corporations law (new) - fall 2008

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Corporations Outline - Fall 2008

Open Book Final Three Essay QuestionsOffice Hours 2-4, Room 222

I. Introduction: Why have a corporation?A. Efficiency and the social significance of enterprise organization: Most corporate relationships are

contractual in the sense that they are voluntarily entered into and may be customized or fine tuned byexpress agreement. The agency is the simplest form of a business organization and may be

terminated at any time by either the principal or the agent.B. Wealth Creation and the Corporate Form of Organization: facilitating individual efforts to create

wealth is wise public policy.C. Efficiency Theory:

i. Pareto Efficiency:a. Pareto Optimal distribution of resources is efficient when, and only when, resources are

distributed in such a way that no allocation can make at least one person better off withoutmaking another person worse off. Through voluntary exchange, individuals reveal their ownpreference for one outcome over another. When all parties experience a net utility gain, thenwe can be certain that there is a net utility gain from the transaction overall.

However, it is virtually impossible for courts to make important decisions that do not makesomeone worse off.

ii. Kaldor Hicks Efficiency (Wealth Maximization): An act/rule is efficient when it leads to an overall

improvement in social welfare, if at least one party would gain from it after all those who suffereda loss as a result of the transaction were fully compensated. It is efficient if gains won by A aresufficient to compensate losses to B and still have excess.

iii. Courts try not to choose efficiency justifications because it is difficult to determine what a cost isand what a benefit is.

D. Development and the Modern Theory of the Firm:

i. Ronald Coase: While markets tend to move distribution towards efficiency, it is sometimes moreefficient to organize complex tasks within a hierarchical organization with established authorityand compensation structures on a market.

ii. Transaction Cost Theory: When a company tries to determine whether to outsource or toproduce goods or services on its own, market prices aren't the sole factor. There are alsosignificant transaction costs, search costs, contracting costs and coordination costs. Those costsfrequently determine whether a company uses internal or external resources for products or

services. This is the essence of the make-vs.-buy decision.

iii. Agency Cost Theory:a. Agency Cost: Any cost, explicit or implicit, associated with the exercise of discretion over

principals property by an agent.

Types:(i) Monitoring: costs owners expend to ensure agent loyalty(ii) Bonding: costs agents expend to ensure owners of their reliability(iii) Residual: Costs that arise from differences in interest remaining after monitoring and

bonding costs are incurred. Essentially inefficiencies resulting from misalignedincentives.

Types of relationships:(i) Manager and owner

(ii) Majority shareholder and minority shareholder(iii) Firm and third party.

II. Agency:

A. Definition:

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i. Restatement 2d Agency 1: Agency is the fiduciary relationship that results from themanifestation of consent by one person (the principal) to another (the agent) that the other shallact on his behalf and subject to his control, and consent by the other to so act.

a. Essentially a voluntary contractual relationship where one party has the ability to affect thelegal relations of another for the principals benefit.

b. The agency relationship is terminable at will either side can revoke at any time. A breach ofcontract for agency results in damages, not specific performance. A secured lenderrelationship does not result in an agency because there is no protection of the interests of theprincipal.

ii. Scope of Authoritya. Types:

Special Agents: Agents limited to a single transaction

General Agents: Agency contemplates a series of transactions.

Principals:

(i) Fully disclosed: third parties transacting with agent understand that the agent is actingon behalf of a particular principal.

(ii) Partially disclosed: third parties transacting with the agent recognize that they areacting with an agent, but do not know the identity of the principal.

(iii) Undisclosed: third parties are unaware that there is a principal and believe that theagent is her own principal.

b. Both parties have to manifest their intention that the Agency exists. However, an agencyrelationship may be implied by the courts even when the parties have not explicitly agreed to

an agency relationship. It depends on the type of exercise controlled. Jenson Farms Co. v. Cargill, Inc. (Minn. 1981): Cargill lent extensive credit to Warren,

a grain elevator, which was overextended. Cargill got excessively entangled in Warrensbusiness decision making, reviewing the books and when Warren went under, othercreditors went after Cargill as Warrens principal.

(i) Rule: Court agreed and held that Cargill was entangled enough in Warrens businessthat it was acting as Warrens principal and therefore was liable for Warrens debts. Acreditor who assumes control of his debtors business may become liable as a principafor acts of the debtor in connection with the business.

1. Squire thinks this is because the right of first refusal was tied to Cargill

(ii) This is efficient because it mitigates risk of breach and creates assurance ofperformance and therefore more commerce. Policy preference to keep a disclosedprincipal liable because disclosure tends to induce reliance and in this case, Cargill wasin a better position to prevent.

(iii) Pro rata: Each of several partners "is liable for his own share or proportion only, theyare said to be bound pro rata. An example ... may be found in the liability of partners;each is liable ... only pro rata in relation to between themselves."

(iv) Debtor/creditor relationship; principal/agent relationship (principle, agent and thirdparty)

(v) Agency: A, B, C = one person assents to work for the benefit of another, under thecontrol of another (though this doesnt cover the full scope)

1. Footnote 4: Warren ignored the orders, which seems to imply that there was noagency

(vi) Villains/victims: farmers are victims, Cargill is the villain

c. Actual Authority: from the perspective of a reasonable agent. The agent must reasonably

understand from the action or speech of the principal that she has been authorized to act onthe principals behalf.

Express authority: authority was expressly given by principal to agent look to see ifthere is a contract etc.

Implied/Incidental Authority: authority to perform implementing steps that are ordinarilydone in connection with facilitating the main authorized act.

d. Apparent Authority: from the perspective of a reasonable third person authority that areasonable third party would infer from the actions or statements of the principal.

Apparent Authority: reasonable, from contact with the principal, to conclude that theagent has authority. Essentially an equitable remedy provided to prevent unfairness tothird parties who reasonably relied on the principals actions in dealing with an agent. It

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holds even if the principal has expressly limited the agents actions. Also, if its an ordinarytransaction that the agent has repeatedly done in the past, it may bind the principal.(i) This can be in the form of communication, representations made by the principal (such

as through a business card), and former history of the principal (such as if theindividual is well known for a producing a certain type of good, this can be relevant toapparent authority if he no longer produces this good and does not let buyers know).

(ii) White v. Thomas (Ark. 1991): White authorized his agent, Simpson, to attend aland auction and bid on his behalf and Simpson, after realizing she over bid, made anagreement with Thomas to sell him 45 acres of land she had just purchased for White,

indicating that she had power of attorney, when this did not exist. White contendedthat his agent, Simpson, did not have apparent authority to enter into a contract forthe sale of land to Thomas (plaintiff) (he repudiated).

1. Rule: In the absence of a principal and any indicia that an agent has authority toengage in a specific action on the principals behalf, the agent does not haveapparent authority to engage in any such action merely because the agent assertsthat she has such authority.a. Here, Simpson had neither the express nor the implied authority to contract to

sell Thomas a portion of the land. In order for White to be liable, Simpsonsactions had to have fallen within the scope of her apparent authority. Here, theonly indication that Simpson had limited authority was a possession of a checkand Thomas chose to rely on Simpsons claims.

2. An agent cant declare his or her own agency or the extent of his authority.

3. How would you make an inherent authority argument? People that have authority tobuy, normally have authority to sell.a. Why didnt the court go for this argument? Maybe the Court didnt want Thomas

to win.i. Theres also a fact problem the lower court believed White

Inherent Authority: consequences imposed upon principals by law. Agent has the powerto bind the principal even against the principals wishes as long as it is reasonable for thethird party to assume authority in the agent and rely upon it. Gives the general agent thepower to bind a principal (disclosed or undisclosed) to an unauthorized contract as long asthe agent would ordinarily have the power to enter into the contract and the third party isunaware of any changes in its situation. Are agents who can do X, also able to do Y? If yes,then the third party can rely on it unless the principal told them that the agent cant do Y.

(i) This is efficient because if a customer had to investigate an agents authority,

commerce would be slowed. The principal should bear the burden of communication.1. Brooks Brothers Hypo: A Brooks Brothers salesman was only allowed to sell

casual clothing and someone approached him to sell a suit and he sells her the suit.Brooks Brothers would be liable in this case because the salesman had inherentauthority to sell the suit given his job at Brooks Brothers and it was the obligation ofBrooks Brothers to provide notice to customers that there was limited authority. Hehad authority to do X (sell casual suits), presumably, if you can sell casual clothes,you can sell suits, Y.

(ii) Gallant Insurance Co. v. Isaac (Ind. 2000): Gallant was an insurer with ThompsonHarris as its agent. THs authority included the power to bind Gallant on newinsurance policies as well as interim policy endorsements such as adding a new driver.Although it wasnt authorized to do so, TH bound coverage on Isaacs new car althoughthe premium wasnt paid until 3 days later. In between this period, Isaac got into a car

accident. Gallant claimed it was not liable for the losses because the policy was not inforce since the premium was not paid as dictated in the policy and because TH did nothave the authority to renew the insurance policy.

1. Rule: an agent has inherent authority to bind its principal where the agent actswithin the usual and ordinary scope of its authority, a third party can reasonablybelieve that the agent has authority to conduct the act in question, and the thirdparty is not on notice that the agent is not so authority.

2. Here, TH was acting within the scope of its normal authority and Isaac couldreasonably believe that it was bound it was customary for TH to tell its customersthat they were bound.

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3. Actual authority? NO. Apparent authority? Look between the principle and the 3rd

party (Isaac). NO. Inherent authority? YES.(iii) Three situations:

1. Agent does something similar to which he is authorized to do, but in violation oforders (161, 194). The result is that the principal may become liable as a party tothe transaction, even if undisclosed.

a. 161: a general agent for a disclosed or partially disclosed principal subjects hisprincipal to liability for acts done on his account which usually accompanytransactions which the agent is authorized to conduct, although they are

forbidden by the principal, if the third party reasonably believes that the agent isauthorized to do them.

2. Agent acts purely for his own purposes in entering into a transaction which would beauthorized if done for principals benefit. ( 165, 262).

a. 165 releases the principal from liability to third parties for contracts made byagents when the third party knows that the agent is not acting for the benefit ofthe principal.

3. Agent is authorized to dispose of goods and departs from the authorized method ofdisposal ( 175, 201).

If the agent lies about the scope of authority, liable for contractual damages and tort ofdeceit.

e. Agency by Estoppel: 1) failure to act when 2) knowledge and opportunity to act arise 3) in

addition to reasonable change in position on the part of the third person this may make theprincipal liable for the agents actions.

f. Ratification: when an agent exceeds his authority, a principal can affirm the contractafterwards. However, he can be bound under apparent authority for actions by the agent, evenif the agent cant repay the principal.

This creates mutuality because any action by a principal, including knowing delay, canratify the agents work. The principal must repudiate the agents conduct immediately uponknowledge.(i) Repudiation is a defense when agent has NO authority.

1. However, where the agent might have apparent authority then this defense wouldnot be available.

iii. Tort Liability:a. Only the master servant relationship triggers respondeat superior and vicarious liability, not

independent contractor. Definitions:

(i) Master: principal who controls or has the right to control agent within his employ

(ii) Servant: employed by principal who controls or has the right to control (Restatement3d)

(iii) Independent Contractor: Individual who has contracted with another, but it is notcontrolled or subject to control. May or may not be an agent.

If the principal has the right to control the details of the way in which agent performs tasks,the agent is an employee or servant. If the principal has limited control rights, the agent isan independent contractor.

(i) List of Factors taken into consideration Restatement 2d 220.1. extent of control over detail of work provided in an agreement2. required skill to perform3. whether the person employed is engaged in a distinct occupation or business

4. who provides the tools and place of work(who owns goods or property involved)5. length of time of the employment6. method of payment by hour/by job7. intent of the parties8. whether or not regular business of employer9. local common practice.

Humble Oil & Refining Co. v. Martin (Texas 1949): Mrs. Love left her car at a servicestation, which was owned by Humble Oil Co. Prior to anyone touching the vehicle, the carrolled off the premises and struck the Martin family from behind while they were walking

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into the yard of their home. Humble Oil Co. argued that it was not liable, because theservice station was operated by an independent contractor.

(i) Rule: Although there may be an agreement that the nature of a relationship is that ofan independent contractor, the court will look at other factors (such as whether theemployer / vendee had control) to determine whether the relationship is that of anindependent contractor or that of master-servant.

(ii) In this case, the court found that the relationship was more in line with a master-servant relationship because Humble paid important operating expenses, theoccupancy of the premises was terminable at will, had strict supervision over finances,

and gave little business discretion to the service station essentially the purpose ofthe gas station was to sell Humble products. Therefore, Humble was liable underrespondeat superior.

Hoover v. Sun Oil Co. (Delaware 1965): While fueling at defendant's gas station, a firestarted at plaintiff's car. Plaintiff sued defendant, but defendant contended that the gasstation was operated by an independent contractor, James Barone, and thus that thenegligence of Barone's employee should not result in liability for defendant. Plaintiff arguedthat Barone was operating the station as defendant's agent.

(i) Rule: There is no agency relationship between a supplier and retail outlet where theretail outlet is solely responsible for profits and losses and the supplier exercises nodominion or control over the retailer.

(ii) In this case, the Court found no relationship between the supplier, Sun Oil, and theretailer other than a landlord-tenant relationship and that both had an interest in

selling Sun products. Sun asserted no operational control and was not responsible forthe profits and losses of the retail outlet, but Barone was and there was norequirement that Barone had to implement the suggestions that Sun made.

1. Liability in tort requires more control than liability in a contract claim. There wasapparent authority since Sun put the people in Sunoco uniforms and there wasinherent authority since customer expectation is that gas station attendants areauthorized to pump gas. However, Barone was in the best position to preventbecause while Sunoco made regular visits, Barone was under no obligation to listento recommendations.

iv. Agents Duties to Principal:a. Agents Duties:

Obedience: duty to respect definition of the scope of authority

Loyalty: good faith effort to advance the purpose of the agency while achieving no self

benefit that is not:(i) Disclosed(ii) Consented to, or(iii) Fair

Care negligence standard.b. Agents Duty of Loyalty to Principal

An agent is subject to a duty to act solely for the benefit of the principal in all mattersconnected to the agency (Restatement 2d Agency 387)

Unless otherwise agreed, an agent who profits from a transaction must pass profit toprincipals, an agent may not profit even if it does not harm the principal. (Restatement2d Agency 388).

(i) Tarnowski v. Resop (Minnesota 1952): Plaintiff engaged defendant to investigate

a coin operated juke box business opportunity for plaintiff. Defendant misrepresentedthe business to plaintiff saying it was profitable. Plaintiff purchased the business andrealized he had been duped. He sued the sellers for rescission of contract andrecovered in a post-trial settlement. He then sued the defendant for an allegedlysecret commission the defendant received from the sellers during the course of theinvestigation. In addition, the plaintiff sought to recover damages incurred during thetransaction.

1. Rule: Profits of the agent must be passed to the principal whether they are forperformance or violation of duties. Restatement, Agency, Section 407(1). "If anagent has received a benefit as a result of violating his duty of loyalty, the principal

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is entitled to recover for him what he has so received, its value, or its proceeds, andalso the amount of damage thereby caused. . . ." even if there was no damage.

An agent cannot deal with the principal as an adverse party in a transaction connected withhis agency without the principals consent and knowledge. (Restatement 2d Agency 389).

If there is knowledge of adverse dealing, and the principal consents to self-dealing, then theagent is bound to deal fairly with the principal and disclose all material facts to him.(Restatement 2d Agency 390).

c. Trustees Duty to Trust Beneficiaries:

For trusts, ownership and benefits are split Trustee is accountable for any profit made by him through or arising out of the trust, even if

the profits do not result from a breach of trust.

If Trustee commits breach of trust, he is chargeable with (1) loss or depreciation in value ofestate resulting from any breach of trust (2) any profits made through breach (3) any profitthat would have accrued but for breach

(i) In re Gleeson (Illinois 1954):Tenant becomes trustee when landowner dies,Increases rent applied to him and extends lease for next season. Claims too difficult tosecure a new tenant. Trustee was honest with beneficiaries and beneficiaries wouldhave benefited.

1. Rule: a trustee cannot deal in individual capacity with trust property regardless ofany special circumstances or good faith intentions. The power of the trustee is too

great to allow self interest.2. Restatement 2d of Trusts 203: the trustee is accountable for any profit NO

UNLESS OTHERWISE AGREED

a. Compare with 387 of the Restatement of Agency: unless otherwiseagreed, an agent that makes a profit is under a duty to give it to the principal

b. Why this difference? The point of a trust is to split the ownership and benefit soif you can otherwise agree, it defeats the purpose of a trusti. Also, once you have a trust, you cant change it!!!

c. In a corporation, the board is acting on behalf of the shareholders. Question of ifact like agents or trusts.

In dealing with a trust beneficiary, but not on the matter of the trust, the trustee must fullydisclose and must deal fairly with the beneficiary.

III. Partnerships :

A. Definition: UPA a partnership is an association of two or more persons to carry on as co-owners abusiness for profit. Property held in partnership is called tenancy in partnership.

B. Disadvantages of partnerships:i. Higher transaction costs, not good for financingii. Partnership is less stable than a corporation, which has unlimited duration.iii. Investors are personally liable for partnership activities if partnership funds are insufficient.

Partners are jointly and severally liable for contract and tort claims.iv. Very hard to transfer interest in partnership.

C. Agency Conflicts Amongst Co-owners:i. Partnership introduces the dilemma between controlling and minority owners what duty of

loyalty does an active partner owe a passive partner?

a. Meinhard v. Salmon (NY 1928): Salmon and Meinhard entered into a joint venture thatcentered around a twenty-year lease for premises in NY. Meinhard would provide theinvestment capital, Salmon would manage the business, and the two of them would divide upthe profits. Before the lease ended, a third party approached Salmon about a new lease.Salmon entered into the new lease with the third-party and did not tell Meinhard. Meinhardsued for breach of duty of loyalty.

Rule: "Joint adventurers, like copartners, owe to one another, while the enterprisecontinues the duty of the finest loyalty." A partner has a duty to disclose an opportunity tohis partner(s) if the opportunity arises out of the partnership. The Court held in this case

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that the opportunity did arise out of the partnership and thus Salmon had a duty to disclosethe opportunity to Meinhard.(i) This decision extended the duties of partnership far beyond duties under a contract. It

determined that in such a relationship, loyalty must be undivided and unselfish, andthat a breach of fiduciary duty can occur by something less than fraud or intentionalbad faith.

(ii) Dissent: the case should hinge on whether the transaction was unfair or inequitable.Any duty following from the partnership ended at the end of the twenty year period;because the partnership was created to manage the building for the twenty year term,

the dissent felt that deals involving events to occur after the expiration of that termwere of no matter to the partnership.

Rule forces communication amongst partners.

Efficiency: Majoritarian Rule: if we know parties would want a specific provision, then thereisnt really a need to write it in there, BUT if you dont want it, then you need to contractaround it(i) No Imagination Rule: The more efficient default rule is the one that most of the people

want

Its hard ahead of time to think of all the different ways people can take advantage of you

Written by Cardozo (part of the reason why it is so famous) he calls the K a "treaty" tocreate a joint venture

Uniform Partnership Act (see supp.) see p.42 of Supp (S7, #4) re. partnership

Opportunity arises out of the partnership? Agency relationship the agent breached the

duty of loyalty here. While the enterprise continues there is a duty of the finest loyalty equating agent to trustee here, held to something stricter than morals of the marketplace.SO, what exactly should (in Cardozo's view) Salmon have done?

Reading term into a lease? Why should we help out people like Meinhard who didn't helpthemselves in the first place?

D. Partnership Formation:i. What establishes a partnership:

a. Co ownership is not indicative of a partnershipb. Share of gross returns (revenue) does not establish a partnershipc. Receipt of the shares of the profits is prima facie evidence of a partnership

Vohland v. Sweet (Ind. 1982): Sweet originally worked as an hourly employee forVohland Sr. and when Voland Jr. took over, he decided to change Sweets status so that hewould receive 20% of the net profits. However, Sweet did not contribute in the capital or

machineries, a partnership tax return wasnt filed, Vohland was the sole purchaser, andSweet didnt participate in any of the losses.(i) In this case, the Court looked at the sharing of profits as prima facie evidence of a

partnership. And because there was no controlling evidence that there was not apartnership, the court held that the sharing of profits was evidence of the intent of apartnership and therefore held that there was a partnership.

(ii) Sweet wants to be a partner that's what is going on here. He wants something aboveand beyond the 20% he is receiving. He wants an accounting so he can specifically geta percentage of the money that was invested in these plants/this nursery (basicallysaying he wants a cut of the partnership property.

(iii) Looking at profits rather than gross? Profits are riskier. From a practical perspective,why in this case should it matter that the costs were being taken out of his pay. Thecost of the inventory matters you would have to say that Sweet has a property

interest.(iv) What about the title of the truck issue (w/ Sweet wanting his name on it) sweet was

worried about a particular interest! It shows that Sweet didn't expect that he beconsidered a partner. Why did the court protect him anyway.

(v) Rule: In order to have a partnership, there needed to be a voluntary contract ofassociation for the purpose of sharing profits and losses which may arise from the useof capital, labor or skill in a common enterprise. There must also be an intention onthe part of the principals to form a partnership for that purpose.

1. A partnership can be formed by the furnishing of skill and labor by others. Thecontribution of labor and skill by one of the partners may be as a great a

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contribution to the common enterprise as property or money. Therefore, there doesnot need to be capital contribution to be a partner, contribution of labor will suffice.

2. The intent is to do those things which constitute a partnership therefore, if thisintent exists, the parties will be partners notwithstanding that they proposed toavoid the liability attaching to partners or have expressly stipulated in theiragreement that they were not to become partners.

UPA 7: Rules for Determining the Existence of a Partnership:(i) Owning property together does not of itself establish a partnership, whether such co-

owners do or do not share any profits made by the use of the property.

(ii) Share of gross returns does not of itself establish a partnership, whether or not thepersons sharing them have a joint or common right or interest in any property fromwhich the returns are derived.

(iii) Profits received as payments will not create a partnership if these payments are:1. An installment payment on debt2. Wages of an employee or rent to a landlord3. An annuity

4. Interest on a loan though the amount of payment varies with profits of the business5. Consideration for sale of goodwill or other property by installments.

E. Relationships with Third Parties:i. When can an exiting or retiring partner escape liability for partnership obligations?

a. Withdrawing partner still has liability for obligations incurred prior to his departure, but has nocontrol over the business.

b. The retiring partner is not liable for new liabilities after he withdraws and gives notice. Aretiring partner can be let off the hook if creditors agree to do so and the remaining partnersagree. Courts are liberal on creditor agreement to retiring partners. If creditor knows andextends credit, this is valid.

c. Dissolution: dissolution does not relieve partners of liability. It causes the partnershiprelationship to cease as a going concern, but does not mean termination of liabilities.

UPA 36(a): discharge from partnership liability the dissolution of a partnership does notin itself discharge the existing liability of a partner. When a partner agrees to assume theexisting obligations of a dissolved partnership, the partners whose obligations have beenassumed shall be discharged from any liability to any creditor of the partnership who,knowing of the agreement, consents to a material alteration in nature or time of payment osuch obligations.

ii. Claims of Partnership Creditors to Partners Individual Propertya. Partnership has completely separate property and this property is owned by partners as

tenants in partnership. UPA 25(1).

Partner cannot possess or assign rights in partnership property, a partners heirs cannotinherit it, and a partners personal creditors cannot attach or execute upon it. UPA 25(2).

Partners do not own the assets, but rather the rights to the net financial return that theseassets generate profits, losses and distributions. Partners can assign and transfer profitinterests to others.

b. Partners can go into bankruptcy without individual partners being bankrupt.c. Priority of attaching personal assets:

In bankruptcy, creditors of partnership have priority in partnership assets and equal rightsin individual assets of partners.

If not bankruptcy, jingle rule apples partnership creditors have first priority in partners

personal property.iii. Brudney's UPA Problems (on p. 53 of text)a. Ars, Gratia, Artis involved in entity called Argrar. Ars is the manager (puts that into Argrar) and

gets back either 5k/yr or 1/3 profits. Gratia puts in the land and he gets back 1/3 profits. Artisputs in $30k and gets back 1/3 profits. Mayer lends 15k to Artis (putting in the money) andArs and Gratia know about it, but they don't know that Artis in turn is repaying Mayer with ofthe 1/3 going to Artis. Artis knows about some equipment that hurts a customer is Ars liable?

Yes S 12 (see p. 44 in supp) partnership charged w/ knowledge to partners, impute thatknowledge to Ars. BUT that presumes that Artis and Ars are partners yes because they aresharing the profits of a business (joint venture). S 13 also. Is Mayer liable? Probably no (argboth sides of him being a partner or not being a partner).Now, if a customer is injured bc Gratiacommits a tort, is Artis liable? They are both copartners in Argrar (so yes bc copartners are on

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the hook for each other's torts). Is Mayer liable? No if he is a partnership with anyone it is w/Artis, Artis is in a partnership w/ Gratis, but that doesn't mean that Mayer and Gratia are in apartnership together (transitive property). The law doesn't want surprise partnerships sprungon people.

b. Receipt of profits is prima facie evidence that you're a partner, but no such inference thatyou're a partner bc you received profits shall be drawn if profits received were in payment ofan interest on a loan.

F. Partnership Governance and Issues of Authority

i. Nabisco Biscuit Co. v. Stroud (N.C. 1959):There was a two person partnership between

Stroud and Freeman in a grocery store. Stroud let Nabisco know that hed no longer be liable forpurchases made from Nabisco and Freeman would be liable for purchases. Freeman madepurchases anyway, but Stroud wouldnt pay. Court found Stroud was liable because Freemansactions were within the scope of the partnership and Stroud, not being a majority of partners,couldnt prevent Freeman from acting.

Rule: Partners are agents of the partnership entity and when there are two partners,neither is the majority so both have to agree to change the scope of the authority of eitherpartner.

Partnership is a hybrid in which the partnership is the principal and the partners are theagents.

You cant revoke the agents power without telling the agent

Efficiency: you should honor peoples expectation

Nabisco wants to recover unpaid bills. Notion that when you have a partnership and 1 of thepartners makes a K generally all of the partners are liable on that.

When Stroud called up Nabisco and said he wasn't taking anymore bread orders that didn'tdissolve the partnership bc we don't know (and don't think) that that was communicated toFreeman (the partner).

If you want out of a partnership, you dissolve it, but you cant unilaterally change thepartnership's powers/etc.

At the beginning of all this, Freeman had actual authority. The principle manifests authorityWould have been reasonable to Nabisco if this was principle/agent that Freeman hadauthority. BUT whose expectations do we look to for actual authority the agent. Here theagent wasn't notified, Freeman thought he still had the authority. Same principles apply inprincipal/agent situation.

ii. UPA 9: every partner is an agent of the partnership for the purpose of its business and the act

of every partner, for carrying on in the usual way of business binds the partnership, unless thepartner so acting has in fact no authority to act for the partnership in the particular matter andthe person with whom he is dealing has no knowledge of the fact that he has no authority.

a. Partners individually, unless they are authorized to or there is an abandonment of the businesscannot assign the partnership property in trust for creditors, dispose of the good will of thebusiness, do any other act which would make it impossible to carry on the ordinary business,etc.

G. Termination (Dissolution and Dissociation)i. Accounting for Partnerships Financial Status and Performance:

a. Normally, when a partnership dissolves, the assets are split.

b. UPA 29 dissolution is the change in relation of the partners caused by any partnerceasing to be associated in the carrying on as distinguished from the winding up of thebusiness. Essentially when partners cease to carry on the business together.

30: On dissolution, the partnership is not terminated until the winding up of partnershipaffairs occurs.(i) Termination: point in time when all the partnership affairs are wound up

(ii) Winding Up: the process of settling partnership affairs (with creditors) after dissolution(i.e. paying off debts, settling Ks) (UPA 37)

1. When one partner leaves, rights arise and one of the rights that comes about iswinding up. During a winding up, statute contemplates a period where everyonewinds up the business such as taking care of old creditors, paying off creditors, etc.during dissolution, a partner can demand a winding up.

38 contemplates an auction whereas creditors are paid off and rest are distributed amongthe partners.

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c. Adams v. Jarvis (Wis. 1964): There was a dissolution of a medical partnership and plaintiffwanted his share of accounts receivable (which was an asset because it was the legal right tomake a patient pay). There was an agreement indicating that if there was a dissolution, theredid not need to be a winding up. However, the statute called for a winding up.

Rule: a partnership agreement which provides for the continuation of the firms businessdespite the withdrawal of one partner and which specifies the formula according to whichpartnership assets are to be distributed to the retiring partner is valid and enforceable. 38 of the agreement says unless otherwise agreed so the agreement is valid and statuteis a default where there is no agreement. UPA are default arrangements and are the rules

unless owners of a business agree otherwise you are allowed to contract aroundmechanisms in the UPA of how to pay out a departing partner.(i) A legal dissolution does not require a complete winding up of the business, but rather

a legal separation with the withdrawing partner.(ii) There was a good faith duty for the remaining partners to ensure that Jarvis got his

share of the profits and in this situation, partners could have not made a profit bydelaying collecting on the accounts receivable so there would be no cash to pay out ifit was a cash accounting business. Therefore, this is why Jarvis wanted to have shareof accounts receivable so he could get paid.

1. The court held that the remaining partners were obligated to conduct the business ina good faith effort to liquidate the accounts receivable consistent with good businesspractices.

(iii) The formula that they use is: 1/3 * 5/12 = 5/36 = but Dr. Adams doesnt like this

because it creates an incentive to move all payments into January so he gets less thanhis due.

(iv) 802: a partnership can occur after dissolution if you continue acting like a dissolutiondidnt happen = BUT THIS DIDNT EXIST AT THE TIME OF THIS CASE

(v) Lets enforce the contract the way they intended it

d. Dreifuerst v. Dreifuerst (Wis. 1979): 3 brothers own 3 mills in partnership, one wantsdissolution and wind up and sale of assets. There was no partnership agreement and the lowercourt gave an in kind distribution of the assets and split the mills.

Rule: The court found that the lower court did not have the authority to give an in kinddistribution. Under UPA 38 absent an agreement(unless otherwise agreed), dissolutionoccurs through a fire sale auction. Here, although a MI lower court case held that an in kinddistribution was justified in situations where there were no creditors to be paid fromproceeds, a sale was senseless since no third party was interested in the assets and in kind

distribution was fair to all partners, the WI supreme court said it would follow the UPA. Can only have in kind distribution when partners agree to this or when the partnership

agreement calls for an in kind distribution.(i) Policy rationales:

1. In kind distribution affects creditors rights since the whole is more valuable than thesum of the parts. An asset sale provides a more accurate means of establishing themarket value of the assets while in kind can only approximate. The partners havethe power to avoid liquidation through the drafting of their partnership agreement.

2. An auction is a good value of what the asset is really worth

e. Page v. Page (Cal. 1961): there was a partnership for a linen supply business and thebusiness was not profitable for 8 years and when it starting to make a profit, the active partnercalls for dissolution and the passive partner argues that the active partner wanted theopportunity all for himself. The lower court found that although there was no agreement

specifying the terms, there was an implied partnership for term until all the debt was erased a reasonable term to make a profit.

Rule: Normally, partners are not obligated to continue in the partnership until all of theinitial losses have been recovered. Justice Traynor found that UPA 31 holds thatdissolution is caused by the express will of any partners when no definite term orundertaking is specific. Therefore, while partners may agree to continue a business until acertain sum of money is earned or one or more partners recoup their investments etc,absent an agreement or evidence of an implied term the partnership can be dissolved atwill.(i) There are protections for people such as passive partners there are fiduciary duties

on the partners when they are dissolving. Dissolution by a partner must be done in

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good faith. If it is done in bad faith, it is a wrongful dissolution and the breachingpartner is liable under 38(2) (a). To terminate with intent to appropriate the assetsfor the partners own use would violate the fiduciary duty.

(ii) Lower courts standard of reasonable time was not goodH. Limited Partnerships:

i. Limited liability limited to partnership contribution. Creditors can get to the business entity, butnot beyond that to the personal assets of the partners.

a. Can still be active and have limited liabilityii. Enjoy share of profitsiii. Cant participate in management except voting on events such as dissolution. If there is too much

participation, they might be considered general partners and lose limited liability (control test - 303 of the ULPA).

iv. LLCs limited liability, participation in management, transferability of interest, continuity of life ifa member resigns.

v. Whats a venture capital and private equity fund?a. What if venture capitalist cut is fixed?

What beyond the growth provides incentive for these people to do well

IV. The Corporate Form:A. Attributes of a corporation:i. Legal personality with indefinite life

ii. Limited liability for investorsa. Rationale:

Simplifies job of evaluating an equity investment

Encourages risk adverse individuals to invest in riskier ventures.

Increased incentive for lenders to evaluate the business more closely.iii. Free transferability of share interestiv. Centralized managementv. Appointed by equity investors

B. Types of Corporations:i. Public Corporations: usually those with shares sold on the public market to raise large amounts of

capital.ii. Close Corporations: corporations that incorporate for tax or liability reasons, not to raise large

amounts of capital.

iii. Controlled Corporations: usually a single shareholder or a group of shareholders exercises controthrough its power to appoint the board.

iv. In the market: where there is no such person or group exercising control where anyone canpurchase control of the company, but until they do so, no shareholder or group exercises control(how much large public corporation are owned).

C. Formation of corporationsi. Delaware is the hub of incorporation.

a. DGCL 101: can file with the department of state a certification of incorporation, pay a feeand have an incorporated business.

b. 106: upon the filing of a certificate of incorporation, the people that signed will be the bodyincorporate. What goes into a certificate of incorporation:

Name : has to include certain terms such as inc., corp., etc so that people will know thatthey are dealing with an entity that has limited liability.

Address of the office in the state

The nature of the business (often very broad purposes).

The classes of stock and the number of shares in each class

The name and mailing address of the incorporator/s

If the powers of the incorporator are to terminate up on the filing of the certificate orincorporation (optional)

Whether power will terminate upon filing the charter.

Optional items there can be provisions for the management of the business and theconduct of the corporations.

c. Elect directors

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d. After filing, have to call a meeting of the board of directors at which you can draw up by-laws.

109: by laws can contain anything not inconsistent with the articles of incorporation. Ifthe by laws are inconsistent with items in article of incorporation then the article wins.(i) Distinction exists because of who can amend and change the articles and the by laws.

ii. The Articles of Incorporation, or Charter (see above)a. Can contain any provision not contrary to lawb. Must have:

Provide for a voting stock, a board of directors, shareholder voting for certain transactions

If a special or limited purpose

Name the original incorporators State the corporations name and very broadly its business

Fix its original capital structure

May establish the size of the board or include other governance terms and the proceduresfor removing directors from office

iii. Corporate Bylawsa. The least fundamental of the corporations constitutional documents they must conform to

both the corporation statute and the corporations charterb. Generally fix the operating rules for the governance of the corporation

Ex. the existence and responsibilities of corporate offices, annual meeting datec. Sometimes can amend laws, sometimes cantd. Can be created by the shareholders or the directors (in DE for example)

iv. Shareholders Agreements

a. Important in close corporations and some controlled corporations. Often address restrictionson disposition of shares, buy/sell agreement, voting agreements and agreements with respectto employment of officers or payment of dividends.

b. Contracts are specifically enforced where shareholders and corporations are parties but whensome shareholders arent parties, then turns on whether it is fair to non-signatories.

c. Voting trust: arrangement in which shareholders publicly agree to place their shares with atrustee who then legally owns them and is to exercise voting power according to the terms ofthe agreement.

v. Easterbrook and Fischel Limited Liability and the Corporation:a. There are high agency costs in a corporation since managers are legally separate from the

owners of the corporationb. Limited liability decreases the costs of monitoring other shareholders and increases the

incentives for management to act efficiently since free transferability allows a decrease in

share price to cause a displacement of management.c. Limited liability allows shares to be priced per market since there is better information about

firm value.d. Facilitates more optimal investment decisions.e. Increases availability of funds for projects with positive net value.

vi. Transferable sharesa. Advantages:

Allows the firm to conduct business uninterruptedly as the identities of its owners change.Avoids the dissolution/reformation problems that affects partnerships.

Creates an active market for ownership through liquidity and diversification.

Keeps management in check and creates incentive for good management.b. Disadvantages:

Can undermine control arrangements.

vii. Centralized Management: goal is to keep agency cost as low as possible without undulyimpinging on managements ability to manage firm productively.

a. Automatic Self Cleaning Filter Syndicate Co., Ltd. v. Cunninghame (England 1906):There was a shareholder resolution to sell the companys failing assets by 55% majority. Thearticles of the corporation called for a supermajority. The plaintiff sued alleging that thedirectors are agents of the shareholders (the principals) and should be bound by the majority.

Rule: The majority opinion held that a majority of the shareholders is not the principal, butrather the corporation is. The directors do not owe a duty to individual shareholders but tothe corporation itself and this means that the directors owe a duty to everyone who hasinvested in the corporation, not the majority. Therefore, once authorized, directors may act

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according to their own view of what they see the best interests of the corporation to be, andare not subject to shareholder override except in accordance with procedures set out in thecorporate constitution or by statute. Shareholders cant tell the directors directlywhat to do (though they do elect them).

(i) 141(a) DGCL business shall be managed by board of directors as except asotherwise provided by the articles/charter.

1. But not by by-laws cant limit the board of directors this way

(ii) 271 DGCL can only have a sale of assets if the majority of shareholders approve.But, notwithstanding authorization to sell, a board of directors or governing body can

veto this.(iii) Metaphor to principal agent law

Concurrence: metaphor to partnership and contractsb. Structure of the Board:

Charter sets out the structure of the board broadly. The default term of service is one year.(i) Charter can specify that directors are elected by a certain class of stock. But, the

fiduciary duty of each board member is always to the corporation as a whole and notthe class that elected them.

Committees:(i) Advisory committees can be comprised of anyone, but executive committees that

exercise any power must include only directors. Matters that by statute that requireboard action may not be delegated to committee.

Corporate directors are not legal agents of the corporation. Governance powers reside in

the board of directors, not in the individual directors themselves.(i) Therefore, a director can not act unilaterally on behalf of the corporation. However, an

officer can act on behalf of the corporation unilaterally.1. For example, a director can not unilaterally fire an individual, but the CEO can.

Directors act as a board only at constituted board meetings by majority vote (unless supermajority is called for).(i) There must be quorum and notice.

c. Corporate Officers: Agents of the Corporation:

Jennings v. Pittsburgh Mercantile Co. (Pa. 1964): Egmore, an executive at Pittsburghsolicited Jennings to explore a sale and leaseback deal of all company owned land. Egmoreassured board approval and offered commissions. After Jennings solicited a deal, the boarddid not approve and did not pay Jennings his commission.

(i) Rule: The court discussed the apparent authority of Egmore to allow the transaction.With apparent authority, look to the expectations of the third party through priordealings if in the past, the principal has permitted the agent to act, people willeventually infer that the agent has the authority. By not taking actions to the contrarythere is a presumption that the agent has actual authority, BUT an agent cant self-authoritate. In a corporation, its the board of directors acting as a group.

1. Here, there was no apparent authority because there were no similar prior dealings.Since the transaction was so huge, Jennings was on notice to verify authority. Therewas no apparent authority by virtue of Egmores position. Egmore couldnt selfauthorize because directors are individually powerless, need a majority.a. The corporations agents are the directors and the directors agents are the

officers. The group that has the authority to authorize extraordinary transactionsis the directors.

2. Probably best reviewed under inherent authority scope want to show that an agentthat can normally do X, can also do Ya. Here, X is that Egmore had the authority to hire brokers. Y is to authorize a

commission. Court was more worried about selling the land of the corporation so also a Y here. NO INHERENT AUTHORITY HERE. P would argue that Y isauthorized to issue a commission

b. Ask if the court focused on the wrong Yc. Egmore was on the board why couldnt this authorize the sale?

i. Need the whole board

V. Debt, Equity, and Economic Value:

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A. Introduction why talk about this?i. How do you value a company?

a. Ex. Merril Lynch being bought out by BofA

Shareholders of Merril will get shares of BofA board of directors decide all this so theremight be a lawsuit later saying that they didnt get a good deal

Should the court defer to the Board? Who should have a say?

B. Capital Structure: how corporations raise their money two types of investors in acorporation, creditor/debtor investors and equity investors (shareholders).

i. Most corporations issue debt and the most common form are bonds. A bond is a contract to repay

money at a certain interest rate at a certain time. Usually has a maturity date and interest rate(except for zero coupon bonds).

a. Characteristics of bonds:

Tradeable

Standardized so can be easily traded

Restrictions on what corporations can do with bonds

Less risky than equity because of a legal right to periodic payment and a priority claim tothe companys assets over shareholders in case of default.

b. Tax treatment:

Interest paid by the borrower (the corporation) is a deductible business expense.

ii. Equity: Shareholder investment in a companya. Characteristics of equity:

Receive dividends from the corporation

Acquisition buyout can create value.

Shareholders receive the residual claims upon liquidation.b. Tax treatment:

Payment of dividends is not tax deductible but the board of directors does not have afiduciary duty to pay dividends, so there is no obligation to ever pay.

c. Might have preferred stock as malleable as bonds but typically have a stated dividend andpreference in liquidation.

d. What do stockholders have that bond holder dont? A vote for the board of directorsC. Concepts of Valuation:

i. Time value of money having a dollar today is better than receiving a dollar tomorrow becauseyou can invest the dollar today and earn money.

a. Present value of 1.10 one year from now if the discount rate is 5%

PV = FV/(1+r): 1.10/1.05 = 1.0467. so 1.10 a year from now is worth 1.05 today.

b. $100 one year from now will have a higher present value at a lower discount rate, therefore,the lower the discount rate, the higher the present value.

c. If the present value of 120 in one year is 150, the discount factor is:

PV + r(PV) = FV 120 + r(120)=150. so r = .25.d. NPV = PV (to be received) PV (to be invested).

ii. Projects for which the present value of the amount invested is less than the present value of theamount received in return are called positive net present value

D. Risk i. Idea of expected value ex. 50/50 coin toss

a. How do you calculate this? Expected value = probability x amountii. Risk Neutral individuals indifferent between investments if they have the same expected return.iii. Risk Averse Individuals when dealing with different options that have the same expected value,

the risk averse individual will want the investment that has the lowest variance (lowest range ofpossible outcomes).

a. So if option A has a $10 million dollar return with 100% certainty and option B has a 50%chance of $20 million dollar return - the expected value of both is 10 million, but a risk averseperson would chose option A.

b. Problem:

National Hotel seeks to borrow 10,000,000 from Bank for 1 year. NHC offers to pay back11,300,000 as principle and interest in one year. Bank believes there is a 95% chance ofbeing repaid and a 5% chance of receiving nothing. The risk free rate is 6.5% and thepremium on the risk free rate is 2%.

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(i) The interest rate formula: (total repayment amount principal)/principal =interest rate.

1. EV = (.95)(11.3 million) + (.05)(0) = 10.735 mil2. PV = FV/1+r: (10.735/1.065) = 10.079 (lending someone money today will get you

10.079).(ii) Risk occurs when the future is uncertain and here, since there is more than one

possible outcome, there is risk. If people are risk averse, an investment will be worthless to them and one way to compensate is to build in a higher discount rate sincethey will require a higher rate of return.

1. 10.735 mill/1.085 =9.894: basically lending someone 10 million today but onlygetting 9.894, so it is not a good deal.(iii) If you dont care about risk, this is a good investment.

iv. Diversification: many investors invest in a portfolio of stocks to reduce their risk.a. Unsystematic risk: company specific risk that can be diversified away.b. Systematic risk: risk that cant be diversified away. (such as the world economy is going to

enter a period of prolonged recession). The appropriate risk premium and risk adjustedinterest rate depends on the undiversifiable risk. The greater the systematic risk, the greaterthe risk premium and the risk adjusted discount rate are.

E. The Discount Cash Flow Approach to Valuation:

i. First: have to estimate all future cash flows generated by the asset use of termination value,which brings all cash flows from a future year and going into perpetuity into that future year.

ii. Second: have to calculate an appropriate discount rate.a. Weighted average cost of capital calculated as the weighted average cost of debt and the

cost of equity

Cost of debt before tax cost of debt is the interest rate that the firm would have to pay if itwere seeking debt financing presently.

Cost of equity capital asset pricing model (CAPM). Links securities risk to the volatility ofthe security prices.

F. Relevance of Prices in the Securities Market:i. Efficient Capital Market Hypothesis (ECMH): stock prices rapidly reflect all public information

bearing on the expected value of individual stocks.a. What do you assume?

Younger people put a higher value on stock than older people

Theres perfect information as much information as is public and more than you do

VI. Creditor Protection:A. Fundamentals:

i. Creditors are afforded less protection when they lend to corporations than to partnershipsbecause corporations have limited liability. Therefore, creditors can only levy against a pool ofassets that is defined by a fictional boundary.

a. One way the law protects creditors is by requiring corporations to have audited financialstatements (federal laws). Audited means that an allegedly independent auditor vouches thatthe financial statement is truly representative of the state of corporation.

ii. Financial statements:

a. Balance sheets: tries to measure equity (Assets Liabilities). The assets have to balanceliabilities but can have negative equity if liabilities exceed assets.

b. Equity: stated capital + surplus (capital surplus + retained earnings)c. Stockholder equity:

Par value historically, when a corporation issued shares in an IPO, it had to assign a parvalue that would be considered the rough estimate by the corporation of the amount thatwould be paid in the market for the shares. Stockholder equity consists of:(i) Preferred stock(ii) Common stock: par value times shares

(iii) Capital surplus - when shares are sold above the par value and excess capital isbrought in.

(iv) Accumulated retained earnings - the profits that are not distributed by the corporation(v) Capital surplus and accumulated net earnings sometimes called surplus.

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1. The capital account money brought in from shareholders at the time of the originalsale of the companys stock. Corporations were not allowed to issue dividends if itwould cause the capital account to fall in value. This capitalized the corporation andacted as a buffer for the creditors.a. If a company wanted to issue no par stock under DGCL 154 the board of

directors must set aside some discretionary portion of the sale price as thecompanys stated capital.

(vi) Retained earnings = assets minus liabilities minus stated capital minus capital surplusd. Current Assets and Liabilities v. Long Term Assets and Liabilities

Current liabilities have to be paid within a year whereas long term liabilities can be paid inmore than 1 year.

Current assets are assets that can be immediately used to pay a current liability. Oftencash and accounts receivable if you expect them to be paid within a year and inventory ifyou expect to sell within the year. Fixed assets are items such as property, plant andequipment and are sometimes referred to as capital assets. These are assets that are notfor sale and used for a long period of time to manufacture, display, warehouse andtransport.

e. Example

Project: Cost $100, 50% chance pay of $150, 50% chance of $0(i) Firm One

1. Assets = $1002. Liabilities = $0

3. Equity = assets minus liabilities = 1004. 50% chance of $75, 50% chance of $0 = Expected value = 75 + 0 = 755. Cost = $1006. Net = $-25 (75-100) so would not do it7. Leverage ratio = 1 no ratio

(ii) Firm Two1. Assets = $1002. Liabilities = $903. Equity = $104. Cost = $1005. 50% chance of $150 = $30 = 150-90/26. 50% chance of $0 = 07. Expected value = $30 + $0 = $308. Cost = $109. Net = $30 $10 = $20 so would do it10.Leverage ratio = 10

(iii) Delaware = need to take into consideration the shareholdersiii. Income statement looks at corporation in a specific year to value revenues and costs.

iv. Distribution constraints places restrictions on when corporations are allowed to pay dividendsand differs by jurisdiction.

a. New York:

NYCL 510(a): The corporation must be solvent to pay dividends

NYCL 510(b): this is a balance sheet test. Dividends have to be paid out of the capitalsurplus, not out of the stated capital.(i) However, this is not really that great of a protection to creditors because the board of

directors can reallocate money from surplus into the capital account if the

shareholders authorize it.b. Delaware:

DGCL 170: Nimble dividend test: CHECK THIS: directors or a business corporation canpay dividends out of capital surplus, and if there is no capital surplus, can pay out of netprofits in the current or preceding fiscal year. Therefore, companies with negative retainedearnings that nevertheless show a profit may pay dividends.

c. RMBCA 6.40: corporations may not pay dividends, if as a result of doing so, they can notpay their debts as they come due or their asses are less than their liabilities plus thepreferential claims of preferred shareholders.

v. Fiduciary Duties to creditors:

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a. Corporate law subjects directors to certain fiduciary duties to creditors under specificcircumstances.

Directors owe an obligation to creditors not to render the firm unable to meet its obligationsto creditors by paying out to shareholders or to another entity without getting a fair value inreturn.(i) Most often, when a corporation is insolvent, or near insolvency, a corporations

directors owe a duty to consider the interests of corporate creditors.1. Have to consider the community of interests that constitute the corporation.

a. During times of insolvency, shareholders become more risk-loving and the board

is duty bound to limit its risk exposure for the protection of creditors whobecome more risk averse.

Lets say tomorrow you have to pay $100 but thats all you have left. What do you do?(i) Pay it? Lottery tickets?(ii) Same type of thing can happen in a corporation directors have a duty to protect

creditors and shareholders1. Obviously its good for the creditors, but how is it good for the shareholders too???

Less risk so less interesta. After the fact (ex post), shareholders will see it as a bad thingb. Ex ante, think that if they incorporated in DE, creditors will know that they cant

get harmed so it could be betterb. Fraudulent Transfers conveyance law:

Fraudulent conveyance law is designed to void transfers by a debtor that are made under

circumstances unfair to creditors.(i) Under the UFCA and UFTA, present or future creditors may void transfers made withthe actual intent to hinder, delay, or defraud any creditor.

(ii) Creditors may also void transfers made without receiving a reasonably equivalentvalue if the debtor is left without remaining assets unreasonably small in relation to itsbusiness or the debtor intended, believed or reasonably should have believed hewould incur debts beyond his ability to pay as they became due.

c. Shareholder Liability: Equitable subordination: a means of protecting unaffiliated creditors by giving them rights

to corporate assets superior to those of other creditors who happen to also be significantshareholders of the firm. The court can declare that debt to affiliated creditors should betreated as equity and subordinated to other debt (this protects unaffiliated creditors).

This is usually done in a bankruptcy where the subordinated creditor is also an equity

holder and/or officer of the corporation.(i) Costello v. Fazio (9th Cir. 1958):

1. Case involved a partnership between 3 partners where two partners madesignificant contributions. The company experienced significant losses and the twopartners that made significant contributions changed the capital structure bywithdrawing most of their capital, leaving less equity for the company and issuing anote to the company without interest with the rest of the balance. This made Fazioand Ambroise creditors of the company and all three partners had equal capital inthe company. The partnership decided to incorporate and eventually declaredbankruptcy. A trustee in bankruptcy brought an action stating that the creditorsclaims of F and A should be subordinated behind those of the unsecured creditorsbecause they manipulated the situation so that they were ahead of the othercreditors.

2. Rule: The court, in subordinating the loan, held that there are two tests todetermine if subordination should occur:

a. Test 1: whether within the bounds of reason and fairness, such a plancan be justified (the insider/creditor must have, in some fashion,behaved unfairly or wrongly towards the corporation and its outsidecreditors).

b. Test 2: whether or not under all the circumstances the transactioncarries the earmarks of an arms length transaction.

3. The court held that it did not seem that there was an arms length transactionbecause it happened in the anticipation of incorporation and there was no interest

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being paid on the note and the original money that was invested as equity wastranslated into debt and no new money was given as capital.a. The corporation was grossly undercapitalized and this was to the detriment of

the corporation and the creditors this is evidence though but not enough toshow fraudulent intent.

d. Piercing the Corporate Veil:

An equitable doctrine, rarely used in practice. If the veil is pierced, the shareholder loseslimited liability and creditors can go after the personal assets of the shareholder.

Common formula is the Lowendahl test veil piercing requires that the plaintiff show the

existence of a shareholder who completely dominates the corporate policy and uses hercontrol to commit a fraud or wrong that proximately cases the plaintiffs injury.(i) Domination usually equates to failure to treat the corporate formality seriously.

Sea-Land Services v. The Pepper Source (7th Cir. 1991): Sea-Land shipped goods onbehalf of Pepper Source and then was stiffed on its freight bill. The owner of Pepper Sourcealso owned four other business entities which conducted substantially the same work. Sea-Land sought to hold both the owner (veil piercing) and his other companies (reverse veilpiercing) liable.

(i) Rule: Court found that a corporate entity will be disregarded when two requirementsare met.

1. Part One: Such unity of interest and ownership that the separate personalities ofcorp. and owner no longer exist.a. Four factor test for determining unity of ownership:

i. Failure to maintain adequate corporate records and formalities (in sea-land,Marchese did not hold corporate meetings, did not have articles ofincorporation etc).

ii. Commingling of funds or assetsiii. Undercapitalization

iv. One corporation treating the assets of another as its own (in sea-land,Marchese comingled funds).

2. Part Two: Adherence to fiction of separate corporate existence would sanction afraud or promote injustice.

Why did Sea-land want to reverse pierce? Other corporate entities that Marchese ownedcould have gone bankrupt as well and their creditors would get paid first and therefore,Sea-land did not want to become a shareholder because it would be last in line to get

assets. By becoming a creditor through reverse veil piercing, you come in after securedcreditors.

Kinney Shoe Corp. v. Polan (4th Cir. 1991): Defendant created two corporations: firstwas an industrial company (Polan) and second held a lease to a building (Industrial), whichit then subleased to the first. Industrial had no other assets except the sublease. Plaintiffwas the landlord who had leased the building to Industrial. When Industrial did not pay itslease, the plaintiff wanted to go after Polan and its owner. The court applied the two parttest of Sea Land and added a third permissive/optional prong:

(i) Part One: Unity of interest and ownership such that the separatepersonalities of the corporation and the individual shareholder no longerexist.

1. Here there was undercapitalization essentially no assets

(ii) Part Two: Would an equitable result occur if the acts were treated as those

of the corporation alone?(iii) Part Three: Assumption of risk there are situations where the creditor

assumes the risk of undercapitalization. When a creditor can conduct aninvestigation prior to entering into a contract, the creditor will be imputed with theactual knowledge that a reasonable credit investigation would disclose.

a. The court found that Polan was trying to limit his liability and the liability of hiscorporation by creating a paper curtain constructed of Industrials certificate ofincorporation. Therefore, the two prong test was satisfied.

b. However, the court since the third prong is permissive, the district court erred inapplying the third prong to the case at hand because applying it would not leadto an equitable result. Therefore, since Industrial was only a corporate shell and

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since Polan did not follow the formalities of maintaining a corporation, hecouldnt complain that Kinney should have known better.

Tort Creditors: tort plaintiffs often lose veil piercing cases because it is tough to provefraud or misrepresentation.(i) Tort plaintiffs differ from credit plaintiffs because they do not rely on the

creditworthiness of their defendants and cannot negotiate with the tortfeasor ex antefor contractual protections.

(ii) Walkonszky v. Carlton (NY 1966): W was negligently hit by a car driver and suesthe corporation through the theory of respondeat superior. The cab company only had

minimum insurance on the car and the medallion. The only asset the injured personcould go after was the insurance policy. Plaintiff wanted to pierce the corporate veiland reverse pierce to go after all the cab companys other cars.

a. Rule: plaintiff could not pierce the corporation veil. In this case, while there wasundercapitalization, this was not enough plaintiff needed to show some sort offraudulent intent.

Is unlimited liability for tort liability workable?(i) Tort creditors do not have the option to contract and cant assume the risk so limited

liability seems unfair. However, if the rule was joint and severable liability, there couldbe no transferable shares since shareholder capitalization is material to thecorporation.

1. According to Hansmann and Kraakman there would be pro rata share, unlimitedliability but only have to pay the portion of what you own in the company

VII. Shareholder Voting

A. The Role and Limits of Shareholder Voting: the corporate form delegates broad discretion to acentralized management structure. This discretion is limited by corporate by-laws and charter, butvery few corporations place substantive controls in these documents.i. Shareholders essentially have the right to vote, the right to sell and the right to sue.

a. Shareholders want corporations to make a profits (some want in a socially responsible way)and directors want to do so in order to keep their job.

B. Collective Action Problem: since there are millions of shareholders, no one shareholder isgoing to influence management anyway and therefore, investment is purely passive and there isrational apathy. To combat this rational apathy, the SEC has proxy rules that encourage shareholdeactivism.

C. DGCL 211 shareholders must elect directors annually either the whole board or a staggeredboard (allowed under DGCL 141(d)) (most often 1/3).

i. A staggered board makes it very difficult to take over the Board by an aggressive stockholder andlets the board entrench itself.

a. In order to change to a triggered board, the charter has to be amended at a stockholdersmeeting.

Under 242(b)(1): board of directors has to recommend the amendment to the charter andthe shareholders have to vote to approve. Board cant self classify.

Notice: if there is a staggered board, then this will be in the charter therefore, once stockis bought, cant surprise the shareholders and change to staggered.

D. Proxy Voting:i. While there are annual meetings where shareholders can vote, most do not vote at these

meetings because of rational apathy. However, there must be a quorum at the meeting to electthe board.

a. Under 216 of the DGCL can reduce the quorum, but still need a third of the sharesrepresented at the meeting.

ii. Therefore, when a shareholder signs a proxy statement, it gives the board of directors the right tovote on their behalf. This can get expensive because of mailing and postage. Under 212(c)(2)proxies may be done electronically.

iii. Rosenfeld v. Fairchild Airplane Corporation (NY 1955):Plaintiff brought a derivative suitagainst the new board of Fairfield after there was a proxy fight and the new board took money outof the treasury to pay their costs and the old board also got money to pay the costs of the proxyfight.

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a. If the incumbents would have won, then the cost of the proxy battle would have come from thetreasury and the incumbents would have been reimbursed.

Rule: the management may look to the corporate treasury for the reasonable expenses(subject to judicial scrutiny when challenged) of soliciting proxies to defend its position in abona fide proxy contest.

Members of new management can be reimbursed by the corporation for their expendituresin a contest by an affirmative vote of the shareholders.(i) Where it is established that such moneys have been spent for personal power,

individual gain, or private advantage, and not in a good faith effort to advance the

interests of the shareholders, the court may strike down the reimbursement.(ii) Essentially, incumbent managers are always reimbursed; insurgents are reimbursed

only if they win.iv. Shareholder Information Rights:

a. The 1934 Act mandates annual reports by public corporations. States tend to mandate a rightto inspect the books and records of a corporation pursuant to a proper purpose.

Stock list: discloses the identity, ownership interest, and address of each registered ownerof the company. Since the stock list does not contain proprietary information and is easy toproduce, the law makes this list readily available to registered owners.

Books and Records: inspection of books and records run the risk of revealing proprietaryinformation. Delaware courts allow inspection only with a proper purpose and plaintiffscarry the burden of proving a proper purpose and will informally screen plaintiffs motivesand the likely consequences of granting her request.

b. General Time Corp. v. Talley Industries (Del. 1968):Talley Industries, a stockholder inGeneral Time, wanted to obtain a list of General Times stockholders. Under 220 of the DGCLcan obtain a stock list provided he has a proper purpose and the burden is on the corporationto prove that the purpose is improper. Talley Industries wanted the stockholder list to mail outproxies and General Time did not give Talley the list. General tried to take a deposition of

Talley and tried to ask questions about whether shareholder was going to try and take overcorp.

Rule: as long as there was a proper purpose (a proxy fight is proper purpose), then you getthe stock list. Even if there is an illegal purpose or an improper purpose, as long as there isone proper purpose, then stock holder gets the list.(i) It is harder to obtain the financial statement and the court applies a different standard

because it is more sensitive information.

v. Techniques for separating control from cash flow rights: it is efficient to give shareholdersvoting right since they have the strongest incentive in maximizing corporate value, but capitalstructures can be used to affect voting and ownership of shares.

a. There is a statutory prohibition against managements ability to vote stock owned by thecorporation.

b. Circular Control Structures - Speiser v. Baker (Del. 1987): Speiser and Baker establisheda subsidiary of Health Chem (Chem), Medallion, which invested in Health Med (Med) and held10% of the common shares and all of the convertible preferred shares, giving a 95% votinginterest if converted. Speiser and Baker each held 45% of Med and Med received a 42%ownership interest in Chem. Speiser and Baker had a falling-out and Speiser sued to compel anannual meeting, which required Baker's presence, and Baker filed cross-claims andcounterclaims, seeking declaratory judgment that Med not be permitted to vote its 42% stockinterest in Chem.

Under 160(c), shares of its own capital stock belonging to the corporation, or to anothercorporation, shall neither be entitled to vote or counted for quorum purposes.

(i) Corporations can have treasury stock and 160(c) essentially says that no one can votethe treasury stock. If shares are owned by another corporation, they cant vote in themeeting, if the majority of the shares are held by that companys parent corp.Corporation A is not allowed to vote shares in a meeting if those shares areowned by a corporation which Corporation A has a majority stock in.

Rule: 160(c) prohibits the voting of stock that belongs to the issuer and prohibits the votingof the issuers stock when owned by another corporation if the issuer holds, directly orindirectly, a majority of the shares entitled to vote at an election of directors of the secondcorporation.

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(i) Since a broader purpose of the statute is to prevent entrenchment, while the majoritystock of Medallion only owns 5%, it may be converted to 95%.

c. Public shareholders own 90% of A and B owns 10% of A. Public shareholders own 49% of B andA owns 51% of B. B cant vote in A because directors of A own 51% of B.

vi. Vote Buying: a shareholder may not sell her vote or separate her ownership interest from hervoting right for consideration. Attaching the vote firmly to the residual equity interest ensuresthat an unnecessary agency cost will not come into being.

vii. Collective Action problem:a. When voters habitually approve whatever management proposes, the collective action problem

can lead to exploitation of shareholders best interests. Shareholders are going to be rationallyapathetic and will most likely defer to the directors. However, if shareholders dont like thedecision, they dont have to invest in the stock.

viii.Federal Proxy Rules:a. 1933 Securities Act covers any sale by a corporation of its own securitiesb. 1934 Securities Exchange Act covers sales between parties on a public market, applies to

publicly traded companies

Rule 14-a: Commits the SEC to issue rules governing the solicitation of proxies.

(i) 14-a(1): Solicitation includes any request to proxy, any rebuttal of a proxy, or anycommunication with a shareholder that may advance a proxy.

1. Exceptions:a. If the shareholder furnishes a proxy upon the unsolicited request of a

shareholder.

b. If the shareholder furnishes a proxy because he is required to under 14a-7.c. If the shareholder makes a public statement announcing how the shareholder is

going to vote.

(ii) 14-a(2): proxy fights must be registered with the SEC

1. 14-a(2)(b)(1): exempts from filing requirement anyone engaged in preliminarydiscussions who doesnt seek an initial proxy.a. Under 14-a(2)(b)(1) still have to file if:

i. The person engaging in the discussion is the corporation or an affiliate orassociate of the corporation.

ii. The person is an officer or director of the corporation engaging in asolicitation financed by the corporation

iii. An nominee for whose election proxies are solicitediv. Any person who is soliciting in opposition to a substantial transaction with an

alternate suggestion in opposition to the board of directors.v. Any person who is required to report beneficial ownership of the corporations

securities under 13-d (shareholders who own more than 5% interest in acorporation have to file a 13-d).

b. However, do not have to file if the solicitation is made not on the behalf of thecorporation and the total number of persons solicited is not more than 10.

(iii) 14-a(3): cant do a solicitation unless you have provided a person with a definiteproxy statement.

1. Ex. There is an initial communication between Tarpers and other investors andTarpers long term interest is soliciting their proxy. Is this initial communication aregulated solicitation?

a. 14-a(3): no solicitation will be made unless you have provided other party with a

publicly filed definitive proxy statement. Is this a solicitation? Under 14-a(1), asolicitation is:

i. A request for a proxy whether or not in the form of a proxy (herethere is only an initial communication, not a request).

ii. Any request to execute/not to execute or revoke a proxy.

iii. Any communication to a security holder under circumstancesreasonably calculated to result in the procurement, withholding orrevocation of a proxy. Look at the intent of the communication. Thisis present in this example.

2. Look to 14-a(2)(b) for exceptions:

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a. (b)(1): communication that is not seeking to elicit a proxy. Essentially, duringthe time of the solicitation, is the person tying to elicit a proxy. If not, then donthave to file.

i. There are situations where this does not apply to the registrant, or affiliantof the registrant (essentially the corporation) here there is a shareholder.Under b(1)(vi) any person who is required to report beneficial ownershipof the registrants equity securities on a schedule 13-d. Under 13-d,shareholders who own more than 5% interest in a corporation have to file a13-d and therefore 14-a(2)(b)(1) wont apply to you. If you are a smaller

shareholder therefore, you are allowed to have initial communicationswithout filing.

ii. Since Tarpers owns 1% of the outstanding shares, can qualify for the 14-a(2)(b) exception. If Tarpers owned 6%, then would have to file under 14-a(2)(b)(1)(vi).

iii. But under 14-a(b)(2)(b)(2), if you talk to fewer than 10 people, then can doan initial communication. Since here Tarpers is talking to 15 people, shouldtalk to 10 or less.

(iv) 14-a(4),(5): the details of what you have to put in a proxy statement; the form of aproxy

(v) 14-a(6): Have to file a proxy statement with the SEC 10 calendar days before yousolicit a proxy.

(vi) 14-a(7): if a registrant intends to make a proxy solicitation in connection with ashareholder meeting, the shareholder can ask for a shareholder list. The corporationcan either send you the list or can put the shareholders proxy in the registrantsmailing.

1. However, under DGCL 220, corporation has to provide the shareholder list ofshareholders. Therefore, DE law is more burdensome because under federal law,have options.

(vii) 14-a(8): there are situations under which a corporation must provide to theshareholders, in its mailing when it is soliciting proxies, a shareholder proposal thatshareholders want to be voted at the meeting. This is basically a way for theshareholder to get the corporation to solicit proxies for the shareholders includingsocial interest type of proposals.

1. What is a proposal? A shareholder proposal is a shareholders recommendation or

requirement that the company and/or its board of directors take action, whichshareholder intends to present at a meeting of the companys shareholders. Theproposal should state as clearly as possible the course of action that the shareholderbelieves the company should follow.

2. Who is eligible to submit a proposal? In order to be eligible to submit aproposal, a shareholder must have continuously held at least 2,000 in market value,or 1% of the companys securities entitled to be voted on the proposal at themeeting for at least one year by the date you submit the proposal. The shareholdermust continue to hold those securities through the date of the meeting.

3. How many proposals may a shareholder submit? Each shareholder maysubmit no more than one proposal to a company for a particular shareholdersmeeting.

4. Who has the burden of persuading the Commission or its staff that a

shareholders proposal can be excluded? The burden is on the company todemonstrate that it is entitled to exclude a proposal.

5. On what bases may a company rely to exclude a proposal?a. Improper under state law if the proposal is not a proper subject for action by

shareholders under the laws of the state.b. Violation of the law it would cause the company to violate any state, federal, or

foreign law.

c. Violation of proxy rules if the proposal is contrary to any of the proxy rules,including 14a-9, which prohibits false of misleading statements.

d. Personal grievance/special interest if the proposal relates to the redress of apersonal claim or grievance against the company or any other person, or if it is

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designed to result in a benefit to you or to further a personal interest, which isnot shared by the other shareholders at large.

e. Relevance if the proposal relates to the operations which account for less than5% of the companys total assets at the end of its most recent fiscal year, and forless than 5% of its net earnings and is not otherwise significantly related to thecompanys business

f. Absence of power/authority if the company would lack the power or authority toimplement the proposal.

g. Management functions - if the proposal deals with a matter relating to the

companys ordinary business operations.h. Conflicts with companys proposali. Substantially implemented

j. Duplicationk. Resubmissions

i. The SEC generally supports corporate governance proposals, but waffles onsocial responsibility proposals. the Cracker Barrel no action letter holds thatcompanies may have to include proposals in t

corporations law (new) - fall 2008

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