My Business Organizations Outline Prof

My Business Organizations Outline Prof. Ragazzo Spring 2006AGENCYI. Introduction

a. Agent a person who by mutual assent acts on behalf of another and subject to the others control

i. Elements to create an agent:

1. Agreement

a. Both parties assent to the relationship

2. Control

a. The person is subject to the control of the principal

3. Benefit

a. The agent is acting on the principals behalf

ii. General Agent an agent who is authorized to conduct a series of transactions involving continuity of service

iii. Special Agent an agent who is authorized to conduct only a single transaction, or only a series of transactions not involving a continuity of service

b. Principal the person for whom the agent acts; can be disclosed, partially disclosed, or undisclose

c. Agency law governs:

i. The relationship between agents and principals

ii. The relationship between agents and third persons with whom the agent deals

iii. The relationship between principals and third persons when the agent deals, or purports to deal, with a third person on the principals behalf

II. Authority

a. Types of Authority

i. Actual Authority

1. Express ( If principals word or conduct would lead a reasonable person in the agents position to believe that the principal wishes the agent to so act

2. Implied ( Whether a reasonable person in the agents situation would believe through all of the manifestations of the principal, that he had the authority to do something

a. incidental subcategory

ii. Apparent Authority ( the type of authority a reasonable outsider would assume the agent would have based on the principals manifestations to the third parties

1. Requires more than just representations . . . you need conduct, previous course of dealing, etc.

2. Executives (Power of Position)

a. Often have apparent authority, but this differs from state to state

i. EX: The president of a company would always have apparent authority to an outsider despite the fact that he is in realty only a nominal figurehead with no power to bind a company

b. Power of position might also apply to bank tellers, etc. . . . not just executives

3. Implied Authority v. Apparent Authority ( Implied is essentially the same as Apparent authority but it looks through the eyes of the Agents perspective, so there may be times where the two might diverge

a. EX: Where everyone would assume that an agent had authority to do something, but for some reason the principal has limited the agent and the agent has not disclosed this to the third party

i. He would have apparent authority, but not implied authority

iii. Agency by Estoppel ( general estoppel principle; if P led third party to believe he was a principal and T relied on that representation to his detriment

1. The principal must

a. 1) intentionally or carelessly cause such belief on the part of T; or

b. 2) having notice of such a belief and that it might induce other the change their position, the person did not take reasonable steps to notify them of the true facts

2. Very similar to apparent authority

iv. Inherent Authority ( only held by a general agent with continuous obligations rather than one specific purpose1. Arises where the general agent is charged with a broad task and needs to do a smaller task in order to achieve the broader task

2. Operated much like respondeat superior in torts: it would be unfair to allow the principal to reap the benefits of having an agent and escape the detriments when the agent oversteps his bounds

3. 161 disclosed or partially disclosed principals

a. A disclosed or partially disclosed principal is liable for an act done on his behalf by a general agent, even if the principal has forbidden the agent to do the act if

i. The act usually accompanies or is incidental to transactions that the agent is authorized to conduct; and

ii. The third person reasonably believes the agent is authorized to do the act

4. 194 undisclosed principals

a. A general agent for an undisclosed principal authorized to conduct transactions subjects his principal to liability for act done on his account, if usual or necessary in such transactions, although forbidden by the principal to do them

i. No 3rd party belief requirement

b. Ratification

i. The principal is bound to a third party if the agent purported to act on the principals behalf and the principal, with knowledge of the material facts either:

1. affirms the agents conduct by manifesting an intention to treat the agents conduct as authorized; or2. engages in conduct that is justifiable only if he has such an intention

a. EX: the principal, with knowledge of the facts, receives or retains something to which he would otherwise not be entitled

ii. Ratification need not be communicated to the third person, but must be objectively manifested

iii. RULE ( If the principal ratifies the contract, then the ratification is retroactive to the beginning o the contract1. Travels backward in time to make everything okay from the beginning and give the agent authority

a. This may matter

***NOTE: Remember its not possible for a corporation to ratify contracts made before they came into existence, so they adopt; but the difference is that adoption is not retroactive and cant travel backward in timec. MORRIS OIL CO. v. RAINBOW OIL TRUCKING

i. Rainbow entered into an agreement whereby they would use Dawns trucking license for oil fields owned by Morris. Morris and Rainbow entered into a K directly, and M did not know Dawn existed. Rainbow did all of the grunt work. Morris paid Dawn and Dawn would keep a percentage and a clerical fee and forward the rest to Rainbow. Dawn also kept the books

1. Morris sued Dawn for debt incurred by Rainbow for buying diesel fuel and building a fuel dispensera. Theory is that Rainbow is Dawns agent and therefore Dawn is on the hook for everything.

2. Morris points to the agreement b/w Dawn and Rainbow where Dawn reserves complete control over their operations

a. Also said that Rainbow was not the agent of Dawn and could not incur debts other than those in the ordinary course of business relative to terminal management

ii. Court views this as a case of undisclosed agency because Rainbow contracted with Morris in its own name and not through Dawn.

1. RULE ( The undisclosed principal is subject to liability to third parties with whom the agent contracts where such transactions are usual in the business conducted by the agent, even if the contract is contrary to the express directions of the principal

a. This draws on apparent authority principles

i. Any limitation on the agents authority will be binding on the third party only if the third party had knowledge of that limitation2. Also thinks that Dawn ratified the transactions after learning of the debts existence

a. They knew of the debts and assured Morris that they would receive payment from the Rainbow funds that Dawn retained.

iii. They could have also found agency by estoppel

***NOTE: Dawn could have argued that this agreement did not make Rainbow an agent. If Rainbow was just running their own business and paying a licensing fee to Dawn, then there is an argument that there is no agency. However, if Rainbow was really running Dawns business, then they would be an agent . . . . this could be proved by looking at the money: if Dawn kept most of the money, then they Rainbow was an agent, but if Rainbow got most of the money then Rainbow was not an agent.d. When is Third Party Liable to Principal?

i. RULE ( Whenever agents principal is liable, then third party is liable to the principal as well

1. Exception

a. If the principal is undisclosed and the third party would not have done the deal had he known the identity of the principal

e. When is Agent Liable to Third Party?

i. Where Principal is Bound

1. Disclosed Principal ( agent will not be bound to the third party where the agent had actual, apparent, or inherent authority

2. Undisclosed Principal ( agent will be bound even though the principal is bound as well

a. Theory: if the third person thought that he was dealing with the agent then agent should be bound because that is how the agent represented the transaction

b. Majority Quirk

i. If the third person obtains a judgment against the principal, the agent is discharged from liability even if the judgment is not satisfied1. undisclosed principal is likewise excused if third person obtains judgment against agent

c. Minority

i. Neither the agent nor the principal is discharged by a judgment against the other, but only by satisfaction of the judgment

3. Partially Disclosed Principal ( general rule is that agent will be liable where the identity of the principal was not known

III. Agents Duty of Loyalty

a. TARNOWSKI v. RESOP

i. P wanted to buy a business and employed A as agent to investigate a particular business and advise him on it. A lied to P about the facts of the business and cause P to buy the business. A received a $2000 secret commission from the seller of the business.1. The issue is what duty the agent has to the principal in regard to the profits A received for making the saleii. RULE ( All profits made by an agent in the course of an agency belong to the principlewrongly acquired or not.

1. Principle does not have to suffer damages2. Policy

a. The law will not allow an agent to place himself in a position where his own private interests diverge from those of the principal

3. Principal will have an absolute right to the $2000 bribe, irrespective of the success of the business, or any other recover made by the principal

iii. Two Major Duties:

1. Duty of Loyalty (fiduciary)a. In this case, it is taking the bribe from the seller

b. Damages:

i. The principal is entitled to all benefits received by the agent

ii. Also entitled to be indemnified by the agent for any losses that result from the improper transaction

2. Duty of Care (Tort)a. In this case, its the unwillingness to investigate the deal by the agent

b. Damages

i. Answerable for all the injurious consequences of his tortuous act that were reasonably foreseeable

1. Under a tort action, the agent can only be liable if the business venture fails, because otherwise there are no damages.

iv. The best thing to show is breach of Duty of Loyalty because you can avoid questions of negligence, etc.

v. RAGAZZO: You could also probably sue for FRAUD if the agent knew the representation were untrue because he had an obligation to disclose adverse facts to his principal

PARTNERSHIPI. Partnership Formation

a. Introduction

i. RUPA 101(6) ( Partnership is an association of two or more persons to carry on as co-owners a business for profit (same as UPA 6)

1. RUPA 202 ( receipts of profits of a business is prima facie evidence of a partnership (UPA 7(4))

a. Creates a rebuttable presumption that you will have to overcome with other evidence

ii. RUPA ( law of Delaware

1. Supersedes UPA

iii. Objective Fact-Based Standard

1. Court will look to the facts and circumstances of the relationship

2. The subjective intent of the partners does not matter, but instead what matters is whether the circumstances of their relationship constituted the requirements of forming a partnership.

iv. Liability

1. Each partner is personally liable for the debts of the partnership

a. This means that it is very helpful to plaintiffs if they can establish that a partnership exists, because it puts more people and pockets on the hook for their claim

v. Four-Element Test (non-UPA/RUPA)

1. Some court require all of the following four elements where there is no express agreement:

a. 1) an agreement to share profits

b. 2) an agreement to share losses

c. 3) a mutual right of control or management of the business

d. 4) a community of interest in the venture

2. Other courts simply state that the presence or absence of these elements is evidence, but not a requirement, of partnership relation.

b. MARTIN v. PEYTON

i. A banking partnership was in financial difficulties, so they entered into an agreement with a few individuals to loan them liquid securities to get more cash. In compensation for the loan, they were to receive 40% of the profits of the firm until the loan was paid off and the return made.

1. They men did not believe that they were becoming partners, but rather just lenders

a. We know that intent doesnt matter, but rather the nature of the relationship

2. The issue is whether they are partners and whether they operated as co-owners of a business for profit

ii. Court looks at the key provisions of the loan agreement:

1. Profits

a. There is a cap on how much money they can receive, so they are not true business partners

2. Veto Power

a. Court says veto power alone doesnt give them enough control to consider them partners . . . they need some control b/c $2.5 million of their money is at stake

i. They also have no affirmative control to bind the company to any transaction or make the company do something

3. Loss Sharing

a. This was limited by other measures for the lenders, but not for the true partnersiii. Court determines that there is not enough to find a partnership based on these facts

c. LUPIEN v. MALSBENDEN

i. Malsbenden works at the location but thinks that he is just a lender. He put up $85K of his own money and spent a lot of time at the car dealership. The loan had no provision for the payment of interest, and was to be repaid from the proceeds of each car sold.

1. The plaintiff deals almost exclusively with Malsbenden

ii. Proof of Partnership:

1. An agreement, either express or implied, to place their money, effects, labor, and skill, or some or all of them, in lawful commerce or business with the understanding that a community of profits will be shared

a. Express agreement is not required . . . it is possible for parties to not intend a partnership, but still create one

iii. Court looks at a number of factors to determine that a partnership existed

1. Loan did not have fixed payment schedule, but rather would only be repaid as cars were sold

2. No interest on loan

3. Had the right to participate in the control of the business4. He created the contract with the plaintiff

***NOTE: There is a tradeoff between being a lender and being a partner. Once M decided to exert that much control, he gave up the ability to only be considered a lender and instead assumed partner status. II. The Legal Nature of a Partnership

a. Entity or Aggregate Status

i. UPA1. A partnership is not a person and does not enjoy entity status the way other business organizations do.

a. Consequences:

i. Partnership cannot sue under its own name . . . all partners must join the suit

ii. A third party cannot sue the partnership

1. Instead, they must sue the individual partners collectively

iii. Partners are jointly liable for the debt

1. Implicates the need to sue all partners in one suit or else risk having the suit dismissed

2. Contrary to this theory, however, UPA allows partnerships to own property in the partnerships name

ii. RUPA

1. 201 ( a partnership is an entityIII. The Ongoing Operation of Partnerships

a. Management

i. UPA

1. 18 all of the following provisions are subject to being altered by the partnership agreement

a. (a) - each partner should be repaid for his contributions to the partnership

i. each partner should share equally in the profits and contribute to the losses according to his share of the profits

b. (b) the partnership must indemnify a partner for any payments made in the ordinary and proper conduct of its business

c. (e) all partners have equal rights in the management and conduct of the partnership business

d. (g) no person can become a member of a partnership without the consent of all of the partners

e. (h) any difference arising as to ordinary matters connected with the business may be decided by a majority of the partnersi. no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners

f. RUPA 401 is substantially similar

ii. RUPA

1. 401 ( See UPA 18 aboveiii. SUMMERS v. DOOLEY

1. Summer and Dooley entered into a partnership agreement. D couldnt work anymore so S was the only partner actively running the business. D hired a replacement, but S wanted to hire a third person as an employee of the partnership, but D objected. S still hired the third person.

a. S sued for reimbursement of the employment costs of the third person under UPA 18(b)2. D argues UPA 18(h) ( all decisions regarding ordinary matters of the business require consent of the majority of the partners

a. Each partner gets one equal vote regardless of investment in the partnership unless altered by the partnership agreement

3. S argues UPA 18(e) ( all partners have equal right in the management and conduct of the partnership business

a. Therefore, S has just as much of a right to hire someone as D does;

i. and by refusing to hire, S cant carry on the business of the partnership

b. Ds rebuttal to this argument is that this reading of the statute directly conflicts with 18(h)

i. Most would side with this argument and say that 18(e) only means to say that all partners have a right to be consulted on partnership decisions, but they might not get to have their view followed b/c of 18(h)

4. Court follows 18(h) and states that a majority did not consent to the hiring. He made it very clear and actively objected

a. Therefore, S had no right to hire the third person.

5. RAGAZZO: Absentee Partner Argumenta. 18(h) is just a default rule that can be contracted around.

i. By virtue of Dooleys non-participation, there was an implicit agreement that Summers would run the business and D would be more like a passive investor

1. This is an acceptable argument because partnership agreements dont have to be in writing

b. The only problem with using this argument in this particular case is that S went to D and asked if it was okay . . . indicating the S still thought D had a vote***Even where there is a written partnership agreement, changes in the way the partnership is actually conducted, not just changes in the way in which it has been explicitly agreed that the partnership will be conducted, may constitute amendments of the partnership agreement for purposes of 18 or 401(j)

iv. Management of Partnerships

1. Changes in course of conducta. See note immediately above

b. If a partnership is managed in a way that is contrary to the partnership agreement, this could create an implicit agreement to amend the partnership agreement

2. Participation

a. UPA 18(e)/RUPA 401(f)

i. Both provisions state that all partners have equal rights in the management and conduct of the partnership business

b. Most courts treat this provision as simply requiring that ever partner must be consulted in partnership decisions

i. This was the failing of Summers argument in the above case

v. Choice of Law

1. UPA does not provide any guidance

2. RUPA 106 ( a general partnerships internal affairs are governed by the law of the state in which the partnership has its chief executive office

b. Indemnification and Contribution

i. UPA 18 (a)-(f)ii. RUPA 401 (a)-(e), (h)iii. Indemnification

1. If one partner pays off a partnership obligation in full, or more than his share, he is entitled to indemnification from the partnership for the difference between what he paid and his share of the liability

a. Partnership liability

i. Each partner will be liable in proportion to the profit shares

iv. Contribution

1. Where the partnership pays off an obligation in full, the partnership has a right to require contribution from each individual partner for their share of the obligation

a. Partner liability

IV. The Authority of a Partner

a. Apparent Authority

i. Every partner has apparent authority to carry out the ordinary business, unless the third party has knowledge of the limitations placed on the partner in the partnership agreement

1. This means that as to the outside world, every partner will be liable for the actions of other partners acting with apparent authoritya. EX: Dooley will be on the hook to the employee that Summers hired despite Dooleys lack of consent . . . the remedy will be for Dooley to seek reimbursement from Summers

2. The partner who acted with actual authority, but with apparent authority would then be liable to the rest of the partners to reimburse for any losses

b. RNR INVESTMENTS v. PEOPLES FIRST COMMUNITY BANK

i. Limited partnership created to develop land and build houses. General partner had all of the management decisions, but had to get approval from the limited partners to go over budget on any one project. GP took a loan for more than approved budget and then the company defaulted on the loan.1. RNRs defense to foreclosure was that the bank failed to inspect the partnership agreement which stated that GP had no authority to take out this loan with prior approval form other partners.

a. Places duty on the bank to inspect

ii. RUPA 301 ( in order for apparent authority to be defeated, if the conduct was in the ordinary course of partnership business, the partnership must give the third party actual notification1. Must either have:

a. 1) Actual knowledge

b. 2) Receive notification from partnership

i. effective upon receipt

***There is NO CONSTRUCTIVE KNOWLEDGE

2. Policy ( the risk of loss from partner misconduct more appropriately belongs on the partnership than on third parties who do not knowingly participate in or take advantage of the misconduct

iii. RUPA 303 ( can file a statement with a designated public official stating any limitations of authority on some or all of the partners

1. Operates as constructive knowledge only for real property transactions

a. Any other transaction still requires the actual knowledge or notification of the third party (see comments)

2. If the person had no notification of this, then this is of not help to the third person in a non-real property transactiona. No constructive notice

i. One exception is with real estate

iv. Test

1. Step 1: Whether the conduct is a normal incident of partnership business

a. If the loan is taken because of financial difficulty, then it is not in the ordinary course of business and no apparent authority

i. If the loan a project loan, then it is a normal incident

b. In this case, taking loan is in the normal course of business because they develop real estate2. Step 2: Whether the third party had knowledge of the partners limitations

a. See 301 above . . . just having the agreement on file at the office does not give third-parties constructive knowledge

c. NORTHMON INVESTMENT CO v. MILFORD PLAZA ASSOCIATESi. Court makes a distinction between the apparent authority to the outside world and the ability to bind partners within the partnerships

1. Determines that the other partners are not bound to the agreement because of their right to consent to agreement with third-parties provided for in UPA/RUPA

2. Also points to their equal rights in the management and conduct of the partnership business

ii. Court decides that other partners are not bound by the lease agreement entered into by the other partner . . . therefore, any liability would fall squarely on the one partner who entered into the agreement

d. UPA

i. 9 - Apparent Authority ( a partner has authority to bind a partnership by any act for apparently carrying on in the usual way the business of the partnership of which he is a member and third party does not have knowledge or restrictions1. Controversy

a. UPA is unclear as to whether they are talking about the course of business of the particular partnership or the course of business of similar partnerships in the same line of business

b. RUPA resolves this controversy in favor of the latter

2. Knowledge

a. Actual knowledge; or

b. When he has knowledge of such other fact as in the circumstances shows bad faith

i. Creates an implied or inquiry notice that is ill-defined

ii. RUPA remedies this

e. RUPA

i. 301 - Apparent Authority ( partner liable for act in ordinary course of: (i) the particular partnership business; or (ii) the business of the kind carried on by the partnership (i.e., other partnerships in a similar line of business) and third party does not have knowledge of the restrictions1. Knowledge

a. Only actual knowledge or receipt of a notification of a partners lack of authority will meet the standard

i. No duty of inquiry for third party

ii. 303

V. Liability for Partnership Obligations

a. UPA

b. RUPA

i. 306 ( partners are jointly and severally liable for all obligations of the partnership

ii. 307

1. (a) a partnership may both sue and be sued in its own name

2. Exhaustion rule

a. A judgment against a partner, based on a claim against the partnership, cannot be satisfied against the partners individual assets until the assets of the partnership are exhausted in satisfying the judgment3. A judgment against a partnership is not by itself a judgment against a partner, and cannot be satisfied from a partners assets unless there is also a judgment against the partner

c. DAVIS v. LOFTUS

VI. Partnership Interests and Partnership Property

a. UPA

b. RUPA

c. RAPOPORT v. 55 PERRY CO

i. Two families owned 50% each of a partnership. Later, the Rappoports assigned a 10% interest out of their share to the adult children. The Parnes family refused to recognize the children as new partners.

1. R points to the partnership agreement which seems to indicate that in the case of immediate family, no consent is required.

ii. RULE ( no new partners can be admitted without the unanimous consent of the partners

1. An assignee may be made without consent, but he is only entitled to receive the profits of the assigning partner

iii. Court determines that the provision only provides for the assignment of an interest in the partnership, but not for the admission of new partners1. This just means they have a right to receive whatever partnership distributions are made in accordance with that interest

a. No right to see information or make decisions

2. Points to another provision in the agreement where they made it clear that the heir of a dead partner could become partner

a. This shows that they knew how to do it

i. Granted all the rights and privileges

b. The language was different in the assignment clause, and therefore, normal partnership law will apply

d. Partnership Property

i. Two Options for Property:

1. Partnership property

a. Can be transferred by the partnership

b. Creditors partnership can reach immediately, while creditors of individual partners cannot

c. On dissolution, property must be sold or valued along with other partnership property and distributed to partners accordingly

2. Property of the partner that is loaned to the partnership

a. Cannot be transferred by the partnership

b. Creditors of individual partner can reach immediately, while creditors of partnership cannotc. On dissolution the property is normally returned directly to the partner

ii. UPA treats the partnership as an entity for property ownership purposes

1. 25

a. Partners hold the property under tenancy in partnership

b. Partners have no right to possess property as an individual and cannot individually assign his rights in the property

i. Therefore not subject to attachment by an individual creditor of one partner

2. In practice, all incidents of ownership are vested in the partnership

iii. RUPA

1. 203 ( property acquired by the partnership is property of the partnership and not of the partners individually

2. 204 ( presumptions concerning whether property is owned by partnership or by individual partner

3. 501 ( a partner is not a co-owner of partnership property

a. purpose is to abolish UPA concept of tenancy in partnership

e. Partnership Interests

i. RULE ( You can freely assign partnership interests, but you cannot assign to a person your status as partner

1. This means that partners can use their interest to secure a debt to creditors

2. Assigning partner will remain a partner

ii. Limitations on Creditors

1. Creditor cannot levy on the interest so as to be a substituted partnera. Also cannot sell their interest to a third party who will be substituted as a partner

2. Creditor does have the right to receive any distributions to which the assigning partner would otherwise be entitled as well as any dissolution interest

3. RUPA 601(4)(ii) ( explicitly permits the non-assigning partners to expel the assignor from the partnership

a. UPA ( allows for dissolution of the partnership

iii. How creditors of individual partners collect on debts

1. Get a charging order from a judge

a. effectively requires any distributions made to go straight to the creditor

2. Foreclose on the interest (UPA 28; RUPA 504)

a. somebody will buy the right to distributions . . . often its the creditor

3. Force dissolution

a. Buyer has the right to compel dissolution if:

i. the term of the partnership has expired; or

ii. the partnership is at will

iv. Creditor Priority

1. Partnership creditors have priority over separate creditors as to partnership assets, and if debts to partnership creditors remain unpaid after partnership assets are exhausted, partnership creditors are put on a parity with separate creditors in dividing up the partners individual assets

VII. The Partners Duty of Loyalty

a. UPA

b. RUPAi. 404 ( the only fiduciary duties a partner owes to the partnership and theother partners are the duty of loyalty and the duty of care

1. Duty of Loyalty

a. To account to the partnership any profit or benefit received in the conduct of the partnership business

b. To refrain from dealing with the partnership on behalf of a party with adverse interests to the partnership

c. To refrain from competing with the partnership

2. Duty of Care

a. Limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law

3. (e) a partner does not violate a duty merely because the partners conduct furthers his own interest ii. 103(b)(3) ( Duties may not be waived or eliminated in the partnership agreement, but the agreement may identify activities and determine standards for measuring performance of the duties if not manifestly unreasonable (see 103)

c. MEINHARD v. SALMON

i. Partnership created between Salmon and Meinhard. Agreed to have partnership for 20 years. At the end of the partnership, Salmon negotiate a new deal to benefit himself and cut Meinhard out of the deal. Salmon had not told Meinhard anything about the new negotiations.

1. Meinhard sues for breach of fiduciary duty

ii. RULE ( Partners owe to one another the duty of the finest loyalty . . . not honest alone, but the punctilio of an honor the most sensitive, is then the standard of behavior

1. Court equates this duty to that of a fiduciary

a. But remember that they are not true fiduciaries because all partners have an individual interest in making money for themselves

iii. Because of this standard of loyalty, Salmon was required to disclose the negotiations he was in

1. Salmon took advantage of his position of being the managing partner by profiting from it rather than seeking the best interests of the partnership 2. At the very least, he should have told Meinhard about the opportunity iv. This case stands for the proposition that partners have a duty to treat other partners fairly

1. This opens managing partners up to suits and keeps them looking over their shoulder

a. Obviously, the other partners could abuse this ability to sue, but the danger of general partners abusing their position was deemed ot be a greater danger than a few frivolous lawsuits.d. TEXAS

i. Cuts out the fiduciary duty to other partners1. So you will never see the term fiduciary in the Texas statutes and instead they just list the duties:a. Loyalty, care, not to cut partner out of business, but not fiduciary

i. This is because there is some inherent selfishness involved in the relationship

ii. Texas statute functions the same as RUPA, but just takes the overblown language out.

e. Suits by a Partner Against a Partnershipi. UPA

1. Suits were limited to actions for an accounting (22) or for dissolution

ii. RUPA

1. 305 ( changes the wording of UPA 13 to allow for suits by partners against the partnership on a tort or other theory during the term of the partnership rather than being limited to only dissolution or an accounting

VIII. Dissolution I: By Rightful Election

a. UPA

i. 29 ( dissolution of a partnership occurs any time a partner ceases to be associated in the carrying on of the business

1. This means that a partnership dissolves every time a partner leaves . . . however, most partnerships remedy this harsh consequence with a continuation clause in the partnership agreement

ii. 30 ( when a partnership dissolves, it continues until the winding up process is completed

iii. 31 ( The following are automatic causes of dissolution:

1. Termination of the definite term specified in the agreement

2. By express will of any partner when no definite term is specified

3. By express will of all the partners who have not assigned their interests before or after the specified period

4. By expulsion of any partner according to their power bestowed by the agreement

5. By the express will of any partner in contravention of the partnership agreement

6. Death of a partner 7. Bankruptcy of any partner8. By court decree

***Partners can avoid this by providing for its continuation in the partnership agreement upon the happening of any of the above eventsiv. 38 ( Unless the partners otherwise agree, each partner has the right to have the partnership property applied to discharge its liabilities and the surplus paid in cash to each partner upon dissolution and after winding upv. 40 ( Rules for Distribution

b. RUPA treats partnership as an entityi. 601 Partner Dissociation1. Same general event2. The difference is that the partnership is not dissolved

a. See 801 for events that cause a mandatory dissolution

ii. 602

1. A partner has the power to dissociate rightfully or wrongfully at any time

a. If wrongfully, will be liable for damages to the partnership

iii. 603 Effect on partners dissociation

iv. 701 Purchase of dissociated partners interest

1. Partners interest will be bought by partnership for a buyout price

a. Gets the greater of the amount that would be his share had the partnership been liquidated or sold as a going concern

v. 801 Event causing mandatory dissolution

c. CREEL v. LILLY

i. Several guys creates a partnership to sell NASCAR memorabilia. The managing partner dies. Wife of dead partner seeks to dissolve the partnership by winding it up and selling the assets in order to make a final distribution. Other partners just want to pay her the dead partners pro rat share of the partnership and continue the business

1. Wife sues

ii. Court cites the default rules under UPA

1. A partnership dissolves upon the death of a partner

a. The partnership may continue its business upon the consent of the dead partners estate or through the exercise of a continuation clause in the partnership agreement

iii. RUPA changes the UPA default rules:

1. Considers partnership an entity

a. Allows for the partnership to continue even with the departure of a member because it views the partnership as an entity distinct from its partners

2. Calls it Partnership Dissociation

a. RULE ( upon the change of the membership of the partnership, the existing partnership may be continued if the remaining partners elect to buy out the dissociating partner

i. Otherwise, you can follow the old winding-up and liquidation approach

3. 801 ( lists the specific events that still cause a dissolution . . . if not listed, then the partnership can use the buy-out provision

iv. This court finds the UPA liquidation provision to be too harsh in practice and looks for a way to get out of enforcing it

1. Policya. Liquidation can be harmful and destructive measure, especially to a small business, and often unnecessary to determining the true value of the partnership

2. Court announces that where there is a good faith and accurate valuation of the partnerships assets, that liquidation is unnecessary so long as the partnership makes a payment of the estates proportionate share

a. Otherwise, liquidation would be too unfair to the remaining partners and probably even provide a lower price to the estate

***NOTE: One factor that the court considers in the legislatures recent adoption of RUPA, which eliminates the UPA default rules . . . also seems to have a soft spot for the small business context.

d. Distributions in Dissolution

i. UPA 40

1. Priority 1: outside creditors2. Priority 2: partners for obligations other than capital or profits

3. Priority 3: partners in respect to capital

4. Priority 4: partners in respect to profits

ii. UPA 18

1. Partners must contribute to losses sustained according to his share of the profits

e. Services Partnersi. The UPA rules create issued for service partners who contribute no capital and only services

1. EX:

a. C: 100K; S: 0K

i. Profits are to shared 50/50, but nothing said about sharing losses

b. Wind-up Value: $130K

i. Option 1: There is a 30K profit, so

1. C gets 115K

2. S gets 15K

ii. Option 2: Value Ss services at 30K, so

1. C gets 100K

2. S gets 30K

***Court will find an implied agreement that personal services qualify as capital contributions to the partnership

***Many courts are willing to interpret the situation in this manner because the other result just seems unfair

2. EX 2:a. Some contributions

b. Wind-up value: 0K (loss of 100K)

i. Option 1 (UPA)

1. S must share in the losses, thus

a. S contributes 50K to C

ii. Option 2 (UPA-plus)

1. Give S credit for 30K in services

a. S: pays 35K to C

b. This way, both lose 65K

iii. Option 3

1. S can argue that there was an implied agreement that S would not share in the losses because he was a service partner

a. Therefore, B has to eat his 100K loss because S was essentially like an employee of the company

3. What court usually do

a. Profits ( usually find service to be a capital contribution

b. Losses ( usually follow option 3 but at worst follow option 2

***The problem with this area of the law is that court have to imply agreements . . . we should fix the rule rather than implying another one to get around the real rule

ii. RUPA 401 ( continues the UPA capital loss allocation rules1. Comments point out that partnerships with service partners should foresee this problem and take the time to alter this rule in the partnership agreement

f. Joint Venture Dissolution Distributionsi. Special Rule ( some courts have held that a service partner need not contribute toward a capital loss where the enterprise is a joint venture rather than a partnership.

1. This rules seems to be more a product of courts finding a reason not to use partnership law in this context

g. PAGE v. PAGE

i. Oral partnership agreement made by two brothers. The plaintiff is a one partners wholly-owned corporation who holds a $47K demand note and wants to dissolve the partnership to get its money out.1. The issue is whether this is a partnership for a term because the UPA allows automatic dissolution by the express will of any partner when no definite term or particular undertaking is specified

a. D claimed that this was a for a term because they intended to let the partnership run until the debts of the business were paid off

ii. Court determines that this was not a partnership for a term

1. What the partners claim was a term, was no more than a common hope that the partnership earnings would pay for all necessary expenses . . . the is not a definite term or particular undertaking

iii. UPA 31(1)(b) ( dissolution of the partnership occurs by the express will of any partner where there is no fixed term

1. LIMIT

a. Good faith because of the fiduciary relationship between partners, this is implied

i. As a partner, you cant obtain an advantage over other partners by dissolving the partnership

iv. D claims Bad Faith; and this means that the dissolution attempt should be unsuccessful

1. Thinks that now that the business is making money, he really just wants to keep all the profits for himself2. Court responds by stating that each partner has an absolute right to terminate the partnership

a. If found to be a wrongful dissolution because of bad faith, there are statutory remedies available to the other partner

***Remember MEINHARD CASE: you cant steal the business from your partners

h. Partnership Breakup Under UPA

IX. Dissolution II: By Judicial Decree and Wrongful Dissolution

a. UPA

i. 38 ( Where dissolution was wrongful, the remaining partners have the option or remaining in business or winding up the business and distributing the assets1. But they must buy out the dissolving partner (no goodwill)b. RUPA

c. DRASHNER v. SORENSON

i. Three men formed a partnership. Drashner began drinking too much, got arrested, bounced a check, and hung out in bars rather than attending to his work.

1. Drashner was unhappy about he amount of money being paid out and this seems to be the root of his neglect of his duties

a. Drashner demanded more money to be distributed, and the partners refused, so D elected to dissolve the partnership

2. T.C. finds that Drashner committed a wrongful dissolution

ii. Court finds this to be a partnership for a term

1. Partnership was contemplated to exist at least until the advance of the original capital was recouped

2. Therefore, dissolution of the partnership by Drashner was wrongful

iii. Remember UPA 38

1. Partners have the option of either winding up the business or continuing the business where the dissolution is wrongful

a. Can disregard good will when valuing partnership

2. RUPA 701(b) is different

a. Wrongfully dissociating partners get a buyout price that represent the greater of the going concern or liquidation value at the time of dissociation

i. Goodwill Rule is rejected!

iv. RULE ( When dissolution of the partnership is found to be wrongful, the court will not consider good will when valuing the partners share of the business (at least under UPA)

d. Wrongful Dissolution

i. UPA (38)1. Consequenc to wrongfully dissolving partners:

a. Damages

b. Valuation of his interest that does not include goodwill

c. Continuation of the business without him

2. These consequences are regardless of whether or not the dissolving partner was acting in good faith

a. So the penalties for guessing wrong acts as a severe disincentive to partners who want to dissolve

ii. RUPA (701)

1. 602 ( list types of wrongful dissociation . . . if not on list, then its rightful

a. 1) a dissociation that is in breach of an express provisions of the partnership

b. 2) a withdrawal of a partner by the partners express will before the expiration of the partnership term or the completion of the undertaking

c. 3) a partner has engaged in wrongful conduct that adversely and materially affected the partnership business

d. 4) a partner has willfully or persistently committed a material breach of the partnership agreement or of a duty of care, loyalty, good faith, and fair dealing

2. Reject the No Goodwill Rule

3. Wrongfully dissolving partner will get the greater of going concern or liquidation value, reduced by damagesa. Partner will always be subject to damages for the wrongful dissolution (602)4. Payments dont need to be paid until the expiration of the term if there is one, but still bears interest

e. Rightful Dissolution

i. UPA every partner has the right to leave the partnership, whether rightfully or wrongfully1. If dissolved rightfully, then remaining partners may agree to continue the business

a. If nothing in the partnership agreement, then they must include the leaving partners in the decision to continue the business . . . otherwise the leaving partner would want the assets distributed\

2. Leaving partner receives full share of the partnership . . . including the value of goodwillii. RUPA

1. Two Forks

a. Dissociation ( 701

i. Just make the payment prescribed:

1. Greater of going concern or liquidation value

b. Dissolution ( 801 (winding up)

i. 801 list events that require winding up

f. Expulsion of a Partner

THE CORPORATE FORMI. The Characteristics of the Corporation

a. General Attributes

i. Limited Liability ( shareholders are not personally liable for corporate obligations; managers are also typically not liable

ii. Freely Transferable Ownership ( shares of stock can be bought and sold freely

iii. Continuity of Existence ( the legal existence of a corporation is perpetual and thus stable in terms of long-term planning

iv. Centralized Management ( normally managed by a board of directors and shareholders have no right to participate in management

v. Entity Status ( a corporation is a legal person so it can sue and be sued, as well as own propertyII. Selecting a State of Incorporation

a. Delaware

i. This is a popular state of incorporation for publicly-held corporations

1. Takes an enabling approach to regulation

b. Other states

i. Many smaller business choose to incorporate in whatever state they do most of their business

1. This is because of tax consequences

III. Organizing a Corporationa. DGCL

b. Authorized and Issued Stock

i. Certificate of incorporation designates the classes of stock and the number of shares of each class, that the corporation is authorized to issue

1. Certificate must either:

a. Designate the terms of each class or

b. Authorize the board to issue portions of the authorized class in series from time to timeand to designate the terms of each series as it is issued

ii. Issuance ( the actually sale of stock

1. Only stock that has been authorized can be issued

2. Just because stock is authorized does not mean that has been issued

c. Basic Models of Corporate Finance

i. Bonds/Debentures ( a promise by the company to pay a certain amount on a certain date

1. Represents money borrowed by the company from the general public

2. Bonds are secured obligations

3. Debentures are unsecured obligations

4. Indentures

a. General contract entered into between the borrowing company and the trustee

i. Company has certain business obligations that are monitored by the trustee

ii. Stock (Two Forms)

1. Preferred

a. Hybrid stock that combines the ownership element of common stock and the senior nature of debti. No promise of repayment like bonds have

b. Gives the holders preference in the event that the directors are able and willing to pay a dividend

c. Often carries a periodic dividend

i. Before dividends are paid to anyone else, they must first go to preferred stock

ii. Often cumulative . . . must make all back payments of dividends before dividends can be paid to common stock

2. Common ( conceived as equity interests in the corporation so the holders are the owners of the corporationa. Lowest on the totem pole as far as payments are concerned

b. Investors require higher return

c. Usually carries voting rights, but doesnt have toIV. Preincorporation Transactions by Promoters

a. Liability of Promotors

i. RULE ( when a promoter makes a contract for the enefit of a contemplated corporation, the promoter is personally liable on the contract and remains liable even after the corporation is formed

1. Exception:

a. If the contracting party knew the corporation was not inexistence and nevertheless agreed to loos solely to the corporation for performance

b. Liability of Corporation

i. When corporation comes into existence:

1. Corporation is liable only if they ADOPT the contract:

a. Either impliedly, or expressly

2. Can adopt by any number of means, but if they accept the benefits of the contract, then it is assumed that they have adopted the contract

ii. Is promoters liability released?

1. Generally NO!

a. Unless the parties have agreed to release the promoter upon the corporation coming into existence and adoption of the contract

V. Process to Become a Corporation

a. DGCL

i. 101(a) ( Any person or entity can become a corporation by filing with the Secretary of State its Articles of Incorporation

ii. 102(a) ( The Articles of Incorporation MUST include:

1. Name of corporation

2. Address of company and name and address of registered agent

a. This is so anyone can know where to serve the corporation in the event of a lawsuit

3. Nature of the business

4. Kinds of shares to be offered

5. Name and address of incorporators

a. These are just the people who actually file the documents

6. Name and address of persons who are to serve as directors until the first annual stockholders meeting

iii. 102(b) ( Articles MAY include:

1. Any provision for rules of running the corporation

2. Provisions reducing certain personal liability for directors with the exception of duty of loyalty, good faith, and improper personal benefit cases

***Essentially, you can put whatever you want into this section provided it is not illegal

iv. 106 ( corporation comes into existence immediately upon the proper filing of the certificate of incorporation

v. 108 ( after filing the certificate of incorporation, the incorporators of temporary board members shall meet to adopt by-laws and elects board members

vi. 109 ( By-laws

1. Shareholders have power to adopt/amend by-laws

2. Can also give this power to Board if in certificate of incorporation

3. You can have anything you want in the by-laws so long as they are not illegal

VI. Consequences of Defective Incorporation

a. DGCL

b. De Jure Corporation ( a corporation organized in compliance with the requirements of the state of incorporation

i. It is legally in existence and followed all of the steps to register

ii. Substantial compliance is enough to satisfy this requirements c. De Facto Corporation ( Exists when there is insufficient compliance to constitute a de jure corporation, but the steps taken toward formation of a corporation are sufficient to treat the enterprise as a corporation with respect to third parties

i. Even though registration was defective, you will still be treated as a corporation with respect to the outside world

1. The significance is that shareholders continue to enjoy limited liability despite the fact that they are not a coporation

ii. Elements1. Statute under which incorporation is possible

a. Not really important because its possible everywhere

2. Must make a good faith colorable attempt to incorporate

3. Actually use or exercise corporate powers

d. Corporation by Estoppel ( equitable remedy whereby courts hold that a party who has dealt with an enterprise on the basis that it is a corporation is estopped from denying the enterprises corporate status

i. Effective only for a specific transaction

ii. Three Branches

1. Branch 1

a. Where representatives of the corporation claim that they are a corporation to T and later T sues; the representatives are estopped from claiming that they are a corporation2. Branch 2a. Technical Branch ( where defendant tries to keep corporation from suing by claiming that they are not a corporation and cannot sue

3. Branch 3a. A third party who has dealt with an enterprise on the basis that it is a corporation seeks to impose personal liability on the would-be shareholders, who in turn raise estoppel as a defense

i. This is the most important branch

1. Similar to De Facto theoryb. Difference b/w de facto and estoppel

i. Estoppel doctrine is broader than the de facto theory

1. Estoppel ( focuses on the assumptions of and beliefs of the parties to the transaction

a. Only work in contract situations

2. De Facto ( looks at how close the corporation itself came to actually incorporating (colorable attempt standard)

iii. DGCL

1. 329 ( codifies these principals

iv. Model Act States

1. Allow the first two branches of estoppel, but eliminated as to providing limited liability to would-be shareholders

a. This is because the Sec. of State returns a piece of paper certifying as conclusive proof that you have complied with incorporation requirements

b. Exception ( those who didnt know that incorporation was defective are still protected

e. Who may be held liable?

i. If the corporation is neither de facto, dejure, nor corporation by estoppel then courts differ on which shareholders may be held liable1. Model Act 2.02

a. All those who assume to act for the corporation are liable

i. This means managing shareholders are liable while passive shareholders still retain limited liability

2. General trend in all jurisdictions eliminates liability for those who dont actively participate in the management of the business

VII. The Classical Ultra Vires Doctrine

a. Classic Doctrine

i. RULE ( If you are not explicitly authorized to perform something in your articles of incorporation, then any actions outside of your authorization is void

1. Includes contractual obligations

2. EX: Train company was not authorized to build railroads so all contracts on that matter are void

b. DGCL

i. Practically abolishes any notion of the ultra vires doctrine

ii. 124 ( a corporation is not allowed to use the ultra vires nature of its action to escape an obligation under a contract

1. A shareholder only has standing to challenge contracts that are executory (not fully performed) on the companys behalf

a. So even if you have standing you must fit into this requirement

2. A shareholder can always later sue officers for their former act under the theory that it was ultra vires

a. The problem is that in practice most companies have VERY GENERAL purpose statements

c. GOODMAN v. LADD ESTATE CO.

i. Director of Westover took out a personal loan, upon which Westover acted as a guarantee on the loan. Director defaulted and Westover had to pay, so now shareholders are challenging base dont he Ultra Vires doctrine1. Nothing in the purpose clause of the corporation authorized the company to act as guarantee on loans to their employees

ii. The court finds that this was ultra vires because not contained in the purpose clause

1. This would still be ultra vires today because guarantying a loan on a swimming pool has absolutely no legitimate corporate benefit

iii. NOTE: Corporations are not required to have a very detailed purpose clause anymore . . . can simply state that their purpose is to make money

1. The only useful aspect of still using a detailed purpose clause is if you are a minority shareholder and want to exert control over the company

iv. Taken Share Rule

1. Based on principal that you dont get to challenge corporate conduct that you previously voted for

a. It follows that if a person buys your shares, they also have no right to challenge the corporate action as long as the purchaser knew of the action

d. INTERCONTINIENTAL CORP v. MOODY

i. There is a general rule that the corporation itself cannot challenge ultra vires conduct, but a corporations shareholder can

1. RULE ( nevertheless, this case stands for the proposition that a shareholder can try to enjoin an ultra vires action even if he has been solicited to do so by the corporation, provided the shareholder is not the corporations agent

e. Ultra Vires only comes up in TWO Situations1. 1) When they actually admit that they were not acting in the interests of the shareholders

a. See Ford Case . . . Henry Ford actually admitted that he was just embarrassed about making crazy profits

2. 2) ??????VIII. The Objective and Conduct of the Corporation

a. General Rule ( The corporation has an obligation to maximize corporate profits

i. However, there are a few slight exceptions to this general rule where it is okay for a corporation to act in a manner that is not meant to maximize corporate profits.

b. Interest Other than Maximization of the Shareholders Economic Wealth

i. AP SMITH MFG v. BARLOW

1. Corporation decided to make annual gifts to Princetons general fund and the action was challenged for being ultra vires.

a. Corporation argues that they are expected to make contributions by the public and that it will create goodwill

2. RULE ( you may do things to benefit society as a whole and that dont necessarily benefit shareholders if the impact on shareholders is small

a. EX: Giving $100M to a charity

i. If you are a $600B company, then its probably okay

ii. If you are a $600M company then its probably NOT okay

***RAGAZZO: There is always a way to make an arugment that an action benefits the shareholders unless it is just completely crazy . . . just dont be stupid like Henry Ford

ii. DGCL 122(9) ( explicitly authorizes corporations to make donations for the public welfare or for charitable, scientific or educational purposes

CORPORATE STRUCTUREI. The Allocation of Legal Powers Between Management and Shareholders

a. DGCL 141(a) ( Unless otherwise provided in the articles of incorporation, the business of the corporation shall be conducted by or under a board of directorsb. CHARLESTOWN BOOT v. DUNSMORE

i. Company had two directors: Willard and Dunsmore. In the process of winding up the business, the shareholders want the directors to take the advice of how to do so by and outside person. Directors dont ignore the shareholders and proceed to lose a ton of money in liquidating the business

1. The issue is whether the shareholders can tell directors to deal with an outside consultant

ii. Court holds that directors DO NOT have to listen to shareholders

1. Rule ( directors have full discretion in using their own judgment unless the articles of incorporation or by-laws limit them

a. The shareholders remedy is to vote out directors or sell their shares if they are unhappy with the management by the Board

2. Shareholder remedies

a. Vote them out

i. Provides no immediate help

b. Negligence suit

i. Directors are required to use ordinary care and diligence in the care and management of the business

ii. But directors may have lost all of their money by then

iii. What is the solution for a case like this?

1. The shareholders want to add a director to the board, but the board is resisting2. Amend by-laws to say that there shall be three directors instead of twoa. DGCL 109 ( Shareholders can hold a vote to amend by-laws

i. You need to be able to call a shareholders meeting

b. DGCL 211 ( only directors can call a shareholders meeting

i. Model Act allows majority of shareholders to call a meeting

c. DGCL 228 ( Written Consent

i. Any action required to be taken by a shareholders meeting can be taken with out the meeting if you get written consent from the required amount of stockholders to taken the course of action

1. The idea is that if a majority consent, then there is no need to meet

ii. In this case, 216 states that you need a majority vote to amend by-lays . . . so if can get a majority written consent, then the by-laws are amended

3. According to 228, you just need to type up a consent form stating that that you are seeking to create a new seat on the Board, and once 51% approve, the new seat is created.

4. Who takes the new seat?

a. DGCL 223(a)(1) ( default rule is that directors would elect a person to fill the empty seat, unless otherwise provided for in the AOI or By-laws

i. So we need to also amend the by-laws to state that stockholders will fill the vacancy

b. While we are at it, we need to also include a provision nominating Osgood as the third director

5. SUMMARY

a. The written consent will contain three things

i. 1) We hereby create a third director seat

ii. 2) We hereby amend the voting rules to state that shareholders will fill vacant seats

iii. 3) We hereby appoint Osgood to the Board6. Precatory Resolutions

a. 142(b) ( it is the job of the board of directors to hire and fire officers

i. but that doesnt mean that shareholders dont have a say in things

b. These are resolutions voted upon by the shareholders regarding a decision that is really in the Boards discretion.

i. EX: If they want to remove an officer, only the Board can do this, but they can still pass a precatory resolution stating that it is the view of the shareholders that the officer should be removed

1. The Board can then choose to listen or not, and if they dont then you remove them through the procedure outlined above. c. Removal of Directors

i. DGCL 141(k) ( any director may be removed with or without cause by a majority of the shareholders at a shareholders meetingd. SCHNELL

i. RULE ( The directors hold legal power subject to a supervening duty to exercise such powers in good faith pursuit of what they reasonably believe to be in the corporations interest1. This means that just because something is technically legal doesnt mean that the Board can automatically do it . . . still subject to good faith standard

e. BLASIUS INDUSTRIES v. ATLAS CORP

i. Blasius owned 9% of Atlas and proposed to do a huge financial restructuring of the company. Wanted to pay a lump sum out to shareholders and create a highly leveraged company . . . based on theory of making it lean and mean.

1. Directors disagree and block his proposal

2. Blasius responds by proposing to add eight more directors to the Board (the most allowed by by-laws) and thus gaining control of the Board

a. The Board responds by immediately adding two more seats and appointing their friends

i. DGCL 109 ( allows Board to amend by-laws

ii. DGCL 221 ( allows board to fill seat vacancies

ii. Court frames issue as whether the Board may validly act for the principal purpose of preventing the shareholders from electing a majority of new directors.1. States that the shareholder voting process is afforded more protection than most other areas in the corporate structure

2. Have to get around rule that the corporation is owned by the shareholders and run by the Directors

a. Sees the action more as directors protecting their own power rather than the corporation making a decision about business matters

i. Therefore outside of business judgment rule

iii. Adopts a Compelling Justification Standard

1. RULE ( In cases where board action interferes with shareholder voting rights, the Board bears the burden of demonstrating a compelling justification for such actiona. EX:

i. Might be okay where majority shareholder was taking action that was detrimental to a minority constituencyb. Cannot simply be a paternalistic the board knows best logic

i. Paternalism can never be the argumentii. Keep in mind that what is compelling is always in eye of the beholder2. In this case, this was a 9% shareholder . . . he was a minority himself, and needed quite a bit of outside support to accomplish any of his goals

a. The board could have spent money to campaign against the shareholder, but they were not allowed to undercut his voting rights by taking their course of action of exercising power

iv. RAGAZZO: This should never have happened this way

1. The Board should have filled all of the potential director spots long before this situation ever arose

a. With a full Board, it would have taken more than a year to gain the majority of the Board because of staggered board

i. DGCL 141(d) ( allows for staggered boards

1. (k) if you have a staggered board, you can only remove for cause

a. the purpose is to make sure change happens gradually

b. But since they had open seats, there was an opportunity to take over immediately and foil the purpose of the staggered boardf. INTL BROTHERHOOD OF TEMSTERS v. FLEMING CO

i. Board of Fleming adopts a poison pill which makes it impossible for a takeover to occur unless the Board approves. The Teamsters object to this because it limits their ability to make a bunch of money in a takeover1. Teamsters propose an amendment to the by-laws requiring any shareholder rights plan to be approved by the shareholders

a. The Board does not like this proposal and likes having a defense that doesnt require a shareholder approval

ii. Board argument

1. DGCL 157 ( subject to any limitations in the certificate of incorporation, the corporation can issue any rights in regard to stock

a. According to board, any limitation would need to be in articles of incorporation

i. 242 ( changes in articles of incorporation require both shareholder and board approval

iii. Court rejects Board argument and states that this can be done by changing the bylaws and not the articles of incorporation

1. Shareholder rights plan endorsement statutes

a. This state does not have one of these

b. Without one of these, the court says, the corporation is subject to general corporate governance, which means that shareholders can make rules by amending the bylaws

g. MM COMPANIES v. LIQUID AUDIO

i. MM held a large portion of stock in Liquid and proposed to elect two new directors to current seats, and expand the board by four seats and nominate new board members

1. Liquid refuses to call a special meeting and appoints two more of their own people to director seats

***The only reason this was possible was because the AOI was poorly drafted and did not contain a limit on the amount of board members . . . a staggered board is worthless if there is not cap on number of directors seats

ii. Court uses Blasius Compelling Justification Standard in stead of business judgment rule1. RULE ( this standard is appropriate when a board of directors acts for the primary purpose of impeding or interfering with the effectiveness of a shareholder vote

a. Board bears the burden of proof of showing a compelling justification

b. Actions do not have to prevent them from voting, but merely impede the effectiveness of the stockholder vote in an electioniii. The point of this case is to show that De. Supreme Court will apply Blasius

II. The Legal Structure of Management

a. Choice of State of Incorporation

i. Choice of Law

1. A corporations internal affairs are governed by the law of its state of incorporation

2. A firm can incorporate in any state it chooseseven in a state in which they do no business

ii. Close Corporations

1. Usually incorporate in the state where they do the majority of their business

2. Problems with incorporating in another state

a. You will have to pay several taxes:

i. 1) Franchise Tax

ii. 2) Doing-Business Tax

b. These taxes are lower if you incorporate in the state where you do most of your business because the taxes overlap . . . otherwise tax bill is higher

iii. Publicly-Held Companies

1. Delaware is a popular spot . . . why?

a. Adopts a hands-off enabling approach

i. Makes it manager friendly

b. Everyone copies Delaware lawc. Predictive case law and a knowledgeable bench

i. Every judge is a corporate law expert and therefore you know the decisions are at least informed ones

iv. Race to the Bottom Theory

1. E.g., Teamsters Case

a. Delaware allows a manager to stand between shareholders and their money . . . and since managers get to pick where they incorporate, they are going to pick where they personally benefit the most

v. Race to the Top Theory

1. If managers were overly favored by Delaware, then shareholders would make less money; but this is not the case

a. Therefore because people are still incorporating in Delaware, it must mean that Delaware promotes efficiency in the corporate structure

***RAGAZZO ( Delaware law may not be as manager-friendly as it is cracked up to be (see Blasius, Liquid Audio, Flemming).

b. Directors Informational Rights

i. Common Law

1. A directors has a wide-ranging right to information concerning the corporation, which may be exercised through inspection of books, records, and documents

2. Split in cases law

a. Line 1 ( directors intent is deemed irrelevant

b. Line 2 ( director cannot have a hostile intent in exercising his right to the information

III. Formalities Required for Action by the Board

a. DGCLi. Quorum

1. 141(b) ( the default rule is the majority of the Board must be present; may be altered to as low as 1/3 or as high as they want by the bylaws

a. Measured by total number of authorized seats

i. So if there are vacancies, they still count toward the quorum

ii. Voting1. 141(b) ( The vote of a majority of those present is required to take action

a. Even when someone abstains, this is effectively a no vote because those abstaining are included in determining what the majority is

b. Requirements can be altered by the AOI or bylaws

i. LIMIT ( you have to at least require more than 50% or else both sides could win

b. Committees

i. Boards can delegate decisionmaking authority to committees

1. There may be a short list of things that cannot be delegated, but almost anything can be delegated

IV. Authority of Corporate Officersa. Authority in General mirrors rules of agency law

i. Express Actual Authority

ii. Implied Actual Authority

1. EX: Officer has been given the authority to buy and sell real estate for the company. He hires a realtor . . . this is implied.

iii. Apparent Authority

1. Jurisdictions are split in two

a. View 1: President has power to take ordinary actions, but not extraordinary actions

i. EX: can hire an employee for two-year term, but cannot sign a lifetime contract

ii. This is the majority rule

b. View 2: Officers have little or no apparent authority in regard to their nominal position I the company

i. Substantial Minority

ii. TEXAS follows this rule

1. As a consequence, you have to make sure that an officer has authority

a. Accomplished by having the secretary of the company give a certificate stating exactly what his authority entails

b. Secretary will have apparent authority to certify actions on behalf of the company so at least they are on the hook for this

b. Authority of Corporate Officers

i. President

1. Majority Rule ( president has apparent authority to bind his company to contracts in the usual and regular course of business, but not to contracts of an extraordinary nature

a. Factors

i. Economic magnitude of the action

ii. Extent of risk involved

iii. Time span of the actions effect

iv. Cost of reversing the action

2. Minority Rule ( Texas

ii. Secretary1. Always has apparent authority to certify the records of the corporation, including resolutions of the board

a. Certification is conclusive in favor of a third party relying on the certificateV. Formalities Required for Shareholder Action

a. DGCL

i. Notice

ii. Quorum

1. 216 ( majority of the shares entitled to vote constitutes a quorum

a. can be changed

iii. Voting

1. Ordinary Matters

a. 216 ( majority of shares present at meeting

i. abstaining votes count as no votes

b. TX ( majority of those voting

2. Fundamental Transaction

a. EX: amending AOI, merger, sale of substantially all assets, dissolution

b. DE ( majority of those shares entitled to vote

3. Electing Directors

a. 216 ( Plurality wins from votes taken

4. Written consent

a. Shareholders can act by way of written consent

VI. Cumulative Voting

a. Straight Voting a shareholder can cast, for each candidate for election to the board, a number of votes equal to his number of sharesi. Under this system, 51% ownership gives you 100% of the power because you can outvote the opposition on every matter and no one can stop you

b. Cumulative Voting a shareholders can cast for any single candidate, or for two or more candidates, as he chooses, a number of votes equal to his number of shares he holds times the number of directors to be elected

i. EX: 4 spots to be elected; holds 500 shares

1. Shareholders gets 2000 votes that he can cast is any way he sees fit

ii. This method allows for more proportionate representation on the board of the minority ownership

c. Why would a minority want access to the board if their representative will always be outvoted on the board?

i. Minority will have greater access to information

1. This is valuable to investors

d. DGCL 214 ( Delaware is a straight voting state unless otherwise provided for in the AOI

i. Texas: used to be cumulative, but changed to mirror DE

VII. Limited Liability

a. DGCL 102(b)(6) ( the AOI may include a provision imposing personal liability for the debts of the corporation on its stockholders to a specified extent; otherwise, the shareholders shall not be liable for the payment of the corporations debts.b. Introduction

i. General Rule (

1. under modern statutes, a shareholders risk is ordinarily limited to his investment . . . amounts to whatever they paid for their shares

ii. Veil Piercing

1. Always

a. Siphoning of Money

b. Fraud

2. Sometimes

a. Inadequate capitalization plus failure to follow formalities

c. FLETCHER v. ATEX

i. Court finds no veil piercing1. Alter Ego Theory

a. Elements:

i. 1) that the parent and the subsidiary operated as a single economic entity

ii. 2) that an overall element of injustice or unfairness is present

b. Notice that Delaware does not require a showing of fraud

ii. Court feels that all of the arrangements are legitimate and do not comply with the alter ego standard

1. Cash management system

a. Even though some money is kicked up, they have strict accounting for creditors and have all funds earmarked2. Can only veto big decisions

a. This is common with any stockholder . . . they have no control over day-to-day operation

b. Did not dominate the subsidiary

3. Atex followed all formalities

a. Common officers and directors is not enough

i. Overlap of the two boards was negligible

d. WALKOVSKY v. CARLTON

i. Carlton owns a cab company. He has ten corporations, each holding two cabs per corporation. One of his cabs hits P and P want to reach assets of other corporations holding cabs by piercing the veil

1. P wants to pierce in two ways

a. Horizontally ( makes the other cab corporations liable for the action of the corporation that owned the cab that hit P

b. Vertically ( make Carlton personally liable for the liabilities incurred by the corporation

ii. Viel Piercing

1. RULE ( Courts will disregard the corporate form whenever necessary to prevent fraud or to achieve equity

a. Look at general rules of agency

i. Whenever anyone uses control of the corporation to further his own rather than the corporations business he will be liable

iii. Ps theory is FRAUD

1. Carlton had very little capital in the business, paid out much of the corporations cash, and only carried the minimum insurance coverage required by law

iv. Court determines that W does not make a claim because they allege no allegations that he conducted the business in a personal capacity

v. Minimum Capitalization Principle

1. Court notes that there is not minimum capitalization requirement in NY

a. DE does not have one either

b. TX used to have one, but changed

c. This is a policy decision where the legislatures have decided that it is more important to encourage business growth rather than provide for adequate capital in the event of claims made

vi. Minimum Insurance

1. He complied with the statute, and therefore any more would be a decision for the legislature

vii. RAGAZZO: The only thing you could allege that he has done wrong is siphoning off money

1. It is unlawful for a corporation to make a transfer without adequate consideration if it puts you in financial problems

a. 4 Uniform Fraudulent Transfer Act

2. You cannot intentionally cause inadequate capitalization once the business has begun . . . this is fraud

a. In a piercing claim, you just need to show some siphoning in order to get to the owner of the corporatione. MINTON v. CAVANEY (CA)i. Cavaney was the attorney for a corporation that ran a swimming pool. He also acted as secretary, treasurer, and director. The company followed no formal procedures and was inadequately capitalized. Now its bankrupt. Little girl drowns in the pool

1. Issue is whether it is appropriate to pierce the veil

ii. Inadequate capitalization by itself is not enough to pierce the veil

1. But it is always a factor

2. Failure to follow formalities can also play into piercing the veil if the corporate structure is disregarded

a. In this case, the company had both factors cutting against them

iii. The court determines piercing was appropriate

1. Business was inadequately capitalized

2. Failed to follow formalities

a. Records were kept in Cavaneys office

iv. The way this case reads, it makes it look like inadequate capitalization might be enough for veil piercing

1. RULE ( Many courts will hold that inadequate capitalization plus failure to follow procedures would be enough to pierce

a. The court that would not follow this rule would argue that failure to follow procedures can never be a factor because of our policy toward small business that they do not have to follow formalities

b. TX ( explicitly states that failure to follow formalities should not be considered in veil piercing context

2. This case could have come out either way . . . it just depends on the view of the particular court

***Siphoning is always always a justification, but beyond that its up for grabs . . . it will depend on how the judge feels about the actions in relation to how unfair the actions are to creditorsf. SEA-LAND SERVS v. PEPPER SOURCE

i. This is an extreme case of a man who owned several corporations. All of the companies shared money and the owner took personal loans out from each corporation

1. The more significant aspect of this case is that it is a contract case

ii. RULE

1. A corporate entity will be disregarded and the veil of limited liability pierced when two requirements are met

a. 1) There must be such unity of interests and ownership that the separate personalities of the corporation and the individual no longer exists; and

b. 2) Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice

2. Factors

a. Failure to maintain adequate records or comply with formalities

b. The commingling of funds or assets

c. Undercapitalization

d. One corporation treating the assets of another corporation as its own

iii. Contract Context

1. Usually, courts will say that the other party could have required the owner of the corporation to personally guarantee the contract

2. States are split

a. TX (statute) ( no veil piercing in contracts cases unless there is an actual fraud on the creditors

b. Middle Ground ( use all of the same weight factors unless there is an actual fraud on creditors

c. Sea Land ( apply the rule the exact same as in a tort case

g. UNITED STATES v. BESTFOODS

i. The plaintiff is trying to do something slightly different in this situation. They are seeking to hold the parent liable without piercing the subs veil on the ground that the parent directed the subsidiarys operations.

1. As a result, P seeks to make the parent directly liable rather than vicariously liable

ii. This case shows that you are still liable for what you did yourself

1. Here, the parent took direct control of environmental clean-up from the sub

a. Therefore they are directly liable

iii. Where individual wears more than one hat for parent and sub:

1. Just because he is liable as an officer of the sub does not mean that the parent is automatically liable

a. You still need to build your Atex case that he was acting in the role as officer of parent rather than officer of subVIII. Equitable Subordination of Shareholder Claims

a. RULE ( When a corporation is in bankruptcy, debt claims that a controlling shareholder has against the corporation may be subordinated to the claims of other persons, including the claims of preferred shareholders, on various equitable grounds.i. The import of this rule allows the court to put parent corporation at the back of the line if they find that parent acted unfairly in managing the sub.

1. Undercapitalization seems to play an important role

b. Not as much of a penalty as rescinding a fraudulent conveyance or piercing veil, but just another tool in the courts bag when they find mismanagement and questionable arrangements

c. Uniform Fraudulent Transfer Act

d. Bankruptcy Code 548

SHAREHOLDER INFORMATIONAL RIGHTSI. Shareholder Informational Rights Under State Lawa. Inspection of Books and Records

i. DGCL

1. 219

2. 220 ( shareholders can investigate matters reasonably related to their interests as stockholders including corporate wrongdoing

a. (c) shareholder has the burden of proof to show his purpose is proper for the types of records that he wants

ii. SAITO v. MCKEESON, INC

1. Shareholder suspects serious accounting wrongdoing so he wants to see the books so that he can implement a derivative suita. The issue is what limitations on this right exist

2. 220

a. Must show proper purpose

i. Once established an secondary improper purpose will not bar the information3. No fishinga. You have to have some objective reason to believe that the corporation did something wrong

i. Inspection right is limited to those books and records that are necessary and essential to accomplish the stated, proper purpose

b. In this case, he had enough proof because they voluntarily released the adjusted financials for the previous three years

4. Standing Problem

a. Company wont give up records from before P was an owner . . . cites analogy to contemporaneous-ownership rule

i. Requirement under derivative action

b. The court rejects the companys argument

i. The inquiry is reasonably related to his complaint

ii. Even where in pursuit of derivative action:

1. Exception ( where the claim involves a continuing wrong that predates purchase

c. RULE ( the date on which the stockholder first acquired the corporations stock does not control the scope of records available under 220

i. If pre-purchase activities are reasonably related to the stockholders interest as a stockholder, then the stockholder should be given access

5. Third-Party Documents

a. Corporation objects to providing document prepared by outside advisors

b. RULE ( the source of the documents and the manner in which they were obtained by the corporation have little or no bearing on a stockholders inspection rights.

6. Subsidiary Documents

a. RULE ( stockholders of a parent are not entitled to inspect a subs books and records absent a showing of a fraud or that a sub is in fact the mere alter ego of the parentiii. General Rules

1. Common Law ( a shareholder acting in good faith for the purpose of advancing the interests of the corporation and protecting his own interest as a stockholder has a right to examine the corporate books and records at reasonable times

a. Most state have enacted more restrictive statutes

2. Mixed Purposes

a. Once it is determined that the shareholder has a proper purpose, any improper secondary purpose is irrelevant

iv. PILSBURY v. HONEYWELL (Minn.)1. Honeywell was making munitions for Vietnam war; Pillsbury opposed the war and was a shareholder. They wanted Honeywells shareholder list in order to make proposal to end munitions manufacturing at the companya. Burden is on the corporation to show the improper purpose

2. Corporation objects because this is a political motive and not an economic motive

a. Stockholder claims that they have a right to communicate with other sharheolders

b. Court agrees with Honeywell and says that the real purpose is to oppose the Vietnam War and this is not a proper purpose

3. CREDIT BUREAU CASE (DE)

a. Rejects this Pillsbury Case as it applies to requests for stockholder lists

i. The desire to solicit proxies for a slate of directors in opposition to management is a purpose reasonably related to SHs interest

1. Any secondary purpose in seeking the list is irrelevant

b. Pillsbury plaintiff would be able to get the shareholder list under this Delaware rule

v. How do you counteract the Credit Bureau Case rule?

1. Keep the stock held in the name of the investing institutions (e.g., Goldman Sachs, Meryl Lynch, etc.).

a. People who want stockholder lists really want a NOBO list

i. This is the list of beneficial owners who tell the investing institutions how to vote and where to send their dividend

1. Investing institutions supply corporation with this information

b. DE ( the company has to give you a NOBO list if they have one, but do not have to create it for you if they dont have access to onei. Puts you on the same ground as the company in case of a proxy fightII. Proxy Contests

a. ROSENFELD v. FAIRCHILD ENGINE

i. New board of insurgents agreed to pay both sides expenses in a proxy context. 1. P challenges the propriety of these payments

ii. Incumbant Directors

1. RULE ( Incumbant directors have the right to incur reasonable and proper expenses for solicitation of proxies and in defense of their corporate policies, and are not obligated to sit idly bya. Limitation:i. Good faith

ii. Not a purely personal power contestiii. Not grossly excessive spending

b. The company has an obligation to figh