the 3P for damages suffered by 3P who relied on agent’s purported authority
a
...
Duty to Inquireà sometimes there is and sometimes there is not (Smith)
5
...
“Ostensible Authority”à A person is accountable for an appearance of authority arising solely form the
principal’s failure to use ordinary care
a
...
03
SMITH v
...
APPARENT AUTHORITY
Foster, manager of manufacturing services, was employed by Fentron and
led HH&J to believe that he had the authority to sell material on behalf of
Fentron, but in fact Foster’s efforts were unknown to Fentron and contrary
to its policies and direction (gave HH&J business cards, they made check)
Whether the court’s finding of apparent authority is supported by
substantial evidence
RULES:
(1) Both actual and apparent authority depend on objective
manifestations
...
Actually (subjectively) believe A has authority to act for P; and
b
...
Further, the third person must
believe the agent to be authorized
...
Obviously,
manifestations must be communicated to the
claimant before they have either effect
Manifestations to 3P can be made by the P in person or through anyone
else, including the grant, who has P’s actual authority to make them
HOLDING: HH&J had sufficient notice that it
should have further investigated
c
...
Duties of the Principal
1
...
P is typically required to compensate the A & comply in good faith [§470]
i
...
Duty to Good Conduct §437
iii
...
If make authorized payments necessary in executing P’s affairs; or
2
...
The right to indemnification is subject to a few limitations § 440
a
...
(3) If A’s loss resulted from enterprise which knew to be illegal
c
...
Ex
...
Duty to Compensation § 441
a
...
To Third Parties
a
...
Duty of Good Faith & Fair Dealing through A
c
...
3P liable to P as if made K directly with P—§ 292
ii
...
1
...
To act with standard of care and with the skill which is standard in the locality for kind of work
employed to perform and in addition, ant special skills
b
...
i
...
In practice, however, such losses are insured by the employer and the insurer
would not pursue a claim against a judgment-proof employee
...
But the risk is there for employees in marginal cases where the employer or its
insurer believes it can recover a loss from the employees
c
...
MCLLARKY: AGENT’S DUTY OF CARE
D installed water heater in Carrier’s home, existing water heater was
installed by different plumber 4 years ago & D told Carrier was
probably under warranty and would try to obtain credit, returned to
other plumber but didn’t receive credit; once offers to get credit from
old plumber = becomes agent in some sense
Whether there is evidence in the record to support a finding of breach
RULES:
1
...
a
...
”
4
...
An agent cannot be held liable to the principal
simply because he failed to procure for him
something to which the latter is not entitled
REASONING:
The ∏ was not guaranteed a refund by the Δ
...
The Δ did make a reasonable
attempt to obtain a refund for the ∏
...
Under ordinary circumstances, the promise to act as an A is
interpreted as being a promise only to make reasonable efforts to
accomplish the directed result
...
2nd § 377, cmt
...
The duties of an agent toward his principal are always to be
determined by the scope of the authority conferred
...
Duty of Disclosure §381
a
...
*Material to P’s decision-making process
OLSEN v
...
AGENT’S DUTY OF DISCLOSURE
Vail contracted to sell land to Lindholm (3P), and needed Rickstrew’s
property to provide access to Olsen’s property
...
Olsen found out Lindholm paid more
for Rickstrew’s property he tried to sue Vail, claiming he was his agent
ISSUE: Whether the information known to and withheld by Vail
Associates would, if disclosed, have assumed actual significance in the
deliberations of the Olsens in regard to the sale of the estate property or
significantly altered the total mix of information available to them?
RULES:
1
...
To discharge its fiduciary duty of good faith and loyalty, a real
estate broker or A must disclose all facts relative to the subject
matter of the agency relationship that may be material to the
decision the principal is about to make
3
...
A breach of fiduciary duty occurs if the broker, as A, conceals
from the seller, as P, “material” information
i
...
, “information that bears upon the transaction in question
...
An agent is thus required to disclose to the principal any facts
“which might reasonably affect the principal’s decision”
b
...
“Material Information”à the matter is
material if a reasonable person would attach
importance to its existence or nonexistence in
determining his choice of action in the
transaction in question
[no strict answer, depends on circumstances]
REASONING:
1
...
It was widely assumed that, for purposes of
access, any potential purchaser of the estate
property, including Lindholm, would also attempt
to purchase the Rickstrew property
a
...
Although the per-acre price of Rickstrew
property would have been valuable information to
the Olsens in their dealings with Lindholm, Vail
did not have this information prior to singing of
the sale contract for estate property and therefore
could have not disclosed it to the Olsens
There is no suggestion in the record that Vail attempted to
represent both the Olsens, as the seller, and Lindholm, as buyer, in
the sale of the estate property, despite the fact that Vail and
Lindholm had a contact throughout the course of negotiations
3
...
Fiduciary Duty: loyalty, act in P’s best interests and not adversely
i
...
If do have P’s consent, duty to deal fairly with P and disclose all facts which
A knows or should know would reasonable affect P’s judgment—§ 390
b
...
Suit against P v
...
ii
...
The Economic Loss Rule
i
...
” (See Tuchman v
...
)
1
...
GELFAND v
...
He was
terminated, claiming Horizon owes him commission/overrides;
Horizon claiming breach of fiduciary duty w/ one of sales (wife had
1/3 interest in land sold, she got profit for him)
Where a fiduciary has, by violating his obligation of loyalty, made it
possible for others to make profits, can be held accountable for these
profits regardless of whether he has realized them?
RULE: Where a fiduciary has, by violating his obligation
of loyalty, made it possible for others to make profits, he
can be held accountable for these profits regardless of
whether he had realized them
HOLDING: A court is not obligated to compel a
fiduciary to reimburse the beneficiary for 3P profits
...
iii
...
Termination of Agency—§105-116
a
...
Terminates when 3P has notice of termination of authority, manifestation by P that no longer
consents, etc
...
Inadvertent Liability
a
...
No coherent legal theory to guide, look to case law
c
...
Deep Pocket Theory
i
...
e
...
CARLTON
PIERCING CORPORATE VEIL
Plaintiff injured when taxicab struck him
...
Although independent of one another, the corporations were alleged
to have operated as single enterprise
...
RODD ELECTROTYPE
**FIDUCIARY DUTIES AMONG SHAREHOLDERS
The controlling shareholder sold his stock to defendants; however,
defendants refused to purchase plaintiff's stock
...
On appeal, the court held that in a close corporation, all shareholders
owed one another a strict duty of utmost good faith and loyalty
...
W
...
HOWEY
INVESTMENT CONTRACT
At issue was whether certain transactions constituted "investment
contracts" within the meaning of the Act
...
S
...
S
...
An investment
contract meant a contract, transaction, or scheme whereby a person
invested his money in a common enterprise and was led to expect
profits solely from the efforts of the promoter or a third party
...
Investment has been made
2
...
Bought in order to obtain financial return
(expectation of profits)
4
...
Investors provided the capital and
shared in the earnings and profits; respondents managed,
controlled, and operated the enterprise
Because respondents failed to abide by the statutory and
administrative rules in making their offerings, they
violated the Act
OUTCOME:
The Court reversed a judgment affirming dismissal of
petitioner's action, brought to restrain respondents from
the offer and sale of unregistered and non-exempt
securities, in violation of federal securities laws
...
I
...
Introduction
a
...
You cannot create limited liability, it must be by state action
b
...
NOTE: Does not mean that you have one person,
but that you have one owner (the concept is “sole ownership”)
...
e
...
(NOTE: there is no need to file any
document with the state to formalize or legitimize their
undertaking)
Obligations: Each partner is jointly and severally liable for all
debts, including tort liability, of the business and each will be
an agent for the other, will full agency authority to bind one
another on obligations of the business
...
Rights: Partners will recognize a pro rata share of the
business’s income or loss on their personal income tax returns
Definition: A general partnership with an important
modification: the partners are not personally liable for all debts
and obligations except to the extent they have agreed to be (for
contractual obligations) or bear personal fault (for tort
obligations)
...
General Partners in a LP are like general partners in a
conventional partnership (i
...
, have personal liability
for the debts of the business)
...
They do not
have agency authority as limited partners, although
they can contract otherwise
...
Creation: Created only when a document is filed with a
designated office in the state
Definition: A LLLP is a limited partnership in which the
general partner(s) has limited liability, akin to the liability of a
partner in an LLP
...
Definition: A LLC is the newest option for an entrepreneur,
offering the benefits of limited liability, taxation as a
partnership, and management flexibility; It is possible to have a
one-person LLC
Limited Liability Company (LLC)
Obligations: Liability is limited in the sense that owners
(called “members”) are not liable as such for the debts of the
business, in the same way that partners in an LLP are not liable
...
Creation: Must file a document with the state to create an LLC
c
...
The limited partnership statutes historically were an overlay on general partnership statutes in the sense
that the latter governed the rights, obligations, and liabilities of general partners in the limited
partnership
...
Therefore, a court considering a governance problem related to a limited partnership would look
to the general partnership statute
i
...
Any passive investment may be deemed a “security,” and the issuer of that security must register the sale with the
Securities and Exchange Commission (and perhaps state regulators), or find an exemption from the registration
requirement
...
An organizer can elect to have the entity taxed as a corporation, rather than as pass-through entities for the
purposes of federal income taxation
...
Recent changes in the federal tax law (“check-the-box” regulations), have allowed unincorporated
entities to choose between pass-through taxation and corporate taxation
a
...
Recent legislative changes have facilitated conversions form one entity into another, and the merger of different
kinds of entities
...
Various statutes allow for easy conversion of, for example, a corporation to a LLC or the merger of a
LLP and a LP
II
...
If (1) two or more persons associate together (2) to carry on as (3) co-owners of a business (4) for profit they have formed a
partnership, whether or not intended to form a partnership
a
...
Manifestations are either by word, conduct or both
c
...
Fundamental aspect—contract-based relations among partners
e
...
S
...
Importance of Case Law
a
...
RUPA §104(a) principles of equity & law supplement act
c
...
Formation: writing / oral; conduct & circumstances (obj
...
Pre-Requisites
a
...
Refer to partnership as association; consensual relationship
2
...
Looks at objective intent—Byker
b
...
They must have the right to share in business’s profits
2
...
Majority rule—loss sharing is not pre-requisite
e
...
Default Rules
1
...
Applicable only in the absence of contrary agreement btw parties
3
...
Ex
...
Mandatory Rules
1
...
3P consent is also necessary
a
...
RUPA §301: partner has power to bind partnership through apparently usual acts
3
...
RUPA §103—general rule, relations btw partners is governed by partnership agreement
b
...
When making amendments need to check §103 to make sure not prohibited
ii
...
Limit the ability of partners to “dissociate” themselves from partnership
f
...
Aggregate
a
...
OR is a partnership merely an aggregation of its partners, with no separate legal identity of its own?
1
...
Approaches
1
...
Embodies both approaches, sometimes reflecting entity & something aggregate
2
...
Partnership is entity, distinct from its partners
b
...
Joint Ventures
a
...
Normally subject to JV agreement, otherwise GP statute and case law
BYKER V
...
intention
Agreed to undertake various businesses together, no written agreement, 2
jointly served as GPs/shareholders and agreed to share profits & losses
equally; when 1 was struggling funneled cash from other business/personal
contributions
...
Arguing there was a GP underlying all of their business activities
...
New statute of intent à objective
a
...
Inquiry involves looking at parties’ actual
conduct in their business arrangements
c
...
Written agreement not required
Remanded back to TC w/ objective analysis
h
...
The following factors are relevant to whether a partnership or joint venture has been formed:
1
...
Express of an intent to be partners in the business
3
...
Sharing or agreeing to share:
a
...
Liability for claims by third parties against the business; and
5
...
NOTE: No one factor is dispositive and not all factors need to be satisfied
b
...
received an equity interest in Firm upon being named as a proprietary partner, and she
would have ben liable for the Firm’s substantial losses
ii
...
member of Executive Committee, which managed day-to-day operations
1
...
By focusing on the fact that her views sometimes did not prevail confuses
participation with control
3
...
Spousal Relationship
1
...
Note that the usual indicia of a partnership are blurred by the marital relationship
c
...
A person may have the liabilities of partner if that person allows others to hold him out as a partner and
that person may be able to bind the partnership as though a member of it
2
...
Partnership Property
1
...
Holding Property
a
...
(1) Property purchased with partnership funds is partnership property
c
...
Conveying Property: §302, U§10
e
...
Partnership statutes make it clear that partners are agents of the partnership (UPA § 9; RUPA § 301)
2
...
provides for an optional statement of partnership authority specifying the names of the partners
authorized to execute instruments transferring real property held in the name of the partnership
b
...
DENIAL §304
3
...
Summers shows importance of having agreements à deadlocks in decisions
b
...
Any difference arising as to ordinary matters connected with the partnership business may be
decided by a majority of partners
i
...
SUMMERS: there are only 2 partners = there is no majority
SUMMERS V
...
(2) Apparent Authority
a
...
If the statement is recorded in the appropriate office for recording interests in land, it
can serve as notice of authority
ii
...
Regarding apparent authority of partner, UPA / RUPA have similar, not identical, language:
i
...
RUPA § 301: A partner binds the partnership when his act is “for apparently carrying
on in the ordinary course the partnership or business or business of the kind carried on
by the partnership”
No duty to investigate /
NOTE: courts treat theses identically, despite their differences
inspect GP agreement
c
...
RUPA § 301, the determination of whether a partner is acting with authority to bind
Was there actual
the partnership involves a two-step analysis:
knowledge or notice?
1
...
If YES, the inquiry ends
apparent authority
2
...
(THIS IS WHERE THE ISSUE IS IN RNR
ii
...
*Absent knowledge = no duty to investigate
a
...
The law is not uniform in the area of partnership fraud
6
...
a
...
No estoppel when authority to act outside their business—ROUSE
c
...
“Knowledge”—person knows a fact if person has actual knowledge (cognitive
awareness) of fact—RUPA § 102
ii
...
Absent actual knowledge, 3P have no duty to inspect partnership agreement or inquire
otherwise to ascertain the extent of a partner’s actual authority in the ordinary course of
business; even if have reason to question it
1
...
RUPA imposes greater risks on GP than UPA
RNR INVESTMENTS LP V
...
RNR claiming affirmative defenses—the bank
failed to review the limitations on the GP’s authority in LP
agreement—said the bank negligently failed to investigate and to
realize that the general partner had no authority to execute notes, a
mortgage, and a construction loan agreement and was estopped from
foreclosing
...
ISSUE: whether the Bank had actual knowledge or notice of
restrictions on the general partner’s authority?
ROUSE V
...
e
...
No constructive knowledge
2
...
Nothing to indicate that Bank had actual
knowledge or notice of the restrictions on
the general partner’s authority
3
...
Court held not acting as authority w/ firm
HOLDING/REASONING:
Key to this case: When Rouse went to Riker and Riker in
reliance upon their reputation as a law firm, stated the purpose
of her visit (to obtain legal service), and was introduced to
Fitzsimmons as a member of the firm who would provide the
desired service, she had no justification therein for relying upon
the responsibility of the partnership for any disconnected
services assumed by Fitzsimmons outside one that was
characteristically within the practice of law
(1) That the investment of the funds in
mortgages was within the scope of the
defendant law firm’s practice; or
(2) within the scope of Fitzsimmons’
apparent authority
• NOT a characteristic function of
practice of law to accept clients’
money for deposit and future
investment in unspecified securities
at the discretion of the attorney
• Has not been done by attorneys with
such frequency or appropriateness as
to become a phase of the practice
• The law firm did nothing to indicate
that Fitzsimmons had any authority
to act in their behalf outside the
practice of law
b
...
Business Judgment Rule
i
...
(1) in good faith;
owes to GP & other partners are
2
...
(3) in a manner the partner reasonably believes to be in the best interests of
the partnership
a
...
If the business judgment rule applies, court typically will
not further review the decision in question
ii
...
Failing a showing that it was fair, the decision maker is
liable for damages resulting from the decision made
e
...
UPA does not specifically address the duty of care partners owe each other
1
...
RUPA § 404(c) directly addresses a partner’s standard of care:
1
...
STANDARD: gross negligence
a
...
This standard does not apply to partners
ii
...
Partners in better position than ordinary principal to watch
out, supervise, and when necessary, intervene
iv
...
Joint Venture Partner
3
...
Committed w/in scope of joint business venture
b
...
Did not result in physical injury to person or property
i
...
Piazza Construction
ii
...
Indemnify Partners
1
...
Even though P may have been negligent
2
...
e
...
**Evidence of the different standard from above
2
...
An act can further part personal and part business purposes and still occur in
the ordinary course of the partnership—MOREN
1
...
JAX RESTAURANT
PARTNERS’ RIGHT TO IDEMNIFY
(2004)—Partner brought child to work bc the restaurant needed her
help, stuck his hand in dough-presser, crushed his hand, father brought
action against restaurant; Jax trying to claim that Moren would have to
indemnify partnership if damages were awarded
RULES:
1
...
Under the plain meaning of RUPA, a partner has a right to
indemnity from the partnership, but the partnership’s claim of
indemnity from a partner is not authorized or required
a
...
RUPA § 401(c): A partnership shall indemnify a partner for
liabilities incurred by the partner in the ordinary course of the
business of the partnership
c
...
It is undisputed that Nicole Moren
was acting for the *benefit of the partnership by
making pizzas when her son was injured, and even
though she was simultaneously actin in her role as a
mother, her conducted remained the ordinary course of
the partnership business
TAKE AWAYS
v No obligation to indemnify as long as injury
occurred in ordinary course of business
v Does not matter that she was negligent
v She was benefiting partnership
{came into restaurant to help}
v Does not matter also acting in role as “mom”
(2) Duty of Loyalty—RUPA §404
f
...
The duty of loyalty limits the ability of a partner to hire his or her spouse
h
...
Partnership
i
...
Prohibited from:
1
...
Taking business opportunities from which partnership might have benefitted
or that partnership may have needed—MEINHARD
a
...
Using partnership property for personal gain RUPA §404(g)
4
...
Joint Venture
i
...
When partnership = all partnerships rules apply, with possibly one exception:
1
...
the courts may limit the ventures’ duty of loyalty
iii
...
Duty of loyalty encompasses duty to DISCLOSE
v
...
NOTE: to the eye of an observer, Salmon held the lease as owner in
his own right, for himself and no one else
...
NO duty to make sure partner gets into the deal—up to 3P
i
...
In this case, he would have to disclose the usurpation of a business
opportunity
...
SALMON
DUTY OF LOYALTY
FACTS: Gerry leased Hotel Bristol to Salmon for term of 20 years
(long time), Salmon & Meinhard made a joint venture—Meinhard
(responsible for capital; money guy) was to pay Salmon half the
amount of money to reconstruct, alter, manage and operate property &
Salmon was to pay him 40% of net profits for the first 5 years and then
50% each year after but Salmon had “sole power to manage, lease,
underlet and operate building
...
This chance he was under a duty to concede
The fact that Salmon was in control as the manager
charges him with the duty of disclosure
§ since only through disclosure could opportunity
between him and Meinhard be equalized
§ for Salmon, the rule of undivided loyalty is
relentless and supreme
The subject matter of the new lease was an extension of
the subject matter of the old one
§ a managing co-adventurer appropriating the
benefit of such a lease without warning to his
partner might expect to be reproached with
conduct that was underhand, or lacking in
reasonable candor,
§ if the partner were to surprise him in the act of
signing the new instrument
DISSENT: There was no general partnership, merely a joint
venture for a limited object, to end at a fixed time
...
*This was
a new venture, not a renewal—NORTON said this may have
been in line of business, duty to give them that opportunity
(3) Duty of Loyalty—Conflict of Interest ON EXAM: 404(a)-(d); 103(b)(1)-(10)
j
...
The partner itself
ii
...
An organization in which partner has a material financial interest
k
...
This is an exclusive list
i
...
Partners oblige themselves to share risks and benefits and to carry out the enterprise with the
highest good faith toward one another (i
...
with the loyalty and care of a fiduciary)
m
...
In all proceedings connected with the conduct of the
partnership, every partner is bound to act in the highest good faith to his copartner and may not
obtain any advantage over him in the partnership affairs by the slightest misrepresentation,
concealment, threat, or adverse pressure of any kind
i
...
Can you eliminate fiduciary duties entirely by contract?
a
...
but: (1) the partnership agreement may identity specific types or
categories of activities that do not violate the duty of loyalty, if not
manifestly unreasonable; or
c
...
ADV of reducing the duty of loyalty by agreement?
a
...
AT&T
DUTY OF LOYALTY: COI
FACTS: AT&T had minority partners w/ fractional interest, key assets
were the right to own licenses for various cellular radio frequencies;
minority owned less than 5% of each partnership, AT&T invoked
majority interest & sought to buy out minority partners, offered to buy
for higher price but since some refused, AT&T sold assets of
partnership to affiliated entity at appraised value & gave minority
partners pro rata share—did not have choice necessarily = could have
gotten above FMV or FMV, but AT&T was going to buy
HOLDING: controlling partner does NOT violate duty of loyalty to
the partnership or to dissenting minority partners where controlling
partner causes partnership to sell all its assets to an affiliated party at a
price determined by a third party appraisal, when the price paid was
fair at time as a matter of law and no bad faith exists as a matter of law
REASONING—RUPA §404
• partnership agreement expressly allows for sale
of partnership assets by majority vote
• Under Karle, a partner may lawfully purchase
partnership assets from another partner,
provided that they:
o act in good faith
o pay fair consideration, and
o disclose material information
AT&T fully disclosed their intent to
buy assets AND offered a fair deal;
even a change to get higher price
*NO EVIDENCE OF SELF DEALING
Maden’s Concurrence in J&J Celcom
o RUPA 404: the only fiduciary duties are the duty of loyalty + duties set forth in (b) and (c)
§ 404(b)(1): requires partner to refrain from taking more than its fair share of profits
§ 404(b)(2): refrain from having adverse interest (duty of disclosure)
§ 404(b)(3): duty not to compete before dissolution of partnership
§ 404(e): partner may act in their own interest
§ 404(f): allows “transact business” w/ partnership on same terms as may with 3P
o Partnership may waive duty of loyalty unless “manifestly unreasonable”
§ 103(b)(i): specific types of activities that do not violate DOL
§ 103(b)(ii): all partners or number of percentage may authorize (AT&T majority)
RUPA represents a shift away from the fiduciary view and toward the libertarian view by
o Expressly limiting fiduciary duties
o Sanctioning a partner’s pursuit of self-interest, and
o Allowing partners to waive most fiduciary duties by contract
A partner’s duty of loyalty to the partnership
and the other partners is limited to the
following:
RUPA §404: General Standards of Partner’s Conduct
1
...
To refrain from dealing with partnership in the conduct or winding up of the partnership
business as or on behalf of a party having an interest adverse to the partnership
3
...
Dissociation and Dissolution
1
...
Dissolution—point @ which partnership stops function as forward-looking enterprise & begins to wind
up its business
3
...
In the area of DISSOLUTION, RUPA implemented an important change in the law:
i
...
”
1
...
RESULT:
a
...
The underlying philosophy of the UPA was that partnerships were
not separate legal entities but, rather an aggregate of individuals
ii
...
The departure of a partner under RUPA did not dissolve the partnership
2
...
Rather, the departing partner is characterized as having “dissociated”
from the partnership and the partnership continues without him
b
...
RUPA § 601 lists 10 events that will cause dissociation
(see SS page 286-287) OR page 411 in E&E
4
...
The dissolution provisions of RUPA are contained in § 801
a
...
With several narrow exceptions, they are not included in the
list of mandatory terms in §103
ii
...
However, unlike under UPA, partners under RUPA can
simply deny the event of dissolution
iv
...
Two Avenues for Dissociation
**Most should be dealt
“Switching provision”—if partner’s dissociation results in dissolution, the switch activates
w/ in partnership agrmt
Article 8 (wind up); and IF NOT = Art
...
Continuance-Buy-Out: RUPA §701-04—NO DISSOLUTION
**Generally know how
1
...
If you continue, there has to be a buyout
scheme works for a
a
...
have in partnership agreement the details of any buyout
c
...
§702(a)—dissociated partner’s lingering power to bind
4
...
stating the name of partnership & partner dissociated w/ firm
b
...
RATIONALE: partnership is an ongoing business and if just had to liquidate
it anytime the partner wanted to get out, that may not be desirable
c
...
There are a set of provisions under §7 dealing with the dissociating
partners’ interests and the liability of the dissociating partner(s); or
under §8 there are provisions for winding up (a process that goes
beyond the dissociation of a partner; where you are actually going
to liquidate and terminate)
i
...
§801: mandatory dissolution—conditions that must be proven
2
...
prosecute & defend actions & proceedings
4
...
settle disputes by mediation or arbitration
6
...
§701(a) default rule
• dissociated partner entitled to be bought out, interests will
be purchased—buy out = MANDATORY
• entirely subject to PA
§701(b) and (c) determining buy out price (E&E p
...
Trans
§703: DP’s liability to other persons
covers DP past diss
...
debts
§704: statement of dissolution
• optional
• outside notice 90 days after filing
• cancels prior state on authority [§303(d)]
• restricts authority to transfer real property [§303(e)]
RUPA ARTICLE 8 Winding Up = DISSOLUTION
§801: sets up bases for mandatory winding up
§803: Right to Wind Up
• non-wrongful DP’s rights
• list of activities a winding-up partner may participate in
§804: Power to Bind Post-Dissolution
• appropriate for wind-up process
• as to creditors lacking knowledge, within the acting P’s
pre-dissolution authority
§806: P’s liability to other partners after dissolution
• liable to other P’s for share of winding-up liabilities, but
with termination
§807: settlement of accounts
• distribution of property
• contributions to P’s on liquidation
§805: statement of dissolution
• 90 days past filing effectiveness
• limited effect under §303(d) and (e)
INCORPORATION: the decision is part of a “planning process,” that considers and balances numerous corporate code, tax,
business, financial, and personal factors of choice
...
, partnerships, or corporations
...
INITATING THE PROCESS *common factors to consider/weigh
“Players”
How many going to be involved? Who are they? What are they like? How are they likely to
interact? What do they hope to achieve? (I
...
if only 1, partnership or JV would be inappropriate)
Purposes & Objectives
Assess/balance immediate & future purposes sought for enterprise
• View in the overall scope of planning for the future
• I
...
if going to be long-term venture, requiring outside financing = corporation suitable
• I
...
if going to be “tax-oriented” = GP or JV would be ideal
Financing Requirements
Depends on the size of the enterprise
• if large group of investors/obj
...
w/ limited person of duration
Taxation
Complexity, Formality,
Cost of Organization
Securities Laws
• death of SH does not affect legal for
• may not be advantageous—locked into economically destructive relationship
Partnership—easiest dissolution method
Differences btw partnership & corporation
Corporation—taxed as entity
• Disadvantages
o *Double Taxation—corporate earnings taxed to the corporation at corporate
rates, w/ any subsequent dividend distributions to SH being taxed as ordinary
income to SH (less any permitted annual dividend exclusion or exclusion granted
for inter-company dividends) w/o any deduction to the corp
...
from its SH as well as pay interest on
loans from SH in order to avoid double taxation
o time its income distributions, in form of salaries & dividends, by currently
declaring them & then paying them at later time in year when income is actually
earned by corp
...
effectively
avoids double taxation
o & permits corp
...
itself
GP—profits & losses attributable to partners individuals
*organization of CORP requires from formality than general or limited partnership
• articles of incorporation must be filed w/ fee
• as well as bylaws, minutes, stock certificated, transfer register
• other than GP, LL—corp
...
e
...
w/in ambit of federal & state security laws
LP—may face similar problems
GP—not a security // LLC—interests determined under Howey investment contract test
2
...
Local in nature—preferable for entity to be incorporated under laws of home state
b
...
formed in another state = qualify to do business as foreign corp
...
laws of the state of incorporation
i
...
taxation matters & requirements to maintain resident agent in both states
c
...
= may want to incorporate under Delaware
3
...
Comes the public perception of enterprise or its products/services
b
...
co
...
or limited—indicates organized
c
...
names to not be similar to the names of any domestic corp
...
That have
qualified to do business in the state
d
...
Contact secretary of state to see if name available
ii
...
Postscript on Pre-incorporation Problems
“Promoter” person(s) who have an idea for enterprise and endeavor to bring it about, solicit other parties to invest or
otherwise participate in venture, prearrange physical facilities & supplies to be formed, engage in various other activities in
contemplation of new entity
a
...
Agreement btw promoter and prospective investor
1
...
at a specified price & pursuant to specified terms
2
...
Doesn’t have to be in writing—but would preserve expectations + avoid future disputes/litigation
ii
...
Subscribed shares cannot be issued until corp
...
MAJOR LEGAL CONSIDERATION
1
...
Subject to general registration of such laws, unless exemption can be shown
b
...
Promoter Activities
i
...
ii
...
PROBLEMS in these situations:
1
...
Created the appearance in his dealings w/ 3p that corporation is in being
b
...
K indicating corp
...
3p knows the corp
...
who is liable—until corp
...
other courts look to intent of parties—promoter may not be liable at all
iv
...
will not become liable unless there is adoption of the K
v
...
Co-promoters; may require at least fair-dealing & good faith
2
...
and its directors concerning pre-incorporation promoter
activities and Ks
c
...
GENERAL RULE: it must be demonstrated that:
1
...
exercising power assumed by its might be incorp
...
There has been bona fide attempt to organize corp
...
There has been actual exercise of corp
...
Pre-Incorporation: useful to clarify the thinking of participants; if organization will take considerable amounts of time,
extensive financial commitments, binding further financing
6
...
•
•
•
Dividends (declared by directors)
Upon sale of stock from any appreciation in value
Upon liquidation—common stockholder will be last in priority
of payment after secured creditors, unsecured creditors, PS
Economic return from investment will be:
Junior interests
•
•
•
•
•
Bear greatest risk of loss in event of failure of enterprise
BUT have controlling / sole voting rights
Able to exercise control over corp’s destiny primarily through
election of directors + major corp changes
Not fixed—capable of infinite expansion
More than one class = rearrange voting / taxing structures
Preferred Stock
Given a preference—in terms of dividends & liquidation
•
•
Dividends not deductible by corporation for tax purposes
Fixed on annual basis
•
•
•
Rate of dividends to be paid, whether/extent to accumulate
Whether shares are redeemable, participate in “earnings”
The voting rights given
Creature of contract
Title: Business Enterprise
Description: 2nd year law student at a top 50 law school. This is my Business Enterprise outline (69 pages - I received an A in the class). It is a quick and dirty overview of all of the important topics on the BAR exam. For example, it covers agency law, partnership, franchise agreements, sole proprietorships, the corporate structure, close corporations, shareholder rights + derivative suits, issuance of securities, etc.
Description: 2nd year law student at a top 50 law school. This is my Business Enterprise outline (69 pages - I received an A in the class). It is a quick and dirty overview of all of the important topics on the BAR exam. For example, it covers agency law, partnership, franchise agreements, sole proprietorships, the corporate structure, close corporations, shareholder rights + derivative suits, issuance of securities, etc.