Business Associations (Professor Casey, Fall 2008)1. Essential Agency Law Concepts

1.1. Agency - the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, AND consent by the other so to act (consent by both required)1.1.1. Restatement (Third) 1.01; p. 4-6 of textbook

1.1.1.1. You do not have to have consideration for agency

1.1.2. General notes:

1.1.2.1. Fiduciary duties of agents include the duty of care, the duty of loyalty, and the duty of disclosure

1.1.2.1.1. Care - exercise the degree of care and skill that would be the standard in the locality; duty to act within the scope of your authority; duty is nonwaivable

1.1.2.1.2. Loyalty - agent must act for the sole benefit of the principal

1.1.2.1.2.1. Cannot profit from the agency except as agreed; confidentiality

1.1.2.1.2.2. Duty can be waived in part

1.1.2.1.3. Disclosure - agent has to promptly provide information to the principal

1.1.2.1.3.1. Nonwaivable

1.1.2.2. Agency costs - when you have someone acting on your behalf, that can give rise to liability

1.1.2.2.1. Divergence costs - agents behave differently than how the principals want them to behave

1.1.2.2.2. Monitoring costs - the costs of trying to make sure that the agents are doing what you want

1.1.2.2.3. Incentive costs - when you provide incentives to get them to do what you want

1.1.2.2.4. Bonding costs - when you try to get them on the same page as you, to get them to do what you want them to do (like by giving stocks)

1.1.2.3. An artificial entity can act only through agents

1.1.2.4. Partnerships involve the law of agency, with each partner being an agent for the partnership

1.1.2.5. The most common agency relationship is the employment relationship

1.1.2.6. Basic fiduciary duty runs only from agent to principal

1.2. Master - A principal who employs an agent to perform service in his affairs and who controls or has the right to control the physical conduct of the other in the performance of the service1.2.1. Servant - an agent employed by the master

1.2.2. Independent contractor - a person who contracts with another to do

something for him but who is not controlled by the other nor subject to the other's right to control with respect to his physical conduct in the performance of the undertaking

1.2.2.1. Can either be, or not be, an agent

1.3. Authority - the power of the agent to affect the principal's rights and duties1.3.1. Actual authority (RTA 2.01) - at the time of taking action, the agent

reasonably believes, in accordance with the principal's manifestations to the agent, that the principal wishes the agent to so act

1.3.1.1. Express

1.3.1.2. Implied

1.3.1.2.1. Also, respondeat superior - the employer is responsible for the torts of his/her employee if acting w/in the scope of employment

1.3.2. Apparent authority (RTA 2.03) - the power held by an agent or other actor to affect a principal's legal relations with third parties when a third party reasonably believes that the actor has authority to act on behalf of the principal and that belief is traceable to the principal's manifestations

1.3.2.1. The difference b/w the two types of authority is that actual authority flows from the principal to the agent whereas apparent authority flows from the impression created by the principal in the mind of a third person

1.3.2.1.1. Third party MUST have had some contact with the principal

1.3.2.2. In many instances, the scope of apparent authority is as broad as an agent's actual authority

1.3.3. Inherent authority - arises from the agency itself and without regard to either actual or apparent authority (RTA 2.11)

1.3.3.1. Authority arising by implication from the authority actually or apparently granted

1.3.4. Incidental authority

1.3.4.1. Authority to do incidental acts that relate to a transaction that is authorized

1.3.5. Implied authority - authority that may be inferred from a prior course of conduct by the principal

1.3.5.1. Apparent authority is destroyed if the third party knows, or has reason to know that A is no longer authorized to act for P

1.4. Disclosed and undisclosed principals1.4.1. Disclosed - a principal is disclosed if the third party knows the

identity of the principal at the time the transaction is entered into

1.4.1.1. The principal becomes party to the contract; the agent does not

1.4.2. Partially disclosed principal - one whose identity is unknown but the third person is on notice that the agent is in fact acting on behalf of some principal

1.4.2.1. The partially disclosed principal becomes immediately bound to any authorized contracts entered into by the agent

1.4.3. Undisclosed principal - a principal is undisclosed if the third party is not aware that the agent is acting on behalf of anyone when in fact the agent is acting on behalf of the principal

1.4.3.1. The agent becomes personally liable, and has the rights and remedies available to any party to a contract

1.4.3.2. The undisclosed principal is also liable ot the third part if the agent was acting within the scope of his actual authority

1.5. Termination of Agency relationships (which are consensual). Terminated when:1.5.1. The objective of the relationship has been achieved

1.5.2. When the agent dies or becomes incompetent

1.5.3. When the principal or agent determines to end it

1.5.3.1. If the relationship is based on contract, the decision to terminate it may be a breach of contract

1.5.3.2. But APPARENT authority only ends when it is no longer reasonable for the third party to think there is an agency relationship (3.11)

2. Business Forms and the Problem of Agency Costs (CHART ON P. 192)2.1. Forms:

2.1.1. Sole proprietorship - a business owned by a single person

2.1.1.1. The owner is personally liable for all business obligations

2.1.1.2. Most common type of business in the US

2.1.1.3. No statutes govern formation; the only formality is that the name of the business must be registered

2.1.2. General Partnerships (GP) - See UPA 6, and 7(3); and RUPA 202

2.1.2.1. The default form for business that is owned by more than one person, if nothing else is specified

2.1.2.2. An oral agreement to share profits may be sufficient to establish the existence of a general partnership; written is better

2.1.2.2.1. Profit-sharing is a hallmark of partnerships

2.1.2.3. Very fragile - according to 1997 UPA, a partner may leave the partnership at any time

2.1.2.4. Disputes may be resolved by dissolution or dissociation if all else fails

2.1.3. Limited Partnerships (LP) - See ULPA

2.1.3.1. Exclusively a creature of statute

2.1.3.1.1. In the absence of statute, all partners are general partners, regardless of their private understanding

2.1.3.1.2. Uniform Limited Partnership Act of 1976

2.1.3.1.2.1. A limited partner is not liable for the obligations of a limited partnership unless he is also a general partner or he participates in the control of the business

2.1.3.1.3. Limited Partnership w/a Corporate General Partner - involves the use of a corporation as the sole general partner

2.1.4. Limited Liability Partnership (LLP)

2.1.4.1. Is NOT a limited partnership!

2.1.4.2. A general partnership in all respects except that BY STATUTE the partners have no personal liability for obligations that exceed the assets of the general partnership

2.1.4.2.1. Exception: Partners in an LLP have full personal liability for claims arising from their own misconduct

2.1.4.3. Particularly popular among law and accounting firms

2.1.4.4. LLP designation MUST be in the name of the company, in order to put third parties in notice

2.1.5. Limited Liability Limited Partnership (LLLP)

2.1.5.1. A limited partnership with both general and limited partners, but the general partners have the protection of the LLP election

2.1.5.2. Used only in certain relatively narrow situations

2.1.6. Limited Liability Company (LLC)

2.1.6.1. Provides limited liability for all participants, whether or not they are active in the management of the business

2.1.6.2. Permits total flexibility in internal management

2.1.6.3. Essentially, provides the benefits of the corporation without the limitations and rules applied to corporations

2.1.6.4. No participant is personally liable for firm obligations

2.1.6.5. Approved in all 50 states

2.1.6.6. Formed by filing a document with the state official

2.1.7. The Corporation

2.1.7.1. Formed by following the procedures set forth in the incorporation statute

2.1.7.2. Existence begins upon the filing of the Articles of Incorporation

2.1.7.3. Provides limited liability for all investors and participants

2.1.7.4. Consists of three tiers:

2.1.7.4.1. The shareholders, who are the ultimate owners

2.1.7.4.1.1. Shareholders rights: 1. Vote. 2. Sell. 3. Sue.

2.1.7.4.2. The board of directors

2.1.7.4.3. The officers, who implement the decisions of the directors

2.1.7.4.3.1. A single individual may simultaneously act as shareholder, director, and officer

2.1.7.4.3.2. There is typically separation of ownership and control in large public corporations; investment is separated from management

2.2. Theories of the firm:2.2.1. Traditional

2.2.1.1. An entity created by the state

2.2.1.2. Shareholders are the owners are the firm and so the corporation should be managed in their interests

2.2.2. Nexus-of-contracts

2.2.2.1. The firm is not an entity that is capable of being owned, because the corporation is a bunch of contracts, and contracts cannot be owned

2.2.2.2. Models the firm not as a single entity, but as an aggregate of various inputs acting together with the common goal of producing goods or services

2.2.2.3. The role of the state is to enforcing private contracts, which found the corporation

2.2.2.4. However, the corporation should still be managed in the shareholders interests because it is the most efficient result

2.2.3. Team Production Model

2.2.3.1. Corporate assets belong not to shareholders but to the corporation itself

2.2.3.2. Shareholders, directors, and officers benefit from "team" production

2.2.3.3. Boards exist not to protect shareholders per se, but to protect the enterprise-specific investments of all members of the corporate team

2.2.4. Stakeholder

2.2.4.1. You worry about everyone who has a stake in the company, not just the shareholders

2.3. Types:2.3.1. Closely held - one or a few owners

2.3.2. Publicly held - hundreds or thousands of owners

2.3.2.1. The fundamental dividing line between closely held or publicly held is whether a public market exists for ownership interests in the business

2.4. Why Choosing the Form Matters:2.4.1. Decisions binding the firm - who makes them

2.4.2. Legal rights and responsibilities, especially regarding debts

2.4.3. Taxation

2.4.4. Disclosure - how often the firm must disclose information about its operations and financial condition

3. Partnership Basics and Problems of the Modern Law Firm3.1. The Partnership

3.1.1. Need for a written agreement, because this may avoid future

misunderstandings

3.1.1.1. In the absence of a written agreement, the relationship b/w the partners will be governed by the provisions of the applicable state partnership statute

3.1.2. Sharing of Profits and losses

3.1.2.1. May be done on a flat percentage basis, fixed by salary, or on a percentage

3.1.3. UPA (1997)

3.1.3.1. All liability is joint and several

3.1.3.2. Radical change: It reverses the general rule of individual partner responsibility for most partnership debts if the partnership has elelcted to be a limited liability partnership

3.1.3.3. A judgment creditor must first exhaust partnership assets before proceeding directly against one or more partners

3.1.4. General partners can force dissolution if it is not in the agreement

3.1.5. Departing partners must give notice before departing

3.1.6. Expulsion is allowed, but you need to show bad faith of that partner (typically)

3.1.6.1. Generally, this is conduct outside business decisions

3.1.6.2. If dissolution is forced, you must dissolve and force a new partnership

3.1.6.2.1. Otherwise, there is just a buy-out of the ousted partner's interest

3.2. Limited Liability Partnerships3.2.1. Statutes

3.2.1.1. Broad shield statutes - protection against tort and contract; you're liable only for yourself

3.2.1.2. Narrow shield statutes - only tort protection; you are liable for your partners' business decisions

3.2.2. "LLP" must be in the name

3.2.3. In this business form, everyone is still a manager; in limited partnerships, there are general and limited partners, and limited partners don't manage

3.3. Law Firm Partnerships3.3.1. Most are now LLPs, since they are not taxed, whereas LLCs are

subject to franchise taxes

3.3.2. Reasons that associates cite when departing a firm:

3.3.2.1. To stay home (mostly women)

3.3.2.2. Leaving for a position that has less money but better hours

3.3.3. "Cash and carry" associates - the associates who come to your form are associates who are willing to work high hours, but only in the short term, in order to be able to pay off student loans, put some in savings, and ultimately leave the firm after a few years

3.3.4. Levers of Law Firm Profitability (Factors that affect profitability):

3.3.4.1. Billing Rates - increased billing rates leads to increased profits

3.3.4.2. Realization - the value of the Hours Worked x Your Billing Rate, divided by Fees Collected

3.3.4.3. Leverage - the ratio of attorneys who do not have equity (mostly associates) divided by the number of equity partners

3.3.4.3.1. If you increase the number of attorneys without equity, you have higher leverage, and the average profit per partner increases

3.3.4.4. Utilization (Productivity)

3.3.4.5. Margin (Costs)

3.3.5. Bane v. Ferguson - See UPA (1997) 9(3)(c)

3.3.5.1. Firm dissolved, and Bane sued b/c he lost his retirement benefits

3.3.5.1.1. Claim of violation of UPA - rejected b/c the cited provision of the act was to protect partners, not former partners

3.3.5.1.2. Claim of violation of fiduciary duty - partners have fiduciary duties to other partners, but not to former partners

3.3.5.1.3. Claim of breach of contract - There was no breach b/c the plan instrument expressly decrees that the death of the plan was upon the dissolution of the firm, and nowhere was there a commitment to maintain the firm in existence

3.3.5.1.4. Claim of violation of the duty of care - there is no precedent for imposing tort liability on careless managers for the financial consequences of the collapse of the firm

4. Partners' Rights, Fiduciary Duties, and Potential Liabilities4.1. Partners' Rights and Liabilities

4.1.1. Partners are liable to third parties as principals

4.1.2. Partners are jointly and severally liable for the debts of the business

4.1.3. Partners are general agents of the partnership

4.1.4. Partners share equally in control, unless they agree otherwise

4.2. Partners' Fiduciary Duties:4.2.1. Common law duties:

4.2.1.1. Duty of Care

4.2.1.2. Duty of Loyalty

4.2.1.3. Duty of Disclosure

4.2.2. Duties under Statute:

4.2.2.1. UPA 404 - restricting the scope of common law duties

4.2.2.2. UPA 103 - contracting out of common law duties

4.2.3. Fiduciary duties are fundamental to the partnership relation because of the agency power of the partnership to bind other partners

4.2.4. Meinhard v. Salmon

4.2.4.1. Salmon leased the Hotel Bristol for 20 years, and relied on

Meinhard for the necessary funding; Salmon operated the business, and Meinhard got 40% of the profits for the first five years and 50% thereafter; both parties were to bear losses equally

4.2.4.1.1. After the lease was up, Salmon entered into a new lease, this time without Meinhard, for 20 years, with options for renewal up to 80 years

4.2.4.1.2. Salmon told Meinhard nothing about this lease; when Meinhard found out, he demanded that the lease be held in trust as an asset of the venture

4.2.4.2. Legal result:

4.2.4.2.1. Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of loyalty

4.2.4.2.1.1. Meinhard had been given no chance to compete

4.2.4.2.2. Salmon didn't disclose, and Salmon was not loyal

4.2.4.2.3. "A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate."

4.2.5. UPA, Section 6, defines partners

4.3. Documents4.3.1. Certificate of limited partnership

4.3.2. Partnership agreement

4.3.2.1. When docs are in conflict, if the conflict is between partners, the partnership agreement prevails

4.3.2.2. When docs are in conflict, if the conflict is between a partner and 3rd party, the certificate prevails

4.4. UPA 404, Fiduciary duties of loyalty and care defined4.4.1. UPA (103) - Effect of Partnership Agreement

4.4.1.1. Partnership may NOT eliminate the duty of loyalty; but agreement may identify specific types or categories of activities that do not breach the duty of loyalty

4.4.2. NABISCO v. Stroud - deals with a partner's actual authority

4.4.2.1. What either party does with a third person is binding on the partnership

4.4.2.2. All partners are jointly and severally liable for the acts and obligations of the partnership

4.4.2.3. Nothing in the agreement restricted Freeman's power and authority, so he could bind the firm

4.4.2.4. UPA s 18(h) - Disagreements are to be settled by a majority of owners

4.4.2.4.1. Since there was no majority (each owned 1/2), Stroud could not restrict Freeman's authority

4.5. Management of Partnerships4.5.1. Partners have equal rights to participate in management and

conduct the partnership's business

4.5.2. Each partner has one vote

4.5.3. Majority determines ordinary course decisions

4.5.4. Unanimity required for acts outside the ordinary course and to amend partnership agreement

4.5.5. Each partner has right to full and complete information about the partnership and its business

4.5.6. Partners may contract for classes of voting and financial rights

4.6. Partners' authority4.6.1. Partners have actual and apparent authority to bind the firm to

obligations relating to the business of the partnership

4.6.2. Each partner is an agent of the partnership

4.6.3. Partners may define the authority of each partner by agreement

4.6.3.1. Smith v. Dixon - A partnership is bound by the acts of a partner when he acts within the scope, or apparent scope, of his authority

4.6.4. Key provisions: UPA 9 and RUPA 301

4.6.4.1. It's not just the business of the partnership in question; it's the business of the KIND carried on by this particular company

4.6.4.2. Rouse v. Pollard - Partner's conduct was not within the course of business of the practice of law within NJ, and so his partners were not liable for his conduct

4.6.4.2.1. But see 306(c), which caused a different result in Roach v. Mead

4.7. Transferability4.7.1. Limited partners can transfer their interests; general partners

cannot

4.7.1.1. This is because general partners have managing power and limited partners do not

5. Partnership End Games: Dissociation and Dissolution5.1. Statutory provisions

5.1.1. UPA (1914)

5.1.1.1. UPA (1914) s 29 - "Dissolution" is defined as a change in legal relationship "caused by any partner ceasing to be associated in the carrying on of the business."

5.1.1.1.1. This definition refers to a change in the personal relationships among partners within the partnership and has nothing to do with the disposition of assets, or closing down or selling the business

5.1.1.2. UPA (1914) s 30 - "Termination": Partnership ceases entirely at the end of winding up

5.1.1.3. UPA (1914) s 37 - "Winding Up": Orderly liquidation and settlement of partnership affairs

5.1.2. RUPA (1997)

5.1.2.1. S 801 - "Dissolution": the onset of liquidating of partnership assets and winding up its affairs (differs significantly in meaning from 1914 UPA)

5.1.2.2. S 601 - "Dissociation": a partner leaves, but the partnership continues

5.1.2.2.1. If business continues, RUPA Article 7

5.1.2.2.2. If business is going to wind up, RUPA Article 8

5.1.2.2.3. S 602 - "Wrongful dissociation"

5.1.2.2.4. When does dissolution follow dissociation?

5.1.2.2.4.1. 801.1 - In an at-will partnership, where a partner dissociates under express will

5.1.2.2.4.2. 801.2 - Expressed will of at least half of the remaining partners to wind up the partnership business

5.2. Grabbing and Going Issues5.2.1. Occurs when a dissociating partner tries to take other partners,

associates, and support staff (and maybe even clients) with him to a new firm

5.2.2. Partner who is going to defect can plan in his/her head the departure, but is limited in the amount that he/she can execute on that plan before departure

5.2.2.1. Planning to leave does NOT violate the partner's fiduciary duties, but he may not compete with the firm while he is still there

5.2.2.2. Key issue: The client should have the right to choose who his attorney is, and has a right to follow the attorney to a new firm

5.2.2.3. Partners are prohibited from sharing confidential information with their new firms

5.2.3. Fiduciary duties of departing partners:

5.2.3.1. It is ok to discuss a desire to leave with a colleague

5.2.3.2. It is NOT ok to send out confidential information from old employer to new employer

5.2.3.2.1. Once at new employer, if you happen to REMEMBER this information, it might be ok to share it...you just cannot take thedocuments and such with you

5.2.3.3. It is ok to recruit partners and associates while at the old firm,but only AFTER you've announced you're leaving

5.2.3.4. It is NOT ok to transmit to the new employer salary information about employees at the old firm

5.2.3.5. It is ok to take one's own personal desk file

5.2.3.5.1. Gibbs v. Breed, Abbott, and Morgan provides these rules

5.2.4. Reverse gravity - occurs when a lawyer dissociates, he doesn't try to bring a client with him, and the firm doesn't try to pick up that client's work

5.2.4.1. Malpractice liability and grievances can result

5.3. Buy/Sell Agreements

5.3.1. Redemption agreements - the firm/entity purchases the shares of the departed partner

5.3.1.1. Used when there are more than 2 or 3 partners

5.3.2. Cross-purchase agreement - some or all of the remaining partners will buy the departing partner's share

5.4. Expulsion of a Partner5.4.1. In the absence of something in the partnership agreement

authorizing expulsion, there is no common-law right to expulsion

5.4.1.1. If the partnership agreement includes an expulsion provision, then the statute supports the partnerships right to expel - See UPA 31(1)(d)

5.4.1.1.1. "Dissolution is caused without violation of the agreement between the partners by the expulsion of any partner from the business bona fide in accordance with such a power conferred by the agreement between the partners"

5.4.1.1.2. Also see RUPA 601(3)

5.4.1.1.2.1. "A partner is dissociated from a partnership upon the occurrence of any of the following events: the partner's expulsionpursuant to the partnership agreement"

5.4.2. In the absence of an expulsion provision in the agreement, what can the firm do to expel a partner?

5.4.2.1. Firm must dissolve the partnership, and then immediately re-form without the undesirable partner

5.4.2.2. The downside is that they must distribute some assets to the unsavory partner

5.4.3. Limit to expulsion

5.4.3.1. Good faith, which cannot be waived

5.4.3.1.1. Acting in "bad faith" is acting in an economically predatory manner

5.4.3.1.2. Expulsion of a partner motivated by economic self-interest would be the only manifestation of bad faith

5.4.3.1.2.1. Bohatch v. Butler & Binion - Bohatch was NOT expelled for economic reasons, and thus the expulsion was upheld

5.4.3.1.2.1.1. "A partnership exists solely because the partners choose to place personal confidence and trust in one another." Since they couldn't trust Bohatch, they had a right to expel her (NB: there WAS an expulsion provision in agreement)

6. Inadvertent Partnerships and Concluding Matters6.1. At common law, a sharing of profits was often deemed

conclusive of the existence of a partnership

6.2. Statutory solutions:6.2.1. UPA (1914) s 6, 7

6.2.1.1. Section 7.4 states that such sharing is "prima facie evidence" of a partnership except that in certain cases "no such inference shall

be drawn"

6.2.2. RUPA s 202(c)(3) states that a person who receives a share of the true profits of a business "is presumed to be a partner" unless the payments are received in some other capacity

6.3. Case law6.3.1. Martin v. Peyton

6.3.1.1. Shows that there is a difference b/w a lender and a partner

6.3.2. Smith v. Kelley - focuses on the INTENT to create the partnership

6.3.2.1. "A partnership is a contractual relationship, and the intention to create it is necessary"

6.3.2.1.1. All parties must have this intent

6.3.2.1.2. The conduct of the parties over a 3 1/2 year period confirms that,although appellant was held out to the public as a partner, between themselves a partnership relationship was not intended to be and was not created

7. Introduction to Limited Partnerships7.1. Elements of the Partnership Relation

7.1.1. See UPA s 6, RUPA s 202

7.1.2. Four Elements of a partnership

7.1.2.1. An Association

7.1.2.2. Of Two or More Persons

7.1.2.3. To Carry On as Co-Owners in a Business

7.1.2.4. For Profit

7.1.3. Summary of the Four Indicia of Partnership

7.1.3.1. Did the participants in the enterprise agree to share profits?

7.1.3.2. Did they agree to share losses?

7.1.3.3. Was there a community of interest, a focus on a common commercial enterprise?

7.1.3.4. Who exercised control over the enterprise?

7.2. Doctrine of Partnership by Estoppel7.2.1. UPA s 16, RUPA s 308

7.2.2. Elements

7.2.2.1. IF a person represents himself as being a partner in an enterprise

7.2.2.2. AND a third party reasonably relies on the representation and does business with the enterprise

7.2.2.3. THEN the person who was represented as a partner is personally liable on the transaction, even though that person was not in fact a partner

7.2.3. Partnership by estoppel protects third parties ONLY, and does not create partnership rights and duties between partners and putativepartners

7.3. Limited Partnerships7.3.1. Every state except Louisiana has adopted the Uniform Limited

Partnership Act of 1985

7.3.1.1. Two classes of owners: General Partner (usually a corporation, since not many want liability) and Limited Partners

7.3.1.1.1. You need at least two partners.

7.3.1.1.2. Two classes: one general, one limited.

7.3.2. The Control Rule - A limited partner shall not become liable as a general partner unless, in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business

7.3.2.1. Safe harbors that would be excluded from this control rule are in RULPA 303(b)

7.3.2.1.1. ReRULPA has only been enacted by 15 states

7.3.3. Characteristics of Limited Partnerships

7.3.3.1. Formation and Function of Registration

7.3.3.1.1. Certificate of limited partnership from secretary of state

7.3.3.1.2. The name must contain the abbreviation "LP," in order to provide notice

7.3.3.1.3. Either a written agreement (partnership agreement) will govern the relationship, or the ULPA rules will apply

7.3.3.2. Profit and Loss Sharing

7.3.3.2.1. Proportional - Limited Partners share according to their share of contributions

7.3.3.2.1.1. Unlike general partnerships, in which, under the UPA, partners share profits and losses equally

7.3.3.3. Management and control

7.3.3.3.1. General partners' rights and duties

7.3.3.3.1.1. GPs have the primary authority to manage the business

7.3.3.3.1.2. Save fiduciary duties (loyalty/care) as partners under UPA

7.3.3.3.2. Limited Partners rights and duties

7.3.3.3.2.1. LPs have no fiduciary duties

7.3.3.3.2.1.1. Can acquire duties by acquiring a right to control

7.3.3.3.2.2. Not an agent

7.3.3.4. Partner's fiduciary duties

7.3.3.4.1. Loyalty, care, good faith, if a GENERAL PARTNER

7.3.3.5. Liability to third persons

7.3.3.5.1. General partners:

7.3.3.5.1.1. Agents of the partnership

7.3.3.5.1.2. Unlimited liability for the debts of the business

7.3.3.5.2. Limited partners:

7.3.3.5.2.1. Not agents. no authority to bind the partnership.

7.3.3.5.2.2. With rare exception, are not liable for the debts of the business

7.3.3.5.2.2.1. Old rule: LP treated as a GP when participating in

management - the right to control $ was enough

7.3.3.5.2.2.2. ULPA Rule: Not liable, even when making decisions and participating in management and control of partnership - Sec. 7 (1916)

7.3.3.5.2.2.3. Most states: Control rule - limited partner isn't liable unless also a GP, or if LP takes part in control of the business. In such cases, the LP is considered a GP only to those third parties transacting with the LP and who REASONABLY BELIEVE the LP is a GP and would have same liability as a GP

7.3.3.5.2.3. To the extent LPs are liable, their liability is limited to the capital they promise to contribute

7.3.3.5.2.3.1. ReRULPA changes - said it was ok for a corporation to act as the GP in a limited partnership

7.3.3.5.3. Admissions of new partners

7.3.3.5.4. Dissociation

7.3.3.5.4.1. General partners: same as for P's in a general partnership

7.3.3.5.4.1.1. No dissolution

7.3.3.5.4.1.2. GP becomes a mere economic interest holder - look to limited partnership agreement

7.3.3.5.4.1.3. No mandatory buyouts

7.3.3.5.4.1.3.1. LPs rely on management by GP; unfair to permit buyout

7.3.3.5.4.2. Limited partners

7.3.3.5.4.2.1. No right to dissociate

7.3.3.5.4.2.2. Sections 602 and 603 of ULPA (1976)

7.3.3.5.4.2.3. If the partnership agreement is silent as to withdrawal, the limited partner will be engaging in a wrongful dissociation if he tries to withdraw inappropriately

7.3.3.5.4.2.4. Limited partner becomes a mere 'interest holder" in the enterprise. Retains only the right to distributions

7.3.3.5.5. Dissolution

7.3.3.5.5.1. Judicial dissolution

7.3.3.5.5.2. If a limited partnership ceases to have two partners, one who is an LP and another who is a GP, the LP automatically dissolves after 90 days

7.3.3.5.6. Transferability

7.3.3.5.6.1. General partners can't transfer their interest unless the agreement permits it or all the GPs agree

7.3.3.5.6.2. Limited partners' interests are assignable - free transferability of economic interests

7.3.3.5.7. Tax Advantages

7.3.3.5.7.1. Flow-through taxation is attractive to passive investors

7.3.3.5.7.1.1. In flow-through taxation, the earnings are taxed as personal income in the hands of the partner; the firm itself is not taxed

7.3.3.5.7.1.2. Kitner regulations - a firm not incorporated under state law might be considered as a corporation for tax purposes (BAD)

7.3.3.5.7.1.2.1. This was done away with via the IRS "check the box" scheme

7.3.4. 21st century limited partnerships: LPs still the clear choice for venture capital funds and Family Limited Partnerships, but not much

else

7.3.4.1. Venture Capitalists often sit on the boards of the companies they capitalize

7.3.4.1.1. Venture capital funds often have a corporate general partner

7.3.4.1.1.1. Venture capital funds invest in new companies without a proven track record

7.3.4.2. FLPs permit savings on gift and estate taxes because these taxes are calculated on the basis of the value of the interest received by the donee, not the cost of the interest to the donor

7.3.4.2.1. Parents organize and manage the partnership (as GPs)

7.3.4.2.2. Gift limited partner units up to the annual gift tax exclusion

7.3.4.2.2.1. Used for estate planning and tax avoidance

8. Limited Liability Companies (LLCs)8.1. Purpose of an LLC - to create an entity that offers investors

the protections of limited liability (like corporations) and the flow-through tax status of partnership8.1.1. 1) Limited liability; 2) separate legal entity; 3) defaults to partnership

tax features; 4) chameleon management; 5) creditor protection provisions

8.2. Statutes - Uniform Limited Liability Company Act8.2.1. Embodies more partnership concepts than most existing state LLC

statutes

8.2.1.1. Whether a court views an LLC as more like a corporation or a partnership determines how it will rule in a particular case

8.2.1.1.1. In 1994, the DE Supreme Court saw the LLC as like a corporation in Poore v. Fox Hollow Enterprises

8.2.1.1.2. In 1999, it saw the LLC as like a partnership in Elf Atochem NorthAmerica, Inc. v. Jaffari and Malek LLC

8.2.1.1.2.1. Based this ruling on the LLC agreement, which resembled a partnership agreement

8.3. Background8.3.1. Started in Wyoming , and provided that LLC could be member-

managed, or manager-managed

8.3.2. In 1988, IRS issued a public ruling that classified WY LCCs as partnerships; that's all they needed to take off

8.3.2.1. 1997 - New IRS "check the box" system

8.3.3. Mostly replaced Subchapter S corporations - has all of the benefits and none of the drawbacks

8.3.4. Laws now vary WIDELY from state to state

8.3.4.1. Delaware is the leading jurisdiction

8.3.5. PLLCs - Professional LLCs - only a licensed professional in a profession listed in the statute can be in a PLLC

8.3.5.1. Each member of the PLLC is liable for his or her own acts, but

not liable for the acts of any other member of the PLLC

8.4. Characteristics8.4.1. Formation

8.4.1.1. File paperwork (Articles of Organization) with the designated state office, and pay a fee

8.4.1.1.1. Articles of Organization (also called a charter) must include the statutorily required information

8.4.1.1.2. The other key document (but NOT on file) is the Operating Agreement

8.4.1.1.2.1. It doesn't have to be in writing, but should be

8.4.1.1.3. LLC begins its existence when the Articles of Incorporation are FILED

8.4.1.1.3.1. If there is a conflict between the documents, the court will look at who the disputes are among to determine which document prevails

8.4.2. Management and Control

8.4.2.1. Manager-managed firm

8.4.2.1.1. The manager controls the business

8.4.2.1.2. Typically, managers are also members, but they don't need to be under most state laws

8.4.2.1.3. Managers are the agents of the LLC and have the apparent authority to bind the firm

8.4.2.1.4. Firm is liable for the torts of the manager-members

8.4.2.1.5. Firm is NOT liable for the torts of manager-nonmembers, unless typically liable under some form of agency law like respondeat superior

8.4.2.2. Member-managed firm (DEFAULT RULE)

8.4.2.2.1. If the operating agreement is silent as to how the firm is to be managed, it is assumed to be member-managed

8.4.2.2.2. Members have the authority to bind the firm

8.4.2.2.2.1. Members are agents of the firm

8.4.2.2.2.1.1. Have the broad authority that general partners would have in a general partnership

8.4.2.2.3. Firm is liable for the torts of the members

8.4.3. Authority

8.4.3.1. Third parties can seek out information of whether a member is a manager by seeking out state records in a separate document, theCertificate of Authority

8.4.3.1.1. An LLC that really wants to make clear the authority structure will file a Certificate of Authority, but this is not mandatory

8.4.3.1.2. It serves to put third-party creditors on notice

8.4.4. Voting

8.4.4.1. LLCs, if member-managed, are by majority vote

8.4.4.2. If manager-managed:

8.4.4.2.1. Managers are elected and removed by majority vote

8.4.4.2.2. Then, the managers will decide all matters, except those matters governed by statute

8.4.4.3. Members vote per rata (i.e., based on how many shares you own)

8.4.4.3.1. Default rule in half the states

8.4.4.3.2. In the other half, it's like a partnership rule - 1 member, 1 vote

8.4.4.3.3. New members of the LLC require a unanimous vote under many state laws

8.4.5. Limited Liability and piercing the corporate veil

8.4.5.1. Members can only lose what they've invested (this is the BIG ADVANTAGE of the LLC)

8.4.5.2. Manager-members usually enjoy the same liability as to third parties that non-member managers enjoy

8.4.5.2.1. Large creditors will thus demand that certain members co-sign on large loans

8.4.6. Fiduciary duties - Part of the default rule structure of the LLC

8.4.6.1. Who owes:

8.4.6.1.1. Duties owed by manager to members in manager-managed LLC

8.4.6.1.2. Duties owed by members to one another when LLC is manager-managed

8.4.6.1.3. Duties owed by members to one another in member-managed LLC (closest to duties in a GP)

8.4.6.2. Basic duties:

8.4.6.2.1. Duty of care - parties must act in a non-negligent manner, which means that they must act on an informed basis

8.4.6.2.2. Duty of loyalty - encompasses self dealing, as well as any actions that place the fiduciary in a role that competes with the LLC

8.4.6.2.2.1. It requires that transactions that pose conflicts of interest be structured and consummated so as to mitigate such conflicts and to protect the party to whom the fiduciary duties are owed

8.4.7. Transferability

8.4.7.1. Original WY statute wanted to make clear that the interests were NOT transferable, b/c it would then look more like a partnership

8.4.7.2. However, most statues now say members CAN transfer, so long as the operating agreement provides, or all LLC members consent

8.4.7.2.1. What gets transferred ends up looking more like the law of partnership interest (distributional interest)

8.4.7.2.1.1. The transferable interest does not give the transferee any right to manage the LLC or participate in the management

8.4.8. Continuity

8.4.9. Tax Advantages

8.4.9.1. LLCs can elect flow-through/check-the-box taxation

8.4.9.2. Use of S corporations before there was the LLC

8.4.9.2.1. How does an S corporation differ from an LLC

8.4.9.2.1.1. Subchapter S added to allow certain companies to be taxed like corporations

8.4.9.2.1.1.1. After IRS elected "check-the-box", it is unclear why companies would choose to elect S corporation status instead of LLC status

8.4.9.3. Why aren't LLCs used as a structure that the public can invest in?

8.4.9.3.1. LLCs wouldn't receive the pass-through tax treatment if they sold shares to the public

8.4.9.4. Why is an LLC more attractive than a limited partnership (LP)?

8.4.9.4.1. You don't have to find a general partner for an LLC like you do with an LP

8.4.9.4.1.1. i.e., you don't have to find a general partner to assume liability

8.4.9.4.2. The partners can take part in management in an LLC and still not be liable

8.4.9.4.3. There can be only one partner; thus, it is advisable to tell a sole proprietor to make his company an LLC with himself as the only limited partner

8.4.10. Name - "LLC" must be in the name

8.4.11. Comparison b/w LLC and S Corp. - You will never select S corp. unless you plan to be bought out or merge, as LLCs cannot do this without tax implications

9. Development of Corporate Law and Its Sources9.1. Overview (Remember that ownership is separate from control)

9.1.1. Formation - filing the appropriate documents with the secretary of state, such as Articles of Incorporation

9.1.1.1. File a certified copy of the Articles of Incorporation

9.1.1.2. Pay a filing fee

9.1.1.3. Filing will designate a local agent to receive service of process in that state

9.1.2. Firm Governance, management, and voting

9.1.2.1. Common voters select the board of directors

9.1.2.2. Board of directors elect the CEO and other officers

9.1.3. Authority to Bind the Firm

9.1.3.1. Control rests with the board of directors and its delegated agents, but the investment capital comes through shareholders, whohave very limited influence on the board of directors

9.1.3.2. Board has the ultimate authority to make decisions of the firm

9.1.4. Financial Rights and Capitalization

9.1.5. Liability to Third Parties

9.1.5.1. Limited Liability, except for piercing the corporate veil (shareholders) and violations of fiduciary duties (directors)

9.1.6. Taxation

9.1.6.1. Double Taxation if a C Corp; Pass through taxation if an S corp.

9.1.7. Transferability of ownership interests

9.1.8. Life span of the firm

9.1.8.1. Dissolution requires a majority of the outstanding shares

9.2. Development of Corporate Law9.2.1. Forming corporations

9.2.1.1. State statutes govern

9.2.1.2. Attributes of "plain vanilla" corporation at formation

9.2.2. Selecting State of Incorporation

9.2.2.1. Why Important: Internal Affairs Doctrine - the law of the state of incorporation is the law that governs the internal affairs of the company

9.2.2.1.1. Sole exception: California has sought to apply specific provisions of its corporation statutes to corporations formed in other states but whose principal business activities are in California

9.3. Why Delaware Wins (as the granting of corporate charters is primarily a state process, even though the Feds can do it)9.3.1. Four basic reasons:

9.3.1.1. Flexible, advanced statute that is pro-management

9.3.1.2. Legislature that is very responsive to management

9.3.1.3. Favorable state bar with experience in resolving business disputes

9.3.1.4. Court of Chancery has NO juries

9.3.2. Other factors:

9.3.2.1. DE cut the tax rates by at least half of the next-leading state

9.3.2.2. Was willing to listen to corporate management's ideas on how to revise the statute going forward

9.3.2.3. More than half of the corporations are incorporated there

9.3.2.4. About 20% of state's budget comes from franchise taxes from corporations incorporated there

10. Incorporating the Firm and Basic Corporate Documents10.1. Incorporation

10.1.1. Statutory provisions

10.1.1.1. Formal requirements for filing of documents: MBCA 1.20-1.26

10.1.1.2. Names: MBCA 4.01-4.03

10.1.1.2.1. Name must include an abbreviation for "incorporated"

10.1.1.2.2. Name has to be distinguished upon the records of the secretary of state

10.1.1.3. Duration: MBCA 3.02

10.1.1.3.1. In some states, the corporation is required to state its period of

duration (some corporations say "perpetuity")

10.1.1.3.2. MBCA's default rule is that the corporation will be assumed to be perpetual unless a different period of duration is set forth in the Articles of Incorporation (3.02)

10.1.1.4. Capital structure - the securities that the corporation has power to issue

10.1.1.4.1. Fixes the initial capital structure - set the number high so you don't have to amend later

10.1.1.5. Purposes - Articles of Incorporation MAY, but need not, set out purposes and powers

10.1.1.5.1. Purposes generally set forth in a very broad statement

10.1.1.6. Powers: MBCA 3.02 - laundry list of general powers

10.1.1.7. Registered office and registered agent: MBCA 5.01-5.04

10.1.1.7.1. For service of process

10.1.1.8. Initial directors and Incorporators: MBCA 2.05

10.1.1.9. The Number of Incorporators, Directors, or Shareholders

10.1.1.9.1. At least 3 shareholders, and at least 3 directors; only one incorporator

10.1.1.10. Size/Composition of Board

10.1.1.10.1. MBCA 2.02(b)(2) requires ONE director or more; some state statutes still require 3

10.1.1.11. Initial capitalization: No initial capitalization required under MBCA

10.2. Dartmouth College v. Woodward10.2.1. A corporation is "an artificial being, invisible, intangible, and

existing only in contemplation of law. It possesses only those properties which the charter of its creation confers upon it, whether expressly, or as incidental to its very existence."

10.2.2. It is a concept of federalism that states have the power to grant corporate charters

10.2.3. DE is the most popular choice for public and non-public companies

10.3. Internal Affairs Doctrine10.3.1. State of incorporation has the exclusive right to regulate the

internal affairs of the corporation

10.3.1.1. "Internal affairs" includes: What needs to be in the Articles, what it means to incorporate, what matters in the by-laws, the issuance of shared stock, voting rights, duties of directors and officers, corporation's powers, etc.

10.3.1.2. EVERYTHING ELSE is governed by the law of the state where the corporation DOES ITS BUSINESS - where are headquarters, employees, customers?

10.3.2. CA tries to ignore the internal affairs doctrine. Delaware's response? That CA is ignoring the "full faith and credit" clause and

commerce clause

10.4. Preparation to Form10.4.1. Prepare a business plan

10.4.2. Choose state of incorporation

10.4.3. Negotiate and Draft Shareholders' Agreement (which cannot be executed until corp. is formed); must be signed by initial shareholders

10.5. How to Form10.5.1. Prepare Articles of Incorporation pursuant to applicable statute

10.5.2. Have incorporators execute articles

10.5.3. File articles with appropriate state authority and pay fee

10.5.3.1. Corporation's existence BEGINS when the articles are FILED; filing is the action by which the state official ACCEPTS the articles

10.5.3.1.1. The articles can be rejected

10.6. Articles of Incorporation10.6.1. Standard information in Articles: Name of corporation, address,

duration, registered office and agent, capital structure, purpose and powers, size/combination of board

10.6.2. Optional provisions: voting, shareholders and shares, management

10.7. How Charter amended10.7.1. Directors vote to initiate a shareholder vote (under MBCA 10.01)

10.7.2. Then shareholders vote to amend

10.7.2.1. You don't see that in public corporations

10.8. Organizing the Corporation, MBCA 2.05 (As distinguished from forming the corporation, MBCA 2.03)10.8.1. Routine organization tasks: Prepare by-laws, draft call of

organizational meeting and prepare minutes, obtain corporate seal and minute book, obtain blank stock certificates, ensure stock is properly issued, qualify corporation to do business in foreign states, arrange for opening of corporate bank account, obtain taxpayer and employer identification numbers, prepare employment contracts and special arrangements, draft call meeting of shareholders and prepare minutes

10.8.2. Preparing by-laws, MBCA 2.06(b)

10.8.2.1. A by-law CANNOT be inconsistent with the articles of incorporation; this WILL be on exam

10.8.2.1.1. The articles of incorporation are the prime document, and thus trump the by-laws

10.8.2.1.2. By-laws do not have to be filed publicly

10.8.2.1.3. Typical Structure: Article I, Stockholders; Article II, Board of Directors; Article III, Committees; Article IV, Officers; Article V, Stock; Article VI, Indemnification; Article VII, Miscellaneous

11. Ultra Vires Acts, Corporate Charity, and Social

Responsibility11.1. Ultra vires: Acts in excess of the corporation's powers (as

chartered)11.1.1. At common law, an ultra vires transaction was void since the

corporation lacked the power to enter into the transaction

11.1.1.1. Even in its heyday, it the doctrine never applied to torts or illegal acts

11.1.2. Rationale: Since the corporation was chartered by the state, it can have no more powers than that which it was given by the state

11.1.3. The ultra vires doctrine has now been abolished in nearly all jurisdictions

11.1.3.1. How courts eroded the doctrine:

11.1.3.1.1. It was unfair because it allowed parties to weasel out of a contract they didn't like, and it created commercial uncertainty

11.1.3.1.2. Voidable but not void

11.1.3.1.3. Executory contracts only

11.1.3.1.4. Ratification recognized

11.1.3.1.4.1. If the shareholders had taken some act that ratified, or approved, the contract, then ultra vires was not applicable

11.1.3.1.5. Estoppel recognized

11.1.3.1.6. If full performance, doctrine inapplicable

11.1.3.1.7. Charter provisions interpreted broadly

11.1.3.1.8. No offensive use

11.1.3.2. How legislatures eroded the doctrine

11.1.3.2.1. Initially, state corporate statutes were amended to authorize a wide variety of corporate purposes and powers

11.1.3.2.2. Later, state corporate statutes were amended to permit corporations to use general purpose clauses

11.1.3.2.3. MBCA 3.04

11.1.4. What remains of the doctrine

11.1.4.1. Activities that are directed towards some UNLAWFUL business

11.1.4.2. For activities that are not ultimately directed toward business

11.1.4.2.1. Like giving to charities, not-for-profits, and religious groups -just "gifting" away the assets of the corporation

11.2. Application of the Doctrine of Ultra Vires to Corporate Giving11.2.1. MBCA 3.02(13) and 3.04

11.2.1.1. Donations - court determines reasonableness based on the size of the donation

11.2.1.2. Limits on corporate donations other than reasonableness:

11.2.1.2.1. Which charity

11.2.1.2.2. Who runs it

11.2.1.2.3. Connection with the donating firm

11.2.1.3. Must show clear and compelling evidence that the donation will increase profits - Friedman's idea

11.2.2. Advantages of Corporate Giving

11.2.2.1. Favorable tax treatment

11.2.2.2. Increased corporate goodwill and name recognition

11.2.3. Disadvantages

11.2.3.1. Questionable alignment with company's business

11.2.3.2. Conflicts of interest

11.2.3.3. Lack of disclosure - corporations are not required, by law, to disclose their charitable contributions

11.2.3.4. Excessive size of contributions

11.3. Corporate Social Responsibility (intertwines with theories of the firm)11.3.1. A corporation's constituencies that management could be

concerned about: Executives and Directors, employees, the community, customers, suppliers, creditors, shareholders

11.3.2. Two conceptions of the corporation

11.3.2.1. The corporation as private property of its stockholder-owners

11.3.2.1.1. Its purpose is to advance the purposes of these owners and the function of directors is faithfully to advance the financial interests of the owners

11.3.2.1.2. This model maximizes wealth creation, and argues that it should be the corporation's sole objective

11.3.2.2. The corporation as a social institution

11.3.2.2.1. This view sees the corporation as not strictly private, but tinged with a public purpose

11.3.2.2.2. To law and economics scholars, this model is barely coherent and dangerously wrong

12. Premature Commencement and Defective Incorporation12.1. Promoters and Pre-Incorporation Contracts

12.1.1. Promoter - a person who, acting alone or in conjunction with one or more other persons, directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer

12.1.1.1. Often referred to as a "founder" or "organizer" of an enterprise

12.1.1.2. Five functions

12.1.1.2.1. Discover and investigate business opportunities

12.1.1.2.2. Bring parties together - To match "A" with "B"

12.1.1.2.3. Formulate business plans

12.1.1.2.4. Devise financial plans/raise capital

12.1.1.2.5. Incorporate the business (probably the most important, for this class)

12.1.1.3. Potential Fiduciary Liability

12.1.1.3.1. Duty of loyalty to deal fairly with all participants in the venture and with the corporation

12.1.2. Corporation's Liability for Pre-Incorporation Contracts (Until there is a principal, there can be no agent of the corporation)

12.1.2.1. A newly formed corporation is NOT liable for contracts entered into by promoters; instead, the promoters are liable

12.1.2.2. The corporation CAN become liable by some affirmative act

12.1.2.2.1. Affirmative Act requirement

12.1.2.2.1.1. The affirmative act must evidence that the corporation has consented to the previous contract(s). Two theories:

12.1.2.2.1.1.1. Adoption - if the affirmative act evidences that the company intends to be bound, but it doesn't evidence that the promoter is no longer liable, then we say that the corporation has adopted the contract; adoption does NOT relieve promoter of liability, individually, for that contract

12.1.2.2.1.1.2. Novation - extinguishes the old contract, and extinguishes the liability of the promoter, and replaces promoter with the corporation as party to the contract

12.1.2.2.2. Evidence of adoption:

12.1.2.2.2.1. Express: A formal corporate resolution adopting the contract, taken by the Board

12.1.2.2.2.2. Implied: Later acts by the corporation that are consistent with, if not in furtherance of, the contract (such as the corporation making payments under the contract)

12.1.3. Potential Promoter relationships:

12.1.3.1. Promoter as a non-recourse agent: in instances in which the third party doesn't have any recourse against that promoter unlessthe corporation is actually formed

12.1.3.2. Promoter as a best-efforts agent: Promoter promises to use his best efforts to make the contract come to fruition

12.1.3.3. Promoter as an interim contracting party (more common) -The promoter enters into the contract with the third party, until the new compnay is incorporated and takes on the contract (novation); the corporation is then substituted for the promoter

12.1.3.4. Promoter as an additional contracting party (common as well) - The parties don't always agree about which relationship they have, especially as between these third and fourth options

12.1.3.4.1. DEFAULT RULE: PROMOTERS ARE LIABLE

12.1.3.4.1.1. Promoters are liable for pre-incorporation contracts absent evidence of the parties' contrary intent, as indicated fromdocuments or the circumstances surrounding the transaction

12.1.3.4.1.2. Rule benefits third parties, and hurts promoters by exposing them to a lot of risk

12.1.3.4.1.2.1. Reason: We want to encourage third parties to deal with promoters and form corporations, but they won't do so if nobody can be held responsible if the corp. isn't formed

12.1.3.4.1.2.2. Reason 2: It makes more sense to have the promoters liable than the unformed corporation (which may NEVER form)

12.1.3.4.1.3. Evidence of contrary intent: Promoter's signature

12.1.3.4.1.3.1. A contract should NEVER be signed in the name of a corporation until after the corporation is formed

12.1.3.4.1.3.2. How did the promoter sign? If his name is not listed at all, but there is a space between the corporation's name and "By Joe Schmoe", this probably means that he has no liability

12.1.3.4.2. There can be no limited liability before the certificate of incorporation is filed

12.2. Defective Incorporations12.2.1. Common incorporation errors: 1) Wrong address in articles; 2) no

agent for service of process listed; 3) Improper name/firm name already in use; 4) articles filed in the wrong county; 5) signature missing from the articles; 6) Other information missing from the articles; 7) filing fee requirement not met (not paid, or wrong amount); 8) failure to file articles of incorporation

12.2.1.1. Two kinds of disputes follow:

12.2.1.1.1. Voluntary creditor disputes (contract disputes)

12.2.1.1.1.1. Voluntary creditors had the opportunity to research the good-standing of the corporation in advance

12.2.1.1.2. Involuntary creditor disputes (where a tort has occurred)

12.2.1.1.2.1. In most of the tort cases, the involuntary creditor will not have had the opportunity to research the good-standing of the corporation in advance

12.2.1.2. Why do defects matter?

12.2.1.2.1. Because if it was not filed properly, it becomes a general partnership, and the folks who thought they were shareholders are not partners that share liability

12.2.2. Types of Corporations

12.2.2.1. De jure

12.2.2.1.1. Sufficient compliance with statute

12.2.2.1.2. Incorporator sheltered from liability from everyone, including State

12.2.2.2. De facto corporations - unsuccessful attempt to incorporate due to defect - GENERALLY ABOLISHED NOW

12.2.2.2.1. A court may treat a firm not properly incorporated as thought it were a corporation if the organizers:

12.2.2.2.1.1. In good faith tried to incorporate

12.2.2.2.1.2. Had a legal right to do so (there was a law under which they could have incorporated), AND

12.2.2.2.1.3. Acted as a corporation

12.2.2.2.2. At common law, the incorporator could be sheltered from creditors

12.2.2.2.3. Under modern statutes, the de facto doctrine has generally been abolished and personal liability imposed

12.2.2.2.3.1. See MBCA 2.03 and 2.04

12.2.2.3. Corporation by estoppel (another defense used by shareholders)

12.2.2.3.1. A court may treat a firm not properly incorporated as though it were a corporation if the party dealing with the firm

12.2.2.3.1.1. Thought it was a corporation,

12.2.2.3.1.2. And the third party would earn a windfall if it were allowed to argue that the firm was not a corporation

12.2.2.3.1.2.1. Properly applied, should be used AGAINST the third party, and NOT against the corporation

12.2.2.3.1.2.2. CANNOT be invoked by INVOLUNTARY creditors

12.2.2.4. Liability under MBCA 2.04 - "All persons purporting to act 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."

13. Limited Liability: Piercing the Corporate Veil13.1. Piercing the Corporate Veil: When a court disregards the

corporate entity despite the fact that it was a validly formed corporation, thus allowing the plaintiff to hold the shareholders directly liable

13.2. The doctrine of limited liability13.2.1. Third parties are assumed to accept the fact that they have no

recourse against the shareholders

13.2.2. MBCA 6.22, the modern default rule: Shareholder immunity, unless by their own acts

13.2.3. Benefits of limited liability: Encourages investment, encourages management risk-taking, promotes diversification by investors, promotes functioning of public securities markets, and reduces monitoring costs

13.2.4. Potential abuses and costs of limited liability: Impedes corporatecreditors from obtaining relief from fraudulent or unfair corporate transactions, operates unjustly against tort victims (might not get adequate compensation), allows firms to externalize tort risks, allows blatant and delibert "misuse" of the corporate form (by shareholder-managers)

13.3. The Piercing Doctrine - an anti-statutory equitable remedy13.3.1. Courts do NOT, EVER, pierce publicly-held corporations

13.3.2. When the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons

13.3.2.1. This is essentially the reverse of defective incorporations

13.3.3. When will a court invoke the doctrine and impose liability? (Five key findings)

13.3.3.1. Type of firm, number of shareholders

13.3.3.1.1. Courts pierce when the firm is a closely held corporation with one to three shareholders

13.3.3.2. Who is the plaintiff

13.3.3.2.1. Courts pierce when the plaintiff is a voluntary (e.g., contract rather than tort) creditor

13.3.3.3. Who is the defendant (tort claims usually cannot pierce)

13.3.3.3.1. Courts more likely to pierce when the defendant is an individual shareholder (natural person) rather than a corporate shareholder

13.3.3.4. What did the defendant do

13.3.3.4.1. Courts more likely to pierce when the defendant actively participated in firm management

13.3.3.5. What did the defendant fail to do

13.3.3.5.1. Courts are more likely to pierce when corporate insiders failed to follow formalities

13.3.4. In addition, it must present an element of injustice or unfairness

13.3.4.1. Other factors: - THERE MUST BE MULTIPLE FACTORS PRESENT TO PIERCE

13.3.4.1.1. Failure to observe corporate formalities

13.3.4.1.2. Undercapitalizing the firm - This cannot be the ONLY factor

13.3.4.1.3. Commingling corporate and personal assets - This is a BIG one

13.3.4.1.3.1. When an individual treats a corporation as an instrumentality through which he is conducting his personal business, a court may disregard the corporate entity

13.3.4.1.4. Siphoning off of assets

13.3.4.1.5. Deceiving creditors or other similar wrongdoing

13.3.4.1.6. Firm as an alter ego of another firm

13.3.4.1.7. Fraud

13.3.5. The Titanic Strategy - if you have an enterprise with a significant risk of liability, then you divide the assets and liabilities among brother/sister corporations in order to limit the plaintiff's access to all the assets of the enterprise

13.3.5.1. Think the Seon taxicab company, which had 2 cabs; but 9 other taxi companies were owned by defendant with 2 cabs each

13.3.5.1.1. The injured plaintiff tried to pierce the corporate veil of Seon, and used the enterprise liability theory to sue the other companies

13.3.6. Enterprise Liability Doctrine - A court may treat all pieces as belonging to one enterprise from which creditors may be satisfied

13.3.6.1. Horizontal liability amongst entities that are really all part of one larger entity

13.3.7. Delaware's Approach

13.3.7.1. Law of piercing is pro-defendant (pro-corporation)

13.3.7.2. Absent a showing of fraud or that a subsidiary is in fact the

mere alter ego of the parent, a common central management alone isnot a proper basis for disregarding the separate corporate existence

13.4. Alternatives to Piercing the Corporate Veil13.4.1. Uniform Fraudulent Transfer Act

13.4.1.1. Requires a transfer, so it will only help voluntary creditors (lenders) and not involuntary creditors (tort victims)

13.4.2. Deep Rock Doctrine

13.4.2.1. Doctrine of equitable subordination; Courts may subordinate the claims presented in bankruptcy by controlling shareholders to the claims of other creditors or preferred shareholders on the ground that the controlling shareholders acted unfairly or inequitably

13.4.2.2. In other words, a court may disallow an insider's claim entirely or make the claim subordinate to claims of non-insiders

13.4.2.3. What happens:

13.4.2.3.1. Corporation declares bankruptcy

13.4.2.3.2. Loans made by an insider (controlling shareholder) are treated as shares of stock owned by the insider

13.4.2.3.3. Insider's claims are subordinated to other creditors

13.4.2.4. Also applies where a parent company assets such claims against a subsidiary

13.4.2.5. Goal: To protect creditors from controlling shareholders making distributions to himself first in bankruptcy

14. Limited Liability: Reverse Piercing and Successor Liability14.1. Reverse Piercing (when a shareholder or creditor tries to use

the firm's assets to satisfy his debts)14.1.1. General rule: an entity's assets are shielded from the creditors of a

shareholder

14.1.2. Two kinds of reverse piercing:

14.1.2.1. Insider - the controlling shareholder argues that the court should ignore the entity's shield and allow the shareholder to satisfy his or her own personal debts by accessing the assets of the corporation

14.1.2.1.1. Most courts REJECT this argument; but see Cargill

14.1.2.2. Outsider - A creditor argues that the court should ignore the entity's shield and allow the shareholder to satisfy his/her debts by accessing the assets of the corporation

14.1.2.2.1. The law is unsettled on this point; see Pepper v. Litton for example

14.2. Successor Liability14.2.1. Three ways to structure acquisitions:

14.2.1.1. Asset purchase

14.2.1.1.1. Acquiring corporation can pick and choose which assets it wants to purchase

14.2.1.1.2. Firm A purchases the assets of Firm B

14.2.1.1.3. Firm A is only liable for the liabilities of B that it WISHES to purchase

14.2.1.1.3.1. Buyer can avoid liabilities he wants nothing to do with

14.2.1.2. Stock purchase

14.2.1.2.1. Acquiring firm purchases the majority of the stock

14.2.1.2.2. Firm A buys shares directly from the shareholders of Firm B

14.2.1.2.2.1. This is sort of a "middle ground" of liability

14.2.1.2.2.2. The acquirer of shares cannot pick and choose liabilities, but it also doesn't automatically become liable for all liabilities of Firm B

14.2.1.3. Merger or consolidation

14.2.1.3.1. Acquiring corporation blends with target corporation

14.2.1.3.2. See MBCA 11.07, 12.01

14.2.1.3.3. Firm A gets ALL the liabilities of Firm B

14.2.2. General Rule: NO LIABILITY if structured as an ASSET PURCHASE

14.2.2.1. Rationale: A corporate successor is not a seller and bears no blame in bringing the product and the user together

14.2.3. Four recognized common-law exceptions to the general rule

14.2.3.1. Agreement

14.2.3.1.1. Usually an implied agreement, but can be express

14.2.3.1.2. If Firm A impliedly agreed to assume certain liabilities, then they assume those liabilities

14.2.3.1.3. It is wise, then, to expressly state in the asset purchase agreement that you assume no liabilities other than those expressly assumed in the contract

14.2.3.2. De facto merger

14.2.3.2.1. The transaction amounts to a consolidation or merger of the firms

14.2.3.2.2. Court must look at if Firm B was dissolved after the sale, and how soon that dissolution happened after the sale

14.2.3.3. Mere continuation of previous entity

14.2.3.3.1. The acquiring corporation is merely a continuation of the selling corporation; courts generally don't follow this one

14.2.3.4. Fraud

14.2.3.4.1. The transaction is entered into fraudulently in order to escape liabilities

14.2.4. Tort law exceptions

14.2.4.1. Product line exception - if the product line is continued once the sale occurs, there can be liability

14.2.4.2. Continuation of the enterprise exception - exists only in a

minority of jurisdictions

14.2.5. Liability under statute

14.2.5.1. Pro rata liability on liquidating distribution for a limited time (MBCA 14.06-07, limiting liability to 3 years from sale date)

14.2.5.2. Obstacles to legislative reform - any state that would impose reforms would lose manufacturing charters

15. Corporate Capital Structure and Voting Rights15.1. Financing the Corporation

15.1.1. Outside Sources of Capital (Inside sources of capital are earnings)

15.1.1.1. Debt - created via borrowing

15.1.1.1.1. Secured debt - different types of bonds

15.1.1.1.2. Unsecured debt

15.1.1.1.3. Subordinated debt

15.1.1.1.3.1. Interest paid to creditors by firm is tax-deductible

15.1.1.1.3.2. This is important to firms, because it allows them to have lower taxable income

15.1.1.2. Equity - stock ownership

15.1.1.2.1. Preferred stock. Ways shareholders are preferred

15.1.1.2.1.1. Dividends

15.1.1.2.1.1.1. Common shareholders cannot receive dividends until the preferred shareholders are paid theirs

15.1.1.2.1.1.2. Dividends are fixed

15.1.1.2.1.1.3. Dividends are higher than common-stock dividends; also, can participate in common-stock dividends

15.1.1.2.1.1.4. Dividends are cumulative, or partially cumulative (this means that the dividend accumulates, and must be paid before common stock receives dividends)

15.1.1.2.1.2. Liquidation

15.1.1.2.1.2.1. In the event of the sale of the firm, preferred shareholders have the option of receiving X dollars per share before the commonshareholders receive anything

15.1.1.2.1.3. Redemption

15.1.1.2.1.3.1. The right to sell your shares back to the company (redeem them)

15.1.1.2.1.3.2. Preferred shareholders thus have the option to force the firm to buy back their shares

15.1.1.2.2. Common stock

15.1.1.2.2.1. Right to residual assets of the firm, if there are any upon liquidations after all debts have been paid and preferred SH have been paid

15.1.1.2.2.2. Also gets voting rights (most preferred don't have voting rights)

15.1.1.2.2.3. Right to dividends/distribution of profits

15.1.1.2.2.4. Who holds this stock? Founders & employees (or in the case of public companies, held by public shareholders)

15.1.2. Legal Capital Rules

15.1.2.1. Issuance of shares (shares defined in MBCA 1.40(22)

15.1.2.1.1. Classes of shares, and rights of common shareholders, set forth in MBCA 6.01

15.1.2.1.2. Series of shares within a class - MBCA 6.02

15.1.2.1.3. Dividend preference

15.1.2.1.3.1. Preferred stock pays a fixed quarterly dividend. These are mandatory

15.1.2.1.3.1.1. The board must declare the dividend if it is financially and legally able to do so

15.1.2.1.3.2. Common stock gets paid a variable dividend based on the corporation's earnings

15.1.2.2. Par value and watered stock

15.1.2.2.1. Par value is the value that was assigned to the stock when it was first issued and valued for sale

15.1.2.2.1.1. It was the minimum price the corporation set for the sale of its shares (but NOT the actual cost)

15.1.2.2.1.2. It was a way for the firm to know the minimum capital it would have to pay its creditors

15.1.2.2.1.3. Par value has gone out of favor because of the regulated securities market

15.1.2.2.2. The failure to sell stock at par value led to what was called "watered stock"

15.1.2.3. Modern practice

15.1.2.3.1. MBCA 6.21 - Issuance of shares

15.1.3. Optimal Capitalization

15.1.3.1. By capital structure, we refer to the management's decisions on the amount and type of debt and equity that the corporation will issue

15.1.3.1.1. Shareholders want investments in new, riskier projects in order to maximize their investment

15.1.3.1.2. Creditors want safer business plans in order to ensure that their money is returned to them

15.1.3.1.3. Debt (leverage) is less risky than equity, and thus costs less; italso creates a tax benefit that equity does not

15.1.3.2. Debt Financing Through Debt Securities

15.1.3.2.1. Bonds - a corporation obligation secured by a lien or mortgage on corporate property

15.1.3.2.2. Debenture - an unsecured corporation obligation

15.1.3.3. Benefits of leverage/debt

15.1.3.3.1. Management can pledge its own assets or pledge the firm's assets

15.1.3.3.2. Reduce the cost of capital by promising to pay back loans in a shorter period of time

15.1.3.3.3. Give investors a preferred, or priority, return

15.1.3.3.4. Give investors some measure of control, or at least ability to

monitor, what's going on in the business

15.1.3.3.5. Seek financing from investors who are knowledgeable about the business and the industry

15.1.3.4. Risk of leverage/debt

15.1.3.4.1. Shareholder gets a greater return than the creditors if the corporation is successful

15.1.4. Overview of Securities Offering Regulation

15.1.4.1. Securities laws do not only apply to public companies, and do not only pertain to stock offerings

15.1.4.2. Securities Act of 1933

15.1.4.2.1. Objective: Mandatory disclosure to investors (either register securities with SEC or find an exemption from registration)

15.1.4.3. Hierarchy of claims on the Corporation's cash flow:

15.1.4.3.1. Secured Debt

15.1.4.3.2. Unsecured Debt

15.1.4.3.3. Subordinated Debt

15.1.4.3.4. Preferred Stock

15.1.4.3.5. Common Stock

16. Conflicts Among Owners: Problems of Close Corporations16.1. Board authority to make distributions

16.1.1. MBCA 6.40 - The Board may authorize distributions to its shareholders

16.1.1.1. Distributions include: 1. Compensation; 2. Cash for goods and services; 3. Dividends (paid in cash OR stock); 4. Stock repurchases

16.1.2. MBCA 8.01 - Requirements for and Functions of the Board of Directors

16.1.2.1. Makes Strategic decisions (general objectives and goals of the firm, developing a business plan)

16.1.2.2. Makes Enterprise decisions (appointing executive team, establishing top level of corporate policies)

16.1.2.3. Makes Governance and Investment decisions (adopting/amending by-laws, determining the capital structure)

16.1.2.4. Makes Ownership decisions (determining whether to sell assets or merge, whether to initiate a proposal for shareholder voting)

16.1.2.4.1. Most ownership decisions come within the "final period" of the firm - right before merger, sale, dissolution, or bankruptcy

16.2. Protection for corporate creditors16.2.1. State law statutes

16.2.2. Common law of corporations (piercing the veil, Deep Rock, enterprise liability, directors' breach of fiduciary duties)

16.3. Protection for minority shareholders16.3.1. Shareholders' agreement (MBCA 7.32)

16.3.2. Whether or not there are protective clauses in the articles of incorporation

16.3.3. Shareholders control the board, b/c common stock elects the board of directors (MBCA 8.01)

16.4. Ways controlling shareholders harm minority shareholders16.4.1. Terminating minority shareholder's employment

16.4.2. Removing minority shareholder from the board

16.4.3. Compensating minority shareholders excessively

16.4.4. Refusing to declare dividends

16.4.4.1. Reasons for withholding dividends:

16.4.4.1.1. Taxes - if the firm pays out distributions as bonuses, rather than dividends, it has tax advantages

16.4.4.1.2. To reinvest in the firm

16.4.4.1.3. A lack of profits for a particular term

16.4.5. Judicial Review of minority shareholders' oppression claims:

16.4.5.1. General rule: Minority shareholders must prove the directors' bad faith in order to compel payment of dividends

16.4.5.1.1. "The mere existence of an adequate corporate surplus is not sufficient to invoke court actio to compel such a dividend. There must also be bad faith on the part of the directors." - Gottfried v. Gottfried

16.4.5.1.2. Minority shareholders have no power to compel a liquidation of the company in order to get a distribution that way

16.4.5.1.3. Indicia of "bad faith"

16.4.5.1.3.1. If the directors benefit their own personal interests instead of the corporation as a whole

16.4.5.1.3.2. If the majority shareholders were going to subject themselves to high personal income, and therefore a higher income tax, that could be evidence of bad faith

16.4.5.1.3.3. Offers to purchase minority's shares at bargain basement prices (evidence of "freeze-out")

16.4.5.1.3.4. Firing, however, is NOT necessarily an indicator of bad faith

16.5. Other statutory provisions and general information16.5.1. MBCA 7.32 validates a buyout

16.5.1.1. Types of buyouts

16.5.1.1.1. Cross-purchase (other shareholders buy)

16.5.1.1.2. Redemption (the corporation buys)

16.5.2. MBCA 8.01(a) mandates that each corporation must have a board of directors, other than under exceptions listed in 7.32

16.5.3. Shareholders' equity = Assets - liability

16.5.3.1. Shareholder equity has many components

16.5.3.1.1. Stated capital (the number of shares issued x the par value of the shares)

16.5.3.1.2. Capital surplus (the number of shares that were sold x actual price charged for those shares)

16.5.3.1.3. Retained surplus/retained earnings/earned surplus (the difference between the capital surplus and the stated capital)

16.5.3.1.3.1. MBCA 6.40 - as long as the corporation isn't insolvent, and the distribution wouldn't make the corporation insolvent, the distribution must be made

16.5.4. MBCA 14.30(2) - grounds for judicial dissolution

16.5.5. MBCA 14.34 - statutory buy-out remedy

16.5.5.1. Election to purchase in lieu of dissolution

16.5.5.2. (e) gives guidance to the court in order to determine "fair value" of shares

16.6. Fiduciary duties of directors (Intro)16.6.1. Directors are fiduciaries because they exercise control: Having

power and authority to benefit others and having control over assets

16.6.2. Two main duties:

16.6.2.1. Duty of care - deals mainly with the failure of managers to do their jobs

16.6.2.1.1. Managers must exercise business judgment with due care (i.e., BE INFORMED)

16.6.2.1.2. Quite easily satisfied under modern corporate law; actions alleging a breach of the duty of care are likely to fail

16.6.2.1.3. The applicable standard of conduct is that directors are not permitted to act with GROSS NEGLIGENCE

16.6.2.1.3.1. Must be adequately informed when it comes to making decisions

16.6.2.1.3.1.1. MBCA 8.30(a) - Sets forth the standard of conduct for the board of directors

16.6.2.1.3.1.1.1. Duty of care depends on whether you're an inside director or an outside director; insiders have more information about the company and thus are held to higher standards

16.6.2.1.4. STANDARD OF REVIEW - THE BUSINESS JUDGMENT RULE

16.6.2.1.4.1. It is a standard of review, and NOT a standard of conduct

16.6.2.1.4.2. Courts will abstain from reviewing the substantive merits of the directors' conduct

16.6.2.2. Duty of loyalty - addresses self-dealing by management

16.7. Donahue v. Rodd Electrotype (Characteristics of closely held corporations)16.7.1. A closely-held corporation is one which integrates ownership and

management

16.7.2. A closely held corporation is typified by three things:

16.7.2.1. A small number of stockholders

16.7.2.2. No ready market for the corporate stock

16.7.2.3. Substantial majority stockholder participation in the management, direction, and operations of the corporation

16.7.3. A close corporation bears a striking resemblance to a partnership

16.7.3.1. Just as in a partnership, the relationship among the stockholders must be one of trust, confidence, and absolute loyalty if the enterprise is to succeed

16.7.3.1.1. The standard owed by partners to one another is "the utmost good faith and loyalty" - this is a strict standard

16.7.4. Basic holding: Fiduciary relationship exist within closely held corporations

16.7.4.1. This holding has been widely cited and accepted, EXCEPT in Delaware

17. Conflicts Between Management and Shareholders: Problems of Public Corporations17.1. The Public Company Governance Puzzle

17.1.1. Separation of Ownership and Control in a Public Corporation

17.1.1.1. Ownership - Stockholders

17.1.1.2. Control - Directors

17.1.1.2.1. See MBCA 8.30 - Board must have inside and outside directors

17.1.2. Shareholders Rights:

17.1.2.1. Vote

17.1.2.2. Sell

17.1.2.3. Sue

17.1.3. Impact of Sarbanes-Oxley on Corporate Governance

17.1.3.1. Didn't really give any new rights

17.1.3.2. Required that the board establish an independent audit committee (with independent directors) whose composition is dictated in part by the statute, and in part by regulations promulgated under the statute

17.1.3.3. Set requirements for the number of independent directors

17.1.3.4. It marked an intrusion of the federal government into an area traditionally regulated by the states: the internal affairs of a corporation

17.1.3.5. Prohibits corporations for arranging for an extension of credit from the corporation to the directors (no loans to directors)

17.1.3.6. CEOs and CFOs must certify that the internal controls of the company are effective

18. The Fiduciary Duty of Care: Taking Care and the Business Judgment Rule18.1. Duty of Care

18.1.1. Standard

18.1.1.1. In many jurisdictions, the standard is that of ordinary negligence

18.1.1.2. In Delaware, the standard is gross negligence ("reckless indifference" or "deliberate disregard" of the shareholders' interests)

18.1.1.3. MBCA 8.30 - "Under similar circumstances" language designed to draw a distinction b/w insiders and outsiders, so thatinsiders would be held to some higher standard of care

18.1.2. What "due care" means in practice

18.1.2.1. Attentiveness

18.1.2.2. Reasonable investigation and consideration (process)

18.1.2.3. Rational basis for action

18.1.3. Shareholders' ability to enforce

18.1.3.1. Very little ability, in practice, to enforce this duty because it is so vague, and b/c directors are protected by the Business Judgment Rule

18.2. The Business Judgment Rule18.2.1. A presumption that in making a business decision, the directors of

a corporation acted on an informed basis, in good faith and in thehonest belief that the action taken was in the best interests of the company (Sullivan v. Hammer)

18.2.1.1. Absent an abuse of discretion, this judgment will be respected by the courts

18.2.2. It is a STANDARD OF REVIEW, rather than a standard of conduct

18.2.2.1. Courts will abstain from reviewing the substantive merits of the directors' conduct

18.2.2.2. MBCA 8.31 - Codification of Business Judgment Rule

18.2.3. Purpose of the rule: To avoid judicial second-guessing of the directors' business decisions

18.2.3.1. Absent some cause to believe that the board abused its discretion, there is a strong presumption against a review of the duty of care

18.2.4. Key question

18.2.4.1. NOT whether this was a careful decision, or a good decision; but rather, who made the decision, and how (was it RATIONAL)

18.2.4.2. We typically do not even get to the question of the duty of care unless the directors are not entitled to the business judgment rule

18.2.5. 5 Requirements for Application:

18.2.5.1. Directors exercised their business judgment

18.2.5.1.1. There has to be an ACTUAL DECISION - if there was no decision at all, the business judgment rule does not apply and cannot be used to shield

18.2.5.2. Directors were disinterested

18.2.5.2.1. This means they had no conflicts of interest

18.2.5.3. Directors were reasonably informed under the circumstances (process)

18.2.5.4. Directors acted rationally and did not waste corporate assets

18.2.5.4.1. Rational-basis test (Thus, irrationality is the outer limit of the BJR)

18.2.5.4.2. A showing of waste requires proof that the consideration received by the corporation is SO clearly inadequate that no rational director, or person of sound business judgment, would have deemed it worth what the corporation paid or received

18.2.5.4.2.1. These claims are "possibly nonexistent"

18.2.5.5. Directors did not engage in fraud or illegality

18.2.6. Burden on plaintiff to rebut presumption

18.2.6.1. Plaintiffs are not entitled to discovery until after a court concludes that the business judgment rule does not apply

18.2.6.2. Damages. MBCA 8.31

18.2.6.3. Standards of conduct for directors. MBCA 8.30

18.2.7. LBO - Leveraged buy-out

18.2.7.1. Popular in the 1980s

18.2.7.2. The raider would come in, buy up the corporation and then engage in cost-cutting and b/c leverage was used (all borrowed money) for the transaction the company had payments of principal of interest that needed to be paid

18.2.7.3. Smith v. Van Gorkum - not protected by business judgment rule because they didn't inform themselves REASONABLY about the merger decisions

18.2.7.3.1. Court also found gross negligence

18.2.7.3.2. Main idea: Circulate an agenda in advance of board meeting, provide all info beforehand, rely on experts, and make a record

18.2.7.3.3. MBCA 8.25, 8.30, 8.31 - make clear directors are entitled to rely on information opinions or reports

18.2.7.4. Legislative response: De. 102(b)(7) and a "second race to the bottom"

18.2.7.4.1. b) the certificate of incorporation may contain any or all of the following matters:

18.2.7.4.1.1. 7) A provision eliminating or limiting personal liability of a director ... for damages... for breach of a fiduciary duty, provided that the provision shall not eliminate or limit the liability of the director:

18.2.7.4.1.1.1. For any breach of the director's duty of loyalty

18.2.7.4.1.1.2. For acts or omissions not in good faith or which involve a violation of the law

18.2.7.4.1.1.3. For any transaction from which the director derived personal and improper benefit

18.2.7.4.2. This means directors can act with gross negligence and not be

held liable under the duty of care

18.2.7.4.3. MBCA Analogue: 2.02(b)(4) to De. 102(b)(7)

18.2.7.4.3.1. Similar legislation in 40 states

18.2.8. Ultimate Impact: Boards may be able to violate a duty of care and still be protected by the business-judgment rule

19. The Fiduciary Duty of Care: Exculpatory Statutes, Good Faith, and Related Duties to Monitor and Disclose19.1. Malone v. Brincat - the seminal case in DE on disclosure

responsibilities19.1.1. Director's fiduciary duty to the corporation and its shareholders is

a triad: due care, good faith, and loyalty

19.1.1.1. But the duty of good faith is NOT a separate duty; rather, it is a component of the duty of loyalty

19.1.1.2. In reality, then, the only two duties are good faith and loyalty

19.1.1.2.1. The duty of loyalty includes honesty

19.1.1.2.1.1. Directors who knowingly disseminate false information that results in corporate injury or damage to an individual stockholder violates their fiduciary duty, and may be held accountable

19.1.1.2.1.2. Whenever directors communicate publicly or directly with shareholders about the corporation's affairs, with or without a request for shareholder action, directors have a fiduciary duty toshareholders to exercise due care, good faith, and loyalty

19.1.1.2.1.3. Covered under Chapter 16 of MBCA - requiring an annual financial statement

19.2. Stone v. Ritter - Monitoring19.2.1. Necessary conditions predicate for director oversight liability

(failure to monitor):

19.2.1.1. The directors utterly failed to implement any reporting or information system or controls, OR

19.2.1.2. Having implemented such a system or controls, they consciously failed to monitor or oversee its operations, thus disabling themselves from being informed of risks or problems requiring their attention

19.2.2. If a director makes NO decision, he is not entitled to the protection of the business judgment rule; but director oversight is conceptually distinct from director decision-making

19.3. Gall v. Exxon Corp. (NY)19.3.1. The decision of corporate directors whether or not to assert a

cause of action held by the corporation rests within the sound business judgment of the management

19.3.1.1. Plaintiff must be given an opportunity to test the bona fides and independence of the Special Committee through discovery

19.3.1.2. The Litigation Committee device adopted by Exxon to seek dismissal of the Gall suit has become the standard response of publicly held corporations to derivative suits brought or threatened by shareholders which the corporation does not desire to have pursued

19.4. Aronson v. Lewis (DE)19.4.1. Demand can only be excused where facts are "alleged with

particularity" which create a reasonable doubt that the directors' action was entitled to the protections of the business judgment rule

19.4.1.1. When is a demand futile, and therefore excused?

19.4.1.1.1. The Court of Chancery must decide whether, under the particularized facts alleged, a "reasonable doubt" is created that

19.4.1.1.1.1. The directors are disinterested and independent, AND

19.4.1.1.1.2. The challenged transaction was otherwise the product of a valid exercise of business judgment

19.4.1.1.2. Thus, only in the presence of this type of reasonable doubt is demand deemed futile

19.5. Nature of derivative litigation19.5.1. Derivative litigation - a suit brought by shareholders, on behalf of

the corporation, against the directors for breach of fiduciary duty

19.5.1.1. The shareholders receive no direct benefit; the corporation receives any compensation from suit

19.5.2. Distinguishing direct and derivative claims

19.5.2.1. Look at 1) who suffered the harm, and 2) who would receive the benefit of recovery

19.5.2.1.1. In direct litigation, the shareholders are harmed, and the shareholders recover

19.5.2.1.2. Why the characterization matters:

19.5.2.1.2.1. The procedures that apply in the litigation

19.5.2.1.2.2. Whether the lawsuit can be discussed by the corporation

19.5.2.1.2.3. Who recovers damages, AND

19.5.2.1.2.4. Who pays litigation fees and expenses

19.5.2.1.3. Danger of abusive litigation and sweetheart settlements

19.5.3. Weeding out abusive litigation

19.5.3.1. Plaintiff must verify complaint

19.5.3.2. Plaintiff must have owned equity (shares)

19.5.3.3. Plaintiff must have been shareholder when the alleged wrong occurred (to ensure plaintiff didn't acquire shares just to start litigation)

19.5.3.4. Plaintiff must continue to own shares from the time of the wrongdoing all the way through final judgment

19.5.3.5. Courts may order plaintiff to pay defendants' frees and costs under certain circumstances

19.5.3.6. Plaintiff must post security for defendants' litigation expenses

19.5.4. The demand requirement - Most important limitation

19.5.4.1. As a substantive requirement, and as a pleading requirement

19.5.4.1.1. Required in most states, and modeled after FRCP 23.1, which requires that the complaint state with particularity the efforts that were made for demand upon the board

19.5.4.1.1.1. If no demand was made, the reasons must be stated

19.5.4.1.2. Hence, there is NO mandate that the plaintiff make a demand; rather, there is a requirement that the complaint state whether demand was made; and if not, why not

19.5.4.1.3. The statutes also do not specify the effect the court should give to the plaintiff's failure to make a demand, nor to the board's nonresponse to a demand given

19.5.4.1.4. Is in fact considered a procedural AND a substantive requirement

19.5.4.1.4.1. Most states have interpreted the "demand-pleading rule" to mean that the demand must be made unless demand would be futile

19.5.4.2. MBCA approach: Universal demand approach

19.5.4.2.1. 7.42 of MBCA

19.5.4.2.1.1. No shareholder may institute a derivative suit unless he has filed demand with the board; he MUST actually make a demand, not just plead that he has done so

19.5.4.2.1.1.1. Exception: Unless irreparable injury to the corporation would result by waiting for the expiration of the 90 day period

19.5.4.2.1.1.1.1. Still, CANNOT assert "demand futility" under MBCA

19.5.4.2.2. 7.44(a) - to dismiss a derivative suit under certain circumstances

19.5.4.3. Mechanics of demand

19.5.4.3.1. Shareholder writes a letter to the board, the CEO, and maybe the general counsel of corp.

19.5.4.3.1.1. No specific format or content required; just needs to set out what the grievance is

19.5.4.3.2. The board has two choices: Accept the demand, or refuse the demand

19.5.4.4. Purposes of demand

19.5.4.4.1. In order to give the corporation the opportunity to resolve the dispute through negotiation, so it never would get to litigation

19.5.4.4.2. Board needs an opportunity to consider how suit would affect their business

19.5.4.4.3. To give firm a better position to investigate the claim, preserve documents, interview witnesses; to appoint an investigative committee

19.5.5. Terminating derivative litigation

19.5.5.1. Demand refused

19.5.5.1.1. Shareholder can just go away

19.5.5.1.2. Shareholder can file a derivative suit

19.5.5.1.2.1. Corporation will move to dismiss suit

19.5.5.1.2.1.1. If the suit is dismissed, corp. wins

19.5.5.1.2.1.2. If the motion is denied, suit continues

19.5.5.2. Demand Excused

19.5.5.2.1. New York Approach - Gall v. Exxon Corp.

19.5.5.2.1.1. When there is an allegation of violation of fiduciary duties by the board, the board may:

19.5.5.2.1.1.1. Amend the by-laws to appoint 2 or 3 new directors, and then use a litigation committee, composed of these new directors, to investigate claims

19.5.5.2.1.1.1.1. LC nearly always recommends dismissal of the suit, because of empathy towards the directors and because a lawsuit is never good for the corporation

19.5.5.2.1.1.1.2. LC relieves the court of the burden of reviewing the merits of shareholders' complaint

19.5.5.2.1.2. Standard of review: Litigation committee's decision to dismiss should be reviewed under the BUSINESS JUDGMENT RULE

19.5.5.2.2. Delaware Approach - Aronson v. Lewis

19.5.5.2.2.1. Test for demand futility: Whether under the particularized facts alleged, directors and officers are disinterested and independent, AND whether the challenged transaction was the result of the exercise of a valid business judgment

19.5.5.2.2.2. When does DE excuse demand?

19.5.5.2.2.2.1. A majority of the directors has a financial interest in the transaction

19.5.5.2.2.2.2. Management is entrenched

19.5.5.2.2.2.3. The defendant controls the majority

19.5.5.2.2.2.4. When the business judgment rule is not available

19.5.5.2.2.3. What standard of review for litigation committee's decision to dismiss?

19.5.5.2.2.3.1. Two step approach:

19.5.5.2.2.3.1.1. Procedural inquiry - Defendants must prove the committee members' independence from the defendants, their good faith, and the reasonable investigation supporting the legal and factual bases for the committee's conclusions

19.5.5.2.2.3.1.2. Substantive inquiry - Even if the committee's recommendation passes the first step of the inquiry, the trial judge may apply his or her own "independent business judgment" as to whether the lawsuit should be dismissed

19.5.5.2.3. Common law approach. Five reasons to excuse demand:

19.5.5.2.3.1. Corporation threatened with irreparable harm

19.5.5.2.3.2. Corporation unresponsive to demand

19.5.5.2.3.3. Corporation closely held

19.5.5.2.3.4. After demand, board decided to take no position

19.5.5.2.3.5. Demand was futile

19.5.5.3. Demand made and accepted

19.5.5.3.1. Shareholder makes demand

19.5.5.3.2. Board accepts demand

19.5.5.3.2.1. Corporation files lawsuit, or dispute settles

19.5.5.4. Settlement

19.5.5.4.1. Court Approval required for settlement or dismissal

19.5.5.4.1.1. MBCA 7.45

19.5.5.4.1.2. The proponents of the settlement have the burden to show that it is in the best interest of the corporation

19.5.5.4.1.2.1. Courts often accept a corporation's settlement, based on the notion that "a bad settlement is better than a good trial"

19.5.5.4.2. Who really pays: Indemnification and insurance

20. The Fiduciary Duty of Loyalty: Self-Dealing20.1. Distinguished from Duty of Care

20.1.1. Duty of care deals more with competence; duty of loyalty deals more with conflicts of interest

20.1.2. Management actions implicating the duty of loyalty

20.1.2.1. Self-dealing transactions

20.1.2.2. Usurping corporate opportunities

20.1.2.3. Competing with the corporation (often linked with usurping, above)

20.1.2.4. Bad faith failures of oversight

20.2. Self-Dealing Transactions20.2.1. Examples: Sales of property by the firm to a director, or vice versa;

contracts between the firm and a director; transactions between the firm and a director's relative; transactions between a parent corporation and a subsidiary that is not wholly-owned by the parent; transactions between corporations with interlocking directors; executive compensation

20.2.2. Modern trend: A transaction is valid if it was approved by a disinterested majority of the board and was deemed to be fair

20.2.2.1. By 60s and 70s, If the majority was interested, the transaction was voidable at the insistence of the firm's shareholders, withoutregard to fairness

20.2.3. Statutory safe harbors

20.2.3.1. By 1994, nearly every state had some kind of safe harbor statute providing that self-dealing transactions that were approved by a disinterested majority of directors or shareholders were not voidable if full disclosure were given

20.2.3.1.1. Ex: Del. 144(a)(1) - "Intrinsic fairness" test

20.2.3.1.1.1. This section removes the cloud of interested director self-interest and prevents the invalidation of a transaction SOLELY because an interested director was involved

20.2.3.1.2. Ex: MBCA 8.60-8.63 (also called "Subchapter F")

20.2.3.1.2.1. Under this rule, a conflict of interest transaction is not voidable by the corporation if:

20.2.3.1.2.1.1. It has been approved by disinterested directors or shareholders, OR

20.2.3.1.2.1.2. The interested director establishes the fairness of the transaction

20.2.4. Waste

20.2.4.1. NEVER protected by the business judgment rule

20.2.4.2. The Corporate Waste Standard

20.2.4.2.1. An exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade

20.2.4.2.2. Most often associated with a transfer of corporate assets for no corporate purpose or for which the corporation receives nothing inconsideration (which is almost never the case with executive compensation)

21. The Fiduciary Duty of Loyalty: Executive Compensation21.1. Fairness review:

21.1.1. The relation of the compensation to the executive's qualifications, abilities, responsibilities, and time devoted

21.1.2. The corporation's size/complexity, revenues, earnings, profits, and prospects

21.1.3. The likelihood incentive compensation would fulfill its objectives

21.1.4. The compensation paid to similar executives in comparable companies (i.e. in the same industry)

21.2. Problems in Close Corporations21.2.1. No approval by either disinterested directors or shareholders

21.2.2. Compensation is material fraction of corporation's earnings

21.2.3. Compensation eliminated funds available to pay dividends

21.2.4. Exit problems for minority shareholders

21.2.5. Oppression of minority shareholders

22. The Fiduciary Duty of Loyalty: Usurping Corporate Opportunities22.1. Corporate Opportunity Doctrine

22.1.1. Rule: A corporate fiduciary cannot usurp corporate opportunities for his or her own benefit unless the corporation consents

22.1.2. Tests for corporate opportunity:

22.1.2.1. Interest or expectancy

22.1.2.1.1. Plaintiff must show that the corporation had a pre-existing interest in the opportunity and that the fiduciary interfered with that (very narrow)

22.1.2.1.2. Line of business (Guth v. Loft)

22.1.2.1.2.1. Very fact-sensitive; looks at how closely related the opportunity is to the line of business of the corporation

22.1.2.1.3. Fairness (Durfee v. Durfee & Canning; p. 803)

22.1.2.1.3.1. An open-ended test; looks at the total circumstances to see whether it would be unfair for the fiduciary to have taken theopportunity

22.1.2.1.4. Two-step combination (Miller v. Miller)

22.1.2.1.4.1. Look at whether the opportunity was in the line of business, and then look at the circumstances to determine if acquisition by the fiduciary was unfair

22.1.2.1.5. ALI Principles of Corporate Governance 5.05

22.1.2.1.5.1. Defines corporate opportunity broadly

22.1.2.1.5.2. Approach is that the fiduciary has to first offer the opportunity to the corporation, with full disclosure of the nature of the opportunity

22.1.2.1.5.2.1. Without disclosure, there is liability per se

22.1.2.1.5.3. The corporation must reject the opportunity before the fiduciary can take advantage of it

22.1.2.2. Typical remedies for usurpation

22.1.2.2.1. Recovery of profits realized by the usurping fiduciary

22.1.2.2.2. Recovery of lost profits and damages suffered by the corporation

22.1.2.2.3. Imposition of a constructive trust on the investment/assets of the business opportunity